AFO. ABI Financial Outlook. Forecast Report Summary and conclusions. December ABI Financial Strategies and Markets Division

Transcription

1 AFO ABI Financial Outlook Forecast Report December 2010 ABI Financial Strategies and Markets Division Economic Analysis Office

2 This Report was prepared on the basis of information available as at December 17, 2010, and its preparation was coordinated by Riccardo Benincampi, Vincenzo Chiorazzo and Gianfranco Torriero. Author (summary and conclusions section): Vincenzo Chiorazzo The members of the AFO banking panel were: Associazione Nazionale fra le Banche Popolari, Banca delle Marche, Banca di Piacenza, Banca Monte dei Paschi di Siena, Banca Nazionale del Lavoro - Gruppo BNP Paribas, Banca Passadore & C., Banca Popolare di Bari, Banca Popolare di Milano, Banca Popolare di Puglia e Basilicata, Banca Popolare di Sondrio Spa, Banca Popolare Pugliese, Banco Desio, Banco Popolare, Credito Valtellinese, Deutsche Bank Spa, Iccrea Banca S.p.A., UBI Banca, UGF Banca, and UniCredit Group.

3 OVERALL OUTLOOK 1. The macroeconomic outlook offered by this Report is less reassuring than that outlined six months ago. Many of the concerns foreshadowed in our forecast report of last July have essentially come to pass: a slowdown in the pace of recovery and, above all, a widening of the problems affecting the sovereign debt market. Looking beyond the short-term figures, it now seems clearer that the period of turmoil cannot yet be considered to be behind us, and that problems which are at once both new and old make medium-term outlook rather uncertain. The United States faces the risk that deflation could halt the deleveraging process underway in its private sector, such that American policy-making authorities are devoting all means at their disposal both conventional or otherwise to avoiding this eventuality. Europe, in turn, has had to contend with a succession of sovereign crises, a new phenomenon that has seen the old compulsions towards a two-track euro resurface. 2. In this scenario of overall weakness, in which growth still looks set to be modest (for Italy, little more than 1% on average over the three-year period of ) and inflation kept under control, monetary policies in contrast with fiscal policies will remain expansionary, with the exit strategy postponed, extraordinary measures remaining largely in place, and expectations regarding the future level of monetary rates remaining depressed; the level of long-term rates will consequently remain moderate by historical standards. 3. In the scenario depicted by our forecasts (which we have prepared, as usual, on the basis of inputs from the research divisions of the major Italian banks), the efficacy of the Italian banking system emerges as obviously affected by this climate of uncertainty, though efforts will be made by the sector to limit this impact: the volume of loans, recovering in recent months, should grow steadily at more than the expected rate of economic growth, which is in any case modest, whilst funding activities should easily succeed in achieving their financing objectives despite the effects of the current crisis. The low rate of economic growth and low interest rates should ensure that future profitability will remain contained, at a level slightly lower than forecast in the previous Report and significantly less than has been the experience in the last decade, notwithstanding careful cost-controls, especially in the area of staff costs. 1

4 * * * RECENT ECONOMIC DEVELOPMENTS 4. The most recent trends indicate mixed macroeconomic developments, with the U.S. continuing on the same path of not particularly sustained growth as during the preceding three months, production activity in China and India remaining brisk, and Japan, closely on their heels, also showing brilliant results. In the euro area, growth rates were similar to those in the U.S., but with a certain degree of variance in results due mainly to the isolated performance of Germany, which, with an annualized growth of 3.9%, is today more than any other country the powerhouse of the European economy. 5. In many ways, the German economy today seems like a happy oasis, exhibiting strong recovery in production, good employment performance, satisfactory profitability levels in industry, and a good climate of confidence all against a backdrop of stability evidenced first and foremost by limited price growth. Taken together, these results seem to be the intentional outcome of a good combination of economic policies and private-sector decisions. The mix of economic growth, low inflation and balanced public budgets is the product of measures aimed at developing labor productivity and an income policy geared towards moderation. It is not, however, without consequences in terms of growth of trade imbalances within the monetary union: Germany s impressive current account surplus is in contrast with the continuous deterioration of the foreign trade position of almost all the other European economies. Not unlike China s impact on a global scale, Germany in addition to being Europe s locomotive now also risks becoming a generator of local imbalances that could weigh heavily on the long-term prospects of the euro area. It would seem necessary for processes aimed at increasing productivity, accumulating capital (especially in higher-tech sectors) and improving the overall efficiency of the production system, to be implemented in many of the European countries that have not yet done so (including Italy). However, in order for this necessary process to avoid having a depressive effect on the entire euro area, and for it, instead, to improve the area s development potential to the benefit of all, it is equally the case that it needs to be conducted within a framework of strong European economic policy coordination, which, for Germany, could involve foregoing some short-term benefits. 6. Germany s economic surge, its splendid isolation, and the high degree of 2

