Financial Stability Report No. 1 - 2015

Global risks are subsiding but are still significant - Improving growth pros-pects for the advanced economies have attenuated the risks to financial stability, but there are still areas of vulnerability. Growth is slowing in the emerging economies, which are exposed to the risks of a possible rise in official interest rates in the United States and a further appreciation of the dollar. The fall in oil prices could have adverse effects on the sustainability of debt in the oil-producing countries. Geopolitical tensions could trigger sudden increases in the volatility of financial asset prices.

The situation in Greece is a potential factor of instability - The uncertainty sur-rounding the negotiations between the Greek authori-ties and European institu-tions over the completion of the macroeconomic adjustment plan is causing sovereign spreads in the euro area to widen again. The Eurosystem stands ready to cope with the financial market repercussions of an aggravation of tensions, but the deterioration of the situation could provoke unpredictable consequences.

The Eurosystem has adopted measures to counter the risks associated with low inflation… The risks to euro-area financial stability generated by low growth and stubbornly low inflation have diminished since the start of the Eurosystem’s public securities purchase programme. The plan is already working its effects: medium- and long-term inflation expectations are adjusting upwards, while government securities yields have decreased, turning negative even beyond five-year maturities in some euro-area countries.

…while taking care to preserve the orderly operation of markets - Market indicators have shown no signs of disequilibrium in prices or trading volumes. The procedures for conducting the Eurosystem’s asset purchases have been designed in such a way as not to distort the formation of securities prices.

Macroeconomic improvement can facilitate fiscal adjustment - In Italy the return to growth and a rise in inflation rates can speed up the adjustment of the public finances. The 2015 Economic and Financial Document presented by the Government estimates that the ratio of debt to GDP will begin to come down in 2016 thanks to the improving economic picture and the curbing of the budget deficit.

Households’ financial situation is solid - The level of Italian households’ debt remains low, and indebted house-holds’ vulnerability would be limited even in the event of a decline in nominal income or a rise in interest rates.

Firms’ profitability decreases, but growth prospects are improving - Firms’ profitability has declined further, but the latest surveys indicate that the outlook for sales and investment is improving, especially for large and export-oriented firms. Overall, firms’ financial positions have continued to strengthen gradually. Liquidity and the conditions of access to credit have improved. However, a significant number of heavily indebted small and mid-sized firms are still having difficulty accessing credit.

The slackness of economic activity still weighs on banks’ credit quality… The continued weakness of economic activity and the incorporation in banks’ balance sheets of the results of the asset quality review led to an increase in the flow of non-performing loans in the fourth quarter. Nevertheless, coverage rates are still rising. Measures are being studied to reduce banks’ stock of non-performing exposures, which would help to boost lending to households and firms and hence strengthen the economic recovery.

…and profitability - Loan loss provisions ab-sorbed practically all of banks’ operating profits in 2014, and their ROE was negative. Banks are going ahead with reorganization, which in recent years has delivered efficiency gains by reducing the number of branches and employees. A recovery in earnings will depend strictly on the growth of the economy.

Banks’ capital ratios continue to rise - Banks’ endowment of capital has continued to expand. By the end of last year the CET1 ratio of the Italian banking system had risen to 11.8 per cent, and the ratios of the two largest groups were aligned with those of the other major European banks.

Exposure to interest rate risk is limited for banks… Italian banks’ vulnerability to interest rate risk is low. Even for the most highly exposed intermediaries, the potential losses to the net value of assets and liabilities are far below the official warning threshold.

…and insurance companies - Italian insurers are among the least exposed in Europe to interest rate risk, even in the case of an extended period of low nominal yields. Most have balanced cash flows, with good matching of yields and duration between assets and liabilities. The impact of shifts in the yield curve on the net value of assets and liabilities would be modest even under stress scenarios. Insurance companies remain exposed to the risk of changes in sovereign risk spreads.

Italian markets are liquid - The Eurosystem’s public securities purchase pro-gramme has had positive effects on the liquidity of the Italian equity and corporate bond markets, which are not involved in the plan. The yields on government securities have come down sharply; in the first two months of the year there were large-scale purchases from abroad. Yields have also fallen significantly in the Italian markets for ABS and covered bonds, which are specifically targeted by Eurosystem purchase programmes.

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