I INTRODUCTION

In 2016, the Italian banking sector mainly focused on:

  • a the management of the high stock of non-performing loans (NPLs);
  • b the new season of capital strengthening initiatives;
  • c the precautionary recapitalisation procedure; and
  • d the first application of the Banking Recovery and Resolution Directive (BRRD).

Although the 2016 stress test coordinated by the European Banking Authority (EBA) confirmed the overall soundness of Italian banks (four out of the five Italian banks that underwent the stress test performed above the European average), the European Central Bank (ECB) and the Bank of Italy requested banks to significantly reduce their high stock of NPLs (€356 billion). Several actions have been taken to promote more efficient management of NPLs (see Section VII, infra). The introduction of a state guarantee on the senior tranche of securitised bad loans and the reforms introduced by Law Decree No. 59 of 3 May 2016, which reduce the average credit recovery time, are aimed at increasing the value of the NPLs and developing the NPL market (see Section VII, infra). Furthermore, the main banks, insurance undertakings and banking foundations have set up alternative investment funds Atlante I and Atlante II to backstop banks’ capital increases and acquire junior tranches of securitised NPL (see Section VII, infra). Taken as a whole, it is expected that these measures will ultimately translate into more business opportunities for Italian and foreign investors active in the NPL market and, thus, into an increase in the volume of NPL transactions.

To counterbalance the negative effects on the banks’ balance sheet of the write-down and the disposal of the NPLs, the ECB required some banks to further strengthen their capital ratios. In this context, Banca Monte dei Paschi di Siena (MPS), after failing to complete a private-sector recapitalisation, applied for a precautionary recapitalisation under Law Decree No. 237 of 23 December 2016 (see Section VII, infra). Moreover, between February and March 2017, Unicredit SpA – Italy’s largest bank – increased its capital by €13 billion. It is likely that in the next month other banks will strengthen their capital ratios; indeed, on 17 March 2017, Banca Popolare di Vicenza SpA and Veneto Banca SpA applied for a precautionary recapitalisation, thus revealing the current weakness of the bank–industry relationships in Tuscany and Veneto, which were previously the drivers of the Italian economy.

At the end of 2015, the Bank of Italy placed four medium-sized banks under resolution and disposed of the transfer of their assets to four bridge banks fully owned by the national resolution fund. After short postponements of the deadline for the sale of the four bridge banks, between January and March 2017 three banks were sold to Unione di Banche Italiane SpA (UBI) and one to BPER Banca SpA (see Section III.iv, infra). The different approaches taken by the competent authorities on the resolution of the four banks and the state’s envisaged recapitalisation of MPS has led to a lively debate on the relationships within the BRRD and the precautionary recapitalisation, and also in light of the related effects on retail investors.

Although the Italian banking system’s capital ratios slightly improved from a prudential standpoint in 2016, the profitability of the leading banking groups fell. This was partly due to the extraordinary expenses they incurred in contributing to the deposit guarantee scheme and the national resolution fund. Indeed, the low purchase price of the bridge banks significantly drained the resources of the national resolution fund, and thus created significant turmoil in the banking sector (see Section III.iv, infra).

Finally, with regard to regulatory issues, Italian banks are focusing on updating their IT systems to comply with the provision that implements the EBA guidelines on the security of internet payments (see Section VII, infra); preparing to comply with the forthcoming implementing measure of the MiFID II package (see Section VII, infra); and, with respect to cooperative credit banks (CCBs), adapting their structure and governance to the new requirements introduced by recent legislative reforms (see Section II, infra).

Banking groups

Common equity Tier 1 ratio (%)

1

Unicredit SpA*

10.82

2

Intesa Sanpaolo SpA

12.8

3

Banca Monte dei Paschi di Siena SpA

11.5

4

Unione di Banche Italiane SpA

11.68

5

Banco Popolare SpA**

14.7

Data updated as at 30 September 2016. Source: quarterly financial reports. Note that these data could change consequent to the capital strengthening measures (including MPS’ precautionary recapitalisation) already carried out or envisaged by these banks in 2017.

* Unicredit SpA is included in the list of global systemically important banks published by the Financial Stability Board (FSB) in November 2016.

** The merger between Banco Popolare SpA and Banca Popolare di Milano SpA on 1 January 2017 created the new joint-stock company Banco BPM SpA, Italy’s third-largest banking group.

ii THE REGULATORY REGIME APPLICABLE TO BANKS

Besides EU legislation (specifically the Capital Requirements Directive (CRD IV),2 the Capital Requirements Regulation (CRR)3 and the Single Supervisory Mechanism (SSM) Regulation),4 the principles governing banking activities and investment services are contained in Legislative Decree No. 385 of 1 September 1993 (Banking Act) and Legislative Decree No. 58 of 24 February 1998 (Financial Act) respectively. In 2016, both these Acts underwent an in-depth review to, inter alia align national legislation with Regulation (EU) No. 1024/2013 and implement Directive 2014/49/EU on deposit guarantee schemes; reform the structure and governance of CCBs; and enable Italian and EU alternative investment funds to carry out lending activities.

