Italian bank DTAs: non-performing loans, regulation and tax rules

Deferred tax assets or DTAs have built up in the banking systems of Southern European countries, including Italy. The process started in 2007 and has accelerated in 2010. The main reasons behind such increase are higher levels of non-performing loans as economic conditions have deteriorated, and tax rules.

Previously, loan losses and write-downs were only partly deductible from the taxable income of Italian banks in the year they were recognised. The surplus of corporate income tax paid by banks gave rise to DTAs, part of which was not deducted from regulatory capital and so inflated bank solvency ratios.

As a result, Italian banks were not incentivised to accelerate the cleaning up of their balance sheets. To encourage them to do so, the Italian government has changed the tax rules. Banks can now immediately deduct all losses and write-downs from their taxable income. This is reducing the build-up of DTAs and is having a less positive effect on bank solvency ratios than the previous tax rules.