COMPARING FINANCIAL SYSTEMS Lesson 9 The Italian financial system
What you will learn in this lesson The main features of the Italian banking system. The size and significance of non-depository institutions. The comparatively small use made of equity finance by Italy in the past. The role of social and political influences upon the past development of the system.
Introduction The Italian financial system is bank-based rather than market-based. Firms have raised funds principally through the banking system. Founding families continue to play an important part in the ownership of many firms, limiting the role played by the equity market. Takeovers and mergers remain relatively uncommon except for the large numbers that have taken place in the banking sector in recent years as part of the restructuring of that sector. The bond market remains predominantly a market in government bonds and has in the past contributed little to corporate finance. The relationship between banks and firms has typically been close and important. Thus, the Italian system has similarities with the other systems in continental Europe, although it also has a number of individual features.
The development of the Italian financial system Italy s social and economic history had left it with a shortage of private capital able to engage in banking. Italy saw two waves of formation of foreign banks during the nineteenth century. In the 1860s these were mainly French subsidiaries, and in the 1890s they were German. The investments made in the 1860s were not very successful, whereas those in the 1890s were, and Italy advanced substantially. In 1893, after the Banca Romana crisis and under the menace of a bank run, the Banca d Italia, the Italian central bank, was constituted as part of an overall reorganization of Italy s banks of issue. Capital markets did not develop very much at all during this period. When the foreign banks faced domestic crises and withdrew, they left a lack of domestic institutions to provide finance. After World War I, the Italian government stepped into fill the void and used the Istituto per la Ricostuzione Industriale (IRI), (Italian Reconstruction Finance Corporation) to help provide finance for industry.
The development of the Italian financial system Prior to the 1930s there had been a succession of bank failures and financial crises and the position deteriorated during the economic crisis of the 1930s. Public intervention followed and most of Italy s banks became state-owned, either directly or under the control of charitable, non-profit-making foundations that were themselves government supervised. The state has played an important role in providing funds for Italian industry ever since. The Banking Act (1936) derived from the determination to ensure the stability and security of the system (like Glass Steagall Act in the US). The law created a rigid demarcation between financial institutions in providing corporate finance. Commercial banks (standard credit institutions) were only allowed to conduct short-term (up to 18 months) deposit and lending business. Medium- and longer-term financing was to be provided by investment banks (special credit institutions).
The Italian banking system after 1936 In fact, commercial banks were given slightly more freedom, since they could grant medium-term loans not exceeding 8% of their deposits as long as loans to any one institution did not rise above 15% of capital. However, such loans had to be individually authorized by the central bank (Banca d Italia). Banks were also prohibited from acquiring participating interests in industrial companies. The development of branch networks was discouraged by the Banca d Italia which demanded evidence that there were valid economic reasons for any such expansion. The banking system that developed was one with a very large number of small local banks that faced very little competition. As a consequence, banks became very bureaucratic and did not provide a high level of service. Savings products provided by the banking system were few and unsophisticated.
Banks, state and firms In the larger public sector banks appointments of top officials became highly politicized. Furthermore, the banks had little chance of raising share capital. The structure of Italian capitalism also contributed to the way in which the financial system developed. The family remained central to the operation of capitalism much longer than in comparable countries. The average size of firms remained small. Even today, over 50% of Italian manufacturing firms employ fewer than 100 workers (in the UK, for example, this is true of under 20% of manufacturing firms). Many of the larger firms continued to have large family shareholdings. Many other large Italian firms were owned either directly or indirectly by the state. Under these circumstances there was very little call for an equity market and its contribution to the growth of the Italian economy has been small.
More recent developments Following the formation of the European common market in 1957, the Italian economy grew very rapidly. However, when growth rates in all Western economies turned down in the 1970s, much of the burden in Italy fell upon the Italian state, especially since much of the country s heavy industry was state-owned. Continuing regional problems and public attitudes made it difficult for the government to finance increased expenditure through high taxation. Italy embarked upon a series of large budget deficits. However, savings ratios in Italy were high. Given the unsophisticated nature of savings vehicles provided by the banking system and the existence of exchange controls that made it difficult for capital to leave the country the government was able to finance its deficits through the domestic sale of securities, although at an increasing cost in terms of interest rates and payments.