The regulations implementing these principles are primarily set by the Bank of Italy, in particular through Circular No. 229 of 21 April 1999 and Circular No. 285 of 17 December 2013, as significantly amended throughout 2015 (Supervisory Instructions; see Section VII, infra); and Consob, the independent public authority responsible for regulating the Italian securities market, notably through intermediaries, issuers and market regulations. Further rules can be set by the Ministry of Economy and Finance (MEF) and the Interministerial Committee for Credit and Saving (CICR), whose powers were recently reduced (all four together, supervisory authorities).5 Specific powers in the anti-money laundering field are ascribed to the Financial Intelligence Unit.

The laws and regulations on the banking and financial markets govern lending, deposit taking, securities activities and cross-border operations. Although deposit taking is reserved to banks, the Bank of Italy regulation of 8 November 2016 clarified the conditions and limits under which certain activities (e.g., lending-based crowdfunding) fall outside the savings collection regime, and that thus can also be performed by non-regulated entities. Lending activities can be carried out by banks, financial intermediaries, insurance undertakings and special purpose vehicles, subject to limitations. Since February 2016, EU alternative investment funds have been able to carry out lending activities, if certain requirements are met, as is the case for Italian investment funds.

While Consob continues to be responsible for the securities market, following the SSM’s entry into force in November 2014, the tasks ascribed to the Bank of Italy changed as a consequence of the distinction between significant (SIs) and less significant banks (LSIs), and the key role played by the ECB. Specifically, under the SSM:

  • a the ECB is responsible for supervising Italian SIs, with the assistance of the Bank of Italy; resolving on the application to obtain and withdraw a banking licence and the authorisation to acquire qualified or controlling shareholdings in banks, regardless of their significance (see Section VI, infra); and ensuring the effective and consistent functioning of the SSM and the Bank of Italy; and
  • b the Bank of Italy’s tasks mainly consist of supervising the LSIs; monitoring all Italian banks in relation to transparency, consumer protection and anti-money laundering matters; and assisting the ECB in supervising the significant Italian banks.

Foreign banks may carry out business in Italy through the establishment of a branch, or on a cross-border basis, in accordance with a procedure that differs for EU and non-EU banks. EU banks can start mutual recognition activities after a notification procedure between the home country authority and the Bank of Italy, whereas non-EU banks can only operate after being duly authorised to do so. In June 2015, the Bank of Italy amended the non-EU banks regime to extend the minimum requirements under a business plan; widen the applicable regulations; and deny authorisation when the foreign deposit guarantee scheme to which the non-EU bank adheres does not comply with the Italian scheme.

Similar principles apply to Italian banks when they intend to undertake banking activity in other EU countries, including the authorisation to be granted by the Bank of Italy when Italian banks wish to operate in a non-EU country.

Currently, there are 69 banking groups and 587 banks (among which 139 belong to banking groups), and a total of over 30,000 active bank counters, established in the Italian banking market. Regarding the presence of foreign banks, more than 865 operate in Italy without a permanent establishment (up 100 from 2015), while 84 have set up a local branch (down six from 2015).6

Regarding legal form, 163 banks are incorporated as companies limited by shares, 317 as CCBs and 23 as mutual banks.

In 2016, CCBs underwent significant changes to reduce sector fragmentation and promote capital strengthening without affecting the essentially mutualistic and localised nature of CCBs. These changes include the mandatory adhesion to a banking cooperative group to obtain the authorisation as a cooperative bank, the parent company duty to be set up as a company limited by shares and the right to issue financial instruments (Law Decree No. 18 of 14 February 2016). In November 2016, the Bank of Italy established the minimum organisational and operational requirements for parent companies of mutual banking groups; minimum content (e.g., corporate governance, internal control system and prudential requirements) of ‘cohesion contracts’ between a parent company and its affiliated CCBs; and requirements that the Bank of Italy must verify have been met to create a mutual banking group (Circular No. 285 of 17 December 2013 as amended on 2 November 2016).

Finally, the reform introduced by Law Decree No. 3 of 24 January 2015 required, inter alia, mutual banks to either change their company form into that of a joint-stock company or reduce their asset value to within the €8 billion threshold. However, in December 2016, the reform’s implementing provisions were suspended due to the questionability of the constitutional legitimacy of the restrictions on shareholders’ withdrawal rights. This prevented the two largest mutual banks (Banca Popolare di Sondrio ScpA and Banca Popolare di Bari ScpA) from transforming into joint-stock companies.

iii PRUDENTIAL REGULATION

i Relationship with the prudential regulator

The reach of the Bank of Italy’s prudential supervision is extensive and penetrating. This widespread and strong supervisory regime managed to better mitigate the consequences of the financial crisis in Italy than was seen in many other countries, and encouraged significant capital increase transactions that led to an average increase of up to 11.9 per cent of the common equity Tier 1 ratio.7

In implementing CRD IV and CRR principles, the Bank of Italy exercised its discretionary power to further increase the banks’ minimum initial capital from €5 million (as provided by CRD IV) to €10 million (see Section III.iii, infra) and exempt banks belonging to a group from holding the liquidity requirements on an individual basis (see Section III.iii, infra). With reference to the capital conservation buffer, in October 2016 the Bank of Italy adopted the transitional period set forth in the CRD IV, thereby requiring credit institutions to maintain a capital conservation buffer of 1.25 per cent from 1 January 2017 to 31 December 2017, 1.875 per cent from 1 January 2018 to 31 December 2018 and 2.5 per cent from January 2019.