5 volatility in the financial markets due to the increased level of sovereign risk in various countries, give rise today to a great deal of uncertainty regarding growth prospects in the short to medium term for the countries of the euro area. In this climate of uncertainty, the effects of the financial crisis continue to shape monetary policies. 7. The U.S. financial situation is amply exemplified by a divergence in trends between, on the one hand, shrinking private-sector debt, conducive to finding an equilibrium level of leverage, and on the other, a strong surge in public-sector debt, stemming from efforts to prevent the American economy from sliding into a state of deflation. Indeed, as has been well-explained by Krugman, in the American situation, it is crucial to vouchsafe the process of private-debt reduction without overly penalizing economic and price growth. Recent economic data seems to suggest that these fiscal efforts are, on the one hand, achieving success in sustaining domestic demand, which is now growing at a good pace, but on the other hand, that a notindifferent proportion of that momentum is being lost to foreign producers. Seen in this light, the underlying reasons for the continual pumping of liquidity into the financial system by the Fed, and American protests at the excessive undervaluation of the Chinese currency, become all-too-clear. 8. For its part, the financial situation of the euro area is marked by sovereign-debt crises. Analyses carried out in the Report highlight the bearing that the measure of a country s net foreign position and hence the notion of net total debt-to-gdp has on the market s choice of targets. The group of countries currently experiencing difficulties is without question characterized by a substantial net foreign debt position, whilst Italy s lower foreign indebtedness explains why the country is relatively insulated from the effects of the ongoing crisis in Europe. Whilst developed Europe is in difficulty, transitional Europe seems to be holding up better against the onslaught of the crisis. Recent experience shows that, contrary to what some feared, the strong presence of foreign banks, particularly from the euro area, in the ownership structures of the banking systems of transitional Europe, has not created problems of instability in the financial systems of Eastern European countries, because European banks consider investment in Eastern Europe to be long-term and strategic for their development prospects. OUTLOOK: THE GLOBAL SCENARIO 9. This Report revises assessments of global growth prospects downwards. After 3

6 recovering well this year, global GDP should slow down significantly in 2011 (from 4.5% to 3.9%), to then return to growth at rates similar to those forecast for this year. This U-shaped trend is likely to be experienced by all the principal economic zones, with the leading role played by the BRIC economies, whilst U.S. growth looks set to be feeble by its own standards. Vis-à-vis the forecasts made in July, the main downward revisions relate to U.S. economic growth, both as regards the provisional figure for 2010 as well as the forecast trend for the next two years. The growth outlook for the BRIC countries and the euro area as a whole remains essentially unchanged, with a better performance in 2010 than previously forecast for both areas. In terms of prices, the anticipated trend in the price of oil has been revised significantly upwards for the next two years: in 2012, it should on average be priced at $92 a barrel, a figure 48% higher than the average in This increase should not fundamentally alter the trend in domestic prices of either the U.S. or the euro area, which, under the dampening effect of a weak economic situation, should gradually rise to converge at a growth rate of close to 2%. 10. In our forecast scenario, monetary policies are unlikely, in any event, to concern themselves overly with the possibility of inflationary pressures stemming from a rise in oil prices. We have essentially retained the policy-rate level outlined in the previous forecast scenario, whilst further prolonging the expected timing of a rate rise. Thus, in 2011, reference rates in both the United States and Europe should remain roughly at their 2010 levels, to then increase by six- to nine-tenths of a point on average in the last year of the forecast period. With respect to long-term rates, we have taken into account all the concerns regarding the development prospects of the American and European economies, determining a further flattening of the yield curve. Based on long-term yields remaining substantially stable over the two-year forecast period, the differential between the long-term and short-term segments of the yield curve is expected to fall from % in 2010 to % in THE OUTLOOK FOR THE EURO AREA AND ITALY 11. For the euro area as a whole, we have largely endorsed the growth scenario envisaged in the last Report, even though performance in 2010 has been better than expected. After growth at 1.6% this year, internal and international uncertainties point to a slowdown to 1.3% next year, essentially bouncing back in 2012 (to 1.5%). At any rate, the momentum of growth will continue to hinge on the capacity of 4

