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Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Netherlands Bank, Amsterdam, 20 November 2015.
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Fabio Panetta: The distributional consequences of monetary policy Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Netherlands Bank, Amsterdam, 20 November 2015. * * * I wish to thank Piergiorgio Alessandri, Andrea Brandolini, Francesca Carta, Giuseppe Ferrero and Roberto Piazza for their help in preparing this text. 1. Introduction Inequality in income and wealth has been trending upward in most of the developed countries in recent decades (Figure 1). The magnitude and timing of the increase have varied considerably from country to country; the rise in inequality has been particularly pronounced in the United States and the United Kingdom, possibly because of the predominant role of capital markets in those economies (Figure 2). Although the trends most likely depend on a number of familiar drivers that are well identified in the literature – such as globalisation, skill-biased technological change, the rapid growth of the financial sector 1 – the global financial crisis has brought monetary policy (MP) itself into the picture as a possible additional factor. The argument for this hypothesis runs as follows. Over the past seven years central banks have adopted unprecedented expansionary measures, exploiting both conventional and unconventional policy instruments. If monetary policy has systematic distributional effects, and if monetary expansions redistribute resources “from the poor to the rich”, then MP may indeed now be contributing to or accelerating the long-run trends that we can observe in the data. Before going into this issue, it is important to recognise that if one examines inequality from the global perspective, the picture is very different. As Figure 3 shows, in contrast to the trend in within-country inequality, since the 1980s international inequality has diminished rather than intensified. 2 What is more, the very factors that increase inequality within countries can reduce inequality between them. This certainly holds for the structural drivers of inequality, such as globalisation. Intriguingly, it may be true of monetary policy as well. Research has found that a fall in interest rates in the United States stimulates cross-border credit flows and investment in the rest of the world, because it allows the large global banks to raise funds cheaply in the “core” of the financial system and invest them profitably in the “periphery.” 3 Leaving aside the implications for financial stability, this means that the recent monetary expansions in the US and in Europe may have boosted income in relatively poorer parts of the world, thereby reducing between-country inequality. As ever, when we deal with inequality we must be careful to define the phenomenon and the constituency we have in mind. Nevertheless, many central banks are now under scrutiny, with questioning of the distributional implications of their policies “at home,” which makes the topic of this conference an important and timely one. Avoiding the discussion may do more harm to central bankers’ Trade linkages with countries that have large endowments of unskilled labour can increase the relative wages of skilled workers in the “home country” through a Stolper-Samuelson terms-of-trade effect, thereby accentuating inequality. Changes in production technology can have analogous effects if they result in a more than proportional rise in the productivity of (and demand for) such workers. The growth of finance may play a role if the financial sector generates abnormally high salaries. Lakner and Milanovic (2015). Rey (2013); Bruno and Shin (2015). BIS central bankers’ speeches reputation than engaging expressly with distributional issues. In my remarks today I will examine two questions. The first one is positive, or descriptive: How should we think about the distributional implications of monetary policy, both in general (Section 2) and within a monetary union (Section 3)? The second is normative, or prescriptive: How, if at all, should central banks take inequality into account when setting the course of monetary policy (Section 4)? 2. The complex distributional implications of monetary policy Quantitative easing (QE) and low interest rates have highly vocal critics on both sides of the Atlantic. These critics have pointed out that a policy aimed explicitly at lowering the yields on safe assets is a policy that necessarily hurts – even “expropriates” – ordinary savers. Ford and Vlasenko (2011) contended that “By lowering interest rates to historically unprecedented levels, the Fed’s policy has deprived savers of interest income they normally would have earned on savings accounts […].” 4 They have been echoed in Europe by the president of the German Savings Association, Georg Fahrenschon, who accused the ECB of, “stand[ing] for an unprecedented phase of low interest rates that expropriates the saver, damaging the savings culture and putting more and more pressure on the self-provisioning of people.” 5 This criticism emphasises the immediate effects of monetary policy on households’ interest income. If these effects were to dominate, then a monetary expansion would indeed hurt savers who derive a significant fraction of their income from deposit-like assets. 6 We probably all agree that, ceteris paribus, low interest rates and high inflation tend to help borrowers at the expense of lenders/savers. But that “ceteris paribus” clause, always debatable, is particularly troublesome in this context. Indeed, what makes the foregoing criticism fragile, in my view, is that it relies on a short-term, partial equilibrium view of monetary policy transmission. Focusing exclusively on the interests associated with deposits is mistaken: monetary policy can generate distributional effects through a number of other income- and wealth-related channels, 7 and if we are to determine how well grounded the criticisms are, we clearly need to develop a holistic view of how these channels work. First of all, monetary expansions normally raise the prices of some financial assets; 8 there is ample evidence, in fact, that while QE has indeed compressed the yields on a range of longterm bonds, it has raised the prices of shares. 9 Second, looking beyond finance, real assets like housing are likely to play a key role. Research has demonstrated that monetary policy also works through real estate markets: 10 by compressing both the short and long end of the yield curve, monetary easing typically stimulates mortgage lending and, as a consequence, boosts house prices. 11 This channel might be particularly important for QE, whose express objective is to lower long-term interest rates. William Ford was the eleventh president of the Federal Reserve Bank of Atlanta. “A common Europe has to be built on trust”, Börsen-zeitung, 22 March 2014. The problem could be compounded by “segmentation” (à la Williamson, 2008): if economic agents differ in their ability to trade in financial markets, the benefits of an increase in liquidity will be reaped exclusively or primarily by those who have better access to the markets and can exploit more direct relations with the monetary authority – which is to say, “banks”. See e.g. Coibion et al. (2012). Rigobon and Sack (2014). Clayes et al. (2015). Indeed, some studies have concluded that housing debt and real estate wealth play a crucial role in the transmission mechanism – see e.g. Cloyne et al. (2015). Jordà et al. (2014) reach these conclusions with a dataset that spans 140 years and 17 countries. BIS central bankers’ speeches This means that even if we consider only direct portfolio effects, we should conclude that savers do not necessarily stand to lose from a monetary expansion: those who own real estate and/or a sufficiently diversified portfolio of financial assets – in practice, a good proportion of all savers – may actually benefit in relative terms. As I will show presently, in the euro area housing is likely to be a particularly important factor. The picture is complicated still further if one takes a general equilibrium perspective. Expansionary monetary policies designed to fend off deflation and stimulate economic growth also generate higher real interest rates over the medium term. 12 In other words, from a longer-term perspective the interest income channel would appear to work in the opposite direction to that posited by the critics. Since what really matters for savers is the real return on their savings in the longer run, this reading may well be more persuasive than an exclusively short-term focus. Furthermore, if monetary expansions succeed in stimulating economic activity significantly, they will increase both labour income and corporate profits, which are ultimately distributed as dividends to “savers” too. What matters for inequality, then, is the combination of two factors. The first is the sensitivity of labour and capital income to a monetary intervention: wages may rise relatively more or less than corporate profits. This is likely to depend on a number of structural features of the economy, including the share of labour and capital in production and the structure of the labour market. The second factor is the distribution of labour and capital income across households. In this respect it is important to bear in mind that labour is the main source of income for the middle classes. Figure 4 gives the breakdown of income sources across quintiles of the distribution in the United States, showing that even there, where households are more active in financial markets than in Europe, labour accounts for over half of total income in up to 80 per cent of all households 13 and that its share of total household income is highest for the third and fourth quintiles. Capital and business incomes generally account for a much smaller share; they are quantitatively significant only for the top income quintile. Thus if a monetary stimulus sustains employment and wages, its effects will benefit a very large part of the population and go relatively less to the top income groups. Furthermore, labour earnings at the bottom of the income distribution may be relatively more sensitive to the business cycle; 14 if this is the case, successful countercyclical MP might help low-income households above all, attenuating inequality. This suggests that monetary expansions could well decrease – not increase – inequality. This brief discussion suggests the considerable difficulty of determining the net distributional effect of a monetary policy intervention a priori. To me, this is primarily an empirical issue, in which the conclusion depends on a series of economic and institutional characteristics. And I think the difficulty stems mainly from the fact that it involves many dimensions that need to be considered jointly. Since monetary policy works through both income and wealth channels, at the very least one should examine their distribution in the population jointly and not singly. Figure 5 reports data on the ratio of debt service to income (DS-I) in the euro area from the Household Finance and Consumption Survey (HFCS), plotting on the vertical axis the fraction of households whose DS-I ratio exceeds the level shown on the horizontal axis. To distinguish the relatively poor from the rich, there is a separate curve for each gross income quintile. Low-income households clearly bear a much heavier burden of debt than their high-income counterparts. In the bottom quintile (yellow line), roughly four tenths face monthly debt payments of 40 per Bindseil et al. (2015). The exception is households in the lowest quintile, for which transfers are more important. Heathcote et al. (2010). BIS central bankers’ speeches cent or more of gross income. This fraction drops to less than two tenths in the second income quintile (solid blue line), and is practically nil for the top quintile (dashed blue line). This ordering basically holds for pretty much all DS-I values. Furthermore, the curve for the bottom quintile is set sharply apart from the others: servicing debt, that is, is only a problem, practically, for the poorest group of households. This empirical regularity suggests that the anti-QE camp has put forward arguments that are not fully consistent with one another. Criticising QE at the same time for “hurting savers” (like the first set of quotations above) and for “helping the rich” 15 becomes problematic if in reality these turn out to be two largely overlapping categories. In conclusion, it seems fair to say that our understanding of the relationship of monetary policy to inequality has lagged behind the mounting political debate on the issue. Bernanke (2015) proposed a simple “litmus test” to cut through our difficulties in forming a complete picture of the effects of QE: “If the average working person were given the choice of the status quo (current Fed policies) and a situation with both a weaker labour market and lower stock prices (tighter Fed policies), which would he or she choose?” This question would appear to offer a fitting background to our discussion here today. 3. Inequality in a monetary union In the euro area, the debate has stressed another potential distributional spillover of monetary policy: redistribution of resources not only within countries but also between the member states of the monetary union. Naturally, the effects of monetary policy on the member states may well be asymmetric, and very strong views on the way the asymmetry works in this particular case have been expressed. To cite one: “While households in countries strongly affected by the crisis are relieved, others, namely German households, are suffering from the very same measures.” 16 To the extent that within the cross section of households an expansion produces winners and losers and that these are unevenly distributed across countries, monetary policy may of course also reallocate resources across national borders. To be sure, in a fully integrated economic union this would not be an issue. In the euro area it might be, though, because the lack of a common fiscal policy framework means there are no tools to neutralise the potential distributional effects of MP. However, the concerns about the redistributional effects of monetary expansions across euro-area countries reflect an oversimplified representation of the monetary policy transmission mechanism. In fact, understanding these cross-country effects is, if anything, even harder than grasping within-country effects. One difficulty is simply measurement. The data are not comparable across countries because of differences in the definitions of income and wealth, the way taxes are treated, the primary sources used, and often the processing of the data. Measuring income and wealth consistently in a large economic area is not easy. 17 And where the status quo itself is measured inaccurately, gauging the impact of a shock (monetary or otherwise) becomes problematic at best. 18 “Britain’s richest 5% gained most from quantitative easing,” The Guardian, 23 August 2012. Holzhausen and Sikova (2014). The statistical traditions of European countries can differ significantly: some rely mostly on administrative archives, others on sample surveys, still others on a combination of the two. There are pros and cons to each, of course, but clearly these methodological differences can influence income comparisons. Furthermore, the experience of statistical agencies (including our central bank departments) has shown that input data harmonisation is far more demanding than output data harmonisation. Going forward, however, there is no reason to be pessimistic. We have made notable progress in the past two decades in measuring income, which should serve as an encouragement to improve our measurement of BIS central bankers’ speeches The most serious difficulties, however, are conceptual. There are many forms of crosscountry heterogeneity that have to be taken into account in assessing the distribution of gains and losses, and these are hard to bring together to form a unified picture. Clearly, as my earlier observations indicate, two important aspects of this problem are the balance between net borrowers and net savers and the rate of home ownership (see Section 2). The interaction between these two factors is also relevant: a monetary expansion is doubly beneficial for people who purchased their homes with a mortgage, because it brings an appreciation of the value of the house and a decrease in the real cost of debt servicing. An equally important role, lastly, is played by the transmission of monetary policy through housing markets and the associated dynamics of house prices. In short, we would expect the recent expansionary monetary policies to have produced the greatest benefits for the households who (i) are highly indebted, (ii) own a house, (iii) have a mortgage, and (iv) are in countries where real estate prices have risen significantly. All four of these characteristics are quite heterogeneous across countries within the euro area either structurally or conjuncturally (in the recent past). Figures 6 and 7 portray the composition of households’ portfolios in the area according to the HFCS released in 2013. Figure 8 shows real house price indices in the same countries over the last decade. Debt levels vary significantly. They are extremely low, for instance, in Italy and in Austria, where households accordingly obtain only moderate benefits from a monetary expansion; they exceed 50 per cent of total net worth in the Netherlands, where by this metric household leverage is far higher than in the US (Figure 6). On the asset side, on average non-financial assets account for a significantly greater share than in the US (Figure 6). They consist mainly of primary residences (Figure 7), although additional properties are also quantitatively significant in Finland, Germany, Portugal and Spain, where they account for roughly 20 per cent of households’ total assets. 19 Finally, in some countries, such as the Netherlands, a fairly large fraction of the real estate portfolio is funded by mortgage loans (Figure 7). If you were to use these data to form a rough view of who might have been a relative winner (“plus”) or a loser (“minus”) from expansionary MP, you would obtain the following picture: • Italian households have low debt (minus); they hold a relatively large share of nonfinancial assets, including housing (plus), but they experienced a decline in house prices from 2010 onwards (minus). • German and Austrian households, who have comparably low debt levels (minus), hold a relatively smaller housing stock (minus) but make relatively more use of debt to fund their real estate purchases (plus), and enjoyed a significant rise in house prices (plus), possibly because of more powerful transmission of the monetary stimulus in the euro-area “core” than in the “periphery.” 20 • In the Netherlands, debt levels are extremely high (plus), housing ownership is significant (plus), and mortgages play an even more important role than in Austria or in Germany (plus). House prices dropped, but the fall – which began in 2009, well before the start of the ECB’s aggressive policies – was arguably due to the bursting of a bubble. Insofar as it was successful in smoothing this downward adjustment, QE may have generated larger gains here than elsewhere (though of course they cannot be measured without formulating a “no-QE” counterfactual hypothesis). wealth as well. Accordingly, from the beginning we have supported the Eurosystem’s collection of better data through the Household Finance and Consumption Survey. The difference matters, because the appreciation of a second home, or a property that has been purchased specifically for investment purposes, can be more readily turned into cash. In the “core” of the area MP had a direct impact on the borrowing costs ultimately faced by households; in the “periphery”, by contrast, costs were heavily affected by country-, bank- and borrower-specific risk premia. BIS central bankers’ speeches The signs are conflicting, and conclusions accordingly hard to draw. Clearly if we move further towards the “general equilibrium” view that I advocated earlier, the complexity only increases. As Figure 9 shows, European equity markets too have displayed widely divergent patterns over the last few years. In Italy and Austria prices are hovering around their levels of five years ago, while the German and Dutch markets have rebounded and are now 25 to 50 per cent higher than in 2010. As we know, national labour market dynamics have also differed greatly. This heterogeneity reflects a number of structural and cyclical factors, but it probably also depends on asymmetries in the transmission of monetary policy. In conclusion, as soon as we move beyond the initial, naïve borrowers-versus-savers dichotomy we find that identifying the “winners” in the euro area becomes an extremely difficult task. 4. Two good reasons for central banks to care about inequality, and an excellent one to study it: it shapes the transmission mechanism Given how little we know about the distributional implications of monetary policy, central banks should certainly not think of attenuating inequality as an additional implicit policy objective. But this does not mean that they can – or should – simply ignore the issue. There are at least three reasons why, on the contrary, we must take it seriously. First of all, a central bank that fails to take the redistributional effects of its decisions into account will also be missing some aspects of the transmission mechanism, and may be less effective in pursuing its macroeconomic and financial stability objectives. We ordinarily assume that the transmission of monetary policy to the real economy relies on two mechanisms: nominal rigidities (by changing nominal interest rates the central bank is able to affect real interest rates and real wages) and intertemporal substitution (a fall in real rates increases aggregate demand by stimulating consumption and investment). These may indeed play a central role in a representative-agent world, but thinking in terms of representative agents is not sufficient. In reality, there are many forms of heterogeneity among households that can have a strong influence on the transmission mechanism. One is the distribution of housing and mortgage debt in the population. Households with mortgages to pay appear to adjust their consumption significantly after an unexpected change in interest rates, whereas renters and outright home-owners are far less sensitive. 21 Another one is demographics. By increasing inflation, an expansionary monetary shock reduces the real value of retirement accounts. This generates a negative wealth effect for the “old” while at the same time creating an incentive for the “young” to work harder and save more. 22 These mechanisms may operate even in the absence of nominal rigidities. Although their quantitative impact is still being studied, it should be clear by now that it is not wise to ignore them altogether. From this perspective, the structure of household incomes and asset portfolios (and hence the inequality of wealth and income) is only one of the multiple forms of heterogeneity that central banks should and normally do monitor in order to understand how their policy tools work and to carry out their policy mandate more effectively. The second reason is that complacency might take central banks down a path leading ultimately to the loss of independence. If a side-effect of monetary policy decisions is increasing inequality to a socially unsustainable level, the government may decide to act to rein this trend in; such action could include pressuring the central bank to behave differently, or even curtailing its independence. Cloyne et al. (2015). Sterk and Tenreyro (2015). BIS central bankers’ speeches A third, admittedly more speculative reason has to do with hysteresis. Imagine a world in which monetary policy increases inequality, leading to an excess of savings (“saving glut”) that drives the natural real interest rate steadily down. With a lower natural rate, all else equal, the probability of hitting the zero lower bound is greater. This may heighten the danger of slipping into a period of persistent low interest rates, low inflation, low growth, and greater inequality. In this way the original policy action can have a permanent impact on future policy choices and on the CB’s ability to discharge its mandate. This example is speculative, of course, but it illustrates a problem that may deserve more attention: insofar as monetary policy affects inequality and, additionally, shocks to inequality do not revert quickly, today’s monetary policy actions can have feedback effects over periods stretching well beyond the “medium term” as central banks generally define this concept. 5. Conclusions Inequality is unquestionably a crucial dimension of public policy. Every society has views on how resources should be distributed among citizens, and democratic governments have the duty to give substance to those views. And even if the crucial ethical aspects of this problem could be neglected (but they should not), the implications of mounting inequality for economic stability and prosperity would be a compelling reason to take the phenomenon very seriously. High inequality can hinder growth, sow the seeds of financial crisis or prompt social unrest. 23 As a consequence, how monetary policy affects the distribution of income and wealth within the economy is an important question. Unfortunately, we know very little about it. Given the state of the art, it would appear inappropriate – or at best premature – to treat distributional outcomes as an additional objective for central banks (prioritising interventions that supposedly reduce inequality), or even as a constraint on the pursuit of their primary objectives (say, by precluding interventions that strengthen macro-financial stability but may have unwanted distributional effects). In this sense inequality is, and should remain, the domain of fiscal measures designed and implemented by democratically elected governments. This is especially true in a monetary union where fighting inequality may imply redistribution across countries. Monetary authorities lack the knowledge, the tools and most importantly the political legitimacy to act directly on the distribution of income and wealth. This is not to deny that the actions of central banks can carry distributional implications, or that these may be inconsistent with the preferences of the public. In thinking about this issue, it may be helpful to draw an analogy with other realms in which public policy makers systematically take decisions that are welfare-improving but have undesirable distributional implications. A prime example is environmental policy. Any measure that encourages the exploitation of renewable energy sources (as by subsidising wind and solar power) will generate an international redistribution of income away from oil and coal producers; given that some of these are not “rich” in relative terms, such a reallocation may well increase international or inter-regional inequality. Yet no one would criticise a “green” policy agenda on these grounds. If anything, the issue is how to control this redistribution and build international consensus for a reform that aims to improve welfare on a global, world-wide basis. Another example is major infrastructural projects that benefit the broader community but are detrimental to local residents (the costs being measured in terms of well-being, not money: no one wants to live next to an airport or a highway). Once again, these tensions are ordinarily resolved by compensating the people who must bear the costs of the project with additional distributional interventions (for instance, by building schools and amenities to accompany roads or airports). Why should the distributional spillovers of monetary policy be treated differently? Acemoglu and Robinson (2000), Rajan (2010), Ostry et al. (2014). BIS central bankers’ speeches For researchers, the task today is to provide policy makers with more information and more tools to deal with the interplay between monetary policy and the distribution of income and wealth. In this regard, the renewed interest in the transmission of monetary policy in economic models with heterogeneous agents is particularly welcome. To further this effort, the Bank of Italy, together with the CEPR, is organising a conference on “Monetary policy after the crisis” next June in Rome. The conference is intended to stimulate discussion on how our conventional wisdom on the transmission mechanism should be revised, in order, for one thing, to take heterogeneity into account. For monetary policy makers, on the other hand, the main task is to keep from getting carried away by superficial debates before that information becomes available. It is hard to deny that right now, ideology counts for more than objective science in the debate. We of the central banking community should do everything we can to ensure that this trend is inverted as quickly as possible. BIS central bankers’ speeches References Acemoglu D. and Robinson J.A. (2000), “Why did the West extend the franchise? Democracy, inequality, and growth in historical perspective”, The Quarterly Journal of Economics 115(4), 1167–1199. Atkinson A. B., Piketty T. and Saez E. (2011). “Top incomes in the long run of history”, Journal of Economic Literature, 49(1), 3–71. Bindseil U., Domnick C. and Zeuner J. (2015), “Critique of accommodating central bank policies and the “expropriation of the saver”: a review”, European Central Bank Occasional Paper no.161, May. Bruno V. and Shin H.S. (2015), “Capital flows and the risk-taking channel of monetary policy”, Journal of Monetary Economics 71, 119–132. Clayes G., Darvas Z., Leandro A. and Walsh T. (2015), “The effects of ultra-loose monetary policies on inequality”, Bruegel Policy Contribution no. 2, June. Cloyne J., Ferreira C. and Surico P. (2015), “Monetary Policy when households have debt: New evidence on the transmission mechanism”, manuscript. Coibion O., Gorodnichenko Y., Kueng L. and Silvia J. (2012), “Innocent bystanders? Monetary policy and inequality in the U.S.”, NBER Working Paper no.18170. ECB (2013). “HCFS Report on the results from the first wave”. Heathcote J., Perri F. and Violante G. (2010), “Unequal we stand: An empirical analysis of economic inequality in the U.S., 1967–2006.” Review of Economic Dynamics 13(1), 15–51. Holzhausen A. and Sikova S. (2015), “The impact of the low interest rate policy on private households in the Eurozone”, Group Public Policy & Economic Research working paper no.176, September. Jordà O., Schularick M.H.P. and Taylor A.M. (2014), “Betting the house”, NBER Working Paper no. 20771, December. Kuhn M. and Rios-Rull, J.-V. (2013). “2013 Update on the U.S. earnings, income, and wealth distributional facts: A View from Macroeconomics”, manuscript. Lakner C. and Milanovic B. (2015), “Global income distribution: from the fall of the Berlin Wall to the Great Recession”, The World Bank Economic Review, September, 2–30. OECD (2015), “In it together: Why less inequality benefits all”, OECD Publishing, Paris. Rajan R. (2010), Fault Lines: How hidden fractures still threaten the world economy, Princeton University Press. Rey H. (2013), “Dilemma not Trilemma: The global financial cycle and monetary policy independence”, manuscript. Rigobon R. and Sack, B. (2004), “The impact of monetary policy on asset prices”, Journal of Monetary Economics 51(8), 1553–1575. Sterk V. and Tenreyro S. (2014), “The transmission of monetary policy through redistributions and durable purchases”, manuscript. Williamson S.D. (2008), “Monetary policy and inequality”, Journal of Monetary Economics, 55, 1038–1053. BIS central bankers’ speeches Figure 1: Trends in real household incomes in the OECD Source: OECD Income Distribution Database. Notes: Income is disposable household income, net of direct taxes on market income and gross of cash transfers. Disposable income is adjusted for household size. Unweighted averages of 17 OECD countries, normalised to 1985=1. Figure 2: Income share of top 1% (per cent of total gross income) United Kingdom United States Northern Europe Finland France Germany Netherlands Southern Europe Italy Portugal Spain United States, United Kingdom Source: The World Top Income Database. Notes: The top 1% share measures the share of total income going to the top percentile of the income distribution. Income is market gross income excluding capital gains. The unit of analysis is, in most cases, the family; exceptions are Italy and Spain, where the unit is the individual. BIS central bankers’ speeches Figure 3: Trends in overall income inequality, “within” and “between” countries Within-country Global Between-country Source: Lakner and Milanovic (2015). Notes: inequality is measured by the mean log deviation index. Overall income inequality (right axis) is obtained as the sum of within-country inequality (left axis) and between-country inequality (right axis). Figure 4: Income heterogeneity in the USA by gross income quintiles 95% 75% other transfer 55% business capital 35% labor 15% -5% 1st 2nd 3rd 4th 5th Source: Khun and Rios-Rull (2013). Notes: based on the Survey of Consumer Finances 2013. The units of observation are households, identified as sets of persons who are financially dependent on an economically dominant person or couple. BIS central bankers’ speeches Figure 5: Distribution of debt service-to-income ratio in the euro area by gross income quintiles Source: Household Finance and Consumption Survey. Notes: The debt service-to-income (DS-I) ratio is the ratio of total monthly debt payments to gross monthly household income for indebted households. For each income quintile, Q1 to Q5, the vertical axis reports the fraction of households within the quintile whose DS-I ratio exceeds the value reported on the horizontal axis. Figure 6: Household portfolio composition (per cent of net worth) -50 -100 Non financial assets Financial assets Liabilities Source: OECD Wealth Distribution Database. BIS central bankers’ speeches Figure 7: Real estate assets and liabilities as share of total assets (%) Other real estate loans Other real estate property Principal residence loans Principal residence -20 -40 Source: OECD Wealth Distribution Database. Figure 8: House price dynamics in the euro area Source: Eurostat. Note: House price indices for new and existing dwellings, deflated by the private consumption deflator and normalised to 100 in 2010. BIS central bankers’ speeches Figure 9: Equity price dynamics in the euro area Source: Datastream. Note: equity price indices deflated by national consumer price indices and normalised to 100 in January 2010. BIS central bankers’ speeches
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Introductory remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the conference "Micro and Macroprudential Supervision in the Euro Area", Università Cattolica del Sacro Cuore, Milan, 24 November 2015.
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Fabio Panetta: Micro and macroprudential supervision in the euro area Introductory remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the conference “Micro and Macroprudential Supervision in the Euro Area”, Università Cattolica del Sacro Cuore, Milan, 24 November 2015. * * * 1. I am pleased to welcome you all to today’s conference on micro- and macroprudential supervision in the euro area. First of all, let me voice my warm thanks to Università Cattolica del Sacro Cuore for hosting the event. The conference focuses on two developments that are reshaping the European financial landscape: the creation of a single micro-prudential supervisor in the euro area, namely the Single Supervisory Mechanism (SSM), within the broader context of a prospective Banking Union; and the institution of a new macro-prudential framework. Banking Union represents a strong, vigorous response to the financial crisis. It rests on three pillars: the SSM itself, a Single Resolution Mechanism and the harmonization of existing national deposit guarantee schemes. The idea underlying the design for Banking Union was to restore confidence in the European banking sector and to preserve and enhance financial integration. The ultimate objectives are safeguarding financial stability and ensuring efficient resource allocation within the euro area so as to support economic growth. In this context, the new macro-prudential framework definitely has a crucial role to play. The crisis has made it clear that a narrow focus on the soundness of individual banks can cause supervisors to overlook emerging threats to the stability of the entire financial system. Macroprudential policies are designed to smooth the financial cycle in both expansionary and contractionary phases, working counter-cyclically to prevent the emergence of systemic risks. The toolkit available to banking supervisors is now larger but also more complex. The incentives of micro- and macro-prudential authorities tend to be aligned during economic expansions, but they may well diverge in downturns. When the economy is weak, it is more difficult to strike the right balance between micro- and macro-prudential policies. In my view, this is one of the main challenges that European policymakers face today. These are the reasons why Banca d’Italia, in its capacity as central bank in charge of banking supervision and financial stability, has organized this conference. We have invited two eminent, authoritative speakers to address us on these two topics. Danièle Nouy is Chair of the Supervisory Board of the SSM and an experienced banking supervisor and regulator both in France and internationally; and Claudio Borio, Head of the Monetary and Economic Department of the Bank for International Settlements, is one of the world’s leading researchers in the field of financial stability and macro-prudential policies. Please bear with me, before I leave the floor to Danièle and Claudio, for a few introductory remarks on the topics of the conference. 2. Since its inception, one year ago, the SSM has made remarkable progress. Within the span of just months, a sketchy organization chart has been converted into a fully-fledged institution, with over a thousand professionals from different countries and varied backgrounds. The SSM has developed quickly into an integrated system based on close cooperation between the European Central Bank and national supervisors. Together, throughout the year we have been dealing with both bank-specific and system-wide supervisory issues. A good deal of effort has been devoted to establishing the basis for a common, fair supervisory framework. In its short life to date, the SSM has already helped in the stabilization of the Eurozone, which is a prerequisite for growth. The Comprehensive Assessment enhanced transparency and dispelled doubts about the resilience of Europe’s major banks. Together with national BIS central bankers’ speeches and European policies – above all the monetary policy measures decided by the Governing Council of the ECB – the SSM is contributing to the normalization of credit conditions for firms and households. The important steps already taken need to be followed by further progress on several fronts. The overarching issue is to forge ahead towards European integration. We should not forget that the financial crisis was originated by the lack of progress in European integration following the launch of the euro. The project for Banking Union helped to defuse the crisis and set the process back in motion. We must not make the same mistake twice. The process of integration cannot be allowed to stall again. Moving from broad principles to more practical issues, a number of challenges lie ahead for the Single Supervisory Mechanism. Let me mention a few. a. The SSM will need to establish common regulatory and supervisory practices, consolidating the level playing field and removing the barriers that prevent the integration of the European banking sector. A good instance of the effort that will be required to achieve this goal is the SSM’s work on options and national discretions, directed to overcoming the residual differences in the national implementation of the CRR and CRDIV rules. A public consultation on a draft text was launched just a few days ago. b. Reinforcing cooperation and trust among the actors involved, from the ECB to the National Competent Authorities, is also crucial to our success. The Banca d’Italia, like the other NCAs, is fully committed to the SSM. Being part of “something bigger” is a challenge that we already faced with the launch of the monetary union, but the single supervisory mechanism is if anything an even greater challenge. If they are to contribute effectively to the monetary policy-making process, the members of the Governing Council need to understand the economic conditions that prevail on average in the Eurozone. The members of the Supervisory Board have to make decisions bearing on over 120 large banks. Considering that before the launch of the SSM each NCA was responsible for only a handful of these banks, you realize just how great the additional analytical effort imposed on NCAs under the new regime actually is. It will require substantial investment in human capital and deepgoing organizational changes. c. Since its launch, the SSM has focused its supervisory action mostly on banks’ capital position. Concentrating on the construction of a strong capital base was fundamental to restoring confidence, which had been severely undermined by the financial crisis. Now that the comprehensive assessment has demonstrated that the European banking system is solid, it is essential to avoid inducing pro-cyclical behaviour by banks, which would curtail lending to the economy. Given that the SSM covers 123 major euro-area banks, its micro-prudential decisions may have macroeconomic consequences. This poses significant challenges for both micro- and macro-prudential authorities, at a time when little is still known – in theory as well as in practice – about the functioning of macroprudential policies. There is broad agreement that at present the main danger to financial stability stems from low real and nominal economic growth. The ECB’s programme of quantitative easing is directed to countering these risks. In most countries and on average in the Eurozone, aggregate credit growth remains subdued. The credit-to-GDP gap – the main indicator laid down by the Basel rules as a guideline for activation of the countercyclical capital buffer – is well below its historical average, but in recent months we have nevertheless witnessed several national macro- prudential decisions that resulted in a further tightening of financial conditions. Naturally, there are reasons for these decisions; since a full discussion of these developments would take me too far afield here, let me just emphasize that the decisions are a good example of the complex way in which monetary, micro- BIS central bankers’ speeches and macro-prudential policy decisions interact. A number of regulatory developments complicate matters still further: to mention only a few, consider the ongoing phase-in of the capital rules, the adoption of stringent liquidity requirements, the introduction of the TLAC framework, and the implementation of the BRRD. 3. The question, in conclusion, is how we should steer micro- and macro-prudential tools towards the objectives of stability and growth. Our answer will be crucial for the euro area and Italy, where banks play a predominant role. I am sure that Danièle and Claudio will help us to advance our understanding of this critical issue. My own answer is strong, close coordination. Ensuring consistency between micro- and macro-prudential policies – and, based on what I have just said, monetary policy as well – is absolutely necessary to support the economic recovery. As I have already observed, guaranteeing a strong capital base was essential to regain full confidence in the solidity of the European banking system and to provide adequate financial support to the real economy. But capital strength cannot be the sole line of defense against the risk of bank instability; if it were, the job of supervisors would be much easier than it is. What is more, the particular path by which stronger capitalization is attained is not a matter of indifference. Micro- and macro-supervisors need to devise a balanced, coordinated modus operandi. The best guarantee that such an arrangement can be achieved in the Eurozone is the institutional setup, which assigns macro-prudential powers to national competent authorities as well as to the ECB Governing Council and the SSM Supervisory Board. Events like this conference can certainly make a valuable contribution to the current debate. Thanks again to Università Cattolica, to the speakers and to all of you for your participation. BIS central bankers’ speeches
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference "The Bank of Italy's Analysis of Household Finances - Fifty years of The Survey on Household Income and Wealth and the Financial Accounts", Rome, 4 December 2015.
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Ignazio Visco: The Bank of Italy’s analysis of household finances Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference “The Bank of Italy’s Analysis of Household Finances – Fifty years of The Survey on Household Income and Wealth and the Financial Accounts”, Rome, 4 December 2015. * * * Andrea Brandolini contributed widely to these remarks with perceptive suggestions and insights. It is a great pleasure to close this conference celebrating 50 years of the Bank of Italy’s Survey on Household Income and Wealth (SHIW) – and 51 of Financial Accounts. Over half a century, both the micro-data of the former and the aggregate estimates of the latter have provided essential information for the economic and statistical analyses carried out at the Bank of Italy, informing and influencing its policy-making process. There is also a personal note, however. Throughout my long professional life at the Bank, I often relied on these data. I hope that you will forgive me if, in these concluding remarks, I shall indulge in some personal memories. Prologue: the survey forerunners Household budgets have long attracted the attention of social scientists. Since the mid-19th century many researchers have gathered detailed information on expenses and revenues of individual households. These budget data stimulated studies on the consumption behaviour of families of farmers, manual workers and clerks, and contributed to the detection of empirical regularities such as Engel’s law. Italian economists and statisticians played a crucial role in formalising these results. In his classical article on “The Early History of Empirical Studies of Consumer Behavior”, George Stigler refers to Rodolfo Benini and Corrado Gini as the authors of the first modern statistical demand studies, and to Gustavo Del Vecchio as the first to estimate, in 1912, a (food) consumption function. Using budget data for a number of countries, Del Vecchio calculated an income elasticity comprised between 0.4 and 0.8, with an average of about 0.6. 1 The paper presented to this conference by Neri, Rondinelli and Scoccianti implies an income elasticity of about 0.66, although for total expenditure rather than for food alone. 2 A surprising regularity, a century later! However useful to study consumer behaviour, individual budgets cannot tell us much about the distribution of income or expenditure. In June 1947, the Italian Minister of the Budget Luigi Einaudi – who was still formally the Governor of the Bank of Italy, before being later elected President of the Italian Republic – advocated at a meeting of the Constituent Assembly the need to produce a report on “the standard of living of Italian citizens, their incomes, the social categories into which they are divided”. Thereafter, Einaudi, Del Vecchio, then serving as the Treasury Minister, and Giuseppe Pella, the Finance Minister, commissioned a sample survey on household incomes with the purpose of providing a sound basis for economic policies. The survey was conducted by Istituto Doxa, a private agency for G.J. Stigler, “The Early History of Empirical Studies of Consumer Behavior”, Journal of Political Economy 62, 1954, 95–113; G. Del Vecchio, “Relazioni fra entrata e consumo”, Giornale degli economisti 54 (n.s.), 1912, 111–142, 228–254, 389–439. Del Vecchio did not use Italian data, because individual budgets were relatively scarcer for Italy than for France or Germany. However, Giovanni Vecchi has recently dug out as many as 11,500 individual budgets for the period 1855–1911, plus another 9,500 for the years until 1965. See S. Chianese e G. Vecchi, “Bilanci di famiglia”, in G. Vecchi, In ricchezza e in povertà. Il benessere degli italiani dall’Unità a oggi, Bologna, Il Mulino, 2011, 355–389. A. Neri, C. Rondinelli and F. Scoccianti, “The marginal propensity to consume out of a tax rebate: the case of Italy”, Bank of Italy, mimeo, 2015. BIS central bankers’ speeches the analysis of public opinion founded and directed by Pierpaolo Luzzatto Fegiz. 3 It cost 16 million lire, approximately 400,000 euros at today’s prices. A second (smaller) survey was conducted and published by Doxa in 1951. By digging through the Bank of Italy’s archives, it was recently found out that this survey was not only eventually paid for in full by the Bank, but was also designed with the help of economists in its Research Department. Its Director, and the Bank’s Governor 25 years later, Paolo Baffi, set in a letter to Luzzatto Fegiz that the main purpose of the survey was “ascertaining the prevalent opinions on the allocation of a given income rise… between consumption and saving, after distinguishing the former into current expenses and durable goods and the latter into direct investment (real estates and businesses), financial assets and other savings”.4 For some unknown reason the Bank’s primary role in this survey was not publicised, but it testifies to the involvement of the Bank of Italy in the first attempts to measure the income and the consumption behaviour of Italian households. This involvement is remarkable as it reveals the early support of the Bank for the use of representative probability sampling. Official sample surveys were still in their infancy: they had become accepted by statistical agencies in the United States only in the 1940s with the start of the Current Population Survey. 5 The Bank’s position is even more significant when seen against the background of an environment which was not necessarily favourable to this statistical tool. 6 The readiness to engage in these new statistical techniques is an example of the Bank’s attitude towards paying attention to and taking advantage of developments at the frontier of research. The Survey has continued to be a source of innovation. This has happened, for instance, as regards the dissemination of its results: first, in the 1980s, with the release of anonymised micro-data to academic researchers; then, with the participation since the 1990s in the Luxembourg Income Study, an international cooperative project for the assembly and standardisation of income data at a household level. The integration of use and production of statistical data The Bank’s involvement in the (second) Doxa survey is also noteworthy since it shows that the statistical collection was conceived as closely connected with the needs of economic analysis from the outset. This is not to be taken for granted. Still in 1985, Zvi Griliches observed that “while economists have increased their use of surveys in recent years and have even begun designing and commissioning special purpose surveys of their own, in general, the data collection and thus the responsibility for the quality of the collected material is still largely delegated to census bureaus, survey research centers, and similar institutions, and is divorced from the direct supervision and responsibility of the analyzing team”. 7 The history of the Bank of Italy’s SHIW is not one of “divorce” between producers and users but The citation from Einaudi’s speech and the subsequent information are drawn from P. Luzzatto Fegiz, “La distribuzione del reddito nazionale”, Giornale degli economisti e Annali di economia 9 (n.s.), 1950, 341–354. A. Baffigi, A. Brandolini, L. Cannari, G. D’Alessio, “L’indagine sui bilanci delle famiglie italiane. Metodi, confronti, qualità dei dati”, Bank of Italy, mimeo, 2015. See C.F. Citro, “From multiple modes for surveys to multiple data sources for estimates”, Survey Methodology 40, 2014, 137–161. See A. Baffigi, “All’origine dell’indagine sui bilanci delle famiglie della Banca d’Italia”, Bank of Italy, mimeo, 2015. On the usefulness, but also on several limitations attributed to the use of the “representative method”, an influential opinion was that expressed by Corrado Gini in an article co-authored with Luigi Galvani. See C. Gini and L. Galvani, “Di una applicazione del metodo rappresentativo all’ultimo censimento italiano della popolazione (1° dicembre 1921)”, Annali di Statistica, series 6, 4, 1929, 1–107. Z. Griliches, “Data and Econometricians–The Uneasy Alliance”, American Economic Review Papers and Proceedings 75, 1985, 196–200. BIS central bankers’ speeches rather of intense, if at times thorny, dialogue. In the early 1990s, I remember Governor Carlo Azeglio Ciampi’s reluctance to accept my proposal to create a Statistical Division within the Research Department on the grounds that the Bank’s economists were those who knew best which statistics were needed, and therefore were also best suited, as potential users, to being involved in their production. A good example of the need for dialogue between data producers and economic analysts is credit rationing. In order to estimate the extent to which households have no access to credit, we require a complex set of interrelated questions, first asking respondents whether they had thought about applying for a loan, then whether they actually made the application, and finally whether they got it. Credit-rationed borrowers are the households which were denied a loan, or not granted the entire amount requested. On the basis of a long time series that starts in 1989, credit conditions are confirmed to have eased in Italy in 2014 from the peak reached in 2012, although we are not yet back to the pre-crisis situation. The rich formulation of the questionnaire also allows for the monitoring of a broader concept of borrowing constraints, which considers what we once called in an article on borrowing constraints “discouraged borrowers”, that is the households which refrain from asking for a loan because they anticipate that their application will be turned down. 8 Likewise, the assessment of financial vulnerability and over-indebtedness relies on detailed information and analysis that combine data on income, debt service payments and liabilities. This is shown by the papers by D’Alessio and Iezzi, and Bartiloro, Michelangeli and Rampazzi discussed in this conference, 9 as well as by the regular use of the SHIW data in the regular analysis of macroeconomic developments and financial stability. 10 The anticipations of economic agents, whether consumers or businessmen, play a central role in the decisions they make, but their measurement is far from straightforward. 11 Unsurprisingly, household expectations have been a recurrent topic in the Survey. As shown by Alfonso Rosolia, households were asked already in the first Surveys in the mid-1960s whether they anticipated an income increase or reduction a year ahead, and how they would allocate any income gain between saving and various consumption items. The eagerness of the Bank’s researchers turned this question into a far more sophisticated exercise in the Survey for 1989, when respondents were confronted with a full probabilistic format about the prospects of their labour or pension earnings in the next year that has now become, in a simplified formulation, part of the core section of the questionnaire. The attention to household expectations is important to shed light on consumer behaviour. For instance, in the early 1990s it was used to quantify the impact of subjective earnings uncertainty on precautionary saving. 12 The paper presented by Olympia Bover finds that the subjective expectations on house prices matter for predicting the spending behaviour of L. Maccan, N. Rossi and I. Visco, “Saving and borrowing constraints”, in A. Ando, L. Guiso and I. Visco (eds), Saving and the Accumulation of Wealth. Essays on Italian Household and Government Saving Behavior, 273–304, Cambridge, Cambridge University Press, 1994. G. D’Alessio and S. Iezzi, “Over-indebtedness in Italy: how widespread and persistent is it?”, Bank of Italy, mimeo, 2015, and L. Bartiloro, V. Michelangeli and C. Rampazzi “The vulnerability of indebted households during the crisis: some evidence from the euro area”, Bank of Italy, mimeo, 2015. See, for instance, the Financial Stability Report or research documents such as that by S. Magri and R. Pico, “The household credit market after five years of crisis and recession: evidence from the survey on household income and wealth”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers) 241, 2014. I extensively discussed the problems in measuring inflation expectations in my Ph.D. dissertation, later published as Price Expectations in Rising Inflation, Amsterdam, North-Holland, 1984. L. Guiso, T. Jappelli and D. Terlizzese, “Earnings uncertainty and precautionary saving”, in A. Ando, L. Guiso and I. Visco (eds), Saving and the Accumulation of Wealth. Essays on Italian Household and Government Saving Behavior, 214–245, Cambridge, Cambridge University Press, 1994. BIS central bankers’ speeches Spanish households. 13 Yet we should not overlook the difficulties that respondents face in answering probabilistic questions. In the Survey for 1989, 57 per cent of households anticipated a rise in income, by 6.5 per cent on average, but as many as one out of five households did not answer. In the last wave of the Survey the proportion of households which failed to provide an answer fell to below 5 per cent, but the overwhelming majority, 83 per cent, predicted no income change one year ahead. This might be reasonable given the recent income dynamics, but may also signal their difficulty to account for uncertain outcomes. There is a need for further research, but experimenting on measuring expectations is a worthy exercise. It has undoubtedly enhanced the Survey’s reputation. Indeed, Charles Manski included it among the few “major platforms for methodological exploration and substantive research” on the use of probabilistic formats to elicit expectations. 14 Manski also mentioned only one survey of firms using probabilistic questioning to elicit business expectations: the Italian Survey of Investment in Manufacturing. This has also been carried out by the Bank of Italy since the mid-1980s and is a good example of cross-fertilisation among different research areas. Micro-data as a necessary complement to macro-data Eliciting expectations or measuring complex economic concepts is not the only accomplishment of the SHIW. Its main contribution has been to allow us to account for the heterogeneity of household characteristics and behaviour in the analysis of the Italian economy. When it started in the mid-1960s, the Bank of Italy’s Survey provided virtually the first detailed information on the budgets of Italian households since the Doxa survey of 1948. Its information proved extremely valuable. Drawing again from my own personal experience, I remember using the Survey data in the mid-1970s to calculate the dispersion of earnings among income earners, and its decomposition into the within- and between-sector components, possibly one of the first “official” applications of the exact inequality decomposition proposed by Henry Theil. 15 For a few years, these calculations were published in the chapter on the labour market of the Bank’s Annual Report, integrating the aggregate information on productivity and wage dynamics, and the SHIW main results are still regularly published in the Annual Report. The availability of a relatively long span of estimates on the distributions of earnings, income and, for a shorter period, wealth in Italy has allowed for the documentation of the decline of income inequality among Italian households until the mid-1980s and its subsequent increase. The extent of the rise in the last decades is smaller than that observed in many other advanced countries – the United States and the United Kingdom mostly in the 1980s, Sweden and Finland in the 1990s – but the level of income concentration in Italy is still relatively high when compared at an international level. 16 These inequality series have been widely used by external researchers, and are included in many international compilations O. Bover, “New results on household subjective probabilities of future house prices”, Banco de España, mimeo, 2015. C.F. Manski, “Measuring Expectations”, Econometrica 72, 2004, 1329–1376; the citation is at pp. 1341–2. H. Theil, Economics and Information Theory, Amsterdam, North-Holland, 1967. See A. Brandolini and T.M. Smeeding, “Income Inequality in Richer and OECD Countries”, in W. Salverda, B. Nolan and T. M. Smeeding (eds), The Oxford Handbook of Economic Inequality, 71–100, Oxford, Oxford University Press, 2009. BIS central bankers’ speeches used for research in social sciences, assembled at the World Bank, the UNU-WIDER, the OECD or by academic researchers. 17 My first approach to the Survey had occurred even earlier, when Francesco Frasca, Ezio Tarantelli, Carlo Tresoldi and I used its data for 1971–73 to provide additional microeconomic evidence on the consumption function. 18 As we had no access to micro-data at the time, our assessment was based on comparing cell mean values from cross tabulations of the kind shown in this conference by Alfonso Rosolia. Yet these “granular” data were crucial to study, however crudely, demographic and life-cycle effects, something which was not possible with the aggregate time series. In particular, we could not find, for Italy, the dissaving at old ages observed for other countries, and attributed this result to the system of social security and the family structure prevailing in the country. The Survey’s micro-data have later become a precious source to investigate consumption and saving. An important example of this strand of research is the volume Saving and the Accumulation of Wealth. Essays on Italian Household and Government Saving Behavior, edited in 1994 with Albert Ando and Luigi Guiso from a conference held in January 1992. It includes contributions from quite a few participants in this conference. Reconciling micro and macro During its long life, the SHIW has undergone several changes aimed at improving its quality. Some of them have created discontinuities, which have to be taken carefully into consideration when using results from different waves to construct time series. In order to overcome some of the definition problems, the historical archive now allows researchers to access micro-data from different waves in a common format. Today’s celebration has provided the opportunity to release an entirely revised historical archive as well as to upload selected time series on the Bank’s website. A major overhaul of the Survey took place in 1986–87, following a conference held in Perugia in February 1985. Albert Ando, a close personal friend of many of us and for many years an invaluable consultant of the Bank, played a crucial role in that restructuring. Albert made two important points. First, he argued that it was necessary to increase the size of the sample, possibly reducing its frequency to offset the cost increase, in order to capture the behaviour of small demographic groups (he had in mind distinguishing an old person living alone from an old person living with a younger person). Second, he stressed the inability of the Survey to measure financial assets and liabilities, implicitly suggesting that some serious effort was necessary to cover these variables satisfactorily – although he admitted to having no special insight into how to do so, because this inability appeared to be a “peculiarly Italian problem”. 19 Both Albert’s suggestions were implemented: the sample size was doubled to around 8,000 units in 1986, and since 1987 the Survey has been carried out every two years and contains detailed questions on all wealth holdings. Information has considerably improved, See Deininger and Squire’s Measuring Income Inequality Database (http://go.worldbank.org/UVPO9KSJJ0), Milanovic’s All the Ginis Dataset (http://go.worldbank.org/9VCQW66LA0), the World Income Inequality Database (https://www.wider.unu.edu/project/wiid-world-income-inequality-database), the Social and Welfare Statistics Database (http://stats.oecd.org/BrandedView.aspx?oecd_bv_id=socwel-data-en&doi=data-00654en), Atkinson and Morelli’s Chartbook of Economic Inequality (http://www.chartbookofeconomicine quality.com/). F. Frasca, E. Tarantelli, C. Tresoldi and I. Visco, “La funzione del consumo. Analisi su serie trimestrali e su dati cross-section”, in Banca d’Italia, Modello econometrico dell’economia italiana (2ª ed.), “La funzione del consumo in Italia (stesura provvisoria)”, 32–102, Roma, 1979. A. Ando, “Le indagini campionarie sui bilanci familiari: l’esperienza estera”, in Banca d’Italia, Le indagini campionarie sui bilanci delle famiglie italiane: Perugia, 8–9 febbraio 1985, Numero speciale dei Contributi all’analisi economica, 139–149, Roma. BIS central bankers’ speeches but not all measurement problems have been sorted out, as observed by Gambacorta and Neri. 20 In particular, as is well known, the measurement of financial assets still fall short of the corresponding aggregate in the financial accounts: a serious problem of consistency between micro and macro evidence. 21 The financial accounts are also one of the Bank’s statistical products. After the Second World War, Paolo Baffi strongly encouraged the collection of aggregate statistics on assets and liabilities of the institutional sectors, and in 1949 the Bank’s Annual Report published a table of flows, called the “national monetary balance sheet”, broken down into public and private sectors. This accounting scheme was the embryo of the financial accounts that first appeared in the Annual Report for 1964, thanks to the work of Franco Cotula and others. 22 Financial accounts have been published regularly by the Bank ever since. The completion of financial accounts was an important accomplishment, but it still fell short of producing a fully integrated set of sectoral balance sheets. Over time, the Bank has frequently engaged in the estimation of the value of real assets, with a particular focus on households. I contributed to this effort in a paper with Carlo Tresoldi, where we used the Survey data to compute the value of dwellings. 23 This exercise was occasionally repeated, for instance in an Appendix to the volume Saving and the Accumulation of Wealth prepared by Pino Marotta, Patrizia Pagliano and Nicola Rossi, 24 until 2007 when the Bank first published the Supplement to the Statistical Bulletin on “Household Wealth in Italy”. With the recent publication by Istat, the Italian statistical office, of the stock of non-financial assets by institutional sector, we are now in a position to estimate for the first time the full balance sheets for the Italian economy. Producing Italy’s integrated wealth accounts is a challenge that Istat and the Bank cannot avoid facing. It is not the only one. I already mentioned the consistency issues for the micro and macro evidence for wealth, but similar problems arise for income. Moreover, flows and stocks need to be reconciled, both at the micro and macro level. Extending the scope of the data we collect definitely enriches our information set, but also calls for a much greater effort to reconcile the indications that diverse sources may provide. Not only flows: the importance of household wealth This long-standing concern for household wealth does not stem from mere academic curiosity. At the opening of the final conference of the Luxembourg Wealth Study held here in Rome in July 2007 at a time when we had not yet any hint of the incoming global financial crisis, 25 I observed that “I still have the definite impression that in the last fifteen years there has been a substantial rise in wealth-to-income ratios in the developed countries. This has been especially the case for housing wealth. According to the Survey of Consumer Finances, R. Gambacorta and A. Neri, “Wealth and its returns: economic inequality in Italy, 1995–2014”, Bank of Italy, mimeo, 2015. R. Bonci, G. Marchese and A. Neri, “Financial wealth in Italy's financial accounts and survey of household income and wealth”, in Financial Accounts: History, Methods, the Case of Italy and International Comparisons, Banca d’Italia, Roma, 2008. See R. De Bonis and A. Gigliobianco, “The origins of financial accounts in the United States and Italy: Copeland, Baffi and the institutions”, in R. De Bonis and A.F. Pozzolo (eds), The Financial Systems of Industrial Countries. Evidence from Financial Accounts, Berlin, Springer, 2012. C. Tresoldi and I. Visco, “Un tentativo di stima della ricchezza delle famiglie (1963–1973)”, Rivista di diritto finanziario e scienza delle finanze 34, 1975, 516–524. See G. Marotta, P. Pagliano and N. Rossi, “Income and Saving in Italy: a Reconstruction”, Banca d’Italia, Temi di discussione 169, for details. I. Visco, “The Luxembourg Wealth Study: Enhancing Comparative Research on Household Finance”, 2007, https://www.bancaditalia.it/pubblicazioni/interventi-direttorio/int-dir-2007/visco_050707.pdf?language_id=1. BIS central bankers’ speeches the ratio of real assets to household disposable income in the United States rose from 3.7 in 1992 to 4.8 in 2004; in Italy, according to the SHIW, from 5.3 in 1993 to 6.4 in 2004. This is clearly a pattern shared by many other countries. On the other hand, net financial assets show a much more moderate trend. Overall, there seems to be little question that over this long period wealth has increased at higher rates, for many countries much higher rates, than household disposable income”. The work by Thomas Piketty has shown that these trends began even earlier, in the 1970s, 26 although the global financial crises may have somewhat modified them. In the United States the ratio of real assets to household disposable income fell back to 4.2 in 2013, although in Italy it still stood at 6.6 in 2014. The increase in wealth may reflect the accumulation of personal savings or changes in asset values. But saving rates do not seem to show marked increases; if anything, in some countries they have been on a declining trend. So, much of the substantial rise in wealth-to-income ratios was due to asset prices. This raises several questions, that matter from analytical as well as policy perspectives. Why have we been observing such a long-term trend in asset prices? What is it that made for such a significant change in the prices of real, and perhaps to a lesser extent, financial assets relative to consumer goods and services? The financialisation of economies, the growing role of stock exchanges, the privatisation of State-owned firms, the expansion of household insurance technical reserves (due to the crisis of public pension schemes) can go some way towards explaining the rise in the ratio of financial wealth to GDP. 27 In particular, there may be merit in considering the changes in shelter costs for owneroccupied housing as part of general consumer price changes. In this case, one should conclude that the prices of housing services went up substantially compared to other consumer goods and services. Yet, in part housing expenditure is clearly of a capital-good nature. One should also conclude that house owners were able to extract substantial rent from their accumulated real estate. 28 As I observed in the July 2007 conference of the Luxembourg Wealth Study, “in the first case we have an issue of relevance for monetary stability, in the second for financial stability, especially as house prices have been moving faster in relatively short periods of time and the larger house values have been used as collateral in financial deals”. Conclusions: lessons from the past and challenges for the future These remarks on the Bank of Italy’s SHIW and the financial accounts are drawn from my own memories, but I hope to have also illustrated some important lessons that we can all draw from the experience at the Bank. Let me briefly recapitulate them here: 1. Undertaking research means being receptive to innovation and to exploring new statistical and analytical techniques; 2. The production and use of statistical data must be seen as fully integrated activities; 3. Micro-data are a necessary complement to macro-data: they are both essential to forming a comprehensive view of the functioning of the economy for policy-making purposes; T. Piketty, Capital in the Twenty-First Century, Cambridge, Harvard University Press, 2014. R. De Bonis, D. Fano and T. Sbano, “Household aggregate wealth in the main OECD countries from 1980 to 2011: what do the data tell us?”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers) 160, 2013. Using Survey data, it is possible to show that capital gains on housing have a positive effect on consumption for homeowners, but a negative one for renters. See L. Guiso, M. Paiella and I. Visco, “Do capital gains affect consumption? Estimates of wealth effects from Italian households’ behavior”, in L.R. Klein (ed.), Long-run growth and short-run stabilization: essays in memory of Albert Ando, 46–82, Cheltenham, Elgar, 2006. BIS central bankers’ speeches 4. The joint consideration of micro and macro evidence for the same phenomena, and of related stocks and flows, raises important issues of consistency, an old problem made more evident today by the richness of available statistics; indeed, the micro/macro and stocks/flows reconciliation are a challenge for all statistical bodies; 5. And, obviously, there is a need to pay attention to both stocks and flows. These observations hold for economic and statistical research at the Bank in general. They are evidence of the Bank of Italy’s long-standing effort to stimulate cross-fertilisation and dialogue among different research areas, avoiding what is sometimes called the “silos culture”. I believe that this attitude, which is not necessarily shared elsewhere, is very important and should be preserved. The scientific community is now wondering about the future of household surveys. Bruce Meyer, Wallace Mok and James Sullivan have recently noted that “large and nationally representative surveys are arguably among the most important innovations in social science research of the last century”, but have extensively dealt with the problems plaguing household surveys and weakening their capacity to describe economic and social phenomena. 29 There are new powerful statistical methods that can be used to improve them, such as the integration with administrative archives and web surveys to reach a more mobile and digital population. There are new rich and only partly explored sources of information, the “Big Data” residing on the internet. As has been mentioned by Federico Signorini in his opening remarks, Bank researchers are also exploring these new territories, confirming our attitude towards innovation. Yet, I think that the SHIW, possibly transformed, will be with us for many more years to come. To conclude, I wish to thank the many people who have made it possible for our Survey to reach its venerable age: the economists and the statisticians in the Bank of Italy, the interviewers and the staff of the agencies that have conducted the Survey in the field, the many academics and external users that have used it for their research and have helped us to improve it. Our deepest gratitude obviously goes to the 154,000 thousand households that have voluntarily accepted to be interrogated, some of them many times, on the difficult and confidential issues investigated by the Bank of Italy’s Survey. B.D. Meyer, W.K.C. Mok and J.X. Sullivan, “Household Surveys in Crisis”, Journal of Economic Perspectives 29, 2015, 199–226. See also C.F. Citro, “From multiple modes”, op. cit. BIS central bankers’ speeches
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Keynote address by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Rome Investment Forum 2015 "Financing Long-Term Europe", Rome, 11 December 2015.
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Salvatore Rossi: Finance for growth – a capital markets union Keynote address by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Rome Investment Forum 2015 “Financing Long-Term Europe”, Rome, 11 December 2015. * * * I would like to comment on the proposal for a capital markets union (CMU) by raising three questions, and giving some tentative answers to all of them. The first question is: do we actually need a CMU in Europe? Should it really be a priority in the European policy agenda? My answer is a resounding “yes!”. The question may seem rhetorical, given the tide of apologetic documents, papers, and seminars (including perhaps this one) that have been dedicated to the project since its official launch last year. However, I think it”s important to keep in mind the reasons for that “yes”, because hesitations and even open dislike are quite widespread in some countries and sectors. The fact is that the European economies, with the partial exception of the UK, are strongly dependent on banks for their financing needs. Too dependent. Let me explain why. A wide literature (I have in mind for example a very recent piece of empirical research by Langfield and Pagano, 2015), shows that economic growth tends to be lower in economies with a bank-based financial structure, particularly at times of falling asset prices, and systemic risk to be higher. A “bank bias”, as L&P dub it, is bad, in any circumstance. But even if we believed, just for the sake of the argument, in the optimality of banking dominance in our financial systems, here comes another hard fact: also as a consequence of the new regulatory and supervisory framework, banks are less and less willing to lend money to risky borrowers such as SMEs, because of the heavy burden of non-performing loans which is the legacy of the crisis; because more capital is required against risky assets, and capital is costly. Requests for more capital buffers come from all international regulating bodies, both at the global level (Financial Stability Board, Basel Committee) and at the European level (Single Supervisory Mechanism – SSM), as a shield against a new, devastating financial crisis. Up to now, in Europe the effect has been procyclical: notwithstanding the cheap, abundant liquidity supplied by the ECB, banks are reluctant to increase lending to the real economy. The corporate sector, especially in southern Europe, is mostly made up of SMEs, for which access to financial and capital markets is difficult, if not impossible. Hence, we have an inconsistent trio: an economic structure mostly requesting bank finance, regulators concerned with the risks posed by banks” activity, and banks consequently stepping back from ample parts of the credit markets. How to sort ourselves out? One way is to move the European financial structure from intermediaries towards markets (Visco, 2015). This will indeed require national efforts, but more is needed: an integrated European-wide capital market, with harmonised and SMEfriendly rules. In other words, a CMU. The second question is: can we consider a European CMU a realistic project? This time my answer is much more doubtful. The idea for a CMU was first put forward by the President of the European Commission before the European Parliament in July 2014 (Juncker, 2014), in very ambitious language. Last September the Commission presented an action plan to transform that enlightened vision into reality (EC, 2015). From one document to the other the degree of ambition was apparently scaled down. As Nicolas Véron (2015) recently noted, the plan “mostly boils down to pruning existing rules and correcting some of [the] EU”s own recent regulatory overreach”. BIS central bankers’ speeches But this is supposed to be the normal business of the Commission. Let”s check whether this harsh judgment is well founded. What does CMU mean in substance? It means creating a single market of non-bank financial services: the belated completion of the Single Market project of the “80s. A first attempt at merging European financial markets fifteen years ago did not succeed. In the goods market the main obstacles to integration were technical standards: harmonising them was the crucial move. In the financial services market, obstacles are of various kinds: every country has its own legal system, tax treatment, accounting standards, and prudential regulation (Danielsson et al., 2015). These specificities are entrenched with local costumes and traditions, and in some cases they protect national champions. Harmonising the myriad of laws, taxes, and regulations in a short period of time, as the urgency of the matter would require, is extremely challenging. The most delicate problem has to do with the UK. It’s quite obvious that a European CMU excluding the City of London would have little sense. But the UK Government is highly sensitive about London’s competitive advantage as the financial hub of Europe, and the issue will remain almost intractable until the referendum on the UK remaining part of the European Union is held. The third question is: what can be done to facilitate/accelerate the process of creating a panEuropean CMU? The approach followed by the action plan is a step-by-step one. Such an approach was recommended, not by chance, by most of the stakeholders involved in a wide public consultation held by the Commission in the first half of this year. Is it the right approach? In principle, one might have preferred a bolder attitude, one that addressed simultaneously and directly all the needed harmonisation in the fields, for instance, of bankruptcy laws, taxes, investor protection and market infrastructure regulations: a Thatcher-like “big bang”. But that would have been definitely unrealistic. What the action plan intends to do, and I quote a key passage of the document, is to proceed “from the bottom up, identifying barriers and knocking them down one by one, creating a sense of momentum”. Among those to be knocked down first are, according to the plan: • red tape and information asymmetries making it too costly for SMEs to list on equity and debt markets; • specific rules in both the new European insurance regulatory framework (Solvency 2) and in the capital requirement regulation for banks (CRR) preventing insurance companies and banks from getting more involved in the business of financing infrastructure investment; • a sort of damnation still weighing on securitisation after the global financial crisis (asset-backed securities were labelled “toxic sludge”), while, if simple and transparent, it could be a fundamental tool to bridge the gap between SMEs and financial markets. • and so on and so forth ... These are all good intentions. Are they sufficient to create a “sense of momentum”? We will see. The risk is that we fall into a sort of “Ten Little Indians” trap. A risk still present, for example, in the banking union story. Banking union was conceived as an institutional framework with three pillars (Rossi, 2015): 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. But the outcome has been different. The SSM was swiftly realised because it was seen as a prerequisite for restoring mutual trust among countries after the sovereign debt BIS central bankers’ speeches crisis. But mistrust has remained. On the crucial issue of bank resolution, after long and tiresome negotiations it has been decided that sharing the cost of a banking crisis among all the eurozone countries is not for now; it is foreseen as the final step in a process lasting many years, and in any case it will involve private funds only (the Single Resolution Fund, financed by all the eurozone banks). 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 (anyhow, the use of national public money is in general forbidden by state aid rules). As to the SDIS, it was first postponed to an indefinite future; more recently, a proposal has been presented by the European Commission, but envisaging the same manyyear process before reaching a mutualisation such as the one established for the Single Resolution Fund. The CMU, needless to say, is a totally different endeavour. Still, overcoming the variety of national habits and interests will be a formidable task, the inherent difficulty of which must not be underestimated if we want CMU eventually to succeed. References European Commission, 2015, Action Plan on Building a Capital Markets Union, http://ec.europa.eu/finance/capital-markets-union/index_en.htm#action-plan. Danielsson, J., et al., 2015, Europe’s proposed capital markets union: Disruption will drive investment and innovation, http://www.voxeu.org/article/europe-s-proposed-capital-marketsunion. Juncker, J-C, 2014, A New Start for Europe: My Agenda for Jobs, Growth, Fairness and Democratic Change, Opening Statement in the European Parliament Plenary Session, Strasbourg, 15 July, http://ec.europa.eu/priorities/docs/pg_en.pdf. Langfield, S., Pagano, M., 2015, “Bank bias in Europe: effects on systemic risk and growth”, ECB Working Paper Series, 1797, May, https://www.ecb.europa.eu/pub/ pdf/scpwps/ecbwp1797.en.pdf Rossi, S., 2015, Towards a European Banking Union: a euro-area central bank supervisor as a first step, Lecture at the Central Bank of Russia, April, https://www.bancaditalia.it/pubblicazioni/interventi-direttorio/int-dir2015/Rossi_02042015.pdf. Véron, N., 2015, Europe’s capital markets union and the new single market challenge, http://www.voxeu.org/article/europe-s-new-single-market-challenge. Visco, I., 2015, Investment Financing in the European Union, OECD-Euromoney Conference on Long-Term Investment Financing, 19 November, https://www.bancaditalia.it/pubblicazioni/ interventi-governatore/integov2015/Visco_19112015.pdf. BIS central bankers’ speeches
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 22nd ASSIOM FOREX Congress, Turin, 30 January 2016.
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Ignazio Visco: The stability of the Italian banking system Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 22nd ASSIOM FOREX Congress, Turin, 30 January 2016. * 1. * * Recent economic developments At the start of the year, the international economic outlook became more uncertain. In the advanced countries the recovery is continuing, but it appears less robust than was hoped for just a few months ago. In China, as in other emerging economies, growth has slowed amid heightened fears of a further deceleration. Weakening demand is partly responsible for keeping the price of oil and other fuels at historically low levels and for reducing the prices of other commodities. In the euro area growth continues at a moderate pace, but inflation is struggling to return to a path consistent with price stability; there are risks of second-round effects from consumer price developments to wages, and of a disanchoring of expectations. The Governing Council of the ECB has resolved to reconsider its monetary policy stance in March when new macroeconomic projections will be available; it reconfirmed that there are no limits on how far it is willing to deploy the instruments available within its mandate. Monetary policy is supporting euro-area economic activity and, by countering the deflationary effects of international developments, has been unwavering in the pursuit of its objective. It cannot, however, act in isolation; the risks to growth and financial stability must be addressed with the help of budgetary policy and by pressing ahead with ongoing reforms. In Italy the recovery is progressing at a comparable pace to that of the euro area. The boost from exports has weakened, as elsewhere in the euro area, but the contribution of domestic demand has strengthened, thanks to rising household consumption and the increase in inventories; the recovery in investment is still uneven, reflecting uncertainty over foreign demand. The rise in the number of those employed has continued, as has the shift towards more stable forms of employment, partly thanks to social contribution relief and new labour law provisions. In the final months of last year bank lending to the private sector turned upward again; business lending has stabilized, with some fluctuations; lending to households, which had already picked up, accelerated further and residential mortgage loans have been expanding since the summer. The average cost of new business and home mortgage loans has dropped further, to 1.9 and 2.6 per cent respectively in November; the differential with respect to the euro-area average has been wiped out for business loans and is less than 0.3 percentage points for new home loans. However, substantial differences remain between firms that are vulnerable and the – generally larger, mostly exporting – firms in sound financial shape. In November, bank credit expanded by 4.0 per cent on an annual basis in the manufacturing sector, was barely positive in the service sector – partly owing to the contraction in lending to firms that provide real estate services – and remained negative for the construction sector. While loans to businesses with 20 or more workers rose, those to smaller firms continued to decline. The difference in borrowing costs for loan amounts above and below €1 million is 1.5 percentage points, 0.4 points below the peak recorded during the crisis; at the start of 2008 it was 0.7 points. As we reported in our Economic Bulletin, Italy’s output could increase by around 1.5 per cent in 2016 and in 2017. This scenario assumes that domestic demand, and especially investment, will continue to strengthen. The uncertainty in the international arena and its impact, at times chaotic and violent, on the financial markets pose evident risks. BIS central bankers’ speeches In recent weeks the stock markets have seen brusque movements, with bank stocks being especially volatile, particularly those of certain Italian banks. In addition to uncertainties regarding the international situation, the volatility in Italian bank stock prices reflects the doubts and concerns that have arisen concerning asset quality, in part related to the alarmist interpretation of a simple request for information by the ECB. Tensions of this magnitude are not justified by the underlying conditions of Italian banks. As the President of the ECB also recently stressed, non-performing loans in banks’ balance sheets were examined as part of the comprehensive assessment performed in 2014, the necessary provisions were made, and there will be no new requests to increase them or to strengthen banks’ capital. The climate surrounding the resolution of four banks that had been placed under special administration has also contributed to the volatility. 2. The resolution plan for four banks On 22 November of last year the Italian Government and the Bank of Italy applied the new rules approved by the Italian Parliament following its transposition of the Bank Recovery and Resolution Directive (BRRD) to resolve the crisis at Banca delle Marche, Banca Popolare dell’Etruria e del Lazio, Cassa di Risparmio di Ferrara and Cassa di Risparmio di Chieti. Together they held around 1 per cent of system-wide deposits. Contributing to the collapse of these banks, affected like all the others by the deterioration in loan quality due to the length and depth of the recession in Italy, were grave episodes of malfeasance. Detailed information on the handling of these crises and on the supervisory actions that preceded them can be found in documents now available on the Bank of Italy’s website, which follow on from the explanatory note published on 20 December regarding the bank rescue decree. Naturally we stand ready to provide any further information should this be required by Parliament. In accordance with the law the decision to place a bank in special administration is taken only in the event of very substantial losses and serious irregularities that compromise the bank’s ability to meet its capital requirements and threaten its very stability, or when it becomes clear that the management appointed by the shareholders are no longer capable of coming up with a credible plan for its restructuring. Before special administration is imposed, steps are taken that include, based on the circumstances, making changes to its governance structure, preparing new business plans, adopting capital strengthening measures and selling off assets or business units. This sequencing was followed in all four cases, as in all the other bank crises that the Bank of Italy has handled (about 100 in the last 15 years), in a diligent and timely manner, and in accordance with the existing regulations. The resolution was initiated, in the absence of alternative market solutions, in view of the irreversibility of the collapse and the emergence of unsustainable liquidity tensions. Despite the best efforts of the special administrators, and the launch of negotiations with several potential counterparties, no concrete offers were forthcoming from investors indicating their willingness to assume the risks associated with the impaired assets, against a backdrop of worsening macroeconomic conditions and the new regulatory environment. Unlike what happened in the past it was not possible to seek financial support from the Interbank Deposit Protection Fund, which, although it draws on the resources of the member banks, in the European Commission’s interpretation is tantamount to state aid and as such – according to the procedures announced and followed by the Commission since 2013, to which I will return shortly – can only be disbursed subject to burden sharing, i.e. by first imposing losses on shareholders and subordinated creditors. Discussions in this regard between the Commission and the Italian government have been lengthy and painstaking. The document published on the website of the Ministry of Economy and Finance on 23 December sets out the issues in detail. BIS central bankers’ speeches A dispute at that point with the Commission, or indeed before the European Court of Justice, would not only have led to grave uncertainty for the stability of the system, with even more serious consequences for the banks involved and for investors but, under the current accounting rules, would also have required the banks concerned to set aside an amount to cover the cost of a potentially negative outcome with risks for business continuity. Intervention by the Fund would in any case have required authorization from the ECB, as the supervisory authority, which in turn would have had to request an opinion from the Commission’s Directorate-General for Competition. Having ascertained the absence of any concrete alternatives, other than the far more traumatic option of liquidating the four banks, the Bank of Italy, with the approval of the Ministry of Economy and Finance, implemented the new resolution procedure provided for by the BRRD immediately upon its transposition into Italian law on 16 November 2015. Recourse to this procedure made it possible to use the new tools introduced, in particular the creation of four bridge banks and a company for managing the bad debts of the banks under resolution. This intervention guaranteed the continuity of the essential services provided by banks. The assessment of the losses and therefore of the resolution costs was made in accordance with strict European rules and was in no way discretionary. The particularly conservative estimate of bad debts is in keeping with the provisions of the BRRD and with the interpretation of the rules on state aid adopted by the Commission during its talks with the Italian government; it roughly corresponds to the theoretical average market value of their immediate divestment. The costs were borne predominantly by the banking system through the newly-established Resolution Fund, but also by holders of shares and subordinated bonds; there was no transfer of public resources. The heavy sacrifice made by shareholders and subordinated bondholders was inevitable given the new regulatory framework. Had this intervention not been made, a compulsory administrative liquidation would have eroded value and generated losses for holders of ordinary bonds and unsecured deposits; it would also have jeopardized regular banking activity, with widespread repercussions at local level. Thanks to the new capital resources and the good quality of the assets, and under the guidance of the completely overhauled governing bodies, the bridge banks to which the businesses were transferred resumed lending to the local economies, as the banks in crisis had no longer been able to do so. The new banks had their bad debts written off and were recapitalized, thereby creating the conditions necessary to make them attractive to investors. In approving the rescue package, the European Commission requested a very brief time frame for the banks’ divestment. This procedure has begun over the last few days. Parliament has recently approved the establishment of a Solidarity Fund – to be funded entirely by the banking system – to compensate investors holding subordinated bonds issued by the four banks under resolution; in the arbitration procedure, compensation is contingent on verification of whether banks have violated their obligations of due diligence, fairness and transparency as provided for by the Consolidated Law on Finance. The procedures and conditions for eligibility shall be established by ministerial decrees. The Bank of Italy has assured the authorities involved of its complete cooperation. Based on the legislation in force, and in line with European law, the Bank of Italy does not exercise control over the issuance of bonds or other bank funding instruments; these decisions are adopted independently by banks in compliance with the limits and conditions provided for by law and by the supervisory authorities. Savings flow into the banking system in various ways. Bank deposits are the savings that are afforded the best protection on three levels: supervision of banks’ stability, now entrusted to the EU’s Single Supervisory Mechanism, of which the Bank of Italy is part; the rules on transparency and fairness to which banks are subject for the opening and management of deposit accounts, to be complied with under the supervision of the Bank of Italy; and the guarantee scheme, which protects deposits of up to €100,000 for each account holder. BIS central bankers’ speeches Bank bonds and shares are investment instruments. As such, there is no guarantee that their value can be preserved, but in order to protect investors their placement must comply with the obligations, harmonized throughout Europe, of due diligence, fairness and transparency, and the risks and returns of each instrument must be correctly set out and fully understood. The supervisory authorities are unceasing in their oversight of banks in financial difficulty, though oftentimes the general public is not aware of this. In most cases their actions help to prevent the emergence of crises and thus avoid the costs involved in managing and resolving them. No supervisory action in any country can entirely eliminate the risk of banking crises, especially in times of deep recession. 3. The new European legislation on banking crises The legislation on banking crises has two potentially conflicting objectives: maintaining financial stability – which leads to interventions in support of troubled banks to avoid systemic repercussions – and preventing banks from behaving opportunistically in the expectation of public intervention. Following the global financial crisis, the prevailing position at international level has leaned towards the latter objective, far more so than in the past. This change in direction has certainly been influenced by the massive public interventions for rescuing banks that have weighed heavily on the state finances of many countries, in some cases jeopardizing their stability. To reduce the likelihood and size of bank bail-outs to be borne by the taxpayers, rules have been drawn up that would allow the costs of a crisis to fall mainly on a bank’s creditors. At the end of 2015 the Financial Stability Board drafted strict requirements on total loss absorbing capacity (TLAC) for global systemically important banks, focusing on subordinated instruments and envisaging their gradual entry into force by 2022. There have been rapid, sweeping changes in European legislation. In 2013 a Communication from the European Commission had provided for the immediate application of a new burden-sharing scheme which, in the event of a bank crisis, imposed losses on shares and subordinated bonds as a prerequisite for public intervention. In 2014 the BRRD, approved by the Council and the European Parliament, extended that scheme, starting this year, to include ordinary bonds and deposits of over €100,000 (bail-in); among the latter, those held by households and small businesses receive preferential treatment. As part of the burden-sharing scheme and according to the resolution procedures defined by the BRRD, resolution measures were implemented last November for the four banks mentioned earlier. During this delicate changeover at European level, insufficient attention was given to the transition period. At the technical meetings that laid the ground for the BRRD, the Ministry of Economy and Finance and the Bank of Italy argued, without mustering the necessary support, that an immediate and, more importantly, retroactive enforcement of the burdensharing mechanisms to 2015, and subsequently of the bail-in, could – in addition to a costlier and less plentiful supply of credit to the economy – have posed risks to financial stability also in relation to the treatment of creditors who had subscribed bank liabilities many years ago, at a time when the possibility of losing the original investment was very remote. Our views were expressed in the Bank of Italy’s official publications. A gradual, less abrupt transition would have been preferable. This would have enabled investors to be fully acquainted with the new rules and to adapt their choices to the new regulatory environment. A targeted approach, with the application of the bail-in to only those financial instruments with a specific contractual clause to that effect, and a sufficient transition phase, would have allowed banks to issue new liabilities subject to express bail-in conditions. Such an approach, particularly the emphasis on subordinated instruments, would have been more in keeping with that adopted by the Financial Stability Board in setting the TLAC requirements. BIS central bankers’ speeches A clause in the BRRD provides for its review, to be started no later than June 2018. The opportunity must now be seized, drawing on the experience gained to date, to align European legislation more closely with international standards. In Italy the share of household savings invested in bank bonds is considerably higher than the euro-area average. This is largely due to how these bonds were taxed between 1996 and 2011, which made after-tax interest on bank bonds relative to medium-term deposits much more attractive. When the preferential tax treatment ended, the bonds were gradually replaced with deposits or asset management products as they came to maturity. Given the current term structure, if there were no new purchases, the stock of bonds held by households would be halved by the end of 2017 (from around €200 billion to €100 billion), and would fall below €20 billion in 2020. Under the new BRRD rules and with the launch of the Single Resolution Mechanism (SRM), the resolution procedure is activated when there is a public interest at stake, particularly if it is necessary to preserve the stability of the financial system. In all other cases of evident crisis, the only option is to wind up the bank. Among the initiatives the Italian banking system must evaluate to limit the costs of a crisis for investors are voluntary intervention mechanisms – in addition to the mandatory deposit guarantee schemes – to which, in accordance with the European Commission’s stance, the rules on state aid would not apply. The cost of participation would be compensated by the benefits that all intermediaries would reap, thanks to increased customer confidence and greater systemic stability. Banks should carefully weigh the advisability of such mechanisms. 4. The situation of Italian banks Italian banks’ regulatory capital is much higher today than it was in the past. Since the end of 2008 the highest-quality capital ratio has risen on average from 7.1 to 12.3 per cent. Contrary to what happened in other countries, capital strengthening was achieved without weighing on the public finances. The limited support afforded to banks by the Italian State ultimately generated a net profit in the form of interest and other remuneration. Other countries instead reported substantial losses. Italian banks increased their capital despite the fact that the crisis had severely hampered their income capacity. With the cyclical turnaround, profitability has started to improve. In the first nine months of last year annualized ROE was about 5 per cent, against 3 per cent recorded in the same period of 2014. Loan loss provisions as a share of gross operating profit declined from 70 to 57 per cent. Seven years of crisis have inevitably left a mark in terms of non-performing loans. Since 2008 more than 90,000 firms have been declared bankrupt and more than 4 per cent of households have suffered a reduction in earnings owing to a family member losing their job; industrial production is now over 20 per cent lower; almost one million fewer people are in employment. This has affected households’ and firms’ ability to repay bank debt. Nonperforming loans now amount to around €360 billion or 18 per cent of the total. More than half are recorded as bad debts and are subject to lengthy and onerous procedures to seek their partial recovery. As the crisis unfolded, the Bank of Italy acted to ensure the steady increase of NPL coverage ratios which now stand at 45 per cent, in line with the European average; for bad debts the coverage is around 60 per cent. Collateral held by banks against non-performing exposures amounts to approximately €160 billion. As the economic recovery proceeds, the flow of new bad debts is gradually decreasing. We expect the improvement to continue in the coming months. It will take time to clear the stock of bad debts, whose large volume depresses market assessments of banks, makes bank funding costlier, and generates high capital requirements. We have long advocated the need for measures designed not to alleviate individual banks in difficulty, but to soften the impact of the deep and protracted recession and to foster the BIS central bankers’ speeches development of a private market for non-performing debt where this struggles to emerge by itself. I referred to such measures two years ago before this same audience, noting the need to assess their compatibility with EU legislation. It was not, however, possible to proceed owing to the interpretation given to the rules on state aid. In my view this interpretation fails to take sufficient account of the gravity of the macroeconomic shock; at the same time it seeks to avoid, through state intervention, preferential treatment in one jurisdiction rather than another, an undoubtedly valid objective which might perhaps have been assessed over a longer-term horizon than that beginning with the sovereign debt crisis. But progress on other fronts has and can still be made. Last summer new measures on bankruptcy and foreclosure proceedings were adopted to speed up credit recovery. Although we still need time to appraise the results in full, feedback from market operators indicates that the first effects are beginning to be seen. Further legislative provisions, in addition to those already passed, could further cut credit recovery times: a thorough review of bankruptcy legislation with a view to creating incentives for the rapid settlement of disputes and to removing the obstacles that hinder or delay out-of-court settlement; new measures on how the courts are organized. When I addressed the Italian Banking Association last July, I underlined how a reduction of two years in credit recovery times could substantially decrease, eventually even by half, bad debts as a share of the total. The Ministry of Economy and Finance has reached an agreement with the European Commission on a government guarantee scheme for senior tranches of securitized bad loans. The agreement does not require banks to make further provisions and marks an important step toward the creation of a secondary market for non-performing loans, ending the uncertainty of the past few months. Easier access to resources to finance the purchase of these loans enables them to be sold more rapidly and may lead to a non-negligible increase in their market value. Along with possible new measures to expedite credit recovery the scheme could help to consolidate the balance sheets of Italian banks and improve their ability to finance the real economy. There has been mixed market reaction to the announcement of the agreement; a detailed analysis of its terms and effects will improve its reception. Banks must step up their intervention in this area. The Bank of Italy will soon undertake a statistical survey of bad debts, designed to help banks to do more. It is time that the management of non-performing loans be given resources proportional to their weight on balance sheets, adopting a more business-oriented approach, bank size and operating model permitting. Failing this, their management should be outsourced to specialized operators, with gains in efficiency and effectiveness. Moreover, the share of non-performing loans (almost one third of the total) to firms in temporary difficulty but with sound chances of making a turnaround, especially given the strengthening of the economic recovery, could be managed better. Proper coordination of the banks involved is essential, as is the intervention of corporate restructuring specialists. Another fundamental question that banks cannot ignore concerns the need to keep costs down, stemming not only from the prolonged period of low inflation and low interest rates, which have compressed net interest income, but also from the evolution of the financial system that obliges banks to increase operational efficiency, especially those which, as is the case in Italy, are focused on traditional intermediation. Technological developments call for changes to banks’ branch networks, which are still too numerous, and to the cost, size and composition of staffing. To facilitate the implementation of these measures, limiting the economic and social costs, traditional unemployment benefits could be complemented by the industry’s solidarity funds. The strength and nature of the measures aimed at recouping efficiency must be tailored to each intermediary’s needs. Greater efficiency must partly be achieved through recent and upcoming reforms of corporate governance. The conversion of the cooperative or popolari BIS central bankers’ speeches banks into joint stock companies, in addition to encouraging more effective governance structures, will enable consolidation dictated not by the reform law or by the supervisory authorities but rather by market forces. This process could involve the revamping of a small number of intermediaries, which we have been monitoring for some time, now also under European supervision. Mutual banks, a highly fragmented sector, are facing strong competitive pressures and have been severely affected by Italy’s prolonged economic downturn. The need for greater consolidation, something we have long called for, has become more pressing. The reform being finalized, while preserving the mutualistic nature of these banks, will strengthen systemic resilience and improve corporate governance. * * * Italy is emerging from a recession of exceptional duration and intensity, eclipsing the depression of the 1930s. The crisis has put severe strain on firms and households, and has caused a spike in bankruptcies and unemployment. Its impact on the banking system, which is rooted in the real economy, has been violent. Though shaken, it has endured. Now that the indicators point to a more favourable economic outlook, banks must put themselves in a position to effectively counter future risks. Europe now has a common regulatory framework for bank crisis management. This provides for a vast array of instruments, some borrowed from Italy, others new to us. The most radical innovation is the obligation for holders of capital and debt instruments issued by banks to bear a much higher proportion of the costs of a crisis than in the past. The European Commission’s strict interpretation of this principle means it is no longer possible to manage a crisis by resorting to the Interbank Deposit Protection Fund and the Mutual Banks Deposit Guarantee Fund, without sacrificing investors, as had traditionally been the case in Italy. On the one hand the new European rules on banking crises require that investor awareness be raised, as we have repeatedly said in recent years; on the other the transparent and accurate presentation by banks of investment opportunities must be guaranteed. The implementation of burden sharing at four Italian banks has been a lesson: warnings alone, however often they are repeated and included in specific brochures, cannot in themselves prevent risks to reputation and stability; nor is it enough to tell the banks that capital instruments must only be sold to those who can fully evaluate their sometimes complex risk and return profiles. Additional legislative action should be considered, mainly to take into account circumstances where conflicts of interest may be more pronounced, such as the placement with retail customers of complex financial instruments by the issuing bank. Discussions on this topic are ongoing with the competent authorities. To considerations regarding bank stability, which fall within the purview of the Bank of Italy, must be added the no less important ones related to market integrity and the fair treatment of investors, for which Consob is responsible. In order for the regulations protecting investors to be fully efficacious, the latter must be able to make proper use of the information they are given and to make wise investment choices. Recent international surveys have demonstrated that public awareness of financial matters is particularly lacking in Italy. We must invest in educating people on the characteristics of the most common financial instruments, on fundamental concepts such as the notion that a higher return corresponds to a higher risk and that the failure to diversify investments is always a gamble. For years, the Bank of Italy has supported financial education programmes in schools, with the voluntary cooperation of many teachers, and it is currently seeking to coordinate with additional private and public initiatives. But financial education must involve everyone as a matter of priority. BIS central bankers’ speeches The flow of bad debts, which swelled during the crisis, is gradually ebbing. We must now manage the legacy of the past. The guarantee scheme recently agreed with the European Commission will prove useful for facilitating the divestment of bad debts. The closing of this chapter and a decisive reduction in uncertainty will allow the reactivation of this market. However, it must be clear that no reasonably conceivable measure can cancel at a stroke the stock of bad debt. Rather, the banking system must tackle it with determination, in a medium-term horizon. No less important is the need to continue working on legislative and organizational procedures to improve and streamline the credit recovery, by assessing the effects of the public measures already undertaken and, where necessary, implementing new ones. Italian banks are well capitalized, thanks also to the prudent and swift action taken by the Bank of Italy and, for over a year now, to European supervision, in which we are fully engaged. The stock of non-performing loans is amply covered by provisions and guarantees. The current economic situation is favouring a recovery in profitability, for banks and non-financial firms alike. Now is the time to address and decisively reduce structural costs, and to lay the foundation for robust growth, to the benefit of banks themselves and of the economic system as a whole. Confidence is essential to the stability of the banking system. At a time in which the short-term economic outlook remains favourable, but uncertainty and market volatility appear to be on the rise, the best way to strengthen stability is to aim to be unequivocal in both intent and deed. It is an objective wholly within our reach, provided all actors play their part: banks, supervisory authorities, Government. The Bank of Italy’s commitment can be counted on. BIS central bankers’ speeches
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Keynote address by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the International Finance Corporation, 7th Annual Global Trade Partners Meeting, Milan, 17 February 2016.
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Luigi Federico Signorini: Policy and regulatory issues confronting the current global economic and financial environment Keynote address by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the International Finance Corporation, 7th Annual Global Trade Partners Meeting, Milan, 17 February 2016. * * * Ladies and gentlemen, Thank you for inviting me to this important conference. Trade is key to prosperity and finance is key to the development of trade. The role that monetary policy and financial regulation play in ensuring a stable and efficient financial environment is therefore, I believe, of interest to this audience. Without any pretence of generality, in my speech I shall take up a selection of policy and regulatory issues confronting the global economic and financial environment at the moment and discuss briefly the policy response and agenda. Inflation Low inflation remains a challenge, in the euro area and beyond. We in the Eurosystem take this risk very seriously. The adverse effects of a long period of low inflation are well known. When the economy is at the lower bound of nominal interest rates, the room for conventional monetary policy shrinks. Since debt contracts are fixed in nominal terms, a fall in inflation increases the ex-post real debt burden for borrowers; with long-dated debt this effect may persist for years. With very low inflation even otherwise favourable supply shocks, like the effects of increased supply on fuel prices, may not be an unmixed blessing. Research at the Bank of Italy has shown that, when the zero lower bound is binding, even a negative cost-push shock may generate a negative and protracted decline in output.1 A protracted period of low inflation and a string of negative inflation surprises increase the risk of de-anchoring of long-run inflation expectations. A symptom of this risk is the tendency of long-term inflation expectations to move together with short-term expectations. Some of the studies we have conducted at the Bank of Italy show that this risk is material, but also that it can be countered:2 the correlation of long- and short-term expectations in the euro area has increased, but the announcements of monetary policy measures have had a perceptible impact in weakening this correlation. The aim of the decisions taken by the Governing Council of the ECB is to counter the risk of persistent downward pressures in prices. Our assessment is that the effects of the Asset Purchase Programme (APP) on financial markets and on the real economy, in the euro area and in Italy, have been significant and largely consistent with our initial estimates. Between November 2014 and the beginning of January 2016, the yields on ten-year government securities decreased by about 40 basis points in the euro area, and by about 90 basis points in Italy; the adjustment of portfolios towards assets in other currencies led to a depreciation of the euro of 13 per cent against the dollar and 6 per cent in nominal effective terms. Credit supply conditions also improved: the cost of new loans to firms has declined by Neri and Notarpietro, 2014. Cecchetti, Natoli and Sigalotti, 2015. Natoli and Sigalotti, 2016. BIS central bankers’ speeches 70 basis points since mid-2014 in the euro area (120 basis points in this country). This is pretty much in line with what we initially expected.3 Estimates made at the beginning of last year indicated that the APP would have a significant effect on GDP and on inflation in the euro area; for Italy, we estimated a cumulative effect on GDP of 1.4 percentage points over two years and an increase in inflation of 0.5 percentage points per year. In the past 12 months, the expansion of world trade has fallen short of what was expected; the negative contribution of commodity prices to inflation is now much greater than initially assumed. Nonetheless, GDP has so far grown in line with expectations and projections for 2016 have remained virtually unchanged, thanks to the on-going shift towards a more domestic driven recovery; headline inflation was in line with the projections until the autumn, although it decreased significantly in December and January. The more favourable financing conditions and the depreciation of the euro associated with the ECB’s unconventional measures have largely offset the effects of a less benign external environment on economic activity. But the risk that they may again start to affect long-term inflation expectations must be countered. Despite the positive effects of the programme, the current inflation outlook is not yet in line with the objective of monetary policy. This reflects global headwinds, which have been – and still are – much stronger than was expected when the programme was launched. The persistent weakness in inflation suggests that continued action is still needed on the monetary side. The Governing Council of the ECB will review and possibly reconsider its monetary policy stance at the next meeting in early March.4 As President Draghi re-affirmed, we do not give up pursuing our mandate. Banks Banks’ stocks have had a rough start to 2016. As of yesterday, in the US, the euro area and Italy, banks’ stock prices have fallen by about 19, 24 and 29 per cent, respectively, year-todate, and by 20, 30 and 28 per cent year-on-year. Increased uncertainty in the global economy has surely contributed to a revision in expectations of banking profits. Furthermore, a factor in the eyes of the markets may be the effect of regulation and especially of capital requirements as the closing round of the Basel III standards approaches. Basel III has indeed increased capital requirements in quantity and quality. This was necessary in the wake of the financial crisis, which exposed weaknesses in the previous international framework, especially a treatment of trading-book risks that was too lenient and a definition of capital that was too lax. Regulators have succeeded in strengthening the capital basis of banks. Capital ratios, besides being a multiple of what they used to be years ago, are also defined in a much more robust way. While this may have had a negative impact on return on equity in the short-to-medium run, it has increased the resilience of the banking system and should ensure a more sustainable level of profitability, net of risks, in the longer term. Many changes, however, have already been implemented and, one assumes, have also been amply digested by the markets. The concern today is that a number of final pieces still missing to complete the Basel III standards (such as finalising the leverage ratio, constraining internal models and completing the review of the OpRisk and Trading Book frameworks) will end by significantly increasing banks’ capital requirement again. On this I need to be clear: I do not think that a further significant increase is justified; neither is it envisaged. While individual increases may be appropriate for outliers, the overall result of Cova and Ferrero, 2015. Draghi, 2016. BIS central bankers’ speeches this final round of rule-making should be broadly neutral. This is not just my personal view: the Basel group of Governors and Heads of Supervision said as much in their January statement. As a member of the Basel Committee and of various Financial Stability Board structures, I am committed to work towards ensuring that this aim is duly pursued at the technical level. In Europe certain further factors need to be considered. With 2016 the European Banking Recovery and Resolution Directive (BRRD) has come into full force. Investors know that they may be called upon to take losses in the event of a bank’s distress, with public support a more remote possibility. The shift of the burden of bank crises from public to private capital was a conscious political decision at the European level; that this would reflect on the market valuation of banks’ capital and debt was to be expected. However, there are elements that have increased market uncertainty and sensitivity and that need to be taken into account when, as already foreseen, the BRRD is revised in the light of experience, as Governor Visco recently said. It is especially important that the European concept of ‘bailin-able’ instruments is brought as fully as possible into line with international standards (reference here is to the TLAC concept), ensuring legal certainty, awareness of investors and a clear procedure in the event of resolution. Furthermore, there seem to be lingering market concerns in Europe about legacy assets. Opaque financial assets are one issue that needs to be tackled. In this speech I intend to concentrate on non-performing loans (NPL). The global financial crisis and the ensuing recession caused a deterioration in bank credit portfolios. According to a recent analysis by the IMF5), NPLs in the European Union countries more than doubled between 2009 and 2014. The increase in NPLs is therefore by no means unique to Italy: however, as their level as a proportion of loans is especially high in this country, let me confront the issue head on. There are two reasons for the high NPL/loans ratio in Italy. The first is structural: procedures for recovering a credit in the case of default or distress of a borrower are typically lengthy in this country, which means that, all else being equal, NPLs stay on a bank’s balance sheet for longer and therefore their ratio to outstanding loans at any given moment is higher6. The second reason is that in Italy the length and severity of the recession was unique among major European countries, with a fall in GDP of almost 10 per cent, and in industrial production of almost a quarter, from peak to trough (2008 to 2014). This took a toll on banks. Banks in Italy mostly have a traditional business model and tend to stick to the core business of commercial banking. The Italian banking system therefore shouldered the first phase of the financial crisis fairly well, owing to its negligible exposure to toxic assets. But this also meant that it was affected by the deterioration in the economic situation: provisions for credit losses absorbed on average more than 95 per cent of operating profits over 2012–2014. That said, let me say clearly that concerns are vastly overrated. While they depressed bank profitability for a few years, hefty provisions (spurred by supervisory action, first by the Bank of Italy alone, then by the Single Supervisory Mechanism) meant that the coverage ratio of NPLs in Italian banks grew from 39 to 45 per cent between 2012 and 2015. Within the broader category of NPLs, provisions for “sofferenze” (loans to debtors in full distress) reach 60 per cent of gross amounts. Moreover, around two thirds of NPLs are collateralised. Increases in capital ratios have also been substantial. Provisioning levels for NPLs are currently in line with IMF, 2015b. Our estimates suggest that a reduction of two years in credit recovery times could substantially decrease, by up to one half in steady state, the ratio of bad debt to total loans. This suggests that government action to reduce the length of judicial procedures is a key ingredient for a reduction of the stock. BIS central bankers’ speeches the European average and no new requests for higher provision levels or capital are foreseen, as President Draghi recently clarified. As the economic landscape gradually improves, the flow of new NPLs has trended down over the past two years. The rate of new non-performing loans stood at 3.6 per cent in the third quarter of 2015, more than two percentage points below the peak reached at the end of 2013. Our models forecast a further steady reduction in 2016. Running down the existing stock of NPLs will, of course, take time. Let me mention, however, a series of developments in this respect. Last year the Italian bankruptcy law was amended, with several provisions intended to facilitate out-of-court restructuring agreements and shorten court proceedings for forced sales of collateral. Additional measures have recently been announced by the Government. As a result, the length of bankruptcy procedures is expected to diminish appreciably. This will reduce the time NPLs stay on banks’ balance sheets and at the same time is expected to improve the secondary market for bad loans. The tax treatment of loan losses, which used to be extremely unfavourable for Italian banks, has also been brought broadly into line with practices elsewhere. Finally, a recent agreement between the Ministry of Economy and Finance and the European Commission will introduce a government guarantee scheme for senior tranches of securitised bad loans, which is also expected to support the secondary market. Macro-prudential policy I shall now move away from Italy, back to more general issues, and talk briefly about macroprudential policies, a set of tools which in the past few years has started to complement two long-established ones (monetary policy and prudential supervision) in the overall pursuit of financial stability. The macro-prudential policy set sits on the intersection of the other two sets. Europe, as you will know, now has a rather developed set of rules and institutions to apply macro-prudential measures; other jurisdictions have been experimenting with them to various degrees. Much has been written about macro-prudential policy, but as it is still, comparatively speaking, in its infancy, much is yet to be learned about its working and potential. This is not the occasion for a comprehensive treatment of such a large subject. I would like to offer just two points for reflection. First, the relation between macro-prudential and monetary policies should be well understood. Macro-prudential policy is not meant to undo what monetary policy does; in this respect, it is useful that monetary authorities have a significant responsibility in the decision-making process for macro-prudential measures in many jurisdictions. More specifically, if monetary policy is enacted with a view to fostering bank lending generally, it would make little sense to use macro-prudential tools to restrict bank lending generally as well. On the other hand, carefully targeted macro-prudential measures do have a role to play in tackling any undesired side-effects of monetary policy in specific sectors or markets: think, for example, of a real estate market bubble in any particular country of the euro area. We have had many examples of measures enacted to that effect in Europe recently. They should be seen as complementary to monetary policy, not undermining it. Second, macro-prudential measures should not be seen in isolation and it is important to think jointly about micro- and macro-prudential regulation. The line between the two regimes is thin: on the one hand, because they rely on a largely overlapping set of policy tools; on the other, because when micro-prudential policies are implemented simultaneously on the entire banking system (as with the introduction of new prudential standards), this has macro implications that should not be overlooked. Consequently, I think that we should develop an ability to understand and measure what I term the ‘overall prudential stance’, that is to say, the combined effect of all prudential measures, and to do so in a way that is comparable to the way we understand and measure the monetary or fiscal stance. Today, we have no such measure, either in the euro area or globally. Understanding the way prudential action works at the macro level is BIS central bankers’ speeches more challenging than in the case of monetary or fiscal action because (i) the micro and macro policy frameworks are different, with separate governance structures; (ii) each comprises a large set of policy tools; (iii) these tools can vary across countries; and (iv) we still know too little, as I said, about transmission mechanisms. But constructing a holistic measure of the prudential stance, difficult as it may be, is an important research and policy programme. Non-banks Stricter regulation of banks is one factor behind the increase in non-bank financing, especially market-based funding, that we have seen in the past few years. A more diversified set of financial channels is welcome, especially in Europe where the composition of firm financing appears to be too heavily tilted towards bank financing. The increase in non-bank financing, however, poses a whole range of regulatory questions that I cannot cover extensively here. Let me point to a couple of issues, specifically concerning asset management companies, which I think deserve attention at the present juncture. Market-based funding sits at a crossroads between market and prudential regulation, often done by separate regulators with different mandates, and I think that the importance of the latter has increased. Asset managers now operate with larger portfolios, but in a context of thinner market liquidity. The main concern is the potential interaction between reach for yield, possible undervaluation of credit and liquidity risks and a decline in secondary market liquidity. Under stressed conditions, this may result in rapid asset re-pricing in certain markets such as corporate bond markets. These potential liquidity strains may be increased by the recent growth in assets under management in open-ended mutual funds that invest in less liquid assets while offering on-demand liquidity to their unit-holders. The risk of fire sales triggered by massive redemption requests to open-ended funds which invest in illiquid, long-term securities, while remote, should not, therefore, be overlooked. This would call for policies to limit the funds’ structural liquidity and maturity transformation, such as some alignment of redemption rules with the asset classes the fund is allowed to invest in (Italy has some such regulations in place). Authorities should also consider whether and how to incorporate investment funds into system-wide stress testing exercises, to form a view on how funds’ selling impacts the market and how this in turn feeds back into funds’ asset price declines and further redemptions. Finally, data gaps (concerning e.g. investment funds’ leverage, liquidity and maturity transformation) should be addressed; in awareness of this, the Bank of Italy is contributing to the Data Gap Initiative launched by the G20 Finance Ministers and Central Bank Governors in October 2009 and expanded in 2015. Capital flows in emerging market economies The final point I would like to touch on concerns the risk of capital flow reversals in Emerging Market Economies (EMEs), a risk that is frequently mentioned in the flagship reports of the international financial institutions and deserves attention. Two main developments have, in my view, contributed to the evolution of this risk in the last decade. First, global factors have assumed an increasing role as driver of capital flows towards EMEs. It is now largely accepted that major capital flow episodes (surges, sudden stops, flights, retrenchments) can be associated with the evolution of global factors (i.e. global risk aversion, global interest rates, global growth).7 Recently, the IMF8 has provided a thorough analysis of the mechanisms driving the strong increase in the corporate debt of non-financial firms across major EMEs. One of the points emphasised by the IMF’s analysis – based on micro data – is Forbes and Warnock, 2012. Rey (2013) highlights the co-movements of different classes of capital flows with global factors. IMF, 2015a. BIS central bankers’ speeches that firm and country specific characteristics appear to have become less and less relevant, compared with global factors, in explaining leverage growth, issuance and spreads in emerging markets. Second, the composition of capital flows towards EMEs has changed. While, up to a few years ago, cross-border banking flows were the main driver of the increase in capital flows towards EMEs, more recently portfolio flows have grown in importance. Low yields in advanced economies (AEs) have spurred an extensive search for yield. An increasing fraction of global capital has been allocated to governments and corporations in EMEs, with large inflows into cyclical sectors like mining and energy. At the same time banks have been retrenching from some activities and risks, not least because of the new post-crisis regulation. Although bank loans still account for the largest share of EME debt, the share of bonds has nearly doubled over the last decade, and increased issuance has been largely absorbed by investment funds held by individuals and institutions domiciled in the AEs. These two developments have increased the potential exposure of EMEs to extreme capital flow episodes and altered the effectiveness of the policy tools which can be used to limit the inherent risks. One issue is extending some elements of the prudential framework to the non-banking sector, something I have just mentioned. Another issue concerns the effectiveness of the global financial safety net (GFSN). Key components of the GFSN are each country’s own FX reserves, Regional Financing Arrangements resources and IMF resources. Regional Financing Arrangements have grown in importance in recent years (the European ESM and the BRICS’ Contingent Reserve Arrangement are two examples). Also, the financial crisis has highlighted the importance of central bank swap arrangements – including the conversion of temporary bilateral liquidity swap arrangements into standing arrangements. Achieving consensus on the required size and the most useful role for each component is a clear priority at the G20 level and one of the main aims of the Chinese presidency. Regarding the size, i.e. the amount of resources needed to confront a sudden stop crisis, the evidence seems to show that overall existing effective resources in the GFSN would be sufficient in most plausible scenarios, provided all components can be effectively put to use; in the case of a systemic sudden stop scenario, the IMF’s resources would be called upon to play a key role.9 The last point has implications for the discussion of the Fund’s resources that is to take place in the coming months, specifically concerning extending the 2012 bilateral loans and raising the overall IMF quotas in the context of the XV General Review of Quotas. Of course, the existence of a carefully designed and properly sized GFSN does not reduce the role that macro-prudential policy needs to play in limiting the risk and the consequences of extreme capital flow episodes in EMEs. Ladies and gentlemen, Trade is one of the hallmarks of civilisation. In the semi-brutish state of bellum omnium contra omnes, the war of all against all that certain old philosophers assumed to have existed before the emergence of civilised polities, trade would have been next to impossible. Trade flourishes on physical security, legal certainty, honesty, and peace. It also needs technology, another feature of human civilisation, and not just for the physical delivery of goods and services, as this audience knows perfectly. From barter to specie, to fiat money and letters of credit, to the more complex arrangements of today’s trade finance, the Denbee, Jung and Paternò (2016). BIS central bankers’ speeches progress in credit and payments technology has multiplied the potential prosperity gains from trade. Financial technology, however, like all technology, carries risks as well as the ability to increase productivity. Global financial regulation has to adapt to the evolution of finance. I have taken this opportunity to review some current issues in financial policy and regulation. Much progress has been made in making the international financial system more resilient. The effort will not stop. Risks evolve and alertness to new risks is essential. The international regulatory and monetary policy community is, and must remain, fully aware of this need. References Cecchetti, S., F. Natoli, L. Sigalotti (2015), ‘Tail comovement in option-implied inflation expectations as an indicator of anchoring’, Banca d’Italia, Temi di Discussione (Working Papers), No. 1025 Cova P., G. Ferrero (2015), ‘The eurosystem’s asset purchase programmes for monetary policy purposes’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), No. Denbee, E., C. Jung, F. Paternò (2016), ‘Stitching together the global financial safety net’, Bank of England Financial Stability Paper, No. 36 Draghi M. (2016), Introductory statement to the press conference, Frankfurt am Main, 21 January 2016 Forbes K. J., F. E. Warnock (2012), ‘Capital flow waves: surge, stop, flight and retrenchment’, Journal of International Economics, No. 88: 235–251 IMF (2015a), ‘Corporate leverage in emerging markets – a concern?’, chapter 3, Global Financial Stability Report, October 2015 IMF (2015b) ‘A Strategy for Resolving Europe’s Problem Loans’, September 2015, IMF Staff Discussion Note, No. 19 Natoli F., L. Sigalotti (2016), ‘An indicator of inflation expectations anchoring’, Banca d’Italia, mimeo Neri S., A. Notarpietro (2014), ‘Inflation, debt and the zero lower bound’, Banca d’Italia Questioni di Economia e Finanza (Occasional Papers), No. 242 Rey H. (2013), ‘Dilemma not trilemma. The global financial cycle and monetary policy independence’, Federal Reserve Bank of Kansas City Economic Policy Symposium BIS central bankers’ speeches
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Keynote address by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of IVASS (Istituto per la Vigilanza sulle Assicurazioni), at the IVASS Conference 2016, Rome, 3 March 2016.
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Salvatore Rossi: The launch of Solvency II – the implementation of the new regime: open issues, implications for business models, and effects on institutional and financial communication * * * Keynote address by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of IVASS (Istituto per la Vigilanza sulle Assicurazioni), at the IVASS Conference 2016, Rome, 3 March 2016. Ladies and gentlemen, I am delighted to welcome you to this Conference on the launch of Solvency II. I want to thank Victoria Saporta, Chair of the International Association of Insurance Supervisors (IAIS), Gabriel Bernardino, Chair of the European Insurance and Occupational Pensions Authority (EIOPA), Frank Grund of BaFin and all the other panelists, for kindly accepting our invitation. I also want to thank you all, the audience, for being so numerous. This is the proof that the topic we will be discussing today – namely the Solvency II implementation challenges we are facing only two months after the entry into force of the new regime – is of great relevance, for both regulators and the industry. Indeed, this is not the first conference on Solvency II and will not be the last. Actually a lot of other conferences and seminars have already taken place since the project started. But we still need some more discussion, and a deeper and wider comprehension of the implications of this multifaceted issue. We will start with a keynote speech by Gabriel Bernardino. Two panel discussions will follow. The first one on the most relevant and controversial aspects of Solvency II implementation. The second one devoted to a specific but crucial feature of the new framework: information disclosure. The panelists are very distinguished and well known representatives of both the supervisory community and the industry. The moderators will be Ferdinando Giugliano, former editorial writer of Financial Times, now at the Italian newspaper la Repubblica, and Fausto Parente of IVASS. Alberto Corinti, member of the board of IVASS and of the management board of EIOPA, will offer some concluding remarks. I am sure that we will gain important insights from today’s debate, also based on everybody’s concrete experience in the past few weeks of the new regime. Now a few introductory words on my part. Solvency II was born on 1st January 2016 after a pregnancy lasting more than 10 years. We all remember the last thrilling moments when the Directive Omnibus II, essential for advancing the project, seemed for a while too hard to be agreed upon. A failure would have put the childbirth at deadly risk. But we made it. EIOPA had a fundamental role in that delicate process. It impressed a decisive push when it adopted the interim measures for the preparation to Solvency II in 2013. That move energized the whole insurance sector (both supervisors and the industry), keeping its attention high in view of the final goal of the new regime. Notwithstanding the long and complex preparatory works, not each and every detail is fully fixed yet, nor, I would add, fully understood. That is why we organized this Conference. Of course, we are not going to solve all our doubts today. In our ordinary work we continuously bump into new implementation problems, asking ourselves how to practically deal with this or that aspect of Solvency II. To some extent it is physiological, as it always happens when one moves from theory to practice. I am confident that at the end of the day we will be able to exploit all the benefits of the new regime, while minimizing the implementation costs. BIS central bankers’ speeches Let me briefly touch upon what are – to my understanding – the key points we need to tackle now. First of all, we need to stimulate and accommodate a thorough cultural change in the insurance sector. The transition from the Solvency I static/historical approach to the Solvency II forward-looking one is revolutionary. It is not rhetoric: in the banking sector the same revolution – back in the remote past by now – required years to be digested by all the stakeholders. In a risk dominated environment, supervisors are expected to systematically challenge undertakings on their risk profile/appetite and on their ability to pursue it; for instance, supervisors should periodically discuss with the board of each company its risk profile and long-term strategies. IVASS has already taken some steps in this direction. One example: immediately after an on-site inspection we convene a dedicated meeting with the board of the company, to discuss the outcome and possible corrective measures. In our experience not all board members are always willing and able to sustain such a constructive dialogue with the supervisors, especially in small undertakings. But that is essential in the new regulatory framework. It is a cultural gap. We have to work together on it. All cultural changes require time, effort and perhaps even some pain. What is important is to keep moving ahead – step by step but constantly – towards the main goal: a forward-looking approach in assessing risks and vulnerabilities. Both camps have to adapt their way of reasoning: supervisors when analysing data coming from undertakings, the latter when, for example, performing the Own Risk and Solvency Assessment (ORSA). A second key point is what I consider now the top priority for the supervisory community in the EU: harmonization and convergence of supervisory practices. We cannot consistently manage a common regulatory framework if we accept for too long a playing field which is not level, arbitrages among national supervisors, discriminations in the protection of policyholders along national borders. This was often the case under Solvency I, with so many national differences permitted by the EU directives. Solvency II allows a much more limited number of national specificities. We can more easily work on harmonizing supervisory practices, pointing to a really common approach. This means identifying the best practices and being ready, each of us, to adopt them in our national sphere even if they do not come from our own experience. It is not easy. Day-to-day supervision remains in the national supervisory authorities’ responsibility, with their different stories and long years of experience. Spreading the best practices, irrespective of where they were developed, would sometimes require forgoing national pride in order to embrace the cause of rationality and efficiency. I believe EIOPA can do a lot in this field. Not only because “enhancing convergence” is in its mandate, but also because it is in the best position to collect and compare all the different approaches, identify and recommend the best ones, promote their common adoption, while acknowledging differences on aspects that actually merit to be treated differently. To accomplish this task the tools are already there. Let me just mention the finalization of EIOPA’s supervisory handbook, which we believe is “the” essential tool. Hence, IVASS very much supports it and is actively working on it. Another important tool in order to select and share best practices is the “peer review work”. Even in this case, we will need time. From our side, I can assure that we are seriously committed to such collective effort. A third key point is public disclosure. Solvency II will be a fantastic opportunity to better understand the risk profile and the business model of each company, for all the stakeholders: supervisors first, but also market analysts, board members and managers, journalists, politicians, and the public opinion. The market disclosure rules foreseen by the new legislative framework will really allow everybody interested to have access to the financial BIS central bankers’ speeches position of an insurer with an unprecedented level of detail. The inherent sophistication and complexity of Solvency II, however, raise issues that need to be addressed. It is essential that such informative treasure be of high quality, that could be easily understood and used. A possible complication stems, at least in our country, from the coexistence of the Solvency II informative approach with financial statements based on accounting standards not matching the former. It may be a source of confusion and misunderstandings, possibly endangering the reputation of both supervisors and companies. It will be interesting to exchange views on that today. Let me conclude, ladies and gentlemen, with a word of caution. Solvency II is just a regulatory framework. It designs the urban map, it imposes one-way streets and speed limits, it deploys traffic lights and traffic officers. All this infrastructure has just been changed, and today we are going to discuss how to ease the transition towards the new regime. But the traffic itself, the thousands of cars and drivers in a modern city, well, that is the market. And the insurance market, all over the world, is now facing a bigger challenge than the one posed by a change in the rules of the game, though radical. The challenge is twofold. A structural one: technological innovation. The other one is apparently of a conjunctural nature, but it is actually persisting almost like a structural feature: that is the environment of low and volatile financial returns in which we have been living for years now. I said low, I could have said negative, in the short-term segment of financial markets. How fast will the new technologies disrupt the traditional way of conducting the insurance business? How long will monetary policies keep interest rates at the present unprecedented levels, or even lower? Nobody knows, and every opinion is legitimate. But the whole business is rocked by these developments. Understanding the trends and the challenges behind the current state of affairs in the insurance market should be a common endeavor for regulators/supervisors and the industry. For the time being, we have to work together in order to make the implementation of Solvency II as smooth and effective as possible, also for the purpose of strengthening the insurance sector and make it capable of resisting the present headwinds and catch the opportunities of tomorrow. Thank you for your attention. BIS central bankers’ speeches
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference "The ECB and Its Watchers XVII", debate on "Should the current monetary policy framework be adjusted to meet (new) post-crisis challenges?", organised by the Center for Financial Studies, Frankfurt am Main, 7 April 2016.
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Ignazio Visco: Should the current monetary policy framework be adjusted to meet (new) post-crisis challenges? Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference “The ECB and Its Watchers XVII”, debate on “Should the current monetary policy framework be adjusted to meet (new) post-crisis challenges?”, organised by the Center for Financial Studies, Frankfurt am Main, 7 April 2016. * 1. * * I will comment on three issues. First, is the (below but close to) 2 per cent objective still appropriate? Second, why does inflation remain low? Do global forces dominate, and is monetary policy still effective? Third, should financial stability considerations interfere with monetary policy? Is the (below but close to) 2 per cent objective still appropriate? 2. The 2003 evaluation of the ECB’s monetary policy strategy considered three arguments, 1 which appear all the more valid today. All of them suggest that price stability must be achieved and preserved through timely and effective action. 3. First, the risks of deflation and of policy rates hitting the lower bound have been shown to be a serious issue, more than we thought in 2003. For more than one year now we have had negative or barely positive inflation and a short-term nominal interest rate close to its lower bound, a condition that in 2003, when we assessed our monetary policy strategy, was considered to be very unlikely. 4. Second, there is still need to “grease” the adjustment of relative prices in the euro area, within and especially across countries. Price and nominal wage rigidities still exist, notwithstanding the reforms in the goods and labour markets that have been implemented in recent years; structural differences across countries remain considerable. 5. Third, as to the upward bias in the measurement of consumer prices, if anything, there is more reason today to believe that this is an issue that deserves attention. Let me quote as an example a recent article in The Economist (March 19, 2016), reporting interesting evidence on a ‘digital price index’ that Adobe is developing with the help of two academics (Pete Klenow of Stanford University and Austan Goolsbee of the University of Chicago). The index (which is based on anonymised sales data collected from websites that use the Adobe software) suggests that official statistics are likely to measure the price dynamics of certain goods incorrectly, in particular consumer technology, and, as a result, might significantly overestimate inflation. 6. Let me also add that we should pay attention to the interactions among these (and other) conditions. A very relevant aspect is that too low inflation for too long makes it more difficult to deal with public and private debt. Related to this, as shown by recent research, the interaction of falling inflation and nominal interest rates at the ZLB with nominal debt and downward nominal rigidities can lead even favourable transitory supply shocks (such as a reduction of the price of oil) to have negative effects on economic activity. 2 “The outcome of the ECB’s evaluation of its monetary policy strategy”, ECB Monthly Bulletin, June 2003. Neri, S. and A Notarpietro, “The macroeconomic effects of low and falling inflation at the zero lower bound”, Banca d’Italia, Temi di Discussione (Working Papers), No. 1040, 2015. BIS central bankers’ speeches Why does inflation remain low? Do global forces dominate, and is monetary policy still effective? 7. Low inflation certainly has a global dimension. It reflects developments in oil prices; deflationary pressures coming from the Chinese economy; possibly technological change. But it also reflects domestic developments that should not be underestimated. Domestic factors operate both via expectations and via economic activity, and in both respects conditions in the euro area differ from those in other main advanced economies. 8. Although declining inflation expectations has been a global phenomenon, since the end of 2014 the risk of a de-anchoring has increased particularly in the euro area, where expectations have reached lower levels than in other advanced economies. 3 A measure of this risk can be inferred from the probability that large changes in short-term expectations will be passed on to long-term expectations. 4 This indicator climbed from October 2014 until mid-January 2015 in the euro area, while no increases were recorded in the U.S. or the U.K. over the same period (Figure 1). After the extension of the APP to include public sector securities the indicator decreased sharply, but remained volatile and above the historical average. 9. Let me also point out, in this respect, that the importance of expectations of low inflation in determining wage outcomes, and thus giving rise to second-round effects, may be increasing. In Italy, in some recently signed collective contracts it was agreed that parts of future pay rises will be revised downwards in the event that the inflation rate falls short of current forecasts; according to our simulations, a generalised adoption of this type of contract would significantly decrease the rate of growth of wages and this would in turn be reflected in the dynamics of consumer prices. 10. Very low inflation in the euro-area also depends to a large extent on the persistence of economic slack and high unemployment. In the euro area the negative correlation between unemployment and core inflation or the rate of growth of negotiated wages is very evident even from a simple descriptive analysis (Figure 2). Supporting growth and employment is thus crucial to bringing inflation back to target. Indeed, ongoing work carried out at the Banca d’Italia based on micro-data suggests that after the crisis nominal wages became more reactive to unemployment in Italy, France and Spain; in Italy a reduction of unemployment by 3 percentage points would result in an increase of wage inflation in a range of 0.5–1.0 percentage points. 11. But is monetary policy still capable of supporting inflation and activity? The short answer is yes. Although we are not happy with the current outlook for inflation (and we are also only moderately satisfied with the growth outlook) there is no doubt that the counterfactual would have been much worse and could have led to a deflationary spiral with severe consequences both for the real economy and the financial sector. For a comprehensive description of the APP, its impact and remarks on the evaluation of possible unintended consequences see: Ignazio Visco, “Global Monetary System: Our Currency, Your Problem?”, Remarks to the Monetary Policy Panel, UBS European Conference, London, 11 November 2015. The indicator is based on the probability of co-movement of long-term and short-term inflation expectations. Technically, it is calculated as an odds ratio over a rolling window of 250 working days and ranges from zero to infinity; an increase indicates a closer link between sharp decreases in short-term and in long-term expectations; low values indicate that long-term expectations are better anchored. For details on how the indicator is constructed see F. Natoli and L. Sigalotti, “An indicator of inflation expectations anchoring”, Banca d’Italia, Temi di Discussione (Working Papers), forthcoming. BIS central bankers’ speeches 12. Constructing counterfactuals is always difficult, but estimates by Banca d’Italia staff (which do not consider possible non-linear effects) show that in the absence of the monetary policy measures adopted between June 2014 and December 2015, both annual inflation and GDP growth in the euro area would have been lower by about half a percentage point in 2015–17. The expansion of economic activity in 2015 would have been slightly below 1 per cent, against an observed 1.6 per cent; inflation would have been negative, at about –0.5 per cent, against 0.0. 5 These estimates are consistent with those of the Eurosystem and the ECB staff.6 Regarding Italy, the effects are estimated to be somewhat stronger: absent the monetary impulse, the Italian recession would have ended only in 2017; inflation would have remained negative for the whole three-year period. 7 13. The commitment to pursuing the objective of price stability shown by the Governing Council has been essential for stemming the de-anchoring of expectations and maintaining the ECB credibility, which is crucial to avoiding the risk of a deflationary spiral. When inflation remains far from target for a prolonged period, the risk of deanchoring may be compounded by economic agents revising their expectations for future inflation to take account of surprises registered in the past, to an extent that also depends on the share of agents that lose their trust in the central bank’s objective. 8 14. In order to bring inflation back to target, it is essential to support aggregate demand. The unconventional measures adopted by the Governing Council of the ECB are contributing to increased spending on consumption and investment goods. And I am confident that the effects we have observed so far will be strengthened by the new decisions we took on 10 March: the strengthening of the APP and the inclusion of corporate bonds, together with the introduction of new targeted refinancing operations, will contribute to a further decline of the cost of borrowing in the private sector. 15. A recent debate has centred on the notion of “helicopter money”. Obviously this is a “very unconventional” policy, targeted at directly affecting consumption and investment by households and firms. Such an extreme measure would undoubtedly be subject to operational and legal constraints; the redistributive implications and the close ties with fiscal policy would all make it very complex, all the more so in the euro area given its institutional framework. As recently noted by President Draghi, and reiterated by Benoît Cœuré and Peter Praet, helicopter money is not currently part of the discussion in the Governing Council, although no policy tool within our mandate can or should be dismissed a priori. 16. This discussion is noteworthy, not much per se, but because it underlines the concern that monetary policy is left to act in isolation. Indeed, the fact that monetary policy is still effective does not mean that it can support macroeconomic stability on its own. In order to achieve satisfactory growth, it needs to be complemented by budgetary policies aimed at creating appropriate macroeconomic conditions, as well as by further reforms aimed at increasing potential output growth. In the past years of crisis, monetary policy has bought time for the decisions in other spheres of policy See Locarno, A., A. Notarpietro, and M. Pisani, “Sovereign risk, monetary policy and fiscal multipliers: a structural model-based assessment”, Banca d’Italia, Temi di Discussione (Working Papers) 943, 2013). Mario Draghi, “Global and domestic inflation”, speech at the Economic Club of New York, 4 December 2015; Vítor Constâncio, “In defence of monetary policy”, 11 March 2016. Estimates computed using the Banca d’Italia Quarterly Model. 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), No. 252, 2014. BIS central bankers’ speeches making, but beyond a certain limit such a role would inevitably run into unintended consequences. Should financial stability considerations interfere with monetary policy? 17. My reading is that it is important to consider the implications of monetary policy for financial stability, but that financial stability depends on adequate nominal growth. It is thus dangerous if monetary policy fails to pursue its own targets. As highlighted in the latest (November) Financial Stability Review of the ECB, banks’ profitability and debt-sustainability continue to be challenged by a weak economic recovery. 18. Are concerns for financial instability – due to the very accommodative monetary policy – currently justified in the euro area? It does not seem so. Indicators of imbalances in housing and credit markets do not point to increasing vulnerabilities in the euro area as a whole: estimates of over-valuation of residential property prices do not signal widespread risks (Figure 3), and the financial cycle is still negative (Figure 4). Of course, aggregate data may mask heterogeneous developments across and within countries. But in the event of risks in specific sectors and/or countries, appropriate macroprudential measures can be implemented to limit their accumulation. * 19. * * A protracted, very accommodative monetary policy involves risks which need to be monitored carefully, and low or negative nominal rates for too long may hurt some institutions. But the current low level of interest rates in the euro area is not a bizarre choice of the Governing Council of the ECB; rather, it reflects the slack in the economy and dangerously low actual and expected inflation. A less accommodative monetary policy in the current circumstances would be harmful to everyone. The only sustainable way to raise nominal rates is to strengthen growth and job creation. These are necessary conditions for bringing inflation back to target and preserving price stability in the interest of all euro-area citizens. And this is why we need to be ambitious in our decisions. The stronger our actions today, the sooner these conditions will be fulfilled. BIS central bankers’ speeches Figure 1 Indicator of co-movement between short/long-term inflation expectations for extremely negative variations Note: The indicator is based on the probability of co-movement of long-term and shortterm inflation expectations. It is calculated as an odds ratio over a rolling window of 250 working days; an increase indicates a closer link between large reduction in short-term and long-term expectations. See F. Natoli and L. Sigalotti, “An indicator of inflation expectations anchoring”, Banca d’Italia, Temi di Discussione (Working Papers), forthcoming. Figure 2 Core inflation, negotiated wages and unemployment in the euro area Source: European Central Bank and Eurostat. Note: core inflation excludes energy and unprocessed food. BIS central bankers’ speeches Figure 3 Over/undervaluation of residential property prices in the euro area Source: European Central Bank, Financial Stability Review, November 2015. Note: over/undervaluation estimates are based on four different methods, two statistical and two model-based. A positive figure indicates overvaluation, i.e. prices above longterm average (in the case of statistical models) or fundamental values (in the case of economic models). Figure 4 Domestic credit-to-GDP gap in the euro area Source: European Systemic Risk Board and Banca d’Italia’s calculations. Note: the credit-to-GDP gap is calculated as the deviation of the ratio of total credit to nominal GDP from its recursive one-sided Hodrick-Prescott trend. GDP-weighted average of euro area country gaps. BIS central bankers’ speeches
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Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Conference "European Banking Union and bank/firm relationship", CUOA Business School, Altavilla Vicentina, 7 April 2016.
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Salvatore Rossi: The Banking Union in the European integration process Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Conference “European Banking Union and bank/firm relationship”, CUOA Business School, Altavilla Vicentina, 7 April 2016. * * * How we got to a Banking Union The Banking Union is the latest born sectorial union in Europe. Differently from the Monetary Union, it was not born in a positive and joyful climate, as that accompanying the new proEuropean thrust between the 80s and 90s of last century. It came into being as a hurried response to a situation of extremely serious crisis, which threatened the very essence of the European Union, at the start of this decade. Immediately after the outbreak of the global financial crisis – an epidemic which spread quickly from the original US onset to the rest of the world – Europe started to be worried about its banks. There was a widespread belief that, in the presence of big European intermediaries operating on a global scale, national supervisory and crisis management systems were getting increasingly less effective. The European reaction was typical for the EU institutional architecture: a stratification of complex bureaucratic bodies with unpronounceable acronyms. Since 2011, the national regulatory and supervisory authorities and the European Committees coordinating them were placed under the umbrella of the European System of Financial Supervision (EFSF), made up of the European Systemic Risk Board (ESRB) and the three sectorial European Supervisory Authorities (ESA): the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA). This complex and heavy structure began to crumble when the so- called “sovereign debt crisis” became serious in Europe. Let us not be deceived by the highly technocratic sound of this expression. It was actually a rapid and wide spread of a basic doubt on the very meaning and purpose of the European Union and on the single currency in particular. A doubt that began to creep in not only among academics, but also among leaders and peoples of all European countries. The genie got out of the lamp and since then it has not been put completely in again. The crisis was triggered by the disclosure of the very poor conditions of the Greek public accounts between late 2009 and early 2010. It was like a long compressed spring being released. The Northern European countries voiced loud and clear that they did not trust the will of Southern countries to make their economies more healthily competitive and financially sound. Southern countries on their turn started to complain about the inadequacy of a strict financial orthodoxy at a time when it was necessary to avoid sinking into a new big depression by means of expansionary policies. International markets and investors understood immediately that the possibility of a political split on the euro could no longer be ruled out and started to “price” it in when assessing government bonds which – one day in the future – might be denominated in a reborn national currency (either very devalued or revalued). We saw the spread between the yield of the bonds of “peripheral” countries and that of the German bund peak to levels that should be unthinkable in a monetary union. It was immediately clear that banks were the weak link in the chain. There’s indeed an obvious link between the public finance and the financial statements of the banks in a given country. Banks normally – I would say naturally – invest a considerable part of their assets in government bonds of the countries where they operate, mainly for the management of their liquidity; if yields go up, the value of those bonds falls and banks must BIS central bankers’ speeches record losses in their accounts; at the same time raising funds on the wholesale market becomes more expensive. Banks undergoing difficulties raise the suspicion in the market that they will be saved by the State, which makes the perspectives for the public budget even worse. A vicious circle that must be broken 1. Hence the idea of a Banking Union. European banks – it was stated – must be perceived as a European, not a national, issue: if one of them goes into crisis it must be clear that the solution will be found at a European, and not at a national, level. The Four Presidents’ Report illustrating the project was presented in June 2012. However it was immediately clear that the implementation of this project would be undermined by the geopolitical conflict that was tearing Europe apart. It consisted in three key pillars and a “joint”. The key pillars were: a single resolution mechanism for banks within the euro area – the main pillar – together with a single deposit insurance scheme in case of a bank’s liquidation and a single supervisory authority, operating on the basis of common standards and practices. The “joint” was a sort of public and common financial safeguard clause (backstop), supporting both crisis resolution procedures and the deposit insurance scheme. This joint had already been identified as the existing European Stability Mechanism (ESM). The view that the prerequisite for all this was the creation of a single supervisor was immediately put forward, because this would have helped eliminate the mutual distrust, and so it had to be the starting point. The Single Supervisory Mechanism (SSM) was set up in a record time: it was made up of the European Central Bank and the national supervisory authorities, and became operational in November 2014. Such rapid implementation was possible thanks to a provision in the Treaty expressly assigning the ECB prudential supervision functions. In addition, the SSM could right from the beginning rely on a whole set of common prudential rules (single rulebook), contained in the package of regulations CRR/CRD4 which had already transposed Basel III agreements in Europe. In the meantime, crises of banks of different sizes had spread in many European countries, due to reasons ranging from the burst of real estate speculative bubbles, as was the case in Spain and Ireland, to the contagion of “toxic” instruments in structured finance, as in Germany. Banks in distress were saved using public resources (bail-out): 240 billion euro in Germany, borne by German taxpayers, 50 billion in Spain, financed with the European funds collected by the ESM, 40 billion in Ireland and almost the same amount in the Netherlands, and so on. In Italy public intervention was only a tiny fraction of those just mentioned and – what’s more – took the form of a loan, very profitable for the State. On the other hand, in Italy the burden of deteriorated loans was getting heavier and heavier, mainly as a consequence of the long recession. The massive public bailouts of European banks ended in the first half of 2013. In July 2013 the European Commission issued a Communication laying down guidelines on State aid, binding for all the member States. Since then State aid could be granted only under very stringent conditions and subject to a “burden sharing” by shareholders and subordinated bondholders: a principle similar to the “bail-in” underpinning the new European Bank Recovery and Resolution Directive (BRRD), which was being drafted. The new way of solving banking crises In April 2014, the European Parliament approved the BRRD, which fully introduced, as from 2016, the bail-in principle. Since the beginning of this year the Single Resolution Mechanism (SRM) has become fully operational in the euro area, the first – and central – pillar of the As to the nature of the vicious circle see L. F. Signorini, Speech for the round of meetings “Towards a European Banking Union”, Università Cattolica di Milano, 27 March 2014. BIS central bankers’ speeches Banking Union, managed by yet another new authority, the Single Resolution Board, supported by similar newly set-up national authorities. The founding principle of this new regulation is not: “European banks are a European issue”, but: “European taxpayers must be protected against banking crises”, those in their own countries and especially those in other countries. The cost of a banking crisis should no longer be borne by the taxpayer but by the saver/investor. The idea is that if a bank goes into crisis, to the point of being “failed or likely to fail”, and no market solution can be found, there are only two viable options: to liquidate it, i.e. to close it down permanently, stopping all operations and freezing all creditors until, years later, it is clear what remains after the liquidation of assets; or, in case of an overt public interest in the bank’s survival, to bail it in, placing the burden of covering losses and reconstituting the required regulatory capital primarily on shareholders, bondholders and large depositors, i.e. those with more than 100.000 euro (not protected by deposit insurance schemes). If those resources are not enough, the Single Resolution Fund intervenes. This fund is privately financed by the contributions of all the other banks belonging to the system. The first applications of this scheme, in Portugal and in Italy, despite the partial form in force until the end of last year (i.e., the burden sharing), have shown limitations and risks. The sacrosanct principle of taxpayer protection is not being questioned, but a debate is still possible and necessary about its rigid and mechanical application, in a context of equally rigid, when not misinterpreted and analytically unsound, protection of competition in the banking market; it is like treating banks as all other businesses, such as a supermarket or an advertising agency; and not like companies that, while competing with each other, rely on the confidence of savers, that is an impalpable and volatile public good, the loss of which may threaten the stability of the entire financial system, thus of the entire economy. Taxpayers and savers are not alien to one another, but they represent, as a whole, the same community, that of citizens. Thus, the functioning of the SRM from now on appears to be affected by uncertainties. On the one hand, decisions on the introduction of completely innovative standards and rules have been centralized in Brussels. Some of the BRRD rules leave room for discretion, aimed at balancing the different objectives of a “resolution” procedure: protection of taxpayers, but also of systemic stability, depositors’ protection, continuity in the supply of essential financial services. These objectives may conflict: pragmatism, flexibility, and reasonableness will be necessary to reconcile them 2. On the other hand, the regulatory framework is still evolving; the international standards for the Total Loss Absorbing Capacity (TLAC), issued last November by the Financial Stability Board for large global banks, will have to be transposed in Europe, consequently modifying the current provisions of the BRRD. During the technical negotiations on BRRD held in 2013 the Italian authorities (the Bank of Italy and the Ministry of Finance), had formally argued, presenting supporting documentation 3, in favour of applying the bail- in tool only to newly issued bonds expressly containing a contract term entrusting the authorities with the power to write-down or convert them upon the occurrence of the conditions for resolution. In addition, to allow time for investors to become aware of the new rules and for banks to provide an adequate buffer of bail-inable liabilities, we insisted on the need to defer the entry into force of the new rules to 2018. The objections raised in technical contexts, by both the Bank of Italy and the Ministry For a discussion of the application and procedural aspects of the new crisis management system, see F. Panetta, Hearing at the Finance and Treasury Commission of the Senate, 29 October 2015. I. Visco, Speech at 22nd Congress ASSIOM FOREX, 30 January 2016. BIS central bankers’ speeches of Finance, were not taken into account. The political pressure coming from the Northern European countries prevailed. A temporary public backstop still needs to be designed for cases where the application of the bail-in might exacerbate, rather than alleviate, the risks of systemic instability. It would be fully consistent with the provisions of the Key Attributes of Effective Resolution Regimes of the Financial Stability Board, that are the global standards for the resolution of large financial intermediaries’ crises. The lack of such instrument is not accidental: it reflects the unwillingness of many European countries to consider the possibility that the taxpayers of country A may pay, even temporarily, for the crisis of a bank in country B. According to this view, banks, although now supervised and subject to resolution by European institutions, must ultimately remain a national matter. The single deposit guarantee scheme The second key pillar of the Banking Union (the European deposit insurance scheme) seems to be still a long way in the future. The last Five Presidents’ Report of June 2015 underlined the need to continue moving ahead in relation to the single deposit insurance, because without it the euro runs the risk of being unable to absorb generalised confidence shocks; the Report recalled that – in comparison to national systems – a common guarantee scheme is more likely to be neutral over time for public finances, because risks are more spread and contributions are levied on a wider range of intermediaries 4. The European Commission recently made a proposal – submitted to Ecofin last December – to change the SRM Regulation in order to create a European Deposit Insurance Scheme (EDIS), fully funded by private resources provided by all banks in the euro area. The proposal was submitted for consideration to the Council, which set up a special working group. The EDIS is intended to establish a mutual system of private deposit insurance based on the Deposit Insurance Fund (DIF), to which the already existing national funds would gradually transfer the resources collected by the participating banks. The scheme would guarantee the same protection in all the countries participating in the SSM; it would increase confidence in the European banking system on a level playing field. The EDIS should be established in three stages. In the first one (reinsurance, until 2019) the DIF would cover up to 20 per cent of the financial requirement or the losses of national funds. In this stage the DIF would provide assistance only after the national funds have used all the available resources (both ex-ante contributions and ex-post ones, in case additional funding is needed). In the second stage (co-insurance, from 2020 to 2023) the share of the financial commitment and of the cost of the assistance borne by DIF would gradually increase (up to 80 per cent); in this stage the intervention by the DIF and by the national funds would occur in parallel. In the third and last stage (full insurance, from 2024), the DIF would provide all funding. Thus, we are talking about a scheme which does not envisage any public backstop, and has a very long transition. Nonetheless such proposal has faced firm opposition from some countries (among which Germany, the Netherlands and Finland). They call for the harmonisation of major national regulations – bankruptcy laws, collateral framework, tax rules, company law and consumer protection – before mutual guarantee schemes are even For an in-depth study of the Five Presidents’ Report, see I. Visco, European Union: progress or regress?, Speech at the 50th Anniversary Conference of Istituto Affari Internazionali, 13 November 2015. BIS central bankers’ speeches discussed; and, above all, they call for the preliminary introduction of prudential requirements for banks’ sovereign exposures. Discussions seem to be deadlocked. A climate of mistrust still prevails along national borders. * * * Let me sum up. The Banking Union original plan envisaged that if a European bank went into crisis, the first common funds to be used to save it should be private, but, if that were necessary to preserve financial stability, then also public funds should be used; should the crisis not be resolved and the bank be wound up, deposits below a certain threshold should be guaranteed, again with common private funds, but, if need be, with public ones as well; a unified approach to banking supervision at the European level would prevent suspicions of favouritism and moral hazard by national authorities. The Single Supervisory Mechanism has been fully in place since a year and a half now. It is working, despite having been developed in a very short time and despite the objective coordination difficulties among authorities with different histories, traditions and practices. Cooperation between the national and the central level, after some initial friction, is now smoother. The Single Resolution Mechanism has only recently become fully operational and differs from the original project. It presents implementation issues and also risks for the systemic financial stability. The single deposit guarantee scheme is still missing and there are heated discussions about its design. Therefore the Banking Union implemented so far is neither perfect nor complete. Its difficulties are those of the entire European Union. Those who recognize its indispensable role and care about its fate must work with renewed determination to strengthen it. BIS central bankers’ speeches
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Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the SUERF/BAFFI CAREFIN Centre Conference "Central banking and monetary policy: Which will be the new normal?", Milan, 14 April 2016.
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Fabio Panetta: Central banking in the XXI century – never say never Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the SUERF/BAFFI CAREFIN Centre Conference “Central banking and monetary policy: Which will be the new normal?”, Milan, 14 April 2016. * * * Accompanying figures and the table can be found at the end of the speech. 1. Introduction At first glance, today’s global economic outlook gives plenty of ammunition to the critics of central banks. Take the euro area – though its problems are by no means unique – where notwithstanding a strongly expansionary monetary stance, inflation is persistently low, growth is weak, and the recovery far more fragile than one would hope. It is unsurprising that in this environment we have got caught in a crossfire of questions on the nature of monetary policy. Is the ECB pursuing the right objectives? Is it doing so effectively? Zero or negative rates and intrusive asset purchase programmes could cause all sorts of distortions, including financial bubbles or inequalities? Is the ECB fully aware of this? And if so, does it care? These are important and intellectually challenging questions, and I will refer to them below to structure my remarks on “what (I think) we learned” about monetary policy from or after the financial crisis. However, they also raise a key point that to my mind is by far the most important lesson we can take from the last eight years: when it comes to monetary policy, “never say never”. When H.G. Hawtrey wrote about central banking being an “art” in 1932, he could not possibly have foreseen the policy palette that central bankers would have at their disposal in the 21st century. For that matter, central bankers in the early 2000s could hardly have imagined it either. When put to the test they proved braver and more creative than anyone – including those within their own ranks – could have expected. Two factors forced them to push the envelope: the end of the Great Moderation and their determination to do “whatever it takes” to keep the economy stable. Pablo Picasso – admittedly a far better artist than your average central banker! – notoriously gave this piece of advice to his students: “Learn the rules like a pro, so you can break them like an artist.” Central bankers learned and followed the (Taylor) rules for many years, but were quick to break them when they seemed out of step with the times. This is to their credit, irrespective of the many questions that can be raised about their specific choices, and of the uncertainty that continues to surround their ultimate success. But the fact remains that the woes of the euro area do raise interesting questions about the nature and conduct of monetary policy. In the remainder of this talk, I will focus on four of them. First, its objectives: should monetary policy continue to focus on price stability? Second, its effectiveness: does it have sufficient tools to fight deflation or lowflation? Third, its interaction with financial stability: should exceptional monetary expansions be avoided, so as not to trigger excessive risk-taking? Fourth, its distributional implications: does it increase income or wealth inequality? I will address each of these questions in turn. 2. Is the pursuit of price stability still warranted? (Yes!) The popularity of inflation targets is at one of its all-time lows. Some remain sceptical of the need to use monetary policy to fight low inflation if or when the latter is mainly due to swings in the price of oil. Others, such as Issing (2016), argue that central banks should be more “patient” and focus on longer-term horizons. Still others have suggested that the potential BIS central bankers’ speeches costs of ultra-expansionary monetary policies are likely to outweigh their benefits (Borio, 2015), particularly in cases where low inflation mostly reflects positive supply shocks.1 In principle it is true that there are times when monetary policy should simply “look through” a few consecutive observations of low, or even negative, inflation. Reacting to the short-term vagaries of the price level can be counterproductive. However, this argument can easily lead to an underestimation of the costs and risks of deflation that arise when inflation expectations become de-anchored, when nominal rates are at their lower bound, and when debt (public and private) is high. Deflationary pressures pose a serious problem when they become entrenched in firms’ and households’ behaviour. Research at the Bank of Italy shows that adaptive learning can play an important role in this sense (Busetti et al., 2014). If agents have incomplete knowledge of the behaviour of their central bank and learn from inflation outturns (bounded rationality), the effects of negative surprises may become extremely persistent. In particular, the shocks that hit the euro area over the last two years would reduce inflation by at least 1 percentage point more than in a standard rational expectation model (see Figure 2). Besides being a problem in its own right, this would also imply that the (standard) models central banks use for forecasting may become inaccurate and provide poor guidance for policy decisions. Our research also shows that there is a concrete risk of an outright de-anchoring of inflation expectations (Cecchetti et al., 2015). As long as expectations are well anchored, changes in relative prices or supply shocks should affect the price level in the short- but not in the longrun. Hence, the correlation between short-term and long-term expectations provides a gauge of de-anchoring risk. In the euro area this correlation has risen in recent months. In particular, the probability of downward changes in short-term expectations becoming associated with variations in longer-term expectations has increased substantially (Figure 3). Technicalities aside, it is clear that even declines in inflation due to favourable supply shocks may have adverse consequences when nominal interest rates are at the zero lower bound and debt levels are high.2 To cut a long story short, it is crucial that central banks keep pursuing their price stability target. 3. Is monetary policy approaching its limits? (No!) The next question is whether central banks can achieve their goals when interest rates are at the zero lower bound. Are their tools up to the task? This debate has intensified since the ECB Governing Council’s decision of last March, but it is hardly new: doubts about the effectiveness of monetary policy, as well as claims that it has now “really” reached its limit have been voiced after each round of monetary expansion in the last eight years on both sides of the Atlantic. The effectiveness of monetary policy might be hindered because of the ZLB; because “you cannot push on a string”; or because monetary stimulus is necessarily weaker after a financial crisis, when firms and households want to deleverage and the bank transmission channel is broken (Masciandaro, 2016). My initial response to this question is contained in the title of this speech: “never say never”. There are no obvious limits to what central banks can do. The suspicion that they might really run out of tools and ideas is understandable, but it is backward-looking and has proved groundless more than once already. My considered response is that we now have enough information to reject the conclusion that the recent monetary policy initiatives did not work. There is an apparently technical but actually crucial point that I would like to make before getting to the crux of the matter. To assess a policy intervention (monetary or otherwise), one From this perspective the Great Depression is considered an outlier, a unique historical event with limited general lessons on the cost of deflation. See, inter alia, Neri and Notarpietro (2015). BIS central bankers’ speeches needs to look at the counterfactual and not, or not only, at the data. The question is not whether we are happy with the current levels of growth and inflation, but whether we would be happier if the interventions had not taken place at all. This complicates the issue, making it more dependent on the assumptions one makes to get an answer, but it is the only serious way to perform a policy assessment.3 The unconventional measures adopted by the Federal Reserve and the Bank of England have proven effective in supporting asset prices and in narrowing inflation and output gaps (Williams, 2014; see Table 1). Casiraghi et al. (2016a) offer a similar assessment for the Italian economy. The measures introduced by the Eurosystem lifted GDP by almost 3 percentage points from 2011–13. Looking forward, our estimates suggest that the Expanded Asset Purchase Programme (EAPP) could boost GDP in Italy by more than 2 points over a three-year horizon, and sustain prices by more than 1 percentage point. The EAPP is not a beggar-thy-neighbour policy: it may imply a depreciation of the exchange rate, but this is not the only, or for that matter indispensable, transmission channel. The fall in the medium- and long-term yields of a broad set of financial assets puts downward pressure on bank lending rates and supports investment. Wealth effects from financial prices may give an additional boost to household consumption in the medium term (our estimates for Italy suggest that a 10 per cent increase in financial wealth would raise consumption by 0.5 percentage points in the medium term). Increases in residential house prices, together with the decline in long term rates, support residential investment. The evidence we have so far on the effects of the programme is consistent with those predictions. The cost of new loans to households and firms in the euro area has fallen by 60 and 70 basis points, respectively, since mid-2014. For Italian firms, the cost of borrowing has come down by 120 basis points (Figure 4). The performance of Italian GDP last year was broadly consistent with our estimates, as we reported in our last Economic Bulletin (Figure 5). Of course, monetary policy cannot work alone. Its positive impact on the performance of the Italian economy was possible in light of the reforms implemented at the national level, such as the reform of the labour market, the emphasis on the spending review, the gradual reduction of the tax burden. Inflation responded positively to the programme in the first three quarters of 2015. It subsequently weakened, but that has much to do with a worsening of global conditions. At any rate, without the programme the inflation forecast for 2016 would have been about half a percentage point lower. It is clear that the challenges to price stability remain significant. However, these estimates suggest that there is little ground for arguing that monetary policy is powerless, or that central banks are now approaching the limits of what they can deliver. I would therefore caution against listening to the siren song of those who claim the opposite. We should never forget that inflation is ultimately a monetary phenomenon. This is no mere theoretical statement. The success of the Bundesbank in the 1970s depended directly on this view, on the fact that central banks should not give up on price stability, and that they had the means to achieve it. That this view was quite unpopular at the time, when many wanted central banks to forgo controlling prices, should ring a cautionary bell today. Of course, we cannot fine-tune the economy with monetary policy alone. Its transmission mechanism entails “long and variable” lags and it can be stronger or weaker depending on the state of the economy, which in turn is influenced by a broad range of policies. Hence, it can be dangerous to let monetary policy be the only game in town. This takes us straight to The long debate on the causes of the Great Moderation clearly demonstrates that it is impossible to distinguish ‘good luck’ from ‘good policy’ by just looking at the data: you need a model. The moderation has long since gone, but that principle applies equally to the problem we are discussing today. BIS central bankers’ speeches the next question I would like to discuss, namely the relation between monetary and fiscal policy. 4. The policy mix Many have advocated a key role for expansionary fiscal policy in lifting activity and employment (among others, Krugman, 2008). Bernanke argued that the poor performance of the euro area compared to the US after 2009 may have reflected the fact that fiscal policy was tighter than warranted by economic conditions.4 In his Jackson Hole speech in 2014, President Draghi also signalled that fiscal policy was “less available and effective” in the EA, that it “could play a greater role” and that “the existing flexibility within the rules could be used to better address the weak recovery and to make room for the cost of needed structural reforms” (Draghi, 2014). By and large, the data seem to support these views. Indeed, looking at the cyclically adjusted primary balance, the fiscal stance in the euro area was less expansionary, if not contractionary, than in other advanced economies following the onset of the financial crisis (Figure 6). The case of the euro area is, of course, peculiar in this respect. Not only is there no single fiscal policy, but many countries are also constrained in their ability to use fiscal policy countercyclically on account of high debt levels and/or political pressures. This issue has been important in the unfolding of the crisis and remains critical today. Nevertheless, maintaining a contractionary fiscal stance is clearly problematic in the current context. Furthermore, significant heterogeneity among European countries means that some economies have the leeway for an expansion that might prove beneficial for them and for the rest of the area. The complementarity of monetary and fiscal policy also lies at the root of the debate on “helicopter money”, i.e. the direct financing of consumption or public investment. As President Draghi has remarked, the concept is an interesting one and is currently being discussed by academic economists, though interpretations of what it means vary widely. It also presents a number of complexities, both in accounting terms and legally. It is an important debate, which should not be dismissed lightly, but the fundamental message we can take from that discussion is perhaps not for central banks, but for fiscal authorities. To paraphrase the title of an old article by Franco Modigliani, we should not forsake stabilisation polices (Modigliani, 1977). The importance of fiscal discipline is indubitable, particularly in the light of the recent tensions in euro-area sovereign bond markets; but overly restrictive or otherwise misguided fiscal strategies might mean that, in this stabilization effort, fiscal policy becomes part of the problem instead of part of the solution. 5. Monetary policy and financial stability Should financial stability considerations interfere with the determination with which central banks pursue their primary target? I would start by emphasizing the strong link between price and financial stability in the medium run. It is hard to maintain a sound financial system in a (persistently) depressed economy. All measures aimed at closing output and price gaps after a long recession are therefore compatible with the financial stability objective of reducing systemic risk. True, this link may be loose in the short run (as Masciandaro recently restated). A large body of evidence suggests that risk appetite is endogenous and is affected by monetary policy. Bernanke (2015). BIS central bankers’ speeches Investors take on risk, potentially up to undesirable levels, when monetary conditions are too loose. This is by now well documented for both bank lending and market finance.5 The first issue is how to identify this phenomenon. In order to spot changes in investors’ risk attitude, policymakers need to look at a broad set of information. Monetary policy decisions must be taken on the basis of indicators such as credit developments, bank lending conditions and asset prices.6 In my view, the data speak quite clearly as of today. The Italian credit cycle, measured by a detrended credit-to-GDP ratio, turned negative around 2010 and has remained so ever since (Figure 7). The same is true of the euro area overall. Figure 8 shows a cyclical indicator that combines information on housing and financial prices and on credit aggregates. The indicator shows that the euro area is lagging behind the United States in terms of financial recovery, and that cyclical conditions in Europe are still mildly negative. This does not mean that risks may not be rising in individual countries or sectors, but nor does it signal “excessive risktaking” in the aggregate. The second issue is what to do if and when the indicators signal an increase in systemic risk. My answer is that macroprudential policy should be used as the first line of defence. Of course, monetary policy can also play a role, but the debate on what exactly this role should be is far from over. Monetary policy has the advantage that “it gets in all of the cracks” of the financial system (Stein 2013), but it might also be a blunt instrument, as the benefits of fixing sectorial imbalances through it may be offset by large macroeconomic costs (Svensson, 2015). Macroprudential policies instead can rely on a broad set of instruments (such as timevarying capital requirements, caps on LTVs, DTIs, risk weights, etc.) targeted at specific financial imbalances. National macroprudential authorities can address local risks, as has recently been done in a number of countries, without altering the monetary stance. Against this background, let me emphasize that the key question is not whether monetary authorities should take financial stability issues into consideration – the answer is “yes” and they already do. The issue is rather whether the micro- as well as the macroprudential authorities take the macroeconomic implications of their policies fully into account. I recently argued that the interaction between monetary policy and micro- and macroprudential supervision is indeed an issue, and one that matters for two reasons.7 First, even from the microprudential perspective (and a fortiori from the macroprudential one) there is a clear link between capital requirements, credit, and economic activity. This link is likely to be particularly important in bank-based financial systems such as the euro area. Second, in and of itself slow growth poses a major medium-term risk for financial intermediaries. This implies that as long as there are no signs of generalized excessive risk-taking, it would be wise not to tighten the supervisory stance too much: this would guarantee that other stability-oriented policies do not undermine the efforts of monetary policy, delaying a recovery that banks need as much as firms and households. Furthermore, when calibrating their interventions, supervisors should take into account the complementarity of micro- and macrosupervision, which rely on the same set of tools and similar transmission mechanisms. The overlap between micro- and macroprudential policies is particularly strong in economies with concentrated banking sectors, where the separation between “micro” and “macro” is tenuous. At a minimum, this complementarity gives macroprudential authorities in the euro area another reason not to be too restrictive (micro requirements are already high). Beyond that, it suggests that microprudential authorities may Borio and Zhu (2012); Jimenez et al. (2014), for bank lending. Bekaert et al. (2013), for market finance. Alessandri et al. (2015). See Alessandri and Panetta (2015). BIS central bankers’ speeches also want to reconsider their choices and ask themselves whether micro requirements are being tightened too much, or too abruptly, given the state of the economy. 6. The distributional effects of monetary policy Another important concern is that the current monetary policy stance may disproportionately favour the rich (those who own more financial assets and benefit from large capital gains) while “expropriating” pensioners’ savings via very low interest rates. Moreover, refinancing and open market operations are directed at favouring banks, rather than the average person. This issue clearly deserves our attention.8 Rising inequality poses delicate ethical issues. History suggests that it might also hinder growth and make our economies less stable. Furthermore, although inequality lies squarely outside the mandate of central banks, if their decisions were to affect income distribution systematically, some might think that they should be overseen more closely by the government. Hence, the very independence of central banks might be at stake. As a general point, let me stress that it would be a mistake to deviate from a policy that is welfare-improving for the economy as a whole purely on the basis of distributional concerns. If we agree that monetary stimulus is necessary to improve the conditions of the Eurozone, we should pursue it without hesitation. The distributional spillovers of a socially optimal policy (if any) should be kept in check by other means, and not by giving up on the policy altogether. In other words, monetary policy should increase the size of the cake and leave the distributional choices to other policies. Second, it is crucial to think about this problem from a general equilibrium perspective. A monetary expansion can affect income and wealth through a number of channels. It boosts financial assets that are held by the rich, but it also makes debt less onerous, thus helping the poor. It stimulates profits and capital markets, but it also raises employment, which is the main source of income for the poorest. We do not yet have a full formal model of these mechanisms, but this is no justification for not giving them serious consideration, or for focusing on one of them in isolation while ignoring the rest. Ongoing research at the Bank of Italy tries to build up this “general equilibrium” view from micro data. The project examines the impact of unconventional monetary measures on a large number of variables in individual Italian households’ balance sheets.9 The main finding is that the traditional effects of monetary policy via activity and employment have prevailed even during the global crisis. By far the most relevant short-term distributional implication of expansionary monetary policy remains that, by stimulating the economy, it positively affects the incomes of the less well-off, whose jobs and wages are more sensitive to cyclical fluctuations. Financial benefits for wealthy households due to capital gains do emerge, but they are smaller than the advantages for the low-income population stemming from the improvement of labour market conditions and from the lower cost of debt. Overall, inequality decreases. (Figure 9). To those who are sceptical of this particular result, or of model-based estimates in general, I would ask Bernanke’s simple question: “If the average working person were given the choice of the status quo (current Fed policies) and a situation with both a weaker labor market and lower stock prices (tighter Fed policies), which would he or she choose?”.10 I believe the average person, or median voter, would be in favour of the current stance, both in the US and in Europe. These themes are developed further in Panetta (2015). Casiraghi et al. (2016b). “Monetary policy and inequality”, Ben S. Bernanke’s blog, June 2015. BIS central bankers’ speeches 7. Conclusions The crisis has taught us many lessons about central banking. The most important is that monetary policy is not a mechanical exercise carried out by wooden technocrats: central banking remains as much of an art today as it was in the 1930s. It is thanks to their creativity, coupled with their determination to do “whatever it takes”, that central banks have avoided a meltdown of the financial system and another Great Depression. But the mission has not yet been accomplished. Although the euro area is giving encouraging signs, its recovery from the worst crisis in its history cannot be taken for granted and, as of today, remains subject to significant risks. In such an uncertain and fast-changing environment, central bankers’ proven willingness to be bold, decisive and innovative gives much ground for optimism. References Alessandri Piergiorgio, Pierluigi Bologna, Roberta Fiori and Enrico Sette, 2015, “A note on the implementation of the countercyclical capital buffer in Italy”, Bank of Italy Occasional Paper, No. 278. Alessandri Piergiorgio and Fabio Panetta, 2015, “Prudential policy at times of stagnation: a view from the trenches”, Bank of Italy Occasional Paper, No. 300. Bayoumi, T., G. Dell’Ariccia, K.Habermeier, T. Mancini-Griffoli, F. Valencia (2014), “Monetary policy in the new normal”, IMF staff discussion note, April. Bekaert Geert, Marie Hoerova, and Marco Lo Duca, 2013, “Risk, uncertainty and monetary policy”, Journal of Monetary Economics, 60(7): 771–788. Bernanke, Ben S., 2015, The Courage to Act: A Memoir of a Crisis and its Aftermath, WW Norton & Company, New York. Borio Claudio and Haibin Zhu, 2012, “Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?”, Journal of Financial Stability, 8(4): 236–251. Borio Claudio, 2015, “Revisiting three intellectual pillars of monetary policy received wisdom”, Speech at Cato Institute, November 12. Busetti Fabio, Giuseppe Ferrero, Andrea Gerali, and Alberto Locarno, 2014, “Deflationary shocks and de-anchoring of inflation expectations”, Bank of Italy Occasional Paper, No. 252. Casiraghi Marco, Eugenio Gaiotti, Lisa Rodano, and Alessandro Secchi, 2016a, “The impact of unconventional monetary policy on the Italian economy during the sovereign debt crisis”, International Journal of Central Banking, forthcoming. Casiraghi Marco, Eugenio Gaiotti, Lisa Rodano, and Alessandro Secchi, 2016b, “A ‘reverse Robin Hood’? The distributional implications of non-standard monetary policy for Italian households”, mimeo. Cecchetti Sara, Filippo Natoli, and Laura Sigalotti, 2015, “Tail comovement in option-implied inflation expectations as an indicator of anchoring”, Bank of Italy Working Paper, No. 1025. Correia, Isabel, Emmanuel Farhi, Juan Pablo Nicolini, and Pedro Teles, 2013, “Unconventional Fiscal Policy at the Zero Bound”, American Economic Review, 103(4): 1172–1211. Cova Pietro and Giuseppe Ferrero, 2015, “The Eurosystem’s asset purchase programmes for monetary policy purposes”, Bank of Italy Occasional Paper, No. 270. Draghi Mario, 2014, “Unemployment in the euro area”, Speech at the annual central bank symposium in Jackson Hole, August 22. Gabriel Jiménez, Steven Ongena, José-Luis Peydró, and Jesús Saurina, 2014, “Hazardous Times for Monetary Policy: What Do Twenty-Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk-Taking?”, Econometrica 82(2), 464–505 BIS central bankers’ speeches Gomes Pedro and Hernán Seoane, 2015, “Made in Europe: monetary-fiscal policy mix with financial frictions”, mimeo. Friedman, Milton, 1972. “Have Monetary Policies Failed?”, American Economic Review 62(2), 11–18. Issing Otmar, 2016, “Nothing is written in stone”, interview with the financial daily BoersenZeitung, January 21. Krugman Paul, 2008, “Optimal fiscal policy in a liquidity trap”, mimeo. Mankiw Gregory and Matthew Weinzierl, 2011, “An Exploration of Optimal Stabilization Policy”, NBER Working Paper No. 17029. Masciandaro Donato, 2016, “Le banche centrali e la maledizione dei vincitori”, article in Il Sole 24 ore, January 10. Modigliani Franco, 1977, “The monetarist controversy, or, should we forsake stabilisation policies?”, American Economic Review, No. 2, pp.1–17. Neri Stefano and Alessandro Notarpietro, 2015, “The macroeconomic effects of low and falling inflation at the zero lower bound”, Bank of Italy Working Paper, No. 1040. Panetta Fabio, 2014, “The Distributional Consequences of Monetary Policy”, Speech at De Nederlandsche Bank, November 20. Stein Jeremy C., 2013, “Overheating in Credit Markets: Origins, Measurement, and Policy Responses”, Speech at Federal Reserve Bank of St. Louis, February 7. Svensson Lars E.O., 2015, “Monetary Policy and Macroprudential Policy: Different and Separate”, FRB of Boston’s 59th Econonomic Conference, October 2–3. Williams John C. (2014), “Monetary Policy and the Zero Lower Bound: Putting Theory into Practice”, Hutchins Center for Fiscal and Monetary Policy at the Brookings Institution, Washington, D.C. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Testimony by Mr Ignazio Visco, Governor of the Bank of Italy, before the Sixth Standing Committee (Finance and Treasury) of the Italian Senate, Rome, 19 April 2016.
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Ignazio Visco: Fact-finding inquiry on the Italian banking and financial system and the protection of savings, also regarding supervision, crisis resolution and European deposit insurance Testimony by Mr Ignazio Visco, Governor of the Bank of Italy, before the Sixth Standing Committee (Finance and Treasury) of the Italian Senate, Rome, 19 April 2016. * * * The macroeconomic context and its impact on banks From 2008 to the present day Italy has been buffeted by the worst economic crisis of the post-war period. The trouble started with the explosion of defaults in the US subprime mortgage sector and soon spread to the markets for several complex and difficult-to-value assets, dubbed “toxic” When it became apparent that several European banks – but not Italian ones – also had considerable exposure to these instruments, the euro-area interbank market all but collapsed. Then came Europe’s sovereign debt crisis, which originated in Greece and rekindled the financial crisis. Beginning in the summer of 2011 the tensions spread to Italy; the further contraction in international interbank lending was countered by the ECB’s extraordinary refinancing operations. Interest rates on Italian government bonds soared far above those of the corresponding securities in other euro-area countries, especially Germany. Only with the announcement, in the summer of 2012, of exceptional monetary policy measures designed to combat unjustified and excessive market rate rises in the euro area did the tensions begin to subside. Inevitably, however, they had already been transmitted to the banking market and, coupled with the drying up of the wholesale funding market, led to a sharp increase in the cost of credit and a consequent thinning of supply. This, in turn, exerted a brake on manufacturing activity which lasted over three years and was compounded by unresolved structural problems in Italy’s economy. Europe is now slowly exiting the crisis. The recession’s legacy is especially heavy in Italy: the loss in real GDP compared with the pre-crisis peak amounts to around 9 percentage points, while industrial production has shrunk by about a quarter; in the euro area as a whole, output has generally held steady and industrial production has contracted by around 10 per cent, much less than in Italy. Developments in national banking systems have closely mirrored those in the respective economies. In the first phase the crisis hit the systems that were exposed to toxic assets: the United States, the United Kingdom, and a number of euro-area countries. The result was widespread bank failures, countered by large-scale state support. Italy’s banking system, which was not exposed to toxic assets, emerged almost unscathed from the early stages of the crisis. It was, however, profoundly shaken by the deep and prolonged recession. In those years Italian banks, whose main business consists in lending to firms, recorded heavy loan losses: in the period from 2008 to 2015 these totalled about €200 billion, eroding 73 per cent on average of operating income. The banks responded with large capital increases. At the end of last year, the ratio of their core equity capital to risk-weighted assets reached 12.3 per cent, compared with 7.1 per cent in 2007. The average capitalization gap with respect to European banks as a whole, whose core equity ratio was 13.6 per cent at the end of last year, also reflects the massive recapitalizations with public money that occurred in several other euro-area countries. BIS central bankers’ speeches All in all, Italy’s banking system proved resilient. This was confirmed by the IMF in September 2013, in the foreword to its Financial Sector Assessment Program (FSAP), in which it gave a favourable judgment on Italy’s supervisory system. 1 The Bank of Italy’s supervisory action Banks specializing in traditional retail services – as is the case in Italy – are more vulnerable than others to periods of recession, especially if deep and prolonged. The exceptional contraction of the Italian economy has dented banks’ earnings capacity and saddled them with a large volume of non-performing loans, reflecting widespread business failures and the decline in employment. When, as occurred on a number of occasions, the repercussions of the crisis were aggravated by imprudent policies or episodes of mismanagement, the deterioration of banks’ assets became critical. In this difficult context, the Bank of Italy’s supervisory action prevented the onset of a profound and system-wide banking crisis. Where necessary, it adopted corrective measures within the scope of the powers conferred on it by law. Only with the transposition of CRD IV in 2015 did these powers become more incisive, making it possible to remove individual bank executives or to impose changes in management and control bodies, powers which the Bank of Italy had long advocated and whose absence had been heavily criticized by the IMF. For the long period in which these powers were lacking, moral suasion took their place, albeit with the objective limits this entailed. Well before the launch of the single supervisory mechanism in November 2014, the Bank of Italy called on credit institutions to strengthen their capital bases and make their balance sheets more transparent. Inspections of write-downs of non-performing loans at the main banks in 2012–13 partly determined the adoption of stricter provisioning policies and the consequent raising of these loans’ coverage ratios. This restored the credibility of the largest intermediaries when they turned to the market to raise capital. The capital resources raised, in excess of €40 billion from 2008 onwards, allowed banks to comply with increasingly strict rules even in adverse economic conditions. Calls for capital strengthening were flanked by robust corrective action on corporate governance, risk measurement and control methodologies, and internal controls. Taken together, these measures enabled Italy’s banking system – with just a few exceptions – to pass the European-wide comprehensive assessment. But even constant, incisive supervision cannot prevent the outbreak of financial ills, especially in a fragile economic environment. Italian and European law and the prudential supervisory model successfully ushered in by the Basel Committee promote the business independence of banks. Bank executives take most of their decisions without prior supervisory control; they are responsible for their actions first and foremost to the shareholders. The supervisory authority cannot systematically encroach on their decisions, even when they adopt imprudent or short-sighted policies. Banks are businesses, after all. They are subject to market forces; their directors must be in a position to take fully independent decisions. The success of supervision in preserving sound and prudent management depends on many factors, not least the full transparency of directors, management and shareholders in their dealings with supervisors. However widely it has exercised its powers of sanction and notwithstanding numerous reports to the judiciary, banks have not always reacted promptly, “The Italian financial system is coping with a severe and prolonged recession at home and the crisis in Europe. The system has so far managed to overcome these shocks and indeed expand domestic deposits and build additional capital buffers. In contrast to other countries, the latter was accomplished without significant state support”. BIS central bankers’ speeches nor have the corrective measures adopted always been sufficient. Rash and occasionally fraudulent behaviour by top management are also partly to blame for the deterioration in banks’ situation. Supervision aims to reduce the likelihood of a crisis occurring and to mitigate its consequences. As a rule anomalies and irregularities emerge or are confirmed following indepth inspections. Whenever they have been identified, the Bank of Italy has acted with the maximum determination. Any suspected criminal acts have been reported immediately to the public prosecutor’s office. The situation has not changed with the entry into effect of the single supervisory mechanism; the inspections of the banks classified as significant, including those that brought to light the irregularities at the two former popolari banks, Banca Popolare di Vicenza and Veneto Banca, were conducted by the Bank of Italy’s inspectors, and the schedules for the investigations and any subsequent interventions were drawn up in full agreement with the Bank of Italy. Identifying irregularities or illegal acts is neither easy nor automatic. There is a widely held belief among the public that the Bank of Italy’s supervisory and investigative powers are limitless. On the contrary, pinpointing anomalies that are sometimes carefully concealed requires painstaking in-depth analysis and finely-tuned investigative techniques, such as confiscations and searches, which are exclusively judicial powers. Despite this, the Bank of Italy’s supervision has dealt decisively with problem banks, enabling them to repair imbalances in their economic and financial situation. Most of these cases are not known to the public at large: with few exceptions, the Banking Law stipulates that any news, information or data that is acquired by the Bank of Italy in the course of its supervisory activities is covered by professional secrecy. In some instances (Banca Monte dei Paschi di Siena, Banca Carige and, more recently, Banca Popolare di Vicenza and Veneto Banca), given the banks’ poor economic and financial conditions, weak liquidity positions, and grave irregularities, restoring the necessary conditions for staying in business required a radical shake-up of directors and management and substantial capital increases, some of which are now being finalized. For an analysis of specific aspects relating to these banks’ conditions and a detailed description of the supervisory action undertaken by the Bank of Italy, please consult our website. 2 For now, I will limit my observations to the following main points. Over the years the Bank of Italy’s inspections of Monte dei Paschi di Siena examined all the main areas of operation: capital adequacy, liquidity position, financial risks, performance of the Italian government bond portfolio, credit quality, and the adequacy of management and internal control bodies. Little by little, as the off- and on-site inspections began to pinpoint problems and shortfalls, the Bank of Italy intervened with increasing forcefulness. In November 2011 this culminated in the summoning of the top executives of Monte dei Paschi and its Foundation (the principal shareholder at the time), who were asked to implement rapid and sweeping change, something that came about in the months that followed with the appointment of a new Managing Director and the replacement of the majority of the members of the Board of Directors and Board of Auditors, as well as a major management shake-up. As is well known, the bank’s previous management had failed to transmit to supervisors the information that was vital for a full recognition of the scale and nature of several operations that had been carried out in violation of the law. The Bank of Italy imposed heavy sanctions on those responsible and brought the case to the attention of the judiciary, to which it offered its full cooperation. https://www.bancaditalia.it/media/approfondimenti/index.html. BIS central bankers’ speeches All in all, the actions taken enabled anomalous high-risk practices to be identified and brought to an end, impelling Monte dei Paschi di Siena to reinforce its organizational safeguards and controls. The bank continues to be closely monitored nonetheless. The supervisory review and evaluation process (SREP) for 2015 highlighted the persistence of several weaknesses, most importantly the share of non-performing loans. This was partly due to the highly expansionary lending strategy pursued before the crisis, which the bank is now actively addressing. Structural solutions have also been called for, such as mergers with other credit institutions. In the case of Carige, in recent years the Bank of Italy’s supervisory activity focused on the group’s weak capital position, which failed to meet the highest standards of Basel III that were about to be introduced, the progressive deterioration in the quality of its loan portfolio, and malfunctions in corporate governance arrangements and controls. The inspections conducted in 2013 confirmed these weaknesses and brought to light further, more clearly detailed issues, such as the existence of conflicts of interest on the part of the group’s top management. They also stressed the need for decisive and timely intervention to make a clean break with the past, enabling a proper rebalancing of corporate governance powers and the adoption of strategic repositioning and capital strengthening plans. Following the inspections, sanctions were applied and the public prosecutor’s office informed. The new top executives appointed at the end of 2013 launched a restructuring plan in line with the requests advanced by the supervisory authorities. Despite the results obtained, the volume of non-performing loans remains substantial and, as for other banks, the unfavourable macroeconomic context continues to pose major challenges to earnings. Events at the two former popolari banks came to the public’s attention when there were new reports of inquiries launched by the judiciary, with which the Bank of Italy had been cooperating for some time. In the debate that ensued the Bank of Italy’s actions were repeatedly called into question, often based on mistaken premises or fundamental misunderstandings. In the case of Banca Popolare di Vicenza, most of the criticism was directed at the price of the shares and their funding by the bank. On the first aspect, it is important to specify that Italy’s Civil Code assigns responsibility for setting the price of shares to the general shareholders’ meeting, which votes on a proposal by the Board of Directors. The Bank of Italy has no direct power in the determination of share prices, although it is entitled to question the reasonableness of the procedures followed and the objectivity of the criteria adopted to set the price, which it did. Given the exclusive power of the management bodies in this instance, the Bank of Italy could only advance methodological criticisms but not value judgments. The Banca Popolare di Vicenza did too little for too long and its underlying inertia over the corrective action was therefore sanctioned. Only in 2011 did it issue guidelines for fixing the share price, using an external consultancy service to do so. As a result, the price stayed unchanged for several years before being drastically reduced (as had already occurred for the shares of other listed banks) following findings originating from the anomalies that had emerged in trading in own shares. Regarding this second aspect, in 2013 supervisors intervened on several occasions to remind Banca Popolare di Vicenza of its duty to comply in full with the prudential limits envisaged by law before 2014 and to call to its attention the need to not generate among shareholders expectations of certain and immediate liquidity of their holdings and guaranteed minimum returns. In the course of 2014 it emerged that the bank was buying its own shares without having first sought the necessary authorization. In accordance with the new European supervisory setup, the Bank of Italy planned a targeted inspection for early 2015 to verify these operations. The inspection was again conducted, within the single supervisory framework, by Bank of BIS central bankers’ speeches Italy staff. In addition to revealing unauthorized share buy-backs by Popolare di Vicenza, it highlighted a further problem with the funding of the shares issued in recapitalizations: the bank had not deducted from the supervisory capital the funds raised against the substantial loans it had disbursed to subscribers of its shares, as instead required by prudential regulations. Already after the initial findings of the inspection the bank had been called on to take corrective measures, including a virtually complete change of management. Once the inspection had been completed the bank was ordered to restore capital adequacy buffers to regulatory levels, draw up a new business plan, and strengthen its organization and internal control functions. In accordance with the new business plan, the bank then passed a resolution approving a comprehensive plan to strengthen its capital and radically overhaul its governance, including its transformation into a joint stock company, now completed, a €1.5 billion capital increase, and stock market listing. In the case of Veneto Banca, an inspection carried out in 2013 found major anomalies of a technical and administrative nature, highlighting the practice of disbursing loans to customers against purchases of the bank’s own shares, which were then not deducted from supervisory capital. We did everything in our power: prohibited the bank from disbursing new loans to corporate executives; called a meeting of the Board of Directors to examine the bank’s overall situation and pass the appropriate resolutions; read out to the meeting of shareholders the official request for action to ensure that it was aware of the bank’s situation and of the measures taken by the Bank of Italy; and imposed fines on the persons responsible. At the same time, where it was not in our power to intervene directly, we used strong moral suasion, calling on the bank to replace all of its management boards and to plan a merger at the earliest opportunity. The bank’s response at the time was unsatisfactory. It did not make all the required changes to its governance and continued to engage in conduct contrary to the principles of sound and prudent management, such as granting loans to subscribers of the capital increase made in 2014, which emerged in the course of the follow-up inspection in 2015. Because of the consequent reduction of supervisory capital and further rapid deterioration in the quality of assets, the situation could only be remedied through a €1 billion capital increase, now under way. The Bank of Italy’s supervisory action, ensuring continuity with the past but now endowed with more incisive powers under CRD IV, brought about the replacement of the bank’s president and most of its senior executives and is currently monitoring the implementation of a more radical reform of corporate governance that began with the bank’s transformation into a joint stock company and will be completed with its stock market listing. As regards other banks, delays and resistance on the part of the governing boards have gone hand in hand with a marked worsening of their corporate profiles, particularly their credit risk, and an unwillingness on the part of the market to provide capital support, inevitably resulting in the appointment of a special administrator. This is the case of the four banks placed under resolution in the month of November. Before discussing these banks in greater detail I would like describe briefly the changes that have affected the management of banking crises and determined how these situations are handled. Changes to the framework for banking crisis management Before 2015 the Bank of Italy’s objectives in handling banking crises were to minimize the impact on customers, the payment system, and the banking system as a whole. In many instances, extremely fragile banks were taken over by healthier ones. When a bank was likely to fail, special administration was set in motion and in the worst cases the bank was wound up. BIS central bankers’ speeches Special administration can only take place if the legal conditions for it are met; these include serious violations of regulations, serious irregularities of management, and serious capital losses. The definition of serious applies to irregularities and violations of the law which have a wide-ranging impact on the bank’s situation (for example, repeated violations of antimoney-laundering legislation, serious and frequent conflicts of interest, and opaque ownership structures), which must cease as soon as possible, and which the bank is unlikely to be able to rectify on its own. Capital losses are considered serious when the regulatory minimum capital adequacy ratios are not observed. Special administration does not come out of the blue. As a rule, it is preceded by intensive discussions with the Bank of Italy’s supervisors, repeated attempts to remedy the situation, and a number of inspections, the last of which usually ascertains that it is no longer possible to restore normal business conditions or comply with capital adequacy ratios. This is what happened in the case of the four banks for which a resolution procedure was activated and for the others that were placed in special administration. The latter entails the dissolution of the bank’s administrative and control bodies and their replacement by one or more administrators and a supervisory board. The administrators act independently of the Bank of Italy, which only authorizes certain decisions of particular importance. The functions of the shareholders’ meeting are suspended until the procedure comes to a close. The administrators are charged with ascertaining the true situation of the bank, eliminating irregularities and establishing the conditions to prevent their recurrence, as well as favouring a solution to the crisis that is in the interest of depositors. The task of ascertaining and eliminating the irregularities may take several months. The longest and most complex phase is generally the search for solutions. Since 2008 there have been 65 cases of special administration, most of them ending with the bank’s return to ordinary operation. In about 20 cases, the outcome was the compulsory administrative liquidation of the bank, which occurred more frequently during the crisis. There were no major implications for customers, however, as the failing banks’ exit from the market was managed either by finding other credit institutions interested in an acquisition or by covering the losses with interventions by the Interbank Deposit Protection Fund or the Mutual Bank Deposit Guarantee Fund. This last solution stemmed from the participating banks’ desire to avoid further outlays in the event of liquidation (the principle of least cost). More recently, the economic crisis and the raising of prudential requirements have made it rather impracticable to resort to mergers such as those that had helped in the past to overcome bank difficulties without causing disruption. Moreover, the new European regulatory framework has brought about some radical changes. In particular, the Interbank Deposit Protection Fund’s scope for action has been restricted by the European Commission’s Directorate-General for Competition, which now considers any intervention by deposit guarantee schemes other than the reimbursement of deposits to be tantamount to state aid, even though it is privately financed and decided independently by the fund’s management bodies. 3 Following a Communication issued in August 2013, the D-G for Competition has made intervention of this type conditional on burden sharing, whereby in the event of a bank’s In March 2015 the D-G for Competition initiated a procedure against Italy under Article 108(2) of the Treaty on the Functioning of the European Union for presumed violation of the regulation on state aid in connection with support measures taken by the Interbank Deposit Protection Fund in favour of Banca Tercas, which allowed the crisis to be overcome without involving savers. After lengthy discussions between the Ministry of Economy and the Commission, during which the Bank of Italy submitted several memos, in December 2015 the Commission decided to bring the procedure to a close with a negative decision, which has been appealed before the European Court of Justice. BIS central bankers’ speeches failure the face value of its shares and subordinated bonds must be reduced or the latter converted into equity before any recourse is made to public funds. Burden sharing is not the same as the ‘bail-in’ principle, which was introduced on 1 January this year with the adoption, in November 2015, of the Bank Recovery and Resolution Directive (BRRD). The bail-in rules provide that, before the National Resolution Fund (or, more generally, public funds) can be utilized, the face value not only of shares and subordinated bonds but also of senior claims such as ordinary bonds and deposits of over €100,000 must be reduced. A bail-in respects insolvency rankings: therefore, it is applied first to shares, then to other equity and subordinated instruments, and then to unsecured debts, including ordinary bonds issued by the bank in difficulty. Until the end of 2018, corporate unsecured deposits contribute to the same extent. The crises at the four banks subject to the resolution procedure It is in this new context that the crisis of the four banks resolved in November last year was managed. Details of how the four situations unfolded can be found on the Bank of Italy’s website, to which I refer you. 4 On this occasion, I will confine my remarks to some of the most widely debated aspects that require clarification. The Banca delle Marche group had a number of weaknesses, mainly stemming from its governance and control structures and poor credit quality. These problems emerged more clearly from the three inspections conducted in rapid succession in 2010 and 2011. Based on the findings of the inspection at the bank, major corrective measures were called for. When an inspection at another bank brought to light anomalous transactions involving the Managing Director, Banca delle Marche was asked in June 2012 to find a replacement as soon as possible. At that time it was not in the Bank of Italy’s power to remove bank executives. A new Managing Director was appointed in September of the same year. Also in view of Banca delle Marche’s delay in implementing the corrective measures requested, at the end of 2012 a new inspection was ordered to assess whether Banca delle Marche had allocated sufficient provisions for credit risk. The bank’s efforts to remedy the shortfall were found to be highly unsatisfactory and in March 2013 the inspection was extended to other risk profiles; it was brought to a close in September 2013. The findings were of such gravity that the bank was placed first under provisional management and then on 15 October 2013 into special administration. Inspections at the Carife group focused primarily on the level of risk of its credit portfolio and on its capital adequacy. On more than one occasion the Bank of Italy’s supervisory arm reiterated the need for a reorganization of the group and a strengthening of its control functions. Carife’s liquidity profile was also closely monitored and the strains were only overcome through the issue of government-guaranteed bonds. Owing to the delays in making the corrections requested, at the end of 2012 a full-scope inspection of the group was set in motion. Owing to the extremely serious nature of the situation that emerged – there was no possibility of the group restoring the necessary economic and financial equilibrium on its own in the short run – a special administrator was appointed in May 2013. In 2010 and 2012 two inspections of the Cassa di Rispamio di Chieti group found problems of disorderly growth, irregularities, and poor management. The Bank of Italy ordered the subsidiary’s merger into the parent group and the removal of the Chief Executive Office, who also held the position of Managing Director of the Cassa di Risparmio di Chieti. The supervisory action was then stepped up and the bank was invited on several occasions to take strong measures to put the problems to rights. The feedback from the executives of Carichieti indicated that they were largely unaware of the problems. It was therefore decided in 2014 to conduct another inspection. This not only found a significant deterioration in the http://www.bancaditalia.it/media/approfondimenti/2015/info-soluzione-crisi/index.html. BIS central bankers’ speeches bank’s profitability and capital base but also revealed extremely serious irregularities and regulatory violations, such as the persistent obscuring of information from supervisors, serious administrative anomalies, lack of independence from the controlling bank Foundation as regards decision-making processes, and negligent management of relations with associated parties. Accordingly, on 5 September 2014 Carichieti was put into special administration. Following a series of delays in responding to the Bank of Italy’s requests, an inspection of Banca Etruria was launched towards the end of 2012. Initially, its purpose was to verify the adequacy of the bank’s credit risk provisions but in March 2013 it was extended into a fullscope inspection. It ended in September 2013 having ascertained that the management boards were unable to restore the bank to health and that there had been a considerable deterioration in claims. The capital adequacy ratio was above the regulatory minimum thanks to the €100 million increase made in August 2013. Hence, Banca Etruria was asked to take resolute steps to remedy the problems, including the appointment of temporary management and above all a merger with another bank of suitable standing. The Board of Directors, of which half of the members, the Chairman and Deputy Chairman had been replaced, failed to appoint temporary management and, citing the need to safeguard its local roots and ensure the bank’s independence, refused to entertain the only official offer of a merger made of its own volition by Banca Popolare di Vicenza. The Bank of Italy increased meetings with senior management, calling attention to the fact that the group would have difficulty in the future ensuring compliance with capital adequacy requirements. As no solution was found, a new inspection was conducted in November 2014, which identified serious capital losses and serious irregularities. On 10 February 2015 the bank was put into special administration. As a result of the various inspections carried out at the four banks, fines were levied on the executives totalling more than €11 million. All the inspection reports were forwarded without delay to the judicial authorities. The administrators appointed for the four banks spent considerable time seeking market solutions, contacting a number of banking groups and other intermediaries. However, owing to the lack of interest in banks burdened with a large volume of non-performing loans and a very low capital base, it proved impossible to find a solution involving mergers or acquisitions. At this point the Interbank Deposit Protection Fund signalled its willingness to take part in recapitalizations conducted by other banks. However, the European Commission’s position – which, as I mentioned earlier, likens the intervention of the Fund to state aid – made it impossible to take up the offer. In fact, because of the Commission’s own rules, this interpretation would require burden sharing to be activated first, that is the conversion of subordinated bonds or annulment of their value, something not envisaged in Italian legislation until the implementation of the BRRD in midNovember 2015. It should be noted that had this step been taken without the approval of the European Commission, trusting in a favourable decision by the Court of Justice, under accounting rules it would have entailed allocations to provisions for the same amount as the intervention in order to cover the consequent risk of legal action, completely cancelling its effect. The banks willing to underwrite capital increases would never have participated owing to the uncertainty and legal risks involved. Nor would the ECB, as competent authority, have authorized the operations without the agreement of the European Commission. The Commission, which has direct contact with the Italian Government and not with the supervisory authority, set out its position on several occasions in the course of the technical discussions but only formally notified the Italian Government on 19 November 2015. According to this position, intervention by the Interbank Deposit Protection Fund to prevent a “resolution” procedure under the BRRD was effectively limited to voluntary intervention by the banks belonging to the Fund using resources other than the mandatory funds deposited with it. However, the banking system was unable to organize such intervention in the short BIS central bankers’ speeches time available, owing to the precarious liquidity situation of the failing banks. Moreover, the imminent entry into force, in January 2016, of the bail-in scheme would have extended the annulment of the value of customers’ holdings to ordinary bonds and unprotected deposits before the National Resolution Fund could intervene. The deterioration in the technical situation of the four banks had reached the point of no return. It was no longer possible to delay taking measures to overcome the crisis. Accordingly, the resolution programme had to begin immediately once the new rules introduced by national legislation transposing the BRRD had been put in place. Under this programme, four new entities were created and the business activities were transferred to them to ensure the continuity of essential services, thus allowing them to continue banking activities in their geographical areas and to preserve the goodwill value of the old banks. A vehicle company was then created and the bad debts were transferred to it with the aim of maximizing their recovery value in the medium term. The resolution costs were mostly borne by the Italian banking system through the Resolution Fund and by shareholders and subordinated bond holders. Their sacrifice was proportionate to the valuation of their assets. The start of the resolution procedure requires, in fact, an independent assessor to furnish the Resolution Authority with the elements to ascertain if action is necessary and decide on the most appropriate measures to adopt. For reasons of urgency, a provisional evaluation can be made, which must be followed as soon as possible by an independent final evaluation. With reference to the four banks under resolution, once the reasons of urgency had been confirmed, in its provisional assessment the Bank of Italy had to take into account the communications to Government offices from the European Commission which, interpreting EU law on state aid, indicated that the “real economic value” of the divestment of the bad debts was 25 per cent of the nominal value for the portion backed by mortgages and 8.4 per cent for the unsecured part (with a weighted average of 17.6 per cent). These divestment values were checked in the final valuations made by the independent experts last Friday. The value of the transfer of the four banks’ bad debt was determined to be 31 per cent on average for the portion backed by mortgages and 7.3 per cent for the unsecured portion (with a weighted average of 22.3 per cent). 5 In relation to the disposal of the four bridge banks, in order to maximize the sales price, last January the Bank of Italy, in its capacity as national resolution authority, launched a transparent and competitive selection process to identify potential buyers capable of ensuring the operational and financial continuity of the four banks and the rapid conclusion of the purchase. Several expressions of interest were received from banks and investment funds, located both in Italy and abroad. The next stage of the tender will begin soon and potential buyers will be invited to present their binding offers for the purchase of one or more bridge banks or of all four banks en bloc. The operation will be evaluated by the ECB as regards the eligibility of potential buyers to acquire large shares in banks. Considerations on the BRRD I have recently emphasized the importance of reconsidering the adequacy of the new legislative framework for managing banking crises. Just as the crisis has impaired the quality Other “risky positions” were discovered in the loan portfolios requiring further asset write-downs; the resulting greater capital requirement cancelled the savings made from the lower percentages of the write-downs of the bad debts in relation to the provisional evaluation. BIS central bankers’ speeches of bank credit, the legislative response on crisis management has engendered uncertainty about investing in bank liabilities. An instrument devised to reduce the impact of a crisis must not create the premises to make one more likely: if this is the case, it must be rethought. We must strike the right balance: indeed, investors who have been hit will find no comfort in the fact that they have been protected as taxpayers. Our negotiating approach, repeatedly taken on official occasions, was different: the bail-in tool should have had a contractual nature, with no retroactive effects on previously issued debt securities, and it should have been phased in gradually. In March 2013, during the BRRD negotiations at the EU Council of Ministers, the Bank of Italy and the Ministry of Economy and Finance presented a technical “non-paper” to all the delegations in order to illustrate the reasons for our preference for contractual (or targeted) bail-ins, applied only to newly-issued securities containing a specific clause in the contract recognizing the power of the authorities to write down or convert the securities if the conditions for starting a resolution procedure were met. We were – and remain – convinced that this approach would have given the authorities a credible tool to be used to resolve a bank crisis effectively, with no undesired effects on financial stability and at no extra cost to the taxpayer. According, instead, to the approach that prevailed, a wide range of liabilities are subject to bail-ins, with very few exceptions. This approach can be a source of risk for financial stability. We should not rule out the possibility of temporary public support in the event of systemic bank crises, when the use of a bail-in is not sufficient to achieve the resolution objectives but instead risks compromising financial stability. The specific nature of the banking sector and the requirements of financial stability should also be treated in a more structured way in the European Commission’s approach to competition and state aid. Adopted in 2013 – and based on the unfortunately premature conviction that the difficulties of euro-area banks had by then been dealt with – this approach greatly limits government intervention to support banks that are fundamentally viable in order to remedy market failures that are not originated by prudential shortcomings. In fact, according to the BRRD, any public intervention that counts as state aid (and is not among the few exceptions allowed by the directive) automatically triggers the resolution procedure. This, in turn, determines an overlap and, as a result, the prevalence of competition and state aid policy objectives over the objective of safeguarding financial stability. It does not take sufficient account of the fact that financial stability, in particular that of the banking system, is of vital importance to the real economy. The need to assess the degree of flexibility of the BRRD during the review of the directive scheduled to take place by June 2018 was recalled by the IMF in its Global Financial Stability Report published a few days ago. It highlighted the necessity of applying the new rules (including those on state aid) with flexibility and caution during the changeover to the new regime, when public intervention is no longer admissible but the banks have not yet put in place sufficient buffers to absorb losses without undesired effects on systemic stability. Even in the case of public intervention in the management of bank crises, a company’s value must be preserved as far as possible, enabling the transfer of assets to other intermediaries. Destruction of value clashes with the principles of the BRRD, increases the losses for bank’s creditors, and expands recourse to public resources. To ensure clarity and legal certainty for investors and to encourage the development of the market for bank funding instruments, the order in which creditors get paid in bankruptcy proceedings should be standardized at the European level. Lastly, the third pillar of the banking union must be completed: a fully mutualized deposit insurance scheme at the European level supported by a public backstop, again Europe-wide, to prevent any negative effects on financial stability when the resources of the Single Resolution Fund and the Single Deposit Insurance Fund are not sufficient. BIS central bankers’ speeches The outlook Only a stable banking system can meet the objective, in a lasting and effective manner, of funding households and businesses at a reasonable cost. Today the rules that safeguard stability require more capital, more liquidity, and less leverage; all of this implies fewer revenue opportunities, a pressing need to keep costs down, and the necessity of adopting new technologies more widely. In the aftermath of the crisis, Italy’s banking system faces three main areas of weakness: a high share of non-performing loans, low profitability, and the need to adjust its business model to the new technological and market environment. The three areas are closely interlinked. The reform of Italy’s banking system, already approved last year, aims to raise the quality of corporate governance, strengthen banks’ capacity to raise capital on the market, and to facilitate the disposal of non-performing loans. The reforms also provide an opportunity to encourage bank mergers, allowing risks to be diversified, costs and revenues to be shared, and conflicts of interest to be addressed, including by improving governance arrangements – all in line with the recommendations of the IMF. As regards non-performing loans, we may have reached a turning point. The cyclical recovery is in fact gradually easing the pressure on banks’ balance sheets. Loan loss provisions in 2015 fell to 65 per cent of banks’ operating income, from about 100 per cent in 2014. In the fourth quarter of 2015 the loan default rate (3.3 per cent) fell to its lowest level since the end of 2008. In the same quarter the ratio of gross non-performing loans to total loans stabilized at around 18 per cent. The coverage ratio for non-performing loans (provisions to total non-performing exposures), which has steadily improved in the last three years, now stands at 45.4 per cent, in line with the average for the main European banks. It is also noteworthy that at the end of last year, against €210 billion of gross bad debts (which net of write-downs amounted to €87 billion), the banks held real estate collateral worth about €85 billion and further personal guarantees for almost €40 billion. The consolidation of the recovery is the sine qua non for the continued reduction in the stock of non-performing exposures. The reduction of non-performing loans must be managed without undermining the results achieved as regards capital adequacy. The bad bank solution adopted in numerous European countries prior to the adoption of the new framework on state aid did not prove practicable in Italy. Reducing the stock of NPLs would therefore only be possible by selling bad debts on the market. The Italian State Guarantee Scheme (GACS) defined by the Government following extensive talks with the European Commission would work in this way. The supervisory authority encourages banks to reduce their stock of non-performing loans by every means, including divestments on the market. This objective ought to be pursued gradually, as the President of the ECB and the Chair of the Supervisory Board have reiterated on more than one occasion. In the last few days the private sector has started work on an important initiative, known as the “Atlante Fund”, to provide insurance against systemic risks and facilitate the reduction of the large stock of bad debts. This would mainly be done by ensuring that unfavourable market conditions do not preclude access to the capital market on the part of banks that have already decided on such interventions. Moreover, the fund could purchase securities issued as part of bad debts securitizations, thus reducing their volume without weighing too heavily on banks’ balance sheets. It is expected that the fund will raise resources equal to at least €4 billion from banks, insurance companies, foundations and other institutional investors. It will be managed by a company that is independent from the investors in the fund itself. The operation is currently being evaluated by the ECB. Given that it is an independent initiative of a private nature, it is in line with the European rules on state aid. The Ministry of Economy and Finance has informal contacts with the European Commission to which it has described the project’s key characteristics. BIS central bankers’ speeches For these important projects to be successful additional complementary measures will be required. In the first place, banks must improve their internal procedures for managing non-performing loans. In many cases, the resources allocated to this have remained virtually unchanged since before the crisis, despite the fact that the share of non-performing loans has tripled. Banks must therefore devote new human and financial resources to optimizing the management of these assets. In the context of European financial supervision, the Bank of Italy has been working for some time to persuade banks to make significant progress on this front. We have recently started a statistical survey on bad debts, designed to encourage banks to digitalize their records so as to optimize the management of non-performing loans, whether they intend to sell or recover them. In the second place, progress is still needed to make both judicial and out-of-court recovery proceedings faster and more effective, an area in which Italy is at a particular disadvantage by international standards. I have recently emphasized that if we can cut credit recovery times by two years, we can considerably reduce, even halve, bad debts as a proportion of total loans. Last August the Government approved a reform package that is providing an important boost to the efficiency of the credit recovery mechanism. But more can be done. There is no real conflict between creditors’ and debtors’ rights: recovery times in line with international best practices ultimately lead to better conditions for bank customers and an increase in the availability of credit. The Government’s announcement of further measures to make the procedure for recovering non-performing loans faster and more effective is a step in this direction. In 2015 banks’ profitability showed signs of improvement: ROE returned to positive territory (about 3 per cent for the system as a whole). Nevertheless, it is still low, including by international standards. The flow of loan losses, while smaller than in the past, continues to erode operating income. Banks’ efforts to grow and diversify their sources of revenue and to keep structural costs down must continue and intensify. An essential contribution must come from the review of banks’ traditional business model: that fundamentally based on the presence of large, nationwide branch networks no longer appears sustainable. For traditional services that can be standardized, we must move decisively towards intensive exploitation of technology (for example e-banking and digitalization) and modern-day local branches should focus instead on the provision of corporate finance services for businesses and household savings management. * * * Italy’s banking system, which is primarily oriented towards traditional intermediation activities, and within which the share of loans to total assets remains particularly high, has been dealt a severe blow by what economists call “an exogenous shock”: the long and profound recession which hit the country”s economy after the global financial crisis and, in Europe, the sovereign debt crisis. A crisis that the Italian banks in no way caused but whose impact they inevitably felt. Despite this and without weighing on the public finances, the system as a whole has withstood both the blow of the crisis and the consequent tightening of international regulation and supervision (capital, liquidity, leverage and crisis management): a tightening initially intended to be gradual and limited, which then became marked and rapid, also due to market pressures. The high level of non-performing loans continues to represent the main factor of vulnerability for Italian banks. But the many measures to address them – already taken by the Government, Parliament, other authorities, and the banks themselves – have begun to bear fruit. We need to press ahead so that the banking system can return as soon as possible to fully supporting the economic recovery that Italy needs. BIS central bankers’ speeches
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference "Euro50 Group. The Future of European Government Bonds Markets", Rome, 2 May 2016.
