I INTRODUCTION

In 2017, two important measures to eliminate the risks threatening the Italian banking sector were adopted: (1) the precautionary recapitalisation of Banca Monte dei Paschi di Siena SpA (MPS); and (2) the liquidation of Banca Popolare di Vicenza SpA and Veneto Banca SpA (see Sections III.iv and VII). Moreover, as regards the four banks placed under resolution by the Bank of Italy in 2015, the sale of the corresponding four bridge banks to which their assets were transferred was finalised between January and March 2017 (see Section III.iv).

Emerging from a prolonged period of economic downturn, Italian banks are continuing their efforts to:

  1. manage their stocks of non-performing loans (NPLs);
  2. strengthen their balance sheets; and
  3. improve efficiency and profitability.

Although the recent structural reforms have led to a significant decrease in the overall stock of NPLs (i.e., from €356 billion to €324 billion), the European Central Bank (ECB) and the Bank of Italy requested banks to further reduce their stocks and to implement internal measures to improve efficient management (see Section VII). Throughout 2017, the state guarantee on the senior tranche of securitised bad loans, introduced by Law Decree No. 59 of 3 May 2016 to reduce credit recovery time, facilitated the transfer of NPLs. The state guarantee was issued, inter alia, on the securitisation implemented by Unicredit SpA (Unicredit) – Italy’s largest bank – and Banca Carige SpA (Banca Carige); it is also expected to be issued on the senior tranche of the MPS’s €26.1 billion securitisation. Furthermore, the Italian Recovery Fund (previously Atlante II), the alternative investment fund set up to acquire mezzanine and junior tranches of securitised NPLs, acquired securitised bad loans from, inter alia, the MPS and three small Italian banks that were acquired at the end of 2017 by Crédit Agricole Cariparma SpA (see Section VII). As expected, the many measures adopted in the past few years determined an increase in the volume of NPL transactions and this trend is expected to continue throughout 2018.

To counterbalance the negative effects of the disposal of NPLs on their balance sheets, some Italian banks were required to further strengthen their capital ratios. In 2017, Unicredit and Banca Carige increased their capital by €13 billion and €500 million, respectively. Moreover, the MPS was recapitalised by the State under Law Decree No. 237 of 23 December 2016, and both Banca Popolare di Vicenza and Veneto Banca were liquidated under ordinary insolvency proceedings as a result of the deterioration in their financial position (see Section VII).

The different approaches taken by the competent authorities regarding the critical cases involving Italian banks has led to a lively debate on the new resolution framework introduced by the Banking Recovery and Resolution Directive (BRRD), particularly in light of the related effects on retail investors.

In general terms, although the capital ratios of Italian banks improved slightly in 2017, they still remain below the European average. In addition, recovery of profitability (which has fallen in recent years in part because of the extraordinary expenses incurred by banks in contributing to the deposit guarantee scheme and the national resolution fund) now represents a key priority.

Finally, with regard to the key regulatory issues, Italian banks are focusing on:

  1. reviewing their internal governance to comply with the forthcoming implementation rules on the suitability of corporate bodies (see Section III.ii);
  2. updating their systems to comply with the new rules on payment services (see Sections II and IV);
  3. implementing operational plans on the management of NPLs (see Section VII);
  4. adapting their models to the recently introduced implementation measures of the second Markets in Financial Instruments Directive and the Markets in Financial Instruments Regulation (the MiFID II package) (see Section VII); and
  5. with respect to cooperative credit banks (CCBs), adapting their structure and governance to the new requirements introduced by recent legislative reforms (see Section II).

Banking groups

Common Equity Tier 1 ratio (%)

1

Unicredit SpA*

13.81

2

Intesa Sanpaolo SpA

12.5

3

Banca Monte dei Paschi di Siena SpA

15.2

4

Unione di Banche Italiane SpA

11.65

5

Banco BPM SpA**

11

Data updated as at 30 September 2017.

* Unicredit SpA is included the list of global systemically important banks published by the Financial Stability Board (FSB) in November 2017.

