## 1itaea2020002

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### EXECUTIVE SUMMARY — Recent prudential measures and system progress
- Regulation enhanced by implementation of European Union (EU) regulations and supervision through creation of the Single Supervisory Mechanism (SSM).
- Italian supervisory agencies have experienced staff, supported by advanced information systems and broadly sound supervisory processes.
- Authorities implemented measures that improved governance, facilitated capitalization, raised prudential requirements, and improved asset quality.
- Economic recovery in 2014–2018, together with these measures, helped banks make substantial progress in tackling legacy NPLs and improving solvency ratios.
- Consolidation: in January 2019, about 227 of the 266 mutual banks were merged into two new banking groups, which have been classified as SIs; the remaining mutual banks will enter into an institutional protection scheme (IPS).
- Consolidations reduced the number of banks in the financial system to about 156 (as of June 2019).
- Insurance sector reduced number of insurers from 162 in 2007 to 100 as of June 2018.
- Share of assets of investment funds and other financial intermediaries grew from 15 percent to 18 percent since 2011.

### Banking sector vulnerabilities, exposures and policy priorities
- TLTRO use and liquidity/profitability support:
  - Italian banks are the largest users of the ECB’s TLTRO; Italian banks use close to €250 billion of TLTRO.
  - TLTRO II negative interest rate: -0.4 percent on borrowings for eligible banks.
  - ECB launched TLTRO III in September 2019 ending in March 2021.
- Structural weaknesses:
  - Average capital ratio of Italian banks remains below the euro area.
  - NPL ratios still among the highest in the EU.
  - Some banks have high structural operating costs and corporate governance weaknesses.
  - Banks’ exposure to the sovereign: over 10.5 percent of total assets.
- IFRS 9 transitional arrangements:
  - Will be gradually phased out by 2022.
  - Estimated total impact on capital ratios: around 104 basis points for SIs and 138 basis points for LSIs.
- FSAP estimates on provisioning and NPL reduction needs:
  - Internal workout: €4.9 billion (0.3 percent of GDP).
  - Market-based disposals: €7.2 billion (0.4 percent of GDP) to meet NPL reduction targets agreed with supervisors.
  - Combined additional estimated provisioning needs reported elsewhere as about €5 billion (internal workouts) and €7.2 billion (market sales) in the Executive Summary.

### Solvency and liquidity stress-test results — SIs and LSIs (selected statistics)
- SIs (nine larger banks; end-2018 data):
  - Average CET1 ratio declines by 370 bps to 8.2 percent in the adverse scenario.
  - Baseline aggregate CET1 ratio would decline by 56 basis points to 11.4 percent.
  - Baseline with NPL disposal plan: average CET1 ratio falls by 100 bps.
  - Capital shortfall against capital thresholds (adverse): about 0.2 percent of GDP.
  - Capital needs to bring back CET1 ratio of the nine SIs to the starting level of 12 percent: about 2.2 percent of GDP.
  - Credit risk provisioning largest contributor to CET1 decline: about 5.3 percentage points in adverse; valuation losses from sovereign yields: 1.2 percentage points; higher funding costs: 0.9 percentage points.
  - Two banks fail to meet minimum capital requirements in baseline; three banks representing 8.5 percent of banking system assets would see capital ratios drop below minimum thresholds in the adverse scenario.
- LSIs (Q3 2018 / June 2018 data; 62 institutions sensitivity):
  - An increase in yields similar to 2011 would cause capital of almost a quarter of the sample of LSIs by assets (10 banks) to fall below the 7 percent CET1 ratio threshold.
  - Under an NPL shock, 35 percent of the LSI sample’s assets (14 LSIs) would see CET1 ratio fall below 7 percent.
- Liquidity stress tests:
  - Aggregate LCRs (baseline): SIs 156%, LSIs 229%.
  - Retail scenario LCRs: SIs 92%, LSIs 157%.
  - Wholesale scenario LCRs: SIs 110%, LSIs 189%.
  - Number of banks with LCR<100% (Retail): SIs 9, LSIs 10.
  - Liquidity shortfall (Retail scenario, millions of euros): SIs 16,768; LSIs 1,341.
  - Composition of liquid buffers: general government items comprise 82 percent of the buffer of liquid assets of the LSIs and 67 percent of the SIs.
  - Liquidity positions are relatively comfortable but boosted by significant use of TLTRO and concentrated in Italian government securities.

