I INTRODUCTION

As a result of the 2018 European Banking Authority (EBA) EU-wide stress tests, the four largest Italian banks – Unicredit SpA (Unicredit), Intesa Sanpaolo SpA (Intesa), Banco BPM SpA (BPM) and Unione di Banche Italiane SpA (UBI) – proved to be resilient to adverse market developments. This indicates an overall strengthening in the soundness of the Italian banking system. The parallel stress tests conducted by the European Central Bank (ECB) on all the significant banks (SIs) not included in the EBA sample resulted in the ECB requiring only Banca Carige SpA (Carige) to restore its compliance with the capital requirements. Against this backdrop, after Carige's shareholders voted against a €400 million capital increase, the ECB decided to place the bank under special administration (see Section VII).

In this context, following requests by the ECB and the Bank of Italy to further reduce non-performing loan (NPL) stocks and implement internal measures to improve efficient management, several Italian banks rationalised their loan portfolios through NPL disposals. They also benefited from a state guarantee on senior tranches of securitised bad loans – the Guarantee on Securitisation of Bad Loans (GACS), which was introduced by Law No. 49 of 8 April 2016 to facilitate NPL transfers (see Section VII). The GACS was issued on, among other things, the €26.1 billion securitisation of Banca Monte dei Pashi di Siena (MPS) and the €1.6 billion securitisation of Credito Valtellinese (Creval). In addition, Banca Popolare di Vicenza's and Veneto Banca's NPLs, which were liquidated under ordinary insolvency proceedings in June 2017 (see Section III.iv), were transferred to SGA, a financial intermediary specialised in managing and recovering NPLs and fully owned by the Ministry of Economy and Finance (MEF). As expected, NPL transaction volumes increased throughout 2018, leading to a significant reduction of NPL stocks.

Several extraordinary transactions occurred in 2018 involving medium-sized Italian banks, including acquisitions and mergers. Three regional banks were merged by incorporation into Crédit Agricole Cariparma SpA (Cariparma), and several other small and medium-sized Italian banks were acquired by foreign banks and investment funds that proved to be interested in entering the Italian banking market (see Section VII).

As to the reform of cooperative credit banks (CCBs) and mutual banks, Cassa Centrale Banca became the first parent company of a banking cooperative group consisting of 84 CCBs in January 2019, whereas the two largest mutual banks are still prevented from transforming into joint-stock companies following an Italian Administrative Supreme Court decision in October 2018 to further freeze the reform by requiring a preliminary ruling from the Court of Justice of the European Union (see Section II).

Against the current backdrop of uncertainty, including the government's instability, Brexit and the announced end of the European Central Bank quantitative easing programme, Italian banks are now focusing on the following:

  1. reviewing their internal governance structures to comply with the forthcoming implementation rules regarding the suitability of corporate bodies and adapting their remuneration policies to the newly introduced provisions aimed at aligning the Italian framework with the EBA guidelines (see Section III.ii);
  2. updating their models and systems to comply with the new regulatory framework regarding payment services, deriving from the implementation of the Second Payment Services Directive (PSD2);2 and investment services, following the implementation the MiFID II3 package (see Sections II, IV and VII);
  3. preparing for the upcoming entry into force of the new European legislative package governing capital and liquidity requirements (CRR2 package); and
  4. adapting their business models to the new fintech environment (see Section VII).
Banking groups Common Equity Tier 1 ratio (%)
1 Unicredit* 12.11
2 Intesa 12.4
5 BPM 12.9
3 MPS 12.5
4 UBI 11.79
Data updated as at 30 September 2018. * Unicredit is included the list of global systemically important banks published by the Financial Stability Board (FSB) in November 2018. Source: quarterly financial reports

II THE REGULATORY REGIME APPLICABLE TO BANKS

In addition to the EU legislation (specifically the Capital Requirements Directive (CRD IV)4, the Capital Requirements Regulation (CRR)5 and the Single Supervisory Mechanism (SSM) Regulation),6 the principles governing banking activities and investment services are contained in the Banking Act7 and the Financial Act,8 respectively. In 2017 and 2018, both Acts underwent an indepth review to, inter alia, implement PSD2 and MiFID II, and align national legislation with the MiFIR.9

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 subsequently amended (Supervisory Instructions); and by 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 MEF and the Inter-ministerial Committee for Credit and Saving (CICR, and all four together, the supervisory authorities).10 Specific powers in the anti-money laundering (AML) field are ascribed to the Financial Intelligence Unit.

