During the past two decades the Italian financial system has undergone extensive structural change. As in many other countries, a number of regulatory revisions have enhanced the role of markets in allocating financial resources and transmitting monetary policy. In the field of banking, the reforms have helped engender more competitive deposit, credit, and interbank markets. It is in this framework that Italy’s experience with interest rate liberalization and interbank market development should be considered.

During the past two decades the Italian financial system has undergone extensive structural change. As in many other countries, a number of regulatory revisions have enhanced the role of markets in allocating financial resources and transmitting monetary policy. In the field of banking, the reforms have helped engender more competitive deposit, credit, and interbank markets. It is in this framework that Italy’s experience with interest rate liberalization and interbank market development should be considered.

Historically, the enforcement of legal or administrative controls on banks’ borrowing and lending rates has played a minor role in Italy. Since the end of World War II, restrictions have been imposed only as ceilings on medium- and long-term liability rates: securities issued by special credit institutions until 1993 and medium-term certificates of deposit between 1963 and 1969. Until 1974, banks fixed minimum lending rates and maximum deposit rates through a private agreement sponsored by the Italian Bankers’ Association. This collusive “bank cartel,” in place since 1918, became unstable at the beginning of the 1970s under the pressure of monetary turmoil and was then abandoned.

The objective of this “self-regulating” system was to prevent fierce competition, and the mechanism was welcomed by banking regulators concerned with financial stability. Moreover, for long periods the cartel’s agreements, in particular that on lending conditions, were closely linked to official interest rates, fostering the transmission of monetary policy impulses.

During the 1970s, the introduction of mandatory investment requirements (the portfolio constraint) and administrative controls on credit expansion limited the scope for rivalry between banks. Meanwhile, the attitude of regulators toward competition in banking was changing, with growing concerns about the trade-off between efficiency and stability, the commitment to European Common Market rules, and the shift from direct to indirect monetary policy instruments. The reforms implemented since that decade have gradually eliminated line-of-business restraints, geographical and sectoral segmentation, and barriers to entry. In 1990 an antitrust law specific to the banking industry was passed. The new banking code of 1993 explicitly cites the competitiveness of the financial system as one of the concerns of supervision.

All in all, it is safe to say that since World War II Italian banks’ borrowing and lending rates have been freely determined in the marketplace. They have been affected by regulation only insofar as regulation has shaped market structures. In this framework, the objective of providing credit facilities to selected categories of borrowers, usually assigned to interest-rate controls, has been pursued through a wide array of instruments, ranging from the institution of highly specialized intermediaries to subsidized credit.

Regarding interbank transactions, the development of a deep, efficient, multilateral market has been a long-standing objective for the Bank of Italy. The key reforms in this area were the creation of a computerized clearing and settlement system in 1989, and the introduction of a screen-based market and the reform of the compulsory reserve regime in 1990. The new reserve regime strengthened the role of interbank interest rates as transmission mechanisms for monetary policy.

Government Intervention in Credit Markets


Historically, government intervention in credit markets in Italy was justified on two grounds: first, the problem of credit availability, that is, the difficulties of the private sector in funding investment projects that required long-term finance; and second, the problem of credit cost, which prompted the introduction of special incentive programs to support selected activities or categories of borrower.

The problem of credit availability arises from the lag between when investment projects are undertaken and when their returns begin to accrue. Direct funding on the market may be impeded by savers’ and borrowers’ divergent maturity preferences and by two specific types of risk. First, savers may lack the information needed for proper assessment of the project’s prospects for return. Second, contracts curbing entrepreneurs’ incentives to undertake high-risk strategies may be unfeasible or hard to enforce. These circumstances limit the possibility of raising funds and increase their cost, especially when the lag is substantial. Financial intermediaries play an important role in relaxing some of the constraints on borrowing, in that they are in a better position to select good projects, to monitor entrepreneurs’ actions, and to enforce contracts. The problems of credit availability are usually more severe in the capital-deepening stages of economic development, when financial markets and intermediaries cannot cope with the task of channeling resources to long-lived productive investment.

