The Banking Regulation Review: Italy
The consolidation of the Italian banking sector and the capital strengthening of Italian banks continued in 2020, despite the extraordinary hurdles caused by the outbreak of the coronavirus pandemic.
To face the health and economic crisis, the Italian government introduced several measures aimed at easing households' and businesses' liquidity constraints through legally binding debt moratoria and the temporary freezing of redundancies, as well as the provision of easier access to financing with loan guarantee programmes. Moreover, the European Central Bank (ECB) set up several emergency liquidity facilities and new asset purchase programmes, including funding facilities to foster banks' essential role as credit suppliers and supporters of the real economy.
These measures, together with the global cooperative response, the adoption of the latest expansionary measures, China's strong recovery and the Brexit agreement reached between the European Union and the United Kingdom helped to contain the economic impact of covid-19.
Italian banks faced the crisis from a stronger capital position, maintaining adequate credit supply and meeting credit demands. This solidity was built throughout the years, through a combination of a strong Common Equity Tier 1 (CET1) ratio, which has almost doubled over the past 10 years (current average is approximately 15.1 per cent),2 financial aid measures, which limited the non-performing loan (NPL) rate, and the 2020 legislative reform, which allowed banks to convert a portion of their deferred tax assets into tax credits upon disposal of the assets.
The consolidation of the Italian banking sector has continued throughout 2020 and the beginning of 2021. Various leading banks have combined large, medium and small banking groups to consolidate their market leadership (e.g., Intesa Sanpaolo), expand their geographical presence (e.g., Crédit Agricole Italia) and establish their expertise in niche markets (e.g., Banca Ifis). Despite some attempts to prevent the takeovers, before the courts and supervisory authorities, these transactions have been successfully completed, bringing Italy in line with the transnational trend of having larger, stronger banking groups. As a result of these deals, the new groups are now required to clarify their governance and organisation models, so as to properly deal with the clients, products and infrastructures inherited from the acquired institutions.
While these mergers have further enhanced some institutions and significantly altered the banking geography, other credit institutions have had to resort to material capital injections to prevent the risk of being placed under resolution, special administration or compulsory administrative liquidation (see Section III.iv). In 2020, the Italian Interbank Deposit Protection Fund (FITD) and Mediocredito Centrale (MCC) jointly recapitalised Banca Popolare di Bari SpA for over €1 billion (see Section III.iv).
The combination of the pandemic, the development of new technologies, and customers' increased interest in simpler, safer and smarter banking instruments has necessitated a compulsory reorganisation of the banking business model. Banks are now required to:
- promptly meet the emerging needs of their clients and review their priorities, with the aim of ensuring a more pleasant customer journey, in compliance with the principles grounding the transparency and privacy regulations;
- streamline financing and credit approval processes through improved third-party provision under the second Payment Services Directive (PSD2)3; and
- design new digital products and services that satisfy the needs of new customers.
Italy's EU recovery plan is expected to help the country's banking sector meet the above-mentioned targets.
The chart below details the CET1 ratio of the five biggest banking groups in Italy as at 31 December 2020.
|Banking group||CET1 ratio (%)|
|Data as at 31 December 2020|
* UniCredit is included in the list of global systemically important banks published by the Financial Stability Board in November 2020.
Source: quarterly financial reports
The regulatory regime applicable to banks
In addition to the EU legislation (specifically, the Capital Requirements Directive (CRD IV,4 as recently amended by CRD V5), the Capital Requirement Regulation (CRR,6 as recently amended by CRR II7) and the Single Supervisory Mechanism (SSM) Regulation),8 the principles governing banking activities and investment services are contained in the Banking Act9 and the Financial Act,10 respectively. In the past, both acts underwent an in-depth review to, inter alia, implement PSD2 and the second Markets in Financial Instruments Directive (MiFID II),11 and align national legislation with the Markets in Financial Instruments Regulation.12
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 (together with the Bank of Italy, Consob and the MEF, the supervisory authorities).13 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 significant institutions (SIs) and less significant institutions (LSIs), and the key role played by the ECB. Specifically, under the SSM:
- 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
- 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:
- outsourcing of activities;
- mergers and demergers;
- asset transfers and divestments; and
- 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 59 banking groups,14 98 banks not belonging to banking groups15 and 23,800 active bank counters established in the Italian banking market.16 Regarding the presence of foreign banks, there are 84 Italian subsidiaries of foreign banks.17
Regarding legal form, 122 banks are incorporated as joint-stock companies, 248 banks are incorporated as cooperative credit banks (CCBs) and 22 as mutual banks.18
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 and, in May 2018, the new supervisory instructions to align the special rules applying to CCBs with the new rules on banking cooperative groups (see Section III.ii).
