While Italian banks are somewhat hostage to fortune as the eurozone crisis rages, they certainly can beef up their defences and business models amid a shifting financial landscape. One of the most obvious weaknesses in the sector is the high loan-to-deposit ratios, which have deteriorated since the early 2000s, with deposits now covering only 85% of loans down from 90% at peak coverage. While deposit flight hasn’t been an issue so far, these ratios still create concern. One possible solution would be for banks to move to a more fee-based model with corporate clients. Italian corporates, as is often the case in Europe, tend to be funded through bank loans rather than via capital market activity – something that is no longer sustainable given Italian banks' capital constraints.
Unfortunately, things aren’t as simple as just telling corporates to issue bonds and waiting for the fee money to roll in.
"Disintermediation has to be limited in a country where so much of the economy is based on SMEs," says Federico Imbert, CEO of Credit Suisse Italy. "SMEs are dependent on bank credit; however, there does need to be more disintermediation at the top. Large corporates were allowed to not be proactive and avoid capital market activity in the past because of the easy access to cheap bank credit. This isn’t an option anymore."
Slow transition
Moving to a fee-based approach is a marathon not a sprint. Thrusting SMEs – or even the larger corporates that lack experience in this field – into bond issuance without some kind of support might be a recipe for disaster, particularly in a climate where investors aren’t hungry for risk.
"It’s not self-evident that more disintermediation will be beneficial. European investors are more cautious than those in the US – there’s the risk that if smaller corporates have to enter the capital markets then they may find a lack of appetite for investment," says Guido Banti, co-head of investment banking for Italy at Credit Suisse.
Even the proponents of a shift to a new business model emphasise the need for caution and support in such a transition.
"There needs to be a legal, fiscal and technical framework put in place to allow investors to understand SMEs. This would encourage investment into them and allow SMEs to enter the capital markets," says Paola Sabbione, analyst at Deutsche Bank.
The money freed up from reduced lending would also open up new avenues in banks' retail businesses. The lending that Italian banks typically engage in has never been tremendously lucrative, and new lines of business hold promise as big earners.
"The lack of profitability is a function of the low-risk commercially oriented business structures at the banks and of the current economic cycle. Banks need to look into new product lines," says Giovanni Sabatini, general manager of the Associazione Bancario Italiana.
Potentially lucrative areas of business include asset management and insurance products. These might be better earners than the banks’ lending and mortgage businesses, which could continue to serve as effective ways of hooking potential customers and reliable – if not stellar – sources of revenue.
Unfortunately, a shift to a fee-based model could be hampered by changes in taxation of financial instruments implemented by the Italian government. At the start of the year taxation was harmonised so that financial instruments are all taxed at 20%, formerly corporate bonds were taxed at 12.5% and deposits at 27%. The one exception to this rule is government bonds, which will continue to be taxed at 12.5%, in a bid to boost investor interest in the troubled Italian sovereign debt market.
The change has triggered a boost in fixed-term deposits at Italian banks, which will certainly help institutions struggling with their LTD ratios. However, it may also mean that investors are less attracted to corporate bonds than they may have been previously. Elisa Coletti, banking analyst at Intesa Sanpaolo, indicates that the recent fall in issuance for corporate bonds is more likely to be due to high cost of funding and a lack of demand from institutional investors – cyclical factors linked to the eurozone situation – rather than the taxation changes. Whether it may have an effect on bond issuance and demand in the long term remains to be seen.
A change in business model has a lot of appeal to it – banks could strengthen their LTD ratios while also increasing their historically unimpressive profitability.