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Ignazio Visco: Banks’ sovereign exposures and the feedback loop between banks and their sovereigns Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference “Euro50 Group. The Future of European Government Bonds Markets”, Rome, 2 May 2016. * * * An intensely debated topic in the context of possible further financial reforms, in Europe and internationally, concerns possible actions to address the negative loop between sovereign risk and bank risk. The sovereign-bank nexus was one of the main amplifying factors of financial distress during the euro area crisis. Banks’ difficulties affected sovereigns directly, through the bailout of troubled intermediaries, and indirectly, through the impact of the disruption of lending on the economy. Sovereigns’ difficulties affected banks’ ratings, funding costs, and balance sheets, while the recession worsened their lending portfolios. Before the euro-area sovereign debt crisis, sovereign defaults were regarded as a problem of emerging economies. Indeed, no advanced (OECD) country defaulted on its domestic debt between 1950 and 2010. 1 Therefore, it is not surprising that virtually all national supervisory authorities have exercised the regulatory option to exempt banks’ exposures to their domestic sovereign, denominated and funded in domestic currency, from the standard prudential banking regulation. These exposures are de facto subject to no concentration limits and to a zero risk weight regime. Following the recent euro-area sovereign debt and banking crises, it has been argued that this preferential prudential treatment should be amended. Interestingly, this debate is not new. Initially it took place in the early eighties, when Basel I was crafted. Reaching a consensus on the framework was difficult. Two proposals were eventually tabled, recommending a 20 percent risk- weight on domestic sovereign exposures, and a zero-risk weight, respectively. Eventually the solution to apply a zero-risk weight was chosen, apparently without any empirical analysis. 2 A key role in the choice was played by the recognition of the crucial role of sovereign bonds and securities in the functioning of financial markets, with the aim of fostering the development of local bond markets, and the desire to avoid interference with fiscal policy and monetary policy. In the current debate, possible options range from the “baseline option”, i.e. keeping the current framework unchanged for exposures to the domestic sovereign, to assigning these exposures a non-zero risk weight and/or subjecting them to concentration limits. 3 Those who advocate changing the current framework argue that assigning banks’ sovereign exposures a non-zero risk weight increases capital and thus the resilience of the banking system. Similarly, introducing rules to discourage a high concentration of sovereign exposures would increase banks’ chances of surviving a sovereign default, preventing them from playing a “shock amplifier” role, as in recent cases of distress of sovereigns with weak economic fundamentals. 4 Furthermore, if risk weights accurately reflect sovereign risk, they Reinhart, C.M. and K.S. Rogoff (2011), “The Forgotten History of Domestic Debt”, Economic Journal, 121(552). Goodhart, C. (2011), The Basel Committee on Banking Supervision. A History of the Early Years 1974–1997, Cambridge University Press. J. Weidmann, “Stop Encouraging Banks to Load up on State Debt”, Financial Times, 1 October 2013; European Systemic Risk Board (2015), Report on the Regulatory Treatment of Sovereign Exposures; Dutch Presidency note on Strengthening the banking union and the regulatory treatment of banks’ sovereign exposures, prepared for the informal ECOFIN meeting of 22 April 2016. Battistini, N., M. Pagano and S. Simonelli (2014), “Systemic Risk, Sovereign Yields and Bank Exposures in the Euro Crisis”, Economic Policy, 29 (78). BIS central bankers’ speeches can incentivise banks’ risk management of sovereign exposure by recognising that the higher return from riskier counterparties comes at a cost of increased incurred risk. Also, in case a crowding out of private lending by public debt exists, a risk sensitive approach for sovereign risk could reduce this effect and promote the more efficient allocation of resources, leading to higher investment and higher potential GDP growth. Advocates of the “baseline option” also advance several arguments. First, this option does not really mean “no change”, as recent amendments of the regulatory and legal framework have already made substantial progress towards breaking the banksovereign loop. In Europe, the banks-to-sovereign causal link has been addressed by bankrelated reforms, beginning with the BRRD. On the prudential front, banks’ sovereign exposures are taken into consideration in the capital exercise and stress test frameworks applied since the end of 2011 5 – the results of which are nowadays taken into account in the Pillar 2 capital buffers required within the SREP – and through the forthcoming introduction of the leverage ratio. Furthermore, the European fiscal framework has been enhanced across several dimensions, thus addressing the sovereign-to-bank nexus: the Stability and Growth Pact has been amended, reinforcing both its preventive and its corrective arm; member countries have strengthened their national budgetary processes and institutions; and a surveillance mechanism has been set up for early detection and correction of macroeconomic imbalances. Finally, the European Stability Mechanism was established. Second, tightening regulatory standards on sovereign exposures can hardly be sufficient to safeguard banks against their domestic sovereign default. Direct exposures are just one of the channels that transmit sovereign risk to the domestic banking system. Sovereign defaults are associated with severe economic crises, which have a widespread negative impact on domestic banks quite independently from the degree of their direct exposure. 6 Third, preventing an excessive concentration of risks may be desirable in principle. However, the historical experience shows that in a “normal” economic environment EU banks autonomously reduced their sovereign portfolios (as well as the concentration) without any need for regulatory nudges (Fig. 1). Indeed, the evidence suggests that most EU countries’ sovereign holdings behaved counter-cyclically: they declined during the “normal period” between the introduction of the euro and the beginning of the financial crisis; increased during the crisis period; and started once more to decline in the last two years, as the crisis began to subside (see the cases of Italy - Fig. 2 – and Spain). 7 This pattern suggests that regulation is not an important driver of banks’ exposures towards their own sovereign: throughout this entire period, the prudential treatment of sovereign exposures remained broadly unchanged. It also indicates that high sovereign exposures are a symptom and a consequence, rather than a driver, of the crisis. 8 Fourth, whereas in “normal” times banks’ sovereign exposures declined spontaneously, the imposition of risk weights or – worse – tight concentration limits could create substantive difficulties in “crisis” times. They could be particularly disruptive for banks’ ability to act as shock absorbers in the event of sovereign stress. There is evidence that sovereign debt To be precise, in the EU the capital exercise in 2011 and the subsequent stress tests have amounted to the introduction of a capital charge on sovereign exposures. In spite of this, exposures continued to increase until the sovereign crisis subsided, in 2014. Committee on the Global Financial System (2011), “The Impact of Sovereign Credit Risk on Bank Funding Conditions”, BIS, CGFS Papers, No. 43. Lanotte, M., G. Manzelli, A.M. Rinaldi, M. Taboga and P. Tommasino (2016), “Easier Said than Done? Reforming the Prudential Treatment of Banks’ Sovereign Exposures”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 326. Angelini P., G. Grande and F. Panetta (2014), “The Negative Feedback Loop Between Banks and Sovereigns”, Questioni di Economia e Finanza (Occasional Papers), 213, Banca d’Italia. BIS central bankers’ speeches markets are prone to self-fulfilling crises: if investors believe a sovereign faces fiscal problems, required yields will be higher, which can exacerbate, or even create, the fiscal problems. 9 Probably the clearest recent example of this pattern is the surge in “redenomination risk” in the euro area, connected with undue fears of a break-up of the Monetary Union. To the extent that banks act as contrarian investors (selling assets when markets overheat and buying when they are excessively bearish), purchases of sovereign debt when the sovereign experiences difficulties notwithstanding relatively solid economic fundamentals are actually beneficial to financial stability. There is clear evidence that domestic investors played such contrarian role during the EU sovereign debt crisis, buying sovereign bonds as foreign investors were fleeing (Fig. 2 again for the Italian case; similar patterns have been documented for Spain). 10 Imposing risk weights or setting large exposure limits on domestic sovereign exposures would impair this shock-absorption ability. Exposure limits, in particular, could act as a coordinating device for speculative attacks. Since a change in banking regulation would likely herald a similar change in other parts of the financial system (most notably the insurance sector), the entire domestic financial sector could be affected. Finally, a system which differentiates the risk weights according to the sovereign’s credit risk could end up relying upon ratings issued by the Credit Rating Agencies (CRA). Even advocates of a change in the prudential treatment of sovereign exposures admit that credit ratings of sovereigns have serious shortcomings. In particular, they tend to be backwardlooking and to foster herd behaviour. As such, they could exacerbate pro-cyclicality and ultimately increase financial instability risk. Overall, I believe that today, as 30 years ago, the mere recognition that there is no truly riskfree asset does not per se warrant a change in the regulatory treatment of sovereign exposures. I doubt that further changes in prudential regulation are the right instrument for addressing the sovereign- bank nexus, taking into account that sovereign risk should first and foremost be addressed by strengthening the sustainability of public finances. In this regard, while member states should attain sound fiscal positions so as to make their sovereign paper safer, enhancing economic growth represents the most important factor for putting the public finances on a sustainable path. This is clearly shown by the example of Italy, where the debt to GDP ratio has risen by 33 percentage points since 2007. Back-of-the-envelope calculations show that if Italian nominal GDP had since grown at a similar rate as in the previous ten years, the debt to GDP ratio would now be just 3 points, and not 33 points, higher than in 2007 (actually, it would be slightly below the 2007 level, once the financial support to other European countries is taken into account). 11 This suggests that efforts to rebalance the public finances must be part and parcel of an economic policy designed to create the conditions for robust and lasting growth. I also believe that any reform proposal should be based on a comprehensive approach, avoiding partial equilibrium analyses and capturing all the relevant effects; also, it should be evaluated by focusing on potential benefits and costs in a financial stability perspective, taking into account potential unintended consequences. Considering the pervasive role played by sovereign bonds in modern economies, these can arise in various sectors, well beyond banking. De Grauwe, P. and Y. Ji (2013), “Self-fulfilling Crises in the Eurozone: An Empirical Test”, Journal of International Money and Finance, 34(C). The reason why such a shock absorption role can be beneficial is not because it “enables sovereigns to expand the budgetary stance”, as stated in the Dutch Presidency note cited in footnote 3, but because markets can be subject to excessive movements. “Audizione preliminare all’esame del Documento di economia e finanza 2016”, testimony by the Deputy Governor of the Bank of Italy, L. F. Signorini, Chamber of Deputies, Rome, 18 April 2016. BIS central bankers’ speeches To this end, a deep understanding is needed of: the extension and potential effect of any reallocation of bank sovereign exposures across banks; the interactions with other rules of the Basel framework, including in particular the rules on liquidity; the impact of changes in regulation on the provision of loans to the broader economy; the consequences for monetary policy; the effects on the functioning of sovereign debt markets and on governments’ financing conditions; the impact on other financial market segments. Several of these issues are being investigated at the BIS and also at the EU level, within the European Systemic Risk Board and the Economic and Financial Committee. The impact on market liquidity has been examined in this conference. Changes in the current prudential framework leading to stricter capital requirements on sovereign bonds could incentivise banks to further reduce the two pillars of market-making: sovereign bond inventories and repo activities, which are eroding liquidity in secondary markets. The effects of a regulatory change requiring substantive bank recapitalisations could be destabilising in the transition phase, as it would entail a temporary but negative impact on credit to the economy – an important effect, in the presence of stubbornly low nominal growth and deflation risk. Such an effect is hard to capture analytically, as non-linearities are possible, especially in the presence of financial tensions, and multiple equilibria cannot be excluded. Envisaging a long transition period is unlikely to help, as market participants will probably respond immediately by front-loading future changes in regulation, in order to exploit “first mover” advantages. Ratings have important drawbacks, but practical alternatives are hard to find. If the decision is eventually taken to adopt risk weights on sovereign exposures, mechanisms based on fiscal sustainability indicators, such as those computed by the EU Commission or by the IMF could be considered as an alternative to – or in a suitable combination with – credit ratings. 12 To conclude, the debate on changing the prudential regulation of sovereign exposures was prompted by the recognition that “sovereign debt is not risk-free”. There is no doubt that this is true. However, at the current stage a broad agreement has been reached on the pros and cons of different reform options, not on their overall balance. My personal view is that the potential benefits of a reform are uncertain, while the potential costs could be sizeable. Be that as it may, as long as such a balance remains uncertain, a prudent stance would be to wait for the financial system to fully recover and adapt to the important set of reforms implemented since the onset of the crisis, before making further changes. This would be consistent with the approach chosen by the Governors and Heads of Supervision in their recent statement that new regulatory reforms should “not significantly increase overall capital requirements”. European Commission, Directorate General for Economic and Financial Affairs (2012), Fiscal Sustainability Report, European Economy, No. 8; IMF (2014), Fiscal Monitor, April; Lanotte et al (2016), cit. BIS central bankers’ speeches Note: Foreign holders, alternative definition: foreign holders excluding Eurosystem and round-trip foreign portfolios and funds, i.e. securities held by foreign investors net of those held by the Eurosystem (excluding the Bank of Italy) and those held by foreign individually managed portfolios and investment funds but attributable to Italian investors. BIS central bankers’ speeches
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Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the "Workshop on Stability of the Banking System", organised by the European University Institute (EUI) on the occasion of the annual conference "The State of the Union", Florence, 5 May 2016.
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Ignazio Visco: Asset quality and the new framework for managing banking crises in Europe Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the “Workshop on Stability of the Banking System”, organised by the European University Institute (EUI) on the occasion of the annual conference “The State of the Union”, Florence, 5 May 2016. * * * The sharp adjustment recorded in a number of financial market segments over the last few months somewhat reflects both worldwide and EU factors. Rising uncertainty on world growth prospects, the commodity price drops, persistent low levels of inflation and geopolitical risks may all have played a role. Italian and other European banks were hit hard, due also to concerns on asset quality and regulatory uncertainty, the latter in part, if not exclusively, related to the implementation of the Bank Recovery and Resolution Directive (BRRD), the new European bank resolution framework fully in place since the start of this year. I will focus today on these two issues: asset quality and the new framework for managing banking crises in Europe. Asset quality Concerns about asset quality seem to focus on the valuation of the still large amount of nonperforming loans (NPLs) in banks’ banking books and of Level 2/3 assets in trading books, whose “fair value” is at least partly determined by banks’ internal models and, then, regarded as relatively opaque by the markets. In the case of Italian banks, market concerns about asset quality are to be taken seriously and should not be casually dismissed, even if there are good reasons to believe that they are somewhat overstated. First, at 18 per cent of total loans on a gross basis as of December 2015, Italian banks’ NPLs – whose value, net of provisions, is around €200bn – are certainly sizeable. It should however be observed that banks have on average a high level of guarantees against NPLs; real estate collateral, in particular, amounts to approximately €160bn. Bad loans (or “sofferenze”, i.e. those to debtors in de jure or de facto state of insolvency, whose current net value amounts to €87bn) are more than fully covered by real estate collateral (€85bn) and other personal guarantees (€37bn). Provisions for NPLs have steadily increased since mid2012; at 45 per cent, coverage ratios are now in line with the average for the main EU banks (44 per cent); they are at about 60 per cent for bad loans. Second, the deterioration in credit quality, a legacy of the deep and prolonged recession, has been recently abating. In the fourth quarter of 2015 the flow of new NPLs fell, as a ratio to outstanding loans, to the lowest level since 2008 (3.3 per cent, compared with a peak of 6.0 per cent at the end of 2013). The rate of new bad loans is projected to decline further this year. The NPL ratio is finally peaking; a slight decline was actually observed in Q4-2015 for each of the top 5 banking groups. Third, in recent months there has been a perception in the market (and in the press) that the Supervisory Board of the SSM (the single supervisor in the euro area) is pushing banks to rapidly dispose of their NPLs. Such perception might also have been among the drivers behind the significant fall of euro-area (and Italian in particular) bank stock prices. However, the perception is wrong, as the President of the ECB and the Chair of the Supervisory Board have recently, publicly, clarified. Indeed, an accurate and effective supervisory policy on NPLs must assess the situation at each specific bank. A policy that, instead, pushes banks across the board to rapidly dispose of NPLs in the market would result in a massive transfer BIS central bankers’ speeches of wealth from banks to private (speculative) investors that base their choices upon very high risk premiums and related returns. I am convinced that dealing with systemic NPL issues in Italy necessarily requires a comprehensive strategy: improving banks’ operational environment to manage NPLs; removing inefficiencies in the judicial and extra-judicial procedures that make the “time to recovery” longer than in the rest of Europe; kick-starting the NPL market, which is currently very thin and hence plays little role in resolving the NPL issue. On their side, supervisory authorities (both national and European) for some time have been strongly pushing banks to further improve their on-balance sheet management of NPLs. In the course of last year it became clear that the establishment of a “bad bank” (or, more properly, an “asset management company” dedicated to the system-wide disposal of NPLs) with public support and/or participation would have been in contrast with the interpretation now given by the European Commission to rules on state aid. I had long been advocating the need for measures meant not to alleviate the difficulties of some specific bank but rather designed to reduce the impact of the deep and protracted recession that has hit the Italian economy since the global financial crisis: a solution that had been importantly adopted in other countries, evidently under a different regime and interpretation of the role of state aid rules. As a consequence, last January the Italian Ministry of Economy and Finance has reached an agreement with the European Commission on a government guarantee scheme for senior tranches of securitised bad loans (the so called GACS). These guarantees comply with state aid rules as they are set up so not to be in contrast with what could be considered as market prices for NPLs, even if in Italy a deep and well established secondary market for NPLs does not exist. Therefore, the agreement marks a step toward the establishment of such a market, and also helps by ending the uncertainty accumulated over previous months. Other measures recently adopted by the Italian authorities are also meant to address the root causes of the high stock of NPLs. Those on fiscal deductibility of provisioning have removed a penalising tax treatment of Italian banks. Last summer a first set of measures on bankruptcy and foreclosure proceedings were adopted to speed up credit recovery. The delays and widespread obstacles to court and out-of-court settlement of disputes are in fact a very important reason for the very high stock of NPLs in banks’ balance sheets: a reduction of two years in credit recovery times could even lead to halving the level of bad debts as a share of the total. Feedback from market operators indicates that some effects are beginning to be seen. In the last weeks, a private alternative investment fund (Atlante, managed by an independent Italian asset management company) has been first set up and then formally launched, with a twofold purpose. First, it is meant to support rights issues of Italian banks to reduce the risk that in the light of the current difficult market environment such issues would fail, with potential spillover effects to other Italian banks and ultimately to the entire economy (and there has already been a case where substantial support has been provided). Second, it could invest in bad loans (mainly junior and possibly also mezzanine tranches of securitised bad loans) at prices that may benefit from the organisation, expertise and servicing available within the banking system. The fund has raised resources (more than €4bn) from Italian and foreign investors (banks, insurance companies and other institutional investors). Even if the resources available so far are somewhat limited, the setting up of the fund might well help to unlock the market for NPLs, therefore contributing – from its very start – to the solution of the NPL issue, a solution, however, that cannot but take a non-negligible amount of time. Being a private/market operation, it will be compliant with the current European regulation and consistent with the competition framework. An important contribution to solving the NPL issue should also come from the new measures to speed up the recovery procedures just announced by the Government, which I very much BIS central bankers’ speeches welcome and on which a thorough evaluation of its likely quantitative impact is presently under way. The new European framework for managing banking crises Let me now turn to the challenges we are currently facing, in Italy like in other European countries, in dealing with weak banks, as a result of the financial and economic crisis. The legislation on banking crises has two potentially conflicting objectives: maintaining financial stability – which leads to interventions in support of troubled banks to avoid systemic repercussions – and preventing banks from behaving opportunistically in the expectation of public intervention. Following the global financial crisis, the prevailing position at an international level has leaned towards the latter objective, far more so than in the past. This change in direction has certainly been influenced by the massive public interventions for rescuing banks that have weighed heavily on the state finances of many countries, in some cases jeopardising their fiscal sustainability. In the European legislation there have been rapid, sweeping changes. In 2013 a Communication from the DG Competition of the European Commission provided for the immediate application of a new burden-sharing scheme which, in the event of a bank crisis, would impose losses not only on shares but also on subordinated bonds as a prerequisite for public intervention. In 2014 the BRRD, approved by the Council and the European Parliament, extended that scheme, starting from this year, to include also ordinary bonds and deposits of over €100,000 (i.e., the bail-in). I have recently emphasised, also in the light of the (bad) experience we have gained in Italy with the resolution of four small banks last November, the importance of reconsidering the adequacy of the new legislative framework for managing banking crises. Just as the crisis has impaired the quality of bank credit, the legislative response on crisis management has engendered uncertainty about investing in bank liabilities. An instrument – the bail-in – devised to reduce the impact of a crisis must not create the premises to make one more likely: if this is the case, its design and/or its implementation must be rethought. We must strike the right balance: indeed, investors who have been hit by a bail-in will find no comfort in the fact that they have been protected as taxpayers. And we should not rule out the possibility of temporary public support in the event of systemic bank crises, when the use of a bail-in is not sufficient to achieve the resolution objectives but instead risks compromising financial stability. I have not been alone in advocating such reconsideration. The need to assess the degree of flexibility of the BRRD during the review of the directive scheduled to take place by June 2018 was recalled, among others, by the IMF in its Global Financial Stability Report published a few weeks ago. It highlighted the necessity of applying the new rules (including those on state aid) with flexibility and caution during the changeover to the new regime, when public intervention is no longer admissible but the banks have not yet put in place sufficient buffers to absorb losses without undesired effects on systemic stability. A very recent CEPS paper by Micossi, Bruzzone and Cassella is a welcome contribution on these issues. Indeed, in March 2013, during the BRRD negotiations at the EU Council of Ministers, the Bank of Italy and the Ministry of Economy and Finance presented a technical “non-paper” to all the other country delegations in order to illustrate the reasons for our preference for contractual (or targeted) bail-ins, to be applied only to newly-issued securities (i.e. not applied retroactively to securities issued under a different regulatory regime) that contain a specific clause in the contract recognising the power of the authorities to write down or convert the securities if the conditions for starting a resolution procedure were met. We were – and remain – convinced that this approach would have given the authorities a credible tool to be used to resolve a bank crisis effectively, with no undesired effects on financial stability and at no extra cost to the taxpayer. On the contrary, according to the BIS central bankers’ speeches approach that has prevailed, a wide range of liabilities are subject to bail-ins, with very few exceptions, large corporate sight deposits included and a rather short learning time provided to creditors – especially retail ones. All this, in a world of asymmetric information, can indeed be a source of serious liquidity risk and financial instability. The specific nature of the banking sector and the objective of financial stability should also be treated in a more structured way in the European Commission’s approach to competition and state aid. Adopted in 2013 – and based on the unfortunately premature conviction that the difficulties of European banks had by then been dealt with – the current approach greatly limits government intervention to support banks that are fundamentally viable in order to remedy market failures or negative externalities that are not originated by managerial shortcomings. Indeed, according to the BRRD, any public intervention that counts as state aid (and is not among the very few exceptions allowed by the directive) automatically triggers the resolution procedure. This, in turn, determines an overlap and, as a result, the prevalence of competition and state aid policy objectives over the objective of safeguarding financial stability. In other words, sufficient account is not taken of the fact that financial stability is of vital importance to the real economy. * * * To conclude, in the financial sector there are certainly risks of moral hazard as well as abuses and frauds, which the authorities, including banking supervisors, must prevent as effectively as possible. But prevention is not always possible and in periods of poor macroeconomic conditions risks of malpractice inevitably rise. This is why we need an overall resilient system, with banks well capitalised, better managed and more transparent, costumers with higher levels of financial education and authorities with severe sanctioning powers. This notwithstanding, we have learned that market failures are not infrequent, and information asymmetries and expectations’ coordination problems may trigger sudden and possibly long waves of euphoria or panic. It is by now clear that markets are not always self-equilibrating and when they fail the consequences may be rather serious. On the other hand, markets should operate as much as possible without their force being bridled. 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 the case of banks, this calls for the possibility to recur to public backstops, and in a Union like ours also a supranational one, in the presence of systemic risks and risks of contagion. This is something that still differentiates, contrary to a new apparently established belief, banks from enterprises operating in different industrial sectors. To repeat something that I said a year ago, before the start of the current debate on the consequences of the new regulatory set-up, substantial observance of the rules on market protection and competition remain indispensable. However, in assessing the public role in the prevention and resolution of crises, and not only financial crises, I believe that greater consideration should be given to the characteristics that distinguish policies designed to activate market mechanisms from state aid that distorts competition. BIS central bankers’ speeches
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Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Economic Conference to commemorate the 150th Anniversary of Diplomatic Relations between Italy and Japan "The Economics of Italy and Japan: Historical Development and Future Policies for Stability and Growth", co-hosted by Keio University and Bocconi University, Tokyo, 23 May 2016.
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Salvatore Rossi: The economic progress of Italy – historical heritage and future prospects Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Economic Conference to commemorate the 150th Anniversary of Diplomatic Relations between Italy and Japan “The Economics of Italy and Japan: Historical Development and Future Policies for Stability and Growth”, co-hosted by Keio University and Bocconi University, Tokyo, 23 May 2016. * * * Accompanying charts can be found at the end of the speech. I would like to warmly thank the organisers of this Conference for inviting me to offer my view on the Italian economy before such a distinguished audience, and on such a solemn occasion. I am particularly pleased to share the task of animating this second Part of the Conference with my old friend Deputy Governor Nakaso, and I look forward to hearing from him about the Japanese economy with great interest. We are here to celebrate the 150th anniversary of the diplomatic relations between Japan and Italy: one century and a half, during which our two countries have undertaken enormous transformations, with differences but also with analogies. And because this occasion is a historical one, my approach will be historical as well. I am not a professional historian, so I beg the pardon of those who are. Yet I was helped, in preparing this speech, by experts in the Historical Studies Division and also in the Structural Economic Studies Division of the Bank of Italy, whose contribution I gratefully acknowledge. I will concentrate on the evolution of the Italian economy since the political unification of the country, which took place only five years before the beginning of diplomatic relations with Japan. But let me start with a quick glance at a more remote past, because when looking at the evolution of societies, the ampler the view, the deeper the comprehension. A long historical cycle The Italian peninsula came out of the European Middle Ages, in the late XIII century, as a nascent economic power. It's interesting to notice that one of the main driving forces was monetary: gold, which had almost disappeared from coinage after the fall of the Roman empire, reappeared in Florence in a coin named florin, minted in 1252. A monetary system was actually essential to replace barter and develop manufacture and trade, which were the engines of prosperity. Since then, for about three centuries, and well into the Renaissance period, Italy maintained the lead in western economic growth. The perfection of the arts, from Piero della Francesca to Michelangelo, is witness of the wealth and sophistication of Italian society in those times (slide 2). But after that a long period of decline set in, both economic and political. The guilds, which had been a growth factor in earlier times, became jealous custodians of their privileges, stifling innovation. The ruling classes, satiated with consumption, stopped searching for new horizons. Most European countries achieved national unification in the XVI century, not Italy, which became just their battlefield. In terms of GDP per capita, Italy fell far behind in the European ranking. The very same perception of Italy by foreigners changed. In the XVII and XVIII centuries our land was avidly trodden by young aristocrats and wealthy bourgeois from all over Europe, in BIS central bankers’ speeches search of Roman temples, and eager to buy antiques. Finally, Italy had become the scenario of her majestic ruins (slide 3). Johann Wolfgang von Goethe, the famous German poet and thinker, being a genius, was among the few able to break this arid and exploitative scheme during his journey in Italy, the Italienische Reise he made in the late XVIII century: to him, Italy offered not only the Coliseum, but also interesting conversations with craftsmen, innkeepers, civil servants. In the first half of the XIX century Italy was plagued by underdevelopment and poverty, hitting the bottom of the European ranking in terms of per capita GDP. The evolution since the creation of a unified state Following a struggle lasted half a century, political unification was achieved in 1861, though still partial: Rome and Venice joined the new kingdom only in the following ten years. The new Italian state had to embark on a painstaking effort to put in place the physical as well as the legal infrastructure of a modern country. The first two decades of unity were far from brilliant in terms of growth. One of the major bottlenecks was the inadequate transportation network, especially railways. Only in the 1880s the annual growth rate of the economy surpassed 1 per cent. Early in that decade Italy joined the Gold Standard, which was proof – at that time – that it had a viable economic management. It seemed, for a moment, that the country had reached its place among the European powers. But the international financial crisis of the Nineties had a devastating effect on the economy: foreign capital fled and a housing bubble burst, leaving many bankruptcies behind. Currency convertibility was soon suspended. Financial reconstruction had to start again, but this time under the guidance of a central bank: the Bank of Italy was founded in 1893. While not yet formally monopolist of the currency, the newly created institution had the size and the capability to lead the reorganization, and to avoid major financial crises until the Great Depression. In the XX century Italy benefited from two successive "golden ages" of sustained growth and catching-up with respect to the older economic powers: the fifteen years period preceding the First World War, and the twenty years following the end of the Second World War. We might have expected, or hoped, a third episode of sustained growth following the ICT revolution and the spurt of globalization taking place in the Nineties of the past century, as we could observe in a number of countries, but that did not happen. On the contrary, years of sluggish economic growth and slowing productivity followed. I shall come back to this. The early XX century were a true belle époque for the Italian economy: it became almost self-sufficient in the production of steam engines and locomotives, the equivalent of today's smartphones as icons of progress (slide 4); it entered new fields, such as chemical production. Overall, average annual real GDP growth over the whole period was a hefty 2.6 per cent (slide 5). Substantial merit for this result must be given to millions of Italian migrants: their savings, sent home, allowed the country to pay for the machinery needed to modernize the industry. After Second World War, Italy, in a new democratic political environment, started reconstruction. A burst of hyper-inflation was successfully extinguished in 1947, which allowed entrepreneurs, workers and consumers to focus on re-building the real economy. Italian politicians understood that the future of the country was laying in its ability to thrive in a larger community. The decision to join the European Community in 1957 allowed Italian exports to expand at a dramatic pace. Italian country lands, especially in the South, supplied enough workforce for fast-growing industrial sectors: construction, motorcycles, car making, domestic appliances. While untrained, this workforce was good enough for the mass production of those days. The Italian “miracle” (parallel to the Japanese one) set in. BIS central bankers’ speeches Between 1958 and 1963, real GDP grew at an average rate of 7 per cent, 6 per cent on a per capita basis. To this miracle the Bank of Italy contributed by preserving a stable money, but also by funneling savings towards key projects, such as road and telephone networks. In those days, central bank independence was not perceived as a crucial issue. The central bank shared with the Government the responsibility for key economic policy decisions, and implemented those decisions using the powers it had on the financial market and on banks. Let me recall that in the Sixties Keynesian thinking became dominant in economics, and the Phillips curve oriented decision-making in most countries. Stable money had ceased to represent a goal per se, and was often sacrificed in order to achieve a higher rate of employment. Monetary stability was essentially being judged in terms of the exchange rate, rather than in terms of consumers' purchasing power. The landscape dramatically changed in the Seventies and Eighties, with the oil shocks, double-digit inflation rates in several countries, and a renewed emphasis put on the need for central banks' independence. The hypothesis of a new long-term decline From the end of the Nineties, the Italian economy slowed down markedly. Low GDP growth, falling total factor productivity and shrinking export market shares suggested the idea that Italy was entering a phase of long-term decline (slides 6 and 7). How come? There is a wide consensus by now, to which research done at the Bank of Italy gave a significant contribution, that some features of our economic and social structure had become unfit to the new technological paradigm and global trade environment. I am referring first of all to the insufficient dynamics in firm demographics: that is to say, we had – and still have – too many small firms, too few capable and willing to grow. That reduced the general ability of the economy to exploit the potential gains from new technologies and global export markets. The reasons for such a chronic dwarfism of the Italian corporate sector were rooted in our peculiar "doing business" ecosystem, characterized by a cobweb of laws and regulations affecting economic activity, sometimes redundant and incoherent, often inspired by an anti-market ideology; suffocating red tape; inefficient judiciary. To give you an example, suppose that a successful Italian small firm saw the concrete opportunity to make a dimensional jump, either through internal investment or acquiring a competitor: more often than not it just gave up, and stayed as it was. Why? Because it feared to become too visible to bureaucrats, to tax officials, to unions, to local politicians, to judges. But even when those fears were not justified, the family owners of the firm could decide anyway not to leave the small dimensional class in order not to lose control of the firm. The prevalence of small and medium sized firms was a strength of the Italian economy during the Seventies, thanks to their flexibility, and helped Italy to navigate through the turbulent oil crisis and the subsequent years of stagflation. This same strength turned instead into a weakness when the combined two economic revolutions of the late XX century – ICT and globalization – shocked the world. But the implication drawn by some that Italy had entered a phase of historical decline, like the one following the Renaissance age, was too simplistic. Actually, it was wrong. During the first years of the new century the Italian economy as a whole showed clear signs of reaction and dynamism. But the corporate sector started to split into two diverging buckets: in the first one we could find firms – mostly manufacturers, medium-large size, exporters – that were able to catch the opportunities of the new global environment and BIS central bankers’ speeches raised their productivity and competitiveness. In the second bucket we could find other firms – mostly in the services sector, small, domestically oriented – which were not. According to revised figures recently released by our national statistical office (Istat), labor productivity in the manufacturing sector has increased by 23 per cent since 1995, that of the services sector has remained almost stagnant. As a result, total economy's productivity has increased by a meagre 6 per cent in twenty years, one of the worst performances in the advanced world. Clearly the future of our economy will depend on the relative weights of the two buckets and on the ability of the regulatory and institutional framework to incentivize corporates to climb from the lower to the higher. Since the mid-Nineties, and more decisively after the global crisis, a series of important structural reforms started to be enacted. The inspiring principles were: less state in the economy, a more market-friendly environment, a lighter regulatory burden. The markets of several products and services were progressively liberalized: the banking system was fully privatized, several utilities and publicly-owned firms were transformed into privately-owned companies. Notably, the pension system became a full “pay-as-you-go” system, making it one of the most sustainable in the world, notwithstanding the progressive ageing of the population. The Great Recession damages In the most recent years the impact of the global financial crisis, first, and of the European "sovereign debt" crisis, right after, have rocked the Italian economy, just while it was struggling to adjust to the new technological and global market environment. To give you a sense of the blow inflicted to the real economy by these two shocks combined, the cumulate drop in GDP during the crisis reached 9 percent; industrial production fell by a quarter. The fall in global demand severely hit exporting firms, precisely those that were fighting hard to “go global”. It was the Great Recession. There is a big difference between the two shocks, and that regards the effects on the banking system. In the couple of years following the default of Lehman Brothers, Italian banks weathered the storm. Much like Japanese banks, they were not substantially involved in the "toxic" asset kind of problem affecting banks of other countries. Hence, they were able to absorb the turbulence coming from the recession with no support from taxpayers' money. But the sovereign debt crisis kicked in. It paralyzed the cross border interbank market in Europe. Credit started to decrease, especially to SMEs. The recession deepened. Italian banks, facing a strong rise in non- performing loans and a sharp increase in the cost of funding, saw their profits and capital squeezed, further impairing their ability to support the real economy in a vicious spiral. When the sovereign debt crisis subsided the conditions of our banks improved, but the issue of bad loans still figures prominently on the policy agenda in Italy these days. Risks and opportunities for the future The macroeconomic scenario is now getting better in Italy. A recovery started one year ago. Yet the rates of growth projected for this year and the next one look still insufficient to reabsorb unemployment. We still see a lack of aggregate domestic demand, determining an output gap that we estimate at around 5 per cent. The common monetary policy put in place by the European Central Bank is doing its best to contrast deflationary risks still visible in the euro area. On the fiscal side, Italy has inherited from a long season of excessive current expenditure started in the Seventies a high level of public debt. Hence, fiscal policy has now a limited room for manoeuver, also given the constraints posed by the European rules. The Government is BIS central bankers’ speeches fully using the available flexibility. In terms of composition of the budget, it is aiming at changing it in a more growth-friendly manner. Consumers' and investors' confidence has to be restored, with the help of macroeconomic policies, in order for the Italian economy to eventually close the output gap. But we have to solve an even more important problem, one of a longer term nature: productivity and potential growth still too slow. How to stimulate them is what structural policies should be concerned with. Some important steps forward have been recently taken in this direction: I would just like to mention the labor market reform, the "Jobs Act", which injected a decisive dose of flexibility into the Italian labor market. Other very relevant reforms are in the making, such as that of the judiciary and of the civil service. Much remains to be done to boost potential growth. It's a long and multifaceted endeavor. A key factor is innovation. Let me mention an example of a successful innovation of the past which combines most of the strength of the Italian scientific and artistic culture: the “Vespa” scooter (slide 8). This is a symbol of the Italian design, but also of technological ability, which became a global phenomenon so much that it has been exhibited even in the Museum of Modern Art in New York. The idea of the Vespa came to the manager of an aircraft manufacturer seeking to diversify its products right after the end of WW2. He wanted a totally different product from the existing motorbikes and therefore asked an aeronautical engineer who “hated motorbikes” to design the new scooter. The engineer came up with a completely different design, resembling a wasp, the English for “Vespa”, and with several distinctive characteristics that made it extremely comfortable to ride. It took a few years, but the Vespa turned into an astonishing success, also promoted by Hollywood movies, such as the ride of Gregory Peck and Audrey Hepburn on a Vespa through the streets of Rome in “Roman Holidays”. The lesson that we draw from the Vespa example highlights two ingredients that, still today, are crucial for successful innovations: human capital and what can be called “managerial capital”, i.e. the availability of managers with a risk taking attitude, able to use the latest technology, and capable to think out of the box. While it is difficult to maintain a high propensity to innovate in ageing societies, naturally tending to be averse to “the new”, this is a key challenge for policy, and it requires to keep investing to strengthen the education system at all levels and to promote an entrepreneurial culture in the population, especially among the youths. What Italy and Japan can do together Let me conclude this brief overview with a tiny episode of the past, back in the years following the establishment of diplomatic ties between our two countries. A printmaker, engraver and artist born near Genoa, whose name was Edoardo Chiossone, was selected in 1868 by the Banca Nazionale (the main issuing bank in Italy at that time, subsequently merging with other issuing banks to give birth to the Bank of Italy) to be sent to Frankfurt, Germany, in order to learn updated techniques of banknote printing. Banca Nazionale slowed down its projects in renewing printing technologies. Chiossone was approached by officials of the Japanese Finance Ministry, and invited to move to Japan, to reorganize the printing activity of the State Printing Bureau. Chiossone moved to Tokyo in 1875 and became Head Printer within the State Printing Bureau. The Bank of Japan was still to be founded. He realized there the first modern (i.e. BIS central bankers’ speeches horizontal) Japanese banknotes (slide 9). He maintained this position until his retirement and lived the rest of his life in Japan, never setting foot in Italy again. This story symbolizes, to my view, some comparative advantages of our two countries and the potential of cooperation between us: artistic inventiveness combined with openness to new technologies, adventurous spirit, individualistic curiosity on the Italian part; superior capacity in organizing productive factors, long-term vision, social cohesion addressed towards collective endeavors on the Japanese part. Italy and Japan already cooperate in many fields, from trade to finance, to international institutions and policies. We must strengthen our cooperation, exploit our complementarities, in the interest of our peoples' prosperity. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting (public, not restricted to shareholders alone) for the presentation of the Annual Report 2015 - 122nd Financial Year, Bank of Italy, Rome, 31 May 2016.
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Ignazio Visco: Overview of economic and financial developments in Italy Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting (public, not restricted to shareholders alone) for the presentation of the Annual Report 2015 – 122nd Financial Year, Bank of Italy, Rome, 31 May 2016. * * * Ladies and Gentlemen, This year for the first time the presentation of these concluding remarks does not coincide with the Ordinary Meeting of Shareholders called to examine and approve the Bank’s annual accounts. That meeting, as you may recall, was held on 28 April, and starting next year it will be held by the end of March, as provided for in our new Statute. This is in line with the need that has arisen within the Eurosystem to approve and publish the annual accounts of the euro-area central banks according to a common deadline. Our financial results for the year, then, are already known; let me briefly summarize them. The monetary policy operations conducted in response to the crisis led to unprecedented growth and recomposition of the assets of the national central banks, with the Bank of Italy posting an increase of €57 billion in 2015; the gross profit for the year amounted to approximately €6 billion, practically unchanged from 2014. Given the increased size of the balance sheet and the risks associated with the progressive implementation of the asset purchase programmes undertaken in furtherance of monetary policy aims, the provision for general risks was increased by €2.2 billion. The Bank of Italy’s net profit of €2.8 billion was allocated as follows: €300 million to the ordinary reserve and a dividend of €340 million to shareholders, the same as last year; the amount allocated to the State was €2.2 billion, in addition to €1 billion in taxes. The transition period that Parliament allowed for shareholders to dispose of their holdings in the Bank’s capital in excess of the 3 per cent ceiling expires at the end of this year. As of April, almost 14 per cent of the capital had been transferred to 50 new shareholders. A plan has also been drawn up to make the secondary market for the shares liquid. In its internal management, the Bank has pursued the strategic objectives of consolidating and further strengthening its role within the Eurosystem, improving its services to the public and making more efficient use of resources. This year I will present the Report on Operations and Activities that the Bank is required by law to make to Parliament. Here this morning I will touch on the major events. In 2015 we launched a new plan for the rationalization of the branch network to improve service quality and achieve permanent cost savings. With the closure of 19 branches and 3 detached supervision divisions, chosen on the basis of local demand for the services of each, the network now consists of 39 branches; there were 97 in 2008. With the definitive abandonment of the old provincial branch structure, the branches located in the regional capitals play a central role in the Bank’s new configuration. The larger branches will now take on greater responsibilities in supervising financial intermediaries, safeguarding the interests of bank customers, performing monetary policy operations, and handling the circulation of banknotes and coins. To meet growing public demand, four new Banking and Financial Ombudsman panels will be established by the end of this year in Bari, Bologna, Palermo and Turin, joining those already in operation in Milan, Naples and Rome. After lengthy talks with the trade unions, we have made highly innovative changes to our personnel regulations. The reform reduces the number of hierarchical levels, fosters the organization of work by objectives, and envisages pre-determined terms of office for executives, review of managers’ performance by peers and colleagues, and a strong emphasis on the diversity of skills and professional profiles among our staff. The new BIS central bankers’ speeches organization aims to promote the constant development of our human capital, favour demographic turnover, encourage staff to take on responsibilities, and streamline decisionmaking processes. In order to create a working environment that guarantees respect, inclusion and well-being for all, the Bank made nurturing diversity one of the objectives of its strategic plan for the three-year period now nearing an end. In keeping with this philosophy, the Bank stands ready to apply in full the principles laid down in the new law introducing and regulating civil unions and strengthening the provisions concerning cohabitation. The European Single Supervisory Mechanism has been in effect since November 2014. The staff of the European Central Bank and those of the national supervisory authorities cooperate closely; the joint supervisory teams responsible for the supervision of the most important banks operate in a setting that exploits the diversity of experience. We are committed, along with the other system authorities, to guaranteeing the complete development of common supervisory practices. After the Bank of Italy’s designation as the national resolution authority for banking crises under the new Single Resolution Mechanism, we instituted a Resolution and Crisis Management Unit which reports directly to the Governing Board. The Unit intervenes in crisis management, works with the Single Resolution Board, and oversees the liquidation of banks and financial intermediaries. The Bank of Italy endeavours to prevent money laundering and terrorist financing in Italy, working directly with its Directorate General of Financial Supervision and Regulation and through the Financial Intelligence Unit (FIU). The system assessment recently conducted by the Financial Action Task Force (FATF) acknowledged its efficacy and full compliance with global standards; its competencies and autonomy make the FIU an essential support in investigations and legal proceedings. Targeted regulatory intervention in accordance with the new European rules and with FATF recommendations could be achieved with the transposition of the Fourth EU Anti-Money-Laundering Directive. In 2015 the number of suspicious transaction reports continued to increase rapidly; cooperation with other Italian and foreign authorities has deepened, a particularly important factor in the fight against terrorist financing. The TARGET2-Securities platform for the settlement of securities transactions in central bank money, which the Bank of Italy manages jointly with Deutsche Bundesbank, began operations last June. The launch of this complex infrastructure, developed with the central banks of France and Spain, was a success; the Italian financial system migrated to the new platform on 31 August. By the end of 2017 the TARGET2-Securities platform will be settling securities transactions in 21 countries. This marks an important step towards the full integration of European financial markets. With the completion of this project, we have further consolidated the Bank’s long-established role as provider of high-tech services to the Eurosystem, such as the TARGET2 system for the gross settlement of euro-area payments. We have increased our media presence. The serious episodes involving some Italian banks have spurred us to redouble our efforts to explain, in rigorous technical terms and in the clearest possible way, our supervisory action and the positions taken, in accord with the Government, in discussions with European institutions. The main channel used to publish documents, notes of clarification and interventions is our website. We have reported to Parliament at special fact-finding hearings. We are aware of the importance of timely and effective communication and we are striving to improve its quality, while complying with the confidentiality constraints imposed on us by national law and European rules to safeguard the efficacy of preventive supervisory action and any judicial inquiries. In a year that was once again challenging, all the women and men who work at the Bank of Italy have continued to demonstrate the highest degree of professionalism and a strong sense of responsibility. It is no mere formality that I express, personally and on behalf of the Governing Board, a profound appreciation of their dedication. BIS central bankers’ speeches The monetary policy response to the risks of deflation Notwithstanding signs of strengthening in the first quarter of this year, the euro-area economy remains exposed to global risks. Trade continues to soften, and uncertainty persists regarding the ability of China and other emerging countries to avoid a sharp slowdown of their economies. In the euro area, domestic demand needs to consolidate further in order to counter the slackness of foreign demand. Concerns about the prospects for the European banking system continue to afflict the markets, heightened by uncertainty concerning the macroeconomic outlook, the regulatory stance, and the as yet incomplete configuration of banking union. In some countries, the problems of the economy and public finance are interwoven with those of political instability; in many, hostility to the European project is gaining traction. A negative outcome of the referendum on the United Kingdom remaining in the European Union could engender profound instability. For monetary policy, the main challenge remains the persistence of excessively low inflation, which turned negative in the first few months of this year. This phenomenon is not limited to the euro area. In large part it stems from the fall in oil prices, but it also depends, to a significant extent, on internal dynamics: the margins of unused plant capacity and available labour are wider than in other advanced economies. As I have recalled on several occasions in recent years, like excessively high inflation, an overly subdued price dynamic is also harmful for economic and financial stability, especially when public and private debt are high and growth is weak. Resolute action is being taken to dispel the risk of a prolonged detachment of inflation expectations from the level consistent with the central bank’s objective. In the euro area, the responsiveness of longer-term expectations to the fall in short-term expectations, which is very modest under normal circumstances, remains pronounced, albeit less so than between the end of 2014 and the start of last year. We have acted with determination to encourage the return to price stability; as reiterated by the Governing Council of the ECB at its last monetary policy meeting, in furtherance of this objective we will continue if necessary to deploy all the instruments made available to us in our mandate. Official interest rates have been reduced repeatedly, bringing the Eurosystem’s deposit facility rate to negative levels. At the start of 2015 the Governing Council extended its Asset Purchase Programme to include public sector securities; in December the duration of the programme was prolonged to at least the end of the first quarter of 2017; in March we decided to increase the amount of monthly purchases and to begin, as of June, purchasing investment-grade bonds issued by non-bank corporations. We also introduced new longerterm refinancing operations with conditions rewarding banks that provide more credit to the economy. These measures are of an exceptional scale. The financial asset purchases reached 9.4 per cent of euro-area GDP on 20 May and will reach 17 per cent in March 2017. In the other main advanced countries, the programmes adopted by the central banks have attained even larger dimensions: approximately 20 per cent of GDP in the US and the UK and upwards of 60 per cent in Japan. The evidence demonstrates the efficacy of the expansionary measures. The cost of credit to the economy has fallen and financial fragmentation in the euro area has lessened. The measures have fostered a decline in yields and bolstered the prices of a wide range of financial assets, with a positive impact on consumption, through wealth effects, and on investment, through the fall in the cost of capital. They have buoyed business and household confidence. According to our estimates, without the monetary policy measures introduced between the middle of 2014 and the end of 2015, annual inflation and GDP growth would be about half a percentage point lower in the euro area in the three years 2015–17. For Italy, the estimated effects are more pronounced. BIS central bankers’ speeches The highly expansionary monetary policy stance is the result of well thought out decisions and reflects the weakness of the economy and the risk of deflation. The concerns voiced by some observers that a long period of very low interest rates could have a destabilizing effect on financial markets, adverse repercussions on the profits of banks and other intermediaries, or undesired distributive consequences must be carefully considered; however, they must not be overstated. At present, in the euro area as a whole there is no evidence of an excessive increase in the prices of shares, corporate bonds or houses. The growth in lending in relation to the cyclical position of the economy is moderate. Risks that may possibly arise in specific sectors can be addressed with selective macroprudential instruments, as has already happened in some countries, without interfering with the stance of monetary policy. Very low or negative interest rates can dent the profitability of banks and institutional investors. For pension funds and insurance companies, the risks derive from maturity and yield mismatches between assets and liabilities which may require greater diversification of portfolios, stronger capital buffers, and changes to contractual conditions. For banks, the lowering of rates squeezes interest margins but, besides producing capital gains on their securities portfolios in the short term, it has a positive effect on loan demand and the quality of credit. The impact differs according to the individual bank’s characteristics; the information available for euro-area banks indicates that the overall effects on profits have so far been limited. In the current cyclical conditions the main risks to financial stability, to the profitability of banks and firms, and even to household income continue to come from the uncertain macroeconomic outlook and the persistence of exceptionally low inflation. Strengthening the economy is key to increasing medium- and long-term yields and to mitigating the risks to financial stability. All economic policies must contribute to this objective. Monetary policy must be accompanied by fiscal policies that are consistent with cyclical conditions and with each country’s debt position, and by reform measures designed to permanently increase growth potential and job creation. The Italian economy: recovery and vulnerability Last year, the Italian economy returned to growth for the first time since the onset of the sovereign debt crisis. The positive signs are unmistakable, especially for domestic demand. However, economic activity is still far below its pre-recession levels and is subject to the same uncertainties weighing on the global and the European economy. The recovery, initially concentrated in the manufacturing sector, later spread to services and, somewhat hesitantly, to construction. The improvement in the labour market and the Government’s income support measures have been favourably reflected in consumption. Following a prolonged contraction, capital formation has gradually picked up again. Our surveys point to a further expansion in firms’ investment plans in manufacturing and services. The expansion now also involves industrial firms mainly producing for the domestic market. Contributory factors have included the improvement in borrowing conditions and the temporary fiscal incentives in force since the end of 2015. According to our estimates, the incentives could increase investment by 2.5 percentage points overall in 2016–17. The decline in lending to firms has virtually halted. Banks are actively seeking to use the abundant liquidity at their disposal, above all by lending to firms in a stronger financial position and operating in the manufacturing sector. The cost of credit has come down appreciably for both large and small firms. In relation to GDP, however, investment is still far below its pre-crisis levels, at historical lows. Looking ahead, the main cause of uncertainty is the outlook for foreign demand: firms BIS central bankers’ speeches see heightened geopolitical risks, which affect economic activity adversely both through their direct impact on exports and through the greater caution in investment plans that they induce. As has been observed repeatedly and in many quarters, a relaunch of investment in construction, principally to renovate existing buildings, enhance public facilities and mitigate hydro-geological risks, would have major effects on employment and economic activity. A substantial amount of Italian territory is in fact urban, but there are a great many buildings and infrastructures in a state of disrepair, while little progress has been made to date on environmental protection and energy efficiency. The modernization of our urban heritage also requires legislative initiatives to forge a more effective linkage between national and local norms and to create more favourable conditions for private investment. Achieving this requires a broad consensus, on a par with that required for the conservation and enhancement of Italy’s extraordinary natural and artistic heritage. The signs of economic improvement have now begun to spread to the South and Islands, although the gaps with respect to the rest of Italy have continued to widen. Preliminary estimates indicate that after seven consecutive years of recession, output in this part of the country has stopped contracting. In areas lagging behind it is vital to exploit all the opportunities for investment financing offered by the European Union. Fund utilization was higher last year than in the past, thanks above all to the reallocation of resources from projects behind schedule to those already under way. The impact of this financing on economic growth could be amplified by improving the planning stage and by project selection on the part of central and local authorities that favours direct investment over subsidies to firms, whose lack of efficacy we have repeatedly documented. The demand for labour has begun to grow again, at a higher rate than was expected a year ago and involving areas, sectors and occupational categories passed over by the signs of improvement of 2014. The new rules governing employment relationships have had a positive effect and, as of today, social security contribution relief even more so. The rise in employment has now extended to permanent hirings; it includes the South and Islands. After decreasing for three years, the number of hours worked has risen, albeit slightly, in industry too. Employment held firm in the early months of the year, even though many hirings had been brought forward to the end of 2015 in view of the reduction in social security relief from January onwards. The youth unemployment rate has fallen for the first time since 2007, declining by more than 2 percentage points. Unemployment is still too high, however. Its progressive reduction, crucial to ensuring citizens have adequate living conditions, is also necessary for bringing inflation back in line with price stability. In Italy, as in other countries, the responsiveness of wages to changes in unemployment is high; it is estimated that reducing the unemployment rate by 1 percentage point would correspond to additional wage growth of nearly 1 point over the following three years. Job gains could be greater if the recovery of domestic demand strengthens. Its increase has been greatly influenced by the strongly expansionary stance of monetary policy; fiscal policy has also contributed, although the room for manoeuvre is inevitably limited, given Italy’s high public debt. Yet increasing the economy’s capacity for growth is an essential objective. Both quantitatively and qualitatively, the potential growth rate is not set in stone, a replication of the disappointing performances of the past. Rather, it can be stimulated through appropriate measures; it depends on investment decisions and resource allocation mechanisms. Despite the highly fragmented nature of the productive economy, which curtails its overall competitiveness, the positive performance of many firms on international markets shows that Italy has the potential to recoup the growth gap it has accumulated in the last twenty years. Our surveys show that a considerable number of firms use new technologies, even in the traditional sectors. Signs of vitality are visible throughout Italy, both in manufacturing, with highly innovative and technologically advanced processes, and in services. This has BIS central bankers’ speeches benefited exports; despite the weakening of world trade, they grew faster in 2015 than the potential demand from outlet markets, as they have done regularly since 2010. Italian exporters also succeeded in expanding their market position in mature markets; the gain in sales abroad was exceptionally positive for motor vehicles. However, the high incidence of small firms in our productive economy is a continued source of weakness. Since the beginning of the 2000s, the exports of firms with fewer than 50 workers have failed to keep pace with those of larger firms. Not only do Italian companies start out smaller, on average, than those of the other main European countries, they also find it harder to expand. Support should be given to innovative entrepreneurial initiatives, to business incubation, and to a quicker reallocation of productive resources to firms with better growth potential. In 2012 criteria were established for innovative start-ups to qualify for a broad range of benefits, including incentives for those investing in their equity and a fast track for obtaining guarantees on bank loans. Preliminary evidence indicates that the programme enabled these firms to get larger flows of financing and to sustain higher rates of investment. The priorities for reform are clearly identified: first and foremost, they are to eliminate the obstacles to entrepreneurship posed by illegal activities, inefficiencies in general government and civil justice, shortcomings in the regulation of firms’ market entry and exit, limits to competition, and insufficient resources and incentives for investment in innovation, research and human capital. The results obtained in labour market reform and the reduction of the backlog in civil justice, thanks mainly to the introduction in recent years of measures to reduce litigation, are two examples demonstrating that the reforms undertaken can be effective, even if their effects mostly unfold in the medium term. The rule of law is the sine qua non for growth. Stepping up the fight against tax evasion, corruption and organized crime, giving continuity to the measures put in place in recent years and expediting their implementation, could make it possible to support the activity of the many competitive and law-abiding firms, guaranteeing that everyone follows the rules and that competition is not restricted or distorted. The general government reform approved by Parliament last year is an important step. Its effects on economic activity and on people’s lives will depend on the manner and timeframe of its implementation. The effort to simplify administrative activity and to revamp its organization requires renewed impetus. The initiatives designed to facilitate user identification and the payment of services via the Internet can further the digitization of Italy. Last summer’s changes to the legislation on the management of company crises and the additional measures recently approved will facilitate the recovery of firms whose difficulties are reversible and ease the exit from the market of those that are no longer profitable. To stimulate the entry of new firms it is important that the annual legislative bill on competition be speedily passed. The increase of the ratio of debt to GDP, from just under 100 per cent in 2007 to almost 133 per cent last year, is largely a consequence of the crisis. If during that period real GDP growth had been in line with that of the previous decade and the deflator had evolved in keeping with the inflation target for the euro area, the debt burden would have risen by only 3 percentage points, slightly less than the increase stemming from Italy’s financial assistance to countries in difficulty; had the positive effects of stronger growth on the government deficit been taken into account, the debt burden would have been lower. This simple exercise highlights the risk posed to the economy of a country whose competitiveness is lagging seriously behind and the importance of structural reforms to support its growth potential: they are all the more necessary when the public debt is so high. Following the recession triggered by the global financial crisis, fiscal policy limited the deficit, curbing the growth of the debt-to-GDP ratio. The primary budget balance returned to surplus in 2011 and net borrowing was brought back below the threshold of 3 per cent of GDP in BIS central bankers’ speeches 2012. Keeping primary current expenditure in check played an important role: after recording modest growth in nominal terms up to 2014, it remained practically unchanged last year. Since 2014, when a particularly difficult three-year period for the Italian economy ended, the fiscal policy has become moderately expansionary. The Government seeks to reconcile support for growth with the reduction of the debt-to-GDP ratio, which was appropriately indicated as a strategic objective. In the Government’s plans, the reduction is to begin this year and gain pace in the next three. The way in which the macroeconomic context will evolve could hinder the achievement of this goal in 2016. Careful monitoring of the public finances and the implementation of a programme of privatizations could permit the debt-toGDP ratio to approach the planned objective and ensure a significant reduction in 2017. With a view to supporting a faster, more durable recovery, it is necessary to revamp longdeferred targeted public investment, including in intangible infrastructure; it is also important to further reduce the tax wedge on labour, bolster incentives to innovate and provide income support for the less well-off, hit especially hard by the crisis. While the budget affords limited leeway for these measures today, it is possible in any event to plan their implementation over a longer time horizon. Building Europe: progress and uncertainties The present conditions and prospects of the individual countries of the euro area are closely linked to those of the European construction. For years the area has withstood formidable tensions. The effects of the global financial crisis had not yet been absorbed when the sovereign debt crisis erupted. Triggered by weaknesses in individual countries, that crisis was fuelled by the incompleteness of the Economic and Monetary Union. Hesitancy in defining the procedures for support to countries in difficulty, due in part to the lack of adequate tools, fed fears of a break-up of the area. The spreads on government bond yields widened dramatically, in some cases much more than was justified by the economic conditions and public finances of the countries affected. Measures to deal with the emergency have been progressively flanked by reform of the governance of the European Union and especially the euro area, initiated by intervention on public finance rules and macroeconomic surveillance. In the summer of 2012 the President of the European Council published the report “Towards a Genuine Economic and Monetary Union”, prepared with the Presidents of the Commission, the Eurogroup and the European Central Bank. The report proposed taking, over a decade, concrete steps towards banking and fiscal union and strengthening the democratic legitimation of the common institutions, the embryo of political union. The Governing Council of the ECB reiterated its determination to defend the single currency: the announcement of the possibility of purchasing government bonds on the secondary market was immediately reflected in a drastic narrowing of yield spreads. The reform process outlined in the report envisaged a gradual renunciation of national sovereignty in economic and financial matters and the flanking or replacement of national intervention tools by corresponding common instruments. For banks, the report proposed transferring supervisory responsibility to the euro area and establishing joint crisis resolution and deposit guarantee mechanisms, to be supported with public funds through the European Stability Mechanism (ESM). As to public finance, in addition to implementing the reforms already approved (the Six Pack and the Fiscal Compact), it proposed gradual steps towards the creation of a euro-area budget and the issue of common debt. Most of these proposals were taken up again in subsequent reports, somewhat less ambitious on certain themes, including the Five Presidents’ Report of June 2015. The results have been significant but uneven. The restrictions on the use of national mechanisms were put in place quickly, but the introduction and sharing of their supranational counterparts has been delayed. Likewise, a contained risk-sharing approach was adopted for common intervention to help individual member states in difficulty. The establishment of the BIS central bankers’ speeches ESM has superseded the restrictive tenor of the no-bail-out clause in the European Treaty that would have precluded any form of assistance; however, the financial capacity of the fund is modest as it is supported by limited guarantees of the member states. The new institutional structure and many of the decisions that flowed from it were directed primarily at reducing the risks proper to individual member states or banks, even aside from the possible systemic implications. This, in short, creates a situation of vulnerability: there is the danger not only that national and European authorities will be unable to react adequately to major shocks, but even that they will have trouble avoiding contagion triggered by circumscribed tensions. To effectively reduce overall risk, the measures designed to attenuate specific fragilities must be accompanied by adequate safety nets based on supranational instruments. In the case of the banking system, the possibility of utilizing public resources, whether national or European, as a means of crisis prevention and management has been virtually eliminated. International experience demonstrates that, in the face of a market failure, prompt public intervention can prevent the destruction of wealth without necessarily generating losses for the State, and indeed often producing profits. Greater scope for intervention of this sort, exceptional as it may be, should be reinstated. Moreover, the European Commission’s position on state aid precludes the use of mandatory deposit insurance schemes for purposes of crisis prevention and orderly crisis resolution, even though these funds are private, given that they are financed and independently managed by banks; the effective conduct of recovery and resolution procedures, instead, requires the use of all the tools available. There is no reason to stigmatize as improper state aid those initiatives that help to correct market failures without undermining competition. A rigid interpretation of the regulations on state aid, with little regard for financial stability, has also hindered the plan for creating a company to manage Italian banks’ non-performing loans. With burden sharing and bail-in, it was decided to protect taxpayers by imposing instead a direct cost on savers and investors. The new regulations are a response to events in banking systems other than the Italian one that were directly hit by the global financial crisis and rescued by massive state aid. The new regulations were rightly designed to combat opportunistic behaviour by banks, but their application must balance this objective against that of stability. Contrary to what was proposed by the Italian delegation in official fora, an adequate transitional period was not provided to give all the parties involved time to acquire a full understanding of the new regime, nor has the application of the new system to debt instruments already marketed, even to retail investors, been ruled out. Banking union must ultimately incorporate all the elements envisaged in the original design. The Single Resolution Fund has been created but the resources contributed by the banks, initially subdivided by country, will not be pooled for some time; and no clear determination to use it has transpired. The single deposit guarantee system has not yet been finalized; the European Commission recently presented a proposal, it too envisaging a lengthy period of transition. In both cases there is no provision for a European public financial backstop, which has been called for since the 2012 Report and is necessary to guarantee that banking union has the capacity to safeguard systemic stability. In discussion and in the political debate, the theme of prudential requirements against sovereign exposures is often linked with that of the completion of banking union, on the grounds that risks have to be reduced before they can be shared. The issue needs to be addressed with no preconceived opinions, and without taking hasty decisions that could aggravate rather than mitigate risks. There is no consensus on the overall advantages of the various reform options: furthermore, experience teaches that transitions originally intended as gradual are often suddenly speeded up by the market. In any case, the issue needs to be resolved in a coordinated way at global level and in the proper institutional fora. BIS central bankers’ speeches Poor compliance with fiscal rules in the period preceding the crisis justified their being strengthened, but these last few years have demonstrated how important it is to enforce them taking account, as foreseen by the rules, of exceptional circumstances and the concurrent implementation of longer-term intervention. At the beginning of last year the European Commission established the conditions for applying the flexibility clauses of the Stability and Growth Pact, which can allow national budgets to perform the function of macroeconomic stabilization, at least in part, when necessary. However, not all contingencies can be foreseen; the Commission is often compelled to interpret the margin for flexibility provided by the rules in an unavoidably discretionary manner. A common budget, which can only be achieved by further transfers of national sovereignty and an adequate strengthening of the democratic legitimacy of supranational institutions, would make it possible to implement policies consistent with the cyclical conditions in various economies and in the euro area overall, promptly and with no doubts as to their legitimacy. The single currency needs to interact with a single fiscal policy. To be effective, a fiscal union requires the introduction of common debt instruments and, at the same time, decisions on the treatment of pre-existing national debt with a view to a single euro-area debt. A number of practical proposals to this effect have been put forward, some of them quite recently. In my concluding remarks on this occasion four years ago, amidst very severe sovereign debt tensions, I emphasized the need to increase our common resources, including by instituting a fund to which a portion of sovereign debts could be assigned; these would eventually be redeemed, according to clearly defined rules and without transferring funds between countries, thereby giving rise to a form of fiscal union not lacking cogent rules and powers of control and intervention. The levels of public and private debt, as well as the indicators of the former’s long-term sustainability, differ markedly among euro-area countries. In Italy, for example, the ratio of private debt to GDP is lower than the EU average; that of public debt is very high, while Italy’s sustainability indicators are among the area’s best, thanks in part to a series of pension reforms. On average, the situation in the euro area is comparable to or better than in the other main advanced economies; the less favourable position of European firms is offset by the better situation of households. Yet it is the euro area that is the focus of the markets’ most serious concerns. The area is currently subject to exceptional strains, both economic and geopolitical. The reaction of a large part of public opinion, and in some cases of governments, has been one of fear and rejection; the European project is seen more and more as part of the problem, less and less as the solution. But it is the very magnitude and the diffuse nature of the risks we face that demand a common strategy that goes beyond emergency response. To move forward in the integration process we need to rebuild trust among countries, both at a political level and between ordinary citizens. The first step has to be to tackle weaknesses at the national level, as Italy has done in the past few years and will have to continue doing. However, the effort of individual countries must be sustained by concrete progress in the European construction. Banks and supervision: these last, challenging years Beginning in the second half of 2011, at the height of the sovereign debt crisis, and continuing in 2012, Italian banks had to deal with a significant deterioration in their wholesale funding; although the quality of loans in general was deteriorating, situations of severe difficulty remained limited to just a few banks. In 2013 the International Monetary Fund acknowledged the proven ability of the Italian banking system to contain the effects of the crisis and ensure adequate capitalization by resorting to the market. With the return of the recession, widespread company failures and job losses fuelled a further rise in non-performing loans; in a vicious circle, increased credit risk led banks to tighten supply. Most of our banking system has faced the crisis with courage and BIS central bankers’ speeches transparency, but in more than a few cases the effects of the long, deep recession have been compounded by imprudent and at times fraudulent conduct by senior management. As the crisis unfolded, international banking regulations changed rapidly, especially, as I noted earlier, those on the management of bank failures. The issue of the four banks put under resolution in November needs to be examined in this context. I will not dwell today on the events that led them into crisis, on our supervisory action and our close cooperation with the judiciary; we have described this on many occasions, in statements and notes of clarification, and most recently in my testimony before the Senate on 19 April giving a detailed account of the recent crises involving several Italian banks. Together the four banks accounted for 1 per cent of total system-wide assets. The repercussions of their collapse confirm that even when the banks involved are small, loss of public trust can spread quickly and generate persistent systemic effects. Our intervention ensured the operational continuity of the four intermediaries. The new banks, their balance sheet assets freed of bad debts, are now strengthening their ties with their million or more customers among depositors and small and medium-sized enterprises. Recent Government measures to reimburse the holders of subordinated bonds issued in the past seek to strengthen customer trust. The sale of the four banks on the market is at an advanced stage and adheres to strict criteria of transparency, impartiality and competition; the process is scheduled to be completed during the summer. The assignee of the bad debts is preparing the data necessary for their competitive sale. This could contribute to the development of a market for non-performing loans in Italy. Banking crises are always delicate to navigate for supervisory authorities. They are called upon to minimize the likelihood of collapses and contain the fallout. This responsibility entails a reflection on the causes of the crises, on how they can be identified more quickly and on how on- and off-site intervention can be improved. But an important point should not be forgotten: the laws and the prudential supervisory model that have gained international acceptance over the years, under the impulse of the Basel Committee, are rightly centred on entrepreneurial independence in banking. Supervisory authorities cannot systematically make banks’ operating decisions for them. Anomalies and irregularities are usually discovered or confirmed by on-site inspections; we carry out about 200 every year. Ferreting out these often cleverly concealed situations is not easy and can take time. The supervisory authority performs the difficult job of conducting inspections and investigations; it does not have the tools available to the judicial authorities (such as search and seizure). The powers and responsibilities of the administrative authorities and of the prosecution are, as is only right, kept strictly separate. The full and timely cooperation of the two is obviously essential. Once we have identified a problem, we always aim to lay the groundwork for its resolution. When we uncover evidence of a possible crime we promptly inform the prosecutor’s office. The public is not usually aware of this since, with rare exceptions, the law imposes official secrecy on the reports, information and data obtained by the Bank of Italy in the course of its supervisory activity. There is a precise and important reason for such a rule: to prevent news of isolated incidents from exacerbating temporary or solvable problems and generating destabilizing effects, with serious consequences for all. In the last twenty years we have managed through special administration 125 crises of primarily small banks, 56 of which in the last seven years. Over half the procedures concluded with banks resuming ordinary administration. About a third of the banks involved were liquidated, and liquidation was almost always accompanied by the transfer of assets and liabilities to another bank, thereby guaranteeing the continuity of customer relations. As a result of our intervention it was possible to hold to account those responsible for the failures. Prior to the recent regulatory changes, bank crises were resolved with no costs for depositors or bondholders thanks to the intervention of deposit guarantee funds. We have BIS central bankers’ speeches taken resolute action in the numerous problematic cases which did not go as far as special administration, calling for remedial action, obtaining the replacement of directors where necessary – even with the limited regulatory instruments available, which have only recently been revised – and imposing capital increases. We are aware of the greater difficulties encountered nowadays in dealing with banking crises and the serious consequences that may ensue in terms of investors’ trust. We constantly update our methods and procedures of preventive intervention. We are open to constructive criticism, as we are committed to being accountable for our work. We work closely with government authorities, with the other supervisory and control authorities and the banks themselves. Examples of this cooperation are the creation of the Atlante private investment fund, which has already participated in a capital increase requested by the supervisory authorities, and the initiatives to set up voluntary banking funds for intervention in the event of a crisis. The problems still facing Italian banks Banks in Italy, like those in other countries, are faced today with profound changes in technology and market structure. The still weak economic situation and the uncertainty associated with regulatory changes are compounded in Italy by the large volume of nonperforming loans, which squeeze profitability, and inadequate governance arrangements. Important measures have been taken of late on both fronts; banks need to act swiftly to seize all the opportunities these offer. Net of value adjustments that banks have already made, the stock of non-performing loans comes to just under €200 billion. More than half that amount refers to situations where the borrower’s difficulty is temporary. Looking at bad debts alone, the net value is less than €90 billion. This burden is considerable, but it is in large part backed by collateral whose value was carefully examined in 2014 during the comprehensive assessment of the leading euro-area banks; in addition to this collateral, there are personal guarantees. Overall, the concerns about the quality of Italian banks’ assets must be taken seriously, but without overestimating the extent of the problem. The non-performing loans are largely the legacy of the long and deep recession. We have now reached a turning point. The moderate economic recovery under way since last year is being reflected in a significant decline in the flow of new non-performing loans; in 2015 this was equal to 3.7 per cent of total loans, compared with 4.9 per cent in 2014; for the household sector, the flow is back down to pre-recession levels. The process of normalization continues. One factor that until now has played a role in the growth of the stock of non-performing loans has been the slowness of insolvency and recovery procedures. The legislative reforms introduced last summer and those approved at the beginning of this month serve to speed them up. With the out-of-court assignment of property pledged by firms as collateral, recovery times could shrink to a matter of months from the previous estimate of more than three years, already reduced by last summer’s reforms. The system-wide impact of the measures imposing the stipulation of explicit agreements will increase as they are included in new and renegotiated loan contracts with greater frequency. Shorter recovery times can increase the value of non-performing loans substantially, making it easier to dispose of them on the market. A significant contribution could come from improving the efficiency of the courts; there are considerable geographical disparities in the length of foreclosure and bankruptcy procedures, sometimes even within the same region. The disposal of bad debts could be further facilitated by the state guarantee scheme for securitized bad debts (Gacs), which will help to raise the sale price by making the senior tranches of securitizations more attractive for investors. BIS central bankers’ speeches The growth of the market in non-performing assets will also receive a boost from the investments of Atlante, a private fund that can concentrate on the riskiest securitization tranches. Even with relatively modest resources for the moment, Atlante can demonstrate that buying bad debts at higher prices than those now offered by specialized investors can in fact produce attractive returns. We believe the fund has the determination, independence and professionalism to meet this challenge; the more it succeeds, the more it will become possible to raise fresh resources, creating a virtuous circle. Sale is only one of the ways of dealing with the problem of non-performing loans. Supervisory authorities and banks have a common interest, in this phase, in making the active, efficient and informed management of such loans a strategic objective. Possible improvements range from strengthening internal procedures to outsourcing to specialized operators. As part of its efforts to motivate the banks, the Bank of Italy has recently launched a new periodic survey to gather detailed information on the stock of bad debts, the related collateral and guarantees, and recovery procedures. It lays the basis for vigorous organizational intervention which, in turn, is the precondition for solving the problem, not overnight but within a reasonable timespan. Those responsible for European supervision are aware that the reduction of non-performing exposures can only be gradual. The actual situation of the individual banks will be assessed and the most appropriate supervisory measures identified considering the context in which they operate. At the same time, within the Single Supervisory Mechanism we are striving to make our action more effective with respect to all the risks that bear on banks’ balance sheets, more importantly those associated with structured financial products. The law reforming the cooperative banks has created the conditions for resolving the problem of monitoring the activity of the directors, which in cooperatives can be less than effective or even subject to perverse incentives, and that of constraints on capital-raising in the market. In the largest of the cooperative banks, these weaknesses were particularly serious. The law provides appropriately differentiated remedies. The smallest cooperative banks are offered opportunities, which have to be fully exploited, to improve their overall quality of governance and increase their capacity to raise capital. For large cooperative banks, a sharp break was necessary. Their transformation into joint stock companies makes it possible to solve what had become urgent problems, such as the lack of transparency of directors’ decisions, the selfreferentiality of several top-tier figures, and resistance to change. It must foster consolidations that make it possible to rationalize the banks’ organization, increase profitability and efficiency, and strengthen capital. The law has set an appropriate period of time – ending next December – to allow the largest cooperative banks to plan their strategic choices and carry out all the necessary formalities for their corporate transformation. This process needs to be completed swiftly: waiting until the last minute will expose the banks to uncertainty. The reform of the mutual banks must be carried out fully and without delay; this is indispensable to strengthen the sector and bring its business model up to date, adapting to changing technologies and markets. The Bank of Italy will issue the secondary legislation without delay, in coordination with the ECB; we expect its equally timely implementation by the system. In defining group structures and the relations among the various components, it is necessary to follow strictly entrepreneurial logic, by means of a cohesion pact that gives effective powers to the parent company, and to strive for rationalization and efficiency gains. The mutual banks’ associations can still play a representative role at the national and local level, without undue interference with the group’s strategic planning, operational management and control functions. BIS central bankers’ speeches Banks’ costs and profitability To fund the economy banks must be stable and well-capitalized; they must be able to generate adequate profitability. In recent years profits have been squeezed by the need to adjust the value of non-performing loans; the write-downs amounted to more than €120 billion in the four years 2012–15. With the economic recovery, the impact of this factor is diminishing, but new elements have emerged, such as low interest income, the need to reduce financial leverage, and the fall in the prices of some services due to advances in technology and increased competition. A recovery necessarily entails an increase in efficiency, a curbing of costs, and a diversification of income sources; targeted consolidations, according to sound business projects, can stimulate and abet this process. In 2015 banks’ operating costs – net of extraordinary contributions to the National Resolution Fund – remained stable. The cost-income ratio is 64 per cent, slightly above the average for European groups and below that of the main French and German banks. Nevertheless, given their specific situation, for many Italian banks it remains imperative to take steps to contain costs, including staff costs, by adapting the quality and quantity of personnel to technological and market developments. The business model, grounded in a widespread presence in local markets, is in need of further adjustment by continuing to reduce the number of branches, which last year declined to around 30,000 or 11 per cent less than in 2008. Greater use of technology, starting with further development of digitization, would permit significant cost savings in the provision of traditional services amenable to standardization. In the list published last February by the European Commission, our country still ranked twenty-third in Europe in the use of e-banking, although this is increasing and banks have expanded the array of products they offer through innovative channels. The pronounced disparities between banks of different size show there is room for improvement: the share of households with access to home banking is in fact nearly 60 per cent for the five largest groups, 45 per cent for small banks and barely 35 per cent for minor banks. The savings thus obtained could be fruitfully invested in reorganizing branch networks, concentrating the physical points of contact with customers in a limited number of branches specialized in offering high value added services, such as corporate finance for businesses and asset management for households. A branch network whose design avoids overlap and increases efficiency in contacts with customers is not to the detriment of relations with households and businesses. Another impetus for revisiting the business model is the evolution of the financial system towards a growing role for channels of financing for the economy alternative to banking. Even though non-bank intermediation remains decidedly less well-developed in Italy than in other countries, some recent initiatives – in favour of credit funds, the issuance of loans by securitization vehicles, the financing of businesses via mini-bonds and a more active role of insurance companies – are making for a more dynamic market. This process will be furthered by European measures for the capital markets union. Moving in this direction, we will soon publish for consultation regulations enabling foreign funds to make loans in Italy. Banks can respond to the downsizing of traditional channels by increasing proceeds from the development of new services. In seizing these opportunities, the necessary safeguards to prevent conflicts of interest must be put in place. The changing external context calls not only for greater financial awareness on the part of customers, but also for even stricter controls on the correctness of banks’ conduct. The Bank of Italy is actively engaged on various fronts: it has stepped up its supervisory action with regard to the transparency and proper conduct of banks, with the goal of focusing their attention on service quality and increasing customer satisfaction; it has strengthened the Banking and Financial Ombudsman; it assesses customer complaints of improper practices and assiduously calls upon banks to resolve disputes. Together with Consob and the Government, we are working on enhancing consumer protection and financial education for bank customers, including young people, in BIS central bankers’ speeches the firm belief that this is a structural overhaul that necessitates a national plan, a collective effort, and a long-term commitment. For the banks that are in difficulty, swifter and more resolute cost containment is indispensable. The repercussions on the employees involved may be also softened by the recent expansion of eligibility for the solidarity fund for the banking industry. For minor banks the problems posed by the large stock of non-performing loans, scant diversification of sources of income and the need to adapt to technological developments may be acute. In several cases they must be dealt with by implementing farsighted consolidations that exploit potentially substantial economies of scale and scope. It is necessary to move rapidly in this direction, overcoming the outdated concept of mere local presence which has often aggravated rather than attenuated the problems of the real economy and of the banks themselves. * * * We are slowly, haltingly coming out of a lengthy period of crisis, not only financial and economic. The recovery is not yet on a firm footing. The consensus forecasts are that Italy will not return to pre-crisis levels of income for some time; estimates of our economy’s growth potential are disappointing. We can and must do more. Monetary policy covers the whole of the euro area; its contribution to keeping aggregate demand buoyant is crucial; it is now providing highly favourable conditions that Italy must take advantage of to introduce further structural reforms, which are necessary to relaunch business activity and create more and better job opportunities, particularly for young people. Reforms tend to bear fruit only after some time; the more comprehensive is the project and the clearer the objective, the sooner we can make an impact on confidence and expectations. Our goal must be to lead firms and the economy as a whole back onto a path of sound and steady growth in productivity; innovation and investment must benefit from a nurturing and rewarding environment. The financial system still faces enormous challenges. Efforts to strengthen it must continue. Backed by tangible progress on the European front, creating a more open capital market that will welcome firms which today do not issue shares and bonds is an objective we cannot overlook. Financial intermediaries must become more efficient, more profitable and venture into new areas of operation and so become more stable and safe. The authorities must be pragmatic in seeking to adapt their tools to safeguard stability. The Italian banks have clearly suffered from the crisis; as national and European supervisory authority we now have to handle delicate and difficult situations. We are doing so in an environment that has undergone profound and rapid changes, cooperating actively with all the institutions and authorities concerned. The volume of non-performing loans is large and earning capacity is low. And yet there is widespread determination to overcome the difficulties and once again serve the economy with profit. The measures taken to deal with bad debts, now and in the future, are important; our assessment of the first steps made in this direction is positive; the work must continue with courage and farsightedness. The Bank of Italy, as well as the Government and the banks, will ensure that these measures are as effective as possible on both the technical and regulatory level. To minimize the risk of bank crises, however, we need swift action, structural change, farreaching organizational reform and constant monitoring of the quality of senior management. Major reform measures have been introduced in the last twelve months or so concerning the role of banking foundations and the structure of the cooperative banks and mutual banks. In some cases, pre-existing weaknesses have led to extremely adverse results. Opportunities have now arisen that must be grasped without delay. The process is not an easy one, as recent events have demonstrated. BIS central bankers’ speeches The new European crisis resolution procedures stem from justifiable concerns about how opportunism and favouritism can weigh, including financially, on the community. The new rules must be applied responsibly and advisedly to counter this type of conduct and prevent an irreversible deterioration in a bank’s balance sheet from persisting too long and worsening the effects of its collapse. Adjustments can be suggested to make the crisis resolution procedures more effective and less likely to generate instability, not to prolong irreparable situations but to resolve them in an orderly manner. Such action is part of the efforts to ensure the success of banking union, to which we are fully committed. The European construction is proceeding by gradual and increasingly difficult stages. There has been a significant transfer of sovereignty on economic and financial matters, especially in recent years. It is, in fact, illusory to believe that we can direct the course of the economy and finance, patently global phenomena, from within the limited confines of individual European countries. This construction, however, is lopsided and incomplete; its very sustainability requires that the missing elements be incorporated. Today progress appears more difficult. The legacy of the crisis and the anxieties generated by geopolitical tensions – the migrant emergency and civil wars in nearby countries – have roused in the sentiments of many of Europe’s citizens, and at times in the governments that give voice to them, fears and prejudices once thought long buried. Distrust leads to disaccord; in the exasperated pursuit of mutual reassurance, looking only to short term gain, the necessary steps are hard to take. Moving forward on the basis of a series of compromises is becoming more difficult. European unity is achieved with the development of democratic institutions appointed to manage shared sovereignty. During the crisis the task of safeguarding the stability of the euro area fell almost entirely to monetary policy, owing to the persistent fragility of the other elements of the institutional framework, which were only belatedly and insufficiently rectified. It is not easy to recover trust or a sense of belonging; nor is it possible to ignore the underlying reasons fuelling protest among national public opinion and criticism of political institutions, especially European ones. Well-being and security are basic needs: however, guaranteeing them by responding to global challenges in a fragmented manner and keeping threats at bay by rebuilding national barriers have little chance of success; on the contrary, they inflict inevitable and serious damage. The concrete achievement of monetary union, banking union, capital markets union, and even the prospect of a common fiscal policy, all call for a leap in quality. The identification of shared ground on questions that are fundamental to defining our common European citizenship, such as internal security and the management of immigration, will make it less difficult to proceed with the construction of a “genuine economic and monetary union”. Altiero Spinelli died in Rome thirty years ago. His life was an unceasing testament to the belief that his generation, the one that had both unleashed and endured the fratricidal European wars of the twentieth century, was bound to overcome forever its divisions with the union of the democratic states of Europe. Europe counts him among its founding fathers. To reprise the words of the Ventotene Manifesto, the document Spinelli drafted over seventy years ago with his companions during internment, we still need a union that “breaks decisively economic autarchies”; a union that starts anew from the founding values of the European project: peace, liberty, equality, and the promotion of well-being for all. BIS central bankers’ speeches
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Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 43rd General Assembly of The Geneva Association, Rome, 9 June 2016.
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Ignazio Visco: Financial stability in a world of very low interest rates Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 43rd General Assembly of The Geneva Association, Rome, 9 June 2016. * * * Since the 1980s we have been observing a marked downward trend in nominal interest rates in the major advanced economies. This decline is explained by lower inflation and inflation risk premia, and by a reduction of real interest rates. In these countries real long-term yields have fallen on average from around 5 percent in the early 1980s to about 2 percent before the financial crisis, and to approximately zero percent today. More recently, very low or even negative interest rates mainly reflect the slack in the economy and excessively low actual and expected inflation. The euro area, in particular, is still slowly recovering from two consecutive financial crises and a long recession. Real GDP has only recently returned to the 2008 level and cyclical positions continue to differ across member states. Inflation remains well below the levels consistent with the ECB definition of price stability: it has now been below 1 percent for almost three years and in the last few months it has turned negative once again. Core inflation (which excludes the more volatile components) has not exceeded 1 per cent over the last two years; it reached a historical minimum (0.6%) at the beginning of 2015 and stands only slightly above it in the latest readings. The risk of a de-anchoring of inflation expectations has become material since mid2014 and is still high, although it declined at the beginning of 2015 following the announcement by the ECB Governing Council of its public sector purchase programme. While these considerations indicate that the current low level of interest rates is not an arbitrary choice of central banks, the risks posed by a protracted, very accommodative monetary policy need to be monitored carefully. And so they are. Very low (or negative) interest rates for too long raise fears that they may be a source of financial risks by fuelling asset price misalignments and endangering the profitability of financial institutions. The risk of asset price misalignments (or “bubbles”) is strictly connected to the incentives for an excessive “search for yield” that an environment of low nominal and real interest rates creates for investors and financial intermediaries alike. At present, indicators of imbalances in housing and credit markets do not point to increasing vulnerabilities in the euro area as a whole. To the extent that risks materialise, appropriate macro-prudential measures at a country level can be implemented to limit their accumulation. Moreover, in assessing the risks of excessive “search for yield” we should not forget that the quest for higher yields may also improve the scope for portfolio diversification. In the euro area, institutional investors certainly have room to better diversify their assets. According to recent estimates by the European Commission, for insurance companies and pension funds, the portfolio share of equity instruments is around 10 percent, compared to more than 20 percent in the UK and almost 45 percent in the US. The other main concern for financial stability is that low or negative interest rates may have an adverse impact on the profitability of banks and institutional investors, ultimately putting their financial soundness at risk. In evaluating this issue we should take into account all the effects that low interest rates may have on the balance sheets of financial institutions. In the banking sector, the negative impact on interest income may be counter-balanced by a more favourable effect on other revenues: in addition to one-off capital gains on securities portfolios, an increase in fees and commissions from banking services and – given that low interest rates bring about an improvement in the economy and thus in borrowers’ creditworthiness – a reduction in provisions. Institutional investors may also benefit from a stronger demand for asset management services by households, due to the latter’s need to better diversify their portfolios, as well as from a broader range of investment opportunities thanks to corporations’ greater demand for non-bank debt and equity capital. BIS central bankers’ speeches In the short term, the main risk derives, not least for financial institutions, from the persistently weak and uncertain macroeconomic outlook; the most effective way to reduce this is to lift economic growth and employment. In the euro area, and in the other advanced economies that are still facing subdued activity and too-low inflation, this calls for economic policies to sustain aggregate demand; improvements in the cyclical position will also facilitate the implementation of structural reforms needed to raise potential output and ensure a sustained economic recovery. Non-standard monetary policy measures are especially effective in alleviating the contractionary consequences of economy-wide deleveraging in an environment in which nominal interest rates are hovering around the zero lower bound. We have clear evidence that the measures undertaken by the ECB Governing Council over the last two years have been effective. Estimates, among others, by Banca d’Italia staff (which do not consider further possible non-linear effects) show that in the absence of the measures adopted between June 2014 and December 2015, both annual inflation and GDP growth in the euro area would be lower by about half a percentage point in 2015–17. The expansion of economic activity in 2015 would have been slightly below 1 percent, against an observed 1.6 percent; inflation would have been negative, at about –0.5 percent, against 0.0. These estimates are consistent with those of the Eurosystem and the ECB staff. In Italy, the effects are estimated to be even stronger. From a medium-term perspective, the financial stability implications of a low interest rate environment require a deeper assessment of the fundamental forces shaping real interest rates. In the current debate there are varying views. According to the “debt super-cycle” view, interest rates, growth and inflation are low because of the legacy of the financial crisis; in the medium term they will go back to “normal”. According to the today fashionable “secular stagnation” hypothesis, advanced economies suffer from a persistent imbalance resulting from an increasing propensity to save and a decreasing propensity to invest; excessive savings act as a hindrance to growth and inflation, and pull down real interest rates. A number of supply and demand factors, all characterised by a high degree of persistence, have been considered to justify this imbalance. Demographic developments, high demand for safe assets in emerging economies, increases in wealth and income inequality and a permanent decrease in total factor productivity are the main examples. If we accept, instead, the view of those who suggest that we are in a transition towards the “second machine age”, low interest rates may be seen as the result of an adjustment temporarily characterised by weak demand and high unemployment; in the longer run, productivity gains due to the ongoing digital revolution and many other current and foreseen technological innovations will increase economic growth and raise real interest rates, even if with uncertain consequences for the distribution of incomes. It is not easy to assess which of these views is more likely to be confirmed by the future evolution, but none of them can be totally dismissed a priori; future developments could result in a combination of these different hypotheses. All this considered, it is conceivable that real interest rates will go up in future years, but how far in the future this will occur is very difficult to assess. Since a scenario in which a low interest rate environment extends for a long time into the future cannot be ruled out, it is important to assess its possible impact on financial institutions in order to identify the appropriate responses. The main vulnerabilities for life insurance companies and pension funds would result from maturity and yield mismatches between assets and liabilities. As identified by the 2014 stress test conducted by EIOPA, a low interest rate scenario could put under particular pressure the profitability and resilience of insurance companies with long-term guarantees and negative duration gaps, leading to shortages in their solvency capital ratio. The risk is significant in some euro-area countries; it may be less marked in Italy, thanks to a fundamentally balanced financial structure. To mitigate profitability concerns, life insurance companies and pension funds will have to adapt their business strategies. So far, actions taken by insurance companies have differed BIS central bankers’ speeches depending on whether they are related to new or existing products. For new contracts, there is a general trend to offer lower or no guarantees and develop other types of products, including unit linked policies, in which the risk is held by policyholders and beneficiaries. This is also a response to the new Solvency II prudential regime, which requires additional capital for guaranteed products. For existing contracts, the main actions consisted in reducing the shares of returns distributed to policyholders and, where legally feasible, the renegotiation of contract terms. As far as retirement savings are concerned, the persistently low market yields have strengthened the tendency, already established, to replace defined benefit schemes with defined contribution schemes. The mechanisms to mitigate the risk of the underfunding of defined benefit schemes vary across national jurisdictions; they include increased capital buffers, additional sponsor support and guarantee funds, as well as the reductions of accrued benefits. From a regulatory viewpoint, the introduction of Solvency II for European insurance companies is a major turning point. The new regulatory regime is a valid tool for mitigating portfolio risks. Some provisions were introduced in Solvency II to dampen the impact of interest-rate volatility on insurance companies’ balance sheets, such as those related to the parameters for the extrapolation of risk-free interest rates at very long-term maturities and other measures that are meant to smooth the transition to the new prudential regime; such provisions may also reduce the impact of a prolonged situation of low interest rates. The scope for portfolio diversification has been enhanced by introducing lower capital requirements for investments in high-quality infrastructure and securitisation instruments, as well as in shares of closed-end funds targeting long-term investments and venture capital. In order to deal with system-wide instances of instability, other measures are currently being discussed at a macro-prudential level, including a harmonised EU framework of recovery and resolution for the insurance sector; however, such framework is still at an early stage. The low interest rate environment and the rapid pace of transformation of the supply of financial services make consumer protection as important as ever. Ensuring an appropriate level of consumer awareness and information is a policy priority, especially in countries where households depend, to a large extent, on guaranteed insurance savings products or funded pension schemes. °°° We all face a highly uncertain future environment. A deeper understanding of challenges and possible consequences is crucial for all the stakeholders in the financial industry. Policymakers, financial institutions, firms and households need to be ready to rethink and, if necessary, adapt their behaviour. In the short term, in particular in the euro area, an expansionary monetary policy remains of key importance to supporting aggregate demand and attaining price stability, and to preserving financial stability from debt-deflationary risks. As to the longer term, it is difficult to foresee how the factors affecting real interest rates will evolve; and this uncertainty bears on their current low level. Financial institutions should be aware of the compelling need to effectively adapt their business models, both in their internal organisation and in their supply of products; it will be especially important to fully exploit the new technologies in order to provide the most suitable financial products for firms and households. In any event, access to sound information about issuers and financial contracts, transparent behaviour by firms and financial corporations, improvements in households’ financial education are key prerequisites for the financial sector to effectively allocate risks in the economy. For regulators, the challenge remains one of striking the right balance between allowing financial innovation while preventing it from endangering financial stability. BIS central bankers’ speeches
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Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Launch of the OECD Business and Finance Outlook and High-Level Roundtable "Doing Business in a Fragmented World", Paris, 9 June 2016.
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Ignazio Visco: “Doing Business in a Fragmented World” Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Launch of the OECD Business and Finance Outlook and High-Level Roundtable “Doing Business in a Fragmented World”, Paris, 9 June 2016. * * * I first wish to thank the Secretary General for his kind invitation to me to be here today. As a general comment, let me say that this second issue of the Business and Finance Outlook confirms its character compared with other long-standing reports. It provides valuable in-depth analysis of many topical themes that are critical for a better understanding of the current dismal outlook of the world economy. I find particularly interesting the relationship between corporate finance and productivity, the role of R&D expenditure, the issue of stock market fragmentation, and the implications of heterogeneity of life expectancy across socioeconomic groups. The multifaceted dimensions of the cross-cutting theme of fragmentation are investigated thoroughly. The analyses are backed by rich and original information. For all of these reasons, I wish to congratulate the OECD for this very interesting document. I would like to offer some remarks on a few topics that caught my attention most greatly. Admittedly, this selection was not easy, given the abundance of issues and findings. The report singles out two headwinds to global growth: the reversal of the commodity supercycle, against a backdrop of excess supply capacity and high corporate debt in some emerging market economies (EMEs); and the still modest recovery in advanced economies, associated with two key legacies of the crisis, deleveraging and high non-performing loans. On the policy front, the main challenge identified by the report remains – unsurprisingly – the same as one year ago: how to revive firms’ appetite for economic risk-taking – the entrepreneurs’ “animal spirits” that drive long-term investment projects – so as to fill the gap with financial risk- taking, stimulated by strongly expansionary monetary policies. According to the report, what is needed is a phase of “creative destruction”, characterised by a reallocation of resources towards productivity-enhancing investment and a reduction of excess capacity in sectors such as energy and materials. Structural reforms are seen as the key policy measures with which to accompany this process in both advanced and EMEs. As a result, global growth would accelerate and monetary policy would normalise “safely”. Absent sizeable structural reforms, the main risk would be what the report calls an “inflationfirst” scenario, where a rise in inflation would eventually force central banks to increase monetary policy interest rates, which in turn would prevent an acceleration of economic activity. I fully support the report’s emphasis on the importance of structural reforms to place the global economy on a sound footing and to make markets work better. In fact, the crisis has clearly shown the limits of the self-regulatory capabilities of markets, particularly financial markets, and their consequences on financial and, ultimately, macroeconomic stability. I also agree with the report’s main policy advice, centred inter alia on investments in R&D and incentives for equity financing over debt. However, in order to ensure an orderly adjustment of the global economy and to allow structural reforms to rapidly kick-start the real economy, appropriate macroeconomic policies are also needed. In this vein, I do not share the report’s negative assessment of the current monetary policy stance that would be “harming the prospects of a sustainable recovery”. This view – which appears not in line with the one expressed in other recent OECD assessments and policy BIS central bankers’ speeches suggestions – seems to me to overlook the reasons behind the current monetary stance, while focusing too much on the possible unintended consequences. In a context of very low commodity prices and long-lasting weakness of both global and domestic demand, in advanced countries disinflationary pressures and slack in the economy are still high, although with differences among the main economies. Under these circumstances, a wait-and- see approach to monetary policy would be unwarranted: rather, central banks observe economic developments, ponder risks and may need to act forcefully. The current low level of policy rates is the appropriate reaction to current cyclical conditions, not an arbitrary choice of central banks; a less accommodative stance, particularly given the high debt levels as a consequence of the crisis, could lead to a deflationary spiral with severe consequences both for the real economy and the financial sector. This holds true in particular for the euro area, where unused productive capacity and labour are greater than in other advanced economies. Estimates by Banca d’Italia staff (which do not consider further possible non-linear effects) show that in the absence of the measures adopted by the ECB Governing Council between June 2014 and December 2015, both annual inflation and GDP growth in the area would be lower by about half a percentage point in 2015–17. Of course, a very accommodative monetary policy for a protracted period involves risks that need to be monitored carefully. The report considers the impact of low interest rates on investors’ portfolio choices, noting the rising importance of private equity, hedge funds and real estate investment funds. This analysis highlights that too-low-for-too-long interest rates may spur asset price bubbles and may also stimulate short-termism among investors, i.e. by favouring companies that offer cash-like returns at the expenses of companies that focus on longer-term investment projects. In this respect, let me just observe that portfolio rebalancing that would encourage a higher degree of risk taking is one of the intended channels of transmission of non-standard monetary policies and that currently there are no indications of a generalised overvaluation of financial or real assets in advanced countries. Should excessive risks emerge, targeted macroprudential policies can be used as appropriate. Clearly, monetary policy is not the solution to structural problems (and, as we often say, cannot be the “only game in town”). But I do believe that an expansionary monetary stance creates more favourable conditions to implementing structural reforms: it stimulates aggregate demand and may reduce the possible short-term macroeconomic costs of reforms while helping maintain the necessary political drive and foster consensus regarding their adoption. In the same vein, monetary policy cannot be left alone in the effort to support the economic recovery; it must be complemented by an appropriate use of available fiscal space, with appropriately targeted, growth-enhancing measures, such as investment in infrastructure. On structural reforms, let me also point out that, while increased competition in product markets and more flexibility in labour markets remain important for the enhancing of an economy’s ability to withstand shocks and recover quickly, when designing reforms, it becomes critical to take into account issues such as those raised in the debate about secular stagnation, as well as the structural trends triggered by innovation. For example, it is essential to consider the impact of the digital revolution on both labour demand, which has raised fears of a re-emergence of Keynes’ technological unemployment, and income distribution, as highlighted by James Meade already in 1964. This puts a premium on measures to favour investment in education, life-long learning, training and active labour market policies. Moving on to the fundamental issue of productivity, the report carries out a very detailed analysis of the somewhat puzzling fall in aggregate productivity growth in the aftermath of the crisis. This holds true for non-financial companies in both advanced countries and, above all, EMEs. The firm-level analysis highlights a structural change in the evolution of productivity across companies and sectors: from a single cutting-edge group of “incumbent” companies BIS central bankers’ speeches displaying high levels – but low or negative growth rates – of productivity to the emergence of a second group of “high-growth” companies characterised by faster productivity growth. This finding suggests that it is critical to understand the drivers that underlie these changes. The report rightly emphasises the impact that corporate finance decisions may exert on productivity. Four financial strategies are identified that make a difference between high and low productivity growth at a company level: higher spending on R&D; lower debt-to-equity ratio; higher free cash flow; and more M&A deals. The analysis sheds lights on critical macro-financial linkages. What I find very instructive is that these strategies are all part and parcel of the structural policies that are called upon to trigger economic risk-taking, investment and ultimately growth. As far as financial markets are concerned, two fundamental drivers of change are technology and regulation. This is well documented in the chapter of the report on stock markets, which I find particularly insightful. Here, there seems to be an issue of finding the right balance between the advantage of having more numerous and more specialised trading venues and the disadvantage of fragmenting trading liquidity. The possibility to trade a listed share in various markets promotes competition among providers of financial services. The availability of “dark” trading venues (i.e. with little transparency in pre-trade information) seems to allow institutional investors and other large players to place sizeable orders without giving rise to adverse price changes. On the other hand, it is important that such “dark” trading pools do not undermine a level playing field and a correct handling of conflicts of interest. Putting the various types of trading venues on a more even footing is the objective of some recent regulatory initiatives in advanced countries. The availability of consolidated real-time price and volume data to market participants is another important factor. The report also considers under the notion of fragmentation issues related to the fundamental heterogeneity of economic agents and conditions. A case in point is life expectancy, which varies greatly (both in levels and trends) across individuals depending on socio-economic factors such as education, income and occupation. The report argues that, in regulating retirement, such heterogeneity should be taken into account. The suggested policy implications – namely, improving the measurement and management of longevity risks, broadening the range of annuity products, and tailoring pension arrangements to the various segments of society – have actually long been advocated by the OECD and in other policy fora. What I think should also be underlined is that the development of targeted payout products such as enhanced annuities would also alleviate the pension adequacy problem recently highlighted by the OECD Pensions at a Glance report. Let me conclude with a few thoughts on some broader trends that are of major interest for economists and policy-makers alike. Current demographic developments are widely seen to act as a negative labour supply shock that would reduce future global growth via lower investment and productivity; this could also result in further downward pressure on real interest rates. On the other side, growth is expected to benefit from technological innovation and its positive impact on productivity, although this view is itself disputed by the advocates of the supply-side version of the secular stagnation hypothesis. All these dynamics will also affect income distribution and may fuel already rising inequality. The interrelations among the above key variables may not be fully understood at this time, much less predicted; for sure, they are set to raise critical real and financial implications that require in-depth analysis in future reports. BIS central bankers’ speeches
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 56th Italian Banking Association Annual Meeting, Rome, 8 July 2016.
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Ignazio Visco: Italy’s economy and banking sector in the aftermath of “Brexit” Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 56th Italian Banking Association Annual Meeting, Rome, 8 July 2016. * * * The referendum in the United Kingdom The predominance of votes against the UK remaining in the European Union in the referendum of 23 June has created an unprecedented situation in the history of European integration, whose longer-term implications are difficult to predict. The impact of the referendum result on the foreign exchange and financial markets was mitigated by the actions taken by the monetary authorities, though the tensions only partly subsided in the days that followed. After losing about 6 per cent of its value in the 12 months prior to the referendum, since 23 June the pound sterling has depreciated by 11 per cent against the currencies of its main trading partners and by 13 per cent against the dollar, hitting a 30-year low. The euro has appreciated by 11 per cent against the pound but has depreciated against the dollar, the yen and the yuan; in effective terms it has remained substantially unchanged. The impact on the interest rate differentials between government securities in the euro area has been limited, thanks above all to the stabilizing effect of the Eurosystem’s asset purchase programme: the yield on ten-year Italian government bonds (BTPs) has fallen by 16 basis points, the differential with respect to the corresponding German Bund has widened by 11 basis points. Yet share prices have fallen sharply throughout the euro area, especially in Italy, and volatility has surged. Increased risk aversion among investors has mainly hit securities in the sectors most exposed to a slowdown in growth, among which the banking sector, already weighed down by concerns over balance sheets; the fall in the stock prices of Italian banks was steeper than the euro- area average, with shares tumbling by 29 and 21 per cent respectively. The long-term repercussions of the referendum result on the UK and euro-area economies will depend on the new arrangements for trade and finance resulting from complex negotiations whose outcome is uncertain; in the short and medium term the scale of the effects will depend on the speed and clarity of purpose with which the political authorities respond to this new shock. The changes in interest and exchange rates observed so far do not significantly affect Italy’s prospects for growth. There could be some limited consequences connected to trade links in the event of a sharp slowdown of the British economy: a 10 per cent fall in UK imports, close to the upper limit of the leading analysts’ evaluations, would shave around one quarter of a percentage point off Italy’s GDP in the three-year period 2016–18. Higher risks to the medium-term outlook for the Italian economy and the euro area could stem from the spread of unfavourable expectations which, as our experience of the crisis years has taught us, can have non-linear and difficult-to-predict effects. A tightening of conditions in the financial markets and credit supply, triggered by investors’ flight to safety and by an exacerbation of strains on bank securities, coupled with a general decline in business confidence, would harm investment and growth. What matters most is the ability to adopt measures, at the European and national level, capable of containing the tensions on financial markets, strengthening the banking system and shoring up confidence. The monetary policy toolbox is well stocked but all the other policies must play their part. We must take care that supervision does not itself become a source of tensions. Recognizing the emergence of risks to financial stability, in the last few BIS central bankers’ speeches days the Bank of England has made use of the flexibility inherent in the rules to reduce the countercyclical capital requirements for banks. Italian banks Non-performing exposures and capital adequacy The fall in Italian banks’ share prices reflected, as in other euro-area countries, fears that slower growth could dent banks’ profitability and impair their capital. It was, however, compounded by the large stock of non-performing loans (NPLs), a legacy of the recession, and by concerns that current market conditions could make it harder to sell these exposures or raise capital. Italian banks’ NPL problem is serious but manageable; it must be clearly defined and tackled. This is being done, taking account of the need to deliver both swift and cost effective solutions. The reduction in the stock of NPLs recorded since last autumn is an encouraging sign. The loss of almost 10 percentage points of GDP and about 25 per cent of industrial output during the crisis inevitably had a severe impact on Italian banks’ balance sheets and on the quality of their loans. Without the double-dip recession, the gross stock of bad loans, considering only loans to non-financial firms, which exceeded €140 billion at the end of 2015, would have amounted to about €50 billion, or 5 per cent of all loans disbursed, close to precrisis levels. The growth of NPLs was strongly influenced by recovery times, which until now have been particularly long in Italy; the measures approved in the last year will shorten them significantly. As the Bank of Italy has emphasized in the past, reducing average recovery times even by just two years would have determined, together with a higher valuation of NPLs, a ratio of bad debt to total loans close to half of what it is today. Most Italian banks are capable of dealing with the still fragile cyclical conditions, lending to the economy and competing efficiently on the market. A number of assessments made in the last few weeks put the recapitalization needs of the entire Italian banking system at somewhere in the order of tens of billions of euros, based on the assumption that the total stock of bad loans, and possibly even some of the loans that are “unlikely to be repaid”, must be sold at once by all banks at a price equal to approximately half the value of the bad loans recorded in banks’ balance sheets. In Italy a loan is classified as “non-performing” based on harmonized criteria established at the European level and published by the EBA in 2013, which are largely aligned with those previously applied in Italy and with international practice. For the valuation of non-performing loans in their balance sheets, Italian banks must comply with international accounting and reporting standards (IAS/IFRS). As they permit discretion we have constantly encouraged banks to adopt prudent valuation policies that take sufficient account of the degree of uncertainty in recovery times and flows. Our supervisory action on provisioning in 2012 and 2013 is a clear example of this. In the approach traditionally taken in Italy, NPLs can be divided into at least two large and very dissimilar categories based on the degree of difficulty faced by debtors: of the €360 billion worth of gross NPLs outstanding at the end of 2015, bad loans accounted for €210 billion; €150 billion were in loans classified as “unlikely to be repaid”, past-due or in breach of overdraft ceilings. These two categories of NPLs obviously have different requirements in terms of coverage and write-downs. Both types of loans must be booked in the balance sheets with due prudence, but not at values corresponding to their immediate liquidation. Loans in the second category may return to the performing loans category; indeed, a significant number did so, even in the extremely difficult conditions of recent years. These loans represent “active” credit relationships; it is very likely that even if they experience a particularly difficult phase, debtors will be able to turn a corner and resume the payment of their debts. BIS central bankers’ speeches As for bad loans, both the write-downs already made by banks and the underlying collateral must be taken into account. Net of write-downs, the amount of bad loans drops to €87 billion, of which €50 billion backed by collateral worth an estimated €85 billion, while the remainder are backed by personal guarantees estimated at €37 billion or are unsecured. The value of the real-estate collateral in the balance sheets of Italy’s main banks was revised downward following the euro-area asset quality review (AQR) of 2014, which was conducted using independent, comprehensive and prudent estimates. The average revision was about 10 per cent, compared with 13 per cent for all the euro-area banks subject to review, confirming that the valuation criteria used by Italian banks were substantially correct. In the period following the AQR, the decline in Italy’s real estate prices was moderate; it is also worth recalling that mortgages disbursed by Italian banks have a lower loan-to-value ratio than in the other main European countries. As recent analyses have shown, the bad loan recovery rates actually observed, including in the last few years, are generally in line with the valuations banks use in their balance sheets. This confirms that not even for bad loans can an accurate assessment of their value be based on the assumption that they will be sold immediately. The market value of a bad loan basically depends on two factors: the investor’s profit target and recovery times; higher profit expectations or longer recovery times mean lower prices. Regarding the first factor, in recent years virtually the only buyers in the market for NPLs have been non-European private equity funds seeking very high returns, i.e. 10 to 20 per cent, well above Italian banks’ return on equity, which still averages just under 5 per cent. As for the second factor, the reforms recently introduced to significantly speed up the credit recovery process could have a major impact on the value of bad loans; they must therefore be given the time they need to bear fruit. It will also be some time before the necessary improvements are achieved in the efficiency of Italy’s courts, whose performance continues to vary significantly across the country. The European authorities have also acknowledged on several occasions that solving the problem of NPLs will take time. As the Vice-President of the ECB pointed out just yesterday, it is a lengthy and complex process, the positive effects of which will only materialize over the medium term, beyond the horizon considered in the stress tests. Last year the Single Supervisory Mechanism set up a task force on NPLs. Even the news that a simple request for information had been made in this context triggered considerable turmoil on the financial market at the beginning of this year, highlighting the very sensitive nature of information on supervisory matters and the need to handle it carefully. One of the aims of the task force is to recommend to banks, especially those with high volumes of NPLs, the best practices to adopt in developing an effective strategy to deal with them. Divestment is just one of the options available; other strategies include, as we have often pointed out, more efficient management within the group or outsourcing to a specialized credit recovery service. The majority of NPLs are booked in the balance sheets of banks that are financially sound notwithstanding the impact of the long and deep recession. At the end of last year, “significant” banks with particularly high levels of NPLs and, among the other banks, those with core tier 1 capital ratios below 10 per cent, jointly held €15 billion worth of bad loans net of write-downs, also backed by collateral and personal guarantees. For these reasons it is not correct to speak of the problem of NPLs as if it were an emergency affecting the entire banking system. Effective supervision involves assessing the actual situation of each bank using detailed information, conducting robust analyses, and taking account of average credit recovery times. Essentially, Italian banks have suffered from the effects of the recession; for some of them these have been compounded by weaknesses stemming from their ownership and governance structures, and regrettably, in several cases, by fraudulent conduct. In respect of these banks the supervisory authorities – Italian and, since the end of 2014, European too – have acted within the powers assigned to them; we have given account of the actions taken BIS central bankers’ speeches before the competent institutions and other bodies, publishing detailed reports on our website. The supervisory authorities have called for restructuring plans, which have been drawn up, and are closely monitoring their implementation. It will take time to achieve the objectives; a firming up of the economic recovery with a positive spill-over on banking activity will prove decisive. In some cases, the indispensable recapitalization measures requested by supervisors has been hindered by market difficulties; in others, the recent tensions, which have hit share prices hard, call for resolute action, to promptly signal a reversal of trend, and for possible support measures. The reform process and the coming months Major reforms have been launched in recent years to allow Italy’s financial system to modernize, in line with the new global and European regulatory framework and with economic, social and technological changes. The long overdue reforms of Italy’s cooperative banks (“banche popolari”) and mutual banks (“banche di credito cooperativo”) have been crucial. For the mutual banks, the reform must be implemented quickly and efficiently: public consultation on the secondary legislation will begin shortly. The merging of two large cooperative banks announced a few months ago will be an important test of the system’s capacity for renewal following the reform; we expect other mergers to follow relatively soon. The recent overhaul of the senior management of a leading bank lays the groundwork for an improvement of its capital position and an increase in profitability, in line with supervisors’ and market requirements for global systemically important groups. Other important reforms were adopted between mid-2013 and the first half of this year to remove tax disincentives that have deterred banks from writing down loans and, as I have already mentioned, to speed up credit recovery procedures. These reforms are paving the way for the development of a large and efficient Italian NPL market. The state guarantee scheme to securitize bad loans (“Garanzia sulla cartolarizzazione di sofferenze”) and the launch of a new survey on bad loans will also contribute to the growth of the market. The Bank of Italy has just introduced this survey to collect and rationalize detailed data on bad loan characteristics, on the type of guarantees used to back them and on the status of recovery procedures. We have indeed found that many banks are making insufficient use of modern data management and processing technologies, particularly with respect to loans handled directly by their legal departments. The difficulty of quickly providing potential investors with an adequate and reliable set of information affects the length of time needed to conclude negotiations and is partly responsible for the substantial discounts on the selling prices of bad loans. The first reports should reach the Bank of Italy soon, before the end of next September. Important private initiatives undertaken recently, such as the establishment of the Atlante fund and other instruments aimed at supporting ailing banks (including those in the mutual bank sector), seek to help banks successfully navigate this delicate transitional phase. The initiatives come as a response to the new European crisis management framework, whose rigid application restricts States’ ability to intervene, even when the aim is to avoid contagion and maintain financial stability. But there is still much to be done to improve banks’ industrial strategies. The stress test of Europe’s largest banks, coordinated by the EBA and conducted by the ECB on the euro area’s “significant” institutions, has almost been completed. The results will be published at the end of this month. Exercises of this kind are now a standard part of the supervisory toolbox; the stress test results, along with many other quantitative and qualitative factors, are used by the supervisory authorities to form a comprehensive assessment of the situation of individual banks. Since stress testing is just one of many factors considered by supervisors, the results for the banks tested must be analysed and interpreted in detail. BIS central bankers’ speeches Stress tests are hypothetical exercises that are based on highly adverse macroeconomic scenarios and generally have the greatest impact when the economy is emerging from a protracted, severe recession, as in Italy. In designing the test, the EBA used a static balancesheet approach, i.e., one that deliberately disregards the measures that banks would surely adopt over the 3-year period under consideration to mitigate the negative effects of the hypothetical shock. The authorities in charge of the exercise have clarified that, unlike in the past, any capital guidance derived from the stress test outcomes does not in itself constitute a binding capital requirement to be met by a certain date. In any case, the risk that the exercise could trigger procyclical effects in a fragile macroeconomic environment is to be avoided. In response to the market uncertainty that followed the UK referendum, the Italian government notified the European Commission of its plan, which was approved, to guarantee new bank bond issues until the end of this year and only where strictly needed. As in the past, the banks that take advantage of the guarantee, which will be priced at market terms, must comply with the European state-aid rules. European legislation also allows States to take precautionary measures, including recapitalization, based on stress test outcomes. The current situation, with its many risks to financial stability, requires a public backstop to be used only if needed, in full compliance with EU rules, bearing in mind the potential systemic effects of a future crisis for individual Member States and the euro area as a whole. The argument made by some at the European level that government intervention to support Italy’s banking system should have been carried out in the past, as in other countries, does not take into account how the conditions of the national banking systems have evolved differently over time. The countries that drew most heavily on public resources in recent years did so to address full-blown bank crises, associated with very large exposures to highly risky and opaque derivatives or with loans concentrated in notably overvalued real estate sectors. The situation in the Italian banking system, as also described in the IMF’s Financial Sector Assessment Program (FSAP) of September 2013, was very different back then: Italian banks had not been affected by these issues. In Italy, the increase in NPLs has mainly stemmed from the weakness of the real economy, which has continued until recently, within a regulatory framework that in the meantime has been radically transformed. Today, in order to limit broad-based risks, responses may be needed that, looking forward, recognize the change in circumstances and exploit the room for manoeuvre allowed under the rules. Any future measures to safeguard systemic stability must not serve as a pretext for delaying the important remedial action that is now demanded of intermediaries. Italian banks, especially those in difficulty today, face multiple and important challenges: from the more active management of NPLs in order to sell them or, if they remain on balance sheets, to improve recovery rates, to the achievement of higher levels of efficiency; from the exploitation of the opportunities offered by the technological-digital revolution to the necessary reorganization of branch networks and the launch of ordinary and, if necessary, extraordinary cost-cutting measures, including in relation to staff costs. In the short term the recovery of profitability has been made harder by the repeated calls for a strengthening of capital, and more generally of loss-absorbing instruments, from the supervision and resolution authorities, also in order to comply with increasingly stringent rules. Regulatory changes will reduce banks’ riskiness, endowing them with greater loss absorption capacity, increased liquidity and lower financial leverage. This will stabilize the entire system, making it more resilient to a crisis. But in the meantime, especially in some countries, the new rules risk denting banks’ profitability – already beleaguered by the crisis years – even further, increasing the cost of funding and determining a reduction in the overall size of the banking system, with potentially adverse effects on the availability of funding for the real economy and on banks themselves. The right balance must accordingly be struck BIS central bankers’ speeches between micro and macroprudential considerations; international debate has recently paid closer attention to this question. This same balance must be also sought in the context of the new European regulatory framework for the prevention and resolution of bank crises. The Single Resolution Board has begun work to define the minimum requirement for own funds and eligible liabilities (MREL) needed to absorb losses in the event of a resolution. It is important that the eligible instruments be explicitly subordinated to ensure a clear and rapid allocation of the losses; that an excessive burden not be placed on global systemically important banks, which are required to comply with the total loss absorbing capacity (TLAC) standards; and that the requirement be calibrated in such a way as to avoid procyclical effects. Its introduction must also take into account the time required for the market to absorb a large number of new debt issues. *** The result of the UK referendum is affecting the euro area at a difficult time. The economic recovery has begun but is fragile. Unemployment remains high. Inflation is still very low, far from the levels consistent with the definition of price stability. There is the risk that the already widespread sense of dissatisfaction with the European project will grow. At this juncture it is even more necessary to ensure that further delays in introducing supranational intervention tools do not exacerbate the area’s fragilities and make it more difficult to react appropriately to a shock or to prevent contagion. We do not underestimate the signals of nervousness and anxiety from the financial markets, concerning Italian banks. Together with the other authorities we are acting with determination to promote effective market solutions. Faced with the risk that, in a highly uncertain environment, circumscribed problems could undermine confidence in the banking system, some form of public intervention cannot be ruled out. We trust in a collective commitment to overcome the current difficulties. BIS central bankers’ speeches
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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, 8 October 2016.
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Statement by Ignazio Visco, Governor of the Bank of Italy Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino, and Timor-Leste Development Committee, Washington D.C., October 8, 2016 1. Introduction Global growth remains disappointingly anaemic. Adverse long-term trends in advanced economies – low productivity growth, aging populations – combined with the slowdown in emerging economies and especially heightened geopolitical risks result in a high degree of uncertainty which prompt firms to scale back their investment plans. If we do not act to reverse this situation a self-fulfilling trap of low growth may take hold. Policies both on the supply and demand side are crucial. To take full advantage of the very accommodative stance of monetary policies other policies to support demand and especially appropriate structural reforms should be implemented. The reduction in global poverty experienced in the last couple of decades is a success. It has been facilitated by booming international trade and rapid growth, especially in some populous emerging economies. However, not everybody has benefitted. Guiding political and economic institutions in a more inclusive direction is essential to limiting adjustment costs and facilitating sectorial reallocation. Maintaining market openness to revitalise trade in goods and services may enhance economic growth. Multilateral cooperation among all economies is essential to generate better outcomes and the World Bank should continue to play an important role towards this end. 2. A better and more legitimate Bank A “better” Bank identifies sound examples of previous interventions, using data-driven and evidence-based analysis to systematically assess their degree of success and to implement the lessons learnt. This is necessary not only for proposing transformative development solutions, but also for appropriately managing risks. The recent approval of the new environmental and social safeguards, if properly implemented, may represent an important step in this direction. We welcome the agreement on the dynamic formula in the context of the periodic revision of Bank shareholding. Introducing a dynamic adjustment mechanism, which builds on the Bank’s development mission and global economic reality, will strengthen the IBRD’s legitimacy as a global player. Recognising support for its development mission is essential for strengthening incentives to foster future contributions. The compression factor acknowledges the cooperative foundation of the IBRD and ensures an equitable representation of all shareholders for the years to come. 3. The contribution of IDA to development Over the last decades IDA has provided a fundamental contribution to the long-term agenda of poverty alleviation. It should continue to focus its efforts and resources on the long-term challenges of poverty eradication and sharing prosperity in the poorest countries. With these goals in mind, we expect that a larger group of countries will consider mobilizing resources. We welcome progress in leveraging IDA equity, which will enable the Bank to both target scarce concessional financing to the poorest IDA clients and increase allocations of non-concessional resources to countries at a more advanced stage of development, in line with the different needs and capacities of IDA’s evolving client base. We support the proposal of a window in IDA18 to leverage IFC and MIGA to promote private sector development in IDA-only countries, paying special attention to Fragile Conflict Situations. We nonetheless think that the best way to promote private sector activity in these areas is to address the challenges related to institutional capacity and regulatory framework. 4. The Forward Look We welcome the report on the year-long engagement between the Board of Directors and Senior Management on the medium- to long-term role of the World Bank Group. It provides an important basis for the decisions shareholders should make on the financial capacity. Given the ambitious agenda of the 2030 Sustainable Development Goals (SDGs), the WBG should help address the issue of why the large amount of global liquidity flows only to a limited extent towards capital-poor countries. While this may still be due to global capital market imperfections, differences in fundamentals that affect the structure of these countries’ economies—such as technological capabilities, missing factors of production, government policies, and institutional structure—play an important role. Therefore, the crucial role of the Bank is to build on the knowledge accumulated in so many years of financing for development and help developing economies overcome such shortcomings. In particular, helping countries implement the policies most conducive to a friendly business environment is essential to leverage private sector investments. We recognize that an appropriate funding of the measures to achieve the SDGs in a challenging global economic context may put pressure on the WBG’s financial resources. As the World Bank’s scope of intervention cannot be unlimited, particularly in an international environment where many organizations share the same broad goal of helping the poor, scarce resources should be used with greater efficiency. We need a more intense coordination among all multilateral actors, building on their respective missions and expertise. We strongly recommend an optimized use of resources and enhanced selectivity of interventions, firmly grounded in the Bank’s comparative advantages, with a focus on those clients having limited access to alternative source of funding. In the coming months, it will be pivotal for the Bank to consider where the resources needed can and should come from. The persistence of low interest rates calls the current business model into question. The current income generation capacity is unable to boost capital to support increased lending, even in the absence of strong cost dynamics. This calls for a multifaceted approach which would not exclude widening the revenue base of the Bank, modifying the price of its services, and optimizing its balance sheet, while adhering to the highest standards of budget discipline.
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 92nd World Savings Day "The culture of saving to promote growth" organised by the Association of Italian Savings Banks (ACRI), Rome, 27 October 2016.
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ACRI Association of Italian Savings Banks 2016 World Savings Day Address by the Governor of the Bank of Italy Ignazio Visco Rome, 27 October 2016 There are mixed signals from the global economy. On the one hand, the most recent data show that economic activity is strengthening in the United States and in China, while Russia is pulling out of recession; on the other, the available data for the third quarter point to a fresh weakening of international trade. Overall, uncertainty prevails: the difficulty of predicting the impact of technological development on the economy and employment and managing that of demographic trends has been compounded by growing political and geopolitical tensions. Uncertainty in the European Union has been heightened by a number of specific factors. The tensions associated with managing exceptional flows of migrants, at a time when mutual trust is already impaired, are driving deep wedges in relations between the member states. The proliferation of nationalist movements, which are openly hostile to the single currency and plans for further integration, is casting a shadow on Europe’s future, which has lengthened in the wake of the UK referendum. European politics remains mired in short-termism; individual countries tend to favour internal contingent interests over more far-reaching common initiatives. The outlook for the euro area remains that of stable but moderate growth, with inflation recovering gradually but still excessively low, and elements of persistent frailty in the financial system. Uncertainty is driving firms to increase their liquidity and discouraging investment; it is holding back household consumption while at the same time greater precautionary saving is not going into financing additional business investment. While averting a deflationary spiral, the exceptionally expansionary measures adopted by the Governing Council of the ECB aim to bring inflation back in line with the objective and support demand. But monetary policy by itself is not enough. The absence of a common fiscal capacity that could be used countercyclically is weighing on the euro area, a situation which is all the more worrying when many countries have scant room for manoeuvre at national level and others hesitate to adopt expansionary policies. In any event, monetary policy cannot serve to raise the area’s growth potential. What is needed instead are policies capable, at a time of major change, of recasting the structural traits of our economies. The reforms underway in several countries must continue apace. In Italy, the economic recovery continues but remains stunted. After stalling in the second quarter, economic activity appears to have returned to slight growth in the third, according to the latest data on industrial production and recent business surveys. The recovery is having a positive effect on financial stability: the increase in the employment rate is supporting household disposable income; corporate financial vulnerability indices are improving. Investment is still the main weak point, particularly in Italy. Although it has been on the rise since mid-2015, partly thanks to increasingly accommodating lending conditions, it remains modest compared with that of other European countries and with the levels recorded in the aftermath of previous recessions; in real terms investment remains nearly 30 per cent lower than in 2007. In Italy, the scope for government intervention to support economic activity is limited by the very high level of debt. Our production system has been weakened by the delay in responding to increased competitive pressure in the international markets and to technological innovations. Notwithstanding the improvements obtained with the reforms of recent years, it is still hindered by an environment that is not business friendly, encumbered as it is by excessive bureaucracy, a slow judicial system and illegal activity. Italian banks, like banks in other countries, face a delicate transition, complicated by the need to manage the legacy of the long recession in a still weak economic environment and with regulatory reforms underway. *** An accurate assessment of the conditions and prospects of the Italian banking system should take account of the differences between the various banks and of the measures and reforms adopted so far. Overall, the results of four of the five major Italian banking groups in the recent stress test coordinated by the European Banking Authority are in line with the average for the main banks of the other countries. Banca Monte dei Paschi di Siena, which failed the test, announced, at the time the results were published, a major recapitalization plan to be implemented by the end of the year, which will allow it to dispose of its entire portfolio of bad loans. Even among the remaining Italian banks, both the ‘significant’ ones (under the direct supervision of the ECB with the participation of the national authorities) and the others (with assets below €30 billion, supervised directly by the Bank of Italy according to common guidelines), the difficult cases are well-identified. In the last few years, crisis management has become more complex because of market conditions, which discourage the provision of new capital, and because of changes in the regulatory framework, which no longer allows use of the tools that Italy had long relied on to prevent or resolve bank crises. Nevertheless, the banks concerned are carrying out restructuring operations, taking measures to make managing impaired assets more efficient – where necessary through divestments on the market – and recapitalizing. The sale of the ‘bridge banks’, set up during the resolution of four banks at the end of last year, continues in an open, transparent and non-discriminatory manner. The process takes into account European rules on competition and the prudential requirements established by the single supervisory mechanism. In recent weeks, the deadline for completing the process has been postponed, in agreement with the European Commission. Measures are being taken to overcome crises at ‘significant’ banks and at other banks directly supervised by the Bank of Italy: the latter number about 460, including groups and standalone banks, and account for 18 per cent of the assets of the Italian banking system. Their average size is small, but the dispersion is high: 17 banks have assets exceeding €5 billion, while about 240 banks have assets below €500 million; 355 of them are mutual banks. Supervision of these banks is intensive; the supervisory review process is based on risk profile analysis methods consistent with European guidelines and on regular on-site inspections (roughly one hundred a year). The bank’s overall functionality, its capital adequacy and its asset quality are assessed. Regarding asset quality in particular, inspections include a review of individual credit files to check that loans are correctly classified and the relative valuation adjustments are adequate. At the end of the annual evaluation, the capital ratios deemed adequate for each bank are established, taking the minimum requirement as a basis, and requests to strengthen capital are made where necessary. It is also thanks to this supervisory action that since the end of 2011 the highest quality capital ratio of the banks directly supervised by the Bank of Italy has increased from 11.8 to 15.5 per cent (against an increase from 8.8 to 11.7 per cent for ‘significant’ banks) and the coverage ratio for non-performing loans (NPLs) has risen from 28.2 to 43.6 per cent (against an increase from 40.6 to 45.6 per cent for ‘significant’ banks). The high level of NPLs, a weakness more typical of the Italian banking system than of others, is being assessed by market analysts as well. Some describe the phenomenon as still growing, others suggest that it is underestimated in publicly available data. Given the importance of the questions raised, they deserve satisfactory answers. In Italy, the deterioration in loan quality, aggravated above all by the long recession, recently came to a halt. The ratio of the stock of NPLs to outstanding loans began to diminish at the end of last year. In June this year it stood at 17.7 per cent including write-downs; net of write-downs it was 10.4 per cent, of which 4.8 per cent related to bad loans. Attention should focus on the net amounts, as writing down the value of NPLs is virtually equivalent to writing them off. In the first six months of this year, the flow of new NPLs returned to the levels of 2008, at around 3 per cent of outstanding loans. Provisional data on the third quarter show that the improvement is continuing. Moreover, the NPL coverage ratios continue to grow and are now slightly above the average for the main European banks. A large part of these exposures are collateralized; this should be taken into account in any overall assessment, although without disregarding the possible problems in recovering the collateral, especially in today’s difficult market. Also worth noting is the significant difference between exposures classified as bad loans, for which there is actually no possibility of a ‘cure’, and other non-performing loans (those ‘unlikely to pay’ and past-due debts or credit-line breaches), in which the debtors may be facing temporary difficulties. Without underestimating the risks associated with the latter exposures, it should be borne in mind that proactive management by the banks may make positive cash flows possible and permit a return to normal conditions. As regards managing bad loans, in several cases we have found shortcomings in banks’ organization and governance. These must be resolved so that the banks can take full advantage of the opportunities that have opened up following the recent enactment of new laws to shorten recovery procedure times, potentially bringing them closer to those in the other main countries. Banks are being encouraged to move in this direction by the guidelines on managing NPLs, recently provided for consultation by the ECB and addressed to ‘significant’ banks, and the new detailed survey of bad loans requested by the Bank of Italy, which is currently examining the early findings. The availability of systematic, detailed data will not only help to make the internal management of bad loans more efficient, but it will also encourage their sale on the market, where necessary, by ensuring more transparent information. It should nevertheless be noted that the majority of non-performing loans are held by banks that are healthy overall; because they do not need an immediate sale of bad loans, they can take advantage of generally higher recovery rates than current market prices imply. Moreover, incentives to reduce the ratio of NPLs to outstanding loans, which could have been done quickly had it been possible to set up, with public backing, a company to manage such assets, are now provided by the measures introduced by the Italian authorities over the last two years. These are designed to foster the development of a market for NPLs, in part by shortening the recovery process. In the near future, a large volume of bad loans could be sold or securitized, including through recourse to government guarantees for senior tranches. The timeline for this recovery process should not be cut too short, however. The risks that could arise along the way will be smaller, the more efficient are economic policies in supporting the recovery. *** The action taken to reduce the NPL ratio is essential, but by itself it cannot conquer the challenges facing Italian banks. All of them, not just the ones most weakened by the crisis, must improve their profitability, adapting their business models to a market environment that has been profoundly altered by technological advances and regulatory reforms. By drastically cutting costs without delay and significantly raising efficiency it will be possible to free up considerable funds to invest in technology and in improving the quality of human capital. On occasion, sweeping measures may be taken to reduce staff costs; the social repercussions should be cushioned by using existing unemployment and welfare benefits, the resources of the industry’s Solidarity Fund (the scope of which has recently been extended), and those that will be made available by forthcoming legislation. A greater diversification of revenues could benefit from the provision of asset management services which, while fully satisfying the needs of customers, would also emphasize, in particular, the avoidance of conflicts of interest and, more generally, the protection of customers. This is not merely a legal requirement, it is the cornerstone of a fruitful and long-lasting relationship. Clear and fully transparent transactions with customers help to strengthen the trust placed in banks, the ingredient on which their business hinges. These principles should be in place even when contract conditions change, which is only possible for a valid reason; customers should be properly informed of these in order to make reasoned choices. Mergers and acquisitions, especially among small and medium-sized banks, can certainly facilitate adjustments in business models and a recovery of profitability. Internationally, the authorities are determined to complete the reform of the rules on banks’ prudential requirements (Basel III) as soon as possible; their intention is to avoid at the same time significantly increasing overall requirements. Finalizing the reform will help to dispel the regulatory uncertainties that currently hamper the process of consolidation. The governance reforms introduced recently in Italy facilitate this process; they are starting to bear fruit. Other such operations will follow the important merger of two (former) cooperative banks completed in recent weeks. The transformation into joint stock companies of the cooperative banks affected by the 2015 reform must be completed by the end of this year; it should help them to strengthen their capital, restore profitability and improve credit quality. As regards mutual banks, the reform envisaging the creation of cooperative banking groups makes their strengthening much easier; it should be implemented without delay. *** The difficulties facing the Italian banks will be solved all the more easily the sooner the economic recovery gains a firm footing: non-performing loans will be disposed of more quickly and the recovery of profitability will be less complex. The improved economic outlook would make it possible for saving to fund business investment. For the economy to return to a path of stable growth, however, capital accumulation must, crucially, resume at a more vigorous pace. The measures set out in the ‘Industry 4.0’ plan announced by the Government will provide further impetus for public support to firms’ innovation and investment activity. This action is part of a broader reform strategy that has been taking shape over the years. Important measures have been implemented and are now yielding their first results. The only option is to continue resolutely along this path in order to provide a better working environment for firms, assist the creation of new job opportunities, and reduce the imbalances weighing down our economy and our society. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Testimony of Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Joint Session of the Fifth Committees of the Chamber of Deputies (Budget, Treasury and Planning) and of the Senate of the Republic (Budget), Chamber of Deputies, Rome, 3 October 2016.
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Joint Session of the Fifth Committees of the Chamber of Deputies (Budget, Treasury and Planning) and of the Senate of the Republic (Budget) Preliminary hearing on the 2016 Update of the Economic and Financial Document Testimony of the Deputy Director General of the Bank of Italy Luigi Federico Signorini Chamber of Deputies Rome, 3 October 2016 Mr President, Honourable Members of Parliament, I wish to thank the Fifth Committees of the Chamber of Deputies and of the Italian Senate for inviting the Bank of Italy to give testimony on the 2016 Update of the Economic and Financial Document. Given the brief time that has elapsed since its publication, I will focus mainly on the macroeconomic outlook and on developments in the public finances this year; I will then make some preliminary remarks on the finance plans and outlook for the next few years. 1. The macroeconomic outlook The Italian and euro-area economies continue to benefit from today’s extremely accommodative monetary and financial conditions. The outcome of the UK referendum initially triggered considerable fluctuations on the international markets, which subsequently eased; a few months on, the effects on the markets have proven limited, in part thanks to the action of monetary authorities. Uncertainty persists, however, about the longer-term implications of the UK’s decision to rescind its membership of the European Union. World trade growth has been slower than expected. In the euro area the recovery is proceeding but at a slower pace than a few months ago. Consumer price inflation is inching upwards, but core inflation has yet to record the robust growth required to bring it closer to the inflation objective. According to the ECB staff macroeconomic projections released on 8 September, euro-area real GDP will expand by 1.7 per cent this year and by 1.6 per cent in both 2017 and 2018. HICP inflation is projected to average 0.2 per cent in 2016, and to rise to 1.2 and 1.6 per cent in 2017 and 2018 respectively. In Italy stuttering economic growth in the second quarter – which had not been foreseen at the start of the year – reflected stagnant domestic demand. Lower investment in machinery and equipment was mostly offset by a further increase in that on transport equipment. Since the start of the recovery in 2014, investment in Italy has been more sluggish both in comparison to other euro-area countries and relative to what is generally the norm when countries are pulling out of a recession. Our analyses and findings from business surveys indicate that investment is still being blocked by weak demand expectations and uncertainty about future economic trends, geopolitical developments, and the consequences of the UK referendum. It is no longer demonstrable that credit availability poses a major obstacle to investment decisions; business lending is not growing essentially as a result of weak demand. The differences across categories of firms are significant: trends in loans to firms with more than 20 employees and to those in services are positive, while in the construction sector they remain negative. Interest rates on new business loans continue to fall and the differential with respect to the corresponding euro-area average has been all but wiped out. In the three months ending in August, lending to the non-financial private sector stagnated on a seasonally adjusted basis, while household lending continues to expand (1.4 per cent on an annualized basis); loans to non-financial corporations contracted by 1.2 per cent. For new loans to firms the cost of borrowing has come down by around 25 basis points from the end of 2015. Signs from the labour market are positive overall. In 2015, thanks in part to the social security contribution relief for open-ended hiring and the introduction of contracts with rising levels of protection, employment grew more rapidly than trends in output might have suggested. In 2016 employment continued to expand; during the year there have been signs of a slowdown, possibly also in connection with the retrenchment of social security contribution relief. Following the hiatus of the second quarter, GDP – on the basis of the information provided by the cyclical indicators – could start to increase again in the third, albeit at a very slow pace. In July industrial output rose by 0.4 per cent, returning to the average levels recorded in the second quarter. In September business confidence was bolstered across all sectors of economic activity, also thanks to the more favorable assessments on order books. Household confidence is still relatively robust, but below the levels recorded at the end of 2015. According to September’s Survey on Inflation and Growth Expectations, firms expect to increase investment expenditure overall in the second half of 2016. The macroeconomic outlook in the Update of the Economic and Financial Document is less favourable compared to that of April. According to the current legislation scenario, GDP in Italy will increase by 0.8 per cent this year (as against 1.2 per cent forecast in the spring) and slow slightly in the next (to 0.6 per cent, compared with 1.2 per cent). The downward revision reflects the deterioration of the international context and, in particular, the further weakening of world trade and the rise in oil prices, whose effects on exports and production activities in Italy appear to have been compounded by the appreciation of the exchange rate. The rate of inflation, obtained using the consumption deflator, is expected to reach 0.1 per cent and to rise to 1.7 per cent in 2017. The current legislation scenario for the two years 2016-17 is largely in line with the estimates available today. Among the recent assessments by leading private and institutional forecasters, the Government’s estimate for growth in 2017 is at the lower end of the scale; however, generally speaking the other forecasts discount the negative effects of the increase in indirect taxes envisaged under the EU’s ‘safeguard clauses’, which instead are taken into account in the Government’s unchanged legislation scenario. Following the publication in August of the GDP data in the second quarter, the main forecasters revised their growth forecasts significantly downward for 2017 as well. According to both the OECD’s Interim Economic Outlook released in September and the average assessments of the analysts polled by Consensus Economics in the same month, output will grow by 0.8 per cent in Italy both this year and the next. A less favourable outlook was depicted last 15 September by Confindustria’s Centre for Studies, which estimated an increase of 0.7 per cent this year, slowing to 0.5 per cent in 2017. Compared with the current legislation scenario, the Government’s policy scenario predicts sharply higher growth for next year (0.4 points) and lower inflation (0.8 points). The difference is owing to the cancellation of the VAT hike envisaged under the safeguard clauses coupled with other interventions the Government intends to make in its next budget law. These include public investment in infrastructure, tax incentives for firms that invest, and income support for pensioners. Overall, compared to the current legislation scenario the measures planned for 2017 entail an increase in net borrowing amounting to almost half a percentage point of GDP, and a comparable rise in output. The implicit multiplier in this forecast is high, also in view of the normally lagged response of private expenditure to budgetary measures. The Government estimates that the absence of any VAT increase will contribute 0.3 percentage points to GDP growth in 2017, a rather strong effect when compared to the econometric estimates based on past data. The other expansionary measures are expected to provide a further contribution of 0.3 percentage points. Since much depends on what intervention is taken and how it is implemented, to make any comprehensive assessment it will be necessary to await further details; the priority assigned to forms of investment support is certainly a welcome development. The Government has requested authorization from Parliament to increase the deficit from that indicated in the new policy scenario, by up to 0.4 percentage points of output, in order to finance greater spending necessitated by exceptional events, in particular to secure Italy’s territory and buildings and to manage migration flows. The current policy scenario does not take account of the effects on output of these eventual extra expenses. For the subsequent two years (2018-19), the GDP growth forecasts in the current legislation scenario are unchanged with respect to April’s estimates (1.2 per cent in 2018 and 1.3 per cent in 2019); the policy scenario, by contrast, has revised them downwards, by 0.2 percentage points a year. This change likely reflects the nature of the planned interventions and, in particular, the remodelling of the expected increases in indirect taxes. 2. The public finances in 2016 Compared to April’s Economic and Financial Document, the Update slightly modifies the estimates for this year. Net borrowing is expected to reach 2.4 per cent of GDP, one tenth of a point more than in the April forecast. The variation is mostly ascribable to lower growth expectations; running counter to this was the downward revision of capital expenditure and the upward revision of direct taxes. Although the new estimate is less favourable, the deficit is nonetheless expected to contract compared with 2015 (from 2.6 to 2.4 per cent of GDP). Available data on the cash balance and revenues are compatible with the Government’s estimates for net borrowing. At least in the first seven months of 2016 (compared with the year-earlier period and taking account of the effects of the main operations that have no impact on net borrowing and of a number of temporal asymmetries), it can be estimated that the general government borrowing requirement has improved by slightly more than what would be consistent with the Government’s estimates of net borrowing for this year. The Government’s forecasts of greater direct tax revenues in 2016 are in line with the trends observed so far in revenues for the State budget. In the first eight months of the year, net of lotteries and other gaming receipts, these grew by 4.0 per cent compared with the corresponding period of 2015, driven in particular by the solid performance of self-assessment tax returns. In the Update’s estimates, primary expenditure is forecast to remain basically stable, compared to growth of 1.8 per cent in nominal output. The ratio of taxes and social security contributions to GDP is expected to fall by 0.7 points of GDP. The structural deficit, net of the effects of the business cycle and temporary measures, is forecast instead to increase by half a percentage point of GDP compared to 2015, reaching 1.2 per cent in the policy scenario. In the policy scenario for 2016, the explanation for why net borrowing as a share of GDP falls but the structural deficit increases, can be found in the improved cyclical situation compared with 2015. The contraction of around 1 percentage point in the output gap (measured according to the EU methodology with a time horizon of four years underpinning the macroeconomic forecast) reduced the negative cyclical component of the deficit by more than half a percentage point of GDP; on the other hand, the cyclically-adjusted primary surplus, reflecting the expansionary stance of budgetary policy in 2016, contracted by a similar amount. The further diminution in interest payments (0.2 percentage points) enabled net borrowing to fall this year as well. The deterioration is greater than that indicated in the EU Council’s Recommendations of last July, taking into account the margins of flexibility recognized mainly for structural reforms and investment. In the Government’s assessment, the deviation is ‘not significant’ and should accordingly not endanger compliance in 2016 with the preventive arm of the Stability and Growth Pact. According to EU fiscal rules, in 2016 Italy should have cut its structural deficit by 0.5 percentage points of output, but in July the Council granted its request for flexibility in order to make structural reforms and public investments, totalling 0.75 percentage points of output. The structural deficit can accordingly expand by 0.25 percentage points. To this could be added a further degree of flexibility amounting to 0.1 points in connection with expenditure in response to exceptional events in particular the migration crisis and security, bringing the total deterioration permitted to 0.35 points; the relative assessment, however, will not be made by the Commission until the spring of 2017 on the basis of final outturns. Greater flexibility has been granted on condition that, when the next Draft Budgetary Plan is assessed, the Commission shall verify the fulfilment of the pledge the Government made in the spring to resume the adjustment towards the medium-term objective (budget balance in structural terms). According to April’s Economic and Financial Document, in 2016 debt as a share of output would begin to decline, albeit only slightly (by 0.3 percentage points). In the updated estimates the inversion in the trend has been postponed until next year. In 2016 the ratio of debt to GDP is expected to grow by 0.5 percentage points, reaching 132.8 per cent. Half of the revised estimate (0.4 percentage points) is ascribable to the effect of the reduction in the growth forecasts for GDP, which lowers the denominator of the ratio. The remainder is mostly owing to privatization receipts that were lower than those planned last year and confirmed in April’s Economic and Financial Document (0.1 per cent of GDP against 0.5 per cent). In part owing to unfavourable market conditions, in recent years the number of privatizations actually carried out has always been lower than that originally envisaged. Following the recent revisions to GDP and to the nominal value of debt, the ratio of debt to GDP in 2015 came to 132.3 per cent of GDP, 0.4 percentage points less than the figure published in the spring document. 3. Public finance projections and plans for 2017-19 I will now comment on the outlook for the public finances in the next few years, analysing, as is customary, first the projections on a current legislation basis (baseline estimates) and then the plans that take account of the measures the Government intends to put into effect in the next budget law. Current legislation projections. – Net borrowing is forecast to decrease gradually in the three years 2017-19; at the end of the planning horizon it is expected that the nominal budget balance will have been reached. Compared with the forecasts made in the 2016 Economic and Financial Document, the estimates in the Update have been revised upwards by 0.2 percentage points of GDP in 2017 (to 1.6 per cent) and by around 0.4 percentage points on average for the two years 2018-19. These revisions mainly reflect the slowdown in GDP growth, partially offset by a reduction in interest payments (of about 0.1 percentage points of GDP on average over the three years). The primary surplus as a percentage of GDP is expected to increase from 1.5 per cent this year to 2.1 per cent in 2017, reaching 3.4 per cent at the end of the forecasting horizon, representing a downward revision of about 0.4 percentage points per year on average compared with last April’s estimates. Structural net borrowing is expected to diminish by 0.6 points in 2017 and to continue to decline in the following two years, reaching 0.2 per cent of GDP in 2019 (against a surplus of 0.1 percentage points as estimated in April’s Economic and Financial Document). In the current legislation scenario, general government debt will begin to diminish next year; in the following two years the decline will be more pronounced; at the end of the forecasting horizon public debt will reach 126.1 per cent of GDP. The fall in the debt to GDP ratio in the three years 2017-19 is now expected to be two percentage points smaller than in April’s Economic and Financial Document, which forecast that the reduction would have already begun this year. Plans and measures. – The fiscal stance, measured by the change in the cyclically-adjusted primary surplus, is basically unchanged from that planned in April; also in this instance the changes in the objectives are therefore mostly ascribable to the worsening of the economic situation since April. Fiscal policy is expected to remain expansionary in 2017 and become slightly more restrictive in the following two years. The cyclically-adjusted primary surplus is expected to decline from 2.9 per cent of GDP in 2016 to 2.6 per cent in 2017; in the following two years it should increase steadily, reaching 3.2 per cent of GDP in 2019. Planned net borrowing in 2017 amounts to 2.0 per cent of GDP (against 1.6 per cent in the current legislation scenario). The structural balance is unchanged from the previous year. April’s Economic and Financial Document fixed an objective of 1.8 per cent for net borrowing in 2017 and an improvement in the structural balance of 0.1 percentage points. Given the current economic situation the Government believes it would be counterproductive to make a structural adjustment in 2017. In April’s Economic and Financial Document the estimated output gap for 2017 was negative, at a little more than 1 per cent of potential output; in 2018 the output gap was projected to be zero, turning positive in 2019 (0.7 percentage points). However, the Update – which continues to utilize the European Commission’s methodology – estimates an output gap of -1.7 per cent for 2017, which will be reduced in 2018 and amount to nil in 2019. As already announced in the last Economic and Financial Document, in 2017 the Government intends to avoid the indirect tax increases provided for by the 2015 Stability Law and to only partly offset the effects of this decision with measures to counter tax evasion and elusion together with others to reduce spending. A thorough analysis of the effectiveness of the anti-tax evasion measures taken in the past (for example ‘split payments’ or ‘reverse charges’) would enable prevention and counter measures to be oriented towards the instruments that have actually proved most effective in practice. The safeguard clauses provide for an increase in the VAT rate (and in the excise duties on mineral oils starting in 2018) to ensure higher revenues of €15.1 billion in 2017 and €19.6 billion starting in the following year. The Government has also announced further measures for 2017, mainly in the field of social security and support for public and private investment; these will be detailed in the draft budget law due to be presented to Parliament by 20 October. The Update gives no specific indications as to the main areas of intervention of the fiscal policy measures for the next three years or the expected financial effects in terms of revenue and expenditure. As I mentioned in reference to the macroeconomic scenario, the Government is also asking Parliament for authorization to increase, if necessary, net borrowing by up to a maximum of 0.4 percentage points of GDP in 2017 (€7.7 billion). The request specifies that any increase in the deficit would reflect spending necessitated by exceptional events, in particular to secure Italy’s territory and buildings and to manage migration flows. The policy scenario does not take account of the effects of these potential outlays. Net borrowing is forecast to fall to 1.2 per cent of GDP in 2018 and to 0.2 per cent in 2019. In terms of the structural deficit, the adjustment would begin again in 2018 and a broadly balanced budget (the medium-term objective for Italy) would be achieved in 2019, as already forecast in April’s Economic and Financial Document. The debt to GDP ratio should begin to fall in 2017; at the end of the forecasting horizon (2019) the reduction would be about half a percentage point lower than that indicated in the current legislation scenario. One contribution to this reduction is expected to come from privatizations, whose objectives for the three years 2017-19 are the same as in April’s Economic and Financial Document (0.5 per cent of GDP in each of the two years 2017-18 and 0.3 per cent in 2019). Over the three years, the debt to GDP ratio is expected to decline at a slower pace than planned in the spring (by 6.2 instead of 8.6 percentage points), mainly owing to the smaller-than-expected growth in nominal GDP. As indicated in the Update and in April’s Economic and Financial Document, the numerical criterion of the debt rule will not be met either this year or the next. In April, the distance from the benchmark provided for in the debt rule was shorter; on that occasion, the Government had explicitly recalled the relevant factors – such as low inflation – which suggested that there would be no violation of the rule, despite the failure to reach the benchmark. The Government considers that the objectives in the Update are consistent with EU rules, also in view of the deterioration of cyclical conditions and the revised estimate of the output gap. The European Commission will issue its opinion on this in November, when it assesses the Draft Budgetary Plan. In May the Commission assessed Italy’s Stability Programme, signalling the risk of a significant deviation from the objectives set by European rules and calling for a larger structural adjustment in 2017 in respect of what had been planned. The flexibility margins granted by the Commission in 2016 (0.85 percentage points of GDP) were conditional on the resumption of consolidation in 2017. 4. Conclusions Mr President, Honourable Members of Parliament, Before drawing to a close, I will summarize the main points I wished to bring to your attention and make some concluding remarks. The current legislation macroeconomic scenario for the two years 2016-17 prudently takes account of the worsening of the external situation; on the basis of the information available, the scenario as outlined accordingly appears tenable. The available data on the general government cash balance are consistent with the Government’s estimate of the deficit for 2016. The policy scenario for 2017 projects that GDP growth will be significantly stronger than in the baseline scenario. The objective is an ambitious one. The forecast is based on a mix of budgetary provisions about which the Update does not go into detail. To achieve the desired results, the next budget law will have to be drawn up with great care. Turning to the measures to support growth, it would be a good idea to focus attention on those that could encourage a rapid recovery of both private and public investment. For the latter, in particular, not only must resources be allocated but safeguards also put in place to ensure their efficient and prompt utilization. The recessionary effects of the necessary funding could be limited by pinpointing any waste that can be eliminated and by keeping down general government running costs. If the outturn data confirm the forecasts, the ratio of current primary expenditure to GDP will decline slightly in 2016 as well, continuing the trend of the last two years (data adjusted for the tax credits for employees with medium-low incomes). I believe that the reduction in primary spending is an important result; indeed it is essential that this objective be pursued with increasing determination, if the public finances are to be kept under control without having to rely solely on today’s exceptionally low interest rates and without squeezing investment, whose recovery is essential for growth. The more the efforts made to limit outlays in recent years are systematic and built into an in-depth spending review, the greater, more robust and longer-lasting the results will be. The Italian economy is benefiting from the euro-area’s exceptionally expansionary monetary policy. This is no reason not to act, quite the contrary: other economic policies can and must exploit the space this creates. Lower interest payments allow us to begin to reduce the public debt without slowing the economy – essential for a country like Italy, which has such a large accumulated public debt. Cyclical stimulus enables the short-term costs of structural reforms to be lowered, creating the conditions to accelerate their implementation and making it easier to revive and complete them. Reducing Italy’s debt burden remains a strategic objective. Undoubtedly one of the reasons that this did not start to happen this year was the poor performance of GDP and the difficulties in concluding, in adverse market conditions, the privatizations originally envisaged. Certainly, market conditions are important in deciding which privatizations to carry out and when. If, on the one hand, it is better to make cautious predictions about how much can actually be privatized year by year, on the other, by making clear, ambitious strategic choices, it will be possible to act swiftly and for significant amounts when market conditions so permit. An appropriate privatization strategy should more than help to reduce the debt: flanked by the proper rules and controls, it must also aim to raise efficiency. TABLES AND FIGURES Table 1 Macroeconomic Outlook in the 2016 Economic and Financial Document (EFD) and in the Update to the 2016 Economic and Financial Document (percentage changes) 2016 EFD Update to the 2016 EFD CURRENT LEGISLATION SCENARIO Real GDP 0.8 1.2 1.2 1.2 1.3 0.7 0.8 0.6 1.2 1.3 Imports 6.0 2.5 3.2 4.3 4.0 6.0 2.3 2.2 3.2 3.8 Consumption by households and nonprofit institutions 0.9 1.4 1.0 1.3 1.4 1.5 1.2 0.4 1.0 1.2 General government expenditure -0.7 0.4 -0.1 -0.4 0.8 -0.6 0.4 0.0 -0.3 0.2 Investments 0.8 2.2 2.5 2.8 2.5 1.3 1.9 1.5 2.6 2.8 Exports 4.3 1.6 3.8 3.7 3.5 4.3 1.3 2.5 3.3 3.5 Nominal GDP 1.5 2.2 2.6 2.9 3.0 1.4 1.8 1.8 2.9 3.0 Consumption deflator 0.1 0.2 1.8 1.8 1.8 0.0 0.1 1.7 1.7 1.6 Employment (full-time equivalents) 0.8 0.8 0.7 0.7 0.6 0.8 0.9 0.4 0.6 0.8 POLICY SCENARIO Real GDP 0.8 1.2 1.4 1.5 1.4 0.7 0.8 1.0 1.3 1.2 Imports 6.0 2.5 3.8 4.6 4.2 6.0 2.3 3.3 3.4 4.0 Consumption by households and nonprofit institutions 0.9 1.4 1.4 1.7 1.6 1.5 1.2 1.0 0.9 0.9 General government expenditure -0.7 0.4 -0.3 -0.5 0.8 -0.6 0.4 0.5 -0.4 0.3 Investments 0.8 2.2 3.0 3.2 2.4 1.3 1.9 3.2 3.6 3.8 Exports 4.3 1.6 3.8 3.7 3.4 4.3 1.3 2.5 3.3 3.3 Nominal GDP 1.5 2.2 2.5 3.1 3.2 1.4 1.8 1.9 3.0 3.1 Consumption deflator 0.1 0.2 1.3 1.6 2.0 0.0 0.1 0.9 1.9 2.2 Employment (full-time equivalents) 0.8 0.8 0.8 0.9 0.7 0.8 0.9 0.6 0.8 0.8 Table 2 Main public finance indicators for general government (per cent of GDP) Revenue 44.0 45.3 45.1 45.9 45.6 45.7 47.8 48.1 47.9 47.8 Expenditure of which: interest payments 47.6 46.8 47.8 51.2 49.9 49.4 50.8 50.8 50.9 50.4 4.4 4.8 4.9 4.4 4.3 4.7 5.2 4.8 4.6 4.2 Primary surplus 0.9 3.2 2.2 -0.9 0.0 1.0 2.3 2.1 1.6 1.5 Net borrowing 3.6 1.5 2.7 5.3 4.2 3.7 2.9 2.7 3.0 2.6 Total borrowing requirement 3.8 1.7 3.1 5.5 4.3 3.9 4.1 4.8 4.1 3.1 Borrowing requirement net of privatization receipts 3.8 1.9 3.1 5.6 4.3 4.0 4.6 4.9 4.3 3.5 Debt 102.6 99.8 102.4 112.5 115.4 116.5 123.3 129.0 131.9 132.3 Debt net of the financial support given to EMU countries 102.6 99.8 102.4 112.5 115.1 115.7 120.7 125.5 128.2 128.7 Source: Based on Istat data for the general government consolidated accounts items. (1) Rounding of decimal points may cause discrepancies in totals. ─ (2) The proceeds of sales of public assets are recorded as a deduction from this item. ─ (3) A negative value corresponds to a deficit. ─ (4) Excludes liabilities related to capital contributions to the European Stability Mechanism (ESM) and loans to EMU member countries, disbursed both bilaterally and via the European Financial Stability Facility (EFSF). Table 3 General government revenue (per cent of GDP) Direct taxes 13.8 14.5 14.7 14.1 14.1 13.9 14.9 15.0 14.7 14.8 Indirect taxes 14.5 14.4 13.6 13.4 14.0 14.1 15.3 14.9 15.4 15.2 Capital taxes 0.0 0.0 0.0 0.8 0.2 0.4 0.1 0.3 0.1 0.1 Tax revenue Social security contributions Tax revenue and social security contributions Production for market and for own use 28.3 28.9 28.3 28.4 28.3 28.4 30.3 30.2 30.1 30.1 11.9 12.6 13.0 13.5 13.3 13.2 13.4 13.4 13.2 13.3 40.2 41.5 41.3 41.8 41.6 41.6 43.6 43.6 43.4 43.4 1.8 1.8 1.9 2.0 2.0 2.0 2.1 2.3 2.3 2.3 Other current revenue 1.7 1.7 1.7 1.8 1.9 1.8 1.8 1.9 2.0 1.9 Other capital revenue 0.3 0.3 0.2 0.2 0.2 0.2 0.3 0.3 0.3 0.3 Total revenue 44.0 45.3 45.1 45.9 45.6 45.7 47.8 48.1 47.9 47.8 Source: Based on Istat data. (1) Rounding of decimal points may cause discrepancies in totals. Table 4 General government expenditure (per cent of GDP) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Compensation of employees Intermediate consumption Social benefits in kind Social benefits in cash Interest payments Other current expenditure Total current expenditure of which: expenditure net of interest payments Gross fixed investments Other capital expenditure Total capital expenditure Total expenditure of which: expenditure net of interest payments 10.6 4.9 2.7 16.3 4.4 3.3 42.2 10.2 4.9 2.6 16.4 4.8 3.4 42.3 10.4 5.1 2.7 17.0 4.9 3.4 43.5 10.9 5.4 2.9 18.5 4.4 3.7 46.0 10.8 5.4 2.9 18.6 4.3 3.7 45.7 10.4 5.3 2.7 18.6 4.7 3.7 45.4 10.3 5.4 2.7 19.3 5.2 3.9 46.8 10.3 5.6 2.7 19.9 4.8 4.1 47.4 10.1 5.5 2.7 20.2 4.6 4.2 47.2 9.8 5.4 2.7 20.3 4.2 3.9 46.3 37.7 2.9 2.5 5.5 47.6 37.5 2.9 1.6 4.5 46.8 38.5 3.0 1.4 4.4 47.8 41.5 3.4 1.8 5.2 51.2 41.4 2.9 1.2 4.2 49.9 40.7 2.8 1.2 4.0 49.4 41.6 2.6 1.4 4.0 50.8 42.6 2.4 1.0 3.4 50.8 42.6 2.3 1.4 3.7 50.9 42.1 2.2 1.9 4.1 50.4 43.2 42.0 42.9 46.7 45.6 44.7 45.6 46.0 46.3 46.2 Source: Based on Istat data. (1) Rounding of decimal points may cause discrepancies in totals. Table 5 General government borrowing requirement (billions of euros) Year First 7 months Borrowing requirement net of privatization receipts (a) 78.9 69.9 57.6 36.8 21.4 22.6 Privatization receipts (b) 1.9 3.3 6.6 3.3 3.3 0.8 Total borrowing requirement (c=a-b=d+e+f+g+h+i) 77.0 66.5 51.0 33.5 18.1 21.8 Currency and deposits (1) (d) -1.8 14.7 5.1 5.9 0.3 -5.4 of which: Post Office deposits -2.2 -1.1 -1.5 -0.5 -1.5 -0.6 Short-term securities (e) -11.0 -16.0 -9.5 0.3 3.5 2.3 Medium- and long-term securities (f) 91.7 82.0 44.2 104.1 65.3 90.3 Loans from MFIs (g) -3.6 -4.3 1.7 -2.9 1.8 0.8 Other liabilities (2) (h) of which: loans via the EFSF Change in the Treasury’s liquidity balance (3) (i) 4.9 7.2 -3.2 -1.2 1.8 -8.8 -1.1 -2.1 10.7 -1.8 1.6 -72.1 -3.0 -2.1 -49.8 -0.9 0.0 -65.3 FINANCING (1) Includes Post office deposits, notes and coins in circulation, and deposits held with the Treasury by entities not included in general government. – (2) Includes securitizations, trade credits assigned without recourse by the general government’s supplier firms to non-bank intermediaries, private-public partnership operations and liabilities related to loans to EMU countries disbursed via the EFSF. – (3) A negative value corresponds to an increase in the Treasury’s liquidity balance. Table 6 Public finance objectives and estimates for 2016 (per cent of GDP) Memorandum item: General government Net borrowing Structural net borrowing Primary surplus Debt GDP growth rate Debt 2015 Objectives April 2015 Autumn 2015 April 2016 September 2016 1.8 2.4 2.3 2.4 0.4 …. 1.2 1.2 2.4 1.8 1.7 1.5 130.9 131.4 132.4 132.8 1.4 1.6 1.2 0.8 132.5 132.8 132.7 132.3 Estimates April 2016 September 2016 2.3 2.4 1.3 1.4 1.7 1.5 132.4 132.8 1.2 0.8 132.7 132.3 (1) Economic and Financial Document 2015. – (2) Net borrowing and primary surplus based on data in the Technical Note to the 2016 Stability Law; debt based on data in the 2016 Draft Budgetary Plan. – (3) 2016 Economic and Financial Document – (4) 2016 Update to the Economic and Financial Document. Table 7 Policy scenario in the 2016 Economic and Financial Document and in the Update to the 2016 Economic and Financial Document (per cent of GDP) 2016 EFD Update to the 2016 EFD Net borrowing 2.6 2.3 1.8 0.9 -0.1 2.6 2.4 2.0 1.2 0.2 Primary surplus 1.6 1.7 2.0 2.7 3.6 1.5 1.5 1.7 2.4 3.2 Interest payments 4.2 4.0 3.8 3.6 3.5 4.2 4.0 3.7 3.6 3.4 GDP growth rate 0.8 1.2 1.4 1.5 1.4 0.7 0.8 1.0 1.3 1.2 Debt 132.7 132.4 130.9 128.0 123.8 132.3 132.8 132.5 130.1 126.6 (1) Rounding of decimal points may cause discrepancies in totals. – (2) Gross of financial support given to EMU countries. Table 8 Privatization receipts: objectives and outturns (per cent of GDP) 1.0 Objectives 1.0 1.0 1.0 1.0 Update to the 2013 EFD (September 2013) 0.5 0.5 0.5 0.5 2014 EFD (April 2014) 0.7 0.7 0.7 0.7 Update to the 2014 EFD (September 2014) 0.3 0.7 0.7 0.7 0.7 2015 EFD (April 2015) 0.4 0.5 0.5 0.3 Update to the 2015 EFD (September 2015) 0.4 0.5 0.5 0.5 2016 EFD (April 2016) 0.5 0.5 0.5 0.3 Update to the 2016 EFD (September 2016) 0.1 0.5 0.5 0.3 2013 EFD (April 2013) Outturns Total 0.1 0.2 0.4 0.0 Memorandum item: billions 1.9 3.3 6.6 0.8 (1) The objectives expressed as a percentage of GDP are those indicated in the various planning documents. The objectives and outturns include reimbursements of the capitalization tools issued by the banks and underwritten by the MEF (the ‘Tremonti/Monti bonds’). – (2) The data refer to revenues paid into item 4055 of the State budget (mostly proceeds from the sale of State shareholdings); for 2013, includes also proceeds from the sale of Fintecna S.p.A., not paid into item 4055 but accounted for as a reduction in the borrowing requirement (0.6 billion). – (3) Outturns up to July 2016. Figure 1 Interpolated distribution of the GDP growth forecasts for Italy in 2017 MEF - policy scenario (1.0 per cent) Consensus Economics (0.8 per cent) MEF - current legislation scenario (0.6 per cent) 0.1 0.0 0.3 0.5 0.6 0.8 1.0 1.2 1.3 1.5 (1) Forecasts updated to September 2016. Figure 2 Primary surplus: objectives and outturns (per cent of GDP) 6.0 6.0 5.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 EFD Update (Sept. 2013) EFD (April 2014) EFD Update + Draft Budgetary Plan (Oct. 2014) EFD (April 2015) EFD Update (Sept. 2015) Outturns (Sept. 2016) EFD (April 2016) EFD Update (Sept. 2016) Figure 3 General government debt (per cent of GDP) '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 Source: For GDP, based on Istat data (23 September 2016, press release). Figure 4 Twelve-month cumulative borrowing requirement (monthly data; billions of euros) General government General government excluding financial assistance to EMU countries State sector excluding financial assistance to EMU countries Source: Ministry of Economy and Finance for the state sector borrowing requirement. (1) Excluding privatization receipts. – (2) Excludes liabilities related to Italy’s capital contribution to the ESM and to loans to EMU member countries, disbursed both bilaterally and via the EFSF. – (3) Excludes liabilities in connection with bilateral loans to EMU member countries and Italy’s capital contribution to the ESM; loans disbursed through the EFSF are not included in the state sector borrowing requirement. Figure 5 10-year spreads on government bonds with respect to Germany (basis points) 3,400 2,300 3,400 2,300 Greece Portugal 1,200 1,200 1,200 1,200 1,000 1,000 Greece Ireland Italy Spain France Greece Spain Italy Ireland giu lug ago set apr mag gen feb mar ott dic set nov lug giu ago mag gen feb mar apr ott dic set nov lug giu ago apr mag feb mar ott dic gen set nov lug ago apr mag giu feb mar ott dic gen nov lug giu ago set mag feb mar apr dic gen set ott nov lug ago apr mag giu gen feb France mar Portugal Portugal Figure 6 Average cost of the public debt, average gross rate on BOTs, and gross yield on 10-year BTPs (per cent) 8.0 8.0 7.0 7.0 6.0 6.0 5.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 -1.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Average cost of the public debt Gross yield on 10-year BTPs - 1.0 Average gross interest rate on BOTs Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Address by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Bank of Italy workshop on "Unconventional monetary policy: effectiveness and risks", Rome, 21 October 2016.
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Reflections on monetary policy in the euro area at the current juncture Address by the Deputy Governor of the Bank of Italy Luigi Federico Signorini Bank of Italy workshop on “Unconventional monetary policy: effectiveness and risks” Rome, 21 October 2016 It is a pleasure to welcome you to the Banca d’Italia for this one-day workshop on ‘Unconventional monetary policy: effectiveness and risks’. I understand that you have a full agenda, with nine dense and thought-provoking papers packed into a single day. I will keep my remarks very brief. Your discussions today are sure to be policy-relevant and timely. The Governing Council of the ECB has repeatedly asserted, most recently yesterday, that the asset purchase programme (APP) will continue at the current pace of purchases until at least March 2017, or possibly beyond if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its target. Properly measuring the effects of the APP is therefore a priority for the euro area monetary policymakers. The Eurosystem’s expanded APP has been in place for almost two years, exerting clear and sizeable downward pressure on government bond and other financial asset yields; these, in turn, have had favourable effects on private sector financing conditions. Monetary policy on its own cannot produce growth. It can, however, create favourable conditions for a cyclical upturn; it may facilitate the adoption of other measures, such as structural reforms, by limiting the negative short-run impact that is sometime associated with them. As a joint outcome of the APP and the other extraordinarily expansionary measures recently adopted by the Eurosystem, the cost of bank loans is now historically low and, even more importantly, the dispersion of lending rates across countries is once again close to the levels prevailing in the pre-crisis period. This helps to preserve the integrity of the monetary union. Still, almost ten years after the onset of the financial crisis and five years after the start of the sovereign debt crisis, the slack in the euro-area economy persists. A number of questions are being raised on the functioning of the expansionary measures recently adopted by the Eurosystem. How does the transmission mechanism work when the economy is at the lower bound of the interest rates? Might the working of those measures be impaired after some time? What are the interactions with other developments, such as commodity prices, financial regulation, legacy assets in banking, and conditions in the world economy? Could specific monetary policy measures adopted by the ECB weaken the transmission mechanism by negatively affecting banks’ profits and capital accumulation and hence lower the incentives for banks to engage in lending activities? Many factors are at work, and disentangling the impact of the APP from that of other measures is of capital importance in informing the monetary policymakers’ decisions. Yet, it is no easy task; and that is why solid, in-depth analysis, looking at these issues from different angles and with different tools, is surely needed. The first part of today’s workshop will provide several interesting papers which attempt at doing that. The second half will deal with another question that is being asked in the monetary policy debate, namely whether the current, extraordinarily expansionary monetary policy stance is inducing excessive risk-taking and thereby possibly igniting tomorrow’s financial crises. Low interest rates and yields make investors inclined to search-for-yield and embark on riskier investment strategies. Up to a point, this is not an unintended consequence of the current monetary policy measures, but actually part of the hoped-for transmission mechanism. Portfolio rebalancing is a key component of the mechanism that is expected to transmit the APP to the real economy. It is conceivable, however, that this may eventually go too far and the amount of risk-taking induced by the Eurosystem’s monetary policy exceeds what is optimal and results in more costs than benefits. I do not think there is any evidence that this is happening so far at the aggregate level. There are localized tensions, particularly in the property market in certain member states; these need to be tackled, and are being tackled, by macroprudential measures. Opinions on the respective roles of monetary policy and macro prudential tools differ, as is perhaps natural given that macro-prudential policy is still in its infancy; more research on these topics is therefore welcome. Looking at today’s impressive collection of papers, I have no doubt that the workshop will go a long way towards providing us with answers to many of the questions I listed. I very much look forward to hearing about your findings and the outcome of your discussions. Before the presentations begin, I would like to thank all those that contributed to this workshop, both from the Banca d’Italia and from other national central banks of ESCB or academia. I wish you all a most successful workshop, and a pleasant stay in Rome and at the Banca d’Italia.
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Remarks by Ms Valeria Sannucci, Deputy Governor of the Bank of Italy, at the Rome Investment Forum 2016, Rome, 16 December 2016.
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Rome Investment Forum 2016 Fixing and completing the European Economic and Monetary Union: the costs of the unfinished Banking Union Remarks by Valeria Sannucci Deputy Governor of the Bank of Italy Rome, 16 December 2016 Over the last few years, Europe has undertaken numerous reforms in different areas, from fiscal to banking and financial stability, in what has been an ambitious response to the urgent need to resolve the problems that followed the outbreak of the global financial and sovereign debt crises. Several initiatives have been taken to strengthen European banks: from the definition and application of common rules, to the consolidation of truly European authorities. The Banking Union is a vital element of this strengthening process. The Single Supervisory Mechanism, which was completed in an extraordinarily short period of time, entails very extensive and deep integration of national authorities. While the Monetary Union mostly consisted in the sharing of decision making, the SSM envisages the integration of daily operational processes to be carried out at national and centralized level. The establishment of the SSM, followed by that of the Single Resolution Mechanism, could have been a prelude to a paradigm shift in the level of European integration. However, this has not yet materialized. On the contrary, the Banking Union is still under construction and significant obstacles remain on the path to its completion. Our presence here today therefore provides a timely opportunity to discuss what remains to be done, how to go about it, and ultimately to stress once again how important it is to complete this project, as has been repeatedly highlighted by researchers 1 and numerous representatives of the Eurosystem, first and foremost the ECB President. It is important not only for the sake of the Banking Union project in itself, but also for the achievement of the broader European project. It was no accident that the original blueprint for Banking Union rested on three pillars (banking supervision, crisis management, and deposit insurance): each one is an integral part of the financial architecture needed to safeguard the soundness and the stability of any banking system, and to break the vicious circle between banks and sovereigns. This is particularly important in Europe where, in spite of the multiplicity of sovereign states involved, we aim to achieve a single European banking market with European players. The first pillar of Banking Union, the Single Supervisory Mechanism, avoids misaligned incentives by ensuring that appropriate regulatory and supervisory standards are enforced and, at the same time, levels the playing field for cross-border banking. The second pillar, an 1 Among others, Balassone F., S. Cecchetti, M. Cecioni, M. Cioffi, W. Cornacchia, F. Corneli and G. Semeraro, 2016, ‘Economic governance in the euro area: balancing risk reduction and risk sharing’, Occasional Papers, Banca d’Italia, 344; Goyal R., P. Koeva Brooks, M. Pradhan, T. Tressel, G. Dell'Ariccia, R. Leckow, and C. Pazarbasioglu, 2013, ‘A Banking Union for the Euro Area’, IMF Staff Discussion Note SDN/13/01, February; Schoenmaker D. and A. Siegmann, ‘Winners of a European banking union’, 2013, VoxEU, 27 February; Gros D. and D. Schoenmaker, ‘The case for euro deposit insurance’, 2012, VoxEU, 24 September. incentive-compatible resolution framework, aims at reducing moral hazard; it can also preserve financial stability, so long as adequate provision is made for the eventual use of a public backstop for large and complex financial institutions. 2 The third pillar, a common deposit insurance scheme, would lower the probability of systemic stresses by closing off the channels of contagion, i.e. it would provide an effective buffer against a large number of country-specific shocks, thereby lowering the likelihood of bank runs and overall systemic risk. If the Banking Union were to remain as it is today, the result would neither be compliant with best practices, nor would it have achieved its intended effects. In fact, as Dirk Schoenmaker put it, now that the immediate crisis is past, 'governments have started to shop selectively on the Banking Union list’. 3 In this ‘à la carte’ Banking Union, the absence of common deposit insurance increases the risk of contagion, while a blunt implementation of the resolution framework with no public backstop in place would heighten financial stability risks. As recently noted by the Senior Deputy Governor of the Bank of Italy, the lack of a common fiscal backstop ‘reflects the unwillingness of many European countries to consider the possibility that the taxpayers of country A may pay, even temporarily, for the crisis of a bank in country B. According to this view, banks, although now supervised and subject to resolution by European institutions, must ultimately remain a national matter.’ 4 The outcome is that the bank-sovereign nexus, which the Banking Union was designed to counter, persists, within a complex and incomplete framework. European leaders must therefore not lose sight of the end goal and instead complete the project in a reasonable timeframe. The need to press ahead is made even more urgent by the fact that while the European banking and financial system has demonstrated its resilience, its stability is still at risk. Indeed, risks to Europe’s macro-financial stability have recently intensified. While it is true that the expansionary monetary policy stance in the euro area and in Europe at large is supporting the liquidity of financial markets, curbing tensions on government securities, and M., 2014, ‘European banking: Bailout, bail-in and state aid control’, International Journal of Industrial Organization, vol. 34, issue C, pages 37-43. 3 Schoenmaker D., 2015, ‘Firmer foundations for a stronger European banking union’, Bruegel Working Paper, 2015/13, November. 4 Rossi S., 2016, ‘The Banking Union in the European integration process’, speech at the Conference on European Banking Union and bank/firm relationship, April. 2 Dewatripont easing bank funding conditions, uncertainties have nevertheless increased following the UK referendum and, though perhaps less so, the Italian referendum. Nor, given recent political events, expected policy changes in the United States, and fragilities in emerging economies, are they likely to be dispelled over the medium term. European banks’ profitability and their business model are under extraordinary pressure, due to sluggish growth, low interest rates and, to a differing extent across countries and banks, excess capacity, large stocks of non- performing loans and difficult-to-value (level 3) assets. Meanwhile, low nominal interest rates are squeezing the profit margins of European insurance companies and pension funds. At a recent hearing of the Committee on Economic and Monetary Affairs of the European Parliament, the ECB President warned that a lengthy period of low interest rates has created ‘fertile terrain’ for financial-market risks and called on governments to take action against the risks associated with rising debt levels or excessive valuations, which have resulted in significant vulnerabilities in some European real estate markets. While they are more solid today than they were in the pre-crisis period, in the absence of an adequate, proportionate and properly functioning safety net, Europe’s banks are also more exposed than before to substantial risks to their individual stability. A common EU deposit guarantee scheme is a crucial component of the safety net and should be set up as swiftly as possible. In November 2015, the Commission presented a proposal for a European Deposit Insurance Scheme (EDIS). The idea is to build on the existing national schemes and then gradually move towards a European construction that would be fully in place by 2024. While the introduction of the third pillar is generally accepted in principle, controversy has arisen recently regarding its timing and negotiations are at a standstill due to the opposition of some countries. Introducing common deposit insurance is not enough, though. In order to bolster public confidence and to ensure that the Banking Union has the capacity to safeguard financial stability in adverse circumstances, we also need a common public backstop covering both resolution and deposit insurance. Furthermore, it is important to acknowledge that the ability of the new EU resolution framework to counter systemic crises has been somewhat overstated, especially when combined with the European Commission’s approach to competition and State aid. A recent paper by Emilios Avgouleas and Charles Goodhart warns against large-scale, bail-in centred, recapitalizations and illustrates the ‘danger of over-reliance on bail-ins’ by providing a very insightful description of the risks involved in triggering the bail-in process when risk is not idiosyncratic. 5 While the bail-in tool is actually well-designed for addressing the crisis of individual banks, in the event of a systemic crisis its use risks exacerbating the threats to financial stability rather than stabilizing the system. In those circumstances, the possibility of temporary public support, without necessarily involving banks’ creditors, should not only be considered but favoured, to dispel the fear of contagion and prevent the seeds of another crisis from being sown. Of course, envisaging public support in exceptional circumstances should not undermine efforts to reduce forms of moral hazard that can lead to excessive risk-taking by banks. The risk of imprudent behaviour still has to be contained but it can be tackled in other ways that are more compatible with safeguarding financial stability, along the lines of what happened in the aftermath of the crisis, i.e. by strengthening the prudential framework, adapting the structure of remuneration schemes to reduce incentives for excessive risk-taking, and by making management fully liable in the event of the failure of an institution. At the same time, the burden for taxpayers could be lightened by requiring that public funds be recouped from the banking system at a later stage, when financial stability is no longer at risk – as envisaged by the ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’, drawn up by the Financial Stability Board. 6 To conclude, while much has been done to reduce risks, we lag behind on risk-sharing measures, which are their natural complement. Even for those already in place, such as the Single Resolution Fund, the path to complete risk mutualization is very long. What are the costs of this unfinished construction? An incomplete Banking Union is a source of risk in itself. If neglected for too long, it will discourage banks’ reorganizations and consolidation processes as the cost of funding and capital remain subject to excessive uncertainty, with likely undesirable effects on banks’ ability to support both investment and consumer spending. In this transitional phase, when banks are still building up adequate loss-absorbing buffers and Governments are without their traditional tools of intervention, the risks are even greater. 5 Avgouleas E., C.Goodhart, 2016, ‘An anatomy of bank bail-ins – Why the Eurozone needs a fiscal backstop for the banking sector’, European Economy, 2016.2., 5 December. 6 Financial Stability Board, 2011, ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’, principle 6.5. We should also remember that completing the Banking Union is a priority per se, and should not be conditional on other interventions. I refer, in particular, to the much debated possible change of prudential treatment for sovereign exposures, which is among the measures called for in order to move forward with the creation of the EDIS. A draft report presented to the Committee on Economic and Monetary Affairs of the European Parliaments (ECON) 7 makes the entry into force of the insurance phase of EDIS conditional on reducing risks in the banking sector. In this regard, while recognising that changing the prudential treatment for sovereign exposures could help to break the bank-sovereign nexus, I believe that it should not be considered as a pre-condition for, or an alternative to, the completion of Banking Union. A clear timeline for deposit insurance, as we had for the Single Supervisory Mechanism and the Single Resolution Mechanism, would help reassure markets as to the soundness of the overall banking framework and the willingness of Member States to pursue the final design of the Union. In the meantime, the Single Supervisory Mechanism should continue to focus on further strengthening the resilience of the banking sector. However, we should avoid over-calibration and possible inconsistencies between different measures that might impair the ability of European banks to support the real economy. A path must be identified to guide banks towards adequate levels of capital and loss- absorbing capacity to increase their stability and readiness to withstand adverse market conditions without compromising their capacity to finance the economy and sustain the economic recovery. This is especially true today when banks’ profitability remains low and the recovery in the EU is still struggling to gain momentum. After substantially strengthening capital levels in recent years, EU banks will now be required to increase their loss-absorbing capacity to meet the minimum requirements for own funds and eligible liabilities (MREL). In this regard policymakers face a trade-off: on the one hand, large stocks of liabilities that can feasibly and credibly absorb losses in resolutions contribute to the resolvability of banks and to financial stability, while simultaneously protecting taxpayers; on the other hand, the build-up of adequate buffers of loss-absorbing 7 See European Parliament, Committee on Economic and Monetary Affairs, Working Document on EDIS and Draft Report on the Proposal for a regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme (COM(2015)0586 – C8-0371/2015 – 2015/0270(COD)), Rapporteur Esther De Lange. capacity may be very costly for banks, impair their lending capacity to the real economy, and require time. The review of the legislative framework, starting with the European Commission’s recent proposals, should strike the right balance. In any event, it is indispensable to avoid a needlessly high MREL requirement disproportionate to the effective needs of a resolution. 8 **** Let me conclude with two quotations. In a recent speech at the EMU Forum, Peter Praet said ‘Completing the union is sometimes framed in terms of a trade-off between risk sharing and risk reduction […] I believe both routes need to be followed and to move forward in parallel […]. A European Deposit Insurance Scheme would enhance overall depositor confidence … This is the very foundation of insurance: by pooling resources and risks across a larger and more diverse group, the overall shock-absorbing capacity of the system increases. In this sense, risk sharing turns into risk reduction’. 9 In a working paper published a few months ago on the economic governance of the euro area, a group of researchers at the Bank of Italy reviewed the measures taken concerning sovereigns and banks since 2010 and concluded that Europe is now at a crossroads: ‘either it finds the strength to return to its roots and embraces a second (and deeper) round of reforms based on enhanced risk sharing, or it risks running into pro-cyclical excesses that may finally tear it apart’. 10 This forum may therefore provide a valuable contribution to enhancing the awareness of policymakers about the dramatic, yet possible outcomes of a piecemeal, short-sighted approach to the completion of Banking Union. 8 Bank of Italy, Financial Stability Report No. 2 / 2016, November 2016, p. 36-37. 9 ‘The importance of a genuine banking union for monetary policy’, Vienna, 24 November 2016 10 Balassone et al.
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Panel discussion by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Collegio Carlo Alberto, University of Torino, Moncalieri, 19 December 2016.
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Collegio Carlo Alberto Università degli Studi di Torino Economic Challenges Facing Europe and the World Panel Discussion of Deputy Governor of the Bank of Italy Luigi Federico Signorini Moncalieri, 19 December 2016 Germany and Italy have been called on to chair the G20 and G7 in economically and politically turbulent times, in the world at large as well as in our common European home. Several years down the road, the legacies of the global financial crisis and of the sovereign crisis in the euro area are still apparent. Sluggish growth, high private and public debt, unemployment and underemployment, as well as a general sense of disillusionment among broad swathes of the population are affecting many countries to varying extents. These facts and feelings are also engendering widespread ‘anti-globalization’ sentiment, as well as doubts about the European project. This reaction has deep-rooted causes on which I shall spend a few words later but first of all, let me point out that this is one of the most compelling reasons why coordination between the German and Italian presidencies is so important. We must exploit synergies and join efforts to reach the broadest possible consensus among advanced and emerging economies, taking actions that can stem what I see as a potentially dangerous spiral of rising disaffection and protectionism. The Italian Presidency will continue the work of past G7s in well-known areas, combating money laundering and terrorist financing, fostering international cooperation among tax authorities and enhancing cyber security (the latter an increasingly pressing issue on today’s global agenda). But there is also the intention to promote an open-minded and broad debate on two issues that that go some way to addressing the concerns I mentioned earlier. The first issue, financial regulation, has been at the centre of our agenda since the outbreak of the global financial crisis, when the G20 and its technical bodies took on the task of redesigning financial sector regulations to avert similar shocks in the future. The past few years have seen a comprehensive, radical overhaul of financial regulation. It seems reasonable now to step back for a moment and look at the bigger picture. Have we done enough? Or is it possible that we have been doing even too much? The re-regulation of the banking system has certainly been necessary, timely, and – within the limits of human fallibility – I believe it has done a lot to make banks safer. But we need to know where to stop, at least for some time. We need, first, to give a minimum of stability to the regulatory framework; second, to take stock of the work done and gain experience to evaluate its longer-term effects; third, and perhaps most importantly, strike a balance between securing the financial system and avoiding rules that would overly penalize risk-taking, without which no growth is possible. At the beginning of this year the group of central bank governors and heads of supervision of the G20 instructed the Basel Committee to refrain from ‘significantly increasing overall capital requirements’ 1 at this stage. The Basel 3 package is currently being finalised on this premise. While agreement is not yet assured, I think we are close. Let me take this opportunity to say that my firm view is that an agreement is necessary to give certainty to the financial world. The conditions are there and we should not miss the opportunity. Assuming such an agreement can be reached, in the field of banking regulation the next few years should be devoted to maintaining the regulatory system, not to overhauling it radically once again; we also need to review the rules, by checking for any embedded procyclicality or other unintended consequences, rather than establishing further capital requirements. Efforts to limit banking risks, however, are only part of the answer. The financial landscape is changing apace. The growth of intermediaries outside the banking sector points to the need for new micro- and macro-prudential tools. Work has begun in this area but much remains to be done. Furthermore, a host of innovations (digital currencies, distributed ledgers, peer-to-peer lending, crowdfunding, to name but a few) have opened new frontiers for financial services and started to blur the boundaries of the financial sector itself. There is great potential for financial inclusion and efficiency gains here, but there are also implications for monetary operations and transmission, as well as new risks to stability, integrity, and end-user protection. This raises issues about the Group of Central Bank Governors and Heads of Supervision (10 January 2016); as Stefan Ingves, chairman of the Basel Committee, recently noted, this must be one of the most frequently cited phrases in regulation debates these days. perimeter of financial regulation and the appropriate regulatory and policy measures. The FSB and various standard-setting bodies have already conducted a broad discussion on general themes like definitions, opportunities and risks; it is now time to turn to discussing concrete policy questions. A key point at this stage is to decide what requires swift international coordination, and what is best left, at least for now, to jurisdiction-level experimentation. The G7 and G20 have a key role in steering the process of finalising the post-crisis financial regulation. The second issue that the Italian presidency intends to move forward on is that of inclusive growth. Here, too, there needs to be interaction between the G7 and G20, not least because economic and social marginalization is a concern for advanced and emerging economies alike. Inequality is a new subject to acquire top priority in the G7 agenda, but it is now at the forefront of the political debate. Its causes, trends and political consequences are discussed daily by the media and have become a popular topic in economic research as well. Let me first state one fact that is too easily forgotten. Globalization has been an enormous driver of growth in emerging countries, including in the two largest countries in the world. It has thus reduced overall world inequality. It has lifted millions, indeed hundreds of millions, out of poverty. At the same time, inequalities within countries have increased. This is most obvious in a number of emerging economies. But in advanced economies too, the benefits of globalisation have not been equally distributed. Growth has been more subdued than in emerging economies; the income of the median household in many countries has stagnated over the past decades; the middle classes’ perception of the future has worsened. While this fact is more or less universally true, the causes and effects differ somewhat across countries. In Italy, for example, where the recession has been more severe and protracted than in other advanced economies, younger generations have been hit hardest, with high (though now decreasing) rates of unemployment, a greater risk of poverty, and reduced income and career opportunities. In any event, the perception that there is a need to counter rising inequality and mitigate its consequences is widespread. Policy options to deal with this fact will be the focus of the discussions that we propose to stimulate within the G7 and G20. However, one should be aware that perceptions of economic unfairness and concerns about diminished lifetime prospects, while important, are hardly the whole story; dissatisfaction and disillusionment in our societies, and growing diffidence towards international and supranational institutions, are likely to have broader causes. In other words, the perception that something has gone wrong extends beyond the losers from globalization (as some analyses of the votes in the U.S and U.K. have suggested) 2, and comprises a range of countries with different trends in growth and inequality. This is certainly not the right occasion, nor am I the right person, to propose an exhaustive analysis of this extremely complex phenomenon. The question of what ultimately ‘lies behind it’, and where it will lead, is a very broad question, which must be left to future historians. Many factors are surely at play; most entail both opportunities and risks. Let me briefly allude to two points. First, the fact that we are no longer in a world dominated by a clash between opposing blocks, where long-standing ideologies offered a general frame of reference for political debate, but one in which, to borrow Bauman’s 3 term, social and political identities are more ‘liquid’, has freed minds, which is good. But it also risks making some policy debates narrow and context-free, and fostering identities based exclusively on the narrow local community or on ethnicity, feeding fear or hatred towards those outside a restricted group. The explosion of social media and of new ways of sharing information and ideas, unfiltered by political and cultural elites, is also likely to have played a role. Danny Quah and Kishore Mahububani, Project Syndicate, Dec 9, 2016 ‘The Geopolitics of Populism’. Zygmunt Bauman, 2000, Liquid modernity, Cambridge (UK), Polity. Certainly, there is something very positive and intrinsically democratic about the ease with which so many people can access information and knowledge once reserved to privileged groups and rich societies. On the other hand, users may at times be left with no idea as to the reliability of the facts and depth of the analysis. (Umberto Eco, who passed away earlier this year, would have put it more strongly). In an ideology-free world, this may lead to uninformed policy discussions. Free, unfettered debate is a blessing; the lack of reality checks is not. The reason why I mentioned all this is that I want to devote the second part of this speech to Europe, and attitudes towards the European project, which is certainly suffering as a result of this mood of disaffection and exacerbated localism. Consensus around Europe, which was once very strong in countries such as Italy and Germany, can no longer be taken for granted. People have started questioning what it is for, and what is in it for them. The issue of the ultimate goal of European integration remains very much one of beliefs and identities and I shall not discuss it here (though I shan’t resist confessing to my own at the end). Regardless of such preferences, and just taking as given the considerable degree of integration that has already been achieved, it is fair to ask whether European institutions actually serve their purpose reasonably well, and what can be done to improve how they work. While the disaffection of Europe’s citizens may well be more general in its origins, it cannot be addressed without first answering this question. There are many ways to do so, but let me propose here an institutional perspective which, I believe, has implications that tend to go largely unnoticed but are far from inconsequential. If we look at the architecture of the European Union, it is possible to observe that it now bears a very close resemblance to ‘normal’ constitutions as far as Parliament and the judiciary are concerned, but not at all for the executive branch. Today the EU has an elected Parliament with a central institutional role; it co-decides on legislation, mostly on a par with the Council; it has budgetary and oversight powers; in short, though within a narrower mandate, its status, composition and powers are largely comparable to those of parliaments in any democratic polity. The Union also has a judicial system that ensures the uniform interpretation and application of EU law. While the make-up of its constituent courts is somewhat unique, and while its rulings are obviously confined to matters that the Treaties assign to the Union, the attributions and actual functioning of the European Court of Justice are akin to those of an ultimate court of appeal or a constitutional court in many democracies. The executive function, to the extent that this concept can be applied to Europe, is more unusual. The EU is in the unique position of having two institutional branches with powers of political direction, the Council and the Commission, with very different compositions and sources of legitimacy. Moreover, each branch exercises different functions beyond those typical of governments. The European Council, made up of the heads of the governments of the member states, provides ‘impetus’ and, in a rather vaguely defined but practically important way, sets the policy agenda. It has maximum influence in foreign and security matters. At the same time, national governments, represented at a lower level in the Council of the EU, also play a key role in the legislative process. The European Commission, on the other hand, currently resembles in many ways a government in a parliamentary system. The Commission’s President, while proposed by the Council, must survive a vote in Parliament; Commission members require Parliament’s consent. This is not just nominal: after the 2014 elections, Parliament made it clear that it would vote down any nominee except the Spitzenkandidat of the party that got the most votes. Like a normal government, the Commission manages and implements EU policies and the budget, and represents the Union outside Europe. But it lacks a clear ultimate power of direction. At the same time, in certain fields and with respect to its general function of ‘custodian of the Treaties’, the Commission plays a role that would typically belong to the domain of independent, quasi-judicial regulatory authorities, for example by enforcing competition rules. As an executive body, it is essentially political; as a technical authority, it is bound by objectivity and independence. The two do not square well: making discretionary policy choices and impartially enforcing technical rules are not the same thing. I would also mention in passing that this complexity is heightened by the distinction between the EU and the euro area, the latter having a Euro Summit for agenda-setting and a Eurogroup in a coordinating role. Why do I mention this? Because, regardless of what one thinks about any further moves to full political union, the amount of sovereignty that has already been pooled at the European level, especially in economic and financial matters, is very substantial. When Europe was mostly about things like fishing quotas and agricultural prices, important as these matters are, one could more or less live with a suboptimal arrangement. Now that it has a key role in certain issues that go to the heart of the political debate in any country, such as budget balances and financial stability, this is no longer the case. The issue of a proper executive must be addressed. The lack of a conventional executive branch is paralleled by the lack of some of the instruments typically available to a government. On the eve of the single currency Tommaso Padoa-Schioppa noted that the Union’s ‘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’. 4 Without any clear institutional framework for discretionary political action, but in view of the massive transfer of sovereignty, European economic governance has largely been based on rules: budget rules, the ban on rescues between member countries, rules on banking supervision and resolution, and so on. Rules are necessary, but there is a limit to what they can achieve. You cannot run a large, advanced, diverse economy on autopilot. Corriere della Sera, 3 May, 1998. Most transfers of sovereignty in fiscal and financial matters have been prompted by crisis situations. Since the eruption of the sovereign debt crisis, emergency measures have been progressively accompanied by reforms of EU governance and especially of the euro area, starting with enhanced public finance rules and macroeconomic surveillance. In the summer of 2012, the ‘Four Presidents’ Report’ envisaged complementing or replacing national intervention tools with common instruments. For banks, the report proposed transferring supervisory responsibility to the euro area and establishing joint crisis resolution and deposit guarantee mechanisms, to be supported with public funds through the European Stability Mechanism (ESM). As to public finance, in addition to implementing the reforms already approved (the Six Pack and the Fiscal Compact), it proposed gradual steps towards the creation of a euro-area budget and the issuance of common debt. Most of these proposals were taken up again in subsequent reports, including the ‘Five Presidents’ Report’ of June 2015. Restrictions on the use of national mechanisms were put in place quickly. But the introduction of European instruments has been partial and virtually non-existent on the fiscal side. Member states are now constrained by more rules that say what cannot be done, while the EU has not gained more powers to decide what should be done, nor has it the tools or institutional framework to implement the policies that are needed. This creates a situation of vulnerability: there is a danger that national and European authorities will be unable to react appropriately to shocks. By way of example, let’s consider fiscal policy in some detail. It goes without saying that fiscal rules are necessary in a monetary union. They serve as a coordination mechanism, ensuring that all national fiscal policies contribute to maintaining financial stability in the area. Poor compliance with fiscal rules in the period preceding the crisis justified their being strengthened. Coming from a country with a high public debt, I am especially conscious of this. Let me be absolutely clear: the Bank of Italy has constantly reminded Italian authorities of the importance of fiscal discipline. At Parliamentary hearings on budget plans I have not failed once to underline the strategic nature of the objective of debt reduction. The issue is about what you can realistically achieve through a system based mainly on rules. Simple rules do not work well in practice. It would be unreasonable to take decisions on the fiscal stance without considering the cyclical situation of the economy, or exceptional circumstances. In the absence of a substantial EU budget, some degree of flexibility in the rules constraining national budgets is unavoidable. Thus realism has required the introduction of more and more elements of flexibility, and these in turn have required more safeguards to fend off abuses. With exceptions and counter-exceptions, over time the fiscal rules and their application have become exceedingly complex. It now takes a specialist to navigate the various definitions of objectives and constraints in the Stability and Growth Pact. Certain definitions, like the ‘structural’ budget, rely on statistics that are open to interpretation and debate: there are many possible measures of the output gap, for instance. Waivers for exceptional circumstances require, by definition, a discretionary assessment. The system is too intricate to be transparent to the public, nevertheless, it remains incomplete: in the real world, there is no such thing as a ‘complete contract’. This is one case where the ambivalence between the Commission’s political and technical roles is apparent. There are tensions between the impartial, technical, rule-based assessment that it is called on to perform, and the multitude of real-life circumstances that it faces, in a climate where discussions often reach a heated political temperature. In this context the Commission is unavoidably prone to accusations of arbitrariness. The absence of a substantial European budget and the complications of the Stability and Growth Pact are interconnected. With some fiscal capacity at the European level, the constraints on national budgets could be made simpler. The Commission’s recent focus on an appropriate fiscal stance for the euro area as a whole, and attempt to quantify it for the first time, are welcome developments. My point here is not to discuss whether this quantitative assessment is correct, a subject of intense debate. My point is to stress that in our current decentralized policy setting, implementing whatever aggregate fiscal stance one thinks appropriate is difficult, and may result in a suboptimal distribution of efforts across countries. Automatic stabilizers embedded in a common budget, on which the discussion has mostly focused so far, would partially free national budgets from the pressures arising from adverse cyclical conditions. A common budget, however, could also be used to adopt discretionary measures consistent with the cyclical conditions in various economies and in the euro area as a whole. Discretion does not mean total freedom from constraints: just as they have been introduced at the national level, constitutional limits on spending or deficits can be set at the European level. It only requires acknowledging that it is impossible to govern public finances by rules alone; that no complete contract exists in public finances that can allow a democracy to dispense with open, transparent debate on budget decisions; and that, to the extent that spillovers and the common good require the imposition of significant constraints on national budgets, some fiscal space must be found at the European level. Just to be clear, a common budget for the future does not imply mutualisation of past debt. That is a different discussion. No mechanism should entail permanent transfers across member states. Not only would this be politically unfeasible. My own experience with regional differences in Italy tells me that structural fiscal compensation of economic disparities eventually does not end them – it entrenches them. So, for instance, any EU-wide automatic stabilisers should be designed to be geographically neutral in the long run. The need to complement rules that constrain local action with the constitutional capacity to act at the European level could be illustrated using several different examples besides the fiscal budget. Bank supervision and resolution is another obvious example. Time constraints prevent me from going into detail on this; I will leave that for another occasion. But let me just briefly say that, while banking union has progressed considerably, it must ultimately incorporate all the elements envisaged in the original design: a single supervisor, a single and effective resolution mechanism, with pooled resources and the determination to use them when necessary, a common deposit insurance scheme, and finally a European public financial backstop. This requires effective European resources and decision-making powers, so that institutions can act swiftly, boldly and freely when needed. Building the capacity to act at the European level, and not just rules to constrain national action, requires trust and institutional foresight. Many would say that the current circumstances make such steps politically difficult. There can be no question of trying to forge ahead with measures that many citizens are not prepared to accept. Still, I think it is useful to point to issues in the functioning of European institutions that experience and reflection tell me are important. A Europe that can only say ‘no’ is no consensus winner anyway. I may be biased by a personal lifelong commitment to Europe. I often tell the story that my two grandfathers fought on opposite sides during the Great War. They might well have killed each other. They were, however, on different fronts, and they didn’t. That’s why I say sometimes that Europe is, literally, in my DNA. I understand very well that such memories come to mean progressively less to younger generations. But the young are also those who seem to feel the most disaffected, the most estranged from the ‘establishment’, and the most in need of clearer, brighter long-term prospects. If something does not seem to be working, it is no use refraining from suggesting improvements, such as one can think of. If these suggestions have any merit, the time will come when they become feasible.
