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The sovereign-bank nexus in Italy

7/11/2019

The risk premium on sovereign bonds between Italy and other Eurozone countries (excluding Greece) has widened for a little over a year now. Causes and consequences.

TRANSCRIPT // The sovereign-bank nexus in Italy : July 2019

3 QUESTIONS

François Doux: From both a structural and cyclical perspective, there is a growing gap between Italy and the other Eurozone countries, with the exception of Greece.

François Faure, hello.

François Faure: Hello.

François Doux: Let’s talk about the impact of this gap, or “spreads” as they are also called, on the Italian banking sector. What is the reason for these spreads?

François Faure: The spreads mainly reflect the need to stabilise the public debt ratio. Growth and inflation remain very low. Moreover, the new coalition government seems to be tinkering around with fiscal policy.

François Doux: Could you talk about Italy’s public finances?

François Faure: In 2019, the fiscal deficit should drop below the target of 3% of GDP after the European Commission insisted that Italy revise its budget last December. Even so, with such sluggish growth, fiscal efforts will barely stabilise the debt ratio. Moreover, significantly higher spreads mean that Italy will not benefit from lower interest charges as much as the other Eurozone countries.

François Doux: Fundamentally speaking, why is Italian growth so weak?

François Faure: There are demographic factors, but the main reason is the stagnation of productivity. As a result, there has been no improvement in competitiveness. Yet competitiveness is vital for the Italian economy, which relies on a dense fabric of export-oriented SME. Yet SME are particularly sensitive to any deterioration in price competitiveness.

François Doux: Let’s now turn to the Italian banking sector. What are the consequences of higher risk premiums on sovereign bonds?

François Faure: The immediate impact is on the valuation of public securities held by Italian banks. Based on current interest rates, and considering the maturity of Italian public debt, a 100bp increase triggers a loss of 6.5% on the value of the portfolio of Italian banks. Fortunately, a little more than half of public securities portfolios are held until maturity, in which case Italian banks should not report any losses.

François Doux: This balance sheet risk is well known, but what about credit risk? Tell us about Non Performing Loans of banks.

François Faure: The situation has improved. The overall NPL ratio has fallen in recent years, even though it is still high at 8%, compared to a Eurozone average of only 3%. The stock of NPLs was slashed in half after Italian banks cleaned up their balance sheets. Moreover, companies are in a healthier financial position.

François Doux: Why?

François Faure: First, thanks to corporate deleveraging, the well-known gearing ratio -- debt as a share of capital -- has dropped from 50% to 39% currently. This is the level that prevailed before the financial crisis. Thanks to deleveraging and the decline in interest rates over the past six years, the interest debt burden of corporates has also been slashed in half, enabling companies to rebuild their cash position.

François Doux: Last question. Has the increase in risk premiums also had a negative impact?

François Faure: Yes, of course, because banks could carry over higher risk premiums to deposit rates. Yet this would mainly hit SME, not only because they are more fragile, but also because the majority of credit lines are short term.

François Doux: François Faure, thank you.
On behalf of all of the BNP Paribas Economic Research teams, we wish you a very pleasant summer.
Tune in again after the summer holidays.

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