The NPLs in the Italian Banking System

The NPLs in the Italian Banking System

The 2008 financial crisis has caused a great depression in the global economy and it has been particularly severe in Italy. Consequently, the banking system has suffered deeply the effects of the prolonged recession. The amount of Non-Performing Loans (NPLs) has increased constantly, and now it has reached a dimension big enough to undermine the stability of the Italian banking system. If the problem is not solved, the banks will not be able to restart lending to the real economy, thus creating a credit crunch that would weaken the economic growth. And possibly causing Italy to became the next big European issue.

After the Lehman Brothers collapse in September 2008, the Italian economy has suffered more than any other G7 nation and it is the only one still below its pre-downturn. The recession has been even more severe and Italy has registered a GDP flection of about 10 points in real interest terms (stripping out inflation rate), a gap objectively hard to fill in the short term. This condition has contributed to the weakness of the Italian banking system and to the increase of NPLs. This paper aims to conduct an analysis on causes and consequences on the Italian banking system and the possible attempted or potential solutions to this issue. The dynamics behind Italian banks’ current situation regard the fragmentation of the banking system, a relationship capitalism, lengthy procedures to recover NPLs and the missed recapitalization during the crisis.

Currently, more than 650 banks are present in Italy. This high number has contributed to the fragility of the system, caused an inadequate level of innovation and exacerbated the “relationship capitalism issue”. Indeed, too often the lending has not been allocated in order to maximize profits but to preserve and to develop relationship and special interests. Furthermore, the time for credit recovery in Italy is longer in comparison with other European countries. This is caused by Italian bureaucracy procedures and it contributes to depress the value of the NPLs. The increasing number of insolvent borrowers has led to huge depreciation of assets on balance sheet resulting in losses in the income statement. Billions of NPLs are written in the balance sheets at 45%-50% of their face value. At the end of October 2016, net NPLs (i.e. net value of depreciation) account for € 85.5bn confirming a reduction of 4% in net loans from its peak of € 89bn at the end of December 2015.

Net NPLs | Banca d’Italia and SI-ABI

During the first half of 2016, NPLs have reached € 197bn, decreasing from the record amount of € 201bn in 2015.

Gross NPLs and bad loans trend | Banca d’Italia and SI-ABI

The banks that underperformed in the EBA (European Banking Authority) Stress Test of July 2016 have seen a great reduction of their market cap, since the test showed the need of new capital.

Net NPLs to Loans Ratio | Banca d’Italia and SI-ABI

The ratio of net non-performing loans to total loans amounts to 4.80% in October 2016, showing a small decrease in comparison with 4.94% at the end of 2015 (before the crisis it accounted 0.86%). This ratio (NPL ratio) is much higher in comparison with other main European economies. Nevertheless, the market continues to undervalue the depreciation. As a result, Italian banks have on average lower Price/Book value ratio (0.42) in comparison to other European banks, apart from Intesa Sanpaolo (that has also one of the highest CET1 ratio in Europe).

Relative Valuation European Banks | Fineco S.p.A

Besides the amount, another great problem is the concentration of NPLs in some banks and some geographical areas. In the South of Italy there is a higher NPLs ratio in comparison to the North. Nevertheless, the main problem is concentration among banks: few banks are responsible for a clear majority of the NPLs, due to bad management behavior.

NPLs ratio by Italian Regions

This has caused the bankruptcy of four small central Italian institutes: Banca Etruria, Banca delle Marche, CariChieti and CariFerrara. That have involved in the bail-in procedure. The resolution of four Italian banks towards the end of 2015 was an unexpected event for the market: it introduced an additional risk premium for the whole banking system. Banks can’t handle the volume of the NPLs internally due to the length of the recovery time and the tight European regulation in term of capital requirements. For these reasons banks are trying to sell the NPLs and clean their balance sheets. However, the potential buyers are few: the market currently consists of many forced sellers and a low number of specialist large scale buyers.

Italian Loan Buyers and Vendors | Debtwire and CNBS via Deloitte and KPMG

The Italian Government in order to solve the lack of interested buyers and the spread between the market price and the book value, wanted to create a public vehicle (the Bad Bank) financed with public funds. The goal of the Bad Bank was to acquire NPLs form the banks at a price close to the one they have on their balance sheet.