The weakness of equity markets The bond market became entirely dominated by government debt. Firms seeking capital either provided it themselves through retained earnings or entered into special relationships with investment banks. One such bank, Mediobanca, a government-controlled bank in Milan, became central in financing operations and oversaw the development of close relationships among a number of the country s largest private firms. This was in part a response to the lack of development of bond and equity markets but contributed to the continued slow development of those markets. It was not until the late 1980s that things began seriously to change. The pressures for deregulation, like in other countries, gradually came to be felt also in Italy. Pressure for reform came also from the Italian employers association (Confindustria), which argued that inefficiencies in Italian banking threatened the long-term viability of Italian manufacturing.
Deregulation The Italian Bankers Association (ABI) drew attention to unsystematic ad hoc lending criteria and undisciplined loan-monitoring procedures. The Banca d Italia acted in a number of ways to try to bring Italian banking practices into line with the rest of Europe. The requirement that commercial banks needed special authorization from the Banca d Italia to grant medium- or long-term loans was removed. Administrative controls and regulations on the investment of banks funds in government securities began to be revoked from 1984 on. As soon as the law allowed, the central bank fostered competition by encouraging the merger of smaller credit institutions. After May 1990, Banca d Italia discontinued the policy of limiting and controlling branch networks. A large increase in the number of bank branches.
European banks competition The gradual reduction in restrictions on capital outflow under the terms of the Single European Act, culminating in the removal of the final foreign exchange control by the end of June 1990, had other profound effects: 1. Italian financial institutions had to compete for the funds of Italian savers with foreign savings products; 2. foreign banks increased their presence within Italy. This occurred first in investment banking, with Italian government bond trading becoming dominated by foreign houses including J P Morgan, Morgan Stanley and Salomon Brothers. Later, Deutsche Bank and other EU banks began to make inroads into the retail market. Italian banks sought to diversify by granting medium- and long-term loans through special subsidiaries and by engaging in near-banking business such as leasing and factoring.
The new banking reform Agreements between commercial and investment banks and insurance companies provided for the marketing of the financial products of other institutions. The 1936 Banking Act had to be replaced. A bill to reform the act was tabled in parliament in 1989 but the new Banking Act was not passed until 1 September 1993, coming into force on 1 September 1994. This law, however, incorporated a number of legislative and administrative changes that had been made from 1990 on. The most significant was the Legge Amato (1990) which authorized the transformation of public banks into limited companies. Full legal parity of public and private financial intermediaries (all banks are business firms).
The 1993 Banking Act In May 1993, banks were allowed participating interests in industrial companies up to the limit of 15% of their own funds. The 1993 Banking Act removed the distinction between short-term and mediumand long-term lending. It also introduced a separation between the banks themselves (now all private law limited companies) and the public foundations owning shares in those banks. The foundations were allowed to sell or exchange shares, leading to increased concentration. The law thus led to the existence of bank holding companies with subsidiaries providing medium-term lending, insurance and other financial services. The objective was setting up four or five large financial institutions able to compete internationally.
Increasing competition This objective became more urgent with the translation into Italian law of the EU s Second Banking Directive towards the end of 1995. This was followed by a rush of notifications of intent to offer banking services in Italy from banks based in other EU countries. The Consolidated Law on Financial Intermediation (1998), allowed financial intermediaries to offer a wider range of asset management products. Competition intensified as more banks entered the same markets and the presence of foreign intermediaries increased. The increased competition led to a reduction in the spread between bank lending and deposit rates. This fell from 6 to 4 percentage points between the beginning of the 1990s and the end of 2002.
The privatization process There have been a number of high profile privatizations in the finance industry since December 1993 when IRI, the large government-owned holding company, sold its 64% stake of ordinary stock in Credito Italiano. Other early part or full privatizations included Banca Commerciale Italiana, IMI, a Rome-based banking and financial services group, and the investment bank, Mediobanca. The withdrawal of the public sector from control of the finance industry was slow in comparison with the programmes of privatization elsewhere but sped up in the late 1990s, and the years 1997 and 1998 saw the privatization of a number of the larger banks: Cassa di Risparmio delle Provincie Lombarde, Banca Nazionale del Lavoro, Banco di Napoli, Banco di Roma and Istituto Bancario San Paolo di Torino. The result was that between 1993 and 2002, the share of bank assets possessed by banks controlled by the state or by charitable foundations fell very sharply from 70 to 10%.