### Stress-test adverse scenario calibration (selected)
- Adverse scenario deviations (in percentage points; unless specified otherwise):
  - Real GDP: 2019 -3.4, 2020 -6.9, 2021 -7.2
  - Long-term government bond yield: 2019 1.3, 2020 1.8, 2021 1.5
  - Unemployment rate: 2019 1.1, 2020 3.4, 2021 4.5
- Memo (growth figures preserved exactly):
  - Baseline Real GDP growth (in percent): 2019 0.0, 2020 0.9, 2021 0.7
  - (Adverse) Real GDP growth (in percent): 2019 -3.4, 2020 -2.7, 2021 0.3
  - Cumulative real GDP growth (from 2018): 2019 -3.4, 2020 -6.0, 2021 -5.7
- Adverse scenario assumptions include increase in sovereign spreads of 180 basis points on annual average basis (with yields reaching up to 550 basis points in peak observations) and GDP shock severity reaching two standard deviations in year two of three-year horizon.

### NPLs — stock features, resolution challenges and supervisory recommendations
- NPL stock evolution and coverage:
  - NPLs fell from 16.5 percent in 2015 to about 7.3 percent at end-September 2019.
  - Reduction achieved mainly through circa €145 billion of private NPL sales.
  - NPLs remain above the 3 percent average of the main EU banks.
  - Provisioning coverage (end-June 2019): 52.5 percent (7.6 percentage points above the average of the main EU banks).
- Composition and operational constraints:
  - Over 40 percent of current NPL gross stock categorized as ‘unlikely to pay’ (UTP).
  - Judicial enforcement average time for secured claims: 5 years; insolvency: around 7 years.
- Supervisory findings and recommendations:
  - Staff estimates additional loan loss provisions required: internal workout €4.9 billion (0.3 percent of GDP); market-based disposals €7.2 billion (0.4 percent of GDP).
  - Banks’ NPL plans rely heavily on market disposals and write-offs due to limited internal workout capacity.
  - Recommend continued scrutiny of credit risk and loan loss provisioning, challenge NPL reduction plans, and pay special attention to UTP credits.
  - BdI could consider extending SSM’s gradual path to full provisioning expectations to LSIs with high NPLs.
  - Authorities should further adjust and implement insolvency reforms, increase legal certainty and flexibility of out-of-court foreclosure mechanisms, and enhance the online platform for judicial auctions.
  - Enhance judicial system effectiveness: ensure courts have enough resources and expertise; strengthen specialization and competence of enterprise courts.

### Bank-specific restructuring events (selected)
- Monte dei Paschi di Siena (MPS):
  - Fifth-largest Italian bank with €134 billion assets, loan market share circa 5 percent; fully loaded CET1 ratio 12.6 percent as of September 2019.
  - State recapitalizations: 2009 €1.9 billion (“Tremonti bonds”), 2013 €2.2 billion (“Monti bonds”), both repaid.
  - Precautionary recapitalization €8.1 billion in July 2017 (conversion €4.3 billion junior bondholders; capital injection €3.8 billion).
  - €1.5 billion provided by the State to compensate retail investors for mis-selling.
  - Gross NPL ratio improved from 35 percent at end-2016 to 14.6 percent at end-September 2019.
  - Restructuring plan targets: reduce cost/income ratio from 61.2 percent in 2016 to 50.6 percent in 2021; reduce branches from 1,529 (June 2019) to 1,432 by end-2021.
  - Discussions to dispose around €10 billion NPLs to AMCO; MEF to submit disposal plan to EC for divestment of state ownership by end-2021.
- Banca Carige and Banca Popolare di Bari (BPB) — recapitalization and governance events:
  - November 2018: a €320 million Tier 2 subordinated bond subscribed by voluntary intervention scheme (VIS) of FITD to secure solvency temporarily.
  - December 2018: major shareholder withdrew support for €400 million capital increase; Board resignations.
  - January 2019: ECB appointed three administrators; state guarantee for new bond issuances announced (EC approval for state aid purposes).
  - September 2019: shareholders approved €700 million share capital increase.
  - December 2019 recapitalization completion details: existing shareholders subscribing €23 million; VIS converting €313 million subordinated debt into shares; FITD subscribing €301 million; Credito Cooperativo Italiano subscribing €63 million.
  - January 2020: administrators’ term ended and a new Board was appointed.
  - Strategic plan targets: reduce NPLs to below 5 percent by 2023; achieve breakeven by 2021; return to profit by 2022.
  - BPB: assets circa €13 billion; BdI inspections mid-2019 found capital ratios fell below CRR minima; BdI removed management and appointed two special administrators; end-2019 FITD capital injection €310 million to ensure compliance.