Bid/Ask spread NPLs – Financial Times

The solution failed because of the EU Legislation that considers the Bad Bank as a State aid. Consequently, the second solution attempted has been GACS (Garanzia Cartolarizzazione Sofferenze). The vehicle provides a state guarantee scheme designed to assist Italian banks in securitizing and facilitating the removal of non-performing loans from banks’ balance sheets. The objective of the scheme is to act as a CDS (Credit Default Swap) for the NPLs. Nevertheless, the limit of the GACS is that it doesn’t solve the lack of buyers on the market but it only simplifies the procedures for the demission of the NPL.
For this reason, they tried another solution: Atlante. The purpose of Atlante is to promote the creation and development of an efficient market of distressed assets in Italy and operate as anchor investor in the capital increases of banks in difficult situation.

Unfortunately, most the fund’s resources have been utilized for the capital increase of two Italian banks in severe difficulties (Popolare di Vicenza and Veneto Banca). This meaning that only a small part of the fund (€1.75bn out of €4.25bn) has been invested in NPLs.
The limited amount of resources left to purchase distressed loans has made necessary the establishment of a second fund: Atlante II. The main difference of the fund with Atlante I, is that the new fund can only invest in NPLs. Currently, the fund is still raising capital: today the funds has collected a total of €1.7bn. The world’s oldest bank and the fourth-largest bank in Italy, MPS, failed in December 2016 its €5bn capital increase and is now looking for public help to raise €8.8bn and Fondo Atlante to alleviate the weight of non-performing loans. Moreover, Unicredit bank plans to raise €13.8bn of new equity to shore up its balance sheet, launching the rights issue in the first quarter of 2017 and using the money to help mop up €17.7bn worth of bad debts. As a result, the Italian bank expects to increase net profit to €4.7bn in 2019 from €1.5bn last year and its common equity Tier 1 ratio to more than 12.5% by 2019 from 10.8% at the end of September.

Nevertheless, during 2016, some improvements have been made. The government simplified bureaucracy in order to reduce the time to recovery of NPLs, and so the amount of NPLs sold have increased towards the end of 2016. The great challenges ahead faced by Italian banking system need a profound renovation of the system in order to reinforce the economic growth. For the re-rating of Italian banks, there is no need to solve all the problems of profitability and the NPLs: just a few success stories and the removal of tail risk is enough to change overall perception.

However, the aim is to win a marathon, not the 100-metres sprint. We need to implement decisive actions that will solve the problem completely. Otherwise Italy runs the risk of becoming the next major problem in Europe, a new Greece, but too big to fail.


Alessandro CorteseFinancial Markets Associate

Giulia Maccelli –  Financial Markets Associate

Christoph Koenig – Financial Markets Associate


Everything happening in the Markets: Winners and Losers of 2016

Everything happening in the Markets: Winners and Losers of 2016

Here’s a look at some of the best and worst performing assets in global financial markets as 2016 ends.


British pounds are almost unanimously rated to be the worst performing currency in the year of 2016, which suffered significant devaluation due to the Brexit referendum on 23rd June, 2016. Overnight GBP plummeted, a price UK paid to “leave” the EU. By the end of the London trading session the next day, GBP dropped nearly 9% against the dollar, representing one of the largest single-session selloffs in GBP history. The ride for GBP in 2016 wasn’t a great one, though the value of GBP is expected to stay resilient until further details of Brexit will be revealed.

EUR/USD started with 1.0898 on January 4th 2016, but decreased to 1.0541 on December 30th, despite having achieved the peak of 1.1569 on May 3rd. The average EUR/USD of the year was 1.1062, but it could reach the parity in 2017 as Trump’s expansionary fiscal policies could further strengthen dollar.

EUR/USD Trend 2016 – Financial Times Market Data

With slower economic growth in China, Chinese RMB had its biggest annual loss this year since 1994, therefore the government ended 2016 introducing a new round of capital control measures to help RMB stay strong. The slowdown also weakened the value of Australian Dollar and New Zealand Dollar.