The concentration process The Italian banking system has, in last 25 years, undergone a major restructuring. Although there are still many banks, mergers and acquisitions have reduced their number from 1,176 in 1989 to 604 at the end of 2016. During the process leading to European monetary union, between the end of 1990 and 2002, there were 566 mergers and acquisitions among banks. The target banks in the mergers and acquisitions accounted for nearly 50% of total bank assets. The ownership of banks has become rather more concentrated through the development and growth of banking groups. By the end of 2016, 70 groups encompassed 129 of the 604 banks. More than 80% of all bank branches belonged to the banking groups.
The concentration process Mergers continued among the banking groups and two particularly large mergers in 2006 and 2007 created two banking institutions, large even by European standards: 1. Intesa Sanpaolo (the resut of a merger between Banca Intesa and Sanpaolo IMI, which has a precence in 10 other countries through 14 subsidiaries and large markets shares in central and eastern Europe); 2. Unicredit (the result of a merger between Unicredit and Capitalia, which originally was the biggest bank in the euro area). In 2007, there were also significant mergers between cooperative banks creating two large cooperative banking groups: 1. UBI group (the result of a merger between Banche Popolari Unite and Banca Lombarda e Piemontese); 2. Banco Popolare (the result of a merger between Banco Popolare di Verona and Banca Popolare Italiana). 3. In 2017 Banco BPM S.p.A (the result of a merger between Banco Popolare and Banca Popolare di Milano), has become the third largest retail and corporate banking conglomerate in Italy behind Intesa Sanpaolo and UniCredit.
Foreign Banks in Italy Many foreign banks attempted to acquire controlling interests in Italian banks. They had built up shareholdings in Italian banks but had found difficulty when they attempted to increase their holdings to significant levels. Any acquisition of more than 5% of an Italian bank have to be approved by the governor of the central bank. Further approvals are needed to take shareholdings beyond 10%, 15%, 20% 33% and 50%. The governor in the early 2000s, Antonio Fazio, was believed to have used his power to block the attempts by foreign banks to expand within Italy and also to have opposed several all-italian banking mergers. Both actions would have been in conflict with the aims of the European Commission to produce a more competitive financial system across Europe. There was particular concern over the attempts by the Dutch bank ABN-AMRO to increase its shareholding in Banca Antonveneta beyond the 12.7% it already held. The Banca d Italia approved a takeover bid for this bank being made by the smaller Italian bank Banca Popolare di Lodi (now in BPM S.p.A.).
The Italian banking system The Italian banking system - numbers of banks and branches in Italy at end 1995 at end 2016 Number of banks Number of branches Number of banks Number of branches in Italy in Italy Limited company banks 203 16,744 162 20,544 Cooperative banks 96 4,239 25 3,973 (banche popolari) Mutual banks 619 2,379 334 4,352 (banche di credito cooperativo) Branches of foreign banks 52 78 83 170 Total 970 23,440 604 29,039
The big four The result of these changes has been the development of banking groups similar in size to many of their European competitors. Today the big four are: Unicredit, Intesa Sanpaolo, Banca BPM, Banca Monte dei Paschi di Siena.
The ten biggest banks Rank Company Total Assets (thousands ) 1 UniCredit 856,342,000 2 Intesa Sanpaolo 717,690,000 4 Banco BPM 168,254,920 [4] 5 Banca Monte dei Paschi di Siena 152,832,953 6 UBI Banca 110,687,944 7 Banca Nazionale del Lavoro (subsidiary of BNP Paribas) 78,912,313 8 Mediobanca 69,365,673 9 BPER Banca 64,439,195 10 Crédit Agricole Italia 51,103,823
Formation of banking groups The aim of the formation of banking groups is to preserve brand names while obtaining the benefits of the coordinated monitoring of risks, the curbing of costs and the integration of policies for the production and marketing of services. The Banca d Italia has identified the UniCredit, Intesa Sanpaolo and Monte dei Paschi di Siena banking groups as other systemically important institutions (O- SIIs) authorized to operate in Italy in 2017. Intesa San Paolo and Unicredit banking groups are now among the 15 largest banks in the euro area. Nonetheless, the market share of the top five groups increased too slowly and even the large banks remain small by international standards.