### Profitability, funding costs and market indicators
- Profitability:
  - Rebounded in 2017–18 driven by largest banks; medium banks low profitability though improved; small banks positive in 2018.
  - Ongoing pressures: fintech competition, additional provisioning for NPL disposals, high operating costs.
- Market cost of TLTRO replacement (end-2018 illustrative estimates):
  - Prices of Funding (percent): Retail funding 0.4; ECB’s MRO 0.0; Bond issuance (long term) – low volatility 1.8; high volatility 4.2.
  - Impact of Gross TLTRO Replacement (Percent of banks’ equity): Retail funding 0.5; MRO 0.0; Bonds low volatility 2.2; Bonds high volatility 5.2.
  - Impact of Net TLTRO Replacement (Percent of banks’ equity): Retail funding 0.4; MRO 0.0; Bonds low volatility 1.8; Bonds high volatility 4.2.
  - Funding mix examples (Gross / Net impacts): 30% Retail/30% MRO/40% Bonds (low volatility): 1.3 and 1.0; 30/30/40 (high volatility): 2.7 and 2.2; 50% MRO/50% Bonds (low): 1.1 and 0.9; 50/50 (high): 2.6 and 2.1.
- Market indicators:
  - Banks’ CDS spreads increased substantially in 2018, improved in 2019 but remain substantially above other European banks; individual bank spreads up to 500 bps in Jan-17 to Jul-19 period.

### Corporate sector vulnerabilities and non-bank sectors
- Corporate sector:
  - Net financial assets of corporate sector: -112 percent of GDP.
  - Gross national income of NFCs declined over past decade and remains about 7 percentage points below euro area average as a share of gross value added.
  - Construction and real estate sectors most vulnerable (high debt-at-risk, low interest coverage ratios).
  - Non-financial corporate stress tests: under adverse scenario, median ICR and share of firms-at-risk approach levels seen in 2008–09 and 2012 crises.
- Insurance sector:
  - Life insurers hold about 55 percent of their investment portfolio in sovereign debt.
  - IVASS estimate: upward shift of 100 bps in government yield curve would reduce value of insurance companies’ own funds by 28 percent.
  - EIOPA 2018 stress test: 39 percent of assets held by 12 Italian entities in scope invested in Government bonds (mostly Italian) vs Europe average 24 percent; whole Italian insurance sector sovereign bonds constitute 48 percent of total assets.
  - Average solvency ratio around 150 percent; IVASS sensitivity: several insurers’ solo solvency ratios would fall below 100 percent under an interest rate shock that increases sovereign spreads above 399 basis points.

### Macroprudential policy, regulation and supervision recommendations
- Establish a national macroprudential policy authority; BdI to play a leading role given mandate and experience.
- Enhance macroprudential toolkit: incorporate SyRB and borrower-based tools (LTV, DSTI).
- Prudential policies to moderate sovereign-bank nexus: encourage diversification of sovereign holdings, consider calibrated SyRB, Pillar II measures, positive risk weights for sovereign exposures, or capital surcharges for concentration — implement with gradual phase-in.
- O-SII buffers:
  - Evaluate adequacy; fully-loaded and transitional buffers of Italian O-SIIs are at the lower end of European peers; consider raising buffers with adequate phase-in.
- Regulatory/powers enhancements:
  - Transfer some powers from MEF to BdI (e.g., compulsory administrative liquidation, fit and proper for shareholders/board/management).
  - Strengthen fit and proper rules, supervisory escalation for weak banks, and LSI SREP alignment with SSM.
  - Tighten prudential limit for related party lending; set aggregate limit as strict as large exposure limit in Basel Committee standards.
  - Increase BdI resources for IT/cyber risk, AML/CFT supervision, and on-site inspections.

### Crisis management and safety-net enhancements
- Reinforce bank crisis management framework; priority actions include:
  - Establish a formal crisis management committee including all safety net participants to periodically review preparedness and coordinate responses.
  - Establish additional loss absorbing capacity to enable greater loss allocation to unsecured and uninsured creditors in resolution and liquidation, notably for LSIs.
  - Strictly limit use of public funds in resolution to exceptional events that could undermine system-wide financial stability.
  - Assess DGSs’ funding targets; strengthen backstops; remove active bankers from DGS boards; avoid using DGS resources for failure prevention outside resolution except in exceptional cases with strong prospects for rehabilitation.
  - Use preventive measures outside of resolution or liquidation (“open bank assistance”) only in exceptional cases with strong prospects for successful rehabilitation.
  - Review ELA policy framework in conjunction with the Eurosystem, including (re)confirming solvency/viability at ELA request and disclosure practices.
- DGSs and historical interventions:
  - Ex ante funding introduced in 2016; DGSs remain private-sector consortia.
  - Between 1997 and 2014 FGD conducted 52 ‘preventive interventions’; FITD conducted five such interventions (including three in 2019 still in train).
- EU-level enhancements:
  - Introduction of an orderly liquidation regime for non-systemic banks and pared-back state aid oversight under certain conditions would further facilitate resolution and liquidation.