2016 has been a resurgence year for commodities, with the first annual advance since 2010. Thus, the Bloomberg Commodity Index, tracking returns for 22 components, climbed 11% in the past year.

Natural gas is on the biggest fourth-quarter rally in 16 years, prices grew 60% over this year, pushed by expectation of a severe winter. Wheat, on the other end of the spectrum, has been the worst performer tumbling 14% due to rising global stockpiles.

OPEC and 11 other producing countries plan to start oil supply cuts in the beginning of 2017 to reduce swelling global inventories after a long period of unlimited output. Details of agreement implementation are still awaited but oil has made the biggest annual gain since 2009. While economic growth of top user China and Donald Trump presidency, particularly his infrastructure investment plan, are expected to further bolster demand for metals in the coming year. For the first time in four years Goldman Sachs has recommended an overweight position for commodities, raising both iron ore and oil price forecasts. However, signals on the iron ore prices are mixed – plenty of other banks expect them to be back below $50 by the third quarter as Chinese property market may cool.

Brent Crude Oil Trend 2016 – Financial Times Market Data

Trump’s victory had a detrimental effect on gold – it suffered a 13 percent decline in the fourth quarter of 2016, confirming the negative correlation between gold and U.S. stocks. After the dire end of the year, however, traders are once more bullish on gold as it climbs up 2.6% to 1173 an ounce the first week of 2017. Investors also hold bullish positions in cotton, cattle and crude oil, but aren’t optimistic for corn, cocoa and wheat. Overall, a modest recovery is projected for most commodities in 2017 as demand strengthens, supplies tighten and global economic growth picks up.


The year 2016 was a pretty good one for stocks despite political uncertainty coming from Brexit, Trump, and new elections happening across Europe. In UK, The FTSE 100 broke an all-time high on the final trading day of 2016. In the US, the S&P 500 was up over 10% across the year, the return was 12.5% including dividends. That followed the weak performance of 2015, when the index gained just 1.4%. The beginning of the year was challenging for American stocks, when they have experienced a selloff, driving the Dow Jones industrials at 15,500(now 19.970). However, potential Trump’s expansive fiscal policy and a bounce in commodity prices have been key drivers for markets, offsetting the initial tumble. US banks are expected to boost earnings as a result of higher Treasury yields and a more accommodative regulatory regime promised by the Trump administration. The best performing sectors of the S&P 500 were Energy with a +24% return and Financials with a gain of +20%.

Schermata 2017-01-09 alle 12.20.21.png
S&P 500 Energy and S&P Banks Trend 2016 – Bloomberg via Financial Times

While other developed equity markets mostly struggled in 2016. Europe was hit by Britain’s vote in June to leave the European Union and the European Stoxx 600 was down 1.2%. Despite 2016 was the fifth successive annual gain for the Japan’s Nikkei 225, the index was only up 0.5%, partially due to weak inflationary and macroeconomic data signaling a weakening effectiveness of BoJ monetary policies.

Stoxx 600 Trend 2016 – Bloomberg

The best stock index of the year (in terms of U.S. dollar) was the Brazil’s Ibovespa, driven by the new President Michel Temer replacing Dilma Rousseff after the impeachment, and rising commodity prices. The Shanghai Composite index was the worst (-16%), however it was down -23% at the beginning of 2016, due to an initial loss of confidence in China’s economic growth prospects. The falling yuan has driven investors abroad in search of better performance elsewhere.


2016 was a volatile year for government bonds starting with the immigration crisis, followed by Brexit, Trump’s winning and ending with the veto vote in Italy’s constitutional referendum. U.S. Aggregate Bond Index finished with 1.9% in the closing days of 2016 with the expectation of an increase of US treasury yield accelerated after election results on November 8th, the spread between US 10-year Treasuries and German 10-year Bund widened to 2.224%, marking the widest gap since the fall of the Berlin Wall. The gap signals that investors see strong divergence of economic growth in these two developed markets. Across the Pacific Ocean, China’s 10-year government bond yield has fallen from 4.6% in January 2014 to 2.65% in October 2016, one of the lowest points this year, despite the government’s efforts to contain the bond bubble.