7 European goods to penetrate foreign markets, with export growth exceeding that of imports in each year of the forecast. The contribution of domestic demand, though also rallying, will be decidedly more modest, with consumer demand expected to grow steadily at rates below 1%, whilst investment demand, after the further contraction forecast for this year, should subsequently rise significantly to reach a growth rate of higher than 3% by the end of Table A Italy Basic scenario: main variables % change Real GDP growth Real growth in investments Deficit/GDP ratio (in %) Consumer prices (NIC) Oil price (in $) ECB reference rate (*) Rate on loans (**) Rate on deposits Loans to residents (***) Net doubtful loans (***) Deposits from residents (***) Bonds in euro (***) Interest margin Net interest margin Operating costs EBITDA Net profit (*) annual average. (**) related to households and non-financial firms (***) % change in end of period amounts. For loans and deposits, monetary financial institutions are excluded. Source: Istat Bank of Italy ECB and our forecasts 12. Unfortunately, against this backdrop, the performance of the Italian economy does not look set to distinguish itself in terms of its dynamism (see Table A). Whilst recent economic uncertainties limit growth in 2010 to 1.0%, next year international difficulties could determine a rate of +0.9%, to then reach a growth rate (of 1.3%) at the end of the forecast period slightly higher than the country s current potential. The cycle will be driven by weak domestic demand, while net exports should ensure a constant albeit not particularly significant positive contribution to growth. Household consumption should grow steadily at rates of around %, which, 5

8 given the even weaker trend in disposable income, should lead to an increase in consumer spending of 1.2 percentage points. Investments, after growth of 3% this year, should slow markedly in 2011, before returning to a rate of around 3% in The various investment components will see different trends, with residential investment in recovery throughout the forecast period, whilst investment in machinery and equipment is expected to be highly cyclical. 13. The real growth just described should keep price growth at levels consistent with European targets, despite upward pressure from oil prices: Italy s consumer price index should increase to 1.7% this year, before settling at the 2% mark in the twoyear forecast period of , whilst core inflation should stabilize at 1.5% in the period, and accelerate slightly in the final forecast year. 14. The usual time lag for cyclical trends to spill over into the labor market should lead to a worsening of the main indicators well into 2011, to then recover again only in the final forecast year: the unemployment rate should thus peak at 8.5% of the working population in 2011, more than two points higher than the figure for 2007, before dropping back to 8% in Fiscal policy 15. In the estimation of the banking panel, public finance results should see fiscal balances hold up reasonably well, particularly in terms of flows. In the context of the forecast growth scenario, and after the corrective measures introduced with the recent budgetary maneuver, the deficit-to-gdp ratio should reach around -3% in 2012, thanks to a moderate improvement in the primary balance. Given the ongoing differential between the average cost of debt and the rate of economic growth, the re-accumulation of a primary surplus would not, until 2012, be such as to halt the rise in the debt-to-gdp ratio, which should come in at 119.1% in 2010, 120.2% in 2011, and drop only marginally (to 119.4%) at the end of the forecast period. THE ITALIAN BANKING INDUSTRY: TRENDS AND PROSPECTS Recent economic trends 16. In the face of both an internal and global situation that has been far from serene, the Italian banking sector has succeeded in ensuring an adequate flow of credit to the economy a flow which, after the slowdown of recent months, is now definitely on an upward trend. The latest available figures (to October) show that credit to the non-financial private sector grew at an annual rate of 4.6%, whilst 6

