Italy’s Faster Tax Deductibility of Loan-Loss Charges Is Credit Positive
On 24 June, the Italian government passed a decree, pending Parliamentary approval, that would allow
banks full tax deductibility of loan-loss charges in the year in which they are booked rather than over five
years as currently required. The change is credit positive for Italian banks because speeding up the tax
deduction will reduce the banks’ taxes and increase after tax cash flow that can build cash capital.
The decree will reduce the generation of new deferred tax assets for at least the next two years, when we
expect loan-loss charges to remain high. Since 2010, loan-loss charges have constituted an average of
nearly 80% of the system’s pre-provision profit, reaching a peak of 101% in 2013 (see exhibit). The decree
will also improve Italy’s comparability with other European banking systems.
The limited deductibility of loan-loss charges has generated a substantial amount of deferred tax assets; as
of December 2014, the stock of deferred tax assets generated by the limited tax deductibility of loan-loss
charges was €43 billion.
In line with our forecasts of a moderate recovery in Italy’s economy (we expect GDP growth of less than 1%
in both 2015 and 2016), we expect loan-loss charges to fall slightly. However, it is unlikely that they will
return to pre-crisis lows, and we expect that they will remain a significant factor affecting Italian banks’
profitability. The other major European banking systems allow banks to deduct loan-loss charges in the year
they are booked; this new approach will put Italian banks in line with most banking systems globally,
levelling the playing field.
The new law will not change regulatory capital ratios for Italian banks. In past years, Italian banks have been
allowed to account for the deferred tax assets generated by the deductibility over five years of loan-loss
charges as a component of common equity Tier 1.