I INTRODUCTION

Italy's banking system has progressively strengthened over the past few years, and credit quality has been enhanced by implementing highly selective lending policies.

Indeed, despite the worsening of the macroeconomic situation (due to, among other things, the slowdown in China, the repercussion of the spread of the new coronavirus and the United Kingdom's withdrawal from the European Union), the results of the 2019 European Central Bank (ECB) Supervisory Review and Evaluation Process (SREP) show that most significant institutions (SIs) maintain Common Equity Tier 1 (CET1) levels above the overall SREP capital requirements.

The upturn in economic activity recorded in recent years has helped to improve the quality of Italian banks' assets. This improvement was facilitated by the development of the non-performing loan (NPL) market: between 2016 and 2018, NPL disposals totalled more than €120 billion. This was due to banks being able to access the state guarantee scheme for securitised bad loans and was spurred on by the early results of the reforms to speed up credit recovery proceedings. Consequently, the NPL coverage ratio decreased to 3.7 per cent from 9.8 per cent at the end of 2015, and, according to the NPL reduction plans submitted by both SIs and less significant institutions (LSIs), the number of NPL disposals is expected to remain high in 2020.

Bank profitability has also shown signs of recovery; return on equity has been positive since 2017 and liquidity conditions have progressively improved. Capital ratios, which had decreased due to tensions on the government securities market, are on the up: in September 2019, the CET1 ratio averaged 13.6 per cent, up from the 13.3 per cent at the end of 2018.

Furthermore, the Italian banking system has undergone extensive change and is becoming less fragmented. Indeed, as a result of the cooperative banking sector reform (see Section II), two new cooperative banking groups that qualify as significant groups (Iccrea and Cassa Centrale Banca) were established in 2019, and 226 of the 263 cooperative credit banks (CCBs) have joined them.2 Consequently, the 12 Italian significant groups now hold almost 80 per cent of the Italian banking system's total assets.3

Thanks to the intervention of the Italian Interbank Deposit Protection Fund (FITD), Banca Carige SpA (Carige) seems to have overcome the crisis it hit in 2019: after the period of extraordinary administration that started at the beginning of 2019, Carige completed all the steps needed for its turnaround and reinstatement of its ordinary bodies. A similar situation is now being faced by Banca Popolare di Bari SCpA (BPB) (see Section III.iv).

Against this backdrop, Italian banks are continuing to focus on the following:

  1. preparing for the upcoming entry into force of the new European legislative package, which includes revised rules on capital and resolutions (the Capital Requirements Directive V (CRD V)4 and Capital Requirements Regulation II (CRR II)5 package;
  2. reviewing governance structures to comply with the forthcoming implementation rules regarding the suitability of corporate bodies (see Section III.ii);
  3. updating models and systems to comply with the regulatory framework governing payment services, deriving from the Second Payment Services Directive (PSD2),6 and investment services, deriving from the Second Markets in Financial Instruments Regulation (MiFID II)7 package (see Sections II, IV and VII);
  4. continuing balance sheet repairs and strengthening future resilience; and
  5. adapting business models to the fintech environment (see Section VII).
Banking group CET1 ratio (%)
UniCredit*

12.60

Intesa

13.1

BPM

12.1

MPS

12.6

UBI

12.09

Data as at 30 September 2019

* UniCredit is included the list of global systemically important banks published by the Financial Stability Board in November 2019

Source: quarterly financial reports

II THE REGULATORY REGIME APPLICABLE TO BANKS

In addition to the EU legislation (specifically CRD IV,8 as recently amended by CRD V, CRR,9 as recently amended by CRR II and the Single Supervisory Mechanism (SSM) Regulation),10 the principles governing banking activities and investment services are contained in the Banking Act11 and the Financial Act,12 respectively. In the past, both Acts underwent an in-depth review to, inter alia, implement PSD2 and MiFID II, and align national legislation with the Markets in Financial Instruments Regulation (MiFIR).13

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 Ministry of Economy and Finance (MEF) and the Inter-ministerial Committee for Credit and Saving (CICR, and, together with the Bank of Italy, Consob and the MEF, the supervisory authorities).14 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 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 demergers;
  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.

Banking groups subject to ECB direct supervision are supervised by Banking Supervision Desk I; and all other banks are supervised by Banking Supervision Desk II and Bank of Italy branches. Both Desks have extensive powers that mainly result in supervising national and transnational groups on a consolidated basis, analysing risks and managing administrative proceedings.

