The Interplay between Ex-post Credit Risk and the Cycles: Evidence from the Italian banks

The objective of this research is to empirically examine if both credit and business cycle affect the ex-post credit risk (i.e. non-performing loans) in the banking system of Italy. My sample includes 47 Italian banks for the period 1995Q1-2015Q1. The increase in NPLs post-2008 has put into question the robustness of many European banks and the stability of the whole sector. It still remains a serious challenge, especially in Italy which is one of the countries that has been hit by the financial crisis more than other economies. By employing Fixed Effects, Random Effects and GMM as econometric methodologies I find a positive (negative) association between credit cycle (business cycle) and NPLs. Higher NPLs in Italy are due to adverse macroeconomic conditions (i.e. downward phase of the business cycle) and due to excess credit (i.e. upward phase of the credit cycle). Another important finding is that the Italian NPLs have a symmetric sensitivity between both business and credit cycle. Such findings may be helpful for both senior bank loan officers and policy makers when designing macro-prudential as well as NPL resolution policies.