Banca d’Italia’s Financial Stability Report

Bank of Italy’s most recent FSR became available earlier this month. Below is the Bank’s summary:

Overview

The global expansion proceeds at moderate and regionally uneven rates – The world economy continues to expand moderately with differing regional performances. In Europe the recovery has also involved the countries hit by the sovereign debt crisis. In some of the emerging economies with structural imbalances, growth has slowed and capital outflows have been recorded.

In Europe financial conditions improve in the countries worst hit by the sovereign debt crisis … Financial conditions in the euro area have improved in the last few months. The reduction in the spread on government securities, which has been more pronounced since last autumn, mainly reflects the subsidence of fears of a break-up of the single currency, thanks to signs of economic recovery, the effects of fiscal consolidation and the introduction of reforms in a number of countries, the Eurosystem’s initiatives and the progress made towards Banking Union.

…but the risks are still considerable – Significant risks remain, especially as regards the evolution of the macro-economic situation. Negative consequences for growth and financial stability in the euro area could come from a worse than expected slowdown in the emerging economies or an unexpectedly protracted period of low inflation. Uncertainties also stem from the geopolitical tensions in various parts of the world, in particular the crisis between Russia and Ukraine. On the other hand, the risk that the less accommodative monetary policy stance in the United States might cause an increase in medium and long-term interest rates in the euro area as well has lessened, although it has not disappeared.

In Italy the slow improvement in the macroeconomic situation continues – In Italy the economic recovery is spreading, but it remains fragile. The real estate market is still weak. House prices are still declining, although the fall in non-residential property prices has come to a halt. Foreign portfolio investment in Italy has increased, both in government securities and private-sector securities. Interest rates have declined on all maturities.

The financial conditions of households are sound … In 2013 households suffered a smaller decline in disposable income than in 2012; there was a reduction in debt and a recovery in investment in financial assets. Low interest rates and measures to support borrowers helped to contain the vulnerability of indebted households. It is estimated that the proportion of financially fragile households would increase by only a modest margin even under adverse macroeconomic scenarios.

… but those of firms are still difficult – Although some positive signs are emerging, the financial conditions of firms remain weak. Several large companies have substituted bonds for part of their bank debt; for smaller firms, difficulties in accessing credit, low liquidity and the uncertainties still surrounding the cyclical upswing will remain the main sources of risk in the coming months.

The Comprehensive Assessment is under way – The Comprehensive Assessment of the largest euro area banks is now in progress. The exercise, in which 15 Italian banks are taking part, will permit uniform comparison of bank balance sheets in different countries, helping to reduce the segmentation of European financial markets still further.

Market assessments of Italian banks improve – In the first few months of the year the markets’ evaluations of Italian banks improved considerably, bringing them nearer to those of banks in the other main euro-area countries.

The contraction in credit eases – The contraction in bank lending abated somewhat at the start of 2014. Qualitative surveys of banks found more favourable conditions for credit to households; the conditions of credit access for firms, though slightly better, remain restrictive.

The deterioration in loan quality slows – The deterioration in banks’ loan asset quality has eased. The flow of new bad debts as a ratio to outstanding loans stabilized in the fourth quarter of 2013, and preliminary data indicate that in the first quarter of 2014 it declined. However, the volume of non-performing loans is still growing.

Loan loss provisions hit profitability but significantly raise coverage ratios – The massive loan loss provisions entered in the banks’ accounts at the end of 2013 completely absorbed operating profits, but at the same time they resulted in a significant rise in coverage ratios. This development was welcomed by the markets and may help to revive the market for non-performing loans. Some large banks have announced initiatives to optimize the management of these exposures. The lowering of banks’ operating costs continued, thanks in part to the rationalization of branch networks.

Banks reduce their sovereign exposure – Beginning in the second half of last year, Italian banks have reduced the volume of their government securities portfolio.

The funding gap narrows and repayment of Eurosystem financing proceeds – The funding gap has been brought back down to the levels registered in the middle of the last decade, and the repayment of Eurosystem financing has continued, albeit unevenly across banks. The largest have stepped up their bond issuance on the international markets, returning to positive net issues.

A number of banks announce capital increases – Italian banks’ capital position deteriorated as a result of the massive loan loss provisions made at the end of 2013. A number of banks have undertaken capital increases for a total of €10 billion. Italian banks’ leverage remains lower than that of other European banks.

Risks in the insurance sector are modest – For insurance companies the risks deriving from the protracted phase of low interest rates are modest, thanks in part to insurers’ prudent policies on guaranteed-yield policies. The main risks for the sector stem from the tenuous economic recovery. The soundness of the leading companies is now being assessed by the European insurance authority.

Liquidity conditions in the financial markets are easier – The liquidity of the Italian financial markets has improved further. The systemic liquidity risk indicator is now at its lowest level ever, reflecting heavier trading on the secondary market in government securities.

Banca d’Italia’s financial stability report can be found on the CFS FSR page.