Currently, the supervisory review process consists of the internal capital adequacy assessment process (ICAAP) carried out by the banks under the responsibility of their corporate bodies; and the supervisory review and evaluation process (SREP), entrusted to the Bank of Italy for less significant banks, and to the ECB as far as significant banks are concerned. Whereas the ICAAP mainly aims at quantifying the capital needed to face the risks of the banking business (including country and transfer risks) and set liquidity management measures accordingly, the purpose of SREP is to assess the suitability of these measures – both capital and organisational – and establish the necessary relevant corrective actions (limitations to the distribution of the own funds’ financial instruments, imposition of own funds’ add-on and divestment of assets).

The 2016 SREP process was revised such that, in addition to the imposition of own funds’ add-on (Pillar 2 requirements), the supervisory authorities may also issue Pillar 2 guidance that in the event of non-compliance would lead to intensified supervision and bank-specific measures designed to re-establish a prudent level of capital.

The supervisory review process is carried out in compliance with the proportionality principle, under which corporate governance and risk management processes and mechanisms for identifying the amount of the capital due for risk prevention must be proportionate to the features, business size and complexity of each bank; and the frequency and intensity of SREP must take into account the systemic importance, features and any problematic issues of each institution.

ii Management of banks

Rules governing management and remuneration in banks and banking groups according to CRD IV are set under the Supervisory Instructions, as amended in May 2014. These rules strengthen corporate governance by setting, inter alia, further qualitative requirements to be met by banks’ directors, self-assessment processes of corporate bodies and ad hoc committees for larger banks; and introduce several limits to variable remuneration with regard to its amount and nature.

Corporate governance requirements

To ensure ‘sound and prudent management’ and to achieve their business goals, Italian banks are required to:

  • a choose between three different management structures:

• a traditional system – the most common structure – encompassing a shareholders’ meeting, a board of directors and an auditory board;

• a monistic system, where the control committee is appointed within the board of directors; and

• a dualistic system – adopted by only a few large Italian banks to date – which has a separate management and supervisory board; and

  • b identify the bodies responsible for the three main prudential functions:

• strategic supervision, which concerns the identification of the bank’s targets and supervision over their satisfaction (by examining and resolving upon financial and business plans, and strategic transactions);

• management (including the general director), which concerns the practical management of the bank to meet the targets set out by the strategic supervision body; and

• internal control, which concerns the supervision of the regular performance of the administration activity, and the adequacy of the organisation and accounting systems of the bank to the bank’s targets.

Banks are required to choose a management structure that is in line with their business and medium to long-term strategic goals, and that safeguards the effectiveness of the internal controls system. A specific assessment must be conducted on the structure’s implementing costs to ensure their sustainability.

The composition of the corporate bodies (both executive and non-executive) must be adequate for the complexity and size of the business, and diversified as to age, gender, skills and experience. Each member is required to be fully aware of the powers and tasks ascribed; act in the interest of the institution, without being influenced by the shareholders; and fulfil professional requirements tailored to the bank’s features. Further requirements will be set by the Bank of Italy to ensure the fairness of these bodies having regard to their business relationships, their behaviour with the supervisory authorities, their professional conduct and any other issues that might have an impact. The appointment procedure must also consider the ‘interlocking’ ban, which prevents the member from holding similar positions in competitor banking, financial or insurance undertakings or groups.

The corporate bodies are subject to a periodic self-assessment process aimed at verifying the proper qualitative and quantitative composition of each body, and encouraging the active participation of each director. The process is described in a report that is submitted to the Bank of Italy, upon request.

Italian banks will likely need to adapt their governance structure to the new draft guidance on internal governance and fit and proper assessment of their corporate bodies published by the EBA and the ECB in the last quarter of 2016.

Further rules for larger banks (in terms of assets, size and complexity) are provided to ensure ad hoc committees (internal controls and risks, remuneration, appointments), as well as succession plans for the positions of chief executive officer and general director, to ensure business continuity and prevent economic and reputational effects.

Specific provisions aimed at improving their competitiveness require mutual banks to strengthen the role of institutional investors and facilitate shareholder participation in accordance with the Bank of Italy’s suggestions.

As a result of the amendments to the Banking Act under Legislative Decree No. 72 of 12 May 2015, the Bank of Italy has the power to remove corporate bodies from office when the ‘sound and prudent management’ of the bank is compromised.

Remuneration policies

The management body is in charge of setting remuneration policies in line with the risk appetite and long-term interests of the bank, and coherent with its capital and liquidity ratios. Incentive mechanisms that may lead to breaches of the regulations or the taking of large risks are forbidden.

