Financial Stability Report No. 1 - 2016

Global risks are increasing …

The slowing of the world economy, which has proven greater than expected, increases the risks for financial stability. The historically low level of commodity prices, and of oil in particular, weakens the emerging economies and fuels deflationary pressures in the advanced ones.

… affecting the financial markets

In the early months of the year heightened uncertainty over growth prospects led to a sharp fall in share prices and increased volatility on the capital markets. The decline in prices was most marked for bank securities, especially in the euro area.

Market perceptions of non-performing loans in Italy weigh on banks

Italian banks’ share prices have been dampened by the large volume of non-performing loans, a legacy of the long recession, and by investors’ uncertainty about the outcome of a few scheduled rights issues. The announcement of the launch of the ‘Atlante’ fund by private investors to support upcoming increases in banks’ capital and purchase bad loans was welcomed by the markets.

Eurosystem measures mitigate the risks

The Eurosystem’s expansionary monetary policy measures, which were strengthened in March, are helping to ensure financial stability by supporting growth, reducing the risk premiums demanded by investors and maintaining relaxed financial conditions. There is no evidence that the purchases are causing distortions on the Italian government bond market.

The Bank of Italy’s macroprudential measures are favouring the recovery of the financial cycle

In Italy, the recovery of lending to the private sector is proceeding very gradually and the financial cycle is still weak. The Bank of Italy has accordingly set both the countercyclical capital buffer ratio and the reserve capital ratio for domestic systemically important banks at zero per cent.

The property market shows signs of recovery

The decline in house prices has come to a halt and the number of sales continues to increase gradually. Several indicators show that the recovery should continue in the coming months, with positive effects on financial stability.

Households’ financial conditions improve …

Household finances are benefiting from an increase in disposable income and low interest rates. The main risk is a possible weakening of the economic recovery.

… as do those of firms, albeit with some residual strains

The financial situation of firms is also gradually improving. Debt continues to decline while liquidity continues to grow. The number of bankruptcies is falling and the indicators of firms’ financial vulnerability should continue to diminish in the coming quarters, although they remain high in some sectors.

The quality of bank credit is improving

Banks’ lending criteria, which have been steadily easing, remain cautious nonetheless. The loan default rate continues to fall and the flow of new bad debts should also decline in the coming months. The coverage ratio for non-performing loans, which stood at 45.4 per cent at the end of 2015, is in line with the average for the main European banks; the amount of guarantees on non-performing loans is greater than their book value.

Initiatives are under way to develop the market in non-performing loans

Incentives for developing the market in non-per-forming loans could come from the state guarantee scheme for securitized bad debts (GACS) and from the activities of the Atlante fund.

Liquidity conditions remain good

Tensions over the funding of a few banks at the beginning of the year following the resolution of four banks last November have subsided. There were no outflows of deposits abroad or to other investment instruments. The liquidity of Italy’s banking system can cope with situations of stress. There has instead been an increase in subordinated bond yields, in particular for banks with a high share of non-performing loans. Average funding costs have fallen, reflecting the expansionary monetary policy. The new refinancing operations announced in March will ensure certainty about the cost and availability of funds, reducing the risk of repercussions should market tensions flare again.

Banks’ profitability, while increasing, is still low

Banks’ profitability is im-proving but is still below average compared with other European banks. At the end of 2015 the CET1 ratio reached 12.3 per cent, with significant differences between the different size classes of banks. The recent reform of Italy’s mutual banks (banche di credito cooperativo – BCCs) will strengthen their capacity to access the market.

Risks are low for insurance companies …

Low interest rates continue to have a limited effect on Italian insurance compa-nies’ profitability by virtue of the good matching of duration and yields between financial assets and liabilities. Firms are diversifying their investments but there are no strategies under way to raise risk-return profiles. More unit-linked and multi-class products are being placed, for which the market risk is partly borne by policyholders.

… and in the asset management sector

The Italian asset management sector has continued to expand even during the recent phase of market volatility. Asset managers’ propensity to increase the proportion of capital invested in less liquid but higher yielding assets diminished. The profitability of real estate funds is improving, but remains negative and exposed to uncertainty.

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