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

Source: quarterly financial reports

II THE REGULATORY REGIME APPLICABLE TO BANKS

Besides EU legislation (specifically the Capital Requirements Directive (CRD IV)2, the Capital Requirements Regulation (CRR)3 and the Single Supervisory Mechanism (SSM) Regulation),4 the principles governing banking activities and investment services are contained in Legislative Decree No. 385 of 1 September 1993 (the Banking Act) and Legislative Decree No. 58 of 24 February 1998 (the Financial Act) respectively. In 2017 and 2018, both these Acts underwent an in-depth review to, inter alia, implement Directive (EU) 2015/2366 (Revised Payment Services Directive (PSD2)) and Directive 2014/65/EU (MiFID II); and align national legislation with Regulation (EU) No. 600/2014 (Markets in Financial Instruments Regulation (MiFIR)).

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 Interministerial Committee for Credit and Saving (CICR, and all four together, supervisory authorities).5 Specific powers in the anti-money laundering field are ascribed to the Financial Intelligence Unit.

The laws and regulations on banking and financial markets govern lending, deposit taking, securities activities and cross-border operations. Although deposit-taking is reserved for 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 significant (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 the application to obtain and withdraw a banking licence and the authorisation to acquire qualified or controlling shareholdings in banks, regardless of their significance (see Section VI); 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 the LSIs;
    • monitoring all Italian banks in relation to transparency, consumer protection and anti-money laundering 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 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 activity 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 60 banking groups and 533 banks (of which 129 belong to banking groups)6 and more than 29,000 active bank counters, established in the Italian banking market. Regarding the presence of foreign banks, more than 600 operate in Italy without a permanent establishment (down 265 from 2017), and 93 have set up a local branch (an increase of nine from 2017).7

Regarding legal form, 148 banks are incorporated as companies limited by shares, 279 as CCBs and 23 as mutual banks.8

With Law Decree No. 18 of 14 February 2016, CCBs underwent significant changes that include, inter alia (1) the mandatory adhesion to a cooperative banking group to obtain authorisation as a cooperative bank; (2) the parent company duty to be set up as a joint-stock company; and (3) 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 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 September 2017, the Bank of Italy launched a consultation on new supervisory instructions to align the special rules applying to CCBs with the new rules on banking cooperative groups.

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 and 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 owing to the suspension in December 2016 of the reform’s implementing provisions as a result of the questionability of 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. Therefore, the two remaining mutual banks must now transform themselves into joint-stock companies.

III PRUDENTIAL REGULATION

i Relationship with the prudential regulator

The reach of the Bank of Italy’s prudential supervision is extensive and penetrating. This widespread and strong supervisory regime managed to better mitigate the consequences of the financial crisis than was seen in many other countries, and encouraged significant capital increase transactions that led to an average increase of up to 12.5 per cent of the Common Equity Tier 1 ratio.9

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). With reference to the capital conservation buffer, the Bank of Italy adopted the transitional period set forth in CRD IV in October 2016, thereby requiring credit institutions to maintain a capital conservation buffer of 1.875 per cent from 1 January 2018 to 31 December 2018 and of 2.5 per cent from January 2019.

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 less significant banks, and to the ECB for significant banks. Whereas the ICAAP mainly aims at quantifying the capital needed to face the risks of the banking business (including country and transfer risks) and set liquidity management measures accordingly, the purpose of SREP is to assess the suitability of these measures – both capital and organisational – and establish the necessary relevant corrective actions (limitations to the distribution of the own funds’ financial instruments, imposition of own funds’ add-on and divestment of assets).

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 case 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.

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 risk on banking books, and 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 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 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 European Banking Authority (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 the member from holding similar positions in competitor banking, financial or insurance undertakings or groups.

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

Italian banks will also need to adapt their governance structure to the new final guidelines on internal governance published by the EBA in September 2017.

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

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

Remuneration policies

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

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

  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 those personnel who contributed to significant losses for the bank, or who have acted fraudulently; 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. In March 2018, the Bank of Italy launched a consultation on the supervisory instructions on remuneration to align the Italian regulatory framework with the EBA guidelines of December 2015.