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 23rd ASSIOM FOREX Congress, Modena, 28 January 2017.
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23rd ASSIOM FOREX Congress Speech by the Governor of the Bank of Italy Ignazio Visco Modena, 28 January 2017 Recent economic developments The moderate acceleration in global growth under way since the summer may continue this year and the next, bolstered by the expansionary stance of the fiscal policies announced in the United States and by the effects of those enacted in China and in Japan, where monetary policy is also highly accommodative. The outlook, however, remains subject to a high degree of uncertainty. The scale and components of the new US administration’s policies remain unclear. So far, the increase in medium/long-term interest rates in the United States, also spurred by anticipation of such policies in an economy with close to full employment, has been transmitted to the other main countries to a limited extent owing to divergent monetary policy stances. Adverse effects on the world economy could arise were a further increase in yields, linked to higher risk premiums, not to be accompanied by a parallel improvement in growth prospects and were capital outflows from emerging economies to become more intense. The US administration’s declared intention of slowing down or reversing trade liberalization processes, and the steps it has already taken in this direction, risk triggering tit-for-tat measures in other countries, with negative repercussions for world growth. In the euro area the economic recovery is proceeding slowly. The measures adopted by the ECB Governing Council have greatly curtailed the risk of deflation and paved the way for a gradual return to monetary stability. The rise in inflation in December is, however, largely ascribable to the energy components of the HICP and to other highly volatile items; there are as yet no clear indications of any inversion of trend in the core components driving developments in consumer prices and wage growth, even in countries where unemployment is lower. The Eurosystem’s projections put inflation at barely above 1.5 per cent in 2019. To bring inflation back to a path consistent with medium-term price stability, monetary conditions must continue to be highly accommodative. The Governing Council accordingly decided to extend the expanded asset purchase programme until end December 2017, or beyond, if necessary, and to trim monthly purchases back to €60 billion starting in April. At the end of this year these purchases will amount to around €2,300 billion. The Council expects official rates to be held at levels equal to or below the current ones for a period that extends well beyond the programme’s horizon. The Bank of Italy is continuing its purchases of public-sector bonds, ensuring orderly conditions on the secondary market, including through securities lending operations; for covered bank and corporate bonds we also intervene during the placement of new issues, thereby increasing the availability of funds. There has been intensive and increasing interaction with market operators; since April purchases of asset-backed securities, previously also concluded by external asset managers, will be made entirely by national central banks. In the euro area too, uncertainties abound regarding developments in the real economy. Growth in productivity continues to be insufficient. Capital investment still needs reinforcing. Strengthening output and at the same time addressing the effects – though positive overall – of new technologies on employment requires the contribution, not only in Italy, of other policies and interventions in addition to monetary policy measures. In Italy the production of goods and services continues to increase, though the pace of the recovery is slow and lags behind average rates in the euro area. Labour market conditions have improved; business confidence remains solid while the decline in consumer confidence came to a halt in the autumn. The data for the last two months largely confirm our projections. In the most recent scenario outlined in last week’s Economic Bulletin, gross domestic product is forecast to grow by around 1 per cent on average per year in 2017-19. Nevertheless, the scenario is susceptible to risks. It assumes, aside from favourable conditions worldwide, that medium and long-term yields will remain low and that the pace of growth in lending will continue to pick up in an economy in which alternative forms of financing to banks are struggling to gain a foothold. The maintenance of orderly market conditions, consolidation of growth, recovery of investment and further improvement in the labour market assume above all that Italy will press on with its reforms of recent years. The consequences of greater uncertainty over the political will to pursue an indispensable modernization agenda must not be underestimated. So far, and notwithstanding the less favourable assessments of credit rating agencies, the effects on the financial market have been limited. However, the spread between the yield on ten-year BTPs and the corresponding German Bund is around 50 basis points higher than the average observed in early 2016 and has widened considerably with respect to Spain. Banks and credit risk The economic recovery is being reflected in the indicators of credit quality, which continue to show an improvement. In 2016 the flow of new non-performing loans (NPLs) reached its lowest level since 2008; from the end of 2015 the stock of outstanding NPLs also began to diminish, albeit gradually. Nonetheless, they continue to weigh heavily on the balance sheets of Italy’s banks and there have been repeated calls for better, firmer and more comprehensive management of these exposures. Last June bad loans and other NPLs on the balance sheets of Italian banks amounted to €191 billion net of write-downs, that is 10.4 per cent of total loans. Including write-downs, NPLs came to €356 billion, a figure frequently quoted in debates, which refers to the face value of the exposures and accordingly does not represent their actual weight in banks’ balance sheets. Out of €191 billion of NPLs, net bad loans, i.e. exposures to insolvent debtors, amounted to €88 billion or 4.8 per cent of loans. The remaining €103 billion pertained to situations in which regular repayments may resume, especially if the recovery gains momentum. The bad loan recovery rate effectively recorded by Italian banks averaged 43 per cent over the ten years 2006-15, a proportion largely in line with banks’ balance sheet figures. Our studies point to a wide dispersion of recovery rates: for many banks the margin for improvement is considerable and must be rapidly exploited. The first two rounds of new bad debt reporting received and analysed by the Bank of Italy last year revealed that there is still some way to go in creating detailed and easy-to-access databases. In the two years 2014-15, recovery rates dropped to an average of 35 per cent. This was partly due to an increase in the number of positions closed following ‘en bloc’ market sales to specialized investors: in the ten years considered, the average recovery rate for these sales was 23 per cent, against 47 per cent for positions closed following standard procedures. The market prices of exposures should be assessed bearing in mind that they reflect the very high yields demanded by oligopolistic buyers, which also factor in the possibility of long recovery times; in some cases the existence of a large proportion of long-standing bad debts, already amply written down, explain the particularly low selling prices. The large volume of Italian NPLs has drawn the close attention not only of the supervisory authorities but also of international markets and observers. It requires careful management. The majority of bad loans are held by banks in a sound financial position that therefore do not need to sell them immediately. For the more problematic banks, ridding themselves of a legacy of bad loans is an essential step towards recovery. The best trade-off between sales on the market and internal management is a matter for individual assessment. From this perspective, the draft guidance on NPLs recently issued by the ECB’s Single Supervisory Mechanism advises banks to actively manage these exposures and calls on those with a large proportion of NPLs to draw up suitable plans to reduce them. Numerous well-known factors have contributed to Italy’s high level of NPLs. The most important by far, however, is the long and deep recession, which has undermined many firms’ ability to repay debts, which were not always granted with sufficiently careful assessment. The length of credit recovery procedures has also played a part: if recovery times in Italy were in line with the European average, the ratio of bad debts to total outstanding loans would be about half what it now is. Furthermore, setting up an asset management company with public funding, as other countries have done in the past, has now become impossible owing to the new European rules on State aid introduced in 2013 and their rigid interpretation. Previously, during the sovereign debt crisis, given serious market concerns about the sustainability of Italy’s public debt, any action by the State was unlikely to be successful. Moreover, in contrast to the situation in countries where real estate bubbles burst, the deterioration in bank lending was not confined to specific sectors of the economy; the international institutions and leading forecasters projected a far more rapid exit from the crisis than was actually the case. Many of the necessary conditions for solving the problem of non-performing loans are now in place. As I mentioned earlier, the economic recovery is being reflected in the quality of credit; as it gradually gains pace, the banks will be able to repair their balance sheets. The reforms of the last two years should also improve the credit recovery process. It is still too early to see the full results as the greatest impact will be on ‘new’ bad loans. However, some of the measures, especially those relating to out-of-court solutions for corporate debt restructuring and the transfer of ownership of real guarantees, are already in place and could make a difference to the stock of NPLs: they should be activated without delay. Recovery procedures could be further speeded up by implementing the other tools offered by the new rules: the portal for public auctions (now being trialled); the online register of non-possessory liens and that of foreclosures and bankruptcy proceedings; the extension to consumers of the Marcian Pact forfeiture clause. Further improvements might include additional specialization of judges in bankruptcy proceedings and reducing regional differences in courts’ performance. An important contribution on the European front could come from a regulatory provision eliminating or limiting the measures that discourage banks with advanced internal ratings-based (AIRB) models from selling their NPLs ‘en bloc’. Including the impact of such sales in estimates of the loss given default (LGD) parameter automatically raises capital requirements considerably on all performing loans and consequently reduces capital ratios. Analyses based on a sample of Italian banks show that this reduction could be significant. The measure would take account of the exceptional nature of the present economic situation and the need to combine supervisory with macroprudential objectives. Banks’ capital and support measures An exceptionally deep and protracted recession such as the one experienced by the Italian economy has undoubtedly had serious repercussions for the banks. Nevertheless, at the origin of the worst crises we also find corporate decisions that were undermined by misconduct and distortions in the allocation of credit. The fact that the greatest difficulties involve banks which taken together account for a relatively small share of the industry’s total assets is an indication of the overall resilience of the system. Since the onset of the financial crisis, and partly as a result of pressure from the supervisory authorities, Italy’s banks have almost doubled their CET1 ratios and are continuing to increase them, including by raising funds on the market. The national and European supervisory authorities have been monitoring the most critical situations for some time. The measures adopted were designed to reach orderly solutions and avoid repercussions for the stability of the banking system, within a rapidly changing regulatory environment that precluded any recourse to the instruments successfully used in the past and before the new instruments became fully available. Various measures were taken to deal with the different situations. With the help of the National Resolution Fund, to which all banks contributed, four banks at risk of failure were placed under resolution at the end of 2015, thus avoiding any need for a publicly funded recapitalization, although to cover the losses it was also necessary to reduce the value of subordinated bonds to zero. The only alternative to resolution was to wind them up, which would have cost their creditors even more and involved others in addition to shareholders and subordinated bond holders. Different types of protection were introduced for the subordinated bond holders according to their individual situations and the Interbank Deposit Protection Fund has started disbursing compensation. Despite the difficulties of the current regulatory and market environment, there have been important developments in recent days as regards the sale of the four bridge banks. The agreement for the sale of three of these banks to UBI Banca has been signed and the negotiations for the sale of Nuova Cassa di Risparmio di Ferrara to Banca Popolare dell’Emilia Romagna are at an advanced stage. The sizeable cost of these operations has been borne by the National Resolution Fund and therefore by the banking system. The greatest care has been taken to keep costs down, including by means of an open and transparent sales process conducted in close collaboration with the Ministry of Economy and Finance and the European Commission, which assessed all valid offers on the table from Italian and foreign interested parties. The special purpose vehicle that bought the bad loans of the four banks is continuing its efforts to arrange a sale at the best possible terms and conditions, with the help of independent experts; this requires the information on the loans to be vastly improved. The experience gained in the months since the start of the resolution procedure for the four banks should, however, also lead us to reflect on the potential systemic significance, in a closely interconnected market, of regional banks with a limited catchment area. The measures taken in Italy in 2016 have made it possible to deal constructively with other crisis situations, with the contribution of both the public sector, including as a facilitator, and the private sector, through recourse to various instruments: precautionary recapitalization by the State (recently requested by Banca Monte dei Paschi di Siena); private funds specifically raised to buy NPLs and to strengthen the capital of banks in difficulty, used in the case of two banks (Banca Popolare di Vicenza and Veneto Banca); and the voluntary component of the deposit guarantee funds (to support smaller banks). In full compliance with European rules and to guarantee financial stability, public resources have recently been allocated (up to €20 billion) to support the liquidity and capital positions of solvent banks which, despite achieving a positive result in the baseline scenario of a stress test, must deal with shortfalls found in a hypothetical adverse scenario that is part of the same test. This measure is an important one for Italy as it emerges from the crisis that buffeted its economy and banking sector. State intervention is much more limited in Italy than in almost all other European countries, helping to remove the market’s perception of a risk considered high for the entire banking system. The costs for the public purse will be reduced by burden sharing among equity holders and subordinated bond holders. It will be possible to offset them against the proceeds of future sales of shareholdings. A necessary condition for benefiting from public precautionary recapitalization is the approval by the European Commission of a restructuring plan drawn up by the bank. The injection of public funds into Banca Monte dei Paschi di Siena will presumably use up about a third of the €20 billion set aside by the Government. There is more than enough room to address the recapitalization needs of any other Italian banks that meet the conditions laid down in the decree, in the first place those relating to the results of a stress test. However, for other measures to be implemented the banks must be willing to apply for public support and to deal with the ensuing commitments. Following the capital strengthening carried out under the Fondo Atlante, the senior management of Banca Popolare di Vicenza and of Veneto Banca have been drawing up an industrial plan for their further recapitalization and relaunch, which will soon be presented to the supervisory authorities. The feasibility of a merger will be examined with a view to achieving cost savings and synergies capable of ensuring a return to profitability. The challenges for the banking system Aside from the difficulties of some banks in particular, the banking system as a whole is called on to face new and demanding technological and market-related challenges, on which we have often reflected. This is not only a necessity for Italy: a return to higher and lasting profits is a must for all European banks. The way in which branch networks are structured, services provided, and technologies used, must all be reviewed in a bold and innovative spirit. Value creation in the banking industry has changed and continues to do so; Italian banks can no longer put off much needed restructurings and strategic reviews. Only in this way can they continue to successfully attract investors; only then can they continue to compete effectively and maintain their stability. In some cases capital strengthening on the market will need to continue, as is already happening for some large banks; experience has shown that if requests for new capital are based on clear, ambitious and, at the same time, credible plans, then they are likely to be successful, even in tough market conditions. In other cases, especially for medium-sized banks, mergers are necessary to achieve cost savings and increase operational efficiency. The success of these mergers crucially depends on the ability to streamline banks’ organizational arrangements and to improve corporate governance, also in terms of market perception. The reform of cooperative banks (banche popolari), which pursues the goals of efficiency, transparency and stability, is almost complete: eight out of ten of those with assets exceeding €8 billion – the threshold established by law – have become joint stock companies. The merger of two of them has created a banking group of significant size. Other mergers can be achieved and may act as catalysts for the restructuring of the entire banking system. Last December the State Council requested that the Constitutional Court rule on a number of questions regarding the reform’s constitutionality; the deadline of end 2016 for compliance with the new rules was suspended, as were some parts of the implementing provisions issued by the Bank of Italy as mandated by law. The reform is necessary as it will facilitate capital strengthening for the banks concerned and contribute to improving their governance. The limitation of the right to reimbursement in the event of withdrawal aims to preserve the integrity of capital levels and draws inspiration from the European rules, which are not currently under consideration by the Court. At the beginning of this month the supervisory authority sent a communication to the mutual banks (banche di credito cooperativo) and their central institutions urging them to carry out the reform of their sector rapidly and effectively. Only a swift transition to the new set-up will enable mutual banks to strengthen their capital position where necessary and continue to provide their traditional support to local economies in the best way possible, also in view of banking union. Returning to a level of profitability that enables stable capital strengthening is a fundamental objective for banks, particularly those currently on a weaker footing. A determined and incisive approach to keeping administrative and labour costs down, including for management, must be adopted using all the tools currently available. The density of Italy’s banking network and its productivity do not diverge greatly from those of other euro-area countries. According to the latest ECB data on 2015, average assets per bank employee in Italy (€13.1 million) are lower than the euro-area average (€15.3 million). In Italy there is one bank branch for every 1,993 inhabitants, against an average of 2,170 for the euro area; there are slightly fewer branches in Germany, with one for every 2,397 inhabitants, but more in France and Spain, with one for every 1,770 and 1,493 inhabitants respectively. There is considerable scope for rationalization across the board: though the financial system in the United States has different characteristics from the European one, there are still far fewer branches per inhabitant there (one for every 3,900). It is vital to continue reviewing the network and increasing its productivity, by exploiting rather than being a victim of changes in technology, the market and customers’ habits. *** The recovery continues in Italy, albeit gradually, thanks to the improvement in the global economy and to the expansionary stance of monetary policy. Credit quality is benefiting as a result. All the banks need to take decisive steps to tackle the problem of NPLs: the solutions should be assessed individually. The foundations have now been laid for solving the particularly serious problems of some banks, thanks to the instruments developed and the measures adopted by the authorities. To improve their profits and contribute efficiently to financing the economy, banks must make further progress in containing costs, upgrading technologies, and streamlining their organization and branch network. Updating their business model is also essential in order to provide customers with a broad and innovative range of services for asset management and corporate finance. A stronger recovery and sounder banking system are closely connected and also depend on firms, households and international markets’ confidence in Italy’s ability to carry forward the reforms begun in recent years. To prevent this confidence from being undermined, the country must continue resolutely on this path: by improving the efficiency of the State and of the entire public sector in lawmaking, administration, and the delivery of services to citizens; by creating a businessfriendly environment; and by promoting research and innovation. Stability and reform are essential for development. There are no shortcuts, particularly for a country burdened with such a large public debt and such persistent structural problems. Second thoughts, delays and resistance, not uncommon in some sectors including banking, risk affecting market conditions and undermining the progress achieved during the long economic crisis from which we are now, though slowly and laboriously, emerging. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Riccardo Faini Memorial Conference "Italy's lost productivity and how to get it back", Rome, 13 January 2017.
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Riccardo Faini Memorial Conference Italy’s lost productivity and how to get it back Bank of Italy, Via Nazionale 91 Opening remarks by Ignazio Visco Governor of the Bank of Italy Rome, 13 January 2017 I am pleased to welcome all participants to this conference to remember Professor Riccardo Faini. I first met Riccardo in 1978 when I presented a paper written with Stefano Micossi in the famous monetary workshop held by Franco Modigliani and Stan Fisher at MIT (Riccardo was then a PhD student with Giampaolo Galli and Luca Barbone…). We met often in the following years inside and outside of Italy, socially and professionally, exchanging views and commenting on each other writings. Indeed, issues related to the topic of today’s conference – long-standing poor productivity dynamics in Italy – happened to be at the centre of a couple of professional exchanges between us in the mid-1990s and early 2000s, which I would like to briefly share with you. In 1994, at a seminar on “The New Frontiers of Economic Policy” (Le nuove frontiere della politica economica) organised by the Innocenzo Gasparini Institute for Economic Research (IGIER), I discussed – along with Luigi Spaventa – a paper by Riccardo on wage and productivity differentials (Stesso lavoro, diverso salario?, i.e. “Same jobs, different wages?”) between Northern Italy and Southern Italy – the Mezzogiorno. The starting point of Riccardo’s analysis was that a convergence in nominal wages between the two regions since the late-1960s had not been accompanied by a parallel convergence of productivity levels; the ensuing higher unit labour costs in Southern Italy were thus contributing to higher unemployment there. In order to achieve more wage flexibility in Southern Italy’s labour market, Riccardo’s main proposal was to introduce a third type of wage bargaining arrangement – a regional one – to complement or replace bargaining at the centralised and firm levels, with a view to bringing closer wages and productivity levels while addressing higher unemployment in the South. In my comments I raised some criticisms, but on one major point we were in close agreement, namely that the issue of lower productivity (and higher unit labour costs) in Southern Italy should be addressed not only by reforming the labour market but also by implementing broader structural reforms to overcome well-known distortions of the general institutional, economic and social environment, notably infrastructural gaps, enforcement of property rights, efficiency of the justice system and the public administration. I cannot help but notice that these areas are the same where reforms are called for still today for the Italian economy as a whole. In 2003 Riccardo and I wrote two papers on the dismal performance of the Italian economy. While I was considering a number of structural deficiencies that were risking to have serious consequences on our growth capabilities in the years to come, Riccardo tried to put the unsatisfactory Italian productivity outcome in a hystorical perspective. It is interesting that the titles of our papers had two elements in common: the word “decline” (so popular today) and a question mark. [Riccardo’s paper: Fu vero declino? L’Italia degli anni Novanta (“Was it truly a decline? Italy in the 1990s”); my paper: È veramente in declino l’economia italiana? (“Is the Italian economy really in decline?”). Also noteworthy is that later that year a further paper was published by Giacomo Vaciago, with the word decline in the title but without question mark: Il declino dell’economia Italiana, (“The decline of the Italian economy”).] And it is also interesting that in December 2003 we participated in a conference whose title used exactly these two elements to raise the provocative question: L’Italia: un Paese in declino? (“Italy: a country in decline?”). The conference was jointly organised by Mediocredito Centrale and the Associazione Borsisti Marco Fanno, under the leadership of Michele Salvati, critical of the use of the word, and introduced by Mario Draghi, the then President of the Association. To be sure, as Mario put it in his introductory words, the risk of decline was to be understood not only as Italy-specific but rather as a broader European issue. Riccardo and I were also both somewhat critical of the use of the term “decline” to define Italy’s situation at the time. But we both argued that the risk for the coming years had not to be undervalued. I remember pointing out that Italy’s economy was rather undergoing a phase of “long and difficult transition” because of the need to adapt and respond to the shocks posed by both the “new economy” and technological progress, which had taken the Italian productive system rather unprepared. These issues were already widely debated in the Bank of Italy (where Salvatore Rossi was leading work on the “new economy” and Pierluigi Ciocca summarizing Italy’s challenges as a “problem of growth”). And they were very much being discussed and analysed in the Economics Department of the OECD, that I had been leading, within a wide-ranging and global project on “The sources of growth”. Therefore, I underscored that Italy’s low growth was first and foremost due to structural internal causes, most notably low investment in capital (physical, human, knowledge-based) and correspondingly low ability to innovate, which underpinned what still can be seen as the hallmark of Italy’s fundamental problems: the disappointing dynamics of total factor productivity over the last twenty years or so. Riccardo too related the increased attention paid to the worsening of Italy’s economic performance to the changes in the international economic situation: globalization and the rise of emerging market economies, which threatened Italy’s comparative advantages in sectors of specialization with low intensity of both human capital and technology. To counter the decline story, his main argument was that Italy’s worse aggregate growth in the 1990s in comparison with its peers (France, Germany and the US) was biased by demographic factors: in per capita terms Italy’s growth was only marginally slower (he drew similar conclusions in terms of purchasing power parity). Besides, Riccardo gave heavy weight to the importance of economic developments in the South: in his view, Italy’s decline – to be played down in itself – was mainly a Southern Italy’s problem (“un problema meridionale”). Contrary to what was often stated, in Riccardo’s view the 1990s were not a time that set the beginning of the decaying phase. Signals of underperformance had indeed appeared even earlier: in his paper of 2005 with André Sapir in Oltre il declino (“Beyond the decline”, a book edited by him and others well known Italian economists, some of them here today), he underscored that average labour productivity growth began to fall in the 1960s and 1970s (a result not limited to Italy and, I would say, not unexplainable for a country that had so quickly caught up after WW2 with the most advanced world economies). More importantly, he believed that the 1990s had in many respects laid the groundwork – in terms of adoption of some initial structural reforms – for the country’s economic revenge. He aptly warned of the perils of not continuing the structural reform effort. I shared this warning, and to some extent also the observation that we should look deeper into the past to understand the present. Somehow, I felt that behind the difficulty to disinflate the economy until the mid-1990s and the dismal growth performance following the establishment of the monetary union there were common factors, most notably the very low productivity growth in the (protected and inefficient) service sector of the Italian economy. This made it very difficult to disinflate in the former period, as the increases in nominal wages that were matching the rise in productivity in the manufacturing sector became the benchmark for a service sector lacking the ability to produce similar productivity gains, with higher costs for the same manufacturing sector. With a single currency, in a much wider area and lacking the necessary investment response, global competition and the monetary union were not well responded and resulted in a prolonged period of low growth overall. Perhaps I was less optimistic than Riccardo, but our views were the closest on a few key issues: the structural nature of Italy’s problems, the specific challenges that globalization posed to the country and the “absolute priority” for economic policy: strengthening human capital and investing in education. Italy’s productivity problem today It is unfortunate – to say the least – that Italy’s structural problems of today are broadly the same as those of 15 years ago and the key question remains how to resume Italy’s growth. To this end, getting back “lost productivity” is obviously critical. Perhaps the main difference from past discussions is that today these challenges have to be addressed in a more complex global environment dominated by the legacies of the global financial crisis and faster technological progress. The former has left most developed economies in a period of sluggish economic growth, spurring a lively debate among economists on longer-term prospects and raising increasing concerns among policy-makers. Many scholars have highlighted how financial crises are characterized by slower recovery with respect to non-financial recessions because of inter alia a larger decline in capital accumulation, the stronger impact of the credit shock on young and fast-growing firms, and the huge costs incurred for banks’ recapitalization. Currently, growth is also held back by financial deleveraging, subdued demand, and low inflation (which raises real interest rates). Besides these short-term factors, future growth prospects are weakened by the long-term decline in productivity growth that is affecting all developed countries. Economists have pointed to several factors to explain this slowdown. According to one view, growth in advanced economies may be hampered by inadequate aggregate demand, driven by demographic trends, growing inequality and raising government debt, resulting in a “secular” decline in interest rates. Others link the slowdown to the types of innovation that have emerged overtime: those which took place in the second half of the 20th century (“general purpose technologies” such as electrification) may be much more significant than those that characterize the 21st century (such as ICT and the digital economy). Recent evidence based on firm-level data from several OECD countries seems to show that innovation has not slowed down; rather, the pace at which innovation is spread across the economy (“the diffusion machine”) has weakened. As I have already underscored in past occasions, technological progress is today’s most powerful agent of change: in the “second machine age”, as it has been aptly defined, it poses distinct challenges at both the economic and social level because of a few key features of the digital revolution, first and foremost the greater speed by which new technologies tend to replace labour, even in fields in which human intervention has so far appeared to be decisive. These developments underpin a revival of the concept – proposed by Keynes in 1930 – of “technological unemployment”, which has come to be seen as a possible result of the diffusion of automation, robotics and digitalization, with the risk of a substantial decline in job opportunities and stagnation of wages and incomes in a number of industries and countries. To which extent this general background relates to the Italian economy? Understanding the sources of productivity growth is of utmost importance for Italy. As we have seen, since the early 2000s Italian productivity has been disappointingly stagnant, performing significantly worse than other European countries. It remains relevant to distinguish how much of this poor productivity growth is to be related to Italy’s structural weaknesses or rather due to delayed adjustment to global changes that could be overcome in due time, hopefully earlier than later: I am sure that today’s debate will help make progress in this direction. The work of many Italian economists, some of them are here today including those working at the Bank of Italy, has long highlighted the importance of structural factors that are specific to the Italian economy and to their interaction with the three fundamental changes that have taken place since the second half of the 1990s: globalization, the technological revolution and the demographic transition, especially, but not only, linked to population ageing. On top of all this we have had the establishment of the Economic and monetary union and the adoption of the euro. To all these changes the Italian economy has adjusted very slowly, if at all, and with substantial delay. The result has been the inability to overcome well known structural weaknesses. Some of these weaknesses are internal to Italian firms, which are, when compared to those located in other developed economies, considerably smaller, older, with a lower propensity to innovate and adopt new advanced technologies. Management skills and practices leave much to be desired and are often old-fashioned. To finance their activity firms rely on bank credit much more than what happens in other advanced countries: in this regard, it is well known that this is not the ideal source for financing innovations. The capability of Italy’s productive economy to increase sales and create value added has been also undermined by long-standing institutional weaknesses. Since 2011 Italy has undertaken a vast programme of structural reforms, aimed at creating a more growth-friendly environment. Legislators have approved, in various steps, measures to reduce red-tape, to simplify bureaucratic procedures for starting and running businesses, to improve the efficiency of the public administration and the judiciary system, to prevent and fight corruption, to stimulate innovation, and to achieve a more flexible and dynamic labour market. The process is still ongoing and far from being concluded, even if in several areas there are first effects. The stock of pending civil proceedings is decreasing: our estimates show that some of the measures adopted in the past to reduce red tape and to simplify business start-up regulations have had positive effects on the entry rate of start-ups. The Jobs Act is a wide-ranging reform, that has tackled employment protection legislation, unemployment insurance, wage supplementation funds, active labour market policies and other aspects. But while its long-term effectiveness still remains to be seen, we must understand the risks of going backwards, as reducing labour market segmentation is fundamental in the quest to allocate labour from less to more productive uses, and to boost aggregate productivity. Factors that negatively impinge on aggregate productivity growth by constraining both efficiency gains at the firm-level and the efficiency of the reallocation of resources from low- to highproductive firms have to be decisively addressed. More generally, in order to overcome its low productivity problem the Italian economy must improve its ability to fully seize the opportunities of the digital revolution while governing the consequences that technological progress is exerting on labour demand and the skills required to current and prospective workers. So there is a need to fundamentally improve the environment in which firms are formed, grow and operate, and to invest in knowledge, human capital and the new skills needed to succeed in the years ahead. To a relevant extent, the current wave of technological progress may have made even more difficult to reconcile productivity gains and employment (and wage) growth. This challenge may be greater in Italy if one looks at the past. As recalled by Riccardo Faini in his 2003 papers, Italy did not always succeed to overcome the above potential conflict: between 1992 and 1996, productivity growth was satisfactory but employment decreased dramatically; on the contrary, between 1996 and 2001 rapid employment growth resumed while productivity growth collapsed and its level remained stagnant afterwards. Avoiding a repetition of these dismal dynamics is perhaps the greatest challenge for policy-makers and academics alike.
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Welcome address by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Italian Insurance Supervisory Authority (IVASS), at the 2nd IVASS Conference "Solvency II and small and medium-sized insurers", Rome, 3 March 2017.
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2nd Conference “Solvency II and small and medium-sized insurers” Welcome Address Salvatore Rossi – President of IVASS Bank of Italy’s Congress Centre Rome, 3 March 2017 Ladies and gentlemen, I am delighted to welcome you all to this Conference. I want to thank Gabriel Bernardino, President of the European Insurance and Occupational Pensions Authority (EIOPA), and all the other panelists, for kindly accepting our invitation. This is the second conference we hold in IVASS on Solvency II. This time we decided to focus on a specific topic, the effects of the new prudential framework on small and medium-sized insurers – SMIs from now on. After Gabriel’s keynote speech we will have two panels: the first one will have a more international flavor, while the second one, opened by Bianca Maria Farina, President of the Italian Insurance Association (ANIA), will be focused on the Italian market. The panelists are well known representatives of both the supervisory community and the industry. The moderators will be Karel Van Hulle, one of the founders of the Solvency II framework, former Head of the Insurance Unit at the European Commission, and Ferdinando Giugliano, journalist and economic commentator. Alberto Corinti, member of the Board of IVASS and of the Management Board of EIOPA, will offer some concluding remarks. Why a conference on small and medium-sized insurers? I gave some hints last June, when presenting IVASS Annual Report. At that time only few months had passed since Solvency II entered into force, but we could already notice how difficult this new world had become for small companies. Solvency II pursues the objective – I said in June – of creating a risk-sensitive prudential regime for all and of incentivizing good corporate governance. To this end it has introduced three pillars of new rules: 1) some very complex methods for calculating the capital requirement; 2) a minimum, but still high, level of organizational requirements; 3) and a detailed information system, over and beyond balance-sheet reporting obligations. Smaller firms are finding the investment consequently needed in human, technological and organizational capital something of a burden. Even the IMF has many concerns. Its Report The Insurance sector: trends and systemic risk implications issued in April 2016 1 saw a clear tendency by small companies to run more risks, also in an attempt to cover the growing costs of compliance with rules that have become much more stringent than before. If just one small firm fails, then there may be a loss of confidence in the system. So it is certainly wise for supervisors to be worried; it is not only a matter of market efficiency. Let me concentrate on capital requirements. The main goal of Solvency II is that of linking each company’s capital requirement to the actual risks that it faces. Such risks are self-measured by the company through methods controlled or even validated by the national supervisory authority. Ordering these tools by increasing complexity, we have the so-called "standard formula", then the "undertaking-specific parameters" (USPs), and finally the "internal models". Inevitably, when you go from basic – Solvency I – to sophisticated – Solvency II – you have to accept an increase in the level of complexity. So, no surprise, not only are internal models very complex, but also USPs and even the standard formula. The latter is the method chosen by most SMIs to calculate their capital requirements. Though it is the simplest of the three methods, it is much more complex than the one in use under Solvency I. Many SMIs lament that Solvency II was conceived and developed having the big market players in mind. Is this true? I don't know, but in any case trying to answer such a question would be sterile. A more subtle and useful question is whether the increased complexity of regulation just reflects that of the business, or whether it adds a further, and unnecessary, layer of sophistication to the picture, especially for SMIs. FMI, “Global Financial Stability Report”, April 2016. Are small insurers too small? We may argue that the modern world is "no country for midgets" to paraphrase the title of a famous movie. The two big challenges that the world insurance industry is facing nowadays – digitalization and persistently low interest rates – seem to be even bigger for SMIs, so that many foresee a consolidation of the insurance services supply, with more and more M&As taking place that will significantly increase the average size of companies. Let's consider technological innovation first. On the one hand, digitalization is a unique opportunity for SMIs. Internet of things and big data are revolutionary trends that have the power to induce a deep transformation also in the insurance sector. Technological innovation connects people, integrates and manages data, automates processes, stimulates new products engineering. SMIs will have the chance to play an important role if they are able to cover the many niche markets that will arise. On the other hand, this still largely unexplored world is full of threats, in particular for SMIs. Cyber risk is a clear example of opportunity/threat coming from technological innovation. It is a relatively new and promising market for insurers: as soon as firms and families realize how dangerous cyber risks are, a lot of new insurance policies could be designed and sold. However, insurers themselves may gain more visibility as a target for cyber-attacks while they migrate towards highly integrated and big data storage systems. The higher the sophistication of the security system in place, the lower the exposure. Are SMIs able to use sophisticated enough security systems? That's an open question. Another risky factor for SMIs is the persistently low interest rates environment. It is partly linked with the monetary policies in the current phase of the cycle, but also, in a longer term perspective, with the evolution of longer term fundamentals and demographic trends; it is intertwined with technological change, since it may accelerate it, and so the ensuing M&A process 2. We still don't know how long this environment will last: as for monetary policy, headline inflation has increased lately, largely owing to energy prices, but underlying inflation pressures remain subdued. Most insurance companies are being induced to change their business models, lowering guarantees offered to policyholders or shifting towards products with a stronger "financial" component, or to take more risk on the asset side. SMIs are less equipped to weather this storm. Is a SMI capable of managing more complex, innovative products? Is it capable of managing more risky assets like stocks? Here is another engine of potential consolidation. It is likely that, eventually, market interest rates will have to somehow normalize from the current very low levels. When that happens, the market value of bonds in insurers' portfolios will be reduced. At the same time returns on bonds will get back to more "normal" levels, allowing insurers, in particular life insurers, to offer again to their customers traditional insurance products, with a guarantee attached. That would require new contracts. Timing will be crucial: if the rise in market interest rates is gradual, as well as the shift in policyholders' demand from existing contracts to new ones, then the regime change can be managed by companies and can result in a net benefit for them. Sudden hikes on both fronts may instead be dangerous, and SMIs may be the most affected. That's a further reason for consolidation. But these are market forces. We as regulators must ask ourselves whether regulation itself is such as to induce consolidation, without any explicit prudential reasons to do that. An excessive number of M&As may result in a reduction of market competition, in lack of diversity in insurance coverage, and may eventually feed the never dormant “too big to fail” issue. ESRB, Macroprudential policy issues arising from low interest rates and structural changes in the EU financial system. November 2016. Is proportionality a solution? Proportionality in the application of Solvency II could be a way out of these doldrums. It will be interesting to hear from you on this point. I think that proportionality is a good principle, and its application to the second and third pillar of Solvency II – that is governance and reporting – is certainly worth being discussed. For instance, in IVASS we have been working a lot on the national implementation of the governance requirements set by Solvency II, and we have spent quite some time in thinking on how best to ensure their proportionate application, taking into account the needs of SMIs. Following previous fruitful experiences, we see merits in an early involvement of the industry in this process. We shall be launching a public consultation soon. Applying the proportionality principle to the first pillar – the capital requirement – is instead a more thorny affair. The forthcoming SCR review led by EIOPA and by the European Commission might be an occasion to examine this issue. Insurance companies could take advantage of the public consultation that EIOPA is running. For sure, in the meantime we could make a better use of the existing prudential framework. For instance, the Own Risk and Solvency Assessment (ORSA), on top of being used internally, can serve the purpose of improving the intensity and quality of the dialogue with supervisors. *** To conclude, I very much hope that this Conference could be of inspiration to the reflections and works that both regulators and insurers will conduct on this delicate issue. I wish everybody an interesting and fruitful discussion. Thank you for your attention. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the travelling exhibition on the "Occasion of the 60th Anniversary of the Treaties of Rome", organized by the Historical Archives of the European Union, European University Institute, held at the European Central Bank, Frankfurt am Main, 21 March 2017.
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Historical Archives of the European Union - European University Institute Travelling Exhibition on the Occasion of the 60th Anniversary of the Treaties of Rome ‘EVER CLOSER UNION’ The Legacy of the Treaties of Rome for Today’s Europe Remarks by Fabio Panetta Deputy Governor of the Bank of Italy European Central Bank - Frankfurt, 21 March 2017 I am delighted to speak at this commemoration of the 60th anniversary of the Treaties of Rome, which established the European Economic Community (EEC) and the European Atomic Energy Community. Rome is not only the place where the European project came into being, but also the city that gave Europe its first ‘economic and monetary union’, more than 20 centuries ago. Indeed, if Emperor Augustus could be with us today, he would probably ask: ‘What have you guys been doing all this time? You are still at the point where we left you two thousand years ago!’ But the Emperor would be wrong. The ‘monetary union’ of the ancient Romans emerged through war, conquest and prevarication; ours is based on peace, political consensus and shared welfare. In fact, we have progressed a lot from where the ancient Romans left us. The EEC Treaty was signed on March 25th, 1957, in the Palazzo dei Conservatori. It was an economic compact intended to transform European trade and manufacturing, but also to contribute to the construction of a political Europe. In the preamble, the signatories of the Treaty declared that they were: - resolved to ensure the economic and social progress of their countries by common action to eliminate the barriers which divide Europe, […] - anxious to strengthen the unity of their economies and to ensure their harmonious development by reducing the differences existing between the various regions, […] - resolved by thus pooling their resources to preserve and strengthen peace and liberty. These objectives were pursued by creating a common market and a customs union and by developing common policies. The framers of the Treaty were fully aware of the difficulties that the path towards a united Europe would encounter. The presence of less developed regions, with low incomes and inadequate infrastructures, was definitely a cause of concern. For this reason the Rome Treaty foresaw the establishment of the European Social Fund and of the European Investment Bank, in order to provide financial support and reduce regional disparities. For many years, the development of the European project contributed to economic growth in the Member States: the progressive abolition of tariffs favoured specialization, made it possible to reap the benefits of scale economies and stimulated efficiency and competition, with positive effects on employment and welfare. The EEC subsequently evolved into the EU, becoming an area where Member States cooperate on a wide set of policies and citizens enjoy freedom and peace. In 1999 we introduced the euro, and even during the crisis we accomplished a lot in terms of deepening the Union. And yet, this anniversary takes place in a period of heightened uncertainty. The anxieties generated by the crisis and geopolitical tensions – including the large migrant flows and civil war in nearby countries – have aroused uneasy sentiments among European citizens, thus giving further ammunition to anti-European movements, and narrowing the focus of the economic and political debate to mostly domestic and short-term issues. The divergent views of the Member States on fundamental issues – from migration to economic policy – weaken the EU in the eyes of the international community and in those of European citizens. The reaction of public opinion has been one of concern and rejection. The European project is sometimes perceived as a bureaucratic superstructure and a source of redundant regulations; it is seen more and more as part of the problem, less and less as the solution. Should this situation persist, the future of the Economic and Monetary Union (EMU), and even of the EU itself, cannot – and should not – be taken for granted. In my opinion, the necessary ingredients to strengthen the European project are precisely those that inspired the choices of the founding fathers. First, an unfailing faith in the importance of European integration. As Donald Tusk, President of the European Council, has asked European leaders, somewhat rhetorically: ‘If we do not believe in ourselves, in the deeper purpose of integration, why should anyone else?’ Second, it must be clear that, as President Draghi recently affirmed, for the EMU to be viable ‘Members have to be better off inside than they would be outside…If there are parts of the euro area that are worse off inside the Union, doubts may grow about whether they might ultimately have to leave’. Finally, we must be able to design and put in place institutional arrangements and policies to address the pragmatic and pressing needs of all European citizens. With these objectives in mind, we must admit that up to now we have not been able to claim success. True, during the financial crisis European institutions and Member States have demonstrated their willingness to invest in the European project. Measures have been taken to strengthen the EMU, such as the establishment of the ESM, the launch of the Banking Union, the introduction of new budgetary rules and the extension of multilateral supervision to macro imbalances. However, what we have done so far is not enough. Those measures were often enacted in emergency conditions, and risked producing overlaps, redundancies and sometimes genuine mistakes. In effect, the reaction to the crisis relied almost exclusively on monetary policy. The ECB acted boldly to preserve price stability and to support the real economy. In the absence of its monetary policy measures, economic conditions would have been much worse, possibly leading to a deflationary spiral. Going forward, it will be necessary to increase the incentives for reform and the coordination of economic and structural policies, and shift from an intergovernmental form of management based on the peer review of national policies to the formulation of genuinely common policies. The plan published by the European Commission in November 2012 and the report of the President of the European Council in June of the same year set the stage for a further strengthening of the EMU. The SSM has been a success story. It rapidly became operational in supervising the largest banks and, in the euro area, it has contributed to stabilization, which is a prerequisite for economic growth. However, the Banking Union is still incomplete due to disagreement on the next steps to be taken. The Capital Markets Union is still embryonic, in spite of the fact that the free movement of capital is a long-standing objective of the European Union, dating back to the Treaty of Rome. Finally, some form of fiscal capacity at the euro-area level would improve the management of cyclical conditions in various economies and in the euro area overall. To be fully effective, it would require the introduction of common debt instruments. But, in order to move forward in the integration process we need, above all, to rebuild mutual trust, both at the political level and among citizens. The first step must be to tackle the weaknesses of individual countries, but such an effort must be sustained by progress in the European construction. This is a demanding agenda, but as the late President of the Italian Republic, Ciampi, noted about thirty years ago ‘for the civilization to which we belong [European integration] is the only way to avoid losing the thread that was broken by two world wars and retied by those with the vision to imagine Europe as a community.’ Without an integrated Europe, we may not be able to influence global phenomena such as migration, terrorism, climate change or the vagaries of an increasingly interconnected economy. Returning to my starting point, in order to make our way forward we may need to look back at our history, cherish the good we see in the past and jettison the bad. The Roman ‘economic and monetary union’ was strong because it was backed by political union, and we should strive to achieve such a union – by peaceful means, of course; at the same time it was weak, because it was designed for the benefit of a few to the detriment of many, a mistake that we should certainly try to avoid today.
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Introductory statement by Mr Ignazio Visco, Governor of the Bank of Italy, at an "Open coordinators meeting" of the ECON Committee (European Parliament) for an exchange of views on the economic and financial situation of Italy and prospects for economic governance in the European Union, Brussels, 11 April 2017.
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Ignazio Visco: Economic and financial situation of Italy and prospects for economic governance in the European Union Introductory statement by Mr Ignazio Visco, Governor of the Bank of Italy, at an “Open coordinators meeting” of the ECON Committee (European Parliament) for an exchange of views on the economic and financial situation of Italy and prospects for economic governance in the European Union, Brussels, 11 April 2017. * * * Introductory Statement Mr Chairman, Honourable Members, I would like to thank you for inviting me here today and offering me the opportunity to clarify my views on matters relating to my institutional duties. I will start by focussing on the role that monetary policy plays in the euro area at this juncture, as well as on its limitations. I will then discuss the situation of Italian banks against the background of Italy’s economic recovery. Over the last few years the euro area has experienced a challenging environment indeed. Downward risks to price stability increased sharply after mid-2014. There was a material risk of expectations de-anchoring. The activation of ‘debt-deflation mechanisms’ would have had very serious effects on the economy in a situation of high levels of public and private debt. I believe we at the ECB Governing Council adopted the right set of monetary policy measures to counter these risks. Official interest rates were progressively cut; those on the deposit facility for banks were reduced to negative levels, possibly the most ‘non-conventional’ element of our monetary policy. We supplied base money in very substantial amounts through the asset purchase programme. Finally, we offered banks rewarding refinancing conditions for providing more credit to the economy. The impact of the overall package has been considerable and is still unfolding. Without it, inflation would have been negative in 2015 and in 2016; GDP growth would have been lower too. According to ECB estimates, which we share, monetary policy will raise GDP by more than 1.5 percentage points over the period 2017–19. We expect the effect to be somewhat stronger for Italy, at around 2 percentage points. The measures have also significantly lessened financial fragmentation in the euro area, favouring a more homogenous transmission of the monetary impulse and, in turn, an improvement in financing conditions for firms and households. Although deflation risks have virtually disappeared, inflation remains subdued in the euro area as a whole. The positive dynamics of headline inflation over recent months largely reflects its most volatile components, such as energy and unprocessed food prices. Net of these items, core inflation remains very low, below 1 per cent. It is forecast to return only gradually to values consistent with price stability, as economic slack is progressively absorbed. For this reason it is of the utmost importance, for the euro area as a whole, that we maintain the very favourable financing conditions needed to secure a durable, self-sustained and broadlybased convergence of inflation rates towards our price stability objective. The asset purchase programme, which is set to continue at least until the end of next December, the low level of our policy rates, and the forward guidance constitute a package of mutually consistent elements. A reassessment of this package is not warranted at this stage. Before altering any component of our stance, we need to be confident that a convincing and self-sustained improvement in inflation and economic activity is taking place. To date, we have not seen any sign that this accommodative stance of monetary policy is causing generalised imbalances in the area. The impact of monetary policy measures on bank 1/4 BIS central bankers' speeches profitability has in general been contained. Should any threat to financial stability materialise, macro-prudential measures should be used to limit the build-up of systemic risks and to smooth the financial cycle in particular sectors or geographical areas. While monetary policy has been successful in warding off a deflation trap and no negative side effects have emerged so far, when it comes to achieving a durable recovery monetary policy cannot be left to itself. Aggregate demand must be supported by fiscal policy, whenever and wherever possible. At the same time, potential growth must be reinforced by adopting appropriate reforms to foster technological progress and strengthen human capital. The very magnitude and diffuse nature of the challenges and changes we face – new technologies, global trade, demography, migration – demand a truly common strategy that goes beyond emergency response. It is a fallacy that we can direct the course of the economy and finance, patently global phenomena, from within the limited confines of individual European countries, but a common strategy is lacking. As the crisis unfolded in recent years, measures to deal with the emergency were progressively flanked by reform of the governance of the European Union and especially of the euro area. These reforms, which began with intervention on public finance rules and macroeconomic surveillance, have marked further steps in economic integration: the European Stability Mechanism and the banking union are the most prominent examples. However, we seem to have lost momentum along the way. Today, banking union – whose first pillar, the Single Supervisory Mechanism, has been put together in an extremely short time and at a difficult moment – remains incomplete. The capital markets union is an excellent project, but it is still at a very preliminary stage. In spite of the efforts of many, including members of the European Parliament, moving ahead towards fiscal union appears somewhat difficult. The legacy of the crisis has aroused fears and prejudices once thought 2 long buried. Distrust leads to disaccord; in the exasperated pursuit of mutual reassurance, looking only to short-term gain, the necessary steps are hard to take. Moving forward based on a series of compromises is becoming more difficult. I am convinced that true European integration can only be achieved through the carefully considered development of democratic institutions appointed to manage shared sovereignty. The sovereign debt crisis was also a crisis of trust: interest rate spreads on sovereign bonds increased sharply amidst fears of a euro break-up and redenomination risk. The latter accounted for about two thirds of the increase in the interest rate differential between Italian and German sovereign bonds at the height of the sovereign crisis in 2011. We may now say that Italy is coming out of the worst economic crisis of its history as a nation. From 2008 to 2013, as a result of a double-dip recession, GDP fell by almost 10 percentage points, industrial production by about a quarter, investment by 30 per cent, and consumption by 8 per cent. Fiscal consolidation, even if pro-cyclical, was necessary to regain the trust of markets and to convince our partners of the country’s resolve to address its imbalances. The primary budget balance had returned to surplus by 2011 and net borrowing was brought back below the threshold of 3 per cent of GDP in 2012. Keeping primary current expenditure in check played an important role: since 2010 it has recorded modest growth in nominal terms (around 1 per cent) compared with more than 4 per cent in the previous ten years. As tensions in the sovereign market spread to banks, the latter’s ability to access international funding was impaired and a credit crunch ensued, which added to the contractionary impulse coming from the much-needed fiscal consolidation. This was not offset by an acceleration in foreign demand, either from the rest of the euro area or from other countries. The aggregate fiscal stance of the euro area was also contractionary. Only monetary policy responded by 2/4 BIS central bankers' speeches fighting financial fragmentation and avoiding the looming financial meltdown. Eventually, an economic crisis of these proportions could not leave Italian banks unaffected. Until 2012, the deterioration of bank loans appeared gradual and overall manageable. Still in 2013, the International Monetary Fund acknowledged the proven ability of the Italian banking system to contain the effects of the crisis and ensure adequate capitalisation by resorting to the market. 3 Subsequently, as the level of economic activity remained low longer than forecast by most national and international institutions and analysts, widespread company failures and job losses fuelled a further rise in non-performing loans. We estimate that without the double-dip recession, the gross stock of bad loans to non-financial firms would be about two thirds lower. Nevertheless, at the origin of a number of banking difficulties we also find managerial decisions undermined by misconduct and incautious allocation of credit. It was a potentially devastating combination of factors. Yet, all things considered, the damage to the banking system was centred on few, clearly identified, banks. They have been, and still are, the object of intense supervisory monitoring and intervention. Many risks have been eliminated or attenuated. European institutions continue to play a fundamental role in solving critical cases. The stock of NPLs is slowly but steadily declining, and the economic recovery will accelerate this trend, partly thanks to legislative and organisational changes to speed up credit recovery procedures. The large volume of Italian NPLs requires careful management; the real magnitude of the problem, however, needs to be clarified through careful scrutiny of the specific conditions of each bank. Last December bad loans and other NPLs on the balance sheets of Italian banks amounted to €173 billion net of write-downs, that is 9.4 per cent of total loans. Including write-downs, NPLs came to €349 billion, a figure which refers to the face value of the exposures and accordingly does not represent their actual weight in banks’ balance sheets. Out of €173 billion of NPLs, €92 billion pertained to situations in which regular repayments may resume, especially if the recovery gains momentum. Net bad loans, i.e. exposures to insolvent debtors, amounted to €81 billion or 4.4 per cent of loans. The majority of these bad loans are held by banks whose financial position does not require to sell them immediately. A good NPL management policy combines improving internal workout, choosing adequate governance and incentive structures, addressing problems relating to poor statistical information, and deciding whether to sell NPLs or externalise servicing to a specialised operator. Of the total of €81 billion of net bad loans, only about €20 billion are with banks, significant and less significant, that are currently experiencing difficulties. The average book value of these assets is around 40 per cent of their face value. This is about twice the low prices currently offered by a few market specialists. Based on these prices, the additional provisions that such banks may need to book could be estimated at about €10 billion. This amount of additional provisioning is far 4 below the €20 billion fund set up by the Italian Government at the end of last year to support troubled banks. Moreover, it should not be forgotten that any public support would be accompanied by some burden sharing. The NPL legacy comes from the past. Another and even more serious challenge for all European banks lies in the present and the future and has to do with technology and the shape of the market. Current trends are compressing profitability. It is time for a change in the business model of many banks. The extension of branch networks, the provision of services, and the use of technology must be reviewed in a bold and innovative spirit. This is essential for Italian banks if they want to compete effectively and maintain their stability. 3/4 BIS central bankers' speeches The prospects for the Italian economy have been improving gradually but steadily in the last three years; the moderate recovery is a testimony to the effectiveness of the policies put in place, but also to the need for further intervention. The production of goods and services continues to increase in the current quarter, although the pace of recovery is slow and lags behind that of other large countries in the euro area. Domestic demand is benefiting from favourable monetary and financial conditions, as well as from a mildly expansionary fiscal policy. Labour market conditions have improved. Business confidence is increasing. Bank lending has continued to expand in recent months, even though it remains heterogeneous across firms. Our latest forecasts suggest a further moderate strengthening of GDP growth. As in the euro area as a whole, the outlook, however, is clouded by risks, and tilted to the downside mostly by global geopolitical factors. Economic policy uncertainty – as measured by the most popular indicators – is at very high levels nationally, in the euro area, and outside Europe. Italy has been on a path of reform for a number of years now. Change is beginning to pay off. The effort to modernise the country must go on. 4/4 BIS central bankers' speeches
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Introductory speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at a round table on "Italian companies and banks in the new global challenges", organized by the Italian Banking Association (ABI) and the General Confederation of Italian Industry (Confindustria), in collaboration with the Institute of International Finance (IIF), at the Italian Embassy, Washington DC, 21 April 2017.
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ABI and Confindustria ITALIAN COMPANIES AND BANKS IN THE NEW GLOBAL CHALLENGES Introductory speech by Salvatore Rossi Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance Embassy of Italy in Washington, D.C. April 21, 2017 I would like to thank the organizers of this conference on the Italian economy for inviting me to open the discussion. My thanks also go to Ambassador Varricchio for hosting us in such a beautiful venue, and for his kind words of welcome. Today’s conference centres around three words – companies, banks and global challenges – which, in my view, are the key elements for understanding the dismal growth performance of our economy since the late nineties, its exceptional difficulties during the double recession, its recent recovery, and its prospects for the future. In my remarks I will start by mentioning one important challenge that the whole advanced world is facing, and which affects our economy too: policy uncertainty. I will then focus on the Italian economy, looking at it from a longer perspective. Finally, I will touch on the Italian banks. Policy uncertainty as the main global challenge We see encouraging signs in the global economy, which we are discussing in depth during the meetings here in Washington. But we also see a sharp increase in policy uncertainty, especially in the advanced world. This is a matter for great concern. Policy uncertainty does not mean uncertainty about future political events in this or that country, relating to the emergence of populist movements, but something much more specific: which economic policies will be adopted in our countries in the immediate future, even by traditional political forces? The usual, historical distinction between left and right, labour and capital, is no longer the infallible guide it used to be. Policy uncertainty dampens not only domestic economic activity, but also international trade. Financial markets have so far reacted unemotionally to events such as Brexit or the presidential election in the US, but the kind of uncertainty I am talking about may acquire longer-term dimensions than the macro outlook that markets traditionally consider. If the international openness achieved by our countries diminishes in the future, dire consequences will ensue for small open economies like Italy. If global trade and global value chains shrink, so will productivity. Inward-oriented policies are not the right reaction to political discontent. Protectionism is the wrong response to collateral damage of free trade, the exclusion of many from its benefits. Nostalgia for the past does not eliminate inequality; rather, it aggravates it. Italian companies But let me turn to Italy. Between 2008 and 2013 the Italian economy suffered the worst slump of its history: GDP went down by 9 percentage points, slightly more than household spending, while investment fell by 30 points, industrial production by almost 25 and employment by 4. The double-dip recession was far more severe in Italy than in the rest of the euro area. Since then the Italian economy has gradually recovered, mostly thanks to domestic demand, especially consumption and, more recently, capital spending, but also with a significant contribution from exports. Potential output has been slowly improving too. Three years into the recovery, business investment in Italy is now approaching the average of the ten years preceding the global financial crisis. We expect this positive trend to continue over the current and the next two years, partly thanks to the support of external demand. The latest surveys run by the Bank of Italy on a large sample of companies indicate that the recovery of investment plans is now on a firmer footing, and that the lack of productive capital is being reabsorbed, with the exception of construction spending, which remains extremely low. The common monetary policy designed by the European Central Bank has provided an important stimulus to every component of aggregate demand. But fiscal incentives have also played a role, while respecting the European rules on public finance. However, we need a longer perspective than a purely cyclical one. The large swings since 2008 followed a decade of very slow growth, when the debate centred on the question of whether Italy was in a sort of unstoppable decline. From 1999 to 2007, GDP grew on average by 1.5 per cent per year, where the positive contributions of population and employment growth were accompanied by a disappointing performance on the part of total factor productivity (+0.1 per year on average), which instead recorded significant increases in France (0.6) and Germany (0.9). Such a prolonged sluggishness of productivity reflects structural factors. The interpretation we proposed at the Bank fifteen years ago 1 – nowadays shared by many experts – is that since the mid-nineties Italian companies have been hit by a double world revolution: a shift in the dominant technology (ICTs) that triggered a re-organization of production on a global scale, and globalization. The Italian economy was harder hit by these shocks because of its structural features: most of its companies are small in size and never grow, a characteristic that goes hand in hand with a lower propensity to innovate and worse-than-average management skills and practices. The predominance of small and medium enterprises (SMEs), which was an asset in the past because of their supposed flexibility, is nowadays a liability. Cfr. Rossi (2003), La nuova economia: i fatti dietro il mito (ed.), Il Mulino, Bologna. Let me give you some figures. According to Istat, the national statistical institute, in Italy the private non-financial sector consists of 4.3 million units. Some 30 per cent of total value added is produced by independent workers and very small firms (less than 10 employees), another 30 per cent by large firms (more than 250 employees) and the rest (40 per cent) by SMEs. In Germany and France the number and economic importance of SMEs are also large, but less so than in Italy. The share of firms with an established research and development activity is less than 20 per cent among the smallest companies and above 50 per cent among the largest. Italy is the European country with the largest share of firms in which the whole management – not only the CEO – is in the hands of the family owning the firm. Family management is less modern and embeds lower incentives for technological and organizational innovation. When an Italian SME has the opportunity to grow a lot – and many of them do, even in these difficult years – often it does not. Why? For many reasons. Some have to do with the traditional practices and psychological traits of our entrepreneurs. Others, probably the most important ones, relate to the overall economic context, such as red-tape, high taxes, and inadequate human capital. Clearly, internal and external weaknesses are interconnected. It has been empirically proved, on one hand, that small firm size is associated with the excessive duration of judicial proceedings and with the combination of high taxes and low tax compliance, and on the other that the limited supply of human capital interacts perversely with the weak demand for skills by small firms in low-technology sectors. 2 Cfr. Visco (2014), Investire in conoscenza. Crescita economica e competenze per il XXI secolo, Bologna, Il Mulino. Still, Italy is populated by companies, mostly of medium size, that are highly innovative and competitive on international markets. They have driven the Italian economy’s recovery from the crisis, especially through their export performance. 3 How can we reconcile micro optimism and macro worries? Three magic numbers can solve the puzzle: 25-50-25. 4 We have a quarter of excellent and healthy firms and, at the other tail of the distribution, another quarter with little potential and a high risk of exiting the market. In the middle, there are companies that could become key players but whose growth is currently hampered by the internal and external factors I mentioned before. So, the question becomes: is Italy capable of changing these magic numbers into, say, 50-40-10? The answer lies in the capabilities of the economy and in public policies. The existence of the first has been borne out on many occasions by history and by the literature. 5 The second depends on the people, civil servants and politicians generating together the right policies. We are talking mainly of structural policies: economic development is a long-term issue, barely related to the economic cycle and to macroeconomic stabilization policies. In fact, important structural policies have been put in place in Italy in recent years: for example, the pension reform and the labour market reform (the Jobs Act). However, there is still much to be done if our economy is to become modern and innovative. What I personally have in mind are the legal and education systems, which I believe to be at the heart of all reform. Cfr. Banca d’Italia (2015), Annual Report for 2014, Chapters 5 and 6, pp.43-59. Cfr. Istat (2017), Rapporto sulla competitività dei settori produttivi, Chapter 3, pp. 58-63. Cfr. Giunta and Rossi (2017), Che cosa sa fare l’Italia: la nostra economia dopo la grande crisi, Laterza, Roma-Bari. Of course, the interest of private investors, both domestic and foreign, can encourage the right policies, in a virtuous circle. Italian banks Let me now move on to the situation of Italian banks, which is linked to that of non-financial firms in many ways. The financial structure of Italy is unusual: the leverage of non-financial firms is on average 45 per cent, against 41 in the euro area and 28 in the US, with a ratio of bank debt to total financial debt of more than 60 per cent, against less than 40 in the euro area and 33 in the US. Thus, we have companies that are both more indebted and more dependent on banks. Is the importance of banks in our real economy an obstacle to the recovery, now that they are burdened with non-performing loans (NPLs)? I would say no, for two reasons. 6 First, bank credit to the non-financial sector is expanding, though at a moderate pace. True, lending to households drives the trend, while corporate lending remains modest and varies considerably across firms of different size, but the cost of credit is on average stable at historically low levels. Bank credit fell in the recession years essentially because of the lack of demand. The 25 per cent of good companies I mentioned before do not need much bank credit as they are large enough to have access to the financial markets or to use internal financial resources. The 50 per cent of problematic companies are striving to weather the storm, so their demand for long-term credit has fallen Visco (2017), ‘Exchange of views with the Governor of the Bank of Italy Ignazio Visco on the economic and financial situation of Italy and prospects for economic governance in the European Union’, European Parliament, Committee on Economic and Monetary Affairs, Brussels, 11 April 2017. considerably in past years. Only the 25 per cent of really troubled firms are desperately seeking survival credit, but they probably do not have a good enough credit scoring to get it. A recent Bank of Italy study found no evidence that the NPL stock is significantly impairing the credit allocation mechanism in Italy. 7 The second reason is that the NPL stock, most of which originated with the terrible recession of 2009-2013, is finally being trimmed back by the recovery, though with the usual time lag. But how serious does the problem continue to be? At the end of last year NPLs in Italian banks’ balance sheets amounted to around 170 billion euros net of write-downs, around 9 per cent of total loans. The equivalent figure for the euro area was much lower, around 3 per cent. But Italian banks have much fewer level2/level3 assets, which are no less problematic than NPLs. I refer here to net NPLs, not gross, because that is the indicator of the actual risk run by the banks. The gross figure is an indicator mostly of the state of the economy, rather than of banks. In fact, Italian banks' NPL coverage ratios are higher than the European average: the book value of NPLs (net of write-downs) is now about half the face value. We must also bear in mind that NPLs are a very heterogeneous category, ranging from truly bad loans – loans to failed firms or insolvent households – to those granted to perfectly solvent borrowers who may just be in breach of overdraft ceilings. Net bad loans account for less than half of total net NPLs at Italian banks. They are largely backed by real-estate collateral, whose market value is uncertain, Accornero et al. (2017), ‘Non-performing loans and the supply of bank credit: evidence from Italy’, Banca d’Italia, Questioni di Economia e Finanza (Occasional https://www.bancaditalia.it/pubblicazioni/qef/2017-0374/QEF_374.pdf Papers), 374, available at however: even if we accept the valuation made by the banks and validated by the asset quality review conducted in 2014 by the Single Supervisory Mechanism, the value depends on how easily and quickly one can seize and dispose of the property. That is why an NPL market is struggling to develop and banks prefer to keep most of their NPLs and work them out internally. Forcing all banks to liquidate NPLs immediately may not be the best option. Most NPLs are held by banks whose financial position is such that they do not need to sell them quickly. Some banks, however, are not well equipped to work out NPLs internally. It is very important to eliminate all the inefficiencies in judicial and extra-judicial procedures. Substantive reforms have been undertaken in the last two years. Additional improvements should be sought. The Italian banking system has two interrelated problems: a sometimes cumbersome corporate governance, preventing swift and orderly access to capital markets if need be, and the legacy of the recession, which, together with serious episodes of mismanagement, has hit a few medium and small banks hard. The first problem was recently addressed by a couple of important legislative reforms regarding cooperative banks (Popolari and BCCs, small mutual banks). The second was tackled with the decision of the Government, subject to the approval of the European Commission, to offer public guarantees on newly-issued bank liabilities and to undertake a precautionary public recapitalization of a number of banks (currently three have applied), a tool provided for by the BRRD, the European directive on bank recovery and resolution; 20 billion euros have been budgeted for this purpose. Of course, the significant amount of loan loss provisions has weighed on banks’ gross operating profits. But low profitability is a long-term problem for our banks going forward, because of the evolution of technology and of the market. Indeed, it is a problem for all European banks, but for the Italian banks it is particularly acute. Cutting costs and changing business model are the strategic targets of Italian banks. How they can be achieved remains the responsibility of banks' boards and managers. What we do know is that banks' stability and competitiveness depend on reaching those goals. Mergers and acquisitions, especially among small and medium-sized banks, may be of help. *** The world is changing rapidly, and technology is making low value added retail activities less and less relevant and profitable. Italian companies need to rely less on bank credit and more on banks' market services and on non-bank intermediaries. Transforming our financial structure is one way to put the Italian economy back on track towards sustained and lasting development.
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bank of italy
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting for the presentation of the Annual Report 2016 - 123rd Financial Year, Bank of Italy, Rome, 31 May 2017.
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The Governor’s Concluding Remarks Financial Year 123rd financial year Annual Report Rome, 31 May 2017 rd The Governor’s Concluding Remarks Annual Report 2016 - 123rd Financial Year Rome, 31 May 2017 Ladies and Gentlemen, Carlo Azeglio Ciampi, President Emeritus of the Italian Republic and Governor Emeritus of the Bank of Italy, passed away on 16 September. He joined the Bank in 1946, serving as Governor from 1979 to 1993. Immediately following his appointment he had to address the gravest banking crisis of the post-war period, with the Bank of Italy still shaken by the dramatic events that had seen its top management unjustly accused. During his governorship, he achieved full autonomy of the central bank and created the conditions for bringing high inflation under control; he initiated the construction of a modern payments system, based on the technological infrastructure essential for a large market economy; he began the reform of the Bank’s supervisory activities with a radical revision of the rules and the banking market. Ciampi left a lasting imprint on the Bank’s management, introducing into its institutional culture a working method based on teamwork and an ability to combine different skills. This method was a hallmark of his work in all the positions of high office that he held after leaving the Bank. With his death, Italy has lost a great statesman, a firm believer in the founding values of democracy and in a united Europe, which he considered fundamental to guarantee peace, freedom, equality and prosperity. We are left with the principles that inspired his way of working: a sense of duty, respect for others and awareness of one’s own responsibility. These values help us to understand what is meant by the phrase ‘serving the general interest’, Carlo Azeglio Ciampi’s lodestar throughout his life. In the last six years the monetary policy response to the financial crisis, the sovereign debt crisis and the risks of deflation have had a profound impact on the size and structure of the Bank of Italy’s balance sheet. Assets increased by more than €440 billion to €774 billion. The portfolio of securities held for monetary policy purposes rose from €18 billion to €245 billion. Lending to banks grew by €157 billion. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 As I recalled on 31 March in my report to the Ordinary Meeting of Shareholders, in which I also dealt with the capital reallocation process, the expansion of the balance sheet has not only increased profitability but also heightened risks; these have been addressed by the introduction of capital safeguards. The 2016 financial year closed with a net profit of €2.7 billion; after allocations to the ordinary reserve and dividends paid to the shareholders, €2.2 billion were allocated to the State, in addition to the €1.3 billion paid in taxes. The institutional innovations in supervision and the resolution of banking crises have altered the responsibilities of the Bank of Italy, increasing its tasks. Our remit in the area of safeguarding financial stability has been expanded, while the Bank has strengthened its longstanding role in Europe as provider of high-tech payment, market and statistical services. Before the end of this year private operators will have completed their adhesion to the European securities settlement platform TARGET2-Securities, a complex infrastructure whose entry into full operation makes a crucial contribution to the process of integrating Europe’s financial markets. We give an account of last year’s numerous organizational changes in the Bank of Italy’s Report on Operations and Activities, which is published today together with the Annual Report. At a time of profound technological innovation, these changes have contributed to a reduction in operating expenses, which have come down by 15 per cent in real terms since 2009. During this period the Bank’s staff diminished by 870 to around 6,900. Today secondments to other European and international organizations number more than 150 and have increased sharply since the launch of the Single Supervisory Mechanism. The Bank of Italy holds fast to its principles, mindful of the responsibilities entrusted to it by society and careful to use the resources at its disposal efficiently. My own personal appreciation, that of the Governing Board and the Board of Directors, goes to the women and men who work here: their personal and professional qualities, and dedication to the common good enable the Bank to look with confidence to the changes that the future will inevitably bring. The economic situation and monetary policy The world economy is growing at a rate of more than 3 per cent, supported by expansionary policies in the main economic areas; the rise in investment is providing renewed vigour to world trade (Figure 1). Optimism prevails in the financial markets despite the uncertainty connected with the future stance of economic policies in the United States, the United Kingdom’s exit from The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA the European Union, the high level of debt in various parts of the world, and persistent geopolitical tensions. In the euro area growth is strengthening, led by consumption and investment in capital goods. In 2017, GDP is expected to grow by almost 2 per cent in the euro area, around twice the rate for Italy. Consumer price inflation, which had been practically nil since the end of 2014, has picked up in the last six months, sustained mainly by the rising prices of energy and food products. According to the European Central Bank’s March projections, consumer price inflation in the area will be 1.7 per cent for the year as a whole, but scarcely 1.1 per cent net of the most volatile components (Figure 2). The corresponding figures for Italy are just under 1.5 and 1 per cent. Economic activity and inflation are benefiting from the strongly expansionary stance of monetary policy; fiscal policies are on the whole neutral. The measures we have adopted in the Governing Council of the European Central Bank since mid-2014 have succeeded in averting the risk of a deflationary spiral which, given the high level of debt, both public and private, would have had severe depressive effects on the economy of the entire area. Since March 2016, when the asset purchase programme was expanded, the probability of deflation implied by option prices − which had exceeded 30 per cent at the beginning of 2015 − has gradually diminished and is now almost nil. The downward trend in medium- and long-term inflation expectations has come to a halt. The objective of price stability in the euro area – a rate of inflation below, but close, to 2 per cent sustainable over the medium term – has yet to be achieved. Core inflation remains constrained by unemployment in many euro-area economies and by sluggish wage growth, even in the countries with better labour market conditions. The normalization of inflation expectations still has to be consolidated. Credit demand remains weak. A highly accommodative monetary policy is needed to achieve the full convergence of inflation to the ECB’s objective. A change in the monetary policy stance, to be implemented with the requisite graduality, will serve as confirmation that demand growth and price stability can be self-sustaining in the medium term. Long-term interest rates are very low; besides monetary conditions, this reflects the depth and exceptional length of the recession. Owing to the still high level of debt, it will take more time than in past cyclical recoveries to regain suitable levels of investment demand and, therefore, profitability. Structural factors, such as the slowdown in productivity growth and the effects of demographic trends, are playing a role in keeping yields down. Monetary policy alone cannot guarantee a return to strong and steady growth. The structural problems affecting the national economies must be BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 tackled by expediting the necessary reforms. Where public debt is especially high, deficit and debt reduction must be pursued decisively, with a budget composition that is more conducive to growth; where debt is lower, it is possible to support internal demand, especially through investment in infrastructure in order to avoid an overly large net external position which could provide an argument for protectionist policies. Italy’s economy, though still weak, has been expanding for two years. The cyclical improvement is spreading to most industrial sectors; positive signals have also recently emerged in services and construction, mainly in residential housing, which is benefiting from tax incentives for the renovation of existing homes and from low interest rates. Activity in non-residential building is struggling to gain traction, owing to sluggish public investment. The improved performance of Italian exports, which has kept pace with the increase in world trade, continues to be coupled with a moderate increase in household expenditure, driven by the favourable outlook for income, and more recently, a recovery in private investment. The greatest increase has been in purchases of capital goods, which have a direct impact on the economy’s potential output; this type of investment grew almost 5 per cent last year but is still 14 per cent below the 2007 peak. Italy’s southern regions have also posted growth. Positive indications, though less widespread with respect to the Centre-North, are nonetheless discernible from the data collected by our branches from local economic operators. The gap with the rest of the country remains wide, with a difference of more than 40 per cent in GDP per capita. The balanced development of Italy’s economy necessarily depends on removing the obstacles, not only of an economic nature, that impede the recovery of Italy’s South. Overall, there are still ample margins of slack and firms’ demand for labour is insufficient. This is reflected in the performance of prices while wage growth remains very subdued. Consumer price inflation was slightly negative on average in 2016. Core inflation decreased to 0.5 per cent, but we expect it to increase gradually. At the current rate of growth, GDP would return to its 2007 level in the first half of the 2020s. Apart from cyclical factors, Italy’s economic development is hampered by rigidities in the business environment, the slow growth of productivity, and an insufficient employment rate. Decisions to invest can be encouraged by continuing the reform effort to favour business activity. The positive signals that have emerged must be consolidated. A growing number of firms consider the tax incentives introduced for the purchase of capital goods The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA to be significant; this year they have been expanded to include investment in advanced digital technology. The years of crisis Ten years marked by a double-dip recession – first, the global financial crisis, then, the sovereign debt crisis – and the risk of a deflationary spiral have weighed heavily on the euro-area economy. Euro-area GDP fell by 4.5 per cent during the first crisis and, after recouping 3.5 percentage points, by over 1 per cent during the second, with sharply varying trends from country to country. It was not until 2015 that the economy regained 2008 levels (Figure 3). Some countries were especially hard hit. The Italian economy suffered the worst years it had ever experienced in peacetime (Figure 4). The effects of the double-dip recession proved to be worse than those of the Great Depression. From 2007 to 2013 GDP fell by 9 per cent; industrial production declined by almost a quarter, investment by 30 per cent, consumption by 8 per cent. Today Italy’s GDP is still more than 7 per cent below what it was in early 2008; in the rest of the euro area it is 5 per cent above that level. The problems were exacerbated by the vulnerabilities of EU institutions and macroeconomic and financial imbalances whose importance had long been underestimated in a number of countries. Following Economic and Monetary Union, integration had progressed slowly on the assumption that common rules and market forces would make up for the lack of a unified government policy approach. Nevertheless, the reaction to the global financial crisis was coordinated and incisive. As early as the end of 2008 the major central banks were providing ample liquidity and cutting official interest rates in concert, an unprecedented development; they eventually reduced them even further, to historic lows. At the same time, the European Council approved a macroeconomic support plan. Almost all the countries adopted expansionary fiscal policies; many took measures to stabilize the banking and financial system. In April 2009 the members of the G20 agreed on further actions. Unlike other countries, Italy suffered from the slowness with which it had undertaken the modernization necessary to cope with the challenges of globalization, technological change and monetary union. Structural weaknesses amplified the repercussions of the crisis and further delayed recovery. Between 2007 and 2009 GDP fell by 6.5 per cent, recouping more than 2 percentage points over the next two years. In 2011 industrial production was still 15 percentage points below its pre-crisis level, while Germany’s industrial output BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 had in large part recovered; the volume of German goods exports had already regained 2007 levels, while Italian exports were still 5 per cent below them. During that phase, in many countries the financial support provided by governments to banks was considerable; at the end of 2011 the impact of State aid on public debt amounted to 48 per cent of GDP in Ireland, 11 per cent in Germany, and 7 per cent in the Netherlands and Belgium. In Italy, it came to 0.2 per cent of GDP, reflecting the limited exposure of our banks to the structured finance products that had triggered the financial crisis. The response to the sovereign debt crisis in the euro area that began in 2010, after the true state of Greece’s public accounts came to light, was not so rapid or adequate. The incompleteness of the European construction, with its lack of institutions for managing member state financial crises, contributed to this delay. Concerns about the resilience of the economies that were affected by imbalances in banking systems, balances of payments and public accounts, triggered market turmoil. Borrowing conditions became prohibitive for Ireland and Portugal which, as Greece had already done, requested financial assistance programmes in autumn of 2010 and spring of 2011. Tensions then spread to Italy and Spain, with the dramatic widening of the differentials between their government bond yields and those of Germany. The problems in the government securities market extended to the banks, whose credit ratings were equated to those of their sovereign; the consequent tightening of the credit supply contributed to the start of a new recessionary phase; fears mounted for the break-up of the single currency. To defend the sustainability of the public debt, fiscal policies took on a restrictive stance in the countries that had agreed to assistance and in those that feared loss of access to financial markets; an analogous policy was adopted in other countries as well, including Germany. The lack of a common budget precluded supranational action to counteract the strong procyclical impulse of national policies. At that time macroeconomic conditions in Italy were deteriorating much more rapidly than indicated by our projections and those of the leading international organizations. In January 2012 we forecast a 1.5 per cent drop in GDP (0.4 per cent under a less unfavourable scenario) for 2012 and 2013; in the summer this forecast was revised to 2.2 per cent; in the end, the decline amounted to 4.5 per cent. This result was due in part to the deceleration in international trade and the collapse in confidence in euro-area prospects, which amplified the effects of credit tightening and the budgetary adjustment. The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA In the final months of 2011, monetary policy took on a clear expansionary tone, reinforcing the measures to counter the serious liquidity shortfalls in the banking system and the consequent fragmentation of financial markets. But the need for intervention to safeguard the single currency struggled for recognition in an environment in which tensions were blamed largely on the deterioration in national outlooks for growth and public finances and not also on a systemic risk, such as the potential break-up of the monetary union. After overcoming the differences of opinion on this issue, in the summer of 2012 the ECB Governing Council authorized the purchase of the government securities of countries in difficulty. The announcement sparked an immediate improvement in financial market conditions and fostered a resurgence of capital inflows to the countries affected by the crisis. Monetary measures, European institutional reforms, the credibility gained thanks to the corrective measures of national governments, and the agreements on financial assistance to the Spanish banking system and on the renewal of aid to Greece, all helped to ease financial tensions, bringing interest rate spreads back to regular levels and setting in motion the normalization of economic conditions within the euro area. A contributing factor in this result was the decision to implement the project for Banking Union: the complexity of the reform and the commitment to carrying it out within a very short time frame, at least as regards the Single Supervisory Mechanism, were signals of the strong determination to continue on the path to integration. I have often remarked on the difficulties stemming from the incompleteness of the new framework and the lack of consideration of the risks associated with implementing the new legislation on banking crisis resolution. Two sources of weakness The consequences of the double-dip recession for Italy are most clearly observed in the behaviour of two variables, radically different in nature and dimension, which owing to their rate of growth and current level are frequently cited as Italy’s main problems: namely, the public debt and the loans defined as ‘non-performing’ held by banks. These are sources of weakness that limit the room for manoeuvre of the State and of financial intermediaries; both make the Italian economy vulnerable to market turmoil and can amplify the effects of cyclical fluctuations. In order to assess these sources properly and identify the best strategies to manage their impact, we must first recognize their close connection with the problems of the economy as a whole. On both fronts we must continue to act, BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 with resolve and clarity of purpose, to preserve and reinforce the trust of those who deposit their savings and invest in Italy and its banks. The public debt The ratio of debt to GDP has been at high levels for over thirty years now. Notwithstanding the reduction that began in the mid-1990s, at the outbreak of the crisis it was still close to 100 per cent. Since 2008 it has risen rapidly, to the point of exceeding 130 per cent (Figure 5). Not counting the Treasury’s liquid assets, last year the ratio basically stabilized. Following the most turbulent phase of the sovereign debt crisis, fiscal policy has accompanied the expansionary monetary policy stance, mediating between the necessity of holding debt in check and that of supporting the recovery. Since 2008 the increase in the ratio of debt to GDP has essentially been attributable to the poor performance of the latter. Had real output grown at even the low average rate recorded in the years between the launch of Economic and Monetary Union and the onset of the financial crisis, and had the rise in the deflator been consistent with the ECB’s inflation aim, the larger denominator alone would have determined a debt-to-GDP ratio today comparable to what it was in 2007. Without the crisis, higher growth would also have enabled deficits to be brought down and avoided the need to provide financial support to other countries; the ratio would have been even lower as a result. Long-term projections such as those made periodically by the European Commission indicate no significant risks to the sustainability of Italy’s public debt. This is thanks to the reforms that have assured the financial equilibrium of the pension system, wiping out almost one third of the implicit pension liabilities accrued up to the early 1990s and enabling it to withstand adverse demographic or macroeconomic shocks. Italy’s high public debt is nevertheless a source of vulnerability and acts as a brake on the economy. It makes it more costly to fund productive investment by the private sector; it induces greater recourse to distortionary tax systems, with adverse effects on the capacity to produce income, save and invest; it stokes uncertainty, another way in which it discourages investment; and it leaves less room for macroeconomic stabilization policies. The high debt also exposes the country to a loss of market confidence and phenomena of contagion. The exceptional and abrupt widening of the spread between Italian and German government bonds at the height of the crisis was proof of this; the increase recorded in the last eight months is another such reminder. Every year market placements of debt securities issued by the Italian State amount to around €400 billion. The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA An appreciable and lasting decline in the debt-to-GDP ratio must commence without delay. There must be no repeat of past errors: the failure to reduce the ratio of debt to GDP sufficiently in good economic times forced us to make procyclical adjustments during the crisis. In this current phase of – moderate – recovery, durable consolidation can be pursued through prudent budgetary policies, designed not only to lower the deficit but also to review the composition of expenditure and revenue. Economic growth can be strengthened and the reduction of the debt ratio facilitated by giving greater scope to public investment, rethinking the structure of government transfers, tax subsidies and exemptions, rebalancing the tax burdens on the various sources of income and redoubling efforts to combat tax evasion. With annual growth of around 1 per cent, inflation at 2 per cent, and with the average interest rate on the debt gradually regaining pre-crisis levels, a primary surplus (net of interest payments) of 4 per cent of GDP, which is basically consistent with the Government’s policy scenario, would bring the debt-to-GDP ratio below 100 per cent in around ten years. With higher growth, achievable as part of a package of incisive reforms, a recovery in investment, and a different composition of the public budget, this could happen even faster. Italy has already shown it can deliver and maintain a large primary surplus: between 1995 and 2000 this averaged almost 5 per cent of GDP. Other countries have done even better and for longer periods of time; between 1995 and 2007 the primary surplus averaged more than 6.5 per cent of GDP in Canada and about 5 per cent in Belgium, Denmark and Finland. That is no small achievement, but it is not beyond our reach. According to the Government’s plans, to meet the objectives outlined in the Economic and Financial Document and avoid next year’s scheduled VAT hike will require the definition of corrective measures in the order of 1.5 percentage points of output in the three years 2018-20. A constant, protracted effort to keep the public accounts under control is indispensable to a lasting reduction in the ratio of debt to GDP against a backdrop of a return to stable growth. This would have positive effects on confidence, economic activity, and interest expenses. While not the only answer, given the constraints on public real estate assets and their heterogeneity, and the characteristics of the State’s portfolio of shareholdings, privatizations could help to speed up the reduction of the debt. Non-performing loans The repercussions of the crisis could not but affect banks’ balance sheets. Between 2007 and 2015 the ratio of bad loans to total loans i.e. exposures to BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 insolvent debtors, more than tripled, reaching a level that was still below the peak recorded in the mid-1990s (Figure 6). In several cases, banks’ difficulties were exacerbated by fraudulent conduct and imprudent lending policies. At the end of 2016 Italian banks’ non-performing loans, recorded in balance sheets net of write-downs, came to €173 billion or 9.4 per cent of total loans. The €350 billion figure often cited in the press refers to the nominal value of the exposures and does not take account of the losses already entered in balance sheets and is therefore not indicative of banks’ actual credit risk. Of the €173 billion in net non-performing loans, €81 billion or 4.4 per cent of total loans were classified as bad loans, against which the banks hold real collateral and personal guarantees of over €90 billion and almost €40 billion respectively. The remaining €92 billion are other non-performing exposures, whose nominal value has already been written down by roughly a third. For some of these, a return to regular payments is certainly possible, though to what degree will depend on the timing and strength of the recovery; active management of the positions on the part of the banks is indispensable if the share that become bad loans is to be reduced significantly. Three quarters of net bad loans are held by banks whose financial conditions do not require their immediate disposal on the market. Those held by intermediaries experiencing difficulties, which could find themselves obliged to offload them rapidly, amount to around €20 billion. As we have documented, bad loans are recorded in banks’ balance sheets at values consistent with the recovery rates actually observed in the last ten years. If they were sold at the very low prices offered by the few large specialist debt collection agencies active in the market today, which pursue very high returns, the amount of additional write-downs would be in the order of €10 billion. At the end of 2011 net bad loans held by Italy’s banks made up 2.9 per cent of total loans. A ‘system-wide’ intervention on non-performing loans, involving substantial public funds along the lines of what occurred in other countries, appeared neither justified nor feasible. The increase in bad loans was not concentrated in any specific sector of the economy; the macroeconomic predictions made in the course of 2012 were much more favourable than the results actually achieved. As the sovereign debt market strains grew more acute, government intervention on non-performing loans appeared incompatible with the state of the public finances. In the years immediately following the picture changed rapidly. The recession proved much longer and deeper than originally forecast; the attendant rise in business failure rates and unemployment fuelled the growth of net bad loans, which in 2015 reached 4.8 per cent of total loans. The abatement of the tensions on sovereign debt markets, which began in mid-2012, gathered The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA momentum in 2013, and at that point made desirable the establishment of a publicly supported company to manage banks’ non-performing assets, a possibility which we actively supported. Its fruition was, however, impeded by the position on State aid adopted by the European Commission in mid-2013. In part following the proposals drawn up by European institutions, in recent months the idea has been mooted again. We remain convinced of its potential usefulness, provided that the asset sale prices are not excessively detached from their real economic value, banks’ participation in the scheme is voluntary, and the restructuring plans of the participating banks are properly defined ex ante. Whether or not there is a real determination to proceed down this path must be clarified without delay: uncertainty slows the conclusion of the transactions under way and discourages those that could be completed in the coming months. In 2016 the flow of non-performing loans declined, as did the ratio of non-performing loans and that of bad loans to total lending. The ongoing recovery supports this trend. The sales currently scheduled by the major groups could raise the reduction in the net bad loan ratio significantly. The large stock and low market prices of non-performing exposures reflect Italy’s excessive time to recovery, which is far longer than in the other main European countries. At the end of 2015 recovery times averaged almost eight years for bankruptcies and over four years for property foreclosures. Legislative measures taken in recent years go in the right direction but must be strengthened to ensure a sufficient shortening of recovery times. It would be especially useful to increase the degree of specialization in the handling of insolvency cases, providing for the centralization of the more complex proceedings, including by reviewing the territorial jurisdiction of Italy’s courts. For their part, the banks must make the best possible use of the instruments already available in the form of out-of-court agreements with firms on debt restructuring and the transfer of real estate pledged as collateral. As recent analyses by the Bank of Italy have shown, incentives for the disposal of non-performing loans would derive from the removal of the regulatory disincentives that impede the sale of large amounts of these assets by banks that use advanced internal models for calculating capital requirements. Sufficient and timely information makes the management of non-performing assets less costly, increasing their value; harmonization at European level would facilitate cross-data analysis, with positive effects on the prices and speed of the transactions. The new reporting on bad loans that we introduced last year is a step in this direction, inducing banks to manage these exposures more actively and effectively. Supervisors are mindful of the need to refrain from imposing blanket sales of non-performing loans, which de facto lead to a transfer of resources BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 from Italy’s banks to a handful of specialized investors. However, as indicated by the recent guidelines issued at European level and drawn up with the active contribution of the Bank of Italy, the largest intermediaries (classified as ‘significant’ within the Single Supervisory Mechanism) must adopt strategies to improve the management of these assets together with ambitious operational plans to ensure their substantial and progressive reduction. Possible options include: the creation of separate and specialized management units, recourse to external managers, the sale of the portfolios on the market. We are working to extend the guidelines to the banks under our direct supervision. Labour and growth It is in the labour market in particular that we see the most painful legacy of the crisis: in 2014 the unemployment rate came to nearly 13 per cent, more than double that of 2007 (Figure 7); unemployment among young persons aged 15 to 24 increased from 20 to over 40 per cent; the figures are higher in the South. The gap between the quality of the positions offered and workers’ expectations widened: nearly all fixed-term employees would prefer a permanent position, while two thirds of part-time workers would like a full-time job, compared with two fifths ten years ago. Households’ living standards have fallen, especially for the most disadvantaged. There has been some improvement in the last two years thanks to the cyclical recovery, social security contribution relief and measures to improve the efficiency of the labour market. However, at the end of 2016, less than 60 per cent of people aged 20 to 67 were employed and only one out of two women. About a quarter of people younger than 30, and a third in the South, were not in education, employment or training. These figures are far from those of most other European countries. The question of labour is central. It relates to social integration and personal identity. On the economic level, it should not be seen solely as a cyclical problem: the economy’s growth potential depends on the quantity and quality of the labour force and the capacity of the productive economy to provide adequate employment. Demographic and technological tendencies play an important role, destined to increase in the years to come. According to Istat, whose forecasts even assume a net annual influx of about 150,000 migrants, the number of people aged 20 to 69 will fall by nearly 7 million in the next 30 years. The population older than 70 will increase to about 30 per cent of the total, with important repercussions on the composition of employment and further growth in the demand for jobs in personal care, assistance and health, which in the past 20 years have accounted for over a The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA third of the increase in employment. Increased labour market participation and the efficient and rational inclusion of migrants will be essential to Italy’s future development. But productivity must return to growth. Italy’s economy, much of which lags far behind in the adoption of new technologies, suffered from excessively slow total factor productivity growth well before the onset of the crisis (Figure 8). It averaged annual growth of just 0.2 per cent between 1995 and 2007, roughly a quarter of the rate estimated for France and Germany; and in recent years it has recouped only a small part of the substantial decline experienced during the crisis. The gap with the other countries is particularly wide for small firms (with fewer than 20 employees), which account for 55 per cent of all workers in industry and in non-financial private services. To avoid negative effects on the living standards of Italians, we must bridge this gap and take part in the ongoing digital revolution. Some have predicted that technological progress will sharply reduce jobs and increase inequality. But others maintain that the creation of new occupations will compensate for those supplanted by machines, as has been the case historically. Estimating these consequences is difficult, but the Italian economy appears vulnerable to the processes of automation: according to recent estimates by the OECD, the risk is very high for a tenth of all occupations and high for up to half. Economic policy must take into account the risks and opportunities that stem from these long-term trends, in pursuit of the objective, which is no longer deferrable, of aligning the Italian economy with global dynamics. There is no alternative to increasing productive efficiency, and managerial and administrative capacity: only innovation in the production of goods and services can simultaneously ensure higher incomes and raise the quantity and quality of employment. Improvements are emerging in the sectors where competitive pressures are strongest. In manufacturing, productivity has benefited from a shift of resources towards the more efficient firms, a trend that was under way before the crisis and has picked up further in recent years. The transformation is evident among firms active in international markets: the share of exports from medium- to large-sized firms, which are capable of keeping pace with global demand, has increased progressively. This change must extend to the entire productive system, particularly the service sector where the qualitative and technological lags by comparison with Italy’s main competitors are most severe. In the past the attempt was made to cope with these changes by means of cost reduction alone, especially labour costs. The benefits obtained in terms of employment, while significant, proved ephemeral, because they were not accompanied by the structural change required in many parts of our productive economy. In order for a larger and more highly skilled labour BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 supply to be fully utilized in jobs that satisfy the legitimate expectations of the younger generations, there must be a qualitative leap to help foster innovation and improve the mechanisms that drive resource allocation. To this end, the convinced participation of all concerned is needed: businesses, workers, and public administrators. Over the last five years we have entered an intense period of reform. The aim is to increase the efficiency of the productive economy by modifying the legal framework for economic activity and by intervening on the functioning of the product, capital, and labour markets. We have begun a process designed to enhance efficiency of the public administration and the civil justice system. The battle against corruption has been stepped up. Measures have been introduced to reduce the costs and time needed for firms to enter and exit the market. Provisions have been made to facilitate a change in the composition of payroll employment towards open-ended contracts; active policies in favour of employment have been launched; unemployment benefit programmes have been reviewed. These are the first steps on a long path, which must be followed resolutely, monitoring the implementation of the measures taken. The reform efforts must also be directed at encouraging new business ventures, increasing competitiveness in key service sectors, further simplifying crisis management procedures, reducing handling times in the courts to levels comparable to those of other advanced countries, and eliminating the regulatory and fiscal disincentives to the expansion of firms. Regulatory reform is a complex process whose benefits are not immediate. It must be accompanied with measures to foster the continuous creation of new jobs, also in the short term. Encouraging results have stemmed from the introduction of allowances commensurate with increases in corporate equity, tax breaks for investment in the capital of innovative startups, and the creation of national venture capital funds based on the cooperation of the public and private sectors. The national plan ‘Industry 4.0’ introduced a series of measures to encourage the adoption of the new digital and automation technologies. Ample room for rationalization remains in the allocation of public resources, which must be directed to serve medium- to long-term objectives. Spending on public investments must return to growth: falling since 2010, its ratio to GDP was slightly higher than 2 per cent in 2016, about 1 point less than pre-crisis levels and among the lowest in the euro area. An increase in the resources dedicated to the renovation of existing public and private buildings, the prevention of hydrogeological risks, and the reduction of earthquake damage would have appreciable effects on employment and economic activity, and to a greater extent in the Centre and South. This is not a task that the State can undertake on its own; the private sector must be involved. The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA To deal with change and seize the opportunities offered by the predictably profound transformation of the technological paradigm, economic policy must engage above all with human capital. In Italy, both formal education levels and reading comprehension and logical and analytical skills, are far below those of the other advanced countries, even among the young. There are widespread shortcomings in the school system and in higher education; private and public funding of research and instruction at university level remains very low by international standards. Also on account of the technological lag, many sectors of the productive system have little inclination to invest in on-the-job training, or, more generally, to offer opportunities to qualified workers; in the end, the returns on education are low, reducing the incentive for young people to improve their skills. Investing in education and knowledge creates citizens who are more aware and workers who are better able to discharge rapidly changing tasks and functions. This is an essential condition to the more equitable distribution of labour and its remuneration. The effects of the reform will require time to materialize, relying as they do on the behaviour of citizens. The reforms will not suffice if the presence of firms whose profit margins depend on illegal activity, tax evasion and corruption continues to be widespread. These practices distort competition and reduce the resources available to invest in infrastructure and services for the community and in higher value-added projects. Illegality in all its forms is a source of injustice and the cause of diminished economic well-being. Banking supervision and the challenges for banks During the years of crisis, banking supervision was engaged on several fronts. Liquidity checks were intensified, and at the moments of greatest tension conducted intraday. The volume of assets eligible as collateral for Eurosystem or market funding grew substantially. A series of targeted inspections that commenced in the second half of 2012 resulted in significant value adjustments in respect of non-performing loans. Between 2009 and 2014 coverage ratios rose by 5 percentage points for the major banks and by almost 11 points for the others; today these ratios are higher than the European average. We have urged – and where necessary required – banks to attain higher levels of capitalization; this action continued with the launch of Banking Union, even at times of tension in the credit and capital markets. Between the onset of the crisis and the end of 2016, the CET1 ratio of capital to risk-weighted assets was raised by 4 percentage points for the leading banks, to 10.4 per cent on average, and by 5 points, to 15.5 per cent for the rest of the system. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 In an economy in which four fifths of firms’ financing comes from banks, as I observed earlier the contraction in economic activity inevitably had repercussions on the banks. Their profitability and capacity to generate capital deteriorated, as revenues diminished while loan losses increased. On average in the three years 2013-2015 loan losses wiped out 90 per cent of their operating profit. The benefits of the economic recovery are now slowly showing up in banks’ balance sheets. Last year’s negative results partly reflect the low level of interest rates and one-off costs sustained to incentivize early retirements; another contributing factor was the substantial write-downs on loans made in the closing months of 2016. In the first quarter of this year the operating profits of the leading groups held broadly stable, while write-downs were reduced by about a fifth. Lending to the non-financial private sector continued to grow at an annual rate of around 1 per cent. The success of the UniCredit Group’s very substantial capital increase on the market is an important marker of confidence. The crisis struck especially those banks which were already weak, owing in part to shortcomings in corporate governance and imprudent – in some cases illicit – granting of credit. This was the case of the four banks placed in resolution at the end of 2015 and of the groups currently engaged in capital strengthening. In cases of serious irregularities, we imposed the most severe sanctions applicable under the law. In cases of malfeasance, suspected offences were promptly reported to the judicial authorities, initiating our cooperation during our on-site inspections. The major reforms enacted in recent years were designed to correct the shortcomings of banks thrown into relief by the crisis. Since the end of 2015 eight of the ten largest cooperative banks, whose operations extend far beyond the sphere of the local community, have been transformed into public limited companies. The reform has strengthened the incentives for monitoring the activities of these banks’ directors, improved transparency in corporate management and enhanced their capacity to tap the capital markets. It provides for increased members’ attendance at meetings, defusing the risk of concentration of power in the hands of organized minorities. The merger of Banco Popolare and Banca Popolare di Milano at the start of this year created the third largest banking group in Italy. Mutual banks, with the reform currently being implemented, can have recourse to the market and increase their support for local economic activity with greater efficiency and security while preserving the mutualistic spirit that distinguishes them. Our supervisory activity was conducted during a period of intensive change in international and European banking regulations. Above all, the design of a new system for managing bank crises and, before that, the more restrictive interpretation of the rules on State aid, marked a radical new departure, as The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA I have observed on several occasions. In the downturn the risks of the transition were underestimated. In applying the new rules, financial stability must not be jeopardized. In adherence to the principles underpinning the new European rules, authorities’ interventions must be designed to preserve the value of banking activity, to the benefit of savers and borrower firms. We cannot run the risk of undermining confidence in the banks and in the savings in their custody. Effective crisis management requires extremely prompt and decisive action, close cooperation among all those involved, and the clear definition of responsibilities and priorities. This is how in the past even severe strains were overcome in Italy without damage to savers or the credit system as a whole. Today, under the new European arrangements, crisis interventions are assigned to multiple, mutually independent authorities and institutions, both national and supranational, with decision-making processes relatively incompatible with rapid intervention. Effective coordination is lacking. In market conditions in which the transfer of banking assets is very difficult, the competent European authorities now treat preventive intervention by deposit protection funds as equivalent to State aid, even though these funds are completely private and their utilization is determined by entrepreneurial considerations, not by interventions by authorities. The use of public funds, even though it may be economically and financially advantageous, is subject to stringent limits even after shareholders and subordinated creditors have been bailed-in. In recent weeks, at the end of a laborious and complex process, the procedure for the sale of three of the four banks placed in resolution was completed; for the fourth, the process is nearing conclusion. Negotiations are continuing between Italian and European authorities for precautionary public recapitalization – an instrument envisaged by the Bank Recovery and Resolution Directive – of Banca Monte Paschi di Siena, Banca Popolare di Vicenza and Veneto Banca. Negotiations are at an advanced stage for the sale of three small banks to a large French banking group, with the financial and operational intervention of a voluntary fund constituted by most Italian intermediaries. The banks under our direct supervision are continuously monitored, which involves intense on-site inspection activity as well as off-site analysis. In years past these checks have enabled us to resolve problems in the areas of corporate governance, organization, and risk management. In 2016 we conducted 95 inspections of banks under our direct supervision, in line with the average of recent years. In most cases the inspections embraced the whole spectrum of the bank’s business. The checks on credit risk, which centre on loan classification and the adequacy of the banks’ write-downs, are very thorough; a selection of individual loans are screened and a very large proportion of the entire portfolio is checked. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 For the 101 banks (not counting mutual banks) under our direct supervision, last year the prudential review process produced positive assessments in 60 per cent of the cases. The 35 per cent that were put on a ‘watch list’ will be subject to more intensive and stringent controls and interventions. The remaining ‘critical’ assessments referred to small banks at which corporate reorganizations and recapitalizations are now under way, among other purposes to deal with the potential capital shortfalls that emerged following the assessments of the effects of adverse scenarios. In the mutual bank sector, in the three years 2014-16 on-site inspections were carried out at two thirds of the sector’s 330 banks; 60 in 2016 alone. Also in this case the problems that emerged consequent to the prudential review involved only a limited number of intermediaries, at which interventions are under way or nearing completion to resolve the difficulties with a view to their inclusion in the larger groups that will be created as a result of the reform. For two large groups, together with the ECB in 2018 we will conduct a comprehensive assessment like that held in 2014 for the banks subject to joint European supervision. At the Italian banks classed in 2016 as significant, 34 inspections were made last year on behalf of the Single Supervisory Mechanism, conducted mostly by Bank of Italy inspectors, and in the most important cases with the participation of staff from other member country authorities. Another 11 inspections dealt with questions of transparency and money laundering at those banks. Our inspectors also took part in checks at large foreign intermediaries. In exercising the powers and duties that the law assigns to the Bank of Italy in the area of banking products, in 2016 we reminded 90 intermediaries of the need for full and prompt compliance with the rules on transparency and correctness in customer relations. Appropriate corrective measures were required and sanction proceedings initiated where necessary. As a result of these controls, banks refunded some €35 million of improperly debited fees to customers. The activity of the Banking and Financial Ombudsman, to which the Bank of Italy provides organizational support, is expanding rapidly. In 2016 alone the Ombudsman received some 22,000 complaints and handed down 14,000 decisions, three quarters of them in favour of the customer. Although these decisions are not binding, in virtually all cases the bank abided by them; this resulted in the refunding of another €13 million. The Bank of Italy’s controls in this area are complemented by our financial education initiatives; we are taking an active part in the launch of a national financial education strategy. The revision of Italy’s anti-money laundering regulations for implementation of the fourth European directive has now been completed. The new framework confirms the role and organization of the supervisory The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA authorities and Italy’s financial intelligence unit (UIF). The Unit’s position within the Bank assures its independence and effective preventive action. In its ten years of existence our system has worked well, as is shown by the declining number and decreasing gravity of the criticisms raised in the course of inspections, the growing cooperation of financial institutions in reporting suspicious transactions, and the important contribution of the UIF to investigative and judicial activities. Given the high threat of terrorism, procedures for investigation and cooperation, including at international level, have been finalized to intercept and counter terrorist financing. Today, Italian banks are called on to change in order to bring profitability back up to adequate levels. This is the spirit in which they must address the challenges of technological progress and the evolving structure of markets. They must proceed resolutely in the rationalization of branch networks, the even radical overhaul of governance structures, and the reduction of the cost of labour, at all levels. The spread of new forms of financing of the economy alternative to bank credit, involving the direct access of firms to investors and the capital market, may enable the banks themselves to broaden and diversify their sources of income. A significant contribution can come from corporate finance and asset management services; these lines of business, while permitting less stringent capital requirements, demand special attention to ensuring correct relations with customers. The growth of forms of intermediation hinging on the use of technology heightens competition and itself makes possible a wider range of services. Digitalization also comes with operational risks, however, and makes infrastructures vulnerable to external attacks. Customers’ confidence depends crucially on transparent information, correct conduct, and data security. The computer emergency response team formed together with the Italian Banking Association and the participation of banks and other financial sector entities is acting effectively. International coordination for IT security is indispensable. Within the framework of the G7 a programme of cooperation has been initiated with the objective of developing common lines of action to strengthen the protection of financial entities, private and public alike. * * * The global economic scenario has been transformed by sweeping commercial, financial, technological and demographic change. Italy has struggled to respond, and this explains the difficulties it has encountered in lending vigour to the strengthening recovery. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 The need to exit the crisis has called for, still calls for, an exceptional effort. Just as exceptional is the commitment necessary to return to a path of stable, high growth and to resolve the question of jobs, which are so difficult to create, maintain, and transform, a question that is of vital importance today not only in the economic sphere. The main lesson of the crisis is that imbalances must be corrected quickly, otherwise sooner or later the price will have to be paid. On the subject of reforms, on the state of the public finances, on banks, we must keep moving forward, not backward. The structural adjustment of the economy requires the continued removal of restrictions on business activity and further encouragement of competition and innovation. We must remain open to technological progress because there is no alternative if we want to create jobs and well-being. The choice of economic policies and the decisions made by each of us require a comprehensive vision: to respond to these challenges we need to invest heavily in knowledge and in new and interconnected skills, essential to combatting the threats to employment and attenuating the inequalities that the digital revolution risks accentuating. Italy must take advantage of the consolidating recovery to accelerate the necessary structural adjustment to the public accounts; the high public debt is a serious source of vulnerability which weighs on the country’s economy. A credible debt reduction plan may gather its own momentum. It could trigger a virtuous cycle similar to the one which allowed us to adopt the euro. We could pay no better tribute to the memory of Carlo Azeglio Ciampi, who defined just such a plan and implemented it. The banking and financial sectors must profoundly modernize to meet the challenge posed by technological competition. Some, albeit hesitant and small, steps have been taken. The legacy of the double-dip recession, endured but not caused by Italian banks, must be left behind. The banking system as a whole is not experiencing a crisis, but its strength is inextricably linked to the health of the economy. Various problematic situations pertaining to individual banks have been resolved or are in the process of being resolved; in Italy and Europe we are working on open cases intensively and with determination. The flow of new non-performing loans is slowing; those inherited from the past must be actively managed in order to accelerate their reduction. We can debate the methods used to avoid excessive losses but this is an obligatory step to regain the trust of the markets and recover profitability. To this end, additional progress in reforming the civil justice system is important but not in itself sufficient. We must continue with conviction along the path of cost reduction, corporate reorganization, and the adoption of efficient corporate governance The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA structures. This is not something that only affects a few banks facing difficulties but also healthy banks if they want to remain so. It is an illusion to think that Italy’s economic problems could be solved more readily outside of Economic and Monetary Union. A departure from the euro, which is often discussed with scant knowledge of the facts, would not serve to heal the structural defects of our economy; it certainly would not lower interest expenses much less would it magically lower our debt level. On the contrary, it would generate serious risks of instability. Italy’s competitiveness is not suffering from an overvalued currency; the current account in the balance of payments is in surplus; our spending power has been defended. The European rules on the public finances contain some elements of flexibility, to be invoked by always paying careful attention to the scale and rollover of the debt. Monetary policy has done what had to be done for the area as a whole, aiming at guaranteeing price stability by sustaining demand; it will continue to do so in the appropriate time and manner. There is often talk about when we will commence monetary policy normalization, though not always with the necessary analytical rigour. Some speak of desiring a forced acceleration, others by contrast, conjure up the spectrum of potentially drastic consequences. When the decision is made it will mean that aggregate demand conditions and prices in the euro area have been restored to the desired levels. At national level the exit will be manageable if all the actors involved behave responsibly. Looking forward, the gradual return to higher interest rates if growth levels increase should not concern us unduly. What should worry us instead is the risk that rates increase as a result of a fall in market confidence, the consequences of which, given the weight of public debt, could prove serious. We are facing difficult issues in Europe: the exit of the United Kingdom from the European Union, growing migration flows, the threat of terrorism. The biggest obstacle is the dearth of confidence that has developed in recent years, the return of mutual mistrust and prejudice among member states and between the peoples of Europe and its institutions. We must take arms against these tendencies. The process of European integration has guaranteed seventy years of peace and prosperity. It has made it possible for many generations of young adults to study abroad and to develop a sense of belonging, surmounting linguistic and cultural barriers; it has provided working adults with new job and professional growth opportunities; it has intensified trade and strengthened financial ties. Europe must remain an anchor of stability in a world that appears ever more unstable and politically unpredictable. The willingness to cooperate more closely on issues such as immigration, defence, security, justice and BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 representation at international fora is undoubtedly a positive signal. We must continue on this path, tackling the issues that still stand in the way of effective economic governance of the euro area. At times we also criticize European rules that do not satisfy us completely or the decisions by European authorities of which we do not approve, but we do not do so to question the path of European integration. We believe – and we have reiterated this on many occasions – that one of the problems that the crisis has laid bare is precisely the incompleteness of European integration, especially in the areas of the economy and finance. European governance in these sectors has to date relied almost exclusively on rules that, in an exaggerated pursuit of mutual guarantees, constrain the choices of each country. The result has been a Union that is better at prohibiting things than at getting them done. This is evident in the public finances; in the absence of a common budget, it has been hard to lend support to the economic recovery. It is also evident in the management of bank crises and in the preservation of financial stability, where the splitting of powers among a large number of authorities makes it difficult, at times, to identify the measures to be adopted and slows actions that, to be effective, must instead be taken extremely quickly. Proceeding by means of compromises is becoming increasingly difficult. Completing Banking Union and establishing a capital markets union are clear and immediate objectives. The true completion of the European construction, however, will only be achieved with the development of democratically designated institutions mandated to exercise common sovereignty. The difficulties we have faced in these critical years have been arduous as are the challenges that remain. For the Bank of Italy this means being increasingly effective in fulfilling its role, enlarging its scope and sharing responsibilities at European level. The process of bringing Italy back to a path of growth has begun, but must be lent greater support. The changes will require time, commitment and sacrifice. Measures to sustain demand can moderate the economic and social costs of the transition, but economic policies must be far-sighted and highlight the benefits to society. Consensus must be built by setting out and communicating clear and ambitious plans that are firmly grounded in reality. I am confident that, notwithstanding the political uncertainty, Italy will achieve results that serve the public interest, never forgetting those who have been left behind, freeing the economy of futile constraints, privileged positions, and accumulated and emerging delays. All the opportunities now afforded by innovation must be seized to develop a robust economy, a stable financial system, and a more equitable society for all. The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA FIGURES Figure 1 GDP growth % % World Euro area -1 -1 -2 Italy -2 -3 -3 2012 2013 2014 2015 2016 2017 2018 2019 Sources: Istat, Eurostat and IMF. Forecasts: Bank of Italy, ECB and IMF. Figure 2 Inflation % % World Italy Euro area -1 -1 2012 2013 2014 2015 2016 2017 2018 2019 Sources: Eurostat and IMF. Forecasts: Bank of Italy, ECB and IMF. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 Figure 3 GDP (2007=100) Euro area (excluding Italy) Italy 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sources: Based on Istat and Eurostat data. Note: GDP at chain-linked values. Figure 4 Per capita GDP in Italy (1929=100; 2007=100) 1929-1938 (Great Depression) 2007-2016 (Great Recession) Source: Bank of Italy historical reconstruction. Note: GDP at chain-linked values. The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA Figure 5 Public debt/GDP and GDP in Italy (GDP: 2007=100) % GDP (right-hand scale) Public debt/GDP Source: Based on Bank of Italy and Istat data. Note: GDP at chain-linked values. Figure 6 Bad loan ratio and GDP in Italy (GDP: 2007=100) 6% Bad loans/total loans GDP (right-hand scale) Sources: Based on Istat data and supervisory reports. Note: Ratio of bad loans to total loans, net of write-downs; GDP at chain-linked values. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2016 Figure 7 Unemployment rate % % Euro area (excluding Italy) Italy Source: Based on Eurostat data. Figure 8 Per capita GDP and productivity in Italy (average annual growth rates) % %6 Per capita GDP Productivity -1 -1 -2 -2 -3 Post-Unification Giolitti era (1861-1896) (1896-1913) Early inter-war Great Depression Post-war period Pre-Maastricht Post-Maastricht Great Recession Treaty period Treaty (1995-2007) (1919-1929) (1973-1995) (1929-1938) (1950-1973) (2007-2013) Recovery -3 (2013-2016) Source: Bank of Italy historical reconstruction. Note: Total factor productivity; GDP at chain-linked values. The Governor’s Concluding Remarks Annual Report 2016 BANCA D’ITALIA Printed by the Printing and Publishing Division of the Bank of Italy Rome, 31 May 2017
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Remarks by Ms Valeria Sannucci, Deputy Governor of the Bank of Italy, at the launch event for the "Partnership for capacity development in household surveys for welfare analysis", Rome, 19 June 2017.
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Partnership for capacity development in household surveys for welfare analysis LAUNCH EVENT Remarks by Valeria Sannucci, Deputy Governor of the Bank of Italy Rome, June 19 2017 Good morning ladies and gentlemen, On behalf of Governor Visco, I am pleased to welcome you all to the Bank of Italy in Rome. It is indeed an honour today for the Bank of Italy to host the distinguished representatives of the World Bank and of all the institutions involved in this important Memorandum of Understanding (MoU). As part of its legal mandate, the Bank of Italy currently promotes technical cooperation with central banks and other institutions in the emerging countries. Through staff training activities and consultancy, the Bank aims at helping to improve the institutional capacities of the beneficiary institutions, establishing relationships that strengthen reciprocal ties. Moreover, the Bank is Italy’s representative in numerous international organizations and institutions, such as the World Bank, cooperating with them in various ways, with the ultimate purpose of promoting international financial stability and a smooth functioning of the payment system. The partnership we are launching today is thus an integral part of this more general context. The cooperation between the World Bank and the Bank of Italy in the field of statistics was not born today. In October 2015 another MoU between these two institutions was entered into. On that occasion, several areas of collaboration were pointed out: improving the availability, quality and cost-effectiveness of data production to inform policy making in low and middle income countries; engaging in research on subjects of common interest; promoting the harmonization of household surveys; and engaging other entities, such as research institutions and local academia, to give additional support to the abovementioned activities. In this framework, our institutions co-founded the Center for Development Data (C4D2) in Rome, with which we have been working for the past 2 years. Let me now share with you my personal satisfaction in having contributed to launching a project that has organized such a wide and knowledgeable team of institutions which can significantly improve the statistical data for welfare analysis in developing countries and in our countries too. Contributing to the achievement of a world free of poverty is the ultimate goal for which all economists should bear responsibility. To this end, economic growth, although necessary, may not be a sufficient condition for everyone to make progress. Nowadays there is great concern about the possible effects of technical progress and globalization on inequality. Both in developed and developing countries, political institutions must constantly monitor the different segments of their populations to ensure that no one is left behind and promote a shared prosperity. In this perspective, sample surveys acquire a strategic role. Cooperation in this field arises from the awareness that macroeconomic data are not enough for economic analysis. It is essential to look at the distribution of phenomena and not only at averages, in particular when dealing with household welfare and inequality. Microdata derived from household surveys are not only a powerful descriptive tool; they can be employed in more complex statistical analyses to study how variables as different as an individual’s occupational status, social environment and personal values relate to consumption and saving behaviour. General models can thus be adapted to new scenarios and to the measures referring to estimated subgroups. Throughout its history, the Bank of Italy has been an active producer of statistics, and in particular of household survey data. In June 1947 the then Governor Luigi Einaudi, during the work of the Constituent Assembly of which he was a member, advocated the need for collecting information on the standard of living of Italian citizens. By the 1950s, the Bank of Italy had already worked with Doxa, a private company, on conducting surveys on household finances. In the early sixties, the Bank of Italy conducted several pilot surveys on the income, consumption and savings of Italian households and in 1966 the first official survey was conducted. Since then, the Bank of Italy has interviewed almost 200,000 households in what is now called the Survey on Household Income and Wealth (SHIW), collecting biannual data on several aspects of economic behaviour. SHIW data have been often used in the Bank of Italy to carry out structured research projects on the main economic themes, like saving and consumption behaviour, ageing and the pension systems, distribution of wealth, measures of well-being and financial vulnerability. Moreover, the availability of a database containing a large amount of information on Italian households has enabled policy measures to be evaluated, thereby contributing to an informed public debate. Thanks to the free availability of anonymous microdata, survey data have also been widely used for academic research. A recent bibliography of scientific works that over time have used the survey data included over 800 articles by more than 450 authors at the end of 2016. This has improved the accountability of the Bank and enriched the economic debate. Over the years, the Bank of Italy’s statisticians have explored the methodological issues of the SHIW in detail, focusing both on its potentials and pitfalls. While a standard methodological report allowing for the analysis of standard errors is always attached to each survey report, specific studies have been carried out on various topics, like unit non-response, measurement errors, underreporting and micro-macro reconciliation. This long experience has taught us that in sample surveys the adoption of best practices in the collection of survey data can significantly increase the reliability of estimates. Moreover, if the move towards the standards is widespread, comparisons are also positively affected by the change, adding value to each statistical source. For a number of years the Bank of Italy has been promoting projects aimed at harmonizing SHIW data with those obtained from other surveys, such as the Luxembourg Income Study and the Luxembourg Wealth Study. In recent years our survey has become part of the Eurosystem's Household Finance and Consumption Survey (HFCS), coordinated by the European Central Bank. The HFCS includes harmonized surveys on household income and wealth from 18 euro-area countries, as well as Poland and Hungary. The network of participants has proved to be a very valuable forum for exchanging experiences in conducting surveys and fostering the adoption of uniform best practices. We hope the expertise acquired on these technical grounds can be useful for the present project. In fact, at the present time, survey data do not always share common standards regarding sampling, coverage, definition of variables or valuations and estimation methods as more standard statistics like national accounts do. This is particularly true in the developing countries, which often face peculiar difficulties in conducting sample surveys, due to a lack of population lists, logistic problems in territories, and so on. Improving the availability of reliable data production is a valuable ingredient for promoting evidence-based policy making; this is why, although it is a costly exercise, it is crucial for low and middle-income countries to invest in this field. The cooperation starting today will initially focus on training with the objectives of improving the quality and coherence of international training for statistical capacity building on microdata, and of supporting training activities in these fields based in low and middle-income countries. In particular, the project will implement a training program for statistical capacity building in household surveys, through some week-long training courses and workshops, to be held in the Bank of Italy’s premises, and with training sessions in various statistical training centres in Africa. By adopting a training of trainers (ToT) approach, the project will exploit a multiplier effect, spreading the ability to deal with sample surveys beyond the participants and reaching a large number of low and middle income countries. A further and no less important aim of this project is building a network which includes experts from many developed and developing countries. The exchange of experiences can be beneficial for improving statistical capacity in household surveys and fostering convergence towards common standards. Let me conclude with the words of Luigi Einaudi which have often been quoted by those who have succeeded him as Governors of the Bank of Italy. All policymakers, all institutions should base their modus operandi on the principle ‘Conoscere per deliberare’ (know, then decide). 1 It expresses the need for a policy based both on knowledge and data, as can be derived from microsimulation model estimations when analysing alternative scenarios and policy measures. 2 Einaudi would certainly have approved the efforts we are all making in pursuing this current project. He would also have appreciated the presence of a number of important Italian institutions here today. It is important that the Bank of Italy is not alone in this endeavour. Cooperation with the Italian Ministry of Foreign Affairs and International Cooperation, the Italian Agency for Development Cooperation, the Italian National Institute of Statistics and the Italian National Institute of Health means fostering dialogue among different disciplines and recognizing the multidimensional nature of human well-being, the measurement of which is the aim of household surveys. Yet it also testifies to the commitment of leading Italian public institutions to working together to strengthen our cooperation with developing countries. L. Einaudi, Prediche inutili, Opere di Luigi Einaudi, Volume II, Einaudi, Turin, 1964 (first edition 1956). See for example Ando and Nicoletti Altimari, ‘A microsimulation model of demographic development and households’ economic behaviour in Italy’, Temi di discussione (Working Papers), 533, 2004, and Michelangeli and Pietrunti, ‘A microsimulation model to evaluate Italian households' financial vulnerability’, Questioni di Economia e Finanza (Occasional Papers), 225, 2014.
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Testimony by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the III Standing Committee on Foreign and European Community Affairs and XIV Standing Committee on EU Policies, Chamber of Deputies Rome, 26 April 2017.
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III Standing Committee on Foreign and European Community Affairs and XIV Standing Committee on EU Policies Brexit: the possible economic and financial effects Testimony of Luigi Federico Signorini, Deputy Governor of the Bank of Italy Chamber of Deputies Rome, 26 April 2017 Mr Chairman, Honourable Members of Parliament, I would like to thank the Committees for inviting the Bank of Italy to comment on the United Kingdom’s exit from the European Union. I will begin with a brief description of some well-known institutional aspects and then make some comments on the possible economic (for the United Kingdom, Europe and Italy) and financial repercussions. At this point in time, my observations can only be preliminary ones. Institutional aspects: negotiations, exit and future relationships Following the agreements reached in Lisbon in 2007, an article was added to the Treaty on the European Union – the constitutional basis of the EU – which explicitly provides for the possibility that a member state might wish to withdraw, and regulates the relative procedure. This is Article 50, now well-known after being invoked for the first time by the UK on 29 March in Prime Minister May’s letter to the President of the European Council. Article 50 envisages four phases. The first one, already completed, requires the outgoing member state to notify the European Council of its intention to withdraw from the European Union. The other steps are as follows: the Commission is given a mandate to negotiate the withdrawal agreement according to the guidelines unanimously established by the Council; the Commission conducts the negotiations on the withdrawal agreement; and both parties approve the agreement. The United Kingdom will not participate in the Council’s decisions; aside from that, it will retain meanwhile all the rights and obligations arising from its EU membership. Given the geographical proximity, the long, shared history and the deep-seated economic integration of the UK with the rest of Europe, there is a great deal of discussion on both sides as to how the withdrawal will take place and what relations will be established afterwards, with comparisons made between hard and soft Brexits, concepts that have yet to be clearly defined. In principle there are two separate but related negotiations. One concerns the exit agreement as such, to which the procedure of Article 50 refers. It should cover issues such as the position of people and firms that live and work in the EU, thanks to the current freedom of movement, but will find themselves on the other side of what will again become an international border in all respects in 2019: this applies to British citizens in Europe and to European ones in the UK. This agreement might establish transitional rules and temporary or permanent, conditional or unconditional, recognition of status, on people’s right to stay where they are and continue with their current activities. Another important issue, which will presumably be covered by the withdrawal agreement, is the UK’s financial obligations towards the EU as a member state. The other negotiation concerns relations between the two parties after the withdrawal, including any trade agreements. Although the two negotiations are linked conceptually and certainly politically, they could in theory have different outcomes. For example, an agreement may be reached on the exit but not on subsequent relationships; in any case, the agreement on the new relationships will only be formally stipulated at a later date. It is also not inconceivable that the negotiations are a complete failure, which would lead to the hardest of hard Brexits (except in the case of an extension of the two-year deadline, which the Treaty allows if decided unanimously). Both sides have indicated their wish to avoid a traumatic conclusion and to reach an agreement, as called for in a recent speech by Barnier, the European Commission’s chief negotiator; it is to be hoped that they hold to this intention so as not to cause serious and avoidable personal and economic problems. As far as post-Brexit trade relations between the UK and the EU are concerned, in theory there are four possibilities. 1. Accession to the European Economic Area (EEA) to which Iceland, Liechtenstein and Norway belong, as well as EU member states. Membership of the EEA ensures full participation in the European Single Market for non-EU states and entails accepting the ‘four freedoms’ (the free movement of people, goods, services and capital), with the same rights and obligations as EU member states, including a financial contribution. However, though non-EU states must apply the rules for participating in the single market, they do not decide them within EU institutions, such as the Commission, the Parliament and the Council. 1 2. Participation in a customs union with the European Union, as in the case of Turkey. This union provides for the free movement of goods, the obligation to implement the relevant European regulations and a waiver on deciding own customs duties and on the possibility of reaching independent trade agreements. 3. A free trade agreement. 2 Switzerland, which is a member state of the European Free Trade Association (EFTA), as are Iceland, Liechtenstein and Norway, is not a member of the EEA, but over time it has stipulated over one hundred bilateral agreements with the European Union (including the free movement of goods and people, but not of services and capital) and is required to implement the relative European regulations. Depending on the scope of the agreement, ratification by all EU member states could be required. 4. If no agreement were reached, trade relations would be governed by World Trade Organization regulations. In this case, the Most Favoured Nation (MFN) clause would apply, which prohibits any form of discrimination: each state undertakes to extend to every other state the same treatment granted to all countries with which there are no specific bilateral trade agreements. In practice, however, neither membership of the EEA nor of a customs union seem realistic options. The former would impose the free movement of people and the obligation to implement the ‘acquis communautaire’, both of which the UK wants to abolish; the latter, as well as laying down certain regulatory restrictions, would greatly curb the UK’s freedom to decide independently on its trade relations with other countries. The UK government’s notification of withdrawal makes a general reference to a ‘deep and special partnership’ with the EU, but effectively appears to exclude staying in the single market. The most likely scenario – if there is no change of heart – is that the UK will become a real ‘third country’ for the EU. Under this hypothesis, the question is whether it is possible to reach at least a free trade agreement, which would benefit the common interest; the notification letter expresses a desire for it to be ‘bold and ambitious’. At this stage, the nature, timeframe and contents of any future agreement cannot be predicted. Negotiations are yet to begin; the UK government’s stance will also depend on the outcome of the recently announced general election. We may imagine that the main topics of negotiation will be the trade of goods and, above all, financial services. There are free trade agreements with nearly one hundred advanced and emerging countries, including Switzerland, Canada and South Korea. The agreement recently concluded with Canada is particularly interesting since, as well as eliminating customs duties, it makes access to public tenders and investments easier and facilitates trade in services. If, or for as long as, there is no agreement, the trade relations between the EU and the UK will be governed by WTO regulations, unless there are specific transitional agreements, and the MFN clause will be applied. The economic impact United Kingdom – In the short term, the negative effects on the UK’s economy that many expected immediately after the referendum failed to materialize. GDP growth actually increased in the second half of 2016, rising from 1.6 to 2.4 per cent on an annual basis, and employment continued to rise. Much depended on the strongly expansionary measures introduced by the Bank of England in August and on a more accommodative fiscal policy stance. On 3 August 2016 the Bank of England cut its Bank Rate by 25 basis points; resumed the purchase of UK government bonds; and launched new schemes for corporate bond purchase and for extending loans to commercial banks. The HM Treasury put a brake on the fiscal consolidation process. Analysts have progressively revised growth forecasts upwards for 2017, but continue to expect a slowdown over the year. According to the most recent consensus estimates, growth in the UK’s GDP is expected to average 1.7 per cent over the year, slightly below that of 2016. The most significant effects of the referendum have been on the sterling exchange rate, which has depreciated by about 10 per cent since 23 June, both against the euro and in nominal effective terms (that is, against all the other main currencies, weighted according to their trade with the UK); inflation rose by nearly 2 percentage points, to 2.3 per cent in March. The severe tensions besetting international financial markets around the time of the referendum dissipated quickly (Table 1). The economic policy uncertainty index rose in late June and early July, but then returned to pre-referendum levels (Figure 1). It cannot be ruled out that any tensions arising from negotiations with the EU may trigger new bouts of financial volatility over the next few years, especially if they coincide with renewed concerns on the markets as to the cohesion of the Union. What may happen in the long term remains uncertain. Openness to trade, immigration, and foreign investment generally promote growth, while a decrease in these factors, especially if it occurs in a climate of increasing protectionism at global level, could create significant costs for the UK economy in terms of innovative capacity, competitiveness, and productivity growth. This would also occur in the EU market, though on a more limited scale and would vary from country to country, depending on their links with the UK. The UK market is quite a small one for the EU, accounting for 7.1 per cent of total exports; in contrast, the EU is the destination for 44 per cent of UK goods. According to our studies, if the UK and the EU imposed reciprocal trade tariffs, the long-term economic cost to the British economy would be significant, particularly if productivity growth diminished at the same time; the repercussions for the euro area would instead be small. Brexit is expected to have an impact on the EU’s budget, to which the UK makes a positive contribution. From 2010 to 2015, even taking into account the rebate negotiated by Margaret Thatcher in 1984 and the rebate received by the UK for its partial participation in justice and home affairs policies, the country contributed over €13 billion a year on average while receiving less than €7 billion. Moreover, the EU will no longer receive the customs duty collected in the UK; instead it will collect the duty levied on British exports to the EU. The overall effect is still difficult to assess. Discussions are still under way about the UK’s financial obligations to the EU when it leaves (the Brexit bill). Calculating the amount is a complex and controversial matter. One question is how the UK’s share of the EU total should be calculated (it amounts to about 15 per cent of gross national income but 12 per cent in terms of contribution to the budget after rebates) and what asset and liability items should be included. This will probably be one of the most delicate issues faced during the exit negotiations. Italy – Unfavourable economic developments in the UK would in any case not have any major repercussions for Italy in the short term. The slowdown that the Bank of England has forecast for 2018-20 would have a negligible impact. Even if the UK experienced such a deep recession as to reduce imports by 10 per cent over a three-year period, we estimate that the effect on Italy’s GDP would be at most 0.25 percentage points. 3 Italy’s trade and financial ties with the UK are not as close as those of other major euro-area countries (Table 2). In 2015 Italian exports to the UK amounted to 1.8 per cent of GDP, against 2.7 for France, 3.2 for Spain and 3.7 for Germany. Imports amounted to 1.1 per cent of GDP, again less than for the other countries. Italy mainly exports machinery and mechanical engineering products, agri-food products, transport equipment, clothing and footwear, and tourism services. The bilateral balance on goods is very positive for Italy, while the balance on services is generally even. Italy’s financial ties with the UK are not as close as those of the other main European countries, as regards both portfolio investment and direct investment. In June 2016, Italian residents’ portfolios included €60.8 billion worth of UK-issued securities (that is, 3.7 per cent of GDP, compared with France’s 10.1 and Germany’s 5.9). Italian investors have limited exposure to exchange rate risk between the euro and sterling, with securities denominated in sterling accounting for little more than 1.1 per cent of the total. At the end of 2015 Italian direct investment in the UK stood at 1.4 per cent of GDP, compared with significantly higher percentages for the other leading euroarea countries. UK investment in Italy amounted to 2.2 per cent of Italian GDP. If negotiations for a free trade deal between the EU and the UK are unsuccessful, trade between the two will become subject to customs duties. To have an idea of the potential economic impact for both sides let us assume that the UK applies the current EU tariffs at least until it has put its own tariff system in place; in other words, the trade tariffs that the EU Economic Bulletin 3/2016. currently applies outside the area will apply between the area and the UK. On this basis, and considering only the impact effect (i.e. excluding any reallocation of trade flows), customs duty on goods exported by the 27-member EU to the UK would total about €16 billion and the duty on British goods exported to the EU-27 over €6 billion. Customs duty would on average represent a higher proportion of the value of goods (5.2 per cent) for exports from the EU-27 to the UK than the other way round (3.9 per cent) because of the different sectoral composition. In fact, tariffs differ considerably across goods categories. Close to one fifth of the value of EU27 exports to the UK relates to motor vehicles, which carry very high duty. Moreover, as the structure of exports differs across EU-27 member countries, the average incidence of the tariff applied to exports to the UK would also differ. In the case of Germany, the tariff would be similar to the EU-27 average; for France and Italy it would be slightly less; Ireland, Spain and Poland would be faced with average duties in excess of 6 per cent. If the existing European tariffs were applied to Italy’s exports to the UK, in the case of machinery and mechanical engineering products, a sector that accounts for 20 per cent of Italian exports to the UK, the effect would be small (about 2 per cent of the value). The difference would be greater in the case of agri-food products (almost 10 per cent), clothing and footwear (8.2 per cent), and above all motor vehicles, even though the sector accounts for a much smaller share of exports to the UK (12 per cent) than in other countries (Germany 33 per cent, Spain 32 and Belgium 26). Even with a free trade agreement, the UK would have to pay the administrative costs associated with the ‘rules of origin’, i.e. certification that goods being exported to the EU-27 (and many of the inputs needed to manufacture them) do not come from countries subject to EU customs duty. Differences in regulations and other non-tariff measures could further increase the cost of trade. Financial regulation, banks and market infrastructure Financial regulation – One of the biggest unknowns of Brexit is what shape future financial relations will take, starting with the regulatory aspect. As an EU member state, the UK is part of the single market in financial services in which the single passport applies. Thus, a bank authorized in one member state can operate in any other member state (by establishing branches or through the free provision of services) under a system of notification and without the need for authorization. Prudential controls are conducted by the authorities of the home member state; the host state is responsible for anti-money-laundering and consumer protection. With Brexit the single passport will be withdrawn. British banks will be treated like thirdcountry banks: they will need to obtain a licence in all the member states where they wish to operate and will become subject to supervision by their host country. UK-based banks and economic policymakers and financial regulators view the possibility of losing the single passport with trepidation, fearing that the City will lose part of its role as a financial centre for Europe and the world. At present, many non-EU banks (especially American and Asian ones) have their European legal and operational headquarters in the City, thus gaining access to the European financial market as well as to plentiful professional expertise and specialist services. When it leaves the EU the UK’s supervisory framework will, by definition, be ‘equivalent’ because – partly in consideration of the commitments set out in Prime Minister May’s letter of notification – European regulations will initially be incorporated en bloc in the UK’s internal regulations. Any changes made subsequently will have to be examined to ensure that equivalence is maintained. Supervisory ‘equivalence’, as defined in the EU’s financial legislation, gives some benefits to third countries. Most of these are exemptions from specific requirements, but in the case of investment services (MIFID/MIFIR2) and alternative investment funds (AIFMD) the legislation effectively gives equivalent third-country financial intermediaries a single passport of sorts in all EU member states, though only with respect to their professional clientele. Ensuring that domestic financial legislation stays aligned with that of Europe would make it easier for UK banks to set up a presence in countries, like Italy, that only grant authorization after verifying the standard of home country supervision. Under a proposal of the European Commission included in the Review of the Capital Requirements Directive and Regulation, in the future, third-country banks that are of systemic importance in the area would have to set up an intermediate parent undertaking (IPU) in Europe. The IPU and its subsidiaries in the EU would be subject to consolidated supervision and crisis management under European rules. Hence, the major UK banking groups – many of which are spin-offs of international groups – would presumably be required to set up an IPU. The UK will certainly try to reach agreements with the EU-27 that allow it to keep some of the benefits that London banks enjoy in terms of access to the European market. It is impossible to predict what these agreements will be or how they will affect London’s competitive advantage. Brexit also means that the European Banking Authority (EBA) headquartered in London will have to find a new home. The decision, which will be taken in the coming months, is connected to an on-going debate on possible changes to the architecture of European system of financial supervision. The Commission has launched a public consultation prior to introducing new legislation. The present model is a sectoral one: the EBA is responsible for the banking sector, the EIOPA (headquartered in Frankfurt) for the insurance and pension fund industry, and the ESMA (based in Paris) for securities and markets. One of the options considered (with some variations) would reduce the number of authorities to two: one for banks and insurance and the other for markets and securities. The debate is further complicated by the fact that the competencies transferred to the European level differ across sectors and activities (for example, more competencies are transferred for regulation than for supervision, except in the case of the banking industry where the application of the Single Supervisory Mechanism to the euro area alone has created a further difficulty). Banks – As far as Italy’s banking system is concerned, the importance of UK-based banks is limited. The 16 banks with branches in Italy account for 0.6 per cent of lending to customers. The majority of them (11 of the 16) belong to third-country groups that have established their European headquarters in London. They only have a significant role in some specific segments (advisory on extraordinary financing and placements, syndicated loans, and guarantees) relating to large corporations. Some international banks may move part of their activities from London to another European country, via either new or existing subsidiaries. The effect on Italian banking will probably be minimal. Moreover, there are about 80 UK banks operating in Italy without a branch, through the free provision of services. They could continue to do so, failing any specific agreements, only if they set up a subsidiary in an EU member state. The scope of their activity in Italy is also limited. There are very few Italian banks in the UK. The leading Italian banking groups jointly have six branches in London, mainly involved in trading and investment banking; they use the City to access the international wholesale funding market, though on a smaller scale than before the financial crisis. If they decided to move the management of these activities after Brexit, the cost is unlikely to be very high. The Italian banks have limited exposure to UK residents: at the end of 2016 it was just under €34 billion (1.3 per cent of the Italian banking system’s total exposure), three quarters of which consisting of loans to other banks and financial corporations. Market infrastructure – Since 2007 Borsa Italiana Group has been controlled by London Stock Exchange Group (LSEG), which owns two important financial market management companies (MTS and EuroTLX), the Italian central counterparty (Cassa di Compensazione e Garanzia) and the central securities depository (Monte Titoli). In March of this year the interbank deposit market management company (e-MID) also came under the control of an English group. LSEG and Deutsche Börse had already planned a merger in 2016. The European Commission, however, recently announced that it had blocked the plan, which in its opinion would have created a virtual monopoly of the clearing market for fixed-income instruments: in fact the new group would have included the four central counterparties with the largest volume of business in this segment. Competition in clearing for equity derivatives would also have been significantly reduced. Even if they are controlled by a foreign entity, the trading and post-trading management companies remain fully responsible for all operating processes. They are supervised at the domestic level by the Bank of Italy and Consob. Indeed, unlike banks, markets and market infrastructure are supervised at the solo level, rather than on a consolidated basis. Controlling shareholders can be located outside the EU provided they meet the requirements of integrity and capital adequacy. When the UK leaves the EU, the Bank of Italy and Consob will need to have closer contacts with controlling shareholders. When some of the cooperation mechanisms envisaged by European legislation are no longer in place, the Italian authorities will have to step up their efforts in the sphere of crossborder supervisory cooperation, as well as increase their bilateral cooperation with the UK supervisory authorities. At European level, Brexit raises a matter of some importance regarding the supervision of central counterparties, since euro-denominated financial instruments, especially derivatives, are mostly cleared by UK-based entities.4 We will need to make sure that supervision of UK central counterparties does not fall below the level set by European regulations for the main stability profiles: prudential supervision, currency of cleared contracts, and market control. ESMA proposed a review of EMIR to strengthen the process of recognizing the third-country CCPs and provide forms of direct supervision by the European authorities. In the weeks to come, the Commission will publish its proposed review of EMIR; the prospect of the UK’s exit requires this aspect to be carefully considered as well. *** Prime Minister May’s letter triggered for the first time the process by which a Member State can leave the Union. Difficult negotiations will now begin, although they will not be lengthy since the Treaty imposes strict time limits, given the technical complexity and political sensitivity of many of the issues. Both sides will require foresight and good will. For example, in the case of interest rate swaps, 50 per cent of global trades and 90 per cent of standardized swaps (i.e. which have to be cleared through a central counterparty) are cleared by the London-based LCH Group Ltd. and a very large share is denominated in euros. To the surprise of many analysts, there were no immediate adverse effects of the UK’s decision to exit on confidence, investment or the economic outlook. There was a significant but orderly devaluation of sterling. There is no reason to expect any serious direct and immediate repercussions on the Italian economy and banking system. Nevertheless, we cannot rule out the possibility that difficult negotiations, especially if they interact with the increasing global and European political and institutional uncertainty, could at a certain point trigger further market turbulence. It is unlikely that Italy would be immune. For us, the only way to prepare is to reinforce internal stability, to deal with any fragilities perceived by the markets, and to pursue the path of reform. What will happen in the long run is as yet difficult to foresee. History teaches us that international openness is, at the end of the day, a powerful driver of economic growth. An economist may find it hard to believe that a country’s prosperity can be furthered by creating barriers to the free movement of goods, capital and people. Naturally, a great deal will depend on future trade and financial agreements and on global developments. In any case, this is more of a risk for the United Kingdom than for the rest of Europe or the world. Allow me to close by saying that, personally, I will miss my British colleagues in the European institutions that I participate in: not only because of their skill and level of preparation, which have always been admirable, but I will also miss their pragmatism, dislike of red tape and openness to the market, which has generally characterized their approach. I can only hope that 40 years of working together has allowed us all to learn from each other’s best qualities. Table 1 Effects of the Brexit referendum on the finanical markets (changes between 23 June 2016 and 12 April 2017) Market Share prices Index Change S&P 500 (USA) 11% Eurostoxx 600 (Europe) 10% DAX (Germany) 19% FTSE MIB (Italy) 11% FTSE 100 (UK) 16% Nikkei (Japan) 14% Hang Seng (Hong Kong) 17% S&P 500 Banks (USA) 31% Eurostoxx 600 Banks (Euro area) 15% GERMANY DS – Banks (Germany) 11% FTSE All-Share Italy Banks (Italy) 0% FTSE 350 Banks (UK) 22% EUR USD -6% GBP EUR -10% GBP USD -16% Germany 10 bp Italy 90 bp. UK -32 bp USA 49 bp Sovereign spreads SPREAD ITA GER 10Y 80 bp. Expected volatility VIX -1 pp CDS prices ITRAXX Europe 2 bp ITRAXX Senior Financial -2 bp Bank share prices Exchange rates 10-year yields Gold Oil 1% Brent 10% Sources: Based on data from Thomson-Reuters Datastream and Bloomberg; bp: basis points; pp: percentage points Table 2 Economic and financial relations between the main EU countries and the United Kingdom (as a percentage of GDP) Portfolio investment at end-H1 2016 Trade in 2015 Direct investment at end-2015 Assets Liabilities Assets Liabilities 1.1 3.7 6.6 1.4 2.2 2.7 2.1 10.1 11.4 5.6 3.7 Germany 3.7 2.1 5.9 7.2 4.8 1.1 Spain 3.2 2.1 2.6 4.0 7.1 5.3 Exports Imports Italy 1.8 France Sources: Based on data from Bank of Italy, Eurostat and the IMF (Coordinated Direct Investment Survey and Coordinated Portfolio Investment Survey). Notes: (1) Goods and services. – (2) End-of-period stocks; data based on statistics provided by the country holding the assets. – (3) End-ofperiod stocks; data based on the statistics provided by Italy and, for the other euro-area countries, by the United Kingdom. Figure 1 Economic policy uncertainty index (daily values and 7-day moving average) daily values moving average Source: Based on EPU index data. 01/04/2017 01/03/2017 01/02/2017 01/01/2017 01/12/2016 01/11/2016 01/10/2016 01/09/2016 01/08/2016 01/07/2016 01/06/2016 01/05/2016 01/04/2016 01/03/2016 01/02/2016 01/01/2016 Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the conference "Unione Bancaria e Basilea 3 - Risk & Supervision 2017", organized by the Italian Banking Association (ABI), Rome, 14 June 2017.
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Associazione Bancaria Italiana Unione Bancaria e Basilea 3 – Risk & Supervision 2017 The Italian banking system and the exit from the crisis Speech by the Deputy Governor of the Bank of Italy Fabio Panetta Rome, 14 June 2017 The economic situation and outlook Growth in the euro area is firming up, driven by the accommodative monetary policy stance and increased international trade. In Italy the recovery has been under way for more than two years and is taking hold. Recently released data from Istat indicate that in the first quarter of this year GDP grew by 0.4 per cent, pushed up by household consumption and firms’ inventories. Investment, which had been accelerating strongly since the start of 2016, slowed, but this should only be temporary. Our analyses suggest that firms will expand their production capacity once again in 2017. After the sharp increase at the end of last year, exports are continuing to grow in parallel with world trade. The recent positive performances are partly unexpected and must be analysed carefully; they will have to be confirmed in the months to come. They are, however, consistent with improvements in the labour market. Although excess labour supply depresses wage growth, the number of people in employment continues to increase, with an acceleration in April, and this despite the termination of the incentives for hiring new employees on permanent contracts. Inflation is rising but its core component remains weak. Similar developments can be seen in the euro area. Although the risks of deflation have declined, upward pressures on prices have not emerged to the extent that they are self-sustained in the medium term or that justify a revision of the monetary policy stance. The outlook for the Italian economy is favourable. In the forecasts published last week, we calculated that GDP could grow by 1.0 per cent in the current year and by 1.2 per cent in the two following years. The national accounts data released a few days ago (and not included in our forecasts) suggest higher growth at the end of the first quarter, which would raise GDP growth, other things equal, to 1.3 per cent on average in 2017. The gap between Italy and the other euroarea economies should continue to narrow. The banking system has almost completely adapted to the new economic environment and to the comprehensive regulatory reform that followed the crisis. There are important open issues that require the banks and the authorities to be fully committed. After going through an unprecedented recession and setting out on a path of capital strengthening under very difficult conditions, the positive performance of the real economy has now created the pre-conditions for Italian banks to move out of the stage where they are just reacting to the crisis. Regulatory developments and supervisory action Banking regulations introduced in response to the financial crisis are having a profound effects on prudential and accounting rules and on supervision. The new regulations are compressing the size of the banking sector. The Basel III rules raised capital requirements, limited leverage, and established stringent liquidity requirements. Additional capital requirements are envisaged for systemically important banks. Several countries have introduced measures to separate lending from the financial activities that banks carry out on their own account. Other capital measures, of which I will comment today, are in the final stages of preparation as part of the completion of Basel III. Looking ahead, these regulatory changes will make banks less risky, increasing their capital and liquidity and lowering their leverage. However, banks’ profitability and the development of the lending market will be under pressure, with potential repercussions on the availability of credit for the real economy. In the euro area these developments are coupled with a limited role of capital markets in financing business. Most of the new regulations have been implemented and are already producing effects. A pause is now desirable to allow time to adapt to the new system and to prevent the continuous introduction of new rules from itself becoming a source of uncertainty. Outstanding issues must be solved rapidly. The first important issue is that of internal models. The measures currently under discussion would reduce latitude in calculating risk parameters and limit the unjustified variability of riskweighted assets, which are the denominator in capital ratios. Differences among countries have emerged in capital requirements measured with internal models. This issue is less important for Italian banks, which have so far made limited use of such models. However, it is essential to reach an agreement on the matter to ensure a level playing field with foreign banks, which have made broad use of internal models for a long time. By taking steps to develop internal models, even within a consortium and subject to verification by the supervisory authorities, the Italian banking system could align itself with those of the other main European countries on this issue. The Targeted Review of Internal Models (TRIM) project recently launched by the Single Supervisory Mechanism (SSM) assesses the compliance of significant banks’ internal models and ensures uniform supervisory practices. The review covers models for credit risk as well as for market and counterparty risk. Over 100 assessments are scheduled in 2017, in which Bank of Italy staff will be actively involved. The goal is to swiftly eliminate any deviation from the regulations; misalignments with the practices set out in the TRIM Guide will be assessed at a later stage. 1 Italian banks must plan in advance any adjustments to their risk measurement systems, anticipating potential consequences on capital. They have already made significant progress, but much more remains to be done. A second important issue to ensure more effective supervision and a level playing field at European level is the removal of uncertainty in the valuation of bank assets. The assets and liabilities recorded in banks’ balance sheets as Level 2 (L2) and Level 3 (L3) instruments play a key role, as their evaluation is particularly complex. Their value is not directly inferable from market prices but must be estimated using complicated techniques. Coupled with the difficulty of distinguishing between L2 and L3 contracts, this can lead banks to make valuations whose goal is to keep down capital requirements through accounting and regulatory arbitrage. Classifying a contract as L2 instead of L3 has several advantages. First, it is possible from the outset to book profits equal to the entire difference between the actual transaction price and the fair value estimated through internal models (known as the day-1 profit). Second, it limits the ‘stigma’ associated with holding large amounts of L3 instruments, which analysts regard as highly risky assets. Because of their high degree of complexity and low level of standardization, L2 and L3 instruments are illiquid; their quick sale would likely entail a substantial discount on their fair value. When the high risks embedded in these financial instruments emerged in the United States in 2008, the value of L2 assets decreased by 15 per cent and that of L3 assets by 21 per cent, with troughs of 31 per cent and 57 per cent respectively. 2 If not properly accounted for in the valuations, illiquidity could give rise to fictitious profits representative of hidden risks. Moreover, the actual value of L2 and L3 portfolios is difficult to assess, as it cannot be inferred from the prices recorded in the markets but is instead estimated using models based on variables whose liquidity is also low or nil. The total value of the complex instruments held by euro-area banks is very high. L3 and L2 assets total €162 billion and €3.3 trillion respectively; L3 and L2 liabilities amount to €143 billion and €3.1 trillion. The total amount of these instruments is twelve times greater than that of net nonperforming loans. Two national banking systems hold 73 per cent of the euro-area total and five banks (none of them Italian) 58 per cent. The available data do not tell us whether the risks Italian banks show misalignments in the credit conversion factor and in the prudential treatment of exposures in default. As regards this last point, the estimation of the loss given default parameter must take into account the recovery processes still under way. See B.W. Goh, D. Li, J. Ng, K. Ow Yong, ‘Market Pricing of Banks’ Fair Value Assets Reported under SFAS 157 since the 2008 Economic Crisis’, Journal of Accounting and Public Policy, 2015, 34:2, 129–145. embedded in assets in these classes are covered by liabilities in the same class. Only with a “perfect hedge” would the underlying risks be offset. The uncertainty about the valuation could therefore manifest itself through both an overestimation of assets and an underestimation of liabilities, thereby compounding the risks rather than cancelling them out. Since its establishment the SSM has tackled resolutely the issue of loan valuation, especially for non-performing loans, or NPLs. Opaque, illiquid and difficult to evaluate, L2 and L3 instruments are in many ways similar to NPLs, although they require much lower capital charges. Especially in a stress scenario, a decrease in the prices of these instruments could have systemic repercussions. It is therefore crucial to enhance supervision of the accounting and prudential treatment of L2 and L3 instruments and of the appropriateness of the values recorded in banks’ balance sheets. Within the SSM the Bank of Italy will submit a specific proposal to this effect to the Supervisory Board. While most of the issues mentioned so far mainly concern large banks, many others affect smaller ones. An example is the new IFRS 9 accounting standard, which will change loan valuation starting from 2018; banks will have to recognize provisions for expected losses and no longer only in relation to defaults. This will lead to an increase in loan loss provisions as soon as credit quality worsens. The new standard will force banks to improve the allocation and assessment of loans and to adopt new criteria to measure credit risk and calculate loan loss provisions. To make the impact on banks’ supervisory capital more gradual, the European Commission has proposed a five-year transition period. The methods and procedures, however, will have to be in effect at the beginning of next year. Supervisory authorities, both in Europe and in Italy, are closely monitoring the adjustment process, for example through ad hoc surveys. For Italian banks the progress is mixed; in many cases there are delays in project governance, information quality and model development. They must be tackled and eliminated rapidly. Starting next year the prudential filter on available for sale (AFS) exposures towards central Government will be removed for Italian less significant banks as well, following the SSM’s decision to lift them for significant banks starting from October 2016. Smaller banks must assess carefully the impact of this measure on their capital ratios and should start planning as of now any necessary countermeasures. The move to IFRS 9 and the removal of the AFS filter will increase the volatility of regulatory capital. The effect on banks could be more pronounced in Italy owing to the high level of sovereign exposures and to the fact that securities with a lower ratings display greater volatility. Scenario analysis based on changes in the interest rate and risk premium curves is a very useful tool for capital planning. In adopting IFRS 9, banks will be allowed to decide whether to allocate government securities to portfolios other than the AFS one. The consequences of the introduction of the MREL requirements will also be far from negligible, as banks will need to issue liabilities capable of absorbing losses if a resolution procedure is initiated. When fully phased in, the rules will make crisis management easier, but in the short term they will increase costs by a factor that will depend on the choices − still being debated − regarding the calibration of the requirement and the nature of eligible liabilities. The funding instruments that qualify for compliance with the MREL requirements are costlier than those currently in the balance sheets, especially in countries like Italy characterized by a large share of bank liabilities placed with retail customers − who could become unwilling to hold instruments potentially subject to bail-in − and by the limited development of institutional investors, i.e. those more interested in liabilities of this kind. The difficulties and costs of compliance with the MREL requirements will be greater for smaller banks owing to their limited access to wholesale markets and less liquid issues. This will have to be kept in mind when setting the requirements for this type of bank. More generally, an excessive burden should not be placed on small banks, in adherence to the principle of proportionality. For example, for such banks there is a tendency to rule out the existence of a general public interest, which is necessary to initiate resolution procedures. In spite of this, the current regulatory framework calls on these banks to pay into a crisis management system from which they cannot benefit. As part of the review of EU regulations, some thought should be given to measures that respond to the needs of smaller banks, which play a key role in lending to small firms, the backbone of the Italian economy. Crisis management In the crisis years the Bank of Italy dealt with numerous cases of banks in difficulty. Since 2011 there have been 36 special administration procedures. In 17 cases where it was not possible to find a market-based solution, the process led to the start of compulsory administrative liquidation. These cases involved small banks and accounted for a combined 0.2 per cent of Italian banks’ total assets. In market conditions where it has become difficult to transfer bank assets, the new European regulatory framework makes managing the crises of large banks problematic. Action is entrusted to a plethora of authorities and institutions − national and European − which are independent of each other, have non-aligned objectives and have no effective coordination in place between them. This extends the time necessary for a solution and makes the decision-making process inefficient and not very transparent, with the very real risk of confusing the responsibilities of the actors involved. Recent experience shows that these problems can be mitigated as long as there are concrete market solutions. The new rules have so far been interpreted in a such way as to deny recourse to some of the tools used in the past to manage problematic company cases without causing disruption. In practice, this makes crisis management more complicated. In particular, preventive intervention through deposit guarantee funds is not allowed today, as it is considered equivalent to state aid; in this regard the Italian government lodged an appeal with the European Court of Justice. Furthermore, excessively stringent limits have been established for the use of public funds, even if advantageous financially and following the full involvement of shareholders and subordinated bond holders; this is the case even in the presence of serious risks for systemic stability or contagion of financial intermediaries. Effective crisis management requires a rapid and reliable time frame, a clear definition of priorities and responsibilities, and full cooperation between the entities involved. In respect of the European regulations, the action of all the authorities must aim to preserve the value of the banking business to the benefit of savers, employees and the companies to which they lend. In the absence of these conditions, the vulnerability of the banks in crisis will increase, as we have seen in practice. The difficulties that preceded the agreement on the precautionary recapitalization of Banca Monte dei Paschi di Siena and the long and troubled discussions involving Banca Popolare di Vicenza and Veneto Banca are not due to financial constraints, since the resources earmarked by the Italian government are much greater than those needed to restructure these banks. The difficulties stem from regulatory obstacles, which can and must be removed. A solution for these two Veneto banks must be outlined very shortly, protecting savers and guaranteeing the continuity of the business relationships maintained by the many small and medium-sized enterprises based in an economically important area of the country. The Italian authorities are totally committed to resolving this problem. Non-performing loans The problem of non-performing loans is easing as the economy recovers. The flow of new NPLs in relation to total loans now stands at 2.7 per cent, which is lower than before the crisis. The stock, net of loan loss provisions, is also diminishing, from 10.9 to 9.4 per cent of total loans in 2016. The disposals already scheduled by the main Italian banking groups will speed up the rate of decrease. The Bank of Italy has voiced its opinion on the matter of NPLs on several occasions. I will therefore simply mention again the key issues and refer you to other documents for a more detailed analysis. 3 One of the first issues relates to the strategies adopted by banks to manage NPLs. Farreaching changes are necessary here. The guidelines published by the SSM are an important point of reference; the Bank of Italy is extending them, with the necessary adjustments, to the banks under its direct supervision. There are a large number of options from which the banks can choose and they should take advantage of them. The Italian banking system is now more aware of the various incentives, as is clear from the initiatives already under way, but a stronger and broader commitment is needed. Banks need to get the most out of the instruments available for out-of-court settlement with firms regarding debt restructuring and the transfer of real estate collateral. The measures will only be effective to the extent that the banks make use of them. Complete and reliable information on NPLs also needs to be made more widely available. The new system for reporting bad loans introduced by the Bank of Italy is a step in the right direction. There is ample scope for improvement in the quality of the data reported. In many cases the information on the status of recovery procedures and the nature of the collateral is incomplete. Approaches differ as regards ongoing procedures; not all banks act promptly. More effort is needed to reduce the backlog and exploit the new database to the full. The information must become part of the dossier provided to senior management so that strategies can be developed to maximize recovery rates. Another important issue concerns the length of judicial proceedings. The global reform of arrangements with creditors that the Government has set in motion, incorporating the Rordorf Committee’s proposal in a draft bill, will effectively lead to more efficient procedures and better See I. Visco, The Governor’s Concluding Remarks, 31 May 2017; F. Panetta, Seminario istituzionale sulle tematiche legate ai non-performing loans, 15 May 2017; C. Barbagallo, I crediti deteriorati delle banche italiane: problematiche e tendenze recenti, 6 June 2017. outcomes. Rationalizing and simplifying procedures – the aim of the delegated legislation – is an important step forward. Organizational changes to encourage judicial specialization within the court system (particularly as regards arrangements with creditors) could be introduced within a short space of time. A law effectively creating specialized sections of the courts across the country – possibly by reviewing the competencies of the different courts and pooling at least the more complex proceedings – would bring further improvements. Part of the problem of the excessive length of judicial proceedings is not due to the legislative framework. The Italian courts vary widely as to the duration of proceedings for bankruptcy and arrangements with creditors. According to data by the Ministry of Justice, comparing the situation in the north and the south of the country, at the end of 2015 the average duration of mortgage foreclosure proceedings was 2 years in the Trieste court district and 8.2 years in that of Messina. In the case of bankruptcy proceedings the duration ranges from 4.8 years in Trento to 15.4 years in Messina. Improving the efficiency of the courts where proceedings take longer than average would be of considerable help in reducing the stock of NPLs. Large fire sales of NPLs can only be a solution when the bank’s stability is at risk. The generalized adoption of policies aimed at selling off NPLs, which would effectively lead to an unwelcome transfer of resources to the detriment of Italian banks but to the advantage of a few specialized investors, mostly foreign, operating in an oligopolistic market for NPLs must be avoided. This type of policy would erode banks’ own funds at a time when raising capital is still beset with difficulty. A solution to the problem of NPLs is on the horizon, but as in the past it will take time.4 The banks still need to tackle it resolutely, following prudent provisioning policies and improving the way they manage internally not only NPLs but also exposures with a smaller degree of impairment. They should assess whether or not to keep impaired loans on their balance sheet according to the real likelihood of recovery. Business models As they overcome the legacy of the double dip recession, Italian banks must equip themselves with the means to cope with the new competitive environment, one in which technology plays a central role. The rise of Fintech companies, which provide financial services at various points of After the lira crisis of 1992, the bad debt ratio jumped from 5 per cent that year to 10 per cent in 1996. The bad debts generated by the crisis were absorbed by banks’ balance sheets over the following four years, with the bad debt ratio dropping back to 5 per cent in 2001 (see Pierluigi Ciocca, ‘Sulla questione del problema bancario’, mimeo, 2017). production, and the entry of major web companies in the payment services market bring strong competitive pressure to bear but also support innovation. These may represent valuable opportunities for the banks. There is no single, winning business model. Our analyses indicate that profitable banks are active in many different sectors but have in common a high efficiency and productivity. Of the 125 banking groups supervised by the SSM, about 20 have had an average ROE of at least 6 per cent in the last three years. This subset has a low cost-income ratio, mainly thanks to much higher than average unit revenues. Such results are achieved by combining technology with human capital and efficient organization. Last year, the operating costs of Italian significant banking groups were higher than the average costs of their ‘virtuous’ competitors by about 0.5 percentage points of total assets. This is a considerable gap, even adjusted to take account of non-recurring expenses; it is largely due to staff costs. Measures already taken to rationalize branch networks and reduce personnel will go some way towards reducing the discrepancy, but they must be accompanied by more efficient labour organization with the assistance of technology. In order to ensure that cost cutting does not diminish the quality of the products offered or the effectiveness of internal controls, it will be necessary to adopt strategies to increase human capital. The need to re-assess costs and revenues is particularly pressing for small and medium-sized banks, whose reduced scale of operation limits their capacity to invest and achieve economies of scale and scope. Consolidation can be an opportunity, particularly for banks not belonging to mutual banking groups. Progress in this direction could be achieved through measures designed to forge closer bonds between banks, along the lines of the institutional protection schemes introduced by European legislation and already adopted in other countries; this would make it easier for them to obtain liquidity or capital in case of need. Improving the structure of the financial system, with the markets playing a greater role in financing business, is part and parcel of the current transition. The Government has introduced several measures in this direction and a capital market union is one of the objectives pursued at European level. As I have pointed out in the past, it is in the banks’ interest to support these changes, which will bring benefits to our corporate sector. Conclusion Now that the economic recovery is gaining strength, progress in the Italian banking system can be pursued with determination. Gradually eliminating the risk factors that have been clouding analysts’ perception of Italian banks will facilitate this process; banks can now focus on their main objective: to restore profitability. The conditions are now right for Italian banks to approach the challenges of the new market context with confidence, once again providing full support to the economic recovery. Those challenges can only be overcome with commitment and determination.
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Remarks by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the presentation of the Bank of Italy's report on economic developments in Lombardy, Milan, 5 July 2017.
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Remarks by Luigi Federico Signorini at the presentation of the Bank of Italy’s report on economic developments in Lombardy Luigi Federico Signorini Deputy Governor of the Bank of Italy Milan, 5 July 2017 Italy has emerged from the longest and deepest recession in peacetime memory. Slow and hesitant at first, the recovery is gradually strengthening, and for two years now the trend has been clearly positive. Of course, the road ahead is still long and fraught with uncertainty. Notwithstanding its recent growth, Italy’s GDP remains seven percentage points below the level of early 2008. Spain’s is about to reach that level, while France and Germany have already outstripped it by five and eight points respectively. Nor should the risks on the horizon be underestimated. And yet, even taking account of the lost ground that will be difficult to make up, recent economic developments have been undoubtedly favourable. In the first three months of this year Italy’s GDP grew by 0.4 per cent, exceeding the expectations of the leading forecasters. Exports have continued to expand. In the last few years the growth in Italian export sales has outpaced that in demand from outlet markets. This was not the case between 1999 and 2009, when Italian firms struggled to keep up with competition from emerging economies and even from the other developed countries. The improved export capacity of Italian firms has been especially important as it has supported GDP growth in the most testing times of the crisis. Since 2010 Italy’s market shares have stabilized. Since 2013 there has been a surplus on the current account of the balance of payments. Italy’s net foreign debtor position has diminished rapidly in recent years, from 25 per cent of GDP in 2013 to 15 per cent at the end of last year. The investment-to-GDP ratio had shed five percentage points since 2007, when in 2014 it hit a postwar low of 17 per cent. The fall in investment was one of the most conspicuous signs of the crisis: the poor economic outlook discouraged it and its collapse in turn lowered GDP and productivity, making the outlook even worse and triggering a vicious circle. Years of low investment led to fixed capital not being renewed, lowering production capacity and contributing to weak GDP growth on the supply side too. However, little by little since 2014 investment has recovered, though the trends by sector and type vary greatly. Purchases of capital goods – machinery, equipment and transport equipment – have risen by almost 11 per cent in the last three years: as a share of GDP they are back near pre-crisis levels. By contrast, spending on construction has lagged behind for longer. Between 2008 and 2014 it contracted uninterruptedly, weighing heavily on the overall investment-to-GDP ratio, which to date has hardly risen at all. Yet even this sector has shown some signs of a revival starting last year. The signs are clearer in the residential sector, which has long benefited from tax incentives for the renovation of existing buildings, while the non-residential construction sector is still struggling to pick up and public investment has been on a trend decline since 2010. Why has investment returned to growth, at least in machinery and equipment? The Bank of Italy’s econometric model can give us some quantitative answers. According to our estimates, 1 almost half of the growth recorded is attributable to the improvement in the credit market: the strongly expansionary monetary policy stance has recently led to a reduction in the cost of capital and fostered more relaxed supply conditions. Yet the gradual improvement in demand and increased confidence on the part of firms have also contributed by one third; if the favourable economic situation continues, then this factor’s contribution should increase. Lastly, government policies to encourage spending on capital goods have also made a significant contribution, which we estimate at around one fifth of the total. As is well known, various tax incentive schemes for See the box ‘The trend in investment and the cyclical recovery’ in the Bank of Italy’s Annual Report for 2015, 2016. investment have been set up and implemented in recent years, especially in favour of advanced technology. The results of the Bank of Italy’s annual business survey (to which, as always, the Bank’s regional research network has made a vital contribution) show that in 2016 tax benefits for investment provided considerable support, and will do so to an even greater extent in 2017. We estimate that these benefits are going to boost investment by 3.5 percentage points overall in the period 2016-18. The fact that they are of limited duration is also important: part of their short-term effect is that firms bring forward their spending plans. Our surveys show that in 2016 investment was higher for small and medium-sized manufacturers, which had been particularly hard hit by the recession. They also indicate that investment will expand further this year: the share of manufacturing firms that plan to increase investment in 2017 was much higher than the share of those planning to reduce it. The slowdown recorded in the early months of the year is therefore expected to be temporary. Household spending also continues to rise. The recovery has been driven until now by the durable goods sector, which had contracted more than the others in the early stages of the crisis, but in recent years has fared comparatively better owing to the highly accommodative financial conditions. Loans to households in the form of home purchase mortgages and consumer loans have increased considerably. The latest available data show that the increase in household spending is now extending to services. Real estate wealth, which accounts for over 60 per cent of net Italian household wealth, has turned upward again thanks to the initial signs of a recovery in prices. Confidence indicators remain high. Yet the main driver of consumption is the improvement in income levels and prospects. Last year households’ disposable income increased in real terms by 1.6 per cent, double the figure for 2015; it continued to grow, though at a slightly slower rate, in the first three months of this year too. The consequent improvement in households’ economic conditions is partly due to net job creation. Employment has been increasing since the second half of 2014, though with some fluctuations in the monthly data. The growth is wholly attributable to payroll employment, which has now exceeded pre-crisis levels, while the number of self-employed workers has continued to fall. The recovery in employment has been greater than the mechanical effect of the increase in GDP. This may be partially ascribable to the results of various measures introduced over the last few years, such as those on social security contribution relief, and the reform process that began with the Fornero Law (Law 92/2012) and continued with the approval in 2015 of the legislative decrees of the Jobs Act. According to our estimates, 2 these measures have especially benefited payroll employment and permanent contracts. This is an overview of the recent changes in the main macroeconomic variables. But what is the current situation and what is the short-term outlook? For the quarter just ended, our estimates suggest overall GDP growth more or less in line with that of the previous quarter. The latest quantitative and qualitative indicators all point to a fresh increase in economic activity in services and to a return to growth in manufacturing, which in recent months had stalled a little. Sestito, P., and Viviano, E. (2016) ‘Hiring incentives and/or firing cost reduction?’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 325. Forecasts beyond the short term are always uncertain. However, our central projections continue to be moderately favourable. On 9 June we published the Bank of Italy’s macroeconomic projections prepared as part of the Eurosystem staff macroeconomic projections: these suggest that GDP will rise by 1.0 per cent this year, before accelerating to 1.2 per cent in the subsequent two years. The projections will be updated as usual in the Economic Bulletin to be published on 14 July, incorporating the new data which will become available in the meantime. Just the revised GDP estimates for the last quarter of 2016 and the first quarter of 2017, released by Istat after the closure of our projections exercise, raises the outlook for the growth achieved so far in the current year by about 0.3 percentage points. Growth in global demand is expected to continue and leading international forecasters are actually predicting that it will strengthen this year and the next. Nothing can ever be taken for granted in these matters; there is continuing uncertainty about the future stance of US trade policy and the consequent possibility of a global shift towards protectionism, which would curb demand and might cause tensions at international level. However, for the time being at least, the economic forecasts are positive. As we heard during the presentation of the report on economic developments in Lombardy, these positive trends are being confirmed at regional level. In the last 15 years Lombardy has almost always boasted higher GDP growth than that for Italy as a whole, though it has lagged behind − as the report points out – comparable European regions in terms of economic development and productive structures, both as regards per capita income and firms’ innovation capacity. Indicators of industrial activity and of firms’ investment plans in 2017 are encouraging and could foreshadow Lombardy’s gradual convergence towards the more advanced areas of the EU. Growth is also starting to take hold in the southern regions. The data collected by our branches from local economic operators also provide positive indications, though these are less widespread than in the CentreNorth. For the labour market too, after widening at the height of the recession, since 2014 the gap between the Centre-North and the South has narrowed. Those who have been listening up to now might have received the impression that the picture is almost uniformly optimistic, perhaps in contrast with the often bleak overtones that continue to mark the current debate on the state of Italy’s economy. So, in the interest of balance, I wish to reiterate the two essential provisos I made at the outset. First, growth is moderate and we are still nowhere near bridging the chasm in our living standards opened by the crisis that hit the Italian economy between 2008 and 2012, which was − and it bears repeating − the deepest and longest ever experienced in Italy in peacetime memory, and much deeper than that suffered by the other major European countries. Second, several elements of uncertainty weigh on the medium-term outlook; some of these are exogenous, while others are more within our control. By way of conclusion, I would now like to share with you some brief thoughts on the first point and some slightly longer observations on the second, particularly on the need to accomplish what lies within our power − which is a lot. Let me first say that even before the crisis the Italian economy was growing more slowly, not only than the emerging economies but also than the other major advanced countries. And while the recession appears to have swept away the old debate about Italy’s ‘decline’, its intensity, so much greater in Italy than elsewhere, was probably due at least in part to the same structural problems that for years had been holding the country back. We must now tackle them. These are recurring themes among attentive observers and ones which the Bank of Italy and the ECB never fail to underscore: the need for structural reforms in the labour market and in the market for goods and services; greater efficiency in the justice system and in general government; simpler legal and taxation systems. Despite the crisis, or perhaps precisely because of its harsh impetus, Italy has embarked on a far-reaching programme of structural reform. Much has been done, more than that for which we sometimes get credit. Significant results have been achieved, for example in the areas of labour and pension reform. But much remains undone. We must not stop, much less go back, because our future growth depends on this. My second point turns on the relationship between cyclical movements and economic policy priorities, especially those of fiscal policy. It is about the choices that can shelter our country from the uncertainties of the global economy versus those that on the contrary could exacerbate them. With all these provisos the improvement in the economy is real; so what should we do with this ‘cyclical dividend’? The answer that the Governor of the Bank of Italy gave a few weeks ago in his concluding remarks is clear. We must exploit the available leeway to develop a gradual and credible plan to lower our debt-to-GDP ratio, a fundamental source of fragility for our economy. The ratio has been high for more than 30 years. In the mid-1990s, with the prospect of joining the euro, the reduction got under way (about 12 percentage points in five years, between 1995 and 2000); at that time Italy succeeded in generating significant primary surpluses over an extended period, a necessary step for gradually reducing the debt-to-GDP ratio. Unfortunately, the crisis has led to another, sharp increase, connected with the exceptional contraction in economy activity and very low inflation. The high debt ratio did not allow the government to use fiscal policy to support aggregate demand during the double-dip recession. In fact, market concerns about the sustainability of Italy’s accounts made corrective measures necessary at the height of the sovereign debt crisis. In those days, Italy’s vulnerability to the vagaries of the economic cycle and to every murmur from the markets was palpable; there was a tangible risk of triggering a spiral of recession and debt. I believe the lesson we can draw from this is clear: in other words, the importance of getting our public finances in order, to the greatest possible extent, during favourable phases in the macroeconomic cycle. In recent years it has been wise to mediate between the competing needs of public finance and those of the economy: pursuing budgetary consolidation too eagerly while hoping to trigger a recovery could have had deleterious procyclical effects. A balanced approach has been made possible, among other things, by the flexibility allowed in implementing EU rules on public finances, in connection with the adverse cyclical conditions, structural reforms and some exceptional events. Also owing to the continuation of the crisis, the goal of achieving a structurally balanced budget in 2015 indicated in the 2013 Update of the Economic and Financial Document (EFD) was postponed several times. The latest EFD sets the objective of a substantially balanced budget for 2019 but, as we know, there is still some uncertainty about the measures needed to accomplish this. It is now time to dispel this uncertainty. Economic conditions have improved, the cyclical recovery is turning out to be stronger than expected, interest rates are low, and international developments have become more favourable. And it is during such favourable phases that the conditions for courageous decisions are created. As our Governor has said, ‘there must be no repeat of past errors: the failure to reduce the ratio of debt to GDP sufficiently in good economic times forced us to make procyclical adjustments during the crisis’. Progress can be made in this sense as and when the cyclical upturn is reflected in the public finances. But let’s not delude ourselves that we have a tesoretto (treasure hoard) to spend, as we sometimes hear people say; let’s not forget the debt mountain in whose shadow we live and which we must attempt to reduce, for our own sake and for the sake of future generations. The cost of servicing the debt weighs heavily on Italy’s public finances. Between 1999 and 2016 average annual interest expenses came to around 5 per cent of GDP. Italy must necessarily rely on high taxation levels or curb its primary expenditure in response. As happened between 2011 and 2012, worsening market sentiment about the soundness of Italy’s public finances could push these costs up further. In any event, the uncertainty this entails holds back private economic activity in Italy. But the launch of a credible plan would reassure the markets and would in some way be selfsustaining. For a country with such a high debt, we should remember that the spread game could trigger a virtuous circle just as much as a vicious one, depending on whether or not we succeed in coming up with serious and credible plans for lowering it. Even though the Great Recession is behind us and we hope to never see anything of that kind again, one day or another the economic cycle will start to worsen again. This is inevitable, and it has always been so. Today the markets are relaxed, monetary policy is exceptionally expansionary and interest rates are exceptionally low. These conditions cannot last forever. What we can do today is work to make our country stronger, more resilient and more capable of reacting to adverse economic cycles and to changes in market sentiment. We must continue down the path of structural reform and do what we can to start to lower the debt. In a nutshell, we must not miss this opportunity.
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association, Rome, 12 July 2017.
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Italian Banking Association Annual Meeting Address by the Governor of the Bank of Italy Ignazio Visco Rome, 12 July 2017 The current economic scenario and the outlook The Italian economy has gained strength. The latest economic indicators confirm that production is picking up. All in all, the most recent surveys of households and firms signal persistently high levels of confidence and a resumption of investment; the outlook for exports and employment remains favourable. The upturn in growth has had a positive impact on lending, even though firms’ demand for financing is still weak, reflecting the ready availability of own funds and the problems facing certain sectors. If the economy is to continue to strengthen, the global cycle must keep improving, there must be no increase in the volatility of international financial markets, and monetary and credit conditions in the euro area must remain highly expansionary. In early June the Governing Council of the ECB confirmed its commitment to maintaining a very substantial degree of monetary accommodation. To ensure a sustained convergence of inflation towards the price stability objective, it expects that official interest rates will remain at present levels for an extended period of time, and well past the horizon of the net asset purchases, which will run until at least the end of this year. But to erase the legacy of the most severe economic crisis in our nation’s history, the consequences of which can be seen in the record levels of unemployment, the public debt-to-GDP ratio and the ratio of non-performing loans to total outstanding loans, we need more than just a cyclical recovery. In Italy economic development is still hampered by the rigidities and inefficiencies of the environment in which firms operate and by weak productivity growth. The process of reform must continue, requiring a collective commitment, far-sightedness and measures to mitigate the costs of the transition. Banks, too, must change, seeking to become more resilient and to regain an adequate level of profitability. The success of this transformation depends on the entire economy returning to a path of sustained and enduring growth to which banks must contribute; at the same time banks must be prepared for the possibility that it may take a long time to achieve a more satisfactory rate of expansion in production. In 2016 and in the first few months of this year both new NPL flows and their ratio to total loans fell. This is a trend that should be encouraged through active management of these exposures. To recover profitability, additional decisive steps must be taken to cut costs, reorganize business models, adopt effective corporate governance arrangements, and engage in mergers. More investment is required to enable banks to meet, including by updating their business models, the challenges posed by the sweeping changes taking place in technology, regulation, market structures, and client demands. The resolution of episodes of bank crisis A number of banks experienced particularly severe difficulties, which could not be blamed on the decline in productive activity alone. When the crisis began, these banks were already in a weak position owing to deficiencies in their governance structures and imprudent lending practices, compounded, in some instances, by malfeasance. Over the last few weeks important steps have been taken to resolve some of the most serious cases. The precautionary recapitalization of Banca Monte dei Paschi di Siena was approved, an orderly liquidation of Veneto Banca and Banca Popolare di Vicenza was undertaken involving the use of State funds, and the sale of Nuova Carife, the last of the four banks put in resolution at the end of 2015 to be placed on the market, has been concluded. As for other troubled, but small banks, the public authorities, the banks’ own directors and fellow institutions are committed to finding solutions. The measures chosen eliminate the tail risk that in recent months has weighed on conditions at individual banks and on the sector as a whole, especially as perceived by financial operators. This is borne out by the positive response of the markets to the announcement of the most recent decisions. The decisions complied fully with European legislation and procedures. To the extent that these permitted, efforts were made to find the solution that best protected the interests involved. The use of state funds, which have a good chance of being recovered, should be viewed in this instance as a necessary response to specific market failures, but as exceptional, also in view of the underlying principles of the new European rules. The measures adopted arose from a process that was made particularly complex – and exceedingly long – by changes in the institutional and legislative framework. The management of banking crises today is entrusted to a multiplicity of independent authorities and institutions. There is a lack of effective coordination for setting priorities and establishing guidelines on the margins of discretion afforded by law. This is also demonstrated by the problems that have arisen in finding a solution to the crises at the Veneto banks. There must also be specific procedures in place to account for the decisions taken. To build on the progress made to date, the plans that have been drawn up must be implemented with dedication and determination. Banca Monte dei Paschi di Siena must begin the corporate reorganization and turnaround contemplated in its multi-year business plan, which has been scrutinized by the European institutions and which is capable of returning it to an adequate, and enduring, level of profitability. The precautionary recapitalization approved by the European Commission on 4 July avoided the very serious consequences of a resolution procedure; it permits an €8.1 billion recapitalization, of which €3.9 billion injected by the State and €4.2 billion resulting from the conversion into shares of capital instruments subject to burden sharing. To prevent or end disputes over the placement of these instruments with non-qualified customers, the State can acquire up to €1.5 billion worth of the shares resulting from the conversion in exchange for senior bonds issued by MPS. Overall, in exchange for public funding of no more than €5.4 billion, the State will acquire a share in the bank’s capital equal to about 70 per cent. The recapitalization will be completed by early August with the issue of the ministerial implementing decrees. The operation will enable the bank to raise its capital ratios to levels comparable to those of its main competitors; to free itself of its entire portfolio of bad loans and increase the coverage ratios on the remaining non-performing loans, also thanks to the Atlante fund; to significantly raise efficiency, productivity and profitability by offering early-retirement incentives to a large portion of its staff; to again contribute fully to financing the economy. Once adequate profitability levels have been restored, the State will sell its holding on the market, maximizing its investment. For Veneto Banca and Banca Popolare di Vicenza, precautionary recapitalization was not an option due to the lack of sufficient private resources to cover the losses they were likely to incur in the near future. The losses estimated by the European authorities involved in the procedure increased progressively during their assessment of the restructuring plan; that same assessment included a negative opinion on the banks’ ability to return to an adequate level of profitability. It therefore became necessary to examine the alternatives to precautionary recapitalization. On 23 June 2017, the ECB declared that the two banks were ‘failing or likely to fail’. The Single Resolution Board (SRB), the European authority responsible for the management of bank crises, agreed with the ECB’s assessment and concluded that there were no alternative market or supervisory measures that could prevent the failure of the banks. The SRB further concluded that resolution action – as a substitute for liquidation – was not warranted in the public interest. The Italian Government and the Bank of Italy, in close cooperation and in constant communication with the European authorities, therefore resolved the crises of the two banks by means of compulsory administrative liquidation in accordance with the European rules and the principles of the Consolidated Law on Banking. The Decree Law issued by the Government on 25 June 2017 offered a suitable framework for dealing with the two banks, including by making provision for the public sector support necessary to guarantee their orderly exit from the market. The liquidation was carried out in such a way as to ensure the continuity of existing business relationships and to limit the effects of the crisis on the productive economy. Shareholders and junior bondholders participated in the losses, but no bail-in was used, which would have included senior bondholders as well as customers with deposits above €100,000; provision has also been made for compensating some retail junior bondholders. The European Commission found these measures to be fully compatible with the rules on State aid as defined in the Treaty on the Functioning of the European Union; it also found that the public intervention satisfied the conditions set out in the 2013 Communication on State aid to support banks in the context of the financial crisis. This Communication established that shareholders and junior creditors participate in the costs and, if the liquidation calls for the en bloc sale of the struggling bank’s assets and liabilities, that the acquirer be chosen through an open, competitive and non-discriminatory process so as to select the most advantageous offer and minimize the effects on the public finances. That is what occurred, in full compliance with the agreed rules and conditions. The selection process involved six potential acquirers: four were Italian (the two leading banking groups, a mid-size bank and a major insurance group) and two were large European banks. At the close of the process, two binding offers had been submitted; Intesa Sanpaolo’s was the only one that could ensure the continuity of the two banks’ critical functions. The acquirer must now proceed to integrate and restructure the assets and liabilities sold as part of the operation. The banks in liquidation continue to hold, on the asset side, shares and other stakes totalling €1.7 billion and all their non-performing loans (€9.9 billion net of write-downs); on the liability side, they hold capital, junior bonds and risk provisions totalling €6.2 billion. The €5.4 billion difference constitutes a debt to Intesa Sanpaolo, which simultaneously acquires all the other assets and liabilities of the banks in liquidation. This debt (which may be revised upwards to €6.4 billion following the due diligence on the performing loans) is guaranteed by the State, which has also granted the acquirer other guarantees, with an estimated fair value of €400 million, to cover various risks. The immediate burden on the State consists of a cash injection of €4.8 billion, of which €3.5 billion to Intesa Sanpaolo to cover its capital needs following the acquisition, and €1.3 billion to cover the cost of the restructuring measures that Intesa Sanpaolo must implement. As a counterpart of these undertakings, the State is a creditor vis-à-vis the banks in liquidation and will be reimbursed through the sale of their assets. The non-performing loans will be assigned to Società di Gestione delle Attività (SGA), which will have to work towards eventually obtaining recovery rates consistent with those implied by the loans’ book values, which are net of write-downs. The costs of a standard liquidation procedure (‘atomistic liquidation’), the only available alternative once precautionary recapitalization has been excluded, would have been much higher for customers, the banking system, and even the State. The situation of Italy’s banks and the problems currently being addressed Credit quality continues to improve, sustained by the economic recovery. The ratio of new non-performing loans to total outstanding loans has fallen to the levels prevailing before the crisis, dropping to 2.4 per cent in the first quarter of this year. The stock of NPLs has also fallen: at the end of March, the ratio of NPLs to total outstanding loans fell for the significant banking groups as a whole to 9.2 per cent, net of write-downs, from a peak of 11.4 per cent recorded in the second half of 2015. The coverage ratio had reached 53 per cent, compared with an average of 45 per cent for the leading European banks. Sales and securitizations currently under way will lead to a further significant drop in the volume of net non-performing exposures: in the next twelve months their share of the total could fall below 8 per cent. This process must continue. The reforms of the credit recovery procedures launched in Italy in recent years are a step in the right direction; they must be strengthened to ensure a sharp reduction in recovery times. As I recalled in May, it would be especially useful to increase the level of specialization in the handling of insolvency cases, providing for the centralization of the more complex proceedings, including by reviewing the territorial jurisdiction of Italy’s courts. For their part, banks must make the best possible use of the instruments already available in the form of out-ofcourt agreements with firms on debt restructuring and the transfer of real estate pledged as collateral. All financial intermediaries must increase the availability of sufficient and timely information on non-performing exposures, essential for making the management of these assets more efficient and less costly, thereby facilitating their sale. The new reporting on bad loans that the Bank of Italy introduced last year, motivated by the scant availability of computerized data at banks, is providing a significant contribution to improving the management criteria for non-performing loans. The Commission has asked the European Banking Authority to consider launching a similar initiative for banks in all member states. The first results of the new NPL reporting confirm that the survey has prompted the banks to speed up actions to improve data organization and digitalization. The quality of the responses was initially poor but has become better, partly thanks to monitoring by the Bank. There is still room for improvement: in many cases the data on the status of recovery procedures and on the type of assets pledged as collateral are incomplete, particularly as regards valuations. Approaches to the recovery procedures differ considerably: some banks are not taking sufficiently prompt action. Efforts should be stepped up to eliminate the backlog and take full advantage of the possibilities offered by the new database. By exploiting the information to the full it will also be possible to conduct a more active management of non-performing exposures other than bad loans, raising the rate of reclassification to performing and adjusting coverage levels where necessary. Unlikely-to-pay exposures account for half of total NPLs; swift action is required to maximize their value, especially by means of restructuring agreements to set firms back on the path to sustainability. The 2015 reform introduced tools that give financial creditors far greater room for manoeuvre under these agreements; they should be exploited fully. The debate at European level is focusing again on the practicality of setting up a specialized company for managing the non-performing assets with public support to reduce the weight of these exposures in banks’ balance sheets and to develop the NPL market. As I have already pointed out, we believe that introducing this type of measure could be useful, provided it is finalized as soon as possible. To be truly successful, the disposal price of the assets should not diverge too much from their real economic value. Banks’ participation in the scheme should be voluntary and the various elements of their restructuring plans should be decided beforehand. Europe is also considering the introduction of mechanisms that set compulsory minimum write-downs, increasing over time, on new loans to be classified among non-performing exposures (known as calendar provisioning) – so as to reach high levels of coverage fast. Should such mechanisms be introduced, even with the necessary graduality, the significant differences in civil justice processes and loan recovery times across Europe would acquire even greater weight. The creation of cooperative banking groups is proceeding along the lines set out in the reform law. At the end of this process, two of the three new groups (Iccrea and Cassa Centrale Banca) will be ‘significant’ for supervisory purposes and will therefore be subject to direct supervision by the ECB. Before this happens, the two groups must undergo a comprehensive assessment, based, as in 2014, on an asset quality review and a stress test. This is currently scheduled for the first half of next year and will be tailored to take account of the fact that the institutions will not only be new to Italy’s banking sector but will also still be taking shape. Certain key elements are essential for the reform to be successful. The parent banks must complete a difficult transformation over the next few months to enable them to head very large and complex groups. Extensive discussions are already under way with the supervisory authorities, which will need to approve the main contractual clauses: by-laws, cohesion contracts and crossguarantee schemes. The process must now continue apace: organizational and decision-making mechanisms must be strengthened, senior management must possess high levels of competency and professionalism, and the steps needed to integrate IT systems must be rigorously planned. The comprehensive assessment should be prepared well in advance; in terms of capital adequacy, the parent companies will have to draw up plans enabling them – with equanimity and right from the word go – to establish the new groups. The participating banks must begin to operate in harmony, under the guidance of the parent company, well before the groups have been formally established. The asset quality review will need to be thoroughly updated to take account of the necessary value adjustments and write-downs already entered in this year’s balance sheets. The Bank of Italy is committed to strengthening the other banks under its direct supervision in order to increase their efficiency and productivity, promote the supply of innovative services for households and firms, and diversify their sources of income. For their part, banks are being called on to undertake wide-ranging action, including mergers to facilitate investment, economies of scale and, where necessary, access to capital markets. A first step towards greater integration could be recourse to consortiums to provide services and the pooling of data for internal models to compute capital requirements. In line with other countries, a more decisive step would be to introduce Institutional Protection Schemes (IPS), which do not remove the autonomy of individual banks but give rise to mutual support agreements that can be activated in the event of capital or liquidity needs. Expenses, income and structural changes in the banking industry The significant progress made in overcoming the grave difficulties of some banks and the gradual improvement in balance sheet conditions throughout the banking industry are undoubtedly positive developments. Several factors, however, are altering the context in which banks operate: changes in demand for financial services, technological progress and the digital revolution, and the regulatory reforms introduced in the wake of the financial crisis. The profitability of European banks has diminished considerably over the last ten years. The global financial crisis first hit the large merchant banks, who earn much of their income on the capital market. The recession and sovereign debt crises then took their toll on the balance sheets of banks whose core business is lending. Italy’s banking sector suffered a particularly sharp fall in profits; the return on capital, which was about 10 per cent in the middle of the previous decade, has been virtually nil for the last five years, exceptional factors aside. At the same time, the profits of Italian banks have been eroded by heavier losses on loans and a drop in income. Because of corporate crises in particular, from 2008 to 2016 write-downs on loans absorbed 80 per cent of operating profit. Interest income is now one third lower in relation to total assets than in the middle of the last decade; other income has also diminished. As the economic recovery gains strength, the outlook for the banking industry is improving, though only gradually. A return of new NPL flows to normal values will reduce the cost of credit risk. More intensive economic activity will spur households’ and firms’ demand for loans and financial services; eventually, profits could be boosted by higher interest rates. However, it is still unclear how much of the drop in banks’ net income is due to the economic cycle and how much to long-term factors. The growth in lending to firms may continue to be hampered by the ample supply of internal funds. The non-financial corporations sector has been a net creditor of the other sectors of the economy since 2012; this is an anomaly with respect to the past, but one that is also present worldwide. The modest expansion in lending to firms can also be put down to a gradual strengthening of their financial structure. Since 2011, leverage (i.e. the ratio of financial debt to its sum with net equity) has diminished by 7 percentage points. The share of bonds in total financial debt has risen by 5 percentage points, to 11 per cent; the proportion of bank loans has similarly diminished. Initially, the switch between the two types of financing concerned only a small number of firms, typically the big industrial groups already active on the bond market; it has now spread to small firms as well. The greater financial soundness of firms and their more diversified sources of finance are a positive, long-sought-after, development. If the trend takes root, it will make Italy’s financial system more resilient by splitting macroeconomic risk among a much larger number of investors. For many banks, however, it will potentially reduce credit and income growth. The challenge is to exploit the large pool of information on firms and on the economic system to offer new services. This process requires qualified human resources and an ability to interact with investors and markets without entering into any conflict of interest. The sweeping reform of the rules on bank capital launched in the aftermath of the crisis significantly increased the quantity and quality of own funds and inevitably put pressure on profitability. Going forward, the completion of Basel III, the introduction in Europe of requirements regarding loss-absorbing liabilities in situations of crisis, and the adoption of new accounting rules for write-downs on loans will bring further pressure to bear, notably on the cost of wholesale funding. For the banks that are unable to withstand this pressure it is important to prepare in advance measures that will make it as easy as possible for them to leave the market by means of mergers or sales, and at no cost to ordinary customers. To help the banking industry adapt more rapidly to the new environment, all the problems not yet solved by the regulations must be addressed without delay. An interval in the process of changing the rules would be welcome, not only to allow the banks to fully adapt to the new system, but also to prevent the incessant production of rules from itself becoming a source of uncertainty, and thus a hindrance to banking activity. Over a broader time frame, the growth of digital technologies is bound to increase the pressure of competition and squeeze banks’ profit margins. The availability of information on households’ and firms’ economic behaviour has increased enormously in the last ten years, as has the ability to process it. A new group of companies, called Fintech, are using this data to create innovative products, processes and business models. Already today they are in a position to offer financing and investment services, financial consultancy, and retail and wholesale payment services in competition with traditional banks. In the light of these developments and of the uncertainty surrounding the potential growth in business volumes and income, the banks are being called on to make an exceptional effort to reduce operating expenses, improve efficiency, and redirect spending towards investment in innovation. Greater use of digital technologies in the production and distribution of services will have a significant impact on the organization of labour, on its quantity and quality, and on how it is used. The number of payroll employees in the banking industry has fallen by 12 per cent since 2008, a trend that is bound to continue, including through the adoption of well-designed early retirement incentive schemes. During this period of transition, cost-cutting measures should apply to overall compensation as well, at all levels, and should reduce the many organizational duplications. A by no means small number of banks are still struggling to keep pace with the rapid reorganization of distribution channels. To date, the increase in the role of digital channels and the reduction in traditional ones have mainly concerned the largest banks. Since 2008, the number of branches has decreased by 5,000, or 15 per cent, a trend that will inevitably continue, both here and in the other main European countries. At the end of 2016, just over half of bank customers had access to online banking facilities. Investment aimed at exploiting the opportunities offered by the new frontiers of the digital economy is growing, but it is still restricted to a small number of large banking groups. Barely a third of banks have started projects to exploit internal big data and organize information on customers’ habits and potential requirements. The main obstacle is the lack of technology and of human and financial resources; it must be overcome if Italy’s financial industry is to remain competitive and continue to create value for the economy. *** The crisis that hit our economy has disrupted banks’ activity. The equilibrium that ensured almost a decade of growth and stability for Italian banks between the last millennium and this has been broken. However, as the problems of failing banks are solved and the economy recovers, the risk that the system may not hold up is receding. The market’s assessment of the outlook for Italy’s banks has improved in recent months, leading to a robust recovery of their share prices. Much remains to be done before the sector reaches a state in which the banks are able to generate sufficient profits to support the levels of capital adequacy imposed by the rules safeguarding the stability of individual banks and of the system as a whole. The supervisory authorities cannot stand in for the banks’ senior management in corporate decision-making. Their task is to prompt those responsible for strategic decisions to evaluate the opportunities and risks of the new environment and make a realistic assessment of their bank’s strengths and weaknesses. Reinforcing corporate structures, improving efficiency and productivity, seeking alliances or mergers to overcome the limitations imposed by size, and investing in new technologies, are key elements in the effort to reinvigorate the Italian banking system. 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Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the 31st Adolfo Beria di Argentine Conference on "Italy's banks in the new European system: positives and negatives", Courmayeur, 23 September 2017.