The laws and regulations on 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 thus can also be performed by non-regulated entities. Lending activities can be carried out by banks, financial intermediaries, insurance undertakings, special purpose vehicles (subject to limitations), EU alternative investment funds and Italian investment funds, if certain requirements are met.

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 SIs and less significant banks (LSIs), and the key role played by the ECB. Specifically, under the SSM:

  1. the ECB is responsible for:
    • supervising Italian SIs, with the assistance of the Bank of Italy;
    • resolving on applications 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); and
    • ensuring the effective and consistent functioning of the SSM and the Bank of Italy; and
  2. the Bank of Italy's tasks mainly consist of:
    • supervising LSIs;
    • monitoring all Italian banks in relation to transparency, consumer protection and AML matters; and
    • assisting the ECB in supervising Italian SIs.

As clarified through a letter addressed to EU SIs published in June 2017, the ECB also has supervisory powers granted under Italian law in relation to, inter alia, the following operations involving Italian SIs:

  1. outsourcing of activities;
  2. mergers and de-mergers;
  3. asset transfers and divestments; and
  4. amendments to by-laws.

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, and are subject to stricter requirements. Following the implementation of MiFID II, non-EU banks are now allowed to provide investment services for retail clients in Italy exclusively through the establishment of a branch.

Similar principles apply to Italian banks when they intend to undertake banking activities in other EU countries, including the Bank of Italy's authorisation for an Italian bank wishing to operate in a non-EU country.

Currently, there are 53 banking groups, 505 banks (of which 131 belong to banking groups)11 and more than 25,000 active bank counters established in the Italian banking market. Regarding the presence of foreign banks, 692 operate in Italy without a permanent establishment (up 92 from 2018), and 37 have set up a local branch, bringing the total number of branches to 64 branches (a decrease of 29 from 2018).12

Regarding legal form, 137 banks are incorporated as companies limited by shares, 265 as CCBs and 22 as mutual banks.13

With Law Decree No. 18 of 14 February 2016, CCBs underwent significant changes that include, inter alia, mandatory adhesion to a cooperative banking group to obtain authorisation as a cooperative bank; the parent company duty to be set up as a joint-stock company; and the right to issue financial instruments. Subsequently, in November 2016, the Bank of Italy adopted implementing regulations to set, inter alia, the minimum organisational and operational requirements for parent companies of cooperative banking groups, and the minimum content of cohesion contracts between a parent company and its affiliated CCBs (Circular No. 285 of 17 December 2013 as amended in November 2016). Furthermore, in May 2018, the Bank of Italy published new supervisory instructions to align the special rules applying to CCBs with the new rules on banking cooperative groups (see Section III.ii).

Finally, following the reform of mutual banks introduced by Law Decree No. 3 of 24 January 2015, eight of the 10 largest mutual banks (those with an asset value above €8 billion) were transformed into joint-stock companies. Two of them subsequently merged, forming Italy's third-largest banking group. The remaining two largest mutual banks (Banca Popolare di Sondrio SCpA and Banca Popolare di Bari SCpA) were prevented from transforming into joint-stock companies following the suspension in December 2016 of the reform's implementing provisions as a result of questions regarding the constitutional legitimacy of the restrictions on shareholders' withdrawal rights. In March 2018, the Italian Constitutional Court concluded that the question of constitutional legitimacy was unfounded. However, in October 2018 the reform was suspended again by the Italian Administrative Supreme Court as a result of a preliminary ruling requested to the Court of Justice of the European Union (the deadline for the transformation was extended to 31 December 2019).

