Business Models in Banking: Is There a Best Practice?

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1 Business Models in Banking: Is There a Best Practice? Welcome Address Gregorio De Felice Chief economist, Intesa Sanpaolo Università Commerciale Luigi Bocconi Milano, 21 September

2 First of all, I d like to thank Professors Andrea Resti and Giuliano Iannotta for having organised this International Conference. They made a great job, collecting a series of papers of very high level from all over the world. And I would like to thank all the distinguished economists who accepted to attend this Conference today. The agenda is so tight and the topics to be analysed so numerous that I am tempted just to say Thank you for coming and good work!. However, I think that especially in this moment it is important to point out some aspects regarding the Italian banking system in an international perspective. The Financial crisis and Italian banks Italian banks have enjoyed a position of relative strength during this financial crisis, thanks in part to the restructuring process carried out in the Nineties but also thanks to their better business model. All of them, except for a few exceptional cases, reported a net profit in 2008 and in the first half 2009, although earnings were down on the year before. The previous profitability gap existing between Italian and European banks has been inverted: in terms of ROE, from a gap equal to 6.4 percentage points, Italian banks passed to a positive difference of 1

3 13.4 pp (5.4% versus -8.0% of the main European banks on average on 2008 figures). This relatively better soundness has meant that Italian banks have not required emergency public intervention, in contrast to many other countries. I think there are some specific reasons that explain this resilience. Low financial leverage Specifically, thanks to prudent policies and decision making, Italian banks are less leveraged than their European counterparts. In December 2008, the financial leverage of Italian banks stood at 22 (total assets/tier 1 capital) vs. 33 for major banks in the Euro area. In addition, capital adequacy, as measured by the Basel capital ratios, is broadly commensurate with the risks assumed. Italian banks are characterised by good quality capital, since the core component is higher 1. In addition, ever since the outbreak of the crisis in 2007, no Italian bank has reported major liquidity issues, thanks in part to the vigilant management policies implemented on this front. 1 As Bank of Italy Governor Draghi noted in a recent address: Capital has remained generally above the regulatory minimum. The method of calculation of the capital ratios is based on more prudent criteria than is the case in other countries. 2

4 Strong retail players What is more, the widespread territorial presence has enabled Italian banks to face the difficulties engendered by the crisis on the interbank and public bond issuance markets by drawing on a broad base of customer deposits, at a time of elevated risk aversion among small investors. Therefore, in contrast to our international competitors that have been hit harder by the crisis, Italian banks have not had serious liquidity or funding issues and have been able to manage the crisis without sustaining any particularly severe shocks. They are therefore less dependent on artificial forms of outside funding and liquidity support. Traditional business model Unlike major international banks, in recent years Italian banks have operated in accordance with a traditional business model based on keeping the risks on their balance sheets and on the predominance of commercial banks core business, with respect to financial activity, which has always been residual. 3

5 With reference to December 2008 data from a panel of 29 European banking groups, customer loans make up 63% of the assets of Italian banks, and financial operations just 18%, vs. 38% and a whopping 47% respectively for the EU banks average (excluding Italy). For major banks in the United Kingdom, France and Germany, financial assets outstrip the customer loans. In addition, major Italian banks have the highest business loan weighting, at an impressive 40% of assets, more than double the EU average (16%). Except for Spain, business loans account for less than 20% of assets among large banks in the other major European countries, with German banks recording a low of just 8%. The outlook In order to continue fulfilling their role in supporting the economy even during a difficult recession, banks must first of all have solid and robust financial fundamentals. It is however inevitable that lending becomes more cautious in troubled times like these. While this global financial crisis has not had severe repercussions on Italian banks because it originated in a business segment to which they are little exposed, the recession does impact on their core business. 4

6 The key is asset quality. During an economic recession, this factor is particularly important for banks which, as in Italy, focus on lending to customers. After years of steady reductions in the weighting of problem loans, some signs of deterioration in asset quality have emerged since the end of The economic crisis means that the business of Italian banks is going to be more difficult than in the past. Our task is to continue to ensure good lending, to support innovative projects and initiatives, and to help struggling firms with restructuring, where appropriate and if the prospects are positive. At the same time, banks must avoid bad lending as this would be deleterious for the economy as a whole. In this case, it should be difficult to find justifications in case of a new wave of financial turmoil. Finally, I think it s clear that banks (all banks in the world) have to think their business models over. The stabilization process underway, the current improvements towards normality cannot allow to forget the enormous risks we ran. We cannot run the risk of a collapse of the international financial system again. Therefore the right adjustments have to be adopted even if the situation now seems normalising. 5

7 This is why Intesa Sanpaolo strongly support this initiative. This is the first edition of this conference but our aim is having an Annual conference on banking issues here at Bocconi University since it is not a difficult forecast foreseeing that banking issues will continue to be crucial for politicians, regulators and economists in the coming years. 6