Notes on Financial Stability and Supervision no. 38 - A cost analysis of Italian banks classified as less significant institutions (LSIs)

Over the past decade, Italian banks' profitability has been strongly influenced by credit risk trends. In the current market environment, where the cost of risk still remains low, operational efficiency is one of the key drivers of variation in banks' profitability.

An analysis of end-2022 data shows that the cost/income ratio for Italian less significant institutions (LSIs) varies considerably depending on the business model. Specialized banks have a lower cost/income ratio than traditional banks and those whose main business is asset management. However, variability is also high within the same business model. Among traditional banks, the most numerous and representative of Italian LSIs, the cost/assets ratio for less efficient banks is higher by almost half, despite an average return on assets in line with that of other banks. In order to identify the key drivers of some banks' low efficiency, the two main cost components - i.e. staff and other administrative expenses - were analysed separately.

The evidence confirms that LSIs' limited operational efficiency is primarily attributable to traditional banks and does not appear to be a systemic phenomenon, but rather a bank-specific condition, which is thoroughly assessed by the Bank of Italy's supervisory function in the context of microprudential supervision. Cost management is key, particularly for staff and IT expenses, safeguarding - at the same time - revenue-generating investment and costs necessary for risk management functions. Size remains an important variable in assessing the sustainability of business models. In addition to short-term initiatives aimed at cutting costs further, greater revenue diversification and potential mergers with more efficient intermediaries are possible ways forward to improve efficiency and profitability in the medium term.