The cost problem arises when the market’s incentives for the allocation of financial resources do not correspond to government priorities as reflected in specific government programs.

In Italy, the problem of credit availability for long-term investment dates back to the country’s industrial take off in the late nineteenth century, following national unification. Credit to such important sectors as real estate and agriculture was accorded protection by specific legislation, but the real problem was the scarcity of long-term funds for industrial investment, which emerged as a serious hindrance to stable economic growth. Organized stock markets were thin and erratic, subject to fluctuations because of highly speculative trading; they could hardly provide a reliable source of finance. Based on the “universal bank” model imported from Germany, commercial banks gathered savings from the public in the form of deposits and invested them in businesses, both granting loans and subscribing firms’ equity. The high degree of concentration in Italian industry limited the banks’ opportunities for efficient risk diversification. What is more, too often risks were magnified by the moral hazard stemming from collusion between banks’ and firms’ managers at the depositors’ expense. The fragility of the system led to recurrent bank crises. The government’s active role as lender of last resort during the Great Depression of the 1930s ultimately resulted in public control of a large part of the industrial and the financial sector of the economy.

In 1936, a banking law was enacted that shaped the financial structure of Italy for the next half-century. The regulatory system that was installed established a clear-cut separation between two types of credit institution, namely, ordinary credit banks and special credit institutions (SCIs). Broadly speaking, banks were allowed to engage in short-term intermediation while SCIs specialized in medium- and long-term credit. All credit institutions’ investment in the equity of nonfinancial firms was severely restricted. The rationale underlying this regulation was twofold. First, it was intended to prevent banks from getting into difficulties resulting from maturity mismatching and the immobilization of liquid deposits into illiquid assets. Also, the provision of long-term finance was considered to require specific skills and specific regulation. Special credit institutions proved to be a powerful instrument for state intervention in the credit markets. Nonetheless, SCIs were autonomous credit institutions, not government agencies. On a number of occasions the tasks imposed by the public sector conflicted with the efficient management of SCIs as banking institutions.

The Role of Special Credit Institutions

The SCIs were specialized not only by maturity but also by type of activity. In accordance with their main focus, the SCIs were generally classified into four categories: real estate, agricultural, industrial, and public works credit institutions. Moreover, each institution’s business could be further restricted to specific geographical areas and/or categories of borrowers. The large majority were publicly owned or controlled by publicly owned banks. The fact that SCIs were directly or indirectly under public control, virtually the only intermediaries operating on a long-term basis, and highly specialized made them the preferred channel for government programs aimed at directing credit flows. This occurred in two ways: the creation of new institutions for specific purposes as explained above and the almost exclusive attribution to the SCIs of the administration of credit subsidy programs.

Italian SCIs numbered 28 in 1936 and 92 in 1992, half of them operating as autonomous subsidiaries of large publicly owned banks or savings banks also under public control. The group of industrial credit institutions expanded from 6 to 28, mainly because of the establishment of 15 institutions intended to support small and medium-sized firms on a regional basis. During this period 10 public works institutions were created as autonomous bank subsidiaries to finance public sector investment. In 1991, SCIs accounted for 36 percent of the total credit granted by banking institutions to resident customers. The percentage of subsidized to total loans granted by SCIs was 20 in 1991; it had peaked at about 33 percent in the mid-1970s.

The high degree of specialization of SCIs worked at first as a growth factor, at least numerically, but later became a source of intrinsic weakness. Until the 1980s, the liability side of SCIs’ balance sheets consisted of bonds, advances from banks, and medium- and long-term certificates of deposit. Exact maturity matching between assets and liabilities was difficult, however, since the market for instruments of very long-term maturity fell short of the need for financing loans. In part, this was because legislation on interest rate subsidies used to impose loan maturities longer than those accepted by savers. Market interest rate increases thus usually entailed a considerable strain on the institutions’ liability management. This explains the introduction of interest rate controls on SCIs’ certificates of deposit during the 1960s. In the 1970s, with soaring inflation, savers shifted their portfolios toward liquid assets, and for the SCIs the interest rate risk was compounded by funding shortages. The problem was overcome by administrative controls. In 1973, in an effort to stabilize the monetary aggregates, the monetary authorities required banks to invest a proportion of their deposits in securities, including the bonds of the special credit institutions. This portfolio constraint remained in place in a variety of specific arrangements until 1987.

