Effect of the Financial Crisis on Italian Banks: Analytical Essay

Introduction

This paper is about the effect of the financial crisis on Italian banks. The financial crisis can be divided into two different phases: the first is the subprime phase from 2007 to 2008, while the second is the sovereign debt and redenomination risk phase from 2010 to 2012. During the first part of the period, Italian banks were stronger than other different countries’ financial systems, but the system became weaker in the second phase of the crisis (Cosma and Gualandri, 2012).

In the first chapter, the paper describes the two periods of the crisis. In particular, Cosma and Gualandri (2013) underline how Italian banks reacted positively in the subprime phase and the deterioration of the second phase. The initial positively reaction is visible from the little quantity of public facilities used in Italy during that period; the situation is different in the second part of the crisis which caused a strong recession and difficulties for the financial system, where banks increased the level of non-performing loans (NPLs) and used a large amount of long term financing operations (LTROs) (Cosma and Gualandri, 2013).

In the second part, there is a specific analysis of the impact of the crisis on banks, in particular during the worst period, and a description of their financial situation and reactions to these events.

Discussion

The financial crisis can be divided into two different main phases: the first is the subprime phase which covers the years 2007-2008, the second is the sovereign debt and redenomination risk phase from 2010-2012. Italian banks reacted in different ways to the phases of the financial crisis. In fact, while in the first period Italian banks were stronger than others, in the second period they were hit hard by the sovereign debt crisis.

The law impact of the crisis on Italian financial system is shown by the rare use of public facilities concentrated in the first years of the period.

In fact, after the outbreak of the crisis, the Central Bank decided to adopt unconventional monetary policy in addiction to the conventional policies which have been used since that moment. In particular, the aim of these policies was to restore the price stability and to give a new impetus to the economy; unconventional policies had to be exceptional and temporary, hence the denomination “unconventional”, but, in reality, they are still used today. The difference between the conventional and unconventional policies is very subtle and it is often only a matter of applying conventional policies to non-standardized terms and conditions. For instance, after the outbreak of the financial crisis, the list of assets eligible as collateral was expanded, to include securities that were not previously accepted. Among these non-standard measures, there were the long-term refinancing operations.

Italian banks, in the first period of the crisis, used only 5% of the public facilities with respect to the entire amount of them which have been given in Europe. From this point of view, Italian financial system was more stable than other countries: the worst result was recorded in England with the 45% of public facilities asked by the country, but negative and worrying data are also recorded in Germany with the 16%. On the other hand, the percentage of Greece was surprisingly low, considering the total level of resources made available in Europe. Other European countries with positive outcomes were Switzerland (2%), Spain, Portugal, Austria, and Denmark (all of them with 1%), and then the best country which was Iceland with 0% of public facilities used.

The beginning of the crisis and the reaction of Italian banks

The financial global crisis began in the summer of 2007 when the first financial problems arose in the interbank market and in the market of innovative financial instruments, the asset backed securities (Abs), issued in the context of securitization transactions. The spread of securitization transactions distorted the credit market. The possibility of transferring risk to the credit market had led to imprudent and risky management practices in the granting of loans: a correct assessment of creditworthiness was not carried out. Some mortgages were defined as “subprime”, due to the high risk of non-repayment. Moreover, securities deriving from securitizations could be subject to further transactions of second or third level, thus causing asymmetric information in financial markets.

In September 2008, one of the most important American investment banks, the Lehman Brothers, crashed. However, until that moment Italian banks managed to overcome the difficulties and not to suffer serious damage. The value of the shares of the most important Italian banks collapsed, but less than other international banks; profits were decreasing, however, banks were not losing cash; in fact, declining profits was important, but not at the level of other banks which had serious difficulties; furthermore, the level of capital was higher than the value prescribed by the authorities of prudential regulation (Cosma and Gualandri, 2013). The reasons of Italian banks’ positively reaction were essentially two: one was connected with the model of business adopted by the financial intermediaries and the second was the national supervision focused on the rules established by the Central Bank of Italy. The structure adopted by Italian banks was the traditional banking system, according to which the activity was focused on the collection of savings in the form of deposit and on the loan of a portion of that funds, thus obtained, through credit operations. Banks’ portfolios had a law level of risk and their business was based on stable funding; moreover, in the first years, Italian banks had not adopted financial innovations, like securitization operations, at the same level of other international banks. Therefore, Italian banks had a strong structure capable of facing the difficulties of the moment. The other reason of the resilience of Italian financial system was the control entrusted to the Bank of Italy. The rules given by the Central Bank were very strong and did not allow to grant risky loans. It was a prudential supervision aimed at preserving the stability of the system and being ready to face any crisis. The Italian supervisory system, also for the choice of the capital requirements of the banks – based on Basel I agreement- was more careful than other European countries.

However, after the Lehman Brothers collapse, Italian banks suffered a lack of confidence of the entire financial system and a lack of liquidity, due to the problems to obtain liquid funds from the interbank market. Despite this, most of Italian banks had made positive profits during that period and only four of them (Banco Popolare, Banca Popolare di Milano, Monte dei Paschi, and Credito Valtellinese) used public facilities given by the government like Tremonti bonds. The latter were securities computable in banks’ regulatory capital, without voting rights; they aimed at strengthening banks’ capital and increasing their competitiveness.

The second phase of the crisis and the reaction of Italian banks

Italian banks began to suffer the effects of the crisis in the second phase: the sovereign debt crisis. On that situation, the best characteristic of Italian banks, the traditional banking system – which allowed them to overcome many difficulties during the subprime phase – became a point of weakness. The cause of these problems was the increase of non-performing loans in banks’ balance sheets and the relative and low use of public facilities granted by the European Central bank, which other states had used on a large scale to face the crisis. In fact, Italian banks used only 0.3 % of the gross domestic product (Mediobanca R&S, 2012). Until 2010, the damage to Italy was not important because of a law exposure to the sovereign debt of Greece, Ireland, Portugal, and Spain (Cosma and Gualandri, 2013). However, then the situation worsened as a result of the entire and systemic negative situation of the market and the demands to the banks after Basel III. In 2011, the sovereign debt of peripheral states increases, in particular of Spain and Italy; there was not a solution to the Greece crisis and the instrument granted by the European Central Banks were not enough. Because of its high debt, Italy was seen as a risky state, and this cause for Italian banks an increasing in funding coasts, a decreasing in the value of guarantees and then the situation worsened after the stress tests and the requests by the European Banking Authority (EBA). In June 2012, the problems of the major Italian banking groups had been solved, except for Monte dei Paschi di Siena. The latter suffered huge losses deriving from the acquisition of Banca Antonveneta with the creation of special derivates and was subsequently hit by a serious scandal related to the management of these instruments. On that occasion, the government decided to take special measures, the so-called Monti Bond, to restore the situation of the bank Monte Paschi di Siena.

However, the deep recession of june 2012, caused the deterioration in banks’ credit quality and a rise in non-performing loans in their balance sheet. The increase in the risks of loans granted to companies, especially PMI, and the consequent reserves of banks, necessary to grant these loans, caused the phenomenon of credit crunch in Italy (Gualandri e Venturelli, 2014) and led the Bank of Italy to carry out specific checks on non-performing loans. The EBA (2013) survey, on the basis of the dara collected in 2012) revealed differences in the level of deterioration of credit among various European countries. However, a confrontation between several countries is problematic and often led to distorted outcomes, due to the different parameters that are used in each country (Bank of Italy 2013, Financial Stability Report, n. 5, April; EBA 2013).

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