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XXXI Adolfo Beria di Argentine Symposium La banca nel nuovo ordinamento europeo: luci e ombre Ideas for the future of Italy’s financial system Salvatore Rossi Senior Deputy Governor of the Bank of Italy and President of IVASS Courmayeur, 23 September 2017 CONTENTS Italy’s banks in the new European system The problems besetting the ‘business of banking’ today The transition of the Italian financial system The rules are changing Technology and its uses are changing The system’s transition Italy’s banks in the new European system Italy’s economy was already weak when the 2007-08 global financial crisis struck. Its productive system was structurally incapable of delivering innovation, efficiency and genuine development; its financial system was overly reliant on banks. The old dinosaur that was its banking system had already begun to stir back to life, but many banks lagged behind as a result of ingrained bad habits in governance and management. These weaknesses fed on each other and were decried at conferences and publicly condemned. Given that they were also deeply rooted in the country and its history, at least its recent history, a solution appeared remote. If you get a raging temperature when already under the weather, you run a serious risk, as Italy did in these years. The country is only now coming round and while not yet decisive, the signs are encouraging. What happened outside our borders in recent years – worldwide efforts to draw up new regulations for finance, banking union in Europe and its first faltering steps – will be analysed by future historians. 1 Europe’s banking union is here and we must ensure it functions smoothly, starting with the Single Supervisory System (SSM) and the Single Resolution Mechanism (SRM) established in Frankfurt and Brussels. I will return to this point shortly. For an overview of these events from Italy’s perspective, see I. Visco, speech at the 23rd ASSIOM FOREX Congress, Modena, 28 January 2017; S. Rossi, ‘The Banking Union in the European integration process’, delivered at the conference on European Banking Union and bank/firm relationships, CUOA Business School, Altavilla Vicentina, 7 April 2016. From a legal perspective, banking union formally rests on numerous and complex legislative acts, which I will refer to using their English acronyms. For the euro area only, there are the two SSMR and SRMR Regulations establishing the new bodies tasked with supervision and banking resolution, dating from 2013 and 2014 respectively; for the European Union as a whole, we have CRD IV (the Capital Requirements Directive), followed by the CRR (Capital Requirements Regulation), both from 2013; finally, there is the BRRD (Banking Recovery and Resolution Directive), from 2014, and the DGSD (Deposit Guarantee Schemes Directive), also dated 2014. Several of these acts are still being revised and refined. On the question of banking resolution, a vital component in the overall project for banking union, the European Commission’s July 2013 Communication updated its own earlier interpretation of the rules on State aid in the banking sector. Taken together, the BRRD, DGSD and this Communication have played an important role in the case of the failing Italian banks that were wound up, placed under resolution or sold to other banks. Banking union makes sense if markets and investors believe that Europe’s banks are European first and foremost, and only then Italian, German or French. It follows that if a bank is in difficulty, it must be a matter for Europe, not just for the country in which that bank is headquartered. This implies the sharing of risks, both at private and public level, a concept that many countries have yet to accept. For several good reasons, I might add. However, one point must be clear: banks run many risks that have to do with how they are managed, but they also share with the State in which they are established – and whose government bonds they hold in their portfolios – what is commonly termed sovereign risk. In the euro area today this is a reflection not only of idiosyncratic factors in that State, but also of the possibility – which the markets continue to entertain, though much less than in 2011 – of a euro break-up and the redenomination of credits into renascent national currencies. This element of risk must be eliminated by driving the message home at every opportunity: whatever happens, the euro will endure. Proceeding with banking union necessarily implies sharing banking risks: all countries must work to make this a reality. The problems besetting the ‘business of banking’ today What problems do Italian banks face today, now that the fall-out from the crisis, specifically the ratio of non-performing loans, is slowly diminishing? Essentially, our banks generate too little profit, even excluding the cost of bad loans. To understand why, it helps to look at what has happened internationally. Over the last five years the return on capital and reserves, namely the return on equity (or ROE), of our banks has been virtually nil, while in the euro area ROE has been just under 2 per cent and in the United Kingdom it has hit 3; in the United States it has reached as much as 9 per cent. Italian banks have not only had to make enormous write-downs of non-performing loans on their balance sheets, they have also had to bear higher costs than in other countries. Up to now, traditional lending, especially when concentrated around smaller customers, has obliged banks to allocate a large amount of human resources per unit of revenue; moreover, for our major banks labour productivity, expressed as the value added per employee, is modest, averaging €124,000 over the last five years, compared with €170,000 for a sample of large European groups with similar business models. The low interest rate environment, created the world over by monetary policies, has squeezed interest margins and reduced profits. Although this is a global phenomenon, Italian banks have suffered more than those of other countries owing to their traditional business model: for several years their ROE has been much lower than the cost of capital, which does not make it easy for them to find new funding on capital markets. As we see, Italy’s entire financial structure is in difficulty. Despite the progress made in recent years, we still have companies that are poorly capitalized (as well as too small on average) and a bloated banking sector within the financial system. And yet the overall size of Italy’s financial sector is no greater than that of other advanced countries. On the contrary! At the end of last year, the financial debt of the private sector (excluding banks and other financial entities) was below 120 per cent of GDP, compared with around 160 per cent in the euro area, the United Kingdom and the United States. But, for our companies, equity finance accounts for only 46 per cent of their total liabilities, compared with an average of 53 per cent in the euro area. Moreover, they turn mainly to banks rather than to financial markets or non-banking intermediaries: bank loans represent more than 60 per cent of firms’ financial debts, while the euro-area average is not even 40 per cent and in the United States and the United Kingdom it is one third. As a result, Italian banks, even the largest ones, have specialized in retail lending to firms. They are therefore more exposed to adverse cyclical conditions. The transition of the Italian financial system The rules are changing The response of governments and supervisory authorities to the global financial crisis has focused on two key concepts: ‘more capital in banks’ and ‘no more taxpayer-funded bail-outs’. This is not all: action has been taken on liquidity, securitizations and off-balance-sheet transactions. Limits on leverage have also been recognized as necessary supplements to risk-based capital requirements. Even stricter rules have been envisaged for systemically important financial institutions. Instead, less attention has been paid, at least so far, to two extremely important non-banking topics: the shadow banking system and over-the-counter derivatives transactions. Has the pendulum swung too far towards rules for banks? Many institutions have naturally begun to think so. The Basel Committee on Banking Supervision is where the world’s supervisory authorities are now debating this question, during the negotiations on the proposed Basel III reform package, which should reinforce and refine banking supervision rules. I have three observations to make, in line with the stance adopted by the Bank of Italy. First observation. A period of adjustment for the reforms will be needed to produce a stable legal framework, otherwise uncertainty will increase, as will risks and the costs of banking. We must allow the rules to settle into place and then look at their effects on business conduct and models. The burdens, especially for smaller banks, need to be reduced where possible, though how this is to be done is a subject for discussion. Second observation. The desire for a period of stability is not to be confused with an easing of the rules, and the USA is currently wrestling with this problem. The Fed has defended the reforms it made in response to the global financial crisis by showing how they have strengthened the banking system without limiting economic growth. However, the new administration has yet to define its negotiation strategy. This uncertainty, which can occasionally be seen in the position taken by American representatives in some international forums, deprives the entire international community of important leadership. Third observation. Work is ongoing in the euro area on regulatory and institutional reforms. This is a good thing as banking union is still incomplete. Yet in Europe, we also need to consolidate what has already been achieved, starting with the SSM and the SRM, the two organizations responsible for the supervision and resolution of euro-area banks. Practices need to be harmonized by taking the best from each national system without prejudice. Progress is under way, including a contribution from Italy, and must be continued. Rules can contribute to forging the business model for all banks. If the rules change, banks must take this into account when deciding on their identity and strategy. We hope that the uncertainties in the global and European regulatory framework will be dispelled as soon as possible, because banks, especially in Italy, must reinvent and redefine themselves; and do so also in the light of new technologies. Technology and its uses are changing FinTech is the new buzzword at the centre of any debate on the future of banking. FinTech companies make use of existing technology, and of new technology as it becomes available, to offer financial products to their customers that up to a few years ago could only be purchased through a bank. This business is expanding rapidly in the markets for loans, payment services, and financial advice and has managed to attract substantial funding from venture capital and private equity firms: last year such firms invested more than $13 billion in FinTech. This is still a trifling amount compared with the trillions of dollars involved in global finance, but its growth is exponential. Until very recently, the banks benefited from being the main gateway to the financial world for most of the population. By providing a simple but fundamental product like the current account, they were able to reach a vast client base and make profits. Today, FinTech companies are trying to unpack the bundle of financial services offered by the banks, leaving the latter with only the least profitable ones. FinTech uses innovative data analysis techniques (artificial intelligence and machine learning) to process efficiently the information that individuals and companies put online, sometimes unknowingly (big data). Using this data, algorithms calculate the creditworthiness of those applying for a loan and the result is available, on digital platforms not requiring a bank to act as intermediary, to the savers who directly disburse the financing. The method seems particularly profitable when an individual or a small company is asking for a loan: in this case, according to the advocates of FinTech, an algorithm based on big data is far more efficient than an office peopled by bank clerks. FinTech companies are radically changing the relationship between clients and financial service providers, even in terms of usability. They mainly meet the needs of younger people, enabling them to conduct financial transactions at any hour of the day or night using their mobile devices. This poses a serious threat to traditional banks. The only factor that keeps borrowers and lenders tied to a traditional bank is trust, based on familiarity with other human beings behind a counter or even based purely on a brand. This is an imponderable factor, one that is difficult to predict. Certainly, the banks will have to give much more importance to the digital distribution channels and radically alter the way that client data are analysed and stored. Substantial investment in technology and human capital will be necessary. Another option for traditional banks is to acquire one or more FinTech companies, as seems to be happening with payment services. Smaller banks could team up with FinTech companies and outsource some of their own business, as has happened in many English-speaking countries. FinTech also raises questions and problems for those with a public responsibility as financial regulators and supervisors. There is a risk, for instance, of enlarging the boundaries of shadow banking, that is financial entities that elude any kind of supervision. Progress cannot be stopped, but it should be pointed in the right direction in the public interest. We are already considering the best approach to take. The system’s transition The financial crisis, the global reaction that widened and hardened the perimeter of banking regulation, the tumultuous developments in technology and in the market and, in the case of Italy, the long-standing problems in the structure of the economy require that our financial system be transformed. The changes are already under way, and the system is in a state of transition. Throughout the euro area, the banking system has progressively consolidated since the crisis. At the end of last year, the number of banks was just over 5,000, a drop of 25 per cent compared with eight years ago, while the number of residents per bank branch has grown by more than 30 per cent. In Italy, the first figure is in line with the euroarea average, while the second is lower (19 per cent), but nonetheless considerable. Similarly, the productive capacity of Italy’s banking industry is no more excessive than that of the euro area. At the end of last year, the number of residents per bank in Italy was about 100,000, much higher than the average of 67,000 in the euro area and 48,000 in Germany, even if the number of residents per bank branch was lower: about 2,000 compared with 2,300 in the euro area and 2,600 in Germany. However, the future does not so much hinge on the number of banks and bank branches, as on the composition of the financial system and the types of activities that banks undertake. I mentioned earlier that our financial system perceives firms as being overly indebted, especially towards banks but without them having benefited in terms of profitability. In order to increase the profitability of the Italian banking system and make it sounder, counterintuitive events are necessary: firms must increase their capital and diversify their sources of financing in order to reduce the role played by banks in the financial system. Signs of this are already apparent. The moderate expansion in bank lending to firms in recent years, despite its recent recovery, is also a result of this process. From 2012, firms’ leverage (the ratio of debt to debt plus equity) has fallen, the share of bonds in total financial debt has increased and the share of bank lending has diminished in equal measure. Changes in the composition of financing sources, initially limited to large industrial groups already active in the bond market, are now being seen among smaller firms as well. Over the past few months individual savings plans (PIR funds) have been introduced, i.e. instruments offering tax breaks and designed to channel investment directly towards Italian firms. The experiment has thus far been a success, attracting a net amount of approximately €5 billion. Special Purpose Acquisition Companies (SPAC) are another relatively new addition to the market, with growing success: in essence they are small private equity funds that gather resources from a limited number of investors solely on the basis of the personal reputation of the promoters. The resources are used to purchase equity in a target company, to be acquired within a set time limit after the vehicle has been established. SPACs are listed companies and serve to accelerate the listing of the target company. *** It is not enough for Italy to change the composition of its financial structure. Banks must advance their business model by accepting and facilitating a narrowing of their traditional role. In the long run, regulatory and technological changes make the Italian model of banking that prevailed in the ten years prior to the global financial crisis no longer sustainable. However, the transition to a new model is far from being free of obstacles and risks. For example, the immediate repercussions on employment of a rebalancing of the financial structure that lowers the share of the banking sector must be considered carefully, and tools to upgrade the skills of redundant staff must be set up – as we have already begun doing. There is no one solution. Each bank is a unique case and generalization must be avoided. Some banks might increase the supply of bond or share placement services to small and medium-sized enterprises, leveraging the wealth of information gathered over time: in short, this would translate into less direct credit but greater support and the provision of collateral for firms seeking access to financial markets. Other banks might remain totally retail-oriented but enhance their use of digital tools, boosting their online channels and expanding the transactions and services available through them. Such decisions are up to the banks. Analysts and supervisors can only try to glimpse the trends and prospects that, interspersed with risks, lie in the mist that always clouds the future. Of one thing we can be certain: the financial and banking systems cannot remain as they are if we want our country to return to a path of growth as it has done in the past.
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Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at a conference to mark the 49th edition of Credit Day "Banks, other financial intermediaries and firms: what needs to be done for Italy's development", organized by the Associazione Nazionale per lo Studio dei Problemi del Credito (National Association for the Study of Credit Problems), Rome, 4 October 2017.
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49th Credit Day Banks, other financial intermediaries and firms: what needs to be done for Italy’s development Finance and development Speech by the Senior Deputy Governor of the Bank of Italy and President of IVASS Salvatore Rossi Rome, 4 October 2017 INDEX Italian finance has begun to change .................................................. 4 Yet this is not enough .......................................................................... 5 Firms .............................................................................................. 6 Institutional investors...................................................................... 8 The rest of the financial market .................................................... 10 The outlook ......................................................................................... 11 The theme of this year’s Credit Day is not new, but the Italian economy’s current status makes it relevant and topical once again. What role can finance play in transforming our economy’s cyclical growth into real, long-lasting, structural growth? The type of growth that Italy hasn’t seen for the last 20 years, though it alone can help us lower unemployment levels, improve the quality of labour, and raise living standards in a stable way? In other words, put Italy at the top of the list of advanced countries, as it was in the past? By finance we mean all the financing activities on the part of families and firms, undertaken by financial intermediaries such as banks or other non-bank professionals or entities working directly in the financial and capital markets. We will look at it in terms of both supply and demand, and will then assess both the behaviour of those needing financing and the products offered to satisfy those needs, including the manner in which they are offered. For some time now we have been saying that Italy’s financial structure must change if we also want the productive economy to move towards greater growth. We would like firms to make greater use of the markets and to rely less on financial intermediaries, especially banks. Paradoxically, by downsizing their role banks may find a path towards greater profitability, offering higher returns on their growing capital. In essence we would like a virtuous cycle, one that fosters greater growth for the economy and more stability for the banking system. The reasons behind this wish are well established so I will not dwell on them: most important of all is the fact that growth feeds on innovation, which is a riskier proposal than proven, traditional productive activity, and it is best to finance innovation with capital rather than loans, especially bank loans, because banks are, and must be, more risk averse than the rest of the financial community. Two weeks ago in Courmayeur I focused on the glass being half empty, that is, the road that still separates us from this objective. Today I would like to look first at the glass being half full, focusing on the progress that has been made over the past few years. 1 My analysis will focus on firms and their demand for financing. Italian finance has begun to change Since 2011, private-sector firms’ leverage has fallen by more than 7 percentage points to 42 per cent (excluding banks and other financial professionals, calculated as the ratio between debt and debt plus net capital). This reduction has affected firms of all sizes. In large firms (those with more than 250 employees or with assets or turnover above €50 million) this was mostly due to an increase in net capital, thanks to the positive effects of the recovery, which has favoured both higher market value for capital and the reinvestment of profits in firms. The allowance for corporate equity (ACE), a measure enacted in 2012 which finally gave risk capital and debt the same tax treatment, also played a part.2 However, the weakening of this measure as of this year will greatly limit its effects going forward. Leverage has decreased in the other size classes too, though mainly due to the decline in bank loans: many small firms, already greatly in debt, have left the market or found it difficult to renew their credit lines. See I. Visco, Address by the Governor of the Bank of Italy, Italian Banking Association, Annual Meeting, Rome, 12 July 2017. On the effects of the ACE, see N. Branzoli and A. Caiumi, ‘Tax incentives and financial stability’, Banca d’Italia, Questioni di economia e finanza (Occasional Papers), forthcoming. Recourse to the stock market has increased, especially in recent years. Between 2014 and 2016 over 60 firms were quoted on the stock exchange, mainly on the Alternative Investment Market (AIM), a market segment with lower entry costs. In the same period, investments by private equity and venture capital firms in risk capital returned to pre-crisis levels of around €5 billion a year. Despite the positive contribution from various public schemes, such as the Italian Investment Fund and the Business Register for innovative start-ups, the share of investment in start-ups or in high-growth firms is still modest by international standards: in 2016 it stood at 15 per cent, against 23 per cent in Germany and almost 40 per cent in France and Spain. During the crisis, not only did the relative weight of debt and risk capital change, but so did the composition of firms’ sources of debt, with a growth in bonds to the detriment of bank lending. Since 2011 the share of bonds in overall financial debt has risen by 5 percentage points to 12 per cent; that of loans granted by Italian banks has fallen in equal measure to 61 per cent. During the most acute phases of the credit restriction triggered by the global financial crisis and then by the European sovereign debt crisis, recourse to the financial market proved to be feasible only for a few large industrial groups that were already active in that market. However, the number of issuers has grown in recent years, also among small firms, thanks to the removal of tax burdens and legal constraints on unlisted companies: for example, around 140 firms have issued minibonds worth over €10 billion since the relative measure came into force in 2012. Yet this is not enough Now we come to the half empty glass. The progress made is undeniable, but there have not been sufficient changes to the Italian financial structure. Our system still puts too much emphasis on financial debt and not enough on risk capital, and banks continue to play too big a role in it, which then backfires, making them more vulnerable during the negative phases of the economic cycle. This makes life more difficult for those who want and are able to invent, to paraphrase the historian Carlo Maria Cipolla, ‘new things that please the world’, which is the only way to create solid economic development. This slow progress is explained by the particular characteristics of Italian firms, which influence demand, and those of financial entities, which influence supply. Let’s look at some of them. I must warn you that I shall be focusing on insurance companies, regardless of their current importance in corporate financing, for reasons connected not only with my role but also with the future prospects for this issue. Firms Let’s begin with the demand side, or rather with firms asking for loans. I don’t think anyone will be surprised if I remind them that Italian firms are smaller than those in the other advanced countries. It is a well-known fact, the causes and consequences of which have been widely debated. In a recent book written by Anna Giunta and myself, which cites official Istat data for 2012, the issue is summarized as follows: ... our economy ... has a great many firms with a very low average number of staff: more than 4,426,000 firms in industry and services average 3.7 employees each (9.2 in the manufacturing sector) ... in Germany microfirms (up to nine employees) make up 84% of the total, in Italy 95%; 39% of employees in German industry work for large firms (250 employees and over), in Italy 22%. 3 A. Giunta and S. Rossi, Che cosa sa fare l’Italia. La nostra economia dopo la grande crisi, Laterza, BariRoma, 2017. Company size and type of governance are inter-related and here we can see another characteristic of our firms from an international point of view: they are family firms not only as regards ownership and top management but also as regards the second and third lines of command. 4 Recent analyses show that between 2008 and 2015 this tendency increased. 5 Small family-owned firms where there is a strong presence of family members in management are less productive, more poorly managed and less inclined to innovate – and there is plenty of empirical evidence to support this.6 This is already sufficient to explain why this kind of firm tends to approach a bank when it needs external financing rather than issuing bonds to be traded on the market or selling its own shares privately to a fund or publicly on the stock exchange. I would like to quote a couple of recent research papers on the Italian market, written by Bank of Italy economists, according to whom, in line with findings in the international literature, firms’ recourse to the bond market essentially depends on three factors: the need to fund new investments; the company’s reputation and transparency vis-àvis investors; and balanced financial and capital conditions.7 For our companies to want and be able to obtain funds from non-bank financial institutions or directly on the market, they need to: increase the level of management transparency; improve the quality of governance; produce balanced and credible financial statements and industrial plans; and undergo a profound cultural shift, including by acquiring new financial skills and A. Giunta and S. Rossi, op. cit. M. Bugamelli and F. Lotti, ‘Productivity growth in Italy: a tale of a slow-motion change’, forthcoming. M. Bugamelli, L. Cannari, F. Lotti and S. G. Magri, Il gap innovativo del sistema produttivo italiano: radici e possibili rimedi’, Questioni di Economia e Finanza (Occasional Papers), 121, 2012. For an international comparison see N. Bloom and J. Van Reenen, ‘Why do management practices differ across firms and countries?’, Journal of Economic Perspectives, vol. 24(1), 203-224, 2010. M. Accornero, P. Finaldi Russo, G. Guazzarotti and V. Nigro, ‘First-time corporate bond issuers in Italy’, Banca d’Italia, Questioni di Economia e Finanza, 269, 2015; N. Branzoli and G. Guazzarotti, ‘Il mercato dei private placement per il finanziamento delle imprese’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 262, 2015. developing relations with investors whose needs are very different from those of a traditional bank. All this is already within the reach of many mediumsized and large firms. This needs to extend to other companies too. Institutional investors On the supply side, the first requirement of a thriving economy is to have a large number of active institutional investors: insurance companies, pension funds and other asset management entities involved in managing savings, which facilitate the flow of resources to innovative firms with high growth potential. In Italy, the share of managed assets in households’ total financial assets remains below the average for euro-area and English-speaking countries, despite strong growth in recent years (in 2016 the total volume managed by institutional investors exceeded €1.4 trillion and reached 85 per cent as a proportion of GDP). More importantly, only a small share of these resources currently flow into the productive system. Institutional investors hold just over one tenth of corporate bonds. In France, where the capital market is more developed, the share is over 40 per cent. 8 And that is in a context where total bond issues are at much lower levels than in Italy. Investors are certainly deterred by the limited development of pension funds and of intermediaries specializing in the placement and underwriting of corporate debt instruments, such as private debt funds, but there are also more wide-ranging reasons. Let’s look at the insurance sector. Insurers’ investments to cover technical reserves focus on Italian government securities, with little appetite for corporate bonds, much less equity. So far, insurance companies have M. Accornero, P. Finaldi Russo, G. Guazzarotti and V. Nigro, ‘The Italian corporate bond market: missing investors or missing issuers?’, Banca d’Italia, forthcoming. shown limited interest in the legislative and regulatory changes made to encourage investment in productive firms. Prudential regulation on own funds obviously influences this approach. As we know, Solvency II introduced the principle that insurers’ assets – on which the solvency capital requirement is calculated − must be valued according to riskiness, instrument by instrument. The metrics are very granular and complex even when using the simplest of the three permitted methods, i.e. the standard formula. Non-rated bonds and unlisted shares are seen as very risky instruments with high capital absorption; however, it is precisely these instruments that small and medium-sized enterprises (SMEs) can issue, and it is these, alternative to traditional bank loans, that we would like Italy’s numerous SMEs should make use of. At IVASS we conducted a survey of insurance companies’ investment policies one year after the launch of the new regulatory framework. They have not changed much. So the marked preference for government securities, especially Italian ones, and corporate bonds with a high rating is not new. Solvency II added the strong argument of capital absorption to insurers’ deep-rooted reluctance to invest in securities that are not perceived as very safe. The issue of financial support for SMEs, and the part that insurance companies can play in this, is not just an Italian problem, but rather a European one. The project for a capital markets union must take into account any regulatory obstacles posed by Solvency II. The European Commission has recently sent a Call for Advice (CfA) on the matter to the European Insurance and Occupational Pensions Authority (EIOPA), which shall reply by the end of February 2018. Among the points which EIOPA will have to address are insurance companies’ investments in non-rated bonds, unlisted equity and strategic interests, and how these are treated in order to calculate the solvency capital requirement. The idea is to reduce capital absorption without sacrificing anything in terms of the prudence needed in assessing a company’s capital adequacy − in short, to rationalize rules rather than soften them. At IVASS we observe these possible developments at EU level with great interest, aware that Italy’s economic and financial structure badly needs to evolve. We are supervisors, of course, and our mission is to guarantee that insurance companies are sound in the best interest of the insured. We must never forget that. But we are always ready to step in when reason and common sense must be added to the rules that we are called upon to set at European and national level. The rest of the financial market If further progress is to be made in overcoming the difficulty of matching the demand and supply of funds then it is important that markets, technologies and stakeholders develop the capacity to ‘bundle’ corporate risk into financial instruments that meet the needs of final investors, such as insurance companies, pension funds and households. An example of this is venture capital funds, which use their ability to evaluate young and highly innovative firms to reduce the very high idiosyncratic risk of individual firms for their investors. Similarly, securitization companies can offer investors bonds with different risk/return profiles bundled into portfolios of assets not individually negotiable. Banks play a crucial role in this evolution of the productive system’s model of financing, a role that affects not only firms but investors and infrastructure as well. Banks can exploit their knowledge of the country’s entrepreneurial fabric and their key position in the distribution of savings products, and they can provide valuable financial advisory services, helping those firms that can gain access to the stock market or to forms of financing other than loans; they remain at all times an indispensable reference point for small firms. Offering a broader range of services can in turn help them to diversify their sources of income. The outlook Opening up firms to external investors and developing a non-bank financial industry are among the objectives of Europe’s capital markets union project. The European Commission recently published a report taking stock of progress so far and relaunching the whole project. 9 It is the most promising international scheme in this area, despite the uncertainty and lengthy negotiation times typical of European projects. In the meantime, Italy needs to make a move. In an attempt to increase the share of savings invested in the productive system, the Government has recently set up individual savings plans (Piani Individuali di Risparmio, PIR), asset management products that are eligible for reduced taxation. Just a few months after their introduction, the amount of funds collected, over €5 billion, is more than the Government itself had projected. This is good news, although the risks should not be underestimated, particularly as regards investor protection. Another instrument that is fairly new to Italy and is proving increasingly successful is the SPAC (Special Purpose Acquisition Company). Basically, it is a small private equity firm that gathers funds from few investors on the basis of the promoters’ personal reputation. The money is then used to gain control of a single target firm, which must be acquired within a stated period of time of having set up the SPAC. A SPAC is listed and it in turn speeds up the target firm’s listing. Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions on the Mid-Term Review of the Capital Markets Union Action Plan, COM(2017) 292 final. These are all interesting signs, and they need to take firm hold. Italy’s entire financial system must change to address the best and most innovative firms, helping them to grow. The whole of Italy’s economic future depends on it. Designed by the Printing and Publishing Division of the Bank of Italy
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 93rd World Savings Day "What are the prospects for saving?", organized by the Association of Italian Foundations and Savings Banks (ACRI), Rome, 31 October 2017.
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ACRI Association of Italian Savings Banks 2017 World Savings Day Address by the Governor of the Bank of Italy Ignazio Visco Rome, 31 October 2017 A strengthening economy After five years of weak growth, world trade is again expanding at a steady pace and global GDP is clearly gaining strength. Despite geopolitical tensions, the outlook is favourable in most economies and financial market conditions are very relaxed, reflecting a reduced perception of risk. Buoyed above all by expanding domestic demand, GDP growth is picking up in the euro area as well; the risks of deflation have disappeared. Excluding the most volatile components, price increases remain low at just over 1 per cent. This reflects rather modest wage growth in many economies, including Italy, owing to still high levels of underutilized labour. Last week, in the ECB Governing Council we decided to continue making net purchases of government securities and private bonds until the end of September 2018, or beyond if necessary, recalibrating the monthly purchases to €30 billion as of January 2019. We stand ready to strengthen the programme if conditions become inconsistent with further progress on inflation. We expect official interest rates to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases. The principal payments on maturing securities will continue to be re-invested for some time after the end of the purchases, and in any case for as long as necessary. These decisions will allow a high degree of monetary accommodation to be maintained even going forward. The cyclical indicators and the data gathered from surveys indicate that growth is continuing to gain strength in Italy too, thanks to reforms, international economic conditions and a strongly expansionary monetary policy. Employment has increased to levels close to those recorded before the global financial crisis and continues to rise. The renewed growth in lending and the outlook for the banking sector Economic expansion in Italy has been accompanied by an uneven recovery in lending, which has been concentrated among households and among those firms that have strengthened their financial position and are now ready to invest and expand their production capacity. Lending is once again increasing in manufacturing and services, while the construction sector continues to reduce its debt from the particularly high pre-crisis levels. Our surveys on banks and firms point to a gradual upturn in demand for financing, driven by the recovery in investment and favourable credit access conditions. Interest rates remain very low and, since the second half of 2015, have been basically equal to the euro-area average. Meanwhile, credit quality continues to improve. In the second quarter of this year the flow of new non-performing loans fell to 2 per cent of total lending, a level consistent with the average observed in the years prior to the global financial crisis. The stock of non-performing loans is also decreasing rapidly: net of write-downs, in June it had fallen to €150 billion, equal to 8.4 per cent of total loans, from the peak of €200 billion, or around 11 per cent of total loans, reached in 2015. The ratio of bad debts to total loans has declined from 4.8 to 3.9 per cent. Over the next few months, disposals and securitizations already under way and those recently announced by a number of banks will further drive down the stock of NPLs, which, net of existing write-downs, should fall below 8 per cent of total loans in the early months of 2018. Banks’ balance sheets need to be further bolstered to make them better able to withstand, now and going forward, the risks still weighing on the economic outlook. Banks are responding to this also by referring to the ECB’s ‘Guidance to banks on non-performing loans’ issued in March 2017. The measures to reduce the burden of non-performing assets announced last July during the European Council are a step in the right direction. This is also the aim of the introduction, which should be gradual and properly calibrated, of a calendar approach to write-downs for future non-performing loans. The reforms passed in Italy in recent years have shortened the duration of credit recovery proceedings; there is room for further action. The recent passage of the enabling law laying the ground for a comprehensive reform of legislation on corporate crises and insolvency proceedings will provide a major contribution to this. The principles and criteria set out in the enabling law must be implemented and translated into rules that can truly speed up credit recovery times, preserving as much as possible the value of companies that are still in sound condition. Banks must make full use of the tools that have recently become available in the domain of out-of-court settlements with firms for the restructuring of debts and the transfer of assets. Moreover, having suitable and timely data on NPLs is indispensable for more effective internal management and to facilitate their sale on the market at adequate values. Despite the improvement observed following the survey we launched last year, banks still need to make progress in this area too. The first six months of 2017 saw an improvement in the overall operating profitability of Italian credit institutions. The return on capital, net of extraordinary components and annualized, nevertheless still stands at around 2 per cent, reflecting the increase in write-downs caused by the securitization of non-performing loans. The CET1 ratio has risen from 11.5 per cent to 13.1 per cent, partly as a result of the precautionary recapitalization of Banca Monte dei Paschi di Siena carried out in July. I discussed the steps needed to regain profitability and meet the challenges posed by regulation, digitalization and competition in my address at the Annual Meeting of the Italian Banking Association. Resolute action is required, restructuring where necessary and fostering consolidation where possible. Stronger signs of recovery and a favourable outlook for the economy are an opportunity that must be acted upon swiftly. Italian households’ saving and wealth The saving rate of Italian households, which used to be high by international standards, is now below the average for the main euro-area countries. It has fallen from 19 per cent in the mid-1990s to 8.6 per cent in 2016. This is a reflection of changes in various domains; among them, the fast-paced development of the financial sector, which has increased households’ ability to obtain loans and redistribute consumption over their lifetime, the sharp fall in interest rates, which has made those loans cheaper, and demographic trends. During the years of the financial crisis, the decrease in the saving rate was partly due to low disposable income and households’ attempts to limit the repercussions on consumption. Our surveys on household income and wealth show that the decrease was larger in the case of young people, who were hardest hit by the impact of the recession on the labour market. An increase in the ability to save therefore needs to be fostered by developing adequate supplementary pension schemes. The total net wealth of Italians is almost nine times households’ disposable income. In per capita terms, this is comparable to the other main European countries and, like them, the predominant share (almost two thirds) is in housing and other real assets. While the propensity to borrow has risen owing to the structural factors I mentioned earlier, it remains low by international standards. The total financial liabilities of Italy’s households amount to 62 per cent of disposable income, compared with a euro-area average of nearly 100 per cent and even higher ratios in the English-speaking countries. Today, households’ investment in financial assets stands at more than €4,200 billion. These are a popular form of investment among the public and an important factor of social inclusion and integration. Over 90 per cent of households have at least one post office or bank account; in the mid-1960s, when the Bank of Italy instituted its sample surveys of household budgets, that share barely surpassed 25 per cent. Greater participation by households in the financial market has been accompanied by a gradual increase in portfolio diversification and in the share of savings invested in more risky assets. Bank deposits and post office savings have long been the main form of investment (Figure 1). Since the 1970s, a large proportion of savings has been channelled into government bonds; the 1990s saw the first significant investments in private sector securities and, above all, in investment funds. Since then, pension funds and individual pension plans have been gradually included in households’ portfolios, and at the end of last year individual savings plans were introduced, accompanied by tax incentives. The ratio of cash and deposits to total assets, which at the start of this century had declined to 20 per cent, has since risen to nearly 30 per cent in response to the fall in market rates and to the insecurity sparked by the financial and sovereign debt crises. At about 8 per cent, or roughly €340 billion, the share of public and private sector bonds today stands at its lowest level since 1950. These securities include €110 billion worth of bank bonds, of which about €20 billion in the form of subordinated debt (Figure 2). Some 30 per cent of households’ bonds will expire within a year, 70 per cent by 2020. Since the end of the 1980s, the stock of shares and equity interests, investment fund units, insurance reserves, and pension funds has increased significantly (from 35 to 58 per cent of financial assets). Investment fund units have experienced particularly strong growth (from less than 3 per cent in 1990 to 12 per cent today) as have insurance reserves and pension funds (from 8 to 23 per cent). The share of savings invested in pension funds, however, remains below that recorded in mainland Europe. The diversification of investments in assets bearing higher risks and returns remains a characteristic of the wealthiest households, although it is gradually spreading to broader swathes of the population. In Italy just 6 per cent of households hold investment fund units and 9 per cent insurance savings products and pension fund units; in Germany and France the percentages are 13 and 9 respectively for investment fund units, and 46 and 38 for insurance savings and pension funds. The protection of savings The wide range of instruments available and the numerous financial operators allow savers to make the choices best suited to their needs, to plan for the future, and to deal with unforeseen events. This is a victory that must be defended and extended. However, it can make decisions more complex, and increase counterparty, market and liquidity risks, which are often interrelated. The main criterion to be followed for proper investment management remains that of diversification. Savers should demand that this principle be followed, even when they rely on third-party advice. Two broad categories of public policy contribute to safeguarding savings: that designed to guarantee the stability of the financial system and that aimed at protecting savers as consumers of financial services. This is a much more complex matter than it was in postwar Italy, when it was written into our Constitution; it requires the contribution of many different actors, including savers themselves. Economic policies that can foster growth are essential for the protection of savings. The value of financial assets derives from that of real assets: a company’s share and bond prices rise or fall according to its state of health. An economy that does not grow cannot generate the resources necessary to recompense the capital invested in companies, to bear the burden of public debt or to enable households to repay their debts. Weak economic growth has even more serious effects on financial wealth if there is also a surfeit of debt in some sectors. The recent financial crisis provides dramatic examples of how serious these risks are. In Italy it is precisely the combination of structurally low growth and high public debt that has exacerbated the problems of the banking sector. A crucial safeguard for financial wealth is price stability. Several times in Italy’s history, long periods of high inflation have led to unfair reallocations of wealth, above all to the detriment of small savers who are less able to guard against the erosion of the value of money. The return to monetary stability, following a loss of purchasing power of almost 90 per cent between 1973 and 1995, dates back just over twenty years. Most recently, the greatest threats have come from the risk of deflation. The fall in prices increases the real value of debts, propelling the economy towards recession and eventually undermining financial stability. The monetary policies implemented by central banks are a bulwark against this risk. Macroeconomic policies go hand in hand with those designed to ensure the strength of the financial system overall and particularly that of the banking system. The crisis has led to more pronounced regulatory action at international level, aimed at reducing the riskiness of banks. This has resulted in an increase in the quantity and quality of banks’ capital, the introduction of liquidity requirements and of constraints on maturity transformation, and the imposition of financial leverage limits. Corporate governance systems have been reinforced and additional prudential requirements have been adopted for systemically important institutions. The banking crisis management system has also been overhauled, with the clear intention of placing the burdens primarily, if not entirely, on the holders of banks’ liabilities, with the exception of depositors covered by guarantee schemes. The consequences of these changes have been particularly important in Italy, where tools such as the preventive use of deposit protection funds, which had long been used successfully in crisis management, have become unavailable according to the interpretation of the rules on State aid established at EU level. Despite the greater constraints imposed by the new European regulatory framework during a far more serious economic recession, considerably fewer resources have been deployed in Italy to resolve banking crises than in almost all the other main countries. The events of these difficult years should be assessed according to the conditions existing at the time and the information actually available when decisions were made. At the end of 2013, the International Monetary Fund, following its periodical assessment of the Italian financial system (Financial Sector Assessment Program, FSAP), had carefully analysed the data on individual banks and judged that the Italian banking system was particularly resilient and that its supervision was strong and effective. Banking supervision significantly reduces the chances of banking crises occurring, but it cannot entirely eliminate them. Supervisory inspections require accurate and complex analyses, both on- and off-site; they cannot use the powers that the law reserves for the judicial authorities and the police forces. In most of the difficult situations experienced by individual banks, an analysis of the data available, an examination of the risk factors, the complaints appraised and the inspections conducted made it possible to maintain sound and prudent management and to resolve tense situations in a determined yet restrained way. Banks are businesses; under normal conditions, even difficult ones, the supervisory authority cannot assume the role of the corporate officers. Transactions executed rapidly in order to evade checks or to circumvent rules and restrictions may compromise a bank’s stability. The most serious violations were identified in time and were promptly reported to the judicial authorities, even though this is not always enough to avoid a crisis. Over the last few years, resolving banking crises has proved a lengthy process. This reflects the changes made to the regulatory framework and the multitude of authorities and institutions involved. We must take a closer look at the causes of the delays and work towards shortening the banking crisis management procedures. Every type of investment is risky. Some instruments benefit from a guarantee scheme put in place in the public interest: this is the case for deposits below €100,000. This type of safeguard protects savings in their simplest and most accessible form, thereby contributing to financial stability, preventing bank runs, and minimizing the risk of contagion among banks. The protection of other forms of savings relies on different instruments but can never completely remove the risk of loss. At the end of the 1980s, the Interbank Deposit Protection Fund (Fondo interbancario di tutela dei depositi) was established in Italy, flanking the mutual banks’ deposit guarantee scheme. Thanks to these two funds, to the small proportion of non-deposit liabilities and to the use of public resources, until the entry into force of the new European regulations, Italian banking crises generated losses only for the shareholders of the institutions involved. Immediately following the outbreak of the global financial crisis, European legislators rightly decided to strengthen and harmonize deposit guarantee schemes, making them obligatory. In 2014 they considerably restricted the protection of financial instruments other than deposits below €100,000 so as to prioritize the safeguarding of taxpayers over bank creditors. As I have remarked on several occasions, the transition to the new system was abrupt; banks were not given sufficient time to issue new debt instruments capable of absorbing losses in the event of a crisis, and instruments that had already been issued were not exempt from the new rules. The protection of savings entails taking action to avoid the unintentional assumption of risk on the part of savers. The preventive tools employed to pursue this objective are the rules and checks on transparency and on the propriety of relations between banks and customers; the contribution of financial education campaigns is essential. A third tool is the ex post settlement of disputes both in court and out of court. Customer relations must be underpinned by transparency and proper conduct; this applies both to traditional banking services (such as current accounts), where the Bank of Italy’s monitoring ability has been enhanced since 2010, and to the offering of investment and insurance products and services, which is monitored by Consob and IVASS respectively. The Antitrust Authority contributes by countering the adoption of improper commercial practices. The presence of distinct authorities is a result of the specific features of, and regulations applicable to, the various regulated sectors and of the contractual risks and structures involved. In the current regulatory context, a close working relationship among the authorities is even more important to minimize overlaps and to avoid loopholes in the safeguard mechanisms. In recent years, the Bank of Italy has strengthened the rules and controls relating to bank services and products, as well as the management of exposures and the support of alternative dispute resolution schemes. With regard to improper conduct, in addition to sanctions on banks for regulatory violations, we have taken steps to eliminate anomalies and called for the restitution to clients of amounts unduly paid: in the three years 2014-16 approximately €200 million were reimbursed. The Banking and Financial Ombudsman (ABF) was established in 2009 to settle rapidly disputes between customers and financial intermediaries. The ABF works completely independently, with support from the Bank of Italy in terms of logistics and resources. In 2016 four new panels were set up in addition to the existing three; overall, their technical secretariats are staffed by over 100 Bank of Italy employees. Consob’s Financial Dispute Arbitrator started work at the beginning of the year to resolve disputes involving financial investments. Further instruments will soon be included in the transparency rules to stop products being proposed if they are not suited to customer needs. The new rules on the development, introduction and control of financial products placed on the market (product governance) and on the remuneration and bonuses of sales networks will help to prevent opportunistic behaviour on the part of financial intermediaries. However incisive, legislative obligations and protection measures alone are not enough; we also need to protect consumers by increasing their capacity to sift through the information at their disposal. Financial education is not only a response to the crisis, it is an indispensable requirement in the face of changes in the investment instruments on offer. Basic financial skills are essential not only to defend against the risk of misconduct or fraud, but also to make the right choices in line with personal needs and financial circumstances. In some countries the aim of expanding financial education has been explicitly included in the mandate of the authorities that protect savings, often in the context of a more general national strategy, as is the case in Italy today. The recent establishment of the Committee for the Planning and Coordination of Financial Education Activities is indicative of the importance that the Italian authorities give to the aim of increasing the public’s awareness in the fields of finance, insurance and pensions. The level of Italians’ financial know-how and skills is one of the lowest for adults in the OECD countries. In Italy there is little knowledge of basic concepts such as the importance of portfolio diversification and how interest payments are calculated. The situation is better among young people: the latest OECD-PISA assessment, relating to 2015, indicates that the financial literacy of Italian 15-year-olds is in line with the European average and has clearly improved since the last survey. This is encouraging because it indicates that the work done in schools in recent years is starting to bear fruit. The Bank of Italy’ financial education project reached more than100,000 students in the 2016-17 school year. *** The composition of Italian households’ financial wealth has changed greatly over time. New risks call for new forms of protection for different forms of investment. It would be unthinkable to try to limit savers’ choices or unduly curtail the independence of financial operators; this would have a high cost in terms of the economic system’s efficiency and people’s wellbeing. We need to guarantee correct, transparent information and a regulatory framework able to embrace change. We need to step up financial education programmes and make people more aware that there is no such thing as a totally safe investment. The protection of savings calls for monetary stability and financial stability. Through their decisions and actions the central bank and the supervisory authority pursue these aims vigorously; supervision of the conduct of individual banks is steadfast and intensive. We have no hesitation in giving an account of our actions to the Institutions and to the country. Figure 1 Composition of households’ portfolio of financial assets: 1950-2017 (end-of-period data; per cent) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2017 Deposits and cash Shares and equity interests Insurance products and pension funds Government securities and bonds Investment fund units Other assets Source: Bank of Italy. (1) For 2017, the data refer to June. Figure 2 Composition of households’ portfolio of financial assets: June 2017 (per cent) 2.8 23.3 31.4 Deposits and cash Government securities and bonds Shares and equity interests Investment fund units Insurance products and pension funds 11.7 8.0 Other assets Government securities Non-bank private bonds Ordinary bank bonds 22.8 Subordinate bank bonds Source: Bank of Italy. 0.5 3.2 2.2 2.1 Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Convention of the Asociación de Mercados Financieros, Madrid, 6 November 2017.
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Annual Convention of the Asociación de Mercados Financieros Recent developments and open questions in the European banking industry Speech by Governor of the Bank of Italy Ignazio Visco Madrid, 6 November 2017 Ladies and Gentlemen, It is an honour and a privilege to address this assembly. I would like to express my gratitude to Governor Linde and President Prados del Amo for the kind invitation to be here today. I will take this opportunity to share with you some reflections on the state of the European banking industry, of which Spanish banks are a fundamental part. I will start with some considerations on the evolving structure of the sector; I will then move on to the issue of profitability; and I will conclude with my take on the main open questions we need to address over the coming months. The long journey: evolving structure of the European banking industry since the financial crisis Since the global financial crisis, the European banking industry has undergone a considerable structural transformation, along three closely intertwined dimensions. The first one concerns the profound changes in both regulation and institutional set-ups. Capital requirements have been raised, leverage has been limited, and stringent liquidity requirements have been established. The institutional set-up has also been completely modified. In a very short time frame, the Banking Union has been launched, with the introduction of the Single Supervisory and Single Resolution Mechanisms (SSM, SRM). A new framework for managing banking crises has been adopted. Although the third pillar of the Banking Union – the European Deposit Insurance Scheme – is still lacking and in other dimensions advancement is slow, the overall progress has been remarkable. It would perhaps have been unimaginable only a few years ago and testifies to the strong determination to continue along the path to European integration. The second dimension of structural change relates to the contracting size of the European banking sector, which not only reflects the tightening of regulation but also other factors, such as the need for banks to clean up their balance sheets, the impact of technology, as well as the increased role of non-bank financing. In the aftermath of the crisis, the total assets of the euro area banking sector declined significantly both in absolute terms, by 15 per cent between 2008 and 2016, and relative to GDP; leverage has been reduced across the board, and especially in countries where it was higher. The downsizing of the European banking sector is also the result of important changes in its industrial organisation, which represent the third dimension of structural transformation. Between 2008 and 2016 the number of euro area banks declined by around 25 per cent, with Spain being one of the countries where the reduction was greatest. The number of branches is also decreasing and the use of resources is generally becoming more efficient. Overall, this set of structural changes is delivering positive results. The European banking system is enhancing its resilience and all actors involved are contributing: regulators, banks, and supervisors. There is, however, no room for complacency. As I will discuss next, legacies from the crisis still linger and remaining vulnerabilities call for continued vigilance and unwavering determination on all sides. Out of the woods? Not yet: some crisis legacies are still with us The issue that epitomises the problems left on the table is low profitability. On the aggregate, the return on equity of euro area banks has not yet recovered since the financial and sovereign crises, and remains low by historical and international standards. There are, however, important heterogeneities: small and medium-sized banks are still suffering, while larger intermediaries are recovering. In 2017, net interest income improved for some intermediaries, while fee income, supported by the asset management business, increased more broadly. Profitability is also well below estimates of the cost of equity for most banks. Despite the differences across banks and jurisdictions – in Spain, for example, the gap is relatively smaller than elsewhere – the problem extends across Europe. The causes of the phenomenon can be traced back to both transitory factors – such as the legacy assets from the adverse cyclical developments – and structural elements, including the need to adjust the business model to technological change and to the new regulatory environment. The ongoing recovery of the global and the euro area economies contributes to addressing the transitory impediments. However, analyses and simulations from various sources seem to suggest that for a non-negligible part of the European banking sector this may not suffice to recover adequate levels of profitability. Going forward, the target for banks’ profitability may actually prove to be lower than the one deemed appropriate by some international institutions, such as the IMF. Indeed, once the transition to the new regulatory regime is completed, and a safer banking system has emerged from the reforms, investors might reduce the returns that they expect to receive from banks. In other words, in future months the “reform dividend” may translate into a lower cost of equity. Indeed, estimates of the cost of capital for European banks show that it has declined significantly since the beginning of the year, although it remains higher than the average in countries, like Italy and Spain, that have been hit particularly hard by the financial crisis. This is a key issue that deserves further analysis and that we have to keep monitoring closely. A contribution to closing the gap must also come from banks’ efforts to increase profitability in a structural way. This is something that concerns most banks, those facing difficulties as well as those that currently show healthy conditions. Against this backdrop, while there is no single winning business model, the experience of the most profitable banks provides useful guidance for both costs and revenues. On the revenue side, a greater diversification of the sources of income in favour of high quality financial services can help compensate for the prolonged compression of interest margins. A progress in this direction is already visible, but international comparisons suggest that there is ample room for improvement. The expansion of non-bank financing and technology-based intermediation, despite increasing competition, also offers banks opportunities for broadening their revenues by focusing on the provision of related and complementary services, for example in the areas of corporate finance and asset management. Benefits for income generation can also come from mergers and acquisitions geared towards exploiting economies of scope and scale, and facilitating investment and access to capital markets. Those of a cross-border nature can also foster financial integration. On the cost side, there is a broad consensus that operational efficiency needs to be improved resolutely. Since the beginning of the crisis, the banks’ cost-to-income ratio has deteriorated in the majority of countries. In many cases this has reflected the reduction in revenues per unit of assets, while the cost-to-asset ratio has often improved. In Spain there has been a major effort in streamlining branch networks; the number of branches has dropped by almost 40 per cent since 2008. In Italy the figure is less impressive, 15 per cent, but progress has been made nonetheless. As in other countries, there is room for further streamlining – not only as regards branch networks but also operational costs, including, where appropriate, labour costs and managers’ remunerations. Cost savings coming from further rationalisation can be used to redirect spending towards investment in technology and innovation, which can go a long way to enhancing productivity. Needless to say, further progress in the clean-up of balance sheets is also necessary to increase profitability. Encouraging signals are emerging: as the economic recovery consolidates, credit quality is improving. In Italy, which is one of the countries where the problem of non-performing loans (NPL) is most acute, the flow of new NPLs relative to total outstanding loans has fallen to the levels prevailing before the crisis. The stock of NPLs is also falling quite significantly, and disposals currently under way will lead to a further drop over the coming months. It is important that such disposals are implemented in an orderly fashion, in order to avoid fire sales and keep the market price of NPLs at levels consistent with their recovery rates. Indeed, sales at very low market prices, which reflect high returns required by the buyers, would put undue pressure on banks’ balance sheets and, ultimately, lead to a contraction in the supply of credit to the real economy. This clean-up of banks’ balance sheets must continue, both in Italy and elsewhere. For this to happen, European banks must strengthen their strategies for NPL management. In this respect, the guidelines published last March by the SSM are an important point of reference and indicate several possible options, from the creation of separate and specialised management units, to the recourse to external managers, and to the sale of portfolios on the market. The stock of NPLs in banks’ balance sheets depends crucially on the length of the recovery procedures which in turn depends on the protection granted to the creditors by the law in the event of insolvency of the debtors and on the time that courts take to enforce the law. In Italy the stock of NPLs is high also because the outflows are small, due to the very lengthy judicial recovery procedures. Reforms recently introduced to significantly speed up the credit recovery process are already positively affecting the market price of NPLs; such effect will continue in the coming years. In Spain, as a legacy of the crisis, banks have taken large stocks of foreclosed assets onto their balance sheets. In other countries, other vulnerabilities, such as for instance the large concentration on banks’ balance sheets of complex and illiquid activities – those classified as Level 2 and Level 3 assets, need to be closely monitored. A public consultation has recently been launched on a draft addendum to the ECB guidelines considering the introduction of mechanisms that set compulsory minimum write-downs, increasing over time, on loans that will be classified as non-performing. It is important to recall that, in the current context, any policy action needs to strike a delicate balance between the goal of speeding up the resolution of the NPL problem and the goal of preserving financial stability. In particular, supervisors should refrain from imposing measures that de facto imply blanket sales of NPLs on banks, which in the current circumstances would lead to a fall in the market price of NPLs and thus to a transfer of resources from the banks to a handful of specialised investors operating in an oligopolistic environment. This type of policy would erode banks’ own funds at a time when raising capital can still be difficult, thereby putting the ongoing recovery at risk. While there is no question that, especially because of the positive effects of the recovery, banks should make clear progress in the management of NPLs, I would dare to evoke the great nineteenth century Italian writer Alessandro Manzoni, who in his masterpiece “I promessi sposi” had the Spanish Gran Canciller de Milán Antonio Ferrer say to his coachman during a famous riot in 1629: “Pedro, adelante con juicio”. Looking forward: expectations for a safer and sounder industry, and open questions The financial crisis has spurred a global regulatory response influencing almost every aspect of the banking industry: lending, securities and derivatives trading, funding, bank supervision and resolvability. Such reforms have led to more demanding capital and liquidity requirements, less room for banks to exploit leverage, stronger constraints on their organisational structure to ensure resolvability. Further adjustments will come as single pieces of the reform package, such as the requirements regarding loss-absorbing liabilities (TLAC and MREL), are implemented. Moreover, the adoption of the new accounting standard IFRS9 in 2018 will change loan valuations: banks will have to make provisions for expected losses and no longer only in the event of a default. The new standard will force banks to improve the allocation and assessment of loans and to adopt new criteria to measure credit risk and calculate loan loss provisions. A key priority now is to rapidly reach – after a too long negotiation period – an agreement on the finalisation of the Basel 3 reform package aimed at reducing the ample variability of risk-weighted assets as calculated by internal models. Following that, a period of regulatory stability – free from further rule-changing – would be opportune, not only to allow banks to fully adapt to the new system, but also to avoid the incessant production of rules becoming in itself a source of uncertainty, and thus a hindrance to banking activity. Looking ahead, there is reason to be confident. Expectations are for a sounder and gradually more profitable European banking industry. This is also borne out by the market’s assessment of the outlook for banks. The completion of the regulatory reforms will dispel the uncertainty that is still preventing the market from fully perceiving the benefits of the reduction of excessive risks in banks’ balance sheets. But we know that the stakes are high. For those banks that will not be able to withstand the increased pressure, it is important to prepare measures in advance that will make it possible for them to exit the market in an orderly fashion. Should new crisis situations emerge, preserving financial stability will hinge critically upon the availability of an effective crisis management framework, one characterised by prompt and decisive action, close cooperation among all the parties involved, and a clear definition of responsibilities and priorities. This is how in the past even severe strains were overcome without damage to savers or the overall economy. The experience gathered thus far within the new European framework for bank recovery and resolution can teach us important lessons on whether the new set-up also meets such criteria. In particular, besides the resolution of Banco Popular in Spain, earlier this summer three crisis situations were tackled in Italy, leading to the precautionary recapitalisation of Banca Monte dei Paschi di Siena, and to the orderly liquidations of Veneto Banca and Banca Popolare di Vicenza. All these decisions complied fully, albeit in different ways, with European legislation and procedures. To the extent permitted by these rules, efforts were made to find the solution that best protected the interests of all parties involved; the recourse to public funds represented only a small fraction compared to the taxpayer money employed just a few years ago by other countries in overhauling their own banking systems. The measures adopted have been successful in eliminating the tail risks weighing on both individual banks and the sector as a whole. In fact, over the last six months, stock prices of major Italian banks rose by 25 per cent, against the 11 per cent on average for major European banks. However, these initial experiences have also highlighted some inadequacies and pitfalls in the new resolution framework. In the Italian cases, the final decisions were adopted only following a lengthy and complex process due to the fact that in some instances (e.g. the precautionary recapitalization foreseen by the BRRD) the new framework entrusts the management of banking crises to numerous mutually independent authorities and institutions, both national and supranational. Such a framework is hardly compatible with rapid intervention and lacks an effective coordination mechanism for setting priorities and establishing guidelines on the margins of discretion afforded by the law. Moreover, no specific procedures are in place to account for the decisions taken. A further lesson that can be drawn from the recent cases is that it is important to preserve margins of flexibility in the framework, as even relatively small banks’ failures, if not properly managed, may have extensive and, at times, systemic consequences. Even the resolution of a middle-sized bank could have been problematic, had the overall economic and financial conditions made it difficult to identify possible buyers and the bail-in of senior bond and relatively large deposit holders become inevitable. Overall, these experiences can be taken to support the view – which I have voiced in several occasions in the past – that the new resolution framework does not fully take into consideration the risks associated with its own implementation and thus needs further fine tuning. The new rules were rightly designed with the goal of contrasting opportunistic behaviour by banks, but their application must also take into account the broader objective of safeguarding financial stability. I believe that the transitional period foreseen in the implementation of the new framework has been too short for all parties involved to adequately adjust to the new regime. This has been especially important in light of the fact that some of the crucial elements for the overall balance of the framework – such as the availability of adequate loss absorbing liabilities in banks’ balance sheets, just to mention one among several others – were not yet in place. Furthermore, in my opinion the interpretation of the new rules on the management of banking crises and on state aid in some cases has been overly restrictive, denying recourse to some tools used in the past to effectively manage crisis situations without causing undue disruption. For example, recourse to the preventive intervention by domestic deposit protection funds is now treated as equivalent to state aid, and thus not permitted, even though these funds are entirely private and their utilisation is guided by entrepreneurial considerations, and not by the authorities’ decisions. In addition, the use of public funds to address banking problems, even in specific circumstances where it may be economically and financially advantageous, is now subject to very stringent limits even after shareholders and subordinated creditors have been bailed-in and the old management completely replaced. The interpretation of state aid rules as put forward in the EU legislation in 2013 has severely limited the possibility to establish a publicly supported asset management company (AMC) to deal with banks’ NPLs. I strongly believe that protecting taxpayers’ money must be a priority in managing banking crises. But I also think that the seriousness of macroeconomic shocks, the negative externalities that come from the dismal performance of the real economy, the market failures that result from the lack of a robust secondary market for NPLs are important conditions that may justify the recourse to public funds. This recourse might have been excessive in Europe in the years following the global financial crisis, but the reaction to such an excess may have also been somewhat extreme. It is important to carefully evaluate the costs directly and immediately borne by the State in each single intervention. However, those that may arise from a mismanagement of the crisis should also be carefully considered. To some extent this consideration may explain why the AMC hypothesis has recently returned to the spotlight. Under some proposals, an AMC should be established at the national level but in accordance with a common European framework. This implies that the conditions under which it would comply with the EU regulatory set-up, including the BRRD and the rules on state aid, should be properly spelled out. In order to address the NPL problem successfully, such a company would need to attract a relatively large number of banks. Banks’ participation in the scheme should be voluntary, and subject to standard restructuring plans defined ex ante. Most importantly, NPL transfer prices should be determined so to make the AMC profitable, but without making them excessively detached from their real economic values (i.e., the values that could be reasonably recovered over time). All this leads me to suggest that the opportunity to improve upon the new regime of bank crisis resolution should not be missed. This can be accomplished through the review of the BRRD scheduled for 2018, as well as via the ongoing negotiations on issues related to the implementation of the MREL requirement and the completion of the Banking Union. In particular, the framework should envisage adequate tools to address banking crises of a systemic nature. Ways to limit contagion externalities should be considered, possibly allowing for the recourse to state aid in situations of serious market turbulence, and devising mechanisms to properly address liquidity crises. Some shortfalls can be addressed along the road towards the completion of the Banking Union. Indeed, the Banking Union is still missing two very important pieces: the availability of common public funds to support resolution procedures in the case of ailing banks – the Single Resolution Fund’s fiscal backstop – and a common bank deposit insurance scheme, again supported by a common public backstop. These are key ingredients for the overall balance of the new system: in their absence, it would not be easy to counter the views of those who claim that the fiscal backstop should remain a national prerogative and that, therefore, the national authorities should have the final say in all interventions aimed at minimising the overall costs of the distress. Furthermore, we should also reflect on how to deal with possible crises of banks for which the existence of public interest, necessary for the initiation of a resolution procedure, is denied. This is the case for the smaller banks, but it may also apply, as it has been recently the case, to banks considered significant within the SSM. Indeed, it would be difficult to object to the observation that the current framework calls on these banks to pay into a crisis management system from which they cannot benefit. * * * To conclude, progress on all these fronts – and, more generally, toward a deeper European integration – can be achieved only if we overcome the mutual distrust and prejudice among member countries that have developed in recent years. In doing this, we should strive to give sound and fair application to the principles underpinning the new European rules, preserving the value of banking activity, to the benefit of savers and borrower households and firms. Thank you for your attention. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the joint ECB and Bank of Italy conference "Digital transformation of the retail payments ecosystem", Rome, 30 November 2017.
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Digital transformation of the retail payments ecosystem Welcome address by Ignazio Visco Governor of the Bank of Italy at the ECB and Banca d’Italia joint conference, Rome 30 November 2017 I am pleased to welcome all the speakers and participants to this conference on the ongoing digital transformations in the retail payments ecosystem. The programme is remarkable: many key issues for central banks and the private sector will be discussed in these two days. Let me take this opportunity to thank the organizers at both the Bank of Italy and the European Central Bank for putting together such a broad and relevant array of topics. The fast evolution of digital technologies promises to deliver benefits but it also creates new challenges for the payment system and its stakeholders. Today’s conference is an opportunity to take stock of recent advances, to evaluate possible future landscapes in retail payments and to discuss the challenges and opportunities they pose to central banks and the population at large. I am sure that maintaining a continuous dialogue among central bankers, private sector representatives and academics on the subjects that will be discussed in this conference will contribute to the efficiency and safety of our payment systems. The diffusion of digital technologies is having pervasive effects on our society. Today, around eighty per cent of the European population has a smartphone, personal computer or tablet to navigate the internet. We use the internet to perform many fundamental activities that influence our behaviour and productivity, such as communicating and searching for information. The rise of e-commerce is also having substantial, and at times disruptive, effects in many industries. Digital innovations, such as big data and artificial intelligence, are used for medical diagnoses, in the transportation sector and to select the news that is reported on social media. The explosive growth of electronic devices controlled through the internet suggests that the “internet-of-things” will play an important role in our daily lives. As the youngest, tech-savvy generations approach adulthood, the effects of these phenomena are bound to become even more significant than they are today. The digital transformation of our society has also changed the type of payment instruments we use. Indeed, the more we use digital distribution channels in our consumer expenditures, the more we need digital forms of money to pay for these transactions. But there is also a cultural change behind this process. Credit and debit cards are increasingly used in brick-and-mortar stores, and in some countries banknotes are no longer the most common means of payment. The highly dynamic landscape of payment systems is ever evolving. While new technologies, such as those used for instant payments, are rapidly approaching, newer ones are right behind. Last year we held a conference here at the Bank of Italy on the applications of blockchain technology in the financial markets. What last year still seemed to be a technology in its infancy is now increasingly put to work in use cases. As with all new technologies, it is expected to deliver efficiency gains: according to its proponents, some of these gains will come from easier diffusion of information and have the potential of altering the payment systems landscape. However, the extent of its impact is still uncertain, as many aspects of its practical implementation are yet unknown. Nevertheless, blockchain technology is getting a great deal of attention from practitioners and the financial markets. Not long ago the stock price of a British company more than tripled after newspapers reported the company’s plan to add the word “blockchain” to its name! So large was the gain that the company felt compelled to publicly clarify that its development of blockchain products was still at an early stage of research and development. Thus, the digital revolution is posing new challenges to central banks, both as regulators of payment systems and as providers of money and payment infrastructures. Many of them are already being tackled, but many still lie ahead. Through significant investments in technology in the payments industry, both central banks and market operators increased the supply of efficient payment services and ensured their security and reliability to foster public confidence in (new) electronic means of payment. In Europe, the establishment of the Single Euro Payments Area (SEPA) was a milestone achievement in this context. With widespread access to the internet, consumers are now continuously connected and have come to expect commercial and financial services to be available at their fingertips in real time. All over the world we are seeing a rapid increase in the level of interest in payment solutions that allow money to be sent from person to person through instant payment applications. On 21 November, the pan-European instant credit transfer scheme established by the European Payments Council (EPC) went live thanks to the efforts undertaken by the payment service providers (PSP) and automated clearing houses (ACH). Now, nearly 600 payment service providers from eight European countries (including Italy) may choose to offer instant payment solutions based on the new scheme whose scope will progressively span to include thirty-four European countries. To further facilitate the integration of the euro area and to complement the services of ACHs, last June the Eurosystem decided to develop an instant payments settlement system in central bank money, the Target Instant Payment Settlement (TIPS). Bank of Italy will be deeply involved in its development. Dramatic technological advances in the financial system are creating new opportunities for payment users. However, they also pose new challenges for traditional intermediaries who are now exposed to heightened competition from digital platforms that also offer payment services. Banks no longer compete (only) with each other but also with non-banks and must deal with the challenges that stem from the developments in financial technology (Fintech). In the European context, technology driven transformations in the payment system are also supported by regulatory interventions that increase competition and innovation. In 2007, the Payment Service Directive (PSD) introduced a new category of payment service providers, the “Payment Institution”. The new directive (PSD2), which will take effect in January 2018, paves a stable path towards further innovation by regulating the activity of “third parties providers” (TPP). These are Fintech firms that offer payment initiation and account information services by exploiting the new business opportunities provided by technological innovation, positioning themselves between payment service providers and final customers. The PSD2, while requiring banks to share customer information with TPPs, provides that the activity of the latter be authorized and monitored by the supervisory authorities. Thus, by fostering innovation and competition, the directive aims at ensuring a level playing field in the payment services sector and protecting consumers. Moreover, it focuses on the security of payment services, with the objective of achieving a high level of harmonization through a common regulatory approach within the European Banking Authority (EBA): under the PSD2, the EBA has been tasked with developing standards and guidelines that enhance cooperation among all national competent authorities. The Bank of Italy actively participated in the adoption of the new directive, supporting the Government since the start of the Italian EU presidency in the second half of 2014 when the text of the PSD2 took shape. We are now fully cooperating at European level, where we also chair the European Banking Authority’s Standing Committee on Payment Services, and will continue to share our experience, both as regulator and supervisor, to help ensure an appropriate balance between the public interest, security, innovation and competition. The ongoing digital transformation in the payment ecosystem and the new regulatory approach are posing new challenges. Oversight of the new payments systems will have to be carried out while new technologies and business models are introduced. The risks associated with these innovations will have to be faced, such as those stemming from vulnerabilities in the assessment, processing and storage of information, as well as those that threaten cyber security, which may impair the public’s confidence in the payment system. It is possible that all these challenges will push us towards a new paradigm in implementing policy and supervising the payment system in the new technological era. In this context, a continuous dialogue between regulators and the industry facilitates the introduction of innovations that have the potential of generating broad-based benefits. At the same time, risks and unintended consequences will have to be carefully evaluated and countered. Most of the issues we are facing today are covered by the topics that will be discussed during this two-day conference. I am confident that it will not only provide food for thought but also new insights on how to reap the benefits and counter the risks associated with the digital transformation of payment systems. * * * Let me conclude with some open questions, the answers of which could outline the future landscape of the retail payments ecosystem. In the economy, digital means of payments are increasingly common. Today we do not know whether they will ever completely replace physical means of payment or when this might be. It will depend on the preferences of consumers and firms. As providers of currency, central banks need to make sure that they are at the technological frontier in their production and, as regulators, that people will continue to trust the system, be it physical or digital in nature. So, how should central banks promote trust in the payments system in this age of digitalization? What new legal and regulatory issues will be raised by the introduction of the new payment instruments? How will the necessary coordination of the different actors in the payments system be achieved in a deeply evolving set-up? And how will the necessary stability of the financial system be maintained? I am looking forward to learning some of the answers and to listening to the presentations, the panel discussions and the keynote speeches that promise to make this conference particularly interesting. To close my welcome remarks I would like to mention that thirty years ago, under the strong encouragement of Tommaso Padoa-Schioppa, a major project was finalized in the Bank of Italy with the drafting of our White Paper on the Payment System. In a companion article (published in Moneta e Credito in 1988), my late friend and colleague Curzio Giannini, who was one of the main contributors to that project, observed that the payments system is a “complex apparatus [of rules, intermediaries and instruments] that serves a simple purpose: allowing the execution of payments in money associated with the circulation of goods and services”. As regulators and providers of means of payment, we have to ensure that the digital transformation of retail payments will encourage the exchange of goods and services among households and firms, helping them to reap the benefits of the new technologies and to share them widely.
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Opening remarks by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Bank of Italy conference on "How financial systems work: evidence from financial accounts", Rome, 30 November 2017.
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Bank of Italy conference on ‘How financial systems work: evidence from financial accounts’ Opening remarks: Luigi Federico Signorini, Bank of Italy, Deputy Governor Thursday, 30 November 2017 It is a pleasure to welcome you to the Banca d’Italia for this workshop. As a former head of the Statistical Directorate I am particularly happy to see such a distinguished list of speakers and guests on this occasion. I would like to thank all those who contributed, from other institutions, from academia, and from inside the Bank. Financial accounts have a long history and we take some pride in having worked on them almost from the beginning. As many in this room will know, the first model accounts were developed by Morris A. Copeland for the US.1 The picture above, which has a nice vintage feel to it, summarises his idea of the economy as a money circuit, showing the connections between the institutional sectors. In 1955 the Federal Reserve published its first version of the annual flow of funds. Italy’s first financial accounts appeared about ten years later, in the Annual Report of the Banca d’Italia for the year 1964. We were among the first countries for which financial accounts became available. Of course, the pioneering work at the Fed was an inspiration, but there had been some significant preparatory work here as well. Since the 1940s Paolo Baffi, who was to become Governor many years later (1975-79), had been working on reconstructing Copeland M. (1952), A Study of Moneyflows in the United States, NBER, New York. Here we draw from De Bonis R. and A. Gigliobianco (2012), ‘The origins of financial accounts in the United States and Italy: Copeland, Baffi and the institutions’, in De Bonis R. and A. Pozzolo (eds.), The Financial Systems of Industrial Countries. Evidence from Financial Accounts, Springer. the financial statements of the institutional sectors. He was influenced by Giorgio Mortara, an eminent statistician and his teacher, and by Wesley Mitchell, whose work on business cycles he had translated.2 They used to tell a story here at the Bank of Italy about how Baffi visited the Federal Reserve Board in the mid-1950s, as Head of Research, to discuss the construction of financial accounts. Proof that this was no myth was recently discovered in our historical archives in the form of several letters (one is pictured below) exchanged between William McChesney Martin, Chairman of the Board of Governors of the Federal Reserve System from 1951 to 1970, and Donato Menichella, Governor of the Bank of Italy from 1950 to 1960. Baffi stayed at the Fed for a few months in 1956. In the 1960s other countries – the UK and Germany among them – began to publish national financial accounts on a regular basis. These accounts became part of a triad that also included non-financial national accounts and input-output tables.3 Real national accounts had begun to be compiled following the Keynesian revolution, as the invention of macroeconomics and the definition of the attending concepts (income, consumption, investment, savings) prompted the development of statistical methods to produce a reasonable approximation of the real-world counterparts to those concepts. The first release of the United Nations’ Systems of National Accounts came in 1947. Once the statistical foundations for real national accounts had been laid, moving on to financial accounts seemed natural. As we were soon to learn, this was no easy task. Even more, making the two sets of macro accounts consistent, i.e. integrated – a logical and easy step in theory – was in fact very difficult in practice. The effort to understand and possibly control business cycles after the devastation of the Great Depression was itself a powerful driving force for the development of financial accounts. Financial variables such as bank loans and deposits, bonds and shares, arranged within a consistent framework, were seen as necessary to get a full picture of the cyclical factors in the economy. Baffi was worried about the lack of good data: ‘At the Research Office, where we follow and analyse statistics, principally of a monetary and financial nature, we find ourselves poorly equipped to understand the movements of non-monetary aggregates, barring those associated with foreign trade and the manufacture of some products. Yet such movements are among those at the root of financial phenomema …. We are at a similar disadvantage as regards our knowledge of the problems encountered by business enterprises …’ (excerpts from a letter written in January, 1941). Klein L. R. (2003), ‘Some Potential Linkages for Input-Output Analysis with Flow-of-Funds’, Economic Systems Research, 15, September, 269-277. The availability of information on financial flows may also have been regarded in those days as instrumental to economic planning; in some Western countries this was considered a very important and effective tool of economic policy in the post-war period. With illusions of top-down planning long forgotten in many market economies, this point is easily overlooked nowadays, but it was surely another significant factor in those times. There was a golden age of financial accounts between the 1960s and the early 1970s. James Tobin, among others, used them to look at the way agents allocate wealth across financial and non-financial assets; in his Nobel Memorial Lecture in 1981, he discussed ‘Money and finance in the macro-economic process’ using flow-of-fund tables. Tobin and others had built models based on the interaction between the real and the financial sectors. This idea was taken up by central banks. For instance, the 1986 version of the Bank of Italy Quarterly Econometric Model contained a complete description of the links between saving, non-financial investments and financial flows.4 Financial accounts were also a rather popular subject for research. Surveys of the literature list around 250 works on flows of funds published in twenty years or so after Copeland’s book.5 Interest in financial accounts declined in the 1980s, only to pick up again after the crisis. Many factors were at play: a growing focus on the micro foundations of macroeconomics; an increasing concentration on inflation as a target, and on money and credit aggregates as instruments, for monetary policy; some neglect of interconnections across the financial system; and much trust (too much, one would say in retrospect) in the self-correcting mechanism of price adjustments, which implied less interest in the quantities (flows and stocks) that make up financial accounts. On the statistical front, the main effort then was directed at fuller international harmonisation of real statistics, which resulted in the 1993 System of National Accounts; at the same time, as I mentioned earlier, integrating real and financial accounts was proving elusive. On these issues see Ando A. and F. Modigliani (1975), ‘Some reflections on describing structures of financial sectors’, in Fromm G. and L. R. Klein (eds.), The Brookings Model: Perspective and Recent Developments, New York, North-Holland. Cohen, J. (1972), ‘Copeland’s Moneyflows after Twenty-Five Years: A Survey’, Journal of Economic Literature, 1, March; Bain, A.D. (1973), ‘Surveys in Applied Economics: Flow of Funds Analysis’, The Economic Journal, December; Roe, A.R. (1973), ‘The Case for Flow of Funds and National Balance Sheet Accounts’, The Economic Journal, 330, June. Financial accounts continued to be used, though to a lesser extent, by economists such as Wynne Godley and Raymond Goldsmith.6 Then the Asian crisis of the late 1990s showed the importance of sectoral financial connections and the need to study the balance sheets of banks, firms, and households.7 Since the start of monetary union, the ECB’s monetary analytical framework has included financial accounts as a tool for cross-checking its ‘first pillar’ (economic analysis) against its ‘second pillar’ (monetary analysis).8 However, it was the global financial crisis that generated renewed interest. A lesson of the crisis was that tracking sectoral imbalances was important; that an excessive level of debt may cause vulnerabilities; and that therefore the pursuit of financial stability required monitoring the level of corporate and household debt and the leverage of financial institutions. Finance was no longer a mere veil. In 2011 the European Union adopted a surveillance procedure to monitor and correct macroeconomic imbalances. Among the indicators used are three key elements of the financial accounts: the stock and the flow of private sector debt and the change in the financial sector’s liabilities.9 Finally, the importance of the interactions between the real economy and the financial sector for econometric modelling is now well-recognised and efforts are being made to integrate macro-financial relationships for key sectors such as non-financial corporations and households into large macro models.10 Godley constantly followed the idea that economic models should be founded on flows and stocks, and developed consistent models of the US economy and the economies of other countries (see Godley, W. and M. Lavoie, 2007, Monetary Economics: An Integrated Approach to Money, Credit, Income, Production and Wealth, Palgrave MacMillan, Basingstoke). Goldsmith dedicated his research programme to the building of national and sector balance sheets, exploiting the financial accounts time series. See Goldsmith R. W. (1969), Financial Structure and Development, Yale University Press; Goldsmith R. W. (1985), Comparative National Balance Sheets, A Study of Twenty Countries 1688-1978, The University of Chicago Press. See Allen M., C. Rosenberg, C. Keller, B. Setzer and N. Roubini (2002), ‘A balance sheet approach to financial crisis’, IMF Working Papers, No. 210, International Monetary Fund, Washington, D.C. See L. D. Papademos and J. Stark (2010), Enhancing Monetary Analysis, ECB, in particular chapter 7, ‘Cross-checking and the flow of funds’. Actually, before the crisis we wrote a paper on the use of financial accounts and other statistics for the analysis of financial stability. See R. De Bonis, G. Grande, S. Magri, L. F. Signorini and M. Stacchini (2005), ‘Financial stability: an overview of Bank of Italy statistics’, Irving Fisher Committee Bulletin, 23, October. For an example see Duca, J. and J. Muellbauer (2014), ‘Tobin lives: Integrating evolving credit market architecture into flow of funds based macro-models’, in A Flow-of-Funds Perspective on the Financial Crisis, Vol. II, Palgrave Macmillan, Basingstoke. We also draw from Muellbauer J. (2016), Macroeconomics and consumption: Why central bank models failed and how to repair them, Vox.eu, 21 December. Here at the Bank of Italy financial accounts have been used rather intensively in research over the years. An incomplete list of articles and books based on Italian financial accounts includes around 100 works by Bank of Italy authors alone. Research has covered, among other things, the structure of the Italian financial system, household wealth, firms’ financial structure; convergence of financial systems, and macro financial imbalances. A 2012 collection of essays on the evolution of financial systems is one example. We regularly comment on financial accounts statistics in the Annual Report, the Economic Bulletin and the Financial Stability Report. Let me now turn briefly to purely statistical issues. As I mentioned, the Bank of Italy has regularly published the country’s financial accounts (stocks and flows) since the 1960s; yearly stocks have been reconstructed for the main institutional sectors as far back as 1950. Below is the first statistical manual we published in 1969. We implemented the SEC79 standards (and showed quarterly figures for the first time) in the early 1990s, the ESA95 standards in 2002 (during my time in Statistics), and the ESA2010 standards in 2016. Over the years countless methodological improvements have been made to coverage and estimation methods. Many people here will be familiar with the multiple challenges of using diverse sources, often designed for non-statistical purposes and lacking common methodological standards, to obtain consistent statistics;11 of reconciling inconsistent classifications; of building Here we draw from De Bonis R., C. Giron, L. Infante and G. Quirós (2017), ‘Financial accounts uses’, in P. van de Ven and D. Fano (edited by, 2017), Understanding Financial Accounts, OECD. statistical bridges across valuation criteria (historical cost vs. market prices) and recording conventions (cash vs. accrual); and of credibly interpolating low-frequency data. Work continues on these and other fronts and there is still much to do. Tomorrow Luigi Cannari will talk to you about some of the main pieces of work in progress, including the reconciliation of micro and macro financial data; the integration of financial and non-financial assets in a consistent balance-sheet framework for each sector; and the improvement of statistics on cross-border flows and holdings. Before I leave the floor, let me take this opportunity to pay tribute to the memory of our colleague, Andrea Generale, a talented, committed researcher and then regulator, who passed away a year ago after a long illness. Besides being a highly qualified senior professional, Andrea was generous and open with everyone. He had a lifetime commitment to the analysis of banks, corporations, financial institutions and financial systems. For some time Andrea coordinated the Bank’s research on financial flows and significantly contributed to our body of research based on the use of financial accounts.12 We shall remember him with affection and gratitude. This is all on my part. I see that you have a full agenda, with three keynote lectures and twelve papers packed into one and a half days. I wish you all some very fruitful and enjoyable presentations and discussions. One contribution is in Bartiloro L., R. De Bonis, A. Generale and I. Longhi (2008), The financial structures of the leading industrial countries: a medium-term analysis, paper presented at the conference “Financial Accounts: History, Methods, the case of Italy and International Comparisons”, Perugia, December 2005. Designed by the Printing and Publishing Division of the Bank of Italy
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Keynote speech by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the joint ECB and Bank of Italy conference "Digital transformation of the retail payments ecosystem", Rome, 1 December 2017.
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DIGITAL TRANSFORMATION OF THE RETAIL PAYMENTS ECOSYSTEM CYBER SECURITY – THE BALANCE BETWEEN COOPERATION AND REGULATION KEYNOTE SPEECH BY FABIO PANETTA, DEPUTY GOVERNOR OF BANCA D’ITALIA At the joint ECB and Banca d’Italia conference Rome, 1 December 2017 Information and communication technologies play a fundamental role for people, businesses and the public sector. Digital transformation is modifying the economic system and the whole of society at unprecedented speed. Innovation is having a powerful effect on the financial sector. The value chain is becoming more complex, and the participation of non-financial providers is increasing. The tech giants as well as the new fintech start-ups are expanding the supply of innovative services to a broad and diverse customer base through new business models. As a result, confidence in the financial sector is no longer based on bilateral trust between customers and service providers but is dependent on the governance of digitalization and especially on the reliability and safety of the products offered. Emerging risks in the digital ecosystem The increasing role of digital platforms is creating enormous benefits for users. At the same time it is offering ill-timed advantages for new groups of hostile agents, such as hacktivists, fraudsters and criminal and terrorist organizations. By exploiting the vulnerabilities within cyberspace, these agents may endanger the provision of digital services or disrupt critical infrastructures. The new risks are exacerbated by the complex network of interconnections that forms the digital ecosystem: the ‘Internet of Things’ is exploding and the number of interconnected devices is expected to grow at an unprecedented pace, to more than 200 billion in 2020.1 The area at risk is expanding enormously. Any weakness in security controls, any vulnerability in technology may offer an entry point for cyber attacks. In the financial sector, cyber attacks can create disruptions that propagate instantly and globally with effects that are hard to predict. Recent cyber attacks, like the one against the Central Bank of Bangladesh, exemplify the vulnerabilities – of both process and technology – that affect interbank payments and core financial infrastructures, which were once considered less exposed to cyber risks. As the Financial Stability Board has emphasized, certain cyber attacks 2 show that the vulnerability of financial institutions is a systemic issue, although it is unlikely as yet to represent a real threat to global financial stability. These attacks were a wake-up call for regulators and financial authorities, emphasizing that the safety of cyberspace is not just a prerequisite for the reliability of financial services but also an essential element of financial stability. Cyber risks threaten the core functions of the financial sector, including banking operations, payments and securities settlement. Central banks and, more generally, public authorities may themselves be on the radar screen of cyber attackers; cyber security is no longer a matter for specialists but a policy priority. The pillars of an effective cyber security strategy In today’s world, central banks, regulators and supervisors face the formidable challenge of ensuring that the technological revolution does not undermine trust and confidence in the financial system. This is no easy task: like acrobats walking a tightrope, the authorities must strike the right balance between potentially diverging forces such as innovation, complexity and the safety of the system. This entails enhancing and complementing the traditional regulatory and supervisory approaches with the adoption of an effective toolkit tailored to address cyber risks. From 2 billion in 2006. Source: World Economic Forum, Mitigating Risks in the Innovation Economy. How Emerging Technologies are Changing the Risk Landscape, (September 2017). Such as the Wannacry campaign in 2017 and the Corkow Malware in 2015. In 2016 the G7 published a set of widely applicable recommendations encapsulating cyber security best practices for public and private financial entities. They were followed last October by the ‘fundamental elements for effective assessment of cyber security for the financial sector’. Having in mind these G7 principles, I would like to focus the rest of my speech on the main pillars on which – from a central bank’s view – an effective strategy should be based: regulation, cooperation and risk awareness. The first pillar: regulation Regulation is a crucial component of an effective strategy to ensure sustainable innovation and preserve cyber security. A number of European laws have recently introduced requirements and obligations for both private companies and public bodies in order to increase cyber security in critical sectors of the economy. A general framework is given by the Network and Information Security Directive (NIS-D), which establishes security-related obligations for critical service providers, including credit institutions, stock exchanges and financial infrastructures. To guarantee data protection and the privacy of personal information, the General Data Protection Regulation also imposes strict security requirements for private and public entities, including financial firms. Specifically focusing on the financial field, the second Payment Services Directive (PSD2) has introduced security requirements throughout the payment cycle: from payer authentication to communication between service providers, security risk management by financial firms and the reporting of major incidents to the authorities. The European Banking Authority (EBA) was delegated to issue secondary regulation. The Guidance on cyber resilience for financial market infrastructures was published by CPMI-IOSCO in 2016. To ensure its harmonized implementation within the euro area, the Eurosystem has delivered a cyber resilience strategy that national supervisors must adopt to enhance the cyber resilience framework of financial institutions. However, regulation alone is not sufficient to protect the financial system from cyber risks. Indeed, excessive reliance on regulation may even have undesirable side effects owing to the complex interactions between different regulatory levels, such as domestic versus international legislation or economy-wide versus sector-specific rules. Hence, other forms of intervention are necessary, such as cooperation. The second pillar: cooperation Owing to the existence of externalities, individual intermediaries may lack sufficient incentive to contribute to the supply of a common good – cyber security – that would generate benefits for their direct competitors as well. They may be tempted, therefore, to free ride on the action of other companies and to under-invest in security-enhancing projects. In this situation, central banks, as third parties entrusted with preserving financial stability, may act as a catalyst to stimulate cooperation, centralized cyber threat intelligence and information sharing initiatives. 3 At European level, the recent establishment of the European Cyber Resilience Board (ECRB) under the Eurosystem cyber resilience strategy is a valuable example of virtuous cooperation among public authorities, financial market infrastructures and critical service providers to enhance the cyber resilience of the European financial ecosystem. Financial authorities may also leverage such cooperative initiatives to promote effective practices and tools for cyber risk assessment, including simulations and tests, which are difficult for individual firms to implement in isolation. This is a new paradigm, in which authorities and regulated entities work closely together, complementing compliance with a collaborative approach. This allows the authorities to gain a deep understanding of the level of cyber resilience achieved and of any additional initiatives required. The third pillar: promoting risk awareness The third pillar of action focuses on the human factor, as in cyber security people are still the weakest link. For example, the spread of cyber extortion (ransomware) – which is becoming one of the major threats to digital businesses – can be attributed to several factors. Some are technical, 4 but the Threat intelligence may support financial institutions in taking the right decisions to prevent cyber attacks, effectively protect their critical assets and respond appropriately in the event of a successful cyber attack. Information sharing about cyber events through trusted channels facilitates a sector-wide response to large-scale cyber incidents (CPMI-IOSCO, Cyber guidance, 2016). We refer to the growth of ransomware-as-a-service, easily and cheaply accessed on the dark-web by cyber criminals, or the availability of crypto-currencies as a ransom payment tool. Today, cyber attacks can easily be organized, even by purchasing as-a-service packages and simple downloads for installation on rogue servers. In 2016, 638 million ransomware attacks were recorded, 167 most significant ones are totally human related: the growing habit of working remotely on personal devices, combined with users’ lack of attention to cyber risks, can easily open the door for attacks on corporate critical information assets. Employees, consumers and public officials need to be educated about the risks that can arise from new technologies. The financial authorities are in the best position to promote long-term education initiatives and cyber awareness campaigns. The role of the authorities: the experience of the Banca d’Italia For central banks, translating all these principles into concrete action means first of all strengthening internal governance and cyber security capabilities. Let me talk about the Banca d’Italia’s experience in this area. To ensure a comprehensive strategic vision and the alignment of internal and institutional policies, a cyber security steering committee has recently been set up at Board level. Under this governance, the Banca d’Italia’s three-year strategic plan envisages two specific initiatives: one focuses on protecting the Bank’s critical assets by reorganizing security functions inside the IT Department; the other focuses on enhancing the cyber resilience of Italy’s financial sector by adapting the Eurosystem cyber strategy in line with the Italian National Cyber Security Framework and keeping an open dialogue with the competent national bodies. On the cooperation front, the Banca d’Italia and the Italian Banking Association have sponsored the establishment of the Italian Financial Cyber Security Unit (called CERTFin), which coordinates information sharing and cyber threat intelligence among the participating financial companies, allowing them to share critical information and enhance the awareness of cyber risk beyond what would be possible within the perimeter of their own organization. Since January 2017, CERTFin has examined more than 800 cyber events, sharing with its members any lessons drawn and circulating more than 150 warnings on potential compromises to individual financial firms. It cooperates with similar national and international cyber security bodies. Furthermore, CERTFin cooperates closely with government cyber security agencies, contributing to national cyber security. times more than (source: SonicWall, annual report www.forbes.com/sites/leemathews/2017/02/07/2016-saw-an-insane-rise-in-the-number-ofransomware-attacks/#3d5df45558dc). - Conclusions Digital innovation and cyber security are two faces of the same coin and so cannot be addressed separately. Hostile agents and criminals have always existed. However, compared with other threats or other types of crime, cyber attacks are rapidly evolving and, given the central role of cyberspace in modern economies, represent a concrete global risk. In the final communiqué of the G7 meeting held in Bari in 2017 under the Italian Presidency, finance ministers and central bank governors stated that they ‘recognise that cyber incidents represent a growing threat for our economies and that appropriate economy-wide policy responses are needed. No point of cyberspace can be absolutely secure as long as cyber threats persist in the surrounding environment’. Transposing this principle into concrete action is challenging and requires us to recognize that cyberspace is a global public good. Ensuring its security, openness, reliability and interoperability falls under the joint responsibility of governments, public institutions, private industry and researchers. How should we tackle this challenge? One answer lies in the words of the Roman philosopher Seneca: Longum iter est per praecepta, breve et efficax per exempla. 5 After two thousand years, this sentence is more than ever pertinent in describing an effective approach to innovation. In the field of cyber security, regulatory or supervisory tools may become less effective unless accompanied by other concrete action: as our experience has shown, the authorities may support joint initiatives with the private sector on information sharing and the promotion of best practices, playing a role as trust-builder to foster the broad and open participation of all stakeholders. This approach may help us respond appropriately to digitalization by reconciling innovation, security and competitiveness. Thank you for your attention. ‘The way is long if one follows precepts, short and effective if one follows examples’.
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Laudatory speech by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, for Andrew G Haldane, Executive Director and Chief Economist of the Bank of England, who was awarded the 1st Ferdinand Pecora Prize for the Regulation of Banking and Finance, Palermo, 15 December 2017.
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1st Ferdinand Pecora Prize Of dogs, black swans and endangered species: a perspective on financial regulation Laudatio of Andrew G. Haldane by Luigi Federico Signorini Palermo, 15 December 2017 I am happy to deliver the laudatio for Andrew Haldane on the occasion of his nomination, by unanimous decision of the International Rome Conference on Money, Banking and Finance, as the first person to be awarded the Ferdinand Pecora Prize. It is also a pleasure to welcome in Palermo a brilliant colleague and a friend. Ferdinand Pecora was a native of this island. He was born in Nicosia in 1882, and emigrated to the United States as a child, in 1886. There, he started his career as an assistant district attorney in New York City, where he earned an excellent reputation as a prosecutor. But his good credit eventually turned against him: his application as district attorney was rejected, due to fears that an overly fervent Pecora could bring local politicians to court. After this turn of events, Pecora left the district attorney’s office for private practice until the beginning of 1933, when he was appointed Chief Counsel to the US Senate’s Committee on Banking and Currency. In this assignment he was the fourth – and last – chief counsel in the inquiry launched by the Senate Committee to investigate the causes of the Wall Street crash of 1929. It was largely as a result of what came to be known as the ‘Pecora Investigation’ that the US Congress passed the ‘Glass-Steagall’ Banking Act of 1933, the Securities Act of 1933, and the Securities Exchange Act of 1934. This set of measures produced a radical change in the architecture of financial supervision in the United States, establishing a system that was to last for about two generations. The Banking Act mandated federal deposit insurance and separated commercial and investment banking; it created a Federal Open Market Committee and restricted bank competition and ‘speculation’. These simple yet powerful measures were meant to prevent the recurrence of severe financial crises. Was this arrangement optimal? Maybe it was fit for the times; but, decades later, the intellectually unavoidable trade-off between stability-oriented supervisory constraints and efficiency-oriented market freedom resurfaced in the policy debate. Beginning in the 1970s, in a changed cultural climate and with memories of the Great Depression fading, the Glass-Steagall rules were gradually weakened. The idea of unshackling market forces had growing appeal in academia, and was adopted and powerfully advanced by a banking industry eager for deregulation. Eventually, the pendulum swung all the way to the other extreme, not just in one country but globally. At some point, minimum capital ratios seemed to be all that was needed to safeguard financial stability; beyond that, the markets were assumed to know best. 1 Financial innovation in the industry, coupled with the somewhat insouciant attitude of (some) supervisors, especially about the quality, i.e. the loss-absorbing capacity, of capital instruments (and a neglect for liquidity regulation, and a vast overestimate of the modellability of trading-book risk, and much else), paved the way for a seemingly golden era of impetuous growth in finance, flourishing The Bank of Italy was a rather reluctant follower. We always kept stricter requirements on the composition of Tier 1 capital than was mandated by the Basel accords, and maintained for some time our own maturity transformation rules. On the latter, I regret to say, at some point we felt unable to go against the tide and formally abolished them in 2006. However, we still kept an eye on risks linked to maturity mismatches, and Italian banks were never allowed to go for a Northern Rock-style mismatch. innovation, mind-boggling complexity of instruments and transactions, and very fine profits for banks. We know how it ended. The shock of the crisis called for a rethinking of a purely laissez-faire approach to finance. To some, the idea was a return to what could be termed the old, safe ‘Pecora way’: an about-turn towards Glass-Steagall and the concept of ‘narrow banking’. To most, it was rather coming back to the Pecora method: a cautious, thorough assessment of the evidence, and a reappraisal of the fundamental trade-offs inherent in banking and financial regulation. Andy has contributed to this debate in many ways, often bringing a fresh perspective. Inquiring about the nature of financial regulation has been Andy’s main field of interest over the past decade. One of the most important dimensions of the debate on optimal regulation is the trade-off between simple/rough/robust rules on the one hand, and a risk-sensitive/sophisticated/granular approach on the other; Andy’s memorable metaphors, and more importantly the reasoning behind them, have loomed large in that debate. Like Mr. Pecora’s, Andy’s investigations were prompted by a dramatic financial crisis. Unlike Mr. Pecora, Andy lacked a specific parliamentary mandate. He investigated out of his own initiative from his office in Threadneedle Street: first as the Head of the Systemic Risk Assessment Division; then as Executive Director for Financial Stability; and finally, since June 2014, as Chief Economist and member of the Monetary Policy Committee of the Bank of England. Along this path, by the way, Andy also managed to get a nomination by TIME magazine as one of the 100 most influential people in the world in 2014. It is certainly fitting that the first edition of this Prize is going to someone who, like Ferdinand Pecora, has helped us think through the potential, the objectives and the pitfalls of financial regulation. Andy’s contributions have been many and diverse; I won’t be able to do justice to all of them. In 2009 Andy denounced the perils of an increasingly tight and potentially asymmetric relation between banks and the State. 2 His thoughts had wide resonance in the banking world. We always knew that the relationship between banks and governments is tricky. However, the Lehman collapse and then the European sovereign debt crisis brought the debate on ‘too-big-to-fail’ (TBTF) and systemic externalities to a new level. Andy played a significant role in this debate. The issue of the ‘right’ size of banks is one that Andy tackled more than once, from different angles. 3, 4 One of his key contributions was to remind us that diversification and diversity are not the same thing. Size and scope increase the benefits of diversification, so big banks (that is, larger portfolios) ought to be highly diversified and less prone to idiosyncratic risks. But global banks that are fully diversified cannot logically be diverse: they must hold the same portfolio. And this means Alessandri P, Haldane AG, Banking on the State, September 2009. Haldane, AG, The $100 billion question, March 2010. Haldane, AG, On being the right size, Beesley Lecture at the Institute of Directors, London, 25 October 2012 (then published on the Journal of Financial Perspectives, 2, 1, 2014). that they are likely to be more prone to a systemic collapse after a very bad aggregate shock. A simple look at what happened to some large international banks in the latest financial crisis illustrates how real this problem can be. 5 This is also an example of how risks that may not appear significant from a microprudential perspective may actually become much more worrisome if assessed through a macroprudential approach – a viewpoint whose importance Andy was among the first to stress. Another channel through which TBTF status can endanger financial stability relates to the balance between idiosyncratic and aggregate risk. Regardless of their portfolios, large banks are particularly exposed to sovereign risk and policy uncertainty, two sources of aggregate risk. At the same time, the spread-risk relationship, i.e. the sensitivity of banks’ funding costs to bank risk, weakens when a bank is thought to have TBTF status. Put differently, in relative terms large banks take less idiosyncratic risk, but more aggregate risk. This can make the system inherently riskier, and it is one of the reasons why many regulatory initiatives have tried to tackle the TBTF problem and reduce its externalities. 6 The related issue of the bank-sovereign loop is also dear to Andy. 7 Andy has been an advocate of the idea that economists should communicate more with, and ideally learn more from, ‘proper’ scientists, and that some of the tools employed by biologists and engineers could be deployed in the financial sphere, too. His work on financial networks is motivated by the intuition that financial crises spread pretty much like diseases, through contagion mechanisms that depend on the nature and structure of the linkages between banks. 8, 9 A key message from Andy’s work is that network complexity can be good or bad for financial stability. The reason for this is that highly interconnected interbank networks exhibit a knife-edge property. In the case of small shocks, the connections across banks (such as loans and repos) typically serve as risk sharing and mutual insurance devices, making the system more resilient. Beyond a certain threshold, however, they act as amplifiers, generating broad and unpredictable default cascades – an extreme form of systemic risk. Once again, the appeal of this story is immediate when thinking about our recent history: increasingly complex financial networks seemed to deliver greater stability for a long while, until Lehman – a large shock – came along. The most vivid example of this principle that comes to my mind, however, has nothing to do with finance. On the 28th of September 2003, Italy was hit by a massive electricity black-out when a storm caused a tree flashover that interrupted the energy supply coming from Switzerland. This interruption increased the burden on the rest of the network, causing a number of other cross-border See e.g. Tracking banks’ systemic importance before and after the crisis, Banca d’Italia, QEF no. 259, January 2015. https://www.bancaditalia.it/pubblicazioni/qef/2015-0259/QEF_259.pdf. Regulatory initiatives range from introducing a capital surcharge to placing limits on bank size, implementing a full structural separation of investment and commercial banking, and enhancing banking competition (see Haldane, AG, 2012, On being the right size). Alessandri P, Haldane AG, Banking on the State, September 2009. Haldane AG, Rethinking the Financial Network, April 2009. Gai P, Haldane AG, Kapadia S, Complexity, concentration and contagion, Journal of Monetary Economics, 58 (5), 2011. energy lines to switch off, then domestic generators to switch off as well. Within a couple of minutes the entire country had been left in the dark and it stayed there for hours-with one exception: the island of Sardinia,10 a peripheral node of the network, essentially unconnected to the rest. The conclusion appeared to be that while isolation may imply lower efficiency and higher volatility in normal times, it can deliver more resilience to unusual shocks. As a matter of fact, on the 28th of September 2003 people in the ‘periphery’ were watching TV while people in Rome and Milan – the core of the network – had to cast about for candles. Andy forcefully argued that complexity can be a problem for regulators as much as for the entities and activities they aim to regulate. 11, 12 In his thought-provoking Jackson Hole speech of 2012, Andy famously suggested that ‘catching a Frisbee’ is in some ways like ‘catching a crisis’. One of the reasons why certain mammals (dogs especially, but even humans to some extent) tend to be successful with Frisbees is that, rather than sitting down and trying to solve dynamic control problems, we stick to simple rules that are not ‘optimal’ in any sense but work fine most of the times. More generally, in an uncertain environment simple rules-of-thumb can work better than complex decision-making systems. Seen in this perspective, the growing complexity of financial regulation is in itself a source of concern. As Andy noted, under Basel I a bank could calculate its capital requirements with pen and paper. That is inconceivable with the current rules. Since the establishment of Basel II, which allowed banks to compute their own capital requirements through internal models, the complexity and granularity of such models has exploded. Model complexity and uncertainty, coupled with shortseries of data, make calibration difficult and robustness questionable. An issue the framers of Basel II did not, in my opinion, get quite right concerns incentives. They thought that using the banks’ own models to compute capital requirements would align banks’ and supervisors’ incentives, and improve both the banks’ risk management practices and the risk sensitivity of prudential requirements. Such a mechanism does exist, but it is of the second order. The first-order incentive for bank model-builders is to save costly equity capital. It would be unfair to say that regulators at the time were blind to this fact; they just thought that supervisory validation would easily fend off abuse. Well, maybe, but not easily. The dark side of granularity and sophistication are complexity and opaqueness, which make validation a daunting task. Despite all supervisory activity, in fact, the regulatory risk density of banks’ assets came to vary wildly across banks. It was not always obvious that variation in risk density related to variation in actual risk. 13 Plus a few minor islands. Haldane AG, Madouros V, The dog and the Frisbee, Jackson Hole Symposium, 2012. Haldane AG, Multi-polar regulation, International Journal of Central Banking 11(3), June 2015. Italian IRB banks have typically been in the high range of risk density. This depends partly on the fact that their business models are largely oriented to credit risk, which especially under Basel II was penalised vis-à-vis market risk in terms of risk weights; and partly on the liberal use of output floors in the Bank of Italy’s supervisory practices, already under Basel II. The use of output floors, set at adequately high levels, has been recognized as a useful tool to address the variability in the capital requirements for credit risk. See, e.g., Basel Committee on Banking Supervision, Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches, March 2016. As I just mentioned, there is another element to the dark side of internal models: lack of robustness. Financial risks are not always amenable to analysis via tractable, well-behaved probability distributions. Crucially, what seems to work reasonably well 95% or even 99% of the times, can fail spectacularly in a crisis. When black swans fly, models flounder. (The question of whether dogs can catch black swans like Frisbees is still open to debate.) The finalisation of Basel III reforms, recently signed off by the G20 Group of Central Bank Governors and Heads of Supervision, tackles the robustness vs sensitivity trade-off through the simple device of putting a floor to the amount of risk-density reduction that banks can achieve through their own models. The debate on floors has been fierce. Opponents claim that they compress risk sensitivity too much and are obviously no first best. But there is no such a thing as a first best in the difficult art of bank regulation; only reasonable compromises based on experience, often bad; the usual catchphrase to describe compromises involving elements of both complex and simple, rough-and-ready, Frisbee-catching rules is that you need ‘belts and suspenders’. (I would add, ‘… and braces’, both to account for the three-pronged system of capital requirements under Basel III – models, output floors, leverage ratios – and to do some justice to the European dialects of the tongue). Andy is of course free to disagree, but it seems to me that the final Basel III compromise goes some way towards heeding his call for simple models and simpler regulatory rules and practices. It is by no means simple in itself, of course; but it does contain comparatively simple backstops to avoid some of the pitfalls of complexity. Andy himself might just say: ‘you do not fight complexity with complexity’. 14 At a minimum, you cannot delude yourself that regulatory complexity is a cure-all. As I mentioned, regulators are faced with a trade-off. Simple rules are transparent, robust to model risk and more difficult to ‘game’; but they may fail to penalise risk-taking adequately. Complex rules may be risk-sensitive, but they are more prone to manipulation and model failure. Furthermore, both are subject to the Lucas critique: unlike Frisbees, banks and markets adapt to the rules, and this makes the task of the regulatory ‘dog’ harder. Now that Basel III has finally been completed, it is time to look ahead. The financial system keeps evolving. Some of the challenges that Andy examined in his past work remain critical; new problems have emerged; other issues will surely come up in the future. Not all financial risks materialise in banking, and the financial ecosystem is much more complex today than it was in the Ferdinand Pecora’s times. Risky activities tend to shift between the traditional and the ‘shadow’ banking sector. If it is hard to regulate banks, it is even harder to monitor the evolution of risks in the more lightly regulated segment. The lack of data does not make it any easier. This theme is now at the forefront of the FSB agenda, 15 and rightly so. A recent emphasis on regulating financial activities rather than specific entities, or classes of entities, is meant to overcome the differences between traditional and shadow banking activities. Haldane AG, Madouros V, The dog and the Frisbee, Jackson Hole Symposium, 2012. See FSB Chair’s letter to G20 Leaders on ‘Building a safer, simpler and fairer financial system’, July 2017. Focusing on activities rather than institutions makes sense. However, large systemic players do deserve close monitoring. I believe this applies not only to big banks but also to other institutions such as asset managers, pension funds or CCPs, which could be equally systemic, and which we know far less about. 16 Asset managers perform a number of business activities that may look different ex ante but often turn out to deliver highly correlated returns ex post. Hence, the risks from such individual activities add up; they are not diversified away at the macro level. Like asset correlations, business activity correlations can vary over the cycle, intensifying in bad times. It is also possible that asset managers’ activities have become structurally more correlated over the years, owing to the diffusion of common investment strategies across different business activities. Asset managers also operate with large portfolios, and often in markets where liquidity is low. This generates a material risk of abrupt price corrections caused by shifts in a few systemic agents’ portfolio allocations (agents that are highly diversified but not diverse, to borrow Andy’s concept). These shifts can stem from maturity mismatches: open funds can invest in long-term and (structurally or occasionally) illiquid activities, and this can give rise to fire sales in case of a redemption shock, with spillovers between asset classes and types of investors. 17 The FSB has begun studying the impact of large investors’ strategies on market liquidity, starting with a simulation exercise on fund redemptions. This line of inquiry is important. Differently from the case of banks, it is not the resilience of individual institutions that needs to be tested, but rather the presence of shock amplifiers in the market. This is why potential investment-strategy loops are a subject of attention for the FSB. Some of these issues were very usefully examined by the Bank of England and the Procyclicality Working Group, chaired by Andy. 18 Procyclicality is a pivotal issue for financial stability. The idea that markets are inherently procyclical is hardly new; however, new forms of procyclicality are likely to emerge as a result of technological innovation (such as high-frequency and algorithmic trading, robot advice, or volatility trading) and growing market concentration. Contrarian investors may become an endangered species, and as such they should be protected. The role of market supervisors may also have to change. Traditionally their mandates are mostly centred on disclosure and investor protection, i.e. on ensuring that investors are fully aware of risks and can take informed decisions on an individual basis. However, if one recognises that market liquidity crises and shock amplification have a systemic impact and are therefore a matter for regulatory concern, then financial stability must find a way into market supervisors’ mandates. This change requires an adaptation of culture as well as laws. It is happening, but slowly. Global pipes: challenges for systemic financial infrastructure, Speech given by Sir Jon Cunliffe, Deputy Governor Financial Stability, at the Official Monetary and Financial Institutions Forum, London, 22 February 2017. On the risks posed by the asset management industry, but also on the opportunities that asset management offers, see ‘The age of asset management?’, speech by Haldane, AG, at the London Business School, London, April 2014. See, for example, Procyclicality and Structural Trends in Investment Allocation by Insurance Companies and Pension Funds, A Discussion Paper by the Bank of England and the Procyclicality Working Group, July 2014. The regulatory agenda is crowded and is moving fast. Andy has greatly contributed to shaping it in the past. His creativity and eclectic approach to economics, and his ability to be provocative in a clever, constructive way, have been an asset to the policy making community. I have little doubt that they will be equally valuable in the future. We need, more than ever, people who can think ‘out of the box’ and actively spur the debate. After all, concentration and correlation are as bad for ideas as they are for financial assets. The central banking community counts on Andy to mitigate that risk. The records suggest that Ferdinand Pecora was ‘an astute prosecutor with a sharp wit and acerbic tongue’. 19 Andy’s tongue may not be acerbic, but his wit is sharp. Today you had the chance to discover that he is also an excellent speaker. ‘A History of Notable Senate Investigations prepared by the United States Senate Historical Office’, https://www.senate.gov/artandhistory/history/common/investigations/pdf/Pecora_investigation_citations.pdf. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 24th Congress of ASSIOM FOREX (the Italian financial markets association), Verona, 10 February 2018.
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24th ASSIOM FOREX Congress Speech by the Governor of the Bank of Italy Ignazio Visco Verona, 10 February 2018 Global growth strengthened considerably last year although uncertainties remain linked to future US trade policies and possible upward shifts in risk premiums in the financial markets. Monetary policy in the euro area has staved off deflation but inflation is still far from the levels consistent with monetary stability. Economic activity in Italy appears less dependent on the expansionary stance of monetary and fiscal policies. The consolidation of the recovery requires us to proceed with the economic reform effort. Prudent budgetary policies will help make markets more confident in the reduction of the public debt-to-GDP ratio. Lending to households and firms is expanding and loan quality is improving, partly thanks to the successful handling of the most critical situations in the banking sector. The reduction in non-performing loans must continue, exploiting the favourable economic conditions. Competitive pressures and a challenging regulatory environment have made it urgent for banks to continue to limit costs and to fully recoup profitability, including through additional mergers. These needs are especially pressing in the mutual banking sector, where the 2016 reform must be implemented in toto. Notwithstanding the progress made since the outbreak of the crisis, the institutional arrangements of the European Union and of the euro area remain a work in progress. Diminished trust among member states has led to a sterile conflict between calls for risk reduction versus those for risk sharing. These proposals are instead complementary. Only by acknowledging this can solutions be found from which all countries can benefit. Recent economic developments The economic expansion is increasingly broad based at global level. According to the estimates of the main international institutions, in 2017 world output returned to growth at a rate of more than 3.5 per cent; this year it is expected to rise by almost 4 per cent. The favourable outlook remains vulnerable to the repercussions of possible trade restrictions and to a potentially abrupt increase in risk aversion in the markets. Domestic demand in the euro area is being sustained by rising employment and very accommodative financing conditions. Exports are continuing to improve, driven by the uptick in foreign demand. According to the Eurosystem’s forecasts, this year output will expand by 2.3 per cent, a similar pace to that recorded in 2017. Inflation remains low, however, reaching 1.3 per cent in January; core inflation also continues to be weak, partly because of the effects of wage moderation in many economies. Monetary policy is working. The strong cyclical momentum and ongoing reduction of economic slack have strengthened confidence among the members of the ECB’s Governing Council that inflation will gradually converge towards the inflation aim of a rate below, but close to, 2 per cent in the medium term. This is why we recalibrated our monetary policy interventions last October, while maintaining the highly expansionary conditions intended to ensure a lasting return to price stability. We have extended the duration of the APP until September of this year, trimming our monthly purchases to €30 billion. The Eurosystem will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases, and will continue to provide abundant liquidity to the banking system until at least the end of 2019. The Council expects to keep interest rates at their present levels well past the horizon of the net asset purchases. Inflation, after falling slightly at the start of this year owing to the base effect associated with the temporary increase in energy commodity prices in 2017, is expected to rise gradually to levels consistent with the target in the second half of 2020. The risk of deflation has been averted but it is proving difficult to push up inflation expectations. Exchange rate volatility poses one of the main risks to the inflation outlook, also given the high sensitivity of forex markets to the announcements of monetary and government authorities. The euro exchange rate is not among our objectives per se but it can have significant repercussions on the transmission of monetary policy; disorderly developments, especially if triggered by factors unrelated to the macroeconomic fundamentals, can make it harder to achieve price stability. The decisions of the ECB’s Governing Council will continue to be shaped by economic data and by the inflation outlook. We will be patient in pursuing the inflation objective and perseverant on the monetary stance adopted. In Italy GDP rose sharply in 2017. According to initial estimates, it rose from 0.9 per cent in 2016 to 1.5 per cent last year. Employment continued to expand (0.8 per cent in 2017), while the unemployment rate fell to 10.8 per cent in December, its lowest level since August 2012; hours worked per employee also increased moderately from the low recorded in the first quarter of 2015, and grew by 0.5 per cent in the first nine months of 2017. The expansion of productive activity is being driven by the global cyclical upswing and expansionary economic policies, but it is also benefiting from the reforms undertaken in recent years. Progress made in the labour, capital and services markets has begun to bear fruit; it has enabled Italy to benefit from the global and European recovery and has meant that the consolidation of growth is no longer supported by cyclical factors alone. Investment has increased since the summer. The effects of monetary policy, which has kept financing costs very low, have been flanked by those of tax incentives for the purchase of capital goods and digital technologies. Although uncertainty about whether these incentives will be maintained in 2018 may have prompted businesses to bring forward some of their investment to 2017, the outlook remains favourable: our surveys indicate a further expansion in capital accumulation for 2018, supported primarily by demand expectations. The vitality of Italian companies is evident in the sharp increase in innovative start-ups entered in the companies register (currently over 8,000, a more than fourfold increase from 2014), the healthy performance of exports, which are estimated to have risen by more than 5 per cent last year, and the current account surplus on the balance of payments, which in 2017 rose to almost 3 per cent of GDP. Positive developments in the external account are helping to improve our country’s net debtor position, which in the space of just over three years has gone from 25 per cent to less than 8 per cent of GDP, its lowest level since 2002. This year GDP is expected to grow at a rate of about 1.5 per cent and should remain above 1 per cent in the next two years as well. The virtuous circle of supply and demand is gaining momentum: the rise in households’ disposable income and the decline in firms’ spare capacity mean that the improved outlook is increasingly translating into higher consumption and investment. This scenario assumes that financial conditions will remain accommodative. When the improvement in GDP and inflation in the euro area reaches a level that justifies raising interest rates, our economy will not suffer provided that domestic economic policies have been able to consolidate the current recovery, leaving investors in no doubt as to the Government’s commitment to following a prudent fiscal policy without straying from the reforms undertaken in the last few years. This path must be pursued with determination in order to improve public services, increase competition in the private sector and stimulate greater investment in human capital. At the current projected rate of growth, the low level of household debt and the significant decrease in firms’ indebtedness make increases in the cost of borrowing, even considerable ones, sustainable. Banks and insurance companies in turn face little exposure to the effects of a rate hike. Public debt is still too high in relation to GDP but its average residual maturity of more than seven years ensures that the rate increase will pass through to the average cost of debt very gradually. Aside from the primary surplus, developments in the debt-to-GDP ratio will depend on the differential between the average cost of debt and nominal GDP growth; therefore, the lower the sovereign spreads on Italian government securities and the more our economy is in line with that of the rest of the eurozone, the lower will be the impact of a rate increase. We should not be concerned about the normalization of monetary policy, but rather with the credibility and effectiveness of the reforms and the process of reducing the debt-to-GDP ratio. Banks Lending to the private sector in Italy is expanding again. Loans to households remain brisk while those to firms are gaining pace in the manufacturing segment and expanding slightly again in services; the decline in lending to the construction sector is still pronounced, but is abating. Credit supply conditions are favourable overall; demand by firms has been limited by the ample availability of internal funds and greater recourse to non-bank financing. The ratio of new non-performing loans to total outstanding loans has fallen to below pre-crisis levels; in the third quarter of last year it came to 1.7 per cent (1.2 per cent for households, 2.6 for firms). For two years now, the stock of NPLs has been falling, with an acceleration owing to major sales of bad loans completed last year. The total stock of NPLs, net of loan loss provisions, has fallen from a peak of €200 billion in 2015 to €140 billion (equal to 7.8 per cent of total loans), with bad loans alone decreasing from €86 billion to €60 billion (3.5 per cent). The economic environment is helping banks continue to strengthen their balance sheets and reduce their NPLs, actions which, since 2012, have been the focus of our recommendations and supervisory interventions. There is still ample room to improve the efficiency of the bad loan management and recovery process, specifically by making information on the status of the recovery proceedings more readily available. The banks that are most effective in doing this obtain recovery rates that are much higher than the industry average. More pro-active management can also lead to a large portion of unlikely-to-pay loans (which make up about half of all net NPLs) being classified as performing again. In the coming weeks the European Commission and the Single Supervisory Mechanism will finalize their proposals for writing down non-performing loans over time (calendar provisioning). In its proposal the Commission suggests introducing minimum, or Pillar 1, requirements that all EU banks will have to meet. That put forward by the Single Supervisory Mechanism, instead, sets supervisors’ expectations for the NPL coverage ratio under a Pillar 2 approach. A reduction in NPLs is necessary to lower banks’ risks and funding costs. This should be pursued through measures that take into account the starting conditions, are sustainable, and do not have potentially destabilizing procyclical effects. They should also ensure a level playing field to banks operating in different environments, especially in terms of a swift and efficient civil justice system, something Italy still needs to improve on. The European Commission will also submit a proposal to establish national asset management companies, which may or may not be publicly sponsored, and which would specialize in the management of NPLs. These companies would be able to achieve economies of scale in their debt recovery activities and enjoy greater bargaining power when selling NPLs in the market, including through securitization. To attain these objectives, adequate incentives must be put in place to encourage banks’ voluntary participation in the asset transfer scheme under conditions that do not make it excessively rigid and in reality impracticable. A new EU-wide stress test was launched a couple of days ago with the publication of the methodology and the macroeconomic scenarios that will be used in the exercise. The results will be released in early November. The test will cover 48 banks, of which 33 euro-area significant banking groups, four of them Italian. At the same time, the Single Supervisory Mechanism will carry out an analogous exercise on the other significant banks, taking into account their smaller size and lower degree of complexity. Compared with the ones utilized in previous exercises, the methodology for this year’s stress test incorporates the new IFRS 9 accounting principle. The move to the new standard, in force since the beginning of this year, will help to enhance transparency and prudence in banks’ valuation of loans. This is a good opportunity to increase write-downs and spur the development of a market in non-performing assets. At the same time, the incorporation of the new standard makes the methodology used for the stress test more complex; this will have to be taken into account when interpreting and assessing the results of this year’s exercise, also with respect to previous years. As in 2016, no pass-fail threshold has been set. Supervisors will use the results to carry out their supervisory review and evaluation process. While still low, the profitability of Italy’s leading banks improved in the first nine months of last year. Return on equity was 4.4 per cent, compared with 1.4 per cent in the same period of 2016. According to banks’ expectations, profitability over the coming years should be sustained by a reduction in loan loss provisions, an increase in asset management fees, and a decrease in operating expenses. But an in-depth review of banks’ business models is inevitable in Italy, as it is throughout the EU. Some important factors that could dampen profitability must not be underestimated. Regulatory changes as well as any additional write-downs made in connection with the sale of NPLs could affect loan-loss provisioning. Competition in the asset management market is bound to grow, as is the scale of operations necessary to be profitable. The costs for banks, which are burdened by persistently high staff expenses, will be affected by investments in new digital technologies, which have been limited so far but can no longer be delayed. Moreover, the entry into force of new EU rules on the required loss-absorbing capacity in a crisis and on the provision of investment and payment services is expected to push up wholesale funding costs, competition for certain services, compliance costs and those related to ensuring that customers are fully protected. Banks must therefore take action on several fronts to recover profitability and competitiveness. This means cutting expenses further, merging or entering into consortiums to exploit cost and revenue synergies, and investing in order to respond effectively to the challenges and opportunities brought about by the development of the Fintech sector. Increasing transparency towards customers must be viewed not as a legal or regulatory requirement but rather as essential to becoming more competitive. The provision of new products and services must ensure that customers fully understand the information essential for accurately assessing the potential risks and returns. The recent agreement on the completion of Basel III reforms, which will start to be applied in 2022 and enter into full effect in 2027, marks the culmination of the responses to the shortcomings in the regulatory framework that were highlighted by the global financial crisis. Without raising the overall capital requirements significantly, it contributes to reducing regulatory uncertainty in the banking system. An important objective of the agreement is to limit excessive variability in banks’ risk-weighted assets, as this can impede comparability of capital ratios and undermine investors’ trust in the calculation methods used by banks to compute capital requirements. While mutual banks’ (banche di credito cooperativo, BCCs) solvency ratios continue to be higher than the system average, the gap has been narrowing given the squeeze on profits and the impossibility of raising equity on the market. The measures taken to cope with the serious deterioration in loan quality have proved less effective than those adopted by other banks. The BCCs are now facing an NPL ratio that is more than 2 percentage points above the average and substantially lower coverage ratios. The implementation of the reform of the sector, and the creation of cooperative banking groups, must be swiftly carried out if the BCCs are to overcome the disadvantages of their small size and continue to support the local economy while upholding the values of cooperation and mutual benefit. The groundwork for the establishment of cooperative banking groups must be laid more rapidly, with the affiliated institutions fully supporting their future parent companies. Business plans should be tailored to ensure that the objectives of the reform are achieved forthwith; these include openness to the capital market, robust corporate governance and internal audit arrangements, allocative and operational efficiency, and a reduction in NPLs. Any delay or resistance to change would eventually endanger the success of the reform. Banca d’Italia is examining the application by Cassa Centrale Raiffeisen to set up a local banking group, and discussions are currently under way with Iccrea and Cassa Centrale Banca on their applications to establish the two significant groups that will be placed under European supervision. Before this happens, both will undergo a comprehensive assessment of their balance sheets. The parent banks must draw up suitable capital strengthening plans to be put into effect as and when necessary. Europe The tools and reforms introduced in recent years in unfavourable economic conditions have enhanced the euro area’s ability to withstand macroeconomic and financial shocks. The European Stability Mechanism has been launched to provide financial assistance for EU countries in difficulty, budget rules have been tightened, the ECB has introduced outright monetary transactions, and the Single Supervisory Mechanism and Single Resolution Mechanism, the first two pillars of banking union, have been set up. This progress would have been unthinkable only a few years ago: in a short space of time we have overcome formidable political, legal, economic and organizational difficulties. Today the European reform process is still struggling to make headway. Although the debate is ongoing and the key problems have been identified, there is a deadlock between those who would prioritize action to reduce macroeconomic and financial risks in the individual member states and those who are calling for the rapid adoption of common safeguards against the consequences of such risks, given the absence or paucity of national tools. This deceptive dichotomy, however, rooted in misunderstandings and scant mutual trust, has come to condition the drafting of European rules for managing bank crises and to impede the completion of banking union. The result is a system without a safety net, one that lacks the new European financial backstops for the Single Resolution Fund and the deposit insurance scheme, while the national tools and procedures used by many countries for the management of bank crises, even in recent years, are now out of bounds. In a context such as this, stricter rules and common supervisory and resolution mechanisms cannot prevent the outbreak of crises – even just of liquidity – nor can they adequately limit the consequences. This needs to be acknowledged and the necessary adjustments devised. The experience of recent years has demonstrated how important it is to leave an opening that will allow situations with the potential to disrupt financial stability to be successfully managed. Risk reduction and risk sharing are complementary first and foremost in relation to public finance. A high debt-to-GDP ratio is a source of vulnerability: it discourages investment and impedes growth; it exposes countries to a loss of market confidence and financial contagion. Budget flexibility is essential in a cyclical downturn, but further progress, i.e. strong lasting growth of output, is impossible with a large deficit. Italy cannot delay setting in motion a steady and tangible reduction in the debt-to-GDP ratio. The reduction of the time needed to achieve this requires budgetary discipline above all else. Structural reforms to increase the economy’s growth potential are essential. We should bear in mind, however, that in the absence of adequate safeguards, a country’s recovery efforts can be rapidly thwarted by negative shocks. To avoid this happening, risk-sharing measures could be considered in order to reduce the sensitivity of national budgets to macroeconomic conditions, thereby avoiding the rapid accumulation of debt during adverse economic cycles and the adoption of procyclical policies in an attempt to limit it. This lower sensitivity can be achieved by shifting some important automatic stabilizers to the European level and handing over responsibility for adopting the necessary discretionary measures, for example with programmes for large infrastructure projects, for managing immigration or for common defence. It is technically possible to introduce this ‘common budget’ without it becoming, as some countries fear, a source of permanent transfers towards more structurally indebted countries. This would help greatly in reducing the asymmetry of a situation in which there is a single monetary policy but a fragmented fiscal policy. Measures geared to repurchasing outstanding securities can help to reduce the public debt-to-GDP ratio more rapidly. National initiatives of this kind, funded by privatization programmes for example, can encounter both operational and quantitative constraints. A faster reduction of public debts in euro-area countries than that guaranteed by prudent budget policies could be achieved by issuing European debt securities to remove a portion of those issued by member states from the market, with clearly defined procedures and without transferring resources from one country to another, giving form to a fiscal union to be accompanied by binding rules and powers of control and intervention. As I have recalled on other occasions, various concrete proposals have been made in this direction. The new common debt instrument could serve as the kind of safe asset typically found in advanced countries with a national currency; the reduction of member states’ national debts would eliminate potential sources of financial instability; the greater scrutiny of public accounts that would accompany this measure would shelter the euro area from the risk of new increases in public debt at the national level. Some of the proposals put forward in the European debate seem to rely on the possibility of proceeding sequentially, putting risk reduction before risk sharing. These proposals identify the main source of vulnerability in the euro area as the ‘doom loop’ between banks and sovereign debtors and suggest breaking it by discouraging banks from investing in government securities and by setting up orderly procedures to restructure public debts deemed unsustainable. This is a simplified vision of the origins and management of financial crises, which in any case does not pay sufficient attention to the risks that could ensue from rapid and broad movements of capital within the market for European government securities. This question should be dealt with pragmatically. Changes in the prudential treatment of government securities held by financial intermediaries (such as risk-weighting or introducing quantitative limits), particularly if badly designed or wrongly calibrated, risk being counterproductive. Especially at times of system-wide tensions, they can end up by generating the very crises they were supposed to prevent, triggering episodes of financial contagion or fuelling speculation. In any case the link between banks and sovereign debtors is not limited to financial relationships but is channelled, above all, through the effects that both sides exercise on economic activity. It is unrealistic to think that the restructuring of a large public debt, however orderly, could be achieved without serious consequences for the national economy and for the European economy as a whole. *** The difficulty of straddling the paths of risk reduction and risk sharing is evident. There are sizeable obstacles to overcome, both in reaching a consensus and in the practical implementation of reforms destined to profoundly change our European identity. It is often claimed that the time is not yet ripe for political union. Yet with foresight, we can take important steps in this direction. Italy is called on to make an authoritative contribution to the current European debate. The more steadfast and credible its commitment to improving Italy’s growth potential and ensuring financial stability, the stronger its position will be. Banca d’Italia’s supervisory work, including in the realm of the Single Supervisory Mechanism, will continue to push the banks to make the most of the opportunities offered by the current economic climate and to proceed decisively with strengthening their balance sheets, reducing NPL stocks, and increasing profitability. This is necessitated by the spread of new technology, growing competition on the financial markets, and increasingly prudent rules. To strengthen growth in the medium term, further steps must be taken towards structural reforms, improving public services, and rationalizing and stabilizing the tax laws. This is not a question of European rules, this is about the balanced development of our economy, its inherent strength. An increase in the public deficit is no substitute for reform and could prove counterproductive, since the problem of the national debt cannot be sidestepped. Even without the constraints of the Stability and Growth Pact, the need remains for us to make responsible choices. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Bank of America Merrill Lynch Italy Day Conference, London, 19 February 2018.
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Bank of America Merrill Lynch Italy Day Conference Italian Banks: where they stand and the challenges ahead Remarks by Fabio Panetta Deputy Governor of the Bank of Italy London, 19 February 2018 1. The macroeconomic picture In 2017 Italian economic growth strengthened considerably more than had been expected at the beginning of the year, while economic expansion became more balanced across demand components and economic sectors. GDP has been supported by domestic demand. Households’ consumption has benefited from steadily improving labour market conditions and rising confidence. Investment expenditure has grown at a robust pace, supported by positive demand developments and favourable economic policies, as well as by reduced uncertainty and growing confidence. Investment in productive capital has regained much of the decline recorded between 2008 and 2013; it is expected to attain pre-crisis levels next year. The recovery in the construction sector, while far from complete, has been continuing for some time. Exports, which have been expanding at or above potential foreign demand since 2010, have continued to perform well, in spite of the appreciation of the euro since last summer. The current account surplus has been positive since 2013 and has exceeded 2.5 per cent of GDP in the last two years. This is the main driver of the significant improvement in Italy’s negative net international investment position, from 27 per cent of GDP in 2014 to below 7.5 per cent at the end of 2017. Looking ahead, if the current account evolves in line with our projections, which are close to those of the IMF, Italy’s net international investment position will turn positive in three years from now. After increasing by more than 30 percentage points since the beginning of the crisis, in the last three years the debt-to-GDP ratio has remained broadly stable thanks to the pick-up in GDP growth and to persistent primary surpluses. In particular, according to preliminary estimates, in 2017 the debt-to-GDP ratio declined by about half of a percentage point of GDP. 1 Yet, public debt in Italy remains at a high level. The opportunity offered by the ongoing recovery must be seized to reduce the debt-to-GDP ratio with increasing determination. Progress on this front and on structural reforms will help reduce the persistent growth gap with respect to the EU average. On February 15 the Bank of Italy released a first estimate of the general Government debt for 2017; the final figure will be released in April, with the Notification of the data on public finances to Eurostat. The National Statistical Office will release the 2017 figure for nominal GDP at the beginning of March. 2. Banks: the recent past and the current situation The Italian banking industry is emerging from a prolonged period of distress. The ongoing economic recovery and the resolution of important critical cases 2 have drastically reduced tail risk and are helping to improve confidence. During the financial crisis, Italy’s banking system proved much more resilient than expected by many observers. The recession suffered by the Italian economy was significantly deeper than for other European countries, yet the costs for the taxpayer – in the form of public support to ailing banks – have been much lower than elsewhere. The costs of the crises have been largely shouldered by bank shareholders and by the banking sector itself. 3 The banking system is now on a recovery path. Improvement is becoming visible in several areas. Lending to the private sector has been growing again since the end of 2016 (Fig. 1); various indicators suggest that the continued slow expansion is being largely driven by low demand for lending by firms, rather than by restrictions on supply by banks. 4 Credit risk is improving. The flow of new non-performing loans (NPLs) has been decreasing since 2014. It is now about 2 per cent of total loans, below the pre-crisis average (Fig. 2). 5 Banks are also selling very large amounts of NPLs on the market: €30 billion in 2017 alone, while more than €25 billion are expected to be sold in the first half of 2018. This represents a sharp increase from annual sales recorded in the previous five years (about €5 billion on average). As a result of these trends, the NPL stock is diminishing at a remarkable pace (Fig. 3). Including the sales that will be completed in the next few months, by mid-2018 the volume of NPLs net of provisions will amount to less than €140 billion, almost one third below the peak of 2015. The net NPL ratio will stand at 7.8 per cent, against 10.8 per cent in 2015. Considering only In 2017 the Italian State intervened to recapitalize Banca Monte Paschi di Siena and to liquidate Banca Popolare di Vicenza and Veneto Banca. Moreover, the four banks put into resolution in November 2015 were eventually sold. At the end of 2017 Italian GDP was still almost 6 percentage points below its pre-crisis level, whereas for the euro area it was 5.6 points above. At the end of 2016 the impact of State aid on public debt amounted to 22 per cent of GDP in Ireland, 9.5 per cent in Austria, 7.2 per cent in Germany, 4.6 per cent in Spain, and 3.2 per cent in the Netherlands. The average for the euro area was 4.5 per cent. In Italy it is currently estimated at 0.8 per cent of GDP (this figure includes the public interventions listed in Footnote 2). Survey data collected from both banks and firms highlights that in recent years banks’ credit supply policies have been very expansionary. Moreover, firms’ liquidity buffers are at historically high levels. In the next few months the volume of new NPLs and provisions might be affected by one-off effects related to new accounting and prudential rules (IFRS9 and calendar provisioning; see below). bad loans, the ratio amounts to 3.5 per cent. The coverage ratio has been increasing in recent years and, as I will remark later on, it is now in line with recovery rates. Exposure to the domestic sovereign is decreasing. The fall since the peak of 2015 amounts to €120 billion, almost one third of the initial stock. Gradual improvement is also observable on the liabilities side. In 2017 net bond issues in the wholesale market turned positive for the first time since 2015, driven by the unsecured component (Fig. 4). Funding costs are declining, as are credit spreads over other leading banks (Fig. 5). The cost of equity has declined by three percentage points in 2017. In the first nine months of 2017 the annualized ROE of Italian Significant Institutions – the banking groups under the direct supervision of the Single Supervisory Mechanism (SSM) – net of one-off revenues, was 4.4 per cent against 1.4 per cent in the same period of 2016. Capital adequacy has increased: at end-September the common equity tier 1 of Italy’s banking system represented 13.6 per cent of risk-weighted assets, up from 12.6 per cent twelve months earlier. The Italian banking sector is making significant changes to its industrial organization. Following a reform of the mutual banking sector, more than 300 small cooperative banks (the so-called banche di credito cooperativo) will soon form three large banking groups. The largest cooperative banks (banche popolari) were transformed into joint stock companies, as required by a law approved in 2015. Two of them subsequently merged, forming Italy’s third largest banking group. 3. The outlook for banks: key challenges and factors of change Against this overall improvement, there are still vulnerabilities to be addressed and challenges to be met. I will focus on three key issues for banks and the Italian financial system as a whole: de-risking, profitability, and firms’ access to non-bank sources of finance. 3.1 Bank de-risking De-risking is a key factor in banks’ efforts to contain the cost of funding and to attract fresh capital. The sources of risk differ across jurisdictions and business models. For traditional lenders, especially in economies severely hit by the crisis, the main source of risk is the NPL legacy. Italian banks are among them. Reducing NPLs is an uncontroversial policy objective, and I fully support efforts by banks, supervisors, and national and European authorities to address the problem. Last March the SSM published its NPL Guidance, calling on Significant Institutions with high NPL levels to actively tackle the problem and produce NPL reduction plans. The Bank of Italy actively contributed to this task and was the first national competent authority to issue a similar Guidance for the banks under its own responsibility (the so-called Less Significant Institutions). 6 The issue is not whether to address the high NPL ratio, but how to do it. Some commentators have been advocating the imposition of a swift and generalized disposal of NPLs. This policy is designed to rapidly reduce the perception of riskiness of the banking system. However, it would come at a potentially high cost, because of the gap between book values and market prices of NPLs. This gap does not imply that NPLs are under-provisioned in banks’ balance sheets. First, it is primarily attributable to the very high returns required by the buyers and to accounting rules. 7 Second, in recent years for Italian banks recovery rates on bad loans have been around 35 per cent of the original loan value in net present value terms, broadly in line with the net book value of bad loans observed on average in banks’ balance sheets. 8 A generalized sale of NPLs on the market would imply a large transfer of resources from banks to buyers. While the secondary market for NPLs is showing signs of rapid growth, it is still opaque and relatively oligopolistic. Simultaneous, blanket sales would further depress market prices, magnifying the gap between the book and market values of NPLs. The result for banks would be significant losses and reduced capital. This could have unintended effects on individual banks as well as macroeconomic consequences through a contraction in credit supply in countries where high NPL stocks are a concern for several banks. The Guidance for Italian LSIs is available at: http://www.bancaditalia.it/compiti/vigilanza/normativa/orientamentivigilanza/Guidance-NPL-LSI.pdf?language_id=1. Ciavoliello, L.G., F. Ciocchetta, F. M. Conti, I. Guida, A. Rendina, G. Santini (2016) ’What’s the Value of NPLs?’, Notes on Financial Stability and Supervision, 3 (https://www.bancaditalia.it/pubblicazioni/notestabilita/2016-0003/). Conti, F.M., I. Guida, A. Rendina and G. Santini (2017) ‘Bad loan recovery rates in 2016’, Notes on Financial Stability and Supervision, 11 (https://www.bancaditalia.it/pubblicazioni/note-stabilita/2017-0011/index.html). These considerations suggest that there is a speed limit when dealing with NPL reduction. Banks and supervisors should aim for the maximum speed, but heed the limit. This concept should come as no surprise, and is not new. 9 In countries where the high NPL phenomenon is widespread, such as Italy, exceeding the limit might entail tensions on several banks at once. Such a problem could only be addressed by mobilizing public resources, a choice made by many countries 10 during the financial crisis but one that is no longer contemplated under the current European legislative framework. The Action Plan presented by the European Council last summer goes in the right direction, proposing measures to help banks improve their NPL internal management, to boost the efficiency of secondary markets for distressed assets, and to reduce the duration of judicial proceedings for the credit recovery process. 11 Following the Plan, the European Commission issued for consultation an important proposal that envisages a gradual increase of provisioning, to a coverage ratio of up to 100 per cent in the steady state. The proposal would take the form of a regulation and would be a Pillar 1 measure. The measure would be applied to NPLs stemming from new loans, to allow banks to adjust their lending policies to the new rule and to grant them an adequate transition period. The SSM is working on a non-binding Guidance to address the same issue under a Pillar 2 framework. The two proposals, which will be finalized in March, should be adequately coordinated to achieve optimal results and to avoid generating confusion among banks and investors. The European Council also stressed the importance of public Asset Management Companies (AMCs) and encouraged the European Commission to develop a blueprint for setting them up. Making banks’ participation voluntary is necessary to avoid possible instability due to a generalized surge in credit losses. The transfer price, while allowing the AMCs to be profitable, should not be far from the real economic value of the assets. In order to reduce uncertainty, ex-ante guidelines should be provided on how to estimate market prices and real More than 125 years ago the famous Austrian economist Carl Menger wrote: ‘Consider … the owner of a stock … who is obliged through sudden distress, or through pressure from creditors, to convert it into money. The prices which it will fetch will be highly accidental … And this holds good of all kinds of conversions which in respect of time are compulsory sales’. In a footnote he continues: ‘Herein lies the explanation of the circumstance why compulsory sales, and cases of distraint in particular, involve as a rule the economic ruin of the person upon whose estate they are carried out, and that in a greater degree the less the goods in question are saleable. Correct discernment of the uneconomic character of these processes will necessarily lead to a reform in the available legal mechanism.’ Carl Menger, 1892, ‘On the Origin of Money’, Economic Journal, pp. 239-255. See Footnote 3. See http://www.consilium.europa.eu/en/press/press-releases/2017/07/11/conclusions-non-performing-loans/pdf. economic values, on the building blocks of the restructuring plans, and on the governance and funding of the AMCs. The blueprint should clarify to what extent the BRRD and State aid rules could be interpreted in a way that facilitates NPL disposals. Given the importance of this initiative, it is key to avoid the risk that overly tight criteria could end up preventing the creation of an AMC. But on the NPL front more can and must be done by banks themselves. In many cases action has been slow. NPLs have been left to the back office. This attitude is now changing due to the application of the SSM Guidance addressed to Significant Institutions that I mentioned earlier, which requires banks to define precise NPL strategies and operational plans. Particular emphasis is placed on governance issues. As I have mentioned, the results of these efforts are already visible in the reduction of the stock of NPLs, but a lot remains to be done to optimize the management of these assets and speed up the solution to the NPL problem. A first crucial issue is information quality. Banks need high-quality, detailed information to maximize value extraction from NPLs and to develop consistent reduction strategies. NPL buyers also need it, to perform the necessary due diligence rapidly and at a low cost so as to reduce the bidask spreads currently prevailing on the NPL secondary market. For this reason, in 2016 the Bank of Italy introduced a new system for reporting bad loans, asking for detailed data on the status of recovery procedures and the nature of the collateral. The quality of NPL databases is already better, but there is ample scope for further improvement. We will continue our action on this front. A second issue is the duration of judicial proceedings. It is well known that in Italy the credit recovery process is long (Fig. 6) and that this contributes to driving up the stock of NPLs. The legislative reforms introduced in 2015 and in 2016 12 are helping to shorten the recovery process, but further progress is necessary to converge to the EU average. The wide heterogeneity in the duration of proceedings across different Italian courts 13 suggests that progress is possible also without the intervention of the legislator, via efficiency-enhancing organizational changes at the individual court level. The benefits of these changes would extend well beyond the issue of NPLs; they would improve credit allocation, reduce the cost of credit for borrowers, and improve the perception of the ease of doing business in Italy, with important benefits for economic growth. In countries such as Italy the introduction of mechanisms requiring a 100 per cent coverage of NPLs calls for an aggressive approach by the Government to reduce the length of credit For an analysis of the main measures taken in the past ten years, see: Giacomelli, S., S. Mocetti, G. Palumbo and G. Roma (2018), ‘Civil justice in Italy: recent trends’, Bank of Italy Occasional Papers, 401, http://www.bancaditalia.it/pubblicazioni/qef/2017-0401/index.html. The duration of insolvency procedures ranges from 4.8 years in the most virtuous districts to 10 years in the less efficient ones. The duration of real-estate foreclosures ranges from 2 to 8 years. recovery procedures. Until then, the implementation of these mechanisms will need close monitoring. I argued above that de-risking is a key factor for banks to contain the cost of funding and to attract fresh capital. Some commentators link de-risking to the creation of a European Deposit Insurance Scheme (EDIS), the missing pillar of the Banking Union, arguing that regulators should tighten prudential rules on sovereign exposures to break the link between banks and the sovereign. 14 This proposal does not fully consider the fact that the microeconomic and macroeconomic costs of such a prudential reform could be sizeable, while the benefits are uncertain. The bank-sovereign nexus, in fact, goes well beyond simple direct credit exposures, and depends above all on the impact that both banks and sovereigns have on the real economy. Furthermore, in some circumstances increasing banks’ sovereign exposures may actually play a stabilizing role. 15 These considerations, shared by most global supervisors, recently led the Basel Committee to leave unchanged the prudential treatment of sovereign assets. The problem of high public debt should be addressed by Governments directly, with determination. It should not be improperly tackled with prudential regulation. More generally, while it may make sense to start from a clean slate before going forward with EDIS, blind spots should be avoided. While NPLs or sovereign bonds may represent a source of risk for some banks, for others – such as large intermediaries engaged in investment banking – risks take the form of a high incidence of complex financial instruments, those classified for accounting purposes as Level 2 and Level 3. These are, to a large extent, assets and liabilities not directly traded in active markets or marked to model, whose value is difficult to assess. At the end of 2016 there were about €3.6 trillion of these instruments on the assets side and €3.2 trillion on the liabilities side of the balance sheets of euro-area Significant Institutions. The total is €6.8 trillion, about 12 times that of net NPLs of all euro-area banks. 16 See for example Wolff (2016), ‘European Parliament testimony on EDIS’ (http://bruegel.org/wpcontent/uploads/2016/05/EDIS-EP-statement.pdf). See Lanotte, M., G. Manzelli, A.M. Rinaldi, M. Taboga and P. Tommasino (2016), ‘Easier said than done? Reforming the prudential treatment of banks' sovereign exposures’, Bank of Italy Occasional Paper, 326, https://www.bancaditalia.it/pubblicazioni/qef/2016-0326/QEF_326_16.pdf). On the same subject, see also: https://voxeu.org/article/recent-developments-regulatory-treatment-sovereign-exposures. The reason for considering this total rather than the net value is that the available data do not tell us if and to what extent the risk embedded in assets is effectively hedged by liabilities. See Roca, R. and F. Potente (2017), ‘Risks and challenges of complex financial instruments: an analysis of SSM banks’, Bank of Italy Occasional Paper, 417 https://www.bancaditalia.it/pubblicazioni/qef/20170417/index.html?com.dotmarketing.htmlpage.language=1. Level 2 and Level 3 instruments play an important role in the functioning of the financial system. However, the available information is limited, in spite of their huge volumes. Their complexity and opacity create substantial room for discretionary accounting and prudential choices by banks, which have incentives to use this discretion to their advantage. As a result, valuation risks are unknown, but probably non-negligible. Overall, a serious debate on de-risking cannot ignore the risk posed by Level 2 and Level 3 instruments. One area where in my view the new European regulatory framework needs further work is crisis management. The number of authorities involved at European level has grown strongly; their responsibilities are not clearly attributed and the objectives assigned to them are not always aligned. We have also seen in practice how – in the absence of a reserve of liabilities able to absorb losses in the event of a crisis (MREL) – this arrangement may lead to risks to financial stability, especially in view of the fact that the rules, their interpretation, the procedures themselves have become more complex. For banks subjected to TLAC and MREL requirements, this state of affairs will come to an end when the new equilibrium is achieved (requirements are fully phased in and respected by these banks). For the other, smaller banks, liquidation remains the only tool to address a crisis. I believe that this is unsatisfactory. 3.2 Bank profitability Low profitability is a second challenge – in my view the key one – that Italian banks must face. It is not just an Italian issue: most European banks are still unable to create enough value to meet investors’ expectations. However, the gap between the cost of capital and profitability is larger on average for Italian banks, in spite of the recent improvements. The problem is partly cyclical. Provisions originating from the recession have been the main driver of ROE (Fig. 7). As the recovery strengthens and new NPLs ebb, provisions are diminishing and profitability is re-emerging. However, in the first nine months of 2017 provisions still absorbed almost two thirds of the operating profits of Italian Significant Institutions. 17 A second cyclical determinant of weak profits is the low net interest margin, which in turn is driven by a combination of low interest rates, a flat yield curve and anemic credit growth. Again, the economic recovery is reducing the impact of these factors. We expect net interest income to grow in the next two years, driven by credit growth and a steepening of the yield curve. Over the last three years banks needed to increase the coverage ratios to sell impaired assets on the market. This, together with a steady increase in non-interest income (50 per cent since 2008, mainly through fees and commissions; Fig. 8), will improve the outlook for profits. According to the plans of the Italian Significant Institutions, average ROE is expected to increase to 9 per cent by 2019, substantially closing the gap with the cost of capital. However, risks to this scenario are mostly on the downside. Various factors contribute to this assessment. The digital revolution is reshaping financial markets, creating opportunities but also risks for banks that fail to adjust rapidly. New players are entering the financial services market, offering traditional banking products at a lower cost. Banks’ payment services, brokerage and asset management fees and even interest income are being tested by FinTech companies. Regulatory changes are a second structural shift to which banks need to adjust. Recent reforms have increased capital and liquidity buffers; the new resolution and liquidation regime requires a large volume of liabilities with high loss absorption capacity. Furthermore, banks must also comply with additional requirements, such as those on anti-money laundering and consumer protection. The new Markets in Financial Instrument Directive (MiFID2) will enhance consumer protection, but at the same time it will increase the burden of compliance. The benefits of these regulatory changes are clear: banks are safer than in the past. At the same time, achieving pre-crisis profitability levels has become extremely challenging. Indeed, an industry with much lower risk levels should entail lower returns and cost of equity. To face these challenges banks need to take firm action to reduce costs and achieve efficiency gains. 18 Massive investments in information technologies and in human capital are necessary. Progress is ongoing on this front. 19 Against this background, a key avenue to improve efficiency and profitability is bank consolidation. Indeed, some of the factors of change are having an impact on scale economies and the optimal bank size. Setting up the technological infrastructure needed to do banking business today requires conspicuous investment; in the face of negligible marginal costs, this is a factor increasing scale economies. Fixed compliance costs have also risen considerably in recent years, due to stricter and more pervasive regulation. In countries where a widespread adoption of new technologies has been coupled with large IT investments by banks, intermediaries tend to exhibit a higher ROE than elsewhere, sustained by a low cost-income ratio. Italian banks are reducing their branch network and are increasingly relying on digital resources. The number of branches at the end of 2017 was 20 per cent lower than in 2008. Ambitious programs of staff reduction and internal restructuring have been announced (and in many cases are being implemented) by all the largest banking groups. Past experience suggests that mergers and acquisitions, if properly designed and based on sound industrial projects, can yield material efficiency gains. 20 Many Italian banks can obtain remarkable benefits from consolidation. They must explore this possibility in order to obtain the efficiency gains, the technological skills, the product and geographical diversification that are necessary to compete successfully in the domestic and international market and to finance the real economy. 3.3 Firms’ financial structure The last issue I wish to address is firms’ financial structure. The regulatory changes introduced in the aftermath of the global financial crisis are inducing banks in many countries to deleverage and to reduce their appetite for risk. In economies like the Italian one, where firms – by international comparison – are relatively small and heavily reliant on bank credit, the consequences of such reforms for the financing of the real economy must be analyzed carefully. In order to mitigate possible unintended consequences, the development of a more diversified financial system is a priority for the Italian economy. In recent years the Italian authorities have introduced tax incentives and administrative simplifications to reduce the overall cost of IPOs, to incentivize bond issues and to stimulate investment in innovative startups. The legislation on ACE (allowance for corporate equity) is helping to improve firms’ capitalization levels. The adoption of consolidated international contractual practice has prompted the entry of foreign specialized operators in the private debt placement market. Cooperation between the public and private sectors has stimulated the creation of venture capital funds. 21 To encourage the demand for financial instruments issued by Italian companies, the 2017 budget law has introduced tax exemptions for long-term individual savings plans (Piani Individuali di Risparmio, PIR). These measures have produced encouraging results. Since 2011 the share of bonds among firms’ total financial liabilities has almost doubled, to 12.6 per cent last September (from €90 In Italy, between mid-1995 and the mid-2000s, mergers and acquisitions triggered a restructuring process that allowed the banking industry to absorb excess capacity. In connection with the far-reaching consolidation that took place, between 1995 and 2004 large productivity gains were achieved: total assets and value added per employee grew respectively by 4.6 and 2.4 per cent per year at constant prices See Focarelli, Panetta and Salleo (2002) “Why Do Banks Merge” Journal of Money, Credit, and Banking, v. 34, and Focarelli and Panetta (2003) “Are Mergers Beneficial to Consumers? Evidence from the Market for Bank Deposits” American Economic Review, v. 93, 4. Thanks to a public-private partnership, the Fondo Italiano di Investimento between 2012 and 2016 created two venture capital funds of funds that invested €100 million in venture capital private funds; the size of the Italian funds involved in these transactions is equal to €400 million. billion to more than €150 billion in absolute terms). The number of firms issuing bonds is increasing; moreover, while in the past only large industrial groups were active in the market, now recourse to bonds is spreading to smaller firms. Also the number of IPOs has been relatively high in recent years. We need to consolidate and accelerate these trends, to stimulate the growth of capital markets and improve the financial soundness of Italian firms. Significant progress on the capital market union, one of the objectives pursued at European level, would be an important move in this direction. Building a genuine capital market union does require far-reaching legal changes, such as EU-wide company and bankruptcy legislation. Banks can play an important role in helping firms access alternative sources of external finance and can benefit from this process. The shift towards a less bank-dependent financial structure of corporates can provide banks with a valuable opportunity to broaden their revenues, by focusing on the provision of related and complementary services in the area of corporate finance and asset management. This will require intermediaries to acquire adequate human resources and technological capacity in order to exploit the large pool of information on firms, to interact with investors and markets, and to avoid conflicts of interest. Conclusions To conclude, now that the economic recovery is gaining momentum, banks can make further progress in strengthening their balance sheets. De-risking, via a rapid reduction of NPLs, is under way. Profitability, though still low and affected by the structural shifts imposed by the digital revolution and by the recent wave of regulatory reforms, can benefit from bank consolidation. The conditions are there for Italian banks to face the challenges posed by the new regulatory and market environment. The improvements obtained in the recent past will allow them to support economic growth and more solid, financially diversified, enterprises. It will also let them face the challenges of the next decade: cross-border integration, digitalization and competition by FinTech companies. Thank you for your attention. Figure 1. Bank loans to firms and households (yearly rate of change; per cent) -1 -2 -3 -4 -5 -6 Households Source: Bank of Italy. Figure 2. New non-performing loans to performing loans (quarterly data, annualized and seasonally adjusted; per cent) Source: Bank of Italy, Central credit register. Firms Figure 3. Net non-performing loan ratio and coverage ratio (percentage of outstanding loans) (1) Expected mid-2018 data are calculated considering September 2017 data for banking groups and June 2017 for stand-alone banks. NPL disposal by MPS (expected by mid-2018) is also taken into account. Figure 4. Bonds issued and matured (yearly data; billions of euros) Source: Based on Dealogic. Figure 5. Bond yields (daily data; amounts and percentage points Source: Based on Bloomberg. Figure 6. Relationship between the NPL ratio and time for enforcing contacts (EU area; percentage points and number of days) Cyprus Greece ∆ NPL Ratio (%) Ireland y = 0,023x - 4,7845 R² = 0,4175 Italy Slovenia -5 - 1.000 1.200 1.400 1.600 time for resolving a dispute through a local first-instance court (# of days) Source: ECB Consolidated Banking Data and World Bank Doing Business Database. 1.800 Figure 7. Cost of risk and ROE (annualized data; basis points and percentage points) Source: Bank of Italy. Figure 8. Gross income: dynamic of interest and non-interest income (annualized data; indices, 100= December 2008) Source: Bank of Italy. Figure 9. Sources of funding and leverage of Italian firms (annual flows in billions of euro and per cent) Source: Bank of Italy and Cerved. (1) Leverage is calculated as the ratio of financial debt to the sum of financial debt and net equity at market prices. (2) Adjusted leverage is calculated by removing the effects of changes in the market value of net equity. A value above (below) the solid line indicates, for a given year, a decrease (increase) in the market value of equity. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the meeting to celebrate the publication of "Carlo Azeglio Ciampi. Writings in the Nuova Antologia", organized by the Bank of Italy, Florence, 12 March 2018.
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Carlo Azeglio Ciampi Writings in the Nuova Antologia Speech by Deputy Governor of the Bank of Italy Luigi Federico Signorini Florence Regional Branch 12 March 2018 Introduction 1. On the day Carlo Azeglio Ciampi was born in Livorno, on 9 December 1920, the Italian daily Corriere della Sera featured, among other things, a political and institutional maelstrom and two important economic questions. The former was related to the Government’s ‘resolution to apply the Treaty of Rapallo’. Under the treaty, the city of Fiume (hotly contested by Italy and Yugoslavia in the wave of nationalist sentiment that followed the end of the European war and the dissolution of the Hapsburg Empire) was to become an independent state. Gabriele d’Annunzio’s self-proclaimed Italian Regency of Carnaro was opposed to this solution, and called instead for Fiume’s annexation by Italy. A few weeks later, the ‘Bloody Christmas’ clashes signalled the end of the Regency under the guns of the Italian navy and army, sent by the last Giolitti government. As for the two economic questions, one regarded the regulated price of bread: this had been set during the war but by 1920 had become unrealistic owing to wartime inflation and had to be heavily subsidized, creating a gaping hole in the public accounts. The abolition of the subsidy was entrusted by Giolitti to Marcello Soleri, Under Secretary for Food Provisioning and Consumption, and was approved in February 1921. Although it met with strong opposition at the time from several political parties (as reported in the Corriere), the measure made a substantial contribution to rebalancing the budget. The second question was the subject of a second-page article written by Luigi Luzzatti, entitled ‘Nuova carta moneta?’ (‘New paper money?’), which allowed the newspaper to highlight the ‘deep concern about an increase in money in circulation which is having noticeable effects on prices and exchange rates’. ‘If prices and exchange rates go up, the money press is to blame’, observed the columnist. 2. Back then these issues recurred so frequently that perhaps traces could be found on any given date. I quote them nevertheless, because it is still somewhat amusing to think that if one picks up the Corriere published on the day Ciampi was born, one finds references to the three lodestars (if I may call them that) that guided his personal, professional and institutional life, from the outset of his career to the highest offices he held: the stability of the currency, balanced public finances, the ideal of a united Europe. The latter, however, should not be read in opposition to love for the smaller, national homelands; rather, Europe was to be founded on a healthy sense of patriotism – to stand as a bastion against the fratricidal destruction seen repeatedly in the course of history. In the two volumes of his contributions to the journal Nuova Antologia, all three stars are very clearly visible. Europe 3. I shall begin with the third star, the European ideal, to which Ciampi’s writings return again and again. This aspect, perhaps, strikes me more than anything else. 4. In 1966, recalling his time spent in Scanno in Abruzzo, from 1943 to 1944, while waiting to try and get beyond the front of the Italian Co-Belligerent forces (the regular army, which after the 1943 armistice started fighting alongside the Allied forces), Ciampi wrote: ‘During that time, we became convinced – and it is a conviction that still drives and sustains us – that the European Union must be created for reasons that go far beyond economic considerations. We must remain fully aware of the tragedies that can be triggered by the rekindling of nationalism, creating a risk of moral and political decline that has certainly not diminished in our time, as witnessed by the tragedy of the former Yugoslavia. Europe must either move towards a Union solidly based on common institutions, or risk going backwards. We must not forget the dramas we have lived through, to spare our children and our grandchildren a similar fate.’ 1 5. For the success of the European project, however, the knowledge that ‘for the civilization to which we belong, [political union is] the only way to avoid losing the thread that was broken by two world wars and retied by those with the vision to imagine Europe as a community’ 2 is only a necessary, not a sufficient condition. What is also needed is ‘the creation of institutions that are appropriate for the new size of the European Union, which allow us to face up to our responsibilities towards European citizens’. 3 6. Allow me to underline the previous sentence, which is taken from a speech in 2002, when Ciampi was called on to give the laudatio at the awarding of the International Charlemagne Prize of Aachen to ‘the euro – our money’. These words are still pertinent today. Compared to one generation ago, today’s Europe is indeed ‘a new size’, not only because the number of member countries has increased, but also – and really above all I would say – because the areas in which we have pooled sovereignty have increased greatly. In the last twenty years there has been a formidable transfer of sovereignty in the economic, monetary and financial fields. Ciampi was one of its driving forces. The European institutions have adjusted in part, at times making unexpected progress, at others falling behind. Today, while the debate on the completion of economic union continues, other questions have returned to the fore, and are once again among those 'Quei giorni a Scanno fra ’43 e ’44’, in Scritti nella Nuova Antologia, vol. 1, p. 103. See also in the same collection, ‘Diario marzo-aprile 1944’, vol. 2, pp. 31-52, ‘La tragedia di Cassino’, vol. 2, pp. 141-46 and ‘L’amicizia italo-tedesca al servizio dell’integrazione europea’, vol. 2, pp. 115-116. The Governor’s Concluding Remarks for 1987, Banca d’Italia, 1988, p. 33, (http://www.bancaditalia.it/pubblicazioni/relazioneannuale/1987/en_cf87_considerazioni_finali. pdf?language_id=1). ‘Culture nazionali e civiltà europea’, in Scritti nella Nuova Antologia, vol. 2, p. 74. closest to the heart of sovereignty: security, border controls. These are challenging areas which are of intrinsic common interest and are difficult to deal with at a national level. But they cannot be properly managed together without ‘appropriate institutions’. 7. We can draw some lessons from the experience of Europe’s economic institutions. The incompleteness of Economic and Monetary Union, as we know, returned dramatically to the fore, propelled first by the financial crisis and then by the sovereign debt crisis. The year 2012 saw the publication of the so-called ‘Four Presidents’ Report’ 4 which proposed taking, in the course of a decade, concrete steps towards banking and budgetary union, and supplementing or replacing national intervention tools with similar supranational instruments. The Report also suggested accompanying this gradual transfer of sovereignty with a strengthening of the democratic legitimization of common institutions. 8. Most of the proposals in the Report have been included in later and more detailed documents and certainly not all of them have remained a dead letter. Indeed, the steps taken over the last few years have been extraordinary in some respects: at a time when the economic situation has been particularly challenging, the EU and the euro area’s institutional and regulatory framework has been broadly redesigned, filling glaring gaps. And yet the progress made has been uneven. Notably, while restrictions were rapidly placed on the use of national levers, the introduction and complete pooling of supranational instruments have lagged behind. 9. This is not the place to mull over issues that Governor Visco and the rest of us have dealt with on many occasions. Namely, the incompleteness of the banking union, the fact that the capital markets union is still in its infancy, and the marked asymmetry – the ‘lameness’, as Ciampi would have called it 5 – of an institutional architecture that, despite having a single monetary policy, continues to have a fiscal policy that remains largely fragmented along national lines, albeit in the context of an increasingly intricate regulatory network. Instead I should like to make a more general comment, to which many other observations can be directly or indirectly linked. 6 10. Though differing in many ways from the traditional sovereign state, the European Union has a framework whose legislative and judicial branches resemble those of many normal constitutional democracies. Nowadays the Union has a Parliament Towards a genuine economic and monetary union. Report by the President of the European Council, in close cooperation with the Presidents of the European Commission, the Eurogroup and the European Central bank. (http://data.consilium.europa.eu/doc/document/ST-120-2012INIT/en/pdf). ‘Il futuro dell’Europa’, in Scritti nella Nuova Antologia, vol. 2, p. 96; and passim. I covered this topic in more detail just over a year ago at the Collegio Carlo Alberto: ‘Economic Challenges Facing Europe and the World’, (https://www.bancaditalia.it/pubblicazioni/ interventidirettorio/int-dir-2016/Signorini_Moncalieri_19122016.pdf). which, according to the Treaties, has a status, make-up and powers comparable to those of a national parliament; it has courts of justice that ensure the uniform application of European law in very conventional ways. In contrast, executive power works in a rather peculiar way. There are two institutions that share power of political direction, namely the Council and the Commission, with a division of roles that I believe to be unique, and with different forms and sources of legitimacy. Both, 7 moreover, perform non-governmental functions: the Council shares the legislative role with the Parliament, while the Commission has some tasks typically associated with independent authorities, which are hard to reconcile with its political role – a combination which is a perennial source of controversy. 11. The distinctive nature of the Union’s institutional framework is not without consequences. The absence of a single governing body results in a lack of certain tools typically used by the executive branch, which greatly hampers the discretionary action of the European ‘government’. The Union’s economic governance is therefore essentially based on defining the rules and checking that national governments comply with them. It is this imbalance between rules and discretionary governance, far more than the oft-discussed lack of democratic representativeness, which is the most unusual feature of the European constitutional framework. This situation is not accidental: it arises from the reluctance of member states to confer what they see as excessive powers on a central government. Yet what is sometimes forgotten is that, since a considerable portion of sovereignty has already been pooled at European level in various sectors (and for good reason), these arrangements create a paradox: with little discretionary power at European level and little at national level, the entire system appears inflexible. 12. A far-sighted view would be required to solve this paradox. I do not know if this is possible today; certainly, it will not be unless a climate of trust, which seems to have been lacking recently, is rebuilt between countries and between European citizens and institutions. In his ‘Concluding Remarks’ at the annual meeting of shareholders in 1988 Ciampi recalled the progress made in creating a ‘genuine, united Community that can stand alongside the United States and Japan as a point of reference in the world economy’, and concluded, ‘The major disputes about minor issues appear to have subsided: though the road ahead is still arduous, the way is now clear for progress towards the completion of economic union, which will prepare the ground for political union’. It is to be hoped that the current European debate also dismisses the ‘minor issues’ and regains a sense of direction that will allow us – to quote Mario Draghi, one of Ciampi’s successors at the Bank of Italy – to ‘avoid remaining prisoners of incomplete Strictly speaking, the European Council, consisting of the Heads of State or Government, which ‘sets out political priorities’ and has no legislative functions, is constitutionally a separate body from the Council of the European Union, and performs legislative functions in various assemblages at ministerial level. Both, however, are in essence the expression of national governments. projects’.8 It is not, or at least it is not only a question of an ideal vision: the incompleteness of the project can seriously undermine its actual effectiveness and social acceptability. We see examples of this every day. 13. Ciampi belonged to that generation and that school of thought which, in the spirit of Jean Monnet, saw every step towards building Europe as the forerunner of the next inevitable steps. In 1998, on the eve of the birth of the euro, he said he was convinced that ‘when eleven countries begin to jointly manage this common currency, they will realize […] that other things will need to be jointly managed too […] This is the slope along which the single currency will roll […] a slope which, with the same inexorable strength as gravity, will force the main policy domains, and not just the domain of economic policy, into a framework of cooperation’. And yet while he described the euro as ‘an example of imagination in power’, and underlined that ‘putting the cart of the single currency in front of the horse of political union had been a unique historical initiative’, Ciampi also warned us about the need for unflagging commitment: ‘We now need even more imagination and creativity to blend elements of sovereignty and supranationality, States and federation, and unity and diversity into an efficient institutional framework’. 9 Money 14. ‘The independence of the European Central Bank and its primary objective of maintaining price stability are solemnly enshrined in the Maastricht Treaty: there can be no divergences, no doubts of interpretation.’ 10 But the autonomy of central banks, as the articles printed in the Corriere della Sera on 9 December 1920 remind us, is not part of the natural condition of mankind; quite the opposite. 15. How much power or discretion the Sovereign can exert in printing money is an age-old question. In the West, the idea that sovereigns could not exercise this prerogative in a discretionary manner without endangering the well-being of their subjects or even their own, dates at least as far back as Nicole Oresme and his Treatise on the origin, nature, law, and alterations of money, written six and a half centuries ago. But the task of translating these principles into institutional rules that would sanction the separation of the State Treasury and the ‘money press’ took a long time and varied from country to country. In Italy the matter was settled between 1981 and 1993 with Ciampi the undisputed protagonist of that process. ‘The Monnet method: its relevance for Europe then and now’, Mario Draghi, President of the ECB, Award of the Gold Medal of the Fondation Jean Monnet pour l’Europe, Lausanne, 4 May 2017, (https://www.ecb.europa.eu/press/key/date/2017/html/ecb.sp170504.it.html). ‘L’esaltante avventura dell’euro’, in Scritti nella Nuova Antologia, vol. 1, pp. 182-183. ‘Il governo dell’economia in Italia e in Europa’, in Scritti nella Nuova Antologia, vol. 1, p. 148. 16. In one of the essays in the Nuova Antologia, Ciampi recalls the first, crucial step in this direction in a conversation with Giovanni Spadolini, who on 15 June 1981 – as the newly-appointed President of the Council of Ministers – asked the governor to ‘describe the economic situation to him as clearly as possible’. ‘This I did’ – Ciampi recalls – ‘by largely repeating what I had said two weeks earlier on 30 May at the Bank of Italy’s annual meeting of shareholders, in the governor’s traditional ‘Concluding Remarks’. The situation was complicated. Driven by the second oil shock, annual inflation had risen above 20 per cent […] To defeat it, I had called for a series of structural and behavioural changes, a kind of monetary constitution, indicating three pillars’. The first two pillars were incomes policies and new rules and strict constraints on public expenditure; the third was the ‘full autonomy of the Bank of Italy to prevent any interference in the creation of money by government expenditure centres’. 11 17. When he outlined his government programme on 7 July 1981, Spadolini said nothing about the third pillar, but he ‘de facto approved the new arrangements for financial transactions between the Treasury and the Bank of Italy, which Andreatta, already Treasury Minister in the previous government, had agreed with me in April 1981 and which took effect in July that same year. This ended the Bank of Italy’s obligation to purchase Treasury bills not sold at auctions.’ 12 18. That ‘divorce’ marked the beginning of a process which would ultimately lead to the Governor of the Bank of Italy being made responsible for setting official interest rates in 1992 and to the end of the Treasury’s permission to borrow up to 14 per cent of its budgetary expenses from the central bank in 1993, for a token interest rate. ‘In this way’, Ciampi again recalls, ‘the independence of the Bank of Italy was given full recognition’.13 19. To those who believed in those days that excessive attention was being paid to price stability, in his ‘Concluding Remarks’ in 1981 Ciampi responded that in previous years high inflation had ‘not only caused vast and unintended transfers of wealth and created the forms of inefficiency that are due to unpredictable and volatile relative prices’ but had ‘also changed the very essence of the currency by largely stripping it of its function as a store of value and leaving it only a humble role as a unit of account and medium of exchange. A complex trading economy cannot function without a unit of value that is reliable both in the present and with regard to the future.’ 14 20. The return to monetary stability was a success. After reaching 21 per cent in 1980, inflation fell to 6 per cent in 1986 and to 3 per cent in the mid-1990s. However, while ‘Ricordo di Giovanni Spadolini’, in Scritti nella Nuova Antologia, vol. 2, pp. 152-153. ‘Ricordo di Giovanni Spadolini’, in Scritti nella Nuova Antologia, vol. 2, p- 160. ‘Ricordo di Giovanni Spadolini’, in Scritti nella Nuova Antologia, vol. 2, p- 160. Concluding Remarks, Banca d’Italia, 1981, p. 37, (http://www.bancaditalia.it/pubblicazioni/relazioneannuale/1980/en_cf80_considerazioni_finali.pdf?language_id=1). the monetary ‘pillar’ was built without delay, the other two, incomes policies and public expenditure, were only partially completed. This, wrote Ciampi, ‘cost the country dearly. It slowed economic development; it weakened the currency.’ 15 21. No longer Governor, it was again Ciampi acting as Minister of the Treasury in Prodi’s government, who steered Italy’s participation in the single currency from its inception. The end of the long ‘return to stability’, which began in 1981 and was pursued with determination in subsequent years, coincided symbolically with the completion of a fundamental step in European integration. To Ciampi’s mind the two elements were indissolubly linked: ‘If […] we look again at the patterns of events in our economy in the 1980s and 1990s we can see a defining dual motif: the return to stability and the creation of Europe. Stability, which until the mid-1960s our country had proved capable of delivering together with strong development; Europe, which had been uppermost in our hearts and minds since the end of the Second World War’. 16 22. It may be worth recalling here as an aside a perhaps little-known fact, which Ciampi alludes to in another essay: ‘As Minister of the Treasury, I wanted the image of Castel del Monte [on the one cent euro coin] as a tribute to Frederick II, an Emperor who was at once German and Roman, the embodiment of a supranational ideal.’ 17 The public finances 23. To talk about the third of Ciampi’s lodestars, public finance, we need to return to the three pillars of stability, more specifically to the non-monetary ones. In recalling, years later, the events of the Spadolini administration, Ciampi underlined their importance: ‘the government programme that the Prime Minister […] presented to Parliament indicated that the reining in of public spending, together with the cost of labour, would be a fundamental part of the fight against inflation’. He said that ‘regrettably, in finalizing the budget, its contents were first affected by the conflicts that emerged within the Government and among the economic Ministers, and then by the modifications made during the Parliamentary debates which, in large part, tended towards easing the budget’, adding ‘the gap between the budget’s results and its objectives was particularly wide. The deficit-to-GDP ratio, which had already increased from 9.3 per cent in 1980 to 10.7 per cent in 1981, jumped to over 13 per cent in 1982’. Lastly, he recalled that ‘at the end of May 1982 […] I deemed it necessary to make a ‘1981: emergenza economica e nuove vie per il risanamento’, in Scritti nella Nuova Antologia, vol. 1, p. 68. ‘Per la riconquista della stabilità e la creazione dell’Europa’, in Scritti nella Nuova Antologia, vol. 1, p. 121. ‘Italia e Germania: un comune impegno europeista’, in Scritti nella Nuova Antologia, vol. 1, p. 252. public comment on the gap between the acknowledgment of the problems and the inadequacy of the proposed solutions, expressing with great clarity the risks and concerns deriving therefrom’. 18 24. In his writings Ciampi expressed his constant concern that ‘growth [could be] disrupted by fiscal disorder’. 19 Nearly 15 years later, at the end of 1995, speaking from a medium-term perspective he complained again about ‘the prolonged lack of consistency between the consolidation and convergence objectives set out by Parliament and the Government in connection with the process of European integration, and the manner in which the public finances and wage negotiations were actually managed’. 20 25. Shortly afterwards, however, it fell upon Ciampi to reorganize the accounts, a requisite for Italy’s entry into the European Monetary Union. The success of this endeavour hinged upon three characteristics which marked Ciampi’s entire career: his insistence on an accurate diagnosis of problems; his urging of clear objectives; and his awareness of his personal responsibilities, an indispensable precondition for mobilizing the energies of all. 26. In his speech before the Chamber of Deputies where he presented the Economic and Financial Document (EFD) for the three years 1997-99, Ciampi clearly described the diagnosis, objectives, and responsibilities. The diagnosis is clear: ‘the new Government was forced to acknowledge the changes that had taken place […] in the macroeconomic context. In addition, a thorough analysis of the public accounts demonstrated […] a worsening with respect to the projections’. The objective, however, remains unequivocal: ‘Italy’s participation as of 1 January 1999 in the third phase of the Economic and Monetary Union’. Lastly, on responsibilities, he emphatically and clearly stated that the EFD outlined the future of Italy’s economy and public finances and that ‘this future is still in our hands. Nothing is inevitable or predetermined, there is no room for fatalism’.21 The importance given to technical diagnosis aligns Ciampi with the tradition of the Bank of Italy, where he himself once said he received his ‘Masters in Economics’. 22 In an essay dedicated to Einaudi, Ciampi recalled the origins of that tradition in the important analytical work carried out by Menichella and the Bank, which contributed to the success of the 1947 stabilization measures. ‘1981: emergenza economica e nuove vie per il risanamento’, in Scritti nella Nuova Antologia, vol. 1, pp. 69-73. ‘Operare Europa, pensare Europa, sognare Europa’, in Scritti nella Nuova Antologia, vol. 1, p. 167. ‘1981: emergenza economica e nuove vie per il risanamento’, in Scritti nella Nuova Antologia, vol. 1, p. 68. ‘Quale futuro per l’economia e per la finanza pubblica’, in Scritti nella Nuova Antologia, vol. 1, pp. 79-83. ‘I ministri del Tesoro raccontano’, in Scritti nella Nuova Antologia, vol. 2, p. 214. 27. He had the chance to underline concisely and effectively the importance of an impartial diagnosis in the 1981 meeting with President Spadolini mentioned above. Indeed, he recalled that, after having ‘invited him to describe the economic situation to him as clearly as possible […] Spadolini listened very closely, took several pages of notes in his own handwriting and when he had finished, commented that the outlook he had described was even bleaker than he had thought. We agreed’ – said Ciampi – ‘that one can construct something on worries but not on illusions’.23 28. That he was very clear on the motivations underlying his actions in his successive roles as Governor, Prime Minister, Minister, and President of the Republic, I believe is sufficiently apparent from all that I have said so far. What I would still like to underline is Ciampi’s habit of taking full responsibility for each role he held while simultaneously including others and encouraging them to take on their own responsibilities. It’s that idea of ‘it is up to us’ – a phrase used by his predecessor Donato Menichella – that appears in all of his written work and, even more importantly, in his actions. Again, while presenting the EFD for 1997-99, Ciampi said, ‘it has taken Italy four years to step away from the abyss, halve its deficit, and virtually wipe out its foreign debt. A country such as this does not deserve to be excluded from the fundamental transition towards Europe’s new political and economic framework’. And he warned that ‘failure would only be due to a lack of faith in ourselves, in our doubting our strengths during the final leg of the journey […] We have twenty months ahead of us. Not a single week must be lost’. 24 29. Today, we have no such tight deadlines, but the challenge is hardly different from the one we faced in the 1990s. We have to complete the task of consolidating the public finances, as was done so determinedly in those years, deploying structural measures to curb the debt-to-GDP ratio’s tendency to escalate and bringing about a rapid contraction. Last year, when the Bank of Italy was called on to testify before Parliament during the debate on the 2017 Update of the Economic and Financial Document, I stressed the ‘need to seize the opportunity offered by the current situation […] to strengthen the public finances and visibly reduce the debt, our perennial weak point, and to lay the foundations for long-term growth’. I again stressed that a ‘credible commitment to ensure orderly public finances is essential if we are to ensure that a gradual return to normality in eurozone monetary and financial conditions does not widen the gap between the cost of the public debt and economic growth, as this would, in turn, set off a vicious circle, causing the debt to expand’.25 As Ciampi would have remarked, and in fact did in 1996, ‘it is a matter of regaining a degree of freedom in the ‘1981: emergenza economica e nuove vie per il risanamento’, in Scritti nella Nuova Antologia, vol. 1, p. 66. ‘Quale futuro per l’economa e per la finanza pubblica’, in Scritti nella Nuova Antologia, vol. 2, p. 92. Preliminary hearing on the 2017 Update of the Economic and Financial Document, pp. 10-11, (https://www.bancaditalia.it/pubblicazioni/interventi-direttorio/int-dir-2017/en-Signorini-031017.pdf). adoption of budget policies that has been lost, or at least greatly curtailed, owing to the structural imbalance of our public finances. This freedom is particularly important in a system such as ours, which has to turn economic policy around and redirect it towards growth and employment’. 26 Conclusions 30. Carlo Azeglio Ciampi’s qualities cannot be fully appreciated without considering his cultural roots. The writings collected in these two volumes clearly illustrate his intellectual heritage; though never explicitly named, this heritage is apparent from the citations: Mazzini, Cavour, Einaudi, De Gasperi, and onwards to Giovanni Spadolini, Paolo Baffi and Tommaso Padoa Schioppa. In an article written in 2009, he is more explicit and precise about this heritage: ‘My advanced age,’ Ciampi wrote at the time, ‘leads me increasingly to seek out people and voices from the past; whether this is to recapture the spirit of youth or to lighten the burden of my present weakness, I do not know. Sometimes, I will pick up, at random, an old piece of writing: books of literature, history or politics that were my companions years ago. Many of them are the voices of writers that I, too, consider to be among ‘my elders’: from Ruffini to Calogero, from Salvatorelli to De Ruggiero, from Omodeo to Calamandrei, right up to my near contemporary Galante Garrone. Whatever the specific subject of their writing, I am always surprised to discover that single, unbroken thread that runs through our history, from the Risorgimento to the Republic via the Liberation’. 27 31. Ciampi was known to be fascinated with the Italian Risorgimento. His passionate interest in this period of history, so far removed from the rampant Chauvinism of the Fascist years, led him to view the European Union not as a threat to national identity and culture but as a means of ensuring their survival and expansion within a global framework because, as he said, ‘no one alone can nurture their invaluable cultural, civic and religious heritage, which is an integral part of our European identity’. 28 32. From the same cultural roots sprang Ciampi’s vocation to ‘serve the general interest’. The Italian patriots were not only fighters, ‘they were an honest, disinterested ruling class present in every town and every region of Italy’. 29 To serve the general interest, ‘in his own words, … “you do not – indeed should not – have to be an exceptional human being, a saint, a hero or an anchorite, [but] you do need to believe firmly in the basic values of democracy; importantly, you should set realistic goals for the development of ‘Quale futuro per l’economa e per la finanza pubblica’, in Scritti nella Nuova Antologia, vol. 2, pp. 82-83. ‘Per i giovani e la patria europea’, in Scritti nella Nuova Antologia, vol. 2, p. 266. ‘Culture nazionali e civiltà europea’, in Scritti nella Nuova Antologia, vol. 2, pp. 74 and 79. ‘I giovani, il Risorgimento, il sogno dell’Italia unita’, in Scritti nella Nuova Antologia, vol. 2, p. 62. society; you only need to be an honest, capable man or woman, practising the values and beliefs that you preach, and ... look on the task you have undertaken above all as a civic duty”’. 30 This is why, when Ciampi took responsibility for tasks with which he was entrusted at difficult times, ‘tasks [I quote another of his successors, Ignazio Visco] that he sometimes imagined would, as he put it, prove beyond his power’, 31 he managed to set aside all his doubts and hesitations. 33. It has been said that we owe Ciampi more than just his contribution to the economy: we owe him ‘a great and enduring belief in the capabilities of Italians’. 32 During the inception of the euro, in May 1998 Ciampi told the Chamber of Deputies that ‘Italy has given Europe what the European Union most needs: proof of how much a country and a people can do when they are given a great purpose and put all their best efforts into achieving it’. 33 Now that we have come through a ruinous economic crisis and find ourselves half way along a path of reform which has already greatly changed the functioning of our economy and will continue to change it even more; now that we are called on once again to make our voice heard clearly in the European debate, Carlo Azeglio Ciampi would exhort us to prove that we can do again what we did in the past: when faced with momentous choices, we have always taken the course that was difficult but right. Ignazio Visco, Ciampi a Via Venti Settembre, p. 5, (https://www.bancaditalia.it/pubblicazioni/ interventi-governatore/integov2016/visco-141120126.pdf). Ignazio Visco, Ciampi a Via Venti Settembre, p. 5, (https://www.bancaditalia.it/pubblicazioni/ interventi-governatore/integov2016/visco-141120126.pdf). G. Nardozzi, ‘Il governatorato di Carlo Azeglio Ciampi (1979-1993)’, in Governare la moneta – La Banca d’Italia da Einaudi a Ciampi, Biblioteca della Nuova Antologia, Edizioni Polistampa, Florence 2004, p. 168. ‘Operare Europa, pensare Europa, sognare Europa’, in Scritti nella Nuova Antologia, vol. 1, p. 177. Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Bank of Italy - CEPR Conference, Centre "Carlo Azeglio Ciampi", Rome, 15 March 2018.
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Bank of Italy – CEPR Conference Labour market participation: Forces at work and policy challenges Welcome address by the Deputy Governor of the Bank of Italy Luigi Federico Signorini Centre “Carlo Azeglio Ciampi” Rome, 15-16 March 2018 Ladies and Gentlemen, it is a pleasure to welcome the participants to the Bank of Italy-CEPR conference on ‘Labour market participation: Forces at work and policy challenges’. 1 A well-functioning labour market is essential for sustaining growth and maintaining social cohesion. The purpose of this conference is to improve our understanding of the secular changes affecting both labour supply and demand, the attendant threats and opportunities, and the policy challenges. I shall briefly discuss these changes, look at some of the policy measures already undertaken in various jurisdictions, and propose a few open issues for discussion. Trends in labour supply In Europe, labour force participation has increased considerably over the past few decades and, despite marked heterogeneity across countries, has now drawn level with the US. According to the latest data, it was equal to 73 per cent in 2017, around ten percentage points above the level recorded in the early 1980s. There are three main drivers of this development. The first is the growing involvement of women in market work. Female participation in the EU has increased by about 20 percentage points since the early 1980s, reaching 68 per cent in 2017. This reflects various factors: technological progress that has reduced the time required for unpaid household work, greater availability of flexible working arrangements, increased supply of affordable childcare services and more sharing of household work between men and women. With reference to the US, the contribution of female employment to the occupational structure will be the focus of one of the papers to be presented this morning. 2 The second driver is increased education, a feature that is positively associated with labour market attachment. In Europe, the share of individuals aged 20-64 with academic or advanced professional education rose by around 10 percentage points in the last 15 years, reaching 30 per cent in 2017. The greater labour market attachment of persons in central age brackets has more than compensated for the lower participation of younger individuals, who now tend to remain longer in education. I wish to thank Eliana Viviano and Francesco D’Amuri for their assistance in preparing this speech. Cerina, F., Moro, A., and Petersen Rendall, M. (2018), ‘The role of gender in employment polarization.’ The third driver is migration. Immigrants’ labour market participation is high, and their share in the working age population has increased significantly in developed countries (e.g. in Europe from 4.4 per cent in 2002 to 8.2 per cent in 2016). Few papers in the literature have found a negative impact of migration on employment of host-country workers; on the contrary, given that foreign-born and native workers have different skill sets, their respective labour services are often found to be complementary. 3 The positive contribution to labour market participation of some demographic factors is likely to slow in the future. Notably, the baby-boom bulge in the age structure, which for a long time has sustained the share of working-age population, is now starting to push up the share of retirees. For given retirement rules, ageing reduces the participation rate. According to the European Commission, 4 however, the share of active individuals aged 20-64 will still increase by 3 percentage points between 2016 and 2070, owing in part to increases in the statutory retirement age in many countries. Future trends in migration are exceedingly difficult to predict. Migration pressures are likely to increase, as more people in less-developed countries cross the threshold between absolute poverty (which affords no opportunity to move) and that condition where one has acquired the minimum amount of knowledge and resources required to pursue a better life elsewhere. On the other hand, in developed countries issues about the social acceptability of immigration loom increasingly large in the political debate and the management of migrants’ flows and their integration are highly controversial. Trends in labour demand Trends in the demand for labour are driven by the twin primal forces in contemporary economies: technological progress and globalisation. Many fear that downward pressures are deriving from both of these forces in the advanced economies. Historically, there have always been concerns that technological innovation would have negative effects on employment, especially during downturns. In this never-ending debate, views have been rather disparate, with prominent economists occasionally – and not always prudently – venturing into dismal predictions. In the third edition of his Principles of political economy and taxation (1821), Ricardo wrote: ‘The opinion, entertained by the labouring class, that the employment of machinery is frequently detrimental to their interests, is not founded on prejudice and error, but is conformable to the correct principles of political economy’. 5 Peri, G. (2016), Immigrants, Productivity, and Labor Markets in Journal of Economic Perspectives, 30(4). European Commission (2018), Ageing report 2018 - Underlying Assumptions and Projection Methodologies. Ricardo, D. (1821), The Principles of Political Economy & Taxation. London: New York: J.M. Dent; E.P. Dutton, reprinted in 1911. In his famous essay ‘Economic possibilities for our grandchildren’ (1930), Keynes wrote: ‘We are being afflicted with a new disease of which some readers may not yet have heard the name, but of which they will hear a great deal in the years to come – namely, technological unemployment. This means unemployment due to our discovery of means of economising the use of labour outrunning the pace at which we can find new uses for labour.’ 6 He also thought that in one hundred years there would no longer be a need for humans to work much at all. Three hours of work per day would suffice to satisfy the ‘old Adam in most of us’, he said, that is, mankind’s innate urge to produce with ‘the sweat of his brow’. We have twelve years left to reach this goal. 7 In the words of Mokyr et al., 8 ‘if someone as brilliant as David Ricardo could be so terribly wrong in how machinery would reduce the overall demand for labour, modern economists should be cautious in making pronouncements about the end of work.’ Our experience so far is that, in the long run, technological change improves living standards by boosting productivity and increasing output and consumption, without destroying jobs in the aggregate. 9 Average working hours have indeed come down, but they are nowhere near the level Keynes imagined. Doomy predictions suggesting that machines would at a certain point in the future have ‘an absolute and a comparative advantage over humans in all activities’ 10 are likely to prove misplaced. 11 However, technological advances do imply changes in the occupational structure. In recent years, many have detected one such change in the form of a ‘polarization’ of the labour market. Middle-range jobs involving routine-intensive tasks, which can be easily automated, have been hardest hit; as a share of total employment, they have fallen by about 7 percentage points in the US and 9 points in Europe. 12 At the same time, increased employment opportunities have arisen at both ends of the skill distribution. The demand for high-skill professionals has increased because their skills complement technology. But the demand for low-skill workers has also increased, because jobs that are intensive in certain manual tasks (such as personal care services) are not easily replaced by technology, while greater productivity in the rest of the economy and higher incomes translate into greater demand for such services. Keynes, J.M. (1930), ‘Economic Possibilities for Our Grandchildren’, in Essays in Persuasion, New York: W.W. Norton & Co., reprinted in 1963. Ibid, Chapter II. Mokyr, J., Vickers, C. and Ziebarth, N.L. (2015), ‘The History of Technological Anxiety and the Future of Economic Growth: Is This Time Different?’, in Journal of Economic Perspectives, 29(3). Autor, D. (2015), ‘Why are there still so many jobs?’, Journal of Economic Perspectives, 29(3). Mokyr, J., et al, op. cit. DeLong, B. (2017), ‘Inclusive AI: Technology and Policy for a Diverse Urban Future’, speech delivered at the Citris and Banatao institute. OECD Employment Outlook 2017, Chapter 3, p. 121, Figure 3.A1.1. Middle-skill occupations include jobs classified under the ISCO-88 major groups 4, 7, and 8 (clerks, craft and related trades workers, and plant and machine operators and assemblers). Globalisation reinforces this trend. Stronger international competition favours the rise of ‘superstar’, winner-takes-all firms, thus improving the conditions of their workers (not to mention their owners or managers) over all others. At the same time, in many advanced economies delocalisation depresses the demand for intermediate-skill workers employed in the production of tradable goods. The implications in terms of income polarisation are not always obvious. One paper that will be presented here shows that the increase in labour demand at the opposite poles of the skill distribution has also generated endogenous supply responses, such as higher female labour market participation and a rise in immigration. 13 Another paper shows that more innovative firms pay higher wages not only on average, but even to low-skilled workers. 14 However, while the long-run effect of technological change, based on historical evidence, is likely to be entirely beneficial, in the short run disruptions and displacements are to be expected, and many jobs will be at risk. Policies cannot ignore this. Reforms The challenge is therefore to find ways to enable economic systems to reap as many of the long-run benefits as possible, while alleviating any short-run costs of structural change. While a unique first-best solution does not exist, both theory and experience point to the usefulness of certain structural reforms to foster widespread, inclusive growth of employment opportunities. I shall briefly mention three policies that are (or should be) on the agenda of most countries: (i) measures to sustain participation; (ii) measures to improve human capital; (iii) measures to make structural adaptation easier and fairer (‘flexicurity’). Sustaining participation – There are three main developments that can affect participation: • achieving gender parity in participation rates; • extending the working life; • managing migration flows and effectively integrating immigrants. Progress in women’s participation has been substantial in Europe, but in most countries parity remains a distant prospect. The difference between male and female participation rates is currently around 10 percentage points in the European Union and in the United States; despite recent progress, the difference is twice as large in Italy. More flexible working hours and family-friendly workplace arrangements are two ways of Basso, G., Peri, G. and Rathman, A. (2017), ‘Computerization and immigration: theory and evidence from the United States’, NBER WP 23935. Aghion, P., Bergeaud, P., Blundell R. and Griffith, R. (2018), ‘The Innovation Premium to Low Skill Jobs’. achieving more inclusive participation (and, incidentally, a more equitable distribution of household chores). In many European countries there is plenty of scope for further improvement, e.g. concerning the supply of childcare facilities. The continuing increase in life expectancy makes raising the retirement age unavoidable to ensure that pension systems are sustainable; this in turn is bound to result in higher participation rates in the older age brackets. Many European countries are revising, or need to revise, their public pension systems. According to the assessment made in the Macroeconomic Imbalances Procedure by the European Commission released one week ago, 12 members of the European Union have issues concerning the long-term sustainability of their public finances, partly due to pension expenditures. 15 For those countries that adopted ambitious reforms it is important not to backtrack on them in the future. Already legislated pension reforms will imply in Europe, between 2016 and 2070, an increase in the statutory retirement age of more than two years; 16 the impact on labour force participation for the 55-64 age class will be substantial (12 percentage points). The increase will be much stronger in Italy, where radical reforms enacted gradually over the past two decades have transformed what used to be one of the least sustainable public pension systems into one of the most sustainable. Between 1990 and 2016, average age at retirement had already increased from 57 to more than 62; it is expected to have increased by a further five years by 2070. Participation rates in the 55-64 age class are projected to be among the highest in large European countries. (Let me add that we need to revise the age brackets we typically use: ‘65+’ can no longer be taken as synonymous with ‘presumed retired’.) One might think that an ageing workforce would be less productive or innovative, or that grey heads keeping their jobs for longer will displace younger workers. There can be different points of view on this. On the one hand, recent research concerning Italy17 shows that the unexpected increase in the employment of mature workers that took place after changes in public pension rules in 2012 did not reduce employment in other age classes. On the other hand, a paper 18 to be presented tomorrow finds a negative impact of ageing on dynamism and growth. Managing migration is the trickiest challenge of all. Good, dispassionate, data-based economic research may help set the stage for an informed public-policy debate. One paper that will be presented tomorrow 19 on the impact of the regularisation of undocumented migrants on the labour market in Spain is very much in this spirit and provides interesting, nuanced results. European Commission (2018), European Semester Winter Package: reviewing Member States’ progress on their economic and social priorities. European Commission (2018), The 2018 Ageing Report: Underlying Assumptions and Projection Methodologies. Carta, F., D’Amuri, F. and von Wachter, T. (2018), ‘Workforce ageing, pension reform and firms’ dynamics’, Bank of Italy Occasional Papers (forthcoming). Engbom, N. (2018), ‘Firm and Worker Dynamics in an Aging Labor Market’. Monras, J., Vazquez-Grenno, J. and Elias, F. (2018), ‘Understanding the Effects of Legalizing Undocumented Immigrants’. Education – The improvement in the education level of the European workforce during the past ten years is partly due to targeted policies (though the latter differ greatly across countries). For all the progress that has been made, however, there is evidence that European education systems are still struggling to equip workers with the skills they need. A recent survey 20 shows that, especially in southern European countries, an increasingly large share of workers are both over-educated, i.e., they received extra education not required for the job, and under-skilled, i.e., they lack certain specific task-related abilities. This suggests that many European education systems have not quite succeeded in integrating general and vocational education in an efficient, balanced way. The former appears to be biased towards purely academic knowledge, and to neglect the adaptable, problem-solving abilities required in the labour market. The latter focuses too narrowly on specific skills, which raise employability in the short term, but rapidly become obsolete. 21 In respect of education, Italy has a problem of its own. Indicators of formal education (years of schooling, levels of educational attainment at specific ages) have long been significantly lower in Italy than in other countries at a comparable level of development. For a long time this did not seem to matter much. In the 1970s and 1980s, Italy’s ‘industrial districts’ (clusters of small, specialised manufacturing firms) prospered largely on the strength of a peculiar, highly localised form of human capital, acquired in vocational schools, through on-the-job training, and through general social interaction (sometimes called the ‘local industrial climate’). In that context, the returns to formal education appeared to be low. Since then, however, the increasing global importance of technologyrelated skills has radically changed the picture; the ‘industrial climate’, important as it is, is no longer enough. In fact, inadequate human capital development is, I suspect, one of the reasons behind the unsatisfactory productivity growth of the country in the past couple of decades. Favoured by (piecemeal) reforms, some progress is being made along both dimensions of education: average schooling is up, and international comparisons of skills for young cohorts are now less unfavourable than they used to be. However, a gap remains, and in my opinion it receives less systematic public-policy attention than it deserves. 22 Increasing flexibility, providing safety nets – Growing empirical evidence shows that greater labour market flexibility, coupled with policies that reduce labour market duality, results in better outcomes. For example, countries that entered the Great Recession with more flexible labour markets have generally shown greater resilience. Flisi, S., Goglio, V., Meroni, E., Rodrigues, M. and Vera-Toscano, E. (2017), Measuring Occupational Mismatch: Overeducation and Overskill in Europe—Evidence from PIAAC, in Social indicators research, 131(3). Krueger, D. and Kumar, K.B. (2004), ‘Skill-specific rather than general education: A reason for US–Europe growth differences?’, Journal of economic growth, 9(2); Hanushek, E.A., Schwerdt, G., Woessmann, L. and Zhang, L. (2017), ‘General education, vocational education, and labor-market outcomes over the lifecycle’, Journal of Human Resources, 52(1). Brandolini, A. and Cipollone, P. (2001), ‘Multifactor productivity and labour quality in Italy, 1981-2000’, Bank of Italy Working Papers, 422. Bugamelli M., Lotti, F. (2018) Productivity growth in Italy: a tale of a slow-motion change, Bank of Italy, Occasional papers, 422 Colonna, F. (2017), ‘Chicken or the egg? Human capital demand and supply’, Politica economica, 33(1). The issue is how to balance fast system-wide reallocation with sufficiently comprehensive individual security: while not easy, this balance can in principle be pursued through flexible labour regulation accompanied by an appropriate form of protection for those who lose their jobs, by retraining, and by active labour policies. Four papers will be presented at this conference that deal with these issues: specifically, the effectiveness of short-time work subsidies in saving jobs, 23 the relationship between workers’ flows in multi-plant firms and firing restrictions, 24 the relevance of advance layoff notices for workers’ reallocation, 25 and the effectiveness of active labour market programs. 26 In the past few years, many European countries have taken steps to improve the functioning of the labour market. 27 The LABREF dataset of the European Commission, which records all reforms in employment protection legislation, lists almost twice as many measures in 2008-2013 as in the previous seven years. In Italy, the number of reforms grew by a factor of seven during those years, while the reform process continued in 2014 and 2015. Reforms extended the coverage of the unemployment benefit system, enhanced active policies, and increased the flexibility of labour market rules, notably by making firing procedures simpler and less uncertain. The French reform of 2017 goes much in the same direction. Available research has shown that the Italian reforms have contributed to creating new stable jobs after a period of prolonged stagnation, and to accelerating the conversion of temporary into permanent jobs. 28 One paper along these lines will be presented tomorrow. 29 The path ahead Europe has made considerable, if uneven, progress in improving labour-related regulation in the past few years. Even though the profound scars of the Great Recession are still visible in many countries, employment levels are now higher than they were before the crisis started in 2008; the share of individuals actually participating in the labour market is also at its highest level ever, reflecting both increased dynamism in our societies and the effect of policies that have reduced disincentives to work. Still, much remains to be done. Cahuc, P., Kramarz, F. and Nevoux, S. (2018), ‘Short-Time Work and Employment in the Great Recession in France’. Cestone, G., Fumagalli, C., Kramarz, F. and Pica, G. (2018), ‘Insurance Between Firms: The Role of Internal Labor Markets’. Fredriksson, P., Cederlöf, J., Nekoei, A. and Seim, D. (2018), ‘Consequences of advance layoff notice for workers and firms’. van der Klaauw, B. and Ziegler, L. ‘A Randomized Experiment on Matching Unemployed Workers to Employers’. Turrini et al., (2015), ‘A decade of labour market reforms in the EU: insights from the LABREF database’, IZA Journal of Labor Policy, 12(4). Sestito, P. and Viviano, E. (2018), ‘Firing costs and firm hiring: Evidence from an Italian reform’, Economic Policy, 93(33). Boeri, T. and Garibaldi, P. (2018), ‘Graded Security and Labor Market Mobility: Clean Evidence from the Italian Jobs Act’. Labour markets are excessively segmented between insiders and outsiders. Due to persistent rigidities and to less favourable economic prospects than in the past, younger generations entering the labour market today face worse job prospects, in terms of stability, career profiles, and wages, than those enjoyed by previous generations. Technological trends might reinforce the dualism between high- and low-skilled workers. Trade protection or a retreat from the technology frontier would be myopic. Increasing and improving general education and supporting (re-)training are, instead, a priority to make growth more inclusive. A difficult balance needs to be struck between cushioning individual workers from the most disruptive effects of change and fostering the active adaptation of the individuals themselves and of society at large. There is ample scope for further research. I have already mentioned some of the papers in this conference that focus on certain key subjects. Let me mention, by way of conclusion, three additional open issues: • Do we know enough about the actual cost effectiveness of active labour market policies in different institutional frameworks? I have not yet seen much research contrasting the outcomes of such policies with alternative uses of public money, such as a reduction in the tax wedge on labour. • Do we know enough about what drives the efficiency of the matching process between job-seekers and vacancies? Do we understand the reasons for persistent geographical and skill misalignments? What is the key to designing policies to target structural, longterm unemployment? • Finally, many are puzzled by how little wage cyclicality is normally observed, especially at the aggregate level. Can this be due to composition effects, i.e., to the fact that negative demand shocks usually hit low-skilled or low-tenured workers hardest? What is the impact of nominal wage rigidities, and of job-seekers’ behaviour? Barbara Petrongolo, who is to deliver the first speech in this conference, will focus precisely on this last point. I do not want to encroach any further on her presentation. It is therefore high time for me to close these remarks – and to wish you all a stimulating and lively discussion. Designed by the Printing and Publishing Division of the Bank of Italy
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Speaking notes by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the 2018 Conference on "New Frontiers in Banking: from Corporate Governance to Risk Management", Faculty of Economics, La Sapienza University, Rome, 16 March 2018.
