In a context of monetary policies with a strong expansionary orientation (to favor economic recovery) and restrictive fiscal policies (to respect the Community deficit and public debt constraints), the normalization of markets it requires a change in investor confidence and a change in the possibility and propensity of intermediaries to take risks (particularly in the transformation of maturities) and of institutional investors to lengthen their investment horizons.
Indeed, the crisis has led – inevitably – to a series of restrictive measures on the behavior of intermediaries and institutional investors which forced them to reduce the credit risk and the liquidity risk.
These are timely and correct interventions to guarantee the stability of intermediaries and create the conditions for the reconstruction of "trust".
However, such interventions could not fail to have a procyclical effect on the current crisis.
The best known and most evident is the (more than) doubling of primary capital required to offer a certain level of financing to the economy (small and medium enterprises in particular).
The Prometeia Report dedicates a series of insights to this theme.
Taking 100 the credit granted to small and medium-sized enterprises (or rather their risk weighted asset) it was necessary to have 4 basic capital.
Obviously, as the Report clearly points out, in the current context of lack of confidence and lack of capital, a mix of these two effects is taking place.
The second, less evident but equally relevant intervention, is the one on liquidity mismatches.
Also in this case the Prometeia Report highlights the critical aspects.
In a situation of drying up of the wholesale medium-term financing markets, banks have been forced (again correctly to safeguard their stability) to reduce the mismatches between the duration of funding and loans.
As a result, in rare cases the banks have managed to increase long-term funding, while in the vast majority they have had to reduce the disbursement of medium-long term loans, reorienting themselves towards short-term ones.
A third factor affects institutional investors. The imposition of so-called "risk budgets" (tolerable risk amount in products managed on behalf of customers) has a correct and prudential logic: it prevents managers from operating by assuming risks that are not consistent with the mandate received from subscribers.
However, risk budgets are measured using market volatility (or a more or less complicated transformation thereof). It follows that an increase in volatility, even if in the absence of any manager activity, leads to exceeding the risk budget and therefore to the obligation to sell medium-long term shares or bonds to buy short-term assets.
In practice the behavior of institutional investors is reversed that instead of "buying when markets go down" they are forced to "sell when markets go down".
The fourth factor is the reinterpretation of Mifid constraints by intermediaries in a crisis context. The evaluation of the Mifid risk profiles is unfortunately always based on the saver's net present value regardless of the investment horizon (in summary, the BTP which guarantees a fixed coupon is always more risky than a BOT even if the saver's objective is to have constant coupons).
In the context of the crisis, with an obvious increase in litigation, intermediaries have a natural propensity to minimize the risk of litigation with customers by favoring the sale of securities or risk-free short-term assets.
A fifth and final factor (direct consequence of the previous ones) is the temporary imbalance of weights between management bodies and internal control bodies in the governance of financial intermediaries.
After years of absolute dominance of the management bodies and mere formal fulfilments by the internal control bodies, we have moved on to a phase of inertia of the former and of strong proactivity of the latter
If the proactivity of the internal control bodies is certainly a positive factor for the sustainable development of activities in a context of controlled risk, the inertia of the former is a phase to be overcome.
Intermediaries need, at the same time, management bodies that are active and ready to assess the risk of new initiatives and internal control bodies that are equally proactive and vigilant on compliance with the agreed risk levels.
A lack of the former delays the normalization of the financial and credit markets which need active intermediaries in the assumption and management of the relative risks.
All these factors have led financial intermediaries and institutional investors to reduce the disbursement of credit (especially in the medium-long term) and to reduce investments in shares or other forms of risk capital.
This phenomenon has accompanied the phase of low investor confidence and has made it very difficult for companies to access medium-term financing or the capital market.
The only strongly anti-cyclical policy it was that of the central banks which guaranteed intermediaries and the authorities an abundant and continuous short-term liquidity flow.
However, the problem is: if intermediaries do not favor the transformation of maturities and institutional investors do not diversify on risk capital, abundant liquidity achieves the minimum objective of guaranteeing working capital to companies and protect intermediaries from default from liquidity but not the ultimate goal of financing investments and encouraging the collection of venture capital.
So what can be the steps to accelerate the return to normalization of the financial and credit markets?
A first factor is il tempo, thanks to the progressive implementation of the new rules and new behaviours.
We will start from new bases with physiological behavior on the markets when the banks have reached the level required for the new capital ratios and the balance on the more stringent constraints of transformation of maturities, when the end investors have reached the new balance of "risk budget ” on structurally higher levels of volatility, when intermediaries will “accompany” savers on the intermediate part of their risk profiles by reducing the portion of the portfolio invested in liquidity or very short-term assets.
A second factor is related to governance balances in financial intermediaries: the imbalance between the "passivity" of the management bodies and the "activism" of the internal control bodies cannot be sustainable in the medium term.
The trend towards risk reduction, in a private company, can only give way to a more balanced phase of governance which aims at taking a conscious risk but at sufficient amount to remunerate the capital.
If this balance, necessary to remunerate capital, could not be achieved, the private nature of financial intermediaries would end up being called into question.
The third factor can only be the return of saver confidence. This is a factor influenced both by macro events (such as the growth of their disposable income) and by the effects induced by financial intermediaries, those described above), and finally, again, by the time factor (accustomedness to acting in a context at risk higher).
The normalization of the credit market and the securities markets could then be favored by regulatory interventions on institutional investors and savers.
For institutional investors they should be studied opposite anti-cyclical rules to those in force and described above (risk limits based on market volatility): the new rules should encourage purchases when market volatility increases (and the bearish trend) and should instead push institutional investors to sell when volatility decreases (and we are witnessing an upward trend).
The role of these end investors with a long-term perspective should in fact be that of an anti-cyclical stabilizer of the market.
For savers, it would be necessary to separate savers who aim to minimize the risk of fluctuations in the present value of securities (BOT investors, i.e. sensitive to price risk and insensitive to the risk of instability of the return on their savings) from annuity investors which instead have the objective of minimizing the risk of interest fluctuations (long-term BTP investors, i.e. investors sensitive to the risk of not collecting coupons of a given level and completely insensitive to the market value of the security).
Under current legislation, "annuity" savers who consider themselves "absolutely risk averse" are unable to invest in long-term assets because these securities (because of the duration) are classified by intermediaries as high-risk assets.
Long-term investment is therefore hindered, with damage, obviously, not only for "annuity" savers but also and above all for issuers (primarily businesses) that would need long-term financing.
Europe and, above all, Italy need a normalization that will allow a return to a physiological situation of the credit and securities markets. The "time factor" is now working in the right direction. If, then, it were also possible to work on the other factors described "at no cost" (both behavioral and regulatory) perhaps savers and businesses could derive significant benefits in a reasonable time.