### NPL management operational guidance and legal reforms
- Supervisory recommendations for LSIs:
  - Extend SSM’s expectations for gradual provisioning path to LSIs with high NPLs.
  - Provide practical guidance on forbearance, time constraints, going vs gone-concern valuations, collateral valuation constraints.
  - Conduct targeted diagnostics of enterprises to avoid unsustainable forbearance; consider partnering with specialist firms for one-off projects.
- Legal/judicial reform priorities:
  - Strengthen insolvency administrators regulation; fine-tune early warning mechanism; improve liquidation efficiency; consider consolidation of creditor priorities; reform special regime for large enterprises.
  - Enhance judicial system resources, specialization of judges, and expand competence of enterprise courts.

### Financial integrity, market conduct and investor protection
- AML/CFT:
  - Well-developed legal/institutional framework with improvements needed; May 2017 decree upgraded framework.
  - Continue enhancing tools for risk-based AML/CFT supervision, especially for non-banking institutions; ensure dissuasive and proportionate sanctions; robust beneficial owner due diligence.
- Investor protection and conduct:
  - Mis-selling of subordinated bank bonds hindered crisis management and loss-absorbing capacity.
  - MiFID II and related measures reduced retail holdings of subordinated debt; supervisors should monitor sales of instruments subject to bail-in and assess post-issuance procedures.
  - Investor compensation only where clear evidence of mis-selling.
  - Increase frequency of on-site inspections; institute supervisory cycle for all regulated entities.

### Appendix I — Key Figures (selected series preserved exactly)
- Real GDP Growth by year: 2015 0.8, 2016 1.3, 2017 1.7, 2018 0.8, 2019 0.2, 2020 0.4, 2021 0.7
- Fully loaded CET1 ratio (September 2019): 13 percent (1.5 percentage point below EU peers).
- NPLs: 16.5 percent in 2015 to about 7.3 percent at end-September 2019 (aggregate figures reported elsewhere also show 8.1–8.4 percent for 2019 series in FSI table).
- Provisioning coverage (end-June 2019): 52.5 percent.
- Nominal GDP (billions of Euros) by year: 2015 1,655.4, 2016 1,695.6, 2017 1,736.6, 2018 1,765.4, 2019 1,779.0, 2020 1,805.7, 2021 1,837.3
- Public Debt by year (percent of GDP): 2015 135.3, 2016 134.8, 2017 134.1, 2018 134.8, 2019 135.7, 2020 136.1, 2021 135.7
- Return on Assets (ROA) by year: 2012 -0.1, 2013 -0.8, 2014 -0.2, 2015 0.3, 2016 -0.5, 2017 0.6, 2018 0.5, 2019 0.3
- Return on Equity (ROE) by year: 2012 -0.9, 2013 -11.5, 2014 -2.8, 2015 3.4, 2016 -7.7, 2017 7.5, 2018 6.1, 2019 3.9

### Risk Assessment Matrix — Key risks (preserved language)
- Sharp rise in risk premia that exposes financial vulnerabilities: Overall Level of Concern: Medium; Relative Likelihood: High.
- Weak domestic demand due to low productivity and failure to address crisis legacies: Overall Level of Concern: High; Relative Likelihood: High.
- Weaker-than-expected global growth: Overall Level of Concern: Low/High (noted idiosyncratic regional likelihoods).
- Rising protectionism and retreat from multilateralism: Overall Level of Concern: High.
- Increase in Italy-specific risk premia and widening of spreads due to political uncertainty: Overall Level of Concern: Medium; Relative Likelihood: High.
- Coronavirus outbreak causes widespread and prolonged disruptions: Overall Level of Concern: Medium; Relative Likelihood: High.

*Source: EXECUTIVE SUMMARY and IMF staff report content contained in 1itaea2020002 — IMF Financial Sector Assessment Program materials provided in the content unit.*

### EXECUTIVE SUMMARY __________________________________________________________________________ 7

### EXECUTIVE SUMMARY

### Recent prudential measures and system progress
- Regulation enhanced by implementation of European Union (EU) regulations and supervision through creation of the Single Supervisory Mechanism (SSM).
- Italian supervisory agencies have experienced staff, supported by advanced information systems and broadly sound supervisory processes.
- Authorities implemented measures that improved governance, facilitated capitalization, raised prudential requirements, and improved asset quality.
- Economic recovery in 2014–2018, together with these measures, helped banks make substantial progress in tackling legacy NPLs and improving solvency ratios.

