1. Rapporto sulla Stabilità Finanziaria Novembre 2013 Paolo Angelini Head, Financial Stability Unit - Banca d’Italia Modena, Università di Modena - 19 Novembre 2013

2. Outline of the Presentation o The macroeconomic context o The real-estate market o The financial condition of households and firms o The banking system

3. Main risks for financial stability (EA, Italy) : Trend o economic outlook o uncertainty on sovereign debt o financial fragmentation o credit risk in the banking sector Overview of Main Risks

4. o The EA economy resumed growth in 2013. Upturn will continue in 2014. o Italy: leading indicators con- sistent with cyclical upturn o Confidence is rising, IP is stabilizing. Positive growth fo- recast for 2014 and 2015 o But recovery remains fragile both in Italy and in the EA. Financial risks still significant Macroeconomic Context Euro Area: coincident indicator of GDP growth Italy: industrial production and confidence

5. 5 Italy’s RE Market: Weak but Stabilizing oItaly has not experienced a housing bubble. Price dyna- mics consistent with funda- mentals oProperty mkt still weak, but with signs of stabilization oNo. of transaction stabilized for both residential and non residential property oIn Q2 the fall in house prices eased (0.6% qoq) Italy: residential property (2005=100) House prices in Europe (2000=100)

6. 6 Households’ Financial Conditions oItalian households have sound financial conditions: oDebt/disposable income ra- tio is low; debt is declining. oOnly 25% of households have financial debt. Share of financially vulnerable house- holds is low (3% of total in 2013 and 2014) oFinancial wealth is high oThe main risks derive from weak income growth Financial assets / disposable income Financial debt / disposable income (%)

7. 7 The Financial Condition of Firms oFirm profitability is still low, affected by recession. Len- ding conditions are still tight oFinancial debt is falling. The increase of leverage has ended oEntrepreneurs’ assessment of investment conditions is improving rapidly Firms’ assessment of investment conditions Debt and leverage of non-financial firms (%)

8. 8 The Financial Condition of Firms (2) oFirm confidence is benefiting from the payment of general government arrears (€27bn in 2013, 20bn 2014); €14bn disbursed up to October 2013 oUp to now, funds have been used mainly to reimburse commercial and bank debt

9. Banks’ Key Problem: Rising Credit Risk o Credit quality is deteriorating, driven by loans to non-financial corporations. o HHs more resilient o Gross (operating) profits have resumed growth in 2012 (but 2013 results like- ly affected by low rates) o The increase in provisio- ning is eating up a large part of gross profits. Net profitability is low

10. Banks’ Key Problem: Rising Credit Risk (2) o Gross operating profits sufficient to cover loan loss provisions in 2013 and 2014 o The flow of new NPL and of bad loans to non financial companies are showing signs of a turnaround New NPLs of non financial firms (% of loans) New NPL rate New bad loan rate

11. Italy’s Classification Standards Are Rigorous oItalian banks follow prudent supervisory standards oIf Italian banks followed the standards used by several large European banks (e.g. excluding fully-collateralized NPLs) then: othe NPL ratio would be 1/3 lower ocoverage ratios would be higher by 20 pct. points oNPL definition proposed by EBA is in line with (or less comprehensive than) Italy’s definition NPL ratio of Italian banks (% of loans) Coverage ratio of Italian banks (% of NPLs)

12. Stock of NPLs Will Have to Be Reduced oMarket for assets securitization very thin. Price differential between supply and demand of NPL large but likely to narrow: oThe Bank of Italy’s recent action on value adjustments oReduced financial market fragmentation (economic recovery, SSM comprehensive assessment) oThe Stability Bill for 2014 provisions on tax treatment of loan losses and value adjustments

13. Banks’ Holding of Sovereign Bonds o Large purchases of domestic sovereigns over 2 years. a.ample differential sov’s vs loans b.precautionary demand c.fragmentation oIn last 3 months sov. portfo- lio shrank (€10bn), due to improvement in (a), (b), (c). oSov. mkt conditions improving. Not just rates and spreads: foreign holdings are increasing Purchases of sovereign bonds by Italian banks Italian sovereign bonds of non-residents €bn

14. The Funding Gap is Low o Total funding is contracting (in part as a result of banks’ choices). o The funding gap has narrowed to very low levels Growth in bank funding: contributions (percentage points; 12-month changes) Funding gap (€bn and %)

15. Liquidity Conditions and Eurosystem Borrowing o Overall liquidity position is satisfactory o Dependence on ECB fun- ding significant but falling o banks (especially large ones) have regained access to wholesale markets o Available eligible assets continue to increase o Ongoing work to make revolving loans (an Italian feature) and pools of loans pledgeable Availability of Collateral for Italian banks 302 bn. 334 bn.

16. Capital Positions Continue to Strengthen Bank capital injections by the public sector in selected countries (€bn) Italy: 0,3% of GDP o Capital ratios have increased continuously since 2008, as a result of both capital issues and lower RWAs o The amount of public funds injected into the banking system by the Italian State is low

17. Banks’ Leverage is Low o Leverage (total assets/ tier 1 capital) remains low o Level 3 assets are negligible Leverage: main European banking systems (December 2012) Source:Bank of Italy, FSR n 6 European banks’ level 3 assets (%)

18. Capital Needs: the FSAP of the IMF o IMF (FSAP, Sept. 2013): 32 banks, individual data: o capital need in stressed conditions €bn. 6.0-13.8 (0.4-0.9% GDP) o shortfalls mainly in small-medium local banks o Estimates of private analysts: based on heterogeneous hypotheses and methodologies, but results are of similar magnitude

19. Summary Assessment & Outlook o The Italian banking system has shown strong resilience in the face of an exceptional economic crisis o A successful, gradual exit from currently stressed condition is possible o SSM and BSA will enhance transparency. They are not a further problem. They are part of the solution

20. o Economic recovery after a double dip recession is the critical success factor for Italian banks. It is a precondition to start reduction of the stock of nonperforming loans and to restore profitability o Expectations for key ECB interest rates to remain low for as long as necessary provide support to recovery o Continuing national efforts at reform of the economy and consolidation of public finances are key Summary Assessment & Outlook

21. Thank you!