The development of branch networks Following the removal of restrictions on the development of branch networks, the total number of bank branches has been increasing steadily, rising from 23,440 at the end of 1995 to 29,039 at the end of 2016. This was more than double the number of bank branches (12,174) in existence in 1980. The great growth in the number of branches in Italy reflected the previous underdevelopment of the Italian system and the limitations imposed until 1990 on the formation of new branches by the Banca d Italia. However, today there is the tendency for banks to reduce the size of branch networks, like in the UK, with a reduction of branches from 32,471 to 29,039 between the end of 2007 and the end of 2016.
The Banca d Italia The Banca d Italia was until the beginning of 1999 the bank of issue and the government s principal banker. It also played a role in the supervision of the Italian banking system. It retains the last two of these three roles, having become a member of the European System of Central Banks (ESCB) and having passed over its monetary responsibility to the ECB. The Banca d Italia was founded in 1893 as a private company but became part of the public sector in 1936. It derives its primary role as responsible for monetary stability from article 47 of the 1947 Italian constitution. This is a vaguely worded article which does not mention the Banca d Italia by name but talks of encouraging savings and controlling credit. Until 1992, the Banca d Italia was far from being independent of government.
Conflicts between BoI and the government The Comitato Interministeriale per il Credito e il Risparmio (CICR) was responsible for monetary policy issues and bank supervision policy. It was made up of the Treasury, Finance and other economic ministers, with the governor of the Banca d Italia only being present at meetings in an advisory capacity. The Minister of Finance, together with the Minister for Trade, was responsible for all foreign exchange policy decisions and appointed or dismissed presidents of public banks in consultation with the political parties. The problem of financing the government s large budget deficits led to regular conflicts between it and the Banca d Italia. Until 1981 the Banca d Italia was required to take into its own portfolio any government securities not taken up by the market. Although this requirement was annulled, the government continued to make constant use of a cash advance facility which obligated the Banca d Italia to provide up to 14% of projected budgetary expenditure.
Conflicts between BoI and the government In January 1983 the Banca d Italia made use of a 1948 legislative decree under which, when the Treasury persistently exceeded the limits of the cash advance facility, it could suspend its payments to the Treasury and force Parliament to resolve the conflict between the central bank and the Executive. Parliament responded by approving legislation requiring the Banca d Italia to grant the Treasury extraordinary additional finance. However, as required for membership of economic and monetary union, steps were taken in the first half of the 1990s to increase the power of the central bank relative to that of the elected government. In February 1992, the authority to determine the discount rate was transferred from the Minister for Finance to the central bank and in June 1994 the Banca d Italia assumed responsibility for determining minimum reserve policy. For a time, however, government continued to attempt to influence the bank through the method of appointment of its top officials.
The banking authorities The Banca d Italia s executive directorate is composed of the governor (a fixed term of six years, renewable only once) and three other members. All of whom are chosen by the governing council on which sits the bank s 13 regional office chairmen. Appointments must, however, be confirmed by the Italian President in consultation with the government. As supervisory authority, the Banca d Italia evaluates proposed consolidation projects and monitors their implementation. It assesses the adequacy of risk measurement and management systems and calls on parent companies to take prompt action to rationalize branch networks and integrate information systems and procedures. The bank has the power to investigate in cases where increased concentration may reduce competition. It can issue warnings to banks, can order compensating measures such as the closure or sale of branches or a temporary ban on the opening of new branches and, where anti-competitive behaviour is found, can levy fines on the banks involved.
Italian savings The potential for securities markets in Italy has been high for a long time because Italian savings have been second in volume only to those of Japan. Savings ratios have been falling in recent years but remain high by international standards (higher than the average for the Group of Seven countries. Italian households also stand out by international comparison for the low level of their debt. Although the liabilities of households have risen considerably in recent years, largely for the purchase of housing, the ratio of financial liabilities to assets remained well below the figures in other major industrial. However, Italian savings products have until recently been unsophisticated and only a small proportion of Italian savings has in the past been professionally managed.
