The risks to financial stability ease ... The massive injections of liquidity by the European Central Bank and national governments' measures to counter the euro-area crisis halted the downward spiral of increased sovereign risk, banking system difficulties and the deteriorating economic situation, which in the last part of 2011 threatened to become systemic.
... but do not disappear - In April, tensions reemerged, signalling that risks are still serious. The advanced countries' economic and financial prospects are clouded by fears concerning public finances and the robustness of world growth. The recent agreement to increase the intervention capacity of intergovernmental mechanisms to support euro-areaeconomies in difficulty has allayed but not eliminated investors' concerns. In the euro area, market turmoil resurfaces rapidly as soon as fears arise concerning the effectiveness of the measures for fiscal consolidation and economic growth. Worries about the severity and duration of the recession are aggravated by concerns about the lending capacity and soundness of banks, which are nevertheless strengthening their capital.
Italy makes significant progress to improve its public finances ... In Italy, the fiscal consolidation measures taken since mid-2011, the provisions curbing pensions and progress with reforms to raise the economy's growth potential have restored confidence in the sustainability of the public finances. The improvement on the government securities market has been significant, although in recent weeks it has been partially eroded by the resurgence of strains, which originated outside Italy. Our simulations, which assume that the government's measures are fully effective, show that the debt-to-GDP ratio would begin to fall in 2013 even if the cost of the debt rose and growth were lower than expected.
... but is affected by contagion and the recession - The yield spread between Italian and German government bonds is nevertheless still large, owing in part to speculation that has driven German interest rates down to exceptionally low levels. In the current phase of cyclical weakness and market volatility it is essential to forge rapidly ahead with the vast programme of structural reforms that can influence expectations of future growth, without which it would be more difficult to strengthen the fiscal consolidation process and seize the opportunities offered by the global economic recovery.
The leverage of Italian households and firms is low - In Italy, the private sector's financial condition remains balanced. But, households and firms are feeling the effects of the recession and the strains in loan supply. The problems have been circumscribed by the measures that the Government has introduced in the last two years to support indebted households and firms and by the agreements among the organizations representing banks, firms and consumers. A high percentage of the firms that have benefited from loan moratoria have subsequently returned to making regular repayments.
The strains in lending conditions are abating ... The contraction in bank lending towards the end of 2011 reflected the credit supply constraints arising at the time from the instability of the sovereign debt market; the resulting pressures on bank liquidity prompted intermediaries to tighten their lending policies, thereby accentuating the deceleration in lending caused by the fall in the demand of households and firms. The dynamic of lending is also affected by the worsening of credit quality.
Recent signs suggest that the tensions in lending conditions are subsiding: rates on loans to firms
have turned downwards; and the quarterly Bank Lending Survey for Italy signals an improvement
in lending standards in the early months of 2012.
... reflecting the reduction in banks' refinancing risk ... These developments reflect the decline in sovereign risk in the first quarter of 2012 and, above all, the intervention of the Eurosystem, which has greatly reduced banks' refinancing risk in the medium term. Italian banks now have the liquidity needed to meet maturing liabilities and finance the economy, and they also have an ample stock of additional collateral. In recent surveys conducted by the Bank of Italy the major domestic banks have indicated that they plan to use some of the funds obtained from the ECB to revive lending to households and firms.
The improvements in lending standards should be able to impact, with the usual lags, on the actual growth of lending. Progress in returning to normality will depend on the situation in the sovereign debt market, the functioning of the international capital market and the trend of economic activity. Our projections indicate that lending should pick up again in the final part of 2012. The flow of new bad debt in relation to lending is expected to start falling in the second half of 2012.
.... but it is necessary to reactivate the wholesale funding markets - However, central bank financing cannot represent a permanent source of fund-raising. It is essential that banks maintainaccess to the international wholesale funding markets. The positive signs of a revival in bond issuance in the first few months of the year have faded with the resurgence of sovereign debt strains.
The exposure towards countries in difficulty is low, that towards Italian sovereign debt increases - The Italian banking system is one of the least exposed towards the euro-area countries in difficulty, both directly and indirectly (via claims on foreign banks themselves exposed to these countries). In the first two months of this year Italian banks began buying Italian government securities again after the pause in the last part of 2011. Nearly 60 per cent of the purchases were made by small and medium-sized banks, which took a very small share of the medium-term financing disbursed by the ECB.
It is essential to continue strengthening banks' capital, while not restricting credit to the economy ... The capital of the main Italian banking groups has been increased further: their core tier 1 ratio has risen to 9.3 per cent. The capital strengthening is proceeding as part of the European Banking Authority initiative, with account taken of the need not to restrict lending to the economy.
... and maintaining their profitability - The outlook for banks' profitability remains uncertain.It should benefit from the easier fund-raising conditions, but the recession could slow down lending and prolong the deterioration in the quality of banks' assets. Beyond the short term banks must continue to take steps to achieve further large efficiency gains.
The government securities market continues to function regularly - Government securities have been placed regularly, even in the difficult conditions at the end of 2011. From January to April 2012 the average cost of issues fell significantly compared with the fourth quarter of 2011owing to the decline in the risk premium and the rebalancing of issues towards the short and medium term. The residual life of the debt (6.8 years) nonetheless remains one of the longest in the euro area. By the middle of April, 40 per cent of the issues of public securities scheduled for the whole of 2012 had already been made. The liquidity of the secondary market for government securities has improved: bid-ask spreads have come down by half from the record levels of the end of 2011, and the size of quotations has increased again. In the first part of 2012 non-residents have continued to make net disposals of Italian government securities; however, for the first time for several months, they have made significant net purchases of short-term paper.
