Assessing Financial Stability Risks from the Real Estate Market in Italy

We provide an analytical framework for assessing financial stability risks arising from the real estate sector in Italy. This framework consists of two blocks: three complementary early warning models (EWMs) and a broad set of indicators related to the real estate market, to credit and to households. We focus separately on households and on firms engaged in construction, management and investment services in the real estate sector. Since in Italy there have been no real estate-related systemic banking crises, as vulnerability indicator we consider a continuous indicator represented by the ratio between the annual flow of bad debts related to the real estate sector and banks’ capital and reserves. We contribute to the recent literature on EWMs by implementing a Bayesian Model Averaging (BMA) based on linear regression models with a continuous dependent variable of vulnerability and an ordered logit model with a discrete dependent variable of vulnerability classes. Both models exhibit good predictive abilities. Based on the BMA projections for the period from the third quarter of 2015 to the second quarter of 2016, banking vulnerability related to the real estate sector is expected to gradually decline.