As to Italy's banking structure, there are currently 52 banking groups, 104 banks not belonging to banking groups and more than 25,000 active bank counters established in the Italian banking market.15 Regarding the presence of foreign banks, 835 operate in Italy without a permanent establishment (up 143 from 2019), and 60 have set up a local branch (a decrease of four from 2019).16

Regarding the legal form, 127 banks are incorporated as joint-stock companies, 254 as CCBs and 22 as mutual banks.17

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. 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 BPB) 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 2020 by Law Decree No. 34 of 30 April 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 13.6 per cent of the CET1 ratio for SIs.18

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 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 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 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 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.

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 and October 2018. 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. They also introduce several limits to the amount and nature of variable remuneration.

The regulatory framework described below is likely to be revised following implementation in Italy of the new CRD V provisions.

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 to finalise the CRD IV implementation and align the Italian framework to the 2017 ECB guide and European Banking Authority (EBA) guidelines on fit and proper assessment. The decree, the final version of which has yet to be published, 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,19 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 Financial Stability Board 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 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 above rules, Italian banks were required to review their remuneration policies by no later than the date of approval of the 2018 financial statements to avoid reducing their capital bases and ensure that a sound capital structure is maintained.

The above regulatory framework is likely to be revised following implementation in Italy of the new CRD V provisions concerning, among other things: (1) the minimum deferral of part of the variable remuneration; (2) the introduction of equal pay for male and female workers; and (3) the possibility for listed banks to pay their managers with equity-linked instruments.

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 CET1 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 UniCredit SpA has been identified as a G-SII and is required to maintain an ongoing capital buffer of 1 per cent of its total risk exposure; and
    • other systemically important institution (O-SII) buffer: four Italian banking groups – UniCredit, Intesa Sanpaolo SpA, Banco BPM SpA and Banca Monte dei Paschi di Siena (MPS) – have been identified as O-SIIs and will have to achieve a buffer of 1, 0.75, 0.25 and 0.25 per cent, respectively, by 2022 (the buffer from 1 January 2020 to 1 January 2021 is 0.75 per cent for UniCredit, 0.56 per cent for Intesa and 0.13 for Banco BPM and MPS).

In this context, Italian banks are also strengthening their capital for the upcoming implementation of the CRD V and CRR II provisions on the total loss-absorbency capacity, the net stable funding ratio (NSFR) and the leverage ratio.

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 January 2020, 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.

Within 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)20 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 Nos. 180 and 181 of 16 November 2015, which set out the BRRD rules and updated the Banking Act and Financial Act accordingly. A few days after this implementation, four regional banks were placed under resolution, in accordance with a programme that 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 rights, assets and liabilities in force as at the resolution date to the bridge institutions, with the exclusion of written-down shares and bonds; and
  4. the transfer of NPLs from the bridge institutions to an asset management vehicle.

As a result of the above, the four bridge institutions restarted their banking business, and regained a key role in the local economy. Furthermore, the government set specific measures to restore the written-down subordinated bondholders.

Between January and March 2017, three banks were sold for a symbolic purchase price to UBI Banca SpA (UBI) and one to BPER Banca SpA (BPER) at the end of a competitive bidding process that lasted a year.

In addition to the BRRD implementing regulations, Italian banks are still subject to the local regime, which, depending on the nature of the bank crisis, envisages:

  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 at January 2020, three 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 June 2017, Banca Popolare di Vicenza and Veneto Banca were placed under compulsory administrative liquidation after the ECB declared the two banks as failing or likely to fail. 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, further specific measures were set to restore subordinated bondholders – and 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, the ECB placed Carige under special administration and, to encourage the bank's recapitalisation and the reduction of its NPLs, the Italian government issued Law Decree No. 1 of 8 January 2019. The decree allowed Carige to obtain a state guarantee on newly issued liabilities and loans granted by the Bank of Italy at its discretion, and to apply for a precautionary recapitalisation. In December 2019, the FITD, together with the voluntary intervention scheme set up within the FITD and Cassa Centrale Banca, participated in a €700 million capital increase. The capital increase resulted in the FITD becoming Carige's main shareholder and in the bank returning to ordinary administration without having to be resolved or placed under compulsory administrative liquidation.

Furthermore, at the end of 2019, BPB was also placed under special administration due to asset losses, and the FITD intervened restore the bank's capital and prevent potential adverse consequences arising from its precarious condition. A framework agreement to restructure and recapitalise BPB was consequently entered into between the FITD, its voluntary intervention scheme and a state-owned company.

