Liaisons Dangereuses: Banks and Firms
The credit market in Italy is showing signs of a persistent recession, as the latest data published by the Bank of Italy and the Italian Banking Association (ABI) indicate.
On the real economy front, in July, the seasonally adjusted index of industrial production fell by 7.3%. ABI data indicate a 2% decline in GDP and a forecast for 2013 of -0.2%. And the most recent IMF reports actually forecasts a recession lasting throughout 2013. On the financial front, ABI data show that the total amount of bank loans made to households and non-financial companies recorded a downward trend of -1.9% compared to -1.1% in July. In the area of ​​credit to businesses, the segment of short-term loans has undergone a decrease of 3.8%, while medium-to-long term loans are declining by a milder -1.3%.
Ultimately, regardless of the view adopted, the relationship between the real economy and the financial economy does not show clear signs of recovery. However, it may be useful to take stock of some elements that can help us better understand the situation that the Italian economy is experiencing.
Firstly, it is not entirely clear what the cause-effect relation determining the currently depressed credit market actually is. The banking system attributes the decline in credit to recessionary effects in the real economy (as the economy slows down, the demand for credit drops). By contrast, industrialists argue that the crisis of industrial production is due to the credit crunch and credit rationing for certain types of businesses. Incidentally, the data of the Bank of Italy reported a slowdown in lending more pronounced for SMEs than for larger firms.
Secondly, regardless of the cause-effect relationship, the deterioration in the macroeconomic environment has had an impact on the level of riskiness of bank assets. Several analysts argue that the growth in bad loans is one of the most significant threats that the Italian banking system will have face between now and the end of 2013. While having a more reduced exposure to toxic assets compared to other EU countries, Italian banks are most affected by real effects on their portfolio of loans.
Thirdly, as in other peripheral countries of the eurozone, the recent sovereign debt crisis is having an obvious spillover effect on the real economy. Faced with political uncertainty in Europe on the direction to be taken to ensure protection to highly-indebted countries and the conequent volatility of sovereign debt markets, the country risk premium becomes a risk premium on the entire private sector. The increased cost of funding the debt translates into higher costs of financing for firms. A higher cost of credit further depresses the economic performance of Italian firms.
The way out of this vicious circle lies in a mix of increased country credibility at the international level, greater confidence in the ability of the Italian government to deal with sustainable level of debt, thereby reducing the level of interest rates in the medium term.
If these factors led to a reduction in the spread of 200 basis points (as indicated by the Bank of Italy), the current positive trend for Italian exports could consolidate and, in the face of weak domestic demand in the coming year, would enable the Italian economy to jump on the train of global macroeconomic recovery more quickly, which would enable the country to contain the debt-GDP ratio.