They were extendible
How extendible notes work
Despite the attractive economic rationale for issuing short-dated transactions, not all jurisdictions have fully embraced them. One noteworthy aspect of the credit dislocation has been the absence of any noise about the Italian banking system. A regular feature of the credit spread widening was for Italian credit to be among the first to suffer. But this time things have been different. Italian banks are little mentioned as a possible cause for concern. In fact, Italy’s banks have outperformed the financials sub-set of the iTraxx index.
One reason why Italian banks are at relative peace in the banking turmoil is that they have remained focused on domestic activity. But it’s also because of their excellent liquidity position. In the past five years Italian banks have been the most willing sellers of medium-term debt.
During the period from September 2002 to March 2006 the average tenor of Italian banks’ senior financing was 5.9 years. The contrast with Spanish and UK banks could not be more stark, where the average was just 3.5 and 3.6 years, respectively. It is ironic that having baulked at the cost of longer-term debt when liquidity was ample it will probably cost substantially more to refinance these short-dated securities now.
Conservative and expensive
The reason for the Italian banks’ strong position goes back to the Italian central bank’s supervisory instructions for banks made way back in September 2002. These set stricter limits on the maturity profile of Italian banks’ debt and sought to enhance asset-liability maturity matching. In other words: the regulator wanted to limit the use of short-term financing to fund longer-term assets. This type of conservative approach is relatively expensive and can put banks’ return on equity under pressure compared with banks operating in more liberal jurisdictions.
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Italians like it long |
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Average tenor of European banks’ senior financing (Sep 2002 – March 2006) |
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Source: Dealogic |
Still, under these rules, Italian banks had a strong incentive to issue new debt with a maturity of more than five years. So Italian banks were issuing five-year and seven-year floating-rate notes when their UK and Spanish counterparts were happily conducting much of their term funding in the form of 18-month FRNs and money market securities.
It was the then central bank governor, Antonio Fazio, who pushed Italian banks down this conservative funding route. Fazio resigned in 2005 following controversy about his handling of Banca Antonveneta’s proposed sale to foreign buyers. But although international commentators at the time might have compared Italian banking negatively with the rest of western Europe, Fazio showed some prescience. At a 2001 conference he said: "The abundance of liquidity, amplified by international banking transfers, has contributed to the dislocation of market quotations from values consistent with economic fundamentals for extended periods of time... Fluctuations in the market value of stocks and real estate can undermine the stability of financial institutions, especially banks." It is a shame that other regulators did not heed his words.