Specialization also implied vulnerability to idiosyncratic shocks. In the 1970s, some industrial credit institutions suffered badly from the structural difficulties of such key sectors as chemicals and steel. Real estate credit institutions’ activity became strictly correlated with real estate market cycles, and the same went for agricultural SCIs with respect to farming. The lending of public works institutions had always been strictly tied to public sector investment plans.

In the 1980s, these difficulties were eased by allowing gradual but sub-stantial despecialization. At the same time, the constraints on long-term lending by commercial banks were relaxed. This process culminated in the early 1990s. In 1990, specialization was limited to maturity constraints, while banks were allowed to incorporate SCIs that had previously operated as independent subsidiaries. In 1993, banking legislation was consolidated into a code (the 1993 Banking Law) that coordinates the 1936 Banking Law with the many subsequent provisions, particularly those of the 1980s. In line with the Second Banking Directive of the European Community, the code allows the universal bank model to be adopted in Italy. The “universal bank” can operate without maturity constraints and is permitted to conduct all types of financial business not restricted by law. The restraints on equity investment in nonfinancial firms have been relaxed. Banks can opt to specialize in long-term intermediation by making a provision in their by-laws that precludes sight liabilities.

At the end of May 1995, only 35 former SCIs were still operating. Two of them have elected to limit their activity to long-term intermediation, evolving toward the investment bank model.

Aims of Government Intervention

Over the past fifty years, central and local authorities have adopted many programs providing credit facilities. A 1992 report by parliament reckoned that provisions for credit subsidies to firms were contained in 121 different central government budget titles. The classification proposed here is not comprehensive and provides only a general outline.

Regional Development

Credit facilities were a cornerstone of the massive programs to foster economic growth in the relatively backward regions of southern Italy. The intervention of the state through credit markets complemented the substantial direct investment programs of publicly owned firms and other transfer flows. In 1953 three new publicly owned industrial credit institutions were established to provide credit and financial support and to administer subsidies in these regions. In 1957 a major program was launched to promote economic development through the creation of industrial districts. Credit subsidies were tailored to small and mediumsized firms concentrated in selected areas in order to exploit positive agglomeration externalities. However, the program was never implemented in its original format. The criteria adopted to define the districts and the “small and medium-sized firms” were modified repeatedly. In the end, the scheme proved to be generous but poorly designed. In 1965 a new law addressed the issue, seeking to organize public assistance to the southern regions in the form of medium-term plans. Subsequently, periodic legislation revision (in 1971, 1975, and 1986) altered the mix of instruments (for example, capital grants, interest subsidies, and tax exemptions) and provided new funds. Moreover, several programs not specifically designed to even out regional disparities also provided preferential treatment for borrowers resident in the South.

Small and Medium-Sized Firms

Given the relevance of small and medium-sized firms in the Italian economy, since 1952 they have been the concern of at least four general appropriations laws. Indeed, an entire class of institutions was created to provide credit and financial services on a regional basis. Local authorities also implemented a number of specific programs for artisans and other small businesses, to provide capital for growth and to ease financial constraints. Small and medium-sized firms experience a higher mortality rate than large ones, so banks charge higher risk premiums for them and more often ration their credit. Moreover, such firms usually have little effective power to bargain with banks over loan conditions.

Economic Sectors

The agricultural sector benefits from special credit conditions fixed by a law passed in 1926 regarding fiscal treatment and insurance provisions. Subsidy programs were introduced in 1961. Since the 1970s, public intervention has been regulated by the European Common Agricultural Policy, and subsidies are provided by local authorities. In the 1970s, several programs directed at the industrial sector were implemented, providing support to large firms in financial distress and helping them convert to new lines of business. Other sector-specific facilities were provided to shipbuilders, wholesale and retail trade, and the transportation industry.