As a result of the forthcoming implementation of the new rules, Italian banks will be required to review their remuneration policies, 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 from 2018);
  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: to be gradually increased from 1.875 per cent in 2018 to 2.5 per cent in 2019;

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

• global systemically important institution (G-SII) buffer: only one Italian bank has been identified as a G-SII and must maintain a capital buffer, which will gradually increase from 0.75 per cent in 2018 to 1 per cent in 2019; and

• other systemically important institution (O-SII) buffer: four Italian banking groups – UniCredit, Intesa Sanpaolo SpA (Intesa Sanpaolo), the MPS and Banco BPM – have been identified as O-SIIs and will have to achieve a buffer of 1 per cent, 0.75 per cent and 0.25 per cent, respectively, by 2022 (the buffer from 1 January 2018 to 1 January 2019 is zero for Banco BPM, 0.06 per cent for the MPS, 0.19 per cent for Intesa Sanpaolo; and 0.25 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 2017, banks that meet the above regulatory capital requirements can conservatively distribute net profits in dividends, with the aim of continuing to fulfil all requirements even if economic and financial conditions worsen. Conversely, failure to comply with the above thresholds will prevent institutions from carrying out any such distribution.

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

In the context of the prudential regulations, a key role is ascribed to management of the liquidity risk, both as funding liquidity risk and market liquidity risk. To prevent these risks, Italian banking groups, Italian banks not belonging to a group and Italian branches of non-EU banks (the latter according to the proportionality principles)10 are mainly required to identify and measure their exposure to liquidity risk, establish a liquidity risk’s tolerance threshold, and carry out stress tests to assess the adequacy of the liquidity reserves on an ongoing basis. The specific liquidity requirements under the CRR do not apply individually basis to Italian banks belonging to a group (see Section III.i).

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 (9 per cent of the risk weighted assets);
  3. 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 non-performing loans from the bridge institutions to an asset management vehicle (€1.6 billion overall);
  5. the bid process of the bridge institutions, led by the Bank of Italy as a shareholder of these institutions through the national resolution fund; and
  6. the carrying out of the programme in accordance with the commitments that the government undertook to the European Commission.

As a result of the resolution programme, the four bridge institutions restarted the banking business and again played a key role in the local economy, supporting 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 Banca SpA (UBI) and one to BPER Banca SpA (BPER) at the end of a competitive bid process that lasted one 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, 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 2018, two banks were under special administration (see below)); 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.

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’. 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.

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 the customer; 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 the client’s knowledge of the services provided. This approach has led credit institutions to diversify their internal structures and procedures to safeguard each kind of client and adhere to mandatory out-of-court settlement systems, as seen in the subsequently adopted measures on transparency, investment services and anti-money laundering, and in the banking and financial arbitrators fields.

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

With Legislative Decree No. 37 of 15 March 2017, the Banking Act was integrated with specific provisions regarding transparency and comparability of fees related to payment accounts, payment account switching and access to payment accounts with basic features. Consequently, the Bank of Italy approved some integrations to the 2009 provisions on transparency of banking and financial transactions and services with reference to, inter alia, the notion and content of ‘basic accounts’, communications to customers and organisational requirements of banks.

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;11 and
  2. pre-contractual liability occurs where contracts between a bank and its customers are not executed as a result of unfair conduct of the bank;
  3. 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 anti-money laundering regulations (notably Legislative Decree No. 231 of 21 November 2007) were replaced by administrative sanctions (see Legislative Decree No. 8 of 15 January 2016). Although criminal liability is personal, 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
  4. administrative liability mainly consists of the liability of banks, corporate bodies, top managers and heads of internal functions that breach certain provisions concerning, inter alia, the integrity and reputation requirements and the regulatory fulfilments.