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 than was seen in many other countries, and encouraged significant capital increase transactions that led to an average increase of up to 13.2 per cent of the Common Equity Tier 1 ratio.14

In implementing the CRD IV and CRR principles, the Bank of Italy exercised its discretionary power to further increase banks' minimum initial capital from €5 million (as provided by CRD IV) to €10 million (see Section III.iii) and exempt banks belonging to a group from holding the liquidity requirements individually (see Section III.iii).

Currently, the supervisory review process consists of the internal capital adequacy assessment process (ICAAP) carried out by banks under the responsibility of their corporate bodies; and the supervisory review and evaluation process (SREP), entrusted to the Bank of Italy for LSIs and to the ECB for SIs. Whereas the ICAAP mainly aims to quantify the capital needed to face the risks of 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 own funds' financial instruments, imposition of own funds' add-ons and divestment of assets).

Starting from the 2016 SREP process, in addition to the imposition of the 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 reestablish 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 capital due for risk prevention must be proportionate to the features, business size and complexity of each bank. The frequency and intensity of SREP must take into account the systemic importance, features and any problematic issues of each institution.

In 2017, the provisions of Circular No. 285 of 17 December 2013 on the supervisory review process were amended with respect to, inter alia, early intervention measures, interest rate risks on banking books and the limitation of exposures towards shadow banking entities.

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:

  1. choose between three management structures:
    • a traditional system (the most common structure) encompassing a shareholders' meeting, a board of directors and an auditory board;
    • a monistic system, whereby 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 board and supervisory board; and
  2. 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. In August 2017, the MEF published for consultation a draft decree on suitability requirements of members of banks' corporate bodies and key function holders in order to finalise the CRD IV implementation and align the Italian framework to the 2017 ECB guide and EBA guidelines on fit and proper assessment. The draft decree significantly strengthens the existing standards of suitability and introduces new criteria to assess the suitability requirements (i.e., fairness, competence, collective suitability, independence of mind, time commitment and limits on the number of directorships).

The appointment procedure must also consider the interlocking ban, which prevents members from holding similar positions in competitor banking, financial or insurance undertakings or groups.

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 at the request of the Bank of Italy.

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), and succession plans for the positions of chief executive officer and general director, to ensure business continuity and prevent economic and reputational effects.

Specific provisions to align the special rules on CCBs with the rules on cooperative banking groups were introduced in the Supervisory Instructions, concerning, among other things capital structure and shareholder categories, articles of association and extraordinary transactions, and territorial competence.

Finally, 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 a 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 a 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 October 2018 to meet the CRD IV provisions and the recommendations issued by the EBA and FSB policies, state that, among other things:

  1. 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;
  2. 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, depending on the bank's specific status;
  3. malus and clawback arrangements also apply to the incentives due or paid to personnel who contributed to significant losses for a bank or customers, acted fraudulently, or acted contrary to laws, regulatory or statutory provisions or ethics codes; and
  4. 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 to the amendments to the Supervisory Instructions on remuneration issued by the Bank of Italy in October 2018 to align the Italian regulatory framework with the EBA guidelines of December 2015, the new key provisions concern, among other things:

  1. the definition of fixed remuneration;
  2. the inclusion of carried interest payments in variable remuneration;
  3. amendments to the procedure to identify staff whose work has a material impact on the bank's risk profile; and
  4. the inclusion, under specific conditions, of golden parachutes in the calculation of the ratio between the fixed and variable components of remuneration.

As a result of the new rules, Italian banks are now required to review their remuneration policies by no later than the date of approval of the 2018 financial statements, with particular focus on the variable component, to avoid reducing their capital bases and to ensure that 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, for which the minimum capital required is €5 million). This capital must consist of:

  1. 4.5 per cent of Common Equity Tier 1 ratio;
  2. 6 per cent of Tier 1 ratio (a favourable tax regime applies to additional Tier 1 items);
  3. 8 per cent of total capital ratio; and
  4. any additional capital requirements imposed under the SREP (see subsection i).