### Financial system structure and consolidation (selected facts)
- In January 2019, about 227 of the 266 mutual banks were merged into two new banking groups, which have been classified as SIs; the remaining mutual banks will enter into an institutional protection scheme (IPS).
- Consolidations reduced the number of banks in the financial system to about 156 (as of June 2019).
- The insurance sector reduced the number of insurers from 162 in 2007 to 100 as of June 2018.
- The share of assets of investment funds and other financial intermediaries in the financial system grew from 15 percent to 18 percent since 2011.

### Banking sector vulnerabilities and exposures
- Italian banks are the largest users of the ECB’s TLTRO, which provides substantial support to banks’ liquidity and profitability.
- Many banks still suffer from low capital levels, low profitability, and weak asset quality.
- The average capital ratio of Italian banks remains below the euro area.
- NPL ratios are still among the highest in the EU.
- The FSAP estimates additional loan loss provisions needs of about €5 billion based on recovery rates of internal workouts (mostly related to loans identified as unlikely to pay), and an additional €7.2 billion for banks to meet the NPL reduction targets agreed with supervisors (through market sales).
- Some banks’ high structural operating costs and corporate governance weaknesses continue to weigh on profitability.
- Additional regulatory requirements, including MREL for larger banks, will further impact profitability.
- Banks’ exposure to the sovereign increases potential impact of downside shocks, including through the risk of a substantial economic contraction and rising credit spreads.

### Solvency and liquidity stress-test results (selected statistics)
- Based on end-2018 data for nine larger banks (significant institutions or SIs), the average CET1 ratio declines by 370 bps to 8.2 percent in the adverse scenario.
- Capital shortfall against the capital thresholds from that result is small: 0.2 percent of GDP.
- Capital needs to bring back the CET1 ratio of the nine SIs to the starting level of 12 percent is about 2.2 percent of the GDP.
- For smaller banks (less significant institutions or LSIs), using Q3 2018 data, single-factor sensitivity analysis indicates vulnerabilities:
  - An increase in yields similar to the one observed in 2011 would cause the capital of almost a quarter of the sample of LSIs by assets to fall below the 7 percent CET1 ratio threshold.
  - Under an NPL shock, 35 percent of the LSI sample’s assets would see their CET1 ratio fall below 7 percent.
- Liquidity stress tests suggest relatively comfortable positions, albeit boosted by significant use of TLTRO and with a high concentration of liquid assets in Italian government securities, increasing vulnerability to sovereign risk.

### Key policy recommendations and supervisory priorities
- Adopt measures to further improve banks’ capital levels and operational efficiency, guided by stress test results and thorough review of banks’ business models and governance.
- Consider more timely escalation of corrective measures for weak banks to effect improvement (e.g., in capital levels, operational efficiency, governance) or achieve consolidation or orderly winddowns when needed so that weaknesses do not persist or worsen.
- BdI could consider extending the SSM’s approach that sets expectations for the gradual path to full provisioning of the existing NPL stock to LSIs with high NPLs.
- Continue scrutinizing banks’ credit risk and loan loss provisioning practices and challenge the progress and ambition of banks’ NPL reduction plans; pay special attention to “unlikely to pay” (UTP) credits given potential for under-estimation of risks.
- Further adjust and implement recent reforms to the insolvency regime to strengthen NPL resolution; increase legal certainty and flexibility of out-of-court foreclosure mechanisms and enhance the online platform for judicial auctions.
- Enhance effectiveness of the judicial system, ensuring courts have enough resources and expertise to handle insolvency cases timely.
- Consider using prudential policies to moderate the sovereign-bank nexus, with gradual phasing-in to minimize potential market disruptions.
- Establish a national macroprudential policy authority and enhance the macroprudential toolkit, including incorporation of the SyRB and borrower-based tools.
- Upgrade some aspects of supervisory agencies’ regulatory powers; address banks’ governance weaknesses by quickly adopting amendments to fit and proper rules for banks’ management.

### Crisis management and safety-net enhancements
- Reinforce the bank crisis management framework; priority actions include:
  - Establish a formal crisis management committee, including all safety net participants, to periodically review preparedness and coordinate responses.
  - Establish additional loss absorbing capacity to enable greater loss allocation to unsecured and uninsured creditors in resolution and liquidation, notably for LSIs for which a resolution strategy is foreseen.
  - Strictly limit the use of public funds in resolution to exceptional events that could undermine system-wide financial stability.
  - Assess DGSs’ funding targets to ensure adequacy; strengthen backstops; remove active bankers from their boards; and avoid using DGS resources for failure prevention outside of resolution or liquidation except in exceptional cases with strong prospects for successful rehabilitation and restoring long-term viability.
  - Use preventive measures outside of resolution or liquidation (i.e., “open bank assistance”) only in exceptional cases with strong prospects for successful rehabilitation.
  - Review certain aspects of the policy framework for emergency liquidity assistance (ELA) in conjunction with the Eurosystem.
- Enhancements to the EU crisis management framework—such as potential introduction of an orderly liquidation regime for non-systemic banks and pared-back procedures for state aid oversight under certain conditions—would further facilitate resolution and liquidation.