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

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

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

A positive impact on the length of proceedings aimed at assessing the above liabilities, and particularly civil liability, arose from a reform by the Ministry of Justice. This reform, which was mainly aimed at strengthening the alternative dispute resolution mechanisms to streamline the judicial apparatus, contributed to lowering the number of Italian civil litigation cases to the European average (approximately 2,600 against 100,000 individuals) and improving Italy’s position in the enforcing contracts ranking published by the World Bank Group (108th in 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 the undertaking of Switzerland, Liechtenstein, the Principality of Monaco and the Vatican State to provide information and data concerning Italian clients, and undertook to implement the OECD Common Reporting Standard on financial activities from 2017. The automatic exchange of information between the Swiss and Italian tax authorities became effective on 1 January 2017.

V FUNDING

Italian banks fund their activities in a wide variety of ways in terms of sources (retail, wholesale and central bank liquidity), 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.

The 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 continued to expand strongly, offsetting the contraction in the volume of bonds held by households. In September 2017, the funding gap (i.e., the share of loans not covered by retail funding) was below 4 per cent, compared to 9 per cent in September 2016.

VI CONTROL OF BANKS AND TRANSFERS OF BANKING BUSINESS

i Control regime

In the past decade, the acquisition process of stakes in Italian banks has undergone intense revision following the increase of investments of foreign banks in the Italian market and the implementation of the Acquisitions Directive,12 subsequently replaced by CRD IV.

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

The procedure entails:

  1. 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) are satisfied. The competent authorities’ assessment covers elements such as the sustainability of financial leverage, the complexity of the corporate chain, and the acquirer’s ability to provide additional funds to the target banks in a state of stress.

ii Transfers of banking business

Transfers of undertakings, going concerns or goods, or other obligations or rights (such as receivables, debts and contracts) identifiable as a ‘bulk’13 (transfer) are governed by Article 58 of the Banking Act and Title III of the Bank of Italy Circular No. 229 of 21 April 1999.

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

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 quickens and reduces the costs of the transfer, ensuring at the same time that all charges and guarantees maintain their validity and priority once all the notification duties have been complied with, without any further formality being needed.

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

VII THE YEAR IN REVIEW

The Italian banking sector underwent extensive changes in 2017, which have continued in the first quarter of 2018.

The impact of the resolution of four regional banks on the Italian banking sector confirmed that loss of public confidence can quickly spread and generate major systemic effects (see Section III.iv). Under the resolution, however, non-subordinated bondholders were fully protected, and retail subordinated bondholders benefited from the innovative compensation mechanisms introduced with Law No. 208 of 28 December 2015.

To improve their balance sheets and enhance overall profitability, the ECB and the Bank of Italy required some banks to dispose of their high stock of NPLs and to consequently strengthen their capital ratios. In this context, following the failure of the private-sector recapitalisation, the MPS applied for a precautionary recapitalisation under Law Decree No. 237 of 23 December 2016 (the government authorised the allocation of up to €20 billion for 2017). The total recapitalisation amount, €8.8 billion, was covered through burden-sharing and the State’s subscription of newly issued MPS shares, which resulted in the State holding 68.2 per cent of the bank’s capital. In March 2017, Banca Popolare di Vicenza and Veneto Banca also applied for a precautionary recapitalisation, but did not obtain authorisation from the European Commission. As a consequence, the two banks were placed under compulsory administrative liquidation (see Section III.iv) and, in June 2017, Intesa Sanpaolo acquired, for €1, their banking businesses and some of their assets, liabilities, goods, rights and legal relationships – excluding NPLs, subordinated bonds, shareholdings and other legal relationships not considered functional to the acquisition. In this context, the State provided €4.8 billion in cash injections and up to nearly €12 billion in state guarantees for securing the deal.

During the recapitalisation of the MPS, retail subordinated bondholders who were victims of mis-selling and fulfilled certain eligibility criteria could apply for compensation involving an exchange of their converted shares into senior MPS bonds. In the case of Banca Popolare di Vicenza and Veneto Banca, retail subordinated bondholders involved in the burden-sharing were given access to the compensation mechanisms introduced with Law No. 208 of 28 December 2015 and, in this respect, Intesa Sanpaolo committed to contribute €60 million to the compensation.

