The world recovery is weak and not broadly based - The global economic picture is still uncertain. There has been perceptible improvement in the United States and Japan, thanks in part to support from monetary policy. The euro area continues to be weighed down by uncertainty over the development of the sovereign debt crisis.
In Europe, significant risks for financial stability persist - The crisis of the banking system in Cyprus and the political uncertainty in Italy played a role in halting the improvement in financial conditions in Europe. The repercussions on the markets were nevertheless cushioned by the progress on fiscal consolidation made in a number of countries, by the advance towards a single banking supervisory system and by the enduring stabilizing effects of the approval by the European Central Bank of the Outright Monetary Transactions programme last September. In recent weeks the tensions have subsided to some extent.
The main risks for financial stability, particularly in the euro-area countries most exposed to the sovereign debt crisis, relate to the danger that the recession may be prolonged by a spiral of weak demand, sovereign risk and bank fragility. Vulnerability has also emerged in some economies enjoying exceptionally low interest rates on government securities in the presence of persistently large budget deficits, high private debt, and weak real-estate and labour markets. On the international capital markets yield spreads for corporate bonds have fallen to historically low levels, prompting fears of a correction.
In Italy the recession continues; the public finance balances improve - In Italy the risks for financial stability stem from the contraction in economic activity. Positive signs derive from the progress in the field of the public finances, which will make possible the closure of European Union's excessive deficit procedure, and the improvement in the current account of the balance of payments, which has returned to surplus thanks to the continuing moderate growth of exports as well as the fall in imports. In the real-estate market, prices and sales are falling. The recession and tensions in the supply of mortgage loans weigh on the short-term outlook. The risks for the banking system derive chiefly from exposures to construction firms.
Households reduce financial assets and debt - Shrinking disposable income is inducing house-holds to pare their holdings of both foreign and domestic financial assets and to curb their borrowing. Indebted households' financial difficulties have been alleviated by a diminution in the burden of debt service, due to a mortgage payment moratorium, to the fall in short-term interest rates (to which over two thirds of mortgages are indexed), and to the spread of flexible loan contracts that permit borrowers to alter the size of repayment instalments at no additional cost.
The condition of firms worsens - Firms are feeling the effects of the recession. Negative factors include the accumulation of suppliers' commercial claims on general government and the difficulty in obtaining financing. Benefits should stem from the rapid implementation of the recent measure unfreezing a first tranche of public sector payments to suppliers.
The supply of credit is held back by borrower risk - The contraction of lending to the private sector continues. It stems from declining demand for loans and from the tightening of supply conditions by banks, itself due above all to the increasing riskiness of borrowers and the persistent fragmentation of wholesale funding markets. For small firms the financial tensions are exacerbated by difficulty in accessing external sources of finance alternative to bank credit.
The flow of new bad debts on business loans has increased, especially in the construction industry. The default rate on loans to households remains low.
Loan loss provisions increase, owing in part to supervisory intervention - The Bank of Italy has stepped up its supervisory action with inspections to check the adequacy of banks' policies to deal with the deterioration of loan quality. Strengthening the quality of banks' assets and increasing the coverage ratio (defined as the ratio of provisions to non-performing loans) are necessary to maintain investor confidence and a satisfactory flow of credit to firms and households.
International comparisons of non-performing loans are affected by differences in classification criteria - If calculated by the same standards as those applied by leading international banks, Italian banks' ratio of non-performing to total loans would be lower than indicated in their balance sheets; and the coverage ratio for non-performing loans would be higher than the average for a sample of large European banks, and rising over time.
What is more, in international comparisons Italian banks are at a disadvantage as a result of the slowness of credit recovery procedures due to the malfunctioning of the civil justice system. This lengthens the period for which bad loans are kept on balance sheets, which, other things being equal, inflates bad debts in proportion to total lending.
Retail funding grows, but uncertainty leads banks to keep recourse to the Eurosystem constant - The growth of the retail component imparts stability to Italian banks' funding and reduces the funding gap. Nevertheless, the uncertainty that continues to impede access to the wholesale funding markets has prompted banks to keep recourse to Eurosystem funding stable and to increase their holdings of eligible assets.
The main risk for banks' liquidity consists in a lowering of the sovereign rating and the consequent reduction in the value of assets eligible as collateral with the Eurosystem; the reduction of the volume of eligible government-guaranteed bank bonds will be gradual, and its effects will be circumscribed.
Loan losses affect banks' profitability and require cost-cutting - Banks' profitability has been compressed by very substantial loan losses and provisioning, necessitating incisive measures to contain costs. The budgets of the main groups indicate that profitability will be low again in 2013.
Banks' capital position continues to strengthen - The core tier 1 ratio of the main banking groups rose further, to 10.5 per cent. The preliminary results of the IMF's stress tests show that the Italian banking system as a whole is adequately capitalized and hence capable of withstanding adverse shocks. The adaptation to the new capital requirements of Basel III continues. For the Italian banks taking part in the Basel Committee's monitoring programme, the additional capital they would need if the new rules were already fully in effect has diminished drastically over the past two years.
The conditions of insurers are improving - The profitability of Italian insurance companies has turned positive, thanks to capital gains on their government securities portfolios. Their solvency ratios are well above the minimum requirements. Italian insurers have not suffered significantly from the low level of interest rates, which is causing concern instead for insurance companies in the European countries where government securities yields are at historic lows.
The liquidity of the Italian financial markets is improving. In the money market the cost of funding has come into line with that in the euro area as a whole.
The liquidity of the government securities market improves - The placement of government securities continues smoothly, in keeping with the Treasury's issue schedule. The periodic issue of bonds with maturity beyond ten years has been resumed. Issue yields began falling again in April. The most recent data show substantial inflows of capital, suggesting that purchases of Italian government securities by foreign investors are continuing.