Additional requirements are:

  1. liquidity coverage ratio (100 per cent);
  2. leverage ratio (3 per cent based on the Basel Committee's framework, not yet implemented as a minimum requirement); and
  3. buffers, as follows:
    • capital conservation buffer: 2.5 per cent; 
    • 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 (UniCredit) has been identified as a G-SII, and must maintain a capital buffer of 1 per cent; and
    • other systemically important institution (O-SII) buffer: three Italian banking groups – UniCredit, Intesa and Banco BPM – have been identified as O-SIIs and will have to achieve a buffer of 1, 0.75 and 0.25 per cent, respectively, by 2022 (the buffer from 1 January 2019 to 1 January 2020 is 0.06 for Banco BPM, 0.38 per cent for Intesa; and 0.50 per cent for Unicredit).

    Italian banks belonging to a banking group are exempted from the application of the liquidity coverage requirement on an individual basis, while banking groups – 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 2018, 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 Bank of Italy branches, in respect of banking groups other than those under (1). Both Desks have extensive powers that mainly result in the 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 management of the liquidity risk, both as a 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 principle)15 are mainly required to identify and measure their exposure to a 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.

    iv Recovery and resolution

    Italy implemented the BRRD through Legislative Decrees No. 180 and No. 181 of 16 November 2015, which set out the BRRD regime and updated the Banking Act and Financial Act accordingly. A few days after implementation of the BRRD, 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:

    1. the full write down of the banks' shares and subordinated bonds for overall amounts that exceeded €1 billion and €500 million, respectively;
    2. the setting up of four bridge institutions with new corporate bodies and capital ratios;
    3. the assignment of the rights, assets and liabilities in force as at the resolution date to the bridge institutions, with the exclusion of the written-down shares and bonds;
    4. the transfer of NPLs from the bridge institutions to an asset management vehicle.

    As a result of the resolution programme, the four bridge institutions restarted banking business and again played a key role in the local economy, supporting small and medium-sized regional 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 for a symbolic purchase price to UBI and one to BPER Banca SpA at the end of a competitive bid process that lasted a year.

    In addition to the BRRD implementing regulations, Italian 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:

    1. special administration: a short-term temporary measure aimed at verifying the possibility of restoring adequate capital buffers, and 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 January 2019, two banks are under special administration); and
    2. 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.

    After having applied for a precautionary recapitalisation under Law Decree No. 237 of 23 December 2016, in July 2017 MPS completed a total recapitalisation of €8.8 billion covered through burden-sharing and the state's subscription of newly issued MPS shares. As a result, the state currently holds 68.2 per cent of MPS's share capital.

    In the same year, Banca Popolare di Vicenza and Veneto Banca also applied for a precautionary recapitalisation, but did not obtain authorisation from the European Commission. In June 2017, the two banks were placed under compulsory administrative liquidation after the ECB declared the two banks as failing or likely to fail. In this case, the BRRD framework was not applied as the Single Resolution Board concluded that resolution action was not warranted in the public interest. The banking businesses of the two banks (along with some of their assets, liabilities, goods, rights and legal relationships) were acquired by Intesa for a symbolic purchase price; NPL subordinated bonds, shareholdings and other legal relationships were excluded from the acquisition.

    With the 2018 Budget Law, the government set specific measures to further restore subordinated bondholders – and in this case, also shareholders – of banks placed under compulsory administrative liquidation between 16 November 2015 and 1 January 2018 that had suffered financial losses due to violation of fairness and transparency duties.

    In January 2019, Banca Carige was placed under special administration by the ECB. Furthermore, to encourage the recapitalisation of the bank and the reduction of its NPLs, the government issued Law Decree No. 1 of 8 January 2019 (converted into Law No. 16 of 8 March 2019), which allows Banca Carige to obtain a state guarantee on newly issued liabilities and loans granted by the Bank of Italy at its discretion, and apply for a precautionary recapitalisation.

