Italian banks may be able to compete with one another more easily now, but they must gain efficiency in order to make a mark in the global marketplace.

Two years after a reform law partially deregulated the Italian banking system, the country's banks are struggling to adjust to the more competitive environment of an economically integrated Europe. Italian banks are freer now to merge their each other and expand their branch networks, but efficiency remains low by European standards.

"If the banks are to adapt successfully, they must place a greater focus on their operating efficiency and core profitability," warned a recent Standard & Poor's Corp. report. "A real concern for Italian banks is that, unless they can strengthen their home bases, it will be unrealistic to try to compete on an international basis."

Political Influences

Italy's heavily politicized banking system is characterized by too many banks and not enough branches. The country has about 1,085 banks, but bank accounts and bank branches per capita lag by European standards. A case in point: Each of Italy's 16,000 branches serves an average of 3,729 people, compared to about 1,800 customers per branch in Spain, Germany, France, and Britain.

Also, the Paris-based Organization for Economic Cooperation and Development has estimated Italian banks operate at an average cost-income ratio of 70.1%, compared to less than 66% elsewhere in Europe. A big problem is rigid labor laws that limit flexibility.

"It's very difficult to lay off people in Italy," said Roberto Bella, banking analyst at Standard & Poor's in London.

Another source of trouble: 80% of the banking sector is state-owned, which invites management based on political patronage rather than competence.

Since 1990, legislation has tried to correct some of these weaknesses. Private shareholders operating through joint stock companies can now own up to 49% of the public banks. Branching has also been liberalized.

Italian bankers, for the most part, applaud the new legislation. "At last, the major banks will have the size required for the European market," said Giovanni Rio, first vice president at Banco di Roma in New York.

Many banks have taken advantage of their newfound freedom to open highly automated "light" branches, which employ four to seven people instead of the customary 30 to 50. These smaller branches allow banks to expand into new markets at less cost.

The Bank of Italy has said it would like to see five or sic national, multiservice banks emerge to compete successfully in a unified European market.

Since 1990, several big mergers have been announced. For example, the new Banco di Roma holding company will comprise three Rome-based public-sector banks: Banco di Roma, Banco di Santo Spirito, and Cassa di Risparmio di Roma. Their merger, which will be closed in August, will make Banco di Roma Italy's largest banking group, with 1,100 branches nationwide, including 204 in Rome.

Also, state-owned Credito Italiano of Milan is seeking to acquire privately held Banco Nazionale dell' Agricultura, in which it already holds a 4% stake.

Strength on Asset Side

Italian banks are also trying to modernize their technology to catch up with the rest of Europe. Last year, they invested $3.26 billion in information technology, up 10% from 1990 and almost 30% since 1988. Such investment is expected to jump another 30% by the end of next year.

Italian banks possess some natural strengths.

The nation's economy is characterized by a predominance of small- and medium-sized companies that have few alternatives for raising capital. So Italian banks are better able to find good lending opportunities than their European counterparts, even during an economic downturn.

"With the middle-size customers, you have transactions that are big enough that they don't require too many administrative costs to be handled, so they tend to be the most profitable ones," said Mr. Bella of S&P.

On the other hand, funding costs are high for Italian banks because of their difficulty in competing for deposits in a market where government debt sops up so much investment. The Standard & Poor's report questioned the effect on credit quality as Italian banks seek out new and unfamiliar customers.

"We have some concerns that, in the future, asset-quality problems may increase for the whole system," Mr. Bella said.

Last year, Italian banks performed better than expected, despite an economic recession. Net profits at the largest banks increased by an average of 3%. The best performance was turned in by Italy's largest savings bank, the privately owned Cassa di Risparmio delle Provincie Lombarde. Cariplo, as the bank is known, posted profits of $244 million, up 6.5% from the previous year.

Even scandal-plagued Banca Nazionale del Lavoro, the largest state-owned bank, reported that net profits rose 3.1%, to $61 million, despite about $2 billion in nonperforming loans to Iraq.

BNL's Atlanta branch has been under investigation since August 1989 for making $5 billion in unauthorized loans to Iraq.

Despite BNL's Atlanta disaster, Italian banks have been showing renewed interest in the U.S. market. Cariplo recently opened a loan production office in Chicago and is also eyeing Los Angeles. State-owned Banca Commerciale Italiana has stated an interest in acquiring a U.S. bank; in 1987, it made a run at the former Irving Trust Co., since acquired by Bank of New York.

But the main international thrust for Italian banks is clearly Europe, as the continent's economies move toward integration. Germany and France are of particular interest, since they account for more than one-third of Italian trade. Several Italian banks recently opened branches in Lyon, France, to take advantage of trade ties between northern Italy and southern France.

"Most of them are following Italian-related business -- multinationals that have operations in Italy or clients that have some type of import/export business between Italy and other countries," Mr. Bella said. [Tabular Data Omitted]

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