9 credit to households and businesses grew at an annual rate of 3.4%, with both sets of data exhibiting marked acceleration compared to the trends of a year earlier. An analysis of credit flows indicates that the acceleration in growth appears to be due primarily to lending to the production sector, which, after the decline of recent months, is now showing positive signs of strong acceleration. Credit to households, on the other hand, whilst maintaining high rates of annual growth, is now showing a trend towards consolidation. 17. The positive outlook for credit in Italy is further confirmed by a comparison with the growth of credit in other major European countries and by the trend in the credit intensity index. Regarding the former, whilst just before the crisis broke out credit to households and businesses in Italy grew less on average than in the other three main countries of the euro area, since the beginning of 2009, lending to Italian households and from the middle of the same year businesses experienced growth rates significantly higher than those elsewhere in Europe. Similarly, growth in the level of credit per unit of output, although slowing down, remained positive in Italy, with the third quarter of 2010 seeming to indicate that a process of recovery is underway. So what factors explain Italian credit s good performance compared to international trends? Among the various possible responses to this question, the Report draws particular attention to two factors: the better capacity of the Italian banking system to absorb the squeeze pressures stemming from the recent financial crisis, and growth in banking risk. The Report provides a careful analysis of both these factors by, on the one hand, examining the endogenous and exogenous components of the credit-squeeze indicators developed by European and U.S. central banks (that is, bank lending surveys), and on the other, comparing the growth in the level of risk during the current recession with that during the recession of the early 1990s, which comparison indicates that there has been a significant structural improvement in the quality of credit (taking into account the different troughs in the real economic cycle and differences in the monetary cycle). 18. However, despite the underlying improvement, it should be borne in mind that the level of risk has increased, thus making it important to assess what the latest trends indicate with respect to short-term prospects. The data from the second quarter of 2010, appropriately seasonally-adjusted, shows that if the number of defaults is considered (and thus a concept close to the rate of default is used), it is not yet possible to identify a stabilization point for growth in risk; if, on the other hand, reference is made to default amounts (and therefore the product of the default 7

10 rate and exposure at default EAD), then it emerges that the acute phase of the crisis can be pinpointed to the third quarter of 2009, and that currently there is a slow return to normal levels of risk. Broken down for the various sectors, this behavior is determined primarily by the level of risk of lending to non-financial firms, whilst both consumer households and household-firms show growing levels of risk that have not yet stabilized, though these are well below the levels for non-financial firms. 19. Funding activities (especially short-term) slowed down significantly, seemingly as a result of the bond-market difficulties being experienced by the euro area: as at October, total funding, net of bonds in bank portfolios, was growing at a rate of 4.9%, nearly two points lower than that recorded a year earlier. Remaining particularly weak, even if showing signs of recovery, is bond growth, which at least in part, is feeling the effects of the state of nervousness that has engulfed the euro area. In particular, it seems notable that, whilst at the beginning of the financial crisis Italian banks had to endure a loss of credit-rating for sectoral reasons, they subsequently paid and are still paying a premium for reasons associated with country-risk: a premium which can currently be estimated at basis points. This fact, coupled with the flattening of the yield curve, goes a long way to explaining the weak growth in bank bonds, which for the first time in over a decade saw their share of total funding fall. 20. In a difficult environment, the banking sector forged ahead with its capital strengthening strategy: during the first six months of 2010, the principal capital ratios increased by 5-tenths of a point for the top 5 Italian banking groups, and by marginally less for the system as a whole, which in any case had higher capital levels to start with. Thus, since the end of 2007, the capital base of the Italian banking system has increased by nearly 2 percentage points, already bringing the current level of Tier-1 capitalization (without considering the impact of the redefinition of capital quality) in line with the required capital level as represented by the sum of the minimum requirements and the capital conservation buffer (8.5%). Prospects 21. The forecasts arrived at by the ABI economic analysis office and the panel made up of representatives of the research divisions of the major banks stem from the recent economic developments described above and, compared to the previous 8