    In line with recent amendments to the BRRD, the Banking Act was amended by Law No. 205 of 27 December 2017 to introduce a new class of unsecured debt instruments, which rank in an intermediate position between senior and subordinated liabilities in the insolvency hierarchy.

    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:

    1. contain the typical risks related to their banking activity (credit risk, market risk, liquidity risk, and operational or legal risk);
    2. maintain the conditions of liquidity and risk contractually established;
    3. ensure the service's continuity as regards customers; and
    4. 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.

    During 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 their clients' 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 AML, and in the banking and financial arbitrators' fields.

    In 2018, the Bank of Italy published several consultation documents aimed at implementing European provisions on, among other things, product governance, AML and investment services.

    On 5 December 2018, the Bank of Italy updated its 2009 transparency provisions to align the Italian regulatory framework with the EBA's guidelines on product oversight and governance arrangements for retail banking products. Banks are now required to, among other things, implement processes for the design and market launch of products, as well as for their reviewing over their life cycle.

    On 13 April and 31 July 2018, new provisions were published for consultation by the Bank of Italy to implement Legislative Decree No. 231 of 21 November 2007 and align the Italian regulatory framework with AMLD IV.16 The provisions concern, among other things, conservation and use of data and information for AML purposes; policies, controls and procedures; and customer due diligence.

    To implement the MiFID II and MiFIR provisions, in August 2018 the Bank of Italy published for consultation a new regulation on the requirements to be met by intermediaries that provide investment and asset management services; and amendments to the Supervisory Instructions regarding the authorisation of Italian banks to provide investment services and the cross-border provision of investment services.

    Conduct of business is also 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 clarification 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:

    1. civil liability is governed by the Italian Civil Code and may be classified, as per general principles, as contractual, non-contractual or 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;17 and
      • pre-contractual liability occurs where contracts between a bank and its customers are not executed as a result of the unfair conduct of the bank;
    2. criminal liability primarily covers any unauthorised banking and financial activity. During 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 AML 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, a bank can incur an administrative liability when its corporate bodies and top management commit a crime in the bank's 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
    3. 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 the law while keeping confidential the information concerning the involved individuals.

    In determining a sanction, the Bank of Italy considers the extent and length of the breach, the economic status of the addressees and the damage caused to third parties. New provisions governing administrative 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 the provision of a 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 the ECB. The Bank of Italy regulation of 18 December 2012 was further amended in January 2019 to introduce the new AML provisions deriving from the implementation of AMLD IV.

    A positive impact on the length of proceedings aimed at assessing the above liabilities, and particularly civil liability, arose from a 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 individuals18) and improving Italy's position in the enforcing contracts ranking published by the World Bank Group (111th in 2018, 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. Since the confidentiality duty for Italian banks was repealed in 2012, Italy has obtained an 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), types 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 in the past few years because of the financial crisis.

    Still-weak credit growth and a reduction of public sector securities in bank portfolios have reduced banks' financing needs, which were largely satisfied by increased retail funding. Deposits have continued to expand strongly, offsetting the contraction on bond funding as a consequence of tension on the sovereign debt markets.19 In September 2018, the funding gap (i.e., the share of loans not covered by retail funding) was below 2 per cent, compared to 4 per cent in September 2017.20

    The funding structure of banks is influenced by the monetary policy of central banks, including the quantitative easing programme. Shrinking bank margins caused by withdrawing from the ECB bond-buying programme and tensions on interest rates could have negative effects on the financing of the real economy and on the banking system.