Securities markets The large budget deficits of the 1970s and 1980s led to securities markets being dominated by the market for public debt. From 1980 to 1991, that debt grew almost sixfold. Relative to national income it rose from 59 to 102%. By 1996, General Government Gross Debt was 123.4% of GDP. This limited the development of the equity market and accentuated the corporate sector s preference for bank or internal sources of financing. The Italian government debt market is now the third largest in the world in nominal terms, behind those of USA and Japan. Until recently, most of the relatively small number of private bonds have been issued by publicly owned companies such as public banks or the Italian state railways. Bonds directly issued by the corporate sector have represented only a tiny proportion of the total amount outstanding.
Bond market In common with the rest of the euro area, the Italian bond market has grown considerably since the launch of the single currency. Between 1998 and 2002 the ratio to GDP of the stock of resident companies bond issues on the domestic and international market rose from 28 to 47% in Italy. Banks had been responsible for the issue of 10.5 % of the stock and firms for only 1.5%. However, much of this growth has been attributable to banks, which use the proceeds of bond issues to fund their loans. Non-financial firms have been increasing their use of the bond market but still do so far less than do American firms. By international standards the corporate bond market in Italy remains underdeveloped. In the early 2000s, Italian corporate bond issues fell back slightly, against the euro area trend, following the collapse of the two large Italian industrial groups: Cirio and Parmalat.
Public sector bonds At the end of 1995, 88% of the total stock of outstanding bonds and government securities consisted of public sector bonds or bills. After 1996, as part of the Italian government s drive to meet the convergence criteria for membership of economic and monetary union, the public sector deficit began to fall. By 2003, government debt had fallen back to 106% of GDP. This reduction in the need for the public sector to sell new debt provided some scope for the re-emergence of a corporate bond market. Subsequent to the financial crisis of 2007-2009, however, the government debt again rose to 132.6% of GDP in 2016, because of fallen in the latter. The securities issued by the Treasury are of standard types ranging from Treasury bills to floating rate issues. Denominations are small enough to allow private investors to participate in the fortnightly auctions through financial intermediaries. The result is that around two-thirds of the public debt consists of securities placed in the domestic market with the greater part held by households, firms and institutional investors.
Public sector bonds The market was reformed in 1988, with a group of institutions becoming market makers quoting bid offer prices on various bonds as in the UK and USA. Previously, Treasury bonds had been sold by banks forming a consortium and subscribing to a whole issue even if at prices below the equilibrium level. There had been government arm-twisting of financial intermediaries to ensure the sale of bonds. The market was reformed in part because of the perceived need to attract foreign investors following the removal of exchange controls which increased the possibility of Italian savings flowing abroad. There has indeed been a considerable growth in non-resident holdings of government securities in recent years. In 1988 also an efficient screen-based secondary market for government securities (MTS), was established. This has now been privatized and around 200 Italian and foreign intermediaries engage in the trading of Italian government bonds and those of other EU governments. In addition, there are retail markets for government and corporate bonds.
Public sector bonds In 1996, non-residents owned only 15% of Italian public sector securities. By the end of 2003 this had grown to 49%. Subsequent to the European crisis of sovereign debts in 2011, this share fell. In 2016, non-residents owned only 33% of Italian public sector debt.
Equities markets Change has been slower to come in equities markets. By September 2017, there were still only 333 companies listed on the Italian stock exchange in Milan in comparison with 647 listed companies in Germany and 1,060 listed in France. The relatively underdeveloped state of the Italian stock market is also shown by its capitalization. At the end of 2016, the ratio of the value of listed companies to GDP was 39% compared with 90% for the euro area as a whole and around 180% in the USA and the UK. The equity market had grown in the 1980s and 1990s, but progress had been slowed by the way in which the stock exchange operated. What are the major reasons?
Some historical reasons A 1913 law had given a monopoly over transactions to brokers. They were meant to be pure brokers, acting only as agents. However, the market did not work well in the late 1980s. No one was compelled to use the stock exchange and only 20% of transactions went through the exchange; the average availability of a company s share capital on the market was very small. The official market was thus thin and speculative and was a market for insiders. There were no rules of conduct or investor protection. Specifically, there was no law on insider trading and no rules requiring public takeover offers. This all led to many complaints that share deals were frequently rigged by big groups, that small investors were crucified and that the market was characterized by secret pacts and the atmosphere of a private club.