Total Return of Global Financial Assets 2016 – Bloomberg via Deutsche Bank



Luca CartechiniHead of Financial Markets
Yiping Zhang – Financial Markets Associate
Kseniya Shitova – Financial Markets Associate

Credibility of Central Banks – A comprehensive analysis of ECB and FED effectiveness

Credibility of Central Banks – A comprehensive analysis of ECB and FED effectiveness

On the 1st of January 1999, the ECB assumed responsibility for monetary policy in the euro area, with the primary objective of maintaining price stability, keeping the euro area’s target inflation rate (calculated using the Harmonized Index of Consumer Price, HICP) below, but close to 2% over the medium term. This objective has even been reinforced with the ratification of the Lisbon Treaty in 2007. Seventeen years later in 2008 the global financial crisis erupted causing the greatest economic recession since 1928. Since then the ECB has been put under additional pressure to advise on regulation and enforce banking supervision while fostering economic growth. Extremely unconventional monetary measures have been taken to achieve this objective and a recover of the economy and productivity.

On the 12th of November 2008, the first measure was implemented by cutting the interest rates for deposits, overnight loans and the Main Refinancing Operations. The two main objectives of this move were to provide greater liquidity to commercial banks and depreciating the currency against the US dollar, allowing a greater competitiveness.

Despite the large amount of capital lent through MROs and LTROs, banks preferred to buy bonds instead of lending to families and enterprises, not fulfilling their function as middleman between the ECB and the real economy.

On the 26th of July 2012, Mario Draghi famously announced that the ECB was willing to do “whatever it takes”. Consequently, launching new measures to support the countries, which were facing economic and financial difficulties. In September of that year the Outright Monetary Transactions (OMT) were introduced.

The OMTs key points were: Unlimited ex-ante bonds purchase quantity; one-year and three-year maturity bonds purchase; transactions performed in the secondary market sterilizing the exceeding liquidity. While this programme was initially controversial, as it questionably occurred outside of the ECB’s legal framework, it did achieve its expected outcomes, as bond yields in the weaker countries declined. On the 5th of June 2014, the ECB announced the first series of TLTROs (Targeted Long Term Refinancing Operations) which linked the amount borrowed and lent (expected mortgages) to private sector, aiming to incentivize banks to increase their lending.

Although the ECB had implemented all these unconventional measures, no significant positive effect had been seen.  The PMI index evolution show a soft recovery ignited by Draghi’s first moves.


That is why on 22nd January 2015 Mario Draghi introduced an extended Quantitative Easing program, the Asset Purchase Program (APP), which allows the purchase of Eurozone government bonds. This programme allowed for € 1,140 billion in bonds to be purchased and lasted 19 months (supposedly, from March 2015 to September 2016), injecting even greater liquidity into the market. The bond purchases provided greater monetary stimulus to the economy while the key ECB interest rates were kept at their lower bound. Furthermore, an easing of monetary and financial conditions occurred, making access to finance cheaper for firms and households. This tends to support investment and consumption, and ultimately aims at helping the economy reach its targeted inflation rate. This move was unexpected from market who rejoiced vigorously, pushing European stock indexes up to multiyear highs. DAX index, the one who benefited the most from the ECB’s new plan topped 12000 points.

After one year of the extended QE program some doubts arose about the effectiveness of the ECB’s monetary policy, raising the credibility of monetary policy issue and igniting criticism from some member states, such as Germany, mainly for the negative impact on people’s savings.

In response, the ECB surprised the markets in March 2016, by cutting key interest rates, expanding the asset purchase program to 80 billion monthly and deferring the end to March 2017. In addition, the percentage of bonds that can be purchased has changed from 33% to 50% and the purchase program includes also some high-rated companies’ shares other than covered bonds and asset-backed securities. Four new TLTROs (TLTRO II) are being issued every three months, starting from June 2016 with an interest rate, which is linked to the participating banks’ lending patterns. The more loans that participating banks issue to non-financial corporations and households (except loans to households for house purchases), the more attractive the interest rates on TLTRO II borrowings becomes.