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 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 legislator 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 2019, the Bank of Italy adopted several regulations to implement European provisions on (among other things) product governance, AML, investment services, transparency and consumer protection in the provision of banking and financial services. More specifically, in March 2019, the Bank of Italy updated its 2009 transparency provisions to align the Italian regulatory framework with PSD2, the Mortgage Credit Directive21 and the Consumer Credit Directive (CCD).22 The transparency provisions were further amended in June 2019 to align the Italian regulatory framework with the Payment Accounts Directive.23

In March and July 2019, new provisions concerning policies, controls and procedures and customer due diligence were published by the Bank of Italy to align the Italian regulatory framework with the Fourth Anti-Money Laundering Directive (AMLD IV).24

To implement the MiFID II and MiFIR provisions, in December 2019, the Bank of Italy published a new regulation on the requirements to be met by intermediaries that provide investment and asset management services. The Bank of Italy also amended the Supervisory Instructions with respect to the domestic and cross-border provision of investment services by Italian and foreign banks.

Conduct of business is also subject to disclosure duties 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 MiFID II;
    • 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;25 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 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 Bank of Italy regulation of 18 December 2012 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 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 2,500 against 100,000 individuals)26 and improving Italy's position in the enforcing contracts ranking published by the World Bank Group (122nd in 2019, up 11 positions on 2018).

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), the economic and financial environment and the monetary policy of central banks, including quantitative easing programmes. 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.

In 2019, the total amount of retail funding was almost equal to that of loans to households and firms. The funding gap (i.e., the share of loans not covered by retail funding) was almost zero. In June 2019, the NSFR, which will be a binding requirement in 2021, stood at an average of 114 per cent for Italian SIs and none of the banks had a ratio below 100, which is the regulatory minimum.27

Bond issues on international markets supported the recovery seen from the start of 2019, following the easing of tensions on the government securities market. These issues are all eligible for use in the calculation of the minimum requirement for own funds and eligible liabilities (MREL) subject to bail-in, part of which must include senior non-preferred or subordinated securities.

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,28 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 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'29 (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 (financial intermediary), 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.

In 2019, banks continued to largely rely on this procedure to dispose of NPLs quickly and effectively, and, with the NPL ratio still being significant, this trend is likely to continue in 2020.

VII THE YEAR IN REVIEW

Over the past few years, the Italian banking system has progressively strengthened. The profitability of Italian banks increased between 2018 and 2019, as did average capitalisation levels of the major banking groups, which were buoyed by increased profits recorded during this period.

In this context, the Italian banking system demonstrated a growing tendency towards consolidation and aggregation between banking operators. More specifically, in November 2019, the merger by incorporation of Unipol Banca SpA into BPER took effect, and in February 2020, Intesa, Italy's second largest bank, announced its intention to carry out a business combination with UBI, Italy's fifth largest bank, to enhance value and create a European leader through a stronger Italian footprint. In 2019, the reform of CCBs, designed to achieve much-needed efficiency gains and economies of scale and meet the challenges associated with the transformation of the banking sector, was completed with the creation of the new Iccrea and Cassa Centrale Banca cooperative banking groups, into which 226 out of a total of 263 CCBs were merged. Consequently, the number of Italian stand-alone banks decreased from 505 in 2018 to 104 in 2019. Furthermore, Italy faced its first voluntary withdrawal of a banking licence in June 2019: doBank SpA renounced its banking licence and changed its corporate name to doValue SpA to enable it to pursue its core business, which is managing NPLs through doValue itself and an affiliate, which is a financial intermediary whose business has been extended to enable it to provide both financing and payment services.

Moreover, in December 2019, UniCredit announced its intention to significantly reorganise its group structure. The announcement included the possibility of the bank establishing an Italian unlisted sub-holding company for its foreign affiliates. This is to optimise the MREL in the medium term, thereby reducing intragroup exposure and improving group resolvability.

After successfully completing a comprehensive capital strengthening and de-risking operation, Carige, which was placed under special administration at the beginning of 2019, carried out a €700 million capital increase, mainly subscribed by the FITD and Cassa Centrale Banca, which was essential for the bank's turnaround and reinstatement of its ordinary administrative bodies. BPB, which was placed under special administration in December 2019, is currently undergoing a similar procedure and was the addressee of a set of measures adopted by the government to improve access to credit by establishing a development bank.