As in many other countries, exporting firms have benefited from two types of facilities: exchange risk insurance and subsidized credit.

Public Works

Public works institutions were established mainly to fund central and local government projects for public utility modernization, the construction of hospitals and other public facilities, and large infrastructure networks such as railroads, highways, and communications.


Housing policies in the form of subsidies to the building sector and to households were introduced relatively late in Italy compared with other countries. An initial law was passed in 1965, followed by a more comprehensive plan in 1978 that was revised in 1992.

Other Horizontal Programs

These include subsidies to applied research aimed at technological innovation, to cooperative firms and, most recently, to environmental protection projects.

In recent years, the extension of credit facilities has been considerably reduced for two reasons. One is the effort to limit the growth of public sector debt, with a growing concern about efficiency. The second stems from the restrictive position of the European Commission with respect to government subsidies. In particular, all government programs that produce competitive advantages for particular firms are incompatible with Single Market rules.

Credit Subsidies

Government provision of credit facilities has occurred under a variety of technical arrangements. The programs are set down in specific laws detailing the eligibility requirements, the time horizon, and the competent authorities (government departments, interministerial committees, and local authorities). If the facility is in the form of an interest subsidy, the minimum and maximum loan maturity is also specified. The administration of the funds is usually assigned to banking institutions, mainly former SCIs. In what follows, for simplicity’s sake, the competent authorities will be referred to generically as government departments, and the banking institutions as banks.

The technical instruments most frequently used are subsidies as a fixed percentage of the value of the investment undertaken; interest subsidies (subsidized credit); revolving funds; special funds administered by banking institutions (previously SCIs, now banks); and the insurance of credit risk, either directly or through the funding of special agencies.

Interest rate and capital expenditure subsidies have been the preferred investment incentives. From the point of view of the borrower, they are substantially equivalent. They differ in the distribution of the governmental budgetary burden over time and in the role played by banks. For capital expenditure subsidies, banks usually provide only administrative services. Transfers may also be made directly by government departments or agencies. The situation is different for interest rate subsidies, since banks have to fund the loans and bear the credit risk. Revolving and special funds have been used in place of interest rate subsidies for programs that would have entailed difficulties for banks in issuing the corresponding liabilities.

The scheme adopted in Italy for managing interest subsidies is based on two key rates: that received by the bank (the reference rate) and that paid by the borrower (the subsidized rate). The former is calculated as the unit cost of funds for the bank plus a fixed commission for intermediation. The subsidized rate is laid down in the law regulating each specific incentive program or is determined by governmental authorities. The difference between the two is funded by government budget appropriations. Under this scheme, all the borrowers eligible for a certain program pay the same subsidized rate, while all the intermediaries are remunerated at the same reference rate.

The way in which subsidized rates are set may have significant consequences for both the number of borrowers served and the overall budget outlay. Until the 1960s, subsidized rates were set at fixed levels in almost all programs. Under the reference rate mechanism, this implied the possibility of government expenditure rising with market interest rates. In the case of lags in updating budget funds, an increase in interest rates meant fewer projects could be financed. During the 1970s, when market interest rates soared, this became a serious problem. Since then most programs have anchored the subsidized rate to the reference rate.

The general scheme for interest subsidies has proved unsatisfactory because of the overlapping of two decision-making units, namely the bank, which needs to assess the worthiness of the project, and the government department in charge of determining whether it is worth subsidizing. Spillovers from one screening procedure to the other are likely to be inefficient, given the different concerns of the two decision-making units. In particular, it is usually difficult for a bank to deny credit after the project has been positively evaluated by the government department.

The parliament is now examining a government proposal aiming at totally separating subsidy programs from the decision to grant credit. Under the new scheme, the reference rate would be abolished and the borrower would negotiate an interest rate directly with the bank. If the project turned out to be eligible, the subsidy would be provided directly to the investor by the government department according to the prevailing market rates. The two screening procedures would be performed without reciprocal interference.