Following positive rulings of the Italian Constitutional Court (2018) and the Court of Justice of the European Union (2020), in July 2020 the Italian Administrative Supreme Court revoked the suspension of the mutual bank reform's implementing provisions introduced by Legislative Decree No. 3 of 24 January 2015. The decision, which was the result of a lengthy jurisdictional process, allowed mutual banks with an asset value of above €8 billion to reform as joint-stock companies, and confirmed the ability of CCBs and mutual banks to defer the redemption of shares held by withdrawing shareholders and to limit the amount to be redeemed in full or in part, on condition that the redemption limits imposed when exercising the option are proportional to the prudential situation of the banks concerned.
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 15.1 per cent of the CET1 ratio for SIs.19
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 Supervisory Review and Evaluation Process (SREP), entrusted to the Bank of Italy for LSIs and to the ECB for SIs. Whereas the ICAAP mainly aims to quantify the capital needed to face the risks of banking business (including country and transfer risks) and set liquidity management measures accordingly, the purpose of the 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 under review by the Bank of Italy to allow the implementation of, among other things, the new CRD V provisions, which are aimed at strengthening the existing rules concerning corporate governance of banks and banking groups.
The draft regulation includes: (1) mandatory gender diversity rules; (2) ethical standards to be approved by banks; (3) the direct applicability to Italian banks of the CRD V provision on related-party transactions; and (4) the duty on banks to issue internal regulations setting out the procedures for managing shareholder relationships.
Corporate governance requirements
To ensure sound and prudent management and to achieve their business goals, Italian banks are required to:
- 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
- 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 in terms of 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 November 2020, the MEF issued a decree on suitability requirements for members of corporate bodies and key function holders of banks and the main categories of intermediaries. The decree will strengthen the standards of suitability as it includes detailed criteria to assess, among other things, the fairness, professionalism, competence, independence and time commitment.
The appointment procedure must also consider the interlocking ban,20 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, the Bank of Italy has the power to remove corporate bodies from office when the sound and prudent management of a bank is compromised.
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.
The Supervisory Instructions, in compliance with CRD IV provisions and recommendations issued by the European Banking Authority (EBA) and Financial Stability Board policies, stipulate that, among other things:
- 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 articles of association 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;
- 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;
- 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
- 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:
- the definition of fixed remuneration;
- the inclusion of carried interest payments in variable remuneration;
- amendments to the procedure to identify staff whose work has a material impact on the bank's risk profile; and
- 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.
The Bank of Italy is currently reviewing the regulatory framework described above with the aim of implementing the provisions on the basis of the CRD V's principles. The draft regulation, provides, inter alia: (1) gender neutral remuneration policy mandatory rules; (2) new provisions on risk-takers; and (3) further specification on the application of remuneration on the basis of the proportionality principle.
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:
- 4.5 per cent of CET1 ratio;
- 6 per cent of Tier 1 ratio (a favourable tax regime applies to additional Tier 1 items);
- 8 per cent of total capital ratio; and
- any additional capital requirements imposed under the SREP (see subsection i).
Additional requirements are:
- liquidity coverage ratio (100 per cent);
- leverage ratio (3 per cent based on the Basel Committee's framework, not yet implemented as a minimum requirement); and
- buffers, as follows:
- capital conservation buffer: 2.5 per cent;
- countercyclical capital buffer: from zero to 2.5 per cent; 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 per cent, 0.75 per cent, 0.25 per cent and 0.25 per cent, respectively, by 2022 (the buffer from 1 January 2021 to 1 January 2022 is 1 per cent for UniCredit, 0.75 per cent for Intesa and 0.19 for both 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 2020, the ECB and the Bank of Italy issued several measures to support banks to fund the real economy and address operational challenges brought about by covid-19. These include allowing banks to operate temporarily below the level of capital set under the Pillar 2 Guidance, the capital conservation buffer and the liquidity coverage ratio, and to partially use capital instruments that do not qualify as CET1 capital (for example, Additional Tier 1 or Tier 2 instruments) to meet the Pillar 2 Requirements. These measures provided significant capital relief to banks and supported the economy during the crisis.