To this end, the Supervisory Instructions, as amended in November 2014 and May 2015 to meet the CRD IV provisions and the recommendations issued by the EBA and FSB policies, state, inter alia, that:

  • a the ratio between fixed and variable remuneration cannot exceed 100 per cent. The ratio may be increased up to 200 per cent if so provided in the by-laws and approved by a shareholders’ resolution with a qualified quorum. The latter must be based on a proposal made by the strategic supervision body outlining the concerned personnel, the rationale of the decision and its compatibility with the prudential rules;
  • b at least 50 per cent of the variable component must consist of shares or equivalent ownership interest, which, in any case, the Bank of Italy can prohibit, due to the bank’s specific status;
  • c malus and clawback arrangements also apply to the incentives due or paid to those personnel who contributed to significant losses for the bank, or who have acted fraudulently; and
  • d remuneration and incentive clauses that do not comply with EU and local regulations are void and automatically replaced by the parameters set out by these regulations.

Banks apply the above requirements in accordance with their features, size and complexity of business, based on their classification as ‘major’, ‘middle’ or ‘minor’ banks. Major banks must fully comply with the remuneration rules, whereas middle and minor banks benefit from some exemptions.

As a result of the EBA guidelines of December 2015 and the ECB letter of December 2016, Italian banks are currently reviewing their remuneration policies, with particular focus on the variable component, to avoid reducing their capital bases and to that ensure a sound capital structure is maintained.

iii Regulatory capital and liquidity

Italian banks must hold regulatory capital at least equal to the minimum capital necessary to be authorised to exercise their activity (€10 million, except for cooperative banks, where the minimum capital required is €5 million). This capital must consist of:

  • a 4.5 per cent of common equity Tier 1 ratio;
  • b 6 per cent of Tier 1 ratio (a favourable tax regime applies to additional Tier 1 items);
  • c 8 per cent of total capital ratio; and
  • d any additional capital requirements imposed under the SREP (see subsection i, supra).

Additional requirements are:

  • a liquidity covered ratio (to be gradually satisfied from 80 per cent in 2017 to 100 per cent in 2018);
  • b leverage ratio (3 per cent, as from 2018, based on the Basel Committee’s
    framework); and
  • c buffers, as follows:

• capital conservation buffer: to be gradually increased from 1.25 per cent in 2017 to 2.5 per cent in 2019; and

• countercyclical capital buffer: from zero to 2.5 per cent; to date, the Bank of Italy has maintained the countercyclical capital buffer rate (for exposures to Italian counterparties) at zero;

• global systemically important institution (G-SII) buffer: only one Italian bank has been identified as a G-SII and must maintain a capital buffer, which gradually increases from 0.50 per cent in 2017 to 1 per cent in 2019); and

• other systemically important institution (O-SII) buffer: three Italian banking groups – UniCredit, Intesa Sanpaolo and Monte dei Paschi di Siena – have been identified as O-SIIs and will have to achieve a buffer of 1.00, 0.75 and 0.25 per cent, respectively, by 2021 (the buffer is zero from 1 January 2017 to 1 January 2018).

Specific exemptions apply to Italian banks belonging to a banking group, which are exempted from the application of the liquidity coverage requirement on an individual basis; and Italian banking groups, which – subject to certain conditions – are exempted from calculating the leverage ratio of exposures to entities that belong to the same group and are incorporated in Italy.

In accordance with the ECB recommendations of December 2016, banks that meet the above regulatory capital requirements can conservatively distribute net profits in dividends, with the aim of continuing to fulfil all requirements even if economic and financial conditions worsen. Conversely, failure to comply with the above thresholds will prevent institutions from carrying out any such distribution.

For banking groups, compliance with the regulatory capital requirements is supervised by (1) ‘Banking Supervision Desk I’, with reference to banking groups subject to ECB direct supervision; and (2) ‘Banking Supervision Desk II’ and the Bank of Italy’s branches, in respect of banking groups other than those under (1). Both Desks have extensive powers that mainly result in supervision of national and transnational groups on a consolidated basis, analysis of risks and management of administrative proceedings.

In the context of the prudential regulations, a key role is ascribed to the management of the liquidity risk, both as funding liquidity risk and market liquidity risk. To prevent these risks, Italian banking groups, Italian banks not belonging to a group and Italian branches of non-EU banks (the latter according to the proportionality principle8) are mainly required to identify and measure their exposure to liquidity risk; establish a liquidity risk’s tolerance threshold; and carry out stress tests to assess the adequacy of the liquidity reserves on an ongoing basis. The specific liquidity requirements under the CRR do not apply on an individual basis to Italian banks belonging to a group (see Section III.i, supra).

iv Recovery and resolution

Italy implemented the BRRD through Legislative Decrees Nos. 180 and 181 of 16 November 2015, which set out the BRRD regime and updated the Banking Act and Financial Act accordingly. A few days after the BRRD’s implementation, four banks that jointly covered approximately 1 per cent of Italian deposits were placed under resolution, in accordance with a programme issued by the Bank of Italy as ‘resolution authority’, which provided for:

  • a the full write-down of the banks’ shares and subordinated bonds for an overall amount of over €1 billion and over €500 million respectively;
  • b the setting up of four bridge institutions with new corporate bodies and capital ratios (9 per cent of the risk weighted assets);
  • c the assignment of the rights, assets and liabilities in force at the resolution date to the bridge institutions, with the exclusion of the written-down shares and bonds;
  • d the transfer of non-performing loans from the bridge institutions to an asset management vehicle (€1.6 billion overall);
  • e the bid process of the bridge institutions, led by the Bank of Italy as a shareholder of these institutions through the national resolution fund; and
  • f the carrying out of the programme in accordance with the commitments that the government undertook towards the European Commission.

