The Italian story

Just like Germany, Italy is dominated by a large number of banks (740 in 2012) and the five major banks had only 40 percent of total assets in 2010 (see Figure 10). However, the structure of banking is also influenced by the macroeconomic landscape, which is dramatically different from the German one. As shown in Figure 16, Italy suffers from having a government debt to GDP ratio of 135 percent, second only to Greece's 174 percent and in parallel with the debt ratios of Portugal and Ireland.

However, as shown in Figures 17 and 18, the government debt in Italy is to a large extent held in domestic financial institutions, in turn nourished by a traditionally high household savings ratio. Almost 20 percent of the total financial assets of Italian financial institutions are held in domestic government bonds, a much higher percentage than in Greece, Ireland or Portugal where the debt is held to a larger extent by foreigners (even though the national share is rising). Looking only at banks, the share in their total assets of domestic government bonds rose from 6.8 percent in 2012 to 10 percent in August 2013, dominating Spain at 9.5 percent and Portugal at 7.6 percent. During 2013, domestic banks absorbed 75 percent of net issues of Italian government bonds, as contrasted to 60 percent in Spain. Foreign investors are evidently reducing their exposure to the “PIIGS countries,” forcing domestic institutions to pick up the slack.

The domestic dominance has advantages and disadvantages. The advantage is that domestic investors are more stable than fickle foreigners. But the disadvantage is firstly that banks may suffer from increased capital charges in the future or even write-downs or hair-cuts à la Greece. So far this has been avoided by the fact that government bonds in euro financed in euro have been regarded as risk-free under Basel II and hence have required no capital charges for credit risk if held in the banking book. This treatment is, however, likely to change since it was an unintended exception to the Basel rules.

The second risk relates to the losses incurred when yields rise.