Due to the pandemic, in December 2020 the Bank of Italy recommended that LSIs refrain from recognising or paying dividends and interim dividends out of profits in 2021 and, if necessary, limit dividends to a maximum of 15 per cent of the 2019–2020 profits or 20 basis points of the CET1 ratio. 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)21 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 Bank Recovery and Resolution Directive (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. The Bank of Italy has utilised the BRRD's resolution toolkit once by placing four regional banks under resolution a few days after the regulatory framework was introduced.
The four bridge institutions established by virtue of the resolution were sold to UBI Banca SpA and BPER Banca SpA two years after the resolution process began, at the end of a competitive bidding procedure, for a symbolic purchase price.
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:
- 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 2021, two banks were under special administration); and
- compulsory administrative liquidation: to be applied when a crisis appears to be irreversible and the conditions for resolutions are not fulfilled, and which is a direction to close down a bank and allow the competent court that handles the process to satisfy most of the creditors of that bank.
In September 2020, the Bank of Italy adopted new rules on recovery plans to implement EU Regulation No. 348/2019, which grants resolution authorities certain discretionary powers in determining the qualitative and quantitative criteria to be applied when assessing whether a bank can adopt simplified recovery plans.
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 to 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. BPB, following the transformation into a joint-stock company, returned to ordinary administration in October 2020.
Conduct of business
Appropriate conduct of business is based on the 'sound and prudent management' and 'proportionality' pillars. Banks comply with the sound and prudent management principle when they:
- contain the typical risks related to their banking activity (credit risk, market risk, liquidity risk and operational or legal risk);
- maintain predetermined liquidity and risks ratios;
- ensure the service's continuity to customers; and
- 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 and clients.
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, as well as of preventing minor banks from being subject to the stringent requirements provided for major institutions.
This approach has led credit institutions to diversify their internal structures and procedures to safeguard all types 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.
As a result, the Italian regulatory framework has been subject to an in-depth review to ensure appropriate implementation of the EU provisions regarding (among other things) investment services, AML, transparency and payment services. This has led to, inter alia:
- strengthening corporate governance and internal controls with the aim of increasing the protection of clients, with a focus on both investors and retail clients. This has led to the updating of company policies and, in some cases, wider reorganisation of internal procedures. Additional controls and constraints apply to the outsourcing of control and key functions because of their increased significance, particularly in the context of smaller banks. The new regulations mainly aim to minimise the risk that the outsourcer might jeopardise the bank and its clients, and enable the bank, in turn, to discharge its responsibilities;
- amending the anti-money laundering regulations to include the use of smartphone and new technologies in fulfilling the customer due-diligence duties, and providing additional measures to adequately face the risks arising from both the financial stress caused by covid-19 and the significant increase in e-commerce; and
- detailing the transparency requirements according to the new payment services introduced by PSD2 and their risk level, thus providing for appropriate customer protection depending on the sophistication of the product. Additional transparency duties have been introduced in terms of the information to be provided to consumers, especially with respect to the economic features of lending agreements.
Conduct of business also requires disclosure duties towards the supervisory authorities, clients and the public, entailing both preventive and ex post information reports.22 The Bank of Italy and Consob are, in turn, allowed to request further data and clarification related to the information provided and, if necessary, order inspections and internal investigations. To boost the skills and knowledge of investment firms' personnel, in July 2020 Consob launched a report detailing knowledge and experience requirements that relevant personnel must satisfy in providing investment services.
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:
- 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;23 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;
- 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, the Italian Civil 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
- 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.
With the implementation of CRD IV and the establishment of the SSM, since 2015 the regulatory framework on administrative sanctions has been focused on sanctioning the supervised entities and, subject to certain conditions, their corporate bodies and managers. More specifically, provisions governing administrative liability under the Banking Act provide pecuniary sanctions, with maximum fines of up to €5 million for individuals and up to 10 per cent of the total annual net turnover for legal persons.