In a recent statement at the ECON committee of the European Parliament on the 28th of November, Mario Draghi remarked that: “To increase the effectiveness of monetary policy, fiscal and structural policies are needed that reinforce growth and make it more inclusive”, while in his speech ten days before, stated that “Since the onset of the global financial crisis, 2016 has been the first full year where GDP in the euro area has been above its pre-crisis level. The economy is now recovering at a moderate, but steady, pace, while the employment is growing. We remain committed to preserving the very substantial degree of monetary accommodation, which is necessary to secure a sustained rise in inflation.” Despite Draghi’s reassurances, as well as the unconventional and largely expansive measures carried out by the ECB, one can observe that inflation levels are rising, but still at a too slow pace, currently at 0,5%. The same can be said for GDP growth.


The main question to ask is where is large amount of capital that is being injected into the economy flowing, and why is it not boosting growth?

Low interest rates – the rate on the deposit facility is -0.4% while the interest rate on the main refinancing operations is at zero level – should decrease the cost of financing of the banks and lower the attractiveness of government bonds inducing them to lend to enterprises and consumers. Unfortunately, many factors have contributed obstructing the transmission of money to the real economy and restrained the banks from granting loans. First, the banks are not inclined to lend money for three main reasons: the poorer margins on loans, squeezed by the rates at their lowest level; the necessity to keep risks under control which conflicts with the credit standards’ tightening, particularly on corporations, that can even be worsened by the forthcoming introduction of Basil IV, still under discussion, which is considering to impose the use of standardized credit scoring approaches, instead of the more flexible Internal Standards-Based Approach introduced by Basil II, change which will require higher provisions for risks; at last the harsher capital requirements set by Basil III in 2013, which induce banks to immobilize funds that could be alternatively lent.

It seems that the situation is getting better and banks are finally increasing the amount of loans granted. It is noticeable that the increase is faster since 2015, year of introduction of the Quantitative Easing program. The manufacturing PMI Index for euro area, which measures the performance of the manufacturing sector, is climbing up to the 2011 peaks. Therefore, the introduction of stricter credit rating approaches is highly questionable and more flexibility should be given to lenders.


It is also true that the low interest rate policy and the Asset Purchase Program have contributed to the increase in prices of assets and so the reduction of yields, inducing banks to take greater risks in return for higher returns. Indeed, fixed income prices are at their highest while the German 10Y bond yield is only 0,2%, having been even negative last June for a couple of months. 

Another reason behind the lack of effectiveness of the quantitative easing is that it could not have the impact desired, as interest rates at the inception of the program were already very low. The 3-months Euribor rate was hardly higher than zero.

The conclusion is that monetary policy does little to support growth, when not combined with adequate fiscal and regulatory policies. The IS-LM diagram, or Hicks–Hansen model, can help one better understand the current situation. Last but not least, the world today is in what can be deemed as a “liquidity trap”. A situation in which the central banks cannot reduce the interest rates even further, as doing so has no effect on inflation. Policymakers are pushing negative interest rate policies to stimulate growth. Lower rates are designed to spur savers to spend, redirect capital into higher-return (i.e. riskier) investments, and drive down borrowing costs. This is associated with a weaker currency, making exports more competitive. When a “liquidity trap” occurs and rates go negative, a squeeze on the speed at which money circulates through the economy, commonly referred to as the velocity of money, incurs. Therefore, each Euro generates less and less economic activity, increasing deflationary pressure. As consumers see prices decline, they defer purchases, and growth slows. Deflation also lifts real interest rates, which drives currency values higher. If the ECB persists in this policy, pumping more and more liquidity into the economy, then more negative rates could be on the way.


The austerity measures pursued by the European Union since the beginning of the European sovereign debt crisis at the end of 2009, have constrained the member states to lower their debts and the public spending, exacerbating the fiscal policy and worsening the economic downturn. By the way, it seems that, under the more insistent demand by many member states for more flexibility, EU is overshadowing the pursuit of lower deficits, to focus on the boost of economic growth.