Evolution in equities markets A new bill was presented to parliament in 1989 requiring transactions in equities to go through authorized intermediaries on the official market. The distinction between brokers and market-makers disappeared. New firms became market-makers, brokers, and fund managers with Chinese walls being required. Despite these changes, there were only small increases in the number of companies listed on the Borsa Italiana in Milan in the 1990s and the early part of this century. The gap with respect to the other euro area countries in terms of the number of listed companies continues to widen. Most of the increase in activity that has taken place in the Italian equities market has been associated with the newly privatized companies (particularly those in the banking sector).
Other reasons for the limited growth Studies seeking to identify the reasons for the limited growth of the Italian stock exchange highlight the limited supply of shares because: 1. Italian businessmen s fear of losing control; 2. reluctance to disclose the information laid down for listed companies discourage them from going public. As in other countries, a new market, the Nuovo Mercato (NM), has been established for the listing of high technology stocks. This market is part of a European circuit in which the shares of high technology companies are traded but remains small in itself.
Institutional investors The late 1980s and 1990s saw a marked growth in the professional management of savings. Between 1995 and 1998 the proportion of households entrusting their financial savings to investment funds or portfolio management services rose from 5 to 11%. The proportion of those investing in life insurance products increased from 21.5 to 23.3%. Between the end of 1996 and the end of 2000 assets under management in Italy in individual and collective investment portfolios nearly tripled to just over a 1,000m with investment funds accounting for 58% of the increase. This growth in households demand for individual and collective asset management services was abetted by the passing of the 1998 Consolidated Law on Financial Intermediation, which created a new institution, the asset management company. This has allowed banking and financial groups to rationalize their presence in the various sectors of activity.
Asset management companies From the end of the 1990s there was a rapid growth in asset management companies. These companies provide individual portfolio management services for a growing number of banking groups as well as managing a large part of the portfolios of Italy s main insurance companies. In 2015 there were 80 investment firms with total assets equal to 2,105M (0.13% of GDP). Within the investment funds sector, a fall in bond prices in 1999 and 2000 encouraged a shift of savings into equity funds. At the end of 2000 there were around 1,000 equity funds in operation, twice as many as at the end of 1996. Many of the new equity funds have specialized in foreign equities. Individual portfolio management accounts have gradually spread from higher income investors to a wider customer base. The composition of portfolio management accounts also changed as government securities made way for a growing proportion of shares and corporate bonds.
Insurance industry The Italian life insurance industry has also been relatively underdeveloped until the end of the 1990s. Pension funds have been slow to develop largely because of the generous state pension provision. However, pension funds have started to grow as state pensions have come under pressure as part of the government s attempt to reduce the public sector deficit in order to qualify for membership of EMU. There are two types of pension funds: 1. contractual funds (restricted to specific categories of workers); 2. open funds. The membership of contractual funds has grown significantly. Open pension funds have attracted fewer.
Insurance industry The total assets of life insurance companies have also grown very rapidly in last two decades. There has been a strong tendency towards the concentration of the industry, with several mergers involving foreign insurance companies. Banks play an important role in this market. Ownership links have developed between banks and insurance companies (especially in the field of life insurance, and the cross-selling of products). Business combinations involving banks and insurance companies have frequently been cross-border and have given rise to some of the largest European conglomerates. In Italy, five of the ten largest life insurance companies have links with banks.
Investment funds and venture capital In Europe venture capital business has grown rapidly in the last few years. Closed-end investment funds are very important for the financing of this activity, but it is not well developed in Italy. A decree issued by the Minister of the Treasury in July 1999 removed some of the restrictions on the maximum equity interests that could be held in each company receiving finance and made it easier for investors to enter and exit such funds. This led to increased activity in the venture capital field for a time, with the number of funds in operation almost doubling. Many operations were in the high-tech sectors of information technology, electronics, communications and biotechnology. However, this tendency has had no longer effects.
References Bain K., Howells P., The Economics of Money, Banking and Finance. A European Text, Pearson Education, 2008, ch. 6 Allen F., Gale D., Comparing Financial Systems, MIT Press, 2001, ch. 3