Although the imposition of sanctions is determined in consideration of the extent and length of the breach, the economic status of the addressees and the damage caused to third parties, the supervisory authorities tend to sanction larger banks and intermediaries with fines ranging from €1 million to €3.5 million.
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.
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)24 and improving Italy's position in the enforcing contracts ranking published by the World Bank Group (122nd in 2020, the same position of 2019). Furthermore, in 2020 the Bank of Italy issued new provisions on out-of-court dispute resolution relating to banking and financial transactions and services to increase the efficiency and functionality of the Italian Financial Banking Arbitrator (the Italian out-of-court system for alternative dispute resolution regarding banking and financial services).
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 2020, the total amount of retail funding was higher than that of loans to households and firms. In November 2020, the funding gap (i.e., the share of loans not covered by retail funding) was zero. In June 2020, the NSFR, which will be a binding requirement from 27 June 2021, stood at an average of 121 per cent for Italian SIs, with none of the banks having a ratio below 100, which is the regulatory minimum.25
Since April 2020, the ECB and the Bank of Italy have adopted extraordinary and temporary easing measures to respond to the economic crisis caused by covid-19, including measures to increase the availability of assets that can be used as collateral for Eurosystem refinancing operations, by relaxing the eligibility and risk control criteria.
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 subject to bail-in, part of which must include senior non-preferred or subordinated securities.
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,26 subsequently replaced by CRD IV.
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 per cent, 20 per cent, 30 per cent 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:
- 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;
- 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);
- 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;
- the Bank of Italy's filing with the ECB of a draft decision to authorise or oppose the significant stake; and
- 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.
The Bank of Italy Supervisory Instructions concerning the information and documentation to be filed with the supervisory authority as part of the qualifying holding procedure is under review. Indeed, the Bank of Italy started a public consultation with a view to updating its 1999 regulation to bring it into line with current best practices. This includes clarifying, among other things: (1) the standard set of documentation and information to be submitted; (2) the information to be provided by investment funds and sovereign funds; and (3) the application of the proportionality principle with respect to, among other things, the extent of the assessment and the required information.
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'27 (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 2020, 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 2021.
The year in review
Despite the extraordinary hurdles caused by covid-19, Italian banks continued to strengthen their balance sheets and increase their capital adequacy. These improvements were supported by the wide array of local measures put in place by the Bank of Italy and the central government, and the initiatives taken by the ECB and the EU Commission within the European Union.
In this context, the Italian banking sector demonstrated a significant tendency towards consolidation and aggregation between banking groups. In February 2020, Intesa Sanpaolo launched a voluntary public exchange offer for all UBI Banca's ordinary shares with the aim of further strengthening its role in Italy and becoming a European leader once the merger is complete, which is expected later in 2021. In November 2020, Crédit Agricole Italia also launched a voluntary public tender offer for Credito Valtellinese's ordinary shares, which will likely enable the Crédit Agricole group to further expand its business, and consolidate its competitive position in the Italian market.
In December 2020, MPS completed a partial non-proportional demerger under a wider overall de-risking project for approximately €4 billion. This demerger entailed the transfer of a significant portfolio of non-performing exposures from MPS to AMCO, a wholly owned subsidiary of the MEF, and the consequent reduction of the MEF's stake in MPS.
In 2020, BPB's capital strengthening and overall reorganisation continued. Moving from the recapitalisation of over €1 billion, promoted by FITD and MCC, the bank managed to avoid its resolution and changed its corporate form to a joint-stock company. Capital injections also benefited Intesa Sanpaolo and BPER Banca, of around €900 million and €800 million, respectively. Intesa Sanpaolo carried out a capital increase to serve the public exchange offer for UBI Banca's shares. BPER Banca's capital increase was used to both consolidate its capital requirements and sustain the acquisition of more than 500 branches that had previously belonged to UBI and later transferred to Intesa Sanpaolo, which Intesa had to sell as part of the UBI takeover, to comply with the antitrust laws. In February 2021, Nexi and SIA announced the signing of the binding framework agreement governing the merger by incorporation of SIA into Nexi, with the latter becoming a leading global paytech leader.