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Salvatore Rossi: Which new frontiers in banking? Speaking notes by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the 2018 Conference on "New Frontiers in Banking: from Corporate Governance to Risk Management", Faculty of Economics, La Sapienza University, Rome, 16 March 2018. * * * In the banking business, the concept of frontier – and its crossing – can be intended in several ways. Let’s start with size. After the global financial crisis, banking systems in the large advanced economies have undergone a substantial consolidation process. The number of small banks has decreased; concentration ratios – measured as the share of banking system assets held by the largest five banks – have increased both in the euro area and in the United States. In Italy, at the end of 2016, the share of total assets accounted for by the five largest banks amounted to 43 percent. This process is still under way, and will presumably continue in the foreseeable future. It’s not always a good thing. From a financial stability perspective, big banks should ideally be highly diversified and less exposed to idiosyncratic risks. However, the Lehman crisis proved that big banks may end up holding very similar portfolios, in which case they might become more vulnerable to adverse systemic shocks. In other words, the reduction in idiosyncratic risk might come at the cost of an increase in total risk on their balance sheets. Furthermore, the bigger a bank, the greater the “implicit subsidy” it enjoys in terms of higher likelihood to be rescued in case of distress, either being bailed out or, in Europe, resolved rather than liquidated. It’s the well-known “too-big-to-fail” problem. All in all, big banks are not necessarily safer from a systemic perspective. It’s something that should be evaluated case by case. What about business models? Another “new frontier” for the bank of the future could be a fundamental change in its business model, for instance from traditional retail banking to asset management or corporate/investment banking. The issue there is profitability, and it has very much to do with rules. The current weakness in bank profitability, particularly in Europe, not only depends on macroeconomic cyclical factors, which were very unfavorable in past years, but also on the new requirements in terms of capital and liquidity, that were the regulators’ response to the excessive risk-taking of the pre-crisis era. I don’t think the banking sector could ever be back to the double-digit returns of the past 20 years. It may rather converge to a “new normal” with more low- consuming-capital activities. In any case, a sustained profitability must require cutting operational costs, as well as a lot of investment in new technologies. New technologies are probably the most important new frontier for banks, and I will dwell on them in a minute. Let me first widen the topic of this roundtable a little bit, to the financial system at large. Banks aren’t the only financial players, nor should they be, in perspective, the largely dominant ones, at least in countries like Italy. In this country the financial structure is already evolving, though at a still moderate pace. Non1/2 BIS central bankers' speeches financial firms, especially the biggest ones, are now using equity and bond markets much more than in the past for their financial needs, although still not enough, in my opinion. But in Italy we may need not just more markets. Non-bank intermediaries, such as private equity and venture capital funds, are still underrepresented in the financial landscape. However, from a prudential point of view there’s a delicate balance to strike between a more articulated financial structure, which is desirable per se, and the need not to give “shadow banking” unlimited freedom. We are working, together with our colleagues in the world regulatory circles, on such a difficult puzzle. Let me conclude with some words on the third and most important new frontier that I’ve mentioned before for the financial system: technology. Again I’ll look at this issue from a regulatory point of view. We are observing how digitalisation is already changing the financial business. Although many of our intermediaries, particularly the smallest ones, are lagging behind in the process of digitalisation, the road ahead is clear: we are talking about technologies that are well consolidated, they are not “new” anymore. Fintech firms are a step forward. In a stricter sense, Fintech firms are new players aiming at crowding out traditional intermediaries like banks. Banks are reacting in different ways: some are buying Fintech start-ups and trying to internalize them in their business models, others are establishing partnership agreements and externalizing part of their production function, others are trying to internally develop Fintech-like business units. We don’t know which approach will prevail. What we know is that part of the intermediation chain and of the payment system is moving outside the traditional financial ecosystem. Incumbents are feeling the pressure of these changes. The potential for efficiency gains, increased accessibility to financial services and lower enduser costs are great, but great opportunities always come with great risks. Safeguarding against risks without curbing innovation is the challenge regulators will face in the near future. Existing rules have been designed for traditional activities and intermediaries. It is more and more difficult to understand how, when, and to which agents they can be applied. The temptation to over-regulate, minimizing the risks at the expenses of innovation, may be great. This, however, would not only be against the public interest, but also probably impossible, given the liquid nature of innovation. What regulators may reasonably do is to adopt a pragmatic, flexible approach, coordinated across jurisdictions and based on a continuous dialogue with the industry, as was recently suggested by the FSB. For the time being, approaches and stages of development vary considerably across jurisdictions. The majority of supervisors are still in the early stages of understanding the new phenomena. Continued sharing of supervisory practices in this area is crucial. 2/2 BIS central bankers' speeches
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Opening remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the workshop on "Harnessing Big Data & Machine Learning Technologies for Central Banks", Bank of Italy, Rome, 26 March 2018.
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Harnessing Big Data & Machine Learning Technologies for Central Banks Opening Remarks by the Deputy Governor of the Bank of Italy Fabio Panetta Rome, 26 March 2018 It is my great pleasure to open this workshop on ‘Harnessing Big Data & Machine Learning Technologies for Central Banks’, and to welcome the speakers and participants. I would like to take this opportunity to thank the organizers for putting together such a broad and topical program. Big Data and machine learning are the products of digital technology, whose widespread adoption has important implications for how communication occurs, education is delivered, and knowledge is spread. As we become accustomed to the new digital environment, we are seeing significant shifts in society. Around 80 per cent of Europe’s citizens own a smartphone, personal computer or tablet. The internet is widely used to gather information, communicate and carry out activities that directly or indirectly affect people’s behavior. In Italy 80 per cent of consumers have access to the Internet via a smartphone; half of them have direct access to their checking account and buy goods and services online. Around one third of Italian firms has automated both administrative and back-office activities. The effects of these changes are particularly evident in the financial sector. Globally, the number of users of payment solutions offered by tech giants such as Apple, Google, Samsung or Android has risen from 18 to 144 million in the last two years alone. Amazon Lending1 issued more than one billion dollars in loans last year (from June 2016 to June 2017), three times more than the average over the previous five years. In broad terms Big Data is the application of new techniques to digital information on a size and scale that extends well beyond traditional approaches.2 The word ‘big’ encompasses the volume, diversity and speed with which the data are generated. This idea is synthesized in the three V’s: volume, velocity and variety, as illustrated below. Amazon Lending, the lending arm of Amazon, is a financing service for firms selling through the Amazon platform. Lohr, S., ‘How Big Data Became So Big’, The New York Times, 11 August (2012). Figure Big Data: expanding on three fronts at an increasing rate Data Velocity MB GB TB PB Data Volume Data Variety Central banks could, and definitely should, play an active role in exploiting digital technologies and the enormous amount of data they generate. The flow of high-volume, high-velocity and high-variety information on agents’ preferences and choices can be put to good purpose by policy makers to make better decisions. Along with the traditional data stored in well-defined records, today mobile networks and social media generate a ‘data rainforest’ with diverse sources of semi-structured (such as XML or JSON) and unstructured data (audio/video and free text). The traditional and the new data sources can be used to construct better and more timely measures of economic activity. There are prominent examples of Big Data being used for policy analysis. Big Data is used to estimate unemployment rates or the inflation rates, to improve the forecasts of policy-relevant variables, to compute measures of sentiment of consumers and firms.3 For example, D’Amuri and Marcucci (2017) show that models using Google Trends data give better predictions of US unemployment than those using standard leading indicators. Using online data from the Billion Price Project (BPP), Cavallo (2013) shows that while Argentina’s government announced an average annual inflation rate of 8 per cent from 2007 to 2011, the online data suggested it was actually over 20 per cent, in line with the estimates of some provincial governments, and consistent with the results drawn from surveys of household inflation expectations. Goolsbee and Klenow (2018) use online transactions for millions of products from 2014 to 2017 to demonstrate that online inflation in the US is lower than in the CPI (by around 1.3 percentage points per year) for the same categories. In a similar vein, Daas and Puts (2014) compute a measure of sentiment of the Dutch public using social media messages, which are highly correlated and cointegrated with the monthly consumer confidence index obtained from the classic surveys. The number of potential applications for central banks is enormous, but there are challenges ahead. The technical issues will be discussed in detail in this workshop, but I would like to mention one general, methodological problem now: before using the relationships estimated from the Internet or social media for policy, we have to first ascertain that they are sufficiently robust, representative, and reliable. To do this we have to invest in research. An important field that is deeply affected by the innovative technologies designed to extract value from Big Data is financial stability. Fintech firms use Big Data and new technologies to create new products and grant continuous access to financial services. This is a welcome development, as it increases competition and stimulates productivity. However, the development of new lines of business and closer, direct interconnections between banks, other intermediaries and investors may well affect the stability of the system. Public authorities must carefully examine the changes induced by digital technologies and value innovative projects to preserve the stability, the efficiency, and the security of the financial sector. The complexity is increased by the fact that central banks are at once both users and producers of information and Big Data. Proof of this is the collection of highly granular data on individual bank loans by the Single Supervisory Mechanism (the so called AnaCredit), on daily money market statistical reporting by the European System of Central Banks, and on the trading repositories envisaged by the European market infrastructure regulation. The sheer amount of these granular data makes it clear that the necessary validation processes cannot be performed manually, but will require sophisticated algorithms and techniques such as machine learning or artificial intelligence. Central banks should master these new technologies. The Bank of Italy has created an internal multidisciplinary team on Big Data which includes economists, statisticians and computer scientists from different departments, working in close cooperation with the Directorate General for Information Technology. The team has built a hardware and software infrastructure in order to deal with different kinds of Big Data for both macroeconomic and microeconomic issues. Some of the results will be discussed during this workshop. The analyses focus on using unstructured textual data from social media, in particular Twitter, to compute inflation expectations4 or to gauge retail depositors’ trust.5 See C. Angelico, J. Marcucci, M. Miccoli, and F. Quarta, ‘Can We Measure Inflation Expectations Using Twitter?’. M. Accornero and M. Moscatelli in ‘Listening to the buzz: social media sentiment and retail depositors’ trust’, a measure of retail depositors’ trust by checking Twitter comments. Banca d’Italia, Temi di Discussione (Working Papers), 1165 (2018). Social media are also used to assess customers’ sentiment towards specific companies and its effect on stock returns, volatility and trading volumes.6 Twitter and news are used to measure economic policy uncertainty and to focus on payment card scams, to then relate them to trends in consumer payments. Another strand of research uses data from single online real estate ads extracted from the web to understand the microstructure of the Italian real estate market.7 Let me conclude by thanking once again all the speakers, discussants, panelists and participants for being here. I look forward to hearing more about your findings on Big Data and machine learning, and their applications for central banks and policy analysis. It is important that this workshop brings together researchers from central banks and academia, who can provide a broad variety of perspectives. I am sure we will have two productive and interesting days. See G. Bruno, P. Cerchiello, J. Marcucci, and G. Nicola, ‘Twitter Sentiment and Banks’ Equities: Is there any causal link?’. See M. Loberto, A. Luciani, and M. Pangallo, ‘The Potential of Big Housing Data: an application to the Italian Real Estate Market’, based on data from www.immobiliare.it. References Accornero M. and M. Moscatelli, 2018, “Listening to the buzz: social media sentiment and retail depositors’ trust”, Bank of Italy Working Paper, No. 1165. Angelico C., J. Marcucci, M. Miccoli and F. Quarta, 2018, “Can We Measure Inflation Expectations Using Twitter?”, mimeo. Bruno G., P. Cerchiello, J. Marcucci and G. Nicola, 2018, “Twitter Sentiment and Banks’ Equities: Is there any causal link?”, mimeo. Cavallo A., 2013, “Online and official price indexes: Measuring Argentina’s inflation”, Journal of Monetary Economics, 60(2): 152-165. Daas P. J. H. and M. J. H. Puts, 2014, “Social Media Sentiment and Consumer Confidence”, ECB Statistics Paper Series, n. 5. D’Amuri F. and J. Marcucci, 2017, “The predictive power of Google searches in forecasting US unemployment”, International Journal of Forecasting, 33(4): 801-816. Goolsbee A. D. and P. J. Klenow, 2018, “Internet Rising, Prices Falling: Measuring Inflation in a World of E-Commerce”, Stanford University working paper. Loberto M., A. Luciani and M. Pangallo, 2018, “The Potential of Big Housing Data: an application to the Italian Real Estate Market”, mimeo. Lohr S., 2012, How Big Data Became So Big, The New York Times, 11 August 2012. Designed by the Printing and Publishing Division of the Bank of Italy
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Closing remarks by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the workshop on "Harnessing Big Data & Machine Learning Technologies for Central Banks", Bank of Italy, Rome, 27 March 2018.
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Harnessing Big Data & Machine Learning Technologies for Central Banks Closing Remarks by the Deputy Governor of the Bank of Italy Luigi Federico Signorini Rome, 27 March 2018 Ladies and gentlemen, This two-day workshop on ‘Harnessing Big Data & Machine Learning Technologies for Central Banks’ is now drawing to a close. Let me begin by thanking all the speakers, discussants and participants who have contributed to the success of this initiative. I have the pleasure of sharing with you some thoughts on the main issues. The papers presented during this two-day workshop have left no doubt as to the actual and potential value of big data and their importance for economic analysis. The present wave of data warehousing and business analytics confirms this, with big data poised to deliver topline research and statistical applications in a cost-effective way. Huge amounts of data can provide substantial insights for the private and public sectors, enabling them to transform these data into new products and services for customers and citizens. Big data are already changing some aspects of business in the financial industry with regard to banks, hedge funds, broker-dealers, and other firms. Central banks and supervisors are also interested. The widespread adoption of digital technology has increased the number and depth of information sources of interest to economic analysis and financial stability, two of the core concerns of financial authorities. We are not only voracious data users, we are also big data producers. We collect terabytes of granular data in the fields of banking supervision, oversight of financial markets and payment systems. Central banks can and should harvest the benefits of new technologies. We should select the best technology and exploit its power in turning ideas into actual applications and improved statistical and computing efficiency. The potential is huge, but there are, as usual, pros and cons. There are important trade-offs that must be kept in mind. I see two main issues, or rather groups of issues. One is technical, and some papers in this workshop have pointed to it. We need to keep analysing and experimenting in order to be able to assess the real information value of big data bases. ‘N = All’, as in the popular definition by Mayer-Schönberger and Cukier 1, may sometimes be illusory. Sometimes big data turn out not to be representative of the whole population. For example, Groves (2016) 2 argues that big data often contain few variables and extracting their value requires linkages to other data; furthermore, they lack representativeness. Social media or any other internet-based sources of big data also usually lack full coverage of the population of interest. The availability of massive amounts of data increases the chances of finding an exceptionally good fit in sample when one estimates any model, but a very poor performance out of sample. Big data are harvested from different technical sources and change with consumers’ preferences. Therefore, the parameters estimated using these data can be subject to different forms of instability. This, however, is not unique to big data. Large volumes, variety, and the short-lived nature of data available on web pages make it difficult to accumulate and preserve historical big data; their preservation is hampered by changes in physical storage devices, IT platforms and software. This point deserves attention. Poor preservation or the loss of data could jeopardise the accountability of decisions and research reproducibility. The other key issue with big data is the protection of integrity, confidentiality and privacy of data. Exploitation of data must be respectful of this principle, in legal and ethical terms. The effective application of the relevant laws and international coordination are essential in this field. Let me now conclude by touching on some principles that we follow in the Bank of Italy as large producers, consumers and providers of data. We adopt an integrated approach to collecting and processing banking and financial data. As I have said on other occasions, we have always gathered information from reporting agents following a single protocol and have then used this information for V. Mayer-Schönberger, and K. Cukier, Big Data: A Revolution That Will Transform How We Live, Work, and Think, Houghton Mifflin Harcourt, 2013. R. M. Groves, ‘Nonresponse Rates and Nonresponse Bias in Household Surveys’, Public Opinion Quarterly, Vol. 70(5): 646-675. multiple purposes. 3 This ensures consistency across datasets and intermediaries and reduces the need for burdensome ex-post data reconciliation. We have followed this approach since the 1980s. The Bank of Italy has developed a shared corporate statistical data dictionary and a corporate statistical data warehouse to ensure the uniqueness of reporting models. Both were planned with a view to managing the different areas of statistical and supervisory information as parts of a single system. Although the supervision and central banking functions require their own analytical approaches, their decision-making processes draw on the aforementioned data dictionary and warehouse. The same holds for other uses of the data, such as for research and official statistics. Some of the data we manage are confidential and/or sensitive. The protection of the integrity and confidentiality of data is therefore a key concern. Access to data is suitably restricted within the Bank, and data management follows clear rules on procedures and responsibility. Central banks must also be ready to cope with the increasing demand by the public for access to granular data. As a data producer, the Bank of Italy has always strived to make its statistics available to the widest possible audience. We already share some data with researchers and other institutions, with appropriate and adequate protection of confidentiality, of course. Within the Eurosystem’s Household Finance and Consumption Survey (HFCS), Italian data are available on request alongside those of other euro-area countries. For firms’ data, which are much more difficult to anonymize, the Bank has developed a remote access system called BIRD (Bank of Italy Remote Access to Data), which enables users to perform their analyses online, thereby preserving data confidentiality. Particularly confidential data might require on-site access. The Bank of Italy has started to design a Research Data Centre which will have a suitable taxonomy of confidentiality areas. Cfr. comment by L.F. Signorini to the paper “Ways to improve the use of banking statistics by policy-makers: what is reasonable, what is feasible and what the SSM and the banking union are calling for” by Fernando Restoy. Seventh ECB conference on statistics ‘Towards the banking union –opportunities and challenges for statistics’ ECB (2015). Other European countries have already started to work on this (the Centre d’accès sécurisé aux données in France, the Administrative Data Research Network in the UK and the Deutsche Bundesbank Research Data and Service Centre). In addition, we need to find solutions to allow us to link microdata belonging to different institutions without compromising individual confidentiality. The explosion of granular data provides many new research opportunities. For all the issues I have highlighted, big data have big potential. In the past two days we have just scratched the surface. More research is surely needed. I wish to thank you all very much for your participation. Special thanks to all the speakers, discussants, chairs and participants for making the sessions lively and thoughtprovoking. Finally, I would also like to take this opportunity to thank all those involved in preparing this event. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the conference "A Future for Europe", held in memory of Giacomo Vaciago and organised by the Università Cattolica del Sacro Cuore and the Associazione per lo Sviluppo degli Studi di Banca e Borsa (ASSBB), Milan, 6 April 2018.
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Università Cattolica del Sacro Cuore A Future for Europe. Conference in memory of Giacomo Vaciago Monetary policy in the euro area: past, present and near future Speech by the Deputy Governor of the Bank of Italy Fabio Panetta Milan, 6 April 2018 1. Introduction 1 The figure of Giacomo Vaciago is part of our country’s recent history. Following his studies at the Catholic University of Milan and at Oxford, Giacomo was a Professor of Economics at Ancona and then Professor of Political Economy and Monetary Economics at the Catholic University of Milan. In 2016 the Catholic University awarded him the title of Emeritus Professor, closing the circle that began with his graduation in 1964. The strength of Giacomo’s commitment to society and its institutions is well-known: columnist for the newspaper Il Sole 24 Ore from 1983; advisor to the Minister for the Treasury (1987-1989) and to the Prime Minister (1992-1993); Mayor of Piacenza (1994-1998); advisor to the Ministry of Art and Culture (2003-2005) and to the Minister of Labour and Social Policies (2014-2016). Giacomo was a committed European. His last book, Un’anima per l’Europa (A soul for Europe), posed some key questions about the future of the Union. 2 Four years ago he urged Europeans to ‘pool their virtues rather than their vices’ – something they had often done in the past – and his words still hold true today. But first and foremost, Giacomo was a friend I had the good fortune to work with on several occasions. Our conversations were an opportunity to look more closely at problems and analyse them rigorously, but also a way to defuse situations, tongue-in-cheek. The page commemorating Giacomo on the Catholic University’s website opens by noting that ‘students who attended Giacomo Vaciago’s lessons on Monetary Economics and Political Economy were very fortunate, because they learned things that are not in the textbooks’. Indeed, the monetary policy of recent years can certainly not be found in a textbook: it is no coincidence that Giacomo observed it carefully and was a strong supporter. 3 In a speech I gave in April 2016 my starting point was the observation that in the decade following the collapse of Lehman Brothers central banks have been more creative and I would like to thank Piergiorgio Alessandri, Marco Casiraghi, Pietro Rizza, Stefano Siviero, Emilio Vadalà and Gabriele Zinna for their useful comments and help in preparing the text. ‘Continue along the path of Union? How? Only a small part of what we have today is an economic union: the decisions of national and local governments and the many corporations in each country still count for too much. Nor can we speak of monetary union until banking union has been achieved. So what is lacking in our very incomplete union?’ Interviewer: ‘But can quantitative easing work?’ Giacomo Vaciago: ‘It took Draghi a year to convince the Germans that it was possible and he has never backed down on this; it is he who is the true German at heart’. (AGI Roma, 8 March 2015). enterprising than might have been expected. 4 It’s natural to wonder what has changed in the last two years and to revise those reflections in the light of the challenges that central banks face today. 2. Inflation in Italy and in the rest of the world: the outlook beyond the short term Inflation in the leading economies has been anomalous recently for at least two reasons. First of all, after the onset of the financial crisis, inflation was very low compared with that recorded after World War II (Figure 1). 5 Moreover, it has varied considerably less than in the past. This exceptionally and persistently low inflation has provoked a debate over the adequacy of central bank objectives, tools and strategies. The scale and variety of the monetary policy interventions implemented by the major countries in the last few years is well-known and there is no need for me to list them here. 6 Less well-known is the evidence for the strong impact of these interventions on inflation and growth in the Eurozone. 7 The first clear sign of their effectiveness is the lower risk of deflation: in 2014, before the announcement of the Public Sector Purchase Programme (PSPP), 8 the probability of deflation over a five-year time horizon was more than 30 per cent (Figure 2); 9 this gradually declined to practically nil in 2017. As for growth, our estimates show that the Asset Purchase Programme (APP) raised productive activity by almost 2 percentage points cumulatively in the two years 2016-2017, 10 which is consistent with President Draghi’s assessments. 11 The benefits of monetary stimulus have not come to an end. In the light of the recent positive signs for the economy, last October the ECB Governing Council decided to extend its Cf. Panetta (2016). Low (or negative) inflation rates were more common between the end of the 19th century and World War II. But things were different then: the gold standard limited the money supply and full employment and growth did not influence the decisions of the monetary authorities (Bordo and Schwartz, 1999). Cf. Visco (2016) and Bank for International Settlements (2015). Cf. Casiraghi, Gaiotti, Rodano and Secchi (2016). The PSPP, launched in March 2015, provided for the purchase on the secondary market of public sector securities with remaining maturities of between 1 and 30 years. Purchases are limited to an issue share of 33 per cent, mainly so as not to influence market prices. Estimates were based on inflation option prices; see Cecchetti, Natoli and Sigalotti (2015). Estimates were calculated using the model proposed by Burlon, Gerali, Notarpietro and Pisani (2015). Cf. Draghi (2018). asset purchases until September 2018, reducing the monthly pace from €60 billion to €30 billion, and strengthen its forward guidance at the same time. 12 Inflation and growth signals are encouraging, but the objective has not yet been reached. It is crucial, therefore, to analyse the causes of low-flation. The fundamental question is to what extent low inflation is a structural rather than a cyclical phenomenon. The answer to this question has implications both for managing monetary policy in the short term and for deciding on central banks’ strategies and tools for the next few years. 3. The causes of low-flation Among the root causes of low-flation, experts often cite the structural changes that have taken place in recent decades, first and foremost the globalization and technological progress that are transforming production processes worldwide. 13 Globalization – and with it the entrance of several emerging countries, notably Eastern European countries and China, on the world trade stage – has fostered the delocalized production of goods and services, making inflation in the advanced countries less sensitive to domestic economic conditions, especially in the labour market. In the advanced economies this has caused production costs in a number of traditional sectors to fall, converging towards those of the emerging countries. 14 The second factor, i.e. the spread of new technologies, can directly curb inflation by raising productivity or by exerting downward pressure on wages and by reducing or eliminating certain low-value-added jobs that are increasingly taken over by machines. Productivity, however, has slowed in the advanced economies in the last ten years. 15 Technology can affect inflation indirectly as well, by fostering globalization and the development of global value chains. 16 The ‘Amazon effect’ is one such technology factor: 17 the internet allows consumers to compare prices, thereby reducing retailers’ margins with repercussions on price levels and dynamics. 18 Rates will be raised and reinvestment interrupted only well past the horizon of the ECB’s net asset purchases. See, for example, Jens Weidmann’s speech on 18 January 2018. Cf. Auer, Borio and Filardo (2017). See Manaresi and Pierri (2017). A global value chain is a type of organisation in which the individual stages of production are carried out by companies located in different countries. See Forbes (2016). Cf. Yellen (2017). Thus, a country’s inflation would be largely independent of the domestic economic situation, making it harder for central banks to control it. This is only part of the story, however. Globalization and technology have undoubtedly exerted downward pressure on prices. Such factors have been at play for some time, though, and may account in part for the slow decline of inflation in recent decades, but for the very same reason they cannot explain the rapid decrease of recent years. Moreover, globalization has been slowing lately, not accelerating. This has happened with integration through global value chains: the share of export value added generated outside the exporting country has ceased to grow worldwide since the onset of the crisis in 2008 (Figure 3). 19 The same applies to e-commerce, which in recent years appears to have had less of an effect on prices than before: in the United States the Amazon effect is estimated to have reduced personal consumption expenditure inflation by 0.1 per cent, which is less than the Walmart effect did at the beginning of the millennium.20 The profit margins of traditional retailers cannot keep falling forever: once equilibrium is reached, any cost increases are bound to be transmitted to the prices of final goods. The integration of the markets for goods and factors of production seems to have produced limited effects. The link between Eurozone inflation and global unutilized capacity is tenuous. 21 Empirical analyses support the hypothesis that globalization has not altered the relationship between inflation and output gap. 22 All told, it is difficult to pinpoint the causes of low-flation without resorting to standard explanations from macroeconomics textbooks: a negative output gap and weak inflation expectations. Such an interpretation fits the observation that inflation has become increasingly sensitive to the Eurozone economic cycle in recent years, 23 but the data need to be analysed with care. The rate of unemployment in the Eurozone has diminished by some 3 percentage points since 2013, falling to the current level of 9 per cent. Unemployment is back to what it was before the sovereign debt crisis, but inflation is still below the level observed at that time. This OECD (2017). Charbonneau, Evans, Sarker and Suchanek (2017). Several studies have looked at the possibility of including measures of global value chains and unutilized capacity in analyses of Eurozone inflation based on the Phillips curve; see European Central Bank (2017). See, for example, Gaiotti (2010). Riggi and Venditti (2015). seemingly contradicts the explanation of low-flation as being due to factor underutilization and below-potential economic activity. The contradiction is only apparent, however. The unemployment rate is an imperfect measure of actual labour utilization as it only considers job-seekers. In fact it rises to 18 per cent if labour utilization is calculated to include underutilized labour. 24 The figure is not far off the value recorded in 2013 (20 per cent), at the end of the last recession. 25 Empirical analyses 26 lend support to the hypothesis that wage growth was held down in the last expansionary phase of the cycle by the fact that actual labour utilization was less than the unemployment rate indicated. 27 The second traditional determinant of inflation – i.e. expectations regarding its future path – can also be influenced by low observed inflation. When the economic context is undergoing change, firms and households without exhaustive information about the state of the economy may form their inflation expectations through a process of gradual learning, attributing the greatest weight to recent dynamics. Hence, a series of deflationary shocks (like those observed in the euro area from 2013 on) may contribute to de-anchoring inflation expectations, making convergence towards the central bank’s aim a lengthier and more costly process. 28 This type of mechanism fits the data in the Bank of Italy’s Survey on Inflation and Growth Expectations: in recent years firms’ expectations have been heavily influenced by (low) inflation. Moreover, firms now concur in forecasting low inflation, whereas previously an inflation rate that was far from the objective was associated with a wide dispersion of expectations. This would suggest that low-flation is no longer regarded as an anomaly, but increasingly as the norm. 29 Lower and less widely dispersed inflation expectations entail a risk they will become de-anchored, so that observed future inflation will be more likely to remain low. These trends are reflected in wage negotiations. On several occasions between late 2015 and early 2016, the social partners in Italy did not take inflation expectations into account in their negotiations, 30 so that many of the contracts signed at the time either ignored inflation or Underutilized labour includes part-time workers (who would be willing to work longer hours), job-seekers not immediately available and discouraged workers (those willing to work but no longer actively job-seeking). The number of hours worked per employee is still 4 per cent below the pre-crisis average. Bulligan, Guglielminetti and Viviano (2017). Nominal wages grew on average by 1.3 per cent from 2013, well below the pre-crisis rate. Cf. Busetti, Ferrero, Gerali and Locarno (2014). Cf. Bartiloro, Bottone and Rosolia (2017). This is also due to an attempt by firms to recoup at least part of the pay rises paid in 2013-15 over and above observed inflation. included automatic ex-post wage indexation. In other cases the renewal of expired agreements was postponed. As a result, less than a fifth of the labour contracts in force at the end of 2016 included expected inflation among the parameters for calculating pay rises. Thus, the data indicate that labour is still a widely underutilized factor of production and that inflation expectations reflect the deflationary shocks of recent years. These are cyclical problems, not structural ones. 4. Monetary policy implications These considerations explain and justify the Eurosystem’s current expansionary monetary policy stance, which is designed to stimulate demand, increase factor utilization and exert upward pressure on wages. The goal is to secure a self-sustained return of the inflation rate towards levels that are below but close to 2 per cent, one that is not solely based on current policies or on temporary factors like oil prices. As President Draghi has pointed out, this requires trust in the effects of monetary policy, persistence in pursuing the objective, and patience in waiting for the effects to emerge. The Eurosystem’s policies reflect the degree of prudence required during this phase. The ECB Governing Council has recently recalibrated its asset purchases, both public and private, and has reinforced its forward guidance. It has announced that rates will remain at their present levels for a prolonged period of time, well past the end of net purchases under the programme, which will continue at least until September 2018. In addition, the Eurosystem will reinvest the principal payments from maturing securities for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary. It has also clarified that the intensity of the monetary stimulus will depend on economic and financial conditions in the Eurozone. In March, the Council adjusted its communication to reflect the economy’s lower exposure to tail risk as compared with the past. 31 Naturally, this does not eliminate the need to assess well in advance, even as of now, the implications of monetary policy normalization, which will occur sooner or later. The experience of others countries 32 indicates that the normalization process is a delicate transition, one where Reference to the possibility that the Council might increase the amount and duration of purchases was eliminated following particularly weak inflation dynamics. The Federal Reserve ended its asset purchase programme in 2014 and raised rates for the first time one year later. Only subsequently did it reduce the stock of securities in its portfolio. The Bank of England’s normalization was altered by the unexpected outcome of the EU referendum, requiring additional expansionary measures. tensions and sudden increases in volatility are possible. 33 But even this process, if prudent and gradual, may be managed without shocks to the financial system and the economy. The Federal Reserve Chairman Powell underlined the importance of gradualism in adjusting monetary policy to the macroeconomic outlook and in achieving the Federal Reserve’s objectives. 34 There is no reason to believe that monetary policy normalization in the Eurozone cannot be achieved without shocks to the financial system or the real economy, as long as it takes place gradually, within a context of robust growth. Gradualism is always essential when there is marked uncertainty about current macroeconomic conditions – and in the euro area this largely reflects the difficulty of accurately measuring potential output and labour utilization. Prudence is also needed to ensure that inflation expectations are consistently in line with the objective of price stability following the long phase of low-flation. Lastly, another important factor is the asymmetric distribution of risks – an early exit would involve greater risks than a late one, in that it could hamper the recovery and the return to price stability. The signs are encouraging. For example, labour contracts signed in Italy in recent months have again started to refer to expected inflation. 35 But monetary policy must remain expansionary for an extended period of time. 5. The outlook for the Italian economy The Italian economy is able to absorb a rise in the yield curve as long as it is associated to a strengthening of the business cycle. Compared with the most serious phase of the crisis, GDP has returned to steady growth, boosted by both domestic and foreign demand. The improvement in labour market conditions and in confidence is buoying consumption. Given the favourable expectations for demand, investment has returned to sustained growth; it should regain precrisis levels in 2019. The growth in exports since 2010 exceeds that of potential foreign In the spring of 2013 the first signs of a possible reduction in monetary stimulus by the Federal Reserve provoked a brusque reaction in the markets (the ‘taper tantrum’): interest rates in dollars rose sharply, causing a drop in share prices and an increase in volatility and risk premiums. The Federal Reserve kept its asset purchases unchanged until the end of the year, underlining the difference between changes in the programme and the management of interest rates. An increase in volatility was also recorded in February, when the release of better than expected employment figures generated fears that rates would increase faster than projected. The correction was amplified by the widespread use of ‘short volatility trades’. Cf. Bhansali and Harris (2018). ‘We are in the process of gradually normalizing both interest rate policy and our balance sheet’. ‘In the [FOMC’s] view, further gradual rate increases in the federal funds rate will best promote attainment of both of our objectives’ (Powell, 2018). Some contracts signed in the third quarter of 2017 (trade, telecommunications, goods transport and logistics, postal services) provide for significant wage increases (see Banca d’Italia, 2018). Moreover, unlike in the previous two-year period, they did not incorporate automatic adjustments for actual inflation, which could limit wage growth in a context of low inflation. demand; it was more than 5 per cent in 2017, despite the appreciation of the euro. The balance on current account, which had been positive since 2013, recorded a surplus of nearly 3 per cent of GDP in 2017. The net debtor position has decreased considerably, from 25 per cent of GDP in 2014 to less than 7.5 per cent in 2017, the lowest figure since 2002. According to our projections, the net international investment position will continue to improve over the next three years, to the point where it will turn positive. Against this background, the financial situation of households and firms and that of banks has improved. The latter, as well as recording a sharp drop in the flows and stocks of nonperforming loans, will benefit from the increase in profits stemming from the upturn in market yields. 36 Despite the high debt-to-GDP ratio – partly a legacy of the crisis – an increase in yields under orderly conditions would not put the sustainability of public finances at risk. After increasing by 30 percentage points since the onset of the crisis, over the last few years the debtto-GDP ratio has remained essentially stable thanks to the improvement in growth and to the primary surpluses. Furthermore, the high average residual maturity – more than 7 years – significantly tempers the sensitivity of the cost of debt to interest rate shocks. According to our estimates, a permanent increase of 1 percentage point in debt issuance costs would mean an increase in the ratio of interest expense to GDP of about 0.1, 0.2 and 0.4 percentage points over one, two and three years respectively. 37 While these trends may be reassuring, they are not sufficient to eradicate doubts or fears regarding the sustainability of debt in the medium term. Over the next decade, the public debtto-GDP ratio is expected to narrow, partly owing to an increase in interest rates, but only if the differential between the cost of debt and real GDP growth remains small and budgetary policy is prudent (Figure 4). In this type of scenario, debt could fall to 100 per cent of GDP in ten years if the primary surplus stays in line with the objectives set out last September in the Update to the Economic and Financial Document. 38 The main element in these analyses is not just the real interest rate – ‘r’ as the macroeconomists call it – but the gap between this rate and that of real GDP growth, i.e. ‘r-g’: Bank of Italy (2017a). Bank of Italy (2017a). In the baseline scenario in Figure 4, in which the public debt-to-GDP ratio falls below 100 per cent in 2027, we assume that the primary surplus rises to 3 per cent in 2020, that GDP grows by 1.5 per cent and that the average real interest rate paid on government debt converges to 2.5 per cent over the next 20 years. given the same initial debt, a rapidly growing economy can clearly bear greater financial burdens. 39 We must not forget that the cost of debt also depends on the sovereign spread demanded by investors. Keeping the spread down is obviously easier if the outlook for growth is solid, so robust growth is crucial to ensure debt sustainability against a backdrop of growing interest rates. 40 Without it, no financial alchemy or miraculous measures of austerity can guarantee the correction of the public finances. Nor should we forget that, when the time is right, monetary policy will gradually be normalized at a pace in line with the macroeconomic trends in the euro area as a whole and not with those in Italy. The economic situation is improving in this country, but any increase in potential long-term growth – indicated by g – requires us to persevere resolutely with the reforms already under way to resolve the structural problems of Italy’s economy. It is a question of expanding the potential for growth and no longer, or not only, of narrowing a negative output gap. If we act quickly we will be able to exploit the synergy between monetary and structural policies: an expansionary monetary policy to sustain aggregate demand helps in carrying out reforms, thereby reducing the short-term costs. Seizing the opportunities provided by the current favourable economic situation will also provide greater room for manoeuvre to deal with adverse cyclical situations in the future. Lower public debt would also make it possible to reduce the distortions caused by a high tax burden and to boost investment in human and physical capital. These reflections on the normalization of monetary policy remind us that a prudent budgetary policy is in Italy’s interests, regardless of the indications provided by the international institutions. It is also vital for economic and financial stability, and for growth. 6. Conclusions Monetary policy has played a fundamental role in steering the economy and the financial system out of the crisis. Low-flation makes the current accommodative monetary policy If the cost of debt exceeds GDP growth (r>g), stabilizing the debt-to-GDP ratio requires a primary surplus (revenue exceeding expenditure net of interest payments). The higher the interest rate and the lower the GDP growth rate, the larger the balance needed to guarantee stability. Cf. Domar (1944). For an analysis of the outlook for the public finances in Italy see Visco (2017). A rise in interest rates accompanied by higher growth would not undermine stability even in countries with high debt levels such as Italy and Japan. Only an increase in interest rates that is not tied to prospects for growth would produce risks; cf. Blanchard and Zettelmeyer (2017). necessary. In due course, monetary normalization will have to be gradual and calibrated to the macroeconomic situation. The Italian economy need not fear this normalization process, but it could deal with it from a much stronger position were it not hampered by a high debt-to-GDP ratio. The debate on monetary normalization will bring the topic of reform to the fore. In an economy with high public debt and low productivity, reform is essential for increasing potential growth and making the economy less vulnerable, and it is in everyone’s interest to pursue it. In an interview in 2013, Giacomo Vaciago answered a question on the pros and cons of the Fiscal Compact as follows: ‘I still see people carrying pieces of paper from one office to another in many public institutions … I still get e-mails from people asking me to send a fax or letters that have to be put into envelopes and stamped… If we’re still using 20th century technology we’re clearly not ready for growth’. If we all made a concerted effort to adopt reforms and use ‘this century’s technology’, we would be doing a favour, posthumous maybe, to the colleague and friend we are remembering today. Figure 1: Inflation, 1946 - present Annual growth rates of the consumer price index, 5-year moving averages. Source: C. Reinhart and K. S. Rogoff, ‘From Financial Crash to Debt Crisis’, NBER Working Paper, 15795. Figure 2: Inflation expectations derived from option prices Eurozone risk-neutral 5-year inflation probability derived from the price of inflation options. For the methodology used, see Cecchetti, Natoli and Sigalotti (2015). The risk-neutral probability reflects both expected inflation and risk premiums. The figure shows the change in the probability of inflation falling within various intervals in the next 5 years. The probability of zero or negative inflation is shown in the lower section (dark area) of the figure. Figure 3: Global value chains and inflation For the construction of the data on global value chains, see Borin and Mancini (2015). Core inflation is calculated net of energy and fresh food products and refers to the average for OECD countries. Source: OECD. Figure 4: Simulation of the trend in the debt-to-GDP ratio Baseline scenario: potential growth (g) of 1.5%; average real interest rate on the public debt (r) converging to 2.5% in about 20 years; primary surplus (D) increasing to 3.0% (in 2020). The other scenarios are constructed by adjusting some of the hypotheses in the baseline scenario. Yield shock: r increases by 1 percentage point in 2018, converging to 3.5% in about 20 years. Higher growth: g=2.5%. Lower growth and primary surplus: g=0.5% and D=1.5%. Lower growth: g=0.5%. References Auer R., Borio C. and Filardo A. (2017), ‘The globalisation of inflation: the growing importance of global value chains’, Bank for International Settlements, Working Paper No 602. Bank for International Settlements (2015), Annual Report, Chapter IV. Banca d’Italia (2017), Economic Bulletin, 1. Banca d’Italia (2017a), Financial Stability Report, 2. Banca d’Italia (2018), Economic Bulletin, 1. Bartiloro L., Bottone M. and Rosolia A. (2017), ‘What does the heterogeneity of the inflation expectations of the Italian firms tell us?’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 414. Bhansali S. and Harris, L. (2018), ‘Everybody’s Doing It: Short Volatility Strategies and Shadow’, Financial Analyst Journal. Blanchard O. and Zettelmeyer J. (2017), ‘Will Rising Interest Rates Lead to Fiscal Crisis?’, Petersen Institute for International Economics, Policy Brief, 17-27. Bordo M. D. and Schwartz A. J. (1999), ‘Monetary Policy Regimes and Economic Performance: the Historical Record’, in Handbook of Macroeconomics, vol. 1, ed. J.B. Taylor and M. Woodford. Borin A. and Mancini M. (2016), ‘Follow the value added: bilateral gross export accounting’, Banca d’Italia, Temi di Discussione (Working Papers), 1026. Bulligan G., Guglieminetti E. and Viviano E. (2017), ‘Wage growth in the euro area: where do we stand?’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 413. Burlon L., Gerali A., Notarpietro A. and Pisani M. (2015), ‘Inflation, financial conditions and non-standard monetary policy in a monetary union. A model-based evaluation,’ Banca d’Italia, Temi di Discussione (Working Papers), 1015. Busetti M., Ferrero G., Gerali A. and Locarno A. (2014), ‘Deflationary shocks and de-anchoring of inflation expectations’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 252. Business Community (2013), (http://www.businesscommunity.it/m/_Gennaio2013/cover/Vaciago). Casiraghi M., Gaiotti E., Rodano L. and Secchi A. (2016), ‘The Impact of Unconventional Monetary Policy on the Italian Economy During the Sovereign Debt Crisis’, International Journal of Central Banking. Cecchetti S., Natoli F. and Sigalotti L. (2015), ‘Tail co-movement in option-implied inflation expectations as an indicator of anchoring’, Banca d’Italia, Temi di Discussione (Working Papers), 1025. Charbonneau K., Evans A., Sarker S. and Suchanek L. (2017), ‘Digitalization and Inflation: A Review of the Literature’, Bank of Canada, mimeo. Domar E. (1944), ‘The Burden of the Debt and the National Income’, American Economic Review, 34(4). Draghi M. (2018), Hearing of the Committee on Economic and Monetary Affairs of the European Parliament, 26 February. European Central Bank (2017), ‘Domestic and global drivers of inflation in the euro area’ Economic Bulletin, 4. Gaiotti E. (2010), ‘Has Globalization Changed the Phillips Curve? Firm-Level Evidence on the Effect of Activity on Prices’, International Journal of Central Banking. Forbes (2016), ‘How the Internet Economy Killed Inflation’, 28 September. Manaresi F. and Pierri N. (2018), ‘Credit supply and productivity growth’, Banca d’Italia, Temi di Discussione (Working Papers), 1168. OECD (2017), A Genie in A Bottle? Globalisation, Competition and Inflation. Panetta F. (2016), ‘Central banking in the XXI century: never say never’, Remarks at the SUERF/BAFFI CAREFIN Centre Conference ‘Central Banking and Monetary Policy: Which Will Be the New Normal?’. Powell J.H. (2018), Testimony before the Committee on Financial Services, US House of Representatives, Washington DC, 27 February. Riggi M. and Venditti F. (2015), ‘Failing to Forecast Low Inflation and Phillips Curve Instability: A Euro-Area Perspective’, International Finance, 18, 47-68. Visco I. (2016), ‘Modelli e metodi quantitativi per le decisioni di politica monetaria: limiti e nuove prospettive’ (only in Italian). Visco I. (2017), ‘Sviluppo dell’economia e stabilità finanziaria: il vincolo del debito pubblico’ (only in Italian). Yellen J. (2017), ‘Inflation, Uncertainty, and Monetary Policy’, Speech at the ‘Prospects for Growth: Reassessing the Fundamentals’ 59th Annual Meeting of the National Association for Business Economics, Cleveland, Ohio, 26 September 2017.
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Speech by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Harvard Law School Bicentennial Annual Reunion of the Harvard Law School Association of Europe, Rome, 12 May 2018.
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Harvard Law School Bicentennial Annual Reunion of the Harvard Law School Association of Europe Fintech and banking: today and tomorrow Speech by the Deputy Governor of the Bank of Italy Fabio Panetta Rome, 12 May 2018 1. Introduction Technology and digital transformation are radically changing people’s habits and firms’ activities. They are changing the ways in which people produce, buy goods and services, and interact with each other. Our daily activities increasingly depend on connectivity. In 2016, about 95 per cent of businesses in OECD countries had a broadband Internet connection and more than 75 per cent had a web presence. Half of the adult population had purchased goods or services online, compared to 36 per cent in 2010. Innovation has had a remarkable effect on mobile devices. The smartphones in our pockets have a computing capacity far greater than that of a 1960’s supercomputer, they are a hundred thousand times lighter and ten thousand times less expensive. Last year 1.5 billion smartphones were sold globally – that’s one fifth of the world’s population. Mobile technology and services are estimated to have contributed $3.6 trillion or 4.5 percent to global GDP in 2017. 1 The new technologies are “virtualizing” our everyday tasks, from economic to interpersonal relationships, to the purchasing of goods and services. In the digital era financial, economic and even social inclusion depend on technological inclusion. The effects of digital transformation have not fully emerged yet. It is still hard, at this stage, to foresee all the consequences of the application of artificial intelligence (AI), machine learning, and Big Data. This transformation is replacing intellectual activities, and might do to human thinking what the technological revolutions of the 18th and 19th centuries did to human physical labour. 2 IMF, World Economic Outlook, April 2018. In the last three centuries, four phases of industrial revolution resulted in unprecedented economic and social progress. The first phase (between 1750 and 1830) was characterized by the invention of steam engines, cotton spinning machinery and the railways. The second was triggered by the invention, between 1879 and 1900, of electricity, the internal combustion engine and the provision of running water. The third phase encompassed the computer and the Internet revolution, beginning in the 1960s and peaking in the 1990s. The fourth industrial revolution is the current digital revolution (see R. Gordon (2012), “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds”, NBER, Working Paper No. 18315, August 2012. The financial industry has always been an early adopter of new technology. The first Automatic Teller Machine (ATM) in history was installed in 1967 at a branch of Barclays Bank in London, to allow clients to get cash outside normal working hours. Since then, many automated services such as second generation ATMs, POS systems, debit and credit cards, online trading and online banking services 3 have been offered in response to customers’ demand for immediacy. Thus, the widespread adoption of digital technology in financial markets in recent years should not come as a surprise. The use of digital financial services is set to soar, boosted by rising customer expectation, the spread of Internet, smartphones and tablets, by the steady fall in data storage cost and by the improvement in the processing capacity of computer systems, including via cloud computing. 4 The progress recorded in the last few years is astonishing: for example, the amount of data exchanged internationally is now 45 times greater than in 2005, while the cost of storing information is 10 times lower than in 2010. 5 It is against this backdrop that fintech comes into the equation. 2. Fintech What do we mean exactly by fintech? The Financial Stability Board defines it as “technologically enabled financial innovation that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services.” According to this definition, fintech encompasses a wide range of services and activities. An example may help clarify this. In addition to using banknotes, cheques, or Internet banking, today I can use my mobile phone to transfer money to a friend. All I have to do is to download the appropriate app, type a simple text message and select my friend’s name from my contacts list. My friend would receive the money in a few seconds, and could even reuse it immediately for his own payments. The evolution of financial advisory services provides another example. In the past, when I needed financial advice, I contacted my advisor. In most cases he would not remember my name or my financial situation (although in some cases he would pretend he did!). He would ask for my ATMs are electronic instruments that make it possible to carry out current account operations (cash withdrawals or deposits) without needing a bank clerk to intervene. Point of Sale (POS) systems use electronic terminals that accept non-cash payment instruments, such as debit and credit cards. Cloud computing uses a remote server accessed via the Internet to provide IT software and hardware resources such as the storage, processing or transmission of data. See McKinsey (2016), ‘Digital globalization: The new era of global flows’. account number to check the composition of my portfolio and key information such as my age, income, risk aversion and investment objectives. He would then provide his advice, possibly after one or more face-to-face meetings. Today some fintech companies and banks can offer such advice much more quickly and efficiently through their ‘robo-advice’ services. I only need to provide my code number to a computer which, using artificial intelligence, will select the investment programme best suited to my profile and risk appetite. Financial services are still predominantly distributed through traditional channels. Fintech only plays a significant role in certain segments of the financial sector, such as retail payments, asset management and small loans. But it is rapidly expanding into sectors such as lending-based crowdfunding and chatbox customer relations services. The use of technologies such as AI, Big Data and distributed ledgers (DLT) 6 is also on the rise. Competition from fintech companies is starting to erode the margins of traditional banking. It is estimated that over the next ten years, as fintech firms expand into all market segments, they could erode 60 per cent of the profits that banks generate from retail services. 7 The success of some fintech companies – think for example of the multinational TransferWise 8 – is driving many banks to deepen their commitment to the new technologies. Numerous large banks are expanding their range of digital services by increasing their investment in them and by entering into agreements with fintech companies. In some cases, integration is achieved when a bank acquires a fintech firm. 9 In the countries where online retail trade is most developed, the leading fintech players include tech giants such as Apple, Google, Amazon and Facebook in the United States, and Alibaba and Tencent in China. For example, Apple and Google have developed solutions that allow payment instruments to be used in cooperation with banks. Amazon grants loans to small businesses for a total amount that has now exceeded $3 billion. Facebook allows users in the U.S. to make payments to others in their contacts list and is beginning to lend to small businesses. Alibaba makes payment services available through its affiliate company Ant Financial. Tencent offers a broad range of financial services through its social media app, WeChat. DLT is the technology underlying virtual asset transactions. It is based on a decentralized system with the direct exchange of messages between nodes in a network and the recording of transactions in a synchronized ledger distributed across the nodes (see Bank for International Settlements, Distributed ledger technology in payment, clearing and settlement - An analytical framework, February 2017; https://www.bis.org/cpmi/publ/d157.pdf). See McKinsey (2017) Retail Banking Insights, April. TransferWise, founded in 2011, is an e-money institution that makes it possible to transfer money to and from Europe, Asia, the Americas, Oceania and Africa. An example is J.P. Morgan’s recent acquisition of the start-up WePay. These developments have been facilitated by the complementarity between online platforms, the demand for services by consumers and firms on the platform, and the use of digital payment instruments. Indeed, platforms can be a single point of contact where firms, households and providers of financial services can interact more efficiently, and could become the most effective and widely used means of providing financial services in the future. 3. The outlook for banks in the fintech era The digital revolution raises a number of questions as regards the outlook for the banking sector. A crucial issue is what the future relationship between banks and fintechs will be, and what this will imply for the supply of banking services and for banks’ profitability and market power. The answer to these questions depends on the kind of fintechs we are thinking of. As I mentioned before, the new actors are not just small fintech start-ups, but also the global Big-Techs such as Google, Apple, Facebook, Amazon, Alibaba. The challenges for banks arising from these two groups of competitors are fundamentally different. While fintech start-ups are gaining market shares in specific business lines thanks to aggressive pricing policies, many banks have either established strategic partnerships with them or have taken them over. This way, banks are integrating fintech services into their value chains in order to support their digital plans. The Big-Tech companies represent a much bigger threat for banks, due to their competitive advantages. First, by using their platforms – Amazon is an example – they have access to unique real time information on the products, sales, and customer satisfaction levels of firms using their platform; they can observe revenues and market structure, estimating the firms’ profit-generating capability. They also hold information that they can use to infer consumers’ preferences and living standards. Such information can be exploited to screen firms and customers and assess their credit risk – a function that is at the core of traditional banking. Second, the Big-Techs have a very large customer base, and thanks to their customer-centric business models, they can exploit customer-specific information much more efficiently than banks, that are typically focused on products (deposits, mortgages, etc.). Third, large technological firms are more skilled in managing large volumes of data – especially unstructured data – than banks. Fourth, the Big-Techs have enormous financial strength, and this is apparent in the ample liquidity they have accumulated in the course of their activities and record market capitalizations – not far off $1 trillion in some cases. They can use these resources to expand their financial intermediation business. What will be the impact of the interaction between banks and the new players? On the one hand, digital transformation and recourse to technologies such as AI and Big Data allow banks to cut costs and to improve the quality of the services provided. On the other hand, technology breaks down the traditional barriers to entry in the credit and financial services markets, fostering competition: already today fintech firms are offering technology-intensive low-cost services. It is therefore hard to predict what will be the ultimate effect on the supply structure of financial services and banks’ profitability. I believe, however, that there are already two clear implications. First, banks will have to invest heavily in technology to compete with one another and with new entrants: this is necessary for their very survival. Second, the structure of the financial systems will change radically in the next ten years with the entry of new non-bank operators. Banks need to use technology more efficiently than in the past, when it was used to duplicate traditional activities. They must use remote digital services to replace, rather than flank, the traditional distribution channels, although bank branches will not disappear entirely, because I can’t see many customers getting a mortgage online. Overall, I do not expect independent fintech firms to be able to replace banks. The value chain of banks includes bundled services like deposits, payments, and lending. Fintechs generally carry out one or more of these activities in an unbundled way. Yet, bundling provides powerful economies of scope. If fintechs wish to expand their businesses to exploit such economies of scope, then they will probably have to transform themselves into banks. 4. Role of the authorities: cyber risk and regulation As with all opportunities for progress, the technological revolution raises new issues and may expose customers to little known risks. Two issues deserve close scrutiny by the public authorities: cyber risk and regulation. In this section I will briefly address them in turn. 4.1 Cyber risk Cyber risk can cause enormous damages. In 2017, the spread of two pieces of malicious software called WannaCry and NotPetya led to losses in the hundreds of millions of dollars for their high-profile victims, which include the British National Health Service and shipping giant Moller-Maersk of Denmark. Attacks through the interbank messaging service SWIFT resulted in large-scale theft from customers, including central banks, between 2016 and 2017. Illegal access to confidential emails was a key issue in the U.S. presidential campaign of 2016. The consequences of these events, while serious, are still benign compared with what would happen in the event of a truly systemic cyber crisis: the British insurer Lloyd’s and the American Big Data firm Cyence have estimated that a massive disruption to cloud computing services could cost the global economy more than $50bn. 10 The financial sector is highly exposed to cyber attacks because it makes intensive use of ICT, and because it is highly interconnected at the global level. It is attractive not only to digital thieves but also to politically motivated actors who want to disrupt the functioning of our economies. For these reasons, it was one of the first civilian sectors to enforce strict cybersecurity standards, and perhaps the only one that has achieved significant results in broad-based international cooperation. 11 Central banks and other financial authorities are working to supplement the traditional regulatory and supervisory approaches with the development of public-private cooperation and the adoption of new tools to address cyber risks. A milestone of such an approach was the publication in 2016 by the G7 countries of a set of non-binding principles, addressed to both markets and authorities, to strengthen the security of the financial sector at the international level. 12 Cybersecurity was recognized as a strategic priority, to be tackled at the highest policy level. Various initiatives have been launched at both European and national level. In 2016 the Eurosystem launched the Cyber Resilience Strategy for Financial Market Infrastructure. Consistently with G7 principles, the CPMI-IOSCO guidance and recent European legislation, 13 the ECB and the national central banks will focus on three key areas: first, strengthening the cyber resilience of individual financial market infrastructures, including payment systems; second, increasing the cyber resilience of the entire financial sector; and third, promoting public-private cooperation on cybersecurity for the financial sector at the European level. In Italy, to ensure a comprehensive strategic vision and the alignment of internal and institutional policies, a high-level task force on cybersecurity has been set up within Banca d’Italia. In this regard, the Banca d’Italia’s three-year strategic plan envisages two specific lines of action. One focuses on protecting the Bank’s critical assets by reorganizing security functions within the IT Directorate General. The other focuses on enhancing the cyber resilience of Italy’s financial sector. Lloyd’s (2017), “Counting the cost: Cyber exposure decoded”. The CPMI-IOSCO guidance on cyber resilience for financial market infrastructures is a key example. See “Fundamental Elements of Cybersecurity for the Financial Sector”, followed in 2017 by the “Fundamental Elements for Effective Assessment of Cybersecurity for the Financial Sector”. Directive (EU) 2016/1148 on the Security of Network and Information Services (the so-called “NIS Directive”). On the subject of public-private cooperation, the Banca d’Italia and the Italian Banking Association have created the Financial Sector Computer Emergency Response Team (CERTFin), which coordinates the sharing of information and cyber threat intelligence among banks, financial market infrastructures, insurance companies, markets and trading venues and outsourcers. Since its foundation, in January 2017, CERTFin has analysed and circulated information about 1,000 cyber events; and it has sent more than 200 warnings to individual financial firms about potential attacks, while continuously monitoring vulnerable areas. Lastly, it is important to stress that actions taken by financial-sector authorities must be integrated with national cyber security strategies and frameworks. In Italy, this link is ensured via constant dialogue with appropriate government institutions, including but not limited to national intelligence and law enforcement agencies. 4.2 Basic principles of regulation The regulation of fintech activity is still in its infancy, and the regulatory framework differs from country to country. A review of the choices made in each jurisdiction would require an in-depth analysis, and is well beyond the scope of my comments today. Here I will limit myself to examining the basic principles that in my view should inspire regulation in a sector characterized by the presence of many different kinds of providers – banks, fintech start-ups and the Big-Techs – and the fast pace of innovation. In this context, the main challenge for the authorities is to strike the right balance between the overriding objectives of promoting innovation and competition on the one hand, and those of preserving the integrity of the financial markets and guaranteeing consumer protection on the other. Regulation should be designed in order to achieve such objectives. First, it should guarantee a level playing field, in order to avoid regulatory arbitrage and distortions. Regulation should remain tech-neutral, treating the intermediaries that deliver the same services in the same way, focusing on the products offered and not on the technology or business model used to provide them. Second, given the rapid change that will affect the fintech sector in the future as well, regulation and supervision should be flexible, in order to encourage innovative projects and to avoid any obstacles to the changes that are also likely to affect the supply of technology-intensive services in the future. The strategies adopted to guarantee an “agile” regulatory environment for fintech start-ups differ across countries. In some countries (such as the United Kingdom) innovative start-ups can benefit for a limited time period from regulatory waivers while they test the provision of their services (this is the “sandbox” approach). In other countries, such as Singapore, the authorities may cooperate with fintech firms to develop specific services – possibly through partnerships – in what are commonly called “incubators”. Lastly, in other countries – including Italy – the strategies are based on “innovation hubs”, where the authorities start interacting with the market players (banks, financial companies, innovative start-ups) on fintech-related issues at an early stage, indeed often at the planning stage, in order to provide them with the necessary support for the regulatory and compliance issues. The Banca d’Italia launched in November last year its innovation hub (Canale Fintech), a dedicated space on its web site where operators propose financial projects with innovative features; the aim is to open up a channel of dialogue with operators and to support innovation processes. 14 Each approach has its pros and cons that must be carefully weighed up. 15 Third, a true level playing field would require financial sector authorities within each country – such as bank and insurance supervisors, market authorities, etc. – to cooperate with one another and with regulators in other fields such as data protection, cyber risk, and antitrust. In Italy the Ministry of Finance has recently established a committee for the coordination of fintech-related activities which includes the Banca d’Italia and other national (financial and non-financial) competent authorities. More broadly, given the increasingly international nature of technology and the market for financial services, regulation should have an international dimension: it would be unwise to introduce national rules which could create regulatory barriers across jurisdictions, hampering or even impeding cross-border competition. 5. Conclusions In conclusion, technological innovation is an exceptional tool for making progress. The adoption of digital technologies and a more intensive use of the enormous volume of data available today will enable banks and other intermediaries to reduce their costs and improve the quality of their services. There are huge potential advantages for consumers, firms and for the whole economy. Technology is breaking down the barriers to entry in the credit and financial services markets, and a less efficient player may not be able to survive the ensuing increase in competition. https://www.bancaditalia.it/compiti/sispaga-mercati/fintech/index.html?com.dotmarketing.htmlpage.language=1 For example, regulatory sandboxes face the challenge of striking the right balance between two objectives: encouraging innovation and protecting consumers. I expect the structure of banking and financial markets ten years from now to be very different from what it is now; non-bank operators will probably play a much bigger role. But the spread of these new technologies and the availability of ever more comprehensive information on individuals raises broader and more fundamental questions that I have not addressed in my talk today. Technology is creating the “technological unemployment” that had been foreseen by Keynes already in 1930 16 and is one of the factors further exacerbating income and wealth inequality in both advanced countries and emerging market economies. It also raises the issue of how to guarantee confidentiality in relation to Big Data, how to use it within the limits imposed both by the rules and by the will of our citizens, whose right to privacy must in any case be upheld. We must better define both the legal and ethical limits on the use of Big Data. Recent events in connection with Cambridge Analytica and Facebook have sounded the alarm. We need to think carefully, as of now, about how to make these developments fully compatible with the rights of individuals and about how to square the increasing availability of information on the private lives of each one of us in relation to our political views, state of health, or sexual orientation, with the protection of our personal freedom and with the rules that govern the functioning of a modern liberal democracy. J. M. Keynes (1930) “Economic Possibilities for our Grandchildren”, freely available online. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 1st Biennial Banca d'Italia and Bocconi University Conference on Financial Stability and Regulation, Rome, 5 April 2018.
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1st Biennial Banca d’Italia and Bocconi University Conference on Financial Stability and Regulation Welcome address by Ignazio Visco Governor of Banca d’Italia Rome, 5 April 2018 It is a pleasure for me to open this conference on “Financial Stability and Regulation” and welcome all of you who are here today. This will be the first of a biennial series of conferences on financial stability that Banca d’Italia has decided to organise with the Baffi Centre for Applied Research on International Markets, Banking, Finance and Regulation. I would like to thank the organisers, the contributors to the four sessions, the keynote speakers and the panellists of the policy roundtable that will conclude the conference tomorrow afternoon. In the last ten years or so the objective of promoting and maintaining financial stability has strongly returned to being at the centre of the attention of policy makers in governments, central banks and supervisory and regulatory authorities. Since the global financial crisis, the regulatory framework has been substantially reformed, through the work of the Financial Stability Board, international standard-setters, regional bodies such as the European Commission, and the new laws and regulations established in jurisdictions all over the world. A question that is now often raised is whether enough has been done to safeguard our economies and financial systems from the risks we face from the financial complexity and interconnections that characterise our rapidly changing global environment. But a symmetrical question is also raised, i.e. whether we have gone too far with the introduction of new requirements for financial intermediaries’ capital, liquidity, leverage, not to mention disclosure, reporting and so on. In a nutshell, the issue is whether all this might unfavourably affect the financing needs of the real economy. Answers to these questions are now being debated in international fora such as the Financial Stability Board and the Basel Committee on Banking Supervision. But they are also very much the subject of substantial research, carried out for academic purposes but also by central banks, supervisory agencies and international institutions. This is confirmed by the very large number of papers submitted to this conference and the exceptional quality of the ones that will be presented today and tomorrow. Indeed, benefiting from the perspective of academics and of policy makers, this conference focuses on some of the most hotly debated financial stability issues. Evidence will be presented on how regulation and policy interventions may lead to spillovers that could produce unintended consequences, requiring careful analysis of the policy design and calibration. As the opacity and complexity of structured financial products were among the culprits of the global financial crisis, their impact on financial stability has also been very much scrutinised. In recent years the regulatory landscape for these instruments has been overhauled, with the objective of increasing their transparency and standardisation. The overall impact of these reforms is now the subject of careful evaluation. Other more traditional issues, such as maturity mismatches and the reduction of banks’ fragility to runs coming from the transformation of shortterm deposits into longterm loans, have also, again, been studied in depth. The relevance of liquidity and leverage risks has continued to underpin the introduction of new requirements in the banking sector. However, more should most likely be done, as the issue is not limited to banks that are generally subject to strict regulation and careful supervision, but extends also to the large and somewhat unexplored shadow banking sector. The global financial crisis has forcefully reminded us that excessive leverage, dramatic shortages of liquidity and bank runs are not just a matter of interest solely to economic historians. Indeed, new research has been fostered to understand how runs could be generated in a much deeper and extended financial environment, which tends so much to reflect the effects of the extremely rapid and profound technological innovations that are changing our everyday lives. Three areas of interest not only for policy makers and regulators but also for current and future academic research seem to me particularly important today. The first is about macro-prudential policy and tools. To tame systemic risks in the banking sector, banks’ resilience to shocks is being increased with the introduction of countercyclical and other capital buffers. In particular sectors where price misalignments may become extremely severe, the reduction of the build-up of risks is pursued through the use of specific sectoral constraints. To limit funding risks, the recourse to new liquidity tools is recommended. Yet, much should be done to shed light on the costs and benefits of each tool, on how to best calibrate the ones which are currently being used, and on how new, more effective, macro-prudential instruments, if needed, should be developed. As has long been recognised, the possibility of conflicts between the mandate of macroprudential policies and that of micro-prudential supervision of financial intermediaries is compounded by the fact that the two policies share some of the same instruments while their objectives, however, might be conflicting in some points of the cycle. For instance, during downturns macro-prudential policy interventions would imply the loosening of equity buffers, while a purely micro-prudential perspective may aim to preserve or even tighten capital requirements. How to best coordinate the two approaches is a matter which is still unresolved. In the European Union this difficulty combines with the institutional framework, which is characterised by different layers of central and domestic authorities. Also, most importantly, the interaction of macro-prudential policy with monetary policy, both in its conventional and unconventional forms, provides ample possibilities for future research. In the medium run they reinforce each other. Monetary policy aims at maintaining price stability, which is a pre-condition for a sustained and balanced growth. At the same time, financial stability cannot easily be achieved in a persistently depressed economy. In the short run things are however a bit more controversial. On the one hand, macro-prudential policy can mitigate unintended consequences of monetary policy, such as excessive risk taking in times of very low interest rates. On the other hand, macro-prudential policy can interfere with the transmission of monetary policy to economic activity through its tightening or loosening effects on credit conditions. Research can provide insights on the extent to which macro-prudential authorities should internalise the macroeconomic consequences of their decisions, and on how to smooth short-run conflicts between monetary and macro-prudential policies (as well as those of the latter with other policies and measures in fields such as those of taxation and environmental protection). Dramatic developments in financial technology (Fintech) are creating new services, enlarging the pool of potential competitors of traditional intermediaries, and setting new challenges for macro-prudential authorities. There are many issues that could be fruitfully explored in this second area of interest. Perhaps this is where possible conflicts may arise between traditional banking institutions and new institutions operating in the shadow banking system. There might also be complementarities, the more so if banks learn how to take advantage of instruments such as crowd-funding and/or lending based on major advances provided by technology, for instance the use of big data, the diffusion of machine learning or the recourse to distributed ledgers. A field that is very much under investigation at a policy level is that of the so-called cryptoassets, as the best-known of which being bitcoin. At present, as we concluded two weeks ago in the G20 meeting in Buenos Aires, these assets do not appear to provide serious financial stability risks. However, besides raising concerns from an anti money laundering and counter terrorist financing viewpoint, today’s cryptoassets are all characterised by a number of fundamental problems, such as huge energy consumption, limited scalability and high price volatility, which prevent their use as a reliable means of payment, store of value or unit of account. This also explains why some of us prefer to refer to them as crypto-assets rather than crypto-currencies, as they are more often called, and why issues like the need to preserve market integrity and to ensure consumer protection, are emphasised so much. However, some of these ‘first-generation’ cryptoassets might evolve. It cannot be excluded that stable, sustainable, nonanonymous crypto-assets may end up contributing to the efficiency of the payment systems and to the stability of financial institutions. And perhaps a regulatory framework for Initial coin offerings which guarantees investor protection may foster the use of crypto-assets as a source of fundraising for innovative, high-tech start-ups, promoting innovation and helping new firms to differentiate their sources of funding, with benefits for the overall stability of the financial system. All this clearly deserves serious investigation. There is also a more general question about the future of the technology underlying the functioning of most crypto-assets, the distributed ledger technology (DLT). In financial markets, a complicated system with lots of intermediaries is required to transfer assets, verify who owns what, and reconcile the various records: banks providing custodian services, brokers processing trade orders, exchanges and clearing houses settling transactions. A DLT has the potential to combine the services of these various layers in one single technology, resulting in a cheaper, less intermediated, and potentially more secure system. Transparency in transactions and asset holdings stored on distributed ledgers can also improve regulators’ ability to assess financial system risks and monitor compliance with regulations. The DLT certainly holds the promise of significant economic benefits in the future, but it is still relatively immature and untested. More research is needed to determine whether these changes will ever actually take place. The third area of research that seems to me to deserve further, important consideration concerns the management of banking crises. This issue will certainly be discussed at length tomorrow morning in the last session of this conference, on bank resolution, and in the policy panel on banking crises in the afternoon. As is well known, the response to the global financial crisis also addressed the regulatory landscape for bank recovery and resolution. In Europe, the substantial costs of the public recapitalisation of banks in many countries motivated the introduction of a new bank resolution framework (Bank Recovery and Resolution Directive, BRRD), which increases the burden of losses borne by the private stakeholders of institutions in distress, with the aim of reducing the cost for taxpayers. The use of bail-in tools as a general principle is certainly welcome as long as it is expected to reduce banks’ risk-taking incentives and to reduce distortions to competition associated with too-big-to-fail market perceptions. Yet, when it comes to the specific use of the BRRD, the old saying of “the devil is in the detail” remains valid, as witnessed by the inadequacies of the new framework that emerged during recent cases of bank crisis. As I have mentioned on other occasions, the use of public funds could be less restrained to avoid financial stability risks and economic disruptions that may be caused by a routine recourse to private burden sharing. Of course, this is not to say that, in the different forms that banks’ resolution and liquidation may take, shareholders should not bear the cost of the resolution or the liquidation, administrators and managers should not be removed, or careful recovery plans should not be required. But I am still worried that the straightforward application to banks of the insolvency proceedings normally applied to non-financial companies could lead to unintended consequences, via confidence disruption and contagion, to the rest of the system and to the real economy. And I believe that the issue of how to resolve banking crises in the European banking union in an orderly, quick and efficient manner, also given the difficulty of effectively coordinating all the authorities and institutions involved, still needs to be satisfactorily addressed. This is not to dispute that a well-thought out implementation of bail-in procedures or a proper application of state aid rules in the case of well identified threats to market competition would not be useful. However, theoretical and empirical research should foster a better understanding of the conditions under which a bailin approach is socially optimal. In-depth empirical analysis of the impact of the current implementation of the BRRD on the banking sector and on the real economy is of the utmost importance. The development of effective analytical tools to assess the potential systemic spillovers from different private loss absorption requirements in real-life cases is necessary to guide the decisions of resolution authorities. More generally, how different approaches to loss absorption in the resolution of failing banks affect (and are affected by) the degree of sustainability of public finances is a subject that should be further investigated. As I have said, I expect that the contributions of the papers presented in the bank resolution session and the policy panel that will conclude the conference will provide useful and meaningful grounds to discuss these issues. To conclude, the post-crisis regulatory overhaul that has de jure or de facto provided central banks with a new or a renewed financial stability mandate is here to stay. High quality research, both theoretical and empirical, and fora like this conference, in which recent experiences and new ideas are exchanged in an open minded atmosphere, speed up the pace at which policymakers can learn how to most effectively fulfill such financial stability mandates. With this expectation, I wish all the participants in this conference two very constructive days of open discussion and fruitful exchanges. Designed by the Printing and Publishing Division of the Bank of Italy
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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, at the 97th Meeting of the Development Committee, World Bank Group, Washington DC, 21 April 2018.
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DEVELOPMENT COMMITTEE (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries) NINETY-SEVENTH MEETING WASHINGTON, D.C. – APRIL 21, 2018 DC/S/2018-0022 April 21, 2018 Statement by Ignazio Visco Governor of the Bank of Italy Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste Statement by Ignazio Visco Governor of the Bank of Italy Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste 97th Meeting of the Development Committee April 21, 2018 Washington, D.C. Introduction The global economy is enjoying a moment of robust, synchronized growth. However, trade restrictions may cause an adverse global supply shock, which may be amplified by the pervasiveness of global value chains. This could be compounded by an adverse demand shock, given that the associated uncertainty could have a negative impact on decisions to invest and to consume. Overall, this would lead to a global output contraction. Global public debt as a share of GDP has expanded substantially since the 2008 financial crisis, notwithstanding the debate about deleveraging. The increase has been particularly acute in emerging economies, including those vulnerable to interest rate increases. The World Bank should help these countries to use their budgetary lever to counteract the business cycle, focusing on the quality of public finance while protecting the poorest. Despite all the relief efforts made by official creditors and traditional donors, debt sustainability is becoming a serious concern in many low-income countries that face higher liabilities and an increasingly complex creditor composition. This should prompt the WBG and the IMF to develop a comprehensive joint action plan which carefully considers limits in IDA countries’ absorptive capacity, in order to avoid a further increase in debt vulnerabilities. Strategic framework and reform agenda Eradicating poverty and boosting shared prosperity requires differentiated approaches to specific categories of clients and a willingness to rebalance resource allocation. Low income and fragile countries’ vulnerabilities call for adequate safety nets and for institutions which can expand access to basic services. Middle income countries need a more targeted poverty alleviation strategy, one that tackles institutional and policy constraints through higher value-added knowledge products, and which addresses the remaining infrastructure gap. A clearer IBRD graduation strategy must be pursued, building on the country partnership frameworks agreed upon with borrowers. It should more directly link access to WBG resources to indicators of economic development, access to external finance, and the possibility of leveraging the private sector. Because many of its clients have regular access to capital markets, IBRD lending programs must become more selective and target operations that ensure the highest development impact. The capital increase under consideration should enable the IBRD to finance long-term investments that lie beyond markets’ reach. Improving clients’ capacities to assess risks and strengthening their financial resilience is crucial to enhancing preparedness and readiness for natural disasters. Disseminating knowledge and lessons learned is also important to helping countries enhance their resilience. We remain convinced that these are the areas where the WBG’s comparative advantages lie. The IDA18 replenishment’s renewed focus on fragile and conflict situations adds more challenges and calls for a more effective and integrated approach. To this end, working in partnership with other multilateral financial institutions and mobilizing the private sector is vital to meeting development and resilience challenges. We reiterate our call for the WBG to deploy its skills and to convene public and private actors in pursuit of vigorous, environment-friendly growth in client countries. We view the climate change agenda, and that of global public goods in general, as effectively reinforcing and complementing goals for social inclusion and for private sector development. The Group is making significant efforts in supporting the development of infrastructure needed for private sector growth. It is time to make an additional, targeted effort on the human capital agenda. To this end, improving incentives to foster effective investments in health, education, and social development is essential. The WBG’s financing should continue to focus on long-term development goals, rather than short-term responses to temporary imbalances. This does not mean that the Bank and the IFC have no role to play in economic crises, but good division of labor requires avoiding overlap with IMF instruments. The creation of a new capital buffer for the IBRD should not undermine an efficient use of Bank resources, including those coming from the capital increase. It should not imply a de facto upward revision of the sufficiently prudent minimum Equity-to-Loan threshold of 20%. Current reforms must link strategic priorities to corporate planning, ensuring accountability and laying the foundation for results-informed budgeting. Improving the governance of the Bank’s lending projections, budget, and net income is crucial. Financial sustainability We are pleased that the IBRD’s capital is no longer deployed to cover administrative expenses in excess of revenues. Its business model is now financially sustainable, as it ensures solid income generation to bear future needs. Coverage of direct and indirect costs of lending, including expected loan losses, is achieved while maintaining loan terms well below market rates. Higher rates on loans that tie up the Bank’s capital for longer periods of time will help prevent scarce longterm funds from being diverted to operations that are better served by shorter term loans. The needs of the poorest and most vulnerable are the principal claim on IBRD resources. Accordingly, we favor the establishment of a framework that explicitly takes it into account, with adequate consideration of preservation of the real value of the IBRD’s capital over time. Higher terms for clients with larger capacity will help accomplish the mission of supporting the neediest. Financial sustainability does not ensure efficiency in resource utilization. We encourage Management to continue fostering efficiency and monitoring it by means of sound indicators. The “voice” of the global economy We remain committed to a shareholding review that fully reflects the changing reality of the global economy and strengthens the Bank’s development mission, as agreed to at the 2015 Annual Meetings. The dynamic formula provides a necessary anchor to ensure, over time, adjustment towards an equitable voting power in the IBRD. We also look forward to a review of the IDA voting rights arrangements, which IDA Deputies agreed to discuss at the upcoming Mid-Term Review of IDA18. Concerning the share allocation rule for the IBRD selective capital increase (SCI), we believe ad hoc solutions and arbitrary thresholds should be avoided as much as possible. We agree on the use of unallocated shares – as a one-off measure – to limit extreme cases of under-representation. This will reduce the need for additional SCIs in the future. Today’s proposed arrangement for the IBRD is far from optimal, as we will presumably need several SCIs to bring shareholding closer to the dynamic formula’s outcome. As for the IFC, we recommend moving its shareholding towards that of the IBRD. Hence, we support the proposed SCI, in which shares are allocated to countries with IFC shareholding below their IBRD shareholding, after converting retained earnings into shares. Although some concerns remain regarding the size of the capital package and its bias toward the general capital increase, we recognize that the overall outcome will further strengthen both the financial sustainability and the operational capacity of the IBRD and IFC. This will bring the discussions that have taken place since our Meeting in Lima to fruition. With these goals in mind, we recognize that negotiations have been intense and complex, and represent a valuable effort by all parties, including Management. In the spirit of compromise, we are prepared to join the emerging consensus and to ensure the World Bank Group remain fully legitimate vis-à-vis its diverse stakeholders.
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Keynote address by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the SUERF/BAFFI CAREFIN Centre Conference "Do we need central bank digital currencies? Economics, technology and psychology", Bocconi University, Milan, 7 June 2018.
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SUERF/BAFFI CAREFIN Centre Conference ‘Do we need central bank digital currencies? Economics, technology and psychology’ 21st century cash: Central banking, technological innovation and digital currencies Keynote address by the Deputy Governor of the Bank of Italy Fabio Panetta Bocconi University Milan, 7 June 2018 1. Introduction 1 It is a great pleasure to be here. The topic of this conference speaks to the heart of some of the most challenging questions for central banks today: how is the digital revolution affecting the financial system? What is the impact on consumers, the economy and on central banks themselves? These are complex questions, related to the consequences of the fourth industrial revolution in our society, 2 within which central bank digital currencies (CBDC in short) might one day play an important part. I will not attempt to provide comprehensive answers to all of these questions. Rather, I will focus on some general issues related to the digital transformation of our society, the pros and cons of digital cash (as a means of payment and store of value) and, before concluding, recall some of the open issues regarding CBDCs. 2. The digital transformation of society Technological progress is fostering the digital representation of many of our daily activities. For example, the use of physical letters and postcards has been dwarfed by emails and digital photos, with the estimated number of letter-like items sent worldwide in one year roughly equal to the number of emails sent in a single day. 3 Instant messaging apps such as QQ and WhatsApp allow their estimated three billion users to have digital conversations across the globe. 4 The process of digitization reflects increasing demand for immediacy by individuals, and is transforming our behaviour, our culture and the structure of the economy. I wish to thank Nicola Branzoli and Marcello Miccoli for their valuable help during the preparation of this speech. See Schwab K. The Fourth Industrial Revolution, New York: Crown Publishing Group, (2017) and Gordon R. (2012), ‘Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds’, NBER, Working Paper 18315, August 2012. Source: based on data from Universal Postal Union and Radicati Group. Source: Radicati Group. Digitization has also been prominent in the financial system. For example, the dematerialization of financial assets has been instrumental in the emergence of electronic trading platforms. Online banking, the digital representation of brick-and-mortar bank branches, has gained in popularity since its introduction in the 1990s . The advent of digitization is particularly evident in the payment system. Until not long ago retail payments could only be made with cash or cheques. But these days who uses cheques anymore? Digital innovation in payments has gone even further, with payment tools available directly through an app on a smartphone or even by simply using a smartwatch. The issuance of CBDCs – a digital version of cash – could accordingly be seen as a natural consequence of the broader process of digitization of the financial system. In a world where securities and contracts are dematerialized and traded electronically, where payments are made with smartphones and investment advice is provided by computers, why should cash be only physical? Is the central bank missing out on the benefits of innovation by not issuing a CBDC? Crypto-assets (or virtual currencies as they were called before it was realized that they cannot perform the functions of money) are sometimes associated with digital currency. Let me emphasize, though it is redundant for this audience, that CBDCs have nothing to do with crypto-assets such as Bitcoin. In fact – just like banknotes – a CBDC would be a liability of the central bank and would be backed by its assets. It would be supported by the credibility of the central bank and, ultimately, by the rule of law. Crypto-assets, on the other hand, are a liability belonging to nobody: there is no asset that backs them up and no clear governance structure that can guarantee trust. For these reasons, the value of a CBDC would not suffer from the excessive volatility that affects crypto-assets. 3. The pros and cons of digital cash But let’s go back to the main question of today’s conference: should central banks issue a digital currency? One way to address this issue is from the perspective of an agent (the central bank) in charge of supplying cash on behalf of the State, with the ultimate goal of maximizing social welfare. In this respect it is important to distinguish between the possible role of the digital currency as a means of payment and as a store of value. 5 These are two of the three functions of money. The third one, money as a unit of account, is not relevant here, since a digital currency issued by the central banks would be denominated in the same unit as existing banknotes. CBDCs as a means of payment As a means of payment, a CBDC would add to the available digital payment services, thus increasing the degree of competition in this sector. But the set of tools that permit almost frictionless and instantaneous payments is already large: today we can make a digital payment by wire transfer (through online banking), with credit or debit cards, using Paypal or Apple pay (to name just a few); we can do it via computers, smartphones or smartwatches, by simply putting our wrist close to a point of sale. Competition in the supply of payment services is already high, and the efficiency of the system will increase with the introduction in many jurisdictions of instant payments – yet another alternative to cash. 6 From this vantage point the advantages of a CBDC are at best unclear: its potential benefits in terms of improving the ease of transactions are probably insufficient to justify the involvement of central banks in an activity that is well served by private suppliers. A CBDC could nonetheless improve access to digital payments for specific groups of consumers. In fact, some consumers do not have a bank account – a precondition for using existing digital payment tools. A CBDC could offer them access to these tools at minimum or zero cost. In the United States, the United Kingdom, France and Spain, to name a few high-income countries where one might easily think that financial inclusion is almost universal, the share of the population without a bank account is between 4 and 7 per cent. 7 In Italy the proportion of unbanked households is similar (7 per cent, or 1.8 million households). 8 Survey evidence suggests that account maintenance costs and physical distance from a bank are among the reasons for not having a bank account. However, a closer look at the socio-demographic characteristics of unbanked consumers shows that they have low income but also low education: 90 per cent of the unbanked households are in the bottom half of the income Instant payments (IPs) allow consumers to transfer funds in almost real time. The Eurosystem entered into IPs with the TIPS project, which will offer settlement facilities in central bank money to IPs schemes starting from November 2018. The extent to which IPs will succeed as substitutes for cash is an open question. The experience of the countries where IPs were first introduced is mixed. For example in the UK, where IPs were introduced ten years ago, the average value of IPs is £800, more than an ordinary cash payment and similar to a traditional credit transfer. Demirgüç, A., Klapper, L., Singer, D., Ansar, S., and Hess, J. The global Findex database 2017: Measuring Financial Inclusion and the FinTech revolution, World Bank Group, 2018. Source: Survey on Household Income and Wealth, Banca d’Italia. distribution and have little or no formal education. To the extent that consumers have no access to bank accounts – and thus to digital payment tools – for reasons other than cost, the introduction of a CBDC would not improve the situation. Again, at this stage the available evidence is at best insufficient to justify introducing a CBDC, in spite of the importance of the goal of improving financial inclusion. 9 The introduction of a digital means of payment could be justified by the objective of reducing the cost of cash i.e. outlays for its production, transportation, disposal, etc. Recent estimates suggest that these costs amount to about half of a percentage point of GDP in the European Union every year, 10 or to around €76 billion. By way of comparison, this figure amounts to almost half of the annual EU budget. These estimates are a lower bound of the actual costs, since they do not include households’ costs, such as the time it takes to obtain banknotes (shoe-leather costs), which are difficult to estimate. However, they are shrouded in uncertainty; moreover, central banks, commercial banks and all those who handle cash are constantly striving to improve efficiency. Would the cost of providing a CBDC be lower than that of cash? The costs of managing cash are due to its physical nature and in a digital world they would disappear. Non-monetary costs, such as households’ shoe-leather costs of finding a cash provider, would also disappear if cash were accessible via the smartphone in our pocket. Hardware and software costs would, instead, increase. However, digital technology already plays a crucial role in the financial sector. It is used to transfer commercial bank money, to buy and sell securities, and to process information. It is continuously tested and updated and protected against risks, first and foremost cyber risk. The technology needed to transfer digital cash would likely have strong complementarities with the existing digital networks and infrastructure. This suggests that the overall costs of providing a means of payment may well decrease with the introduction of a CBDC. The potential efficiency gains promised by new technological solutions such as Distributed Ledger Technology (DLT), though still unclear, could also help lower the cost of managing CBDCs. Here I ignore the fact that it is disputable, likely suboptimal and undesirable to assign the goal of improving financial inclusion to central banks. Schmiedel, H., Kostova, G., and Ruttenberg, W. ‘The social and private costs of retail payment instruments: a European perspective’, European Central Bank Occasional Paper 137, 2017. CBDCs as a store of value Another important function of money is as a store of value. The cost of storing cash, a key factor in its use as a store of value, has been estimated at between 0.5 and 1 per cent of the value stored.11 Since it would be completely dematerialized, a CBDC would have very few or no storage costs and would be a convenient way for households and firms to keep liquid wealth. Mattresses could be freed from their role of vaults! In addition to being superior to cash as a store of value, a CBDC would be an asset with unique characteristics, free of credit and liquidity risk. It might be preferred to other instruments commonly used to store wealth, such as bank deposits. The consequences of this have caused concerns: a switch from bank deposits to a CBDC could lead to a funding shortfall in the banking system, with potential adverse effects on the supply and cost of lending to the real economy. In extreme conditions the availability of a CBDC could even increase the risk of a digital bank run. The potential consequences of having a large portion of wealth structurally transferred from bank deposits into a CBDC could be significant for our financial system. Currently in the euro area overnight deposits of non-financial private entities amount to around €6.5 trillion, 20 per cent of the balance sheet of the banking system. I am not convinced, however, that the effects would necessarily be disruptive for banks. First, only some categories of deposits might migrate to the central bank (most likely sight deposits, that pay little or no interest). Second, banks can compete by offering services that CBDCs cannot, such as access to credit and payment services. Third, banks could increase their recourse to wholesale funding. But banks’ business model would be affected. The decrease in callable liabilities could ultimately push towards a ‘narrow’ banking system, 12 that is an operational framework in which banks have little or no maturity mismatch between assets and liabilities. The debate about the benefits of narrow banking goes back centuries, 13 with no easy answer; economists will likely have to examine the issue anew. See, for instance, Witmer, J. and Yang, J. “Estimating Canada’s Effective Lower Bound”, Bank of Canada Review, Spring 2016 or “Banks look for cheap way to store cash piles as rates go negative”, Financial Times, August 16, 2016. See Broadbent, B. “Central banks and digital currencies”, speech at the London School of Economics, March 2016. See Pennacchi, G. (2012), ‘Narrow Banking’, Annual Review of Financial Economics, vol. 4, issue 1, pp. 141-159. The magnitude of these effects will depend on the demand for CBDCs by the public, which in turn will vary according to the currency’s specific, yet still uncertain, characteristics – such as whether it would be remunerated or whether it would be account based or token based. Balancing the risks and benefits The risks and benefits of CBDCs are two sides of the same (digital) coin, related to the role of money as a means of payment and a store of value. Recourse to a CBDC as a means of payment may well have benefits, but their precise nature is uncertain and they may still be too small to justify the introduction of a digital currency. Moreover, the issuance of a CBDC may become less positive on balance if we take into account the potential effects on the demand for commercial bank deposits. The risks and benefits would be affected by the characteristics of the CBDC, but in any event the risks would not disappear altogether. The business case for introducing CBDCs remains at best unclear. However, like all issues related to technological innovation, the costs, benefits and risks of digital currencies are likely to change rapidly in the future. This suggests that central banks should continue to examine the potential effects of digital currencies. Indeed, many of them are currently engaged in research and technical experimentation with a CBDC. The Riksbank, Bank of England, and Bank of Canada, to name a few, are actively analyzing the issue. Some have gone even further, such as the Central Bank of Uruguay, which has launched a pilot project.14 At Banca d’Italia, we are also studying how a CBDC would impact our financial system and monetary policy, and we are working within the Eurosystem on trials using DLT, which might prove useful for a digital currency. Researchers are also actively reflecting on CBDCs. Today’s conference is a notable example. 4. Some open issues As mentioned above, the risks and benefits of CBDCs, together with their impact on the financial system, the real economy and on society, closely depend on their characteristics. 15 The Danmarks Nationalbank is sceptical about whether the benefits of a CBDC can really prevail over its costs. See Gürtler, S., and Rasmussen, S. Central bank digital currency in Denmark?, December 2017. See Bank for International Settlements, ”Central bank digital currencies”, March 2018. Probably the most important issue is whether the digital currency should be traceable or whether it should be designed to guarantee, to the extent possible, anonymity. Cash has always been an incredible instrument: it allows for third-party anonymity in transactions and leaves no trace. While this implies that it is an effective means of payment for illicit activities such as money laundering, the financing of terrorism or tax evasion, it also ensures privacy for its users. The possibility of tracing our digital transactions may have important economic and ethical implications. Imagine for a moment that payments data suggested that spending on alcohol and the probability of defaulting on a loan are positively correlated. Based on such evidence, a bank might decide to reject a loan demand by an applicant with high expenditure on alcohol, even though the correlation does not reflect any ex-ante causal relationship between these two variables but could be simply due, for example, to an ex-post common psychological factor. 16 Though it may be over simplified, this example emphasizes that we need to address carefully the privacy issues that may stem from digitization, and in particular from the introduction of a CBDC. Today these risks are still limited, as in most countries retail transactions are concluded mainly with cash, and the record of our electronic payments represents an imprecise screening device. 17 This is changing rapidly, however. Just who should decide on the degree of anonymity associated with the use of a CBDC? Clearly, this is more than just a technical issue, and as such, the choice does not belong to central banks alone but also to the political sphere. We need to think carefully, right now, about how to make the introduction of a CBDC fully compatible with the rights of individuals and about how to square the increasing availability of information on the private lives of each one of us in relation to our political views, state of health, or sexual orientation, with the protection of our personal freedom and with the rules that govern the functioning of a modern liberal democracy. Another key issue is whether a CBDC should be remunerated or, as in the case of cash, should pay no interest. This choice would have far-reaching consequences for the core activities of the central The introduction of the General Data Protection Regulation might limit the application of profiling but does not make it illegal (see https://ec.europa.eu/info/law/law-topic/data-protection/reform/rights-citizens/my-rights/can-i-be-subjectautomated-individual-decision-making-including-profiling_en). For example, in the EU cash payments represent 65 per cent of total retail transactions. See Schmiedel, H., Kostova, G. and Ruttenberg, W. “The social and private costs of retail payment instruments: a European perspective”, European Central Bank Occasional Paper, no. 137, 2017. bank, from financial stability to monetary policy, but they would also affect other issues, such as the volume and allocation of seigniorage. For example, interest payments would make a CBDC a closer substitute of bank deposits. 18 This would increase the volatility of deposits and, in extreme conditions, could even facilitate a digital bank run (whose probability is increased by the very existence of a CBDC): in bad times, depositors could switch rapidly and at no cost from their bank account to the CBDC. The central bank could limit such risks – for example by setting a ceiling on the amount of CBDC that each individual investor can hold, or by bringing the remuneration to zero for holdings of CBDCs above a certain threshold – but this would raise a number of technical issues. 19 At the same time, an interest-earning CBDC would reinforce the transmission of monetary impulses to banks, households and businesses. 20 In downturns, by lowering the remuneration of the digital currency the central bank could spur banks to reduce deposit rates; it could push them below zero (assuming that cash would no longer be available), improving its capacity to stimulate the economy in extreme conditions without necessarily resorting to unconventional measures. 21 A symmetrical mechanism would be at work in upturns, when an increase in the remuneration of the CBDC (which would represent the floor of market rates) would force banks to take swift action to also increase the remuneration of their deposits. A shift from interest-free cash to an interest-bearing CBDC would affect seigniorage in multiple ways: in addition to the direct effect on interest payments by the central bank (which would have a negative impact on seigniorage), it would have indirect effects by reducing the costs of supplying cash (positive impact) and by increasing the demand for central bank liabilities (positive impact). The overall effect is ambiguous, but it could be non-negligible and have non-trivial distributional consequences: central bank profits, transferred to the State and used as the State sees fit, could change On the contrary, a CBDC without interest would be comparable to cash. For example, a ceiling on individual holdings of CBDC could limit the number or size of payments, as the recipients’ holdings of CBDC would have to be known in order to finalize the payment. See Gürtler, S., and Rasmussen, S. Central bank digital currency in Denmark?, December 2017. See Bank for International Settlements, ”Central bank digital currencies”, March 2018, and Coeuré, B.”The future of central bank money”, speech at the International Center for Monetary and Banking Studies, Geneva, May 2018. If central banks pushed interest rates into negative territory in a world with a non-remunerated CBDC, banks would effectively avoid the negative rates by substituting reserves with digital currency. Banks could adopt this same strategy in a world with physical cash, but the high cost of storing it makes this option less attractive, inducing banks to accept moderately negative interest rates. significantly once currency holders are remunerated. The political economy consequences of this should not be underestimated. Turning now to the specifics of CBDC implementation, central banks should decide whether CBDCs should be token-based – whereby each token represents a particular denomination of the currency, like banknotes – or, like bank deposits, account-based, whereby holdings are accounting records. Again, this choice would have important consequences for a number of key issues such as anonymity (a token-based CBDC would imply a better protection of privacy) 22 or the organization of the central bank. In particular, managing an account-based system with millions of account balances, each potentially changing every day, would require an incredible effort by the central bank. The implementation of a token-based system, instead, would be easier and could be delegated to a private party. In both cases the security and resilience of the CBDC to cyber-attacks must be assured, in order to preserve trust in the currency. Digital hacking of the currency can reap very large rewards, in all likelihood larger than counterfeiting banknotes – the recent attack on the central bank of Bangladesh comes to mind. 23 Undoubtedly hackers everywhere are dreaming about how to violate the digital currency system! The number of questions related to CBDCs is enormous and the public debate about them is only in its infancy. I cannot address all the issues today. But I do wish to emphasize one last point before concluding my remarks. If central banks decided to make an asset – the CBDC – free of credit and liquidity risk, possibly remunerated, and available to anybody at no cost, their role in the economy would fundamentally change. The size of their balance sheets would likely increase, and with it their footprint in the economy. If the CBDC were account-based, central banks would start to interact directly with the private non-financial sector. Are central banks ready to play this new role and to deal with the attendant complexities? In the short term my answer is no. Beyond the short term, greater investment in new technologies and human capital would be necessary to address the challenges associated with issuing a CBDC. See for example Mersch, Y. “Digital Base Money: an assessment from the ECB’s perspective”, speech at Suomen Pankki, January 2017. For instance, a malware installed on the Bangladesh central bank’s computer successfully diverted around $80 million from its accounts. 5. Conclusions The technological revolution is pushing us towards a digital representation of many objects in our daily lives. Banknotes might be next in line. However, there are still many uncertainties on that front. Some of them are economic in nature, such as the efficiency of the payment system and financial stability. Others are related to individual rights, such as the right to privacy. Society as a whole would do well to decide on how to tackle the latter before the central bank steps in. Other issues, which I have not had time to touch on today, but are no less important, are of a legal nature. Can a central bank issue a new form of currency without explicit authorization by the government? If the CBDC is legal tender, does this mean that everybody will need to have the technical means to accept it? In many countries new laws may be required before any concrete steps towards a CBDC are taken. For a central bank, issuing a digital currency is like travelling in a new land: the path to take will be chosen at the same time as the map is drawn. The many uncertainties involved will undoubtedly make the journey exciting and full of discoveries, though a substantial amount of prudence and wisdom will still be required. All in all, this is hardly going to be a purely technical decision. Society as a whole, through its political bodies, will need to be involved. Whether central banks should issue digital currencies – and with what characteristics – remains an open question and I look forward to hearing the views that will be presented today. I remain convinced that physical cash will continue for quite some time to be part of the payment system. It is hard to dispute that money is probably one of the most important and useful social constructs, one that has been with us for around 3,000 years 24 and is still very much in use. Cash is by far the dominant means of payment, both in the euro area 25 and elsewhere, 26 and demand for it has been on the rise in most advanced economies in the last decade. Currency in circulation in the euro area amounts to around €1.1 trillion, and has recorded steady growth rates in recent years. Coins and banknotes have proven to be a resilient technology, it may be too early to call for their complete retirement. See, for instance, Robert A. Mundell, ‘The birth of coinage’, Columbia University, mimeo, 2002. Esselink Henk and Lola Hernández (2017), ‘The use of cash by households in the euro area,’ ECB Occasional Paper series 201/2017. Available at http://www.ecb.europa.eu/pub/pdf/scpops/ecb.op201.en.pdf. Bech, Morten Linnemann, Umar Faruqui, Frederik Ougaard and Cristina Picillo (2018), ‘Payments are a-changin' but cash still rules’. BIS Quarterly Review, March 2018. Available at https://www.bis.org/publ/qtrpdf/r_qt1803g.pdf. While the jury is still out on whether we will have a CBDC, the debate is already bringing benefits. Many central banks, including Banca d’Italia, are experimenting with new technologies such as DLT and Artificial Intelligence, studying how they work and how they can be put to productive use. This research contributes to the advancement of the technological frontier, and helps make the financial system more resilient to technological and cyber risks. These benefits are here to stay, independently of whether one day we will live in a world with digital cash. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Dinner address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Rome Roundtable 2018, Rome, 15 June 2018.
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Bank of Italy – The Global Foundation Rome Roundtable 2018 Rome, 15 June 2018 Dinner address of the Governor of the Bank of Italy Ignazio Visco Your Excellences, Ladies and Gentlemen, it is a pleasure to welcome you to the Bank of Italy. I would like to thank Steve Howard, Secretary General of The Global Foundation, for bringing together so many distinguished guests to discuss the state of the world and how it might be improved. I also thank Jock Murray, Chairman of The Global Foundation, for his kind introduction. I am honoured to set the stage for the keynote address by His Eminence Cardinal Pietro Parolin. Unfortunately, I could not attend the sessions of the first day of this meeting. I regret it very much because you have been addressing themes of fundamental importance for the global economy. These themes appear remote from the main tasks of central bankers, preserving price and financial stability, but at a deeper level all the issues are connected and we should not lose sight of the major changes that affect our societies and economies. In January 2017, Pope Francis’ address to The Global Foundation inspired the main theme of today’s and tomorrow’s discussion. He stigmatized “an ideology of capitalism” that shows “little or no interest for the realities of marginalization, exploitation and human alienation, a lack of concern for the great numbers of people still living in conditions of grave material and moral poverty, and a blind faith in the unbridled development of market forces alone” and invited us “to discern just ways of attaining a globalization that is ‘cooperative’, and thus positive, as opposed to the globalization of indifference”. Obviously, I do not have a clear and short answer to the questions posed by Pope Francis, but I do believe that the issue of labour is central. It relates to social integration and personal identity. At the economic level, it should not be seen solely as a cyclical problem: the economy’s growth depends on the quantity and quality of the labour force and on the capacity to provide adequate jobs in these ever-changing times. Therefore, in my remarks tonight I will first consider the main forces shaping our future and the challenges they pose; then I will hint at the traps that – as policy makers – we should avoid in order to move towards the “cooperative globalization” that we are invited to realize. Over the last decades, four overarching forces have been shaping the world economy: globalization, technological progress, demographic transition and climate change. For the most part, globalization and technological progress have been positive and powerful engines of economic progress and social change. But given their heterogeneous, pervasive and differentiated effects, they have also been the object of fierce critiques and deep-seated fears, which policy makers should not neglect. Globalization is a complex, multidimensional phenomenon, consisting not only of the deeper integration of goods, services and capital markets, but also of the greatly increased mobility of people, information and ideas. The globalization we have experienced over the last quarter of a century could not have been achieved without the technological revolution that today is symbolized by the wide diffusion of computers, the internet, smartphones and robots. This technological revolution is inexorably permeating all aspects of economic and social life. It is radically changing people’s habits and firms’ activities, as well as our way of working, producing, consuming, exchanging information and interacting socially. Statistics concerning the digitalization of the economy tell a clear story: in 2016, about 95 per cent of businesses in the OECD countries had a broadband Internet connection; more than 75 per cent had a web presence; half of the adult population had purchased goods or services online, compared with 36 per cent in 2010. These numbers suggest that, in this digital era, financial, economic and even social inclusion are closely related to technological inclusion. The formidable achievements of globalization and technological progress are too often forgotten as the discussion turns to their shortcomings and risks: − − − − The world economy is today six times larger than 50 years ago, while the total population has increased little more than two-fold, so that average per capita GDP has more than doubled. Over the last 25 years or so more than 1 billion people have escaped extreme poverty (defined as an income below 1.9 dollars per day) while 2.2 billion have been added to the world population. Therefore, about 3.5 billion people have never entered or have escaped this condition. The target of halving the share of people living in extreme poverty has thus been achieved five years earlier than was established within the Millennium Development Goals agreed in 2000 by the United Nations, notwithstanding the exceptional increase in the world population. The so-called emerging economies – once excluded from the global economy and hosts for the largest share of the poor – have substantially narrowed the gap with advanced countries and are today the main contributors to world growth. The mortality rate for children under the age of 5 was halved globally between 1990 and 2015. − Thanks to greater labour mobility, today about 260 million people live in a foreign country, up from less than 80 million in 1970, and flows among developing countries now exceed those towards advanced economies. However, not everybody has benefited in the same way from the economic expansion provided by trade and innovation. Economic backwardness, poverty and high mortality rates are still dramatic problems in many developing countries, especially in Sub-Saharan Africa. Even in the more prosperous countries, many have been left behind. Inequality in the distribution of income has declined dramatically over the last three decades at a global level, mainly as a result of the fast growth of China and other emerging markets that has reduced their distance from the richer parts of the world. However, within most countries differences in income and wealth have risen to historically high levels. Finally, the rapid pace of technological progress and its unprecedented nature make it possible not only to replace physical labour but even to displace intellectual contributions in a variety of tasks once believed to be a prerogative of humans. This has raised fears of a new form of technological unemployment, to which the medium-skilled population is also vulnerable, and has helped to spread a sense of insecurity, raising the demand for protection. The two other factors shaping our present and future conditions – demographic transition and climate change – are not independent from, and have actually been reinforced by, global economic integration and technological progress. Higher living standards and wider access to better healthcare have increased life expectancy across the globe. For the first time in our history, the world faces not only a growing population – estimated to reach almost 10 billion in 2050, up from 7.5 billion today (and 2.5 billion in 1950) – but also an ageing one: there are almost 1 billion people aged 60 or over in the world (13 per cent of the global population) and this age group is growing faster (at 3 per cent per year) than younger age groups. In most advanced countries, as well as in China, declining birth rates, with increased life expectancy, are pushing up the so-called old-age dependency ratio, the population over 64 relative to the working-age population (aged 15 to 64). In Europe, ageing is progressing at a very fast rate: in Italy, the old age dependency ratio has risen from 12 per cent in 1950 to more than 35 today; in Germany, from 14 to 32 per cent. Demographic transition, however, is a global phenomenon: Japan has the oldest population in the world, while in China the dependency ratio has doubled since 1950 and is expected to reach 44 per cent by 2050, up from 13 today. This demographic transition will have a deep and long-lasting economic impact. However, the argument that this impact is inevitably negative rests on the assumption that old people are only unproductive consumers of government benefits. This is not necessarily the case: − − Ageing does not automatically imply being unproductive or sick. A 70 year old today is in many respects much “younger” than a person of the same age 50 years ago and we now have the means to avoid the marginalization of the elderly and to keep them an integral and productive part of society for longer. While in relative terms the old are outgrowing the young, the number of young people in the world is the largest in history in absolute terms, but it is not distributed evenly around the globe. Of the 2.2 billion people added to the world population since 1990, less than 1 in 10 live in advanced countries. Africa, which hosts some of the poorest countries in the world, is expected to have the fastest population increase over this century, reaching Asia in absolute terms. Only an integrated world economy and wise policies can help to spread the benefits of progress more evenly. This also requires that the flows of migration be properly managed. Climate change is linked to what we have been saying so far. The post-war exponential demographic acceleration – the “population explosion” – prompted discussion of the “limits to growth”. At the start of the 1970s, the Report of the Club of Rome, which centred on the predicted depletion of natural resources, raised alarm about the survival of the earth’s ecosystem and of the human race. These projections received great attention from the media, but they were greeted sceptically by many eminent economists of the time. With some reason, the critics noted that the Report failed to account for two major stabilizing mechanisms: the ability of relative prices to rebalance supply and demand and the endogenous response of technology. Notwithstanding the power of these two mechanisms, which makes any long-term projection hazardous, the concern has not abated. The debate on sustainable development – i.e. development that can “meet the needs of the present without compromising the ability of future generations to meet their own needs” – suggests that today it is impossible to ignore the environmental balance of the planet and the reciprocal compatibility, or trade-offs, 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 series of important international agreements (the Kyoto Treaty of 1997 and the Paris Climate Agreement of 2016) have made it clear that two aspects are of special importance: 1) tackling the challenge of climate change at a global level, with the cooperation of all the parties involved; and 2) devising incentives for the invention and use of new technologies to drastically curtail emissions of carbon dioxide and other greenhouse gases. Globalization, technological progress, demographic transition and climate change present us with formidable challenges. But economic integration, scientific progress and improvements in education and health conditions provide great opportunities for forging a more prosperous, more equitable and more sustainable world economy. However, it must be clearly understood that attaining a “cooperative” globalization entails governing the world economy, as it would be illusory to rely solely upon unfettered market forces. As the global financial crisis has clearly demonstrated, effective regulation, adequately funded international financial institutions and strong cooperation among nations are necessary to mitigate risk, grant stability and correct market excesses. Unfortunately, we live in unprecedented bad times for international relations. A retrenchment of policies towards narrowly defined national interests and short-termism in the definition of policy objectives, partly dictated by the continuous monitoring of popular approval and facilitated by the new digital technologies, are the most significant risks today. The US decision to back out of the Paris Climate Agreement and the recent failure to sign a shared Communiqué at the G7 Summit in Charlevoix are clear signs of the dangers to the liberal world order and global cooperation. The trade dispute is revelatory of the difficulties we encounter on the road to cooperation. As is well known, the basic economic teaching on trade policy is that free trade is by far the best option as it grants full exploitation of comparative advantages to all parties involved. Indeed, the current trade system based on multilateral agreements underpinned economic development for decades. Obviously we should not ignore the potential complications arising from different levels of industrialization across nations and the risk of specializing in products that might lock in a country at a pre-industrial stage, as may have been the case for much of North-South trade during the colonial period. But we must consider that, in trade deals, the interests of producers and consumers are seldom aligned. Often the benefits of a given tariff or import quota are concentrated in the hands of few well-organized producers, while their costs, no matter how great in absolute terms, are spread among a large number of unaware and unorganized consumers. A similar conflict between concentrated and diffuse interests also arises in the case of climate change, where a further tension is added, the one between current and future generations. A final example of the difficulties we encounter on the road to cooperation is the reaction to migration. Of course, there are many reasons why migration is met with some resistance by receiving communities. While the concerns of the more vulnerable parts of the population must be addressed, we should recognize that international mobility is a positive force for economic and social development: if properly handled, it could help poor countries to grow by alleviating the pressure on their labour markets, and it could ease the consequences of ageing in richer economies, which need a young labour force to balance falling birth rates. But we should not ignore the conflicts that migration may generate. A first one is between the citizens of rich countries, who enjoy a “citizenship rent” they have received without meriting it, and the citizens of poor countries, who try to escape a poverty for which they have no responsibility. A second one is between young people today, who feel their jobs are threatened by migrants, and the same people tomorrow, as a young labour force is needed now to support their living standards in the future. These are formidable problems that cannot be tackled by policies constrained by geographical borders. The wide-ranging integration of the global economy has brought a corresponding integration of global problems. It would be short-sighted – actually counterproductive – to think that effective solutions can be found exclusively within one’s own territory, following “me first” national strategies. But this is the reality we face. By the same token, an effective solution to these problems requires a longer-term view, a political agenda that is not enslaved by short-termism, since the needed reforms and policies have effects that are not immediate, but are distributed over a long-time horizon. We need to prepare the polity for this kind of intervention, which is now opposed by so many. To shape public opinion, education and information are key. We need to communicate in clear, accessible terms the long-term benefits of openness to trade, to new ideas and to managed migration, while addressing the needs and fears of the most vulnerable parts of the population in advanced economies and in the world at large.
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association (ABI), Rome, 10 July 2018.
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Italian Banking Association Annual Meeting Speech by the Governor of the Bank of Italy Ignazio Visco Rome, 10 July 2018 Cyclical conditions and the economic outlook In Italy, as in the other main advanced economies, economic activity slowed in the early months of 2018, with the signs of deceleration continuing in the spring. The confidence of households and firms has nonetheless remained high, with positive indications also coming from the expansion of bank lending and improvements in the labour market. Although unemployment is still above 10 per cent, employment has surpassed the peaks observed prior to the double-dip recession. In more recent months, both the fixed-term and, to a lesser extent, permanent components have recorded increases. In most of the forecasts made by national and international institutions, Italy’s growth is expected to exceed 1 per cent on average in the three years 2018-20. This scenario assumes monetary policy will continue to be accommodative and financial conditions relaxed, and that there will be a favourable economic environment worldwide. In recent months, however, there has been a notable increase in the risks connected with the United States’ protectionist policies and with disagreements on various fronts in relations between EU countries. Last June the Governing Council of the European Central Bank recognized the progress that had been made towards a sustained increase in inflation rates in the euro area – progress associated with increased employment, greater use of productive capacity, accelerating wage growth, and the recovery in inflation expectations. Though acknowledging that there are still ample margins of uncertainty, it was decided to recalibrate the asset purchase programme and in any event to maintain an ample degree of monetary accommodation in order to achieve the objective of price stability. If cyclical conditions in the area remain consistent with the current medium-term outlook, from October net asset purchases of securities will be reduced from the current €30 billion a month to €15 billion and will cease at the end of the year. The principal payments from maturing securities will continue to be reinvested for an extended period of time after the end of the net asset purchases. The Governing Council also said that it expects to keep interest rates at their present low levels at least through the summer of 2019. This prudent approach is also necessary to counter the risk of sudden surges in long-term yields and of volatility in the financial markets. Given the prospects of growth and of a steady rise in inflation, Italy is in a position to weather the gradual changes in the tone of monetary policy. The high average residual maturity of the public debt, low household debt, reduced business debt, and the fact that banks are sounder and have only limited exposure to the effects of any interest rate rises, will make it possible to contain the risks connected with the structural fragilities of Italy’s economy. The achievement of a satisfactory and stable growth rate is, however, hampered by continued weak productivity growth, the inefficiencies and rigidities of the business environment and the high debt-to-GDP ratio. Addressing these vulnerabilities means continuing to implement systematic reforms and balanced fiscal policies, which are also necessary to maintain the confidence of households, firms and investors. Recent tensions in the Italian financial market demonstrate the importance of a prudent and balanced economic policy stance. Between mid-May and early June, with very low market liquidity, yields on government securities increased across all maturities. Yields on ten-year bonds surpassed 3 per cent for a few days and the spread with respect to the equivalent German bond rose above 300 basis points, while the spreads vis-à-vis the government bonds of the other euro-area countries also widened. The performance of premiums on credit default swaps on government securities shows there were moments when fears of a redenomination of Italy’s debt grew among financial operators. Contrary to what happened at the height of the sovereign debt crisis in 2011-12, the markets did not perceive this to be associated with an increase in the risk of a euro break-up. Pressures eased in the following weeks, when the sharp rise in volatility partially subsided and short-term yields declined, restoring the more usual, positive slope of the term structure. The spread between yields on ten-year Italian and German government bonds has fallen to around 240 basis points; however, it is still more than 100 points higher than the levels prevailing in the first half of May. Maintaining orderly conditions on the government bond market is essential to defend the stability of the financial system and effectively protect the savings of Italians. During the tensions at the end of May, share prices in the banking sector declined sharply. The financial situation of the public sector can influence that of the banking sector through multiple channels. The reduction in the value of government securities held by banks directly affects their assets; it also diminishes the amount of collateral that banks can use in Eurosystem refinancing operations. The challenges for the public finances can lead to an overall deterioration in the creditworthiness of firms, impairing the quality of bank loans. It would be illusory to think that the link between sovereign risk and banking risk can be broken with measures that push banks to drastically reduce their direct exposures. Moreover, in the most difficult years of the crisis, Italian banks, like those of other countries, swam against the tide, and made a profit, buying government bonds when tensions rose and yields increased. When the conditions changed, they began to sell them. Last May, Italian banks held slightly more than €300 billion worth of domestic government bonds in their portfolios, compared with the €400 billion reached at the beginning of 2015. Loan quality The continued economic growth has led to a gradual improvement in the quality of bank credit. The ratio of non-performing loans, net of loan-loss provisions, to total loans system-wide, which had fallen by about 4 percentage points between the peak of 2015 and the end of last year, decreased by almost 1 percentage point more in the first quarter of this year, to stand at 5.3 per cent. The total amount of net NPLs fell to just over €110 billion, down from €200 billion at the end of 2015. About half of the amount comprises exposures classified as unlikely-to-pay, some of which could become performing again. For the less significant banks the share of all NPLs (7.1 per cent) remains higher than that recorded by the significant banking groups (5.1 per cent). The development of the secondary market is making an important contribution to reducing the number of NPLs. This market in turn benefits from the state guarantee on senior debt issues deriving from the securitization of bad loans (GACS). The gross value of the bad loans securitized under the GACS system was approximately €32 billion and it is expected to increase considerably in the months to come. In the last few days, the Government has asked the European Commission to extend the possibility of using GACS beyond the current deadline of September. The improvements made thus far should be consolidated and strengthened. More active NPL management on the part of banks remains fundamental, including in the light of the regulatory changes proposed by the European Commission and the new supervisory expectations of the Single Supervisory Mechanism supplementing the guidelines on NPL management published in March 2017. The strategies proposed by the banks will be assessed on a case-by-case basis as part of ordinary supervisory activity and the measures best suited to reduce the level of NPLs further and to gradually and sustainably adjust the level of provisioning will be adopted. Account will be taken of the fact that the containment of a credit portfolio’s inherent risk must be compatible with the ability to absorb any potential losses from sales. The number and size of firms specialized in credit recovery are increasing, but the level of competition in this sector remains unsatisfactory. Some banks have set up ad hoc units. Progress in developing a liquid secondary market for NPLs and advances in the efficacy of recovery procedures depend on a marked improvement in the quality of the information needed for due diligence purposes and the timely monitoring of the status of the procedures. The analytical reporting on bad loans launched two years ago by the Bank of Italy is making significant strides in this direction. There is still ample room for improvement, however, especially for small banks and with regard to data on real estate appraisals. Every effort must be made to catch up. Measures to increase the probability that likely-to-fail exposures return to performing status must be stepped up. Their success requires different technical skills and operating procedures from those used to manage bad exposures. A market for this type of exposure should also be established and banks should actively seek agreements with turn-around funds to offer firms the managerial and financial resources needed for a re-launch. In recent years there have been improvements in the length of judicial credit recovery proceedings as well. Data on the initial phases of foreclosure proceedings indicate that the 2015-16 reforms are working towards reducing their duration: the length of the pre-sale phase has fallen by about a tenth (from 27.5 to 24.5 months), while that of the sale phase has been nearly halved (from 41.5 to 23.5 months). Nonetheless, overall recovery times remain long. Additional regulatory reforms may be needed to prevent the accumulation of NPLs on banks’ balance sheets and to ensure the necessary flow of loans to households and firms. The enabling law reforming the regulations on corporate crisis and insolvency approved by Parliament redistributes the competencies of judicial offices in the context of bankruptcy proceedings in order to increase the level of specialization of judges. It overhauls the courtbased liquidation procedure: priority must be given to significantly reducing the length of the proceedings by simplifying the process and offering appropriate incentives to the parties involved. The judicial system can also be improved by introducing organizational changes, as the wide variations in the duration of foreclosure proceedings in different courts suggest. The guidelines approved last October by the Superior Council of the Judiciary, designed to encourage the spread of best practices, could make an important contribution in this regard. Additional benefits may come from the imminent launch of the electronic register for foreclosure and insolvency proceedings and crisis management tools. These projects, to which the Bank of Italy is contributing, are at an advanced stage. In addition, the value of extrajudicial credit recovery instruments should not be underestimated. In 2016 the Marciano Pact was introduced in Italy, which provides for the transfer of ownership of real property serving as a guarantee to a business loan in the event of default. However, recourse to this instrument remains limited. The agreement entered into by ABI and Confindustria at the start of this year may encourage its use. The Pact’s importance has been confirmed by the initiatives under way at European level as well. The European Commission recently presented a draft directive which, among other things, provides for an expedited procedure for the out-of-court enforcement of real property guarantees in the context of business loans that is similar to the Marciano Pact. Recent reforms In recent years, the difficulties faced by some small banks have been resolved through acquisitions by other banks, with Italian or foreign financial intermediaries and investors participating in the capital and with the contribution of the voluntary scheme of the Interbank Deposit Protection Fund. In a market in which technological innovations make bank branch networks less attractive to potential investors, crisis resolution has become more difficult. European regulations preclude the use of the resolution tool for small banks, on the assumption that it is not in the public interest to do so. Therefore, in the absence of interested purchasers, there would be no alternative but to liquidate these banks. The impact, even reputational, on the entire category of small banks would be significant. Good corporate governance and access to the capital markets are indispensable for avoiding a crisis. In turn, adequate skills and rigorous monitoring of conflicts of interest are needed for high-quality governance. It is a short step from being a bank that ‘supports local interests’ to being a bank that is ‘trapped by the region’. Virtuous examples of local banks are possible, but they call for high-quality organizational structures and thorough and prudent credit assessments. Recent experience has shown that these operational models can be achieved if local expertise is accompanied by the use of adequate quantitative instruments (such as credit scoring systems) and if high levels of productivity are maintained. Different forms of integration can help in strengthening small and medium-sized banks: outsourcing and sharing certain functions and services, creating specialized purchasing consortiums, and using institutional protection schemes. For small banks, however, the merger or creation of a banking group remain the most effective tool for improving efficiency and guaranteeing market access for recapitalization purposes. In recent years, the governance structure of cooperative banks has been the subject of major reform measures. The reform of the popolari banks has allowed institutions that had grown significantly in size – some of which listed – to take on the legal form that best represents their actual business structure. The governance problems inherent in the cooperative model would have continued to hamper their access to the financial market, especially when it is necessary to rapidly strengthen capital. The transition to joint stock company makes it possible to carry out mergers that would otherwise be difficult to execute, with benefits for the entire banking system. The reform must be seen through to the end so that the remaining large popolari banks can make the necessary improvements regarding the transparency of their governance structure, the ability to access the market, and the possibility to participate in mergers. Italy’s smaller popolari banks, whose transformation into joint-stock companies was not mandatory under the reform, could also benefit from increased integration in some areas such as the pooling of production processes and marketing of their products. Some headway is being made in this direction and must continue. In this year’s Concluding Remarks I also raised the possibility that these banks could take advantage of special institutional protection schemes based on agreements to provide reciprocal guarantees on the solvency and liquidity of their members, along the lines of similar schemes in other European countries, with benefits when it came to calculating capital requirements. This is an opportunity that merits serious consideration. The reform of the mutual banking sector (BCC banks) is proceeding as the law requires. In the next few weeks, the supervisory authorities will adopt measures authorizing the creation of the new cooperative banking groups. Within ninety days of obtaining authorization, the shareholders of the BCCs must approve the amendments to their by-laws and sign the cohesion contract regulating the degree of business autonomy of each individual bank by means of a system of risk assessment. The process of drafting the reform, which garnered broad consensus throughout the sector, took almost two years to complete. The discussions between the supervisory authorities and future parent banks on preparing the applications to create the new banking groups have been intensive. The reform preserves the banks’ cooperative and mutualistic spirit, even within the new regulatory and market environment. Precisely in order to pursue these objectives the law envisages that the BCCs will be majority stakeholders of the new parent banks. As members of a banking group, BCCs can tap capital markets in times of need, warding off potential crises. They can share best practices and centralize key oversight and production functions, with cost and revenue synergies that individual members can exploit while maintaining a relatively small scale of operations. The pooling of horizontal functions means BCCs could focus on developing their regional presence, with benefits for local economies and customer bases. Even the most ‘virtuous’ of these banks could raise their current efficiency levels; businesses and shareholder/customers could gain access to a broader range of products and services. The system of joint and several guarantees would allow the weakest BCCs to take effective and timely action to overhaul their business models, both in terms of their capital positions and the range of services offered to firms and households. Capital adequacy and profitability During the crisis, even when market conditions were especially harsh, Italy’s banks undertook significant capital strengthening. The CET1 ratio, which today stands on average at just below 14 per cent, has almost doubled since 2008. The increase was achieved together with the introduction of stricter rules on minimum capital requirements (Pillar 1) and supplementary requirements by supervisors (Pillar 2) to counter risks not covered under the first pillar. The conclusion, to all intents and purposes, of the Basel III agreement at the end of last year reduced the regulatory uncertainty surrounding the long and complex process of drafting the measures that were first announced and then gradually adopted by the Basel Committee. The progressive application of the rules over a period of five years, from 2022 to 2027, allows banks to plan the necessary changes well ahead of time. The transposition into European law of the agreement finalized a few months ago in Basel has just begun. The Commission has called for the EBA’s technical advice in setting out the procedures for implementing the new international rules, taking account of European specificities and of the need to uphold the principle of proportionality in their application to small banks. The impact of the new rules on Italy’s banks appears modest overall. Recent estimates on a sample of the largest banks suggest that once fully implemented, the CET1 ratio will be lower by around 70 basis points, as against the EBA’s estimate of 140 points for the leading European banks. The impact would mostly derive from the treatment of operational risk; the rule on the minimum requirement for banks that use internal models (known as the ‘output floor’) is expected to have a very limited impact in Italy. This could be reduced further by the steps that the banks will certainly take to adapt to the new rules during the long transitional period prior to full implementation. Banks must make good use of the time available before the introduction of the new rules. Measures to strengthen their balance sheets and improve profitability are fundamental, continuing the action undertaken in recent years. In the first three months of this year, the profitability of Italy’s largest banks improved, continuing the trend observed in 2017. For the significant institutions, annualized ROE rose to 8.4 per cent, from the 5.1 per cent recorded in the first quarter of last year; the cost-to-income ratio fell by around 5 percentage points, to 65 per cent. The average profitability of the less significant institutions is lower: in 2017, the last period for which complete data are available, their ROE amounted to 1.3 per cent, against 4.7 per cent for the significant institutions. For all the banks, and especially for small banks, successfully meeting the challenges posed by stronger competition, regulatory pressures and new technologies, requires incisive action to increase operational efficiency. The reform of the mutual banking sector, which I mentioned earlier, is one of the responses to these challenges. But undoubtedly more must be done, especially in relation to technological change. With the advent of Fintech, marking the marriage of high tech and high finance, the framework of reference is changing rapidly. New players are creating alternative and more efficient business models, often superseding functions traditionally carried out by banks, such as the provision of payment, asset management and securities investment services. Based on market analyses, traditional banks believe that, over a five-year horizon, a number of their activities, corresponding to around a quarter of profits, are at risk. Compared with the new entrants, incumbent banks enjoy advantages stemming from stable relationships with customers and the wealth of data collected over the years. By exploiting these advantages better through the use of new technologies, they can expand the range of services offered, improve the quality of relationships with customers and manage risks more effectively. Investment in this area remains low and is mostly made by the largest banks. This is due to difficulties in adapting organizational arrangements and operational processes, identifying the necessary skillsets and integrating systems with pre-existing technological infrastructures. If the potential of Fintech is not exploited in full, banks run the risk of rapidly losing ground with respect to new operators that are often subject to lower regulatory requirements and to the technology giants that have already emerged in the fields of banking and finance. Against this background, the banks now have to restore efficiency ratios and bolster profits by diversifying their sources of revenue and reducing administrative and labour costs, particularly those associated with a widespread network of branches located around the country. In what is now a mature market, in Italy as in the other European countries, a new phase of banking concentration could help to exploit economies of scale and absorb excess capacity. Efforts to realign the structure of the market have been under way for some time: in the last two years the number of banking groups and independent banks has diminished by about 100, to a total of just over 400, and it will fall further with the creation of cooperative banking groups. By the end of last year, the number of bank branches was down to 27,000, from 29,000 in 2016 and 35,000 at the end of 2008. Between 2008 and 2017, employee numbers have dropped from 338,000 to 282,000. The process of restructuring the market must go on; in 2017 the number of bank branches per 10,000 inhabitants averaged 4.2 in the Eurozone and 4.5 in Italy and their productivity, measured by the ratio of balance sheet assets to number of employees, was €15.2 and €13.2 million respectively. Efficiency and profitability also need to be restored in order to meet the new requirements for loss-absorbing liabilities in case of failure (MREL), as these could lead to a sharp increase in the cost of wholesale funding at a time when the size of renewals could be significant. Indeed, about half of the present stock of outstanding bonds, amounting to almost €150 billion, will mature before the end of 2020. It is important to take into account, as well, the implications of the on-going review of internal models for measuring solvency capital within the Single Supervisory Mechanism, which could lead to higher requirements. Sufficient profit margins and suitable capital cushions have also become necessary in view of the periodical stress tests that the banks are required to run and that the supervisory authorities use to assess the institutions’ ability to withstand adverse macroeconomic scenarios. A new stress test is now being conducted in Europe on the leading banks, coordinated by the EBA and run by the SSM in the countries of the banking union. The results will be published at the beginning of November. The other measures that banks should take to improve efficiency and diversify sources of revenue – and which include offering a broader and better defined selection of asset management services – cannot be governed by opportunistic considerations or shaped by the temptation to exploit privileged positions. Customer centrality, which underpins EU legislation on financial investments (MiFID II) and the guidelines issued by the European regulatory authorities, is key to ensuring the sustainable development of the banking industry. Banks should be encouraged to create and market products and services geared to meeting customers’ new demands or improving the response to existing needs, taking advantage of the possibilities offered by new technologies. Compliance with the rules introduced to promote customer relations based on transparency and probity, on the one hand, and constant monitoring of potential conflicts of interest, on the other, continue to underpin the protection of savings. * * * The reforms launched in Italy and in the rest of the EU to reduce the elements of fragility exposed by the global financial crisis and the sovereign debt crisis have yet to be completed. Willingness to pursue the path taken has gradually weakened; in Europe, some countries have become concerned about the distribution of the costs and benefits of the measures needed to improve the EU’s economic governance; in Italy, the reforms have lost impetus owing to fears about their cost, often borne in the short term, and doubts about their benefits, which will emerge gradually and only in the fairly long term. In such conditions, if faced with a new crisis, we will be far more vulnerable now than we were ten years ago. There remain some fundamental aspects of the banking union that need to be finalized, such as the resolution fund – still without sufficient coverage – and the deposit insurance scheme – yet to be instituted. The new rules have eliminated the national tools for managing banking crises, but they have not replaced them with effective common mechanisms. A similar situation overshadows the public finances: individual countries saw their scope for manoeuvre further reduced when their debt increased after the recession, but no start has been made on creating a pan-European macroeconomic stabilization capacity. Europe needs to overcome the division between those who believe the risks should be reduced and those who maintain they should be shared more equally, a division that has a poor analytical background and serves little political purpose. We can in fact reduce the risks by sharing them: the completion of the banking union and the introduction of a real union of capital markets are a precondition for eliminating financial fragmentation and allowing private capital to act as a shock absorber as it does elsewhere, for example in the United States. A European budgetary capacity would limit the impact of recessions in single member states without weighing on national public finances, thus reducing the risk of sovereign debt crises and the need for rescue measures, which, as experience has taught, are extremely costly. At the same time, it is essential to continue resolutely and visibly reducing the risks in each country in order to win the trust of savers and markets alike. This process needs to be carried out carefully and gradually, however, to avoid creating a breeding ground for new crises, particularly given the lack of a common safety net, and so oblige the countries concerned to adopt overly restrictive budgetary measures while making it impossible for the banks to adequately support the economy. We must not cease our efforts to strengthen Italy’s banking system, particularly the smallest institutes, and to eliminate the structural impediments to realizing our economic growth potential. The banks should provide the financial services that will allow firms to grow and innovate, but a system that is able to grant credit justly and efficiently, even in adverse economic conditions, needs its residual competitive disadvantages to be removed. This is one of the objectives of the action being taken to improve the efficiency of judicial and administrative procedures; we must not stop now. The obstacles to business, innovation and the correct allocation of resources caused by rigidities and delays in public services should also be eliminated. And there is clearly a need for public investment, chosen and carried out with the utmost efficiency, just as there is also need for sweeping and balanced fiscal reform to increase employment and promote economic growth. In such a situation, demand-side policies should be carefully gauged, focusing on public accounts balance and the importance of monitoring the debt-to-GDP ratio. It would be dangerous to rely on such policies alone to help Italy escape the trap of low growth in which it has been confined for so long and resume a path of strong and lasting development. Caution and farsightedness are essential to avoid tensions or potential crises and to prevent Italy’s future generations from inheriting higher debt and lower income. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Remarks by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the Wolpertinger Conference, Modena, 30 August 2018.
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Wolpertinger Conference Banking Union: experience so far and future prospects Remarks by the Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS) Salvatore Rossi Modena, 30 August 2018 1. Rationale for the Banking Union Banking Union (BU) in the euro area is the latest step in a long journey.1 The project for an integrated and unified Europe was designed right after the Second World War and was ambitious but pragmatic: ambitious in the ultimate objective of ensuring peace and prosperity to the European people after centuries of bloodshed; pragmatic because an explicit choice was made to start the process with the economy, instead of the much more challenging political sphere. Still, the political value of the project was clear from the beginning. Monnet called it its ‘sense of direction’.2 The Treaty of Rome, of which we celebrated last year the 60th anniversary, was the first milestone. The project of monetary unification, revived in the 1990s after a first abortive attempt at the end of the 60s, was an even braver achievement. The euro was adopted on 1st January 1999 thanks to the efforts of statesmen and civil servants like Ciampi, Delors, Kohl, Mitterand and Padoa-Schioppa, all belonging to a generation that had not forgotten the wars in Europe. The challenge was enormous: let’s not forget that many in the academic world, especially in the United States, thought the project was economically wrong and politically frail. However, for over a decade, the balance between costs and benefits appeared positive. The real challenge for the European Monetary Union came with the sovereign debt crisis at the beginning of this decade. Prompted by the revelation of the true condition of Greece’s public finances, the crisis rapidly evolved into a basic mutual distrust among European countries: some (public opinion, governments, even national central banks) started to fear that, thanks to the common currency, other countries would finance their profligacy with the money of taxpayers in the first group of countries; the second group of countries began to blame the first group for Rossi (2017). Monnet (1955). imposing excessively ‘austere’ policies on everyone in the name of the common currency. The markets viewed those feuds as a sign that Europeans no longer considered the euro indestructible and that they could call into doubt the irreversibility of the common currency. The possibility of ‘redenomination’ of public debts into re-born national currencies, though remote, started to be priced in and spreads soared, reflecting expectations of devaluation/revaluation. Banks in weak countries, whose balance sheets were full of national public bonds, incurred heavy losses at market value. The prospect of a generalized bank bail out in those countries stoked expectations of an unsustainable evolution of public finance, in a vicious circle. It was a political crisis disguised as a financial one. The Banking Union was initially meant to be a response to that situation.3 The idea was to establish the principle that European banks were first of all European. If one runs into trouble, it’s a European concern, not only a concern for the country where the bank is based.4 The actual implementation of the project took a different direction. The prerequisite of common supervision was realized first: since 2014 ‘significant’ banks are supervised by a European authority (the Single Supervisory Mechanism, based in Frankfurt). Next came the core of the new regime: since 2016 a bank can no longer be bailed out with taxpayers’ money. In the event of serious trouble, it can be either bailed in – that is rescued, but with a big sacrifice being made by shareholders and private creditors – under the direction of another European authority (the Single Resolution Mechanism, based in Brussels), or liquidated. Finally, a European insurance deposit scheme, still to be created, will reimburse small depositors of liquidated banks, with money coming from the rest of the banking system, not from taxpayers. EU Commission (2015). Rossi (2016). The proposal for a public backstop for both the Single Resolution Fund and the Common Deposit Insurance Scheme has been de facto ruled out. The legal framework consists of an intricate web of directives and regulations: on the supervision side are the Capital Requirements Directive (CRD), the Capital Requirements Regulation (CRR) and the SSM Regulation; on the crisis management side, the Bank Recovery and Resolution Directive (BRRD) and the SRM Regulation, together with the Communication of the EU Commission on the application of State-aid rules to banks (Banking Communication). In both areas, the European Banking Authority (EBA, an authority currently based in London but soon to move to Paris, in charge of prudential regulation) has issued a number of implementing guidelines and technical standards. In substance, European banks have become European only in one sense: they are supervised and resolved at the European level. The vicious link between sovereigns and banks has not been severed, but a straitjacket has been imposed on banks to ensure that, should a sovereign experience a flight from its bonds, the country’s banks cannot be bailed out by taxpayers, either of that country or of any other countries. More specifically, a German taxpayer can never be asked to contribute financially to the rescue of an Italian bank whose balance sheet is sinking under the weight of Italian public bonds that are losing more and more market value. If that happens, the creditors of the bank, mostly Italians, must bear the brunt on their own. And there is no longer any question of euro irreversibility, because the case of Greece has shown that a sovereign state can even default without leaving the euro. 2. Experience so far, with the SSM... Any assessment of the BU should take into account the historical trajectory towards the integration and unification of Europe, the external and the internal context, and the political motivations and constraints of the project. We should not overlook the fact that a strong anti-Europe mood has swept through some of our countries in recent years, combining criticism of the European construction, sometimes well-founded, with populistic cries. Bearing this in mind, the first pillar of the BU construction – the SSM – has undoubtedly been a political success so far. Within a couple of years a very complex institutional and regulatory architecture has been set up from scratch, mobilizing ideas and resources from national supervisors (National Competent Authorities, NCAs) and the European Central Bank, under which the Mechanism has been placed. President Draghi called the SSM ‘the greatest step towards economic integration since the creation of Economic and Monetary Union’.5 The SSM relies on more than 6,000 experts based both in Frankfurt and in all the euro-area capitals, working together. Off-site supervision of each significant bank uses a unique format, the Joint Supervisory Team (JST), which is composed of supervisors from both the ECB staff and that of various NCAs. Less significant banks (20 per cent of euro banking assets) continue to be directly supervised by the NCAs, with the SSM (staff and Board) overseeing the process to ensure homogeneity across jurisdictions. A fundamental tool for harmonizing concepts and practices in the area was published a few months ago, the SSM Supervisory Manual.6 But the methodological effort is never-ending: we are now working to improve the Supervisory Review and Evaluation Process (SREP), partly in order to promote convergence in the prudential treatment of significant and less significant banks.7 Further improvements are currently being discussed: how to streamline the decision-making process; how to enhance cross-fertilization in the on-site teams and their community spirit; and how to improve coordination between prudential supervision and anti-money-laundering oversight. The discussions within the SSM Board, the NCAs’ input gathered through written procedures and the contribution of technical working groups have helped to address all the relevant issues, even the most controversial ones. For instance, regarding Non-Performing Loans (NPLs), while everyone agreed on the need for the banks most affected by this problem to get rid of their NPLs, there was much discussion about how to proceed at the SSM level. The solution, which we are Draghi (2015). ECB (2018a). ECB (2018b). now working on, is based on a bank-by-bank approach8 and seems to go in the right direction, without entailing any illegitimate foray into the regulatory field. We should take into full account the specific business models of banks and avoid unjustified differences of treatment. 3. ... and with the SRM The performance of the new crisis management framework is less easy to assess. According to the existing legal framework, if problems arise in a bank, first the SSM is supposed to engineer early intervention to redress the situation. If, in the end, the bank is labelled ‘failing or likely to fail’, the SRM comes into play. The SRM is composed of the Single Resolution Board (SRB), acting as a central resolution authority, and the 19 National Resolution Authorities (NRAs); it has within its remit both significant and less significant banks, but the latter only if they have cross-border activities. The SRM decides first of all whether there exists a public interest to justify the rescue of a failing bank under the common ‘resolution’ procedure. If not, the bank must be liquidated according to national rules. The European Commission ensures that the national government’s financial support, if any, complies with State-aid rules. I do not want to recall here Italy’s painful experience with the four smallto-medium banks put under ‘resolution’ in 2015, because the story is common knowledge by now. The SRM was not yet operative and the procedure was left to the national resolution authority (the Bank of Italy) but the fundamental elements of the new legislative and regulatory framework were already in place, only with the lighter ‘burden sharing’ instead of the bail-in. In almost three years of actual operation, the SRM has stepped in only once, for an important Spanish bank. In four other cases of ‘failing or likely to fail’ banks it concluded that the public interest requirement was not met and diverted them to national insolvency rules, which are not harmonized. The mechanism has shown, in my view, elements of strength but also of weakness. ECB (2108c). Among the strengths, I would cite the strict logic of the construction. If I want to invest my money in a bank’s shares or bonds, or even to make a large deposit, I must know from the outset that I may lose everything and no public entity whatsoever will come to my rescue. Moral hazard is no longer allowed. Banks need much more capital than before, but shareholders and subordinated bondholders must consider them riskier than before and thus request a higher return. Consequently, banks need to be much more profitable. Among the weaknesses I see a lack of clarity so far about the so-called MREL (Minimum Requirements for own funds and Eligible Liabilities to be requested of each bank) and, most important, an apparent divergence of views on the concept of systemic financial stability. I’ll touch upon both later. 4. Challenges ahead Let me talk briefly about some of the challenges we are facing, starting with the SSM. As discussed above, the implementation of the SSM has been successful so far, thanks to the work of all the people involved in Frankfurt, Rome and elsewhere. But the style of supervision needs to be fine-tuned. This does not come as a surprise, since prudential supervision philosophies and practices are different in the various countries, not least because of their historical evolution. Still, it is a matter that needs careful consideration in the light of the final objectives. Having put aside the original goal of the BU – cutting the perverse link between sovereigns and banks – the aim of common supervision of our banks should be to keep them well-equipped to fulfil their fundamental task, that is to provide credit to the healthy part of the economy. A bank crisis, still possible for many reasons, should be addressed in a unified, European way, minimizing the financial involvement of taxpayers and thus moral hazard. What we should avoid as supervisors is losing sight of these final aims in order to pursue a sort of bureaucratic integrity. More capital and fewer NPLs is a prudent and sound policy for banks but if, absurdly, capital requirements were raised to 100 per cent of total assets and NPLs reduced to zero, both stocks and new flows, supervisors would be 100 per cent safe, but the banking business would cease to exist, at least in the form we have known for centuries. Credit would disappear and banks would only invest in the equity of no-risk subjects, such as monopolies and rentiers. We all agree that capital markets should be more developed in continental Europe, and the financing of our economies more diversified, but bank credit will remain important for many years to come, particularly loans to small and medium enterprises, and its regular flow should not be slowed without reason by the obsession of supervisors to avoid blame if one borrower is late with a payment. I come now to the crisis management framework and the SRM. As I said before, the MREL issue needs to be clarified. MREL sets the minimum level of bail-inable items on the liability side of each bank’s balance-sheet. The owners of those items (shareholders and creditors), once identified, become hostages: if the bank falls into the clutches of the SRM, they will be the first to go. A careful and pragmatic calibration of the new requirement is essential. On top of that, banks should be given enough time to meet it without disrupting their business. Then there is the issue of financial stability or, more generally, of macroprudential supervision. The SRM has given the market to understand that the public interest test – set by European legislation to decide whether to proceed with the resolution or consign the failing bank to the national authorities for liquidation – can only be passed in the case of big banks, whose systemic relevance is beyond doubt. This conveys an idea of systemic risk based only on absolute dimensions. It rules out the possibility that smaller or even mid-size banks, if they fail, pose risks for financial stability, even though they contribute to funding the SRM and are subject to MREL. But, at least according to some views, financial stability can be national or even sub-national, and hence affected by the failure of a local bank. We were talking about the alternative resolution-liquidation, but the criticism may be extended to the no-bail-out principle underlying both. The International Monetary Fund has suggested a ‘financial stability exemption’, whereby it is explicitly recognized that the SRM is meant to deal with idiosyncratic events and that the existing arrangements could not solve system-wide crises.9 IMF (2018). Prudential supervision has been micro for decades, if not centuries. The macro-prudential perspective is relatively new and still little understood and not widely adopted around the world. We all know that there can be a tradeoff between micro and macro policy objectives in the financial system.10 For instance, if we want to protect macro financial stability, we may contemplate bailing out a bank with taxpayers’ money, but if we want to avoid any moral hazard at the micro level, we have to rule out as far as possible the involvement of taxpayers in rescuing banks. A balance must be found between these conflicting objectives. 5. Conclusions Let me conclude. In an incredibly short timeframe a comprehensive framework for banking supervision and crisis management in the euro area has been designed and put in place; thousands of experts are working together to achieve common goals; methodologies, tools and resources have been pooled in order to benefit from the best national practices; cooperation between the centralized hubs (in Frankfurt and Brussels) and the national authorities has been fruitful, even in the case of disagreement. Last but not least, banks in the euro area are now stronger than 10 years ago. This positive experience shows that the challenges ahead can be successfully addressed in a pragmatic way. Banking supervision needs to be constructive, not destructive. This is always true, but in the euro area today it needs to be constantly remembered. Prudential rules and practices should be strict but proportionate, and they should always keep the playing field level. We should also take into account the competitive conditions between our banks and banks outside the euro area. We live in times of rapid change in the way financial business is conducted around the world. The application of technology to banks and other financial companies is revolutionizing the market.11 Supervisors need to look forward as Visco (2018a). CGFS (2018), Panetta (2018), Visco (2018b). much as they can. European supervisors, and legislators behind them, need to be particularly forward-looking in their commitment to operate a brand new system of common banking supervision and crisis management. They have to adjust it as drawbacks and innovations emerge. References Committee on the Global Financial System (2018), Structural changes in banking after the crisis, CGFS Papers No 60. Draghi M. (2015), Foreword to the ECB’s 2014 Annual Report on Supervisory Activities. European Central Bank (2018a), 2017 ECB Annual Report on supervisory activities. European Central Bank (2018b), SSM LSI SREP Methodology. European Central Bank (2018c), ECB announces further steps in supervisory approach to stock of NPLs, Press Release, 11 July. European Commission (2015), https://ec.europa.eu/commission/publications/ five-presidents-report-completing-europes-economic-and-monetary-union_en. International Monetary Fund (2018), Euro Area Policies - Financial System Stability Assessment. Monnet J. (1955), ‘Téléfoner Volf … mon cher ami’, Archive de le Fondation Jean Monnet, May. Panetta F. (2018), http://www.bancaditalia.it/pubblicazioni/interventidirettorio/int-dir-2018/panetta-120518.pdf. Rossi S. (2016), http://www.bancaditalia.it/pubblicazioni/interventi-direttorio/ int-dir-2016/en-rossi-070416.pdf. Rossi S. (2017), http://www.bancaditalia.it/pubblicazioni/interventi-direttorio/ int-dir-2017/en-rossi_14062017.pdf. Visco I. (2018a), www.bancaditalia.it/pubblicazioni/interventi-governatore/ integov2018/Visco_05042018.pdf. Visco I. (2018b), http://www.bancaditalia.it/pubblicazioni/interventigovernatore/integov2018/en-cf-2017.pdf. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the 50th Credit Day, Rome, 4 October 2018.
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50th Credit Day Credit, competitiveness and competence: the foundations of development Speech by the Senior Deputy Governor of the Bank of Italy and President of the Italian Insurance Supervisory Authority (IVASS) Salvatore Rossi Rome, 4 October 2018 As President Pellicanò has already said, this is an important day. We are celebrating the fiftieth anniversary of Credit Day, an annual occasion for taking stock together of the world of credit and the role it plays in Italy.1 Italy has changed greatly over the last half century, at least in some respects. In 1968 Italy was emerging from the economic miracle that had turned it into a modern country and was heading for stormy years of social and political turbulence.2 Today, it is still one of the leading advanced economies, though it is threatened by decline. Fifty years ago the credit system was almost entirely public and now it is almost all private. Yet banks continue to do essentially what they have always done: they collect deposits from a vast array of savers and use these resources to make loans to a smaller group, consisting mainly of firms. Italy’s banks find themselves at a crossroads today, as loans may no longer be their fundamental prerogative. That said, we are not here for a history lesson. Today’s conference has a theme and we must engage with that. In my introduction I will take a brief look at its four sub-themes, but in reverse order: development, competence, competitiveness and credit. Development The economic development of a country or a territory is an old and ambiguous concept. Scholars down the ages have defined it in many ways and in various fields of study. The main thing for us as Italians nowadays is that development has to be focused on firms and their ability to innovate and grow. It is firms that My thanks go to Francesco Franceschi, Francesco Manaresi and Francesco Palazzo for helping me write this speech. Any remaining errors are my sole responsibility. For a brief history of Italy’s economy starting from that year, see Rossi, S., La politica economica italiana 1968-2007, Laterza, Roma-Bari, 2007. must use Italy’s resources and talent in order to succeed, and in doing so, to increase well-being for everyone. We know that Italy’s economic development has been stuck for more than twenty years now. From 1997 to 2007, in the decade prior to the world crisis, Italy’s gross domestic product grew by less than one point a year on average, against three and a half points in the rest of the euro area. Then came the double-dip recession towards the end of the 2000s onwards, first originated at the global level and then in Europe; Italy was overwhelmed, far more so than the other advanced countries. In the second quarter of this year, and despite three years of recovery, GDP was still 5 per cent lower than the peak level reached in 2007; it has risen by 6 per cent in the rest of the euro area. How is it that the other economies have grown so much more than Italy’s? By increasing the average efficiency of firms, especially in technology and business organization, the component of productivity that economists refer to as Total Factor Productivity (TFP). From 1997 to the present day, that component has remained flat in Italy, while it has boosted annual average economic growth by half a percentage point in Germany and France and by 0.2 of a point in Spain. Italy’s production system has shown itself to be too fragile and fragmented overall to be able to aim for technological and organizational efficiency, and has become less competitive at international level. Some firms, mainly medium-sized ones, have now emerged from the financial crisis with a renewed capacity to compete and are sustaining Italian exports, but the other firms are still weak. Skills A very important reason for Italy’s firms being at a disadvantage lies in the mismatch between the demand and supply of qualified employees, and therefore in the relative inability of Italy’s education system to provide students with the necessary skills. I’ll refer here to some well-known data from the Organization for Economic Cooperation and Development (OECD), which has long used many research resources and statistics to make a comparative study of education in the advanced countries. There are a quarter fewer high-school graduates in Italy compared with the European average: 60 per cent of the population in the 25-64 age bracket, against 80 per cent. The situation is even worse for university graduates in Italy, as their number is just over half that of the European average, at 17 per cent of working age adults, against 35 per cent. If high-school and university graduates are relatively rarer in Italy, they should be more sought after, yet this is not the case: there are as many instances of over-qualification for jobs in Italy as in other countries,3 especially early in working life.4 These results are not accidental, but rather the outcome of a strategic choice made a century ago and that has never been changed, whereby public resources were channelled more towards nursery and primary schools, less towards secondary schools and even less again for universities and postgraduate studies. This choice was made to solve the serious problem of mass illiteracy at that time in Italy.5 Compared with the major European countries, Italy’s primary schools still receive more public funding than those in France or Spain, and are almost on a par with Germany’s schools. Yet Italy slips back into last place for secondary schooling, just below Spain, and is also in last place for university funding, well below Spain. In any case, the amount of public money set aside overall for education in Italy is lower than that in the other three countries, given similar, mainly public education systems. In other words, the commitment of Italy’s public sector to education is not in proportion to modern-day needs, which combine a drive for scientific research, continuous innovation and cut-throat competition. Such inadequacy is explained both by the amount of resources used and by how much money is spent on the different levels of education. Yet the idea of greatly increasing the resources provided by the public finances or of redistributing them in favour of universities, See Flisi, S., V. Goglio, E. Meroni, M. Rodrigues, and E. Vera-Toscano, ‘Occupational mismatch in Europe: understanding overeducation and overskilling for policy making’ , JRC Science and Policy Reports, 89712, 2014. See Colonna, F., ‘Chicken or the egg? Human capital demand and supply’, Politica Economica, 1, 97123, 2017. See Giunta, A. and Rossi, S., Che cosa sa fare l’Italia. La nostra economia dopo la grande crisi. Laterza, Bari, 2017;. and Bertola, G., and Sestito, P., ‘A Comparative Perspective on Italy’s Human Capital Accumulation’, Banca d’Italia, Economic History Working Papers, 6, 2011. especially postgraduate courses, to forge tomorrow’s scientists and innovators, is unrealistic, politically speaking. However, it is not just a problem of how many resources we have; the education provided also leaves a lot to be desired. The division of secondary schools into high schools and vocational schools with apprenticeships is skewed in favour of the former. Let us not forget that the Constitution assigns the responsibility for professional training to Italy’s regional authorities. Theoretical and academic teaching at university still prevails over technical and practical content and there are still very few graduates in technical and scientific subjects.6 These are all factors that distance Italy’s education system from the needs of industry. One possible policy that would not weigh on the public finances could be to boost professional qualifications and encourage the new higher-education technical colleges that are offering technical specialization courses to high-school graduates, which are making their students highly employable but which are limited in availability because they are linked to local conditions. Other no-cost policies could be devised: for example, simplifying the bureaucratic, administrative and informative framework both of apprenticeship contracts and, at the other end of the spectrum, of PhDs; speeding up the technology transfer from universities to firms by promoting ways to share intellectual property and revenues from patents among researchers and universities; and finally, promoting international cooperation: education policies have remained national, yet various European countries are harmonizing their university systems. Competitiveness The problems of the education system interact with those of the production system, creating a vicious circle: on the one hand there is a lack of qualified human capital that limits firms’ propensity to innovate, on the other, take-up of innovative See OECD, Education at a glance 2017, OECD Publishing, Paris, 2017. technologies is low, thus reducing the return on skills and discouraging investment in human capital.7 In the almost twenty years between 1999 and 2017, investment in intangible goods, more than half of which on R&D and patents, only grew by 30 per cent in Italy compared with 70 per cent in France and Germany and 140 per cent in Spain. In relation to GDP, investment in intangibles in Italy (3 per cent) is today below that of Germany (4 per cent) and France (6 per cent) and on a par with that of Spain that has almost doubled in the meantime. The spread of the new digital technologies, while growing, is still below the euro-area average. As recently as last year, fewer than 10 per cent of Italian firms had introduced a supply chain management system, more than a third less than in Germany and France.8 The fragmentation of the production system into many micro and small firms is the main cause of the low propensity to invest in R&D in the Italian economy. But even when they are of an equivalent size, Italy’s small firms are less productive than those in countries like France and Germany.9 Italian firms start to atrophy at birth; compared with firms in the other developed economies, newborn firms are smaller, grow more slowly and quickly stabilize at a small size.10 Consequently, Italian exports have been in decline since the end of the 1990s and were badly hit by the crisis: the average rate of growth of our exports between 1997 and 2010 (1.8 per cent) was well below that of France (3.5 per cent), Spain (3.8 per cent) and Germany (5.9 per cent). See Visco, I., Investire in conoscenza. Crescita economica e competenze per il XXI secolo, il Mulino, Bologna, 2014. See OECD, Science, technology and industry scoreboard 2017, OECD Publishing, Paris, 2017. See Bugamelli, M. and F. Lotti (eds.), ‘Productivity growth in Italy: a tale of a slow-motion change’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 422, 2018. See Manaresi, F., ‘Net employment growth by firm size and age in Italy’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 298, 2015. These disappointing results can be attributed at least in part to the particular weaknesses in Italy’s production system. Our micro and small firms have been less able to absorb the rise in the euro exchange rate and increased competition from abroad.11 Exports began to recover in 2010, growing at a rate just below that of Germany. One factor was the increased polarization of the Italian production system, with an innovative group of firms - mainly medium-sized - looking beyond Italy, which not only managed to withstand the rigours of the crisis but came through it stronger than before.12 The reorganization of industrial policy, begun in 2012, has produced some encouraging results. Measures in favour of innovative start-ups have increased value added and productivity.13 Policies aimed at the other small and medium-sized firms were more limited. We still need to properly assess the real effectiveness of incentives to spend more on R&D and to make better use of the ‘patent box’. I think we need to continue in this direction, as these policies go to the heart of Italy’s structural problem. There can be no economic growth if we do not resolve this problem. Credit Let’s now turn to the financial aspects. Today is called Credit Day, but it is a good idea to speak more generally in terms of finance, of which credit is only one component. Of course, it is a component with historical importance in Italy, a country where banks have always been at the centre of the financial system. Yet for some years now we have begun to reflect on what kind of financial structure would be best to support the relaunch of Italy’s economic development and therefore the See Bugamelli, M., S. Fabiani, S. Federico, A., Felettigh, C., Giordano and A. Linarello, ‘Back on track? A macro-micro perspective of Italian exports’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 399, 2017. See Accetturo, A., Bassanetti, A., Bugamelli, M., Faiella, I., Finaldi Russo P., Franco D., Giacomelli S., and Omiccioli M., ‘Il sistema industriale italiano tra globalizzazione e crisi’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 193, 2013. See De Stefano, T., Manaresi, F., Menon, C., Santoleri, P., and Soggia, G., ‘The evaluation of the Italian Start-up Act’, OECD Science, Technology and Industry Policy Papers, 54, 2018. most suitable way of funding innovation in our firms, especially technological innovation, and what role the banks and bank lending should play. Let’s start with the observation that the Italian financial system is smaller overall than those of the leading European economies: it stands at about four times GDP - a lower amount than not only the UK, but also Germany and France. Within the financial system in Italy, the banks, as we know, have a much higher weight than in the UK and a higher weight than in Germany and France, albeit only slightly higher. Now, investment in innovation is particularly risky and it is difficult for anyone outside the investing company to estimate possible returns. Hence any funding must be made internally for the most part. This is what we have been witnessing for a few years now: self-financing has covered 90 per cent of this kind of investment, 20 points more compared with 2012. The increase in own funds has been accompanied by a fall in bank debt, whose share of firms’ total liabilities fell from 24 per cent in 2012 to 19 per cent in 2017. In newly-fledged firms, a venture capitalist can be of great help by contributing to the firm’s capital with money available to fund an innovative idea, but also with specialist know-how.14 In Italy, the venture capital industry is, however, quite small on an international scale and it is not easy, even for the most promising innovative firms, to find specialized financiers to participate in their capital. The most consolidated firms can issue and place new capital to fund investment in technology and innovation. In theory this offers some significant advantages: compared with bank debt, equity requires no collateral, reduces moral hazard issues, and allows the investor to share in the profits if the innovative project is a success. The empirical literature shows that in many countries - and in particular in the United States - these advantages are recognized and risk capital often plays a more important role than debt financing for innovation.15 Nevertheless, Italian firms are relatively capital-poor on average: in 2017 financial leverage was about 40 per cent, which is higher than in France, Germany and Spain. See Bronzini, R., Caramellino, G., and Magri, S., ‘Venture capitalists at work: what are the effects on the firms they finance?’, Banca d’Italia, Temi di discussione (Working Papers), 1131, 2017. See Magri, S., ‘Does issuing equities help R&D activity? Evidence from unlisted Italian high-tech manufacturing firms’, Banca d’Italia, Temi di discussione (Working Papers), 978, 2014. Another path for financing innovation involves issuing bonds.16 This is the path that large Italian firms have been pursuing more decisively in the last few years. Compared with other European countries, like Germany, whose financial system is dominated by bank credit, the share of corporate bonds in firms’ total financial debt is greater, at just over 13 per cent against 12 per cent in Germany and the euro area, while it is considerably smaller than in the UK (23 per cent) and the US (41 per cent), but also less than in France (21 per cent). These are the results of strong growth in the post-crisis years. Recent initiatives, such as savings plans (PIRs) and mini-bonds, are helping to strengthen this process. Nevertheless, compared with other countries there is a still a difference due to both the characteristics of Italian firms and to the limited role of institutional investors in Italy. Large firms, especially those already listed and with growth prospects, have a better reputation and are more transparent - fundamental qualities for attracting bond purchasers.17 For small and medium-sized firms, which are very common in Italy, the lack of information available to outsiders is a formidable obstacle to their accessing the bond market. Italian institutional investors hold few private bonds and many public securities compared with the other leading European countries. The small share of pension funds worsens the situation in which there are relatively few Italian institutional investors participating in the corporate bond market. Lastly, let’s look at bank credit, which still plays in Italy a very important role in funding innovation, not only for the largest firms with good credit scores and collateral, but also for small firms, including start-ups.18 As we have already seen, credit is not the ideal financial channel for investing in innovation. However, the banks can play a role in encouraging a broader take-up of bond funding on the part See Accornero, M., Finaldi Russo, P., Guazzarotti, G., and Nigro, V., ‘Missing investors in the Italian corporate bond market’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 450, 2018. See Accornero, M., Finaldi Russo, P., Guazzarotti, G., and Nigro, V., ‘First-time corporate bond issuers in Italy’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 269, 2015. See Bonaccorsi, E. and Nigro, V., ‘The financial structure of Italian start-ups, in good and bad times’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 449, 2018. of the smallest firms, especially in the placement and initial purchase of bonds. They would be acting in their own interest by earning commission fees which have grown in the meantime19 and they would restore balance to a market that is currently dominated by foreign banks. Conclusions To conclude, relaunching the economic development of our country after more than twenty years of stagnation or overly slow improvement is the absolute priority for Italy. If our nation does not increase its wealth it will eventually decline, despite its talent and the capabilities recognized the world over. Development must be harmonized and sustainable over time, but it is a sine qua non. We can only return to financial balance if there is greater development. Nevertheless, relaunching development is not easy; we need to make big changes to Italy’s underlying character and to the political choices of our national community that are deeply rooted in the distant past. On this day, we are examining some of these central aspects: the education system, competitiveness, and the financial system. We must not tire of debating these themes, and we should not hold back or be afraid of expressing our ideas. If the ideas are right and convincing, action will follow. See Albareto, G. and Marinelli, G., ‘Italian banks and market-based corporate financing’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 432, 2018. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Lectio magistralis by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the Ca' Foscari University of Venice Department of Economics, Venice, 5 October 2018.
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Ca' Foscari University of Venice Department of Economics In praise of popularization Lectio magistralis by the Senior Deputy Governor of the Bank of Italy and President of the Italian Insurance Supervisory Authority (IVASS) Salvatore Rossi Venice, 5 October 2018 Introduction This lecture stems from a reflection on the way in which we − all of us − form our opinions and make decisions. The question has many aspects, but here we will deal with one in particular: the information that we consume and the sources from which we gather it. This is a crucial aspect. Opinions and decisions are, of course, shaped by cognitive processes and inspired by religious or political persuasions, but the information that we use is their main sustenance. Combined with our pre-conceptions, they lead us to think one thing or another, and to decide accordingly. And yet, at this historical juncture, Western democracies appear to have a problem regarding the quality of the information that is made available to the public. A lot of this information, it is said, is false or misleading, either through ignorance, superficiality or malice on the part of those who produce it. The fake news phenomenon is part of this debate. Of course, Italy is not exempt from this problem. On the contrary, it is one of its main laboratories. The thesis of this lecture is that nowadays serious manufacturers of information, and scholars in particular, have what has become an impelling and absolute duty to disseminate their knowledge. This should be their main concern. In all fields. Before it is too late. Especially here in Italy. Especially when it comes to economics. The high priests of knowledge versus democracy Fantastical stories and tall tales have always circulated widely among human beings, at all times and in all places. A defining feature of the modern era was the emergence and diffusion of Galilean science, according to which all claims must be subjected to careful empirical scrutiny and there are no absolute dogmas; put simply, we should not believe in fairy tales. Modern science, regardless of whether it is engaged in sending a rocket to the moon or in improving economic welfare, can sometimes be hesitant and imprecise, but it is the best that humanity can offer to draw closer to natural truths. It feeds on skills and talents, it seeks first and foremost to convince the rest of the scientific community of the validity of its findings (even at a long remove), it assigns no role to religions, political ideologies, fads or mass enchantments. For several years now, it has been claimed, in many public debates the opinions of qualified persons have been rejected, if not derided. An idea has gained currency that there is no such thing as difficult problems and complex solutions, and that everything is easy and within everyone’s grasp – both in terms of understanding problems and finding solutions − if only the group of so-called experts, who are only good at perpetuating their own power, can be defeated. The Internet appears to have played an important role in all of this. It lends a voice to anyone with access to as little as a cheap smartphone, even if they are typing in a far-flung corner of the globe. Anyone can write, photograph or film something that will become viral. The traditional intermediation of the experts, of qualified observers, of professional ‘sorters’ of information, has disappeared. It is a grand, liberating bonfire (but so were the book burnings organized by Nazi students in the spring of 1933)1. A revolution of this kind spares no branch of public activity. Economics and economic policy are deeply affected, at a time when these disciplines are at the centre, either directly or indirectly, of almost all the decisions of individual citizens and of governments − even ethical ones. Decade after decade, administrative and technical apparatuses have taken shape in the economic field alongside governments, building up a Shirer, William L., 1961, The Rise and Fall of the Third Reich, Rosetta Books, New York. body of knowledge and practices of their own. This includes ministries, specialized institutes and agencies, independent authorities and central banks. They have developed an autonomous capacity to process information and take action. Until a few years ago, the balance between governments and administrative apparatuses was ensured by a sort of trust in the medium term on the part of the former towards the latter: governments only checked intermittently the validity of these apparatuses’ action − which at times was not merely administrative − limiting their role to that of setting broad political guidelines. But for governments to behave in this way they also had to be intermittently accountable to voters for their track record, for example on the occasion of general elections. Now, as long as voters’ judgement in Western democracies was mediated by the great ideologies that emerged at the turn of the 18th and 19th centuries, this form of intermittent control came naturally. Voters trusted that the people in government would, at least in the medium term, act in their interest; they did not seek to judge their performance in real time because the common ideological bond reassured them. When the ideologies weakened to the point of almost disappearing and the electorate morphed into the audience of a continuous and never-ending show, political marketing became the only language spoken to the masses by politicians operating in democratic systems, and the only language understood by those masses. Today, the conversation between the electors and the elected must be unceasing, uninterrupted and take place through any means of communication, especially ‘instantaneous’ ones such as social media. It is worth noting that this does not apply only to economic matters in a narrow sense, but also to other domains of administrative and political action, for example foreign policy. If a country’s international relations are constantly exposed to changing public preferences and whims; if, to give an account of the state of national interests and international relations, storytelling techniques − to be clear, the same as those employed in TV series – become widespread and are used to stir the public’s feelings; if what counts is the short-term audience share, regardless of the actual medium to long term reality of the national interest; then, a democratic country’s diplomatic apparatus will find it harder and harder to influence the action of a governing class interested only in the real-time advertising of its political stance for the benefit of current and potential voters. Today’s United States of America is a textbook case.2 Does all of this mean that those with technical skills, the high priests of knowledge, are always right and people’s representatives always wrong? That overthrowing the synod of high priests and restoring to ordinary people the power to find simple solutions to their problems is always a revolutionary gesture that must be condemned? Sadly, no. Otherwise, one would not be able to explain the periodic emergence throughout history of vast shifts in opinion or political movements that revolt against the establishment.3 It is necessary, I believe, to reflect on this point: science (including economics) is indeed democratic,4 but only within its own confines. All those who stand outside of it, that is, the body of citizens as a whole, have to trust the fact that the scientific community has strict rules designed to ensure that it can work to the best of its ability in the interests of humanity. If citizens’ overall trust is undermined − as can happen in historical eras, as perhaps the current one is, marked by social and political crisis − this is to the detriment of everyone. And it is of no use for researchers to rebel against the mounting obscurantism by proudly reiterating the established rules. Society as a whole might trust them even less as a result. In other words, making discoveries, innovating, and developing theories and techniques will not suffice. To keep or regain the public’s trust the findings of research must be explained to those outside the field, humbly and patiently and without the haughtiness sometimes displayed by those who are proud of their hard-won knowledge. Technical jargon must be meticulously translated into plain, everyday language, trying to reduce as much as possible the inevitable loss of accuracy that any translation of this kind implies. The day after the meeting between the presidents of the United States and of Russia, which took place on 16 July 2018, the French political scientist Dominique Moïsi gave an interview to Corriere della Sera, which the journalist summarized in the headline: ‘More than diplomacy, this is marketing’. Corriere della Sera, 17 July 2018. Eichengreen, Barry, 2017, The Populist Temptation, Oxford University Press, Oxford. Viale, Riccardo, ‘Politics versus science – terrible examples from our past’, Corriere della Sera, 9 August 2018. In short, we must popularize. But we must do so without ever losing touch with rigorous reasoning and cold, hard facts. At the same time, we must aim for simplicity and clarity in our explanations, no matter how complex the issues at hand. The popularization of economics But what does this mean in practice? Let me give you an example of an inaccurate and misleading myth about the Italian economy, which would benefit greatly from a fair account of the facts, that is, from good popularization. According to this myth, the Italian economy could be prosperous and happy if only Europe, out of Teutonic foolishness, and the market, out of occasional political antipathy, did not impose a financial straitjacket on it. In this oversimplified narrative, there are grains of truth and mountains of lies. The issues are much more entangled and complicated, and it is up to those who have spent a long time studying these problems to make this clearly understood. For now, let’s clarify one thing: the main problem with the Italian economy is that, when something is produced (industrial equipment, a legal opinion, a history lesson), it is not done efficiently enough. In other words, resources are wasted and it costs more to achieve a given level of quality.5 On average, of course. The differences between one firm and another, between one lawyer and another, between one professor and another, are enormous, but overall the Italian economy suffers from a competitive disadvantage and growth gap when compared with other economies. And it has done so for at least the past 20 years. Italy knows how to do all manner of things, but it does them, overall, less frequently and less well than it could.6 This is another reason for the growing and widespread concern about inequality in Italy. An economy that grows little over such a long period, Economics calls it ‘productivity’, but that is jargon I will not use here. Giunta, Anna and Rossi, Salvatore, Che cosa sa fare l’Italia (Bari-Roma: Laterza, 2017). where household income in per capita terms is stuck at late 1980s levels, is an economy that offers few opportunities to its citizens, and especially to the young.7 It is not surprising that two thirds of young people aged between 18 and 34 believe that those who are today setting out to study or work will never attain the same social or financial level as previous generations.8 There are a variety of reasons for this situation and we will not discuss them here. One thing is certain: the problem cannot be solved by encouraging the State to borrow more. The State can do a great deal in this area by spending better and establishing regulations that promote efficiency. If we wanted to tackle the issue from a social equity standpoint (and we would be making a mistake if we were to separate this from production efficiency – you have to bake the pie before you think about how to slice it), once again more debt will not resolve the problem. What we have to do instead is to redistribute taxes between those who have more and those who have less and improve the equalization capacity of many public transfers. Today, Europe and the markets are first and foremost worried about Italy’s public debt which, as everyone knows by now, has risen to more than €2,300 billion, or 130 per cent of one year’s GDP. So let’s ask ourselves: What does Europe mean? What do the markets mean? Europe means all the complicated architecture of institutions (the Commission, European Parliament, European Council, European Central Bank, and so on) and legislation (Treaties, Directives, Regulations, etc.) that limit or influence the sovereignty of the Member States. By their choice. Andrea Brandolini, Romina Gambacorta and Alfonso Rosolia, ‘Inequality Amid Income Stagnation: Italy Over the last Quarter of a Century’, in Inequality and Inclusive Growth in Rich Countries: Shared Challenges and Contrasting Fortunes, Brian Nolan (ed.), (Oxford: Oxford University Press, 2018). Demopolis survey on ‘Italian youth and inequality’ conducted on behalf of Oxfam Italia in September 2018 on a representative sample of 1,040 participants. Let us linger a bit longer on the markets. Markets mean investors. Anyone who has set aside even a modest amount of money anywhere other than in their current accounts and entrusted it to someone else to invest for them: a bank, a financial agent, a friend. Usually these retail investors turn to wholesalers (banks frequently have both in-house) who sell them financial products of various kinds, from the most simple, such as government bonds, to the most complex, such as derivatives, depending on the sophistication of the final customer. The wholesalers (agents who work in the product development departments of banks, or for investment funds or asset management firms) have no homeland, even if they are Italian, German or American by passport and residence. They have the whole world as their playground and they all think more or less in the same way. How many are there? Let’s say, at a very rough estimate, about half a million worldwide. Their goal is to earn the highest returns possible for the same amount of risk so as to satisfy their clients – those retailers who, in turn, must satisfy the investors who have turned to them. They strive to emerge in a highly competitive environment, but basically they use the same methods, chasing news about the financial outlooks of companies and countries one second before their competitors. And the speculators? They also exist, of course. People who use their own money or that of a few associates (hedge funds, private equity funds, and so on) to place bets, even shorting, i.e. betting that a company or country will get into difficulty and that the securities that it issued to fund itself will lose value. But they are pilot fish, not sharks (even if sometimes they are the size of whales). They short (that is, short sell securities that they do not own) when they understand that the immense school of fish that is right behind them – the investors who act on behalf of savers throughout the world – is unsure about what direction to take, to sell or not, and they try to point them toward selling. If they succeed, and the value of the securities sold collapses, they buy them back at a much lower price and honour the previous short sale, at a large profit. They come into play when there is already concern among ordinary investors because of worrying news circulating about this or that company or State. And in any case they are only motivated by the prospect of profit. Which is all the more likely when they perceive in advance that the victim is teetering on the edge and all that is needed is a little push to make them fall. Political sympathies and antipathies do not even enter their minds, it would cloud their vision, which must remain focused on making money. If the market basically means small savers, are domestic savers different from foreign ones? In other words, would I, as an Italian, be more likely to choose, for patriotic reasons, to hold a BTP (an Italian government security) in my portfolio than a French or German saver would? Maybe, but it is highly unlikely. Money is money, and no one likes to lose it for love of country, except in exceptional circumstances, like a war. One economic difference could be that if the Italian State, let us say, were to default, in other words if it were unable to redeem its bonds on time or could do so only in part, it would have to raise taxes to try to get back on its feet, thereby hurting its own citizens, but not the French and Germans as well. Italians might then be more reluctant to rid themselves of domestic government securities, when there is more bad news about their government’s finances, in an attempt to save the State and avoid further taxation. But this is more the reasoning of an economist discussing theory than of the average saver; it is really very unlikely that this can explain the difference in behaviour between Italian and foreign holders of Italian public debt. Another economic reason for the relatively greater inclination of Italian savers to hold Italian government bonds could be this: in the event of a partial default and consequent debt restructuring, the Italian State could seek to protect its savers, at least the domestic retail ones (so not banks or insurance companies), but not the foreign savers. This is also a highly unlikely scenario because it would be counterproductive when thinking of a future return to the international markets and because, in any event, foreign bondholders would avail themselves of the collective action clauses that now protect them. If there is even the remotest possibility of debtor default, that is, the failure to repay debts on time, savers/creditors will protect themselves as best as they can by instructing their investment managers to sell a portion of these riskier securities; it makes little difference whether the savers are Italian, French or German. The official statistics do not help us discover in time if a given wave of sales of Italian public securities originated more from domestic or foreign savers without crossanalyzing various databases and relying on estimates. The markets – that is, domestic and foreign savers/creditors, plus any speculators/anticipators – read the papers, watch TV and follow social media, listen to policy statements and try to understand whether the probability of a State default is increasing or decreasing. For a country that is a member of the euro area, like Italy, they also look at its relationship with the European institutions and EU legislation, because any deterioration in these relationships is a sign of an approaching expectation of a default, even a unilateral abandonment of the euro area. Therefore Europe is important, but only indirectly. It is the markets, as I defined earlier on, that have their finger on the trigger. In conclusion, Italy’s main problem is the average efficiency of the country’s producers: for many years now this has been improving very little or not at all, because the technology used is inadequate, the laws and regulations unfriendly, the public institutions weak, because business owners do not want to expand their companies too much, because, because... Italian society remains unequal also because its economy has little capacity for growth. In any case, the solution is not more government debt. Why it is difficult to popularize economics Reaching a large audience is very hard to do and economics is no exception. Because economic reasoning and facts are never 100 per cent watertight or purely objective. The economy studies human behaviour: therefore it is not an exact science. Even the best economic theories conceived by acclaimed scholars whose good faith cannot be doubted, can be tarnished by prejudice and distorted by noneconomic convictions.9 Economic events – both at a micro or individual and a macro or group level – pose formidable problems of identification and measurement. For example, measuring firms’ investments or those of an entire domestic economy, in a way that can be compared across firms and countries, first requires setting multiple and detailed accounting and statistical standards, identifying the right interlocutors in firms, and formulating the right questions for data collectors: because a productive investment can have a thousand different implications, from the purchase of a pencil On the role of scientific paradigms, Thomas Kuhn is among the most often cited (1962), The Structure of Scientific Revolutions, The University of Chicago. to new software or an entire skyscraper, from the construction of a warehouse to the planning and realization of industrial machinery. It is even more difficult to measure the sentiment and expectations of a local, national or international community: confidence levels, inflation expectations, consumption or investment intentions. For example, if the community to be surveyed is a large one, for obvious cost reasons, it will be necessary to rely on a sample and sampling techniques are highly complicated if the survey is, in fact, a serious one. Official statistical institutions present in all of the countries and international organizations that publish economic and financial data (including Eurostat, the International Monetary Fund, the Organisation for Economic Co-operation and Development) take care of the main knowledge needs in economic matters and they do it in the best way possible. But the need for precise and comprehensive data often trumps clear communication. Moreover, the official institutions are far from being the only sources available. There are also many private statistical centres that supply the media with data, at times well done, at others not. At times they are no more than outright statistical scams. We citizens are not used to paying attention to the sources of the news that rains down on us every day when we leaf through a newspaper, consult the digital devices that most of us have, or look at dear old television. The media is full of tables and charts about various economic facts and almost never indicate sources and methodologies. Even if they were indicated we would not pay them any heed as we normally have very little time to devote to one particular news item. But if the fact is non-existent or measured badly we will receive an incorrect impression which, however mild and fleeting, can leave traces in our psyche and affect our behaviour. It is even worse when we are faced not with non-existent or poorly measured facts, but with mistaken or misrepresented theories. Any statement about the way in which economies work, the laws they obey, the ways in which they pursue the goal of well-being that a society sets itself must correspond to a theory that has been empirically and robustly validated. Otherwise, especially if emotionally persuasive, this might induce the recipients to behave in a way that is contrary to their own interests. In short, we are all extremely vulnerable, exposed to all manner of error or manipulation, even when we believe we are sufficiently evolved so as not to run this risk. The need for effective popularization What can be done to stop the rot? How can we defend ourselves against those who want to manipulate us or who are simply ingenuous or untruthful out of sheer ignorance but whose opinions risk leading us astray? We can appeal to three categories to counter distorted or false information: ordinary citizens, that is, consumers of information; the media, which spreads it; and the serious architects of information, individual scholars, research centres and statistical institutions. Let’s start with the first category: citizens/consumers of information. They must raise their guard, there is no doubt about this. They must become more aware of the need to carefully assess the quality of the economic information that reaches them, first weighing the reputation of the various sources and being wary of those that are unknown or of bad repute. However, this is difficult and takes time; it depends on our individual good will and is therefore a task that no public authority can carry out on our behalf. The media should be the first to select sources based on quality. Few do so nowadays. The media universe has changed greatly with the advent of Internet. The daily and periodical press, which could be relied on more in the past, has lost enormous ground and the digital formats with which it has attempted a comeback have only partly succeeded. Internet-based communication tools, in particular the social networks, have long passed it out, even if for the time being they do not threaten the supremacy of television. Italy’s Communications Regulatory Authority (AGCOM) recently10 confirmed this by measuring the four major categories of media (television, Internet, newspapers, radio) according to the share of the population that claims to use that medium as its main source of AGCOM, Rapporto sul consumo d’informazione, February 2018. information: 56.6 per cent said television and radio were their primary source, 26.3 per cent the Internet and 17.1 per cent newspapers.11 Television and radio, precisely because of their general popularity as channels of information, above all for politics, have, for many years, been particularly exposed to the influence of political parties and movements, which impair their ability to filter news on the basis of genuine scientific facts. This problem also affects the press, which often puts news that is useful for promoting the political and editorial line of a newspaper before objectivity (which is always relative, as we well know, but which nonetheless ought to be pursued). The Internet is inherently anarchic: as we said before, it is a platform that allows everyone to transmit whatever they want, without intermediation or filters. But it is turning into a colossal tool of manipulation by occult intermediaries, in the very name of the democratic struggle against manipulation by the traditional intermediaries of printed news, television and radio. In short, one can hardly rely on the capacity and willingness of the media to start actively distinguishing between good and bad news, with the truth as their only polestar. Let’s turn to those who try to present theories and facts in the best possible way, in the sole interest of advancing knowledge: the authors who claim to be serious. Are they the good guys in our history? Not exactly. Not if they take refuge in the ivory tower of their knowledge and do not care to earn the understanding and trust of the public by disseminating their research and that of the scientific community to which they belong. Here we need to dispel a basic misconception which is insidious especially in countries such as Italy, where the official culture is humanistic: that to disseminate In reality, and as always in these cases, this was a sample survey. AGCOM relied on a well-known market research company, GFK-Italia, an Italian subsidiary of the big multinational GFK. For many years now, this company has used a vast representative sample of the Italian population for carrying out surveys, which apart from substituting the units that naturally disappear, remains unchanged from year to year: technically speaking, a panel. Since it is a company that sells its services to make money, it does not willingly disclose the technical characteristics of the panel or its overall modus operandi. AGCOM provides some technical details in an Annex to the Report, but these are clearly insufficient to get an accurate idea of the reliability of the results. The reader is expected to trust the findings based solely on GFK’s reputation, which is indeed good. So let’s agree to trust them too. But this is an example of the difficulties that one encounters when assessing the quality of the information that surrounds us. is to make vulgar, in a derogatory sense; so that, in addition to being a waste of time, it is to dirty the purity of cultured thought. In reality, dissemination should be the researcher’s highest aspiration if it is done in a way that that does not undermine the strength of the argument and the accuracy of the analysis: to popularize in this sense means, as was mentioned earlier, to translate but also to prune back, to get to the heart of the matter. It is a laborious and complex exercise. It requires vision. In the Anglo-American world which, and this is no accident, has achieved absolute supremacy in all fields of knowledge over the last century, both specialized journalists and scholars, even illustrious ones, manage to spread their knowledge in later years. In their youth they advance knowledge using the techniques and language typical of their field, without worrying about being understood except by their peers. Then, later on, they put what they have learnt and discovered at the service of the wider community. Today this capacity, which has always been very important, has become essential to curb the drift towards superficiality, approximation, falsity and manipulation that threatens to overwhelm us. Those who are in the trenches and struggle to push out the frontiers of knowledge in their own circumscribed fields cannot shake their heads and say: it is none of my business, it cannot be up to me to make myself understood by the lawyer or the plumber next door. And so we become accomplices of those who make of superficiality or manipulation their creed. Those who transform economic or foreign policy into instant political marketing. In short, what was in the past only desirable – that economists communicate reliable and proven economic theories and data more, and more effectively – is imperative and urgent in these times of omnipresent bad or inaccurate economic information, used for political purposes. It is not only the good name of the economic profession that is at stake here. It is the very functioning of our democratic societies. Grafica e stampa a cura della Divisione Editoria e stampa della Banca d’Italia
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 94th World Savings Day, organized by the Association of Italian Foundations and Savings Banks (ACRI), Rome, 31 October 2018.
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ACRI Association of Italian Savings Banks 2018 World Savings Day Address by the Governor of the Bank of Italy Ignazio Visco Rome, 31 October 2018 The protection of savings calls, in the first place, for economic policies to ensure balanced financial conditions, stabilize cyclical fluctuations in the economy, and improve growth potential. Supervising financial intermediaries contributes to the protection of savings; it acts to contain crises and their repercussions on the economy, although it cannot eliminate them entirely. In Italy the long and severe recession was exacerbated by some instances of malfeasance within the banking system which, though few in number, had serious consequences at local level. The deployment of government resources in support of the financial sector was much lower than in the other main European countries. The latest Eurostat data show that its impact on the public debt reached a high of 1.3 per cent of GDP at the end of 2017, while in France, Spain, Germany and the Netherlands, the peaks in the crisis years were around 4, 5, 12 and 13 per cent. At first, the Italian banking system was relatively shielded from the global financial crisis thanks to its traditional business model centred on lending to the economy and to supervisory actions aimed at reducing exposure to risks from structured financial products. Later on, when the recession recurred at the time of the sovereign debt crisis, banks’ close ties with firms and households meant there was a greater impact on loan quality. Despite the adverse economic conditions, the Bank of Italy felt it was vital to ask the banks to significantly strengthen their capital bases, to build up resilience and maintain public trust in their soundness: last June, the common equity tier 1 ratio had risen on average to 13.2 per cent, from 7.0 per cent at the end of 2008. The economic and social cost of even relatively small bank crises can be high, given the role of such banks in collecting deposits and funding investments and consumption. The new European crisis management rules, which were also motivated by a determination to avoid giving further public support to the banks, were introduced somewhat abruptly, making it complicated to manage cases of banks in difficulty. In Italy in particular, it was hard or even impossible to employ the tools that had been used in the past, sometimes also because of the interpretation of the new rules adopted by the European institutions. To mitigate the effects of this situation, the financial sector made voluntary contributions to help resolve the most problematic cases. Measures were introduced to encourage more active management of non-performing loans and accelerate the recovery process; reforms were made to strengthen the governance and capitalization of the popolari banks and the mutual banks (banche di credito cooperativo, BCCs), in different ways according to the size and type of bank. Public funds were employed, where necessary and possible, including to maintain business continuity in cases of liquidation. Financial conditions The yields on Italian government bonds have increased steadily since midMay; those on ten-year bonds reached 3.7 per cent, the highest figure since 2014; with respect to the equivalent German bond, the spread currently fluctuates around 300 basis points, compared with the average of about 130 basis points recorded in the first four months of this year (Figure 1). Between May and August, foreign investors made net sales of Italian securities for a total of €82 billion, of which €67 billion concerned public sector securities. This is high, even taking account of the fact that in June and August the net Treasury issues were negative (by €17 billion overall). Net purchases of foreign securities on the part of Italian residents (€18 billion, mostly in August) contributed to the net outflow of capital. These trends do not reflect a deterioration in the fundamentals of our economy, even if the current cyclical slowdown is more marked than in the rest of the euro area. Unemployment has fallen. The banks’ capital and profitability conditions and credit quality have continued to improve. The surplus on the current account of the balance of payments remains high and has led to a further reduction in Italy’s net international debtor position, which is now close to balance. The uncertainty over the fiscal and structural policy stance and the evolution of relations with the European institutions has contributed to the increase in the risk premium on government bonds. The concerns of domestic and foreign investors about rising public debt and the risk of its redenomination have resurfaced. The trend of the spread between the premium on credit default swap contracts on Italian public sector securities stipulated after the sovereign debt crisis (which also protect against the risk of debt redenomination) and those written before that crisis (which do not offer such protection), indicates that the increase in the spread reflected, in almost equal parts, the increase in the risks of default and redenomination (Figure 2) – risks that feed off one another. Contrary to what happened at the peak of the crisis, when fears had spread about the possibility of a euro break-up, the increase in the risk premium almost exclusively concerned Italy (Figure 3); in the rest of the euro area, investors perceived the risk of redenomination as being very low. The consequences of a prolonged and large increase in the yields on government bonds can be very serious. An increase reduces the value of household wealth and may lead to a worsening of economic growth prospects. High premiums to cover sovereign risk make it more difficult to control the dynamics of the debtto-GDP ratio. This ratio tends to rise in tandem with an increase in the difference between the average interest burden on the debt and the nominal GDP growth rate, compromising the ability of fiscal policy to stabilize the economy; there is then very little room for public investment. The rise in risk premiums on the public debt produces capital losses that worsen banks’ balance sheets; it affects the cost and availability of the funding that financial intermediaries raise on the market and thus their capacity to lend to the economy. Directly or indirectly, sovereign risk affects Italian households. Not only do they hold public sector securities with a nominal value of almost €100 billion, but on the asset side of the balance sheets of the financial intermediaries to which they entrust their savings − in the form of bank deposits, insurance policies, shares in pension funds and managed assets − there are public sector securities amounting to about €850 billion. Since mid-May, the market value of government securities has decreased: for those with a maturity of more than one year, losses have totalled 8 per cent on average. The tensions have inevitably spread to the entire Italian financial market, with a strong depreciation of the indices relating to private sector bonds and to shares; for all the listed companies combined, the stock market index fell by about 20 per cent. The rise in the yields on government securities negatively affects the public accounts as well. Should it not be reabsorbed, the increase recorded so far would mean that interest payments would be higher by about 0.3 percentage points of GDP next year (i.e. more than €5 billion). This additional burden would increase to 0.5 points in 2020 and 0.7 points in 2021. This would increase the primary surplus necessary just to stabilize the public debt-to-GDP ratio. Since the end of May, the cost that banks incur to raise funds by issuing bonds − approximated by the yields on the secondary market − has more than doubled; by 2020, bank bonds amounting to €110 billion will reach maturity, namely about 40 per cent of those currently outstanding. The increase in sovereign risk is reflected in bank share prices which, after growing by 13 per cent between the beginning of the year and mid-May, have subsequently fallen by 35 per cent. Such trends ultimately have a negative impact on the cost and availability of credit for households and firms. So far, banks’ higher capitalization and a more stable funding structure have helped to dampen the transmission of these tensions to bank lending. An assessment of the overall impact on the economy of the increase in sovereign risk is an exercise that is subject to wide margins of error. Yet it is difficult to imagine that a reduction in household wealth, greater difficulties for firms in accessing credit and investing, and a reduced capacity for public sector intervention would not have significant consequences on economic activity. Italy’s public debt is sustainable, but there must be a clear determination to keep it so, by putting the debt-to-GDP ratio on a credible path towards lasting reduction. Any uncertainty about Italy’s committed participation in the European Union and in the single currency must be dispelled, as it fuels volatility in the financial markets. On these conditions hinge the protection of household savings and the ability to support Italy’s economic growth. Cyclical conditions In recent months the outlook for the world economy has become less favourable. Compared with April, the IMF has reduced its global economic growth forecast for both 2018 and 2019 by 0.2 percentage points. The worsening in the forecasts for world trade is more marked and equal to almost 1 percentage point this year and two thirds of a point for next year. The deterioration in the macroeconomic scenario reflects the tensions in trade as well as those that have broken out in emerging countries such as Argentina, Brazil and Turkey. The risks have increased, especially those that could stem from new protectionist measures on the part of the United States. Those implemented so far have affected a limited share of the goods traded at world level, but the reactions of the financial markets have been significant; the repercussions on global economic activity could be amplified by a revision of firms’ spending plans. According to the latest data, GDP growth in Italy will be in the order of 1 per cent this year and will then slow in 2019, net of the effects of the budgetary provisions for which detailed information is not yet available. Business surveys continue to be favourable overall, but there are signs that the trade tensions could lead to a revision of investment plans. This is also why a deterioration of funding conditions in the economy stemming from higher interest rates on public debt must be avoided. In a country such as Italy, where the pace of growth is already slow and has been below that of the euro area for many years now, a further slowdown in economic activity would be felt more deeply than elsewhere. Fiscal policy has limited room for manoeuvre to compensate for a possible contraction in private demand. In this context, priority should be given to measures that incentivize investment in infrastructure, both material and immaterial, and labour market participation. Resources should be concentrated on measures that are clearly directed at supporting economic activity effectively. The common monetary policy responds to the situation of the euro area as a whole. Last week the ECB’s Governing Council, in view of ongoing economic growth and of the gradual increase in inflationary pressures, reiterated its intention to end the net asset purchases at the end of this year. However, taking into account the uncertainty surrounding the outlook for the world economy and for financial markets, as well as the need to support price dynamics in the medium term, the Council has confirmed that it intends to continue to provide significant monetary stimulus. Even after the end of the net purchases, this support will arise from the sizeable stock of assets in the Eurosystem’s portfolio, the reinvestment of the principal as these securities mature and the indication that the key ECB interest rates will remain at their present levels for as long as necessary. Monetary policy normalization is a very delicate process, as the experience of other countries has shown. As I have observed in the past, the Italian economy can withstand an end to the low interest rate regime with no risk to economic activity or the public finances, provided that fiscal policy remains anchored to stability and that the reform process aimed at strengthening the economy continues. Growth potential The growth gap between Italy and the rest of the euro area is a structural problem that cannot be resolved through monetary stabilization policies or by an expansionary fiscal stance. Its main cause is the low productivity of firms which have lagged behind in responding to the drastic technological changes that began a quarter of a century ago. In this period Italian firms have generally not been sufficiently innovative and have grown very little. In addition, Italy has an older population than other countries and a lower rate of labour force participation; young people and adults have lower levels of knowledge and skills compared with other Europeans. General government is not very efficient and conditions for doing business are less favourable than in the rest of Europe. There is less investment, both public and private. This lag is more pronounced in the southern regions, where firms are smaller and less productive on average, where the working-age population has declined over the last ten years, against an increase in the Centre and North, and where the labour force participation rate is over 15 percentage points lower. It is vital to improve the quality of institutions at local level, foster the growth of business and boost education and training: around one third of young people aged 15 to 29 in the South neither study nor work, against just over one sixth in the Centre and North. The measures adopted over the last few years to support innovation and investment have gone hand in hand with the restructuring of the production system launched after the global financial crisis, and the euro-area sovereign debt crisis, which had serious effects on the Italian economy. The rebalancing of the pension system has made an important contribution to the increase in labour force participation of those aged 55 to 64. Rules have been introduced to simplify the red tape for setting up new firms and improving relations between general government and the production sector. There has been a marked reduction in the number of civil litigation cases. The timeframe for the pre-sale phase in foreclosure procedures has been reduced. The liberalization of professional services has led to a more efficient allocation of resources across different occupations. The road to structural reform requires a significant commitment, as results mature slowly. Yet reform is essential. Changes to measures that have already been implemented should be assessed very carefully and the need to provide stability to the institutional and regulatory framework must be borne in mind. Past reforms must be supplemented by further measures to promote innovation, enhance the quality of human capital, increase employment (especially for young people and women), raise the degree of competition in the service sector, improve infrastructure, both material and immaterial, and make government action more effective. The analysis of these problems is shared at national and international level. * * * Against a backdrop of increasingly stringent regulations, Italy’s banks have long been committed to capital strengthening to make them more resilient and expand their capacity to provide loans to households and firms. However, the costs they bear in raising funds on the markets are high. The role of banks and other financial intermediaries is to support and encourage the economy to change and grow. To do this in full they must respond effectively to the challenges posed by technological developments by updating products and production processes, keeping costs down, increasing efficiency and investing in knowledge and staff training. They must continue to nurture their customers’ trust through transparent and virtuous behaviour, thereby proving that banks and finance are not the ‘enemies’ of saving and savers, but rather support them both, for the benefit of the economy. At the same time, banks must not be placed at a disadvantage vis-à-vis international competition. Financial tensions over public debt would ultimately damage banks’ capital adequacy and compromise their access to capital markets, with serious consequences for the economy, for savings and for the well-being of Italians. The protection of savings, like the fight against poverty, calls for the economy to return to lasting growth. The necessary reforms and changes may incur social costs in the short term that have to be alleviated, including through public intervention. This can be discussed at European level: where applicable, all the margins available under the current rules and procedures can be used. Nevertheless, differences of opinion should not lead to an institutional conflict. The financial consequences of a temporary increase in the budget deficit can be mitigated if the necessary adjustment path is drawn up and managed in a climate of open and constructive dialogue, within the framework of the existing procedures. In 2019, almost €400 billion of government bonds will have to be placed on the market to finance those coming to maturity and to cover the deficit for the year. Reciprocal trust is essential if the reform of European economic governance is to be resumed and completed. Problems and challenges have taken on a global dimension in the third millennium and it is unrealistic to think they can be faced within the close confines of individual countries. It is for this reason that Italy’s future cannot be separated from that of Europe as a whole. FIGURES Figure 1 Sovereign risk premium: Italy, Spain and Greece (yield spreads for ten-year government bonds with respect to the German Bund; basis points; daily data) Italy Spain Greece Jan. 15 July 15 Jan. 16 July 16 Jan. 17 July 17 Jan. 18 July 18 Source: Based on Bloomberg data. Figure 2 Premiums for default and redenomination risks on Italian government bonds (credit default swaps; basis points; daily data; 5-day moving averages) Default and redenomination risks Default risk Differential: redenomination risk Jan. 15 July 15 Jan. 16 July 16 Jan. 17 July 17 Jan. 18 July 18 Source: Based on Thomson Reuters data. (1) Premium on the Italian sovereign CDS ISDA 2014 contract with 5-year maturity. – (2) Premium on the Italian sovereign CDS ISDA 2003 contract with 5-year maturity. – (3) Spread between the premiums on the CDS ISDA 2014 and the CDS ISDA 2003 contracts with 5-year maturities. Figure 3 Redenomination risk premium on the government bonds of some euro-area countries (credit default swaps; basis points; daily data; 5-day moving averages) Italy France Spain Portugal Jan. 15 July 15 Jan. 16 July 16 Jan. 17 July 17 Jan. 18 July 18 Source: Based on Thomson Reuters data. (1) Spread between the sovereign debt premiums on the CDS ISDA 2014 and the CDS ISDA 2003 contracts with 5-year maturities. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 64th Conference on Government Studies "Economic development, financial constraints and service quality - investments and guarantees", Varenna, 22 September 2018.