    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 an increase of investments of foreign banks in the Italian market and the implementation of the Acquisitions Directive,21 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 prior ECB authorisation, following 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:

    1. the 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;
    2. the Bank of Italy's notification to the ECB of receipt of the application (unless the Bank of Italy requires any amendments or supplements to be made to the application);
    3. 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);
      • the suitability of the medium to long-term (i.e., three to five years) business plan; and
      • possible money-laundering issues;
    4. the Bank of Italy's filing with the ECB of a draft decision to authorise or oppose the significant stake; and
    5. 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 point (a). The term can be suspended for 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 point (a) above 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 target banks in a state of stress.

    ii Transfers of banking business

    Transfers of undertakings, going concerns or goods, or other obligations or rights (such as receivables, debts and contracts) identifiable as a 'bulk'22 (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 under 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).

    The consent of the customers concerned is not 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 or by the ECB (see Section II).

    The above-mentioned procedure allows banks to benefit from a simplified process that speeds up 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.

    During 2018, banks have largely relied on this procedure to dispose of NPLs quickly and effectively, and it is likely that this trend will continue in 2019. The recent structural reforms adopted to reduce the duration of credit recovery procedures and the ECB guidelines on NPL of March 2017 have, in fact, increased the interest of investors in this kind of transaction.

    VII THE YEAR IN REVIEW

    Two developments witnessed in 2018 were a growing tendency towards consolidation and aggregation between banking operators, and the entry of new players on the financial markets.

    More specifically, consolidation and bank recovery were achieved through capital increases and mergers (e.g., Creval's €700 million capital increase, the merger of three banks into Cariparma, and the acquisitions of medium-sized Italian banks by foreign investment funds).

    Throughout 2018, several players – including Unicredit, Creval and MPS – rationalised their loan portfolios through large-scale NPL disposals using the GACS, which was introduced in 2016 to facilitate NPL disposal and recently extended to March 2019. Furthermore, this highly dynamic scenario has stimulated banks to establish or acquire entities specialised in the management and recovery of NPLs; one such example is the acquisition of FBS SpA by Banca IFIS, a listed bank that is one of the main players in the NPL sector. This acquisition has given rise to the first integrated platform of investment and NPL management on the Italian market.

    The Italian banking system, which in 2018 was subject to both EBA and ECB stress tests, proved to be resilient to adverse market developments. Indeed, following the stress tests, only Carige was asked by the ECB to strengthen its capital ratios.

    Regarding the reform of CCBs and mutual banks, the first CCB group was enrolled on the Bank of Italy's register in December 2018, with effect from 1 January 2019; and the 2018 Budget Law extended the original deadline for mutual banks to transform into joint-stock companies from 31 December 2018 to 31 December 2019.

    The 2018 Budget Law also introduced a €1.6 billion fund to compensate retail junior bondholders and shareholders who were victims of mis-selling by banks placed under compulsory administrative liquidation between 16 November 2015 and 1 January 2018. Following the approval of the implementing decree of the 2018 Budget Law (currently under discussion with the European Commission), retail junior bondholders and shareholders will be entitled to apply for compensation corresponding to 95 or 30 per cent of their original investments, depending on the types of securities they subscribed (see Section III.iv).

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

    One important change in the banking sector in 2018 concerned remuneration policies. Italian banks are now required to adapt their policies to the newly introduced rules no later than the approval date of their 2018 financial statements (see Section III.ii). Furthermore, through the implementation of MiFID II, the Italian legal framework has introduced significant changes for Italian banks that provide investment services. These changes concern, among other things, product governance, product intervention, investment advice on an independent basis, and inducements.

    Following AMLD IV's entry into force, the Bank of Italy placed under consultation new regulations to adapt the Italian framework governing AML and terrorist financing to European rules. More specifically, the main changes that will be introduced aim to promote a risk-based approach in carrying out customer due diligence and allow remote identification of customers through biometric recognition.

    Finally, the implementation of PSD2 is dramatically changing the financial services industry. Specifically, PSD2 provisions allow new entrants to leverage existing banks' data, thereby creating a more level playing field for new competitors to offer a range of products and services to banks' existing customers. Against this background, traditional banking operators are responding with strategies to adapt their current business model, specifically by developing platform services, acquiring or forming alliances with fintech companies, or becoming pure digital banks.

