The 2016 Stability Law introduced tax cuts for households and companies that, along with the privatization plan, gave a much-needed boost to the economy. The banking reform encourages the system to become stronger and leaner through the consolidation process
Italy is seeing the light at the end of the tunnel. After years of stagnation and recession, GDP growth returned on positive territory with +0.8% in 2015 and is set to strengthen this year.
The global economic outlook, however, remains volatile and it certainly affects Italy. Although the National Institute of Statistics (Istat) recently showed that Italy’s growth stopped during the second trimester of 2016 compared to the first one, it has also adjusted positively the estimated growth acquired since January, from 0.6 to 0.7%. “Italy keeps on going on its long journey. 2016 will end better than 2015 and 2015 was better than 2014, this is a fact. But it’s not enough. We are recovering but there is still a lot of work to do,” Prime Minister Matteo Renzi commented.
No one could accuse the Italian Prime Minister of complacency. Far from letting the old machinery rot, his government approved a Stability Law which introduced tax cuts for households and companies, thus giving much-needed oxygen to the economy; while Minister of Finance Pier Carlo Padoan’s strategy of tax cuts, fiscal incentives, and a privatization plan will help boost Italy’s competitiveness and reducing public debt.
“Privatization is part of the structural reform agenda because before you privatize a company, you have to put it in good shape,” affirms Mr. Padoan. “You have to revamp its business model; increase its profitability; and then once you’ve done that, you put it on the market.” Minister Padoan’s strategy indeed aims at increasing the competitiveness of state-driven companies to operate in a market environment.
With regards to the fiscal incentives introduced so far the Ministry of Finance “will continue for the rest of the legislature to provide tax benefits to companies,” he says. “This tax policy matches deliberately with the Jobs Act reform, as it introduces incentives for new, open-ended contracts. We have put tax benefits to further provide support for open-ended contracts and we are registering a solid growth in job figures.”
The government is also taking on what is possibly Italy’s biggest threat: its troubled banking system and the high volume of non-performing loans (NPLs).
Ignazio Visco, Governor of the Bank of Italy, thinks that the issue of NPLs has to be explained differently: “What needs to be understood is that Italian banks’ bad debt is guaranteed to a large extent by collateral, which is mostly real estate. And in contrast to other countries, real estate prices in Italy are not overstated. The issue is that it takes a long time to recover the collateral.”
Mr. Renzi’s political future depends on stemming a bank-induced crisis that may jeopardize the economic resurgence. His banking reform aims at mitigating NPL indigestion, while transforming popolari banks into joint stock companies. The reform also seeks to speed up the process to recover collaterals for NPLs.
Minister Padoan says that the government is taking a “pro-market reform approach” to the banking crisis: “We are getting rid of the hangover of tax credits in the banks’ balance sheets and encouraging the restructuring of the banking sector towards an American-oriented system which could also facilitate raising capital.”
Italy’s struggling banks, unlike others in the euro area that went through similar ordeals, are seeing how the government is hand-tied by new EU rules that constrain its ability to rescue them. The era of massive taxpayer-funded bailouts is over. Now no Italian bank can be recapitalized with public money without first forcing big losses on investors, many of whom are ordinary families without proper financial training.
This so-called “bail-in” approach reflects popular discontent over the government banking bailouts that were the norm in several EU countries just a few years ago. For Mr. Renzi, the new rules are another headache as he tries to find a way to recapitalize banks like Banca Monte dei Paschi (BMPS) without overburdening the small investors that are first in line to take the hit.
As the use of public money is restricted, both private lenders and public officials have resorted to initiatives such as Atlante, an instrument created to intervene in the recapitalization of struggling banks. This €5 billion ($5.6 billion) fund, launched in April, brings together banks, insurers and institutional investors and is run by a private manager. One of the participants in this mechanism is the state-backed bank Cassa Depositi e Prestiti (CDP). Its Chairman, Claudio Costamagna, says that the main objective of Atlante is “re-activating the banking system”.
Left: Pier Carlo Padoan, Minister of Economy and Finance | Right: Claudio Costamagna, Chairman, Cassa Depositi e Prestiti (CDP)
This formula seems to be the way ahead, as an agreement has emerged for a new €2.4 billion fund (dubbed Atlante 2) aimed at alleviating the situation of BMPS. The bulk of the money (€1.6 billion) will come from new contributions on the part of Italian banks and insurers, and the remaining €800 million will be transferred from Atlante 1.
The moves have so far failed to convince investors, and the Italian stock market index Borsa Italiana is not immunized from new losing sprees. However, its CEO Raffaele Jerusalmi thinks that the problem does not lie in the solidness of the banking sector, but in the hastily introduced bail-in policy: “Communication was insufficient. A transition period should have been introduced instead of creating retroactive measures.”
The industry’s efforts are also focusing on banking consolidation, as part of the problem with banks is their high operational costs. One reason for this is their sheer number, as Italy is one of the countries with the highest per capita number of bank branches.
The main development seen so far in terms of banking consolidation is the merger between Banco Popolare SC and Banca Popolare di Milano (BPM) in March, which was Italy’s biggest bank deal in almost 10 years. The merged entity has effectively become the country’s third largest bank.
The operation, which required measures such as boosting capital buffers or writing down bad loans, along with a commitment to create a NPL unit to maximize recoveries, shows the way for future consolidating maneuvers.
Giuseppe Castagna, CEO of the new merged bank, emphasizes how important it is to gain size in a banking environment that has been traditionally burdened by excessive fragmentation: “Despite the fact that BPM was one of the smaller amongst the popolari banks, we were performing better so we could afford to have a merger with a bigger bank. We wanted to take advantage of the economic performance we were recording in order to have a merger to increase our size.”
If Italian banks are to survive, mergers need to be carried out. But there is another factor that crucially increases operational costs: slowness in embracing digitalization. Italian banks are still old-fashioned in their approach, and rely too much on costly branches on the grounds that a direct relationship with clients is essential. Digitalization, by contrast, has been disregarded.
This view, according to Mr. Castagna, is not in tune with the current nature of the banking industry: “The best product doesn’t mean having a branch every 500 meters. You only have to give clients the opportunity to do banking wherever they are.”
As reforms proceed apace, Italian banks are faced with additional challenges such as Brexit, which made their shares slump. However, the inner strengths of the country and the determination of a reformist government make the case for justified, if cautious, optimism.
The biggest brakes and threats to the economy have been rightly identified and tackled by both the authorities and the private sector, and GDP growth has returned after a long absence despite international turmoil. Isn’t it a sign that a renewed Italy is arising?