As a result of the resolution programme, the four bridge institutions restarted the banking business and again played a key role in the local economy, supporting regional small and medium-sized enterprises. Furthermore, the government set specific measures to restore the written-down subordinated bondholders.

After short postponements of the deadline for the sale of the bridge institutions, between January and March 2017 three banks were sold to UBI and one to BPER Banca SpA at the end of a competitive bid process that lasted one year. UBI paid a symbolic purchase price, but undertook to recapitalise the banks by up to €400 million overall.

In addition to the BRRD implementing regulations, the banks are still subject to the existing local regime. This regime provides for the following proceedings, depending on the nature of the crisis affecting the bank in question: special administration, a short-term temporary measure aimed at verifying the possibility of restoring adequate capital buffers, sound organisation and business conditions when the infringements in the bank’s management, the breaches of the applicable regulations or the losses are serious but not irrevocable (as of February 2017, three banks were under special administration); and compulsory administrative liquidation, to be applied when a crisis appears to be irreversible and the conditions for resolutions are not fulfilled, and which is a direction to close down a bank and allow the competent court that handles the process to satisfy most of the creditors of that bank.

iv CONDUCT OF BUSINESS

Conduct of business is governed by the Banking Act (and the relevant implementing regulations), and is guided by the principles of ‘sound and prudent management’ and ‘proportionality’. Banks are able to comply with the first principle when they manage to:

  • a contain the typical risks related to their banking activity (credit risk, market risk, liquidity risk, and operational or legal risk);
  • b maintain the conditions of liquidity and risk contractually established;
  • c ensure the service’s continuity as regards the customer; and
  • d perform their activity prudently and efficiently.

The ‘proportionality’ principle is ensured when the banks set up their measures, procedures and systems in accordance with the size and complexity of their businesses.

Over the past few years, both the supervisory authorities and the EU legislature have referred to the foregoing principles when issuing their laws with the aim of regulating the banking sector more strictly, but also of preventing minor banks from being subject to the stringent requirements provided for major institutions.

Consequently, Italian banks are required to conduct their businesses depending on the type of client, the relevant activity and the client’s knowledge of the services provided. This approach has led credit institutions to diversify their internal structures and procedures to safeguard each kind of client and adhere to mandatory out-of-court settlement systems, as seen in the subsequently adopted measures on transparency, investment services and anti-money laundering, and in the banking and financial arbitrators fields.

Conduct of business is subject to disclosure duties with regard to the supervisory authorities, clients and the public, entailing both preventive and ex post information reports. The Bank of Italy and Consob are allowed to request further data and clarifications related to the information provided.

A breach of the rules governing conduct of business may involve civil, criminal and administrative liability for both the banks and the individuals committing such violations, based on the following principles:

  • a civil liability is governed by the Italian Civil Code and may be classified, as per general principles, as contractual, non-contractual and pre-contractual liability:

• contractual liability mainly occurs when a bank does not comply with the provisions set out in the single contracts executed with its customers, or it breaches the best execution duties under the Markets in Financial Instruments Directive;

• non-contractual liability mainly refers to the liability provided by Article 2049 of the Civil Code, under which employers and principals may be deemed responsible for damage caused by their employees and agents during the fulfilment of their professional duties;9 and

• pre-contractual liability occurs where contracts between a bank and its customers are not executed as a result of unfair conduct of the bank;

  • b criminal liability primarily covers any unauthorised banking and financial activity. Over the past few years there has been an increase in other crimes, such as obstructing the supervisory authorities’ exercise of powers and the occurrence of transnational financial frauds, which entailed a review of deposit guarantee schemes at an EU level. The main rules are provided under the Italian Criminal Code and the Banking Act. At the beginning of 2016, most of the criminal sanctions established for breaching anti-money laundering regulations (notably Legislative Decree No. 231 of 21 November 2007) were replaced by administrative sanctions (see Legislative Decree No. 8 of 15 January 2016). Although criminal liability is personal, banks can incur an administrative liability when their corporate bodies and top management commit a crime in the banks’ interest and no adequate measures were implemented to prevent this crime, in accordance with the criteria under Legislative Decree No. 231 of 8 June 2001; and
  • c administrative liability mainly consists of the liability of banks, corporate bodies, top managers and heads of internal functions that breach certain provisions concerning, inter alia, the integrity and reputation requirements and the regulatory fulfilments.

To minimise the risk of a breach of the applicable regulations, Italian banks are required to set internal ‘whistle-blowing’ procedures that allow staff to flag any potential infringement of law while keeping confidential the information concerning the involved individuals.