*Source: EXECUTIVE SUMMARY, 1itaea2020002 — IMF Financial Sector Assessment Program materials contained in the provided content unit.*

### 2.      Regulatory and supervisory measures taken since the 2013 FSAP have played a key role in

### 2.      Regulatory and supervisory measures taken since the 2013 FSAP have played a key role in 

### Regulatory and supervisory measures and banking-sector recovery
- Implementation of European Union regulations and creation of the SSM and the SRB substantially enhanced financial system oversight.
- Initiatives to improve asset quality included:
  - Publication of supervisory guidance on non-performing exposures.
  - EU Council’s 2017 Action plan to tackle NPLs.
  - Introduction of Garanzia Cartolarizzazione Sofferenze (GACS).
- Reforms strengthened banks’ capital buffers, improved banking sector governance, and consolidated the financial sector through reforms of cooperative banks (popolari and mutual institutions).
- Outcomes:
  - NPL reductions in recent years were significant.
  - Capital levels have improved.
  - Various weak banks were intervened, albeit with more limited burden-sharing than envisaged in the euro area’s unitary regime for bank resolution.
- Remaining challenge: restoring the banking sector to healthy profitability still requires difficult restructuring decisions, particularly among small and medium banks.

### Macroeconomic developments and outlook
- Past drivers of recovery (2014–17): monetary and fiscal accommodation, favorable commodity terms of trade, robust euro area growth.
- Real GDP growth:
  - 2017: 1.7 percent (10-year high)
  - 2018: 0.8 percent
  - 2019: 0.2 percent
  - Projected 2020: about ½ percent
  - Projected medium term: 0.6–0.7 percent
- Recent developments and risks:
  - Pressures on sovereign yields eased with a pro-European government in early September 2019, ECB accommodation, and better-than-expected fiscal policy implementation in 2019.
  - COVID-19 outbreak significantly increased near-term uncertainty.
  - Economy vulnerable to adverse shocks (escalating trade tensions, slowdown in key trading partners, geopolitical events).
  - Modest adverse shocks could increase government debt and raise the risk of renewed market pressure forcing sharp fiscal consolidation, with significant repercussions for the banking sector (funding cost and asset quality).

### Key risks and vulnerabilities — Banking sector
- Support from the ECB:
  - Italian banks use close to €250 billion of TLTRO.
- IFRS 9 transitional arrangements:
  - Will be gradually phased out by 2022.
  - Estimated total impact on capital ratios: around 104 basis points for SIs and 138 basis points for LSIs.
- Remaining structural weaknesses:
  - Average capital ratio of Italian banks remains below the euro area.
  - NPL ratios remain among the highest in the EU.
  - Relatively high operating costs and corporate governance weaknesses in some segments.
  - Profitability could be further impacted by monetary policy normalization and the phase-in of MREL requirements.
  - High bank exposure to the sovereign and high corporate-sector leverage increase vulnerability to downside shocks.

Key statistics on capitalization and asset quality:
- Fully loaded CET1 ratio (September 2019): 13 percent.
  - This is 1.5 percentage point below the average of EU peers.
- NPLs:
  - Fell from 16.5 percent in 2015 to about 7.3 percent at end-September 2019.
  - Reduction achieved mainly through circa €145 billion of private NPL sales.
  - Remain above the 3 percent average of the main EU banks.
- Provisioning coverage (end-June 2019): 52.5 percent.
  - This is 7.6 percentage points above the average of the main EU banks.

NPL resolution and provisioning needs:
- Staff estimates additional loan loss provisions required for banks (SIs and LSIs) included in FSAP stress tests:
  - Internal workout: €4.9 billion (0.3 percent of GDP).
  - Market-based disposals (higher observed loss rates by 13 percentage points on average): €7.2 billion (0.4 percent of GDP) to meet NPL reduction targets agreed with supervisors.
- Banks’ plans to reduce NPLs are heavily reliant on market disposals and write-offs due to limited internal workout capacity.

Bank profitability:
- Rebounded in 2017–18, mostly driven by the largest banks (whose profitability surpassed the EU median in 2017).
- Medium banks: consistently low profitability in recent years, though improved since the euro area debt crisis.
- Small banks: profitability entered positive territory in 2018 after prior years of negative profitability.
- Ongoing challenges: fintech competition and additional provisioning needs for further NPL disposals will continue to negatively impact profitability.