Overall Assessment

The far-reaching reforms introduced during the past 15 years in the Italian financial system have also modified both the role of the government in providing credit facilities and the ways of doing so. SCIs have been turned into banks, the number of credit facilities has been reduced, and the system of subsidization will be reformed. These changes are just part of the general adjustment process of the financial system to the evolving structure of the Italian economy. The mixed-economy model that allowed the remarkable postwar growth has been evolving toward a fully market-oriented model, with an overall reduction of the role of the state in the economy. Changes in the structure of the real economy on the one hand and the development of financial markets on the other are also modifying the links between financial intermediaries and firms.

The role of the state in credit markets should then be assessed, taking into account the evolution of the relationship between the financial structure and the real economy at the different stages of economic development. Here we focus on three important aspects for the recent Italian experience.

1. The overall reduction of the role of the public sector in the economy, occurring at several levels. A major privatization program was started in the early 1990s and is still in progress. Efficiency gains are expected from the market monitoring of firms and banks previously under public control. As far as credit facilities are concerned, the main source of inefficiency has been identified in the wide range of public initiatives supported at the same time. The lack of selectivity has produced three kinds of undesirable outcomes. The first is the difficulty of monitoring results, since the programs have been designed in rather loose terms. The second one relates to the dispersion of resources without a clear setting of priorities. The third is the provision of credit facilities even when other incentives would have been more effective.

2. The feasibility of an efficient and competitive banking system has proved to be hardly compatible with a high degree of specialization and strong involvement of the public sector in controlling credit institutions. The stability problems addressed by the 1936 Banking Law—which imposed strict specialization on financial intermediation (for example, specialized banks for short- or long-term operations)—are now coped with by prudential regulation instruments (for example, capital ratios). Moreover, the development of financial markets allows banks to manage the risks arising from maturity transformation more efficiently than in the past.

3. The financial needs of the corporate sector have changed. As a result of technical progress, the average life of physical capital has shortened and the most basic problems of credit availability have been relaxed. The present issues concerning the financial structure of firms are of quite a different nature. In the description of financial systems, Italy is classified as a bank-oriented system, as opposed to the Anglo-Saxon countries, which are recognized to be more market-oriented, like Germany and Japan. However, the difference in the Italian financial system with respect to other bank-oriented systems lies in the weakness of relations between banks and firms. As a consequence, the role of banks in providing corporate advisory services and in helping financial management has been limited. This has emerged as a serious problem in the turning points of the life of a firm: financial distress, reorganization, or change of scale. Regulation reforms have tried to strengthen the links between bank and firm, allowing a greater scope for banks to hold shares in nonfinancial enterprises.

Interbank Market Developments, Reserve Requirement Reforms, and Monetary Policy

Interbank Market and Monetary Policy

In Italy, the conduct of monetary policy has shifted progressively over the past 15 years from direct to indirect instruments. During the 1980s, administrative controls—ceilings on credit growth and the portfolio constraint on banks—were gradually phased out. The use of indirect instruments means that the control of the money and credit aggregates is accomplished by monetary base adjustments. In Italy, as elsewhere, the monetary base consists by and large of the central bank’s liabilities. The effectiveness of indirect instruments is thus positively correlated with the Bank of Italy’s actual ability to control the monetary base and with the stability of the deposit multiplier.

The Bank of Italy’s power to control liquidity has been enhanced by a number of institutional reforms leading to the complete independence of government budget financing from monetary creation. The first step came in 1981, when the Bank ceased to act as a residual buyer at treasury bill auctions, and full separation was achieved in 1993 with the abolition of the treasury’s overdraft facility on its current account with the central bank. The process took place in the unfavorable context of mounting public debt. The placement of increasing amounts of treasury paper with the general public has been accomplished by primary markets based on competitive auctions and the institution of well-organized secondary markets. The abandonment of floor prices in the auctions, completed in 1992, allows interest rates to be freely determined by supply and demand.

The secondary markets for treasury bills and other securities also assist the transmission mechanism. The Bank of Italy’s liquidity management is now performed mainly through open market operations. The interbank market plays a key role for the efficient distribution of the monetary base through the whole system.