In determining the sanction, the Bank of Italy considers the extent and length of the breach, the economic status of the addressees and damage caused to third parties. New provisions governing this liability under the Banking Act provide a tightening of the relevant sanctions, with maximum fines of up to €5 million, and the mandatory notification of these sanctions to the EBA.

Specifically, a Bank of Italy regulation of 3 May 2016 (which implemented the provisions on sanction proceedings) includes provision on the possibility to submit defence arguments after the inquiry phase; the elements relevant to assess the financial capacity of natural persons and the revenues of entities to determine the sanction amount; and coordination with the ECB concerning the exercise of sanctioning powers over banks directly supervised by ECB.

A positive impact on the length of proceedings aimed at assessing the above liabilities, and particularly civil liability, arose from a recent reform by the Ministry of Justice. This reform, which was mainly aimed at strengthening the alternative dispute resolution mechanisms to streamline the judicial apparatus, contributed to lowering the number of Italian civil litigation cases to the European average (approximately 2,600 against 100,000 individuals) and improving Italy’s position in the enforcing contracts ranking published by the World Bank Group (108th in 2017, up 52 positions since 2013).

Among the political initiatives that affect the banking system are the agreements entered into by the government with various countries to resolve the issue of foreign banking confidentiality. After the confidentiality duty for Italian banks was repealed in 2012, Italy recently obtained the undertaking of Switzerland, Liechtenstein, the Principality of Monaco and the Vatican State to provide information and data concerning Italian clients and undertook to implement the OECD Common Reporting Standard on financial activities from 2017. The automatic exchange of information between the Swiss and Italian tax authorities became effective on 1 January 2017.

v FUNDING

Italian banks fund their activities in a wide variety of ways in terms of sources (retail, wholesale and central bank liquidity), type of securities (shares, bonds, deposits) and funding technique (capital raising, plain bond issuance, securitisation transactions and covered bond offers).

The funding structure is usually influenced by the bank’s specific characteristics (mainly size, incorporated business form and financial strength), and the economic and financial environment. As a consequence, small banks tend to source funding through wholesale bonds far less frequently than medium-sized and large banks, and those channels that provide issuers with a lower cost of funding (such as secured financing) have been boosted over the past few years due to the financial crisis.

In the second half of 2016, the overall funding of Italian banks remained stable: the increase in resident deposits and Eurosystem refinancing compensated for the drop in the number of bonds held by households.

To address exceptional liquidity needs, in 2017 banks can also rely on the state guaranteeing debt financial instruments (under Law Decree No. 237 of 23 December 2016). Notably, between December 2016 and February 2017, three banks issued €13.5 billion in state-guaranteed debt financial instruments.

vi CONTROL OF BANKS AND TRANSFERS OF BANKING BUSINESS

i Control regime

In the past decade, the acquisition process of stakes in Italian banks has undergone intense revision following the increase of investments of foreign banks in the Italian market and the implementation of the Acquisitions Directive,10 as subsequently replaced by CRD IV.

A further noteworthy revision took place in 2014 following the entry into force of the SSM. In line with the SSM principles, the following are now subject to the prior ECB authorisation, after the Bank of Italy’s assessment: the direct or indirect acquisition of (a controlling stake; a considerable stake (i.e., a stake ascribing to the prospective shareholder a quota of voting rights or share capital of the bank equal to at least 10, 20, 30 or 50 per cent); or a stake enabling the holder to exercise a significant influence over the bank’s management (jointly, significant stake). Following the implementation of the BRRD, the Bank of Italy is the competent authority when authorisation for one of the above stakes is granted in a resolution.

The procedure entails:

  • a filing, by the prospective shareholder, of an application with the Bank of Italy outlining, inter alia, a detailed business plan attesting to the financial solidity of the acquisition project, the strategy that will be adopted to purchase the significant stake and the suitability of the prospective shareholder’s group to ensure full compliance with the supervisory rules;
  • b the Bank of Italy’s notification to the ECB of its receipt of the application (unless the Bank of Italy requires any amendments or supplements to be made to the application);
  • c the Bank of Italy’s assessment of the application, with a focus on the prospective shareholder’s financial soundness, good reputation, integrity and professional requirements (see Section III.ii, supra); the suitability of the medium to long-term (i.e., three to five years) business plan; and possible money-laundering issues;
  • d the Bank of Italy’s filing with the ECB of a draft decision to authorise or oppose the significant stake; and
  • e the ECB’s decision on the acquisition of the significant stake (based on EU and local regulations) and notification to the prospective shareholder.

The authorisation procedure takes 60 working days from the Bank of Italy’s acknowledgement of the filing under (a). The term can be suspended up to 20 working days or – if the prospective shareholder is incorporated in a non-EU state, is subject to non-EU regulations or is not a supervised entity – 30 working days.

The authorisation is granted when the ‘sound and prudent management’ of the target bank is ensured and the requirements under (a) are satisfied. The competent authorities’ assessment covers elements such as the sustainability of financial leverage, the complexity of the corporate chain, and the acquirer’s ability to provide additional funds to the target banks in a state of stress.

ii Transfers of banking business

Transfers of undertakings, going concerns, or goods or other obligations or rights (e.g., receivables, debts and contracts) identifiable as a ‘bulk’11 (transfer) are governed by Article 58 of the Banking Act and Title III of the Bank of Italy Circular No. 229 of 21 April 1999.

