However, the banks' focus on their core commercial and retail franchises and their limited reliance on revenues from investment banking and trading operations should help them face the longer-term challenges of operating in a weaker economy, where loan impairment charges are likely to rise.
Trading income in Q308 is likely to suffer from credit spread widening, lower stock prices and the resulting valuation reduction of banks' securities holdings. As the banks' exposure to riskier trading assets remains relatively moderate, Fitch expects the impact to remain manageable. On a positive note, the big Italian banks should begin to benefit from the realisation of cost synergies due to ongoing post-merger integration.
As a result of the banks' recent merger and acquisition activity, their capitalisation has come under pressure. Capital ratios were generally only acceptable as of end-June 2008 and weaker than those of other European banks, with the exception of UBI Banca, which reported a core Tier 1 regulatory capital ratio above 7% at that date. The banks have announced measures to restore capital ratios to more adequate levels, and Fitch expects regulatory capital ratios at year-end to be stronger at the big five banks than they were at end-June, partly due to asset disposals. Capitalisation support measures, which are reportedly being prepared by the Italian government, should help the banks obtain higher capital ratios should this become necessary. Although details on these measures have not yet been made public, Fitch believes higher capital ratios would be beneficial to the five Italian banks as the operating environment in Italy and abroad has become more difficult.
Fitch believes the main challenge for the five largest Italian banks will be to manage their cost of credit in a less benign environment. Although there is no clear sign to date of a general deterioration in asset quality at the banks, the agency expects new impaired loans to increase in coming quarters. The banks have improved their credit risk management substantially in recent years, and Fitch believes they are in a better position to manage their risk exposure than in the past.
Since liquidity began to tighten in the capital markets in H207, the big Italian banks have used their retail client base as a stable source of funding. Bond issuance to retail clients, which has always formed an important part of overall funding, has helped the banks maintain adequate liquidity despite the current tightening for longer maturities. Retail issues have also compensated for lower volumes of issuance to institutional investors. The measures announced in October by the Italian government to facilitate liquidity in the banking system should further underpin the banks' liquidity.
