Financial Stability Report No. 2 - 2015

Global risks are on the rise - The international environ-ment is growing more uncertain. The slowdown in China and the other emerging economies has affected the global outlook for growth and could generate tensions in the financial, commodities and foreign exchange markets.

In the euro area the strains abate - In the euro area, the uncertainty deriving from the situation in Greece has subsided. The recovery in economic activity and the unconventional monetary policy measures are helping to limit the risks. Inflation remains unusually low, however, and reducing public and private sector debt is more difficult.

In Italy the economic recovery is contributing to stability - The strengthening of the economy has reduced the risks to financial stability in Italy. Bank loan supply conditions are improving steadily and bank lending is expected to start growing again in 2016. As a proportion of GDP, credit to the private sector is well below its long-run average values. The sustainability indicators for the public finances remain generally favourable.

Property prices stop falling - The stock of unsold houses is still large, but the situation in the real estate sector is gradually firming up. Property prices have stopped declining, and the leading indicators point to further improvement in the coming months.

The risks for households diminish … - The increase in disposable income and the low level of interest rates are strengthening households’ already sound financial condition. The vulnerability of the financially weakest has also diminished, and debt remains low in spite of a sharp upturn in home mortgage loans.

… and the number of vulnerable firms declines - The improvement in firms’ financial situation is now spreading to the more fragile businesses; profit margins are up slightly. In a macroeconomic environment of recovery consistent with our latest projections, the share of financially vulnerable firms will fall significantly in 2016. Risks could stem from an unfavourable turn in macroeconomic conditions or a sudden rise in interest rates.

Liquidity conditions in the Italian markets relax - After the tensions that arose during the summer as a consequence of the events involving Greece’s sovereign debt and the fall of share prices in China, liquidity conditions in Italy’s financial markets have eased again. However, the high volatility of recent months could also reflect structural changes under way in international markets. At the end of August the Italian financial marketplace successfully migrated to the new TARGET2-Securities settlement platform, which will facilitate trading between market participants based in different European countries and permit more efficient allocation of capital.

Eurosystem asset purchases do not affect the orderly functioning of the Italian government securities market - The Eurosystem’s public sector purchase pro-gramme has proceeded without distorting the price formation mech-anism in the market for Italian government secu-rities, thanks notably to the manner in which the purchases have been conducted – distributed over time and covering the entire spectrum of maturities – and to the securities lending programme that the Bank of Italy started in May.

The situation of Italian banks improves … - The gradual improvement in economic activity has been reflected in banks’ balance sheets. The deterioration in credit quality slowed over the summer months and should continue to moderate in 2016. While still weak, banks’ profitability appears to be picking up, and their capital strengthening has continued, owing in part to capital increases in the first half of the year. The common equity tier 1 ratio of the top five groups rose to 11.8 per cent in June, nearly on a par with the other large European banks.

… and their exposure to interest rate risk is reduced - The exposure of the major Italian banking groups to interest rate risk is quite limited, and in the first half of the year it decreased further. Market risks, after increasing during the summer months, have now fallen back to low levels. Funding conditions remain favourable.

The market for impaired loans has yet to develop - The slowdown in the flow of new non-performing loans has not yet been accompanied by any decrease in the very large stock, which is a legacy of the long recession. This also reflects the difficulty of creating a robust secondary market for impaired loans in Italy, transactions in which have been restricted to date to the large groups. The recent reforms regarding credit recovery procedures and the tax deductibility of loan write-downs and write-offs could help to speed up the resolution of cases of insolvency.

Italian insurers can cope with low interest rates - The prospect of a pro-tracted situation of low yields has put pressure on the European insurance industry. For Italy, the exercises conducted by the insurance supervisor Ivass indicate that Italian insurers as a whole can cope with a scenario of low interest rates over a prolonged period, thanks to the matching between the durations of assets and liabilities. Their capital position has strengthened, thanks among other things to good earnings.

No significant risks emerge in the asset management industry - In the asset management industry, which is ex-panding rapidly, the risks to financial stability are limited owing to the prudent investment strategies of the harmonized funds operating in Italy. Alternative funds, which invest in riskier assets and can leverage their investments, account for only a modest share of total assets under management and are subject to supervisory controls. Real estate investment funds still exhibit vulnerabilities, given the sharp fall in the value of their assets and their poor operating results; the direct exposure of banks and other intermediaries to these funds is limited.

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