11 forecast scenario, foreshadow an easing in the pace of growth of banking activity and a lower income performance. Loans to the non-financial sector should grow this year at a rate, once adjusted for the effects of securitization, by 2.2%, similar to that of 2009, then rising to slightly less than 5% in the final two forecast years. Lending to households and businesses should follow a similar trend, though with higher average growth rates. In particular, the flow of business loans will continually pick up pace, going from an annual decline of 2.3% last year to growth rates of 4.9% in Loans to consumer-households and household-firms, after the slight slowdown expected for this year, should instead grow between 6-7% in the final two years of the forecast period. The level of credit per unit of output should in any case increase throughout the forecast period, and the credit intensity index, calculated on loans to households and businesses, should rise to 98.5% by the end of 2012, 5.5 percentage points higher than in As regards credit quality, our forecasts would be remiss in not pointing out the expansionary effect on doubtful loans of the economic cycle, even though, in comparison with the previous forecast, we have outlined a risk-level scenario that is substantially more moderate: taking into account net doubtful loans, after growing by over 20 percentage points this year, we forecast growth again of 10 percentage points in 2011, before essentially stabilizing in 2012 (-1.7%). Thus, as a percentage of total non-financial sector loans, doubtful loans should go from 1.9% in 2009 to 2.4% in 2011, before falling to 2.3% in Growth in funding should see a marked slowdown compared to recent trends, before again becoming more consistent with the funding needs of lending activity. This year, the level of total deposits (net of repos) and of bonds should remain broadly the same compared with that at the end of 2009, with growth in funding guaranteed solely by growth in repos. In the two years following, bonds should return to growth at an average rate of 6.5%, higher than the average rates for total funding, though lower than those seen more recently. Meanwhile traditional funding through deposits should grow at average rates slightly above 4%, whilst growth in funding through repos is expected to be only marginally positive. 25. As is to be expected given the new regulatory requirements, the capital bases of the banks will undergo a marked increase throughout the forecast period: with an average annual growth rate of 11%, by the end of 2012 the capital and reserves of Italian banks should increase by more than 80 billion euro compared to levels at the 9

12 end of 2010, although, as we shall see, operating profits will only be able to contribute modestly to this. Thus, the leverage ratio, calculated solely on onbalance-sheet assets, should rise between 2010 and 2012 from 9.3% to 10.4%. 26. Once money and financial market-rate trends are taken into account, bank rates should follow a slowly rising trend: between 2010 and 2012, the average rate on loans to households and businesses should increase by 7-tenths of a point, reaching 5.2%, whilst average funding rates should grow by 6-tenths of a point. Thus, the spread between bank rates, after the falls in the two-year period of , should return to growth of one-tenth of a point per year for the two years running from 2011 to In this scenario, the financial crisis currently playing out should only have a weak impact on prices for bank bonds through country-risk, which is expected to increase only marginally during the forecast period. 27. As far as operating results are concerned, the results for the current year look set, to some degree, to fall short of our most recent forecasts is expected to close without the net result of banking activities marking a recovery from the bad result of 2009, due to a significant contraction in the interest margin (-3.6%) that was not completely offset by a slight growth in other income. Stagnation in overall income seems likely to worsen by a further albeit modest increase in provisions, especially on loans, which will counteract the reduction in both the cost elements of banking activities. 28. In the forecast period , bank revenues should return to growth, though at rates in line with the current weak economic climate: the net interest margin should grow at an average annual rate of 2.8%, contributing income resources of 4.5 billion euro. Both the interest margin and other income should similarly contribute to this growth, even if through the pursuit of different strategies. The banks will contend with the modest growth in revenues through tight costcontrol: total operating costs should increase by just 600 million euro. This containment will be achieved principally through a reduction of staff costs (down by 100 million euro), both by means of cutbacks in staff numbers and curbed growth in unit labor costs. Other operating costs should, in any case, also see limited growth, due in part to a rationalization of bank branch networks. All in all, the cost/income ratio should fall by nearly 3 percentage points to 60.1%. 29. The combined effect of these revenue and cost trends should guarantee good 10