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64th Conference on Government Studies Economic development, financial constraints and service quality: investments and guarantees Public investment for developing the economy Address by the Governor of the Bank of Italy Ignazio Visco Varenna, 22 September 2018 In the last decade Italy’s economy experienced the most acute crisis in its history. The double-dip recession, during which GDP contracted by roughly nine percentage points, was followed by an anaemic and bumpy recovery: from 2013 to today, less than half of this lost ground has been recouped. Against this backdrop, there have been calls from many quarters for higher public spending, which can have positive effects on economic activity in the short term and on growth potential in the longer term. The boost from increased spending is usually greater when this is financed by a deficit. It can be even stronger if the investments made are matched by private capital, increasing its returns at the margin and thereby stimulating firms’ investment expenditure. In the medium to long term greater growth potential comes from creating new opportunities for economic activity and stimulating innovation; both can be achieved through the completion of material infrastructure, especially if tech-intensive, and above all through investment in research and knowledge. In the short term the increase in GDP, measured by the ‘investment multiplier’, can be so strong as to exceed the growth in public debt owing to the deficit. But if this fails to trigger the longer-term effect on growth potential, the reduction in the ratio of debt to GDP will be short-lived: the deficit will continue to fuel the debt and GDP will start to grow again at a pace similar to that preceding the spending boost. The size of the multiplier depends on a number of important variables: maximizing the direct impact on GDP requires rapid and efficient interventions and the ability to identify those capable of determining an actual qualitative and quantitative increase in public capital; maintaining orderly financial conditions is vital to prevent the ‘crowding-out’ of private investment, which can be discouraged by a rise in interest rates. The careful selection of the programmes to finance is also crucial for achieving the longer-term effects on growth potential; it must not penalize the resources available for immaterial infrastructure. The constraints imposed by the high public debt must not be overlooked. An unproductive increase in the deficit would end up worsening the outlook for the public finances, feeding investor doubts and raising the risk premium on Italian government securities. This could soon put the ratio of public debt to GDP on an unsustainable course. Given the current public finance conditions and the low efficiency of public administration, any recourse to deficit spending requires caution, to ensure that resources are actually channelled to supporting economic activity in the short and longer term. Even if an effective investment policy were to succeed in putting the economy on a higher growth trajectory, it would still be necessary to define a credible strategy within the confines of fiscal objectives and reform plans, such as to determine a reduction in the risk premium on Italian government securities. In this scenario the ratio of debt to GDP would begin to gradually decline, all the more rapidly the smaller the difference between interest payments and the nominal growth of the economy and the larger the fiscal surplus net of interest expenditure. Public investment and aggregate demand It is well known that so-called ‘direct’ public spending, such as that on investment, can have a stronger impact on aggregate demand than expenditure with ‘indirect’ effects, such as public transfers, a portion of which can be saved by their beneficiaries, to an increasing extent as income rises. Any accurate assessment of the short-term macroeconomic effects of higher public investment is, however, subject to a large degree of uncertainty. The size of the multiplier (i.e. the increase in GDP generated by higher deficit spending) depends on many factors: the extent to which productive resources are utilized, the monetary policy stance and attendant financial conditions; eventual lags and inefficiencies in implementing investment programmes; and the market’s assessment of the outlook for debt sustainability following a spending hike. Simulations made over a short to medium term horizon using the Bank of Italy’s quarterly econometric model indicate that in the most favourable scenario the multiplier is above one and the increase in GDP obtained by higher investment leads to a reduction in the ratio of debt to GDP over a five-year period (Table 1). It is reasonable to suppose that if investments are not carefully selected, or their implementation dogged by waste and inefficiencies, the multiplier would be considerably lower, nearing the (lower) one for spending on transfers. In such a scenario the ratio of public debt to GDP would rise. A similar result would obtain if the spending plan were to stoke investor fears: higher financing costs (for the public sector and therefore for the private one as well) would weaken the stimulus to economic activity from increased investment, while the deficit would widen both because of lower economic growth and the progressive rise in interest expenditure. It is difficult to assess the potential impact of a higher deficit on sovereign risk premiums: the relationship is non-linear and volatile, influenced by many variables some of which are not immediately quantifiable. If the fiscal expansion were accompanied by a deterioration in investor confidence such as that which, for various reasons, occurred between 2011 and 2012, the impact on interest rates could, like then, be especially strong. It is impossible to apply to cases like this the estimates based on the figures recorded in advanced economies in normal financial conditions. Nor should it be forgotten that every year the State must issue around 400 billion euros in public debt. The econometric model does not explicitly take account of the complementarity between public and private capital in firms’ production function. Public investments capable of increasing the profitability of private capital, by encouraging its accumulation, can translate into higher values of the multiplier.1 The empirical literature on this complementarity is extensive but – in part owing to non-negligible methodological difficulties – has not produced univocal findings. The estimated effects nevertheless confirm its importance.2 While the simulations are not fully comparable, econometric exercises conducted by other institutions nonetheless highlight the key role of the factors I mentioned earlier: the reaction of monetary policy, the ability to select investment programmes judiciously and carry them out without delay or waste, and expectations concerning future developments in public finances (Table 2).3 Public investment and growth potential Economic analysis has long recognized that technical progress and total factor productivity dynamics are the true engine of economic growth in the advanced countries, where the driving forces of the initial rapid accumulation of physical See L. Burlon, A. Locarno, A. Notarpietro and M. Pisani, ‘Public Investment and Monetary Policy Stance in the Euro Area’, Banca d’Italia, Temi di Discussione (Working Papers), 1150, 2017. Reviews of the literature are provided in: A. M. Pereira and J. M. Andraz, ‘On the Economic Effects of Public Infrastructure Investment: A Survey of the International Evidence’, Journal of Economic Development, 38, 4, 2013; W. Romp and J. de Haan, ‘Public Capital and Economic Growth: A Critical Survey’, Perspektiven der Wirtschaftspolitik, 8, 1, 2007; and P. R. D. Bom and J. E. Ligthart, ‘What Have We Learned from Three Decades of Research on the Productivity of Public Capital?’, Journal of Economic Surveys, 28, 5, 2014. For a review and comparison of the different estimates, see F. Busetti, C. Giorgiantonio, G. Ivaldi, S. Mocetti, A. Notarpietro and P. Tommasino, ‘Capitale e investimenti pubblici in Italia: misurazione, effetti macroeconomici, criticità procedurali’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 2018 (forthcoming). capital and of labour force growth have waned. An adequate endowment of public capital can facilitate the adoption of new technologies and the reorganization of production processes, also fostering the creation of new firms. It can prove essential in supporting the early development of especially innovative technologies. It must be acknowledged, however, that the relationship between public capital accumulation and economic development, while crucial, remains largely elusive. Of course, public capital comprises not only material infrastructure − such as transport, telecommunications and energy networks − but also the body of knowledge and skills available to an economy. These two types of infrastructure, material and immaterial, share some of the characteristics of public goods, and without government intervention they would be available in insufficient quantity. The State supports investment in immaterial capital in two ways. Directly, through scientific research in public universities and public research institutions and through the provision of education; indirectly, in the form of subsidies and tax incentives to the private sector. There is evidence that both these forms of intervention, if well designed, have a positive impact on economic growth. In a context of rapid technological change, fostering investment in human capital and improving its quality appears equally, if not more, important than investing in material infrastructure, especially in our country. Public spending on education is around 4 per cent of GDP, much lower than the euro-area average (Figure 1). Among the advanced countries, Italy’s labour force has one of the lowest rankings for labour force skills.4 The gap with the other countries is also pronounced for research and development, although this is due almost entirely to the private-sector component of expenditure (Figure 2). Public investment expenditure and infrastructure endowment in Italy In Italy, general government gross fixed capital formation has decreased in recent years and is below that recorded in other European countries (Figure 3). In nominal terms, it has fallen by an annual average of 4 per cent since 2008; while less evident, this downward trend is also visible in the rest of the euro area. As a percentage of GDP, expenditure in Italy diminished from 3 per cent in 2008 to 2 per cent in 2017; the reduction was concentrated in local government entities. The European Commission has recently estimated a public investment gap for Italy.5 See the OECD, Skills Matter. Further Results from the Survey of Adult Skills, Paris, 2016. See the European Commission, Report on Public Finances in EMU, Brussels, 2017. It is worth bearing in mind that the economic meaning of the expenditure items does not always coincide with accounting classifications. The outlays recorded in general government accounts under the item ‘gross fixed investment’ are not entirely allocated to material infrastructure, nor do they represent the totality of the financial resources earmarked for such purposes. About half of the outlays concern other types of expenditure, for example that on plant, equipment and patents. Investment in material infrastructure is also made by non-public sector entities that nevertheless carry out public utility projects (e.g. licenced operators in the railway, motorway, energy and telecommunications sectors).6 Only part of this expenditure goes through government financial accounts and is recorded under ‘contributions to investments’, a very heterogeneous item whose composition is affected by national specificities in the sectoral classification of the entities involved (within or outside the general government perimeter) and the ways in which public utilities are regulated. Measuring a country’s infrastructure endowment is a complex exercise. One can use financial indicators based on the resources employed or instead rely on physical endowment indicators (e.g. the length and density of transport networks, energy and water supply, and telecommunications), which can also reflect topographical differences between regions and the degree of efficiency with which the resources are utilized. Finally, there are indices whose aim is to capture the overall adequacy of infrastructural networks, as far as possible taking account of potential demand, network interconnections, and congestion phenomena. If we use indicators based on the permanent inventory method, which accumulates the time series of annual investment expenditure net of the estimated depreciation, Italy’s situation appears broadly in line with that of the major euro-area economies (Figure 4). Compared with the early 2000s, the gap has widened with respect to France, but there has been an improvement compared with Germany and Spain.7 If we take physical indicators of infrastructure endowment and set them in relation to appropriate variables of scale, we get different results. For example, relative to the population (an albeit very rough measure of the potential demand for In 2017 Ferrovie dello Stato made investments amounting to about €4.5 billion (€4.3 billion in 2016), almost entirely through its subsidiary RFI SpA, which manages the rail network. Autostrade per l’Italia invested about €600 million; the second largest operator, Gavio, invested another €200 million. For the telecommunications network, TIM invested about €3.5 billion. As regards electrical infrastructure, in the two years 2016-17 Enel invested over €2.5 billion, and Terna more than €1.9 billion. For the natural gas network, Snam made investments amounting to about €2.7 billion in the last three years. See the IMF, Investment and Capital Stock Dataset, 2017. transport), the Italian road and railway networks turn out to be much less extensive than those of France, Germany and Spain. Similarly, if we look at the minimum travel time between two regions, weighted by population, Italy is once again at a disadvantage compared with the European average, suggesting the possible effects of congestion (Figure 5).8 Finally, subjective assessments are used to measure the adequacy of a country’s entire infrastructure endowment – and therefore not just transport – though great care must be taken when interpreting them. For example, the World Economic Forum produces a synthetic index covering 137 countries; Italy ranks 58th, far behind all the other major European countries.9 According to a similar study conducted by the European Investment Bank in 2017 (though confined to European countries and municipal infrastructure), Italy is qualitatively analogous to Spain, but behind France, Germany and the EU average.10 All in all we can see a gap between what is suggested by the indicators constructed based on historical expenditure and what can be derived from more analytical indicators of the adequacy of infrastructure networks (Italy is found to be lagging behind the other European countries only by the second group of indicators). It could be assumed that this gap is also partly attributable to less ‘efficient’ completion of public works.11 As I remarked earlier, efficiency is a key variable in determining the macroeconomic impact of investment expenditure, both in the short and long term. Completion of public works While the available data do not enable us to make systematic and detailed comparisons, there is evidence that the average completion times and costs for public works are relatively high in our country. According to the audit performed in 2018 by the European Court of Auditors, Italy has the highest constructions costs of any EU country for completed high-speed rail lines (€28 million per kilometre, compared with €12 million for Spain, €13 million for Germany and €15 million See the European Spatial Planning Observation Network, ESPON Atlas Mapping European Territorial Structures and Dynamics, 2014. See the World Economic Forum, The Global Competitiveness Report 2017-18, Geneva, 2018. See the European Investment Bank, Relazione sugli investimenti 2017/2018, Luxembourg, 2018. See also the Chapter ‘The infrastructural endowment’, Banca d’Italia, Annual Report for 2010 (Abridged), Rome, 31 May 2011. for France). If we add up the costs of projects already completed with those in progress, we find that Italy’s cost per kilometre rises to €33 million, as against €14 million for Spain and €15 million each for Germany and France. Our country also falls far behind in terms of completion times.12 Surveys conducted over the last decade have shown that, in Italy, the average costs per kilometre and completion times for high-speed rail lines have been about three times those of France and Spain; the average costs per kilometre for roads were more than double those of Spain. As for major projects co-financed by the European Regional Development Fund, these studies indicated time and cost overruns in Italy equal, respectively, to more than triple and double the EU average.13 It does not seem that the extent of these differences can be explained merely by the distinctive orographic features of each country. The various phases of construction have differing impacts. The length of ‘transition’ periods, that is, the time between the end of one procedural phase and the start of the next (for example, the planning and awarding of contracts) or between sub-phases (for example, preliminary, final and executive planning), has a considerable impact on project timelines. These periods, which are at least in part absorbed by administrative activities and inefficiencies, account for on average around 54 per cent of a project’s total duration (rising to 60 per cent if one considers only the planning phase). Over the last few years average completion times have risen. The increase has related solely to the tendering and execution phases, while the length of the planning phase has remained fairly stable. But there are wide regional variations: it is estimated that the length of time required in Sicily, Molise and Basilicata to complete the same project is more than 30 per cent higher than that required in Lombardy and Emilia Romagna.14 This means that, over and above addressing a The audit was carried out on the high-speed lines of six European countries and analysed more than 5,000 km of infrastructure on ten high-speed rail lines covering around 50 per cent of the existing lines in Europe. See European Court of Auditors, A European High-Speed Rail Network: Not a Reality but an Ineffective Patchwork, Special Report, 19, Luxembourg, 2018. For a discussion of this topic and the associated references see: I. Visco, ‘Efficient spending on infrastructure’, address by the Governor of the Bank of Italy before the Chamber of Deputies, 19 June 2012 (only in Italian); Banca d’Italia, ‘Infrastructure in Italy: endowment, planning, construction’, F. Balassone and P. Casadio, eds., Seminari e Convegni (Workshops and Conferences), 7, 2011; and Banca d’Italia, ‘The efficiency of infrastructure spending’, F. Balassone, ed., Seminari e Convegni (Workshops and Conferences), 10, 2012. See the Agency for Territorial Cohesion’s report on public works completion times, Rapporto sui tempi di attuazione delle opere pubbliche (only in Italian), 13 July 2018. scarcity of resources or the limitations of the applicable legislation, it is critical that we identify and spread best practices. According to data from the National Anti-Corruption Authority on contracts awarded by Italian municipalities between 2009 and 2014, for equal contract amounts, the tendering and execution phases were shorter for negotiated procedures than they were for competitive ones (by about one year). There is, however, evidence that although there are benefits in terms of cutting times, recourse to more discretional procedures by ‘less qualified’ contracting entities is associated with a decrease in the average productivity of the firms that are awarded contracts.15 Overall, given these considerations, the short to medium term macroeconomic impact of an increase in the resources allocated to public investment could be greater if directed towards projects that are already in progress (if chosen appropriately ex ante) instead of being used to fund new projects. From a more structural standpoint, it is crucial that the entire planning, assessment and monitoring process be rationalized.16 Improvements could result from a more accurate cost/benefit analysis during the project selection phase. A greater focus on the quality of planning (envisaged in the new Public Contracts Code) could, particularly for more complex interventions, make public investment more effective, despite extending the planning phase. More specifically, this could speed up the subsequent phases (especially the executive one), helping to stem the endemic phenomenon of bid renegotiations, which is among the main causes of time overruns and rising costs.17 It is important to reduce transition times. There could also be benefits stemming from the appropriate use of the ‘e-procurement’ systems envisaged under the new Code which, besides ensuring greater transparency, would also reduce timeframes. The proper functioning of all of these instruments depends, however, on there being competent contracting authorities that are able to use them correctly. This is why it is vital that steps be taken to raise professional standards in the public sector, starting with the measures to train the contracting authorities See A. Baltrunaite, C. Giorgiantonio, S. Mocetti and T. Orlando, ‘Discretion and Supplier Selection in Public Procurement’, Banca d’Italia, Temi di Discussione (Working Papers) 1178, 2018. See F. Balassone, ‘Programmazione di bilancio e gestione degli investimenti pubblici: un’agenda aperta’, in Banca d’Italia, ‘The efficiency of infrastructure spending’, cited above. See P. Sestito, ‘ Recepimento delle direttive europee in materia di contratti pubblici’, Testimony on the transposition of European directives on public contracts by the Head of the Bank of Italy’s Economic Structure Division before the Standing Committee on Environment, Territory and Public Works (VIII) of the Chamber of Deputies, 16 June 2014 (only in Italian). which, more than two years after the new Code has come into force, have yet to be implemented. Otherwise, potentially virtuous, but more sophisticated, measures may even have the effect of slowing down less competent administrations. The trend in tenders for public works contracts over the last two years – characterized by a dip in 2016 and by a significant recovery in 201718 – has varied according to the type of contracting authority: specifically, tenders decreased (in number and in value) for ‘less qualified’ contracting authorities, but rose slightly for the others (Figure 6). Investment and sustainability of the public debt The evidence available suggests that Italy’s infrastructure endowment is either inadequate or risks becoming so due to lack of maintenance. At the same time, it is clear that the interventions required must be accompanied by incisive improvements in the selection, planning and carrying out of public works: the fact that Italy’s infrastructure lags behind that of the other main economies is not just due to insufficient financial resources. Given its high debt-to-GDP ratio, Italy must make the best possible use of its resources; only in this way can a spending boost be consistent with debt sustainability. Deficit financing should be used with caution. The dynamics of the debt-to-GDP ratio depend on the primary surplus and on the difference between the average cost of debt and the economy’s growth rate. When I spoke here last year, I underlined how, with an annual average growth rate of around 1 per cent, inflation at 2 per cent (in line with the ECB’s objective), and the average cost of debt approaching pre-crisis levels, the gradual attainment and maintenance of a primary surplus of around 4 per cent of GDP would enable the debt-to-GDP ratio to be lowered to 100 per cent in the space of ten years.19 In that same scenario today, solely owing to the increase in the risk premium on government securities, the reduction of the ratio would be slower (Figure 7a); leaving the primary surplus at current levels, the debt-to-GDP ratio would fall slowly for a few years and then stabilize at around 120 per cent, a still high level that would continue to limit the capacity of the public finances to have a stabilizing effect during recessions and would leave Italy exposed to the turbulence of the financial markets. The difficulties in adapting to the new Code may have influenced this trend. The demand for public works, though recovering, is still lower than it was prior to 2011. See I. Visco, ‘Sviluppo dell’economia e stabilità finanziaria: il vincolo del debito pubblico’, a speech made at the 63rd Meeting of Government Studies on ‘La tutela degli interessi finanziari della collettività nel quadro della contabilità pubblica: principi, strumenti, limiti’, Varenna, 21 September 2017. See also I. Visco, The Governor’s Concluding Remarks for 2017, in the Annual Report for 2017, Banca d’Italia, 29 May 2018. As I have already mentioned, increasing spending on investment by means of deficit financing, without addressing growth potential, would only be of temporary benefit. Reducing the primary surplus by one percentage point of GDP compared with the current level would lead to a small decrease in the debt-to-GDP ratio thanks to the expansionary boost to economic activity; however, with no long-term increase in economic growth, the debt-to-GDP ratio would soon rise again, even if there were no negative reactions on the financial markets (Figure 7b). The situation would be different if the resources obtained by means of a larger deficit were used so as to increase growth potential and if the risk premium on Italian government securities were reduced: with annual growth of more than one percentage point and with the yields on government securities returning to the values recorded at the beginning of this year, the debt-to-GDP ratio would begin to follow a stable, albeit not particularly rapid, downward trajectory. Above all, we must not underestimate the risks which, given the high level of public debt, an unproductive increase in the deficit would expose us to. A negative reaction on the markets – for example a 200 basis point increase in risk premiums, remaining below the level recorded at the end of 2011 – would trigger a rapid increase in the debt-to-GDP ratio; considering the negative impact on economic growth of the increase in interest rates and crisis of confidence, the ratio would soon be on an unsustainable path (Figure 7c). *** The debt reduction plan that I presented last year was an indicative scenario; it is possible to draw up prudent strategies, capable of guaranteeing the stability of the public finances combined with better growth prospects. This is the narrow path that has been much spoken of in these difficult years. We can follow this path slowly, one step at a time, by implementing a series of interventions that gradually produce benefits until all the necessary changes have been made. Or we can try to make the path wider by setting out a comprehensive strategy designed to redirect the public finances to more productive uses and to increase the efficiency of general government, especially in spending programmes aimed at accumulating both material and immaterial public capital and at supporting business activity and innovation. It is in any case essential that the fiscal objectives are and appear to be strongly and credibly oriented towards financial stability, and that the reforms are effectively geared towards sustained – and inclusive – economic growth. TABLES AND FIGURES Table 1 – Macroeconomic impact of an increase (1% of GDP) in public investment expenditure financed through deficit spending according to the Bank of Italy’s quarterly econometric model Years A. Baseline scenario Real GDP 0.9 1.1 1.2 1.2 1.1 GDP Deflator 0.1 0.4 0.8 1.3 1.6 Deficit-to-GDP/ratio 0.7 0.5 0.5 0.5 0.6 Debt-to-GDP ratio -0.5 -0.6 -0.7 -0.7 -0.4 B. Reduced efficiency of investment expenditure Real GDP 0.5 0.7 0.8 0.8 0.8 GDP Deflator 0.0 0.2 0.5 0.7 1.0 Deficit-to-GDP/ratio 0.8 0.6 0.6 0.6 0.6 Debt-to-GDP ratio 0.1 0.3 0.4 0.6 1.0 C. Increase in borrowing costs (*) Real GDP 0.9 0.9 0.8 0.8 0.7 GDP Deflator 0.1 0.3 0.7 1.0 1.2 Deficit-to-GDP/ratio 0.8 0.6 0.8 0.9 1.1 Debt-to-GDP ratio -0.4 -0.1 0.3 0.9 2.0 (1) Percentage changes compared with the baseline scenario. (2) Absolute changes compared with the baseline scenario (percentage points of GDP). (*) Permanent increase of 10 basis points in the yields on short-term government securities and of 50 basis points in the yields on medium-term government securities. Source: F. Busetti, C. Giorgiantonio, G. Ivaldi, S. Mocetti, A. Notarpietro and P. Tommasino, ‘Capitale e investimenti pubblici in Italia: misurazione, effetti macroeconomici, criticità procedurali’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 2018 (forthcoming). Table 2 – Macroeconomic impact of an increase in public investment expenditure: estimates of the main institutions Multiplier Short-term Medium-term Lower efficiency 0.4 0.8 0.2 1.4 2.6 0.7 Expansionary cyclical phase -0.5 0.0 2.0 2.2 1.8 2.5 2.8 2.2 1.0 0.8-1.2 2.5 1.0 0.5-0.6 1.2 1.6 1.3 1.8 1.3 IMF (Panel estimates) Benchmark Higher efficiency IMF (Global Integrated Monetary and Fiscal model) Benchmark Higher efficiency Lower efficiency Expansionary cyclical phase OECD European Commission ECB Benchmark Lower efficiency Source: F. Busetti, C. Giorgiantonio, G. Ivaldi, S. Mocetti, A. Notarpietro and P. Tommasino, ‘Capitale e investimenti pubblici in Italia: misurazione, effetti macroeconomici, criticità procedurali’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 2018 (forthcoming). Figure 1 – Public expenditure on education in the main euro-area economies (percentage points of GDP) 6,0 5,5 5,0 4,5 4,0 3,5 Italy Germany France Spain Euro area Sources: Eurostat, COFOG database. Figure 2 – Expenditure on research and development in the main euro-area economies (percentage points of GDP; 2016) 4,5 4,0 3,5 3,0 2,5 2,0 1,5 1,0 0,5 0,0 Germany Private-sector firms France Public sector Italy Universities and research institutions Source: Eurostat. Spain Private-sector non-profit entities Figure 3 – General government gross fixed capital formation in the main euro-area economies (percentage points of GDP) 6,0 5,0 4,0 3,0 2,0 1,0 Italy France Germany 0,0 Spain Sources: European Commission, AMECO database. Figure 4 – Performance of the stock of public-sector capital in the main euro-area economies (percentage points of GDP) Italy Germany France Spain Source: IMF. The indicator was constructed for 170 countries by applying the permanent inventory method to the data on public investment expenditure from 1960 to 2015; the depreciation rate of public-sector capital is estimated separately for each country. Figure 5 – Transport accessibility index in the main euro-area economies (EU 27= 100; 2011) Germany France Italy Spain Euro area Source: European Spatial Planning Observation Network (ESPON). Share of the EU population that can be reached within four hours using intermodal travel (air, rail, motorway). The y-axis shows the value taken by the index compared with that for the EU 27, which is set equal to 100. The indicator for each country is constructed as the simple average of the provincial indicators. Millions of euros Number of tenders Figure 6 – Number of tenders and amounts by type of contracting authority in Italy Year in which tender was awarded Year in which tender was awarded Low-quality contracting authorities Low-quality contracting authorities High-quality contracting authorities High-quality contracting authorities Source: A. Baltrunaite, C. Giorgiantonio, S. Mocetti and T. Orlando, ‘Discretion and Supplier Selection in Public Procurement’, Banca d’Italia, Temi di Discussione (Working Papers), 1178, 2018. Figure 7a – Performance of the debt-to-GDP ratio under different assumptions Baseline scenario Varenna 2017 scenario Varenna 2017 scenario with the spread at current levels Note: The baseline scenario assumes a primary surplus equal to that forecast for this year in the 2018 DEF (1.9 per cent of GDP), the spread between Italian and German government securities remaining at current values (240 basis points for ten-year bonds), the gradual normalization of monetary policy, and growth potential equal to 1 per cent. Figure 7b – Performance of the debt-to-GDP ratio under different assumptions Baseline scenario Baseline scenario with increased investment (Bank of Italy multiplier) Baseline scenario with increased investment (Bank of Italy multiplier), higher growth potential (2%) and the same spread as in Q1 2018 (150 bps) Note: See Figure 7a. Figure 7c – Performance of the debt-to-GDP ratio under different assumptions Baseline scenario Baseline scenario with increased investment (lower multiplier) and a 200 bps increase in the spread Baseline scenario with increased investment (lower multiplier), a 200 bps increase in the spread and lower growth potential (0.5%) Note: See Figure 7a. Designed by the Printing and Publishing Division of the Bank of Italy
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Testimony of Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Joint Session of the Fifth Committees of the Chamber of Deputies (Budget, Treasury and Planning) and of the Senate of the Republic (Economic Planning and Budget), Chamber of Deputies, Rome, 9 October 2018.
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Joint Session of the Fifth Committees of the Chamber of Deputies (Budget, Treasury and Planning) and of the Senate of the Republic (Economic Planning and Budget) Preliminary hearing on the Update to the 2018 Economic and Financial Document Testimony of the Deputy Governor of the Bank of Italy Luigi Federico Signorini Chamber of Deputies Rome, 9 October 2018 Mr President, Honourable Members of Parliament, I wish to thank the Fifth Committees of the Chamber of Deputies and of the Italian Senate for once again giving the Bank of Italy this opportunity to provide its technical assessment as part of the consultations on the Update to the Economic and Financial Document. The macroeconomic outlook Following the severe crisis of 2008-13, the Italian economy has been recovering for the past five years. Last year GDP growth came to 1.6 per cent, with contributions from all the components of demand, domestic and foreign. In 2018, notwithstanding the overall solidity of domestic demand, the pace of growth gradually moderated, affected above all by the slowdown in world trade. Sales outside the EU nonetheless turned upwards again in August. Fears of a further spike in trade tensions appear to have dented the confidence of firms at international level and risk affecting economic activity even beyond the direct impact on trade of the protectionist measures implemented to date. The situation remains uncertain; the Italian economy is very open to foreign trade and is therefore exposed to the related risks. According to the latest data released by Istat, industrial production fell sharply in July. In recent times the statistical variability of the index has intensified and it is therefore important not to overestimate the meaning of any one reading. Based on our estimates, which draw on updated data on energy consumption and goods flows, in August and September there appears to have been a recovery. It is nonetheless still likely that production in the third quarter will stagnate overall. What happens in the fourth quarter, which has just begun, will mark the point of departure for the level of industrial production growth achieved in 2019. The index based on the assessments of purchasing managers in industrial sector firms also fell during the summer months. The latest cyclical indications are instead more favourable in the service sector. According to our quarterly survey conducted in September, firms continue to expect investment to increase in 2018, albeit to a lesser extent than was expected six months ago. Labour market data continue to be positive. The number of persons in employment in August was up by 300,000 compared with the end of last year, reflecting above all the increase in fixed-term contracts. The employment-intensive nature of the recovery has therefore been confirmed. In recent weeks, signs of tension in the financial markets have intensified. The yields on Italian government securities have turned upwards again. Funding conditions and banks’ market valuations have been affected as a result: in early October there was a steep drop in bank share prices and the CDS spreads of the leading credit institutions were up sharply on the first half of the year. Yet still today the central projection remains that of – albeit rather slower – economic growth in the short term. In July’s Economic Bulletin we had forecast an increase in GDP of 1.3 per cent this year and of 1 per cent in 2019, assuming the full deactivation of the safeguard clauses on indirect taxation. The latest data suggest that, provided economic policy assumptions remain unchanged, growth will be slightly lower both this year and the next. The risks, especially those connected with the performance of world trade and the conditions on Italy’s financial markets, have intensified. The accentuation of the protectionist stances of trade policies, enduring tensions in various parts of the world, and the knock-on effects on business confidence, could dampen world economic activity next year, slowing the impetus provided so far to our economy by the international context. On the home front, protracted tensions on the financial markets would have detrimental effects on the funding conditions of households and firms and on domestic demand. The Government’s current legislation macroeconomic scenario, which does not incorporate the deactivation of the safeguard clauses on indirect taxation, envisages 1.2 per cent GDP growth this year and 0.9 per cent the next. This figure is within the interval of the estimates currently available, even if it is based on assumptions about exogenous variables that are relatively favourable compared with the latest trends. In the two years 2020-21 GDP is expected to expand by 1.1 per cent. The policy scenario raises GDP growth forecasts to 1.5 per cent next year, 1.6 per cent in 2020 and 1.4 per cent in 2021, thanks to the effect of the budgetary provisions. These measures are expected to have a significant impact; the Government’s estimate assumes that the values of the multipliers of the expansionary measures will be higher than those generally estimated for Italy and that the measures set out in the Update will stimulate economic activity already in the early months of next year. A more comprehensive assessment would require details that are not yet available on the composition, design and implementation of the measures, including their funding. While for 2019 the VAT increases envisaged under the safeguard clauses have been eliminated, for 2020 and 2021 the planning scenario continues to incorporate them, at least in part; it therefore results in a future increase in indirect taxation, but how this would be designed and its entity are not indicated in the Update. The Government did, however, already announce that it does not intend to actually implement the increase, and that it will replace it with other measures to cut spending and improve tax revenue collection (these measures are also not specified further at present). In addition to the direct effect of the budgetary measures on economic activity, the impact on the confidence of savers and the market must also be taken into consideration. I will return to this point in the concluding section of my address. The public accounts in 2018 The Update to the Economic and Financial Document (DEF) revises the estimate for net borrowing, bringing it to 1.8 per cent of GDP, from 1.6 per cent indicated in April’s DEF. The revision stems from a reduction of €3.9 billion in revenue, partly connected to lower expected GDP growth, and to an increase of €1.9 billion in interest payments. In September Istat released new national accounts estimates for the last three years. Net borrowing for 2017 was revised upwards, from 2.3 to 2.4 per cent of GDP. Compared with 2017, it is estimated that net borrowing will decrease by over half a percentage point of GDP, owing to an increase in the primary surplus (0.4 percentage points) and a reduction in interest payments (0.2 points). The tax burden will decline from 42.2 per cent in 2017 to 41.9 per cent this year, mainly due to developments in direct taxes. The data observed so far on the borrowing requirement and government receipts appear consistent with a reduction in net borrowing in the current year. Excluding the estimated effects of the main operations that do not impact net borrowing and a number of temporal asymmetries, the general government borrowing requirement in the first nine months of 2018 (estimated by approximating the still unavailable data for August and September with those for the state sector borrowing requirement) decreased compared with the corresponding period of 2017. In the same period, tax revenue entered in the State budget, net of lottery and gaming receipts, increased by 0.5 per cent compared with the same period of 2017, above all thanks to the positive performance of VAT and personal income tax (Irpef) revenue. If the data are adjusted to take account of some asymmetries of a purely accounting nature, the estimated increase in revenue would be greater, and basically consistent with the growth forecasts of general government tax revenue indicated in the Update. In the policy scenario, the structural deficit (that is, cyclically-adjusted and net of temporary measures) is expected to reach 0.9 per cent of GDP. The expected reduction in the structural deficit is less than that for the overall deficit (0.2 percentage points versus 0.5 points); the difference is mainly due to the reduction in the output gap, as the net effects of the temporary measures are extremely limited in both 2017 and 2018. According to the Update, in 2018 the debt-to-GDP ratio will fall slightly, from 131.2 per cent at end-2017 to 130.9 per cent. The reduction is almost 1 percentage point less than that estimated in April, owing to higher net borrowing expectations and, especially, slower nominal GDP growth. As part of its September revision of the national accounts data, Istat adjusted upwards its nominal GDP estimate for the two years 2016-17. Owing to these changes, in both years the debt-to-GDP ratio decreased by about 0.6 percentage points. Public finance projections for 2019-2021 Current legislation scenario. – The Update revises the net borrowing forecasts for the three years 2019-2021 in the current legislation scenario, raising them (compared with April’s DEF) by 0.4 percentage points for next year and by 0.7 points for each of the two years 2020-21. The revision takes account of a worsening GDP growth outlook and of higher interest payments (more than 0.1 percentage points in 2019, 0.2 points in 2020 and 0.3 points in 2021). Notwithstanding this revision, current legislation net borrowing is expected to continue to decrease, also thanks to the safeguard clauses (whose effect is equal to 0.7 per cent of GDP in 2019 and to 1.0 per cent from 2020 onwards): as a percentage of GDP, net borrowing is estimated to fall to 1.2 per cent in 2019, 0.7 per cent in 2020 and 0.5 in 2021. The nominal budget balance, which according to April’s DEF would have been attained in 2020, would now not be achieved in 2021 either. The primary surplus, while rising gradually to 3.3 per cent of GDP in 2021, would be lower than last April’s estimates by 0.4 percentage points on average each year. Interest payments are expected to grow steadily, reaching 3.8 per cent of GDP in 2021. The higher interest payments compared with April’s estimates, made on the basis of the interest rates foreseeable at the time, would amount to about €3 billion in 2019, almost €4 billion in 2020, and about €4.5 billion in 2021. If the tensions observed in the last two weeks, which have heightened further in recent days, were to persist, interest payments could be higher than indicated in the Update. The Update clarifies that the forecasts are made on the basis of the forward rates observed during the period in which the document was prepared, and the macroeconomic scenario was developed on the basis of the information available at 22 September 2018. Ten-year BTP yields have risen by more than 60 basis points in the last two weeks, and those of three-year securities by more than 90 basis points. To give an idea of the relative impact, a permanent increase of 100 basis points in the yields of all government bonds implies that interest payments will be greater by 0.15 per cent of GDP in the first year, 0.3 per cent in the second year, and 0.45 per cent in the third year. Policy scenario. – Compared with the current-legislation scenario, for 2019 the Government plans to raise net borrowing by more than 1 percentage point, to 2.4 per cent of GDP. In the following two years the deficit is projected to narrow again, an outcome to which the partial activation of the safeguard clauses and the resulting VAT increase would also contribute. The remaining safeguard clauses are not quantified in detail in the Update; as I observed earlier, the Government has already announced it does not intend to implement the increase in indirect taxation. In the past, if activated or replaced with equivalent measures, the safeguard clauses served the purpose of attaining a balanced budget within the planning period. In the Update they only help to bring the deficit, at the end of the forecasting horizon, to more or less its starting point in 2018. In fact, the Update does not envisage a reduction in the structural deficit. Rather, it plans to increase it by 0.8 percentage points of GDP next year, bringing it to 1.7 per cent, and to keep it unchanged in the following two years. The Government has announced its intention to resume fiscal consolidation in 2022, the first year beyond the planning horizon; the resumption of fiscal consolidation would be brought forward only if, by 2021, real GDP and employment had returned to pre-crisis levels. The structural deficit will remain at a significant level for a highly-indebted country; this does not afford much room for manoeuvre were it to become necessary to deal with a new cyclical slowdown. The measures and their impact on the economic cycle. – As I have already recalled, in the Government’s estimates the expansionary stance of the budgetary measures raises real GDP growth forecasts by about half a percentage point each year, to 1.5 per cent on average in the next three years. In 2019 the fiscal policy stance (conventionally measured by the change in the cyclicallyadjusted primary surplus) would be expansionary by almost 1 percentage point; in April’s current legislation estimates, it was expected to be restrictive by 0.4 percentage points. In the following two years, the stance is expected to be largely neutral. The macroeconomic effects of the budget depend on its composition and design; therefore, an assessment will only be possible once the details have been made known. In any case, the Update provides an insight into the various areas of planned intervention. The safeguard clauses on indirect taxes are set to be completely deactivated next year and redesigned in the following years. According to our assessments and based on the Bank of Italy’s quarterly econometric model, the expansionary impact of this measure will be limited. This assessment is consistent with the Government’s estimates contained in the Update. The impact could prove even more limited, or nil, if the decision not to increase VAT was already incorporated in households’ expectations. At the same time, the plan is to expand the number of those eligible for the ‘simplified’ taxation system in place for small firms, professionals and tradespeople. The Government has announced that it intends to introduce a new poverty reduction mechanism in 2019 (‘citizenship income’) and to alter the requirements for pension eligibility, making them less stringent. An increase in current transfers – such as those relating to social expenditure – as well as tax relief tend to have modest and gradual cyclical effects; we estimate that the income multiplier associated with these measures is limited. As far as the ‘citizenship income’ is concerned, pursuing the goal of social protection should not disincentivise the supply of labour. A decisive factor in this regard is the amount of the benefit in relation to the potential wage that a worker could earn on the market; looking at the experience of other countries, it should be possible to develop an appropriate design. This is important not only with a view to assessing the cyclical impact of the measure on GDP and employment, but above all in order to refine the tool from a longer-term perspective. According to the Update, the benefit – the amount of which has not yet been officially established – will provide income support to people below the relative poverty threshold. In other countries, the amount of the benefit in proportion to the national relative poverty threshold is usually less than one.1 For a household of just one member, it is less than 50 per cent on average in the EU countries, with a peak (87 per cent) in the Netherlands; in Germany it is 39 per cent, in France, 50 per cent and in Spain, 63 per cent. The conditions that should regulate eligibility for the benefit (especially its withdrawal after a given number of job offers) cannot be applied effectively unless job centres are provided with sufficiently increased capacity. Regarding social security, the requirements for pension eligibility are to become less stringent; this measure will be set out in detail at a later date. We have often pointed out that, when making the pension age more flexible, it is important to respect the actuarial equivalence principle in order to ensure the long-term sustainability of the pension system, now a key strength of Italy’s public finances. Based on available research into the effects of past pension reforms that raised the minimum pension age, it is not possible to maintain that, in the medium-to-long term, an increase in the employment rate of older workers leads to worse job prospects for young people,2 particularly in the private sector. Our calculations based on the relative poverty risk indicator for 2016 computed by Eurostat and on information from the Mutual Information System on Social Protection database (co-ordinated by the European Commission and updated with the assistance of national experts). For an overview of macroeconomic research, see OECD (2011), ‘Helping Older Workers Find and Retain Jobs’, Pensions at a Glance 2011: Retirement-income Systems in OECD and G20 Countries, OECD Publishing. The Government also plans to allocate additional funds for public-sector investment, amounting to 0.2 percentage points of GDP in 2019, rising to over 0.3 points in 2021, inverting the trend observed in recent years. Indeed, public investment has diminished steadily since 2010; in 2017 it represented 2.0 per cent of GDP, compared with almost 3 per cent on average in the previous decade. Investment spending can have a significant impact on GDP growth, not just in the short term but in the longer term as well, if investment helps to achieve a structural increase in production capacity. The Government’s emphasis on the resumption of a major investment programme is therefore something that can be shared. The programme’s effectiveness will depend on elements that cannot be taken for granted in Italy: fast implementation, efficient action, and careful selection of projects to identify those likely to produce a real qualitative and quantitative increase in capital. In view of the recent contraction, there is probably ample scope to make profitable investments; but only if they are properly selected and efficiently realised will they be able to achieve positive externalities for the growth of the economy.3 Given the time needed to select projects and complete the planning and commissioning phases, the increase in spending might not become apparent for some time, diminishing the investment’s contribution to growth in the short term. Funding. – Finally, in order to assess the effects of the budgetary provisions, in terms of both growth stimulus and public accounts, it will be necessary to look carefully at how the costs will be covered once the funding measures have been finalised. According to the Update, part of the funds should come from ending (in whole or in part) existing programmes such as the inclusion income support scheme, the optional tax regime offered to some types of businesses (tax on entrepreneurial income or IRI), and the tax allowance for corporate equity (ACE). Further funding should come from changes to the tax advance percentage rates and from ministerial spending cuts. The public debt In the Government’s programmes, the debt-to-GDP ratio, which is expected to reach 130.9 per cent at the end of this year, should decrease on average by ‘Public investment for developing the economy’, address by the Governor of the Bank of Italy, Ignazio Visco, at the 64th Conference on Government Studies, Varenna, 22 September 2018. 1.4 percentage points a year over the next three years, coming to 126.7 per cent in 2021. Compared with the current legislation scenario, the annual decrease in the policy scenario would be about 0.7 points less, on average: the rise in net borrowing (on average 1.3 percentage points a year) would be offset only in part by the increased growth in nominal GDP. The trend of the debt-to-GDP ratio over the next three years assumes a small reduction in the Treasury’s liquid balance (of about 0.1 percentage points of GDP per year). It is also based on estimated revenue from disposals of assets of 0.3 percentage points of GDP per year in 2019 and 2020, a figure that is in line with the amount forecast in the planning documents of the last two years. The Update contains no details of the planned asset disposals. In the last two years and in the first nine months of 2018, privatisation receipts have been negligible. The evolution of the debt-to-GDP ratio depends on the size of the primary surplus and the gap between the average cost of the debt and the rate of growth of the economy. Movements in interest rates have a considerable effect. Unlike the previous year, this year’s Update includes neither an analysis of the sensitivity of the evolution of the debt-to-GDP ratio to growth and interest rate shocks, nor alternative scenarios for the medium term. Italy’s public debt has a high average residual maturity, more than seven years, which means that the effect of an increase in interest rates at issue on the average cost of the debt will occur gradually. Nevertheless, it can be estimated that at current rates in 2021 interest expense will already be about 0.6 percentage points of GDP higher than in the projections prepared in April. In commenting on the DEF in May,4 I had noted that at the interest rates prevailing at the time, it would have been possible to bring the debt to below 100 per cent of GDP in about ten years, provided that the primary surplus immediately started to converge towards 4 per cent of GDP, absent market shocks. If we were to repeat mechanically the same exercise using current interest rates and assuming that debt consolidation is resumed in 2022, as indicated in the Update, we would find that we would need another ‘Preliminary hearing on the 2018 Economic and Financial Document’, testimony of the Deputy Governor of the Bank of Italy, Luigi Federico Signorini, before the Chamber of Deputies, Rome, 9 May 2018. seven or eight years, in theory, to obtain the same result. This would risk undermining the confidence of savers in the credibility of the debt reduction process. As the Bank of Italy has pointed out on more than one occasion, the success of long-term debt reduction is also dependent on how well the public finances can cope with rising expenditure tied to the ageing population. The Update indicates, rightly, that the pension reforms introduced in the last 20 years have significantly improved both the sustainability and the intergenerational fairness of the Italian pension system. It is critical that we do not lose ground on these two fronts, especially when – as demonstrated by the European Commission’s latest long-term age-related expenditure projections – the risks to the sustainability of the public finances are also increasing due to worsening demographic projections. * * * Restoring the Italian economy to a path of sustained economic development is a structural matter; it depends on the continuation of the reform process of all those aspects of public action and the functioning of the economy and society that affect firms’ ability to compete. Much has already been done: gross domestic product, while still lower than it was before the crisis, has risen by more than 5 points since its 2013 trough; investment has increased by about 15 points; the number of those in employment, which has risen by more than 1 million, has hit an all-time high. The productive fabric of the country has strengthened, especially in the export sector; the difficulties encountered by the banking system have been alleviated with the improvement in the real economy and the reduction in non-performing loans; the balance of payments has recorded a current account surplus since 2013; in June our country’s net debtor position was equal to 3.4 per cent of GDP, almost 20 percentage points lower than it was in 2013. There remain, however, large imbalances in the labour market, widespread income losses compared with ten years ago, and serious problems of poverty and social exclusion. Although the worst of the crisis is now years behind us, there is still much to do to place the Italian economy on a stable path to higher growth. Greater wealth and job creation is also key to helping those who are most vulnerable. Public services should be made more efficient, the quality of our human capital improved, and competitive mechanisms strengthened. In addition to this, the debt-to-GDP ratio should be lowered decisively. The debt is, for Italy, the great multiplier of turbulence. Given its size and the need to service each year a significant amount (around €400 billion), the danger of triggering a vicious circle between the cost of the debt and its share of GDP, with repercussions on the real economy, is ever present. Around two thirds of the debt is currently held by Italian citizens and institutions; but this does not insulate it from the laws of the market, which seeks out yields and flees from uncertainty. Fluctuations in the value of the debt also have an impact on the Italian citizens, households, firms and financial institutions that hold it. Ultimately, a significant portion of our savings is tied to the public debt. A lower valuation of the government bonds held by banks in their portfolios has an effect on their capital requirements; above certain limits, it can reduce their ability to supply credit to the economy. The Update envisages providing a significant cyclical boost to the economy by increasing the deficit; to achieve this, we have to assume high multipliers, which cannot be taken as given. But how effective fiscal policies are in supporting the economy also depends on whether the government’s action is capable of convincing savers and the markets to remain confident in the process to consolidate the public finances. Even assuming the full deployment of the expected expansionary effects of the budget, the Update envisages a slower reduction in the debt-to-GDP ratio than both the current legislation scenario and with respect to the possibilities afforded by today’s economic conditions; it postpones the achievement of a balanced budget to an unspecified date in the future. Given the large amount of bonds that the Italian State must periodically place on the market, the possibility that financial turbulence can arise, even unexpectedly, calls for clarity and certainty in the debt reduction process. Credibility is self-sustaining: bolstering the confidence of savers and investors brings down the risk premium on Italy’s sovereign bonds, facilitates the debt reduction process and makes it more secure. Another matter that deserves attention is the funding of the budgetary provisions. When specifying the planned measures, it would be advisable to avoid accompanying permanent expansionary measures with advances of revenue, other temporary funding measures or safeguard clauses of uncertain application. Narrowing the growth gap with Europe, as stated in the Update, is a key objective; it is also necessary to get the debt-to-GDP ratio under control. Higher growth and greater social cohesion are not at odds with fiscal discipline. Lasting results can be achieved through budget recomposition: devoting a higher share to productive investments, sharing the tax burden more equitably, improving the equalisation capacity of public transfers. These results also rely on structural interventions to improve the underlying capacity of the Italian economy to post higher growth, above and beyond short-term stimuli. Any improvement achieved thanks to public intervention in the areas of income and its distribution will be the more solid, the more it is rooted in solid funding measures and the more carefully it is designed to take account of the incentives to create income and jobs, this being the most reliable way to combat the spread of poverty. TABLES AND FIGURES Table 1 Macroeconomic outlook in the most recent official documents (percentage changes) Economic and Financial Document 2018 Update to the 2018 Economic and Financial Document CURRENT LEGISLATION SCENARIO Real GDP 1.5 1.5 1.4 1.3 1.2 1.6 1.2 0.9 1.1 1.1 Imports 5.3 5.4 4.0 3.4 3.5 5.2 1.7 2.6 2.9 3.5 Consumption by Households and nonprofit institutions serving households 1.4 1.4 1.0 0.9 1.2 1.5 1.1 0.7 0.8 1.1 General government expenditure 0.1 0.5 0.1 0.4 0.6 -0.1 0.4 0.6 0.6 0.5 Investment 3.8 4.1 2.8 2.4 1.7 4.3 4.4 2.2 1.5 1.6 Exports 5.4 5.2 4.2 3.9 3.2 5.7 0.4 2.7 3.4 3.6 Nominal GDP 2.1 2.9 3.2 3.1 2.7 2.1 2.5 2.7 2.8 2.6 Consumption deflator 1.2 1.1 2.2 2.0 1.5 1.1 1.3 2.2 2.0 1.5 Employment (FTE) 0.9 0.8 0.8 0.9 0.9 0.9 0.7 0.6 0.7 0.8 POLICY SCENARIO Real GDP 1.6 1.2 1.5 1.6 1.4 Imports 5.2 1.7 3.0 3.8 4.0 Consumption by Households and nonprofit institutions serving households 1.5 1.1 1.3 1.3 1.2 General government expenditure -0.1 0.4 1.1 0.8 0.5 Investment 4.3 4.4 3.7 3.2 2.8 Exports 5.7 0.4 2.6 3.4 3.6 Nominal GDP 2.1 2.5 3.1 3.5 3.1 Consumption deflator 1.1 1.3 1.4 2.2 1.7 Employment (FTE) 0.9 0.7 0.9 1.2 1.1 (1) The 2018 Economic and Financial Document does not contain the policy scenario. Table 2 Main public finance indicators for general government (per cent of GDP) Revenue 45.2 45.9 45.7 45.7 47.9 48.1 47.9 47.7 46.5 46.4 Expenditure of which: interest payments 47.8 51.2 49.9 49.4 50.8 51.1 50.9 50.3 49.1 48.7 4.9 4.4 4.3 4.7 5.2 4.8 4.6 4.1 3.9 3.8 Primary surplus 2.3 -0.8 0.1 1.0 2.3 1.9 1.5 1.5 1.4 1.4 Net borrowing 2.6 5.2 4.2 3.7 2.9 2.9 3.0 2.6 2.5 2.4 3.1 5.5 4.3 3.9 4.1 4.8 4.1 3.0 2.6 3.4 3.1 5.6 4.3 4.0 4.6 4.9 4.3 3.4 2.6 3.4 102.4 112.5 115.4 116.5 123.4 129.0 131.8 131.6 131.4 131.2 Borrowing requirement Borrowing requirement net of privatization receipts Debt Source: Based on Istat data for the general government consolidated accounts items. (1) Rounding of decimal points may cause discrepancies in totals. – (2) The proceeds of sales of public assets are recorded as a deduction from this item. – (3) A negative value corresponds to a deficit. Table 3 General government revenue (per cent of GDP) Direct taxes 14.7 14.1 14.1 13.9 14.9 15.0 14.6 14.7 14.6 14.5 Indirect taxes 13.6 13.4 14.0 14.1 15.3 14.9 15.3 15.1 14.3 14.5 Capital taxes 0.0 0.8 0.2 0.4 0.1 0.3 0.1 0.1 0.3 0.1 Tax revenue 28.3 28.4 28.3 28.4 30.3 30.2 30.1 29.9 29.3 29.1 Social security contributions 13.0 13.5 13.3 13.2 13.4 13.4 13.2 13.3 13.1 13.1 Tax revenue and social security contributions Production for market and for own use 41.3 41.8 41.6 41.6 43.6 43.6 43.3 43.1 42.4 42.2 1.9 2.0 2.0 2.0 2.1 2.3 2.3 2.3 2.2 2.2 Other current revenue 1.8 1.9 1.9 1.8 1.8 1.9 2.0 1.9 1.8 1.8 Other capital revenue 0.2 0.2 0.2 0.2 0.3 0.3 0.3 0.3 0.1 0.1 Total revenue 45.2 45.9 45.7 45.7 47.9 48.1 47.9 47.7 46.5 46.4 Source: Based on Istat data. (1) Rounding of decimal points may cause discrepancies in totals. Table 4 General government expenditure (per cent of GDP) 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Compensation of employees Intermediate consumption Social benefits in kind Social benefits in cash Interest Other current expenditure Total current expenditure of which: expenditure net of interest payments Gross fixed investments Other capital expenditure Total capital expenditure Total expenditure of which: expenditure net of interest payments 10.4 5.1 2.7 17.0 4.9 3.4 43.5 10.9 5.4 2.9 18.5 4.4 3.7 46.0 10.8 5.4 2.9 18.6 4.3 3.7 45.7 10.4 5.3 2.7 18.6 4.7 3.7 45.4 10.3 5.4 2.7 19.3 5.2 3.9 46.8 10.3 5.6 2.7 19.9 4.8 4.1 47.4 10.1 5.5 2.7 20.2 4.6 4.2 47.2 9.8 5.4 2.7 20.1 4.1 4.0 46.1 9.7 5.5 2.6 19.9 3.9 4.0 45.7 9.5 5.5 2.6 19.8 3.8 3.6 44.9 38.5 41.5 41.4 40.7 41.6 42.6 42.6 42.0 41.7 41.1 3.0 1.4 4.4 47.8 3.4 1.8 5.2 51.2 2.9 1.2 4.2 49.9 2.8 1.2 4.0 49.4 2.6 1.4 4.0 50.8 2.4 1.2 3.6 51.1 2.3 1.4 3.7 50.9 2.2 1.9 4.1 50.3 2.1 1.3 3.4 49.1 2.0 1.9 3.9 48.7 42.9 46.7 45.6 44.7 45.6 46.2 46.3 46.1 45.1 44.9 Source: Based on Istat data. (1) Rounding of decimal points may cause discrepancies in totals. Table 5 General government borrowing requirement (billions of euros) Year First 7 months Borrowing requirement net of privatization receipts (a) 56.9 44.1 58.8 22.5 46.5 24.1 Privatization receipts (b) 6.6 0.9 0.1 0.8 0.1 0.0 Borrowing requirement (c=a-b=d+e+f+g+h+i) 50.4 43.2 58.8 21.7 46.4 24.1 Currency and deposits (1) (d) 5.1 -4.9 0.0 -5.4 8.7 7.6 of which: Post office funds -1.5 0.1 -1.9 -0.6 -1.1 -0.7 Short-term securities (e) -9.5 -8.0 -0.5 2.3 8.9 6.7 Medium- and long-term securities (f) 43.4 62.7 40.8 90.3 65.8 66.0 Loans from MFIs (g) 1.7 1.1 3.7 0.7 4.0 -4.9 Other liabilities (2) (h) of which: loans via the EFSF Change in the Treasury’s liquidity balance (3) (i) -1.0 -2.1 10.7 -0.3 0.0 -7.4 1.0 0.0 13.8 -1.0 0.0 -65.3 1.4 0.0 -42.5 -0.6 0.0 -50.6 FINANCING (1) Includes coins in circulation, Post office funds and deposits held with the Treasury by entities not included in general government. – (2) Includes securitizations, trade credits assigned without recourse by the general government’s supplier firms to non-bank intermediaries, private-public partnership operations and liabilities related to loans to EMU countries disbursed via the EFSF. – (3) A negative value corresponds to an increase in the Treasury’s liquidity balance. Table 6 Public finance targets and estimates for 2018 (per cent of GDP) General government Net borrowing Structural net borrowing Memorandum item: Primary surplus Change in the debt Real GDP growth rate Nominal GDP growth rate Targets April 2017 September 2017 2.1 2.1 1.5 1.3 1.7 1.7 -0.1 -0.4 1.1 1.5 2.3 2.1 October 2017 April 2018 September 2018 1.6 1.8 1.0 0.9 2.0 1.8 -1.6 -0.3 1.5 1.2 3.1 2.5 1.6 1.8 1.0 1.1 1.9 1.8 -1.0 -0.3 1.5 1.2 2.9 2.5 Estimates April 2018 September 2018 (1) Changes in the debt-to-GDP ratio compared with the previous year. – (2) 2017 Economic and Financial Document. – (3) Update to the 2017 Economic and Financial Document. – (4) 2018 Draft Budgetary Plan. – (5) The 2018 Economic and Financial Document does not contain the policy scenario. – (6) Update to the 2018 Economic and Financial Document. Table 7 Current legislation and policy scenarios in the most recent official documents (per cent of GDP) Economic and Financial Document 2018 Update to the 2018 Economic and Financial Document CURRENT LEGISLATION SCENARIO Net borrowing 2.3 1.6 0.8 0.0 -0.2 2.4 1.8 1.2 0.7 0.5 Primary surplus 1.5 1.9 2.7 3.4 3.7 1.4 1.8 2.4 3.0 3.3 Interest payments 3.8 3.5 3.5 3.5 3.5 3.8 3.6 3.6 3.7 3.8 Debt 131.8 130.8 128.0 124.7 122.0 131.2 130.9 129.2 126.7 124.6 GDP growth 1.5 1.5 1.4 1.3 1.2 1.6 1.2 0.9 1.1 1.1 POLICY SCENARIO Net borrowing 2.4 1.8 2.4 2.1 1.8 Primary surplus 1.4 1.8 1.3 1.7 2.1 Interest payments 3.8 3.6 3.7 3.8 3.9 Debt 131.2 130.9 130.0 128.1 126.7 GDP growth 1.6 1.2 1.5 1.6 1.4 (1) The 2018 Economic and Financial Document does not contain the policy scenario. Table 8 Privatization receipts: targets and outturns (per cent of GDP) 0.7 0.3 0.7 0.7 0.7 0.7 0.7 0.7 0.7 DEF 2015 (April 2015) 0.4 0.5 0.5 0.3 Update to the DEF (September 2015) 0.4 0.5 0.5 0.5 DEF 2016 (April 2016) 0.5 0.5 0.5 0.3 Update to the DEF (September 2016) 0.1 0.5 0.5 0.3 DEF 2017 (April 2017) 0.3 0.3 0.3 0.3 Update to the DEF (September 2017) 0.2 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 Targets DEF 2014 (April 2014) Update to the DEF (September 2014) DEF 2018 (April 2018) Update to the DEF (September 2018) 0.0 0.0 Outturns Total 0.2 0.4 0.1 0.0 0.0 Totale net of Tremonti/Monti bonds 0.0 0.3 0.1 0.0 0.0 (1) The targets expressed as a percentage of GDP are those indicated in the various planning documents. The targets and outturns include reimbursements of the capitalization tools issued by the banks and underwritten by the MEF (the ‘Tremonti/Monti bonds’). – (2) The data refer to revenues accounted into item 4055 of the State budget (mostly proceeds from the sale of State shareholdings); the GDP ratios are calculated using the GDP reported by Istat in the press release dated 21 September 2018; the GDP for 2018 is found in the Update to the 2018 Economic and Financial Document. – (3) Outturns up to September 2018. Figure 1 Interpolated distribution of the GDP growth forecasts (1) Consensus Economics’ forecasts are equal to the average of those formulated before 10 September by: ABI, Confindustria, Econ Intelligence Unit, Barclays, Capital Economics, Goldman Sachs, HSBC, Natixis, Prometeia, UniCredit, UBS, Oxford Economics, Bank of America–Merrill Lynch, Centro Europa Ricerche, Moody's Analytics, Banca Nazionale del Lavoro, ING Financial Markets, REF Ricerche, Intesa Sanpaolo, IHS Markit, and Citigroup. The forecasts shown in the graph on 2019 were made prior to the publication of the Update to the 2018 Economic and Financial Document and do not therefore incorporate the budgetary provisions laid down in the policy scenario. Figure 2 General government debt (per cent of GDP) Source: For GDP, based on Istat data (press release of 21 September 2018). Figure 3 Twelve-month cumulative borrowing requirement (monthly data; billions of euros) General government General government excluding financial assistance to EMU countries State sector excluding financial assistance to EMU countries Source: Ministry of Economy and Finance for the state sector borrowing requirement. (1) Excluding privatization receipts.– (2) Excludes liabilities related to Italy’s capital contribution to the ESM and to loans to EMU member countries, disbursed both bilaterally and via the EFSF. – (3) Excludes liabilities in connection with bilateral loans to EMU member countries and Italy’s capital contribution to the ESM; loans disbursed through the EFSF are not included in the state sector borrowing requirement. Figure 4 Gross yields on BOTs and 10-year BTPs, average cost and average residual maturity of debt (per cent and year) Source: Istat, for interest expenses. (1) Ratio between interest expense in the preceding 4 quarters and the stock of the debt at the end of the year-earlier quarter. – (2) The yield at issue is the average, weighted by the issue amounts allotted, of the compound allotment rates at the auctions settled during the month. – (3) Average monthly yield at maturity of the benchmark traded on the online government securities market. – (4) Right-hand scale. Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 1st Bank of Italy-World Bank International Research Workshop "Building Human Capital for 21st Century Jobs", Rome, 15 November 2018.
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1st Bank of Italy – World Bank International Research Workshop Building Human Capital for 21st Century Jobs Welcome address by Ignazio Visco Governor of the Bank of Italy Rome, 15th November 2018 It is a pleasure to welcome you to the first workshop jointly organized by the Bank of Italy and the World Bank on “Building human capital for 21st century jobs”. In the last 25 years the world has been profoundly transformed by rapid technological advancements, the globalization of trade and production processes, demographic trends and intense migration flows. By their very nature, these factors intrinsically spread beyond individual national borders and, therefore, require the support of renewed international and multilateral coordination. No single country can successfully conquer these challenges alone. This makes cooperation a key element for the promotion of sustainable growth and the boosting of shared prosperity. And this enhances the role played by international institutions, as well as their responsibilities. Technological progress in the “second machine age” poses distinct challenges at both an economic and a social level. Digitalization and automation of production phases, the introduction of new materials and the rise of entirely new processes (like data-driven production and artificial intelligence) are drastically changing the functioning of economies and societies in general. This new “knowledge society” promises great opportunities in terms of welfare in the long run, but it also poses major challenges during the initial transition period. The burden of the changes required in the transition is likely to be borne unevenly by different income and social groups, increasing the risk of a substantial decline in employment and wage growth in certain industries and regions, underpinning a revival of the concept – originally proposed by Keynes in 1930 – of “technological unemployment”. Indeed, new technologies are replacing labour at great speed: today’s firms have already begun to automate not only manual and routine jobs, but also data-processing and information-intensive tasks, re-designing productive processes in fields where human intervention previously appeared to be decisive. In France, Germany and Italy the number of robots per worker in manufacturing has doubled in the last 20 years and it has risen fourfold in Spain; the “Great Recession” further accelerated the process. Artificial intelligence allows even non-manual tasks to be automated: think about the increasing number of firms hiring “internet bots” to handle the initial stages of customer services; or consider the growth of language teaching software that, through machine learning techniques, provides customized on-line courses; or the possibilities opened up by the latest generation of virtual personal assistants. Globalization has further fueled the process of technological change, raising other challenges. Major companies have increasingly spread their operations around the world in order to better serve their customers and improve their competitiveness. While corporate revenue and profit growth have been enhanced by globalization, this trend has clearly created strains on those regions and towns in developed countries that have seen jobs and significant portions of key industries relocate to other geographic regions, now benefitting in terms of employment and production spillovers. As global trade between countries has expanded, economic conditions in one nation now have a greater potential to impact economic conditions in others, through the trade of goods and services as well as through capital flows and labour market dynamics. Global frontier firms, such as the major players in the tech industry (the “Big Tech”) are best placed to take advantage of network effects. This advantage can lock-in their market dominance, creating a winner-takes-all dynamic, potentially leading to increased earnings inequality across firms. Concentration allows for greater benefits from economies of scale, but there is a risk that barriers to entry can stifle innovation. The changes that innovation and globalization bring about in the corporate structure and organization and in labour demand clearly need to be understood and responded to. The most significant impact of the current wave of globalization is, again, on the labour market. Whether it is low cost or skilled manufacturing workers in China, software or customer service professionals in India, or highly skilled employees in Eastern Europe, companies can now access new pools of human capital across the globe – a fact that can have a profound influence on their strategy and structure. The availability of a global pool of human capital also presents new challenges as to how firms should organize themselves to take advantage of this opportunity. The uneven distribution of skill requirements and wage levels between advanced and emerging countries has also proved to be a strong push factor for surging migration flows. These changes couple with key secular demographic trends. Higher living standards have increased life expectancy around the globe and, for the first time in history, the world not only is experiencing a growing population (increased by about 50 per cent in the last thirty years and expected to reach 10 billion in the next thirty years, from the 7.5 billion today) but also, in most advanced countries as well as in China, a dramatic increase in old-age dependency rates. One billion people today are aged 60 or over, 13 per cent of the world’s population, and this age group is growing much faster than the younger ones. This trend will bear directly on the rates of workforce participation and, in turn, impact rates of potential economic growth across the industrialized world. At the same time, while in relative terms the old exceed the young, the number of young people in the world is the largest in history. But it is not distributed evenly around the globe: of the 2.2 billion people added to the world population since 1990, less than 1 in 10 live in advanced countries. In addition Africa, which comprises some of the poorest countries in the world, is expected to have the fastest population increase and to reach Asian figures within this century in absolute terms. Future higher pressures on migration flows are to be expected, as well as further, possibly dramatic consequences for climate change. In response to all these changes, which policies are countries called on to design and implement? My view is that the first and most important response to the confluence of rapid technological change, globalization and demographic trends should be to rebuild human capital and, then, to prioritize human capital investment as a key strategy for economic competitiveness and growth. Many observers are now advocating for a greater emphasis on the more creative subjects into a wider school curriculum, integrating science, technology, engineering and mathematics (the traditional acronym STEM) with the arts (STEAM) and reading and writing (STREAM). It is widely suggested that once both manual and data-driven tasks have been automated, human contribution will be concentrated in those creative tasks that will redefine product differentiation: understanding and anticipating the needs and behaviour of consumers, designing the aesthetics of new products and their integration into every-day life. But this is not sufficient: a more complex and comprehensive definition of “human capital” should be endorsed. In the 21st century, the traditional classroom method where knowledge is imparted passively from teacher to students is no longer enough. Today’s citizens are required to develop and continuously refine a large arsenal of both cognitive and non-cognitive skills. They need to be able to search for specific information in the ever-growing digital ocean that is the internet, recognize the quality of this information and process it critically. To adapt to the modern and more flexible model of business organization, the workforce must develop soft skills such as problem-solving attitudes, teamwork, effective communication and negotiation. Workers can survive and successfully exploit the acceleration of the pace of technological innovation only if they “learn to learn”, and continuously update their skills. Re-designing education policies is an extremely challenging task. It requires the ability to assess the quality and quantity of the skills available among the population, determine and anticipate those demanded by the labour market and implement efficient strategies to maintain and update them throughout workers’ lifecycles. Data on available skills is, however, of poor quality and the demand for skills, present and future, is often a black box. In developing countries challenges are even greater as access to basic-level schooling remains an issue for a sizeable share of the population: action will have to be taken to carefully balance equal access to and completion of lower-secondary education with further learning both for school-age children and for adults. These strategies require coherence and co-operation among schools, the private sector and social partners: the world of learning and the world of work must be linked. Formal education attainments do indeed display high complementarity with on-the-job training and other initiatives intended to increase the coherence between the supply and the demand of skills. Human capital investment is key not only to boosting productivity but also to tackling inequality and promoting social mobility, enhancing social capital and maintaining social cohesion. Adults with low levels of education have a higher likelihood of reporting poor health and a lower participation in community groups and organizations. At the same time, more qualified adults are much more likely to feel that they have a voice that can make a difference in social and political life. These results are consistent across a wide range of countries, confirming that skills have a profound relationship with economic and social outcomes in many different contexts and institutions. Investing in skills is far less costly, in the long run, than paying the price of poorer health, lower incomes, unemployment and social exclusion that could lead to political aversion towards technological advancement and progress. Finally, I would like to stress the important role of international cooperation in the management of the long and uncertain transition phase. An institutional synoptic design encompassing all policies (fiscal and welfare, antitrust, and structural reforms) is highly desirable. Greater attention must be paid to the coordination of policies at a supranational level and to the sharing of data and statistics in order to correctly measure and interpret the economic variables as well as the channels through which the effects of these policies will meet their intended target. Let me conclude by thanking the organizers – Emanuela Ciapanna, Fabrizio Colonna and Paolo Sestito from the Bank of Italy as well as Ciro Avitabile, Ritika D’Souza and Roberta Gatti from the World Bank –, all the economists who will be sharing their research over the next two days, and the representatives from both the international institutions and the private sector that will animate our policy panel tomorrow afternoon. I wish all of you a fruitful interaction during this conference.
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Speech Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Conference "Economic Policies, Trade Integration and Sustainable Job Creation. A View from the Mediterranean Countries", organized by the Bank of Spain and the European Institute of the Mediterranean with the support of the Central Bank of Tunisia, Tunis, 16 November 2018.
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Economic Policies, Trade Integration and Sustainable Job Creation: A View from the Mediterranean Countries The regulation of non-bank finance: the challenges ahead’ Speech by Deputy Governor of the Bank of Italy Luigi Federico Signorini Tunis, 16 November 2018 With the completion of Basel 3, the post-crisis overhaul of banking regulation is essentially over; with a limited number of exceptions, the only issues remaining for the next few years will be the implementation of reforms and the evaluation of their effects, intended or otherwise, over time. Banks, however, do not comprise the entire financial sector. Arguably, non-bank financial intermediation has taken on an increasing role in the global financial system and poses new challenges to regulators. The attention of international coordinating bodies such as the FSB is therefore now mainly, and rightly, directed towards what used to be known by the vaguely derogatory name of ‘shadow banking’ but is now more neutrally termed ‘non-bank financial intermediation’. The aim of this speech will be to explore the emerging risks from non-banks, to describe the (not insignificant, but still inchoate) regulatory response so far, and to speculate about a possible agenda for the medium-term future. Global non-bank finance concerns everybody, even countries where banks continue to play a dominant role in the internal financial system, like Tunisia – or Italy, for that matter. In a globally interconnected financial system, no country stands alone; none can remain isolated from market shocks and turbulence whose ultimate source may be in faraway parts of the globe. This is a key point for emerging market and developing economies. Witness the recent experience of the ‘taper tantrum’, when a number of emerging economies faced external financial conditions that had tightened abruptly and higher generalised risk premia in reaction to a policy decision taken by the US authorities. On that occasion the countries affected found that the negative repercussions on their economy stemming from the generalised repricing of assets could not be mitigated through policy actions (either by relying on floating exchange rates or through capital flow management measures). It has also become apparent that a low degree of financial deepening may actually increase the sensitivity of emerging asset markets to external shocks. The issue with non-bank finance, it will be argued, is not the stability of individual intermediaries—micro-prudential risk. As the risk connected to managed assets is borne almost entirely by the ultimate investor, rather than by the manager itself, it is not, or not mainly, the possible default of the manager that should concern regulators. On the other hand, the actions of asset managers may affect the financial system and the general economy through their systemic consequences on market developments. The key questions are then whether, to what extent and under what conditions non-bank intermediation can amplify market movements and determine instability. It is, therefore, essentially a macro-prudential question. Understanding and measuring such risks will require data, research and careful reflection; tackling them is likely to require new or reinforced supervisory tools and, quite possibly, a broader mandate for supervisory authorities. Why do we need a macroprudential framework for the non-bank financial sector? We shall start by briefly reviewing certain macro-stability issues and the reasons why they may have become more significant than in the past. I shall focus on three main issues of concern: (i) pro-cyclicality, (ii) the size of non-bank financial institutions, and (iii) systemic liquidity risks (‘runs’) and leverage risks. Let me tackle the pro-cyclicality issue first. The collective behaviour of asset managers, insurers and pension funds can lead to undue amplifications of market volatility.1 Empirical analyses show that institutional investors’ trading may cause substantial temporary price effects, both at the asset level and at the aggregate level.2 During downturns, trades by institutional investors in financial distress may turn into fire sales, and a temporary price effect may be further magnified so as to put severe pressure on market liquidity.3 This amplification effect can have wide-ranging negative repercussions on the banking sector, on households’ savings, on firms’ funding, and ultimately on the entire economy. A clear example was the outbreak of the financial crisis, when a complex network of connections through derivatives and shadow banking activities turned $500 billion of losses on sub-prime mortgages into $4 trillion of write-downs on assets at global level.4 See for example Chan L. and Lakonishok J. (1995), ‘The behavior of stock prices around institutional trades’, Journal of Finance 50: 1147-1174; Keim D. and Madhavan A. (1997), ‘Transactions costs and investment style: an inter-exchange analysis of institutional equity trades’, Journal of Financial Economics 46: 265-292; Jones C. and Lipson M. (1999), ‘Execution costs of institutional equity orders’, Journal of Financial Intermediation 8: 123-140. See Mitchell M., Pulvino T. and Stafford, E. (2004), ‘Price Pressure around Mergers’, Journal of Finance 59(1): 31-63; estimates vary considerably. For example Edelen et al. (2001) find a 0.86 per cent price reduction on a single day on average (Edelen, R.M. and Warner J.B. (2001) ‘Aggregate price effects of institutional trading: a study of mutual fund flow and market returns’, Journal of Financial Economics 59: 195:220). Coval et al. find a 2 per cent price reduction on a monthly basis (Coval, J. and Stafford, E. (2007), ‘Asset fire sales (and purchases) in equity markets’, Journal of Financial Economics 86: 479-512). Shleifer A. and Vishny, R. (2011), ‘Fire sales in finance and macroeconomics’, Journal of Economic Perspectives 25(1): 29-48. IMF (2009), ‘Crisis and Recovery’, World Economic Outlook, April; Mishkin, F.S. (2011), ‘Over the cliff: from the subprime to the global financial crisis’, Journal of Economic Perspectives 25(1): 49-70. Second, a size problem also exists in the case of non-bank financial institutions, albeit of a different nature than in that of banks. Asset managers, insurers and pension funds provide agency services and hence they bear little credit, market or liquidity risks on their balance sheets compared with banks; the risks are borne by their clients. For example, BlackRock, the largest asset management company in the world, has around $6.3 trillion of assets under management, but only $220 billion (3.5 per cent) of its own. Clearly there is no ‘too-big-to-fail’ problem as in the banking industry. The problem of size here concerns the externalities produced by the asset managers’ portfolio allocation.5 The failure of a ‘too-big-to-fail’ asset manager may create systemic financial instability through its effects on markets. In the extreme event of a failure of a large asset manager, the massive sale of assets in its portfolio may dry up market liquidity, depress asset prices and heighten their volatility. These externalities will have an impact on other institutional investors. For example, they may reduce the liquidity and capital buffers of banks and insurance corporations, or cause significant outflows from other asset managers. Furthermore, increasing size and concentration in the asset management industry also increases the potential for investor herding and for correlated market movements, which can in turn result in financial bubbles and heightened volatility, and which are not justified by market fundamentals. Third, non-bank institutions also carry risks similar to those for banks. Open-end funds providing liquidity transformation services are prone to the risk of ‘runs’ akin to deposit-taking institutions. Investors in open-end funds have the ability to redeem their shares (usually on a daily basis), while funds invest in relatively illiquid securities, such as high-yield corporate bonds and emerging market assets. Shareholders have an incentive to sell their shares when they expect large redemptions since they anticipate that the liquidation value of shares declines as other investors sell theirs. This decline in value could happen for various reasons: for example, the asset manager may use cash buffers and sell relatively more liquid assets first. Asset managers providing securities lending activities to their clients engage in maturity/liquidity transformation, when the cash collateral is reinvested at term and into less liquid, higher-yield securities, and can take on significant leverage risks, including by engaging in synthetic leverage via derivatives (e.g. swaps to increase duration risk). Furthermore, asset managers acting as agent lenders also provide their clients with indemnification,6 bearing own risks against which no regulatory capital is allocated. At the global level, mutual funds and other retail investment funds account for around €6 trillion Haldane, A. G. (2014), ‘The age of asset management’, speech at the London Business School. Indemnification is a form of insurance associated with securities lending. When the borrower of a security defaults on the loan and the collateral received is insufficient to cover the repurchase price of the lent securities, the shortfall is borne by the indemnification provider. in securities made available for lending (44 per cent of the total value of securities made available for lending at the global level).7 There is no precise information on the amount of indemnification provided on assets available for lending, but we know that the largest asset managers are mainly involved in providing indemnification services, and that the scale of exposures can be as large as that of some global systemically important banks. Note also that differently than for banks, the risks for non-bank financial intermediaries are to a large extent not on the balance sheets, making their monitoring and control more difficult. How large are these risks? We do not have a clear answer to this question, as we are still in the process of developing adequate tools to measure them. But there are reasons to argue that the significance of the risks associated with non-bank financial in8termediation has increased in recent years. First, there are quantitative reasons. In the last decade, assets under the management of non-bank financial intermediaries have almost doubled. In 2016, the latest date for which data are available at the global level, they represented a little less than half of the total assets of the financial sector.8 Non-bank credit intermediation was around one third of total bank assets. The growth of non-bank finance has been significant in Europe too: total assets managed by euro-area investment funds have more than doubled in the last decade, from €5.7 trillion at the end of 2008 to €13.8 trillion at end June 2018. The investment fund sector now accounts for nearly 20 per cent of the total assets managed by the euro- area financial sector.9 Second, the asset management industry is significantly more concentrated today than a few decades ago. In the United States, the top 10 managers owned about 5 per cent of the US stock market in 1980, whereas in 2016 they owned about 23 per cent.10 There are further qualitative reasons. The portfolio of asset managers, insurers and pension funds are often highly diversified but less diverse, i.e. their investments are often largely overlapping. This is the outcome of a global quest for risk diversification. These refer to 2015 (latest available). Source: International Securities Lending Association. See also: FSB (2013), ‘Strengthening Oversight and Regulation of Shadow Banking: Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos’, August; FSB (2017), ‘Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities’, January. FSB (2018), ‘Global shadow banking monitoring report’. European Central Bank (2018), ‘Financial Stability Report’, May. I. Ben-David, F. Franzoni, R. Moussawi, and J. Sedunov, ‘The Granular Nature of Large Institutional Investors’, NBER Working Paper No. 22247, May 2016. A multitude of investors diversifying their investments must end up with the same portfolios when the number of assets they can invest in is finite. While diversification helps institutional investors to reduce the risks of their investments, shocks tend to spread more easily across different institutions when portfolios overlap.11 In Europe, for example, investment funds invest more than three fourths (80 per cent) of their assets in securities which are also held by insurers and pension funds. Market stress can be more easily transmitted across markets and asset classes.12 The risks and costs of fire sales in the event of market stress may end up being less easily diversifiable at the macro level. While investment funds, and to a certain extent insurers and pension funds, tend to diversify their portfolios across countries and sectors, banks invest a larger share of their assets in domestic securities. This simply reflects13 the different investment strategies of different financial intermediaries. Banks specialise in resolving asymmetric information issues, so they end up with greater knowledge of specific markets and borrowers than other investors. They have a comparative advantage from investing in the markets that they know better. Like asset correlations, business activity correlations can vary over the cycle, turning all positive or intensifying in bad times. There is also evidence that there are fewer contrarian investors in the market, or that investors traditionally considered as contrarian may behave pro-cyclically in episodes of severe market stress.14 Another sign of increasing risks is given by the fact that asset managers’ activities have become structurally more correlated over the years, owing to the diffusion of common investment strategies across different business activities. New technologies (HFT, algo-trading and robo-advisors) and financial products (ETFs) have made intermediaries more procyclical and quicker to react to market news. The growth of electronic and automated trading has given rise to a series of flash episodes in markets that are among the largest and most liquid in the world.15 What policy instruments are available to limit such risks? Nanda V., Wu W. and Zhou X. (2018), ‘Investment commonality across insurance companies: fire sale risk and corporate yield spread’, Finance and Economics Discussion Series No. 69-2017, Board of Governors of the Federal Reserve System. Manconi A., Massa M. and Yasuda A. (2012), ‘The role of institutional investors in propagating the crisis of 2007–2008’, Journal of Financial Economics, 104; 491-518; Jotiikasthira C., Lundlbad C. and Ramadorai T. (2012) ‘Asset Fire Sales and Purchases and the International Transmission of Funding Shocks’, The Journal of Finance, 67(6): 2015-2050. European Central Bank (2018), ‘Financial Stability Report’, May. Bank of England (2014), ‘Procyclicality and structural trends in investment allocation by insurance companies and pension funds’, discussion paper by the Bank of England and the Procyclicality working group. Bank of England (2017), ‘Financial Stability Issue – November Issue’. There are some policy instruments to mitigate such risks. For example, most jurisdictions have measures in place that preserve the stability of mutual funds and limit the consequences of a sudden run on the part of their investors, such as liquidity requirements, rules restricting the amount of illiquid assets that can be held by open-end funds, redemption suspension and redemption gates. However, the policy framework is still under construction; most importantly, the approach has been mainly microprudential. There is a need to step up analytical thinking and craftsmanship in policy-making, starting by enhancing the policymakers’ ability to assess the relative importance of the different transmission mechanisms, using tools such as macro/systemic stress tests. The fact that we do not yet have a clear idea about how the policy instruments function does not mean that we should not start to experiment with them. A reference can be made for instance to stress testing techniques in bank supervision: stress test methodologies were not advanced before the crisis,16 but the financial crisis highlighted the importance of forward-looking capital adequacy assessment, and stress tests were then effectively employed as a supervisory tool in that perspective and have subsequently been included in the regular supervisory policy toolkit in many countries. A specific issue that will play an important role in future policy debates is how to address liquidity shortage situations for non-bank financial intermediaries. If a large asset manager’s stressed liquidity condition puts the correct functioning of markets at risk, should central banks step in and provide liquidity? If so, who should the recipients of this liquidity be: the stressed asset manager or the market? Under what conditions? The experience during the recent financial crisis, when a number of central banks expanded the scope of their lender of last resort coverage (for example, the Fed provided liquidity to mutual funds, the Bank of England started providing liquidity support to selected broker-dealers and central counterparties and similar arrangements were made by the Bank of Japan) should be a starting point for a systematic approach to these issues. The institutional framework: which authorities should be involved in the supervision of non-bank financial intermediaries? The expanded scope of the activities of non-bank financial intermediaries and the need for a better understanding of the risks posed for financial stability prompts a reflection on the adequacy of the institutional supervisory framework. In most countries, non-bank financial For instance, the pre-crisis attempt by U.S. supervisors to use stress testing for setting risk-based capital charges for Government Sponsored Organisations – Fanny Mae and Freddy Mac – turned out in retrospect to be a gross failure. intermediaries are under the purview of securities and market regulators. These authorities traditionally have a mandate to safeguard investor protection and market integrity rather than to limit systemic risks. Should this change? In particular, should financial stability find a way into market supervisors’ mandates? Should these authorities develop macroprudential policy instruments designed to mitigate systemic risks stemming from non-bank finance? This process will require an adaptation of culture as well as new laws. Central banks must be involved, particularly in view of the ‘macro’ and financial stability perspective, and of their role in the provision of liquidity; for them too, rules, skills and practices will need to evolve further. Coordination between all the authorities involved will be important in order to ensure that supervision is carried out with a macroprudential perspective. FSB work on risks to financial stability from non-bank intermediation At the international level the FSB, where central banks, banking and market regulators are all represented, is the natural forum to analyse and assess financial stability risks stemming from non-bank finance. The FSB has recently taken some preliminary important steps in these areas. First, the FSB has been publishing annually what used to be known as the ‘Shadow Banking’ monitoring report, and has recently been retitled ‘Non-bank financial intermediation’ monitoring report, although it would probably take more than a terminology change to transform shadow banking into ‘resilient market-based finance’. The FSB has worked to improve its coverage by broadening the geographic scope of the data and refining its analysis of risks. The latest report, published in March 2018, also included data from China for the first time. As to the policy area, in 2017 the FSB issued policy recommendations to address structural vulnerabilities in asset management and to mandate the relevant Standard Setter Body (IOSCO) to implement them. This work has led to the development of policy tools for asset managers in the area of liquidity risk management as well as of leverage measures for investment funds to facilitate monitoring for financial stability purposes and to enable comparisons across funds at a global level. The FSB has also made some initial progress in studying the impact of large investors’ strategies on market liquidity, starting with a ‘simulation exercise’ on fund redemptions. This line of inquiry is important. Differently from the case of banks, it is not the resilience of individual institutions that needs to be tested, but rather the presence of shock amplifiers in the market. This is why potential investment-strategy loops are of interest to the FSB. Difficult choices have been made, some of which have possibly led to setbacks. Some examples concern the abandonment of the early attempt to develop a list of systemic non-bank financial intermediaries, together with the preference for relying on an activity-based approach rather than an entity-based approach in addressing the risks from non-bank finance. These were difficult judgments to make. On the one hand, the activity-based approach has its own merits as it allows some activities to be subjected to the relevant rules regardless of which entities are undertaking them. On the other hand, relying solely on an activity-based regulation could leave significant risks unchecked: high levels of concentration and interconnectedness (e.g. large asset managers and CCPs) are good reasons to develop an entity-based regulation for non-banks as well. The FSB will continue to carry out work in this area, focusing on continued monitoring and on the operationalisation of the agreed reforms. The improvement of systemic stress testing will also be an important goal for the FSB, especially as regards enhancing its ability to assess the relative importance of the different transmission and amplification mechanisms of risks and refining its analysis of the behaviour of institutional investors, especially with respect to their willingness to act as contrarian investors in times of market stress. Conclusions These works and debates matter not only in countries where the non-bank financial sector is large. In a globally interconnected financial system, countries with small non-bank financial sectors are often the most vulnerable to these risks. In light of the rapid expansion of asset management activities, the authorities need to be provided with instruments to prevent or mitigate consequent systemic risks, especially for situations where the measures available to asset managers alone would not be sufficient. Managers of individual funds have a mandate to act in the best interests of their own investors and may not be in a position to act in the interest of financial stability. Supervisors of individual funds may not have the information or means necessary to properly assess different funds’ contribution to systemic risk. Thus, a macroprudential approach to the supervision of non-bank financial intermediation should be developed. Different authorities need to work together for a better understanding of the risk of fire sales, spillovers to other financial counterparties and disruptions in credit intermediation, and to design and test potential tools to prevent and mitigate systemic risk. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Testimony of Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Joint Session of the Fifth Committees of the Chamber of Deputies (Budget, Treasury and Planning) and of the Senate of the Republic (Economic Planning and Budget), Chamber of Deputies, Rome, 9 November 2018.
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Joint Session of the Fifth Committees of the Chamber of Deputies (Budget, Treasury and Planning) and of the Senate of the Republic (Economic Planning and Budget) Preliminary hearing on the budgetary provisions for the three years 2019-2021 Testimony of the Deputy Governor of the Bank of Italy Luigi Federico Signorini Chamber of Deputies Roma, 9 November 2018 Mr President, Honourable Members of Parliament, I wish to thank you for giving the Bank of Italy this opportunity to provide its technical assessment as part of the consultations on the budgetary provisions. I will make only a brief reference to the general economic situation, which I described in detail before these committees a month ago. The information that has become available in recent weeks confirms the signs that the economy is weakening. According to the provisional estimate released by Istat, GDP stagnated in the third quarter. Our latest assessments are that industrial production was basically stationary in September and may have diminished in October. The Purchasing Managers’ Index for that month has fallen below the threshold compatible with an expansion of production, both in manufacturing and in services. More positive signals are coming from the demand side: consumer confidence showed an improvement in October, returning to the same level as at the end of last year; according to monthly data on foreign trade, goods exports to EU countries increased in the summer. Financial market volatility has sharpened and risk premia remain high. Overall, given these developments, achieving the growth targets set by the Government for next year is an ambitious goal. The assessment we provided a month ago regarding the macroeconomic effects of the budgetary provisions is largely confirmed in the light of the measures under discussion.1 The expansionary impact projected by the Government appears considerable.2 As I have already remarked, estimates of the macroeconomic impact have a broad margin of uncertainty that also depends on the timing and the details, as yet unknown, of some of the measures. In this speech, the budgetary provisions are defined as the full set of measures incorporated in the ‘fiscal decree’ (Decree Law 119/2018) and in the draft budget law for 2019. With regard to the multipliers of the Bank of Italy’s econometric model see, for example, the work of Bulligan G., Busetti F., Caivano M., Cova P., Fantino D., Locarno A. and Rodano I., ‘Il modello econometrico della Banca d’Italia: un aggiornamento delle principali equazioni di elasticità’, Banca d’Italia, Temi di Discussione (Working Papers), 1130, July 2017. 1. The budgetary provisions: an overview The Government’s budgetary provisions increase net borrowing, with respect to the current-legislation projections, by an average of 1.3 percentage points of GDP per annum in the three years 2019-2021, de-activating the safeguard clauses for next year and reducing, though only slightly, the amount for the following two years. 2019. – The Government plans to carry out expansionary intervention next year to the value of €34 billion, just over a third of which will be financed by increasing revenue and reducing expenditure. The deficit will increase by almost €22 billion (see attached table). Cancelling the increase in VAT rates and customs duties envisaged by the safeguard clauses will lead to a €12.5 billion reduction in revenue. In 2019, it is planned to introduce the ‘citizen’s income and pension’ and to modify the pension system, although the details and the method of implementation of these measures are yet to be defined. The budgetary provisions simply institute two, intercommunicating funds (in the order of €7 billion each) that fix the maximum net cost of the prospective measures. The provisions also allocate additional resources for public sector investment (€3.5 billion). Other expansionary measures include expenditure increases worth €3.4 billion and reductions in revenue of about €1 billion. The measures will be financed to the tune of more than two thirds by raising revenue. The main contribution will come from an increase in taxation of the financial sector and the abolition of the optional tax system applying to some categories of business (IRI – tax on unincorporated business income). The 2019 deficit will come to 2.4 per cent of GDP, which is 1.2 percentage points higher than the current-legislation projection and more than half a percentage point above the Government’s estimate for 2018. According to the Government’s assessments, structural net borrowing will increase by 0.8 points, to 1.7 per cent. As we know, this budget target is under discussion with the European authorities. Last spring the European Commission deemed that Italy was compliant with the debt-reduction rule even though the debt to GDP ratio was not in line with the numerical parameter because it took into account the ‘relevant factors’, including, in particular, compliance with the preventive arm of the Stability and Growth Pact. The budget targets set out in last September’s Update to the 2018 Economic and Financial Document diverge from the rules of the Pact’s preventive arm. Instead of moving towards equilibrium, the structural deficit – that is, net of the effects of the economic cycle and other temporary factors – would increase by 0.8 percentage points of GDP in 2019 and stabilise in the following two years. In a letter dated 5 October, the European Commission requested a revision of the budget targets. The Government confirmed the programme for the next three years by publishing the 2019 Draft Budgetary Plan. On 18 October, the Commission noted a ‘clear and significant deviation from the recommendations adopted by the Council as part of the Stability and Growth Pact’ and asked the Government to provide a justification. Given the deviation, and considering that, as in the past, the reduction in the debt to GDP is not in line with the numerical benchmark, the debt reduction rule will not be respected. On 22 October, the Government confirmed its plans, citing the need to support the economy, and engaged to take all the measures necessary to avoid overshooting the projected net borrowing level. On 23 October, the Commission issued a negative opinion on the Draft Budgetary Plan. As well as noting the failure to comply with the rules of the Pact for 2019, the Commission expressed the opinion that some of the prospective measures (notably the tax amnesty and the change in pension requirements) could represent a step backwards with respect to past reforms and that, should the downside risks for economic performance projected by the Parliamentary Budget Office materialise, the deterioration in the public finances in 2019 would be greater than forecast by the Government. The Commission asked Italy to present a new Draft Budgetary Plan by 13 November. On 29 October, the Commission also announced that it would re-assess Italy’s position with regard to the debt reduction rule and asked the country to submit all the elements it regarded as significant for an overall assessment of compliance with European budget rules. On 5 November, the Eurogroup stated that it was in agreement with the European Commission’s assessment and hoped that, through an open and constructive dialogue, Italy would cooperate with the Commission in drawing up a new Draft Budgetary Plan that was compliant with the rules of the Stability and Growth Pact. Were the Commission to re-issue a negative opinion on Italy’s plan, it could recommend that the Council open an excessive deficit procedure. 2020-2021. – The expansionary measures will be greater in these two years (on average by almost €37 billion per year) as a result of extending the regime forfettario and introducing a substitute tax for sole proprietorships and self-employed workers, granting a special tax rate for firms that re-invest their profits, as well as increasing the funds allocated to public investment and public sector employment. As to the financing of these measures, the absence of the temporary revenue from the 2019 measures relating to the financial sector will be offset by abolishing the ACE (tax allowance for corporate equity) and taking action to counter tax evasion. In the Government’s policy scenario, while the deficit will continue to be significantly higher than the current-legislation projection, it will begin to diminish again in 2020-2021. A contribution will come from the increase in VAT and customs duties as a result of activating the remaining part of the safeguard clauses: these will yield 0.7 percentage points of GDP in 2020 and 0.8 points in 2021. The Government has in any case already announced that it will not in fact apply this increase, but will instead replace it with other, as yet unspecified, measures to reduce expenditure and improve tax collection. In the period 2020-21, structural net borrowing is expected to remain unchanged at the level estimated for 2019. The Government intends to resume the path of adjustment in 2022, the first year after the end of the planning horizon; this could be brought forward, but only if GDP and employment return to their pre-crisis levels before the end of 2021. 2. The main expansionary measures More than three quarters of the additional expenditure envisaged under the budgetary provisions (on average €24.2 billion per year) will be used to create or increase the Funds set up to finance the introduction of the ‘citizen’s income and pension’, to lower the minimum requirements for obtaining a pension, and to revive public investment.3 In the first two instances, resources will be set aside for reforms that have not yet been finalised. Moreover, if the expenditure of one of the funds proves to be lower than expected, the residual amount may be transferred to the other. It is also the Government’s intention to set up special tax regimes for self-employed workers and sole proprietorships, as well as to provide incentives for businesses. The cost of these measures will mainly concern the two years 2020-21. Lastly, funds will be set aside for public sector employment. The Fund for the ‘citizen’s income and pension’. – The Fund for the introduction of the ‘citizen’s income and pension’ will have a total endowment of €9 billion per annum (about €7 billion net of the sums coming from the Fund to combat For public sector investment, this also includes the funds allocated to local governments. poverty, which are presently set aside to finance the ‘minimum income scheme’). The draft budget law only indicates the purpose of the measures: combating poverty, inequality and social exclusion and guaranteeing the right to work. Following the economic crisis, the absolute poverty ratio has risen considerably among households, from 3.5 per cent in 2007 to 6.9 per cent in 2017. The increase has been particularly marked (from 1.9 to 9.6 per cent) among households with a younger ‘reference person’, i.e. under 35 years of age, which include a larger proportion of foreigners (in 2016, in 60 per cent of younger poor households the reference person was foreign). Instead, the poverty ratio is stable – and below average – for households whose head is over 65 years of age (4.8 per cent in 2007 and 4.6 per cent in 2017). Given the amount of resources allocated, the ‘citizen’s income’ should be considerably more generous than the current ‘inclusion income scheme’, not only as regards its amount but also in terms of the number of beneficiaries. It is very important, therefore, that it should be designed so as not to discourage the supply of regular employment by providing for efficacious incentives and sufficient checks to prevent misuse.4 The budgetary provisions allocate part of the Fund’s resources (€1 billion in 2019 and in 2020) to reinforce the employment centres, which at the moment play only a marginal role in matching the demand and supply of labour. If the measures to reinforce the employment centres are to be promptly effective, organisational and regulatory changes will almost certainly be needed as well. Responsibility for the employment centres is split between several levels of government, and the ways in which they cooperate with private sector agencies continue to be ill-defined despite the institution of the National Agency for Active Labour Policies in 2015. We calculate, based on Istat data, that in 2017, only slightly over 25 per cent of job-seekers contacted an employment centre; the share of unemployed workers who found permanent work in the private sector through an employment centre was 2 per cent. People who, because of individual and family characteristics, are at greatest risk of poverty make even less recourse to the employment centres and are less likely to find work through them. Even in countries with greater experience of active labour policies, the likelihood of an unemployed worker finding a job through an employment centre is not high: in 2016, the proportion in France and Germany was 7 per cent. Lastly, in areas with low labour demand in particular, it is important for the employment centres to be able to pass on job proposals originating in other regions. See ‘Preliminary hearing on the Update to the 2018 Economic and Financial Document’, Testimony of the Deputy Governor of the Bank of Italy, L. F. Signorini, Chamber of Deputies, Rome, 9 October 2018. Pension system revision fund. – The budget establishes a ‘Fund for the revision of the pension system through the introduction of additional forms of early retirement as well as incentives for hiring younger workers’. The Fund will have an endowment of €6.7 billion in 2019 and €7 billion starting in 2020. Given that the information on the measures planned is incomplete, it is not possible at this stage to comment on the possible effects. As we have said several times in the past, it is certainly possible to make the current rules more flexible, for example as regards minimum pension requirements. In our opinion, however, intervention of this kind should recognise that the financial sustainability and intergenerational equity of our system is based on the relationship between contributions paid in and benefits paid out. In other words, the amount of an early retirement pension should be adjusted in line with the lower amount of contributions and the anticipated longer disbursement period. Failure to meet this criterion would jeopardise the system’s long-term equilibrium, increasing the burden on future generations. Public investment. – A substantial share of resources is allocated to public investment: a total of around €16 billion over the three-year period (€3.5 billion in 2019, €5.6 billion in 2020 and €6.5 billion in 2021), of which almost €9 billion for central government investment and the rest for local government investment. General government expenditure on gross fixed investment has declined very considerably in recent years, more than in the rest of the euro area. In nominal terms it has decreased by almost 4 per cent a year on average compared with 2008; as a percentage of GDP, it has fallen from 3 per cent in 2008 to 2 per cent. The largest reduction has been at local government level. The analyses at our disposal suggest that Italy lags significantly behind its European partners in this respect.5 Italy’s delay is not only due to scarce financial resources: compared with other countries, costs and average implementation times are higher, even when taking differences between areas into account. See ‘Public investment for developing the economy’, address by Ignazio Visco, Governor of the Bank of Italy, at the 64th Conference on Government Studies, Varenna, 22 September 2018. Fixed investment by local government departments (excluding the effects of privatization receipts) fell by almost 40 per cent between 2008 and 2017 (to €18.3 billion), reaching the lowest point in terms of ratio to GDP of the last 40 years. The decline was common to all areas of the country, but was especially evident in the regions of the South and Islands. The failure of local investment to gain momentum in recent years may be due in part to the friction caused by an overlapping of the implementation phases of several reforms, and particularly to the misalignment between the new harmonised accounting standards (which came into force in 2015) and the balanced budget principle (applied since 2016, replacing the Internal Stability Pact). The Draft Budgetary Law simplifies the framework of the rules to which local authorities are subject by bringing the method of computing the outturn for harmonised accounting closer into line with the method used for the outturn considered for compliance with the balanced budget principle, thereby freeing up funds to allocate for investment. All the local authorities will be affected by the changeover, except the special statute regions, for which the new system will come into force in 2021. On several occasions we have argued that it is desirable to shift public spending from current to investment expenditure. Investment spending, in addition to boosting demand (as its multipliers are usually higher than those of current expenditure), helps to raise the productive potential of the economy as long as the projects are carefully selected and efficiently implemented. It can also help to adopt transparent cost-benefit analyses when selecting projects and procedures to ensure the efficient and relatively rapid execution of the work. It is important to underline that for the macroeconomic effects expected in 2019 to be fully deployed the measures need to be implemented from the beginning of the year. The budgetary provisions also envisage the creation of two new organisational units: the Central Office for Public Works Planning and InvestItalia. The role of the Central Office will be to assist government departments, both central and local, in the assessment of the economic and financial aspects of any intervention, during the planning stage, and throughout the project management. InvestItalia will be charged with analysing and evaluating plans for tangible and intangible investment, assessing the needs for infrastructure modernisation, checking the state of progress of work, and preparing financial and legal feasibility studies. A potential overlapping of competences between the two new units and between them and other existing bodies needs to be clarified. Special tax regimes for sole proprietorships and self-employed workers. – The budget provides for a reduction in the tax burden for sole proprietorships and selfemployed workers. From 2019 the scope of the regime forfettario for small businesses will be extended, with an increase in the turnover threshold to €65,000; from 2020 a new substitute tax regime will be introduced for taxpayers with a turnover of between €65,000 and €100,000. These measures will entail a decrease in revenue of €0.3 billion in 2019, €1.9 billion in 2020 and €2.5 billion when fully operational. Currently, the regime forfettario applies to taxpayers that meet certain requirements regarding the amount of their annual turnover (which must be below a threshold ranging from €25,000 to €50,000 depending on their branch of activity), the amount of their expenditure on auxiliary workers, permanent employees and collaborators, and the cost of capital goods. From 2019 the threshold for annual revenue would be raised for all branches of activity to €65,000; the other requirements would lapse. The regime forfettario would have a tax rate of 15 per cent, calculated on a fixed tax base that is the result of applying to turnover different profit margin ratios according to the branch of activity. This tax would replace IRPEF and IRAP, and businesses opting for the regime forfettario would not be subject to VAT. There would also be a 35 per cent reduction in social security contributions for sole proprietorships. The substitute tax system that would come into force in 2020 envisages a 20 per cent tax rate, which in this case would be based on analytically computed income. There would be no reductions in social security contributions. It can be estimated that the number of taxpayers subject to the regime forfettario will increase by around 60 per cent.6 About half of this increase will be the result of the higher turnover threshold. For new beneficiaries, we estimate that their tax rate will be reduced by an average of about 4 percentage points, to 11 per cent. For those who will benefit from the substitute tax regime from 2020, the 20 per cent preferential tax rate will reduce the average rate by about 7 points. Although the objective of simplification is laudable, some efficiency and equality issues raised by these measures will have to be carefully evaluated. The step effects at the thresholds of €65,000 and €100,000 could discourage firms from expanding and encourage elusive or evasive behaviour in order to keep income levels below the thresholds. Furthermore, the tax burdens of people with similar incomes could vary considerably. Incentives for businesses. – The Government partially confirms some business incentives for high-tech investments and, under certain conditions, is introducing a special tax rate for firms that re-invest their profits. The effects on the public accounts will be modest in the first year of application; in 2020-21 they will be considerable (almost €2.5 billion a year). For tech-intensive investments the budget extends the hyper-amortisation measure, the size of which depends on the amount of the investment concerned (over certain Calculations based on the BIMic microsimulation. For a description of the model, see N. Curci, M. Savegnago and M. Cioffi (2017), ‘BIMic: the Bank of Italy microsimulation model for the Italian tax and benefit system’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 394. thresholds, the special treatment would be cancelled). The incentive has so far supported the adoption of advanced technologies, whose returns can be as high as they are uncertain. While abolishing the ACE, which was designed to strengthen firms’ capital, the budget provides for the introduction of a special tax treatment in the case of re-invested profits to increase employment and invest in tangible capital goods. This measure is a permanent one. It will benefit firms when they make a profit, thus being more effective in favourable phases of the economic cycle. The aim of the measures – to support investment and employment – is certainly commendable, but when introducing changes to incentive schemes, it should be borne in mind that the stability and simplicity of the framework are among the most important ‘boundary’ conditions for business activity. Public sector employment. – The budget allocates €2.9 billion, distributed over the three-year period, for the renewal of the contract for public sector employees. This is in addition to the amounts already allocated today (about €1.5 billion). According to official estimates, the total amount of funds available would lead to an increase in average wages over the three years, reaching just under 2 per cent when fully phased in. Compensation of public sector employees as a share of GDP diminished by over 1 percentage point from 2011 to 2017, falling to 9.5 per cent at the end of last year. It decreased less in the euro area over the same period (0.8 percentage points), reaching 9.8 per cent. From 2011 to 2017, compensation of public sector employees in Italy fell by more than 10 per cent in real terms, while it was basically stable on average in the euro-area countries. The draft budget law also authorises the recruitment, in addition to what is possible under current legislation, of more than 15,000 public sector employees, allocating over €1.5 billion for this purpose over the three years. There has been a sharp contraction in staff turnover in general government since 2012. This resulted in a decrease of around 135,000 jobs per year between 2011 and 2017. For the three-year period 2016-18, expenditure on newly recruited staff is limited to 25 per cent of the expenditure on staff terminated in the previous year. According to the current-legislation projections set out in last April’s Economic and Financial Document, public sector employment is expected to stabilise next year. In past years, the limits on staff turnover and the collective bargaining freeze helped considerably to keep current expenditure down: between 2010 and 2017, primary current expenditure increased on average by about 1 per cent per annum, while expenditure on compensation of employees decreased by an average of 0.7 per cent. After several years of restriction, a cautious easing can be justified. However, it will be important to make use of the opportunity of contract renewals to introduce or strengthen incentive mechanisms, and to ensure that the recruitment of new public sector employees takes due account of the skills, including emerging ones, that are needed to improve the efficiency of general government. 3. Funding On average, over the next three years, the budgetary provisions would generate resources of around €11 billion per year, enough to cover just under a third of the expansionary measures; the remainder will increase the deficit to the extent I have already mentioned. The increase in revenue would amount to almost €9 billion per annum for the next three years. In 2019 more than half would come from a temporary increase in taxation on the financial sector; in the following two years the loss of this temporary revenue would be offset by the cancellation of ACE and by the measures to counter tax evasion and recoup revenue. Other revenue measures of note include the abolition of the tax on unincorporated business income (IRI), which was otherwise due to come into force on 1 January 2019. The tax on unincorporated business income was expected to reduce taxation by nearly €2 billion in the first year and about €1.3 billion from 2020. The optional system, which reduced taxation of sole proprietorships and partnerships with a basic accounting system in order to achieve tax neutrality with respect to their form of incorporation, was introduced in the 2017 Budget Law and should have taken effect from 2018. Last year, its entry into force was postponed until 2019; under the draft budget law it will be abolished. The spending cuts would amount to €3.7 billion next year, €1.5 billion in 2020, and €2.2 billion in 2021. Over the next three years, the cuts will represent, on average, more than one fifth of the resources generated by the budgetary provisions. These include, in 2019, the deferral to the following two-year period of capital transfers to the Italian State Railways. Like last year, part of the cost savings will come from cuts to ministries’ spending budgets (€1.6 billion on average per annum over the three-year period). About a third of these cuts would come from rationalising expenditure on management of the immigration centres; a reduction in military spending would be included (cumulatively €0.5 billion in the three years). The other measures to reduce expenditure would include new, lower limits on tax credits for R&D (the deductible amount would drop from 50 to 25 per cent and the ceiling would be brought down from €20 to €10 million). The expected saving would amount to about €0.3 billion in each of the two years 2020-21. Financial sector taxation. – The budgetary provisions raise taxation on the banking and insurance sectors in the next three years: by €4.3 billion in 2019, €0.5 billion in 2020 and €0.8 billion in 2021. The measures envisaged postpone the deductibility of a number of cost items and increase the amount of tax advances; accordingly, they have a deferment effect. The abolition of the ACE, recalled earlier, will make future recapitalisations more burdensome for financial intermediaries as well. As far as banks are concerned, the budgetary provisions would include changes to the deductibility, on the one hand, of loan write-downs associated with the start of IFRS9 and, on the other, of cost items resulting in tax deferred assets convertible into tax credits (these are loan write-downs made up to 2015 as well as depreciation allowances for goodwill and other intangibles entered in the balance sheet up to 2014). Overall, these measures would produce an increase of €4.8 billion in revenue in the next three years, which would be offset by a reduction in receipts of the same amount in the following years. For the insurance sector, the budgetary provisions envisage an increase in the tax paid on account on insurance premiums. Currently, following the increases introduced in the 2018 Budget Law, the tax paid on account amounts to 59 per cent for 2019 and 74 per cent for the years after. The provisions would increase this to 85 per cent in 2019, 90 per cent in 2020 and 100 per cent in 2021. The expected revenue in the next three years is officially estimated at about €0.8 billion. Again, this would represent an advance on revenue. The fight against tax evasion and measures to recoup revenue. – Revenue from the fight against tax evasion and the recovery of tax receipts, which are relatively modest in 2019 (€0.6 billion), represents over one quarter of the total funding in 2020 and almost one third in 2021 (€2.7 and €3.6 billion respectively). More than half of the revenue (€0.3, €1.4 and €1.9 billion in 2019, 2020 and 2021 respectively) is expected to come from the introduction on 1 January 2020 (1 July 2019 for firms with a turnover above €400,000) of mandatory electronic transmission of data on daily collections deriving from the sale of goods and services. This measure should favour the emergence of the tax base in transactions with final consumers, thanks to the greater timeliness of the information available to the national revenue agency. For the two years 2019-20, there would be a contribution of 50 per cent towards the cost of purchasing or adapting the data recording and transmission equipment required by the regulation, up to a maximum of €250 for purchases and €50 for adaption. The remainder of the revenue is mostly of a temporary nature, stemming primarily from the redefinition and expansion of the procedure for the settlement of tax liabilities first introduced under the 2017 budgetary package. Taken together, the provisions are expected to generate an increase in revenue of €1.5 billion per year on average in 2020 and 2021. The budget also makes provision for the automatic cancellation of debts of up to €1,000 on individual tax bills assigned to revenue collectors from 1 January 2000 to 31 December 2010 and a new tax amnesty, to which no increase in revenue is prudentially ascribed. Under the amnesty, taxpayers would be able to use the DIS tax adjustment form to declare taxable amounts not reported up to 31 December 2017. The adjustment, to be submitted by 31 May 2019, would be permissible up to a limit of €100,000 yearly taxable amount and in any case could not exceed 30 per cent of declared income. The additional taxable amounts reported would be taxed without adding any fines, interest or other fees and at lower rates than those normally applying (with the exception of VAT). The sums owed could be paid in ten half-yearly instalments. The introduction of mandatory electronic transmission of collections data, along with the other instruments to combat tax evasion adopted in recent years (such as the split payment mechanism, new compensation procedures between tax credits and debts, and the extension of e-invoicing to the private sector), aims to exploit the increased availability of data to make controls more incisive and at the same time to encourage greater voluntary compliance and cooperation between taxpayers and the revenue agency. If properly implemented, it can help achieve a structural improvement in the efficiency, fairness and transparency of tax collection. Other measures, especially the tax amnesty, could discourage the regular fulfilment of tax obligations; they should therefore be weighed very carefully. *** The growth gap between Italy and the rest of the euro area is a structural problem. Its most salient features were recalled a few days ago by the Governor of the Bank of Italy:7 low productivity of firms; a population that is on average older than that of other countries; a lower rate of labour force participation; young people and adults with gaps in knowledge and skills compared with other Europeans; general government that is somewhat inefficient; a less favourable business climate than elsewhere; little public and private investment. The list is well known, has been widely discussed and is, I believe, the subject of broad consensus. As the Governor recently affirmed, ‘the road to structural reform requires a significant commitment, as results mature slowly. Yet reform is essential’. The reforms implemented in recent years, or rather decades, have begun to bear fruit. The recovery has generated more jobs than might have been expected: even if GDP remains about 4 per cent below its 2007 level, the number of persons in employment has reached a historical high. The labour force participation rate of women and people in the higher age brackets has increased. The pension system has returned to a sustainable path, following two decades of reform that has risen to the challenge of an ageing population. More recently there have been improvements in the administration of justice and on other fronts. Much, however, remains to be done to tackle the outstanding issues. This is the best way to increase future economic growth potential and thereby to create the resources needed to combat poverty and alleviate the hardship of those who have been left behind. While useful in especially adverse cyclical phases, an expansionary fiscal policy does not guarantee growth in the medium term, and in the long run can jeopardise it. Between 2000 and 2006, before the global financial crisis, Italy achieved a fiscal expansion of almost 5 percentage points of GDP, compared with 1 point in the rest of the euro area. In the same period our economy grew at an average rate of 1.5 per cent, against 2.3 per cent in the rest of the area. In those years the deterioration in the primary surplus, which declined from almost 4 to less than 1 per cent, corresponded with the interruption of the gradual reduction of the debt to GDP ratio, which was substantially unchanged at just over 100 per cent after falling by 12 percentage points in the previous six years. See the speech by the Governor of the Bank of Italy, Ignazio Visco, delivered at the 2018 World Savings Day organised by the Associazione di Fondazioni e di Casse di Risparmio SpA, Rome, 31 October 2018. When the financial crisis struck, the already high deficit and debt reduced the room for manoeuvre of fiscal policy, hindering its full anticyclical deployment. Without such a high debt, Italy would not have suffered the consequences of the sovereign debt crises as violently as it did; it would not have been obliged to adopt markedly pro-cyclical fiscal policies in 2011 and 2012 to preserve investor trust and to avert the risk of being unable to refinance the public debt. From 2014 to 2017, as financial conditions stabilised, the fiscal policy stance turned expansionary (by a little over half a percentage point per year on average). The primary surplus remained at around 1.5 per cent of GDP and the ratio of debt to GDP stabilised at just above 130 per cent. We said last year, at the preliminary hearing on the 2017 Update to the Economic and Financial Document, that to plot a gradual, but assured, path to debt reduction from these levels was the ‘bare minimum’ required and that the commitment to ensure orderly public finances had to be credible in order to avert a widening of the gap between the cost of the public debt and economic growth and therefore a deterioration in debt dynamics. The Government shares the aim of reducing the ratio of public debt to GDP. This goal is nonetheless pursued not by focusing on the achievement of budgetary balance but rather on the stimulus imparted by fiscal expansion. It envisages a significant reduction in the primary surplus in 2019; it does not contemplate a rebalancing in subsequent years. Econometrics is not an exact science, even though its statistical and mathematical tools are highly formalised; assessments of the impact on the economic cycle of the prospective expansionary measures might well vary depending on the hypotheses adopted and the models employed. The multipliers implicit in the budgetary provisions ought to be considered relatively high, even if there is widespread uncertainty about their estimated value. Much will depend on how and when the measures are implemented. The selection of investments and their timely commencement will also be important. The effects of fiscal policy, however, cannot be assessed as though it existed in a void; they are affected by the broader financial conditions, especially important when the debt is so high, which in turn are influenced by announcements and policies. The protracted uncertainty of investors about Italy’s fiscal plans and the credibility of its commitment to bring the debt steadily down, and last, but by no means least, the debate with the EU bodies on compliance with the common rules, have considerably raised the interest rates that Italy pays on its debt. This increase has already cost taxpayers almost €1.5 billion in additional interest expense in the last six months, compared with what it would have accrued at the rates that the markets expected in April; if the rates remain consistent with current market expectations, it would cost over €5 billion in 2019 and around €9 billion in 2020. As the Governor explained in the same speech I mentioned earlier, the increase in the sovereign spread affects the entire economy (households, firms, financial institutions). The increase in interest rates on the public debt has an effect that is somewhat comparable to a monetary squeeze; a squeeze which, however, is much sharper and more rapid than any imaginable (future, gradual) normalisation of the Eurosystem’s policy. This risks thwarting the expansionary stimulus expected from fiscal policy. Faced with a possible new recession Italy would find itself with a relatively high deficit, as before the crisis, and an even higher debt to GDP ratio. The room for manoeuvre would be even narrower. It is not my role to provide indications or formulate precise forecasts, which would in any case be impossible, but to highlight the risks. I believe there is a general consensus that the danger of triggering a vicious circle of deficit, interest rates, confidence and growth has to be avoided. Given the present international financial situation, unexpected episodes of volatility cannot be ruled out, however unlikely they may seem at the moment. Instead, credible control over the dynamics of the deficit and the debt is self-fuelling, and in the final analysis it will expand the amount of resources available to the community. The spread has to be reduced. The signals captured by investors are important. I hope, therefore, that the discussions under way with the European Commission and Council will lead to a solution that de facto reconciles compliance with the rules that bind Italy as a member of the Monetary Union, and ensures a credible process of consolidation in the medium term, with judicious measures to support the economy and with the pursuit of the political objectives of the Government and Parliament. TABLE AND FIGURES Table 1 Effects of the measures incorporated in the 2019 budgetary provisions on the general government consolidated accounts (millions of euros) SOURCES OF FUNDS 12,129 10,165 11,174 Increased revenue (A) Measures relating to the financial sector (net effect) Repeal of ACE (tax allowance for corporate equity) Repeal of IRI (tax on unincorporated business income) Measures to counter tax evasion Settlement of tax liabilities (net effect) Measures relating to gaming and tobacco Reflex effects of measures on public sector employment Other 8,439 4,260 1,986 8,701 2,373 1,236 1,356 1,337 8,929 1,453 1,260 1,912 1,641 1,024 Decreased expenditure (B) Current expenditure Measures to reduce expenditure of ministries of which: to rationalise expenditure on management of immigration centres Other Capital expenditure Reprogramming of expenditure Measures to reduce expenditure of ministries Other -3,690 -1,049 -1,045 -400 -5 -2,641 -1,640 -401 -600 -1,464 -1,414 -1,230 -550 -184 -50 -398 -302 -2,245 -2,335 -1,327 -650 -1,009 -345 -304 USES OF FUNDS 33,976 36,959 36,443 Decreased revenue (C) Remodulation of VAT and customs duties safeguard clauses Extension of the regime forfettario for small businesses (net effect) Subsitute tax on sole proprietorships and self-employed workers (net effect) Cancellation of debts up to €1000 in hands of tax collection agents Special tax treatment of re-invested profits Extension and modification of hyper-amortisation Extension of deductions for property renovations (net effect) Other -13,533 -12,472 -331 -99 -666 -10,724 -5,500 -1,816 -109 -99 -1,948 -368 -595 -290 -10,546 -4,001 -1,370 -1,129 -99 -1,808 -728 -887 -524 Increased expenditure (D) Current expenditure Fund for ‘citizen’s income and pensions’ Fund for pension system review Public sector employment of which: contract renewals Fund for implementation of the government programme Other Capital expenditure Fund for central government investment Investment by local authorities Business support measures Compensation scheme for savers Other 20,444 16,024 6,802 6,700 1,455 4,419 2,200 1,300 26,235 19,218 6,842 7,000 1,568 3,378 7,017 3,000 2,562 25,897 18,172 6,870 7,000 2,105 1,275 1,767 7,726 3,500 2,994 Net change in revenue (E=A+C) -5,094 -2,023 -1,617 Net change in expenditure (F=B+D) current capital 16,753 14,975 1,778 24,771 17,805 6,967 23,652 15,836 7,816 Change in net borrowing (G=F-E) as a percentage of GDP 21,847 1.2 26,794 1.4 25,269 1.3 (1) Calculations based on official estimates contained in the Parliamentary proceedings relating to the draft Budget Law for 2019 and Decree Law 119/2018. – (2) Net of the reduction in the National Fund to combat poverty and social exclusion (€2.2 billion on average per year). – (3) Net of the reduction in the Financial Compensation Fund set up under the 2018 Budget Law (€25 million per year). – (4) Based on nominal GDP in the policy scenario set out in the Update to the 2018 Economic and Financial Document. Table 2 Public finance overview (per cent of GDP) Update to the 2018 Economic and Financial Document Current legislation scenari o Policy scenario Net borrowing 2.4 1.8 1.2 0.7 0.5 2.4 1.8 2.4 2.1 1.8 Primary surplus 1.4 1.8 2.4 3.0 3.3 1.4 1.8 1.3 1.7 2.1 Total revenue 46.4 46.2 46.3 46.3 46.0 46.4 46.1 45.8 45.7 45.2 of which: incidence of taxation 42.2 41.9 42.2 42.3 42.1 42.2 41.8 41.8 41.7 41.3 Primary expenditure 44.9 44.3 43.9 43.3 42.7 44.9 44.3 44.6 44.1 43.2 of which: current 41.1 41.2 40.7 40.2 39.7 41.1 41.1 41.4 40.7 39.9 capital 3.9 3.2 3.2 3.1 2.9 3.9 3.2 3.3 3.4 3.3 Interest expense 3.8 3.6 3.6 3.7 3.8 3.8 3.6 3.7 3.8 3.9 GDP growth (percentage change) 1.6 1.2 0.9 1.1 1.1 1.6 1.2 1.5 1.6 1.4 Debt 131.2 130.9 129.2 126.7 124.6 131.2 130.9 130.0 128.1 126.7 (1) Rounding of decimal points may cause discrepancies. – (2) Revenue and primary expenditure are calculated based on data from the Update to the 2018 Economic and Financial Document, the draft 2019 Budget Law and Decree Law 119/2018. – (3) Includes financial support to EMU countries. Table 3 Main public finance indicators for general government (per cent of GDP) Revenue 45.2 45.9 45.7 45.7 47.9 48.1 47.9 47.7 46.5 46.4 Expenditure 47.8 51.2 49.9 49.4 50.8 51.1 50.9 50.3 49.1 48.7 of which: interest expense 4.9 4.4 4.3 4.7 5.2 4.8 4.6 4.1 3.9 3.8 Primary surplus 2.3 -0.8 0.1 1.0 2.3 1.9 1.5 1.5 1.4 1.4 Net borrowing 2.6 5.2 4.2 3.7 2.9 2.9 3.0 2.6 2.5 2.4 Borrowing requirement 3.1 5.5 4.3 3.9 4.1 4.8 4.1 3.0 2.6 3.4 Borrowing requirement net of privatisation receipts 3.1 5.6 4.3 4.0 4.6 4.9 4.3 3.4 2.6 3.4 102.4 112.5 115.4 116.5 123.4 129.0 131.8 131.6 131.4 131.2 Debt Source: Based on Istat data for general government consolidated account items. (1) Rounding of decimal points may cause discrepancies in totals. – (2) The proceeds of sales of public assets are recorded as a deduction from this item. – (3) A negative value corresponds to a deficit. Figure 1 Profile of VAT rates in the policy scenario (per cent) Figure 2 General government debt (per cent of GDP) Source: For GDP, Istat. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Opening remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Panel on "Institutional investors' asset allocation and the real economy" at "Evolving landscapes of bank and non-bank finance", Bank of Italy-LTI@UniTo Conference, Rome, 7 December 2018.
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“Evolving landscapes of bank and non-bank finance” Banca d’Italia-LTI@UniTo Conference Panel on “Institutional investors’ asset allocation and the real economy” Opening remarks by the Deputy Governor of the Bank of Italy Fabio Panetta Carlo Azeglio Ciampi Centre for Monetary and Financial Education Rome, 7 December 2018 I am very happy to be here today at this joint Banca d’Italia-Long-term Investors conference on the evolving structure of bank and non-bank finance. As the first session already highlighted, the conference provides useful indications on how to stimulate firms’ access to market finance, alongside the traditional banking sector. My role today is to chair the roundtable on “Institutional investors’ asset allocation and the real economy”, which focuses on how institutional investors can contribute to expanding the range of services and the volume of financial resources available to businesses. The panel will benefit from the contributions of distinguished participants, who will share their experience in the field with us. But before we start the discussion, let me briefly explain why, in my view, it is crucial that institutional investors play a larger role in funding the real economy. The global financial crisis of 2008 was triggered and amplified by developments in the banking industry.1 In the preceding years, banks had increasingly adopted the “Originate-to-Distribute” model, so that instead of holding the loans they had originated on their balance sheets, they transferred them to third parties. This weakened incentives to carefully screen and monitor debtors. Loans were repackaged and passed on to other entities, but in many cases the risks ended up being borne by banks’ off-balance sheet vehicles and conduits. The rapid expansion of the banking system made the real economy highly vulnerable to financial shocks. The risks connected with an overstretched banking sector emerged fully during the financial and sovereign debt crises. Since then, regulatory action has been taken to rein in the banking sector. Wider and tighter prudential requirements at the global level2 and, in Europe, the Single Supervisory Brunnermeier, M. K., “Deciphering the Liquidity and Credit Crunch 2007–2008,” Journal of Economic Perspectives 23 (2009), 77–100. The main regulatory changes adopted after the crises include higher capital requirements, the introduction of liquidity requirements and a minimum leverage ratio. Mechanism, the Single Resolution Mechanism and the Bank Recovery and Resolution Directive are acting to discourage excessive risk taking by banks. The burden of bank failures has been progressively shifted from taxpayers to banks’ stakeholders. As an intended consequence of these regulatory changes, banks have been steadily deleveraging, in particular by reducing the riskiest positions on their balance sheets. The contraction of bank intermediation has been accelerated by two factors. First, the macroeconomic environment, with its low level of interest rates and flat term structure, has put further downward pressure on banks’ profitability. Second, banks are facing increasing competition from fintech companies, which use technological innovation to offer services such as payments and asset management. Even though core banking activities have not as yet been significantly affected by these new players, there are reasons to believe that fintech will in time become a more serious challenger in lending and also retail funding.3 Regulatory changes, combined with competition and the low level of interest rates, are paving the way for a contraction of the banking sector. As a result, non-bank forms of financing for the real economy need to be found. This need is particularly acute in the case of small and medium enterprises (SMEs), which are more bank-dependent than larger companies. Accordingly, as the deleveraging of the banking sector began, policymakers started voicing concerns about SME financing. Unfortunately, those concerns proved to be well-founded: during the crisis the deterioration in the economic outlook – together with the tightening of credit supply conditions – led to severe financial strains for SMEs.4 Larger firms, on the contrary, managed to weather the crisis better, partly because they enjoyed relatively easier access to capital markets, which allowed them to offset, at least in part, the decline in bank credit. Cortina, J. J. and S. L. Schmukler, “The Fintech Revolution: A Threat to Global Banking?,” Research & Policy Briefs 14, World Bank, April 2018 and Lumpkin S., J. Mosher, “Framework for digitalization in finance,” in OECD, Financial Markets, Insurance and Private Pensions: Digitalisation and Finance, 2018 and Panetta, F. “Fintech and banking: today and tomorrow,” Speech, 12 May 2018. ECB, “Survey on the access to finance of small and medium-sized enterprises in the euro area,” November 2012, and Rodano, G., N. Serrano-Velarde and G. Tarantino, “Lending standards over the credit cycle,” The Review of Financial Studies, 31 (2018), 2943–2982. These observations regarding the ability of firms to finance themselves in the post-crisis landscape emphasize the importance of facilitating the growth of market finance. Apart from filling the void created by the contraction of the banking system, more developed market-based finance and the accompanying financial diversification will enhance the stability and the efficiency of both the financial system and the real economy. Indeed, the complementarity of bank and non-bank finance and the need to further develop the latter have long been emphasized by Banca d’Italia and other European institutions, which have long encouraged efforts in that direction. A large body of literature supports this endeavour, arguing that firms’ optimal funding structure is diversified, in the sense that it includes both bank and non-bank debt, and that diversification has positive effects on firms’ growth.5 A balanced mix of funding sources is also desirable from an aggregate point of view. Cross-country studies suggest that economies that overly rely on bank funding may be characterized by lower and more volatile long-run growth than more market-based economies.6 There is no question that healthy banks act as shock-absorbers in normal recessions; but when recessions coincide with financial crises, as in recent years, bank-dependent economies are more severely hit than economies with a diversified financial system. In order to ensure a stable and adequate supply of financial resources to the real economy, it is therefore necessary that the deleveraging of the banking sector be accompanied by a greater role for the financial markets and non-bank intermediaries. Institutional investors play a key role in this structural transformation. Indeed, one of the most important drivers of the development of financial markets is the growth of the institutional investor base. It has also been recently argued, for example, that an increase in pension Claessens, S. and L. Laeven, “Financial dependence, banking sector competition and economic growth,” Journal of the European Economic Association, 3 (2005), 179–207. Reinhart, C. M. and K. S. Rogoff, This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009, Cournède, B. and O. Denk, “Finance and Economic Growth in OECD and G20 Countries,” OECD Economics Department Working Papers 1223, OECD, June 2015 and Langfield S. and M. Pagano, “Bank Bias in Europe: Effects on Systemic Risk and Growth,” Economic Policy 31 (2016), 51-106. savings favours participation in capital markets7 and there is evidence that institutional investors have positive effects on corporate governance.8 A look at the development of institutional investors in advanced economies highlights the challenges ahead. Countries in continental Europe continue to lag behind the UK and the US. The gap is all the more serious in the pension funds sector, reflecting the relative weight of funded retirement schemes in national social security systems. The gap is very noticeable in Italy. For example, in 2015 the assets managed by pension funds accounted for less than 10 per cent of GDP in Italy, compared with more than 100 per cent on average in the UK and the US. We definitely need to attain a more comprehensive understanding of the underdevelopment of institutional investors in most euro-area countries. For all of these reasons, policymakers look favourably at the development of market-based financing and the growth of institutional investors. It must be stressed, however, that banks and market-based finance remain complementary, rather than substituting one another, and that a level playing field should be ensured for all financial intermediaries. If regulatory changes put banks at a disadvantage, firms may end up having difficulties accessing both bank and non-bank forms of external finance. Indeed, apart from remaining a vital source of corporate funding, especially for SMEs, banks are uniquely equipped to help firms to access the capital market. Moreover, banks offer contracts (such as overdrafts or credit lines) and services (such as lending assistance) that are often complementary to market-based finance. These contracts and services can be helpful to firms, especially in periods of distress.9 * * * To conclude, the corporate sector would greatly benefit from a more developed market-based segment within our financial systems. Institutional investors play a pivotal role in this structural evolution. At the European Scharfstain, D. S., “Presidential Address: Pension Policy and the Financial System,” The Journal of Finance, 73 (2018), 1463–1512. McCahery J. A., Z. Sautner and L. T. Starks, “Behind the Scenes: The Corporate Governance Preferences of Institutional Investors,” The Journal of Finance, 71 (2016), 2905–2932. Bolton, P., X. Freixas, L. Gambacorta and P. E. Mistrulli, “Relationship and Transaction Lending in a Crisis,” The Review of Financial Studies, 29 (2016), 2643–2676. level, this aim is being pursued by implementing the Capital Markets Union project: enriching the types of financing available to non-financial corporations, broadening the portfolio choices of investors, enhancing the efficiency of financial intermediation, removing barriers to cross-border investment, and increasing funding options for SMEs and infrastructure. In Italy, a number of additional initiatives with similar goals have been taken in recent years, such as minibond issues, debt funds, tax incentives for venture capital and allowances for corporate equity. Yet in Italy, as well as in many other European countries, the role played by the financial markets and non-bank financial institutions is still limited. This is why I am looking forward to discussing these issues with our eminent experts. Designed by the Printing and Publishing Division of the Bank of Italy
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Keynote address by Ms Valeria Sannucci, Deputy Governor of the Bank of Italy, at a workshop, jointly hosted by the Federal Reserve Bank of New York and Bank of Italy, New York City, 30 November 2018.
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Federal Reserve Bank of New York and Banca d’Italia Post crisis financial regulation: Experiences from the two sides of the Atlantic Keynote address by Valeria Sannucci Deputy Governor of Banca d’Italia New York, 30 November 2018 Ten years have passed since the default of Lehman Brothers, which was a turning point in the global financial crisis that had started earlier on, in the summer of 2007. The crisis spread rapidly from the structured products market linked to US subprime mortgages to all financial markets, and ultimately to the real economy, sparking the worst global recession since World War II. The policy makers’ reaction to these extraordinary developments was quick and remarkably well-coordinated. Central banks around the world rapidly lowered official interest rates, and injected liquidity in unprecedented quantities and through a wide range of monetary policy instruments. Fiscal policies became expansionary and supportive of the real and financial sectors, and more serious negative consequences were avoided. Although some of the long-lasting consequences of those events are still apparent today in many economies – in Italy, for instance, GDP as of last December was still 5 per cent lower than in 2007 – a decade later we are finally exiting from the exceptional policy measures taken since then. Central banks in the major advanced economies have gradually started to normalize their monetary policy stance, albeit with different timing reflecting the differences in cyclical conditions across the major economies. The response to the crisis has led to important changes in the rules of the game for banks and financial firms, which are the subject of the analyses presented in the two workshop sessions today. In the immediate aftermath of the crisis, the G20 Leaders established the Financial Stability Board (FSB), building upon its predecessor, the Financial Stability Forum, to promote the repairing of the financial system through a broad agenda of reforms of the international regulatory framework. The reforms were intended to address the imbalances that had gradually been accumulating in the global financial system well before 2007, by strengthening the resilience of financial intermediaries, markets and infrastructures, tackling moral hazard issues and reducing procyclicality in the financial system. In particular, for institutions which pose systemic risks, reforms were aimed at enhancing their capacity to absorb shocks and, in the event of failures, making their resolution easier. To date, substantial progress has been made towards a more stable and resilient global financial system. First, banks’ capital has been substantially increased, and ad hoc capital buffers have been built by systemically important banks. Second, banks’ liquidity positions have also been strengthened with the introduction of rules such as the Liquidity Coverage Ratio and the Net Stable Funding Ratio. Third, the vulnerability of the financial system to contagion on a global scale has been curtailed, by providing incentives to clear over-the-counter (OTC) derivatives centrally. And fourth, the market for complex and opaque securitizations – a form of financial intermediation which played an important role in the run-up to the crisis – has virtually disappeared. In Europe, new rules have been approved in order to promote simple, transparent, and standardized securitizations.1 However, cases such as the recent strong growth of the collateralized loan obligation market in the United States need to be kept under strict scrutiny to avoid repeating past errors. In spite of such progress, significant challenges remain ahead of us and we must maintain the momentum of reform. A significant source of potential vulnerability concerns the non-bank financial sector. Post-crisis reforms of the regulatory framework have been much less advanced in this sector than in the banking sector. Perhaps also as a consequence of this, the share of non-bank financial intermediation has grown seamlessly since the end of the last decade, with non-bank financial intermediaries often performing functions typically carried out by banks, without being subject to comparably stringent regulation and supervision. According to the Financial Stability Board, at the end of 2016, non-bank financial intermediaries held $160 trillion in total assets, about one and a half times the level at the end of 2008, while over the same period banks’ assets have risen only marginally. The non-bank financial intermediaries performing bank-like functions in 2016 held $45 trillion of assets. The asset management industry, the largest sector of non-banking intermediation, has almost doubled in size over the past decade. The growth of non-bank financial intermediation is increasing the sources of finance for the economy, reducing dependence on bank lending Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 lays down a general framework for securitization and creates a specific framework for simple, transparent and standardized securitization. and strengthening the financial system’s resilience. In this respect, it is a welcome complement to bank intermediation, in particular in many European economies, including Italy, which have traditionally been characterized by a bank-centric financial system, with limited room for market-based finance and non-bank financial intermediaries. At the same time, we cannot neglect the risks it may create for financial stability. Some risks are similar to those faced by banks, as non-bank financial institutions are also exposed to risks related to liquidity/maturity transformation and leverage.2 Other risks, however, are of a different nature. The spread of high-frequency, quantitative/automated trading and passive management strategies contributes to making the highly concentrated asset management industry vulnerable to procyclical behaviour, which in turn has the potential to amplify market reactions to macroeconomic news, sometimes in destabilizing ways. A case in point is what happened at the beginning of last February, when some apparently innocuous news on US wage growth led to a stock market crash, with a sudden unwinding of crowded trades, and hugely negative consequences for some market players (who had bet on low volatility). Fire sales and contagion can take place during this kind of events, which could end up having unsettling effects on financial stability, to the extent that they could threaten the resilience of financial intermediaries. Other significant developments that need to be monitored closely due to possible financial stability implications concern technology and financial innovation. The profound changes in financial technology are enabling new institutions, often operating outside the banking system, as well as large technology corporations to offer services which challenge the traditional role of bank intermediaries. These changes blur the distinction between the financial and technology sectors, raise questions concerning the perimeter of current financial regulation, and give rise to new risks, such as those deriving from an increasing dependency on third-party service providers. As the adoption of digital technologies for the provision of financial services spreads, policy makers need to continue monitoring the risks from a financial stability perspective, and consider whether FinTech should be A preliminary initiative on this front is the FSB Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities, 12 January 2017. regulated, who the regulator should be, and what type of regulation would be appropriate. In addressing these issues, we should be guided by the principle of ‘same business, same risks, same rules’. In Italy, the banking law has recently been updated in order to bring the regulatory framework for finance companies, investment firms and other non-bank finance intermediaries more in line with the regime applicable to banks.3 The rationale behind this reform was, among other things, to avoid new forms of potential regulatory arbitrage stemming from the differences in the regulatory frameworks for institutions with similar types of business. A related area is that of crypto-assets. Their financial stability implications are currently limited given the size of the market, as observed by the FSB report published in October. However, this assessment could change over time, as suggested by some experiences, such as the very large swings in their prices, the very rapid expansion in some countries of initial coin offerings,4 the growth of crypto-asset exchanges, and the emergence of crypto-asset funds, futures and similar financial products. Wider use and greater interconnectedness with the core financial system could pose financial stability risks if they occurred without material improvements in the resilience of crypto-asset markets. To support a timely identification of emerging financial stability risks and to explore the possible policy options to pre-empt the build-up of risk and to ring-fence the financial system if risks from crypto-assets become significant, a strengthening of the analysis of the crypto-asset market structure is necessary. Yet the challenges that are facing us today are not only about dealing with the new risks (and opportunities) of financial innovation. After the intense, prolonged reform effort, we need to ensure that the new framework is effectively implemented, thereby providing regulatory certainty and stability so that the financial system can operate in support of economic growth. The reform is based on Legislative Decree 141/2010, which amended the TUB (Consolidated Law on Banking); it was completed by Ministerial Decree 53/2015, which identified the activities subject to reserve. Supervisory regulations for financial intermediaries and groups of financial intermediaries are set out in Banca d’Italia Circular No. 288 of 3 April 2015. Initial coin offerings (ICOs) are public offerings of crypto-assets in exchange for sovereign fiat currencies or popular private crypto-currencies (e.g. bitcoin) through which companies raise capital to fund the early stage development of projects or businesses. ICOs are conceptually analogous to initial public offerings for stocks. A key issue concerns the need for consistent implementation by all jurisdictions, in order to prevent fragmentation of the financial system. In principle, rules commonly agreed upon by the FSB and the Basel Committee on Banking Supervision (BCBS) should lead to a more stable and resilient financial sector and to a better integrated financial system. However, differences in reform implementation across countries might increase the fragmentation of financial systems. An example taken from banking supervision concerns ring-fencing practices adopted by host authorities on banks’ international branches. This is rational from the single regulator’s perspective but could lead to more fragmented global banking and liquidity. Hence, efforts should also be made in the direction of assessing reform implementation, with the aim of achieving a more homogenous application of the agreed rules across regions, including through truly open cooperation and coordination. The large scale of the post-crisis reforms requires a thorough and honest assessment of their effects and of the possible implementation challenges. Work on this front is ongoing in several forums. The FSB has recently prepared two different reports to evaluate the effects of reforms on infrastructure finance and on incentives to clear OTC derivatives centrally. A new project has been started to assess the effects of reforms on SME financing and another is planned to evaluate the implications of the reforms aimed at addressing the systemic and moral hazard risks associated with global systemically important banks (G-SIBs). The FSB is also planning an initiative to explore ways to address the risk of market fragmentation. Reform evaluations naturally entail an appraisal of their unintended consequences. For instance, analyses of the effect of the leverage ratio on banks’ provision of client clearing services have been carried out by the Financial Stability Board together with the relevant standard-setting bodies, and are informing the ongoing effort by policy-makers to improve the regulatory framework. Implementation challenges can also arise in relation to what I see as a trade-off between the ex-ante desire for perfection and the ex-post effectiveness of new regulations. Let me give you two examples. We have had the Bank Recovery and Resolution Directive (BRRD) in Europe since 2014. In the spirit of the Key Attributes for Resolution Regimes agreed by the FSB, this directive aims to strengthen and harmonize bank crisis management in the EU, as well as to minimize the cost to the taxpayers. Among other provisions, the new directive sets a ‘minimum requirement for own funds and eligible liabilities’ (MREL) – similar to the Total Loss-absorbing Capacity (TLAC) requirement for global systemically important banks – to ensure that, in the event of resolution, banks will have sufficient own funds and other liabilities to absorb losses and reconstitute capital. At the same time, its introduction could substantially raise bank funding costs and reduce bank lending. While estimates of these costs are highly uncertain, there are risks of a non-negligible impact on GDP growth. Banca d’Italia has stressed the need to alleviate the adverse effects of the rules on banks’ loss-absorbing liabilities by ensuring that the amount and quality of funds are proportionate to the actual demands of the resolution, and that the transition period is long enough to allow the banks to build up the requirement gradually. Yet when looking at the initial experiences with the application of the new bank resolution regime in Europe, it is clear that more flexibility in applying the available tools would help make the crisis management framework more effective in dealing with problem banks. A useful lesson in this regard can be that of the United States, where flexibility and pragmatism are key ingredients of the policy decisions in this realm. However, for the lesson to be learned, the members of the European Union – a relatively young union – need to reinforce mutual trust, which is the essential glue of any union, but that nevertheless has recently been weakened more than once. All in all, implementation challenges could well lead to some regulations being reconsidered. A second example of the trade-off between an ex-ante desire for perfection and ex-post effectiveness is given by looking at specific components of the banks’ capital. Capital is a key element of bank regulation and it has therefore been a main target of the post-crisis reform, as will be discussed in the second session of today’s workshop. A major innovation of Basel III is the possibility granted to banks to compute the Contingent Convertible bonds (CoCos) as ‘Additional Tier 1’ capital. The favourable regulatory treatment of this instrument has spurred a very strong growth in the CoCo market in Europe. However, while CoCos are designed to strengthen bank solvency on a going concern basis, their use may ultimately come at the cost of increasing financial stability risks. Recent research by Banca d’Italia5 Bologna, P., Miglietta, A., and Segura A., Contagion in the CoCos market? A case study of two stress events. Banca d’Italia Working Papers (Temi di Discussione), 1201, November 2018. has shown that the adverse dynamics of the CoCo market that occurred in 2016 following worrying news about an issuer cannot only be explained by the banks’ fundamentals and hence that CoCos might in fact themselves be a source of financial instability. Although some of the instability may have been transitory, the analysis suggests that this market should be closely monitored and that authorities may need to rethink the role of CoCos, should they prove unable to provide for a smooth bank recapitalization. This brings me to my final remark. There is a concrete risk of losing the reform momentum and conceding ground to calls that are not always disinterested and to mounting pressure to roll back the existing regulations. As recently pointed out by the International Monetary Fund, this pressure should be resisted. We need to learn from the past. Each and every time either regulation or supervision has become lax, excessive risks have been taken and leverage has increased, often leading to abrupt and recessionary swings in the financial cycle. So, during economic expansions we should be aware of the possible illusory perception of things looking more benign than they actually are. To conclude, central banks have emerged from the trial of the financial crisis with a strengthened responsibility in the area of financial stability, which needs to be honoured. High quality analyses and meetings like this one represent a unique opportunity to compare experiences and continue the debate, thus helping policy makers to carry out their mandate more effectively. Designed by the Printing and Publishing Division of the Bank of Italy
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Opening remarks by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the 2nd Workshop on Behavioural Financial Regulation and Policy, organized by the Bank of Italy and the Herbert A. Simon Society, in cooperation with the Max Planck Institute for Human Development, Rome, 11 December 2018.
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2nd Workshop on Behavioural Financial Regulation and Policy Herbert Simon Society and Bank of Italy Opening remarks by Salvatore Rossi Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS) Rome, 11 December 2018 Today we mark the second edition of the Workshop on Behavioural Financial Regulation and Policy here at the Bank of Italy. Part of it will be dedicated to the presentation and discussion of the BeFAIRLY report, which is ambitiously titled “The Behavioural Finance Revolution: A New Approach to Financial Policies and Regulations” (edited by Viale, Mousavi, Alemanni and Filotto). The remaining part of the workshop will be dedicated to issues that are very dear to us regulators: financial education and risk literacy. Subjects that, in the wider context of a consumer protection framework, have seen in recent years some growing and fascinating research advancements, as well as an ever increasing body of evidence coming from implemented policies around the world. In introducing the first edition of this workshop one year ago I suggested that behavioral economics had irrevocably modified the way we frame the real-world economic phenomena in our thinking. And that the debate between those – like you – more eager to integrate or replace the “standard” theory and those that are resisting it, has been beneficial to all its participants, whichever the field of allegiance. I stand by this view. The more an agreed-upon body of knowledge in behavioral economic sciences consolidates1, the more defined and robust would be the set of non-traditional regulatory tools. Especially when considering the workings of the banking and insurance markets, any policy intervention should be well understandable by the industry and the general public. See for example the survey contributions to the recent Handbook of Behavioral Economics – Foundations and Applications, (October 2018), Elsevier, Bernheim D., S. DellaVigna and D. Laibson Eds. It is in this context that an open-ended discussion between regulators, independent academics and the industry, such as the one we are going to experience today, is so valuable. On the one hand the drive of the industry towards value-creating innovations produces what in some instances could be labelled “facts before the theory”. On the other hand the findings of behavioral theorists helps making sense of such data. For example, recent research in behavioral corporate finance has greatly expanded our understanding of managerial conducts. It has shown that even top managers, a rather sophisticated group of individuals, are not immune to biases and seemingly irrational decision making, and that their traits and life experiences are priced by the markets2. Even more relevant are behavioral traits in household finance decisions. Actual investment and consumption decisions that are based on mental accounting3, present bias4 and reference point consumption5, have been recurrently mentioned as possible explanations for “non-traditional” agents’ behavior that is found in the data. We at the Bank of Italy and IVASS (the Italian regulation and supervision authority for insurance), in our consumer protection activity, consider now attentively the insight of behavioral economics. Years ago we were relying mainly on transparency requirements. But full disclosure, while responding to information asymmetry, was not addressing behavioral bias. In the real world consumers have behavioral weakness and difficulty in processing a vast amount of information. On top of that, households’ financial See for example Schoar, A. and L. Zuo, (2016), "Does the Market Value CEO Styles?", American Economic Review, 106 (5), and Malmendier U., (2018), “Behavioral Corporate Finance”, in Bernheim D., S. DellaVigna and D. Laibson, Eds. See Thaler, R.H., (1985), “Mental accounting and consumer choice”, Marketing Science, 4 (3), and the descending literature. For example, Laibson, D., (1997), “Golden eggs and hyperbolic discounting”, Quarterly Journal of Economics, 112 (2). See Koszegi, B. and M. Rabin, (2009), “Reference-dependent consumption plans”, American Economic Review, 99 (3). decisions are taken so rarely that in fact seldom people learn from their direct experience. Therefore our policy approach has been re-oriented, in both regulation and enforcement. Formal compliance has given way to a more substantial approach, requesting producers to be fair in their relations to customers. We have also promoted the creation of alternative dispute resolution procedures, simple, rapid and effective. Arbitro Bancario e Finanziario has been a success: last year over 30.000 complaints were received; the analogous entity for insurance, Arbitro Assicurativo, will be established presumably in the early 2020. However, financial regulation and good supervision could be not enough if consumers do not really understand their financial needs and cannot operate properly their rights: effective financial education is a crucial life skill in order to make financial decisions consistent with personal and family needs. In today’s digital age, financial markets offer everybody easy access to a wide range of financial services and products. But digitalization is two-faced: it can emphasize some behavioral biases, such as short-termism and impatience, but could nudge people into specific virtuous action. The final balance will be positive only if consumers are financially literate. Building a sound financial education is complex, as it requires a long-life approach on three challenging dimensions: knowledge, attitude, and behavior. Financial education goes beyond than just providing information, it is meant to change those three dimensions, in order for people to achieve their financial well-being. Best practices around the world show that experiential learning (such as games, simulations and role plays) helps acquire, retain and put in practice new information. Since 2008 in our main program for students, “Educazione finanziaria a scuola”, we have progressively moved from information to capability, fostering a value-driven approach to economic issues, stimulating the participants’ interest by suggesting “I need it because...”. We have been using movies as a trigger for debating financial issues and behavioral biases. We have also introduced contests and prizes. Our competition “Let’s design a banknote” invites Italian primary and secondary school students to design an imaginary banknote on a given theme; for the current edition, the theme is “money and emotions”. The prize-winning classes receive an amount of money for their school. We will also contribute to the First edition of the Italian Economic and Finance Olympiad. Adults are more challenging: they tend to acquire just the knowledge and skills they need for a specific purpose and their behavior tend to be well-rooted. Furthermore, adults are an extremely heterogeneous population. For example, some immigrants grew up where saving food meant wasting it. Thus the concept of saving must be explained to them with a special care. Let me also add that IVASS is now planning an exercise to measure insurance literacy, a still underexplored dimension of financial capability; even if it is a novel concept, it could become an international benchmark. I would like to stress that, as international experience shows, single institutions cannot fill all the gaps: a nationally-coordinated approach to financial education is a key factor for success. Financial education needs an interdisciplinary approach and strong cooperation among many stakeholders, including academia, private sector and civil society, as well as the public sector, so that all the points of view can be taken into account, from pedagogy to neuro-economy. Last October, some preliminary evidence of the Survey of financial education initiatives in Italy in the years 2015-17 was released. The Survey shows a very fragmented offer of financial education initiatives. As authorities involved in the diffusion of financial literacy, over time we advocated the implementation of a national strategy for financial education, recognizing its crucial role in ensuring a more inclusive growth and gender equality. We therefore strongly welcomed the establishment of the Committee on financial education in August 2017. Since its inception, the Committee has been very active, also thanks to the energy of its Director Annamaria Lusardi, whom I want to thank on behalf of all of us, and the forward-thinking choice to make the most of the existing experience in financial literacy, in Italy and abroad. So far the Committee has achieved many important results. Among them, the Committee defined the Italian National Strategy for Financial Education (NSFE), which defines vision, mission, goals and guidelines. The strategy promotes a holistic approach to financial well-being, also including insurance and social security perspectives. In the strategy, the Committee has been able to take advantage from international experiences – as Annamaria says quoting Isaac Newton “standing on the shoulders of giants” – and building on all information available for our country, such as Bank of Italy survey on adult financial literacy6. We are confident that the Committee will play a constructive and pivotal role in coordinating all efforts in the field of financial education. The Financial Education Month, which took place last October, included over 350 initiatives nationwide: it was a good starting point. There is a further element to keep in mind: we need robust evaluations to identify areas for improvement and to be sure that we make good use of resources. Indeed, evaluation is a crucial aspect for making good financial education. In sum, we need to exploit all available theories, empirical evidence and points of view. Much work still needs to be done, which requires a joint effort by all the actors involved: this conference is an excellent opportunity to lay the foundation of such a collaboration. See A. di Salvatore et al, (2018), “Measuring the financial literacy of the adult population: the experience of Banca d’Italia.” Occasional Papers, N°435, Banca d’Italia, Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Opening remarks by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the 29th (EC)2 Conference on "Big Data Econometrics with Applications", Rome, 13 December 2018.
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29th (EC)2 Conference on “Big Data Econometrics with Applications” Opening remarks by Salvatore Rossi Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS) Rome, 13 December 2018 It is my great pleasure to open this conference and to welcome all the speakers and participants. I thank the organizers for designing such a broad and topical programme. With the increasing digitalization of the economy, data has become central in all the social sciences, and economics is no exception. In fact, some have talked about data being the new oil of today’s world. Econometrics and statistics are therefore becoming increasingly dependent on the availability of huge and heterogeneous datasets. Only few years ago, the econometric profession was rather cautious about Big Data. Classical econometrics is based on theory and so relies on approaches that differ significantly from those of Big Data analytics. Econometricians have been taught for decades to start with a theory and then use data to prove or disprove it. Big Data and machine learning work in the opposite way: they allow one to look for patterns simply by processing huge amounts of data, regardless of possible underlying models. It’s important to note that most econometricians have expressed concern about the reliability and representativeness of such vast datasets. However, it’s becoming evident that Big Data could disrupt traditional econometrics. Data collection from social media has produced unprecedentedly large and complex, though unstructured, datasets on economic agents’ behaviour and interactions, and these are proving to be a goldmine of economic information. We have been working with data analysis for many years, but it is now time to adapt our computational approaches to the new context. The Bank of Italy, because of its multiple functions, follows the evolution of Big Data very attentively. We will discuss this topic in a workshop organized with the Bank of International Settlements next 15 January here in Rome. In the last few years we have progressed along our learning curve. We have combined skills in economics, econometrics, statistics and computer science to deal with the increasing volume, variety and velocity of data, which we have then used to estimate unemployment and inflation, to improve our economic forecasts, and to measure consumer and business sentiment. We, like all central banks, must also be ready to cope with the increasing public demand for access to granular data. As a data producer, the Bank of Italy has always strived to make its statistics available to the widest possible audience. We already share some data with researchers and other institutions, while protecting confidentiality. We have also started to design a Research Data Centre that will provide a safe haven for processing different kinds of microdata. The number of possible applications of Big Data for central banks is huge, but some are critical. The financial services sector handles sensitive information about individuals and firms. More data available in digital format makes life easier for analysts but increases exposure to security breaches. As more services go online, data ubiquity, and hence data security, are proving to be a major challenge for both private companies and central banks. Financial operators are able to gather massive amounts of data about customers and visitors, which are then analysed to generate insights into buying behaviour. Some of this data is personal, and deserves to be protected against inappropriate use. That is a goal that the whole of society must pursue. Another important aspect of these innovative technologies is financial stability. New entries have arrived in the landscape of financial services; Fintech is a portmanteau word meaning any application of digital technologies to finance. Under this label we can include both giants of the digital world wanting to enter the financial market and tiny start-ups whose ambition is to erode the market power of the incumbents. All this is beneficial to competition and productivity in the financial industry, provided that the new entrants are properly supervised. Technology can help to innovate financial products and services currently provided by the traditional industry to the benefit of consumers. However, given all the well-known interconnections between operators in the market, the repercussions of technological innovation on the system’s stability are not clear. Public institutions like central banks and other financial supervisory authorities should examine the matter carefully. The Bank of Italy has created an internal multidisciplinary team on Big Data, Machine Learning and Artificial Intelligence. The team includes economists, statisticians and computer scientists from different departments, working in close cooperation with the Information Technology Department. IVASS, the insurance supervisory authority working under the umbrella of the Bank of Italy, has opened a regulatory sandbox for some aspects of Fintech/Insurtech. To conclude, I am confident this conference will be an important occasion to review the most recent findings on Big Data econometrics and its application to national institutions, in particular central banks, and international organizations. Bringing together researchers from central banks and academia, as we do on this occasion, can provide a broad variety of contributions and perspectives. I am sure we will have two productive and interesting days. Designed by the Printing and Publishing Division of the Bank of Italy
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Opening remarks by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS), at the Bank of Italy - CEPR - EIEF Conference, Rome, 19 December 2018.
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Bank of Italy – CEPR – EIEF Conference Firm Dynamics and Economic Growth Opening remarks by Salvatore Rossi Senior Deputy Governor of the Bank of Italy and President of the Institute for the Supervision of Insurance (IVASS) Rome, 19-20 December 2018 I am delighted to welcome you all to the Bank of Italy, and to open this workshop, which was jointly organized with the CEPR and the Einaudi Institute of Economics and Finance. Over today and tomorrow, 29 original papers will be presented, selected from more than 150. These works have been produced by distinguished scholars from academia and research institutions around the world. They cover a wide variety of topics relating to firm dynamics and its effects on economic growth. Two keynote lectures will also be delivered, and I would like to thank the internationally renowned speakers, Professor Ufuk Akcigit from the University of Chicago and Professor Gian Luca Clementi from New York University. There is no need for me to underline the importance of studying firm dynamics today. The recession which followed the global financial crisis hit the whole world almost simultaneously ten years ago, though to varying degrees in different countries. Firm dynamics is key to explaining the differences in its impact. Country-specific frictions to the physiological exit and entry of firms in the market may severely limit growth prospects for an economy. Italy is a case in point, as I will discuss later. In the short run, they affect and are affected by business cycle fluctuations and financial shocks. At this moment in time, after years of recovery, economic growth is slowing down somewhat all over the world. Forecasts made by international organizations are currently reflecting the decline shown by conjunctural data. Growing trade tensions, political uncertainty, and expectations that monetary stimulus will gradually be reduced in the main economic areas of the world are the most cited facts. In many advanced economies, the economic slowdown is raising concerns about potential output, since the recovery of recent years has not been accompanied by as buoyant an increase in productivity as we might have expected. That’s why firm dynamics is more important than ever before. Innovation and technology adoption by as many firms as possible is the main source of growth and jobs in the economy, and they depend very much on the process of firm entry, survival, growth, and exit through which the market selects the most efficient and innovative players. New and young firms are those which drive input accumulation and output growth. If the most productive firms thrive and the less productive ones exit smoothly from the market, the economic system works well. These ideas are very old, dating back at least to Joseph Schumpeter’s ‘creative destruction’ and they are now an intrinsic part of empirical analyses from all around the world. Indeed, thanks to the efforts of several scholars and research centres, among which I would like to thank the OECD researchers that conducted the seminal FirmDyn project, we now have a lot of comparable data on firms’ entry, growth and exit from the market, over their entire age distribution, in each national system. These country-level indicators are of course deeply affected by business environments and policies. For instance, entry barriers and direct or indirect public subsidies to firms in trouble can alleviate the welfare costs of crises in the short term, but may have long-term negative effects on firm selection and economic growth. To take another example, if the judiciary works badly and private contracts are difficult to enforce, incumbents have a clear advantage over entrants. Finally, if the political system works badly, some firms may escape competition thanks to their political connections. Finance also plays a role in shaping firm dynamics. New businesses need money, which can’t always be provided by banks, because of the riskiness of the venture and the scarcity of collateral. Venture capitalists are the right answer, yet their contribution is quite varied across countries. Technological improvements, for which the Fintech label is a proxy, are now filling these gaps, but the process is uncertain and uneven. For now, at least in some countries, new and young firms have to rely on bank credit and face tight capital constraints. If we leave aside cross-country differences and do some time-series analyses, we notice a decline in business dynamism since the early 2000s all over the world: for most OECD countries, new firms’ entry rates are now significantly lower than at the beginning of the century. What are the causes of this phenomenon? One may be the possible increased market power of incumbents. Another may be the fact that technological change and globalization increase the ability of more productive firms to gain market share. These two possible explanations have markedly different policy implications. The scientific debate is currently ongoing, and during this workshop other possible explanations will be discussed in depth by several presenters. Recent research has highlighted how firm dynamics may have a role in explaining not only long-term potential growth but also business cycle fluctuations. The procyclicality of entry rates could be driven by a tighter selection of new firms during downturns, and slacker entry requirements when the economy is doing well. While this phenomenon is a stylized fact, its implications for the propagation and persistence of aggregate shocks have only been studied quite recently. Moreover, the impact of recessions induced by financial rather than real shocks is still comparatively underexplored. Today’s presentations will also cover these important issues, which have clear implications for policies to stabilize the business cycle. Let me conclude with a few words on Italy. Its lack of business dynamism has been an important determinant of the sluggish productivity growth over the last 20 years according to most research in this field, much of which has been conducted by the Bank of Italy’s economists. From the mid-1990s onwards, aggregate productivity in Italy has grown at a significantly slower pace than in the rest of the euro area. Total factor productivity (TFP) has been virtually flat, and yet at the same time the ICT revolution and the ensuing globalization of production were exploding, helping most other economies to reap enormous benefits in terms of productivity and growth. The inability of Italian firms to do the same is normally attributed to the large share of micro and small firms in the system: those firms invest less in innovation and technology adoption, and are more vulnerable to global competition. Yet the small size of most firms is a dynamic malaise of the system, not a static one, and is caused by the lack of business dynamism. Italian startups grow less and for a shorter period of time than new businesses in other OECD countries. They are poorly selected over their early years of life: exit rates are generally flat over the age distribution, meaning that less productive firms are not wiped out from the market when they are young. As a result, Italian firms are older, smaller and less productive than those from other developed countries. The causes of this lack of business dynamism are manifold. Italy holds negative records for some of the frictions I discussed before: judicial efficiency is particularly low and financial leverage is among the highest by international standards. We have several specific dysfunctions, such as widespread tax evasion, the political connections of entrepreneurs, and cronyism, all of which distort competition in the economy, and slow down creative destruction and firm churning, with negative consequences for aggregate growth. The structural reforms that are needed to put Italy back on track should address these diverse and complementary issues in a bold and coherent framework. * * * Ladies and gentlemen, I believe the discussions you are going to have today and tomorrow will provide important insights for addressing these issues too. I would like to thank the organizers of the workshop: Francesca Lotti and Francesco Manaresi from the Bank of Italy, Salomé Balsandze from the Einaudi Institute of Economics and Finance and the CEPR, and Luigi Marengo from LUISS-Guido Carli University. I also thank Alessandra Piccinini from the Bank of Italy for taking care of the logistics. I welcome you once again and wish you a fruitful exchange of ideas, as well as a pleasant stay in Rome. Designed by the Printing and Publishing Division of the Bank of Italy
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Opening remarks by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Bank of Italy and Bank for International Settlements Workshop on "Computing platforms for big data and machine learning", Rome, 15 January 2019.
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Bank of Italy and Bank for International Settlements Workshop on ‘Computing Platforms for Big Data and Machine Learning’ Opening Remarks by the Deputy Governor of the Bank of Italy Luigi Federico Signorini Rome, 15 January 2019 Ladies and Gentlemen, It is a pleasure to open this workshop and welcome all the participants. Everyone is aware that modern societies are generating an unprecedented amount of digital information. The latest Data never sleeps annual report, published last June, claims that mankind now generates more than 2.5 exabytes of data every day. The increase is bound to continue: by 2020, an estimated 1.7 MB of data will be created every second for every person on earth. The enormous wealth of information that has thus become available has great potential value if effectively captured and aggregated. However, it also poses fundamental challenges that are easily overlooked. Let me open this workshop by briefly mentioning three that I think deserve more attention than they usually get. First, big data are worth little if they are used in a methodologically unsound way. Such data are typically representative only of selective strata of the population; increasing the volume of data will not improve the accuracy of estimates if the estimation procedure does not correct for this. Social media data for example, like many other internet-based sources of big data, are usually based on a biased sample of the population; now-fashionable media-based indicators (of confidence, say, or political trends) are often employed with scarcely a thought for this fact. Relatedly, the careless use of massive amounts of rough data will sometimes result in an exceptionally good in-sample fit, especially with non-parametric or machine learning approaches, but a poor performance out of sample (this is sometimes called the ‘overfitting plague’). Reference texts should place much more emphasis on these facts in order to provide a more rigorous guide to practitioners and, ideally, educate the public at large as the ultimate consumer of processed information. Second, while the world produces a relentlessly growing mountain of data, it has not yet settled on a reliable set of criteria for making (some of) it effectively accessible in the more or less distant future. Large volumes of internet data are casually stored, overwritten and discarded without any consideration for what the next generations will need or want to know about the world today: and this not just in the general pursuit of knowledge, but also for more immediately practical purposes, such as clarifying legal rights. Long-term conservation of data is also hampered by changes in physical storage devices, IT platforms and software. The theory and practice of building archives in the big-data era is in its infancy; it needs to grow up fast. Third, the emergence of big data has raised the importance of data integrity, confidentiality and privacy to a level never seen before. Protection of personal data is central to our societies; one could say that it helps to define them, to the extent that it is inextricably linked to the protection of individual rights more generally. The sheer amount of personal data now available, and the growing ease of connecting individual information across databases, have far-reaching implications for fairness and freedom; they have thus spurred much digital-privacy regulation. The connections with the previous point are, I think, rather obvious (data integrity, for instance, is central to both); so are the implied trade-offs. For instance, the right to be forgotten, increasingly (and, I think, rightly) granted to individuals, conflicts with society’s desire to keep records. No wonder that rules are sometimes inconsistent across different jurisdictions, data domains or legal purposes. A systematic way of weighing conflicting principles against one another should be found. Ideally, one would like to have global standards; international cooperation is therefore to be encouraged as far as possible. However, there are limits to this, at least as long as different societies protect individual freedom to a different extent. For the time being, we have to live with this limitation. The challenges of big data require continuous organisational and technological innovation in the institutions that want to use them effectively and fairly. At the Bank of Italy we have taken several steps in the past few years to enhance our ability to collect, store and exploit huge amounts of data, using state-of-the-art hardware and software. Other institutions are surely doing the same. This workshop is a good opportunity to share experiences. Preserving the confidentiality of individual data is one specific challenge that many institutions represented here will often face. The issue is not just that the social value of statistical analysis cannot override the legal obligation to refrain from infringing on personal privacy, but also that the quality of the data itself is often premised on confidentiality being guaranteed: without it, proprietary data would be impossible to collect, and much sensitive data, such as data on personal wealth, would be next to useless. We are cooperating with other institutions to find ways to reap the value of merging data from different sources, and to make them available – insofar as possible – to independent researchers, while avoiding confidentiality breaks. Let me conclude by thanking once again all the speakers and participants for joining us today. Special thanks go to those who have contributed to organising the workshop. It brings together highly professional data scientists, IT architects and business specialists from central banks, providing views of excellent quality and a broad variety of perspectives. I am sure that you can count on having an interesting and productive day. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 25th Congress of ASSIOM FOREX (the Italian financial markets association), Rome, 2 February 2019.
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25th ASSIOM FOREX Congress Speech by the Governor of the Bank of Italy Ignazio Visco Rome, 2 February 2019 Recent economic developments Since mid-2018 the global economy has been slowing. The euro area has recorded a significant weakening of productive activity; in Italy it has declined. Several factors, some of which are temporary, have contributed to the deterioration of the macroeconomic situation; the foreign demand outlook, firms’ expectations and investment trends have also worsened. In the second half of 2018, industrial production in the euro area declined by 0.5 per cent. The fall was sharpest in Germany (2.2 per cent) and Italy (0.8 per cent), in part owing to the automotive sector’s compliance with the new international legislation on emissions from light-duty vehicles. In Italy domestic demand was affected by heightened uncertainty, initially linked to doubts about the country’s stance on participation in the single currency and then to the difficult passage of the budget law, marked by clashes with the European Commission that were not resolved until the end of the year. The resulting increase in the risk premium on government debt was transmitted to private sector borrowing costs at a time when share prices were falling. Our latest growth projections for Italy in 2019 published in January’s Economic Bulletin stand at 0.6 per cent, in line with those of the leading national and international forecasters, but with significant risks on the downside. Compared with the early December estimates – when the central projection was for 1.0 per cent growth – the revision mostly reflects the incorporation of unfavourable economic data that have since become available, confirmed by those for the fourth quarter released this week by Istat. Other contributory factors were the cutbacks in investment plans reported by firms in our surveys and the worsening of foreign demand expectations. The projections take account of the support given to aggregate demand in the expansionary budgetary measures for 2019, whose effective contribution will depend on how they are implemented. The agreement reached by the Government and the European Commission has partially lowered tensions in the government securities market, with generally positive effects on demand. Economic activity will benefit from the maintenance of highly accommodative monetary conditions. The projections for this year and the subsequent two-year period, which indicate a return to growth of around 1 per cent, are subject to notable risk factors originating both inside and outside of Italy. The main external factors are the performance of foreign trade, vulnerabilities in emerging countries, and the eventual terms of the UK’s departure from the European Union. On the home front, interest rates on government securities remain a significant risk factor. The protectionist stance of US trade policy vis-à-vis China, with which a complex negotiation is under way, and the European Union, already hit by last year’s introduction of aluminium and steel tariffs, could be accentuated. Further uncertainty stems from the slowdown under way in the Chinese economy, partly linked to initiatives designed to limit private sector borrowing, and from the difficult political and economic conditions of important emerging economies. A no-deal Brexit could have serious consequences even if the direct impact on international trade, while strong for the United Kingdom, may prove limited for Italy and for the EU as a whole. Any financial market malfunctions could have major repercussions for all the countries involved and this issue is currently being looked at very closely. Together with the supervisory authorities the Italian government has prepared a number of contingency measures. These provide for an adequate transition period to guarantee the integrity and business continuity of the markets and of intermediaries – both British intermediaries operating in Italy and Italian intermediaries established in the UK – and to safeguard investors and customers. Important decisions have already been taken by the European Commission, which is currently working to ensure the continuity of financial transactions between European intermediaries and British central counterparties. The Single Resolution Board (SRB) has also announced that it will be flexible with European banks in the event that securities issued in the UK no longer count towards the minimum requirement for own funds and eligible liabilities (MREL). As national and European authorities have recalled on many occasions, banks must nevertheless play an active role in the preparations for a no-deal scenario. Since the mid-November peak, yield spreads between ten-year government bonds and the corresponding German securities have narrowed by around 80 basis points. At 250 basis points on average this week, the risk premium on Italian government bonds nonetheless remains high, around double what it was on average in the first four months of last year. The uncertainty surrounding fiscal policy has not disappeared. An agreement with the Commission was reached for 2019, but for 2020-21 numerous questions remain open, especially the future of the ‘safeguard clauses’, whose cost has now gone up to 1.2 per cent of GDP in 2020 and 1.5 per cent in 2021. Were they to be deactivated without any countermeasures in place, the deficit would be around 3 per cent of GDP in both years. For budgetary policy to support economic activity effectively, it must preserve confidence in the improvement of the public accounts and the reduction of the ratio of debt to GDP. The volume of public sector securities to be placed annually on the market is still massive: almost €340 billion just for the rollover of securities maturing in 2019, on top of the roughly €50 billion expected to be needed to finance the deficit. Financial market conditions remain tense. Since last spring’s peak, share prices have come down by 12 per cent in the euro area and by 17 per cent in Italy. In the same period, private bond yields have risen by 40 and 100 basis points respectively (to 1.6 and 2.5 per cent). Italy’s divergence from the euro-area average has been most evident in the banking sector, where stock market indices have fallen by almost 40 per cent on average compared with 30 per cent in the euro area and bond yields have almost doubled, reaching 2.4 per cent, against an average increase of 0.3 percentage points in the euro area as a whole. The higher borrowing costs borne by Italy’s banks have up to now been transmitted to interest rates on loans to a lesser extent than in the past, thanks to the stronger balance sheets of credit institutions and the rebalancing of their liabilities towards financial instruments that are less vulnerable to changes in market interest rates. Signs of a moderate tightening in credit access conditions are nevertheless beginning to emerge from business surveys. Last week the ECB’s Governing Council expressed concern about the increased downside risks surrounding the euro-area growth outlook, which could affect inflation developments over the medium term. The reduction in consumer price inflation, to 1.4 per cent in January, primarily reflects the slowdown of the energy component but at 1.1 per cent core inflation is still struggling to recover. The transmission of the increase in wages to prices has been slowed by the weakness of economic activity in recent months, which has translated into lower profit margins for firms. The Council will continue to pursue the price stability objective – commonly defined as a rate of inflation below, but close to, 2 per cent in the medium term – with tenacity and patience. Significant monetary stimulus will be guaranteed by low key interest rates, the large volumes of securities in central banks’ portfolios and the reinvestment of principal payments from maturing securities, which will continue for an extended period of time. Should the macroeconomic conditions require it, the Council stands ready to utilize all the instruments at its disposal to ensure, with the support of aggregate demand, the rapid readjustment of inflation towards the price stability objective. To reap in full the benefits of the expansionary conditions fostered by monetary policy requires the contribution of reforms to reduce the structural weaknesses of our economy, which magnify cyclical difficulties. Decisive progress must be made in promoting a more business and innovation-friendly environment, encouraging labour market participation, raising the quality of human capital and improving the efficiency of public services. Since 1999, Italy’s annual average growth has been 1 percentage point below that of the euro area. In the absence of consistent structural progress, what at international level are cyclical slowdowns tend to be transformed here in Italy into stagnation and a decline in productive activity. The wellbeing of households depends on numerous factors but the capacity of the economy to grow is vital. Public investment can support it, in tandem with private investment, if rapidly and efficiently executed in the context of a gradual rebalancing of the public finances. Above all, however, interventions to strengthen and modernize the productive structure, to render it more dynamic and capable of creating additional job opportunities, must continue to play a central role in Italian economic policy. Even if, as with past initiatives, they will take time to bear fruit, their implementation can immediately support firms and households’ confidence and, in this way, their propensity to invest and consume. Financial intermediaries The improvement of credit quality in Italy, under way since mid-2015, continued in 2018. In the third quarter the non-performing loan rate decreased to 1.7 per cent, in line with the figures prevailing before the global financial crisis. For business lending, the decline came to a halt in the closing months of 2018 with the onset of the cyclical downturn. In the first nine months of 2018, also following a considerable number of disposals, the stock of non-performing loans (NPLs) decreased from €259 billion to €216 billion gross of loan loss provisions, and from €129 billion to €99 billion net of them. The NPL ratio declined from 6.1 to 4.8 per cent in net terms; the coverage ratio rose by almost 4 percentage points, to 54 per cent. For the significant groups, the reduction in net NPLs, amounting to 4.5 per cent of total lending at the end of September 2018, is consistent with the plans that banks agreed with the supervisory authorities. The requests to raise the coverage ratios for the stock of NPLs, made to all euro-area significant banks, take account of each bank’s specific situation; they will be effective as of next year and envisage the attainment of full coverage over a period extending to 2026 for banks with relatively high net NPL ratios. For the less significant banks, the net NPL ratio stood at 7.1 per cent at the end of September 2018; it exceeded 10 per cent for 50 of the 270 mutual banks, which accounted for about half of the total NPLs held by that category. Of the roughly 100 intermediaries that are not mutual banks, an NPL ratio above 10 per cent was observed for 23 banks, accounting for one third of the NPLs of the sector. The plans to reduce NPLs prepared by the main less significant banks in recent months on the basis of the guidelines issued by the Bank of Italy at the beginning of 2018 are now being examined by the Bank’s supervision department. Projects that envisage cooperation between banks and operators specializing in the management of NPLs can also be a good solution for unlikely-to-pay loans of firms in temporary difficulty. Profitability improved in 2018. In the first nine months of the year, the annualized return on equity rose to 6 per cent for Italian banks as a whole, from 4 per cent in the same period of 2017. The share of revenue absorbed by operating costs, which averaged 65 per cent, nonetheless remains excessively high, especially for the less significant banks (which recorded an average share of 74 per cent). In the period considered, these banks saw their costs rise, while the significant groups reduced them; the gap was especially wide in the staff costs component. The ratio of common equity tier 1 capital to risk-weighted assets (CET1 ratio) decreased from 13.8 to 13.1 per cent in the first nine months of 2018. The reduction reflected the losses connected to the tensions in the government bond market. The impact was greatest for the less significant banks, which generally invest a higher share of their assets in government bonds. Since the end of 2017, when it had reached a low of €280 billion, banks’ exposure to Italian government bonds has risen. At the end of November 2018, the value of the securities in banks’ portfolios stood at about €330 billion, just under 10 per cent of total assets; it remains below the peak of €400 billion registered at the beginning of 2015. The purchases, which were concentrated in May and June, occurred in parallel with the rise in yields, at a time of weak credit demand. Banks’ investments help to stabilize government bond prices in periods of heightened tension and can enable subsequent capital gains if prices recover; however, they expose intermediaries to the risks associated with further drops in prices. The share of securities classified in the portfolio valued at amortized cost, whose temporary changes in value do not affect capital, rose from 18 to 49 per cent on average between the end of 2017 and November 2018; it reached 61 per cent for the less significant banks. This increase helps attenuate the impact of fluctuations in the value of government bonds. The decrease from 4.2 to 3.6 years in the residual maturity of the securities classified in fair-valued portfolios goes in the same direction. The expansion in economic activity and orderly conditions on the sovereign debt market facilitates, together with renewed investor confidence, a gradual decline in the stock of government securities held in banks’ balance sheets, as shown by the significant reduction in exposures between the beginning of 2015 and the end of 2017. The global financial crisis, the sovereign debt crisis and the attendant double-dip recession led to a significant restructuring of Italian banks’ liabilities. There has been a sharp reduction in market funding; risk premiums have increased owing to factors specific to the banking sector and to the changes in the conditions of the public finances. Since 2011, the decrease in interbank funding has been accompanied by a considerable increase in recourse to central bank refinancing. Over the last few years, in the four targeted longer-term refinancing operations carried out between June 2016 and March 2017, the Eurosystem allocated about €240 billion to Italian banks of the €740 billion destined for euro-area banks. These operations have helped to sustain the disbursement of loans to households and firms and to lower the cost. From 2011 to today, net bond issuance on the international markets, mostly by large banks, has been negative overall, at -€47 billion; the share of bonds in total funding has gone down from 11.5 to 9.5 per cent. The recent resurfacing of tensions in the government securities market has made it harder to access international markets. The rate of return demanded by investors on uncovered senior bank bonds with a 5-year maturity is currently around 1 percentage point higher than that demanded for France and Germany’s main banks. The Eurosystem’s liquidity support to banks will continue for as long as the euro area’s financial situation requires it. However, restoring normal access to wholesale markets is a prerequisite for the proper functioning of banking activities; it will also help to limit the costs incurred by medium-large banks for the creation of a buffer capable of absorbing losses, as provided for by the new European rules on crisis management. In the course of this year, the SRB will set an MREL target that is binding for most of Italy’s significant banking groups, providing an adequate transition period for them to reach it, if necessary. During the debate that led to the agreement on the ‘banking package’ at the end of last year (which updates the rules on prudential requirements and reviews the criteria for setting the MREL), we pointed out on more than one occasion the importance of reconciling the need to guarantee appropriate amounts of liabilities that can be used in the event of resolution with that of ensuring they are issued in a gradual and orderly manner, thereby avoiding repercussions on the funding of the economy. Aside from the practical difficulties of implementing a bail-in, eligibility for the resolution procedure is in any case restricted to large banks when this is deemed to be in the public interest, justifying recourse to the Single Resolution Fund. In the event of a crisis for smaller banks, an orderly winding-up can only take place if a bank interested in acquiring assets and liabilities makes a rapid and systematic intervention. In the absence of a purchaser, however, there would be no alternatives to an ordinary or ‘atomistic’ winding-up. This procedure, as well as destroying value, may compromise the continuity of critical services at local level, with possible episodes of more widespread contagion. I believe further reflection is necessary at European level, also in light of the experience of the American Federal Deposit Insurance Corporation (FIDC), on the institutions and measures designed to make the exit of smaller banks from the market less traumatic and as economical as possible. Italy’s banks must continue to strengthen their balance sheets and recover adequate efficiency and profitability levels to be able to deal with the current challenges of the financial sector at global level. More resources are needed to shoulder the costs of compliance, an area which has expanded considerably in recent years and whose legislative framework still requires work in order to make it more proportional. Investment is required to exploit digital technology so as to improve the services provided to customers. To assist growth and make the allocation of resources more efficient, we need a more diversified financial system. The financial needs of firms that are innovative and active at international level cannot be met solely by banks. Despite the progress made over the last few years, the role of capital markets is still too limited, also in comparison with the other large economies in continental Europe. Policies to support non-banking funding sources for firms should be pursued; banks can accompany and benefit from these developments by expanding and innovating the range of services provided. Looking ahead, the biggest challenge is that of technology, which is drastically lowering the cost of transmitting, processing and storing information and favouring the development of new forms of financial intermediation. Entire areas in the financial industry, from payment services to credit supply, from trading in securities to risk management, have already been heavily affected in some countries by digitalization and the rapid growth in the market share of non-bank entities (FinTech). Additional competitive pressures will come from global firms at the cutting edge of technological innovation (including the ‘Big Tech’ firms), which can exploit their presence in very big markets. The authorities must ensure adequate forms of supervision for new intermediaries that take account of their potential and the risks associated with their activities. It is especially important to encourage both FinTech companies and banks to pay due attention to the possible negative consequences of cyber-attacks in a system now steeped in digital technology. We are working alongside the other authorities and intermediaries on maintaining cyber security in the financial sector. We have also reorganized our supervisory department, creating dedicated structures for analysing FinTech, with the aim of anticipating market developments and updating the methods and tools of intervention. * * * The prospects for the Italian economy are less favourable today than they were a year ago. They are affected by downside risks, partly originating abroad, but which still primarily reflect Italy’s own weaknesses, above all the uncertainty surrounding growth, the fiscal policy stance and the resumption of a credible path to reduce the burden of public debt on the economy. A high sovereign risk premium exacerbates the imbalance of the public accounts, undermines the capacity of fiscal policy to support the economy and limits the resources available for investment in infrastructure. The fall in the value of government securities impacts negatively on household savings and leads to capital losses for institutional investors, such as insurance companies and pension funds. Banks also face losses, with repercussions on their funding conditions on the markets; this impairs their ability to supply credit to the private sector and thereby to support production. The activation of this vicious circle has been slowed by the relatively high average maturity of the public debt, the expansionary monetary policy conditions and banks’ capitalization levels. These are positive factors that may, however, turn out to be insufficient in the event of sudden financial market movements, a risk that we have already faced in the past. This risk must be avoided by keeping a close watch on the public accounts ‒ in the short and long term ‒ and through the decisive implementation of cohesive reforms to preserve the trust of savers and regain that of investors. The ultimate goal, requiring perseverance and determination, has to be that of a lasting return to a path of social and economic development. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Keynote lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at the Aaron Institute for Economic Policy Conference 2019, Herzliya, 16 May 2019.
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Ignazio Visco: The economic and financial outlook of the euro area -halfway down “the long and winding road” Keynote lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at the Aaron Institute for Economic Policy Conference 2019, Herzliya, 16 May 2019. * * * The economic outlook This conference comes at a difficult and uncertain juncture for the global economy, the euro area and Italy. After solid growth in 2017 and early 2018, world GDP decelerated significantly in the second half of last year. Although there are signs that the downward momentum might have stopped, in many countries economic activity remains weak. According to the IMF’s latest forecasts, in 2019 the global economy will expand at the lowest rate since 2009, when it recorded a recession. Trade tensions, mostly fuelled by the new protectionist strategy pursued by the United States, and their effects on confidence, especially of private enterprises, are contributing significantly to this poor performance of the world economy. International trade progressively slowed in 2018, falling by 1.0 per cent in the last quarter of the year, and recent data suggest that the economy remained weak in the early months of 2019. The progressive liberalisation of trade that has characterised the last few decades has come to a sudden halt and is being reversed in some important economies. The average tariff rate applied to imports by the United States, for example, more than doubled in 2018 (from 1.5 to 3.3 per cent). More generally, the system of supranational institutions and multilateral rules on international trade that supported the sustained global economic expansion after World War II is encountering serious difficulties. Protectionism is a response – a wrong one – to the challenges of globalisation and technological change, which both have momentous consequences for the job prospects of workers with lower skills. In the OECD countries, for example, the rise of automation is estimated to cause a high probability that as much as one job out of seven will be lost, while three out of ten may undergo significant changes over the next fifteen to twenty years. Even though new jobs will be created, managing the transition will be no easy task. Not enough has been done up to now to make appropriate plans for an affordable, timely and adequate retraining of workers, to invest resources in education, and to combat poverty and inequality. In the shorter term, global risks are still tilted to the downside. The economic outlook remains vulnerable to persistent trade tensions, to a greater-than-expected cyclical slowdown in China, and to the possibility that the United Kingdom exits the European Union without a deal. GDP growth decreased markedly in the euro area as well, to 1.8 per cent in 2018 (from 2.4 per cent in the previous year). The euro area is much more open to foreign trade than the United States and Japan. For this reason its business cycle is highly correlated with the international one. Dependence on external demand is especially high in Germany, where the export-to-GDP ratio is close to a stunning 50 per cent, but it is also significant in France, Italy and Spain (where it is slightly above 30 per cent) due to their integration in the global value chains, including the European ones, commonly known as the “European factory”. In the euro area the negative impact on GDP growth of weaker exports has been amplified by a slowdown in domestic demand. Since mid-2018 the outlook for investment has progressively deteriorated due to the adverse effects of increased global uncertainty on firms’ confidence and capital accumulation plans. The drop in production in the car sector following the introduction of a 1/6 BIS central bankers' speeches new international regulation on emissions from light-duty vehicles has also played an important role. Against this background, the European Central Bank’s monetary policy continues to be highly expansionary. The Governing Council expects official rates to remain at their current low levels at least until the end of 2019 and, in any case, for as long as necessary to ensure the convergence of inflation towards its target of a growth rate of consumer prices “below but close to 2 per cent” to be maintained over the medium term. Even after the first rate hike, the Eurosystem will continue for an extended period of time to reinvest in full the principal payments from maturing bonds purchased under the asset purchase programme (APP). Last March we also decided to launch a new series of targeted longer-term refinancing operations (TLTRO-III), the first of which will be conducted next September; these operations will help to preserve favourable bank lending conditions and ensure the smooth transmission of monetary policy. Our stance does not endanger overall financial stability. In the current situation, the main risks come from the weak growth and inflation outlook. As is well known, the global crisis spurred a widespread debate on whether the mandate of central banks should be broadened to formally include the preservation of financial stability. Even though the latter is certainly a precondition for price stability, this change could raise potential conflicts between the two objectives, undermining the credibility of central banks and the effectiveness of their policies. Preserving financial stability should instead be the main task of macroprudential action. The same considerations apply to regulation and microprudential supervision: each policy can work well only if it has clear objectives and targeted intervention tools to achieve them. The deterioration in the international outlook has also had a strong negative impact on the Italian economy: economic activity progressively weakened in 2018, recording a slight contraction – a so-called “technical recession” – in the second half of the year. Overall GDP growth was just 0.9 per cent last year, around half the level recorded in 2017; all the main international forecasters expect it to decelerate further this year. The slowdown of activity in Germany, with which we share close economic ties, and the fall in business confidence, have been especially important factors in the weakness of aggregate demand and, especially, the marked deceleration in investment by Italian firms. Our surveys confirm that weak capital accumulation reflects greater cautiousness on the part of enterprises in the face of uncertainty about economic and political factors, and the persistent trade tensions. Economic activity returned to slightly positive growth in the early months of this year: according to the preliminary estimate GDP increased by 0.2 per cent in the first quarter of 2019. This trend could continue, especially if the global rebound in investors’ confidence observed since late 2018 proceeds and continues to exert its effects in Italy too. But to fully recover the path of sustainable growth, Italy must tackle its two main structural problems: the stagnation of productivity observed since the 1990s and the high level of public debt. Italy has been growing on average by around 1 percentage point less than the rest of the euro area since 1999. This is the result of the country’s delayed response to the big changes of our era: globalisation and the technological revolution. A short-lived relief provided by fiscal or monetary policy, albeit important, is not enough to solve this problem. To address it, Italy must quickly adopt a consistent growth strategy combining measures to support innovation, with those to improve the quality of human capital, and to create a more favourable environment for “doing business”. Following the double-dip recession associated with the two financial crises that erupted in the past decade (the global financial crisis of 2007–09 and the euro-area sovereign debt crisis of 2010–13), many Italian firms have introduced organizational changes that have enhanced their efficiency, making them more competitive on international markets. The restructuring process has been more intensive in the export sector and, as a result, domestic firms have been gaining 2/6 BIS central bankers' speeches market shares in many countries. It is a process that must continue and be extended to the rest of the economy, supported by appropriate public policies. In recent years various measures have been introduced to support high-tech investments and innovative start-ups. In order to be effective, industrial policy needs stable and appropriate fiscal incentives, while the regulatory framework must be aligned with international best practices. The Italian economy has many strengths that can help support these recent positive developments: private sector net wealth is high by international standards, the debt-to-income ratio of Italian families is low, exports remain strong and the current account of the balance of payments is in surplus – it has been this way for many years now, so much so that the net foreign asset position is balanced. A reduction in the risk premium on Italian public sector bonds is another crucial objective: at the beginning of this week the yield differential with respect to 10-year German bonds was over 270 basis points, more than twice the level prevailing in early 2018, before the latest general elections. The premia on credit default swaps suggest that the yield differential has risen as a result of the increase in both credit risk and the risk of redenomination of bonds in a different currency. The high public debt-to-GDP ratio exposes Italy to the volatility of financial markets, with the annual amount of bonds to be refinanced currently standing at around €400 billion. The average residual maturity of the public debt is above 7 years; therefore, the initial impact of higher interest rates on servicing costs is small but, if the increase in rates persists, it would inevitably weigh on expenditure. Reducing the differential between the interest burden on public debt and the nominal rate of growth of GDP – which is positive in Italy, compared with negative values in most advanced countries and throughout Europe, including in Greece – while maintaining an adequate primary surplus, is therefore of vital importance. The transmission of higher rates from government bonds to the cost of loans for households and firms has been limited so far, thanks to banks’ ample liquidity and improved balance sheets. But signs of tension are beginning to emerge. According to our surveys, credit conditions tightened somewhat, especially for small enterprises, following the increase in banks’ funding costs and the deterioration in the economic outlook. In the longer run, a high risk premium on government bonds would inevitably end up affecting the real economy. A credible strategy to reduce the burden of Italy’s high public debt in the medium term can no longer be postponed and the factors that lead investors to perceive higher risks, such as lax budgetary conditions and the prevalence of transfers and subsidies over growth-enhancing measures, should be tackled. The financial sector: progress and open issues In the euro area banks’ capital position has strengthened considerably. Between mid-2015 and end-2018 the capital (CET1) ratio of the so-called “significant institutions” – those under the direct supervision of the ECB, which account for around 80 per cent of the area’s banking assets – increased from 12.7 to 14.3 per cent. For the entire Italian banking system it stands at 13.3 per cent. In Italy the stronger capital position of banks has been accompanied by a substantial improvement in the quality of their assets, mainly thanks to large disposals of non-performing loans (NPLs). The deterioration in credit quality recorded during the global financial crisis and the European sovereign debt crisis was due for the most part (about 90 per cent according to our estimates) to the negative developments in the macroeconomic outlook. As of end-2018 the ratio of NPLs, net of provisions, to total loans had fallen to 4.3 per cent, more than halving with respect to mid-2015, when it had reached 10 per cent; in the same period, the value of net NPLs diminished from almost €200 billion to €90 billion. According to the plans requested from all banks by the supervisory authorities – the ECB for the significant institutions and the Bank of Italy for the others – the net NPL ratio should decline further, to around 3 per cent at the end of 2021. 3/6 BIS central bankers' speeches Notwithstanding significant progress in Italy and in the rest of the euro area, much remains to be done. Four areas require special attention: banks’ profitability, where intermediaries need to tackle the difficult challenges posed by technology; the appropriate treatment of risks on the asset side of banks’ balance sheets; the management of higher funding costs (and the need to satisfy the new requirements on “bail-inable” liabilities); and the framework for managing banking crises, which has turned out to be rather complex in recent years. Profitability. Despite recent improvements, the profitability of European banks remains weak: the average return on equity (around 6 per cent for the major intermediaries) is barely in line with the cost of equity in the euro area (and is somewhat lower in Germany and in Italy). The reasons are not only those related to the weak economic outlook. Indeed, in Europe the role of banks in financing the economy has been diminishing for over a decade, making it difficult to increase revenues by expanding credit volumes. The transition towards a more market-based financial system is necessary in a modern economy. In this respect, in the euro area non-financial companies continue to be excessively dependent on bank credit. The ratio of bank loans to total financial debts is 36 per cent in the euro area (56 per cent in Italy), against 33 and 27 per cent in the United States and the United Kingdom. By contrast, the share of bonds is still about 10 percentage points lower than in the United Kingdom and 30 points less than in the United States. The market capitalisation of listed non-financial companies is also insufficient: at end-2017 it stood at 25 per cent of GDP in Italy and 60 per cent in Germany, against around 125 per cent in the United States. In order to raise profitability banks must contain costs, diversify the sources of income, and find ways to significantly raise efficiency levels. The changes that are currently taking place in the financial sector pose novel challenges, but also provide fresh opportunities for well-managed financial intermediaries, among which banks can certainly be included. FinTech and Big Tech companies are offering new financial services and exploiting innovative technologies and massive amounts of data. Banks are responding by expanding the range of products provided through digital channels. It is a process that is bound to continue, as more intensive use of new technologies is necessary to compete effectively in the market and achieve adequate levels of profitability. Risks on the assets side. We can draw a number of lessons from Italy’s double-dip recession and the consequences for its banking system of both the global financial crisis and the sovereign debt crisis. The first lesson concerns the treatment of impaired assets, an area where Italy’s experience has been especially important. Following the large-scale disposals of bad loans completed in recent years, in Italy more than half of banks’ total NPLs currently consist in exposures to firms whose difficulties may prove to be temporary (loans defined as “unlikely to pay”). Their management should aim at maximising the probability that these loans become performing again. On the one hand, significant benefits could be obtained if non-financial firms, where necessary with the collaboration of banks, resorted to specialised operators such as “turnaround funds”, able to provide the knowledge and resources to relaunch impaired enterprises. On the other hand, supervisory and regulatory authorities should consider how best to support these strategies, including through the adoption of new specific measures. The current European regulation on minimum coverage of new NPLs, for instance, imposes increasing provisions on loans based only on the time that has elapsed since their classification as non-performing (known as “calendar provisioning”) and distinguishes only between guaranteed and non-guaranteed loans. The difference between bad and unlikely-to-pay loans is instead overlooked. There is therefore the risk of creating perverse incentives for banks to hold fire sales or liquidate NPLs, amplifying losses for both the banks and their customers and discouraging an active management of the credit relationship. This is an area in which regulation could be improved. 4/6 BIS central bankers' speeches Another lesson regards the debate that has intensified in the aftermath of the sovereign debt crisis about the so-called “bank-sovereign nexus” (or “doom loop”). Some have proposed that the prudential treatment of banks’ sovereign exposures be made more restrictive. These recommendations are built on the premise that a capital requirement or the assignment of a risk charge would break the link between banks and the State. But this link goes well beyond the holding of sovereign bonds. Indeed, it is the real economy that provides the most important connection: a restructuring of the public debt, for example, might be so disruptive that firms and households could be swept away by it, damaging the entire banking system regardless of its capitalisation or its holdings of government bonds. These proposals, moreover, overlook the stabilising role that banks, by acting as contrarian investors, can play on bond markets in periods of tension. For these reasons, after almost three years of work and intensive discussions, at end-2017 the Basel Committee decided to maintain the current regulation. The reduction in sovereign risk must ultimately come from sound government policy, as it cannot be obtained by simply shifting sovereign bonds from the balance sheet of one economic sector to that of another. This requires not only balanced and prudent fiscal policies but, most importantly, structural reforms aimed at regaining sustained GDP growth. The latter, in turn, would help make loans to households and firms more attractive, and reduce the share of government debt in banks’ balance sheets. While there has been a heated debate about NPLs and sovereign bond holdings, much less attention has been paid on the risks deriving from the stock of illiquid and opaque assets in banks’ balance sheets, including the instruments classified as Level 2 and Level 3 assets in the fair value hierarchy. These risks are not easy to measure, but available estimates put them broadly on a par with those associated with NPLs. The Single Supervisory Mechanism has recently adopted some initiatives aimed at defining the most appropriate interventions to take adequate account of these risks. These efforts must be intensified. The increase in the cost of funding is the third area that should not be neglected. In the coming years all large banks will have to raise a significant amount of “bail-inable” liabilities in order to fulfil the new global and European regulation on total loss-absorbing capacity (TLAC) and the minimum requirement for own funds and eligible liabilities (MREL). Raising funds may indeed pose a difficult challenge. Regulators and supervisors have to strike the right balance between the need to set appropriate criteria in order to stop taxpayers bearing the cost of future banking crises, on the one hand, and, on the other hand, the need to be sufficiently rigorous, with the risk, in persistently adverse market conditions for many intermediaries, of ultimately increasing the probability of future banking crises. The principle of bailing-in creditors makes sense but its concrete application requires care, especially in the current circumstances. The management of banking crises. Italy’s experience has revealed serious drawbacks in the new European regulation governing small-and medium-size intermediaries which, under the new rules, cannot access the facilities embedded in the so-called “resolution” procedure. For these banks – the vast majority of the roughly 3,000 euro-area institutions – a piecemeal liquidation is the only option currently available in the absence of interested buyers. But liquidation threatens the continuity of the supply of financial services, may imply large losses for both creditors and debtors and, due to potential contagion effects, may pose serious risks to overall financial stability. More must be done in this field, and from this perspective the experience of the United States is especially important. The US Federal Deposit Insurance Corporation – a government entity whose reserves are made up of private funds, but which can activate a large line of credit with the US Treasury – has successfully managed the crisis of almost 500 financial intermediaries since 2007, minimising the harm for the economy at large. It is a lesson that merits careful consideration. 5/6 BIS central bankers' speeches Conclusion Let me conclude. As the economic prospects for the euro area are currently dominated by uncertainty, many analysts fear that should the situation degenerate into a full-blown recession or lead to deflation, monetary policy would be disarmed. This is a mistake. Central banks can rely on a wide range of instruments to support economic activity and, if necessary, the Eurosystem is ready to use them all in order to fulfil its mandate. But monetary policy should not remain alone in sustaining the economy. In the absence of a common European budget, threats to the growth or inflation outlook require greater coordination of national fiscal policies, while structural reforms would provide essential help by boosting productivity dynamics. On the financial front, the most serious difficulties posed by the global financial crisis and the European sovereign debt crisis are now being overcome. In Italy there has been significant progress: NPLs have been halved, provisions have increased considerably and banks’ capitalisation has risen significantly, even though the legacy of the double-dip recession continues to weigh on some intermediaries. Further progress will depend not only on banks’ continued efforts to improve their balance sheets and lending strategies, but, above all, on their ability to rise to the challenges posed by the digital revolution, adopt strategies based on higher investment in new technologies, reduce operating costs and restructure their distribution network. Today there are also risks associated with the incompleteness of the European construction, as we have witnessed since at least 2010. The standstill in the reform of economic governance, due to a mutual lack of trust among countries that developed during the crisis, is particularly dangerous at this stage, as the constraints on national policies have been rapidly made more stringent but the introduction of their supranational counterparts has been delayed. In the economic and financial domain, it is clear what the most immediate steps should be: completing the banking union, rethinking the management of banking crises, and establishing a well-functioning capital markets union. But, at the same time, the reasons for discontent and criticism of European institutions also require a response. We must work to restore mutual trust, enhance security, and to create a sense of belonging. Italy must play its part by working hard and consistently to improve its economic environment and to make a credible commitment to a path of gradual but significant debt reduction. The hope is that, after the forthcoming European elections, the conditions will be established for resuming the reform agenda and pushing it forward with renewed vigour. Otherwise, as the song says, “the long and winding road will never disappear”. 6/6 BIS central bankers' speeches
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting for the presentation of the Annual Report 2018 - 125th Financial Year, Bank of Italy, Rome, 31 May 2019.