Through the late 1980s, the working of the interbank market was far from satisfactory. Transactions effected for temporary liquidity needs were mixed up with long-standing relationships between banks. The ratio of interbank to total bank liabilities was quite high in comparison with other industrial countries. A small group of large banks was structurally on the demand side of the market, generating customer-based arrangements that buffered the transmission of interest rate changes. Almost half of all outstanding liabilities were held in correspondent accounts, allowing the parties considerable discretion in determining settlement and price conditions. A sizable share of the market was also represented by sight deposits, often only formally recallable on demand, on which interest was paid yearly and changes in prices had to be bilaterally renegotiated. The proportion of time deposits was small and the market for the shortest maturities was quite thin. Under these circumstances, the transmission of monetary policy faced two main problems: interest rates on the shortest maturities tended to be excessively volatile given the scarcity of transactions, and the propagation of the signals to longer-maturity deposits was hindered by bilateral customer relationships.

Three Major Reforms

To overcome this situation, the Bank of Italy promoted the establishment of a screen-based interbank market and introduced the mobilization of compulsory reserve deposits. These reforms were reinforced and made possible by the start of a far-reaching program of modernization of the payment system.

Payment System

Until the end of the 1980s, in the interbank circuit the communication of payments data was primarily paper based. Transactions presented for daily clearing at the Bank of Italy branch clearing houses were settled through their respective banks’ accounts with the central bank. Many payments were made bilaterally by mail, giving rise to reciprocal current account credits and debits, which often allowed the banks considerable discretion in determining the time and method of settlement. The scanty use of more advanced technologies increased production costs and lowered the quality of payment services. In particular, the exchange of documents by mail meant that the completion of transactions was slow indeed, generating a substantial amount of “items in transit” between banks, which were a source of uncertainty about liquidity positions. Moreover, the dual settlement procedure increased cash management difficulties, since the banks were not always able to use their bilateral accounts, whose funds were not available on demand, to offset the net debits emerging in clearing. Finally, the large size of the payments entered in these bilateral accounts adversely affected the efficiency of the money market. This situation represented a state of relative backwardness with respect to the other members of the European Communities.

In 1989, the Bank of Italy initiated a general reform of the clearing system and revised the system of centralized accounts. The main changes introduced have been the following: (1) the installation of a procedure for the real-time execution of interbank transactions by the direct movement of funds on banks’ centralized accounts with the Bank of Italy; (2) the implementation of three specialized clearing subsystems: two for large-value fund transfers and one new retail subsystem for the settlement of low-value payments; and (3) the automation of all the phases of the clearing cycle, so that participants can carry out transactions throughout the business day and obtain real-time information on preliminary balances.

In designing the new systems, the aims were to increase the proportion of transactions settled immediately through accounts with the Bank of Italy, to make interbank payments and settlements as multilateral as possible by bringing transactions that were previously settled bilaterally into the clearing system, and to introduce new technology to improve the quality of the service and handle transactions more efficiently. The computerized, real-time settlement system (direct crediting and debiting of centralized accounts at the Bank of Italy) was conceived to handle the payments that require the greatest promptness and reliability. The real-time settlement capability defuses the risks inherent in end-of-day settlement.

Screen-Based Interbank Deposit Market

This market began operations in February 1990. The system has automatic trading procedures and operates under a set of clear and binding procedures agreed to by all participants on a voluntary basis. The fundamental rules are: (1) all trading in interbank deposits between participants is carried out on the screen-based market; (2) participants are pledged to make trades at the prices they quote; (3) transactions are settled exclusively through the clearing house or by entries to the centralized accounts with the Bank of Italy; and (4) the system is managed and the rules enforced by the market’s governing bodies—the Management Committee and the Assembly of Members.

In addition, the system considerably improved the supply of information to the market by providing data for each category of deposit (including volume traded and interest rates applied), which are updated at very short intervals.

