Since the publication of the EBA stress tests adjusted with the AQR (Asset Quality Review, assessment of the quality of assets) conducted by the ECB, Italian banks have come out in a bad way. In fact, 25 banks were "postponed" due to lack of capital, 19,2% of the 130 subjected to stress tests and AQRs, but as many as 9 are Italian (60% of the 15 evaluated). It is legitimate to ask whether the Italian banks have taken this bad vote through their own negligence. Even without wanting to fully absolve them (which they certainly made mistakes), in our opinion, external factors prevailed in determining that result, of which our banks are the victims and certainly not the architects.
We must distinguish two factors: situation and prospects of the Italian economy; effects of a de facto "stepmother" regulation towards our banks. It is known that the performance of the Italian economy – GDP growth, job creation – has been among the worst in Europe for years. Nor does the position change in forecasts of future growth. Therefore, since no banking system can be robust if it operates in a sick economy, this certainly contributed to the bad vote.
The second crucial factor depends on the setting of banking regulation, defined with the concept of Basel 2 at the end of the 90s, centered on Risk Weighted Assets (RWA). For the reasons summarized below, this approach is wrong but, giving credit where credit is due, it must be recognized that, in carrying out stress tests and AQRs, the EBA and the ECB (and the Bank of Italy) had to apply those rules, internationally defined.
Well, the RWA approach by its nature tends to have asymmetric effects between credit activities (loans to the real economy) and financial activities (investments in securities). On the one hand, credit activities almost always produce, with full weighting, equal RWA values because they are unrated or, if they do have one, they are in any case modest ratings which do not mitigate the risk weighting much. On the other hand, financial assets almost always have high ratings, with low risk weighting: 100 euros of assets can be equivalent to just 20 RWAs. In short, €100 of credit assets tend to result in almost €100 of RWA while €100 of financial assets translates into far fewer euros of RWA. As Fabio Pavesi did not miss in last Sunday's Sole24ore, this is precisely the main factor that explains why Italian banks did badly and German ones did well. In fact, Italians have remained mostly anchored to the traditional business model while Germans have largely moved towards finance and, thus, Italians generate lots of credit assets and large RWAs while Germans generate lots of financial assets and low RWAs . Ultimately, Italian banks are required to have more capital than German banks for every €100 of assets held. This explains the fall of Italian bank share prices on Monday 27 October, especially due to deferred banks with higher capital shortfalls (MPS and Carige), a fall that did not occur for German banks.
So should we blame the Italian banks for sticking to traditional business and not being able or willing to move towards finance? The correct judgment is diametrically opposite. Although some financial development that brings companies' liabilities to the market is desirable, the bank exists to carry out traditional activities and also its possible synergies with the financial markets (e.g. securitizations) should derive from conducting those traditional activities well (e.g. know how to distinguish good from bad debtors).
If, on the other hand, a bank only does finance, its reason for existing ceases: it becomes an investment fund, that is, an intermediary that does not invest in customer knowledge but operates exclusively on the basis of public information. And what little credit such a bank offers will tend to be very procyclical: generous concessions when things are going well and a short "credit" arm when things turn ugly. Thus repeating what Bob Hope thought about it: they offer you all the umbrellas you want when it's sunny, but as soon as it starts to rain they want them back.
And, furthermore, is the low risk weighting assigned to financial assets right? It would be so if we had precise and incontrovertible risk measures. Unfortunately, this is not the case. We were reminded of this in 1998 by the virtual bankruptcy of Long Term Capital Management, the stellar hedge fund led by the algorithms of Merton and Scholes (Nobel prize winners in economics for their risk measurement models), which evidently had not measured the risk Well. This was demonstrated again, in 2007-08, by the miserable fate of many structured finance stocks, which went from AAA to "junk" in the space of one morning. Even today, the dominant risk measurement tools (e.g. Value at Risk) are based on unacceptable assumptions such as that of orthogonality between various types of risk, normality in the distribution of risks and do not adequately take into account the phenomenon of "fat queues" ”, that is, of the fact that the materialization of unlikely but devastating events (such as the Lehman bankruptcy and what followed) should not be underestimated.
In a sense, some argue, stress tests are just a response to the perception that risks are imperfectly measured. But this is a wholly unsatisfactory explanation. In fact, the stresses considered may be insufficient to represent the effects of devastating events. In short, a well-known story comes to mind in this regard. The other night I found my friend Gino bending over under the street lamp. I asked him, "Gino, what are you doing?". He told me, "I've lost my house keys and I'm looking for them." And I: “Ah, and did you lose them right under the lamppost?”. And Gino: “No, I lost them somewhere else but this is the only place where there is light”.
A famous maxim read: actions are weighed and not counted. Many have criticized Enrico Cuccia for apparently expressing this concept. But today the regulatory domain of the RWA proposes something similar again: bank assets are weighed and not counted. Could it be that one day some large creditor country (perhaps overlooking the Pacific) will come to question the validity of those weights and will suggest that we go back to counting bank assets instead of weighing them? Perhaps it would be better to think about it beforehand and to return the banks to the service of the real economy, rather than indulging the impulses of a self-referential financial capitalism which is impoverishing Western societies.