Sovereign-bank nexus:
- Banks’ exposures to domestic sovereign bonds: over 10.5 percent of total assets.
  - High exposure introduces linkages via capital and liquidity channels.
  - Accounting strategies in late 2018 moved a large share of sovereign holdings from fair-value to amortized-cost category, tempering the relationship between sovereign spreads and bank regulatory capital to some extent.
- High concentration of sovereign debt renders banks’ capital and liquidity vulnerable to adverse market valuations and impacts banks’ equity prices and funding costs.

Corporate sector vulnerabilities:
- Net financial assets of corporate sector: -112 percent of GDP (slightly more indebted than euro area average).
- Corporate indebtedness drags on total factor productivity growth.
- Gross national income of NFCs has declined through the past decade and remains about 7 percentage points below the euro area average as a share of gross value added.
- Households: wealthiest institutional sector in Italy with overall household debt well below European peers — households unlikely to be a major source of macro-financial risks to banks.

Insurance sector risk:
- Life insurers hold about 55 percent of their investment portfolio in sovereign debt.
- IVASS estimate: an upward shift of 100 bps in the government yield curve would reduce the value of insurance companies’ own funds by 28 percent.

### Systemic risk analysis — Bank solvency and stress testing
- Coverage and data:
  - Solvency stress test used bank data as of end-2018.
  - Covered 9 of the 11 SIs, accounting for about 69 percent of banking sector assets.
  - Two SIs were excluded (one under restructuring and one under special administration as of March 2019).
  - Sensitivity analysis covered 62 LSIs (additional 9 percent of system assets).
- Adverse scenario assumptions:
  - Increase in sovereign spreads of 180 basis points above the baseline on an annual average basis (with yields reaching up to 550 basis points in peak observations).
  - Shock to GDP growth reaching the severity of two standard deviations in the second year of a three-year horizon.
  - Additional assumptions on LGD, including transition of 50 percent of UTP portfolio to bad loans and 20 percent to performing loans.
  - Estimated additional provisions were phased in equally over the 3-year horizon and incorporated in both baseline and stress scenarios.

Stress test results and implications:
- Baseline scenario:
  - Aggregate CET1 ratio of sample SI banks would decline by 56 basis points to 11.4 percent.
  - Two banks would fail to meet minimum capital requirements (one falls short of CAR threshold and another of Tier 1 threshold).
  - When banks’ NPL disposal targets disclosed in annual reports are considered, aggregate CET1 ratio declines by 102 basis points to 10.9 percent.
  - Resulting shortfall in capital vis-à-vis minimum standards: about 0.05 percent of GDP.
- Adverse scenario:
  - Average CET1 capital ratio declines by 370 basis points to 8.2 percent.
  - Credit risk provisioning largest contributor to decline: about 5.3 percentage points.
  - Valuation losses from sovereign yields: 1.2 percentage points.
  - Higher funding costs: 0.9 percentage points.
  - Three banks representing 8.5 percent of banking system assets would see capital ratios drop below minimum thresholds.
  - Capital shortfall against capital thresholds: about 0.2 percent of GDP.
  - Capital needed to restore CET1 ratio of the 9 SIs to end-2018 level of 12 percent in the stress scenario: about 2.2 percent of GDP.
- Alternative assumptions and sensitivity:
  - Increasing loss rates by 20 percent and evaluating CET1 against a higher threshold of 7 percent (including capital conservation buffer) causes an additional bank to fall slightly below the 7 percent CET1 threshold.
  - LSIs vulnerability:
    - An increase in yields similar to 2011 would cause capital of almost a quarter of LSIs by assets (10 banks) to fall below 7 percent CET1.
    - Under an NPL shock, 35 percent of sample assets (14 LSIs) would see CET1 ratio fall below 7 percent.

### Bank-specific restructuring developments (selected)
- Monti Dei Paschi di Siena (MPS):
  - Fifth-largest Italian bank with €134 billion assets, loan market share circa 5 percent, fully loaded CET1 ratio of 12.6 percent as of September 2019.
  - State recapitalizations in 2009 (€1.9 billion “Tremonti bonds”) and 2013 (€2.2 billion “Monti bonds”), both repaid.
  - Precautionary recapitalization of €8.1 billion in July 2017 (conversion of junior bondholders €4.3 billion; capital injection €3.8 billion).
  - €1.5 billion provided by the State to compensate retail investors for mis-selling.
  - Gross NPL ratio improved from 35 percent at end-2016 to 14.6 percent at end-September 2019, mainly due to disposals.
  - Restructuring plan aims to reduce cost/income ratio from 61.2 percent in 2016 to 50.6 percent in 2021 and reduce branches from 1,529 (June 2019) to 1,432 by end-2021.
  - Discussions underway to dispose around €10 billion NPLs to AMCO; MEF to submit disposal plan to EC setting out divestment of state ownership by end-2021.
- Banca Carige:
  - Medium-sized regional bank with assets circa €23 billion.
  - Supervised by the ECB, which requested a plan to restore compliance with capital requirements by end- (content truncated in source).