    VIII OUTLOOK AND CONCLUSIONS

    The global economy has been slowing down since mid-2018. Indeed, economic activity has declined markedly in the eurozone, and Italy has recorded a downturn primarily due to a reduction in foreign demand, companies' expectations and investments. Italian GDP decreased on the previous quarter for the second time in a row, having been further weakened by the negative performance of domestic demand.

    Regarding the banking sector, the higher financing costs that banks are bearing have yet to be passed on to loan interest rates thanks to banks' increased capitalisation. However, signs of modest tightening of conditions for accessing credit have begun to appear.

    Further progress in improving the health of Italian banks and strengthening their balance sheets was seen in 2018, and NPL stocks diminished at a remarkable pace (also due to several bad loan portfolio sales). The decrease in SIs' NPLs appears consistent with the plans agreed between banks and the supervisory authorities. The Bank of Italy is now examining NPL operational plans for LSIs.

    Although profitability has improved, Italian banks need to strengthen their balance sheets and recover adequate efficiency and profitability levels. Major resources are now needed to cope with higher compliance costs, and major investments are required to exploit digital technology and improve service offerings to customers.

    The main challenge that banks must now face is fintech: technology dramatically reduces the costs of transmitting, processing and storing data, and pushes market players towards new forms of financial intermediation. Fintech companies are gaining market share by using new methods of providing financial services (e.g., payment services, credit provision, securities trading and risk management).

    Italian banks are facing significant changes, and important progress is underway to improve the health of the Italian banking system. Tail risks to the banking system have been reduced by measures to improve balance sheets and profitability; however, banks must now continue on all fronts to restore resilience in the banking system and enable it to fully support the real economy. More specifically, the priorities for Italian banks in 2019 remain:

    1. capital strengthening;
    2. credit risk, with a focus on NPLs;
    3. risk management; and
    4. review of governance and business models.

    Furthermore, banks must now comply with additional requirements, such as those deriving from the implementation of MiFID II and PSD2. They must also prepare for the upcoming entry into force of the new legislative package aimed at reducing risks within the EU banking sector by implementing Basel III framework elements such as a total loss-absorbency capacity, a net stable funding ratio and the leverage ratio (CRR2 Package).

    Against this background, technical knowledge and familiarity with the Italian and European banking and financial regulations will be crucial in a regulatory environment that is becoming ever more sophisticated and complex.


    Footnotes

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

    2 Directive (EU) 2015/2366.

    3 Directive 2014/65/EU.

    4 Directive 2013/36/EU.

    5 Regulation (EU) No. 575/2013.

    6 Regulation (EU) No. 1024/2013.

    7 Legislative Decree No. 385 of 1 September 1993.

    8 Legislative Decree No. 58 of 24 February 1998.

    9 Regulation (EU) No. 600/2014 (Markets in Financial Instruments Regulation).

    10 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 coexistence 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.

    11 Data updated up to May 2018. Source: Bank of Italy Annual Report.

    12 Data updated up to January 2019. Source: Bank of Italy registers.

    13 Data updated up to January 2019. Source: Bank of Italy registers.

    14 Data updated up to June 2018. Source: Bank of Italy Financial Stability Report, No. 2, November 2018.

    15 According to the proportionality principle, in exercising its supervisory tasks over these entities, the Bank of Italy may consider policies and strategies adopted by parent companies to face the liquidity risk.

    16 Directive (EU) 2015/849.

    17 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 banks.

    18 According to the 2018 EU Justice Score Board edited by the European Commission.

    19 Data updated up to September 2018. Source: Bank of Italy Financial Stability Report, No. 2, November 2018.

    20 Data updated up to September 2018. Source: Bank of Italy Financial Stability Report No. 2, November 2018.

    21 Directive 2007/44/EC.

    22 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 under 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).