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The Governor’s Concluding Remarks Financial Year 125th financial year Annual Report Rome, 31 May 2019 th The Governor’s Concluding Remarks Annual Report 2018 - 125th Financial Year Rome, 31 May 2019 Ladies and Gentlemen, The Bank of Italy contributes to the definition of monetary policy in the euro area. It is the authority charged with safeguarding financial stability and supervising intermediaries. It manages payment settlement systems, monitors these systems and supervises the financial markets. It conducts economic, legal, and statistical research and provides services to the public. It is perhaps difficult to appreciate the sheer variety and breadth of everything the Bank does, given the many essential tasks it carries out in the public interest. In compliance with transparency requirements and legal obligations, the Bank provides an account of its work in the Report on Operations and Activities which, as is now customary, is published today together with the Annual Report. We are increasingly committed to promoting economic and financial knowledge and to communicating the results of our work. The Bank’s key functions are highlighted in our balance sheet, which I already talked about on 29 March in an Address to the Ordinary General Meeting of Shareholders. This also illustrated the Bank’s capital reallocation, a process which began in 2014 with the reform of the ownership structure, leading to an expansion of the shareholder base. Finally, it presented the results of the financial year for 2018, which recorded a net profit of €6.2 billion, €5.7 billion of which were allocated to the State, in addition to taxes amounting to €1.2 billion. Three of the five members of the Bank of Italy’s Governing Board completed their mandates this year. With the appointment of Fabio Panetta as Senior Deputy Governor, the confirmation of Luigi Federico Signorini as Deputy Governor and the designation of Alessandra Perrazzelli and Daniele Franco to the same role, the board has been fully replenished. Salvatore Rossi and Valeria Sannucci have retired from the Governing Board. They both brought their talents and skills to several sensitive positions within the Bank. The conclusion of his term as Senior Deputy Governor of the Bank of Italy means that Salvatore has also come to the end of his mandate as President of IVASS, which greatly benefited over the years from his drive for innovation. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 I am sure I speak for the Board of Directors in thanking them for their work in the service of our country. Let me add to the gratitude of the entire institution my own affectionate farewell to these two people I count as friends, with whom I have worked very closely over the course of my career and with whom I have shared the by no means light responsibility of managing the Bank during these undoubtedly difficult years. I would like to welcome Alessandra Perrazzelli, who has agreed to put at the service of the general public her considerable experience and proven ability in senior professional positions in Italy and abroad. I would like to welcome back Daniele Franco, whose outstanding technical abilities, along with his steady and balanced judgment, will be of great use to us over the coming years. The contribution of each and every member of the Governing Board is crucial in guiding the Bank’s operations. Yet nothing we do is or would be possible without the commitment and professionalism of all our staff: hired and promoted via rigorous, meritocratic procedures, immune to external pressures, and united by that spirit of genuine dedication to public service of which we are justly proud. Let me extend the heartfelt thanks of the Board of Directors, the Governing Board, and express my own personal gratitude to all the women and men working for the Bank. The international outlook and the Italian economy The system of supranational institutions and multilateral rules that has supported integration and global economic growth since the end of the Second World War has entered a very difficult phase. The trend towards trade openness, which had grown stronger in recent decades, has come to an end. The sharp deceleration in international trade observed in 2018 reflected tensions linked above all to the new protectionist strategy pursued by the United States (Figure 1). A large share of intermediate goods is produced abroad, and by increasing the cost of production factors, protectionist measures ultimately rebound on domestic firms and magnify the effects of tariffs on consumers. The repercussions on production are not confined to those caused directly by trade barriers, but also stem from the deterioration of firms’ confidence, the downward revision of investment plans, and the greater volatility of international financial markets. The International Monetary Fund predicts that global growth will fall to 3.3 per cent this year, the lowest figure since the contraction of 2009. The weaker conditions are widespread and affect areas accounting for over 70 The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA per cent of the global economy. The projections point to a recovery starting in the second half of this year, boosted by expansionary economic policies in the main countries and by the ensuing improvement in financial market conditions. There are still significant risks, however, including geopolitical ones. The slowdown is mainly affecting the economy of the euro area, which is more open to international trade than the United States or Japan. Reliance on foreign demand is particularly high in Germany, the most vulnerable country from this point of view, but also in France, Italy and Spain, countries that are all closely integrated into global value chains, including intra-European ones. The marked decline in business confidence is curbing investment (Figure 2), and in the second half of 2018 the downturn in the automobile industry contributed to the worsening of the macroeconomic situation. The growth projections for the euro area have been steadily revised downwards. According to the main international institutions, GDP growth will be just over 1.0 per cent this year and around 1.5 per cent in 2020: the risk of this trend being less favourable is not negligible. The weakness of production has affected both actual inflation and that expected by the markets. At the same time, the ECB forecast a slower convergence in inflation towards the objective of a level below, but close to, 2 per cent. Last March the ECB’s Governing Council announced that monetary policy would remain expansionary for longer than had previously been indicated. It expects that rates will stay at the current low levels at least until the end of 2019 and, in any case, for as long it takes to achieve price stability. The Eurosystem will continue to fully reinvest the resources obtained from the redemptions of maturing securities held under the asset purchase programme for an extended period of time. From next September there will be a new series of targeted longer-term refinancing operations to maintain favourable conditions on the credit market and the orderly transmission of monetary policy. The Governing Council reiterated that it stands ready to adjust all the available instruments to guarantee convergence towards the inflation aim. In the second half of 2018, GDP declined slightly in Italy. For the year as a whole, the rate of growth was 0.9 per cent, just under half that of 2017. Negative contributions came from the slowdown in output in Germany and greater uncertainty, which in turn was affected by the heightened tensions surrounding government securities. This led to a sharp downsizing of firms’ investment plans. Household spending also slowed, reflecting the deterioration of the economic outlook and sluggish employment rates since the summer. Permanent employment contracts in the private sector turned upward again, boosted by the conversion of fixed-term contracts. These were affected BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 in the second half of the year by the limits introduced by the ‘Dignity Decree’ which, together with the worsening economic situation, are nevertheless reducing the probability of remaining employed at the end of a fixed-term contract. In 2018, inflation stood at 1.2 per cent and the core component, net of food and energy products, remained below 1 per cent. The pace of growth in prices remained lower than in the euro area; the weakening of the economy weighed on labour costs and firms’ profit margins. Even though GDP recorded a slight increase in the first quarter, there is widespread consensus regarding the forecasts for much lower growth this year than the already subdued growth of 2018. To return to higher investment rates and more robust spending on consumption, trade tensions must subside, global financial market conditions must remain favourable and above all, the confidence of firms and households must rise again. According to official estimates, the introduction of a new basic income scheme (reddito di cittadinanza) and new pension measures, without taking account of the restrictive effects of covering the cost, would lead to an increase in GDP of about 0.6 percentage points over the three-year period 2019-21. This assessment appears reasonable if we assume that all the funds allocated are spent. By contrast, the assessment of the effects on employment, which is expected to be half a percentage point higher in 2021, displays ample margins of uncertainty. The tensions in Italy’s government bond market are curbing growth prospects. The yield on ten-year government bonds is almost one percentage point higher than the levels recorded in April of last year. The spread with respect to the equivalent German bond has increased by 160 to around 280 basis points, while it has risen by 140 to 190 basis points with respect to Spanish bonds (Figure 3). The premiums on credit default swaps indicate that both credit risk and the risk of the debt being redenominated in a currency other than the euro continue to push the yields on Italian government bonds upwards; these risks are closely interlinked and in times of tension could rise sharply in market assessments. The pass-through of the greater cost of public sector securities to that of bank loans to firms and households has been modest so far, thanks to the ample liquidity and the improved balance-sheet conditions of intermediaries. Nevertheless, signs of tension are beginning to emerge: surveys indicate that credit supply policies, though remaining relaxed overall, are gradually tightening, especially for small firms; this is due to both the deterioration in the macroeconomic outlook and to higher bank funding costs. It is estimated that, other things being equal, and discounting negative effects on firms’ and The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA households’ confidence, an increase of 100 basis points in the yields on public sector bonds would lead to a reduction of 0.7 per cent in GDP over three years. As acknowledged in the Economic and Financial Document (DEF), the cyclical slowdown is increasing the budget deficit in the current year. The increase in the debt-to-GDP ratio could exceed that indicated in the government’s budget (almost half a percentage point), which assumes revenue from privatizations amounting to about €18 billion (one percentage point of GDP). The structural difficulties of the Italian economy Our country has a number of strengths it can draw on to support economic activity in unfavourable conditions. In this decade, goods exports have kept pace with foreign demand, interrupting the protracted decline in Italy’s share of the global market. The current account balance turned positive again in 2013 and for three years now the surplus has stood at around 2.5 per cent of GDP; the net international investment position is practically in balance. Italy’s ability to compete on the international markets has benefited from the reallocation of exports towards forms of production which are less exposed to the pressures of emerging economies and made by more efficient and larger firms. At the end of last year, household debt was equal to 41 per cent of GDP, as against 61 per cent in the other euro-area countries as a whole; the value of savings, of which more than 60 per cent in real estate, was more than eight times that of income, compared with an estimated seven times for the rest of the area. Firms’ debt is also low: equal to 69 per cent of GDP, against 112 per cent in the other countries. Overall, however, the economy has been struggling to pick up since the double-dip recession. GDP is still more than 4 percentage points below what it was in 2007, and 7 percentage points in per capita terms. Though it has regained the 2007 level of 59 per cent, the employment rate is 9 points below the euro-area average. The development gap has increased in the South of Italy, where more than 18 per cent of the labour force is unemployed, compared with 7 per cent in the Centre and North; the gap is 4 percentage points higher than it was in 2007. The problem is not merely low aggregate demand. In the decade preceding the crisis, Italy also lagged behind the other euro-area countries by around one percentage point per year (Figure 4). Despite the measures enacted, our economy’s capacity to grow and to achieve high employment rates is BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 weighed down by the unsatisfactory quality of public services, inadequate infrastructure, low levels of competition and the distortions associated with widespread tax evasion and corruption, not to mention the obstacles posed by organized crime. The result is an economic climate that is little predisposed to business and its growth, to investment and to employment. To confine ourselves to seeking temporary relief by raising the public deficit could prove less than effective, even counterproductive, if this led to a deterioration in financial conditions and in the confidence of households and firms. The risk of a ‘restrictive expansion’ must not be underestimated; the expansionary effects of a budget can be more than offset by the restrictive ones of higher financing costs for the State and the economy. The high debt-to-GDP ratio continues to be a severe constraint; to lessen it, there must be no delay in defining a rigorous and credible strategy for its reduction in the medium term. Compared with the rest of the euro area, the cost of Italy’s public debt is higher and its economic growth lower. Aside from Greece, on average in the last four years Italy is the only other country to report a large and positive gap between these two variables; at 1 percentage point, this gap has in turn pushed up debt-to-GDP ratio by around 1.3 points per year. In the same period, GDP growth was 0.3 percentage points higher than the average cost of the debt in France, 1.0 points higher than that in Spain. When the gap between the cost of the debt and economic growth is positive, what is needed, if only to stabilize the debt, is a primary surplus (when revenues exceed expenditure net of interest expense). The larger the gap, the bigger the surplus required. The increase of 1 percentage point recorded in the average yields at issue of Italian government securities in 2018 followed a decline of around 3 points between 2012 and 2017. The risk of this leading to a further widening of the gap between the cost of the debt and the GDP growth rate must be countered (Figure 5). Only careful budgetary control and solid prospects for a return to higher economic growth rates can boost confidence in the government bond market and bring yields down towards the levels prevailing in the rest of the euro area. Ensuring that the budget can contribute to a lasting increase in GDP growth calls for incisive interventions in the composition of expenditure and revenue. Greater prominence should be given to programmes better able to stimulate economic activity, as opposed to subsidies and transfers. This must be accompanied by measures designed to limit the distortions introduced by taxation, especially in the labour market, and to step up the fight against tax evasion. Increases in public expenditure or lower revenues must, however, be part of a framework that guarantees financial sustainability and specifies objectives, priorities and sources of funding. The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA Public investment expenditure amounts to about 2 per cent of GDP, one third lower than it was at the start of this decade. The objective of recouping half of the lost ground in three years, with planned increases in spending in the order of 10 per cent per year, assumes a big improvement in the ability to move from identifying what needs to be done to actually getting it done. But it is not enough to simply spend more; resources must be utilized more effectively, by improving the procedures for selecting, assigning and executing the works. By international standards, Italy is behind both in terms of works completed and money spent. A primary surplus of under 0.5 per cent, such as would be obtained in 2020 if the VAT increases under the safeguard clauses envisaged in current legislation were deactivated without any countermeasures, would be incompatible with a reduction in the debt-to-GDP ratio; it would have adverse effects on the risk premiums on public sector securities and, subsequently, on economic activity. Making the deactivation of the VAT clauses conditional on the identification of compensatory measures, as the Economic and Financial Document (DEF) does, reflects these concerns. All the possible options call for a careful and transparent evaluation of the potential effects on demand, economic activity and income distribution. Looking ahead, what Italy needs is a broad-based tax reform. Since the early 1970s, new forms of taxation have been introduced and a complex set of concessions and exemptions progressively put in place, with no comprehensive plan and, not infrequently, with unclear guidance. Reforming only some concessions or restructuring just one tax means continuing this process of stratification. Instead, this must stop, and a stable framework erected that gives certainty to producers and consumers, investors and savers, with measures that reward workers and are pro-business. Account must also be taken of how the various components of the taxation system interact: indirect taxation with forms of low-income support; direct taxation with detractions and deductions; income support with employment incentives; interactions between the various exceptions to the general taxation regime envisaged for each taxable base; and between these components and the fight against tax evasion, taking full advantage of all the available technologies. Italy is a country with a rapidly ageing and shrinking population. While these trends are common to many EU countries, they are more evident here. The medium scenario projection published by Eurostat shows that in the next 25 years, the share of the population aged at least 65 will reach 28 per cent in the European Union as a whole and 33 per cent in Italy; the financial pressures on pensions and long-term care will increase as a result. The population aged between 20 and 64 will fall by 6 million in our country, BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 notwithstanding a hypothetical net influx from abroad of 4 million persons in this age group (Figure 6). The reduction in production capacity linked to demographic trends must be countered with sharp increases in the labour market participation rate and in productivity. The participation rate is still 8 percentage points below the European average, despite having risen in the last 20 years, from 61 to 66 per cent. As in the other countries, the main contribution has come from older workers, linked to changes made to the pension system. The female participation rate has also risen, from 47 to 56 per cent. The increase has nonetheless been less marked than that recorded in the rest of the EU and the male participation rate is still 19 points higher than that of women, one of the largest gaps in Europe. This suggests that there is much potential for increasing labour force participation and highlights the need to act decisively to identify and introduce measures, services and incentives designed to raise the female participation rate. Immigration can help to boost Italy’s production capacity, but the difficulties encountered in attracting high-skilled workers and in integrating and training those who come from abroad. Since the early 1990s, the number of immigrants arriving in Italy has surpassed that of emigrants every year. After falling slightly during the sovereign debt crisis, net immigration has continued to rise, reaching almost 190,000 people in 2018 or 0.3 per cent of the population. The share of foreigners who hold degrees, equal to almost 13 per cent, is less than half the EU average. Productivity and entrepreneurial skills are also being adversely affected by the gradual increase in the number of young people and university graduates leaving Italy every year, reflecting structural lags in the economy. In the space of ten years, youth emigration increased fivefold to reach 0.5 per cent in 2017, while at 0.4 per cent, graduate emigration more than doubled. Italy has been slow to respond to the technological revolution (Figure 7) and economic growth has been badly hit as a result. The sectors comprising the digital economy today contribute 5 per cent of total value added, against 8 per cent in Germany and 6.6 per cent on average in the European Union. Since the outbreak of the sovereign debt crisis, the relative weight of these sectors has declined in Italy, going against the trend in terms of the European average. But we must invest in advanced and green technologies for the very sustainability of economic and social development, and to preserve environmental balance. The gap with respect to the rest of the EU concerns almost all sectors where firms can adopt innovative technologies; in the automation of The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA production processes it is very apparent in countries that have the kind of sectoral specialization Italy has, such as Germany. The development of new generation telecommunications networks remains limited. The role of central government in promoting the introduction of new technologies is similarly modest; the European Commission’s Digital Economy and Society Index (DESI) ranks Italy 19th for digital public services. One of the factors that has slowed the advent of the digital economy has been Italy’s fragmented production structure, mainly comprising small firms, whose ownership and management arrangements often overlap, and which are little inclined to accept external injections of capital, technology and expertise. In 2017, fewer than one fifth of firms with between 20 and 49 workers had adopted at least one advanced technology (such as robotics and artificial intelligence); this share rises to one third among medium-sized firms and is more than half for those with 250 or more workers. The more complex the technologies considered, the wider the gap between small and large firms. The fragmentation of the productive sector has had a negative effect on firms’ capacity to innovate: expenditure on research and development in the private sector amounted to 0.8 per cent of GDP in 2017, less than half the average in OECD countries. It is low in the public sector too (0.5 against 0.7 per cent). At just below 1 per cent of GDP, the share of resources devoted to the university system is roughly one third below the OECD average. In recent years, incentives have been introduced to support investment, research and development, and innovative start-ups. These measures have proved effective overall. Some of these incentives were confirmed in the latest budget law or in last April’s ‘Growth Decree’, recalibrated mostly in favour of small and medium-sized firms. To be effective, industrial policy requires a stable legislative framework that facilitates change in the economy as a whole. Low investment in innovation has been accompanied by the comparatively poor acquisition of knowledge and skills by Italian students and adults; these delays feed into one another, in a vicious cycle that must be reversed. Investments in training that accompany individuals throughout their working lives are also necessary to prevent the risk that the adoption of new technologies, with the attendant drop in demand for the workers most affected by the advent of automation and digitalization, will magnify inequalities of income and opportunity, and reduce employment. Italy’s difficulties are amplified in the South and Islands, harder hit by the double-dip recession than the rest of the country. First and foremost, the business climate in the South needs to improve, especially in relation to guaranteeing legality. The technological gap to be bridged is even wider: the BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 share of value added ascribable to the digital economy, at close to 2.5 per cent, is more than 3 points below that of the Centre and North. The skills gap must be narrowed, public policies made more effective, and the quality of local government and infrastructures improved: 70 per cent of ‘unfinished works’ are located in these regions, of which only 30 per cent are public works. Roughly one third of Italy’s population lives in the South of Italy, which generates almost one quarter of the country’s GDP. The southern regions are becoming poorer still now, owing to the emigration of their youngest and most highly-educated people, mostly to the Centre and North of Italy. In the last ten years, net migration has been barely positive overall, but there has been a large net outflow of young university graduates. It is a trend that has immediate social costs and impacts negatively on the prospects for growth. Over the years there have been numerous attempts to deal with the economic difficulties of the South, with very different interventions whose results, on the whole, have been disappointing. Support measures can contribute to growth in the regions that lag behind; they must not, however, distort the incentives for firms and workers by hindering the optimal use of resources. To improve the economic conditions in the South and Islands and to raise growth potential requires long-term action, fully exploiting the opportunities afforded by European and national funds. It is necessary to intervene in the factors underlying the delays in the South; attempts to compensate for them with monetary transfers cannot be the only solution. The effects on the southern economy of public investment in schools and infrastructure could be highly significant. Banks, finance and supervision Even though banks’ balance sheets continued to strengthen in 2018, the effects of the crisis have not yet been fully reabsorbed and are delaying their response to the profound changes in the industry’s market structure, customers’ habits, financial regulations and technology. As in the rest of the euro area, profitability, though recovering, remains low and the incidence of operating costs is still high; these trends are reflected in banks’ share prices. Some medium-sized banks are still experiencing difficulties, which are being dealt with by the Italian and European supervisory authorities and by the government. Solutions are being actively sought to relaunch banks and to protect those involved. The outlook for banks is still closely linked to the performance of the economy and to the perception of country risk, which affect asset quality and the costs they incur in raising funds on the markets. For the entire The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA banking system, capital ratios, which in mid-2018 were affected by tensions on government bonds, are recovering; at the end of 2018 the CET1 ratio of banks directly supervised by the ECB stood at 12.7 per cent of risk-weighted assets, against an average of 14.3 per cent for significant euro-area banks. Adverse cyclical developments would inevitably affect balance sheets again, so the need remains for continued decisive action to reduce costs and improve profitability. In Europe the use of digital channels in banking intermediation is in constant growth. Over the last decade, the share of customers using the Internet to access their current accounts has almost doubled (Figure 8) and the number of branches has been reduced by about one quarter. The spread of more complex technologies (FinTech) is rapidly transforming the structure of the financial industry. The management and analysis of big data, the use of artificial intelligence and machine learning, and the potential offered by distributed ledger technologies are changing the services provided; they are also opening the sector to new competitors – including, but not only, the Big Techs – that are able to swiftly exploit the advantages of operating in the digital economy and trade. Market estimates indicate that investment in financial innovation, mainly attributable to large technological firms and start-ups, has increased sixfold at global level in the last five years; in 2018 it exceeded $100 billion, one third of which in Europe, but it is still modest in Italy. Italy’s banks are providing more and more traditional services online, in order to increase organizational and operational efficiencies. Almost all banks now permit payments to be made using mobile devices, often for small amounts; over half of them place savings products through digital channels; though on the increase, the number of banks offering loans through portals is still modest (Figure 9). Nevertheless, the delay in responding to the challenges posed by the use of more complex technologies risks the gradual erosion of market shares. According to our surveys, half of the banks have yet to launch or even plan to launch trials in this field, for instance in the use of new instruments for assessing creditworthiness. A relatively limited amount of resources are allocated to these projects and are concentrated among the larger banks. Using technology to provide customized services with greater value added can generate tangible benefits in terms of reducing costs, broadening consumer choice and increasing profitability. The smaller banks, for whom investment at individual level is too costly, can enter joint initiatives for the outsourcing of services designed to promote their products. The spread of new technologies, however, also carries new risks, especially regarding cyber BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 security and customer data protection; IT projects require particular care and advance planning. The Bank of Italy is also experimenting with the use of new technologies in its supervisory activity. Recourse to artificial intelligence is not confined to seeking improvements in forecasting economic and financial variables; it is also useful for analysing the level of investors’ trust in banks and it boosts the effectiveness of anti-money laundering activities. The Bank has long been in contact with market operators offering innovative solutions: since 2017 we have had an innovation hub, ‘FinTech Channel’, on our website. This direct interface with operators in a digital environment makes it possible, by means of advance knowledge of new projects, to assess their compliance with legislation, identify potential problems and consider changes to the rules and procedures applied at national level. The importance of preventing and controlling cyber risks is bound to grow in an increasingly digitalized and interconnected system in which outsourcing is on the rise. The computer emergency readiness team for the financial sector (CERTFin), presided over by the Bank of Italy and the Italian Banking Association, whose members also comprise other sectoral authorities and most financial and technological operators, facilitates the exchange of information during cyber attacks, supports operators in the event of security breaches and helps to improve the effectiveness of firewalls. We play an active part in international cooperation initiatives – especially in the Financial Stability Board, the Bank for International Settlements and the G7 – to define common standards and lines of action to limit cyber risks at national and global level. Bank credit quality continues to improve (Figure 10). Thanks in part to the improved economic situation in recent years, the new non-performing loan rate has fallen below the levels observed before the global financial crisis; in the first quarter of this year it was equal to 1.3 per cent. The stock of non-performing loans declined considerably, especially as a result of some major sales, totalling €26 billion in 2016, €42 billion in 2017 and €55 billion in 2018. Driven by pressure from the supervisory authorities, the increase in sales also benefited from banks’ progress in providing detailed information on the characteristics of exposures and from the greater number of NPL recovery specialists. The coverage ratio reached 52.7 per cent at the end of 2018, 6 percentage points higher than the average figure for the main euro-area banks. Net of write-downs, the ratio of NPLs to total loans fell to 4.3 per cent for the banking system as a whole, down from 9.8 per cent at the end of 2015; according to the plans The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA required of all banks by supervisors, it is expected to reach around 3 per cent at the end of 2021. Due to the reduction in bad loans achieved in recent years, more than half of banks’ net NPLs now consists of exposures to firms in temporary difficulty (unlikely-to-pay). It is important to do as much as possible to enable these loans to be reclassified as performing; as happens in other countries, recourse to specialized investors, such as turnaround funds, can provide resources and knowledge to help firms in difficulty, possibly with the banks themselves. The contribution that the reform of corporate crises can make to effective business restructuring processes will have to be evaluated. In 2018 profitability showed signs of improvement, mainly following the reduction in loan loss provisions and lower operating costs. Nevertheless, the cost-to- income ratio is still high (66 per cent) and the return on equity (5.7 per cent) remains lower than that which investors would require to subscribe newly-issued shares. This gap, which is also affected by the higher country risk, hinders both market access and efforts to strengthen the capital bases of Italian banks. The amount of bank bonds maturing by the end of next year exceeds €70 billion. At a time when yields at issue are high by international standards, raising funds on the market is a major challenge for the bigger banks too: the new crisis management rules require the establishment of an ample reserve of liabilities, capable of absorbing losses and replenishing capital. The need to roll over and increase wholesale funding will tend to reduce net interest income. Market access remains difficult for smaller banks; creating institutional demand for their bonds could bring significant benefits. With the establishment of two cooperative banking groups this year, the reform launched in 2016 to strengthen the overall solidity of this category, while preserving its mutualistic nature, has been enacted. The new groups must combine the benefits of the individual banks’ proximity to and knowledge of local firms with an effective exploitation of cost synergies, in order to increase profitability and the capacity to turn to the market when necessary; maximum effort is vital on these fronts. For the popolari banks classified as less significant for supervisory purposes, last year the cost-to-income ratio was higher than the system-wide average, return on equity was lower, and the stock of NPLs was still high. These banks are in urgent need of close forms of cooperation or mergers that allow them to compete on the market. Such actions are necessary to preserve the capacity to use resources collected locally to finance, with foresight, economic development, especially in southern Italy, where the limited size BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 of banks and the greater riskiness of the business environment affect overall supply conditions. Adequate consumer protection is vital in promoting confidence in the financial system and in individual banks. The latter, in line with the provisions introduced by MiFID II on investment services and with the rules on banks’ product governance, need to orient their behaviour towards the goal of ensuring effective fairness, while taking account of customers’ characteristics and needs. The Bank of Italy is strongly committed to overseeing bank products; it also collaborates with Consob, which is responsible for investment services. In recent years, our interventions on individual banks have been supplemented by thematic action in areas such as the organization of complaints offices, the charging of some fees, unilateral contract changes made by credit institutions, and salary-backed loans. The forms of individual protection offered by the Banking and Financial Ombudsman have been reinforced and there will soon be an ombudsman for insurance disputes too. Over the last few years, the insufficient attention paid by a number of intermediaries to compliance with anti-money laundering rules has become apparent in Europe. The ensuing risks are high and often go beyond national borders. At EU level there is an ongoing debate as to how to strengthen and harmonize the necessary regulatory and supervisory requirements. At a time when the threats of money laundering and the financing of terrorism are particularly significant at international level, efforts to prevent supervised intermediaries from being infiltrated by criminal activities must be a strategic goal for senior management. In Italy supervisory action is unceasing; a specific agreement with the Financial Intelligence Unit encourages cooperation, the identification of risk factors, and coordinated interventions for monitoring and applying sanctions to intermediaries. In the event of suspected criminal offences, the information provided to the judicial authorities is of the utmost importance, and the Bank responds swiftly to any requests they make. The role of markets and non-bank intermediaries in allocating resources is increasing in Europe and at global level. This trend may bring benefits to countries such as Italy, where banking intermediation plays a predominant part. A diversified financial system supports economic growth and mitigates the effects of adverse shocks on production. Deep and liquid capital markets are needed to encourage investment, especially in innovative and long-term projects; specialized operators that facilitate the supply of equity and assist firms in the various stages of their development are also required. In order to prevent disorderly and opaque developments from creating risks to overall The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA stability, the authorities must remain especially vigilant, in the FSB and in the other fora for international cooperation. Between 2014 and 2018, some 116 non-financial corporations obtained listings on the stock exchange in Italy, against 39 in the previous five years, and over 500 companies placed bonds for the first time. The share of household savings entrusted to institutional investors has increased by 14 percentage points over the last decade, to 31 per cent. These developments have been favoured by tax incentives. Recourse to equity has been encouraged as have bond issues by non-listed companies; other incentives have supported investment in venture capital funds and in the securities issued by innovative firms. The introduction in 2016 of individual savings plans (piani individuali di risparmio or PIRs) has favoured household investment in Italian companies’ securities. However, there is still a large gap compared with countries where capital markets are more developed. In France and in the United Kingdom, the ratio of market capitalization of non-financial companies to GDP is more than three times that of Italy and the ratio of bonds to firms’ total financial debt is almost double. Promoting the development of non-banking finance must continue, by assessing the effectiveness of the initiatives already introduced, streamlining interventions and favouring regulatory stability. Frequent changes – as in the case of the repeated revisions of incentives for capitalizing firms and of the reform of the PIRs included in the last budget law – could heighten uncertainty, with negative effects on the allocation of savings and on firms’ financing choices. While for the largest firms, which can stand up to the scrutiny of external investors and sustain the costs of access to capital markets, non-banking finance is sure to become a key point of reference, for most businesses, banks will remain the first port of call for external resources. Healthy firms must be able to count on the support of banks and markets, regardless of their size. Management policies for loans to micro-enterprises and small firms need to select and measure risks carefully; they could benefit from technological innovation, something which is in the interest of both the firms that find it hard to access credit and of banks themselves. Italy and Europe Italy is deeply integrated in the European economy (Figure 11). Some 60 per cent of our imports come from other EU countries, which in turn receive 56 per cent of our exports. In the last 20 years, partly as a result of the Union’s enlargement, exports to EU countries as a share of GDP have increased by BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 almost 5 percentage points, to 18 per cent. Two thirds of direct foreign and portfolio investment in Italy are from EU countries, which are themselves the recipients of 60 per cent of comparable Italian investments. Italy was one of the main beneficiaries of EU transfers for a long time. In the 1980s, annual average net funds amounted to 0.4 per cent of GDP. Partly owing to the accession of new member states, the country’s position then gradually changed. Since the early 2000s, Italy has been a net contributor to the EU budget; since 2014, net outward transfers have amounted to just under 0.2 per cent of GDP per year. France and Germany contribute more (0.3 and 0.4 per cent of GDP respectively). In gross terms, the resources allocated to support disadvantaged regions in our country for the period 2014-20 amount to €34 billion or to an annual average of 0.3 per cent of GDP. Their efficient utilization must be a priority as is determination in overcoming past obstacles. Europe’s institutions promote research and innovation through programmes that channel resources towards shared objectives, facilitate cooperation among member countries’ institutions, and increase opportunities for private-public sector collaboration. Universities, research centres and high-tech firms are important contributors to the EU’s innovation programmes and derive tangible benefits from the opportunities for exchanging information and ideas. If Italy’s research system were larger and better organized, greater resources could be obtained from such programmes. Inflation, which was close to 20 per cent in the early 1980s and still as high as 5 per cent in the first half of the 1990s, reached 2 per cent in the two years prior to the adoption of the euro and stayed around that level until a few years ago; the more recent risk of deflation has been averted thanks to the monetary policy measures in place since 2014 (Figure 12). The single currency has stabilized the reduction in the occult tax that curbed households’ purchasing power and forced the country into making repeated devaluations with temporary benefits for some firms but costs for the wider community. Thanks to the reduction in inflation and exchange rate risk, as well as to the possibility of accessing a bigger financial market, the yields on government securities and those on loans to firms and households came down in the lead-up to the euro. Neither the European Union nor the euro are responsible for Italy’s sluggish growth over the last twenty years; almost all the other member states have performed better than we have. What today are sometimes perceived as the costs of belonging to the euro area are, in reality, the result of Italy’s tardy response to technological change and to global markets opening up. The specialization of production in mature sectors has exposed the economy The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA to competition on prices from emerging countries. Hesitating to reduce imbalances in the public accounts has curtailed the scope for policies on macroeconomic stabilization and for achieving sustainable growth. It is up to us to become aware of the problems and to address them, including with the help of European instruments. Others have done precisely this and done it well. Although the single currency was a vital step on the path to European integration, economic and monetary union remains an unfinished construction. Europe’s architects knew this, and wanted and anticipated greater progress in the future. Even before the introduction of the euro, the unusual status of a Stateless currency had been underlined, as had the institutional solitude of the ECB and the problems posed by the imperfect mobility of capital and labour. Trust was placed in the push that integration would give to the economic convergence of the member states and in a strategy of progressive reforms, to be enacted when the political conditions were right. The risks inherent in this process materialized with unanticipated violence during the sovereign debt crisis. The inadequacy of the euro area’s economic governance was laid bare: the rules of the Treaties failed to guide national policies appropriately and to ensure the necessary coordination; the lack of shared instruments for managing national economic crises has made them longer and deeper, and has raised the risk of episodes of contagion. The proposals for reform drawn up after the peak of the crisis envisaged the gradual strengthening of integration, first in the financial arena and then for public finances. Yet only partial progress has been made so far. The banking union is incomplete and not without flaws, the bases for the capital union are still being laid, and fiscal union has been postponed to an unspecified future date. Efforts to reduce national risks before agreeing to share them – and even then not all risks – end by increasing them and heightening the feelings of precariousness that surround the euro. Risk reduction and sharing must go hand in hand and mutually reinforce one another; the pooling of risks increases sustainability for all. The idea that what is instead needed is to proceed by degrees reflects political and economic concerns linked to residual differences between member states. It is the result of the mutual distrust that developed during the crisis, fuelled by doubts about the ability and desire of countries to tackle problems with the necessary determination and their willingness to draw up rules and policies in the common interest. Standing at the crossroads of the reform process, the euro area’s economic growth is being held back and the area itself continues to be exposed to financial risks. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 Italy has a duty to help Europe exit this impasse and can play a constructive role in identifying the necessary steps for completing economic and monetary union. The more successfully it removes the structural obstacles to a return to a stable growth path, and embarks on a credible reduction plan for its public debt, the more authoritative its voice in Europe will be. What Europe needs are integrated markets in finance, labour, goods and services, with common rules and procedures. It needs coordinated economic policies, built on sharing medium-term strategies and objectives. It needs instruments that enable it to swiftly tackle difficult situations, with decision-making processes that are not encumbered by drawn-out negotiations and uncertain outcomes. Banking union must be accompanied by rules and arrangements for the effective and orderly management of banking crises, so that they are not themselves sources of instability. It is especially important to ensure that a disorderly liquidation is not the only option available for the crises of small and medium-sized intermediaries which, like most European banks, are not subject to resolution, as this would create serious risks for the continuity of financial services, for savers, and for stability as a whole. The new possibilities opened up by the recent pronouncement of the General Court of the European Union on preventive interventions by mandatory deposit guarantee funds should be explored further. At European level, the rules on State aid to safeguard competition must take account of the need to guarantee financial stability and, in any event, must be applied with due proportionality relative to the size of the intermediaries concerned. The widespread concern over high public debts is justified, but the idea that a review of the prudential treatment of sovereign exposures is indispensable to break the sovereign-bank nexus fails to consider that this is primarily sustained through channels other than direct exposures. The main channel is the real economy; a sharp rise in the perceived risk of one State’s debt can quickly trigger a recessive spiral, kindling social tensions with unpredictable results. The blow to the banking system would be severe, irrespective of its capitalization and direct exposure. Nor is there any evidence that the benefits associated with a reform of the prudential treatment of sovereign exposures outweigh the costs, or that the associated reduction in risk could be achieved by simply shifting the public debt securities from banks to other holders. Only a combination of prudent budgetary policies and credible, growth-oriented structural reforms can simultaneously drive a sustained increase in lending and a reduction in public sector securities on banks’ balance sheets. The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA The Euro Summit held last December reached an agreement on strengthening the European Stability Mechanism’s role in managing and preventing crises in euro-area member states. The conditions that countries must respect to access the ESM’s precautionary funding instruments were specified and cooperation procedures agreed between the ESM and the Commission for monitoring the public accounts of the member states. To reduce uncertainty as to how and when a sovereign debt can be restructured, the Summit also decided to introduce ‘single limb’ collective action clauses (CACs) in euro-area government bonds by 2022 and that, if requested by the member state, the ESM could facilitate the dialogue between that state and private investors. This uncertainty, however, only contributes to a small extent to the cost of a possible insolvency crisis. Given the close economic and financial ties between the euro-area countries, the effects of a crisis of this kind would be serious and unpredictable not only for the country directly involved, but also for the others. Europe should seek ways to support the efforts that must be made by member states to reduce their debt. Rigorous and prudent budgetary policies are indispensable, but the lowering of the debt-to-GDP ratio is a necessarily long process, which could be disrupted by events outside the control of individual governments; this is why some form of supranational insurance is needed, for example through the creation of a European debt redemption fund financed by dedicated resources of the participating countries. The heated debate on NPLs and sovereign exposures tends to overlook other significant risks to which banks are exposed. One example is the high stock of illiquid and opaque assets on the balance sheets of some major European intermediaries, which the Single Supervisory Mechanism recently addressed in a series of initiatives to define the necessary interventions. The tendency to have an asymmetric vision of the importance of these risks was confirmed in the decisions of the Euro Summit in December: the possibility of the financial support provided by the ESM to the Single Resolution Fund being made operative before 2024 is conditional on progress being achieved in risk reduction measured solely in relation to NPL volumes and on building up buffers of liabilities to be used in a crisis. The smooth functioning of a currency area requires a single capital market that facilitates access to financing for businesses. In addition, an integrated market helps to absorb local macroeconomic shocks, increases the robustness of the economic system, and strengthens financial stability. Its complementarity with the fiscal union and monetary policy is evident in this regard. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 A fiscal union, which can take different forms but must promote macroeconomic stabilization before all else, would reconcile the full exercise of this function with balancing public accounts in each country. While it is difficult to conceive of any immediate adoption of discretional instruments, it is instead possible to plan for common automatic stabilizers, for example mechanisms that would fund part of the expenditure on unemployment during downturns. Designed in such a way as to avoid systematic cross-country transfers, these instruments would help to make the European employment market more fluid and the benefits of economic and monetary union more tangible. Monetary policy was the sole line of defence during the sovereign debt crisis and against the risks of deflation that emerged in the years thereafter. The ECB’s Governing Council demonstrated its readiness to use all of the instruments available to it and, if necessary, to introduce new ones to pursue the objective of price stability. It was successful, but its actions could have been even more effective had they been accompanied by other economic policies. The introduction of safe assets in the euro area is the common denominator necessary for the completion of the three unions – banking, capital markets and fiscal – that must flank monetary union. By partly replacing national government bonds, a European debt instrument could help to diversify the sovereign exposures of financial institutions; it could reduce the risk of flights to safety by investors in times of market tension triggering massive capital outflows from the countries in difficulty, instead enabling the financial market to play an effective role as shock absorber; and it could be an instrument for funding shared automatic stabilizers. It is possible to design mechanisms that enable a safe asset to be introduced with the necessary safeguards against the risk of opportunistic behaviour. But aside from the rules, the essential requirement for the viability of this solution lies in a renewed and convinced commitment by all to the European project and a willingness to pursue common solutions for common problems. * * * The euro was introduced twenty years ago. It was by no means a given that Italy would be part of the single currency at the outset, but our country was resolute in its pursuit of the economic and financial objectives required to achieve that goal. Expectations were high; taking this brave step towards ever greater union between European countries sealed the commitment to continuing along the path of development built on the rubble of the Second The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA World War; there was little, though some, perception of just how much needed to be done to complete the economic and monetary union or of how great a responsibility was being entrusted to the European Central Bank in the absence of a political governance of the economy. Italy has not responded to other challenges with the same determination. It has been slow to react to the changes imposed by technological progress and by the opening up of global markets, remaining more exposed than other countries to competition from the emerging countries. It has yet to complete the restructuring of the public accounts begun in the 1990s, which involved shouldering the risks connected with its heavy reliance on the financial markets to fund the government debt. Tensions that have also been felt in the other advanced economies have been exacerbated by this dual weakness in Italy. A country where productivity was already sluggish has had to bear the consequences of a global financial crisis that began on another continent and of a sovereign debt crisis which it had done nothing to trigger. The economic and social suffering has been aggravated by the real and perceived difficulties encountered in managing growing migration flows. The euro area had neither the governance nor the tools to deal with crises of this magnitude. In its pursuit of medium-term price stability, the single monetary policy can mitigate common cyclical difficulties, but it cannot intervene in favour of individual countries nor can it solve structural problems, whether they affect just one country or the euro area as a whole. Yet holding Europe responsible for our troubles is a mistake; there is nothing to be gained by it and it diverts attention from the real issues. Italy is still struggling to recover from the double-dip recession as it is paying the price of not being – in terms of public service quality and respect for the rules – a business-friendly environment. It suffers from a serious technological lag, the result of a production structure that is fragmented and counts a high proportion of firms that find it difficult to grow and innovate. It is weighed down by the distortions caused by tax evasion and by the public debt, which makes funding more expensive for households, firms and banks, as well as for the country itself. A state of constant uncertainty squeezes firms’ investment and household consumption. Labour suffers, and social hardship increases. The performance of the economy and country risk in turn affect the conditions of banks. The progress on credit quality, profitability, and banks’ assets observed in the last few years in many cases reflect the significant efforts made, supported by the Bank’s supervisory activities and helped by the improved economic situation and relaxed financial conditions that prevailed BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 up until the spring of 2018. The possibility that macroeconomic risks could again hit a financial sector that has yet to reorganize is a source of vulnerability of which we must be aware. Sustaining growth and easing tensions on the financial markets remain crucial to guaranteeing that this vital component of the economic system is fully functional. If we look beyond the short-term horizon we cannot ignore the risk, implicit in demographic trends, of a sharp deterioration in Italy’s production capacity, and the prospect of strong pressures on public finances. From here until 2030, without the contribution of immigration, the population aged between 20 and 64 is expected to fall by 3.5 million, and by a further 7 million in the subsequent fifteen years. Today, for every 100 people in this age group, 38 are at least 65 years old; in twenty-five years’ time, this share will have risen to 76. Italy’s inability to attract highly-skilled labour from abroad and, indeed, the concrete risk of losing our best and most dynamic workers, makes this outlook even more worrying. A more careful calibration of the budget towards measures to support work and production activities, a rigorous and credible strategy to reduce the burden of the public debt, and broader structural reforms, designed to eliminate bureaucratic and administrative obstacles to competition and investment in physical and human capital, can all help to restore higher growth rates and confidence in the government bond market. This process can be facilitated by effective action to combat evasion as part of a broader tax reform. Everything possible must be done to raise labour market participation rates, by prolonging working lives in line with the increase in life expectancy, and by removing the obstacles facing female workers; the country’s development requires that the South of Italy, where one third of the population resides, be revitalized. It is the job of economic policy to define the legislative framework, by providing adequate incentives and by removing the brakes on production, but it is up to firms to seize the opportunities offered by the market and technology, to be ready to grow, including by opening up to external capital and expertise; it is for students and workers to help effect change by seeking new and more varied skills. The financial intermediaries must prove able, in their own interest, to support this process by demonstrating prudence but also wisdom. This calls for a concerted effort, with no exceptions, and politics must show the way. Italy’s membership of the European Union is vital to return to a path of stable growth: this is where we can respond to the global challenges posed by the integration of markets, technology, geopolitical changes, and migration flows. The institutional development of Europe has accompanied the economic The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA development of all the member countries: it has opened up a bigger market for firms and consumers, made more funds available to support disadvantaged areas, facilitated cooperation on strategic questions, and guaranteed a stable monetary framework. Without Europe we would have been worse off, but if we were to antagonize Europe we would become so. We must work responsibly, constructively, and without prejudice to complete the Union, to help reinforce its institutions, and for the wellbeing of all. There must be no ambiguity about the responsibilities to be shared, the objectives to be pursued or the instruments to be used, all the while in the knowledge that, including for those who save, invest and produce, ‘words are deeds’ and ‘in the dark, words weigh double’. The farsightedness shown by those who laid the foundations of the European project must once again guide our actions today. This is an essential condition for guaranteeing a future of peace and prosperity for the generations to come. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 FIGURES Figure 1 World trade growth 6% 6% Source: OECD. Figure 2 Business confidence of industrial firms (indices: 2000=100) Euro area Italy Source: Based on European Commission data. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 Figure 3 Sovereign spreads (yield spread vs. German government securities; basis points) Portugal Italy Spain Source: Based on Bloomberg data. Figure 4 GDP growth (the dashed lines indicate the average growth for the period) % % Euro area -2 -2 It Ita aly -4 -4 -6 -6 Sources: Based on Istat and Eurostat data. The euro-area aggregate is based on a fixed country composition (EA-19). The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA Figure 5 Average cost of the public debt and nominal GDP growth in Italy: forecasts (per cent; average 2019-20) Nominal GDP growth -1 -1 Average cost of the debt - nominal GDP growth (r-g) -2 Italy Belgium France Germany Greece Portugal Spain United United Kingdom States Japan -2 Source: European Commission, Spring forecast, May 2019. Figure 6 Population in the 20-64 age group: projections (indices: 2018=100) European Union Italy Source: Based on Eurostat data. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 Figure 7 Degree of digitalization (DESI; percentage deviations from the European average) % % -10 -10 -20 -20 -30 -30 -40 DK SE FI NL LU IE UK BE EE ES AT MT LT DE SI PT CZ FR LV SK CY HR HU PL IT BG EL RO -40 Source: European Commission. Note: The Digital Economy and Society Index (DESI) is a composite indicator that measures the digital performance of the European Union and of its member states. Figure 8 Use of online banking % % Euro area Italy Source: Eurostat. Note: Share of the population aged 25-64 years that uses the Internet to access their current accounts. The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA Figure 9 Supply of banking services offered through digital channels in Italy % % Payment services Smartphone applications Asset management Lending to households Lending to firms Source: Regional bank lending survey (RBLS). Note: Share of banks offering their services through digital channels. Unweighted frequencies. For lending to households and firms, the share refers to banks that provide online estimates of what loans would cost. Figure 10 Credit quality of Italian banks (billions of euros) Total NPLs Gross Net Gross Net Bad debts Source: Supervisory reports (consolidated for banking groups and individual for stand-alone banks). Note: The stocks are calculated gross and net of loan loss provisions. Bad debts are a subset of total non-performing loans (NPLs). BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2018 Figure 11 Exports and foreign direct and portfolio investment in Italy (destination/origin; percentage composition) Exports Foreign direct investment Foreign portfolio investment European Union Rest of the world Sources: Based on Bank of Italy, Istat and IMF data. Figure 12 Inflation % % Italy Germany -4 France -4 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 Source: OECD. The Governor’s Concluding Remarks Annual Report 2018 BANCA D’ITALIA Printed by the Printing and Publishing Division of the Bank of Italy Rome, 31 May 2019 Printed on eco-friendly paper
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the session "Finance and financial systems for sustainable development", at the conference "Make Europe the world champion of sustainable development", Sustainable Development Festival 2019, organized by the Italian Alliance for Sustainable Development (Alleanza Italiana per lo Sviluppo Sostenibile - ASviS), Rome, 21 May 2019.
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Sustainable development and climate risks: the role of central banks Speech by Ignazio Visco Governor of the Bank of Italy Sustainable Development Festival 2019 ‘Finance and financial system for sustainable development’ The Italian Alliance for Sustainable Development Rome, 21 May 2019 The question of whether natural resources and the development objectives of nations are compatible is an issue that has long been debated in the field of economics. It dates back to at least the end of the 18th century with the works of Thomas Malthus on food supply and population growth and has re-emerged a number of times since then in the public debate. For example, at the start of the 1970s, in the wake of the demographic explosion and the related exponential growth in consumption, the simulations produced for the project of the Club of Rome on the ‘Predicament of Mankind’ set off an alarm which resonated strongly at international level concerning the risks to the survival of our ecosystems and of the human race itself. It was then observed that the scarcity of natural resources envisioned in that analysis, largely based on a linear extrapolation of the trend under way, did not take sufficient account of two fundamental mechanisms that regulate the functioning of the economic system: the rebalancing capacity of prices and the endogenous nature of technological change. When the resources used in the production of goods and services become more scarce, an increase in their prices discourages demand and provides an incentive to invest in new production methods that utilize fewer of those resources. Although these mechanisms make it particularly difficult to make reliable long-term projections, the fears for ‘sustainability’ – that is, the ability to meet current needs without compromising future generations’ chances of doing the same – have not faded. Over the last three decades the biggest concerns have been in relation to the effects of climate change, a factor for which there are no ‘natural’ market prices. In 1992, following the Earth Summit in Rio de Janeiro, the United Nations Framework Convention on Climate Change was born, giving rise to the Kyoto Protocol (in 1997) and the Paris Agreement (in 2015). In the autumn of that year, Robert Solow, winner of the Nobel Prize for Economics in 1997 for his contributions to modern theories of economic growth, spoke before an audience of environmentalists, stating that: I do not have to remind you that ‘sustainability’ has become a hot topic in the last few years […] As far as I can tell, however, discussion of sustainability has been mainly an occasion for the expression of emotions and attitudes. There has been very little analysis of sustainable paths for a modern industrial economy, so that we have little idea of what would be required in the way of policy and what sorts of outcomes could be expected. Solow feared that the concept of sustainability would remain a slogan, without materializing into policies to encourage the use of sustainable resources. Almost 30 years later, data on the trend in greenhouse gas concentration – the leading cause of global warming – are not encouraging. In fact, the growing use of fossil fuels has pushed the concentration of greenhouse gases to levels that are dangerously close to generating a temperature increase of more than 1.5°C, with potentially catastrophic consequences for our planet according to the United Nations Intergovernmental Panel on Climate Change. Some effects are already evident. At global level, the last four years have been the warmest since 1880. In Italy, 2018 was the warmest year in the past two centuries and 2017 was already characterized by a strong intensification in weather conditions, with severe cases of drought over most of the country that caused serious repercussions on the water supply. Climate change and the risks to the financial sector In Europe, southern countries like Italy will be most affected by the expected consequences of climate change, which pose new risks for the real economy and for the stability of the financial sector. First, there is the ‘physical risk’ stemming from progressive climate change, in particular involving an increase in temperatures, greater irregularity in rainfall patterns and an increased probability of extreme weather events. According to all the main climate change scenarios, Italy will be the European nation that is most exposed to damage caused by its rivers flooding. These phenomena could result in significant losses in terms of human life and costs in terms of the destruction of public and private infrastructure, forcing households, firms and the State to allocate a large amount of financial resources to their reconstruction. The steady increase in temperatures could have permanent effects on the country’s productive capacity. The effects of climate change on the real economy may spread to the financial sector through various channels. Natural disasters interrupt the productive functions of firms and households, increasing their financial vulnerability, reducing the value of the assets pledged as collateral for loans, and making it more difficult for them to repay loans. The increase in climate change-related risks could cause banks to tighten credit towards households and firms in high-risk areas, with possible negative repercussions on the transmission of monetary policy stimuli. If the scale of these effects were to become significant, the stability of the financial system itself could be affected. Analyses carried out by the Bank of Italy highlight the fact that, in our country, more than 20 per cent of loans to the productive sector are granted to residents in areas with a high risk of flooding; moreover, the flow of credit is negatively correlated with risk exposure, especially when the debtors are small and medium-sized firms. Another type of risk, ‘transaction risk’, derives from the possibility that the necessary transition towards a low-carbon economy may occur in a disorderly manner. During this transition, the prices of energy products may increase markedly: climate policies are based on the use of alternative energy sources which are currently more expensive, and on the introduction of carbon-pricing systems, like the taxation of carbon emissions. Since the short-term demand for energy is not very reactive to price variations due to the fixed costs associated with changing the sources and forms of supply, a possible increase in prices would heighten the financial vulnerability of firms and households owing to the higher cost of purchasing energy goods. A sharp drop in the value of assets and infrastructures linked to the mining, transformation and use of fossil fuels (coal, oil and gas) could also trigger a rush to sell the securities of the most exposed companies and may make it more difficult for them to cover their liabilities towards the banking system and the market, with consequences that could significantly affect the economic system and financial stability. The role of the private and public sectors in the transition The public sector cannot be solely responsible for creating stable, fair and inclusive economic growth that respects environmental balances. It is up to the public sector to create a stable and modern regulatory framework, and to define and implement effective economic, environmental, energy-related and social policies that provide incentives that will stimulate new investments. In order to achieve sustainable business practices, strategies must be adopted that take account of the environment, human rights, consumer rights, diversity and best practices in corporate governance, i.e. the Environmental, Social and Governance (ESG) profiles. In adapting to the objectives set by the public sector, the private sector can draw some advantages. In fact, ‘green’ sectors are steadily gaining importance in Italy too. According to Istat estimates, in 2017 the eco-industrial sector expanded markedly: it contributed 2.3 per cent to total value added and employed nearly 400,000 full-time employees. Given its critical role in resource allocation, the financial sector plays a key part in influencing the scope, speed and fluidity of the transition. It can do so effectively if intermediaries also consider sustainability factors in their corporate governance systems and in their risk management and investment strategies. Today, central banks and supervisory authorities also pay close attention to these issues in carrying out their mandates. They are helping to raise awareness and nurture a better understanding of the risks related to the sustainability factors and the channels through which they are transmitted to the financial system. They can disseminate more data, help develop shared analysis methodologies, and facilitate cooperation and the sharing of best practices between the various stakeholders in the financial system. They are trying to provide a good example for all investors through their policies for managing financial resources and the related risks. The Bank of Italy as an investor … This year the Bank of Italy has decided to adopt an investment strategy that integrates ESG factors into the management of its equity portfolio, a move that it announced on its website last week. The principles of diversification and market neutrality, part of the previously used framework, have been maintained and two new assessment criteria have been added. The first excludes investments in shares issued by companies mainly operating in sectors that do not comply with the United Nations’ Global Compact, an agreement signed in 2004 that sets out the principles companies should follow regarding human rights, labour and environmental sustainability, and measures to prevent corruption. The second gives preference to the securities of companies with the highest ESG scores. The new framework significantly improves the environmental footprint of our financial investments: the new shareholdings portfolio is characterized by lower greenhouse gas emissions (a reduction of 23 per cent), and lower energy and water consumption (by 30 and 17 per cent respectively). It also follows that risk management becomes more effective: a comparison of various solutions shows that this approach provides the best risk-return profile and the greatest protection against particularly adverse market trends. For the time being, this strategy is being applied to equity investment; an assessment is under way of the possibility of extending it to other asset classes, such as corporate bonds. As we work towards further improving the ESG profiles in our portfolio, we will provide regular reports on the results achieved, so that our best practices and the methodology we use can serve as a reference for other investors. Aside from ensuring less risk, sustainable investment does not penalize financial performance: numerous studies show that it leads to market returns that are not significantly lower than those achieved using traditional financial models. Good ESG practices enable firms to benefit from competitive advantages stemming from innovation, to mitigate operating, legal and reputational risks, and lead to more efficient resource allocation, all of which tend to lower the cost of capital and to achieve better operational and market performance. For example, some analyses carried out by the Bank of Italy have provided clear evidence of a return premium on the shares of European electricity utilities with lower carbon emissions. Experience has shown that reputational risks and the risk of serious losses for firms and their shareholders can instead arise from inappropriate business practices from an ESG point of view. … and its cooperation with other institutions The increasing concern about the possible consequences of climate change for the financial sector has strengthened international cooperation in the field of sustainable finance, with several initiatives being provided by industry and the institutions. The Bank of Italy has contributed to these projects and will continue to do so. In recent years, in our role as members of the Financial Stability Board, we have discussed the studies of the Task Force on Climate-related Financial Disclosure; we participated directly in those of the G20 Green Finance Study Group; we are giving technical assistance to the Ministry of Economy and Finance for the negotiations on the legislative proposals resulting from the European Commission’s Action Plan on sustainable finance. In this field we have contributed to drafting both the disclosure requirements as regards the sustainability of the financial products offered to customers by market operators – including banks, investment firms and fund managers – and the regulations on new low-carbon benchmarks. Together with the supervisory authorities of the other EU countries, the Bank of Italy will cooperate with the European Banking Authority in carrying out the tasks of identifying the risks that sustainability factors pose to the stability of the financial system, drafting methodologies to correctly assess such risks, and selecting the most suitable prudential treatment. It will also take part in the analyses scheduled by the European Single Supervisory Mechanism, which has included climate change in its risk map for 2019. The Network for Greening the Financial System was founded In December 2017, on the initiative of a number of central banks and supervisory authorities. This forum, in which we participate, has a broad membership at international level, and analyses are conducted and best practices are shared within it regarding the management of financial risks linked to the environment and climate change. The Network aims to develop scenarios, methodologies and studies to integrate environmental and climate risks into microprudential and macroprudential supervision, collect evidence of the existence of risk spreads between ‘green’ and ‘brown’ assets, and draw up common guidelines for the adoption of ESG criteria for managing central banks’ financial portfolios. As part of the activities of the Italian Observatory on Sustainable Finance, set up by the Ministry of the Environment, we carried out a survey in 2018 of Italy’s main financial operators to evaluate their level of preparedness on climate-based risks. The results are mostly in line with those of other surveys and indicate that awareness of the financial risks deriving from climate change remains limited. The issue of sustainability is mainly dealt with from a social responsibility point of view, yet it is generally neglected in the decision-making processes of administrative bodies and in financial risk management systems. Greater effort is therefore required on everyone’s part in order to focus more on these topics. Conclusions The transition towards an economy with low carbon emissions is essential if we want to reduce the risks that climate change poses for our well-being. The financial sector, central banks and supervisory authorities cannot stand in for those who make the policies necessary to decarbonize our energy systems, but they can play an important role in promoting this process. It is in the interests of financial intermediaries to be more aware of how sustainability factors can affect their activities: it would make it easier for them to take into account the corresponding risks in their strategies and governance, thereby helping to improve performance. Central banks and supervisory authorities are working towards making the financial system ready to face this transition. The spreading of new financial instruments could be made easier by: the creation of an EU taxonomy of environmentally sustainable activities and the introduction of [product] labelling schemes (including the standards for green bonds); the wider uptake of the new low-carbon benchmarks; and the application of the new rules on disclosure. Italian investors have expressed considerable interest in sustainable finance, but the supply of products is still not sufficient to satisfy demand: there is room for new projects to be financed, we need the right investment instruments, and it is vital that companies be able to provide the necessary information on the sustainability of their activities. Bibliography Bernardini E, Di Giampaolo J, Faiella I, Poli R, ‘The Impact of Carbon Risk on Stock Returns: Evidence from the European Electric Utilities’, Journal of Sustainable Finance & Investment, 2019. Ciscar JC, Feyen L, Ibarreta D, Soria A (coordinators), ‘Climate Impacts in Europe: Final Report of the JRC PESETA III Project’, Joint Research Centre Science for Policy Report, 2018. Clark G, Feiner A, Viehs M, From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance, Oxford University and Arabesque Partners, Oxford, 2015. Doxa, ‘Il risparmiatore responsabile’, The Sustainable Investment Forum, Milan, 2017. Faiella I, ‘The demand for energy of Italian households’, Banca d’Italia, Temi di Discussione (Working Papers), 822, 2011. Faiella I, Cingano F, ‘La tassazione verde in Italia: l’analisi di una carbon tax sui trasporti’, Economia Pubblica, No. 2, 2015. Faiella I, Natoli F, ‘Natural Catastrophes and Bank Lending: the Case of Flood Risk in Italy’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 457, 2018. Friede G, Busch T, Bassen A, ‘ESG and Financial Performance: Aggregated Evidence from more than 2000 Empirical Studies’, Journal of Sustainable Finance & Investment, Vol. 5, 2015. ISTAT, ‘Il conto dei beni e servizi ambientali’, Rome, 2019. Levi M, Kjellstrom T, Baldasseroni A, ‘Impact of Climate Change on Occupational Health and Productivity: A Systematic Literature Review Focusing on Workplace Heat’, La Medicina del Lavoro (Journal of the Italian Society of Occupational Health), Vol. 109, 2018. Meadows DH, Meadows DL, Randers J, Behrens III WW, The Limits to Growth: Report for the Club of Rome’s Project on the Predicament of Mankind, Universe Group, New York, 1972 (tr. it., I limiti dello sviluppo. Rapporto del System Dynamics Group Massachusetts Institute of Technology (MIT) per il progetto del Club di Roma sui dilemmi dell’umanità, Mondadori, Milan, 1972). NOAA, ‘2018 Was 4th Hottest Year on Record for the Globe’, 6 February 2019. Osservatorio Italiano sulla Finanza Sostenibile, ‘Il rischio climatico per la finanza in Italia’, available on the website of the Ministry for Environment, Land and Sea Protection. Solow R, ‘An Almost Practical Step Toward Sustainability’, Resources Policy, Vol. 19, 1993. Visco I, Perché i tempi stanno cambiando, Il Mulino, Bologna, 2015.
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the G7 Conference on "Cybersecurity: coordinating efforts to protect the financial sector in the global economy", Bank of France, Paris, 10 May 2019.
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Ignazio Visco: Challenges for the financial sector in adapting to cyber threats Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the G7 Conference on "Cybersecurity: coordinating efforts to protect the financial sector in the global economy", Bank of France, Paris, 10 May 2019. * * * Today we are discussing how cyber risk is evolving in the financial sector, and what we should do about it. To set a course of action for the future, I believe we should go back to one fundamental question: why did financial authorities get involved in cyber defence in the first place? Our overarching goal has always been to preserve a high degree of trust in the financial system. This is by no means limited to cybersecurity – it is our raison d’être. That is why we regulate financial risk-taking and why we do not grant disreputable players any licence to banking activities. That is also the reason why we make sure that vital systems such as payment infrastructures are not taken down by hackers. When it comes to financial risk-taking, we all acknowledge that markets fail to deliver socially optimal results on their own, hence regulation and supervision are needed. The same argument applies to cyberspace. Financial firms have their own reasons to protect themselves. They do not want to lose their credibility and their customers because of a cyberattack. But this is not enough. Cyber vulnerabilities have extensive negative externalities – individual entities such as financial institutions do not have the incentives nor the means to internalise them all. Authorities need to rectify this. The nature of cyberspace is such that externalities are not contained within national borders, or within any single sector. One important source of cyber risk for supervised entities is their increasing reliance on third-party suppliers who fall outside the jurisdiction of financial authorities. In the past, attackers have leveraged vulnerabilities in the IT systems of third parties to strike financial institutions. In the G7 Fundamental Elements For Third Party Cyber Risk Management in the Financial Sector published last year, we introduced tenets on the appropriate management of third-party risk. We must now accelerate work on implementation. When it comes to third parties who operate in regulated sectors, such as energy and telecoms, the different authorities must step up their coordination and cooperation efforts. There are two dimensions to cooperation. First, within each country there needs to be a cohesive national system of cyber defence that allows different authorities to work together effectively. In this context, governments have a natural role as coordinators. Attacks are getting more sophisticated. Some involve resourceful actors, such as nation-states and terrorist organisations. The financial sector remains a prime target, and we cannot effectively mitigate the risk by simply mandating supervised entities to follow good practices. Complex attacks can be deployed via obscure tools. Even large financial institutions with excellent (and expensive) defence systems can be lost in the face of cutting-edge threats; they can, of course, work out some of the technical details, but they might miss some of the broader, systemic elements, simply because they ignore relevant information: precedents that affected other sectors; attacker tactics; and effective defences adopted elsewhere. This kind of information is generally available only to intelligence agencies and the military. Cross-sector, nationwide as well as international cooperation is therefore essential. 1/2 BIS central bankers' speeches There needs to be a mechanism within each country that allows appropriate public bodies to coordinate and jointly support, each within its own mandate, the victims of a cyber campaign. In the European Union, the Network and Information Security (NIS) Directive takes this course. Second, cooperation must extend beyond borders given the nature of many of the attacks and the interconnectedness of the financial system. This will always be a challenge because disclosing vulnerabilities to entities from another jurisdiction might endanger national security. Nonetheless, we need to find feasible solutions to this problem, since this kind of infosharing might prove crucial in order to respond to some attacks. The G7, as a group of like-minded countries, remains the most favourable context for international cooperation – the many achievements of the G7 Cyber Expert Group (CEG) provide a good example of what can be done. The CEG was established in 2015 under the German presidency, and it went on to deliver results during the presidencies of four other countries – Japan, Italy, Canada, and now France. We need to persevere on this route. One area that is ripe for more cooperation is the establishment of common security standards for hardware and software, which also covers the growing market for financial technology apps. In the European Union, we have a tradition of very strict safety, physical health and environmental protection standards. We require a Conformité Européenne certification – the CE mark that you see on labels – for any product in certain commodity sectors that enters our markets. Certification mechanisms are not exclusive to the EU – think of the FDA approval process for pharmaceuticals in the US. In the EU, a new regulation (currently under approval) will introduce a mechanism of cybersecurity certification for many products, too. This is an important step, but it would be more effective if G7 countries could converge at least on a subset of requirements. If a service is not safe according to our own laws, it should not be on the market – and there should be a reasonable degree of convergence between laws in like-minded jurisdictions. I would like to conclude by posing two questions. First, I would be very interested to hear from my co-panelists as to what their perspective is on the state of cooperation between authorities and the private sector, especially when it comes to vital infrastructure like clearing and settlement systems. Are regulators in this room happy with what we have achieved so far? What do private institutions think should be improved and how? Second, are we leveraging technology strongly enough? Artificial intelligence (AI) is emerging as a pervasive game changer in our economies. It introduces new possibilities in all sectors, and cybersecurity is no exception. AI facilitates the detection and the exploitation of vulnerabilities – attackers know this, so they are starting to deploy machine learning to analyse and penetrate target systems. Cybersecurity companies use the same AI analytic tools, with the goal of fixing the weak spots. By the same token, authorities could employ AI, let us say, to ascertain whether supervised entities are meeting mandated security standards on a continuous basis. 2/2 BIS central bankers' speeches
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Thirty Years of Bank of Italy in Japan Anniversary Celebration, Tokyo, 11 June 2019.
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Remarks at the Event to Commemorate Thirty Years of Banca d’Italia in Japan Speech by Ignazio Visco Governor of the Bank of Italy Thirty Years of Banca d’Italia in Japan: Anniversary Celebration Tokyo, 11 June 2019 Governor Kuroda, Ambassador Starace, Distinguished representatives of Japan’s authorities, of the financial and corporate sectors, of academic and research institutions, and members of the Italian, European and international communities in Tokyo, I am delighted to welcome you all this evening, and to see several personal friends among you, as we celebrate the 30th anniversary of the establishment of Banca d’Italia’s Tokyo Representative Office, which was officially inaugurated on January 27, 1989 by Governor Carlo Azeglio Ciampi, in the presence of the Bank of Japan’s Governor, Satoshi Sumita. A special word of welcome goes to those of you who also attended that event. Like the Bank of Japan and other central banks around the world, the Bank of Italy has long recognised the value of a stable presence in major international financial centres, for liaising with local authorities, disseminating information on and analyses of the respective economies, and for closely monitoring market developments. The Bank’s first ‘Delegation’ – as our foreign offices were, and still are formally called – was opened in London in 1917, soon to be followed by the New York Office. Our interactions with Japan’s monetary and financial authorities had, of course, been under way well before the opening of our Tokyo Office. As Governor Kuroda recalled, in 1962 Paolo Baffi, then senior deputy governor (Direttore Generale) of the Bank of Italy, came to Japan to deliver a series of lectures on international monetary policy, widely followed by officers from Asian central banks, thus setting strong foundation to future closer relations between our two institutions. What I would like to remember today, however, is another episode that significantly enhanced this relationship. In late 1971, Giorgio Carducci and Tommaso Padoa-Schioppa – two young Bank of Italy officers working in our Research Department – were dispatched to Japan for a study mission by the then Governor Guido Carli, and at the suggestion of the Head of the Research Department, Carlo Azeglio Ciampi – later to become through the years, Governor of the Bank, Prime Minister, Minister of Finance and President of the Republic. Their task was to analyse the financing model of Japanese industrial expansion, and especially the role played by banks in funding capital accumulation, an issue of particular importance for Italy’s economic development. Indeed, this was a situation Italy shared at that time with Japan, and the banking channel is still today the main source of financing for Italy’s predominantly small and medium-sized enterprises. The mission lasted two months and enjoyed the generous support of the Bank of Japan, which went well beyond the already high standards set by the world-renowned omotemashi of the Japanese people: Governor Sasaki assigned an office at the Bank of Japan to Messrs. Carducci and Padoa-Schioppa throughout their stay, and they were constantly assisted by the Bank’s officers, who arranged most of the meetings with other institutions. As Carducci and Padoa-Schioppa noted in their final report, ‘without that precious collaboration, it would have been impossible to conduct the research so rapidly and comprehensively’. The report compiled by Carducci and Padoa-Schioppa offered a synthetic but thorough description of the real, monetary and financial sectors of the Japanese economy at that time. It was published in Italian the following year, contributing to a better understanding in Italy of the foundations and structural features of Japan’s own ‘economic miracle’ (a term we use when talking of Italy’s resurgence from the ashes of World War II in the 1950s and 1960s). A further important step in the direction of extending our interactions with the Japanese monetary and financial system was taken in 1985, with the secondment of a senior Bank of Italy officer as a Financial Attaché to the Italian Embassy in Japan. Today, besides our three Representative Offices there are 14 financial attachés seconded by the Bank to Italy’s Embassies, covering almost sixty economies around the world. With the opening of our own Office in Tokyo in 1989, our presence in Japan was definitely strengthened, and we have since maintained a high level of cooperation with the Italian Embassy, thanks to the efforts over the years of its heads: Mr Rosario Bonavoglia, Mr Sandro Appetiti, Mr Pietro Ginefra and the current one, Mr Angelo Cicogna; and, of course, of the Italian Ambassadors. The Office has greatly benefited from our Japanese partners’ forthcoming attitude and constant support. The frequent exchange of views with the Bank of Japan, as well as with the other financial authorities, and members of the academia and the private sector, has provided us with extremely useful input for our own analyses and policy decisions. It is important to underline that the activity of our Representative Office is not confined to maintaining a fruitful collaboration with Japan’s authorities and financial institutions. It also provides an important contribution, through research and analysis, to our understanding of Japan’s economy and its fundamental role in Asia and in the world. I benefited too from the valuable support of the Italian Representative Office in Tokyo, not only as a Bank of Italy manager, member of the Board and Governor, but also during my missions to Japan when I was the OECD’s Chief Economist during the difficult years of the Asian financial crisis. * * * This cooperation and exchange of views with Japanese authorities and experts has proven beneficial in the past. It will perhaps matter even more in the future, given the challenges that our countries are facing, ranging from navigating a difficult international environment to adjusting to a rapidly ageing society and the spreading of new technologies. Over the last thirty years, the world economy has undergone a profound transformation. Favourable geopolitical developments have combined with spectacular advances in information and communication technologies to spur unprecedented global economic and financial integration. The impact on economic growth and social development has been no less impressive. During this period, the volume of international trade has more than quadrupled, contributing to an almost three-fold increase in global output. While our two countries have benefited from these developments, they have also seen a sharp slowdown in the pace of economic expansion and the emergence of structural impediments that are largely shared by our two economies. Sluggish growth, adverse demographic trends and soaring public debt are challenges we have in common, and the adequate policy responses needed to meet them might be partly based on each other experiences and best practices. The prolonged periods of subdued growth that Japan and Italy suffered since the early 1990s have been driven by a deceleration in productivity, a phenomenon common to many developed and developing nations but more marked in the case of Japan and Italy. In Italy we observed a substantial delay in responding to the significant changes brought by globalisation and technological progress. This delay was exacerbated by the difficulties of small and medium-sized enterprises in innovating and adjusting their governance systems. These factors accompanied the long period of adverse cyclical conditions that followed the global financial crisis and the associated progressive reduction in the entry and exit dynamics of firms. Corporate sector governance and the efficient reallocation of capital in the business sector have often been at the centre of attention in Japan too. Demographic developments contribute to a better understanding of the subdued economic performance, especially in Japan, where the problem of an ageing population emerged earlier. According to UN population projections, in Italy the ratio of people aged 65 and above to the working age population (20-64) is currently about 38 per cent and projected to exceed 72 per cent by 2050; in Japan it is already above 46 per cent and is estimated to rise to almost 78 per cent by 2050. Life expectancy at birth is currently over 82 years in Italy (15 years longer than in 1950) and close to 84 in Japan (20 years above the 1950 level); in both countries it will exceed 87 years by 2050. Japan and Italy are therefore frontrunners in facing the economic and institutional adjustments demanded by this demographic transition, which is unprecedented and has far-reaching implications in terms of productivity growth, the balance between saving and investment, pension requirements and long-term care. There are clear implications here for public finances and asset markets. Mechanical extrapolations of population trends show that a shrinking labour force will exert a significant drag on potential output over the next thirty years for both our economies, even taking into account possible mitigating effects, such as those stemming from immigration. With respect to the old-age related spending borne by public finances, both Italy and Japan have intervened on pensions, even though their increase in the past twenty years has been substantial and is not going to decline for years to come. Additional funding needs will arise from the health care system. Taking also into account nondemographic drivers (such as the effect of technological progress), outlays related to health and long-term care are projected to rise significantly. As Japan and Italy have two of the highest public debt-to-GDP ratios among advanced countries, there is very little fiscal space to accommodate these trends. Slow productivity growth, ageing and high public debt are three interrelated challenges which require a comprehensive policy response. The demographic developments under way and the need to ensure sustainable public finances emphasise the importance of boosting productivity growth. It must be recognised that advances in medical sciences and improvements in living conditions have moved the threshold forward considerably of what used to be called ‘the third age’: as the positive experience of Japan illustrates, senior citizens can be engaged in productive activities, including the provision of all-important community services. Moreover, adequate social policies can encourage a much higher participation of women in the labour force, especially in Italy. Policies to promote innovation and investment in new technologies are crucial. At the same time, as technological progress advances further, taking advantage of its great economic opportunities will require paying close attention, in particular, to the changes implied for the qualitative profiles of labour demand. Appropriate plans will need to be drawn up and consistently deployed to retrain workers, invest in education, fight poverty and inequality, lest these powerful transformational forces undermine social cohesion. Supporting technological innovation, and its efficient diffusion throughout the economy is key to obtaining sustained increases in productivity in the longer term, and to safeguarding the living standards of future generations, as well as the sustainability of our countries’ social security systems and public finances. Nevertheless, it is essential to take into account the effects on the nature and quality of available jobs, which will stem from the extant technological revolution that is proceeding with unprecedented speed and is wide ranging, from automation to digitalisation, from robotics to artificial intelligence. In this respect Japan appears to be better positioned than Italy in some key areas. First and foremost, the quality of its human capital: in Italy only 27 per cent of the population aged 25 to 34 has completed tertiary education, while in Japan this percentage is as high as 60 per cent. Italy and Japan also stand at opposite extremes as regards the older working population: in Italy the percentage of people who have completed tertiary education in the 55-64 age group is the lowest among the G7 countries while Japan has one of the highest. Japan also has a significantly higher R&D expenditure to GDP ratio. These differences help to explain the fact that the contribution of total factor productivity to output growth has remained positive in Japan (although at much lower levels than in the years before the ‘lost decade’), while in Italy it has been negative on average since 2000, only recently showing a weak recovery. Policies to safeguard the benefits of technological progress should go hand in hand with a firm commitment to international integration: it would be a serious mistake to believe that disengaging from global responsibilities could make it easier to achieve long-lasting benefits at home. It is unfortunate that in many respects we have recently observed a deterioration of international relations, with the multilateral, liberal world economic order that presided over many post-WWII developments starting to falter with the emergence of new players and the pressures of new protectionist tendencies. To be sure, international economic relations need to be based on generally accepted rules, which protect legitimate rights and ensure a level playing field for all parties. The system of multilateral regulations and supranational institutions which has provided that framework, supporting global economic development in the post-war era, is now facing serious difficulties, against a backdrop of significant differences in the political systems and economic models of key trading nations. This is making cooperation more complex, but by no means less necessary for the common good, a conviction that Japan and Italy both share. Critical issues for the future well-being of all nations, such as the environmental sustainability of economic development, can only be managed through joint actions, which leverage scientific research and already available technology to ensure that growth does not come at the expense of the environment. Japan’s contribution in this direction has, of course, been essential, as it presided over the adoption of the historical Kyoto protocol in 1997. We may also recall the alarm already raised in the early 1970s by the ‘Club of Rome’, with its report, ‘The Limits to Growth’. * * * We are facing strong headwinds, as Japan knows only too well, being the acting President of the G20 this year. Thorough discussions on all these points took place at the G20 meeting of Finance Ministers and Central Bank Governors held in Fukuoka a few days ago. Indeed, Japan has had the merit of putting at the centre of the agenda those topics that are today acknowledged as being central to global economic prospects, such as ageing, technological development, the need for high-quality infrastructure and a broader health care coverage in developing countries. Italy will take the helm of the G20 in 2021 and I am sure that the path taken by Japan will be both an important legacy and a hard example to follow. In this essential collective endeavour, we know we can count on the full support and determined actions of Japan, which, as president of the G20, is making an important contribution to reaffirming the value of multilateral cooperation for the world’s shared prosperity. There is clearly no shortage of opportunities, including in our own domains of central banking and financial supervision, to continue working with our Japanese friends, and build on the excellent cooperation that our Tokyo Office has contributed to over the last thirty years. As Japan enters its REIWA era with a spirit of renewed confidence, we very much look forward to extending that rewarding partnership for the next thirty years and beyond. Thank you. Grazie. Doumo arigatou gozaimasu.
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Speech by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Euromed Workshop "Non-Bank Finance and Financial Intermediation", Naples, 18 June 2019.
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Euromed Workshop “Non-Bank Finance and Financial Intermediation” Non-Bank Finance: opportunities and risks Speech by the Deputy Governor of the Bank of Italy Luigi Federico Signorini Naples, 18 June 2019 Access to financial resources is essential for growth. The financial system channels resources through intermediaries and markets, allocating them within the economic system. The mix of banks, other intermediaries and market-based finance varies across countries and over time, depending on history, institutions, and stage of financial development, but certain common trends have emerged in the last decade. Since the global financial crisis, the regulation of banks has been redesigned to address the vulnerabilities that led to accumulation of excessive risks. The reforms resulted from a reassessment of the role of banks in the post-crisis world, justified by the adverse systemic effects of their distress. As banks’ role has somewhat shrunk, non-bank financial intermediaries have taken on an increasing role in the global financial system.1 At the same time, advances in technology have fuelled the emergence of technologyenabled financial innovation (“FinTech”), which is one of the areas where non-bank finance is expanding most rapidly. A diversified financial system benefits savers and borrowers because it offers multiple ways of channelling financial resources, including to support long-term investment, and diversifying risks. The non-bank financial sector competes with banks, thereby stimulating efficiency and innovation. It can reduce the vulnerability of the real economy to financial shocks because funding sources for the real economy can be diversified. At the same time, the expansion of non-bank finance poses new challenges to regulators, as the activities of non-bank financial intermediaries can have their own significant implications for systemic risk. In the case of the asset management industry, on which I shall mostly focus today, identifying, monitoring and preventing the build-up of risks from non-bank Based on BIS data, in 2007 banks in the euro area accounted for 70 per cent of financing to the private sector,54 per cent in the United Kingdom, and 34 per cent in the United States; in June 2018 their share declined by 12 and 2 percentage points in the euro area and the United Kingdom, respectively, while it has remained unchanged in the United States, where it was lower. FSB data on total assets of financial corporations in 21 jurisdictions and the euro area show that the share of banks declined by almost 5 percentage points since 2007. finance appears to require fresh thinking, more data, deeper analysis, and, quite possibly, new policy instruments. FinTech opens financial intermediation and credit markets to new players and, at the same time, is bound to change the way traditional intermediaries operate. It can expand access to financial services, increase competition and efficiency, by lower transaction costs; but it may also mean that old risks take new forms and that new (or substantially increased) risks, such as cyber risk, arise. Detecting such evolving and emerging risks requires understanding and closely monitoring FinTech activities, especially with a view to closing regulatory loopholes: among them deviations from the key principle that the same risk should be subject, in effect, to the same regulatory and supervisory treatment, regardless of the nature of the agent and its technical means of operation. There is substantial scope for international cooperation and coordination in these fields because developments in asset management and FinTech tend to cross borders quite easily. There is also a lot to be done in cooperation between different authorities. International coordinating bodies, such as the Financial Stability Board, are the natural fora for the authorities to elaborate common strategies. I shall first review the benefits of non-bank finance; then I shall highlight the potential sources of systemic risk, particularly those from asset managers, and make some considerations about how they are being / should be approached by the supervisory authorities. I shall also touch upon the potential risks from Fintech. As testified by the agenda for these two days of discussion, these issues are relevant for countries facing very different economic and financial conditions. The benefits of a diversified financial system The role of non-bank finance in the global economy has been increasing, and is now at least as significant as that of banks. Data collected by the Financial Stability Board (FSB) show that at the end of 2017 the assets of non-bank financial intermediaries reached 180 trillion dollars, about 48 percent of the global financial sector’s total assets; the assets of banks accounted for 39 percent of the total.2 FSB, Global Monitoring Report on Non-Bank Financial Intermediation 2018, 4 February 2019. The data refer to 21 countries and the euro area, and include insurance companies, pension funds and other financial intermediaries. The non-bank financial sector includes a variety of intermediaries. Some of them perform credit intermediation functions, either issuing loans directly or facilitating credit provision through financial market instruments; others support equity financing in various ways. In certain business models, entities that intermediate market instruments engage in liquidity transformation, maturity transformation, and the creation of leverage just as banks do. These activities used to be referred to as “shadow banking” because they are usually subject to less stringent prudential regulation and supervision than banks. Last year the FSB decided to avoid using this definition, recognising that non-bank credit intermediation can be beneficial, provided its risks are appropriately monitored and regulated. Activities that could generate bank-like risks are identified by the FSB under a narrow definition of non-bank financial intermediation, and include various entities, such as collective investment vehicles with features that make them susceptible to runs; finance companies engaging in loan provision that is dependent on short-term funding; market intermediaries that depend on short-term funding or secured funding of client assets (mostly brokerdealers); trust companies and structured finance vehicles.3 The assets of these entities represent 14 percent of total global financial assets in the jurisdictions monitored by the FSB, and have grown by almost 60 percent since 2007.4 The importance of non-bank finance varies across jurisdictions, and depends, among other things, on the degree of financial development. Non-bank finance tends to be quantitatively more significant in countries with well-developed markets. In the United States, the assets of non-bank financial institutions account for 62 per cent of the total assets of financial corporations, exceeding those of banks. In the larger European economies the sector is less developed: the corresponding figure is about 35 per cent in France and Germany and below 30 percent in Italy and Spain. While in most emerging markets banks are still the largest sector of the financial system, in some of them non-bank finance has grown very rapidly. Banks traditionally perform a key role in the financial system because of the monetary nature of their main funding source (deposits), and their The FSB definition based on economic function is described in its report on “Strengthening Oversight and Regulation of Shadow Banking: Policy Framework for Strengthening Oversight and Regulation of Shadow Banking Entities”, 29 August 2013. Data refer to 29 jurisdictions. ability to bridge the gap between lenders and borrowers through the creation and accumulation of knowledge on the behaviour of the former and the creditworthiness of the latter. One of the advantages of banks with respect to other institutions is that they bundle different information-based products, exploiting synergies between payment services, liquidity provision and monitoring. There is an enormous literature to explain why banks exist, which I cannot even start to summarise here. At the same time banks may be less efficient than other intermediaries in providing certain standardised services in isolation. While bundling can provide synergies and economies of scope, unbundling can allow specialised intermediaries to operate at a lower cost and to exploit other advantages of specialisation. FinTech is widely expected to enhance the ability of non-banks to challenge banks on this ground. In other cases non-bank intermediaries profit from the ability to tailor their services to specific needs. In developing economies, to make one example, finance companies may be important, as they can cater to households and micro and small enterprises, improving financial inclusion; small loans are often bundled with the provision of liquidity services to clients that are too small to be profitable for banks.5 To make another, quite different, example, bank loans might not be suitable – or available – to support businesses engaging in research and development as banks require collateral to mitigate risks; venture capital firms and private equity funds could be more effective in this specific domain.6 From the point of view of savers, collective investment vehicles, such as mutual funds and pension funds, provide investors with a wide range of investment options, with different risk-return profiles. Institutional investors such as insurance companies, and pension funds can focus on long-term “patient” finance more than banks, due to the nature of their liabilities. Non-bank financial intermediaries also facilitate the deepening of financial markets. They channel savings towards market instruments, See A. N. Berger and G. Udell, “A more complete conceptual framework for SME finance”, Journal of Banking and Finance Volume 30 (11), 2006, on the role of different lending technologies to address business opacity. A survey of the role and distinct features of venture capital can be found in B. H. Hall and J. Lerner, “The Financing of R&D and Innovation”, Handbook of the Economics of Innovation, Volume 1, 2010, Elsevier. supporting issuers and providing liquidity and diversification to savers. Asset managers, and other entities that specialise in market finance, increase the efficiency and liquidity of capital markets, and investors’ opportunities for diversification. A vibrant non-bank financial sector increases competition in the financial system, reducing transaction costs and improving the quality of services. Incumbents, including banks, can see some of their advantages eroded as new players enter the market, exploiting economies of scale in specific business segments. Examples of this are institutions offering payment services or asset managers specialised in catering to the needs of investors with certain risk-return profiles. New digital technologies are increasing the options for alternative providers of financial services, because they can be used to unbundle some of the services offered by banks. Technology-driven financial innovation can be particularly beneficial for developing countries because it makes services more affordable and accessible; but it can increase access to finance in advanced economies too. Thanks to technology there are greater opportunities to acquire and process information, reducing some of the traditional advantages of banks. Banks of course can adopt these technologies themselves, but non-bank entities sometimes are in apposition to exploit them more effectively, because they do not have to upgrade legacy systems and internal procedures; they can effectively “leapfrog” them. Some see these developments as an existential threat to banks. The banks’ future is linked to their ability to exploit the unique features of their core mix of activities to the full; but they need to evolve and adapt.7 The benefits of physical proximity to clients afforded by the banks’ traditional large, costly networks of branches, are becoming less important as savers and borrowers can access financial service providers remotely. Banks are in fact reducing the number of branches to cut costs. But in order to reap the benefits of technology they will need to go beyond cost-cutting and adopt farsighted and possibly quite far-reaching innovations in their approach to business and customers. Banks that are both creative and efficient in the use See R.G. Rajan, “Why banks have a future: Toward a new theory of commercial banking”, Journal of Applied Corporate Finance 9 (2), 1996; and A.W.A. Boot, “Banking at the crossroads: How to deal with marketability and complexity?”, Review of Development Finance 1, 2011. of technology, while preserving their traditional business advantages, are likely in my view retain a key role. What is the optimal mix between banks, non-bank financial institutions and markets? The academic debate used to contrast intermediary-based financial systems with market-based ones, often looking for evidence that one or the other was superior. A more nuanced view is now usually held.8 The optimal structure of the financial system is often found to change with economic development9. Whatever the nuances, I suppose most would nowadays agree that a balanced financial system with multiple, lively channels of financial intermediation is likely to provide both healthier competition and better resilience to shocks. Research has shown that when banks are distressed frictions in credit provision have negative real effects;10 in countries that have well-developed markets, firms can borrow by issuing securities when banks tighten credit supply conditions.11 On the other hand, banks can smooth temporary shocks affecting borrowers and somewhat shield them from financial market shocks by supporting financial flows, as suggested by the evidence from studies using microeconomic data on bank-firm relationships.12 Cross-country evidence on various stages of the recent financial crisis has R. Levine, “Bank-Based or Market-Based Financial Systems: Which is Better?,” Journal of Financial Intermediation 11 (4), 2002; for a review of the finance and growth literature see R. Levine, “Finance and Growth: Theory and Evidence,” Handbook of Economic Growth Vol. 1, Part A, 2005. A. Demirgüç-Kunt, E. Feyen, and R. Levine, “The evolving importance of banks and securities markets,” World Bank Economic Review, 27(3). – As economies evolve, the benefit of further developing traditional financial institutions tends to decline whilst that of markets increases. Moreover, an IMF study shows that the relationship between financial development and growth is bell-shaped: financial development increases growth, but the effect weakens at higher levels of financial development, and eventually becomes negative. Considering sub-indices of an overall financial development index, this bell-shaped relationship is due only to the “depth” components of the index; “access” exhibits a positive linear relationship with growth, while “efficiency” has no robust association with longterm growth (IMF Staff Discussion Note “Rethinking Financial Deepening: Stability and Growth in Emerging Markets,” 15/08, May 2015).. G. Dell’Ariccia, E. Detragiache, and R. Rajan, “The real effects of banking crises,” Journal of Financial Intermediation, 17 (1), 2008; R. Krozner, L. Laeven, D. Klingebiel, “Banking crises, financial dependence, and growth,” Journal of Financial Economics 84, 2007. T. Adrian, P. Colla, and H. S. Shin, “Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007-9,” NBER Working Paper No. 18335, 2012. See for example E. Sette and G. Gobbi, “Relationship lending during a financial crisis,” Journal of European Economic Association 13, 2015; P. Bolton, X. Freixas, L. Gambacorta, and P. E. Mistrulli, “Relationship and Transaction Lending in a Crisis,” Review of Financial Studies 29 (10), 2016; W. Jiangli, H. Unal, and C. Yom, “Relationship Lending, Accounting Disclosure, and Credit Availability during the Asian Financial Crisis,” Journal of Money, Credit and Banking 40 (1), 2008. thus provided evidence for both views, which should therefore be seen as complementary rather than mutually exclusive. Another key message from the research literature is that an overly rapid expansion of finance can lead to financial instability, especially if it is accompanied – as is often the case – by equally excessive leverage and risk-taking. This reconciles the long-standing view that financial development is beneficial for growth with post-crisis analyses suggesting that too much finance can be detrimental.13 Stable growth is promoted by the ability of financial systems to provide financial services and perform their allocation function effectively, while keeping risks in check. This rather general and even obvious observation leads me to the second part of my speech, where I shall endeavour to make its implications a bit more specific, and thus also possibly a bit less uncontroversial. The risks from non-bank finance: the case of asset management Benefits do not come without costs. There would be little development without a financial system, yet the economic functions that the financial system performs, such as credit provision and maturity / liquidity transformation, imply the creation of risks. These risks not only affect the stability of individual financial intermediaries: they can also have an impact on the financial system as a whole, with adverse effects on the real economy. A long experience with banking informs the regulation and supervision of the risks generated by banks, imperfect as it will always remain; but as the financial system becomes more complex, risks take different forms and extend to different types of intermediaries; the authorities will need to adapt and evolve in response. I shall focus here on the risks from one industry that I find particularly challenging from a supervisory point of view: asset management. This industry manages a very significant volume of assets, and influences the allocation of financial resources globally. It includes a variety of asset management models, and families of funds investing in products with different risk profiles. Some types of funds, like hedge funds, feature leveraged financial risk, which may See J.L. Arcand, E. Berkes, and U. Panizza, “Too Much Finance?,” Journal of Economic Growth, 2015; S. G. Cecchetti, and E. Kharroubi, “Why Does Financial Sector Growth Crowd Out Real Economic Growth?,” BIS Working Paper, No. 490, 2015; S. H. Law and N. Singh, “Does too much finance harm economic growth?,” Journal of Banking and Finance 41, 2014. be further compounded by securities lending activities and the creation of synthetic leverage via derivatives.14 Others, particularly open-ended funds, perform (among other things) liquidity and maturity transformation, because they invest in financial instruments that often have a longer maturity than the funds’ shares. Asset managers mostly provide investment services as fiduciary agents for their clients; hence, the risks associated with the investments are borne by the owners of the funds’ shares, not by the fund managers. The risks that are traditionally of concern for the authorities mainly involve agency problems and information asymmetries between the investors and the asset managers (misconduct, lack of transparency in the behaviour of the asset managers or investors not fully understanding financial risks). Accordingly, the purpose of market regulation and the mandates of market authorities mainly concern conduct and transparency. When markets function smoothly, liquidity and maturity mismatches can be managed because the asset managers deal with a large number of investors with diversified liquidity needs. In certain situations, however, the collective behaviour of investors can generate significant externalities, leading to excessive procyclicality, amplifying the cyclical properties of asset prices and credit flows. It is well understood that in financial markets procyclicality can be determined by behavioural phenomena (euphoria and panics), such as herding.15 In the case of the asset management industry, procyclicality can be exacerbated by the pricing rules for fund shares, the incentive structure for fund managers and the benchmarking of fund performance.16 Some asset managers provide their clients with indemnification, a type of insurance associated with securities lending. When the borrower of a security defaults on the loan and the collateral received is insufficient to cover the repurchase price of the lent securities, the shortfall is borne by the indemnification provider. See for example D.S. Scharfstein and J.C. Stein, 1990. “Herd Behavior and Investment.” American Economic Review 80; T. Lux, “Herd Behaviour, Bubbles and Crashes,” Economic Journal 105, No. 431, 1995; and Shiller, R. J., “Conversation, Information and Herd Behavior,” American Economic Review, Vol. 85 (2), 1995. For a review of the literature D. Hirshleifer and S. H. Teoh, “Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis,” European Financial Management 9 (1), 2003. Inflexible net asset value (NAV) fund share pricing, that does not factor in the investment losses of trading illiquid assets, can generate a first-mover advantage for an open-end mutual fund and exacerbate the incentive for investors to run. Benchmarking and relative performance mechanisms, which are common tools to address the principal-agent problem in the investment management industry, may lead to a focus on short-term returns and thus reduce the investment horizon of the manager. Incentive structures may increase risk-taking and short-termism by asset managers. In times of stress the behaviour of investors can depress the prices of assets by pushing them well below their fundamental values. If investors fear that the liquidation value of their shares will decline as other investors liquidate their positions, they will have an incentive to redeem their shares. When they invest through funds, their joint behaviour could produce massive redemptions, putting pressure on funds. Funds will be forced to liquidate, with adverse effects on asset prices and market liquidity.17 Trades by large investors are more likely to turn into fire sales, magnifying the impact of temporary shocks on market prices and leading to severe liquidity stress and extreme volatility. As asset prices decline, other intermediaries holding those assets (including banks) face losses, collateral becomes less valuable and borrowers are affected, with negative consequences for the real economy. Interconnectedness is another source of externalities from a systemic risk perspective. Externalities related to interconnectedness can arise because intermediaries are linked through bilateral balance sheet exposures or on the derivatives market, or because they are jointly exposed to common shocks. Ownership links between intermediaries might require the provision of liquidity support in case of fund distress, either because of existing guarantees or committed credit lines, but also with a view to avoiding reputational damage. For very large financial institutions the web of interconnectedness is highly complex and opaque.18 Interconnectedness mitigates the impact of small shocks but can amplify large ones. In asset management, a commonality of exposures can arise because the assets in which funds can invest are a finite set. Each fund holds a diversified portfolio but the portfolios of rationally-managed funds of a certain kind are not likely to be particularly diverse, as most if not all funds will use basically the same insights from finance theory and therefore follow similar investment strategies. If everybody in a market owns more or less the same portfolio and reacts in more or less the same way to disturbances, shocks can be amplified and spread more easily across markets and asset classes. Leveraged funds that rely on borrowing or derivatives may also be exposed to run‑like behaviour if they cannot roll-over funding or positions when they are under stress. J. Abad, M. D’Errico, N. Killeen, V. Luz, T. Peltonen, R. Portes, T. Urbano, “Mapping the interconnectedness between EU banks and shadow banking entities,” ESRB Working Paper Series No 40, March 2017. The real significance of these risk is the subject of an ongoing debate. There are many reasons to believe that they are not negligible, at the very least. Not only is the asset management industry very large, but it is also increasingly concentrated. According to one source the market share of the top twenty firms is more than 40 percent.19 In the United States, the top 10 managers owned about 5 per cent of the United States stock market in 1980; in 2016 they owned about 23 per cent.20 The commonality of exposures is substantial; evidence suggests that during stress episodes bonds with concentrated mutual fund ownership tend to experience larger price drops.21 Some other structural changes may further exacerbate the potential for externalities. First, the diffusion of funds with passive investment strategies, for example ETFs, could create distortions in the pricing of individual securities by applying mechanical investment rules, and thereby amplify trading patterns.22 Second, automated trading may lead to less diversified behaviour in response to shocks, increasing the procyclicality of prices and liquidity.23 Applications of new technologies, such as high-frequency trading, algorithmic trading and robo-advisors, may improve market efficiency and reduce intermediation costs during normal times, but have the potential for making the behaviour of intermediaries (or, indeed, even individual investors in the case of robo-advice) more responsive to market news. More analytical work surely needs to be done, but available studies suggest that mutual fund investments affect price dynamics in less liquid markets, certain share pricing Data from “The world’s largest 500 asset managers”, Thinking Ahead Institute and Pensions & Investments joint research, based on 2017 figures for assets under management. I. Ben-David, F. Franzoni, R. Moussawi, and J. Sedunov, “The Granular Nature of Large Institutional Investors”, NBER Working Paper No. 22247, May 2016. See Manconi A., Massa M. and Yasuda A., “The role of institutional investors in propagating the crisis of 2007–2008”, Journal of Financial Economics 104. More recently, I. Ben-David, F. Franzoni, R. Moussawi and J. Sedunov, show that ownership by large institutions predicts higher volatility and greater noise in stock prices (“The Granular Nature of Large Institutional Investors”, CEPR Discussion Paper 13427, 2019). The International Monetary Fund Global Financial Stability Report, April 2015, reviews available evidence. See V. Sushko and G.Turner, “The implications of passive investing for securities markets,” BIS Quarterly Review, March 2018, for a discussion of the issue. The evidence is ambiguous, see for example “The Shift from Active to Passive Investing: Potential Risks to Financial Stability?,” K. Anadu, M. Kruttli, P. McCabe, E. Osambela, and C.H. Shin, Federal Reserve Board, FEDS WP 2018-060; also I. Ben-David, F. Franzoni, and R. Moussawi, “Do ETFs Increase Volatility?”, NBER Working Paper No. 20071, April 2014. IOSCO Research Report on Financial Technologies (Fintech), February 2017. rules create first-mover advantage incentives, and the behaviour of portfolio managers displays significant herding tendencies.24 Countries with a small asset management industry and less developed financial markets are not immune to these risks. On the contrary, and maybe rather paradoxically, they could be even more subject to volatile capital flows as global players adjust their investment strategies, leading to surges in bond yields and sharp depreciation of the domestic currency.25 There is evidence that international investors engage in more herding and momentum trading in emerging markets than in developed countries.26 Large firms borrow from international markets, often in foreign currency, which exposes them to the refinancing and exchange rate risks from the reversal of capital flows. Policy approaches to risks in non-bank finance The externalities I have just described require a macroprudential approach. One of the lessons from the global financial crisis is that aggregate – i.e. systemic – risk can build up largely unchecked if authorities lack a broad perspective, and that the consequences of a crisis originating in financial markets may extend far beyond the fortunes of individual investors. The authorities in charge of financial regulation and supervision need to be able to monitor the potential sources of risks, to anticipate the build-up of systemic risk, and to deploy instruments to prevent it from materialising when possible; or, failing that, to mitigate their fallout. As I already mentioned, traditionally the focus of the regulation and supervision of the asset management industry has been the conduct of these intermediaries, and its purpose has been to ensure integrity and transparency, See the International Monetary Fund, Global Financial Stability Report, April 2015. While most of the earlier literature focused on equity trading, the different features of other types of assets can result in different herd behavior. Analyses of herding in the U.S. corporate bonds among bond fund managers find that corporate bond herding is substantially higher than the stock market herding (e.g. Cai, F., Han, S. and Li, D., “Institutional Herding in the Corporate Bond Market,” Board of Governors of the Federal Reserve System International Finance Discussion Papers No. 1071, December 2012). E S. Prasad, K. Rogoff, S. Wei, and M. A. Kose, “Effects of Financial Globalization on Developing Countries: Some Empirical Evidence,” IMF Occasional paper 220, 2003. A number of studies focus on emerging markets, investigating the behavior of mutual funds, for a survey see G. Gelos, “International Mutual Funds, Capital Flow Volatility, and Contagion – A Survey,” IMF WP/11/92, 2011; the evidence in the literature suggests that funds tend to avoid opaque markets and assets, and this behavior becomes more pronounced during volatile times, with portfolio rebalancing mechanisms contributing to explain contagion patterns. Also C. Jotiikasthira, C. Lundlbadand T. Ramadorai, “Asset Fire Sales and Purchases and the International Transmission of Funding Shocks,”, Journal of Finance 67(6). given the limited relevance of the risk of managers’ insolvency. More recently, the focus on liquidity management has increased, but still mainly from the perspective of individual funds. These issues should continue to receive all the attention they deserve; but there seems to be a case that they need to be accompanied by a macroprudential approach. The authorities should assess how shocks originating in one part of the financial system can be transmitted to the others components, both directly and through their impact on markets. This is a very challenging objective, requiring data and complex analytical frameworks. One tool that could be useful is macroprudential stress testing. The work on stress testing tools for non-banks is still in its infancy.27 An additional challenge is the identification and design of appropriate policy instruments. Tools aimed at protecting the stability of individual asset managers are available in many jurisdictions, for example liquidity requirements, rules restricting the amount of illiquid assets that can be held by open-end funds, redemption suspension and redemption gates. Their effectiveness for macroprudential purposes should be evaluated. Standards aimed at preventing the excessive accumulation of risk ex ante, such as minimum maturity-matching rules, are more effective in this sense than those meant to manage a fund’s crisis ex-post, such as gates, which may even have counterproductive signalling effects. The former set of standards should in my view include mandatory rules to ensure that funds investing in illiquid assets beyond a certain share of their portfolios may not operate as open-ended funds. Finally, the adoption of a macroprudential approach to the risks arising from asset management could require the adjustment of the institutional framework for financial supervision. In many countries, the authorities in charge of the regulation and supervision of these entities have no financialstability mandate. Should their mandate be expanded to include financial stability? Given the cross-sectoral nature of financial stability risks, if several authorities are in charge of financial stability, how can the exchange of information and the coordination of policies be ensured? Incentives to redesign institutions are usually stronger in the wake of a crisis but tend See the work by Y. Baranova, J. Coen, P. Lowe, J. Noss and L.Silvestri, “Simulating stress across the financial system: the resilience of corporate bond markets and the role of investment funds,” the Bank of England Financial Stability Paper No. 42 (July 2017),. Also S. Calimani, G. Hałaj, S. Zochowski, “Simulating fire-sales in a banking and shadow banking system,” ESRB Working Paper Series 46, 2017. to wane during good times. Consideration of these issues should not be procrastinated until the next crisis. Central banks play a key role in macroprudential policy because their mandate includes in one way or another a macroeconomic and financial stability perspective. They also have access to timely information as a result of monetary policy implementation. Finally, they have the unique ability to provide liquidity through banks. This proved crucial during the global financial crisis.28 In designing the institutional framework for macroprudential policy, authorities should consider if the scope of the lender-of-last resort function should be expanded to include institutions other than banks. Under what circumstances, and how, should central bank intervene if the liquidity stress of a non-bank financial intermediary appears likely to cause contagion and disrupt markets? International cooperation is necessary to avoid regulatory arbitrage. The FSB is the forum that is best suited to coordinating the any efforts to analyse financial stability risks stemming from non-bank finance, and to devise common approaches and regulatory standards. With its annual monitoring exercise the FSB provides the policymaking community with a framework for analysing risks, and a very useful source of data on non-bank finance; the coverage in terms of jurisdictions and the degree of harmonisation of the data have much improved in recent years. The FSB issued policy recommendations in 2017 to address structural vulnerabilities in asset management activities, mandating the IOSCO, the relevant standard setter body, to operationalise them. This work has led to the development of policy tools for asset managers in the area of liquidity risk management, and of leverage measures for investment funds to facilitate monitoring for financial stability purposes and to enable comparisons across funds at the global level.29 The FSB has also made some progress in studying the impact of large investors’ strategies on market liquidity. In a recent pilot simulation exercise, the FSB employed a modelling approach to assess the consequences of market stresses and examined the resilience of liquidity across a range of corporate bond markets.30 The central bank provided liquidity to mutual funds in the United States, to selected broker-dealers and central clearing counterparties in the UK. Similar arrangements were made by the Bank of Japan. IOSCO, “Recommendations for Liquidity Risk Management for Collective Investment Schemes,” February 2018. The approach was an adaptation of a model of the Bank of England. This line of action deserves to be brought further forward. There have been from time to time episodes of hesitations and reversal, such abandoning the idea of identifying globally systemic non-bank intermediaries (in my view an ill-advised move), some timidity in prescribing ex-ante liquidity rules, and now perhaps a sense that all that needed to be done has been done. The risks, however, are too new, too complex and too little understood for any complacency. Continued evaluation of the effectiveness of the available tools in a macro perspective, and increased coverage, as well as improved analytics, of systemic resilience testing, should in my view be actively pursued. FinTech, regulation and systemic risk FinTech, broadly defined, includes very diverse technology-enabled financial innovations encompassing the provision of a whole range of financial services, such as payments, insurance, lending and crowdfunding, trading and investment services.31 FinTech is changing the landscape in which intermediaries and policymakers are operating, as new business models are developed by exclusively Fintech firms or by incumbents responding to competition. FinTech activities can generate institution-specific risks, financial and operational, and systemic risks. The financial risks are not in principle different from those borne by other intermediaries, and depend on the business model adopted by the service provider. For example, some platforms providing FinTech-enabled credit directly match borrowers with lenders, acting as agents. If investments and loans are matched by maturity, and investors are unable to liquidate their investments before the loan matures, the platform bears no liquidity risk. Only a small proportion of platforms currently engage in leverage, as they use their own balance-sheet to fund loans.32 These platforms are exposed to credit risk, like others that offer return guarantees, and could be subject to liquidity risk if investors can liquidate on short notice their positions. The IOSCO maps eight groups of innovations, considering also those in planning, data and analytics, and security. A mapping can be found in IOSCO, “Research Report on Financial Technologies (Fintech), 2017. See the FSB-CGFS “Report on Fintech credit,” May 2017. Regulators and supervisors have to focus their lenses better in order to see more clearly the potential risks arising from each kind of Fintech activity and business model. There is one general principle that should inspire the way authorities tackle FinTech from a microprudential point of view: to the extent that FinTech activities involve the same risks that justify supervision of other activities, they should be regulated and supervised in much the same way. Following this principle also ensures a level-playing field between different institutions (i.e., banks and non-banks) performing the same activities. The current regulatory framework may or may not be adequate to ensure that this principle is followed; in many jurisdictions regulation of non-bank agents that engage in bank-like activities is lighter than that of banks, and many non-financial entities, large and small, appear determined to enter the financial-services field. Authorities should be prepared to evaluate on an ongoing basis the regulatory perimeter and the effectiveness of existing prudential rules. Operational risk, while not unique to FinTech activities, is especially relevant for them, irrespective of whether they are performed by separate service providers or by banks or other, supervised, traditional intermediaries. Cyber risk is not a new phenomenon, but the diffusion of FinTech activities could increase the vulnerability of the financial system due to greater use of digital technologies, which raises the number of potential entry points for cyber-attacks. Another source of operational risk is the reliance of banks and other intermediaries on services provided by third parties. FinTech activities, including those performed by traditional intermediaries, often involve outsourcing one or more functions or processes that are integrated into the value chain; these third parties could be outside the financial system, or within the financial system, but subject to lighter regulation and supervision. Reliance on third parties exposes FinTech activities to the risk of disruptions; furthermore, if these third parties manage confidential data, the legal risks may be substantial. FinTech innovations need to be carefully monitored to avoid that opportunities open up for illegal activities that could pose a threat to financial integrity. These risks have potential implications for financial stability to the extent that their materialisation can trigger distress in an entire sector, or propagate significant stress to other sectors of the financial system and the economy. Developments in FinTech could also become important from a macroprudential perspective if they have the potential to amplify shocks or create new channels of contagion as a result of externalities. I already mentioned ways in which technology may enhance the amplification risk implicit in market intermediation. FinTech can also increase the risks of contagion arising from interconnectedness through several other channels. First, FinTech entities are connected with banks and other financial entities through partnerships or other joint ventures. Digital platforms in some cases intervene at some stage of the value chain of a given financial service. For example, they act as an interface between institutional investors and borrowers or provide screening services for banks. While specialisation of intermediaries in the different stages of credit intermediation may increase cost efficiency, it could also exacerbate agency problems. At this stage, reputation risk and a collapse in trust in one or more large FinTech entities might conceivably be a major source of contagion. Second, digital technologies exhibit very significant economies of scale, which may drive consolidation in the financial industry and in financial market infrastructures, increasing concentration and leading to the emergence of a few systemically important players; similarly, third-party service providers may become fewer and larger, which increases the potential for exposure to common shocks. While policies for microeconomic and financial risks from FinTech are currently defined by individual jurisdictions, there is significant scope for coordination33. Regulatory and supervisory authorities have the difficult job of protecting the safety and soundness of the financial system without curbing innovation. They may be tempted to impose unduly restrictive rules in response to the challenge they face, arising from the complexity and dynamism of technology. Or they could be tempted to lower standards to encourage innovation and attract business, leading to the exploitation of regulatory arbitrage by firms. In European jurisdictions the volume of investment in FinTech companies appears to be negatively correlated with the stringency of financial regulation.34 While the optimal point in this trade-off may be difficult to find, it needs Realistically, one has to recognise that national security concerns may in certain cases dictate limits to cross-jurisdiction cooperation in this field. Barba Navaretti, G., G. Calzolari and A.F. Pozzolo, “FinTech and Banks. Friends or Foes?”, European Economy 2017 (2). to be found; international cooperation is key to avoiding an excessive divergence across jurisdictions. From a macro-financial perspective risks appear to be limited at this stage, but they could increase rapidly if the authorities lag too much behind the market in understanding technological and business developments. International cooperation in monitoring FinTech trends would be highly beneficial; assessing the material nature of the risks arising from FinTech is a difficult task because of the lack of data and experience.35 The FSB is monitoring developments of FinTech in its annual review of non-bank finance, and has just released a report on decentralised technologies.36 Collaboration with the industry can be very useful. In April the European Commission and European Supervisory Authorities launched a new platform, the European Forum for Innovation Facilitators (EFIF).37 Through this network, participating authorities can share experiences from their engagement with firms through innovation facilitators. The Bank of Italy will contribute its experience with its innovation hub.38 Given the cross-cutting nature of FinTech, international coordination on policies is already involving many institutions and standard setting bodies, each according to its mandate.39 The FSB has identified two issues that deserve the authorities’ attention from a financial stability perspective, and should be a priority for international cooperation: managing operational risks from third party service providers, and mitigating cyber risks. Many third party service providers are outside the regulatory perimeter, and the authorities should carefully evaluate whether the existing oversight frameworks are FSB, “Financial Stability Implications from FinTech, Supervisory and Regulatory Issues that Merit Authorities’ Attention,” 27 June 2017. FSB, “FinTech and market structure in financial services: Market developments and potential financial stability implications,” 14 February 2019. The European Commission has developed a FinTech Action plan, as outlined in a document released in 2018 (see “FinTech Action plan: For a more competitive and innovative European financial sector”). FinTech Channel, accessible through the website, is a direct interface through active start-ups and firms that would like to offer technological solutions to banks and financial intermediaries, or the latter if they are directly involved in the development of innovative solutions in the area of financial services, can contact the Bank of Italy. Initiatives have been launched by the Financial Stability Board (FSB), the Bank for International Settlements (BIS), the Basel Committee on Banking Supervision (BCBS), the Committee on Payments and Market Infrastructure (CPMI), the International Organization of Securities Commissions (IOSCO), the International Association of Insurance Supervisors (IAIS), the Financial Action Task Force (FATF). The IMF and World Bank have developed the Bali Fintech agenda in 2018, to guide its work and the dialogue with member countries. appropriate. Cross-border coordination and collaboration may also involve authorities in charge of IT security, especially in the regard to cyber risk. Finally, technology may also offer significant opportunities for authorities to improve their ability to protect financial stability. Many central banks and supervisory agencies are experimenting in this area.40 At the Bank of Italy we are exploring the use of new technologies in supervisory activities: specifically, we are testing ways in which artificial intelligence can help in forecasting economic and financial variables, understanding changes in investors’ sentiment, and improving the effectiveness of anti-money-laundering activities.41 Conclusions A more diversified financial system, with banks and non-bank financial institutions complementing each other, can improve resource allocation and promote growth. Effective regulation and supervision have to ensure that non-bank financial institutions reinforce the financial system, and this requires understanding and managing the attending risks. Certain types of non-bank finance could exacerbate the tendency of the financial system to behave procyclically, and increase the degree of interconnectedness between intermediaries and markets. Authorities should look at a possible macroprudential approach, and consider adjusting the policy framework accordingly, however challenging this may seem. Although FinTech has not raised issues from a systemic risk perspective so far, the authorities need to be vigilant and constantly update their knowledge of how these activities are evolving, to harness the opportunities for innovation while keeping risks in check. Some of the initiatives by early users are described in a survey-based analysis by D. Broeders and J. Prenio, “Innovative technology in financial supervision (suptech) – the experience of early users,” Financial Stability Institute, FSI Insights on policy implementation, No 9 July 2018. Examples are M. Accornero and M. Moscatelli, “Listening to the buzz: social media sentiment and retail depositors' trust,” Bank of Italy Working Paper No. 1165, 2018; M. Loberto, A. Luciani and M. Pangallo, “The potential of big housing data: an application to the Italian real-estate market,” Bank of Italy Working Paper No. 1171, 2018; C. Angelico, J. Marcucci, M. Miccoli and F. Quarta, “Can We Measure Inflation Expectations Using Twitter?”, Bank of Italy mimeo, 2019; L. Arciero G. Bruno, G, Marchetti, J. Marcucci, “Anomaly Detection in RTGS Systems: Performance Comparisons Between Shallow and Deep Neural Networks”, Bank of Italy, mimeo, 2019; G. Bruno, J. Marcucci, A. Mattiocco, M. Scarnó and D. Sforzini, “The Sentiment Hidden in Italian Texts Through the Lens of a New Dictionary”, Bank of Italy, mimeo, 2019. Coordination and cooperation among central banks and market and supervisory authorities is of the utmost importance, not only to avoid negative spillovers across jurisdictions, but also because the exchange of knowledge and best practices yields concrete benefits when navigating such a rapidly changing world. I thank you very much for your attention. The Banca d’Italia is delighted to host this event, and I wish everyone a very fruitful discussion. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association (ABI), Milan, 12 July 2019.
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Italian Banking Association Annual Meeting Speech by the Governor of the Bank of Italy Ignazio Visco Milan, 12 July 2019 The economic situation and outlook The world economy is struggling to regain momentum. According to the main international institutions, GDP growth this year will be at its lowest since the contraction of 2009. In the Economic Bulletin that will be published this afternoon, the pace of international trade growth is estimated to be 1.5 per cent, more than two and a half points lower than in 2018. Downside risks linked to protracted trade tensions, the slowdown in the Chinese economy, and the unknowns surrounding the timeframe and arrangements for the United Kingdom’s exit from the European Union, are weighing on the economic outlook. Growth remains weak in the euro area. The uncertainty regarding the world economy is having a negative effect on exports, manufacturing production, and firms and households’ expectations. According to the projections made in June by the Eurosystem, GDP is expected to increase by 1.2 per cent in 2019, while the forecast for 2020 has been lowered to 1.4 per cent. The growth in prices remains modest and financial markets’ inflation expectations are particularly low. At the beginning of June, the ECB Governing Council confirmed its strongly expansionary monetary policy stance. If there is no improvement in the macroeconomic outlook, further measures will be needed. Over the next few weeks, the Council will continue to consider how to recalibrate the tools at its disposal. Despite the slight improvement in the first quarter of this year, economic activity is stagnating in Italy, owing above all to the slackness of the industrial cycle. According to our surveys, firms expect a slowdown in demand over the coming months and very modest growth in investment over the year as a whole. The central projection included in the Bulletin puts GDP at 0.1 per cent in 2019 and at just under 1.0 per cent on average for the following two years. These estimates are subject to risks connected with both international developments and domestic demand. The confidence of households and firms could be affected by the uncertainties surrounding the budget, which have been dispelled for this year but not for the next. At a time of a generalized reduction in risk premiums, reflecting expectations of greater monetary accommodation in the euro area, tensions on the Italian government securities market have abated. Thanks to the European Commission’s decision not to recommend the launch of an excessive deficit procedure, following the reduction in expected net borrowing for the current year, the yield spread between Italian and German ten-year government bonds narrowed further and yesterday was below 200 basis points. To build on these results and reduce the cost of public debt further, the prudent budget policy stance must be confirmed over a longer time horizon. The yield spread compared with the corresponding German Bund is still around 70 points above the not low levels prevailing in April 2018. The yield spread with respect to Spain, which, like Italy, was severely hit by the sovereign debt crisis, is over 120 points; it had been around half a percentage point in April of last year. If the spread continued to narrow and were the cost of debt to fall below the nominal GDP growth rate, as has already happened in the other euro area countries, it would be easier to lower the debt-to-GDP ratio. Narrowing the spread would also attenuate the risks for credit access conditions. The tensions over public debt securities have pushed down private bond prices and the corresponding issue prices, especially for banks. There has been little effect so far on interest rates on loans, in part thanks to high levels of liquidity and the improvement in banks’ balance sheets. Nevertheless, signs of a tightening of credit access conditions have been emerging since mid-2018, especially for smaller firms and for those in the Centre and South; at a time of weak credit demand, this has led to a moderate contraction in loans to non-financial corporations since the beginning of this year. The conditions of Italian banks Italy’s banking system has progressively strengthened over the last few years, and credit quality has improved. Cautious lending policies, together with the albeit modest economic recovery, has kept the new non-performing loan rate down; prudent provisioning, more effective recovery processes and increasing recourse to NPL sales have driven the reduction in the stock of non-performing loans. Compared with the peak of 2015 and net of loan loss provisions, NPLs have more than halved, falling from €196 billion to €88 billion last March; their ratio to total loans has gone down from 9.8 to 4.2 per cent. Profitability has shown signs of recovery, linked to the reduction in loan loss provisions and the gradual decline in operating costs. Return on equity has been positive since 2017. Liquidity conditions have also progressively improved; some banks have resumed bond issuance on the wholesale markets since the end of last year, though at costs that are still higher than those recorded in the spring of 2018. Capital ratios, which up until last September had been affected by tensions on the government securities market, increased again; last March, the CET1 ratio averaged 13.2 per cent. In the first quarter of this year, the ratio of new non-performing loans declined for firms as a whole, but increased slightly in some sectors (construction and manufacturing); net interest income, which was already low, fell further. The prudent lending policies implemented by banks could mitigate the impact of the cyclical slowdown on the flows of non-performing loans compared with those observed in the past. Operating costs need to come down further so as not to penalize banks’ profitability again. Tensions in the government bond market affect the value of the assets that are eligible as collateral in the Eurosystem, push up funding costs, and have a negative effect on banks’ capital, given the losses on portfolio securities calculated at fair value. In the second quarter of 2018, for example, the increase in yields on government bonds reduced the capital ratio by about half a percentage point on average. Compared with April of last year, the market rates for bank bonds are now higher by about 15 basis points in Italy, while they are 45 basis points lower in the rest of the euro area. The rating agencies are maintaining their negative – or at best stable – outlook as regards any shifts in Italy’s credit rating. This is also why there is an urgent need to define a strategy to support investment and innovative enterprises within a credible framework for public debt reduction. The situation of the less significant banks other than mutual banks (BCCs) is still characterized by specific weak points. For most of these banks, profitability continues to be lower than that of the significant groups and their NPL ratio is higher. Some are affected by inadequate corporate governance and risk control structures. The problems tend to be worse for banks in Italy’s Mezzogiorno, mainly because this region faces greater economic difficulties. Their balance sheet assets are, on average, half those of banks in the Centre and North; their legal form is most commonly that of a banca popolare (9 banks out of 16, against 12 out of 78 in the rest of the country); the assets attributable to the popolari account for more than 90 per cent of the total, compared with 10 per cent in the Centre and North. As we have often pointed out, it is more difficult for popolari banks to turn to the market for the funds they need to strengthen their capital and to finance business growth and innovation. In the past few years, the Bank of Italy has introduced a series of measures covering all smaller banks, in part to prevent the emergence of critical situations. Action was taken to encourage new investors in banks’ capital and, where necessary, mergers with other intermediaries. Banks have been urged to reduce their credit risk and strengthen NPL management and recovery. They have been asked to adopt appropriate measures to reduce operating costs and diversify income flows, for example by using consortium-based initiatives, reorganizing branch networks and containing staff costs. The most problematic situations have been managed through market solutions that safeguarded financial stability and protected depositors. Until the first few months of last year, also thanks to greater confidence in the economic outlook for Italy and the euro area, the involvement of qualified investors made it possible to relaunch a number of banks, whose business models were completely overhauled and adapted to the new competitive scenario. However, in the current market environment, investing in the capital of smaller banks is considerably less attractive. Restructuring operations have become more difficult, partly due to the perception that their possible outcomes are much less certain. In this context, and given the limitations imposed by the European rules for managing crises at smaller banks, the less significant banks must work together to identify solutions to secure their business and relaunch their activities. On the one hand, links with their local area cannot be the only factor in their development; knowledge of markets and operators must be accompanied by more intensive use of new technologies to increase operational efficiency and to make the supply of customer services more competitive. On the other hand, banks must reap the benefits that being larger can bring in terms of economies of scale and a strong capital position. We are mindful that consolidation is a complex process, but preparatory work must begin at once to move in that direction, defining projects of common interest in areas such as technological innovation, the pooling of auxiliary activities and their related costs, and the development of synergies in service provision. It is fundamental to establish balanced governance structures that avoid conflicts of interest and meet the objective of financing the real economy in conditions of full efficiency and adequate profitability. In the last few months, the two new mutual banking groups that are now classified as significant for supervisory purposes have started operations. Most of the BCCs (224 out of 263) have joined these two groups. Fully reaping the benefits of the reforms of this sector will largely depend on the effectiveness of the interaction between the parent banks and the individual BCCs in raising efficiency and profitability, harnessing economies of scope and improving credit management processes, including on the basis of the Single Supervisory Mechanism’s Comprehensive Assessment. The necessary streamlining measures will have to be carried out promptly, particularly in relation to the profitability of the branch networks and their size. The capacity of the BCCs to continue to serve their territories of reference requires risk management and control systems that converge rapidly towards high standards, mostly to prevent the emergence of improper business relationships or conflicts of interest. The parent companies must act decisively when exercising their powers of intervention under the new regulatory framework and when tackling the problems of BCCs with structural weaknesses. Full compliance with the rules on transparency and adequate customer protection are necessary conditions to foster trust in banks and preserve their reputation; such conditions contribute to financial stability. The Bank of Italy is committed to strengthening regulatory defences; supervisory action is aimed at both individual banks and at particular problem areas. The work of the Banking and Financial Ombudsman strengthens individual protection, but a decisively proactive approach on the part of the banks is needed, turning organizational measures aimed at ensuring compliance with rules and provisions into an effective strategic choice. The significance of the risk posed by the financial sector’s possible involvement in criminal activity in connection with money laundering is confirmed by recent events at some major European banks. Targeted initiatives have been launched to strengthen oversight in the individual EU member states, to set up mechanisms for cooperation among national authorities, and to integrate money laundering risk assessments into prudential profiles. It will be possible to assess the effectiveness of these measures in the near future. In Italy, our supervisory activity makes a significant contribution to ensuring that banks are not vulnerable to criminal infiltration; one of our strengths is our proximity to and close cooperation with the Financial Intelligence Unit. In this area too, it is essential that banks remain highly vigilant with respect to the monitoring of risks. Over the years, cooperation with the judicial authorities has been intense: in the three years 2016-18, the Bank of Italy awarded more than 350 technical consultancy contracts, answered almost 700 requests for information, and issued more than 280 communications. Support for the public prosecutor offices most heavily engaged in combatting financial crime has been stepped up. One tangible symbol of this is the memorandum of understanding that will soon be signed with the public prosecutor’s office in Milan, where a team of our experts has already been working since 2009. The challenges posed by regulatory developments The European Banking Authority recently published the methodology to be used for the next round of stress testing, which will begin in early 2020 and involve 50 intermediaries, of which four are Italian. As in the past, the test is not a pass-fail exercise; its goal is instead to support the Supervisory Review and Evaluation Process (SREP). The consultation phase that has just begun is intended to allow banks to prepare for the stress test. The perception that the costs of the stress tests have become high with respect to the benefits has led to a discussion on how to improve this tool. The Bank of Italy is actively involved in this debate. A study we published in recent weeks advocates for two separate tests: the first, to be conducted by the supervisory authorities, for microprudential purposes; and the second, to be carried out by the European Banking Authority in cooperation with the European Systemic Risk Board, for macroprudential purposes. This distinction would be consistent with the regulatory tasks assigned to the different European authorities. Adopting a bottom-up approach, the microprudential exercise would focus on specific risk areas identified as a priority by the supervisors; it would combine static and dynamic assessments based on stress tests carried out by the banks and subject to rigorous quality assurance by supervisors. The top-down macroprudential exercise would instead assess the resilience of the entire European financial sector to systemic shocks, using tests devised directly by the authorities and minimizing the costs for the banks concerned. We hope that there will be a wide-ranging and open discussion on these issues over the next couple of months. In Europe work has begun to adopt the standards approved at the end of 2017 by the Group of Central Bank Governors and Heads of Supervision (Final Basel III). The measures seek to reduce excessive variability in the calculation of risk-weighted assets. The introduction of an output floor for the requirements calculated using internal models and the new rules on market risks approved at the beginning of this year to rebalance the relative weight of credit and market risks in the capital requirements (Fundamental Review of the Trading Book – FRTB) will be of critical importance. There will be a long transition period before the standards enter fully into force. Based on the information available, the effects of the new rules on Italian banks, while not negligible, appear less significant than for the banks of the other major European countries. However, Italian banking groups would do well to seize the opportunity offered by the transition phase to prepare effectively, honing their operational strategies and balancing profitability and capitalization needs. In recent years, episodes of market manipulation and a significant reduction in interbank transactions have jeopardized the integrity and representativeness of the money market reference rates. To counter these risks, a process to review the financial benchmarks has also been launched at European level, in line with the recommendations of the Financial Stability Board. Starting on 2 October 2019, the ECB will publish an index of the unsecured overnight borrowing costs of euro area banks (euro short-term rate, €STR), which going forward will replace Eonia in the indexation of financial instruments. Moreover, it is expected that before the end of the year, Euribor, an important benchmark for indexed mortgage loans and other financial contracts, will complete its migration to a new calculation methodology which, where possible, will use data on the actual transactions of a sample of banks. The use of benchmarks in the financial system is widespread; in Italy a large amount of the banking system’s assets and liabilities is indexed to Euribor. It is essential that intermediaries identify and promptly implement the necessary measures to ensure an orderly transition to the new reference rates, both for dealings with customers and in terms of organizational and operational setups. The objective of the rules on managing banking crises introduced in Europe since 2014 is to enable failing banks to exit the market while minimizing the impact on financial stability and the public accounts. This is a valid objective, whose actual achievement has nonetheless been hindered by factors that require further reflection. Some resolution tools, such as the bail-in, cannot be applied in the absence of dedicated bank liabilities (TLAC and MREL) subscribed by qualified investors and capable of absorbing the losses and recapitalizing the intermediary. It would take until at least 2024 to build up the full stock of these liabilities, also due to the significant costs that banks must incur in issuing them. In the meantime, in order to manage bank crises solutions must be found that make it possible to draw on external sources of funding even in derogation of the bail-in principle. Consistent with the IMF’s recommendations, when there are risks to financial stability these solutions should remain available even after the stock of dedicated liabilities has been fully established. Precautionary recapitalization should be more readily available to address any market failures that restrict the ability of solvent banks to self-finance and to head off the risk of contagion. Regulatory constraints that discourage investors from participating in bank recoveries should be removed; these include, for example, envisaging forms of protection for the financial contributions they provide and strengthening the early intervention tools available to supervisory authorities, including special administration. The resolution procedure established at European level is only applicable to a very limited number of large banks; in the event of a crisis, all the others would be subject to liquidation in accordance with national laws, with no guarantee of this taking place in an orderly manner in a way that avoids any impact on systemic stability. There is an urgent need for European measures establishing a liquidation framework that will not lead to business discontinuity, fire sales of assets, and negative consequences for unprotected depositors, customers and the economy as a whole. One reference model is that of the US Federal Deposit Insurance Corporation (FDIC), under which deposit guarantee systems intervene to facilitate the en bloc disposal of the assets and liabilities of the bank being liquidated (in an institutional framework in which the deposit protection limit is higher than that in Europe and the FDIC is not a super senior creditor). More generally, the relationship between the regulatory framework on banking crises and that on State aid must be reviewed. In addition to eliminating the overlapping of jurisdictions and to clarifying uncertainties as to application, there is a need for discussion and reconsideration of the principle whereby the protection of competition, which underpins the rules on State aid, always takes precedence over arguments for protecting financial stability. Appropriate revision of the European bank crisis management framework could help solve the problem of having failed to provide for an adequate transition phase which the new system would have required. Such a revision would make it possible to take better account of the fact that banks are, by their very nature, exposed to the risks of contagion, unlike, as a rule, companies that operate in other economic sectors. Legislative action on the part of the new European Commission to revise the BRRD could provide an opportunity to rethink the current rules in order to make the European regulatory framework more flexible and more at one with the nature of banking. In the European Union all banks are subject to many regulatory standards which, in reality, were conceived with international banks in mind. While this ensures fair competition within the Single Market and creates a robust framework that safeguards stability, it imposes high compliance costs on smaller banks (despite the simplified rules they benefit from, even on very important parts of the regulations, such as market risk, employee compensation and reporting obligations). Complex risks cannot but require detailed rules. However, an excessively complex regulatory system can itself become a source of risk: it can generate uncertainty as to the application of the rules, can serve as an incentive to conduct business outside the scope of application of the rules, and may result in a disproportionate burden on smaller or more specialized banks. The opportunities and risks presented by technological innovation in the financial arena The challenges posed by technology are inescapable, for banks, for businesses, for each and every one of us. Closing the gap that has accumulated over the last thirty years in economic and financial innovation and in the skills of adults and students requires a collective effort. Banks are expanding the range of traditional services available online but have not yet begun to invest significantly in the latest technologies. In industry, the recovery of competitiveness in the international markets witnessed in recent years must be supported by policies that encourage firms to innovate and expand. However, further progress can only be made if we all recognize the importance of investing in culture and knowledge to provide an education that encompasses not just the student years but people’s entire working lives. Digital technologies make it possible to increase financial inclusion, leading to more efficient resource allocation and supporting investment and economic growth. New ways of collecting large volumes of heterogeneous data and new methods for analysing them (including artificial intelligence and machine learning applications) make it possible to assess customer credit ratings more accurately and the terms and conditions at which loans will be granted. The benefits of using new technologies are greater in the payment segment and in that of loans to firms that operate in sectors and areas in which lending is riskier. The advantages of exploiting digital technologies tend to be greater for smaller banks, whose customers are mainly small firms. Nowadays, a number of crowdfunding platforms put firms in direct contact with both retail and institutional investors, increasing access to funds. The use of distributed ledgers for trading shares of unlisted SMEs, which are currently being tested, reduces the costs of accessing capital markets. These technologies, which are experiencing rapid growth abroad, can also make inroads in Italy, where corporate financing mainly depends on the banking system. Coping with the competition of new digital operators requires that banks lose no time in investing, with adequate safeguards against cyber risks, in both the latest technologies and in the formation of the human capital needed to apply them successfully. In a market in which customer characteristics and habits change rapidly, it is not enough to rely on maintaining trust in traditional intermediaries. The possible introduction of a virtual currency that could make the settlement of some retail and financial transactions cheaper and faster was recently announced; according to its architects, its value would be kept stable with respect to a basket of the main world currencies. The fact that a private currency can originate in a digital context may change the way in which traditional liquidity, market and solvency risks manifest themselves, but it cannot eliminate them altogether. These risks come with others, certainly no less important, linked to the security of savers’ resources, the protection of personal data, its possible use for the purposes of tax evasion, recycling and terrorist financing and, given the potentially vast application of this new means of exchange, to the potentially adverse effects on monetary and financial stability. The attention of regulators, central banks, supervisory authorities and the other institutions involved is at a maximum. The information available still does not permit a complete analysis of the risks associated with this type of proposal and the measures required to counter them. It is important that all the parties involved keep engaging in dialogue and stand ready to intervene to ensure the application of the principle whereby the same activities are subject to the same regulatory safeguards, regardless of who performs them, the necessary security standards are upheld for the proper functioning of financial transactions, and everything possible is done to maintain the trust of savers and to prevent abuses of authority. Account must also be taken of the findings of assessments, still to be completed, of how best to safeguard monetary and financial stability. In any event, the introduction of private virtual currencies may entail risks of a different nature to those directly connected with technological innovation, which in itself is desirable owing to the significant advantages it offers. In this regard, even for the legal tender issued by the central banks, assessments are under way of how best to exploit the opportunities provided by advances in digital technologies. * * * The Italian Banking Association was established on 13 April 1919. In the one hundred years since then, Italy has lived through the difficult interwar years, the economic miracle of the 1950s and 1960s, the decline of growth between the collapse of Bretton Woods and the early 1990s and, finally, a long period also marked by two very severe crises, in which the economy’s growth rate has disappointed and production has stagnated. In this latter period, Italy has paid the price for its delayed reaction to the opening up of global markets and to technological change. It is a delay that has also concerned banks, which are now called upon to make profound changes to deal with competition, including from non-bank intermediaries, and to resume in full their principle role as financers of the economy. Strengthening the solidity and competitiveness of banking systems, in Italy as in Europe, calls for mergers to raise efficiency levels and to improve banks’ ability to make the necessary investments in technology. At this critical juncture, ABI can encourage banks to anticipate these changes as much as possible, by promoting, including at international level, initiatives that favour innovation, the revision of business models, and the strengthening of trust in the banking system. Developments in finance and in the real economy are interdependent; the more efficient financial intermediation is, the more possibilities firms will have to develop their business; economic conditions affect the quality of banks’ credit and their profitability and capitalization. Economic policy must recreate the conditions to ensure this interaction is beneficial and avert negative spirals. Preserving the trust of households, firms and investors requires concrete, resolute action to tackle Italy’s structural weaknesses, accompanied by persuasive, goal-oriented, and unequivocal communication. An organic plan with clear, comprehensive measures, designed to boost firms’ investment and growth, above all of innovative firms, must go hand in hand with a credible strategy to reduce the public debt. The markets have reacted positively to the recent decisions of the Italian government and European Commission, proof that it is possible to trigger a virtuous cycle between budgetary policies and financial conditions capable of conveying a strong and lasting stimulus to economic activity. Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the fourth annual Macroprudential Policy Group research workshop, Rome, 10 October 2019.
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Luigi Federico Signorini: Macroprudential policy - effectiveness, interactions and spillovers Welcome address by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the fourth annual Macroprudential Policy Group research workshop, Rome, 10 October 2019. * * * It is my pleasure to welcome you to the fourth Macroprudential Policy Group research workshop. We are honoured to host an event that has become one of the most important opportunities to discuss macroprudential policy in Europe. I would like to thank the organisers, the keynote speaker, the contributors to the four sessions and the panellists for the roundtable that will conclude the conference this afternoon. The papers to be presented today cover a wide array of topics and will help us to understand crucial features of the transmission mechanism of macroprudential policies. They take stock of the experience accumulated in recent years across the euro area. They also strive to contribute to the development of a measure of the prudential stance, an endeavour that I have always advocated as essential for the conduct of macroprudential policy. Let me spend a few words on this point. The concept of stance should convey information on the overall impact of the policy instruments that have been implemented, on their adequacy in meeting policy objectives given the identified risks, and on the required policy orientation. A credible stance would help to enhance policy communication, reinforce transmission channels and counter potential inaction biases. Certain steps towards setting a framework for a macroprudential stance in the EU have been taken. A notable contribution is a recent European Systemic Risk Board publication, which proposes a “risk-resilience” framework to define the macroprudential stance. In that framework, the amount of systemic risk faced by the financial sector is compared to the level of resilience against negative shocks stemming from microprudential provisions, regulatory aspects or public safety nets, and the additional resilience created by the active macroprudential tools. The macroprudential stance is defined as loose or tight depending on whether the difference between risk and resilience is above or below some pre-specified level that measures the risk tolerance of the authorities, and thus, the “neutral” policy stance. This is an interesting framework and I certainly welcome it as a good starting point for a policy discussion. It is a high-level framework, however, and certain concepts need further development. Without any claim to being exhaustive, I would like to mention three important dimensions along which I think the approach could be further improved. First, the boundary between the effects of micro and macroprudential policies is more artificial than real. The two, while different in purpose, share instruments and are directed to the same participants in the financial markets. Indeed, it is the overall level of micro and macroprudential requirements that affects the ability of the financial system to finance the real economy, both in normal and stressed times. Consequently, a narrow notion of the macroprudential stance should, in my opinion, be replaced with the more comprehensive one of an overall prudential stance, one that would account for how both categories of prudential measures affect the economy. Let me emphasise that this is not just a question of semantics. Microprudential capital requirements, for instance, have been substantially increased after the crisis. In the short run, the contractionary effects on the credit cycle associated with such an increase were, directionally and qualitatively, of the same nature as those associated with the activation of a cyclical buffer. This of course does not mean that it was wrong to do it; an increase in the quantity and quality of bank capital was required to strengthen the banking system, in light of all the shortcomings of the old supervisory rules that the crisis had exposed. However, it was clear to all that there was a 1/3 BIS central bankers' speeches price to pay for this, in terms of tighter credit: at least temporarily, during the transition to the new standards. An overall prudential stance measure would capture this policy tightening; a narrower perspective misses it. Had the former existed, it would have supplied valuable input, for instance, to the discussion on transitional arrangements. The discussion took place anyway, because regulators were qualitatively aware of the issue, but in a sort of informational vacuum. I would thus suggest to devote further thought to such issues of definition. The conceptual framework should also more explicitly capture the idea that one central aim of macroprudential policies is to limit the endogenous pro-cyclicality of the financial sector. Risks tend to be underestimated by market participants during booms and overestimated in busts, resulting in an amplification of cycles. To lean against this procyclical pattern in risk perceptions, the framework for the macroprudential stance should have a clear cyclical perspective. One might also note that, in normal macro-economic discourse, “neutral” is a factual assessment of the stance and is not synonymous with “right”; in certain cases policymakers wish to have a loose, in other cases a tight stance. One way to set this idea within the ESRB conceptual framework might be to say that the macroprudential authorities would need to lower their risk tolerance in booms and thus activate contractionary policies early; symmetrically, they would increase their risk tolerance as booms turn to busts, and thus provide accommodative policy and support growth when the cycle weakens. But whatever the specific phrasing, a more prominent cyclical element would, in my view, be welcome. The use of macroprudential tools, especially the more wide-ranging ones such as the countercyclical buffer, should always be carefully considered in this light. Timing is essential. We may or may not be able one day to fine-tune the prudential stance so as to define an “optimal policy rule” over the cycle but, as a minimum, we should be alert to the risk that the countercyclical buffer may end up to be used like a procyclical one. “Better late than never” is a poor guide to countercyclical action; the Hippocratic injunction to physicians, “First, do no harm”, is more apt. An objective evaluation of the stance, and a cyclical benchmark against which to measure it, would be most useful in this respect. This is an important reason why I look forward to any progress in this field, whether we can ever fine-tune macroprudential policy or not. My third and final point on conceptual issues is that, ideally, the prudential stance should also account for the interaction of macroprudential policies across countries. Euro-area countries are deeply integrated. During stress periods, this may lead financial instability in one country to propagate to other countries, if an inaction bias prevails; the same holds, again symmetrically, for the effect of contractionary measures. How, and to what extent, this can be done is, I think, a matter for further potentially valuable reflection. Before concluding, let me add that a different issue is sometimes raised about the relationship between monetary and macroprudential policy. This is an important and complex issue and it would not be possible for me to discuss it here at any meaningful length. Let me however make one observation that applies especially to tailored macroprudential policies, i.e., the ones that are aimed at preventing instability in specific markets. Such measures, I would argue, are best seen as working, not as a restraint on, but as a complement to, monetary policy. The latter is, by nature, pervasive, and as such it can have unwanted side-effects in certain areas or markets. Should such pockets of vulnerability emerge, authorities can activate tailored macroprudential policies to tackle them. In this context, macroprudential measures do not aim at “neutralizing” the effects of monetary policy. Rather, a targeted use of macroprudential tools creates more room for manoeuvre for monetary policy to follow its price-stability mandate. Recently, various euroarea countries have adopted macro measures to contain imbalances in the real estate sector, sometimes in response to the ESRB’s warnings or recommendations. This is, in my view, a successful example of how monetary and macroprudential policies can complement each other. * * * 2/3 BIS central bankers' speeches It is time for me to close this address. I look forward to the valuable exchange of experiences, insights and evidence that will take place during this conference. I am sure it will help us improve our understanding of the way macroprudential tools can be best used to satisfy our financial stability mandate, and to complement other macroeconomic tools. I thank you all for your participation and your attention. 3/3 BIS central bankers' speeches
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Welcome address by Mr Fabio Panetta, Senior Deputy Governor of the Bank of Italy, at the workshop on "Monetary Policy in the New Normal: Strategy, Instruments and Transmission", Rome, 11 October 2019.
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Workshop on “Monetary Policy in the New Normal: Strategy, Instruments and Transmission” Welcome address by the Senior Deputy Governor of the Bank of Italy Fabio Panetta Rome, 11 October 2019 It is a pleasure to welcome all of you to Banca d’Italia for this workshop on “Monetary policy in the New Normal: Strategy, Instruments and Transmission”. This event, which is organized by the Economic Outlook and Monetary Policy Directorate, has by now become an annual tradition, and brings together academics and central bankers to discuss relevant topics in the policy debate. The focus of this year’s edition is on monetary policy in the so-called “New Normal”. What is the New Normal? Its meaning has changed somewhat over time. When the term was first used, it indicated generically the context in which monetary policy would have been operating after its “normalization”, following a decade of extremely accommodative monetary conditions. By now, the meaning of the term New Normal has become narrower, as it tends to refer specifically to the monetary policy framework that is appropriate to deal with a macroeconomic scenario in which low interest rates, low potential output growth and low inflation last for quite some time. A “low-for-long” environment, in a nutshell. Indeed, since the early 1980s, real interest rates in the advanced economies have been following a declining trend. The estimated natural rates of interest also decreased. These estimates are surrounded by a large degree of uncertainty, but there is by now ample consensus on natural rates being currently lower than they used to be. Several reasons account for this widespread trend, such as demographic changes, productivity developments, the global saving glut and the increased appetite for scarce safe assets. Banca d’Italia economists have tackled this issue in the last couple of years. As we all know, in this low interest rate environment, monetary policy has less space for addressing economic slowdowns, recessions and low inflation. The times of the so-called Great Moderation, when interest rate changes sufficed to steer the economy around, are now over. Monetary policy had to adapt, and it did, in a profound and at times even spectacular and creative way. Central banks have shown great determination and inventiveness in responding first to the global financial crisis and, more recently in the euro area, to risks of deflationary spirals. After more than a decade since the outbreak of the crisis, the time has come to reflect upon how the “art” of central banking has evolved and to draw some lessons for a framework that can serve us well in the future. Having, and communicating to the public, a well-defined framework, as opposed to what Ben Bernanke called the Marcel Marceau communication strategy – that is: watch what I do, not what I say – is particularly helpful whenever one sails into uncharted waters, i.e., when the public does not have enough examples of the central bank’s past behaviour and hence the information vacuum looms unusually large. A review of central banks’ monetary policy strategies could serve this purpose; many central banks are currently involved in doing precisely that. I am sure that this workshop will provide important insights on all these issues. Among the many ways in which the term “New Normal” may be analysed, I am happy to see that today’s papers tackle three questions that are of the utmost relevance in my view. The first concerns the optimal inflation target in a low rates environment. I am sure that the keynote speech by Professor Galí as well as the papers that will be presented in the opening session will help us deepen our understanding of the implications of a low interest rates and low inflation environment for monetary policy. A second issue is about the strategies that central banks should follow: should bygones be bygones? Or should policymakers seek instead to undo past deviations of inflation from the target, adopting what are known as “make-up” strategies? This is one of the most momentous questions that is being discussed within the broad ongoing review of the monetary policy strategy by the Federal Reserve. I am delighted to have with us, as keynote speaker, Paolo Pesenti from the Federal Reserve Bank of New York, and I am eager to hear his insight on these questions. The final issue is the new tools used after the outbreak of the global financial and sovereign debt crises. How do they influence the real economy? Are there limits to their effectiveness? Although the literature is flourishing with studies on unconventional monetary policies, little is known about the transmission mechanism of these tools to the economy. The papers that will be presented in this afternoon’s session will shed further light on these issues. Let me conclude by saying that the New Normal is already with us: returning to the pre-crisis status quo is not only unlikely, it is probably unfeasible. To deal successfully with this New Normal, central banks must keep developing analytical tools and robust models. A continuous interaction between academics and central bankers is the best way to prepare for the challenges ahead. Therefore, I would very much like to thank all the speakers and discussants for taking part in the workshop. I wish you all a fruitful and very productive day. Designed by the Printing and Publishing Division of the Bank of Italy
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 95th World Savings Day, organized by the Association of Italian Foundations and Savings Banks (ACRI), Rome, 31 October 2019.
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ACRI Association of Italian Savings Banks 2019 World Savings Day Address by the Governor of the Bank of Italy Ignazio Visco Rome, 31 October 2019 The economic outlook The trade tensions, the slowdown in China and the persistent uncertainty concerning the United Kingdom’s withdrawal from the European Union have continued to affect the global economy. International trade, which has been declining since last autumn, seems to have contracted in the second quarter as well; for the year as a whole, it is expected to increase but at a rate of less than 1 per cent, the lowest since 2009. In recent weeks, the International Monetary Fund revised downwards its growth forecast for 2019 and 2020 for nearly every country. Going forward, global demand may benefit from the stimulus measures implemented in the major economies, but the risks remain significant and are aggravated by the high level of public and private sector indebtedness in many countries. In the euro area, the sharp drop in industrial activity, especially in Germany, has thus far been partially offset by the performance of the service sector. However, this sector has also started to show signs of weakness. Among the main economies, GDP decreased in Germany while it continued to grow in France and Spain in the second quarter. If the contraction in the German economy persists, it will inevitably spread to other countries. In Italy, economic activity seems to have remained substantially unchanged during the summer, after having grown just slightly in the second quarter. The manufacturing sector has suffered heavily from the close production and trade ties with Germany, as well as from the negative effects stemming from the global context; the sector’s weakness seems to have been offset by a slight expansion in services and construction. In the surveys carried out by the Bank of Italy between September and October, firms expressed less unfavourable opinions on the economic situation and on the trend in demand for their own products in comparison with the opinions expressed at the start of the year. The higher planned investment likely also reflects the reintroduction of tax incentives in April; instead, firms that sell in Germany further downsized their expenditure plans. Despite the contraction in world trade, exports continued to grow in the second quarter; Italy’s current account surplus has helped to further reduce its net foreign debtor position, which is now close to balance. The new tariffs applicable to the European Union, announced by the United States administration, will affect a limited share of Italian exports to the US but the indirect effects could be significant. Thanks to the decline in uncertainty surrounding Italy’s economic policy stance, lessened tensions with the European institutions and greater monetary accommodation, yields on Italian government securities have declined significantly, falling to historically low levels; yields on ten-year bonds now stand at around 1 per cent. The spread with the corresponding German bonds has narrowed, falling from the peak of almost 290 basis points recorded at the end of May to approximately 130 basis points this week (Figure 1). However, it remains higher than the spread of other euro-area countries such as Spain and Portugal. For Italy, the reduction in the spread was in part due to the fall in the debt redenomination risk premium, which came to almost 30 basis points, nearing the level recorded at the start of 2018. Accommodative financial conditions attenuate the contractionary effects that stem from the global situation; for our economy, this is an opportunity that should not be missed. Looking forward, the average debt burden is expected to remain on a downward path, reducing the effort needed to reach a primary surplus that is capable of ensuring balanced public accounts. The decline in interest rates on government securities has already significantly lowered the cost of wholesale bank funding and of corporate bond issues. Interest rates on bank loans to firms and households also fell slightly, though they ran the risk of increasing significantly had tensions not abated on the government securities market over the course of the year. The fiscal stance tries to strike a difficult balance between ensuring sustainable public finances and supporting the economy. To counter the cyclical slowdown effectively, the choice of measures must be based on their effect on aggregate demand; in addition, guaranteeing the attainment of the balances envisioned is essential to avoid a decline in private sector confidence. In order to reduce the debt-to-GDP ratio decisively and durably, we must improve the growth outlook through concrete initiatives that improve the environment in which economic activity takes place. Removing uncertainty on the current and future situation of the public finances is essential to protecting savings, which can only be amassed and increased if the economy grows at sufficiently high rates along a stable and sustainable path. Monetary policy and savings Inflation in the euro area remains at levels that are still too low, and these low levels are pushing down short-term inflation expectations. The risk of a de-anchoring of medium- to long-term expectations has emerged as they have moved further away from the price stability aim (Figure 2). The inflation expectations at the five-year horizon of the participants in the ECB’s Survey of Professional Forecasters have decreased by about 0.2 percentage points since the start of the year, to 1.6 per cent. Those implied by the prices of inflationlinked financial assets, which also incorporate a risk premium, fell by 0.4 percentage points over the five-year, five years forward horizon, to 1.2 per cent. Low inflation and the ongoing economic slowdown must be countered decisively, lest they translate into a further, progressive reduction in inflation expectations or into a re-emergence of the threat of deflation. The ECB Governing Council took timely, appropriate and proportionate action to respond to the cyclical downturn and the worsening inflation outlook by adopting a very broad set of expansionary measures. It decided to restart, effective tomorrow, net asset purchases at a monthly pace of €20 billion (they had reached €80 billion per month between April 2016 and March 2017); to reduce by 10 basis points, to -0.5 per cent, the interest rates on banks’ deposits with the Eurosystem; and to lower the cost and extend the maturity of targeted longer-term refinancing operations. There was unanimous agreement within the Council on the need for action, and broad consensus on the package of measures as a whole, although there were differing views on the individual measures. While the effects of some of them are uncertain, there is no reason to doubt their overall effectiveness. The monetary policy stance will therefore remain resolutely expansionary for as a long as necessary to support aggregate demand and, through this, ensure price stability. Our analyses suggest that the ECB’s asset purchase programme is likely the most effective tool under the current conditions. The effects of the purchases are transmitted through various channels: they have a direct impact on the yields of the securities being purchased; they help to improve credit supply conditions; and they strengthen the monetary stimulus to the entire economy through wealth and portfolio-rebalancing effects. The consequences of a reduction in the key interest rates to even more negative levels – the true ‘non-standard’ instrument among those that have been introduced thus far, given that open market operations have always been in the toolbox of central banks – should be assessed more carefully. The evidence suggests that reductions in the key interest rates have so far had significant expansionary effects. Going forward, however, the risks of undesirable side effects may grow the longer the key interest rates remain at negative levels and, especially, the lower they fall. There is the possibility that banks’ balance sheets will be penalized by a reduction in net interest income, with repercussions on their ability to grant loans, especially to households and small firms, and on the transmission of monetary policy. To counter this risk, we have accompanied the latest reduction in interest rates with the decision to remunerate part of banks’ excess liquidity holdings with the Eurosystem at zero per cent as opposed to a negative rate. In addition, banks’ balance sheets benefit from the very favourable conditions (including negative interest rates) applied to loans granted by the Eurosystem. It has been argued that, as the whole term structure of interest rates remains at very low if not negative levels, there could be an incentive for households, firms and investors to take on excessive risks, fuelling possible misalignments between the prices of financial and real assets and their fundamental economic value. There are currently no signs of a generalized widening in euro-area imbalances. The indicators continue to suggest that the weak phase of the economy is not transitory and they do not signal imminent financial risks. The Governing Council is constantly monitoring these developments. In the years following the global financial crisis, Italian households were cautious in their selection of portfolio investments. The share of deposits in their total financial assets has continued to grow, reaching almost 30 per cent in June, also as a consequence of the reduction in the yields on other financial instruments (Figure 3). In addition, households have significantly reduced their direct investments in bonds, especially government and bank bonds, bringing them to 3.3 and 1.5 per cent of their total investments, down by 3 and 6 percentage points respectively compared with 2007. Purchases of asset management products increased (especially those of insurance products): their share in total financial assets surpassed 31 per cent in June, some 11 percentage points higher than in 2007. Overall, portfolio diversification has increased. Within this context, the activities geared at protecting savers, in which the Bank of Italy, Consob and IVASS each play a part, are especially important. We carry out our role on various fronts. On the one hand, we have strengthened our supervision of bank products, most recently through measures on the handling of complaints, on product oversight and governance, and on the rights of payment service users. On the other hand, we are continuing to expand upon our financial education initiatives for young people and adults, including in relation to the effects of digital technology on payment instruments: we are completing the update of the informational material for students; we will soon launch a new financial education website; and we are working very closely with the national financial education committee. The main way to protect savers is through growth. This objective is currently being pursued by maintaining very accommodative monetary conditions. In the long run, the return on savings necessarily depends on the economic outlook. The unsatisfactory level of market yields is the consequence of the insufficient level of investment with respect to the supply of savings; more generally, it is the result of the weakness in demand caused by negative long-term trends, such as demographic trends, and by cyclical trends, such as the recent sharp increase in uncertainty. If the latter is not tempered, it could further increase the propensity to save for precautionary purposes, leading to a downward spiral in economic activity that would lower, rather than increase, aggregate savings, as convincingly maintained by Ragnar Frisch and John Maynard Keynes during the Great Depression. Policies designed to stabilize the economy, which extend beyond monetary policies, serve to combat this risk by stimulating investment and consumption. There would be less need to maintain our monetary policy measures for an extended period of time − thereby also mitigating the risk of negative side effects − if, in those countries where the public finances permit, fiscal policies were to contribute incisively to strengthening aggregate demand and if Europe’s focus were placed on reforming the structure and functioning of the economy so as to increase the growth potential, about which monetary policy can do little. Banks In Italy the upturn in economic activity recorded in recent years, even if rather modest, helped to improve the quality of banks’ assets, an improvement that has continued in recent months despite the stall in growth. In the first half of this year, the ratio of NPLs net of loan loss provisions to total outstanding loans fell from 4.3 to 4.0 per cent for the banking system as a whole; it was 9.8 per cent at the end of 2015. According to the reduction plans submitted by both significant and less significant banks, this ratio should decrease further, to around 3 per cent by the end of 2021 (Figure 4). Going forward, however, NPLs dynamics could be affected by a protraction of the current phase of cyclical weakness. Efforts to strengthen balance sheets must therefore continue in an orderly but resolute fashion, especially by smaller banks, whose NPL ratios are higher and coverage ratios lower than those of the significant banking groups. The improvement in the quality of banks’ assets was facilitated by the development of the market for NPLs: in the three years 2016-18, NPL disposals amounted to more than €120 billion, gross of provisions; so far this year they came to around €20 billion. This was due not just to the fact that banks can access the state guarantee scheme (GACS) for securitized bad loans, which was renewed in March of this year, but was also spurred by the early results of the reforms undertaken to reduce the length of credit recovery proceedings, which deters investors and affects disposal prices. The expected time needed to sell foreclosed property decreased from more than three years to around two years. The expected length of time needed to complete all preparatory procedures also declined, albeit by only three months, to just over two years. There is still room for further reductions, which can be accomplished in part by following the best organizational practices promoted by the High Council for the Judiciary, whose effects can already be seen in some areas of the country. Progress can also be achieved by turning more frequently to corporate restructuring and turnaround specialists (e.g. turnaround funds). This could lead to some ‘unlikely-to-pay’ loans returning to performing status, benefiting both banks’ balance sheets and the economy. The credit recovery sector has grown significantly in recent years. This development has contributed to the reduction in NPLs in banks’ balance sheets, but it is not free of problems. Inefficient recovery performance can erode value, reintroduce risks to banks’ balance sheets and, in extreme cases, have repercussions on the guarantee provided by the State through the GACS. The Bank of Italy remains highly vigilant in supervising the intermediaries for which it is responsible. Banks’ profitability was helped by low funding costs and the drop in loan loss provisions; excluding extraordinary items, in the first six months of 2019 the return on equity was about 7 per cent on an annual basis. Net interest income remains under pressure, also due to increased competition in the market for loans to high-quality customers. Banks, especially small ones, must continue to diversify their sources of revenue and to contain their costs; less significant banks have reduced their operating expenses by just under 1 per cent in the first half of this year, compared with a drop of almost 4 per cent for the significant banking groups. Better profitability is critical for banks, and not just Italian ones, to enable them to meet the challenges posed by competitive pressures, by prudential regulation, by the new European crisis management framework, and by technological innovation in the financial sector. This is essential for small and medium-sized banks which are still suffering from the effects of the deep and protracted economic recession, especially in the South of Italy. Among other things, these banks face greater difficulties in accessing the market for debt and equity capital. The heterogeneity of financial intermediaries in terms of firm size, business models and corporate form can play an important role in the proper functioning of the system. However, it must be compatible with the safety and soundness of banks, which is essential for them to remain in the market. From this standpoint, achieving various forms of integration could help significantly by unlocking the benefits associated with a larger operating scale, a wider range of products, and the adoption of innovative technologies. With the launch this year of two new cooperative banking groups (Iccrea and Cassa Centrale Banca), this sector can continue to support local economies from a much sounder position. As a result of the reform, the structure of the Italian banking system has undergone extensive change, moving towards less fragmentation. As of last June, the 12 significant groups (which include both cooperative banking groups) held almost 80 per cent of the system’s total assets. Many of the about 90 less significant banks, with the exception of the Raiffeisen banks for which an institutional protection scheme is to be established, operate on a very small scale, which also impacts their ability to adapt their business models to technological change: more than half of them report assets of less than €1.5 billion and over one third of less than €1 billion. Effective integration must be pursued in this sector as well, especially among the smaller popolari banks, which suffer from the typical governance problems that stem from the cooperative banking model. For these popolari banks, the measures and projects we have been suggesting for some time for their strengthening need to be implemented quickly. * * * To make the fullest possible use of the expansionary potential of the monetary policy measures adopted by the ECB Governing Council, the other policies also have to move in the same direction. Fiscal policies that support economic activity in the euro area can deliver a faster return to price stability. To ensure sustained higher growth, reforms are needed to remove any obstacles to development, foster innovation and help modernize the productive system. Acting in isolation, monetary policy can do nothing but continue along the path of ‘non-standard’ measures. This increases the risk of adverse side effects, which, in turn, need to be kept under control using instruments of an increasingly administrative nature. European economic and monetary union is still incomplete. As the President of the ECB recalled last Monday, ‘we need a euro area fiscal capacity of adequate size and design: large enough to stabilize the monetary union’. In the current circumstances, the difficulties arising from the absence of this fiscal capacity are manifest. Such difficulties are not confined to the impossibility of using fiscal policy to support aggregate demand, but also include the resulting obstacles to the conduct of monetary policy and transmission of the related stimulus measures: the euro area feels the consequences of the lack of a common safe financial asset that plays the same role as the sovereign debt securities of other major economies. Yet, Member States could coordinate their policies as they did at the height of the global financial crisis. We should not now rule out this possibility and we should assess in good time, for the purposes of prevention, the scale of the risk of a return to an emergency scenario. Boosting the European economy’s capacity for growth also requires us to focus our efforts on the areas that are the most important today, such as new digital technologies and the protection of the environment. This can be done by drawing up a common public investment programme that is also aimed at improving and redeveloping major infrastructure − energy, transport, and urban services − to enhance service quality, reduce their environmental impact and unleash private investment which, in the absence of any clear strategic direction, today struggles to materialize. This type of programme could help to launch R&D projects and would thus have long-term effects on the EU’s productivity and growth potential. In the climate of mistrust that has emerged in recent years, also following the damage caused by the financial and sovereign debt crises, there is less inclination to consider coordinating national fiscal policies. While waiting for the realization to take hold that action is needed at European level, Italy must make the most of the favourable financial conditions to outline clearly the necessary process of change and initiate it decisively. This process will involve the economy’s productive sectors, the government sector, and the definition of and compliance with the rules. It will require a committed effort to develop the parts of the country that are lagging behind and harness the available resources, especially in terms of human capital. Changing the composition of the government budget to set aside more resources for tangible and intangible investments can stimulate economic activity beyond the short term. However, collective action is required to raise the growth potential: economic policy must create an adequate framework, providing incentives and removing any brakes on productive activities; firms and banks must be prepared to invest in order to seize the opportunities offered by the market and by technology; and everyone must contribute to this change by looking to acquire new and better skills. Making the best use of savings, achieving sustainable economic and social development, protecting the environment and creating jobs all depend on the success of this undertaking. FIGURES Figure 1 Yield spreads between 10-year government bonds (daily data; basis points) Italy - Germany -50 Jan.-18 Italy - Spain Italy - Portugal -50 Apr.-18 July-18 Oct.-18 Jan.-19 Apr.-19 July-19 Oct.-19 Source: Bank of Italy, based on Bloomberg data. Figure 2 Indicator of downside de-anchoring of euro-area inflation expectations (daily data; per cent) 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: Bank of Italy, Economic Bulletin, 4, 2019 (October 2019). (1) An increase signals an intensification of the link between sharp drops in short-term and in long-term inflation expectations. Figure 3 Composition of Italian households’ financial portfolio June 2019 December 2007 7.6% 8.2% 6.7% 23.5% 29.2% 18.7% 2.2% 21.3% 3.7% 20.0% 27.4% 31.4% Deposits Currency Managed assets Shares and other equity Debt securities Other Source: Bank of Italy. (1) ‘Managed assets’ comprise investment funds, life insurance reserves and pension funds (other than severance pay); ‘other’ comprises trade and other payables, derivatives and stock options, severance pay, and any other insurance components not included under managed assets. Figure 4 Ratio of non-performing loans to total loans (per cent) Gross Net 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 June-19 2021 Source: Bank of Italy. (1) The ‘gross’ ratio measures non-performing exposures (bad loans, unlikely-to-pay loans and past-due/ overdrawn exposures) in relation to total loans gross of loan loss provisions; the ‘net’ ratio excludes loan loss provisions. The ratios for 2021 are estimates based on the NPL reduction plans that banks agreed with the supervisory authorities. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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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, at the 100th Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 19 October 2019.
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DEVELOPMENT COMMITTEE (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries) ONE HUNDREDTH MEETING WASHINGTON, DC – OCTOBER 19, 2019 DC/S/2019-0060 October 19, 2019 Statement by Ignazio Visco Governor of the Bank of Italy Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste Statement by Ignazio Visco Governor of the Bank of Italy Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste 100th Meeting of the Development Committee October 19, 2019 Washington, DC The global business cycle remains very weak. Geopolitical tensions, combined with the sharp decline in international trade recorded in the last few quarters, weigh on firms’ confidence and on investment. Employment and wage growth continue to support incomes, mainly thanks to the resilience of services, but manufacturing is particularly sluggish. If the latter proves to be persistent, it will inevitably reverberate across the other sectors of the economy. The main risk to the global outlook once again derives from commercial tensions. Besides the already visible effects of the escalation of tariffs, quantitative restrictions can also have a significant global impact, particularly if accompanied by dislocation of value chains. The introduction of export restrictions in some countries may lead to trade diversion or import substitution, with efficiency losses. After many years of success in the fight against extreme poverty, a substantial and persistent global slowdown may reverse this trend; we are already seeing the rise of poverty in several of the poorest countries. Indeed, poverty risks becoming more entrenched and harder to root out. Business as usual will not be enough. An effective cooperation among all development partners, both bilateral and multilateral, is essential to strengthen the policy dialogue and catalyze the development of the private sector. The battle against extreme poverty needs to be fought in Sub-Saharan Africa and fragile and conflictaffected settings. Because of Sub-Saharan Africa’s slower rates of growth, problems caused by conflict and weak institutions, and a lack of success in channeling growth into poverty reduction, transformational change is needed in those areas. To reach the World Bank Group’s (WBG) goal of bringing extreme poverty below 3 percent by 2030, the world’s poorest countries will likely need to grow at a rate far surpassing historical experience. Moreover, this growth must be highly inclusive, reaching every country. The upcoming strategy for Fragility Conflict and Violence will be a litmus test of WBG engagement in the most challenging environment. Several countries, particularly in Africa, are experiencing a severe deterioration in both domestic and external debt, which may undermine their progress in economic and social development. We welcome the review of the Non-Concessional Borrowing Policy which highlights the weaknesses of current policies and identifies relevant areas for improvement. We expect that the forthcoming Sustainable Debt Financing Policy will be inspired by a rigorous rule-based but non-punitive approach whose underlying principles we fully endorse. We welcome the World Development Report 2020, “Trading for Development in the Age of the Global Value Chains (GVCs).” It is well balanced in identifying the sources of the potential threat posed by protectionism. GVCs are indeed more powerful in supporting growth than standard trade and, notwithstanding the diffusion of labor-saving technologies, can continue to boost growth. The Report rightly recognizes that with rapid technological change and increasingly complex production arrangements, broad-based structural policies—e.g., skill formation and other policies designed to ensure participation in GVCs—provide the highest payoff in enhancing countries’ competitiveness in international markets. A country’s openness—to trade as well as international investments—tends to magnify the benefits of supply-side policies. The success of such a country will then depend even more on its endowment of “immobile factors of production,” such as the quality of infrastructures, the bureaucratic and legal context, the efficiency of the financial system, and human capital. Old-fashioned protectionist policies are short-sighted and, at best, ineffective in preserving comparative advantages. They represent the wrong answer to a legitimate demand for political action from those who have suffered the most from the negative consequences of structural transformations. To tackle these critical issues it is necessary to share the gains of economic integration. In particular, it is indispensable to reinforce the adjustment mechanisms and redistribution policies that can reduce the social burden of structural transformations, especially among the most disadvantaged. These include policies that favor labor mobility, while ensuring an adequate social safety net, along with income support for displaced workers that does not discourage labor market participation and foster poverty traps. To address beyond-the-border challenges to GVC participation, as well as enhance support for regional integration, the WBG should devote more attention to trade policy. For instance, helping countries maximize the benefits of the African continental free trade agreement would be a step in the right direction. In view of economies’ increased synchronization, the World Bank may also want to consider multi-country interventions. The Western Balkans trade and transport facilitation project is a promising example of how to address issues that are common within a region. We are encouraged that countries are responding to the Human Capital Project with concrete action, taking steps to build consensus and awareness, coordinate across sectors, improve measurement, and adopt reforms. It is also encouraging that some countries are trying to achieve better results with a more efficient allocation of existing levels of spending. We strongly support the effort to provide a finer disaggregation of the Human Capital Index (HCI), which may help in designing more informed policy solutions. A national aggregate HCI value can mask significant disparities in outcomes within a country—across regions, socioeconomic groups, gender. It is equally critical to take steps to improve measurement, as a lack of reliable data risks jeopardizing the index’s credibility. The Jobs and Economic Transformation agenda is of key importance in supporting governments to undertake policy reforms that will incentivize the private sector to invest and generate jobs. To this end we need to focus on reforms that can catalyze a shift from informal to formal employment and that can induce productivity-enhancing practices and processes, within and across sectors and firms. The emphasis on “creating and connecting to markets” and “building capabilities and connecting workers to jobs” is particularly relevant to heightening job creation in IDA countries, where the largest labor force growth will take place in the coming years. As rightly stated in the background paper, different models are needed for different countries because of disparities in endowments, exposure to external factors, and varying development stages. The challenge will be how to make those models operational, building on country platforms that include all development partners. As the largest global concessional donor, IDA has a unique role to play in tackling the root causes of poverty and deprivation and promoting inclusive, sustainable, and balanced development. The upcoming IDA replenishment must be supported and we hope that a larger group of countries will consider participating, so that IDA will have adequate resources to fulfil its mission. We favor the confirmation of IDA-18 special themes and the focus on new cross-cutting areas. To address the fundamental determinants of fragility, we support a stronger engagement of IDA in regional programs, including those for Sahel, Horn of Africa, and Lake Chad. We are also confident that the WBG will incorporate a thorough analysis of causes and consequences of migratory pressures in its Strategic Country Diagnostics for these areas. We support the review of IDA’s voting rights and its guiding principles. The IDA Executive Board must define the scope of the review clearly, to ensure an efficient process. This is a prerequisite for its success. Implementing the commitments of the capital package and of IDA replenishment will require a renewed effort, particularly because of the difficulties of doing business in those contexts. Therefore, it is important to strengthen the WBG institutions’ accountability mechanisms to maximize development impact. We are cognizant that scaling up these commitments requires adequate budgetary resources. Nonetheless, to preserve the recently achieved financial sustainability of all the WBG institutions, operational efficiency must be enhanced. This includes a balanced business model of presence in the field. Solid income generation is critical if the WBG is to bear future needs.
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Giornate di economia "Marcello De Cecco", Lanciano, 28 September 2019.
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The euro-area economy and the recent monetary policy decisions Speech by Ignazio Visco Governor of the Bank of Italy Giornate di economia “Marcello De Cecco” Lanciano (Italy), 28 September 2019 First of all, thank you for your kind invitation to take part in this panel on “Europe for All” which concludes this second day of the “Giornate di economia” in memory of Marcello De Cecco. Marcello followed the ECB Governing Council’s decisions and the related analyses and discussions with great interest and with the acumen for which he was known. Today I would like to touch upon three points: 1) the monetary policy decisions that we have just taken; 2) the economic analyses behind them; and 3) the debate concerning, and our assessment of, the effectiveness of the various measures that were adopted. 1. At its September meeting the ECB Governing Council introduced a very broad package of expansionary measures. It lowered the interest rate on deposits that banks make with the Eurosystem (the deposit facility), which has been in negative territory since June 2014, by 10 basis points to -0.5 per cent. It decided to restart net asset purchases at a monthly pace of €20 billion beginning in November, after they were interrupted in December of last year, when they amounted to €2,600 billion since their launch at the end of 2014. It relaxed the terms of its new series of targeted longer-term refinancing operations (TLTRO III) compared with those of the June decision by lowering their cost (to -0.5 or 0.0 per cent depending on the lending performance of the individual banks) and by extending their maturity (from two to three years). It introduced a zero interest rate, as opposed to a negative interest rate, on part of the banks’ liquidity reserves (“tiering”) to attenuate the risk, feared by some observers, that increasingly negative interest rates on the deposit facility could have counterproductive effects on banks’ balance sheets and, in turn, on lending. In addition, we have strengthened our forward guidance concerning the future path of monetary policy, signalling our expectation to keep the key ECB interest rates at their present or lower values until inflation gets to a level consistently close to 2 per cent over the medium term. 2. These decisions were not made in haste: they are the natural conclusion to the analyses started quite some time ago by the Governing Council and, taken together, are an appropriate and proportional response to the worsening macroeconomic outlook for the euro area. In previous meetings, there was already broad agreement that the outlook for economic activity and prices was disappointing. In July, we reiterated our determination to intervene decisively if the medium-term inflation outlook failed to improve. Over the last few months, the signs of economic slowdown and weakening inflation have instead intensified. Geopolitical tensions, including those relating to trade tariffs, and the sharp decline in international trade recorded in the last few quarters have continued to weigh on firms’ confidence, on investment and on industrial production. The assessments of those who, one year ago, expected that the weakening in economic activity would prove temporary and would eventually subside have been shown to be increasingly optimistic. The slowdown was substantial for German and, though less so, Italian industrial production, but it would be naïve to underestimate its scope by considering it an asymmetric shock. If the worsening in the manufacturing sector proves to be persistent, it will inevitably reverberate across the other sectors of the economy. This is confirmed by the most recent data, which point to an area-wide slowdown in activity in the service sector, especially in Germany. In a slowing economy, it is no surprise that inflation has remained very moderate and well below the objective of a close to 2 per cent annual increase in consumer prices in the euro area; even with all the margins of uncertainty, the forecasts indicate that inflation is expected to remain weak over the next two years. We must counter the significant risk that the economic slowdown and the low level of inflation translate into a permanent reduction in inflation expectations or a re-emergence of the threat of deflation. The analyses conducted by the Bank of Italy clearly demonstrate this risk, regardless of the measure of expected inflation used: similar trends have been observed in the expectations derived from the financial markets, which may be affected by excessive reactivity on the part of investors, and in those obtained from surveys of professional forecasters, firms and households. A very recent study by Bank of Italy economists finds that the medium- and longterm inflation expectations in the ECB’s Survey of Professional Forecasters are now much more susceptible to negative surprises to current inflation than they were in the past. This is a finding that confirms the one that our researchers had already obtained based on inflation expectations derived from inflation swaps. By all measures, in recent months, expectations have remained far from the objective of price stability; they increased slightly in the spring, but then turned down again. The Governing Council deemed it necessary to respond promptly to the worsening economic situation, in order to reiterate its intention to confront weakening aggregate demand and its effects on prices, to not fall behind the curve and to counter low inflation expectations with determination. The global financial crisis and the sovereign debt crisis have taught us that in these circumstances excessive prudence is counterproductive: by not responding swiftly to the risks of too low inflation for too long, a lengthier and more incisive measure, which carries greater risks of unintended side effects, is then needed to counter the risk of deflation. 3. There was extensive discussion in the Governing Council on the decisions and measures to introduce; of course, opinions varied and some reservations were expressed regarding certain individual instruments and some of their characteristics. The package of measures adopted received the approval of a majority of the members of the Governing Council. The analyses conducted by the Bank of Italy indicate that there is no reason to doubt their overall effectiveness. In the current circumstances, uncertainty about the effects of the individual instruments is naturally widespread, but our analyses suggest that the purchase programme is, in the present conditions, the most effective instrument (aside from being the most “conventional” one, given that open market operations have always featured in central bankers’ “toolbox”). Our estimates suggest that the impact of the new purchases on economic activity and on inflation, through the contraction of term premia and the transmission to the yields of all financial assets, can be much bigger today than that of a cut in the official rates. From a conceptual and empirical perspective, there is no reason to rule out the possibility of further contractions in term premia, which in any event had already occurred with the consolidation of expectations of the new measures. As I have often observed, the effects of a reduction in official rates to negative values – the truly “unconventional” instrument among those introduced so far by the Governing Council – are surrounded by greater uncertainty. We estimate that so far, the cuts in the reference rates have had significant expansionary effects; down the road, however, their effectiveness could prove more doubtful, especially in view of the downwards rigidity of interest rates on deposits. In any event, it should not be forgotten that the persistence of negative nominal interest rates across a broad spectrum of maturities for lengthy periods cannot be attributed solely to the decisions of central banks, which react to macroeconomic conditions, but rather reflects the enduring underlying weakness of the economy and a possible market response to a resurgence of Fisherian debt deflation. We are still quite far from the “normal” economic conditions to which we ought to return (also in view of the structural factors that could explain lower growth rates worldwide than in recent decades). The introduction of a two-tier system for bank reserve remuneration – which was also adopted in other jurisdictions – is intended to prevent the reduction in official rates to negative values from having, beyond a certain level, the undesirable side effect of impairing banks’ ability to grant credit and, therefore, from being transformed into a restrictive factor. Nevertheless, encouraging greater trading between banks seeking higher returns on their liquidity may spark tensions on money market rates, a risk that is countered by the calibration chosen but one which must still be carefully monitored. In its forward guidance, the Governing Council confirmed its determination to respond symmetrically to inflation developments, in other words to intervene when inflation falls below the target with the same determination as when it rises above it. The aim is to avoid a further downward revision of inflation expectations, or the resurfacing of the deflation risks we successfully countered three years ago, whilst simultaneously guaranteeing financial conditions capable of supporting the economic cycle. Monetary policy resolutely pursues the objective of price stability. To achieve the maximum benefits from our action, the Governing Council unanimously agrees that, given the slowdown in production and the significant downside risks that weigh on the outlook, fiscal policy must make a more incisive contribution to strengthening aggregate demand. During this phase, the countries that have room to intervene can play an important stabilizing role; those with a high public debt must prioritize a rebalancing of expenditure towards measures that are better able to support growth, such as public investment, and to reduce the tax burden on businesses and employment. * * * In conclusion, I think that the package of measures we adopted was necessary and appropriate to counter the cyclical risks and the weak inflation outlook, and fully in line with our previous decisions. In the past, I have always avoided giving my opinion of monetary policy decisions immediately after Governing Council meetings. I have decided to do so today, a few weeks after the last decisions were taken, mainly because of the recent media attention given to the discussion that followed that meeting. Intense and detailed internal discussions on the monetary policy options are indispensable, and always take place. Many observers have wondered whether the dissemination of comments immediately following a common decision is a practice that is counterproductive, useful or even necessary. We can debate the merits of introducing at the ECB the procedure followed by other central banks, where, following their monetary policy meetings, they publish the positions of the participants (as well as the reasons for any disagreements). This solution, which I personally find appropriate, was at one point considered but then rejected by the Governing Council. In his remarkable scientific output, as in his numerous articles for the public at large, Marcello De Cecco always highlighted the close ties between geopolitical issues and economic events. It is interesting today to go back and read one of his last articles published in Affari e Finanza at the end of 2015. It dealt with the decision adopted by the ECB Governing Council in December of that year to expand asset purchases. Just as happened a few days ago, a member of the Council had publicly expressed disagreement with that decision; I am not sure that today the disagreement regarding the possible results of that decision would have been expressed quite so forcefully. I do not think that the comments made by some Governors at the end of the Governing Council meeting were guided by preconceived ideas or by political considerations, as Marcello seemed to think was the case back then, nor were they guided by an abstract division into “hawks” and “doves” as the press sometimes likes to believe. I am sure that these comments reflect the genuine conviction of Council members about the most useful measures for the euro-area economy. However, in the institutional context of the Economic and Monetary Union, it is still important to avoid the risk that, also due to the extemporaneous nature of the remarks made, the positions of the individual Council members be interpreted as an expression of national perspectives or interests, rather than as relating to the area as a whole. For this reason, I believe we all need to work to make our decision-making process as transparent as possible.
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Introductory remarks by Mr Daniele Franco, Deputy Governor of the Bank of Italy, at the FinCoNet Annual General Meeting, Rome, 13 November 2019.
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Business conduct supervision in the financial sector FinCoNet Annual General Meeting Introductory remarks by Daniele Franco Deputy Governor of the Bank of Italy Rome, November 13, 2019 Good morning, I am happy to open the Annual General Meeting of FinCoNet, which is now an important player in promoting sound financial market conduct. The protection of financial consumers is now considered essential for a sound financial system. Its importance grew in the aftermath of the global financial crisis. But it is still a challenge to supervisors. Financial consumer protection was not a supervisory objective until recently. For a long time, it was assumed that an efficient capital market, effective competition among banks, a deposit insurance system, together with prudential supervision and financial market oversight were enough to provide all the protection actually needed. In the late ‘70s, the relevance of information asymmetries in financial markets was eventually recognized. This induced a change in perspective and new initiatives at the national level, at the supranational level (such as the OECD Recommendation on consumer protection in consumer credit in 1977), and at the EU level (such as the first EU Directive on consumer credit in 1977). Financial regulation originally focused on the reduction of information asymmetries by imposing disclosure and mandatory formalities in order to enhance the comparability of products and services. However, the market turmoil of 2008 together with several studies in behavioral finance proved that this was not enough: disclosure and mandatory formalities do not ensure that consumers take a decision in their best interest. Hence, disclosure requirements have been complemented with business conduct requirements aimed at promoting fairness by financial intermediaries. Financial regulation in Europe now requires financial service providers to consider the interest of financial consumers even before their products are offered on the market. Product governance requirements impose that providers take explicitly into account the interest of consumers when designing new products, and test them to assess if they will really serve the interests and the needs of the consumers. This evolution poses a number of challenges to supervisors dealing with financial intermediaries’ market conduct. For instance, there are still differences in the range of tools and enforcement powers that conduct supervision authorities rely on in different countries. As in the case of prudential supervision, public enforcement typically relies on on-site and off-site monitoring powers; but challenges for conduct supervision come from the nature of the analyses required. While prudential supervision can typically rely on a quantitative approach, the protection of financial consumers may require a judgment-based analysis of the quality of customer relation arrangements. Sanctions are of course an essential deterrence tool, and (again, differently from prudential supervision) may be complemented by the power to impose the reimbursement of sums unduly charged (which directly favor damaged consumers, differently from sanctions). Product intervention powers may further enrich the supervisory toolbox, preventing harmful products from being distributed. In addition to public enforcement, effective customer protection may also be based on private enforcement tools. Complaint management, and effective alternative dispute resolution (ADR) schemes enabling customers to seek redress, represent relevant tools. Public authorities may have a role in establishing, or at least promoting, ADR schemes for the financial system. Last but not least, financial education programs may obviously complement regulation and enforcement in ensuring effective consumer protection. Overall, the work of FinCoNet over these years has become extremely relevant in supporting the comparison and evaluation of supervisory instruments, the dissemination of good practices, the analyses of critical issues, the formulation of policy proposals. The Bank of Italy has also devoted a great effort to the development of a comprehensive consumer protection framework in the Italian banking system. In 2009 we established a Banking Ombudsman. In 2014, we established a new Directorate responsible for business conduct supervision and in charge of financial education initiatives. Since then, we have issued several Guidelines for financial intermediaries; the Ombudsman scheme has given solutions to a very large number of complaints filed by customers; banks and other financial intermediaries reimbursed over € 300 million to customers; our financial education activities reach more than 100.000 students every year. However, despite the steps taken so far, we are aware that we are still in the “early age” of business conduct supervision. That is why FinCoNet meetings are important: we believe that comparing practices, sharing knowledge and experiences are essential to ensure financial consumer protection. The agenda of this two days meeting is very rich. You will be able to analyze and exchange views on several relevant issues: the tools available and their effectiveness, the evolving context in your respective jurisdictions, the use of new technology in market conduct supervision. New technologies in the financial system challenge regulators and supervisors, they open up new streams of products and services in a fast-changing market. The rise of “open banking” and the increased accessibility of bank accounts by third parties represent the most visible innovations in this field and are already contributing to reshaping the financial landscape. Conduct supervisors must intensify the use of data and algorithms to increase the efficiency and scope of supervisory actions. On Friday, the International Seminar jointly organized by FinCoNet and the Bank of Italy will provide useful insights on behavioral finance, shedding a light on how this approach can be embedded in supervisory activity.
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Keynote address by Mr Ignazio Visco, Governor of the Bank of Italy, at the OMFIF-Bank of Italy seminar "The future of the Euro area", Rome, 15 November 2019.
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The Economic and Monetary Union: Time to Break the Deadlock Keynote address by Ignazio Visco Governor of the Bank of Italy OMFIF-Banca d’Italia seminar “The future of the Euro area” Rome, 15 November 2019 This seminar comes at a difficult juncture for Europe. The tide of the global financial crisis and the sovereign debt crisis has long fallen, but its poisonous legacy and geopolitical tensions are fuelling distrust, fears and even prejudices once thought long buried. The European construction is at a standstill while progress is badly needed in the key areas, where the Union is better at prohibiting things than at getting them done. Although the single currency was a vital step on the path to European integration, the Economic and Monetary Union remains an unfinished construction. Europe’s architects knew this, and wanted and anticipated greater progress in the future. Even before the introduction of the euro, the unusual status of a Stateless currency had been underlined, as had the institutional solitude of the European Central Bank (ECB) and the problems posed by the imperfect mobility of capital and labour. The risks inherent in this situation materialised with unanticipated violence during the sovereign debt crisis. The inadequacy of the euro area’s economic governance was laid bare. Hesitancy in defining the procedures to support countries in difficulty fuelled fears of a break-up of the euro. Spreads on government bond yields widened dramatically, in some cases by far beyond what would have been justified by the economic and financial conditions of the countries affected, making these conditions all the more difficult to overcome. The proposals for reform drawn up after the peak of the crisis envisaged the gradual strengthening of integration, first in the financial area and then for public finances. Yet, seven years later, only partial progress has been made. The banking union is incomplete and not without flaws, the foundations for the capital union are still being laid, and fiscal union has been postponed to an unspecified future date. Concerns about the public and private financial vulnerabilities accumulated during the crisis and mutual distrust keep progress on hold. While risk reduction and sharing should go hand in hand and mutually reinforce one another, uncertainty around how to proceed, disagreement on the sequence and effects of interventions, and fears of negative spillovers produce a standstill in the reform process. As a consequence, the euro area’s economic integration is being held back and the area itself continues to be exposed to financial risks. This deadlock must be broken and the conditions must be created to allow for steps to be taken in the future that appear impossible today. Against this background, I would like to share some reflections with you, first, on how sovereign and banking risks are being dealt with in Europe, and second, on the state of play of fiscal and capital markets unions. Sovereign and banking risks The widespread concern over high public debts is justified. They are a source of systemic risk. Even if fundamentally solvent, highly indebted countries are more vulnerable to liquidity shocks and negative markets’ assessment of national authorities’ commitment to financial stability. In addition, in a currency area, a sovereign debt crisis can have strong repercussions for neighbouring countries, given the close economic and financial links. A reform of the Treaty on the European Stability Mechanism (ESM) to reinforce its role in preventing and managing sovereign crises in euro-area member states is currently being finalised. It is part of an effort aimed at reducing uncertainty as to how and when a sovereign debt can be restructured. Clarifying the conditions and procedures for restructuring would certainly reduce the part of the cost of a sovereign default which can be attributed to uncertainty over the manner and timing of its solution. But this is only a small part of the cost of sovereign insolvency. Moreover, this is a matter to be handled with care. The small and uncertain benefits of a debt restructuring mechanism must be weighed against the huge risk that the mere announcement of its introduction may trigger a perverse spiral of expectations of default, which may prove to be self-fulfilling. We should all keep in mind the dire consequences of the announcement of private sector involvement in the resolution of the Greek crisis after the Deauville meeting in late 2010. The importance of rigorous budgetary policies at a national level cannot be overestimated. But reducing the debt-to-GDP ratio requires time and there is the risk that a crisis might interrupt the process, without this being the direct consequence of a policy decision. Europe should seek ways to support and protect the efforts that must be made by member states to reduce their debt. This is why some form of supranational insurance is needed, for example through the creation of a European debt redemption fund (ERF) financed by dedicated resources of the participating countries. The mechanism can be designed in a way that prevents systematic transfers across countries while reducing the risk of financial instability for the area as a whole. The introduction of an ERF would strengthen national commitment to debt reduction (as the share of national debt transferred to the fund would be backed by a dedicated revenue stream) and reduce the systemic relevance of (residual) national debt. This would be instrumental in enhancing the credibility of the no-bailout clause and the enforceability of European fiscal rules. In the academic and political debate, the introduction of a sovereign debt restructuring mechanism is often linked to proposals to introduce prudential requirements limiting banks’ sovereign exposures. Here, it is important to bear in mind that the sovereign-bank nexus does not operate exclusively through banks’ direct exposures: a sovereign crisis would also affect banks through an increase in their cost of funding (particularly in the event of rating downgrades) and, above all, through its effects on the overall economy. A sharp rise in the perceived risk of one State’s debt can quickly trigger a recessive spiral, kindling social tensions with unpredictable results. The blow to the banking system would be severe, irrespective of its capitalisation and direct exposure. Thus, if we really want to break the sovereign-bank nexus, we need to reduce the risk embedded in sovereign bonds, not just the amounts held by banks. Moreover, simply shifting risky bonds from the balance sheet of banks to those of other sectors would not reduce the overall risk. Finally, since prudential requirements on sovereign exposures are not imposed in any other jurisdiction, if we were to introduce them in the European Union or in the euro area, we would need to provide financial markets with an alternative “risk-free asset”, such as a Eurobond of some sort − and the debt redemption fund I mentioned before would be instrumental. Reducing banks’ sovereign exposures and the ratio of non-performing loans (NPLs) to total outstanding loans are often considered as preconditions for the completion of the banking union. Other important sources of risk have, however, not been sufficiently considered. Recent initiatives by the Single Supervisory Mechanism to determine the most appropriate treatment of illiquid and opaque assets on banks’ balance sheets are meant to respond to these concerns. Even worse, the vulnerability produced by an incomplete framework for the effective and orderly management of banking crises has also been, and still is, overlooked. On the one hand, consensus has grown around the idea to postpone the implementation of the ESM backstop to the Single Resolution Fund until 2024 unless further progress has been achieved in risk reduction measured solely in relation to NPL volumes (and in building up buffers of liabilities to be used in a crisis). On the other hand, a situation is accepted whereby a disorderly liquidation is the only possible outcome for the crises of small and medium-sized intermediaries which, like most European banks, are not subject to resolution (albeit – it must be noted – they are required to contribute to the Single Resolution Fund). The recent suggestions from Germany on the completion of the banking union is a welcome development in that it shows willingness to keep the dialogue open. However, they fail to address some of the issues I just mentioned. Banking risks are once more exclusively identified with NPLs and sovereign exposures. Moreover, when considering a revision of the prudential treatment of the latter, there is no mention of the need to introduce a European safe asset, which is particularly at odds with the frequent references made to the US model, where the role of federal debt as a safe asset is paramount. An adequate fiscal capacity and the implementation of the capital markets union If sovereign and bank risks management is a source of concern, turning to the state of play of discussions about the fiscal union and the implementation of the capital markets union will provide little consolation. Monetary policy was the sole line of defence against the risk of euro area financial fragmentation during the sovereign debt crisis and against the risks of deflation that emerged in the years thereafter. The ECB’s Governing Council demonstrated its readiness to use all of the instruments available and, if necessary, to introduce new ones to pursue the objective of price stability. It has been largely successful, but its actions could have been even more effective had they been accompanied by other economic policies. Inflation in the euro area remains at levels that are still too low, and these low levels are pushing down short-term inflation expectations once again. The risk of a de-anchoring of medium- to long-term expectations has re-emerged. The Governing Council response has been timely, appropriate and proportionate. But once again we are seeing that to make the fullest possible use of the expansionary potential of monetary policy measures, other policies should move in the same direction. Fiscal policies that support economic activity in the euro area can deliver a faster return to price stability. To ensure sustained higher growth, reforms are needed to remove any obstacles to development, foster innovation and help modernise the productive system. Acting in isolation, monetary policy can do nothing but continue along the path of “non-standard” measures. This increases the risk of adverse side effects, which, in turn, need to be kept under control using instruments of an increasingly administrative nature. As the former President of the ECB recently recalled, “we need a euro area fiscal capacity of adequate size and design: large enough to stabilize the monetary union”. This is no subversive statement. Economic theory as well as the concrete experience of other successful monetary unions, most notably the United States, suggest that the euro area would greatly benefit from the establishment of a supranational fiscal capacity. Indeed, a report on the appeal of a fiscal union − the MacDougall Report − was published as early as 1977 on behalf of the European Commission, and even the 1970 Werner Report makes reference to it. Later on, the technical papers accompanying the 1989 Delors Report discussed the topic in depth. On 3 May 1998, when Europe was completing the last steps before the adoption of the single currency, Tommaso Padoa Schioppa wrote in a column in 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”. Nevertheless, little progress has been made in the way of remedying the asymmetry of having a single monetary policy and yet multiple national budgets, perhaps out of fear of sharing the debts that could result from the operation of a fiscal union. Yet, as I have observed, a common fiscal capacity can be structured in such a way as to avoid systematic cross-country transfers, thus reconciling the full exercise of macroeconomic stabilization with the balancing of public accounts in each country. Fiscal union would make it possible to implement policies consistent with the cyclical conditions in the various member states and in the euro area as a whole, promptly and with no doubts as to their legitimacy. The single currency needs to interact with a single fiscal policy. It has been argued that national fiscal policies could absorb the effects of cyclical fluctuations in member states and that financial markets could provide an insurance analogous to the one that would be provided by a fiscal union. However, cross-country spillovers may reduce the effectiveness of national initiatives and, in the current situation, several national budgets have little room for manoeuvre due to high public debts. In addition, European financial markets are far from being perfectly integrated, which clearly limits their viability as shock absorbers. In the United States, in Canada and in other federal countries, a significant share of individual states’ income variability is offset by the federal fiscal system (estimates based on different methods average at 10-15 per cent for both the US and Canada). The difference between the euro area and fully-fledged federations in terms of shock- absorption capacity is even higher when we look at capital markets. The smooth functioning of a currency area requires a single capital market that facilitates access to financing for businesses. In addition, an integrated market helps to absorb local macroeconomic shocks, increases the robustness of the economic system, and strengthens financial stability. It would also obviously aid the effective and speedy transmission of fiscal and monetary policy measures. But it is a complex endeavour. It entails decisive action towards the harmonisation of company, securities, bankruptcy and tax laws, as well as of supervisory procedures. While such a harmonisation may begin with changes in relevant national legislation and focus on those areas which may produce broader effects, the ultimate goal must be one of achieving a single rulebook. Above all, a single capital market requires a common safe asset. Addressing this gap would support the banking and capital markets by creating a homogeneous product of a high quality and significant size that could become a benchmark for investors and improve financial integration. * * * I do not think that I have to struggle to convince you of the lack of significant progress with the European construction. There has been a substantial transfer of sovereignty on economic and financial matters, especially in recent years. It is indeed illusory to believe that we can direct the course of the economy and finance, patently global phenomena, from within the narrow confines of individual European countries. The construction, however, is lopsided and incomplete; its very sustainability requires that the missing elements be incorporated soon. Today, proceeding by means of compromise is becoming increasingly difficult. Distrust leads to disaccord, and in the exasperated pursuit of mutual reassurance and short-term gains, the necessary steps are hard to take. The concrete achievement of monetary union, banking union, capital markets union, and even the prospect of a common fiscal policy, all call for a leap in quality. Europe must remain an anchor of stability in a world that appears ever more unstable and politically unpredictable. The introduction of a safe asset in the euro area is a clear and immediate objective. It is a technical endeavour, but it is also the common denominator to the three unions (banking, capital markets, fiscal) that must flank monetary union. By partly replacing national government bonds, a European debt instrument could help to diversify the sovereign exposures of financial institutions. It could reduce the risk of flights to safety by investors in times of market tension and enable the financial market to play an effective role as shock absorber, thereby also enhancing the effectiveness of monetary policy. It could be an instrument for funding shared automatic stabilisers within a common fiscal capacity. As I have said, it is possible to design mechanisms that enable a safe asset to be introduced with the necessary safeguards against the risk of opportunistic behaviour. But aside from the rules, the essential requirement for the viability of this solution lies in a renewed and convinced commitment by all to the European project and a willingness to pursue common solutions for common problems. Grafica a cura della Divisione Editoria e stampa della Banca d’Italia
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Testimony of Mr Ignazio Visco, Governor of the Bank of Italy, at the Joint session of the V Committee (Budget, Treasury and Planning) and the XIV Committee (European Union Policies) of the Chamber of Deputies, Rome, 4 December 2019.