From a regulatory standpoint, in 2019, Italy introduced and placed under consultation significant new regulations to meet the EU framework requirements in accordance with the ECB's and EBA's suggestions.

As a result of MiFID II, significant changes have been introduced to Italy's legal framework that apply to Italian banks that provide investment services. These changes concern, among other things, product governance and intervention, independent investment advice and inducements.

Following AMLD IV's entry into force, the Bank of Italy also adopted new regulations to adapt the Italian framework governing AML and terrorist financing to European rules. More specifically, the main changes promote a risk-based approach to conducting customer due diligence and allow remote identification of customers through biometric recognition.

Furthermore, PSD2 is dramatically changing the financial services industry. It allows new entrants to access existing banks' data, thereby creating a more level playing field for new competitors to offer products and services to banks' existing customers. Against this background, traditional banking operators are responding with strategies to adapt their current business models, by developing platform services, acquiring or forming alliances with fintech companies or becoming pure digital banks.

Finally, Italian banks will have to cope with the operational implications of the Lexitor case,30 as the European Court of Justice ruled in September 2019 that Article 16(1) of the CCD is to be interpreted as meaning that the right of consumers, upon prepayment of a loan, to a reduction of the total cost of the loan includes all the costs imposed on the consumer.

VIII OUTLOOK AND CONCLUSIONS

Conditions in the Italian financial and credit markets have improved, and investor confidence has risen, as shown by the sizeable purchases of public sector securities by non-residents, resulting in a considerable reduction in their yields.

The quality of loans continues to improve and the growth of new NPLs remains low. Actions to reduce the volume of NPLs and improve their management will continue, including by smaller Italian banks, which tend to have relatively higher NPL ratios and lower coverage ratios compared to those of the largest groups.

In the first nine months of 2019, profitability rose compared to the same period in 2018, which was helped by low funding costs and a reduction of loan loss provisions.

Italian banks are facing significant changes and important progress is under way to improve the overall 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.

Stronger balance sheets and greater efficiency can be achieved if the banking industry is reshaped in various ways, in terms of size, ownership structures and business models. Initiatives to expand the scale of banking operations, such as mergers and greater integration of business areas across banks, could prove beneficial to the extent that they reduce cost ratios, increase and diversify earnings, and enhance the ability of banks to compete.

Italian banks' priorities in 2020 are, therefore, likely to remain:

  1. capital strengthening;
  2. credit risk, with a focus on NPLs;
  3. risk management procedures, which should be adapted to also manage the risk posed by climate change; and
  4. governance and business model reviews.

In the next few months, the European Commission will present a proposal for the transposition of the Final Basel III prudential standards, which include setting an output floor on the capital requirements calculated using internal models. To cope with the impact of applying these standards, Italian banks will have to seek better organisational and cost-related conditions.

Furthermore, banks must now comply with additional requirements, such as those deriving from MiFID II and PSD2. They must also prepare for the upcoming CRR II and BRRD II packages.

Against this backdrop, technical knowledge and familiarity with 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 Data as at July 2019.

3 Data as at June 2019.

4 Directive 2019/878/EU.

5 Regulation (EU) No. 876/2019.

6 Directive (EU) 2015/2366.

7 Directive 2014/65/EU.

8 Directive 2013/36/EU.

9 Regulation (EU) No. 575/2013.

10 Regulation (EU) No. 1024/2013.

11 Legislative Decree No. 385 of 1 September 1993.

12 Legislative Decree No. 58 of 24 February 1998.

13 Regulation (EU) No. 600/2014.

14 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.

15 Data updated to May 2019, Source: Bank of Italy Annual Report.

16 Data updated to January 2020, Source: Bank of Italy registers.

17 Data updated to January 2020, Source: Bank of Italy registers.

18 Data updated to January 2020. Source: Bank of Italy Economic Bulletin, No. 1, 2020.

19 See Article 36 of Law Decree No. 201 of 6 December 2011, as converted into law by Law No. 214 of 22 December 2011.

20 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.

21 Directive 2014/17/EU.

22 Directive 2008/48/EC.

23 Directive 2014/92/EU.

24 Directive (EU) 2015/849.

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

26 Source: the 2019 EU justice scoreboard (quantitative data).

27 Data updated to September 2019. Source: Bank of Italy Financial Stability Report No. 2, November 2019.

28 Directive 2007/44/EC.

29 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).

30 Polish company Lexitor Sp. z o.o. (Case C-383/18).