The Italian financial cycle: 1861-2011

In this paper we investigate the main features of the Italian financial cycle, extracted by means of a structural trend-cycle decomposition of the credit-to-GDP ratio, using annual observations from 1861 to 2011. In order to draw conclusions based on solid historical data, we provide a thorough reconstruction of the key balance-sheet time series of Italian banks, considering all the main assets and liabilities over the last 150 years. We come to three main conclusions. First, while there was a close correlation between loans and deposits (relative to GDP) until the mid-1970s, over the last 30 years this link has become more tenuous, and the volume of loans has increased in relation to deposits. The banks have covered this �funding gap� mainly by issuing new debt securities. Second, the Italian financial cycle has a much longer duration than traditional business cycles. Third, taking into account the deviation of the credit-to-GDP ratio from its trend, an acceleration of credit preceded a banking crisis in 8 out of the 12 episodes listed by Reinhart and Rogoff (2009). A Logit regression confirms a positive association between the probability of a banking crisis and a previous acceleration of the credit-to-GDP gap. However, there were also periods - such as the early 1970s - in which the growth of the credit-to-GDP ratio was not followed by a banking crisis.