On the 8th of December 2016, Draghi announced that the ECB would scale back the monthly bond purchases from € 80 billion to € 60 billion in March 2017, postponing the end until December 2017, reassessing the support of ECB to markets. Moreover, the ECB would consider (but not necessarily pursue) purchases of bonds with yields below the standing facilities deposit rate (i.e. -0,40%), thereby incurring losses for the central bank, if such purchases were to be made. This announcement provided a largely positive reaction on the European equity markets, while European bond market yields fell even lower and the Euro/Dollar had its largest drop since Brexit, depreciating by 1.5%. Following the announcement of the ECB’s future QE plans, reporters repeatedly questioned whether and when tapering would occur and Draghi insisted that members of the governing council unanimously did not consider such measures.

Europe, to help the ECB to fulfill its task, is considering several non-monetary measures. The Capital Markets Union (CMU), strongly supported by ECB, is expected to come into effect in 2018. Commercial banks are currently hesitating to issue new credit, particularly to SME’s – which account for 99% of all enterprises in EU – due to the size of their large balance sheets. The CMU would enable commercial banks to shift risks away from balance sheets by allowing investors (such as pension funds) to invest in securitized loans. However, it must be stringently regulated, to ensure that the quality of the debt being securitized and sold, meets certain standards. A lesson tragically learned by the recent financial crisis.

The harmonization of fiscal policies among EU member states seems still far away and hard to achieve. At last Europe is changing attitude in direction of a greater allowance for deficit spending and public debt, under the requests received by many member states, which questioned the austerity policy.

Unconventional and expansionary monetary policies have been implemented by the ECB in the past years in response to one of the greatest recession in history. The traditional policies are no longer effective and the Central Bank is now experimenting new solutions, which are contributing to the recovery, even if the results are not as good as expected and Europe has not recovered the pre-crisis economic level yet.

European bodies and the ECB are struggling to boost the economy and to increase the cohesion within the European boundaries through a process of continuous change.

However, many are the threats to the future of Europe. The forthcoming elections in France, Germany and perhaps Italy, on the wave of anti-European and nationalist movements, are likely to increase the uncertainties about the solidity and cohesion of the Union, even more after the stunning result of Brexit referendum. Cohesion that is already under pressure and exasperated because of the different interests and views of the member states about serious issues currently under discussion such as the actions to adopt in response of the massive migration wave that is hitting EU borders (and that can even worsen given the current tragic situation in Syria) or the necessity of austerity policies.

Second, the possibility that the extremely expansionary measures can lead to excesses and to a financial bubble likely to explode once there would be a tightening of the policy (house prices in healthier countries are rising sharply).

Furthermore, the effects of the enhanced divergence between the monetary policies pursued by the ECB and the Fed are still unknown and unforeseeable. The Fed has not surprised investors with the last adjustment on December, even if the signal sent by Janet Yellen was little more hawkish than market is used to. The immediate effect has been a strengthening of the dollar against other currencies and a sell-off European bonds, which showed a rise in yields. The Fed funds futures show that traders are now betting on a faster tightening by US Central Bank. Indeed, the Chairman has announced that there will be at least three more adjustments in 2017. It seems that the era of ultra-low yields is nearing its end in USA, where the economy is recovering strongly and even better are performing the financial markets (Wall Street has reached its historical peaks).

The effects for Europe are difficult to predict, but for sure, the quicker the dollar strengthens, the more destabilizing that is. For instance, a huge amount of emerging countries’ bonds is issued in dollars, thus it would be harder to repay it Moreover many commodities are priced in dollars so they would become much more expensive contributing to a slowdown of global economic activity that depends on the consumption of such resources, on the oil price, which is now recovering after having hit its lowest level at the beginning of 2016.


The ECB is dealing with a testing challenge: achieve a recovery of the European economy and productivity within a global environment characterized by slow economic activity and great uncertainties, while experimenting policies never pursued and whose results are difficult to predict. The difficulties and the threats that can obstacle the fulfilment of the mission are many, so are the opportunities that can be taken. There are too many uncertain factors that make useless and speculative every effort to make predictions. Draghi, which will be in charge until 2019, seems to have clear ideas about how to deal with the task and has already achieved very good results, despite the critics.

Would the ECB and EU bodies be able to face the forthcoming hard times, keeping the EU unity and cohesiveness and achieving finally the economic recovery? Stay tuned.


Conor Marriman, Niccolò Ricci and Alessandro Sicilia