In the wake of the fintech development, the Bank of Italy set-up the Milano Hub, the innovation centre built to support the digital evolution of the Italian financial market and attract new talents and investment. The Hub will represent the venue where the regulator will assist the various operators, collaborate in the development of digital projects and facilitate the quality and security assessment of innovative tools.
From a regulatory standpoint, in 2020, Italy introduced or placed under consultation significant new regulations to meet the EU framework requirements and the ECB's and EBA's guidelines.
In November 2020, the MEF adopted a decree outlining the fit and proper requirements for bank's members of management and control bodies, after almost four years of waiting. To implement CRD V and EBA and ECB provisions, the Bank of Italy published several consultations to ensure mandatory gender diversity in the governing bodies and to amend remuneration policies. Additional measures and consultation papers are expected to fully implement CRD V.
Finally, PSD2 and the forced acceleration of digitalisation caused by the pandemic heavily accelerated the financial services industry. Through the PSD2 provisions, new authorised entities are now allowed to access banks' data and to offer products and services to banks' customers on a more level playing field for economic operators. As a result, traditional banking operators are responding with strategies to adapt their current business models through the development of platform services, acquisitions or partnerships with fintech companies, and the transformation into digital banks.
Outlook and conclusions
Despite the worsening of the economic and financial framework in spring 2020 due to covid-19, the financial and credit markets improved in autumn 2020. This was due to, among other things, the effects of the Italian government's extraordinary support measures, the pandemic emergency purchase programme launched by the ECB, and the improved expectations generated by the European Council's agreement on Next Generation EU, the programme that will finance local economies through EU funds.
To date, the main risks for Italian banks appear to be the potential deterioration of credit quality and a further decline in profitability, although the rate of new NPLs has remained very low, benefiting from government measures on credit and the guidance of the supervisory authorities on the use of the loan classification flexibility.
Capital adequacy improved for SIs and LSIs because of the capitalisation of profits from the 2019 financial year, which were not distributed in accordance with the recommendation of the supervisory authorities.
In this context, key goals will, once again, be the overall resilience of the banking system and its capability to fully and promptly support the real economy that was deeply affected by covid-19. Italian banks' priorities in 2021 are, therefore, likely to remain:
- market consolidation;
- capital strengthening;
- credit risk, with a focus on NPLs;
- business models and, in particular, strategic plans, with the additional aim of assessing the banks' progress in the digital transformation process; and
- governance and business model reviews.
Envisaged topics for the near future include the full implementation of the new EU prudential package, the new challenges in the fintech field, and the evolution of the governance and business model following MiFID II and PSD2.
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 more and more sophisticated and complex.
1 Giuseppe Rumi is a partner, Andrea Savigliano is a managing associate and Giulio Vece is a senior associate at BonelliErede.
2 Data as at September 2020; source: Bank of Italy Economic Bulletin, No. 1/2021.
3 Directive (EU) 2015/2366.
4 Directive 2013/36/EU.
5 Directive (EU) 2019/878.
6 Regulation (EU) No. 575/2013.
7 Regulation (EU) 2019/876.
8 Regulation (EU) No. 1024/2013.
9 Legislative Decree No. 385 of 1 September 1993.
10 Legislative Decree No. 58 of 24 February 1998.
11 Directive 2014/65/EU.
12 Regulation (EU) No. 600/2014.
13 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 Inter-ministerial Committee for Credit and Saving, 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.
14 Data updated to January 2021; source: Bank of Italy registers.
15 Data updated to May 2020; source: Bank of Italy Annual Report.
16 Data updated to January 2021; source: Bank of Italy registers.
19 Data updated to September 2020; source: Bank of Italy Economic Bulletin, No. 1, 2021.
20 See Article 36 of Law Decree No. 201 of 6 December 2011, as converted into law by Law No. 214 of 22 December 2011.
21 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.
22 In 2020, Consob took several measures relating to the second Markets in Financial Instruments Directive aimed at regulating, above all, the information to be given to clients in the context of ex post reporting.
23 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.
24 Source: the 2020 EU justice scoreboard (quantitative data).
25 Data updated to September 2020; source: Bank of Italy Financial Stability Report No. 2, November 2020.
26 Directive 2007/44/EC.
27 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).