13 growth in operating results and even more positive gross profit figures, with the passing of the worst phase of the economic and financial cycle enabling a reduction in provisions. Overall, however, net profits could rise by almost 5.5 billion euro during the period , an increase which, nevertheless, is not such as to alter the depressed levels of profitability ratios for banking activity in Indeed, ROE in 2012 should reach 3.2%, below the already depressed levels for 2008, whilst the level of profits is expected to be approximately half that generated in CAPITALIZATION LEVELS, PROFITABILITY AND GROWTH IN BANKING ACTIVITY 30. The Report, which as usual offers a diverse variety of special-focus sections dealing with a number of real economic and financial issues, also contains a monograph looking at the issue of the links between capitalization levels, profitability and growth in banking activity a topic suggested by recent regulatory developments. Indeed, during the debate over the amendments to the capital accord (the so-called Basel III rules), insufficient attention seems to have been devoted to the conditions necessary for the long-term sustainability of the higher capital levels required. Thus, the monograph presented in this Report does not examine the costs of making the transition to the new higher capital requirements (which new costs stem from a range of regulatory changes regarding volume and quality of capital), but rather the consequences that the revised rules will have on banking operations given the new state of equilibrium that will be created. On an accounting level, it is quite clear that there are equilibrium relationships between the level of capitalization, the level of profitability and the rate of growth in banking activity. These relationships of interdependence raise some interesting issues as well as giving rise to more than one trade-off between different objectives. As higher capital requirements can only be sustained in a situation of greater profitability, this leads to a conflict with the objectives of the new capital accord: if the aim of increased capitalization is to promote a more stable financial system, then the relationship of equilibrium highlighted above means that the need to sustain a higher level of capitalization could trigger a quest for greater profitability by banks, and hence, entail higher risk, which to some extent would cancel out the reduction of systemic risk flowing from the strengthening of their capital base. 31. The force of this potential capital ratio trap, or rather, the range of situations in which it may be sprung, will be at its greatest the lower profitability levels are to begin with, that is to say, close to the levels of profitability needed to ensure the 11

14 stability of current capitalization levels. A comparison between the level of ROA required for stability (that is, capable of sustaining in the long term the chosen level of capitalization) and the ROA level currently achieved by Italian banks demonstrates that the Italian banking system is capable at present of funding a level of capitalization consistent with current regulatory limits relying solely on operating profits. If, however, reference is made to higher capitalization levels (of between 9-10%) in accordance with the regulatory changes agreed in Seoul, and which should soon translate into European and Italian legislative measures, then the need arises for an increase in profitability of between basis points relative to total assets. 32. Banks have a number of mechanisms at their disposal to make up this shortfall, starting with the possibility of issuing new shares. According to our calculations, working on the basis of a share-issue volume equal to the average actually recorded in the last four years, the remaining shortfall can be estimated as 11 basis points at most, which is clearly coverable: in particular, taking for granted that a tight control over costs will be maintained, we believe that this can be achieved by, for instance, cutting into (even if only marginally) the level of dividends paid out. If, then, the situation regarding Italian banks can be considered compliant with the planned capitalization reforms, what about that of other European banking systems? By examining the status of 7 other European banking systems and repeating the analysis carried out in the case of Italy, one can conclude that, given a level of ROA commensurate with the degree of risk of banking activity in each respective country and assuming a normal volume of new share issues, 4 out of 7 countries (namely, Germany, Austria, Belgium and France) should, like Italy, have no difficulty in implementing the Basel III rules. However, the situation would seem to be more problematic for the remaining three countries considered, namely: Spain, the UK and, to a lesser extent, the Netherlands. 33. In order to be in a position to comply with the envisaged capital requirements, the banking systems of these countries will either need to increase their profitability or reduce the growth rate of their activities. In particular, again on the basis of the previously noted equilibrium formulae, the banking systems of Spain and the UK would need to reduce their rates of growth by just over 2 percentage points per annum, whilst Dutch banks would have to rein in their growth by 1 percentage point per year. At the other end of the spectrum, there is ample scope for German banks to increase the pace of growth of their activities. 12