In recent years, Italian banks have been less exposed to high-risk products compared to the banks of other large countries, such as the UK or the US. This is due to not only their conservative behaviour, but also to some tight regulation and supervisory caution. The conservative nature of the Italian financial system has meant that the economy wasn't hit as hard by the financial crisis compared to other major world economies. Forecasts predict that by 2010, the level of US bank losses will reach $1 trillion, compared to $1.6 trillion for the whole of the European banking system.

Figure 1

As you can see in figure 1, the relative losses for Italian banks were very small relative to US and UK banks. Due to their relatively low exposure to high risk products and toxic financial assets, no Italian banks have collapsed or have had to be bailed out. This is a stark contrast to the US - just ask the ex-employees of Lehmann Brothers! In total $490 billion dollars had to be pumped in by the US government to stop their financial system from collapsing. British banks also relied heavily on their government to stop them from going bust. For example Northern Rock was nationalised in February 2008.

However the financial crisis has spread into the real economy and, as a consequence, Italian banks' asset quality and profitability indicators deteriorated last year and are likely to worsen further in 2009 and 2010. Bank financial strength ratings (BFSRs) are generally expected to trend downwards, while the effect on deposit ratings is likely to be more limited due to demonstrated and expected systemic support. The financial fundamentals of Italian banks deteriorated in 2008 and will continue to decline through 2009, largely due to asset quality concerns. Morover, the two largest banks made extensive acquisitions in certain eastern European countries which may be vulnerable to downturns in those economies. Despite their low exposure to the key risky assets, Italian banks suffered along with banks worldwide from the difficulties on the interbank market, fall in their share prices and diminished or vanishing profits as the economy slowed. While they may have operated a relatively cautious lending policy, they were not carrying excess capital reserves and many of them are well integrated into international capital markets. Hence, generally tighter international credit conditions were already obliging Italian banks to restrain their own lending in Italy. The European bank lending survey shows that credit standards have tightened in Italy to a very similar degree as elsewhere. Banks have used ECB liquidity facilities and are energetically selling bonds to the public.

In addition to massive bank losses, trillions of dollars were lost in many other financial markets. Between June 2007 and November 2008 alone, a staggering $8.3 trillion was lost in US financial markets. This comprised of a 20% fall in house prices; a 30-35% fall in futures markets; a multi-trillion dollar fall in home equity; a $2.3 trillion fall in total retirement assets; a $1.2 trillion fall in savings and investment assets; and a $1.3 trillion fall in pension assets. UK financial markets were similarly hit hard, but obviously not on the same scale as in the US.

Figure 2

As shown in Figure 2, house prices in the UK fell in 2008 for the first time in years. In October 2008, the total annual price fall was 12.4%. Unlike in both the UK and US, the Italian housing market did not suffer straight away when the financial crisis hit.

The Italian mortgage market is relatively small compared to other European and major worldwide economies. The market is around 20% of GDP, compared to an EU average of 50%. Most property transactions are financed through savings. Hence the slash in the amount of available credit as a result of the crisis had not affected Italy as much as many other countries. In the US, house prices fell 20% between June 2007 and November 2008. In Italy house prices actually rose, by 4.2% in 2008 and by 1.9% in H1 2009. However Italy finally entered recession in February 2009, and house prices were expected to fall by 7-8%.

In October 2008, the Italian government adopted a series of measures to combat the global financial crisis. The measures were contained in a decree based on an accord struck between the 27 European Union economic and finance ministers. These measures included granting state aid to troubled banks; buying stakes in the banks; guaranteeing new banks loans; increasing the amount of liquidity in the market and making it easier for banks to lend money to each other at lower rates.

The central bank has made €40 bn of treasury bills available to refinance bank debt. In response to the difficulties on the interbank market, the Bank of Italy promoted a collateralised interbank lending clearing facility. The Bank acts as a market facilitator, monitoring the quality of collateral to give participating banks sufficient confidence to maintain liquidity in this anonymous market. Participating banks agree to guarantee the collateral vetted by the Bank, but there is a potential residual liability for the Bank of Italy. Branches of foreign banks can participate only if their own central banks accept a share in this potential liability, a potential disadvantage for such banks. However, as a useful way to overcome the problems on the normal interbank market, the distortion to competition and implicit subsidy involved seem minimal, especially compared with other measures to support banks that have been taken elsewhere.

The authorities should be ready to act to maintain the functioning of the financial system if the downturn accentuates problems for banks. It will also be important to continue to strengthen information-sharing and coordination domestically and with foreign counterpart regulators, both to avoid regulatory arbitrage and to keep track of potential risk. In the longer term, policy should ensure strong competition for both deposits and lending business, within prudent regulatory standards, to promote strong long term growth. Revising capital requirements to make them less pro cyclical is a useful direction to consider, in conjunction with other European regulators.

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