The categories of deposit listed are overnight (24-hour deposits, same-day settlement); tomorrow-next (24-hours, next-day settlement); spot-next (24 hours, settlement at two days); time (one or two weeks or one, three, or six months, settlement at two days); time-deferred (same maturities as “time,” settlement date deferred); and time-day (maturity up to 15 days, same-day settlement). All the above deposits are of fixed duration and are therefore classified as interbank fixed deposits. The screen-based market also lists call deposits (similar to sight deposits) and, since January 1995, a swap contract on interest rates.

Mobilization of Compulsory Reserves

The reform in the system of compulsory reserves introduced in October 1990 allowed banks to mobilize a share of their compulsory reserves. The amount was initially fixed at 3 percent and was subsequently raised to the present 10 percent of the requirement (see below). A bank may draw on the funds in its reserve account up to the prescribed proportion, provided that the average level for the reserve maintenance period (from the 15th of each month to the 14th of the next) does not fall below the reserve requirement. In the event of a bank failing to meet its reserve requirement, the Bank of Italy charges interest on the amount of the shortfall at the penalty rate. The Bank of Italy is also empowered to suspend a bank’s right to mobilize its reserves if it repeatedly fails to comply with its reserve requirement.

The changes in the regulations have been accompanied by a reform in the procedure for managing banks’ lira accounts with the Bank of Italy. Banks can now manage the reserve account and that for ordinary advances as a single account, with deposits automatically applied first to reducing the amount of any outstanding ordinary advances and the surplus, if any, being credited to the reserve account; the order is reversed for withdrawals. However, banks may also distribute their balances between the two accounts at their discretion, in accordance with their planned cash management operations.

Altogether, these reforms produced significant results. Since 1989, payments settled via the central bank have increased from 6 times GDP to 31, almost closing the gap with the other European Union member countries. Measured in terms of total interbank liabilities, correspondent accounts have declined from 40 percent to 15 percent. Average daily turnover on the screen-based interbank market has increased from 7 trillion lire to 20 trillion. More than half of Italian interbank liabilities are now originated by transactions on the screen-based market, and the share of time deposits has had peaks of up to 50 percent. The bulk of trading is concentrated in overnight and tomorrow-next funds. The combined effect of the mobilization of compulsory reserves and the more efficient use of the monetary base thanks to the computerized payment system has gradually reduced the volatility of interest rates. The yield curve of the interbank market now provides reliable information for decision making.

These reforms, together with the abolition of floor prices at treasury security auctions, have modified the relationship between the Bank of Italy’s instruments of liquidity control and interbank market rates. During the 1980s, the causal chain in interest rate determination ran from the treasury bill rate, controlled by the monetary authorities, to the interbank rates. Changes in interbank rates altered the marginal cost of funds to banks and so affected deposit and loan rates. Now the first two links have been switched: the Bank of Italy controls the overnight rate mainly through repurchase transactions on the securities market (providing or absorbing liquidity), and changes in the conditions of the shortest maturity transactions are quickly transmitted through the overall interest rate time structure.

Compulsory Reserve Requirements

The mobilization of compulsory reserve deposits was probably the most important single structural change in the system established by the 1975 reform. Further significant changes were made in 1993 and 1994. This section comments briefly on the evolution of reserve requirements and describes the main features of the system as it is now organized.

Compulsory reserve requirements, introduced in Italy in 1926 to protect depositors, were redesigned after World War II to contribute to the sterilization of liquidity shocks coming from the treasury and, subsequently, to stabilize the relationship between the monetary base and bank deposits. Institutionally, the reserve requirements were set by the Interministerial Committee for Credit and Saving and the Ministry of the Treasury until November 1993, when the parliament enacted a law giving the Bank of Italy the responsibility for setting the reserve requirements within prescribed limits. In this way reserve requirements have been fully recognized as an instrument of monetary policy.

