Why the Italian Banking System that ‘Cruised Over’ the Global Financial Crisis, Found Itself Roiled by the Sovereign Debt Crisis: Reviewing and Highlighting the Key Issues
IGPA Working Paper 20/05/04
49 Pages Posted: 4 May 2020 Last revised: 10 Aug 2020
Date Written: May 4, 2020
The Italian banking sector, except for some few albeit systemically important institutions, to a large extent rode the tide of the global financial crisis (2007-2008) relatively unscathed. The feat owed as much to resilient banks with adequate capital and liquidity, capacity to augment capital without BI support, that is part is attributable to the existence strong regulatory regime that covered most aspects of bank operations, including management and auditing board appointment, investment, transactions with connected parties, governance at both solo and group level, a comprehensive offsite and onsite supervisory regime, and the existence of a strong if not generous deposit insurance system, complemented by the existence and enforcement of a strong multi-stakeholder macroprudential regime that fostered financial stability. Nonetheless, as the financial crisis intensified and begun to roil not on domestic and European financial markets as contagion spread the United States, support from the Italian government through Bank Italia and Ministry of Finance and economy, coupled with the injection of capital from ECB was also an important factor in the equation that not only prevented the spread of contagion throughout the entire banking and financial system, but created the foundation on which a healthier and more sound, transparent, less leveraged, high risk asset weighted capital buffered banking system is emerging. State intervention, however, inevitably exacerbated rising sovereign indebtedness that since 2011 has become the new daunting if not intricate problem for the Italian banking system and economy. This is the more so , given the pivotal role that Italian government bonds contributed to stymying the Italian banking sector from even deeper contraction by strengthening bank balance sheets through injection of new capital, an overhang of illiquid toxic assets and managing toxic liabilities since 2008. Regulatory framework has in the aftermath of financial crisis been enhanced to plug some of the fissures the crisis exposed including protection of minority shareholders, by among other requirements things requiring enhanced governance, appointment of independent directors, giving more say on representatives of minority shareholders through for example the appointment of independent directors; strengthening BI authority to manage troubled banks by enhancing its authority to influence the appointment bank management boards, bank senior officials, and external auditors; enforcing integrity and governance and transparency of banks; minimizing and preventing fraud though transactions involving connected parties; and strengthen deposit insurance regime. However, protection for supervisors from litigation that arises and is consequence of the conduct of their duties, remains a weak point that needs strengthening. The same applies to the opportunity that remains open for bank shareholders to source funds to contribute to bank equity by borrowing which undermines efforts to bolster prudential banking principles, upholding fitness and propriety of bank investors, and reducing undue influence and intervention from vested interests, all of which are aimed at strengthening bank soundness and resilience. Other remaining obstacles that future bank stability in Italy is likely to face include, the still relatively low risk weighted bank capital, lingering NPLs, high concentration of bank ownership among a few banking groups, which also control other subsectors of the financial sector such as insurance services; limited transparency of foundations that control banking groups and sole banks through complex cross ownership schemes; the role of political intervention (requiring court decisions) on issues that should be in the remit of supervisory agencies. On that list other issues that are equally important , while by no means exhaustive one, run the gamut to range from the ex post funding approach for activities of deposit insurance agencies such as repaying compensation to third party depositors which makes the insurance system vulnerable to shortage of funds in the event of a banking crisis. That reduces the ability and capacity of deposit insurance to perform their vital function of mitigating depositor trust in the banking system during times of financial uncertainty and economic turbulence; high indebtedness of municipal and regional governments, which ironically contributed to the success of Italian banking in averting near collapse akin to a pyrrhic victory that occurred in other EU member countries such as Ireland, Greece, Iceland, Portugal, and Spain, hence a legacy of global financial crisis that in part contributes to the high net debt of the general government; sluggish total investment, anemic economic growth that is not high enough to reduce unemployment that hovers above 10 percent, and high cost of doing business. The cacophony of the above problems, will undoubtedly be compounded by the repercussions of the fallout of the COVID-19 on not exponential growth of government expenditure on health care provision, economic stimulus package to rejuvenate and prevent deeper economic contraction across the board from transportation, financial services, tourism and entertainment, manufacturing, and trade and commerce. There is little doubt that EU will have to lend a hand in some way, if the impact that COVID-19 has had on Italy (and Spain) as the worst hit EMU economies, is not to send shock waves throughout EU, thereby providing fodder for anti-EU skeptics to start where ‘Brexters’ stopped-whipping up nationalism-populism to a new dangerous level that unless handled with dexterity and extreme caution, may pose serious threat of not only undermining but most worryingly sound a death knell, to the most successful social, economic, political and cultural integration project to date- the European Union.
Keywords: financial crisis, supervisory regime, sovereign debt crisis, Tremonti bonds, ECB, deposit insurance, precautionary recapitalization, college of supervisors
JEL Classification: E52, E58, G3, 016
Suggested Citation: Suggested Citation