The transfer process provides that the transferee, which may be, inter alia, a bank, an entity belonging to a banking group or a financial intermediary enrolled with the register ex-Article 106 of the Banking Act, gives notice of the transfer to the competent companies register and publishes the notice in the Italian Official Gazette (notification duties).

No consent of the customers concerned is required, but within three months of completing the notification duties, the parties to the contracts under the transfer may exercise the right of withdrawal if there is a grounded reason (in this case, the transferor is liable for any damage suffered by other parties because of the transfer). When the sum of the assets and liabilities transferred is greater than 10 per cent of the transferee’s regulatory capital, the transfer must be authorised in advance by the Bank of Italy.

The above procedure allows banks to benefit from a simplified process that quickens and reduces the costs of the transfer, ensuring at the same time that all charges and guarantees maintain their validity and priority once all the notification duties have been complied with, without any further formality being needed.

This procedure can be used to transfer receivables, including NPLs. It is likely that over the next two years banks will rely largely on this procedure to quickly and effectively dispose of NPLs, particularly in light of the recent structural reforms to reduce credit recovery.

vii THE YEAR IN REVIEW

The Italian banking sector underwent extensive changes in 2016, which have continued in 2017.

The impact of the resolution of four regional banks on the Italian banking sector confirms that even when resolved banks are small or medium-sized, loss of public confidence can quickly spread and generate major systemic effects (see Section III.iv, supra). The resolution procedure did, however, guarantee the business continuity and financial recovery of the four banks – also to the benefit of the local economies where they were located. Moreover, non-subordinated bondholders of the resolved banks were fully protected under the resolution, and subordinated bondholders benefited from the innovative compensation mechanisms for retail investors introduced with Law No. 208 of 28 December 2015. Three of the four bridge banks were sold to UBI and one to BPER Banca SpA after a year of transitional management (see Section III.iv, supra). To improve banks’ balance sheets and enhance their overall profitability, the ECB and the Bank of Italy required some banks to dispose of their high stock of NPLs and to consequently strengthen their capital ratios. To encourage this process, in April 2016 the government promoted the setting-up of the alternative investment fund Atlante, whose units are fully subscribed by the main banks, insurance undertakings and banking foundations. Between April and June 2016, the capital increases of Banca Popolare di Vicenza SpA and Veneto Banca SpA were fully subscribed by Atlante for a total of €2.5 billion.

As part of the capital strengthening measure requested by the ECB, in December 2016 Banca Monte dei Paschi di Siena, whose common equity Tier 1 fell below the regulatory threshold in the 2016 EBA stress test (see Section I), initiated a complex transaction to dispose of its entire portfolio of bad loans, substantially increase its loan loss provisions on the remaining NPLs and raise its capital to €5 billion. However, following the failure of the private-sector recapitalisation, MPS applied for a precautionary recapitalisation under Law Decree No. 237 of 23 December 2016, which sets out measures to address exceptional liquidity needs and provisions for precautionary recapitalisation (the government authorised the allocation of up to €20 billion for 2017). The total recapitalisation amount, €8.8 billion, is to be covered through burden sharing (i.e., the conversion of the bank’s subordinated bonds into equity) and the state’s subscription of newly issued MPS ordinary shares. On 17 March 2017, Banca Popolare di Vicenza SpA and Veneto Banca SpA also applied for a precautionary recapitalisation under Law Decree No. 237 of 23 December 2016.

Between February and March 2017, Unicredit SpA increased its capital by €13 billion, one of the largest capital increases in Europe. Moreover, the first merger of two former mutual banks on 1 January 2017, which led to the creation of Italy’s third-largest banking group, could serve as a blueprint for future consolidations and thereby increase the efficiency and profitability of Italian banks.

From a regulatory standpoint, Italy also introduced, or placed under consultation, significant new regulations to meet the requirements under the EU framework in accordance with the ECB, EBA, FSB and OECD suggestions.

One of the most important changes addressed the burden of NPLs. Specifically, Law Decree No. 59 of 3 May 2016 introduced new mechanisms to ensure more effective protection of entities that grant loans to businesses and information tools to assist players in the NPL market, and amended the regulations governing judicial recovery proceedings. Overall, these new mechanisms have significantly improved the regulatory framework for managing NPLs by introducing targeted measures to reduce recovery times and improve recovery rates. Taken as a whole, it is expected that these measures will ultimately translate into an increase in the volume of NPL market transactions.

Another important change was the Bank of Italy’s amendment to its Supervisory Instructions to implement, among other things, the EBA’s guidelines on security on Internet payments. Due to the emergence of new cyber risks and the increased potential for cybercrime, banks are now required to update their IT systems and improve the Information and Communication Technology (ICT) risk management.