The 1975 reform established a common reserve ratio for all banks except mutual banks, equal to 15 percent of the changes in a reference aggregate defined as the sum of nonbank customer deposits in lire and the liabilities to special credit institutions net of own funds. The interest rate paid on reserve deposits was set at 5.5 percent. Two innovations are noteworthy: the unification of the treatment of commercial banks and savings banks; and the abolition of the possibility of meeting part of the reserve requirements by investing in treasury bills and other securities. With this law, compulsory reserve accounts were held exclusively in the monetary base.

The reform helped stabilize the ratio of monetary base changes to deposit changes. In the following years the marginal ratio was progressively raised to 25 percent in 1982, when the ratio of the stock of compulsory reserves to total deposits was also set at 22.5 percent. The increase in the reserve requirement was intended mainly to neutralize the monetary impact of the treasury’s overdrafts.

The introduction of mobilizability in 1990 was accompanied by a modification in the method of computing the reference aggregate. The end-of-month stock was replaced as reference by the monthlong average of the subjected liabilities. This innovation was made possible by an extensive modernization of banks’ internal systems of information processing, which was also promoted by the Bank of Italy.

In recent years, as the shocks to monetary base creation coming from the treasury have subsided, reserve requirements have been gradually relaxed. At the beginning of 1993 the ratio was lowered to 17.5 percent, and to 10 percent with respect to certificates of deposit with a maturity of at least 18 months. In November, the law abolishing the treasury’s overdraft facility and empowering the Bank of Italy to set the reserve requirement fixed a ceiling on the reserve ratio of 17.5 percent and exempted all liabilities not repayable for 18 months.

In May 1994, the Bank of Italy issued a new regulation transposing the legislative provisions. In accordance with the 1993 Banking Law, which mandates equal treatment for all categories of banking institution, the reserve requirements have now been extended to mutual banks and the former special credit institutions. The main features of the present system are as follows. All banks are eligible. The deposit liabilities subject to the requirement are lira funds received from residents and nonresidents and foreign currency funds from residents. Excluded are repurchase transactions with customers, lira funds from nonresident banks other than branches of Italian banks, all forms of interbank deposits, and certificates of deposit, saving certificates, and bonds not repayable for 18 months. The reserve ratio is 15 percent of the monthly change in the reference aggregate; the change is computed with respect to monthly averages of daily data. The settlement date is the 14th day of the following month. Banks also are required to provide a form containing detailed information on the reference aggregate. Late settlement as well incomplete reports are subject to sanction by the Bank of Italy. Reserve deposits receive interest of 5.5 percent on all compulsory reserves. Finally, banks are allowed to mobilize up to 10 percent of the compulsory reserves to meet their liquidity needs, as explained above.


Since the early 1980s, a sequence of reforms has been introduced in Italy to promote the growth of efficient and competitive markets for financial intermediation. This paper reviewed the main developments in the field of banking concerning the government intervention in credit allocation and the interbank market.

Public provision of credit facilities were introduced in a large number of policy programs adopted over the past fifty years. Given the predominance of bank credit in business firms’ funding, the provision of credit subsidies was a powerful incentive for private investment in particular areas of economic activity. Banks specializing in long-term funding, (SCIs), were required to grant loans at below-market rates, the difference being funded by government (or local) budget appropriations. This scheme was rather unsatisfactory because of the limited autonomy of SCIs, which were bearing the credit risk in the decision-making process.

This sort of public intervention in credit market has been substantially downsized in the last few years following the overall reduction of the role of the state in the economy. The 1993 Banking Law unified supervisory regulation for all banks without any distinction according to maturity specialization. Former SCIs are now banks operating on an equal footing with commercial banks. Finally, a law separating subsidy programs from the decision to grant credit is expected to be approved by parliament.

The interbank market has been shaped by three major reforms. The first was the modernization of the payment system, started by the Bank of Italy in 1989. The new system allowed a considerable increase in the share of the interbank payments settled immediately via accounts with the Bank of Italy and reduced transactions settled bilaterally by banks. The second reform was the institution of screen-based interbank deposit market in February 1990. The third one was the mobilization of compulsory reserves introduced in October 1990. The combined effects of these three reforms have made the interbank market a building block of the money market through which central control of the economy’s liquidity by the central bank has been enhanced.