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

One of the most important changes addressed the burden of NPLs. Specifically, following the publication of the ECB guidelines for SIs in March 2017 and the consultation of October 2017 on an addendum to the guidelines, the Bank of Italy published its own guidelines on the management of NPLs for Italian LSIs in January 2018. In line with the ECB guidelines, the Bank of Italy requested banks to implement, inter alia, medium- and long-term operational plans on the management of NPLs and on performance analysis systems. Taken as a whole, it is expected that these measures will ultimately translate into a further increase in the volume of NPL market transactions.

Furthermore, the implementation of MiFID II, which was completed at the beginning of 2018 through the publication of secondary regulations, introduced some relevant changes for Italian banks regarding, inter alia, product governance, product intervention, investment advice on an independent basis, and inducements.

Other important changes were the implementation of Directive (EU) 2015/849 (AMLD IV) and PSD2 through Legislative Decrees No. 90/2017 and No. 218/2017 respectively, although the secondary decrees and regulations have yet to be issued.

VIII OUTLOOK AND CONCLUSIONS

In 2017, Italian economic growth strengthened considerably, driven by the global cyclical upswing and expansionary economic policies. Public debt appears to be stabilising but still remains high compared to GDP. The latter rose sharply during 2017, supported by domestic demand. Investment, which slowed in the first half of last year, has now increased again. Adequate liquidity in the banking sector has continued to support a modest expansion of credit to households and firms, the quality of which is improving. The decline in lending to the construction sector is still pronounced, but is abating.

Throughout the past year, there has been some progress in improving the health of Italian banks and in strengthening their balance sheets (see Sections I and VII), but banks continue to be strained by NPLs and operating costs, which weigh heavily on profitability. Several bad loan sales have been completed, whereas others involving large amounts are being finalised.

In this context, the competition that banks face – as the traditional banking activities of lending and deposit-taking have been extended to other entities (see Section II) – will continue to grow. Financial markets are now being reshaped by the digital revolution, which simultaneously brings opportunities and risks for banks. New fintech companies are entering the market, introducing new methods of providing financial services.

Furthermore, efforts are being made to reduce fragmentation in the banking sector and, therefore, increase efficiency. In this respect, the reform of CCBs (see Section II) represents a good opportunity to allocate resources more efficiently within the system to enhance competitiveness and stability over the medium to long term.

In general, Italian banks must continue to pursue the goals of cost reduction and full recovery in profitability. More specifically, the top priorities for Italian banks in 2018 are:

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

Banks are now required to comply with additional requirements, such as those on anti-money laundering and consumer protection, the latter being enhanced following implementation of MiFID II. Additionally, uncertainty surrounds various important international regulatory initiatives. On one side, agreement was reached at international level on the reform of prudential requirements (Basel III), which will start to be applied in 2022 and enter into full effect in 2027. On the other side, the new financial reporting standards for assessing financial instruments (IFRS 9) entered into force in January 2018 and is expected to enhance transparency and prudence in banks’ valuation of loans. Further regulatory changes for which banks must be prepared are the net stable funding ratio, the leverage ratio, and the minimum requirements for own funds and eligible liabilities.

The significant changes that Italian banks are facing will reinforce the solidity of the banking system. Recent reforms have already increased capital and liquidity buffers but, at the same time, in order to achieve pre-crisis profitability levels, banks are required to further reduce costs and achieve efficiency gains. Massive investments in information technologies and in human capital are necessary. Bank consolidation will also be key during the coming years to improve efficiency and profitability, to compete successfully in the market and to finance the real economy.

The spread of new technologies, growing competition in the financial markets and increasingly prudential rules require Italian banks to proceed decisively with strengthening their balance sheets, reducing NPLs stocks and increasing profitability.

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.

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

2 Directive 2013/36/EU.

3 Regulation (EU) No. 575/2013.

4 Regulation (EU) No. 1024/2013.

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

6 Data updated up to May 2017. Source: Bank of Italy Annual Report.

7 Data updated up to January 2018. Source: Bank of Italy registers.

8 Data updated up to January 2018. Source: Bank of Italy registers.

9 Data updated up to June 2017. Source: Bank of Italy Financial Stability Report, No. 2, November 2017.

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

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

12 Directive 2007/44/CE.

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