PRICE SETTING ANOMALIES AND BANK PROFITABILITY CONCERNS IN THE ITALIAN RESIDENTIAL MORTGAGE MARKET

After the onset of the financial crisis, the discrepancy between interest rates on new residential mortgages and their reference rates has widened dramatically, moreover, since the third quarter of 2011, their normal relationship has broken down. The aim of this work is to examine the determinants of this trend of new mortgages’ interest rates and to set out the implications on bank profitability. Outcomes from the empirical analysis show that, new mortgages interest rates increased as a result of a concurrent growth of credit risk charges and bank funding costs. Credit risk charges progressively increased starting from the begin of 2009, while the funding cost component boosted only in the fourth quarter of 2011, when an additional charge, which was related to the difference between long-term and short-term bank funding costs was added by Italian banks. As a result, since the end of 2011, the starting point for the interest rate setting of new mortgages does not coincide any longer with Euribor and Eurirs, although they still remain the formal reference rates. Therefore, in order to avoid unnecessary basis risk, a change of reference rate should be considered. As a consequence of the fall in the Euribor and the increase in the cost of deposit, the net interest income related to the outstanding ARMs considerably shrank starting from 2009. The nature of the interest rate risk faced by Italian banks has also changed and should be carefully evaluated. To this end, a better matching of bonds maturity with the typical maturity of residential mortgages and the supply of fixed-rate mortgages with a fixation period lower than 10 years are desirable.