The risks to financial stability stemming from the international economy are decreasing. There are, however, lingering uncertainties about economic policies across regions. The very low volatility observed in the financial markets may be a sign of excessive risk-taking by investors; adverse events could therefore trigger large fluctuations in security prices.
Monetary policy recalibration has reduced uncertainty in the euro area. Crises at some Spanish and Italian banks have been resolved, dispelling most of the systemic risks. Sovereign spreads have narrowed considerably.
The financial vulnerability of Italian households and firms has diminished and will continue to do so as growth proceeds. It could, however, worsen in the very unfavourable scenario of a marked economic slowdown accompanied by a rise in interest rates.
Risks are diminishing in the banking sector. The resolution of crises at some banks during the summer has boosted share prices and reduced the cost of funding. New non-performing loans are decreasing as the economic recovery continues; the stock of outstanding NPLs is also falling sharply. A number of bad loan sales have been completed while others, involving large amounts, are being finalized. Italian banks' capitalization has begun to increase again.
Over the next few months the most significant risks for banks remain first and foremost those tied to the economic outlook: a sharp slowdown in growth would have a negative impact on revenues and credit quality. Pressures on profitability, which is still very low, would make it more difficult to turn to the markets to raise capital. While the cost of equity for the main Italian banks has fallen significantly in recent months, it is still higher than the average for the other European banks.
The solvency ratio of Italian insurance companies is rising. Italian insurers are less exposed to an increase in interest rates than insurers in the other main European countries, owing to good duration matching of assets and liabilities. However, the large share of government securities in their portfolios still leaves them vulnerable to a hypothetical renewal of tensions in the sovereign bond market.
An increase in interest rates, if consistent with the improved economic situation, is fully sustainable by the Italian economy. The debt service capacity of households and firms should remain strong even if borrowing costs rise considerably. The analyses conducted by supervisory authorities indicate that Italian banks and insurance companies have little exposure to the risk of an interest rate rise. The debt-to-GDP ratio can be reduced even if rates were to rise, as this would only gradually affect the average cost of the debt. A high level of public debt is nonetheless a source of vulnerability and the credibility of the commitment to reduce it remains crucial.
The improvement in the financial situation of Italian households, firms and banks, along with the consolidation of the public finances, prompted Standard & Poor's to raise Italy's credit rating and that of some of its major banks and insurance companies at the end of October.