Finally, in May 2016 the Ministry of Economy and Finance placed under consultation an amendment to the Financial Act to implement EU Directive 2014/65 (MiFID II) and adapt the Italian regulatory framework to EU Regulation No. 600/2014 (MiFIR) on markets in financial instruments.

viii OUTLOOK and CONCLUSIONS

In 2016, the general economic upswing improved the quality of Italian banks’ loan books, and the Italian economy continued to recover, albeit slowly. Considering the performance of industrial production and consumption, GDP is estimated to have risen slightly, which was also driven by domestic demand. Indeed, economic activity was stimulated by the revival of investments and the increase in household expenditure. Signs of consolidation in the construction sector – especially in the residential property segment – have been confirmed.

Italian banks are continuing to repair their balance sheets in several ways (see Sections I and VII, supra). Both the flow of non-performing exposures and the percentage they represent on the total stock of loans are declining. Capital strengthening of banks is proceeding, albeit gradually, and liquidity conditions are favourable overall. As with other European banks, profitability remains low due to structural factors and short-term economic development, the latter of which weighs more heavily on Italy, where growth is slower.

In this context, banks may face stronger competition as the traditional banking activity, consisting in lending and deposit taking, has been extended to other entities (see Section II, supra). At the same time, fragmentation in the banking sector will likely be reduced in the cooperative credit banks field as a consequence of the changes introduced by Law Decree No. 18 of 14 February 2016 (see Section II, supra). This regulation could be a good opportunity to more efficiently allocate resources within the system to enhance competitiveness and stability over the medium to long term.

In line with the ECB’s guidelines, the top priorities for Italian banks in 2017 are:

  • a capital and liquidity adequacy;
  • b credit risk, with a focus on NPLs and concentrations;
  • c targeted review of internal models;
  • d compliance with principles for effective risk data aggregation and risk reporting; and
  • e management of the risks associated with outsourcing.

Although the aspects under these last two points are properly monitored, thanks to the measures adopted by the Bank of Italy and ECB, major efforts are required to carefully address credit risk and review internal models. Government measures to tackle potential liquidity needs and support capital strengthening initiatives are also key areas to monitor. It is likely that over the next few months MPS and other banks will increase their capital ratios, including through recourse to the precautionary recapitalisation measure under Law Decree No. 237 of 23 December 2016 (see Section VII, supra).

It will also be interesting to see whether the overall package of measures on NPL management will be able to not only relieve banks’ balance sheets from the burden of NPLs but also develop the NPL market (see Section VII, supra). Finally, to assess the effects of bank shortfalls on investors and consumers generally, the government has decided to establish a commission of inquiry that will also investigate the roots of the banks’ capital shortfalls, the adequacy of regulation and supervision, and the extent of reputational damage.

In general, banks remain vulnerable to both domestic and international shocks that affect capital markets and economic growth. After the UK Brexit referendum, market indicators for Italy’s leading banks deteriorated significantly. Additionally, uncertainty surrounds various important international regulatory initiatives currently being finalised, such as the reform of prudential requirements (Basel III), the introduction of the minimum requirement for own funds and eligible liabilities (MREL), and the entry into force in 2018 of new financial reporting standards for assessing financial instruments (IFRS 9).

Nevertheless, the government’s measures to support bank liquidity and capital will likely sustain growth in loans to households and businesses with the current accommodative supply conditions. The improved economic outlook for the next few years will also assist banks to gradually enhance the credit quality.

The significant changes that the Italian banking and financial sectors will face in the short to medium term will bring new business opportunities for Italian and foreign investors looking to strengthen their presence in or enter the Italian market. Technical knowledge and familiarity with Italian and European banking and financial regulations is crucial given that the regulatory framework is becoming ever more sophisticated and complex.

1 Giuseppe Rumi is a partner and Giulio Vece is an associate at BonelliErede.

2 Directive 2013/36/EU.

3 Regulation (EU) No. 575/2013.

4 Regulation (EU) No. 1024/2013.

5 The supervisory authorities can be divided into two categories: the Bank of Italy (a company limited by shares whose main shareholders are the most notable Italian banking groups) and Consob, which represent the independent authorities; and the MEF and the CICR, whose members are directly appointed by the government. The co-existence of both independent and political authorities is aimed at ensuring the balance of public and private interests and guaranteeing that any legislative reform is shared by both government representatives and exponents of the banking market.

6 Data updated up to May 2016. Sources: Bank of Italy Annual Report and Bank of Italy registers.

7 Data updated up to September 2016. Source: Bank of Italy Economic Bulletin, No. 1, January 2017.

8 According to the proportionality principle, in exercising its supervisory tasks towards these entities, the Bank of Italy may take into account policies and strategies adopted by the parent company to face the liquidity risk.

9 In the Italian banking sector, this kind of liability is frequently found in the working relationships between banks and their brokers with regard to the activities carried out by the latter on behalf of the bank.

10 Directive 2007/44/EC.

11 The contractual relationships may be identified as a ‘bulk’ when they refer to, inter alia, receivables presenting a common distinguishing element (e.g., the assignment ex-Article 58 of the Banking Act of all the receivables owned by a bank as regards a certain person or individual; companies that are part of a certain group; and all the enterprises placed in a certain region).