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Joint session of the V Committee (Budget, Treasury and Planning) and the XIV Committee (European Union Policies) of the Chamber of Deputies Testimony on the functioning of the European Stability Mechanism and the prospects for its reform Given by Ignazio Visco Governor of the Bank of Italy Rome, 4 December 2019 Presidents, Honourable Members of Parliament, I am grateful to the Fifth and Fourteenth Committees of the Chamber of Deputies for this invitation to debate the proposed reform of the Treaty establishing the European Stability Mechanism (ESM). The proposal is the result of a provisional agreement reached last June, based on the Euro Summit understanding of December 2018. As with the Treaty currently in force, it will only take effect once it has been signed and ratified by all Member States. The ESM was introduced in 2012 to bridge one of the gaps in European economic governance: its core function is to grant conditional assistance to euro-area countries that are experiencing temporary difficulties in raising funds on the market, despite having sustainable public debts. Alongside this function the proposed reform introduces a backstop to the Single Resolution Fund (SRF), within the bank crisis management framework. In the talks leading to the agreement and in the accompanying debate, in-depth discussions were also held on the rules on financial aid to Member States and, in particular, the related risks. In this respect, the reform addresses the prerequisites for granting financial assistance and the tasks carried out by the ESM; overall, the proposed changes are limited in scope. The reform makes no provision for, nor does it foresee in the future, any sovereign debt restructuring mechanism. As with the Treaty in force today, there is no quid pro quo between financial assistance and debt restructuring. An assessment of debt sustainability before the granting of aid is already envisaged under the Treaty in force. This is a clause designed to safeguard the ESM’s resources, to which Italy is the third biggest contributor. 1. The origins of the European Stability Mechanism The ESM is the response to part of Europe’s ‘incomplete’ economic governance. Up until the sovereign debt crisis, the European fiscal framework was based on crisis prevention through compliance with fiscal rules that were designed to keep deficits and public debts within the limits considered prudent. It did not provide for a toolkit capable of managing the sovereign debt crises; indeed, the ‘no bail-out clause’ of the Treaty on the Functioning of the European Union, at least in its most restrictive interpretation, seemed to prohibit any measures in support of countries in difficulty.1 The tensions that emerged on the European sovereign debt markets starting in 2010, as a result of the global financial crisis and the considerable imbalances in Greece’s public accounts, strongly affirmed the need for adequate European economic governance. Specifically, the absence of mechanisms for managing a severe financial crisis of a euro-area Member State generated uncertainty, lengthening the timeframes involved in providing support, increasing its cost and feeding the risk of contagion. The first response to the sovereign debt crisis was necessarily of an urgent nature. In spring 2010, financial support to Greece was provided through bilateral loans on the part of euro-area countries (Greek Loan Facility). Shortly thereafter, as the crisis extended to other countries, two common mechanisms were established for the disbursement of financial support: the European Financial Stabilisation Mechanism (EFSM), which is limited in size (€60 billion) and is financed by the European Union, and the European Financial Stability Facility (EFSF), which has greater lending capacity (initially equal to €250 billion, then €440 billion), is temporary in nature, and is guaranteed by the euro-area Member States. The intervention strategy changed abruptly at the end of 2010 with the agreement between France and Germany and with the Council of the European Union’s decision in the summer of 2011 on private sector involvement (PSI) in restructuring Greece’s debt. Following this decision, in the autumn of 2011 the European Banking Authority (EBA) published a recommendation asking the main banks to create ‘exceptional’ and ‘temporary’ capital buffers to address their exposure to sovereign debt. The Council’s decision and the EBA’s recommendation came before the establishment, in 2012, of the ESM and the specification that private sector involvement would be limited to exceptional circumstances and would not be triggered automatically. Outright monetary transactions (OMT) by the European Central Bank were also introduced in 2012. These were conditional on the presence of an ESM assistance programme. It is likely that, had the sequence of events been different (introducing the ESM and OMT before the PSI announcement and EBA recommendation), the effect on the financial markets would have been more contained. The establishment of the ESM was accompanied by a special amendment to the Treaty on the Functioning of the European Union (art. 136(3)). The ESM’s subscribed capital amounts to €704.8 billion, of which €80.5 has been paid in; its lending capacity stands at €500 billion. In addition to having provided bilateral financial support and having participated in EFSF programmes (committing a total of almost €44 billion), Italy’s subscribed capital in the ESM amounts to about €125 billion and its paid-in capital is more than €14 billion. Each member’s share of the ESM’s capital is based on the ECB’s capital keys, which reflect the country’s share in the total population and gross domestic product of the euro area. The portion of the ESM’s capital that is subscribed but not paid in is ‘callable’ at any time if needed, meaning that ESM members are asked to provide the corresponding funding with little advance notice. 2. ESM governance and functions The ESM was established by an intergovernmental agreement, outside the judicial framework of the European Union. It is headed by the Board of Governors, which consists of the 19 Ministers of Finance in the euro area. Unanimous approval is required for all important decisions (including those relating to disbursements of financial assistance and the approval of memoranda of understanding with the countries that receive it). The Board of Governors chooses whether it is chaired by the President of the Eurogroup (as is currently the case) or by a President elected from within the Board itself; terms last two years and may be renewed. For the purposes of ensuring the efficacy of the ESM’s decision-making system, the ESM may operate with a qualified majority of 85 per cent of capital if, in the event of a threat to the economic and financial stability of the euro area, the European Commission and the ECB ask it to make urgent decisions concerning financial assistance. The voting rights of Board members correspond to the number of shares assigned to the respective countries. Germany, France and Italy have shares that exceed 15 per cent and, therefore, may also veto urgent decisions. The ESM’s executive body is the Board of Directors, consisting of 19 members each of whom is appointed by a Governor and has extensive experience in economics and finance. It is headed by the Managing Director who also serves as the ESM’s legal representative. As I mentioned, the fundamental purpose of the ESM is to provide financial assistance, subject to conditions, to member countries experiencing temporary difficulties in accessing the markets, despite having a sustainable public debt. It is not a sovereign debt restructuring mechanism but instead tries to avoid it; as stated in the current version of the Treaty and as reiterated in the proposed amendments thereto, restructuring may only be considered in exceptional circumstances. The Treaty contains a single reference to debt restructuring in recital number 12, which states that ‘in accordance with IMF practice, in exceptional cases an adequate and proportionate form of private sector involvement shall be considered in cases where stability support is provided accompanied by conditionality in the form of a macro-economic adjustment programme’. The Treaty provides for the possibility of the ESM working in conjunction with the International Monetary Fund (IMF). The ESM may open credit lines, disburse loans or purchase government securities issued by the state receiving assistance. Its intervention is never in the form of non-repayable transfers. Support is provided subject to rigorous conditionality and an analysis of the sustainability of the public debt which, according to the rules set out in the current version of the Treaty, is carried out by the European Commission in liaison with the ECB (where possible, also with the IMF). The level of conditionality varies according to the nature of the instrument used: for loans, it is in the form of a macro-economic adjustment programme, described in a dedicated memorandum; it is less stringent with precautionary credit lines to countries with fundamentally solid economic and financial conditions that are suffering the effects of an adverse shock. There are two types of precautionary measures, accompanied by a Memorandum of Understanding that sets out the conditions: the precautionary conditioned credit line (PCCL), for countries meeting the requirements of the Stability and Growth Pact that do not have excessive macroeconomic imbalances or financial stability problems, and the enhanced conditions credit line (ECCL), for countries that do not fully meet the above prerequisites and that are therefore asked to take corrective measures. It should be borne in mind that the ESM may also purchase government securities in the primary and secondary markets. The ESM currently finances itself by issuing debt instruments on the market with maturities that range from one month to 45 years. The ESM has the highest credit rating (AAA) awarded by Fitch and by DBRS, and just below the top rating awarded by Moody’s (AA1, with a ‘positive outlook’). ESM loans benefit from a credit status that is second only to that of the IMF. These conditions make it possible for the ESM to take on debt under highly advantageous conditions. Since 2010, the total amount of financial assistance that has been disbursed through the various tools to euro-area countries in difficulty is equal to more than €480 billion, of which more than €80 billion were provided by the IMF (Table 1). There have been five beneficiary countries: Greece was the main recipient accounting for almost 60 per cent (just under €290 billion), followed by Portugal (more than €75 billion), Ireland (more than €65 billion), Spain (more than €40 billion) and Cyprus (about €7 billion). Spain is the only one of the five countries to have benefited from financial support that was exclusively dedicated to shoring up its banking system. The ESM has granted loans to three countries, totalling about €110 billion (€61.9 billion to Greece, €41.3 billion to Spain and €6.3 billion to Cyprus; Table 2), with fairly long average maturities and relatively low interest rates (a maximum of 1.2 per cent for Spain and Cyprus and 1.6 per cent for Greece). All the support programmes have come to a close: the beneficiary countries are once again able to access the markets for financing. The support disbursed by the EFSF, the ESM and the IMF has already been partly repaid. More than €170 billion are yet to be repaid to the EFSF, approximately €90 billion to the ESM, and less than €10 billion to the IMF. Figure 1 illustrates the repayment plan for the loans issued by the ESM, whose residual lending capacity is currently just over €410 billion (Figure 2). 3. Financial assistance in the proposed reform of the Treaty2 The reform proposal before us covers three main areas: the ESM’s governance and tasks regarding financial assistance to member countries, the conditionality for granting such assistance and the ESM’s function as a backstop for the Single Resolution Fund (I will focus on this last point later on). The proposal also provides for an amendment to the collective action clauses (CACs) included in government securities. The ESM’s governance and tasks regarding financial assistance to member countries. – The reform proposal establishes the independence of the ESM’s Managing Director and staff (Article 7.4 and recital 16) and at the same time strengthens the provisions requiring the ESM’s activities to be compliant with European Union legislation; it also entrusts the European Commission with the related control tasks. Voting rights and procedures remain unchanged. At the end of 2017, the European Commission had put forward a proposal to integrate the ESM into European Union legislation; a solution of this kind would greatly simplify the management of ESM activities and the coordination with the Commission. The ESM is to play an active role in crisis management and in the process for disbursing financial assistance, as well as in the subsequent monitoring thereof; in line with this, the Managing Director is given greater responsibilities, and becomes the reference point for the ESM in all activities connected with granting financial support. This is a new role for the ESM and means that it will flank the European Commission. How the two institutions cooperate will be set out in an agreement to be signed when the amendments to the Treaty come into force (Article 13.8). The terms of the provisional agreement reached between the two institutions in 2018 are echoed in the text of the reform proposals,3 which contains safeguards designed to avoid any duplication of tasks between the ESM and the European Commission. The agreement reaffirms the Commission’s exclusive responsibility for the overall assessment of the economic situation of countries and of their position vis-à-vis the rules of the Stability and Growth Pact and of the Macroeconomic Imbalance Procedure. The reform establishes that the ESM may follow and assess their macroeconomic and financial situations – including the sustainability of their The reform is analysed in detail in C. Dias and A. Zoppè (2019), ‘The 2019 proposed amendments to the Treaty establishing the European Stability Mechanism’, In-Depth Analysis, 11-10-2019, European Parliament. Information and links to the official documents are available on the ESM’s website. The text of the agreement is available on the ESM website. public debt– so that it can intervene promptly as needed (Article 3.1). Therefore, ‘the ESM should not serve the purpose of economic policies coordination among ESM members for which European Union law provides the necessary arrangements’ (recital 15A). Lastly, it is confirmed that ‘the post-programme surveillance will be carried out by the European Commission in liaison with the ECB, and by the Council of the European Union within the framework laid down pursuant to Articles 121 and 136 of the Treaty on the Functioning of the European Union’ (recital 18). In the event of a request for assistance, the reform provides that the ESM’s Managing Director, together with the European Commission (and in liaison with the ECB), assess the sustainability of a country’s public debt and, to better protect the member countries in their role as ESM financers, the capacity of a country to repay the loan. In the event no agreement can be reached on these assessments, the Commission will have the last word on the sustainability of the debt, and the ESM on the capacity to repay the loan (see recital 12A). In addition, the ESM’s Managing Director, again together with the Commission (and in liaison with the ECB), will take part in the negotiation with the requesting country on the conditionality attached to the financial assistance programme, and in the assessment of compliance with these conditions over time (Articles 5.6.g and 13.7). The conditions for granting financial assistance. – The reform more clearly describes some of the principles for the disbursement of funding that are already laid down in the current text of the Treaty and in the guidelines adopted by the ESM. For the purposes of granting any form of ESM assistance, the current Treaty already provides for a prior assessment of debt sustainability (Article 13.1.b). The reform reiterates this provision and, as previously mentioned, introduces alongside it the criterion of the requesting country’s loan repayment capacity (recital 12A and Article 13.1.b of the reform proposal), so far only used in post-programme surveillance. At the same time, the reform clarifies that these preliminary checks are in no way automatic: despite being based on ‘transparent and predictable’ criteria, the authorities that carry out such checks have a ‘sufficient margin of discretion’ to do so (recital 12A and Article 13.1.b of the reform proposal). The reform to the Treaty also reviews the criteria and procedures for obtaining precautionary credit lines. In the case of the PCCL, signing a Memorandum of Understanding (MoU) would no longer be required; this credit line would be granted to countries not subject to a procedure for deficit or excessive macroeconomic imbalances, provided there is a letter of intent in which the requesting country commits to respecting the criteria, which are specified in quantitative terms in Annex III of the new version of the Treaty (Article 14). Those countries which, despite having sound economic fundamentals, do not meet all the criteria set out in Annex III, will be able to have recourse to the ECCL, which would continue to require the signing of a Memorandum of Understanding. Collective action clauses. – The reform to the Treaty envisages introducing − from 2022 − an amendment to the current collective action clauses that, if a country decides to proceed with a debt restructuring, a single vote by government security holders would be sufficient to amend the terms and conditions of all the bonds (‘single limb’ CACs), instead of dual votes (one for each issuance and one for the bonds as a whole; see recital 11 and Article 12.4). This amendment is designed to make any debt restructuring more orderly, thereby reducing the costs linked to the uncertainty over how it will be done and how long it will take. As already happened following the introduction of the current CACs in 2013, this amendment − which does not increase the likelihood of a default but reduces the uncertainty surrounding its outcome − could lead to a fall in sovereign debt risk premiums.4 There is no amendment to the reference in the current Treaty to private sector involvement, which remains strictly limited to exceptional cases and is in no way a precondition for obtaining financial assistance from the ESM (recital 12B of the reform proposal). It is in light of the PSI being confirmed as an exceptional case that we should interpret both the amendments to the collective action clauses and the possibility that the reform gives to the ESM to facilitate dialogue between a country and private investors, only if the country so requests, ‘on a voluntary, informal, non-binding, temporary and confidential basis’ (recital 12). To conclude this discussion of the amendments that the reform intends to make to financial assistance procedures, I would like to point out that a country with high public debt, especially a country with great economic weight in the euro area, must first of all create a situation in which there is no need to turn to the ESM; how to obtain funding is not irrelevant but should not be the focal point. The way forward is to reduce the debt-to-GDP ratio by maintaining an adequate primary surplus, increasing economic growth, and keeping confidence high and the average cost of debt low. The existence of the ESM makes this last task easier because it limits contagion risks, thereby helping to preserve orderly market conditions. G. Tabellini (2017), ‘Reforming the Eurozone: Structuring versus restructuring sovereign debts’, VoxEU.org; A. Bardozzetti and D. Dottori (2014), ‘Collective action clauses: How do they affect sovereign bond yields?’, Journal of International Economics, vol. 92, issue 2, 286-303. 4. The backstop for the Single Resolution Fund The ESM Treaty is also being revised to address the need for a backstop to the Single Resolution Fund (SRF), namely the option of supporting the SRF should its resources prove insufficient to finance the measures it must take. Under the current European bank crisis management framework, the main function of the SRF, managed by the Single Resolution Board (SRB), is to finance the application of resolution tools while minimizing the use of public resources.5 In addition, if needed to avoid contagion risk, the SRF will also be able to absorb the losses directly and help recapitalize the bank under resolution, for a maximum amount equal to 5 per cent of the bank’s liabilities and only after a bail-in equal to at least 8 per cent of the same liabilities. The SRF is funded by annual contributions from all euro-area banks (not just those classified as ‘significant’ for supervisory purposes). The contributions are paid in and gradually mutualized according to a schedule that will see the scheme fully in place by the end of 2023, when the SRF will have reached its target level (at least 1 per cent of the total amount of covered deposits in the euro area, a share that the SRB estimates to be around €60 billion). The private financial resources available to the SRF could prove insufficient in the event of a systemic crisis. The importance of a public backstop was already acknowledged in the late 2013 ECOFIN Council’s conclusions on the Single Resolution Mechanism (SRM). Its establishment was also deemed a priority in the 2015 Five Presidents’ Report on Completing the European Economic and Monetary Union.6 Since the very outset of the negotiations on the SRM, Italy has been one of the most active supporters of the need for a backstop to the SRF, especially one involving the ESM. The reform of the ESM now being discussed introduces such a backstop, whose size is aligned with the actual level of the SRF (as indicated in the Terms of Reference agreed in December 20187 and referred to in Recitals 5A and 15B, as well as in Annex IV of the proposed reform); it therefore goes in the direction ‘Changes in the way banking crises are managed’, FAQ published in the ‘In detail’ section of the Bank of Italy’s website, 8 July 2015. ‘Council agrees general approach on Single Resolution Mechanism’, 18 December 2013, press release; Completing Europe’s Economic and Monetary Union (2015), Report by Jean-Claude Juncker in close cooperation with Donald Tusk, Jeroen Dijsselbloem, Mario Draghi and Martin Schulz. ‘Terms of reference of the common backstop to the Single Resolution Fund’, 4 December 2018, available on the European Council’s website. of bolstering the credibility of the SRF and its effective ability to intervene and, in doing so, reduces the risk of a disorderly management of a crisis at a large bank, which could impact overall financial stability. The reform envisages the introduction of the backstop no later than the end of 2023. The possibility of introducing it earlier is made conditional on further progress in reducing banking risks, something that will be assessed next year. Such progress, however, refers only to building up sufficient buffers to meet the minimum requirements for own funds and eligible liabilities (MREL; that is, the minimum amount of liabilities that can be used for loss absorption or recapitalization of a bank under resolution) and to reducing the NPL ratio (against benchmark ratios of 5 per cent gross of write-downs already booked and 2.5 per cent net of them). However, no mention is made of other types of assets that are risky because they are illiquid or lack transparency regarding their valuation (such as so-called Level 2 and Level 3 financial instruments). Introducing the backstop to the SRF is not the only change that we believe is necessary to complete the current European crisis management framework. As I have emphasized many times, including very recently, mechanisms are also needed to facilitate the orderly exit from the market of small- and medium-sized banks that cannot access the resolution procedure and therefore cannot receive support from the SRF even though they contribute to it. To this end, we should take a close look at the experience of the US’s Federal Deposit Insurance Corporation (FDIC), which during the global financial crisis effectively managed the crises of hundreds of small- and medium-sized banks without adverse effects on overall stability. In fact, the German Finance Minister referred to the example of the FDIC in his recent proposals on completing the banking union.8 Experts at the Bank of Italy have proposed measures that could help to address the current problems.9 We stand ready to provide technical support to the Government in the discussions under way at EU level on this issue. * * * ‘Position paper on the goals of the banking union’, German Finance Minister, November 2019. A. De Aldisio, G. Aloia, A. Bentivegna, A. Gagliano, E. Giorgiantonio, C. Lanfranchi and M. Maltese (2019), ‘Towards a framework for orderly liquidation of banks in the EU’, Notes on Financial Stability and Supervision, No. 15, August. Among the measures proposed are: eliminating the superpriority for deposit guarantee schemes, raising the deposit coverage limit, changing the method for assessing the fulfilment of the least cost criterion, so as to include not just ‘direct’ but also ‘indirect’ costs (arising, for example, from possible contagion effects). The creation of the ESM has strengthened the economic governance of the monetary union and – all other things being equal – has reduced the risks of financial instability for each country and for the area as a whole. It was part of a comprehensive reform whose salient points were already set out in the first report of the four Presidents released in June 2012.10 Made gradually less ambitious in successive official documents, today this original plan remains uncompleted. The proposal to reform the ESM marks a step in the right direction, especially because it introduces a backstop to the Single Resolution Fund. On the issue of assistance to countries in crisis, it does not alter the substance of the Treaty currently in force. It confirms the absence of any automatism in decisions on the sustainability of public debts and rules out any debt restructuring mechanism. As I recently underlined, this confirmation is important because ‘The small and uncertain benefits of a debt restructuring mechanism must be weighed against the huge risk that the mere announcement of its introduction may trigger a perverse spiral of expectations of default, which may prove to be self-fulfilling’.11 I made similar observations on the risks of sovereign crises in my Concluding Remarks delivered in May 2019 and even prior to that on a number of occasions, when the idea of introducing an automatic debt restructuring mechanism for the Member States of the euro area had not yet been fully discarded.12 The proposed changes in financial assistance to Member States reassert principles of common sense that are already inscribed in the Treaty. For the ESM, as for any other lender, it would be nonsensical to grant credit to those whose debt is not deemed sustainable, given that this would constitute a non-refundable transfer. The safeguards in terms of ex ante conditionality and ex post monitoring that flank the financing mechanisms of the ESM have always been, and still are, duly rigorous. They are safeguards that protect the resources that euro-area countries ‘invested’ at the time of the ESM’s establishment and, as I recalled earlier, Italy is the third largest contributor. The proposed reform is, of course, the result of a compromise – between the fears of those who have always rejected any further mutualization of risks and the opposing fears of an unjustified postponement of progress towards ‘genuine economic and monetary union’. The best way to convince everybody of the Towards a Genuine Economic and Monetary Union (2012), Report by Herman Van Rompuy in close collaboration with Mario Draghi, José Manuel Barroso and Jean-Claude Juncker. I. Visco, ‘The Economic and Monetary Union: Time to Break the Deadlock’, keynote address at the OMFIF-Banca d’Italia Seminar ‘Future of the Euro area’, Rome, 15 November 2019. See, for example, F. Balassone and I. Visco (2018), ‘The Economic and Monetary Union: Time to Break the Deadlock’, The European Union Review, Vol. 23– 1-2-3, March-November 2018, 9-22. usefulness of the reform is to see it as a starting point for the purposeful resumption of the path to European integration. A first step could be to announce the intention to incorporate the ESM in European legislation in the medium term. What continues to be lacking is a comprehensive plan for the completion of monetary union, one that introduces a centralized fiscal capacity and a safe asset in the euro area, as well as the completion of banking union. The possibility of introducing a common fiscal capacity capable of flanking monetary policy in the task of stabilizing the euro area must be examined anew; this would enable us to deal with sometimes pronounced cyclical fluctuations, without thwarting the efforts made up to that point in each country to reduce its debt-to-GDP ratio. The process towards completion of the capital markets union must be speeded up including − I would even say primarily − by introducing euro area sovereign bonds, which could replace a portion of national securities in circulation and play the role of safe asset assigned to sovereign bonds in all the other major economies. This result can also be achieved with the simultaneous introduction of some form of European-wide public debt insurance, for example through the creation of a European debt redemption fund (ERF), financed by dedicated resources of the participating countries determined in a way that prevents systematic intra-country transfers.13 Banking union must be completed with a more effective mechanism for managing crises at any intermediary, including small- and medium-sized ones, and with a proper European deposit insurance scheme that guarantees equal protection for depositors, irrespective of where their bank operates. This is where measures to curtail risks such as the ones often proposed by, on the one hand, those who wish to revise the prudential treatment of banks’ sovereign exposures and, on the other, those who stress how important it is not to take a selective approach to banking risks (with the sole focus on non-performing loans), could be usefully inserted. Looking ahead, some thought could also be given to the possibility of introducing limits on the concentration of sovereign bonds in bank portfolios, without distinguishing among sovereign debtors and in any event with a sufficiently high See M. Cioffi, P. Rizza, M. Romanelli and P. Tommasino (2019), ‘Un fondo di ammortamento del debito dell’area dell’euro: cos’è, perché costruirlo, come progettarlo’, Rivista di Politica Economica (forthcoming). For a discussion of similar proposals, see M. Cioffi, P. Rizza, M. Romanelli and P. Tommasino (2019), ‘Outline of a redistribution-free debt redemption fund for the euro area’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 479, 2019; in particular, among the earliest contributions, see V. Visco, ‘Innovative Financing at a Global and European Level’, Hearing before the European Parliament, 10 January 2011 and German Council of Economic Advisors (2011), ‘Assume responsibility for Europe’, Annual Report 2011/12. initial ‘exemption’, but only if the euro area simultaneously decides to introduce a common safe asset. Failing this, among other things, the diversification of bank portfolios of sovereign bonds could not take place in an orderly fashion. As I have already mentioned, it is imperative that the consolidation of the public finances of highly indebted countries remains a credible process, one in which every opportunity provided by the current low interest rate environment is seized without hesitation. If everyone plays their part, it will become apparent that all the Member States hold dear the success of monetary union and, above all, the prosperity and well-being of all European citizens. TABLES AND FIGURES Table 1 Financial assistance disbursed to countries in difficulty (billions of euros) Total 21.4 10.3 8.5 21.7 61.9 Greece ESM EFSF 108.2 Bilateral loans 21.0 31.9 IMF 10.5 9.6 25.3 8.3 141.8 52.9 1.7 6.7 3.4 31.9 Total for Greece 288.5 Ireland EFSF 7.6 4.4 EFSM 13.9 7.8 5.7 17.7 Bilateral loans 0.5 2.5 1.9 4.8 IMF 12.8 6.4 3.3 22.6 0.8 22.5 Total for Ireland 67.6 Portugal EFSF 6.9 11.3 EFSM 14.1 8.0 IMF 13.0 8.2 6.6 3.4 1.2 26.0 2.2 24.3 1.8 26.3 Total for Portugal 76.6 Spain ESM 39.5 1.9 41.3 Total for Spain 41.3 Cyprus ESM 4.6 1.1 0.6 IMF 0.3 0.2 0.4 6.3 0.1 1.0 Total for Cyprus Total assistance: of which ESM: 7.3 31.5 110.2 197.9 59.7 18.9 22.4 10.4 8.5 21.7 481.2 39.5 6.5 1.1 22.0 10.3 8.5 21.7 109.6 Sources: For the bilateral loans to Ireland, National Treasury Management Agency and Macro-Financial Assistance to EU Member States, State of Play – November 2019, European Parliament; for the assistance provided by the EFSF, ESM and EFSM, their respective websites, from the pages on the beneficiary countries; for the support programme for Greece, European Commission, The second economic adjustment programme for Greece, March 2012 and, for IMF loans disbursed to Greece between 2012 and 2014, IMF press releases published at the time of each loan. Table 2 Financial assistance disbursed by the ESM and related repayments (billions of euros) Greece Spain Cyprus Total disbursements Total repayments Total Net Total disbursements 21.4 10.3 8.5 21.7 61.9 59.9 repayments 0.0 disbursements 39.5 2.0 2.1 1.9 repayments disbursements 41.3 1.6 4.0 1.0 3.0 8.0 4.6 1.1 0.6 17.6 6.5 1.1 22.0 10.3 8.5 21.7 109.6 1.6 4.0 1.0 5.0 8.0 19.7 6.3 repayments 39.5 Source: Based on ESM data available at: https://www.esm.europa.eu/assistance/programme-database/programme-overview. 23.7 6.3 Figure 1 Residual debt towards the ESM (billions of euros) Greece Cyprus Spain Source: Based on ESM data available at: https://www.esm.europa.eu/assistance/programme-database/programme-overview. Figure 2 Financial assistance (net of repayments) disbursed by the ESM by country and residual lending capacity (billions of euros) 59.9 410.1 89.9 6.3 23.7 Residual lending capacity Greece Cyprus Spain Source: Based on ESM data available at: https://www.esm.europa.eu/assistance/programme-database/programme-overview. Designed by the Printing and Publishing Division of the Bank of Italy
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Introductory remarks by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Bank of Italy/FinCoNet International Seminar on Financial Consumer Protection, Rome, 15 November 2019.
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Behavioural insights for conduct supervision Introductory Remarks by Luigi Federico Signorini Deputy Governor of the Bank of Italy Banca d’Italia/FinCoNet International Seminar on Financial Consumer Protection Rome, 15 November 2019 It is my great pleasure to open the International Seminar on Financial Consumer Protection, jointly organized by Finconet and the Bank of Italy. The theme of this seminar is the subject of much discussion and a driving force in the evolution of business conduct regulation and supervision. Behavioural economics has provided important insights. We would be well advised to take them into account when framing regulations and performing supervisory tasks in the financial sector. Understanding how people make economic choices is central to economics. Economic models, however, will never be able to do justice to the full range of motivations, reasoning and impulses behind human behaviour. Economics needs to simplify and select. At the same time, it needs to remain open-minded enough to see the pitfalls of simplifying assumptions. Economic models have always been challenged over time, with new approaches subverting the conventional wisdom of the day; as in all sound science, progress in economics has been driven by people challenging received wisdom, pointing out its flaws, and proposing corrections. Yet it has always retained the basic concept that agents will respond to incentives and that in most circumstances the collective wisdom resulting from innumerable fallible individual choices is superior to comprehensive top-down planning, enlightened as the latter may be. Adam Smith did not have to invoke utility maximisation to conceive of the invisible hand, nor did Ricardo to discover comparative advantage: two of the most counterintuitive, and most enduring, cornerstones of economics. Ronald Coase famously stated that “there is no reason to suppose that most human beings are engaged in maximising anything unless it be unhappiness, and even this with incomplete success”; yet this (half tongue-in-cheek) assertion did not prevent him from formulating a theorem about the superiority of private contracts even with externalities, provided property rights are carefully laid down.1 ¹ Actually, as is well known, Coase did not formulate a “Coase theorem”, but he did lay down the theoretical foundations to what is known by that name. Contemporary mainstream economics makes abundant use of formal models that specify what precise quantity is being maximised, and assume that agents make efficient use of whatever information is available. While such assumptions are extremely useful for developing insights into how the world actually functions, nobody believes them literally. “Utility” for instance, (sane) economists will accept, has no well-defined physical counterpart. This means that, while recognising the usefulness of this or that formal model in many cases, one should remain alert to its limits. Consumer behaviour is a case in point. Utility maximisation by consumers has proved to be a fantastic tool for developing compact, elegant models to describe many interesting and crucial features of the real economy. Yet it cannot provide all the answers, especially when you look at consumers’ choices in a concrete environment and reflect upon the best ways to regulate market conduct in legal detail. Converting a useful simplifying modelling device into an article of faith about how the human mind works would be nonsense. One does not need to throw away a century of economic thought to recognise that human behaviour is much subtler and more elusive than that; one needs only some reasonable human heuristics, as it were, and the ability to adapt one’s tools to the task at hand. Nevertheless, it took a while for economists to recognise in full that actual consumer decision-making is rather different from what is expected from a rational agent who single-mindedly maximises a utility function – a major exception being the studies on bounded rationality.2 By contrast, marketing experts developed an understanding early on of how buyers actually make decisions, and found ways to profit from it. Regulators that fail to recognise this asymmetry, and act upon it, would not do a good job. This is not a theoretical point, and the audience today will need no convincing. There is even a plausible claim that the delay in tackling certain financial consumer protection issues contributed to the financial crisis ten years ago.3 Be that as it may, the day-to-day task of ensuring the fair and efficient functioning of the market for consumer finance requires a richer model of consumer behaviour than one based on “utility” maximisation and the full use of information. Hence, the increasing attention now devoted to behavioural economics by financial regulators and supervisors, with the aim of designing and implementing policies that help consumers take financial decisions they will not regret. This seminar will benefit from contributions from the academy and from supervisors. The Bank of Italy strongly supports this interaction. Before leaving the floor to our speakers, let me briefly recall some well-known insights from behavioural economics that have been significant in the evolution of regulation in the field of financial consumer protection, and provide a quick overview of the approach to financial consumer protection adopted by the Bank of Italy. Simon, H.A., “Models of Man, Social and Rational: Mathematical Essays on Rational Human Behavior in a Social Setting”, New York: Wiley & Sons, 1957. G20 High-Level Principles on Financial Consumer Protection, October 2011 (www.oecd.org). Behavioural economics relies heavily on the seminal studies by Daniel Kahneman and Amos Tversky,4 two psychologists, one of whom (Kahneman) got a Nobel Prize in economics for it (Tversky, sadly, did not live to get the share he deserved). This is, by the way, not an isolated case; it bears witness to the fact that the economics profession, in its best moments, is open to contributions from other disciplines to refine its understanding of human behaviour and interactions. Behavioural economics has provided evidence that, when taking decisions, people regularly deviate from certain accepted canons of rationality, as intuition often prevails over reasoning.5 Such deviations are not random. Laboratory experiments, though mostly confined to simulated environments, do provide rather convincing evidence that biases affect the decisions of consumers in a systematic way. For financial services providers, knowledge of this can make competing on quality and prices less attractive relative to leveraging on these biases in their marketing activity using opportunistic business practices. The list of biases is an evolving one; here, I will only mention a few of those that are most relevant from a financial consumer protection perspective and represent a common background for business conduct supervisors. They include: I) mental shortcuts used to generate approximate answers to questions (heuristics); II) the influence of the way information is presented on the way decisions are taken (framing effect) III) the fact that outcomes are usually assessed against a reference point (reference dependence/anchoring effect), implying that different reference points affect the perception of gains and losses; IV) a preference for immediate gratification, resulting in decisions that do not maximise long-term net effects (present bias) – e.g. people overestimate their ability to repay loans, resulting in over-indebtedness; V) the fact that people often demand much more to give up an object than they would be willing to pay for it (endowment effect); this helps explain, e.g., why switching rates among products from different financial services providers are low even when there are no legal obstacles to or monetary costs in doing so. While biases are deeply embedded in the human mind, they have not prevented humans from becoming (for better or for worse) the dominant species on Earth. In fact, in many circumstances, biases and mental shortcuts will “do the trick” and help us to D. Kahneman and A. Tversky. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica, vol. 47, no. 2, 1979, pp. 263–291. Kahneman, D., “Thinking, Fast and Slow”, New York: Farrar, Straus, and Giroux, 2011; Kahneman, D. “Maps of Bounded Rationality: Psychology for Behavioral Economics.” The American Economic Review, vol. 93, no. 5, 2003, pp. 1449–1475. take decisions instantly and without effort that we would not later regret, by and large.6 However, the jungle of finance is in many ways different from the environment where humans have evolved over hundreds of thousands of years. When it comes to financial decisions, mental shortcuts that were efficient for escaping lions or capturing gazelles may prove inadequate to make (say) choices on long-term financial retirement plans. They may prompt consumers to take decisions that they would not have taken based on a more thorough assessment. The evidence from behavioural economics should be enough to convince regulators and supervisors that it is crucial to complement the traditional regulatory approach – based on pre-contractual disclosure to overcome information asymmetries – with behavioural insights. Policy makers have started testing new instruments, examples of which include: I) standardising pre-contractual documents, so that they selectively provide (or highlight) only those pieces of information that are most relevant to the consumer; II) prescribing the use of the most effective channels for interacting with customers: for instance, evidence exists that text alerts and mobile banking apps are much more effective than periodic reports for attracting the attention of consumers that are incurring overdraft charges;7 III) focusing on the overall fairness of contractual relationships, e.g. in order to limit any over-indebtedness induced by present bias; IV) establishing cooling-off periods, i.e. the possibility for consumers to withdraw from contracts, especially in the event of cross-selling practices and distance selling (thus neutralising possible temporary emotional effects), to allow for legitimate and sufficiently timely regret. All these tools are mainly intended to remove information and cognitive asymmetries, and their undesired consequences for the proper functioning of financial consumer markets. In this sense, one could say that they do not depart from the traditional paradigm, whereby the individual’s choices should not ultimately be replaced or unduly influenced by those of the regulator. The aim is to supply consumers with the necessary tools to make informed judgments, rather than to supplant their ability to decide for themselves. Some go further. Proponents of libertarian paternalism maintain that regulators, while still refraining from direct coercion, should endeavour to influence the choices of In a sense, it has been argued that sentiments and intuition, rather than reasoning, have provided the most enduring tool for decision-making in the history of humankind; see Harari, Y.N. “Homo Deus: A Brief History of Tomorrow”, London: Harvill Secker, 2016. FCA, Occasional Paper No. 10, “Message received? The impact of annual summaries, text alerts and mobile apps on consumer banking behaviour”, available on the FCA website (www.fca.org.uk). affected parties in a way that is expected to make them better off8 – an approach also commonly referred to as nudging.9 This view also provides a strong argument (not the only possible one) for regulators to exploit the alternative between the “opt-in” and “opt-out” approaches for financial schemes; when the regulator considers one alternative to be in the best interests of consumers, it can “nudge” them in that direction by making it the default (or “inertial”) choice. The opt-out approach has proved to be quite effective in promoting participation in pension schemes, for example, where it is seen as an effective tool against “present bias”. How far one would go along this road will ultimately depend on one’s view of society. Some would balk at the idea of treating citizens as perennial minors, to be gently prodded, or “nudged”, by a benevolent regulator, to do whatever the regulator considers to be in the consumer’s own best interest. Yet even if one thinks that the individual must remain ultimately responsible for his or her own choices, the insights of behavioural economics remain central for framing those choices in a way that is consistent with known cognitive bias, so as to empower the consumer to make such choices in full awareness. Whatever your approach, the landscape is evolving rapidly. A growing body of experimental research is developing on the effectiveness of regulatory initiatives based on behavioural insights. At the frontier, a series of studies is flourishing on the physiological reaction of financial consumers to external stimulus (neurofinance). What will come out of that, and what one is to do with whatever the results might be, must be the subject of future reflection. For the framework of consumer protection to be effective, it needs more than regulation alone. It must be complemented with supervision, enforcement, and financial education. Let me elaborate briefly on the approach of the Bank of Italy. Based on the understanding that too much information is as potentially harmful as too little information, and that such “information overload” can lead consumers to take financial decisions that they will consider inappropriate in retrospect, the traditional regulatory approach based on a full disclosure regime has evolved. Reflecting changes in the EU legal framework too, regulation of the most common products now provides for standardised pre-contractual information that makes key information adequately salient. The regulator plays a delicate role in selecting the most relevant information, based for instance on the size of the revenues from certain fees and tariffs, and finding ways to increase its visibility. One application of this concept is to require banks to disclose standardised cost indicators for the simplest forms of bank accounts and the most common types of consumer loans. Thaler, R.H. and Sunstein, C.R., “Libertarian Paternalism.” The American Economic Review, vol. 93, 2003, pp. 175-179. Thaler, R.H. and Sunstein, C.R., “Nudge: Improving Decisions about Health, Wealth and Happiness.” New Haven and London: Yale University Press, 2008. Again on the regulatory side, recognising that biases are always in action, and that financial services providers – including banks – may actively seek to exploit them, has led us to introduce – in compliance with the applicable EU legislation – certain business conduct requirements, aimed at increasing the overall fairness of contractual relationships. We abstain, however, from interfering directly with individual decisions of consumers or firms. A few examples of such requirements are: I) provisions concerning the assessment of creditworthiness, to address overindebtedness; II) product governance requirements, concerning the design of new products, consumer-testing activities, as well as distribution; III) sound remuneration policies for sales staff, to mitigate the risk of perverse incentives for misleading the consumer. As regards supervision, since the establishment of a dedicated Directorate in 2014, the Bank of Italy has been moving steadily from the assumption that more information is always better to a focus on salience as opposed to sheer quantity; from mere disclosure to a broader range of issues (including governance and strategy); and from a box-ticking approach to an approach that includes cooperation and guidance. We have thus complemented our supervisory action by issuing Guidelines to clarify supervisory expectations. This approach has proved to be fruitful in addressing issues that are highly significant for consumer protection, such as the remuneration of overdrafts and overrunning, the unilateral variation of contracts, the handling of complaints, and the conditions for consumer credit. For enforcement, we start from the assumption that customers harmed by unfair business conduct and non-compliance with regulatory requirements should be in a position to seek redress in a way that is simple, fast, and inexpensive. To this end, in 2009, the Bank of Italy established an alternative dispute resolution mechanism for the banking sector (the Arbitro Bancario Finanziario or ABF), which has proved to be effective, has become increasingly popular with customers, and has somehow become a benchmark for other regulated sectors. While the ABF’s decisions are not binding, “naming and shaming” is applicable in the event of non-compliance and has proven an effective deterrent. Furthermore, as financial services providers are required to take the ABF’s decisions into account when dealing with complaints from their customers, this enforcement system contributes to increasing the overall fairness of contractual relationships in the banking sector. Finally, a few remarks on financial education. While regulation and supervision may help to address indirectly some of the major flaws in consumers’ choices, there is broad consensus that the empowerment of consumers also requires strategies aimed at increasing their basic financial knowledge. Nowadays people are probably facing increasingly complex financial decisions more often than at any other point in humankind’s history. Ageing and the evolution of welfare imply an enhanced role for life insurance and private pension schemes. The increased range of financial investment choices provides better potential opportunities, but may appear baffling to non-experts. Technological development in payments are transforming, beyond recognition, the way we conduct even the most common transactions. Individuals need to take financial decisions throughout their life, including decisions inherently involving long-term outcomes that are very difficult to predict and assess (e.g., investing early for one’s retirement), which are exactly those where the usual mental shortcuts are most likely to fail. Neither pre-contractual information, nor business conduct requirements will provide the desired policy outcomes if people are not able to grasp at least the fundamentals of finance. International evidence shows that this ability, while perhaps generally unsatisfactory, is even less developed in Italy than in many other countries. This is why the Bank of Italy has devoted a great deal of effort to designing and implementing financial literacy programs. These strive to take into account behavioural biases and to make consumers aware of how they influence their decisions. The Bank also supported the establishment of a National Committee in charge of steering and coordinating financial education initiatives, where we cooperate with many other public and private institutions providing financial education schemes. *** Effective business conduct supervision is challenging. Insights from behavioural economics contribute to its theoretical foundations, and provide useful suggestions for improving the regulatory and supervisory framework. The lessons we are going to learn today will be of great help in shaping our financial control architecture to make it more effective and to contribute to a financial system that is fairer, sounder, and safer for consumers. I wish you all a fruitful discussion and a pleasant stay in Rome. Thank you!
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Closing remarks by Mr Daniele Franco, Deputy Governor of the Bank of Italy, at the workshop on "Big Data & Machine Learning Applications for Central Banks", organized by the Bank of Italy, Rome, 22 October 2019.
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Big Data & Machine Learning Applications for Central Banks Closing Remarks by Daniele Franco Deputy Governor of the Bank of Italy Rome, 22 October 2019 The workshop on ‘Big Data & Machine Learning Applications for Central Banks’ is coming to an end. Let me begin by thanking the speakers, discussants and participants. This is the third workshop organized by Banca d’Italia on these issues. And it will not be the last. Why are we so interested in these topics? A few days ago, the Chairman of the Federal Reserve, Jerome Powell, noted that monetary policy is data dependent. It is adjusted over time in response to new information about the state of the economy. Monetary policy must be based on timely and accurate data. This is why central banks have always made great efforts when it comes to collecting and analysing data. Throughout its history, Banca d’Italia has drawn extensively on data published by the National Statistical Institute and other national and international agencies. But it has also been an active producer of statistics, not only on banking, financial and fiscal variables, but also on firms and households. Banca d’Italia has collected micro-level statistical information on companies since the early 1950s. Back then only a few aggregate statistics were available. We began by surveying the balance sheets of a small group of firms, an activity that was progressively expanded until it became what is now the Survey on Industrial and Service Firms. These days, we collect detailed data on about 5,000 firms. In the early 1960s, the Bank started the survey on household finance. This survey allows us to study the distribution of income and wealth at the micro level in order to analyse the preferences of individuals and the determinants of their economic and financial decisions. In recent years, we have interviewed about 8,000 households in each survey. The digitalization of the economy is changing our lives, the organization of production and our jobs. It also poses new challenges, requiring changes in the way central banks collect and analyse data. The typical indicators used by central banks to measure inflation, investment or economic activity may not fully capture the changes determined by digitalization. For example, online shopping has caused a disruption in the retail sector around the globe along with changes in pricing behaviour. When measuring inflation we should take account of the prices of online stores such as Amazon or eBay. Gross domestic product is one of the pillars of macroeconomic statistics. It is still the most important measure of economic activity and wellbeing. However, the growth of the digital economy, whose output is usually immaterial, limits the role of GDP in measuring economic activity and wellbeing. Digitalization has dramatically changed how businesses are conducted and goods and services purchased. This brings us to the productivity paradox: productivity in industrialized countries is growing less than in past decades while economies are experiencing rapid digitalization. Jerome Powell noted that current statistics may understate productivity growth because they miss the value that we increasingly derive from new technologies, such as internet connections and smartphones. The measurement of the digital economy is now an important challenge for statisticians and economists. We need new methodological insights. To answer some of these questions, in 2016 Banca d’Italia put together a team to assess the potential benefits and hidden risks of Big Data, Artificial Intelligence and Machine Learning. Despite controversies about privacy issues, despite password hacking and other worrisome aspects of online life, the world continues to embrace the internet and social media. It is estimated that more than 5.1 billion people (two thirds of the world’s population) use a mobile phone and 4.4 billion people take advantage of internet services. In 2018 the number of internet users recorded 9 per cent growth (see the We Are Social blog). So we have plenty of new data which can be mined to improve our knowledge of economic developments. To understand and exploit these data we need to bring together different skillsets: those of economists, statisticians, engineers and computer scientists. What are the advantages of these data? In his lecture on ‘Big Data and Measurement: From Inflation to Discrimination’, the MIT Professor Roberto Rigobon said that the biggest advantages of organic data (i.e. Big data) as against designed data (such as administrative data) are that: (i) they reduce the cost of collecting and providing information and (ii) they do not introduce distortions arising from the behaviour of respondents. People don’t lie to their GPS or to Google. The banking and financial industries have also been profoundly affected by these developments. Central banks must react in a timely manner and develop new tools to carry out their missions: monetary policy, banking supervision and payment system oversight. In these two days you have seen many applications which can improve central bank activities. Some papers focused on the extraction of quantitative information from texts and images: this can be useful for forecasting financial market variables, predicting headline inflation, and analysing the real estate market.1 We have seen the utility of machine learning algorithms for combating illicit financial activities and increasing the statistical accuracy of micro- and macro-economic indicators (for example, forecasts of the Index of Industrial Production).2 Some indicators have moved rapidly from the experimental to the production stage. For example, at Banca d’Italia we have developed and now regularly use an indicator of the situation of the main banks obtained using selected tweets.3 We have improved our estimates of Foreign Direct Investment for the Balance of Payments by introducing Machine Learning classifiers.4 We are also working on other sources of information, such as credit and debit card payment data, which should help us to assess consumption, retail sales and other macroeconomic variables.5 These developments present significant challenges. I will mention three. First, there is a risk of biased statistical inference. Big data and, in particular, unstructured data collected from social media may reflect only a part of the population. See M. Loberto, ‘The rental market in Italian cities’, Banca d’Italia, Temi di Discussione (Working Papers), 1228, 2019. See M. Loberto, A. Luciani, and M. Pangallo, ‘The potential of big housing data: an application to the Italian real-estate market’, Banca d’Italia, Temi di Discussione (Working Papers) ’,1171, 2018. See also M. Bernardini, P. Cariello, M. De Leonardis, J. Marcucci, F. Quarta, and A. Tagliabracci, ‘Deriving Indicators from a Large Corpus of Italian Documents’, Bank of Italy Workshop on Big data & Machine Learning Applications for Central banks, October 2019; V. Astuti, G. Bruno, S. Marchetti, and J. Marcucci, ‘News and Banks’ Equities: Do Words Have Predictive Power?’, Bank of Italy Workshop on Big data & Machine Learning Applications for Central banks, October 2019. See V. Aprigliano, G. Bruno, S. Emiliozzi, S. Marchetti, J. Marcucci, and D. Nicoletti, ‘Neural Networks for Macroeconomic Forecasting’, Bank of Italy Workshop on Big data & Machine Learning Applications for Central banks, October 2019. See M. Accornero and M. Moscatelli, ‘Listening to the buzz: social media sentiment and retail depositors’ trust’, Banca d’Italia, Temi di Discussione (Working Papers), 1165, 2018. A. Carboni and A. Moro, ‘Imputation techniques for the nationality of foreign shareholders in Italian firms’, External sector statistics: current issues and new challenges. Irving Fisher Committee on Central Bank Statistics, 2018. See G. Ardizzi, S. Emiliozzi, J. Marcucci and L. Monteforte, ‘News and consumer card payments’, Banca d’Italia, Temi di Discussione (Working Papers), 1233, 2019; V. Aprigliano, G. Ardizzi and L. Monteforte, ‘Using the payment system data to forecast the Italian GDP’, Banca d’Italia, Temi di Discussione (Working Papers), 1098, 2017. Increasing the sample does not improve the accuracy of the estimates if the source of the bias is not understood and dealt with. The use of massive amounts of rough data may result in an exceptionally good in-sample fit but may perform poorly out-of-sample (the curse of overfitting). Moreover, when using Big data, special attention should be paid to the robustness and stability of the estimates over time. The second challenge is privacy. Protecting the integrity and confidentiality of personal data is of paramount importance to our societies. Storing personal data in digital repositories belonging to public and private institutions can be risky. We should avoid any use for illegitimate purposes such as the second-hand trading of personal information. At Banca d’Italia, we are exploring new avenues for utilizing microdata without jeopardizing their confidentiality. In this way data from different institutions can be combined to produce aggregate statistics that are important for understanding economic, financial and welfare issues. We have started experimenting some privacy-preserving algorithms with Istat. We are also discussing these issues with Eurostat and the National Authority for Personal Data Protection. The third challenge concerns the preservation of data over time. While we keep producing a huge amount of data, we have not yet agreed on a shared set of criteria for making these data accessible in the future. It is crucial that technology-neutral standards be established to ensure data availability for future generations. Coordination between statistical agencies, governments, academia and private companies is equally crucial. Timely and accurate information derived from non-traditional data sources, as well as new analytical techniques can help central banks to improve their knowledge of the economy and society, allowing them to make better-informed data-driven decisions. Banca d’Italia is firmly committed to carrying out further research on these issues and to cooperating with other institutions to strengthen methodologies and applications. Future events will certainly be organized to share the results of our research activity.
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Remarks by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the panel on "Central banks, financial integrationand capital flows", Conference "Financial integration and inclusive development: A view from the Mediterranean Countries", jointly organized by the Bank of Spain and the European Institute of the Mediterranean (IEMed) with the support of the Organization for Economic Cooperation and Development (OECD), Madrid, 13 December 2019.
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‘Financial integration and inclusive development a view from the Mediterranean countries’ Banco de España, IEMed, OECD conference Panel on ‘Central banks, financial integration and capital flows’ Remarks by Luigi Federico Signorini Deputy Governor of the Bank of Italy Madrid 13 December 2019 It is a great pleasure to be here. The topic of this session is among the most challenging for central banks today. My contribution will be in four parts. I shall start with some observations on monetary policy and financial spillovers in a financially interconnected world, before moving on to consider the role of the euro area, followed by the implications for the Southern Mediterranean countries. I shall conclude by discussing policy implications. The debate on monetary and financial spillovers in a financially interconnected world Global financial integration has been increasing rapidly over the last twenty years. Cross-border asset and liability positions have doubled as a share of global GDP since the Asian financial crisis of 1997-98. The pace of growth has been faster in advanced economies (AEs) – partly reflecting the disproportionate rise in the gross assets and liabilities of financial centres1 – but it has also been remarkable in emerging economies (EMEs), where the average level of gross external assets and liabilities has reached 60 per cent of GDP, up from less than 40 per cent in 1997 (Fig. 1). Greater financial interconnectedness allows for more risk sharing, increasing each economy’s ability to absorb idiosyncratic shocks; however, it may also intensify the transmission of global shocks, especially those originating from core countries. Capital flow volatility and the cross-border correlation of asset price movements and credit growth have increased in recent years, in connection with unconventional monetary policies put in place in major AEs and with the intensifying search for yield. This has revived the debate over the risks posed by international spillovers, not only to financial stability but also to monetary policy autonomy, particularly in EMEs with less developed domestic financial markets. Lane, P.R. & Milesi-Ferretti, G.M. IMF Econ Rev (2018) 66: 189. https://doi.org/10.1057/s41308-017-0048-y. The classical ‘trilemma’ of international macroeconomics has been called into question. According to this ‘trilemma’, to preserve monetary autonomy, more open capital accounts require more flexible exchange rates. In a well-known paper presented at Jackson Hole in 2013, Hélène Rey contested the validity of the ‘trilemma’.2 She argued that the existence of a global financial cycle, essentially driven by US monetary policy due to the dominance of the US dollar in the international monetary and financial system, has increasingly undermined the usefulness of flexible exchange rates for insulating an economy from external shocks. On the contrary, the financial implications of exchange rate changes may well dominate their real implications, so that exchange rate movements may even exacerbate spillovers (I shall come back to this issue later). According to the ‘dilemma’ view, the only way out is to resort to the management of capital flows, either through explicit controls or by means of macroprudential measures aimed at reducing boom and bust cycles of asset prices. The debate is still very much alive today; indeed, this was one of the key topics at the 2019 Jackson Hole Economic Symposium.3 The question then is which domestic policies and country fundamentals still matter, and how they can be used to tame the impact of volatile capital flows. On the one hand, the empirical literature has provided some evidence that capital controls, in combination with macroprudential regulations, can be effective in reducing the volatility of capital flows.4 Furthermore, studies have found that capital inflows tend to be both larger and more stable in countries with sounder financial systems and better institutions.5 On the other hand, recent research,6 including some conducted by staff at the Bank of Italy,7 has found that, in a more financially interconnected world, exchange rate flexibility helps in mitigating monetary and financial spillovers to EMEs, but it does not provide full insulation. This is true not only for small countries with weak economic fundamentals, but also for advanced economies and large monetary regions. H. Rey (2013), ‘Dilemma not Trilemma: The global financial cycle and monetary policy independence’. Federal Reserve Bank of Kansas City Economic Policy Symposium. https://www.kansascityfed.org/publications/research/escp/symposiums/escp-2019. B. Erten, A. Korinek and J.A. Ocampo (2019), ‘Capital controls: theory and evidence’. NBER Working Paper 26447. I. Buono, F. Corneli and E. Di Stefano, ‘Capital inflows to emerging countries and their sensitivity to the global financial cycle’. Banca d’Italia, Temi di Discussione (Working Papers), forthcoming. M. Obstfeld (2015), ‘Trilemmas and tradeoffs: Living with financial globalization’. In Global Liquidity, Spillovers to Emerging Markets and Policy Responses, edited by Claudio Raddatz, Diego Saravia, and Jaume Ventura, Santiago, Chile. Central Bank of Chile. A. Ciarlone and D. Marconi, ‘Financial spillovers to emerging economies: the role of exchange rates and domestic fundamentals’. Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), forthcoming. The euro area: a dual role Turning to the euro area, let me focus briefly on the international transmission mechanism of monetary policy. Despite being a large economic area, the euro zone is not immune to international spillovers. The relative importance of global versus local shocks is increasing as globalisation and financial markets’ integration advances. US monetary policy, the key driver of the global financial cycle, also influences euro-area financing conditions. At the same time, given that the euro is the second most important currency in the international monetary system, the ECB’s monetary policy is itself potentially a source of spillovers (Fig. 2). In recent years, extraordinary monetary stimulus has also been provided through unconventional monetary policy measures; international spillovers have been sizeable. Traditionally, monetary policy is thought to have cross-border effects mainly through the implied exchange-rate movements. Recent experience, however, has shown that the monetary policy international transmission mechanism may have several dimensions. The international environment is now much more deeply integrated; portfolio substitution by global asset managers acts as a powerful additional mechanism for transmitting financial shocks across monetary areas. Moreover, with policy rates close to their effective lower bound and the Eurosystem’s balance sheet greatly expanded, the entire macrofinancial environment has been transformed. Accordingly, the theoretical framework to study the international transmission of the ECB monetary policy stance has been enriched to take into account the role of the increased global integration of financial markets and the distinctive traits of non-standard measures. Unconventional monetary policy can have significant effects abroad through two relatively new channels. The first is the so-called portfolio rebalancing channel of asset purchase programs, which is likely to impact financial conditions beyond currency area boundaries to the extent that domestic and foreign long-term bonds are substitutes. The second channel – the international bank lending channel – is likely to be even more important across the Mediterranean. The ECB’s accommodative monetary measures, especially those aimed at making credit more abundant, can spur the growth of euro-denominated loans outside the euro area, especially in economies with a significant presence of euro-area based banks. Implications for the Southern Mediterranean countries The issue is quite important for Southern Mediterranean countries. In fact, while capital controls are still stringent in many of them (Fig. 3), the region has become increasingly integrated into global financial markets. Gross external financing needs have grown fast, with few exceptions, and for some countries lie above the emerging and developing countries’ average (Fig. 4). Capital flows to the Southern Mediterranean countries have been quite resilient overall since the global financial crisis and the so called ‘taper-tantrum’ episode in 2013 (Fig. 5), helping to finance ‘twin’ (current account and fiscal) deficits in those countries (Tab. 1). However, the more volatile components of capital inflows (portfolio and banking flows) have become larger than foreign direct investment (FDI). A sizeable share of these inflows has gone to financing the government sector’s large fiscal deficits (Egypt, Lebanon, Jordan). At the same time, the reduction of FDI inflows in the region may also reflect weak fundamentals (feeble growth prospects and policy uncertainty, as well as geopolitical tensions). Portfolio and banking flows are notoriously more volatile than FDI flows, as they are more sensitive to global push factors, such as global risk aversion and real interest rates in core countries, exposing recipient countries to sudden stops. A recent study conducted by the IMF shows that portfolio inflows to the Middle East and North Africa are almost twice as sensitive to changes in global uncertainty as those to other countries.8 Another worrisome feature concerns the currency composition of debt flows. Foreign currency debt has expanded rapidly in many countries over the past decade (Tab. 2), making the financial channel of the exchange rate especially important. For countries with sizeable net foreign currency liabilities, this channel will have IMF, ‘Regional Economic Outlook: Middle East and Central Asia’, October 2019. the opposite sign to the traditional trade channel and may more than fully offset it (i.e. a devaluation can be contractionary). Moreover, for many countries in the region trade integration is primarily with the euro area (Tab. 4) while exchange rates are mainly anchored to the US dollar (with the exception of Tunisia; Tab. 5). This creates potential currency mismatches, especially if export proceeds are mainly euro-denominated while debt obligations are in US dollars. Policy implications Given the interdependencies across the Mediterranean countries that I have just described and the ongoing integration with the euro area, it is natural to ask: how should policies be designed in order to promote sustainable capital flows in the Mediterranean area? The issue of how to deal with undesired spillovers from policies conducted in the euro area and in the US remains a controversial one. I would like to use the remainder of my time to discuss this question from three perspectives: that of the country (or area) generating the spillover effects (‘originating country’), that of the country impacted and, finally, the multilateral approach. Should the central banks in originating countries internalise the spillovers of their monetary policy to the rest of the world? The textbook answer to that question is that central banks pursue domestically-focused mandates: thus, they take into account the adverse effects of volatile capital flows only insofar as they negatively affect global financial stability, and through this channel may generate spillback effects to their domestic economy. Both conceptually and empirically, the measurement of these spillbacks is very challenging as they depend in part on the policy response of the countries affected. However, central banks can limit adverse monetary policy spillovers, notably through transparency and clear communication of their monetary policy decisions and intentions. The 2013 ‘taper tantrum’ episode exemplifies the potentially destabilising effects of policy communication mishaps. In addition, central banks can contribute to the resilience and soundness of their own financial systems with monetary policies designed to support economic activity and with macroprudential policies, as well as in their capacity as financial supervisors where they have such responsibility. This, in turn, contributes to global financial stability, with favourable spillovers to the rest of the world. From the perspective of the countries affected, the question is how can they shield their economies and financial systems from adverse spillovers? Experience shows that having strong domestic fundamentals and sound policy frameworks is essential. This usually includes sustainable budgetary positions; a business environment capable of stimulating investment and attracting FDI; a policy framework that ensures effective regulation and supervision of the financial sector; and the monitoring of private and public debt in foreign currency. Deep and developed domestic financial markets are a necessary condition for building up resilience to external shocks. The consensus nowadays is that exchange rate flexibility might help, but it is no silver bullet. Economies need to have good fundamentals and a comprehensive set of policy tools, including macroprudential and capital management measures, to protect themselves adequately from adverse spillovers. Finally, from a multilateral perspective, it seems that the interdependencies between the policies of both the originator and destination countries call for enhanced cooperation. While formal monetary policy coordination would not be feasible in view of central bank mandates, there is scope for enhancing multilateral efforts to deal with adverse spillovers. Having a platform for the exchange of views is extremely valuable in this regard. I am thinking about this high-level policy dialogue between the Eurosystem and the Mediterranean countries’ central banks. I believe that this is the right forum in which these issues can be framed and discussed on a regular basis. By sharing information and views on the global and domestic economic outlook and on the frameworks within which policy decisions are taken, central banks of the Eurosystem and the Southern and Eastern Mediterranean Countries can develop a better understanding of the respective monetary policies. Enhanced transparency makes policy actions more predictable and facilitates discussions on the mix of policy options to anticipate and address risks in the countries affected. FIGURES AND TABLES Figure 1 International financial integration: gross external assets and liabilities (per cent of GDP) AE EME (right scale) Sources: Lane and Milesi-Ferretti (2017) and IMF. Figure 2 Snapshot of the international monetary system (percentages; data at 2018 Q4 or the latest available) US dollar Euro Renminbi Yen Foreign exchange reserves International debt International loans Source: ‘The international role of the euro’, ECB (2019). Foreign exchange turnover Global payment currency (SWIFT) Figure 3 Capital controls restriction index 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 Algeria Egypt Lebanon Inflows Morocco Outflows Tunisia United States 0.0 Overall Source: Fernandez et al. (2016), update. Note: The dataset considers capital control restrictions on both inflows and outflows of 10 categories of assets. It is based on the analysis of the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). The index ranges between 0 (no restrictions) and 1 (total restriction). Figure 4 Gross external financing needs Change in gross external financing needs, 2018- 06 (per cent of GDP) Algeria Tunisia Lebanon Egypt EMDE Average Turkey Morocco -5 -10 Jordan Gross external financing needs, 2018 Source: IMF, World Economic Outlook, October 2019. Note: Gross external financing needs= current account deficit plus short-term debt. Figure 5 Net capital flows (per cent of GDP) Algeria Egypt -2 -1 -4 FDI Portfolio Other investments -6 Net financial flows FDI Portfolio Other investments Jordan Net financial flows Lebanon -5 -2 -4 FDI Portfolio Other investments -10 Net financial flows FDI Portfolio Other investments Morocco Net financial flows Tunisia -1 -1 FDI Portfolio Other investments Net financial flows FDI Source: IMF, World Economic Outlook, October 2019. Note: Net flows are given by inflows minus outflows. Portfolio Other investments Net financial flows Table 1 Current account balance and general government deficit (per cent of GDP) Algeria Egypt Jordan Lebanon Morocco Tunisia Current General Current General Current General Current General Current General Current General account gov't account gov't account gov't account gov't account gov't account gov't balance deficit balance deficit balance deficit balance deficit balance deficit balance deficit -16.4 -15.3 -3.7 -10.9 -9.0 -8.5 -19.3 -7.5 -2.1 -4.2 -9.7 -5.3 -16.5 -13.1 -6.0 -12.5 -9.4 -3.7 -23.1 -8.9 -4.0 -4.5 -9.3 -6.2 -13.2 -6.6 -6.1 -10.4 -10.6 -3.7 -25.9 -8.6 -3.4 -3.5 -10.2 -5.9 -9.6 -4.8 -2.4 -9.4 -7.0 -4.8 -25.6 -11.0 -5.4 -3.7 -11.1 -4.6 Source: IMF, World Economic Outlook, October 2019. Table 2 Current account position and foreign exchange debt exposure Current account % of GDP Share of foreign currency debt* (in %) Algeria -9.6 n.a. Egypt -2.4 33.6 Jordan -7.3 39.5 Lebanon -25.6 n.a. Morocco -5.5 38.6 Tunisia -11.1 40.5 Sources: IMF External Sector Report, July 2019 and World Economic Outlook, October 2019. Note: *Foreign exchange weights on foreign liabilities. Table 3 Destination of exports and origin of imports as a share of countries’ total exports and imports Algeria Egypt Jordan Lebanon Morocco Tunisia % share of exports to Euro Area 50.6 27.9 2.6 11.0 58.5 68.6 USA 9.4 8.5 26.4 1.9 5.5 2.8 China 1.3 1.3 1.6 3.1 0.9 0.7 Other 38.7 62.4 69.4 84.0 35.1 27.9 % share of imports from Euro Area 27.7 19.7 16.8 34.2 47.0 48.8 USA 0.4 5.0 8.7 7.1 8.0 3.4 China 15.8 9.0 13.6 10.1 9.9 9.6 Other 56.1 66.3 60.8 48.5 35.1 38.3 Source: IMF, Direction of trade statistics. Table 4 Exchange rate regimes and anchor currencies Exchange rate regime Anchor currency de facto de jure de facto Algeria Other managed arrangement basket USD (since 1999) Egypt Stabilised arrangement USD USD Jordan Peg USD USD Lebanon Stabilised arrangement USD USD Morocco Peg basket 60% USD; 40% EUR Tunisia Crawl-like arrangement EUR EUR Sources: IMF, AREAER 2018 and Ilzetzki, Reinhart and Rogoff (2016).
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Opening speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Centesimus Annus Pro Pontifice Foundation - Seventh Consultation Meeting "Ethos, Education and Training: Avenues toward equality and ethical behaviours in the digital era", Catholic University of the Sacred Heart, Milan, 31 January 2020.
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Education in the digital world Opening speech by Ignazio Visco Governor of the Bank of Italy Centesimus Annus Pro Pontifice Foundation – Seventh Consultation Meeting “Ethos, Education and Training: Avenues toward equality and ethical behaviours in the digital era” Catholic University of the Sacred Heart Milan, 31st January 2020 Let me first thank the Centesimus Annus Pro Pontifice Foundation for organising this meeting and its President, my former colleague Anna Maria Tarantola, for her kind invitation. In this talk, I will first describe the main changes that are taking place in the global economy, focusing on their consequences for employment and work opportunities. I will then discuss the role of education in responding to these changes. Over the past 30 years, the world has undergone a radical transformation driven by two main phenomena. The first is technological progress, with the innovations developed in the information and communications sector in the 1990s and, more recently, with the so-called digital revolution. The second is that this process has taken place in the context of a progressive globalisation, i.e. the liberalisation of international trade in goods, services and financial capital, which is being accompanied by strong growth in the cross-country movements of information, ideas and people. These phenomena are having widespread profound effects, right down to our everyday lives: – the introduction of the internet in the early nineties has permanently changed interpersonal communications and is now shaping how consumption and production take place. The rapid development of mobile telephony has favoured its diffusion: while in 1990 there were only two subscriptions per one thousand people around the globe, there is now more than one subscription per head. The share of the global population using the internet has then grown over the last 20 years, from a mere 7 per cent to over 50 per cent, with many countries, and not only the most advanced, well above 90 per cent; – as a result, the digital economy is among the fastest growing sectors. In the European Union it produces about 7 per cent of total value added. The sharp rise in the shares of firms who make a significant part of their revenue by selling online, of those who purchase cloud-computing services and of employees with business access to the internet suggests that in the future this sector will continue to increase rapidly; – the integration of markets and the international fragmentation of production have given rise to so-called global value chains: for many consumer goods, each single component is sourced from the countries where it is produced most efficiently. This has allowed costs to be cut, making the products accessible to a wider range of consumers. These transformations promise great welfare opportunities, but they also pose major challenges at both the economic and the social level. An important source of concern is their impact on the labour market and on the skills required by the production system. New technologies have already started to replace many manual and, especially, routine jobs, cutting costs while possibly creating temporary strains on employment. Data-processing and information-intensive tasks, in which human contribution once appeared to be indispensable, are also increasingly being automated. Recent examples include the introduction of customised on-line language courses based on machine learning techniques, the “internet bots” hired by a growing number of firms to handle the initial stages of customer services, the new possibilities opened up by the latest generation of virtual personal assistants. The combination of globalisation and technological progress has also provided all companies, and not just multinationals, with a new potential pool of human capital from around the globe, such as low cost manufacturing workers from China, software and customer service professionals from India, or skilled workers from Eastern Europe. This may have contributed to generating additional tension in advanced economies, which have seen a significant portion of their key industries relocate to other geographic regions. The burden of these changes is borne unevenly across countries and social groups. In advanced economies, it has generated fears of a revival of the phenomenon that 90 years ago John Maynard Keynes called “technological unemployment”. The experience of countries such as the United States, Japan and Germany, which are at the frontier of technological development and where unemployment rates are close to historical minimum levels, suggests that, as Keynes himself concluded in 1930, technological unemployment may well only be a temporary adjustment phase. Policy-makers, however, cannot ignore the costs of this transition, and every effort should be made to minimise the difficulties for those who are affected the most. Longer-lasting implications may emerge for labour market participation (which is declining among prime-age males in many countries), the quality of occupations and wage inequality. Over the last few years, in fact, the structure of job opportunities has sharply polarised in many advanced countries, including Italy, with expanding demand in both high-wage and low-wage occupations, but diminishing opportunities in middle-wage jobs. More specifically, employment has increased in many managerial, highly professional and technical roles on one hand, and, on the other hand, in occupations such as low-education food service jobs, home aides, security services. Job opportunities have instead fallen in “white-collar” administrative and sales occupations and in middle-skill “blue-collar” production, craft, and repairs. This decline is detrimental to the earnings and the participation rates of the middle-class, affecting, in particular, workers without a tertiary education. New technologies are also having a multifaceted impact on labour intensity (as measured by the average number of hours worked per worker). Bear in mind that, in advanced countries, an important secular trend had been the decline in the average hours worked per worker, which moved in tandem with increases in productivity and wages. In recent decades, however, these trends seem to have changed. Labour intensity, in particular, has shown a “bifurcation”. On one hand, a substantial portion of the global labour force now works very long hours (more than 48 hours per week). On the other hand, there has been a growth of (often involuntary) short-hour and part-time contracts, with the most famous example probably being the so-called “mini jobs” in Germany. Although more research is needed to fully understand the causes of both phenomena, technology seems to have contributed to amplifying them. For those who work more, for example, business smartphones and other digital devices may have blurred the boundaries between work and private life, further increasing the number of hours worked. On the other hand, the so-called “gig economy jobs” (micro tasks, crowdworking, manual services) have fuelled “time-related underemployment”, a form of labour underutilisation affecting those who would be willing to increase their working hours but are unable to do so. Which policies should be designed and implemented to contain the economic and social costs due to higher automation and digitalisation? My view is that the most important response should be to prioritise investment in education: investment that must be inclusive because, as recently argued by Pope Francis, “every change calls for an educational process that involves everyone”. In Italy, for example, the challenge of raising human capital is especially important. Data show that, compared to other advanced countries, Italians spend less time in education, they learn less and, once they are in the workplace, participate in less professional training. As the labour market participation is also low, this brings the share of young people who are referred to as “NEET” (Not in Education, Employment, or Training) to well above the European average. But public investment in education does not mean simply providing more financial resources to schools and universities. Quality spending is needed to improve these infrastructures, because we need schools that are not only endowed with up-to-date ICT tools, but are also sufficiently attractive and comfortable: students should be able to enjoy and fully benefit from their time in attending them. In addition, a far-reaching reflection is needed on both what is taught in schools and on how it is taught. With regard to the content of education, many observers place a greater emphasis on “creative” subjects. It is now widely recognised that a modern school curriculum should integrate science, technology, engineering and mathematics (known with the traditional acronym STEM) with the arts (STEAM) as well as reading and writing (STREAM). In fact, when most routine and data-driven tasks are automated, human contribution will be concentrated in those creative tasks aimed at developing new goods and services or at customising or differentiating existing ones. These tasks require us to understand and anticipate consumer needs and behaviours, to improve the design of new products and to analyse their integration into every-day life. Importance should also be given to financial education, including its digital facets. New technologies in the financial industry are introducing novel products, services and providers. But the growing digitalisation of financial decisions is not always accompanied by an increase in financial literacy levels, even among the younger population. For instance, for Italy, our survey – conducted within the Group of Twenty (G20) using a methodology developed by the OECD – shows a very low level of financial literacy with respect to the G20 average, especially among the least educated respondents, the elderly and women; only about 30 per cent of all the respondents showed sufficient financial knowledge, versus a still low 48 per cent, on average, for the G20. Enhancing financial education, as well as familiarity with digital tools, is needed to raise awareness in the use of digital financial services and help protect customers from digital crimes, such as phishing scams, account hacking and data theft. It is also worth remembering that new technologies are leading to a growing digital footprint of consumers and entrepreneurs. Not only financial service providers but also online retailers, social network platforms, and other internet service providers gather vast amounts of personal information. These data are often used as input for algorithms that profile customers and can draw behavioural predictions. Profiling permits the personalisation of services, but it can also lead to unfair discrimination; in the United States, for example, some cases have emerged of discrimination based on ethnicity and gender. In the broader context of data protection legislation, the European Union has built safeguards against algorithmic bias, which include the right to refuse to be “subject to a decision based solely on automated processing, including profiling”. In the financial sector, this norm applies to decisions on credit and insurance. Financial education would further help to make people aware of the implications of their digital activity, of the use made of their data, and of their rights. An appropriate education would also contribute to limiting the “digital divide”, that is the lack of opportunities available to people without access to the internet. As the diffusion of digital devices is becoming more global and their complexity grows, access to opportunities will depend not simply on having the information and communication tools, but also on having the skills needed to use them. Expanding the content of education alone is, however, not sufficient. As Tullio De Mauro, the great Italian professor of linguistics and former Minister of Education, pointed out some years ago, in many countries school life has been governed by three principles: “first, silent listening in class to the lesson of the teacher who explains, between the chair and the blackboard, what is already written in the book; second, studying the book at home, with exercises; third, back to class with questions to verify the studying of the book”. This traditional method where knowledge is passively imparted from teachers to students is no longer enough. History, arts, literature, languages, mathematics, science, economics will have to be taught in a dynamic context with sufficient room to stimulate creativity, intellectual curiosity, discussion and negotiation with other students, the ability to cooperate, enhance respect for others and foster ethical behaviour. Digitalisation should not become a prison: it is necessary to learn about it, but we also have to be able to debate its merits and be prepared for the tools that will be used in the future. As Malala Yousafzai, the Pakistani activist for the right to education and the youngest ever Nobel Prize laureate, reminded us in 2013: “one child, one teacher, one book, one pen can change the world”. In the quest for a better world today, we could also add new “digital devices”, when used properly, to this list. Improving the content of education and the teaching methodologies is needed to prepare our students not only for what we think is going to matter in the workplace tomorrow, but also for what we do not yet know. We know that today’s workers are required to develop and continuously refine a large arsenal of both cognitive and non-cognitive skills. They need to be able to search for specific information in the ever-growing ocean that is the internet, recognise the quality of this information, process it critically. To adapt to the modern model of business organisation, it is widely recognised that there is a great need to develop “soft skills” such as problemsolving attitudes, teamwork, effective communication and negotiation. However, adequate investment in education is also needed to face the uncertainty that surrounds the jobs and the skills that will matter in the future. The current pace of technological change requires workers to “learn to learn” and to continuously update their skills. Understanding the importance of investing in culture and knowledge, not only throughout our school careers, but also spanning our entire working life and beyond, is therefore the crucial challenge for the global economy. This challenge is even more important in Europe, due to its demographic trends. By 2045 the population aged between 20 and 64 will have fallen by about 30 million in the European Union (and by 6 million in Italy alone). The difficulties for GDP growth and, in turn, public debt, long-term care and pensions will be formidable. Economic development in Europe will continue at a pace similar to that of the past only if progress is made in reviving productivity growth. To this end, it is necessary to put reforms in place which improve the business environment and favour innovation. But a key contribution must come from human capital. As pointed out by Edmund Phelps, the Nobel laureate in economics in 2006, in his analysis of the causes of the slowdown in productivity observed in advanced economies in recent decades, reviving the dynamism of our economies requires rediscovering behavioural attitudes that supported economic growth in the past, such as the desire to create new things, the propensity to explore, the drive to seek better jobs, face new challenges and be successful. Education is the key to reactivating these attitudes. * * * Let me now conclude. As an economist and as a central banker, in this brief discussion I have focused on the role of education and human capital to enhance economic development and to respond to the changes that are taking place in the financial system and in the global economy. But it would clearly be an understatement to think that investing in education matters only for its positive impact on economic growth or on personal finances. As Pope Francis put it in September 2018, “without the right to education there is no real freedom, which allows every person to be the protagonist of their own destiny”. A better education is the key to a better world. It can contribute in a profound way to supporting our sense of civic duty, including increasing respect for others, strengthening compliance with the rule of law, improving trust and cooperation, enhancing solidarity. It is therefore essential to foster values that have an intrinsic worth, regardless of their effects on the economy, and that are key for the social cohesion and the well-being of citizens – values that, today, are most needed. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 26th Congress of ASSIOM FOREX (the Italian financial markets association), Brescia, 8 February 2020.
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26th ASSIOM FOREX Congress Speech by the Governor of the Bank of Italy Ignazio Visco Brescia, 8 February 2020 Economic developments Economic activity in Italy has been virtually stagnant since the early months of 2018, in part owing to the slowdown recorded at European and global level. The latest cyclical indicators have provided conflicting signals. Our business surveys continue to point to expectations of an expansion in demand. Conditions on the financial and credit markets have improved, and investors’ confidence has risen, as shown by the sizeable purchases of public sector securities made by non-residents and the considerable reduction in their yields, and the significant narrowing in the ten-year spread with the German Bund. However, Istat’s preliminary estimate indicates that GDP declined by 0.3 per cent in the fourth quarter of last year, in part likely reflecting especially unfavourable developments in the most erratic components of final demand. Our projections reported in the most recent Economic Bulletin, which were formulated before the release of Istat’s preliminary estimate, suggest that GDP growth will still be very low this year, after remaining virtually unchanged in 2019, but will be higher in the next two years. This scenario is subject to significant downside risks. Much will depend on the performance of the global economy and of our main European trading partners. International trade disputes have abated but geopolitical tensions have risen, though with limited repercussions on oil prices so far. The terms of the future economic relations between the European Union and the United Kingdom, which formally left the Union on 31 January, still have to be worked out during the transition period that will last until the end of the year. An additional risk factor has emerged in the form of the possible repercussions of the spread of the new coronavirus, especially for the Chinese economy, which in recent years has been one of the main drivers of world growth. On the domestic front, for the time being the financial markets are benefiting from diminished political uncertainty. However, it has still not been possible to defeat the chronic vulnerability connected with the medium-term prospects of the public finances and of economic growth. The yield spread between Italian ten-year public sector securities and the corresponding German securities, which is now below 140 basis points, remains almost double the spread recorded for the public sector securities of countries such as Spain and Portugal, which were also hit hard by the global financial crisis and the euro-area sovereign debt crisis. The situation is still affected by the unknowns regarding the implementation of, and possible alternatives to, the increases in indirect taxation provided for by the safeguard clauses in 2021 and 2022 (equal to 1.1 and 1.4 per cent of GDP respectively) and by ongoing concerns about certain trends in our current expenditure. These are compounded by signs of disaffection with the European project and pessimistic assessments of the growth potential of our economy that assume a lack of ability to make the reforms needed to unlock the country’s productive resources. These perceptions must be countered by making the economic environment more conducive to business and innovation, by reducing uncertainty, including around regulation, which acts as a brake on private investment, by grounding changes in taxation in a holistic vision for the tax system, and by implementing in full the government’s public sector investment plan. Slow and fragile economic growth in the euro area continues to affect inflation, which remains well below 2 per cent. In January, price growth increased slightly (to 1.4 per cent), but the core component decreased (to 1.1 per cent, and to 0.5 per cent in Italy) and inflation expectations − not only for the short term − are at very low levels. The ECB Governing Council remains convinced of the need to maintain for a prolonged period of time the current expansionary stance reinforced last September and confirmed in full at its January meeting. The transmission mechanism of monetary policy continues to be effective in supporting investment and consumption. The reduction in the deposit facility rate was passed on to short-term market interest rates and the recovery in the net purchases of financial assets exerted renewed downward pressure on long-term rates. The introduction of a two-tier system for the remuneration of banks’ reserves in excess of the minimum requirement, which took place without generating tensions, is intended to preserve banks’ ability to provide credit to firms and households. An increase in aggregate demand − by supporting labour market conditions, which are still uneven between euro-area countries, and by strengthening wage growth − could facilitate a rise in inflation towards levels consistent with the price stability objective. However, greater support from the other economic policies remains essential to sustain growth in the euro area and to avoid the perpetuation of the extraordinarily low level of market yields, which reflects above all insufficient demand for investment compared with the supply of savings. The Governing Council has launched a review of its monetary policy strategy. As announced, this will be based on a thorough analysis and an open-minded approach. It will have to assess whether there are aspects that require an adjustment, given that, in a context of profound structural change in the world and in the euro area, the challenges connected with the current low inflation levels are different from those historically posed by high inflation. Banks, non-bank intermediaries and market infrastructures In the banking sector, the quality of credit continues to improve. Notwithstanding the weakness of the economy, the flow of new non-performing loans remains low. Net of loan loss provisions, last September the ratio of non-performing loans to total loans averaged 3.7 per cent, against 9.8 per cent at the end of 2015. Actions to reduce the volume of non-performing exposures and to improve their management must continue, above all by smaller banks that tend to have relatively higher NPL ratios and lower coverage ratios compared with those of the largest groups. Market conditions have improved in recent months and banks have reduced the quantity of government securities on their balance sheets. At the end of December, excluding securities held by Cassa Depositi e Prestiti SpA, these holdings amounted to €313 billion or 9.8 per cent of total assets; in early 2015, they peaked at €403 billion. Notably, since last May, intermediaries have made net disposals of almost €40 billion worth of government securities. The role of banks as contrarian investors has been confirmed. In the first nine months of 2019, profitability rose compared with the same period in the previous year. Net of extraordinary components, ROE increased on average from 5.8 to 6.6 per cent, although it is still lower than the cost of equity. The capital base continues to strengthen: in September, the CET1 ratio averaged 13.6 per cent, compared with 13.3 per cent at the end of 2018. Nowadays the traditional banking model offers low returns, for reasons not only linked to cyclical economic developments. Small and medium-sized banks are the most affected and struggle to strengthen their balance sheets owing to high costs and difficulties in gaining access to the capital market; significant economies of scale and scope are needed to successfully fund the real economy. Intermediaries specializing in asset management tend to fare better, as do those distributing financial products through a network of salespeople or those operating primarily in the leasing, factoring and consumer credit sectors. The cost-to-income ratio of the small traditional banks, equal to 72 per cent on average, is higher than that of both the large significant groups (66 per cent) and of the specialized intermediaries (64 per cent). For all intermediaries, the process of restructuring and adapting to the new economic, regulatory and market landscapes, as well as to technological advances, must proceed with determination. Stronger balance sheets and greater efficiency can be achieved if the industry is reshaped in various ways, in terms of size, ownership structures and business models. As I have often pointed out, initiatives to expand the scale of operations of small banks such as mergers or greater integration of business areas across banks can prove beneficial to the extent that they reduce cost ratios, increase and diversify earnings, and enhance banks’ ability to compete on the market. The reform of the mutual banks (BCCs) was designed to achieve the necessary efficiency gains and economies of scale to meet the challenges associated with the transformation of the banking sector, whilst preserving these banks’ original mutualistic spirit. The establishment of two new mutual banking groups brings the number of groups now operating in Italy to 54, comprising 310 banks, while there are 100 stand-alone banks. At the end of 2008, there were 81 groups and 499 stand-alone banks. The two new groups, which this year will be subject to the ECB’s comprehensive assessment, must take swift action to cut costs and rationalize their distribution network by tackling the cases of individual BCCs in difficulty. The financial conditions of the mutual banking groups, their operating model, organizational arrangements and governance must ensure their long-term sustainability. The Single Supervisory Mechanism does not expect these banks to achieve the same profitability as the other intermediaries, but it must be sufficient to maintain adequate capital levels, which are indispensable to continue carrying out their work of funding the economy effectively. Households’ financial assets amount to around €4.4 trillion, two and a half times GDP, a considerable sum by comparison with the countries of mainland Europe, though still below that recorded in the United Kingdom and the United States. Around one third of household wealth is held in cash and deposits, one third in managed assets, and one third is invested directly in shares and bonds, both public and private, and in other assets. The share of cash and deposits, which had declined to 23 per cent in 2000, has gradually increased, reflecting the fall in market rates and the uncertain economic outlook. In the same period, the share of managed assets, which offer instruments that enable a greater degree of risk diversification than that typically offered by direct investment in the markets, recorded a comparable increase. The portion of household financial assets entrusted to asset management institutions is nonetheless still 10 percentage points below the euro-area average and the share for the United States, and some 30 points lower than in the United Kingdom, something that the greater role of public pensions in Italy goes some way to account for. In Italy, around 11 per cent of households’ financial assets are in investment funds, 18 per cent in insurance policies, and 2.5 per cent in pension products. In recent years, the sector has benefited from new regulation. Long-term individual savings plans were introduced by the 2017 budget law and have encouraged households to put their money into investment funds specialized in Italian corporate equity and debt instruments. The first European Long-Term Investment Funds (ELTIFs) have been created. These closed-end funds are dedicated to both professional and retail investors, which invest in both equity and debt instruments. Investment in funds specialized in securities issued by non-financial companies, such as private equity and venture capital funds, remains low by international standards. In the past few years, however, there has been growing investor appetite for this sector: since 2016, the Bank of Italy has authorized the establishment of approximately 70 asset management companies (SGRs) and closed-end investment companies (SICAFs), most of which invest in these assets. The Bank of Italy is responsible for the prudential supervision of most of the components of the non-bank financial system. Specific provisions regulate the activities of asset management companies (SGRs and SICAFs), securities investment firms (SIMs), financial intermediaries included in the Single Register provided for in the Consolidated Law on Banking (‘financial companies’), and payment service providers such as payment institutions (PIs) and electronic money institutions (EMIs). In addition to the companies belonging to the major banking and insurance groups, numerous entities are controlled by industrial groups and private equity funds, and by various intermediaries of a public nature or with a strong public profile (regional finance companies, infrastructural or strategic funds). At the end of last year, there were 159 SGRs operating in Italy, together with 32 SICAFs, 69 SIMs, 202 financial companies and 48 PI or EMI payment service providers. The Bank of Italy’s supervisory activities, which it carries out in tandem with its branches, aim to strengthen intermediaries’ organizational and corporate governance arrangements and internal risk-control systems; the Bank also intervenes in cases of difficulty, requiring financial and balance-sheet restructuring and other strategic and organizational changes. In the most serious cases, the Bank imposes supervisory sanctions and issues restrictive measures, and can even adopt special measures. When managing a crisis, the objective is to prevent disorderly market exits that could have serious repercussions on investors and counterparties. We do not, and cannot, supervise those who offer financial services illegally, without requesting authorizations and by breaking the rules. However, the Bank’s website contains a section with lists of both authorized intermediaries and also of those taken off the list and those found to have operated illegally. There is constant interaction with the authorities and institutions that combat illegal practices and counter the distribution of financial instruments designed solely to evade regulation, including in ways that exploit the opportunities provided by new technologies. The proper functioning of the financial system also depends on the legal and technical-operational efficacy and robustness of its infrastructures, which include trading platforms, central counterparties, and securities settlement systems. The organizational choices and business models of these operators influence the conditions of access, ease of placements, and efficiency and liquidity of trading. The companies that manage Italy’s financial market infrastructures (Borsa Italiana, MTS, Cassa di Compensazione e Garanzia, and Monte Titoli) belong to a group that is controlled by the London Stock Exchange, now situated outside of the European Union. This group is the subject of a major acquisition – whose completion is expected in the second half of this year – which will extend its sphere of activity to include the provision and analysis of financial data. The new group will be among the leading operators in the sector at global level. In exercising the prerogatives assigned to them by law, the Italian authorities are closely monitoring each step of the acquisition. Its implications for the subsidiary companies, in terms of governance, organizational arrangements, financial equilibriums and strategic guidelines, must not endanger the safeguarding of objectives of general public interest. Challenges for intermediaries Italy’s financial sector must continue to face up to the challenges linked with the changes in the macroeconomic context, the regulations and technology, as well as those stemming from climate change. The variety in terms of business models, scales of operation and legal forms may play a useful part in the functioning of the banking industry, but it must be made compatible with these changes and with the basic conditions for the sound and prudent management of intermediaries. As I have pointed out, low interest rates are mainly the result of underinvestment compared with the supply of savings and, more generally speaking, of the weakness in demand following unfavourable trends, both long term and cyclically. In response to the cyclical trends, monetary policy aims to boost demand and avoid triggering a downward spiral in economic activity. It is likely that we will have to live with low yields for some time to come. In Italy, the low yields have so far had practically no effect on financial intermediaries. For banks, the negative impact on net interest income has been offset by the favourable impact on the quantity and quality of credit, together with an increase in fee income. The latter must always reflect the usefulness and effectiveness of the services provided to customers rather than shortsighted rent-seeking behaviour. Insurance companies have also been affected to a limited extent by the low market rates; their adoption of prudent strategies in the past for matching asset durations with those of liabilities limited the effect on their balance sheets. In the longer term, they could counter risks through a greater diversification of portfolio assets and by continuing to adapt their commitments to policyholders to the new market environment. As regards the changes in the regulations, intermediaries will have to make an effort on various fronts, and plan capital needs and the necessary funding ahead of time. As far as non-performing loans are concerned, a calendar provisioning approach to writing down new loans classified as NPLs has been in force in the European Union since last year; it flanks the plans to reduce NPL stocks that banks must submit yearly to the supervisory authorities. By the end of this year, some changes will have to be made that also aim to harmonize at European level the thresholds for classifying loans as having gone into default if instalments are overdue. In a country like Italy, where credit recovery procedures are particularly lengthy, the new European practices for NPLs have encouraged the rise of a non-banking industry for managing them. This new sector must be efficient for the benefit of those investing in it and of the banks. Care must be taken in the phases following the sales and securitizations of bad loans. The professionalism, integrity and organizational and capital strength of the servicers entrusted with these operations are essential. The Bank of Italy recently started an in-depth analysis to evaluate servicers’ performance and to check the overall effectiveness of the current regulatory and supervisory framework. In the case of sales of unlikely-to-pay loans, it is important to encourage the recovery of firms in difficulty as much as possible. As I have already noted on other occasions, benefits may accrue from interventions by operators specializing in company restructuring (turnaround funds) that can provide new funding and specific entrepreneurial skills. The setting-up of buffers for liabilities that can absorb losses and recapitalize intermediaries continues, as per the regulations on crisis management (minimum requirements for own funds and eligible liabilities – MREL). Over the last few weeks, several banks have placed a considerable amount of bonds at lower costs than in the past, including subordinated bonds, taking advantage of the favourable financial conditions. Through this process, we expect that bonds eligible as part of minimum requirements will be held by investors that are able to fully evaluate the risks, in line with the provisions of the regulations for the markets in financial instruments (MiFID). Over the next few months, the European Commission will present a proposal for the transposition of the prudential standards adopted by the Basel Committee at the end of 2017 (Final Basel III). The new rules, which include the setting of an output floor on the capital requirements calculated using internal models prepared by the banks, will gradually come into force in 2022 and will be fully in place in 2027. In order to cope with the impact of applying these standards, which is expected to be lower than the average estimated for European intermediaries as a whole, Italian banks will need to be decisive and continue to seek better organizational and cost-related conditions. Although almost all intermediaries provide basic products and services using digital channels, more can be done in the way of adopting new technologies. The opportunities provided by the digital revolution to the financial industry are as much for reducing costs as for investing the resulting savings in developing products and services that meet customers’ needs better. While fully observing the principles of correct and transparent conduct, this commitment means that, above all, IT security and the control of cyber risks will continue to be necessary; substantial investment is still required to ensure this. Accordingly, adequate instruments and professionalism must be acquired; joint initiatives may be useful here for smaller intermediaries. Lastly, with reference to the impact of climate change, there is increasing debate over how to adapt risk control and management practices to the exposure of assets to extreme natural events, also with longer timeframes than now. Yet the challenges posed by climate change may also prove to be significant opportunities. A decisive acceleration in decarbonization policies, such as that heralded by the European ‘Green Deal’, will foster the supply of ‘sustainable’ products, shown by market surveys to be potentially in great demand. Challenges for the supervisory and crisis management authorities The regulatory and macroeconomic framework that has come into being over the last decade has made finding solutions for the difficulties experienced by the smaller banks a more arduous task. On the one hand, injections of fresh capital, especially in less attractive local areas and markets, are hindered by structurally lower profit margins than before, by the serious legacy of the crisis in the real economy, and by governance mechanisms that are self-serving and lacking in transparency. The response of intermediaries to these latter issues has been slow and inadequate; the related legislative reform process has been difficult and has encountered opposition. On the other hand, the rules existing today rightly put limits on the use of public money for bailouts, though there is some room for flexibility, which was exploited in Italy not without difficulties, when public confidence and the stability of important parts of the banking system were considered to be at risk. Supervision is intensive, including on the smaller banks. It is carried out using the powers allocated to the supervisory authority and in full compliance with the business nature of banking and with the provisions of the law, with no collusion or ‘dirigiste’ intentions. As far as possible, it takes account of the economic and market context in which intermediaries operate, as well as of the difficulties in both the restructuring and recovery processes for banks and in managing crises. As I have pointed out on more than one occasion, with the entry into force of the new European regulatory framework and in the absence of investors interested in purchase and assumption transactions, the only way forward in the event of a crisis is a piecemeal liquidation, resulting in a loss of value and in contagion risks. When dealing with difficult situations, the instruments that the law puts at the disposal of the supervisory authorities are used with great care. The intensity of the corrective measures imposed on intermediaries is strictly proportionate to how far a bank’s financial situation has deteriorated. The press is not aware of successful interventions; most of the interventions are successful, but not all of them can be. Recourse to special administration – the most intrusive of supervisory interventions – occurs as soon as the seriousness of the situation so requires. Nowadays this is an ‘early intervention’ measure: unlike in the past, when searching for possible solutions was an essential part of the special administrators’ work, this measure can only be taken when there is a prospect of recovery; otherwise liquidation is inevitable. This is a very fine line, and we are extremely careful as to how we tread it. Experience shows that in most cases, special administration is an effective instrument that can help relaunch an intermediary or avoid traumatic solutions for crises. Since 2007, around 80 intermediaries have been placed under special administration, more than half of which have subsequently returned to business as usual. When liquidation has been necessary, the support for purchase and assumption transactions provided by deposit guarantee schemes has made an orderly exit from the market possible, usually with no losses for current account holders and savers. Preventive interventions by deposit guarantee funds to avoid the emergence of crises have also been and continue to be an important tool for preserving stability. European legislation explicitly provides for this type of intervention and also establishes a wide range of safeguards to avoid using resources that are compulsorily earmarked for covered deposits (up to the European ceiling of €100,000), which would breach State aid rules. The private nature of Italian funds is a further guarantee of a thorough and prudent assessment in compliance with the least-cost test, according to which interventions other than reimbursing deposits can only be implemented if the cost is lower for the funds than it would be in the event of liquidation. In most cases, preventive intervention has made it possible to manage difficult situations successfully. We have underscored on more than one occasion that the European framework for bank crisis management needs to be equipped with procedures that allow an orderly exit from the market of intermediaries for which the activation of a resolution is not justified by public interest. The specific reference here is to the orderly liquidation adopted by the US Federal Deposit Insurance Corporation (FDIC), which has dealt with the crises of over 500 intermediaries since 2008, thereby averting risks to the overall stability of the banking system. We regularly give an account in our Reports of our supervisory work and of the measures we adopt in this sphere, as we do in other Bank of Italy publications, in the testimonies made before Parliament, and in our public speeches and interviews. We are committed to informing the public more clearly about both our powers and the constraints on what we can do, and we are open to discussion and dialogue. We are continually learning from experience, and we keep abreast of and adapt to the changes taking place in the financial industry. The events that have affected some banks in difficulty over the last few years have brought the topic of the protection of consumers of banking and financial products to the forefront of the debate. It is important that – alongside the legislative action and the supervisory interventions to improve the quality of the information given to customers on the features, costs and risks of the products being sold – intermediaries prioritize the needs of customers when drawing up their placement strategies. The quest for yields by investors and for financial resources by small and medium-sized firms is leading to a wider range of investment instruments that also target non-professional investors, who need to be made fully aware of the higher risks they carry, including their cost structures. The rules in force today identify different responsibilities for the various supervisory authorities. The Bank of Italy is in charge of customer protection for banking and payment products and services, Consob is responsible for this in investment services, IVASS covers the insurance sector, and the Antitrust Authority is responsible for consumer protection in general. The closeness of the functions and powers of the various authorities requires us to strengthen cooperation and exchanges of information. This is essential in a context in which the characteristics of financial instruments tend to change rapidly and their very nature can be difficult to classify, making the precise definition of rules and spheres of control a complex process. We must move beyond the view that sees prudential supervision and conduct supervision as antithetical objectives: providing quality services and maintaining good relations with customers are key factors to strengthening trust in intermediaries and hence their competitiveness, profitability and solidity. This is a clear lesson we have learnt from the experience of these recent and difficult years. The supervisory action carried out by the authorities must be accompanied by measures to improve the public’s financial literacy. To a certain extent, this issue is common to all the advanced countries, in which the multiplication of financial products and investors’ search for yield collide with the sometimes very limited knowledge of financial mechanisms and concepts. The problem is more acute in Italy. According to the latest survey conducted by the Bank of Italy in 2017 based on the methodology developed by the OECD/INFE, only one third of the adult population possesses a sufficiently high level of basic knowledge, compared with half on average for G20 countries (and two thirds for OECD countries). Since 2014, a Bank of Italy directorate has been in charge of customer protection with the objective of strengthening the Bank’s analyses and interventions on supervised intermediaries in areas such as transparency and fair conduct, usury, money laundering, combating the financing of terrorism, and in stepping up initiatives to increase financial education for the general public; these initiatives have involved more than 600,000 students over the last few years. Thanks to the contribution of our branches, we have improved our management of complaints − we processed more than 10,000 of them last year alone. The support provided by the technical secretariats to the seven panels of the Banking and Financial Ombudsman made it possible to look into more than 27,000 appeals in 2019, of which 15,000 ended with decisions in favour of the customer. The Bank of Italy attaches the utmost importance to these tasks. We are determined to commit all the resources necessary for these tasks and we will continue to step up these activities, including by making changes to our organizational structure in the coming months. * * * The challenges I have described and the commitments that stem from them concern each and every one of us. Supervisory authorities must facilitate and accompany the financial system’s adaptation to the new economic and regulatory environment and to technological advances and climate change. In Europe, we must complete the banking union, above all by providing adequate instruments for an orderly management of crises applicable to all intermediaries; a road map must be laid down for the introduction of a genuinely common deposit insurance scheme. Initiatives that could have procyclical effects or jeopardize financial stability must be avoided. As I have observed on previous occasions, to complete the Economic and Monetary Union and make the Eurosystem’s action more effective, greater integration in the capital markets and a pan-European fiscal policy are also needed. A decisive role in achieving these objectives could be played by the introduction of a common risk-free debt security, as is the case in the other major advanced economies. In Italy, intermediaries must be resolute in upgrading their governance structure, their technological assets, and their business models. They must pursue levels of efficiency and profitability that can guarantee their ability to attract capital from the market and support economic activity. However, neither intermediaries nor central banks alone can create growth. In order to achieve a higher path of stable expansion, economic policies are needed that look beyond the one-year horizon of the government budget. Setting out a systematic reform framework encompassing all the individual measures can in itself provide an expansionary boost by reducing the trust deficit, which weighs on government bond yields and private enterprise even more than the public finance deficit does. A return to enduring growth must be pursued in full respect of environmental, financial and social considerations. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Panel discussion by Mr Ignazio Visco, Governor of the Bank of Italy, at the Launch of the "COP26 Private Finance Agenda" for the 26th UN Climate Change, London, 27 February 2020.
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COP 26 Launch “Returns – identifying the opportunity in the transition to net zero” Panel discussion by Ignazio Visco Governor of the Bank of Italy London, 27 February 2020 Let me thank Governor Carney and the conference organisers for their kind invitation. As you know, the growing use of fossil fuels is pushing greenhouse gas concentrations to levels such that, unless forceful measures are taken, will lead to an increase in the temperature of the planet ranging from 3 to 5 degrees Celsius by the end of this century. These are well beyond the threshold of 1.5 degrees that, if surpassed, would bring potentially catastrophic consequences for the world. Stopping climate change is first and foremost a responsibility of national governments, the only institutions that can provide the right incentives to allocate capital to “green” investments, levy taxes on carbon emissions, and introduce regulations limiting the amount of permissible emissions. But the challenge is enormous. Overcoming it will require strong efforts by all institutions and individuals. Given its central role in the allocation of resources, the financial sector can be key in influencing the transition to a zero-emissions economy. Central banks may play their part. First, they can help to raise awareness of the risks related to the sustainability factors and the channels through which they are transmitted from the real economy to the financial system. Second, they can promote the dissemination of more information on environmental risks and favour a better management of climate-related risks by financial intermediaries. Third, they can lead private investors by example, by adopting suitable policies in the management of their own financial resources. In this perspective, this panel discussion gives me the opportunity to describe the main changes that we have recently made to the Bank of Italy’s investment strategy in our capacity as portfolio managers. Specifically, last year we decided to integrate Environmental, Social and Governance (ESG) factors into the management of our equity portfolio. We have also completed background studies to launch, this year, an analogous initiative for our corporate bond portfolio. With regard to the equity portfolio, we have added two criteria to our previous strategy: – the first discards the companies that belong to the sectors excluded by the United Nations Global Compact (controversial weapons and tobacco); – the second gives preference to the companies with the best ESG scores. Here I would like to make three brief points that deserve special attention. They concern the returns of sustainable investment, the problems in using ESG scores, and the principle of market neutrality that, as a central bank, guides our investment strategy. The decision to account for ESG factors has been taken to fulfil our duties in terms of social responsibility and to lead investors by example without hampering our price stability mandate. This change has not undermined the financial performance of our portfolio. A backward test over a ten-year horizon run before we implemented the new strategy showed that the new portfolio would have beaten the previous portfolio and the market benchmark in terms of both higher return and lower volatility. Since we have implemented it, the new portfolio has continued to perform better than the old one both in return and volatility. The fact that constraining the portfolio to fulfil ESG criteria does not penalise its financial performance is not necessarily surprising. Several studies confirm that sustainable investment leads to risk-adjusted returns that are often higher than those achieved using traditional financial models. These findings may be due to a number of reasons. – First, investors may have underestimated environmental and social risks in the past and may not have anticipated the higher returns due to the faster-thanaverage growth of the green sector. – Second, in its practical implementation, the traditional risk-return approach uses historical time series, which make it backward-looking. The sustainability assessment, instead, implies a forward-looking long-term view, which could help to mitigate the “short-termism” that often drives financial investments. – Third, good ESG practices seem to provide firms with a competitive advantage stemming from innovation. They also contribute to reducing operational, legal and reputational risks and lead to a more efficient resource allocation, as resources can be shifted from risk management to productive activities. This lowers the cost of capital and improves market performance. The second issue concerns the problems related to ESG scores. Today, there are neither globally accepted rules for ESG data disclosure by individual firms, nor agreed auditing standards to verify the reported data. Moreover, there are intrinsic difficulties in deciding which indicators are relevant in assigning an ESG score (how we should evaluate, for example, the “social” component of the score), especially when compared to financial aggregates, where the most important indicators, such as revenues, costs, earnings and cash flows, are all widely available auditable items. ESG-score providers rely heavily on voluntary disclosure by firms and on subjective methodologies to select, assess and weight single indicators. This adds to the arbitrary nature of the scores. As a result, ESG scores of individual firms differ greatly across rating agencies if compared, for example, with credit ratings. Our studies find, in line with existing literature, that the correlation between the ESG scores assigned to the euro-area listed companies by three of the main providers ranges from 40 to 60 per cent, compared with a correlation between credit ratings that is over 90 per cent. There is also evidence of biases in ESG scores, which tend to overrate companies that are larger and belong to specific industrial sectors and geographic regions. In building our portfolio, we have carefully selected the ESG provider and we have performed our own calculations, which show a significant improvement in the environmental footprint of the new portfolio. In particular, compared with the composition of the old one, the shareholdings included in the new portfolio are characterised by much lower greenhouse gas emissions (down by 23 per cent) as well as by lower energy and water consumption (by 30 and 17 per cent respectively). The lack of disclosed data and the lack of disclosure standards prevent ESG-score providers from correctly assessing the sustainability of business practices. In Europe, a directive requires large companies to provide information on the way they operate and manage environmental and social challenges; this directive applies to approximately 6,000 companies with more than 500 employees. The importance of this issue, however, warrants further public action for small and medium enterprises and, especially, for enhancing the standardisation of data for all firms. The last issue that I would like to discuss concerns market neutrality. As a central bank, our investment strategy has always been careful in avoiding being a source of market distortion. And this principle of market neutrality has been preserved in the new portfolio: among the companies with a high ESG score, we have selected those that have kept the distance between the new portfolio and the market benchmark below a specific threshold. As a result, we have improved the ESG score of our portfolio at the expense of only a slight increase in the ex ante tracking error vis-à-vis the benchmark (which comprises all the listed non-financial corporations in the euro area). We could question, however, whether this principle should be fully preserved or rather be revised in a context in which, in the absence of further regulation, market forces are pushing greenhouse gas concentrations to levels that will soon be dangerous for the wellbeing of people, not to speak of the stability of the financial system. I believe that this is an important topic, which I leave as an open issue and which certainly warrants further research. Designed by the Printing and Publishing Division of the Bank of Italy
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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, at the 101st Meeting (virtual) of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 17 April 2020.
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DEVELOPMENT COMMITTEE (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries) ONE HUNDRED AND ONE MEETING WASHINGTON, DC – APRIL 17, 2020 (VIRTUAL) DC/S/2020-0028 April 17, 2020 Statement by Ignazio Visco Governor of the Bank of Italy Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste Statement by Ignazio Visco Governor of the Bank of Italy Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste 101st Meeting of the Development Committee April 17, 2020 Washington, DC (VIRTUAL) The crisis The crisis we are facing is unprecedented in its speed, diffusion and depth. And it is a crisis that affects us profoundly: it touches our own lives, our network of social relations, and our way of living as a community. Because the only way to limit the contagion is a protracted period of social distancing, significant economic pain seems unavoidable in all countries. The toll on the real economy — workers, as well as businesses — will be large; and the risk of financial instability will inevitably be high. This exceptional situation requires actions to be taken at all levels: national, regional and global. Indeed, precisely because the crisis is global, the answer must be global. Increased coordination between countries in response to the pandemic will allow all of us to come out of it together, sooner and at a lower cost. And we must recognize that significant external assistance will be needed. If the response falls short of what is required to avoid permanent damage to potential capacity, including human and organizational capital, the scale of long-term costs could be much larger than what we are currently projecting, even under the most severe scenarios. The effects of the crisis will be more acute in poorer and more fragile countries. It is therefore important to engage with less developed countries with all available means. This is first and foremost a humanitarian duty, but it is also in everyone’s interest. Developing countries are not an isolated world: many of them engage in global supply chains, and will remain an important part of the global recovery. To this end, recovery will be faster and broader if every country avoids national retrenchment and ensures the free flow of vital medical supplies, critical agricultural products, and other goods and services across borders, and if we all work to resolve disruptions to the global supply chains. From a medium-term perspective, it is also essential to appropriately fund medical research, not only to obtain a vaccine, but also to produce effective drugs that can treat patients, reducing the number of those needing intensive care, and avoiding the most adverse health outcomes. International cooperation and coordination are key not only for the virus-suppression strategy to be successful on the global scale, but also in the aftermath, as it would be highly beneficial to support production with positive externalities. The World Bank Group response This unprecedented global shock risks unravelling the development gains of the past decades. Limited social protection mechanisms could exacerbate the damage caused by the Covid crisis to far too many workers, particularly those in informal sectors. As a result, poverty rates may climb back to levels not seen in many years. A lack of decisive policy measures can have even grimmer longer-term consequences if human capital accumulation is impaired, e.g. because of adverse nutritional outcomes for children in vulnerable households or school closures. In addition to increasing the resources available for health systems, policy strategy during the emergency must focus on supporting firms, workers and household incomes, as well as preventing liquidity problems from turning into massive defaults. Besides saving lives, the top priority is to maintain the productive capacity of our economies. Preserving the functionality of financial markets and stability of the financial system is a conditio sine qua non for this to work. The World Bank Group (WBG) has acted quickly to respond to the emergency created in several developing countries as a result of the shock to health systems, demonstrating that it is able to respond effectively and in a timely manner to rapidly evolving circumstances. We commend management for their targeted, timely and effective actions: we are in a situation in which choosing to save a dollar today could cost many more later on. We praise the IFC and MIGA’s decisions to provide liquidity to the business sector, either directly or through financial institutions. These interventions should be truly complementary to those of financial authorities worldwide, who are exploiting the flexibility envisaged within existing regulatory frameworks fully and contemplating how to adapt them, if needed, to contain the risk of financial instability. The size of the WBG’s initial response is important, but more must be done. In planning for that, it is important to strike the appropriate balance between alleviating short-term needs and maintaining longerterm development goals. This means operating with an effective division of tasks with the IMF and in coordination with other multilateral development banks, international financial institutions, and the donor community. The diffusion and depth of the crisis put an extra premium on the role of both Bretton Woods institutions, as providers of financial and advisory services and as facilitators of international dialogue. The economic stimulus that is required is an opportunity to respond to both immediate economic needs and long-term development priorities, building resilience to environmental, economic and social vulnerabilities. It presents a chance to kick off a new phase of reconstruction, steered toward poverty reduction and inclusive, sustainable growth. And it may allow us to refocus our efforts towards meeting the Sustainable Development Goals. Most IDA countries lack the resources necessary to mount an emergency response while maintaining adequate spending on health, education, social safety nets, and job creation. We welcome the proposal put forth by the WBG and the IMF and endorsed by the G20 for all official bilateral creditors to temporarily suspend debt-service payments from the poorest countries to help them meet their financing needs. We look forward to an effective coordination and broad participation of all major creditors, to ensure the success of this initiative.
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting for the presentation of the Annual Report 2019 - 126th Financial Year, Bank of Italy, Rome, 29 May 2020.
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The Governor’s Concluding Remarks Financial Year 126th financial year Annual Report Rome, 29 May 2020 th The Governor’s Concluding Remarks Annual Report 2019 - 126th Financial Year Rome, 29 May 2020 Ladies and Gentlemen, Since the beginning of the year, the rapid spread of the new coronavirus all over the world has led to an extremely serious public health emergency. Millions of people have been affected and hundreds of thousands have lost their lives. In order to contain the pandemic, it has been necessary to introduce drastic measures to curtail people’s movements and social interaction, to suspend teaching in schools and universities, and to temporarily close down many productive activities. This is a crisis without parallel in recent history and it is putting the organization and resilience of the economy and society under severe strain. The propagation of the virus has had serious financial repercussions, with a massive shift of funds towards assets deemed to be safer and an abrupt fall in market liquidity. The prices of oil, shares and the bonds of companies with lower credit ratings have plummeted. Sudden capital outflows have led to a marked depreciation in the currencies of the emerging economies. The risks of instability have greatly increased. The immediate effects on worldwide productive activity have been pronounced. Those that have yet to be recorded are hard to estimate. They will reflect non-economic factors first, such as the course of the pandemic, with the possible appearance of new outbreaks, and the duration of the lockdown measures. Much will depend on the scale and effectiveness of the policies launched in various countries, on the confidence of households and firms, and on how much this experience changes our behaviour. Disinflationary pressures could be strong and persistent, and a sign of this is the decline in short- and long-term inflation expectations in the major economies. The depth of the recession could be magnified by new turbulence in the markets, by the heightening of the protectionist tendencies that have emerged in the last two years, and by the spread of firm bankruptcies across economies sufficient to trigger systemic crises in the financial sector. The international economy and the euro-area economy In the scenario analysed by the International Monetary Fund in early April, which assumes an abatement of the pandemic in the second half of the year, the easing of the containment measures and the implementation of large-scale public interventions to support the economy, world trade declines by 11 per cent in 2020. GDP could fall by 3 per cent, in contrast to the 3 per cent increase forecast in January; this decrease is likely to be concentrated in the first half of the year, but the strength of the subsequent recovery remains highly uncertain. The risks in this scenario, which foresees poorer performances than those recorded during the global financial crisis, are tilted toward the downside (Figure 1). The Eurosystem’s projections will be published in a few days for the ECB’s Governing Council meeting. According to the European Commission’s estimates, the fall in production in the euro area will be close to 8 per cent, in line with the average of the latest consensus forecasts, which lie within a range of between 5 and 13 per cent. The reaction of governments, central banks, and supervisory authorities in most countries has been swift and substantial. The advanced and emerging economies decided on extensive increases in spending and reductions in tax revenues: the IMF estimates that the measures adopted up to early April were close on average to 6 and 2 percentage points of GDP respectively; other interventions have subsequently been decided. Public guarantees for particularly large sums have also been introduced on bank loans to households and firms in several countries. Central banks have used multiple instruments to make monetary conditions more accommodative, to counter the tensions on financial markets and to support lending to the economy. The composition and size of the measures introduced by the monetary authorities have reflected the specificities of the institutional frameworks and the role played by banks and markets in channelling credit to the various economies, as well as the differences in the seriousness of the repercussions of the pandemic. From the end of February until now, purchases of securities and loans to the private sector have increased the size of central banks’ balance sheets in relation to GDP by 13 percentage points for the Federal Reserve, by around 8 points for the Bank of Japan and the Bank of England and by more than 6 points for the Eurosystem. Net of gold reserves, this share has risen to 33, 114, 34 and 42 per cent respectively (Figure 2). The ECB Governing Council’s intervention was immediate. In order to sustain lending to households and firms, new refinancing operations for banks were introduced and the conditions applied to the existing ones were improved. The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA The total amount of funds available for targeted longer-term operations was raised to around €3,000 billion; their cost, which was already negative, has been further reduced. To enable intermediaries to benefit in full from these loans and to limit the possible procyclical consequences on the availability of collateral of any downgrades of public and private sector securities by rating agencies, the eligibility criteria and the control measures for the risks applied to assets that can be used as collateral were also relaxed. To counter the risks for economic activity and ensure the orderly transmission of monetary policy to all euro-area countries, which is hindered by widening yield spreads, the Governing Council first strengthened its existing asset purchase programmes (APP), increasing their volume to €360 billion until the end of 2020, and then introduced a new extraordinary programme specifically designed to deal with the consequences of the emergency (the pandemic emergency purchase programme or PEPP). The latter has an envelope of €750 billion this year to carry out purchases of public and private sector securities in a flexible manner, with changes to interventions so as to increase their effectiveness in the time frames, countries and market segments where particular tensions might arise. In March and April, the Bank of Italy purchased Italian government securities at a rate of more than €10 billion a month under the APP alone; there were further interventions, for even greater amounts, as part of the new purchase programme. The range of interventions decided to date is unprecedented; the Council announced that, if necessary, the amount of the extraordinary purchase programme will be increased and its composition reviewed. We stand ready to make further use of the other instruments at our disposal to guarantee that all sectors of the economy can benefit from accommodative borrowing conditions and an ample availability of funds and to ensure that inflation makes a steady return towards the objective of a level below, but close to, 2 per cent. Steps must be taken to counter the significant risk of low inflation and the marked fall in economic activity from translating into a permanent reduction in expected inflation or into the possible resurfacing of the threat of deflation (Figure 3). Also as a result of the high levels of public and private debt in the euro area as a whole, this could trigger a dangerous spiral between the fall in prices and that in aggregate demand. The measures adopted have helped to ease the tensions on financial markets that have nevertheless led to an increase in interest rates in all countries, particularly so in Italy. The yield spread between Italian ten-year government securities and the corresponding German Bund, which had been BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 less than 140 basis points for most of February, widened rapidly to about 300 points towards mid-March; yesterday it stood at 185 points. The fact that it has narrowed over the last few weeks is comforting; it reflects the action of monetary policy and the European initiatives to support production and labour and to boost investment. However, the spread is still almost double those of Spain and Portugal, at figures not consistent with the fundamentals of our economy, which must however be consolidated and upon which we must build (Figure 4). The action taken by the European supervisory authorities has also aimed to support the economy with measures designed to prevent the rules on prudential treatment of loans from exacerbating the recession. The full use of capital and liquidity buffers has been permitted. It has been made clear that the moratoriums on loans must not have undue consequences for accounting and prudential classification. Banks have been invited not to distribute dividends, not to repurchase their own shares, and to be particularly prudent in paying the variable parts of remuneration to executives. Thanks to these measures, Italy’s banks can count on further capital for continuing to finance the economy and dealing with any losses that might arise on loans. Europe’s institutions have made the use of structural and investment funds and the rules on State aid more flexible and have activated the general escape clause of the Stability and Growth Pact, which permits temporary deviations from public finance objectives. Large-scale expansionary budget measures have been launched at national level. According to the European Commission’s assessments, the size of the discretionary policy interventions in the euro area has exceeded 3 percentage points of GDP on average (Figure 5). The European Council and the Eurogroup have also approved the introduction this month of two new instruments designed to provide financial support to countries affected by the crisis, for a total sum of €340 billion. A European Commission fund that will raise resources on the financial markets will be able to grant loans, at favourable conditions and on a case-by-case basis, worth a total of €100 billion to EU countries to be used for temporary wage supplementation, if steady employment relationships are maintained, or for income support for the self-employed (Support to mitigate Unemployment Risks in an Emergency, SURE). The European Stability Mechanism’s new precautionary credit line (Pandemic Crisis Support credit line) will be able to provide loans with an average duration of up to ten years, to be used for the direct and indirect costs of prevention, treatment and healthcare linked to the pandemic. Each country will be able to obtain a credit line, at almost zero cost, for an amount The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA not exceeding 2 per cent of their 2019 GDP; the maximum total amount that can be provided is around €240 billion; loans will not be conditional on adopting economic policy measures and will only be subject to oversight on the allocation of the resources used, as part of the European semester. The European Investment Bank has also introduced a series of emergency measures and established the Pan-European Guarantee Fund (EFG) to mobilize resources of up to €200 billion, mainly to support lending to small and medium-sized enterprises. The Commission has just presented a detailed proposal for the establishment of a new recovery instrument (Next Generation EU). The short-term outlook for Italy and the Government’s interventions The epidemic took hold in Italy earlier than in other European countries. Drastic social distancing measures were adopted to combat the virus and entire production sectors shut down for several weeks, which contribute nearly 30 per cent of national value added and account for around 35 per cent of total employment. The impact has been mitigated by recourse to teleworking. Other sectors not directly affected by the containment measures were also inevitably hard hit, above all the transport sector. Italy’s GDP recorded a fall of around 5 per cent in the first quarter of 2020; the available indicators point to an even bigger decline in the second quarter. As of mid-May, air traffic was down by over 80 per cent compared with last year, motorway traffic by almost 50 per cent, gas consumption for industrial use by almost 15 per cent and electricity consumption by 6 per cent. In the last few months, business confidence indicators and purchasing managers’ indices have tumbled. The measures to combat the virus have slowed its spread; the gradual but clear decrease in the rate of infection made it possible to start reopening production at the beginning of this month. The consequences of this crisis for our daily lives, for how we interact with others, and for the economic decisions of households and firms, may linger for some time to come. It will take time to return to normality, and things will presumably be different from what we were used to until just a few months ago. The Italian government has acted according to the same priorities that have guided interventions at international level, focusing on the response capacity of the health sector and on help for workers, households and firms. The measures launched between March and May raise this year’s government deficit by around €75 billion or 4.5 per cent of GDP. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 The social welfare system, already streamlined and reinforced following the sovereign debt crisis, has been temporarily strengthened by extending the possibility of recourse to wage supplementation schemes and lengthening the duration of unemployment benefits. Support has been introduced for the self-employed, as have specific transfers for categories of workers only partly covered by social safety nets and for households in difficulty. There are further interventions in favour of firms, particularly transfers are envisaged for smaller firms whose turnover has fallen sharply. To support the liquidity of small and medium-sized enterprises and of households, it has been made possible to take advantage of legally binding moratoriums on outstanding loans. Additional moratoriums have been implemented through voluntary agreements. The latest available data indicate that as of mid-May, banks had received nearly 2.4 million applications overall, for a total of just under €250 billion; of these, 84 per cent have been approved and 2 per cent refused, while the remaining share is being assessed. To facilitate firms’ access to bank credit, public guarantees have been made available to the tune of around €500 billion, six times the total of those available at the end of 2019. Based on the latest statement of the task force set up to promote the implementation of the measures adopted by the Government to support liquidity, as of 26 May, the Central Guarantee Fund had received about 395,000 loan applications, for a total sum of €18 billion. Some 90 per cent of applications are for loans of up to €25,000, which are entirely guaranteed by the State. The potential loans to medium-sized and large enterprises guaranteed by SACE and currently being evaluated and processed by banks amount to around €18.5 billion. The granting of guarantees is aimed at preventing liquidity shortages from turning into irreversible crisis situations; even assuming normal enforcement rates, the amount of guarantees available means that looking ahead, the public finances may be encumbered with significant outlays, albeit over a longer period. The abundant liquidity provided by the Eurosystem and the guarantees made available by the State are making it possible to meet firms’ demand for emergency funding. In the two months March and April, lending to non-financial corporations increased by €22 billion, after decreasing by €9 billion in the previous 10 months; annualized growth was equal to almost 17 per cent (Figure 6). While indispensable, support measures for firms that focus on bank lending could destabilize their financial structure, increasing their indebtedness to an excessive degree. The Government has enacted measures to facilitate The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA the capital strengthening of firms. Tax incentives have been introduced for medium-sized enterprises to help both firms making capital increases by the end of 2020 and those subscribing them. The largest firms will benefit from direct forms of public support via the Cassa Depositi e Prestiti. The timing and strength of the recovery that will follow the emergency phase depend on factors that are hard to predict. In mid-May, we presented a scenario analysis for the Italian economy based on alternative hypotheses on the duration and extent of the epidemic, its impact on the global economy and its financial repercussions. The estimates will be updated as part of the Eurosystem staff macroeconomic projection exercise and will be published on 5 June. In the baseline scenario, the fall in production in 2020 would be equal to 9 per cent, greater than that suffered at two different times between 2008 and 2013; the drop would be concentrated in the first two quarters of the year, with a partial recovery starting in the summer (Figure 7). Without the support for demand provided by the fiscal policies set out so far, the contraction in economic activity would exceed 11 per cent. Debt moratoriums and public guarantees on new loans to firms drastically reduce the risk of further amplificatory effects due to a widespread liquidity crisis. In 2021, GDP would recoup about half of the fall. These estimates assume that the containment of contagion at national and global level will continue. A second scenario based on more pessimistic, though not extreme, assumptions regarding the evolution of the epidemic, the magnitude of the drop in world trade and the intensity of the deterioration in financial conditions, would see GDP fall by 13 per cent this year, and a much slower recovery in 2021. In both scenarios, about half of the fall in GDP would be due to the restrictions connected with the provisions suspending business activity and the consequent contraction in disposable income; the remaining half would reflect the slowdown in world trade and the virtual halt in international tourist flows. In any case, the fall in investment would be especially sharp, owing to the marked uncertainty regarding the economic outlook. This is already being confirmed by the traditional surveys of firms, which show a large and widespread downward revision of investment plans; for the first time since 2014, a contraction in investment has been reported, to a similar degree in industry and services, greater for small businesses. The impact of the epidemic on the various economic sectors has been uneven. The immediate effects have been stronger in transport, catering, accommodation, recreation and culture, personal services, and in large BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 swathes of retail trade, all sectors brought to a near halt by the restrictions imposed by the containment measures. Even with a gradual easing of the distancing measures, recovery in these segments will depend on the time it takes for the fears accumulated in the past months to be dispelled. A significant share of the demand for these sectors’ products and services relies on tourism, to which over 5 per cent of GDP and 6 per cent of employment is directly attributable. After the abrupt stop caused by the epidemic, tourism is expected to recover only partially in the second half of this year and in the next; the recovery will be held back above all by the reduction in the number of foreign visitors. This will result in a narrowing of the contribution of tourism to the surplus of the balance of payments, which has traditionally been large. In retail trade, the upward trend in the use of digital sales channels has intensified. The share of online purchases made with electronic cards, equal to 23 per cent last year, rose to 40 per cent in April, buoyed by the food and clothing sectors, and by retail sales of personal or household goods. In the two months March and April, online purchases of food products and basic necessities from large retailers grew by 170 per cent compared with the same period in 2019. These trends are likely to continue in the coming months, accelerating the recomposition of supply, with further developments in business models featuring a mix of traditional and online sales, including for smaller retailers. This process creates new opportunities, but also transition costs; it will tend to reward the most dynamic and innovative firms. The recession will have significant repercussions on the labour market. Compared with other countries, the impact on employment in Italy is mitigated by the freezing of layoffs and ample recourse to wage supplementation, which has affected around 7 million workers so far, almost half of all private sector payroll employees. Labour market participation has decreased by almost 300,000, discouraged by the worsening economic outlook and the restrictions on mobility and production that remain in some sectors. Against this backdrop, the unemployment rate (which declined to 8.4 per cent in March, almost 1 percentage point lower than in February) does not provide a full picture of the true impact of the epidemic. The fall in economic activity has reduced new employment opportunities, affecting above all young people entering the labour market for the first time, seasonal workers, fixed-term employees, and apprentices. It is having a greater impact on the jobs traditionally performed by self-employed workers and on undeclared labour, which is still too widespread in our country. In the short term, social safety nets are countering the impoverishment of large portions of the population and a widening of economic differences, The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA increased by the greater presence of low-income workers in the most affected sectors. Limits to the availability of liquid financial assets among lowerincome households can amplify the consequences of the shock, leading to a significant increase in the number of households unable to maintain an acceptable standard of living. The recession and the measures adopted to mitigate its consequences are having a strong impact on public finances. For 2020, the Government’s macroeconomic outlook envisages a deficit of 10.4 per cent of GDP and an increase of 21 percentage points in the debt-to-GDP ratio, to 156 per cent. Such a burdensome debt legacy requires full awareness of the scale of the challenges ahead. Italy’s economy must find the strength to break free from the inertia of the past and to restore a capacity for growth that has been stunted for too long. Despite the deep wounds inflicted by this crisis and the lingering effects of the previous ones that have yet to be absorbed, there will be no shortage of opportunities in the future, and Italy has the means to exploit them. Returning to the path of development The pandemic and the recession have opened up extremely uncertain scenarios that make it very difficult to map out what form future equilibriums will take. Uncertainty is another reason to act immediately to strengthen our economy and to press on with that comprehensive package of reforms whose course, for the most part, has already been charted. Only time will reveal the results of our actions, but a comprehensive plan makes the future clearer, shapes expectations, and bolsters confidence; it can draw on a number of strengths that have become apparent in these past difficult years. Thanks to the recovery of our exports’ competitiveness and to the high trade surpluses recorded since 2012, Italy’s net external position has reached substantial equilibrium. The financial conditions of banks and firms are better today than in 2007. Italian households’ net, real and financial wealth is high: 8.1 times disposable income against 7.3 times on average in the euro area. Household debt is low by international standards, and is concentrated among those with a greater debt repayment capacity; at the end of 2019, it was less than 62 per cent of their disposable income, against 95 per cent for the euro area on average (with a peak of over 200 per cent in the Netherlands), 96 per cent in the United States, and 124 per cent in the United Kingdom. At the end of 2019, corporate debt amounted to 68 per cent of GDP, compared with 108 per cent in the euro area and more than 150 per cent in France and the Netherlands. In the private sector as a BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 whole, debt was equal to 110 per cent of GDP, more than 50 points lower than the euro-area average (Figure 8). These data nevertheless reveal a disconnect between the resources available and the country’s capacity to utilize them to regain the path of sustained and balanced growth, to return Italy as swiftly as possible to levels of well-being not experienced for more than ten years now, and to offer future generations the chance to improve their standards of living, health and general culture. The demographic trends are not favourable: even taking account of the contribution of immigration (estimated by Eurostat to amount to approximately 200,000 persons on average per year), the population aged between 15 and 64 will decline by more than 3 million over the next 15 years. Nevertheless, assuming that the trends of the last ten years continue in a similar vein, higher female labour market participation and the extension of working lives can enable employment to make a positive contribution to growth, of more than half a percentage point per year. To restore GDP growth to around 1.5 per cent (the average annual level recorded in the ten years leading up to the global financial crisis) will require an average increase in labour productivity of a little under 1 percentage point per year (Figure 9). This objective calls for a sharp rise in tangible and intangible capital investment, and for productive efficiency gains comparable to those observed in the other main European countries. In any event, its achievement presupposes a break from the recent past; it calls for the resolution of those structural problems, which for too long now we have failed to address, and which have become increasingly pressing in a new technological context and a more integrated world. Last year, the ratio of investment to GDP was still three percentage points below what it was in 2007: this year it will decline further (Figure 10). The lags with respect to the most advanced economies cannot be recouped by increasing public expenditure without first improving its efficacy and without making structural adjustments to the economy. While it will remain extraordinarily accommodative for a long time, monetary policy is no substitute for the measures needed to raise growth potential. Resources must be channelled to where the social returns are highest; to do so requires ongoing and substantial improvement in public services, with the necessary simplifications and the right distribution and mindful assumption of responsibilities. The technologies used and the quality and motivational levels of human resources have a profound impact on how administrations operate. We have learnt a lot from this crisis; it has demonstrated the need to fast track the digitalization of working processes and to rethink their organization. The heavy turnover expected in public administration in the The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA coming years will make it possible to hire young, highly-skilled and motivated workers from a variety of backgrounds; we must support and invest in them. The accumulated lag in infrastructure must be overcome, as regards both traditional infrastructure, which must be upgraded and made more efficient, and highly innovative infrastructure, such as the telecommunication networks, which are necessary to support the technological transformation of the Italian economy. The fixed broadband network reaches less than one fourth of households, compared with 60 per cent on average in Europe, and the South of the country is especially penalized. The European Commission ranks Italy nineteenth among the EU states for connectivity. As has been underlined for too many years now, the quality of human capital must be improved, by tackling the underlying problems of schools, universities and the research sector. A better education system generates higher returns; a country that innovates creates better and more widespread job opportunities. The differences in educational outcomes across local territories perpetuate and increase inequalities of income and opportunity. In many cases, school and university buildings fall short on security, comfort and technology, while teacher quality and motivational levels are of vital importance. Households must also be convinced of the importance of investing in knowledge: Italy ranks second last in the European Union on the proportion of young people aged between 25 and 34 with tertiary education; it is ranked first for the share of young people aged between 15 and 29 who neither study nor work. This is a loss of individual opportunities that exposes them to the risk of exclusion and is a waste for society as a whole. Notwithstanding the high degree of efficiency and quality for which research in Italy in renowned, the State invests about €8 billion in its university system, half of what countries similar to Italy invest relative to GDP. Even just the reallocation of a modest portion of the government budget would lead to a marked improvement in youth training and in the ability to produce innovation. This would strengthen Italy’s ability to tap into the European resources allocated to research and would also benefit the productive sector, which invests barely 0.9 per cent of GDP in research, compared with the 1.7 per cent invested on average by OECD countries (Figure 11). The hiring of new researchers, envisaged in the recent decrees, marks a significant break with the past. To stay competitive, businesses must invest in new technology and innovation, open up to sources of external funding and outside professional expertise, and attend to staff training: only by raising productive efficiency and the quality of the goods and services provided can they set their sights BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 on growth. The available tax incentives are substantial by any measure. The positive results of the allowance for corporate equity (ACE) and Industry 4.0 can be built on, by rationalizing and stabilizing these instruments, and by providing certainty to those willing to take up the innovation challenge. The crisis in the tourist sector has made immediately appreciable the economic importance, and not only, of Italy’s natural and historical-artistic heritage that goes to the heart of this country’s identity. This heritage must be protected and made increasingly easy to access in ways that are safe for tourists, so that after the pandemic it can contribute again to growth, even more so than before. The opportunities that will come from the inevitably faster transition to an economy with lower greenhouse gas emissions and more digital technology must be seized. The public resources needed to finance all these measures and to favour the productive use of private funds must come from a restructuring of the public budget, the recovery of the tax base, a reduction in the risk premium on government bonds, and the pragmatic and judicious use of European funds. Excluding interest payments, Italy’s public expenditure is comparable with the average for the euro area as a whole, even if the share of pension expenditure is higher and is destined to increase further, driven by the ageing population. Tax revenues are also broadly aligned with the average of the other countries, even if the tax wedge on labour is higher. Where Italy differs most from the other advanced economies is in the extent of its underground economy and tax evasion, which translates into an excessive tax burden for those who play by the rules. The resulting injustices and profound distortionary effects dent the economy’s ability to grow and firms’ capacity to innovate; they generate privileges of position that damage the efficiency of the productive system. A comprehensive rethinking of the tax system that also takes account of the changes in the social welfare system must set itself the objective of reducing the tax levy on the factors of production. Policies, reforms and actions that return Italy to the path of sustained, widespread and balanced growth would also help to maintain relaxed conditions on the financial markets, thereby lowering the average cost of the debt and favouring the gradual and necessary rebalancing of the public accounts. The underlying uncertainty that weighs on Government bond yields and makes them so high compared with countries that have similar characteristics, can only be dispelled through economic policy choices that look beyond the short term. The sustainability of the public debt is not in doubt, but its high level relative to GDP is being maintained by the low growth potential of the country and is, at the same time, an obstacle to economic growth. Compared with the average for the rest of the euro area, economic growth in Italy is The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA lower and the cost of the debt higher; in the last five years as a whole, together with Greece, Italy is the only euro-area country to have recorded a positive and ample gap between the cost of the debt and economic growth. In these circumstances, a primary surplus in the order of 1.5 per cent of GDP, such as the one recorded over the past six years, would be necessary if only to stabilize the ratio of debt to GDP. By contrast, with an economic growth rate of between 1 and 2 per cent and the narrowing of the yield spread between Italian and German government bonds to levels in line with the two countries’ fundamentals, a primary surplus of that size would suffice to reduce the debt burden by around 2 percentage points on average per year. Growth and fiscal policies would reinforce each other, in a virtuous circle that our country is certainly capable of activating. Italy and Europe A return to robust and lasting growth by Italy is also important for the future of the European economy as a whole. Within the EU, Italy is in third place for population size and GDP. Taking account of the intermediate goods traded in Europe’s value chains, Italy’s share of EU exports to other countries stands at 14 per cent. Italy holds almost €300 billion worth of direct investment in the rest of Europe and more than €1,200 billion in portfolio investment. In the last decade, more than 100,000 European citizens have moved to our country each year on average. Italy contributes decisively to making Europe more attractive to tourists and investors. In 2019, there were more than 60 million European visitors to Italy and 35 million from other countries. In the same way, Europe is important for Italy. European Union countries constitute the main outlet market for Italy’s goods, accounting for 50 per cent of our exports. The trade tensions triggered in 2018 by the resurgence of protectionist pressures on the global scene had already underlined the political and economic importance of the European project in navigating an increasingly complex global situation. The pandemic has abruptly intensified the decline in international trade and highlighted the risks connected with an extremely fragmented production system, based on value chains spread across the globe. In the last two decades, there have certainly been significant economic benefits from production being organized on a global scale but even in more recent times, these benefits had started to wane, particularly in the manufacturing sector and partly as a result of the progress in automation. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 Trade with the rest of the world accounts for almost 20 per cent of EU GDP. If globalization continues to regress after the crisis, the growth outlook for European countries will depend more than ever on internal demand within the area and their capacity to act as one. The European Union is an impressive resource for its citizens. The painful experience of the pandemic today strengthens the case for staying together and not just from an economic point of view. This has been clearly proven by the show of solidarity by the highest representatives of the European institutions, by the leaders and by the peoples of the European nations towards the countries most affected by the pandemic. As I mentioned before, the Commission and the European Council acted rapidly to facilitate national interventions in support of households and firms and new financial instruments were created to support countries in difficulty. The European Central Bank acted decisively, promptly and very effectively. The reciprocal fears and prejudices that resurfaced during the two crises of the last decade, and which have also at times weighed on the important decisions to be made in this delicate phase, must be definitively overcome and rejected with the responsible contribution of each one of us. European countries are called on to face the same challenges. The exceptional fall in demand exposes households, firms, and financial institutions in all countries to risks for which there can only be a joint response. The pandemic has revealed the potential benefits of a common health strategy. Similar considerations to those valid for health apply to other essential services as well, such as education, defence, security and justice. Both public and private debt are destined to rise in relation to GDP in all countries. In the longer term, there will be a generalized increase in public spending connected with population ageing. There must also be a joint effort to protect the environment and take full advantage of technological innovation: the amount of investment needed will call for the economies of scale that only a large market such as Europe’s can guarantee. The environment and innovation were and still are central to the European Commission’s vision for the continent’s development. The investment plan proposed in January under the European Green Deal will mobilize at least €1 trillion in sustainable public and private investment over the next ten years. Considerable financial commitments have been made for innovation as well. The proposal presented by the Commission to the European Parliament two days ago for the creation of new instrument called ‘Next Generation EU’, reasserts the centrality of the environmental and digital transitions. These are flanked by the objective of reinforcing cooperation in the field of health. The proposal includes the establishment of a €750 billion fund for grants The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA and loans to the Member States (€500 billion and €250 billion respectively). The finance raised on the market by the European Commission would be assigned within the multiannual financial framework of the European Union, favouring the countries that have been hardest hit by the crisis. This is an important opportunity to prepare a common response which, alongside the monetary measures, is proportionate to the seriousness of the crisis. In such an integrated area as ours, the difficulties of each country inevitably have repercussions on all the others. Only strong, united and coordinated action will enable us to protect and relaunch productive capacity and employment throughout Europe’s economy. Putting aside any calculations of the financial advantage for each country, the significance of the Commission’s initiative lies in the idea that, in exceptional circumstances, the spending capacity of the EU budget could be increased by borrowing, in order to intervene when and where necessary. The Fund would in fact be financed by the issuance of a common debt instrument by the European Union, which would be the responsibility of all the member countries. Some countries would be net beneficiaries, others net contributors. The role that each country will have to play will depend on its relative needs but also on its capacity to use the resources that will be made available. By participating in defining the current European strategy, Italy is called upon to make an extraordinary effort, both on a technical front and in terms of planning, to make better use of the opportunities offered than it has done in recent decades under EU programmes. By following a path forged together with our partners towards an innovative and more sustainable economy, we would be more likely to return to the path of development. We would contribute to redefining the economic and social model on which the wellbeing of all the peoples of Europe jointly depends, moving in the direction of justice and efficiency. This is the third crisis that the European Union has had to face in little more than ten years. We know very well how difficult it is to manage emergency situations when the institutional framework is incomplete, within which the interventions of individual countries may be constrained by weak conditions and the actions of the European institutions may be limited by a lack of instruments. It is worth repeating that the complex system of legal sources, institutional architecture and competencies must not favour uncertain interpretations of the rules guiding its actions. Some steps – even strides – forward have been taken, but we are still waiting for the qualitative leap described in the reports prepared by the presidents of the main European institutions immediately after the sovereign debt crisis. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 The financial system and the action taken by the Bank of Italy Italian banks find themselves facing the crisis from a stronger position than the one they were in before the double-dip recession of 2008-13. The ratio of the highest loss-absorbing capital to risk-weighted assets rose from 7.1 per cent in 2007 to 13.9 per cent last December. The balance sheets have been cleared of most non-performing loans, which have fallen by two thirds over the last four years (Figure 12). In the first quarter of this year, the banking system’s capital position improved further; a contributory factor was the decision not to distribute dividends, in accordance with the recommendations of the supervisory authorities. No liquidity tensions were recorded and retail deposits continued to grow. So far, the impact of the recession has been apparent in difficulties accessing the bond market, which have been widespread across Europe, and in a moderate increase in loan loss provisions attributable to those banks that have incorporated the unfavourable economic outlook into the models used to compute expected losses. The consequences of the crisis have so far been modest for institutional investors as well. The sharp drop in the prices of financial assets and the rise in their volatility have led to a reduction in the solvency ratio of insurance companies, which nevertheless remains well above the regulatory minimum. The considerable requests for redemptions in the investment funds segment have been met in an orderly fashion, also thanks to the limits on investment in illiquid assets provided for under Italian regulations. Also thanks to the strengthening achieved in recent years, and to the refinancing operations of the ECB, the banking system is now able to support the substantial liquidity needs of households and firms. As a member of the task force established by the Ministry of Economy and Finance charged with overseeing the efficient and rapid roll-out of the support measures for firms, we have issued clarifications and recommendations to intermediaries. In recent weeks, we have also begun to collect targeted data from banks so that we can monitor the extent to which these measures have been implemented. As I recalled earlier, the vast majority of applications for a moratorium have been approved. There have been some frictions in the granting of loans backed by public guarantees. The difficulties leading to delays stem from multiple causes. The volume of applications has been, and continues to be, exceptional; organizational problems and differences between banks’ IT systems may help explain some of the lag times recorded in responses to applications, which have been more marked for smaller banks. The procedures required The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA to implement the measures are complex and involve numerous actors. The legislature has had to strike a difficult balance between conflicting needs: on the one hand, the need to rapidly channel resources to those seriously affected by the fallout of the epidemic; on the other, to safeguard the State, ensuring that the guarantees do not extend to loans that are at very high risk of default or that are susceptible to criminal use. Furthermore, the legislative framework is new and not yet stable. In the absence of any explicit regulatory provisions, banks that fail to conduct a creditworthiness assessment expose themselves to the risk of committing a crime. Intermediaries are also rightly required to carry out the controls provided for by anti-mafia and anti-money laundering legislation, which safeguard against risks that have increased significantly during the emergency. Several amendments are designed to resolve or mitigate some of these problems; in the testimonies we have given before the Parliamentary committees we have addressed these problems and proposed some possible solutions. I am confident that in the coming weeks, with the cooperation of all those involved, we will see substantial improvements in the flow of resources to the economy. Notwithstanding the progress of the last few years, the depth of the recession will inevitably affect banks’ balance sheets in the medium term. The increase in non-performing loans will have to be dealt with in a timely manner, using all available instruments, including those for their restructuring and sale on the market. Should it prove necessary, we must stand ready to explore solutions to safeguard the system’s stability, considering preventive tools to help banks that are facing severe, even if presumably temporary, difficulties. The fall in productive output could exacerbate the problems of some intermediaries that do not have ample capital reserves, especially small banks with traditional business models. We welcome the recent measures designed to facilitate the management of crisis situations at these intermediaries, and view the resources allocated as a first sign of willingness to intervene. However, we continue to be concerned about the inadequacy of the European bank crisis management framework, about which we have spoken on many occasions. The cooperative banking groups formed just under a year ago are now in a position to face the challenges posed by the recession by reaping the benefits of integration. The ability to raise funds on the capital markets is vital today; any steps backward from what has already been achieved would constitute a grave and costly regression. Close ties to local communities and their mutualistic spirit do not remove the need for strong governance and skilled managers, both in the parent company and in the member cooperative credit banks. Profitability must be sufficient to ensure that they are adequately capitalized, a precondition for the performance of their cooperative role. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 In financial intermediation, too, the public health emergency and the containment measures have made the advantages of digital solutions even more tangible. This will inevitably lead to an acceleration of investment in new technologies, which with the achievement of appropriate economies of scale can be made at a lower cost and to greater advantage. These savings, in turn, will make it easier to raise the resources necessary to support investment, including through access to the financial market. There are many areas that could benefit from technological innovation: service distribution, customer creditworthiness assessment and monitoring, and regulatory compliance processes. In the retail payments sector, a traditional incubator of innovation, the opportunities offered by technology can provide real benefits to users of the services. The supply of bank loans to firms through digital channels, which is still very limited in Italy, can now make rapid and substantial progress. The Bank of Italy is active on a number of fronts to address the changes prompted by technological innovation in financial services. We have strengthened dialogue with operators through our innovation hub, our FinTech Channel, and through new procedures to authorize market access; we are collaborating with the Ministry of Economy and Finance in a forum for authorities on digital innovation and participating in the launch of a regulatory sandbox; we support the development of system solutions designed to ensure the proper balance between the need for standardization and competition in innovative sectors, procedures for updating regulations and legal certainty, new investments and risk mitigation. We will soon establish a dedicated unit tasked with proposing and coordinating Fintech initiatives, as well as monitoring retail payment services and instruments. This will allow us to capitalize on the synergies between banknote circulation, electronic payments and digital services, and strengthen our capacity to observe phenomena that could lead to the development of new products in the future. Our efforts remain focused on supporting the development of a broadbased and safe digital economy, providing support for innovative projects promoted by the private sector and ensuring that households, firms and general government derive the maximum benefit. We will promote the nation’s main financial centre, namely Milan, as a digital innovation hub on a European scale. There will also be an office in Milan dedicated to experimentation, to gathering the contributions of Italian and international independent experts and companies, to collaborating with institutions and universities, and to engaging in dialogue with market operators. The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA Advanced data analysis techniques enable us to improve the efficacy of our supervision and control in the areas of anti-money laundering and transparency. The Financial Intelligence Unit for Italy regularly uses them to identify anomalies in financial transactions and to assess, together with the bank’s supervisory arm, the degree of risk of money laundering to which intermediaries are exposed. We are also experimenting new ways of using artificial intelligence to extract specific data from suspicious transaction reports and complaints, with the aim of both identifying phenomena requiring intervention by the FIU and of guiding the work of prudential supervision and consumer protection initiatives. The new Directorate General for Consumer Protection and Financial Education will allow us to focus on improving and making more effective the channels of communication with users of banking and financial services, on strengthening controls on intermediaries’ behaviour, on the drafting of regulations, on reinforcing the Banking and Financial Ombudsman (ABF), and on promoting financial education. The new prudential supervision and supervisory protection organizational framework will strengthen our synergies and collaboration with the other authorities working on the same fronts: Consob in the area of financial services, IVASS as regards insurance products, COVIP for supplementary pension schemes, and the Competition Authority (AGCM) for unfair commercial practices. We continue to cooperate in many areas with the judicial authorities to prevent and combat crime, and to support the efforts of the investigative bodies and the judiciary. Our commitment in the area of financial stability extends to overseeing the markets and the relative infrastructures, especially those that help the government securities market and the payments system function smoothly. We have devoted particular attention to strengthening the financial sector’s cyber resilience, in line with the Government’s national security strategies. Throughout this emergency, we have never failed to ensure the orderly and continuous functioning of the payment and settlement systems that we manage at national and European level. We have continued to provide services to general government and to citizens, including through the online channels that have been gradually set up in recent years. The Bank of Italy’s tasks also still include the crucial one of managing monetary policy. Even at this difficult time, we have contributed to its definition and implementation. Against a backdrop of rising complexity and heightened financial tensions, the frequency and scope of our daily market operations has increased significantly. We have greatly expanded our refinancing of banks, including among eligible loans also those backed by the State guarantees provided for under the recent Government measures. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 As happens each year, more detailed information on our operations is provided in our Annual Accounts, published at the end of March, and in the Report on Operations and Activities of the Bank of Italy, available to you here today, along with our Annual Report. * * * We are living through the greatest public health and economic crisis in recent history. In Italy, as in many other countries, doctors and nurses have been placed under unprecedented pressure. Thanks to their commitment, in the most difficult of conditions, even more dire consequences have been averted. Our thoughts are with the many among them who have paid the ultimate price, with all the victims of this tragedy and with their families. In Italy as in the rest of the world, the economic policy response was aimed first and foremost at managing the health crisis and at slowing the spread of the virus, including through drastic lockdown measures. Extraordinary budgetary provisions have brought relief to households and firms whose jobs, livelihoods, and income have all been affected. If not curbed by these measures, and by grantedly massive and timely monetary policy interventions, such a profound crisis would have had even more deleterious effects on the productive sector and on society as a whole. However, just as social distancing flattens the curve of contagion without eradicating the virus, so do the support measures help to dilute and mitigate the repercussions of the crisis over time without eliminating its causes. Today uncertainty is rife, not only about the course of the pandemic but also about the repercussions on behavioural patterns, on consumption and on investment decisions. We ask ourselves what new needs will emerge and what social mores will be definitively left behind. And we wonder about the possible consequences beyond the immediate term, for how our society and productive activity is organized. In the coming months, demand will slowly begin to pick up. It will be necessary to avoid imprudent behaviour and to keep our guard up to prevent the infection curve from rising again. The productive system must guarantee safe working conditions and address changes in global value chains; supply will also be recalibrated to satisfy the new needs of customers; and investment plans will be revised. During this transition, employment may fall and workers may remain furloughed; consumption will be held back, also owing to the possible increase in precautionary spending driven by apprehension not only about the economic outlook. Social unrest may grow; the budgetary measures are designed to counter this eventuality. The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA After the pandemic wanes, the world will be a different place. While we may to some extent perceive and combat, with all of our strength, the gravity of the social and economic consequences in the short term, for the longer term effects we can only acknowledge what we know we do not know. It is very difficult to predict what shape these new equilibria will take or what new normal awaits us, if indeed it is possible to speak of such things as equilibria and normalcy. To cope with such uncertainty it is, however, vital that today, more than ever before, we rapidly bridge the gaps and overcome the constraints that have long since been identified. Today, more than ever before, because one thing is certain: after the pandemic there will be much higher levels of public and private debt and greater inequalities, not only of the economic kind. Only by consolidating the foundations from which to start again will it be possible to rise to the challenges that we must face. The devastation wreaked by the pandemic is of a different kind to that experienced during a world war and it is hard to compare the two. We can, however, start from an image of how a great war can be managed. Eighty years ago John Maynard Keynes wrote: ‘…it is recognised that the best security for an early conclusion is a plan for long endurance…a plan conceived in a spirit of social justice, a plan which uses a time of general sacrifice’ – we might well say such as the one being made in this period – ‘not as an excuse for postponing desirable reforms, but as an opportunity for moving further than we have moved hitherto towards reducing inequalities.’ It will be vital to put the resources mobilized to good use to overcome the most serious difficulties, to create without delay the conditions for recouping lost ground, to use technological progress to our advantage to return to more balanced and sustainable growth, one that generates employment and also allows us to lower the burden of the public debt, with the right degree of graduality but fearlessly. Let us recall here the strengths of our economy. Notwithstanding the delays and difficulties, especially at regional level, in recent months the network infrastructures have held up, enabling thousands to continue to work remotely. The manufacturing sector is flexible and, since the sovereign debt crisis, has rapidly recovered competitiveness, bringing the balance of payments into surplus. Italy’s net external debt is practically nil. The real and financial wealth of households is high overall and their levels of indebtedness among the lowest in the advanced countries, while those of firms are below the European average. The financial system, stronger now despite the double-dip recession, is in decidedly better shape than it was on the eve of the financial crisis. There are, however, some investments that cannot be avoided, in particular those addressed to innovation in productive activities and BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 improving the environment, investments which must increasingly be interlinked. A business-friendly context requires resolute, rapid and sweeping interventions to raise the quality and efficiency of public services substantially. And we need to emphasize, if possible even more so today, how important it is to invest in increasing the levels of culture and knowledge, from school to university and to research. A renewed economic environment could bear fruit if all the stakeholders who are part of it − firms and households, students and workers, financial intermediaries and savers − are each able to assume full responsibility for their own role. Yet it is not only a question of economics. While the transformations that the economy, society, politics and culture will undergo are uncertain, there will undoubtedly be interactions and reciprocal influences. We have to recognize and be open to many different points of view, interests and needs. It will be necessary to foster rational debate and constructive dialogue among those with different skills and among those whose responsibilities may differ but who nonetheless are neither distinct nor distant entities. What is needed is a new relationship between the Government, businesses in the real economy and in finance, institutions, and civil society. We can avoid calling it, as has been suggested, a need for a new ‘social contract’, but here too we must move in the direction of rational debate and to breathe life into constructive dialogue. A new kind of relationship is indispensable in Europe as well. Each country must use the resources placed at its disposal by the European institutions pragmatically, transparently and, above all, efficiently. European funds can never be ‘free of charge’: Europe’s debt is everyone’s debt and Italy will always contribute greatly to the funding of European initiatives, because it is the third largest economy in the EU. But joint, strong and coordinated action will protect and contribute to relaunching production capacity and employment throughout the European economy. The importance of the Commission’s recent proposal is not in grants substituting loans, but that there will be collective responsibility for funding the recovery: this would be the first step towards fiscal union and the completion of the European project. Embracing this idea with conviction in order to design it carefully and plan its implementation is a necessity that can no longer be postponed. A united commitment is in the collective interest: the dramatic circumstances of today bolster the reasons for standing together, they drive us to pursue a project that can mobilize resources to support growth that is both inclusive and sustainable. Today we hear the phrase ‘we can get through this’ from many quarters. We say it too, but it must not be merely rhetorical optimism; rather we must The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA take on a concrete commitment together. We will get through this by making wise and informed choices and by being farsighted. We will get through this, starting from strong points that we sometimes forget, by finally facing the weaknesses that we sometimes don’t want to see. Many people have lost their lives, many are mourning their loved ones, many fear losing their jobs, but no-one must lose hope. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 FIGURES Figure 1 GDP growth forecasts (per cent) Jan. 2020 forecast -2 -2 Apr. 2020 forecast -4 -4 -6 -8 -6 Advanced economies Emerging economies World -8 Source: IMF. Figure 2 Balance sheets of the main central banks: total assets (per cent of GDP) Bank of Japan (right-hand scale) Eurosystem Federal Reserve Bank of England Sources: Based on data from central banks and national statistics offices. Note: Total assets, not including gold, as a percentage of GDP in 2019. Data at 22 May 2020. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 Figure 3 Inflation expectations in the euro area (per cent) 1.5 10-year 1.5 0.5 0.5 -0.5 -0.5 1-year -1 -1 Source: Bloomberg. Note: Inflation swap rates. Data at 26 May 2020. Figure 4 Sovereign spreads (basis points) Portugal Italy Spain France Source: Based on Bloomberg data. Note: Yield spreads between the ten-year government bonds and the corresponding German Bund. Data at 26 May 2020. The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA Figure 5 Discretionary budgetary measures in response to the epidemic (per cent of GDP) Germany France Italy Netherlands Spain Euro area Sources: The European Commission for the euro area and the Netherlands; national Stability Programmes for Germany, France, Italy and Spain (April 2020). Note: Increase in general government net borrowing in 2020 following the measures adopted in response to the epidemic. Figure 6 Growth in bank lending to firms in Italy (12-month percentage change) -2 -2 -4 -4 -6 -6 Source: Supervisory reports. Note: Updated to April 2020. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 Figure 7 Level of GDP in Italy: scenario analysis (2006=100) Baseline scenario Adverse scenario Sources: Based on Istat data. For the scenarios for 2020-21, Banca d’Italia, Note Covid-19, 15 May 2020. Figure 8 Public and private debt (per cent of GDP) Private Public IT FR DE NL ES Euro area IT FR DE NL ES Euro area Sources: Based on data from Banca d’Italia, ECB, European Commission, Eurostat and Istat. Note: End-2019 data. Private debt: households’ and firms’ financial debt. The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA Figure 9 Long-term scenario for GDP and labour productivity in Italy (1980=100) GDP Labour productivity Source: Based on Istat data. Note: Assessment horizon of the long-term scenario: 2020-35. Figure 10 Long-term scenario for investment in Italy (1980=100) % Investment Investment-to-GDP ratio (right-hand scale) Source: Based on Istat data. Note: Assessment horizon of the long-term scenario: 2020-35. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2019 Figure 11 Spending on research and development (per cent of GDP) Private Public Italy France Germany Spain Japan United United OECD Kingdom States countries Source: Based on OECD data, Main Science and Technology Indicators, 2019/2. Note: 2018 data. Figure 12 Italian banks’ capital and NPLs (per cent of risk-weighted assets and billions of euros) NPLs (right-hand scale) Highest loss-absorbing capital Sources: Supervisory reports (consolidated for banking groups and individual for stand-alone banks). Note: End-of-period data; highest loss-absorbing capital: Core Tier 1 to 2013 and Common Equity Tier 1 subsequently; total NPLs net of loan loss provisions. The Governor’s Concluding Remarks Annual Report 2019 BANCA D’ITALIA Printed by the Printing and Publishing Division of the Bank of Italy Rome, 29 May 2020 Printed on EU-Ecolabel certified paper (registration number FI/011/001)
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary General Meeting of Shareholders, Rome, 31 March 2020.
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Address by Governor Financial Year 126th financial year Ordinary General Meeting of Shareholders Rome, 31 March 2020 th Address by Governor Ordinary General Meeting of Shareholders Rome, 31 March 2020 Ladies and Gentlemen, Italy, Europe, and the entire world are experiencing the same anxiety and difficulty that come with any unprecedented challenge. Aside from posing a deadly threat to public health and putting a severe strain on national health systems, the rapid spread of the Coronavirus disease (COVID-19) has transformed our daily lives, our work processes, the functioning of our schools and universities; the extent of the impact on the economic and financial system will be as wide as it is deep. In carrying out its institutional functions, and in tandem with the other national institutions, the Bank of Italy has taken the necessary action to limit the economic repercussions of the pandemic. While the health of all of our staff is our absolute priority, we continue to guarantee the provision of essential services to the wider public. In my Concluding Remarks delivered on 31 May last, I recalled the changes made to the composition of the Governing Board in 2019: Fabio Panetta was appointed Senior Deputy Governor, Luigi Federico Signorini confirmed as Deputy Governor, and Alessandra Perrazzelli and Daniele Franco also both appointed as Deputy Governors. I wish once again to thank Salvatore Rossi and Valeria Sannucci for their many years of service to the Bank, in the roles of Senior Deputy Governor and Deputy Governor respectively. The Bank is – we all are – hugely indebted to them. On 1 January this year the composition of the Board of Directors changed again. Daniele Franco succeeded Fabio Panetta as Senior Deputy Governor following the latter’s appointment to the ECB’s Executive Board. Our thanks also go to Fabio Panetta; we wish him every success in his new important role. Finally, Piero Cipollone, formerly Managing Director responsible for high-level consultancy to the Governing Board on matters pertaining to the organization of the Bank’s functions and institutional relations, was appointed Deputy Governor. Last year the process of reallocating the Bank’s capital continued. Since the launch of the reform of the Bank’s ownership structure (Law 5/2014), 40.4 per cent of its capital has been reallocated, 7 per cent since March 2019. BANCA D’ITALIA Address by Governor Ordinary General Meeting of Shareholders Of the 143 current shareholders, 115 invested after the reform law was passed (6 insurance companies, 8 pension funds, 10 social security institutions, 29 banking foundations and 62 banks). The nominal value of the shareholdings exceeding the 3 per cent capital limit is just under €2 billion, compared with total capital of €7.5 billion. Last year, the nominal value of the shareholdings exceeding the threshold was €2.5 billion and two years ago it was €2.7 billion. Given that the broadening of the shareholder base is among the goals of the reform, the Bank is desirous that the redistribution of the shareholdings, in accordance with the limits set by law, continue at a fast pace. On behalf of the Board of Directors and the Governing Board, I would like to welcome those who have acquired a shareholding in the Bank’s capital, even if they are not physically present at the meeting today. The annual accounts submitted for your approval show a net profit of €8.2 billion, €2 billion more than in the previous year. This is the highest ever profit posted in the history of the Bank of Italy. After four years of continuous expansion, the balance sheet total of the Bank of Italy, in line with that of the Eurosystem, recorded a small decline linked to fewer monetary policy operations. The size of the balance sheet remains considerable, however: at €1,000 billion, it has expanded by more than 80 per cent since the end of 2014. This has translated into a significant increase in profitability, which has in part been used to strengthen financial buffers against risks. In the last five years, gross profit – before taxes and transfers to the general risk provision – totalled approximately €41 billion. The total amount allocated to the State – also considering the proposed distribution submitted for your approval – is €21 billion, in addition to taxes amounting to €6 billion. Future earnings will depend on developments in the financial markets, on the riskiness of assets, as well as on the monetary policy measures that will be adopted by the Governing Council of the ECB. What happens in the near future will be heavily influenced by how Italy and Europe respond to the emergency, first and foremost in terms of health care, then on an economic and financial plane. We are closely monitoring all developments and the implications of the pandemic for the economy, price stability, the performance of banks, and the financial markets. We have adopted a comprehensive package of measures designed to guarantee ample liquidity to all sectors of the economy and to address the risks of financial fragmentation along national lines, thereby ensuring that monetary policy decisions are transmitted more effectively. Address by Governor Ordinary General Meeting of Shareholders BANCA D’ITALIA The expansionary monetary policy of the Eurosystem and the Bank of Italy’s balance sheet In 2019 the monetary policy of the Eurosystem remained expansionary in order to counter the downside risks to inflation stemming from the weakening economic outlook. In its September meeting, the ECB’s Governing Council lowered the deposit facility rate by ten basis points, bringing it to -0.50 per cent; at the same time it introduced a two-tier system for reserve remuneration, in which part of banks’ reserve holdings in excess of the minimum requirements are exempt from the negative deposit facility rate and remunerated at a rate of 0.0 per cent. Also in September, a new series of targeted longer-term refinancing operations (TLTRO III) was introduced, each with a maturity of three years, to be conducted on a quarterly basis. Initially equal to the average rate on the main refinancing operations over the life of each targeted operation (currently set at zero per cent), the interest rate can be as low as the average rate on the deposit facility, depending on the volume of net lending by banks. Since November, net purchases of public- and private-sector securities have resumed at a monthly pace of €20 billion; this will continue for as long as necessary to strengthen the accommodative impact of the policy rates in tandem with the ECB’s explicit objective of ending the purchases shortly before it starts raising its key policy rates. These purchases are in addition to the full reinvestment of the principal payments from maturing securities purchased under the programme; this too will continue for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation. To mitigate the impact of the ongoing pandemic, in its meeting of 12 March, the Governing Council adopted a broad package of measures. To support bank lending to those most financially affected by the spread of COVID-19 – particularly small and medium-sized enterprises – from June 2020 to June 2021 the conditions applied to TLTRO III will be considerably more favourable. Both the initial rate and the (lower) rate actually applied to counterparties based on the achievement of lending targets have been lowered by 25 basis points and the targets’ attainment has also been facilitated. The maximum amount that the counterparties can borrow through these operations will be raised to €3,000 billion. As a bridging measure, until June 2020 additional LTROs will be conducted at favourable conditions and with full allotment of the amounts requested. Alongside the asset purchase programme already under way, equal to €20 billion in monthly purchases, BANCA D’ITALIA Address by Governor Ordinary General Meeting of Shareholders a further €120 billion has been allocated for additional net purchases until the end of the year, with a significant contribution from the private sector purchase programmes. These measures were further reinforced at the meeting of 18 March last, when the Governing Council announced a new programme for the purchase of public- and private-sector securities amounting to €750 billion this year. This new pandemic emergency purchase programme (pepp) will continue until the end of 2020 but may be extended if the public health emergency continues. Ample flexibility is envisaged for purchases of public-sector securities to enable, should market conditions require it, divergences with respect to the current allocations, both in respect of jurisdictions and asset classes. The range of eligible securities issued by private firms has been extended to include commercial paper of sufficient credit quality; the eligibility criteria for collateral have been relaxed further, to facilitate recourse to refinancing by banks. Within our mandate, we stand ready to increase the volume of purchases, adjust their composition and explore all possible options for supporting the economy in this acutely difficult phase. It was also decided to consider revising past self-imposed limits in carrying out these operations, to the extent necessary to make the interventions proportionate to the current risks; any impediment that might hamper the effective transmission of monetary policy will not be tolerated. The balance sheet At the end of 2019, the Bank of Italy’s total assets amounted to €960 billion, a decrease of €8 billion compared with the year before. Assets continued to consist mostly of securities purchased for monetary policy purposes, equal to €384 billion, of which around €320 billion made up of Italian government securities. Refinancing operations, totalling €220 billion, decreased by €24 billion owing to early repayments on TLTRO II operations, only partly offset by amounts allotted under the new TLTRO III operations. Overall, monetary policy assets make up more than 60 per cent of the total balance sheet. The value of gold rose by almost €20 billion compared with 2018, reaching €107 billion. In line with Eurosystem accounting rules, this appreciation is not recorded in the profit and loss account and therefore did not affect the Bank’s operating result, as it was reflected in a corresponding increase in the revaluation account on the liabilities side. Address by Governor Ordinary General Meeting of Shareholders BANCA D’ITALIA Investment assets, amounting to €140 billion, consist mainly of bonds and, to a lesser extent, equity shares. Since last year, the Bank has modified its investment strategy, integrating Environmental, Social and Governance (ESG) factors into the management of its equity portfolio. Shares of companies that operate mainly in sectors not compliant with the principles of the UN Global Compact have been excluded, those of companies with the highest ESG scores favoured. The Bank is already looking into extending this new investment strategy to corporate bonds as early as this year. On the liability side, the Bank of Italy’s negative balance on the TARGET2 payment system declined for the first time in five years, from €482 billion to €439 billion over the course of 2019. The decrease occurred primarily in the second half of the year, initially as a result of the inflow of capital from abroad, mainly owing to higher demand for Italian government securities, and thereafter due to the net foreign funding by Italian banks, driven by the Eurosystem’s new system for banks’ reserves remuneration, which was also reflected in the increase in deposits of credit institutions (from €89 billion to €102 billion). Finally, the value of banknotes in circulation continued to increase: reported in the Bank’s balance sheet in proportion to its share in the ECB’s capital key, their value increased by €4 billion, reaching €202 billion at the end of 2019. Profitability, risks and organizational measures The gross profit for 2019, before taxes and transfers to the general risk provision, was equal to €10.8 billion. The €2 billion increase over 2018 is mainly attributable to income components that may not recur to the same degree in the future. In particular, the positive performance of the stock markets in 2019 – accompanied by the Bank’s extensive rebalancing of its portfolio to integrate ESG factors – led to a reduction in write-downs and to a marked improvement in realized gains from trading operations. Net interest income, which is central banks’ traditional source of income, also contributed positively to the increase in gross profit, rising by €0.2 billion on 2018 to €9.6 billion. Operating expenses declined by about 1 per cent, reflecting in part lower depreciation. Although there were minor internal changes in composition, staff costs and administrative expenses remained essentially unchanged. In order to cope with the risks to which the Bank is exposed, financial buffers were increased by transferring to the general risk provision the same BANCA D’ITALIA Address by Governor Ordinary General Meeting of Shareholders amount as the year before (€1.5 billion), without affecting the statutory reserves. Taxes for the year amounted to about €1 billion, similar to the figure recorded in 2018 (€1.2 billion). The Bank’s human resource policies are contributing to a generational turnover that is reflected in a gradual decline in the staff’s average age, which was 48.3 years at the end of the year. Women now represent a larger proportion of total staff, rising from 36 to 38 per cent over the last five years. These staff-related initiatives flank those to reorganize the Bank’s structure in order to make the performance of its institutional activities at the service of the public more effective, and to adapt its working practices to developments at national and European level. In relation to this, in July 2019, the statistics function was reorganized to improve the quality of the data produced by the Bank, to make production processes more efficient, and to further develop the methodologies used. In early 2020, the powers of the Financial Intelligence Unit for Italy (UIF) were enhanced by strengthening its inspection and sanctioning functions. Two more organizational changes were also made; the first was to strengthen the Bank’s consumer protection and financial education functions by transferring their activities to a new directorate general; the second was to integrate traditional retail payment services and highly technological and innovative payment services within a single directorate general. As usual, further information on the activities of the Bank and on the organizational and management measures implemented in 2019 is available in the Report on Operations and Activities of the Bank of Italy, which will be published in May, on the occasion of the presentation of the Annual Report. Proposal for the allocation of the net profit Shareholders, Pursuant to Article 38 of the Statute, acting on a proposal of the Governing Board and after hearing the opinion of the Board of Auditors, I present for your approval the Board of Directors’ proposal for the allocation of the net profit. On behalf of the Board of Directors and the Governing Board, I would like to take this opportunity to thank the new Board of Auditors for their valuable contribution. As you may recall, under the dividend policy in force, the amount paid to the shareholders is kept within a range of €340 million to €380 million, provided that the net profit is sufficient and without prejudice to the Bank’s capital adequacy. The difference between the upper limit of the range and Address by Governor Ordinary General Meeting of Shareholders BANCA D’ITALIA the dividend paid to the shareholders may be allocated to the special item for stabilizing dividends, until this item reaches a maximum amount of €450 million. Accordingly, from the net profit of €8,247 million, we propose allocating €340 million as a dividend to the shareholders, equal to 4.5 per cent of the capital. Also this year, we propose allocating €40 million to the special item for stabilizing dividends, which would then amount to €160 million. Pursuant to the Statute, shares exceeding the 3 per cent threshold are not entitled to a dividend. Therefore, the dividend actually due to the shareholders would amount to €251 million. The dividend corresponding to the shares exceeding the threshold, equal to €89 million, would be allocated to the ordinary reserve. As a result, the remaining profit for the State would be equal to €7,867 million which, in addition to taxes for the year amounting to €1,009 million, would bring the total amount allocated to the State, to around €8.9 billion, over €2 billion more than last year. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the OMFIF Roundtable for Public Sector Asset Managers, London, 6 February 2020.
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Sustainable investment in uncertain times: The future of public sector asset management Speech by L. Federico Signorini OMFIF Roundtable for Public Sector Asset Managers London, 6 February 2020 In these remarks, I shall take the point of view of the central bank as an investor, rather than a monetary policy authority. My contribution may thus be seen as complementary to those of other speakers in this session. While profit maximising is not their ultimate objective, central banks do manage substantial funds and have a duty to manage them well, within the limits and for the purpose dictated by their institutional function. In the last few years, the investment profile of central banks has changed significantly because of the substantial expansion of their balance sheets, which in turn was due to the unprecedented scale and non-standard nature of monetary policy actions. As a result, the risks borne by central banks have increased, both quantitatively and qualitatively. Many central banks have begun, or returned to, dealing with less traditional assets, markets and counterparties. This development has raised the profile of asset (and liability) management within central banks, and it has arguably made the management of official reserves and own funds more similar to that of diversified private funds, with a greater focus on controlling risks and enhancing returns. However, there are certain key constraints that central banks must respect. First, while reputation is relevant for private managers as well, it is absolutely essential for central banks to protect their public image and hence their credibility, integrity and independence. Second, as they need to retain the ability to perform their mandates indefinitely and in all sorts of circumstances, central banks must take the long view and adopt an investment strategy that is robust to extreme events over an extended horizon. Finally, two further constraints are generally applied by central banks because of their public nature: neutrality (i.e. interfering as little as possible with market resource allocation, except insofar as monetary policy dictates); and – a point that may be more rarely noticed – ‘lightness of touch’ in daily operations (i.e. avoiding market disruption due to the sheer size of their trades). Let me start with a just a few words on the last topic. Central banks, in particular those managing a large pool of assets, need to pay due attention to market conditions and adopt appropriate trading practices so as to minimise the impact of their trades and avoid generating unintended signalling effects. With this in mind, for instance, we at the Bank of Italy have been gradually reducing the average size and holding period of our active positions in foreign reserve management, while increasing the frequency of trades. Furthermore, we reinvest large bond redemptions by distributing purchases over an entire trading session. Such issues, though highly technical, do have significant implications for the conduct of investment activity at major central banks. Most of the remainder of this speech will be devoted to a couple of topics relating to the ‘long view’ in central banks’ investment: (i) sustainable finance and (ii) strategic asset allocation. The importance of the first issue was underlined during the long, lively discussion of this topic during the previous session. Let me make one point clear from the outset. General policy matters are for governments rather than central banks; in democracy, decisions about broad societal aims are best left to elected politicians. Nevertheless, central banks have been increasingly indicating that they are taking environmental, social and governance (ESG) risk factors more fully into account as investors, that is, in their and risk management strategies.1 Why? There are two reasons for doing so, both linked to the constraints I just mentioned. One is reputation: central banks’ investment policies must be seen as beyond reproach. The second is that, as long-term investors, central banks need to take the long-term sustainability of their investments seriously into account. The discussion on sustainable finance often revolves around a perceived trade-off between ‘doing good’ (to the Earth, or society at large) and ‘doing well’ (for shareholders, or, in our case, the public as the ultimate ‘owner’ of the bank). While shareholder value is certainly not our main concern, this debate applies to a certain extent to central banks too. The concept of sustainability, however, appears to provide a link between doing good and doing well in the long run. Recent experience has indeed shown that, so far, ESG-compatible investment has not underperformed compared with unconstrained investment strategies. (Of course, past performance is no guide to future performance, as they say; we need to keep alert to fashionable bias, and choose carefully.) The Bank of Italy values sustainability in its asset allocation.2 Last year, we announced a new investment strategy that integrates ESG profiles into the management of our direct euro-area equity portfolios. These portfolios total around €9 billion and include shares in about 140 listed companies. Two ESG criteria have been added to the principles of diversification and market neutrality, which were already embedded in our previous strategy. The first principle is to exclude companies that belong to sectors that do not Visco (2019). More information on new ESG criteria is provided in the press release ‘The Bank of Italy values sustainability in its financial investments’ (May 2019, https://www.bancaditalia.it/media/ approfondimenti/2019/informativa-esg/index.html?com.dotmarketing.htmlpage.language=1). comply with the United Nations Global Compact.3 The other is to give preference to companies with the best ESG scores.4 In this way, we have already significantly improved the environmental footprint of our equity investments. Our staff has provided me with very detailed statistics on this. The total greenhouse gas emissions of companies included in the new portfolio are about one quarter lower than those recorded in the previous portfolio. Energy and water consumptions are down by about one third and one fifth respectively.5 Looking ahead, the Bank of Italy intends to enhance its ESG profile further for equity. We are considering the integration of ESG criteria for equity investments in US and Japanese companies through collective investment schemes. In addition, we are about to conclude an in-depth analysis for introducing ESG criteria for managing corporate bond portfolios, in both dollars and euro. Finally, the Bank already considers green bonds issued by supranationals as eligible for its investment portfolio. The size of a potential strategic allocation to these instruments will take into account the liquidity of the market, which is still inferior to that of conventional bonds. Our ESG framework in the equity space has been discussed within the Network for Greening the Financial System (NGFS), an organisation that brings together central banks, supervisors and observers from countries responsible for half of the world’s greenhouse gas emissions. As a member of the Network, the Bank contributed to the NGFS guide for central banks’ portfolio management, published last October.6 In this guide, the Bank’s first-hand experience in sustainable finance is one of seven case studies used as practical examples to ease the introduction of ESG practices among central banks. Let me now turn to the issue of strategic asset allocation (SAA). Due to the increased complexity of the financial system, it has become crucial for central banks and other public-sector financial institutions to base their activities on a sound, comprehensive risk management framework.7 This can be provided by a formal SAA model-based procedure at the centre of the investment process. An SAA takes into account the whole range of risks and opportunities faced by the investor. Note also that having a consolidated view of all significant risks on both sides of the balance sheet is a cornerstone of the IMF’s recently revised ‘Guidelines for Foreign Exchange Reserve Management’.8 Details on the United Nations Global Compact are available at www.unglobalcompact.org. Lanza et al (2019) show that the ESG scores of individual firms are very heterogeneous across agencies compared, for example, with credit ratings. There is also evidence of significant biases in ESG scores, which tend to be overestimated for companies that are larger and belong to specific industrial sectors and geographic regions. These improvements are equivalent to the annual impact of a number of households from 120,000 to 190,000, depending on whether you consider greenhouse emissions or energy or water consumption. NGFS (2018). Bindseil et al. (2009) present a comprehensive structured framework for risk management in central banks. The authors explicitly address the need to overcome the widespread practice of segregating central bank risk management tools between investment and policy portfolios. Yet they refrain from introducing a comprehensive quantitative approach whereby the strategic asset allocation is contingent on the core policy functions of a central bank. IMF (2013). At the Bank of Italy, the SAA risk management framework stands on three pillars.9 First, a single analytical approach integrates all assets and liabilities. Second, we employ a statistical model that estimates the expected return distributions of a wide range of financial asset classes across many currencies, and considers interdependencies and comovements across output, inflation, foreign exchange rates, interest rates, equity prices and so on. And third, we adopt an explicit objective function with related constraints, which aims at preserving the value of the financial resources required to pursue our institutional functions in an effective way and an independent manner, over the long run and especially in adverse scenarios. The theoretically optimal composition of our investment portfolio minimises the average expected loss in the worst 1 per cent of scenarios over a 10-year horizon, subject to two short-term (one year) constraints aimed to avoid the risk of (i) a depletion of financial capital, and (ii) the emergence of accounting losses. Of course, this formal exercise is not used in a mechanical way to determine actual investment decisions. It is, however, a key benchmark against which all our decisions are discussed. The optimal SAA for the investment portfolio takes into account the natural exposure of a central bank to systemic and business cycle risks stemming from its core policy functions. The central bank’s financial structure has to be robust, especially in those adverse circumstances in which its institutional duties may require exceptional risks to be taken. This leads us to consider countercyclical and low credit risk assets for inclusion in the SAA. Such a risk-based approach tends to produce an SAA that is consistent with the conservative bias that we want to impart to risk management. Moreover, by taking a forward-looking and long-term (i.e. through-the-cycle) approach, with clearly defined portfolio rebalancing rules, our optimal SAA also contributes to reducing any procyclical bias in portfolio management. Exposure towards countercyclical assets reduces selling pressure in times of crisis, when these assets tend to appreciate. This is not just theory. Our experience of the last crisis showed that investing in countercyclical assets, such as long-term government bonds and foreign reserves, while maintaining a low exposure to credit risk, paid off in periods of financial distress and provided positive risk-adjusted returns. As a final remark, it may be worth mentioning that the issue of the cyclicality of market investment is not just a concern for the Bank as a manager of its own funds: in our capacity as a macroprudential authority, we also see it as one of the main fronts on which financial stability action should advance.10 Financial markets naturally tend to be procyclical. During booms, higher asset valuations provide investors with more collateral to raise funds and ampler financial resources to invest. Because of herd behaviour, inflows to asset managers, i.e. to markets, Fanari and Palazzo (2019). Signorini (2019). tend to increase when prices are on the rise. Both mechanisms, of course, work in reverse during bust phases and may amplify price volatility.11 Not even central banks’ financial investment has been immune from such behaviour; the issue of procyclical investment by central banks has indeed been widely debated.12 Some argue that financial stability objectives should not interfere with reserve management. The IMF’s Guidelines for Foreign Exchange Reserve Management (last updated in 2013) neither directly address the issue of procyclicality, nor do they say that financial stability should in itself be an objective of reserve management. However, there is broad agreement in principle that due attention should be paid to the risk of a potentially disruptive impact of central banks’ investments on credit and financial markets. The impact of central banks’ investment strategies and the importance of sound practices are now widely recognised in markets where central banks have become key players and their actions are closely followed by market participants. The recent experience of the euro-area sovereign debt crisis is indicative, not only of the ample space that is available to long-term players to act as (selective) contrarian investors, but also of the profitability of doing so. Brunnermeier (2009) and Adrian and Shin (2010). Pihlman and van der Hoorn (2010). References Adrian Tobias, Hyun Song Shin (2010), “Liquidity and leverage”, Journal of Financial Intermediation, 19: 418-437. Bindseil Ulrich, Fernando Gonzáles, Evangelos Tabakis (2009), “Risk Management for Central Banks and Other Public Investors”, Cambridge University Press. Brunnermeier Markus K. (2009), “Deciphering the Liquidity and Credit Crunch 2007– 2008”, Journal of Economic Perspectives, 23: 77-100. Fanari Marco, Gerardo Palazzo (2019), “The strategic asset allocation of the investment portfolio in a central bank”, paper presented at the Bank for International SettlementsWorld Bank-Bank of Canada-Banca d’Italia Seventh Public Investors Conference held in Rome at the Bank of Italy on 22-23 October 2018. IMF, International Monetary Fund (2013), Revised Guidelines for Foreign Exchange Reserve Management, IMF, 1 February. Lanza Ariel, Enrico Bernardini, Ivan Faiella (2019), “Mind the gap, Machine learning ESG metrics and sustainable investing”, paper presented at the CEMLA Conference on Climate Change and its Impact in the Financial System, Mexico City, 5-6 December. NGFS, Network for Greening the Financial System (2019), “A Sustainable and Responsible Investment Guide for Central Banks’ Portfolio Management”. Pihlman Jukka, Han van der Hoorn (2010), “Procyclicality in Central Bank Reserve Management: Evidence from the Crisis”, IMF Working Paper No. 150. Signorini Luigi Federico (2019), “Non-Bank Finance: opportunities and risks”, Speech held at the Euromed Workshop on “Non-Bank Finance and Financial Intermediation”, Naples, 18 June. Visco Ignazio (2019), “Sustainable development and climate risks: the role of central banks”, Speech held at the 18th International Conference for Credit Risk Evaluation “Assessing and Managing Climate Change Risk: Opportunities for Financial Institutions”, Venice, 26 September.
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Speech by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the Panel on "The role of central banks and sustainability in the post-COVID recovery", OMFIF Global Public Investor virtual launch, 29 July 2020.
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Panel on ‘The role of central banks and sustainability in the post-COVID recovery’ Speech by L. Federico Signorini OMFIF Global Public Investor virtual launch 29 July 2020 The extraordinary impact of the COVID pandemic required an aggressive monetary policy response to avert the risk of financial meltdown and sustain economies worldwide. Like all major central banks, the ECB reacted quickly. The measures taken are well known and need not be listed here. They led to further monetary accommodation and an additional, large injection of liquidity; they were effective in calming markets, protecting monetary policy transmission, and preventing a financial crunch and a deflationary spiral. This time, besides monetary policy, other domains of public policy also became active immediately. Fiscal policies responded vigorously and more or less simultaneously across the world, with measures to support households and firms. This included, to varying degrees, debt moratoria, loan guarantees, direct grants to firms, income support, and more. A third actor, namely banking regulation and supervision, also played a key role. However, the most important regulatory actions in my view were those taken before the pandemic, in response to the global financial crisis. Thanks to Basel III (and other actions), when banks were hit by the pandemic crisis, they were considerably stronger than before 2008. This is true worldwide, but let me give you a few key figures on Italy. Between the start of 2007 and the start of 2020, the ratio of the highest-quality capital to risk-weighted assets almost doubled, reaching 14.0 per cent. In March 2020, the mean liquidity coverage ratio stood at 174 per cent of the regulatory requirement; it has increased further in the meantime. (No liquidity requirement existed in 2007). Furthermore, the weaknesses on Italian banks’ balance sheets caused by the sovereign debt crisis have largely been reabsorbed: in March, the net non-performing loan ratio had dropped by two thirds from its 2015 peak, i.e. from 9.8 to 3.2 per cent. Given the strong position in which the banking system entered the crisis, banking authorities worldwide were in a position to encourage banks to use their capital and liquidity buffers.1 Buffers are designed to allow banks to withstand extraordinary stress due to exceptional events, and avoid credit crunches. So far, thanks also to enormous liquidity injections by central banks and ample State guarantees, there are few signs of the kind of credit restrictions that played such a big role in amplifying the economic consequences of the last crisis. Still, uncertainties abound. Usable buffers are important to allow banks to absorb any losses without cutting credit abruptly. Many supervisors, including the SSM and the Bank of Italy, have also asked intermediaries not to distribute dividends or buy back their own shares, and to be extremely careful in paying bonuses.2 In sum, the overall short-term policy response was impressive, and quite effective in mitigating the consequences of an unprecedented crisis. Of course, we shall not be able to say that we are safe until the pandemic has effectively ended. But let’s start looking ahead anyway. I shall make two points. First, one of the legacies of this crisis will be, inevitably, an increase in government debt / GDP ratios. This is manageable–and should be managed, in due course. Continued fiscal support is essential at the current juncture. When the uncertainty recedes, we shall need to address macroeconomic stabilization and fiscal sustainability simultaneously. The long-term sustainability of the debt/GDP ratio depends both on the numerator and on the denominator. The recently agreed EU package is a key tool to allow member states, especially those hit hardest by the pandemic, to fund measures efficiently that increase the potential for growth. It must be put to full use. Second, to avoid market dislocation during the pandemic shock, central banks have trodden unusual ground. Action by the Fed, for instance, included the Commercial Paper Funding Facility, the Money Market Mutual Fund Liquidity Facility, the Municipal Liquidity Facility, the Term Asset-Backed Securities Loan Facility, the Primary Market Corporate Credit Facility, the Secondary Market Corporate Credit Facility and the Main Street Lending Program. I need not mention the numerous ECB programmes. While not all major central banks acted in quite the same way, they all expanded their market intervention tools well beyond the customary limits. This action has preserved stability in markets by reassuring market participants that disruption would not be permitted under the exceptional circumstances of the pandemic–a dramatic, fully exogenous shock. In the longer run, however, it is important that investors do not start seeing central banks as ‘market makers of last resort’, able to protect them against all sorts of disturbances, whatever their origin. The implications in terms of moral hazard would be vast. The Bank of Italy, in line with the decision taken by the ECB for significant banks, allowed all supervised entities to operate temporarily below the level of the Pillar 2 Guidance, the capital conservation buffer and the LCR. The ESRB has issued a recommendation that the relevant authorities request financial institutions under their supervisory remit to refrain from paying dividends, buying back shares and paying variable compensation until at least January 2021. There is a case, therefore, for building up safeguards against moral hazard and excessive build-up of risks in markets. We need to reflect, among other things, on a macroprudential framework for non-bank finance. While Basel III comprehensively redesigned the regulatory framework for banks, change has come more slowly to nonbank financial institutions (NBFIs), especially asset managers, despite the increased size, concentration, interconnectedness and speed of action of the industry. The awareness is growing that NBFI risks involve externalities. With no ‘Basel accord’ for non-banks, there is enough regulatory variation across jurisdictions to allow for reflection on what worked best, or is likely to work best, in managing market stress and avoiding endogenous amplification of shocks. In the past few years, the first FSB and IOSCO recommendations on liquidity and leverage in asset management have opened the way; work on this should continue. An aside on the gold holdings of central banks – answer to a question from the audience. There are historical reasons behind central banks’ large holdings of gold–a relic, whether ‘barbarous’ or otherwise, of the times when gold was the official basis for the international monetary order. There is also an aura of solidity around gold, an instinctive idea that it can be a safe haven in the event of extreme disruptions. There are, in fact, also eminently rational, tecnical reasons to keep gold as part of a central bank’s assets. Portfolio diversification is essential for central banks’ long-run financial soundness and thus, ultimately, for their independence. Some diversification between ‘paper’ assets (if you will allow me this expression in a paperless world) and a commodity, specifically one that people often turn to in troubled times, does make sense. According to the ESCB’s accounting rules, capital gains on gold reserves are not recorded in the profits and loss account, but they do show up in the overall capital position and, in this way, they contribute to the balance-sheet coverage of the Bank’s financial risks. The last few months have provided a textbook example. The Bank of Italy’s estimated financial risks increased unavoidably because of the pandemic (for the twin reasons of (i) increased uncertainty / market volatility, and (ii) an expanded balance sheet); at the same time, the price of gold went from record high to record high, thereby providing coverage. Any significant gold transactions, either way, are likely to weigh on the market, which is one reason why in practice the physical gold owned by the Bank of Italy (and many other central banks) has remained stable for a long time.3 In relative terms, the share of gold in the Bank’s asset portfolio has decreased significantly in the past few years, despite the appreciation of gold, because of the huge policy-induced expansion of the Bank’s balance sheet. At the end of 2019, it was a little more than ten per cent. At 79 million ounces, or 2,452 tons, the Bank of Italy has the third-largest gold holding among central banks, after the Federal Reserve and the Bundesbank. Background evidence on Italian Banks Figure 1 Trends of CET1 and risk-weighted assets of Italian banks and banking groups (1) (per cent) Sources: Consolidated supervisory reports for banking groups and individual supervisory reports for stand-alone banks. (1) Up to December 2013, it shows the performance of ‘core tier 1’and from March 2014, that of ‘common equity tier 1’. – (2) The data for March 2020 are provisional. – (3) Index: 2007=100. – (4) Right-hand scale. Figure 2 Gross and net non-performing loan ratio – Italian Banks (1) (total banking system; per cent) Sources: Consolidated supervisory reports for banking groups and individual supervisory reports for stand-alone banks. (1) Includes loans to customers, credit intermediaries and central banks. Includes banking groups and subsidiaries of foreign banks; excludes branches of foreign banks. Ratios are calculated net and gross of provisions. – (2) The data for March 2020 are provisional. Figure 3 Banks’ investment in Italian public sector securities by IFRS portfolio (per cent) Sources: supervisory reports. (1) All public sector securities, including those issued by local authorities. Excludes Cassa Depositi e Prestiti SpA. The data for May 2020 are provisional. – (2) Includes the cooperative credit banks merged into cooperative credit banking groups. Table 1 Liquidity Coverage Ratio (per cent) 31 January 2019 30 September 2019 31 March 2020 31 May 2020 Significant banks Less significant banks Total banking system Sources: Consolidated supervisory reports for banking groups and individual supervisory reports for stand-alone banks. (1) Banks directly supervised by the ECB. – (2) Banks supervised by the Bank of Italy in cooperation with the ECB.
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bank of italy
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