*International Monetary Fund — Excerpt from Italy FSAP chapter*

### 2018. In order to immediately secure the bank’s solvency position, in November 2018 a €320 million Tier 2

### 1itaea2020002 - 2018. In order to immediately secure the bank’s solvency position, in November 2018 a €320 million Tier 2

### Bank recapitalizations and governance events
- November 2018: a €320 million Tier 2 subordinated bonds was subscribed by the voluntary intervention scheme (VIS) of the Italian Interbank Deposit Guarantee Fund (FITD) to immediately secure the bank’s solvency position; intended as a temporary solution ahead of a subsequent recapitalization.
- December 2018: the bank’s major shareholder withdrew support for a €400 million capital increase, seeking more clarity on the bank’s strategy; majority of the Board of Directors subsequently resigned.
- January 2019: ECB appointed three administrators.
- January 2019: announcement (and EC approval for state aid purposes) of a state guarantee for new bond issuances to support the bank’s liquidity position.
- September 2019: shareholders approved a €700 million share capital increase.
- December 2019 recapitalization completion details:
  - existing shareholders subscribing €23 million;
  - VIS converting €313 million of subordinated debt into shares;
  - FITD subscribing an additional €301 million;
  - Credito Cooperativo Italiano subscribing €63 million.
- January 2020: administrators’ term ended and a new Board was appointed.
- Strategic Plan targets:
  - reducing NPLs to below 5 percent by 2023;
  - achieving breakeven point by 2021;
  - returning to profit by 2022.

- Banca Popolare di Bari (BPB) specifics:
  - BPB assets of circa €13 billion.
  - Full-scope on-site inspection by BdI between June and December 2019; preliminary findings from credit file review indicated capital ratios fell below CRR minimum capital requirements.
  - Mid-December 2019: BdI removed management and appointed two special administrators.
  - End-2019: FITD effected a capital injection of €310 million to ensure compliance with minimum capital requirements.
  - Agreement expectations: new business plan and vote of the bank’s circa 70 thousand shareholders on recapitalization and transformation into joint stock company would be finalized end-June 2020.
  - Ongoing discussions with the European Commission about consistency of the rescue plan with the state aid framework.

### Solvency stress tests — Systemically Important Banks (SIs)
- Top-down solvency stress tests covered 9 out of 11 SIs and considered an Italy specific stress scenario.
- Baseline, with NPL disposal plan: average CET1 ratio falls by 100 bps.
- Adverse scenario: average CET1 ratio falls by 370 bps.
- Main loss drivers:
  - Credit risk is the main source of losses, followed by the increase in interest rates.
  - Main losses arise from the flow of new NPLs; losses associated with higher yields are also significant.
- Notes on breaches and indicators:
  - Baseline - end-2018: Number of banks with CAR<8%+OSII reported in chart (note references).
  - In total, two banks breach the capital thresholds under some scenarios: one bank breaches the Tier 1 target and another the CAR target.
  - Under the adverse end of 2021 without NPL disposal plan: Average CET1 ratio 8.2; asset share of undercapitalized banks (CAR<hurdle) 38.5 (percent of GDP?) [figure shows 38.5]; average leverage ratio 14.4 (percent).
  - Leverage ratio is proxied by Tier1 capital divided by Total assets (non-risk weighted).
- Implementation detail: capital ratio is fully loaded IFRS9 implementation (post phase-in of initial IFRS 9 impact). Adjustments to provisions based on FSAP's use of estimated LGD rates applied and phased-in equally over 3 years in scenarios.

### LSIs: Debt portfolio sensitivity and asset quality
- Debt portfolio sensitivity test findings:
  - Italian debt held at fair value can cause large losses if yields go up.
  - Most losses originated in positions kept at fair value.
  - Debt portfolio shocks can let a meaningful share of the LSI segment become undercapitalized.
  - Distribution of losses shows a few LSIs, including a relatively large one, are more exposed to yield shocks, leading to a large impact on their CET1 ratio.
- Asset quality and loan portfolios:
  - The largest share of NPLs are formed by loans to non-financial corporates (NFC).
  - Smaller LSIs (group 3) have higher NPL ratios.
  - Coverage ratios are also slightly smaller among small LSIs; NPL rates vary widely among LSIs.
  - NPL shocks have meaningful impact on LSIs’ capital ratio.
  - Most losses in case of NPLs shock are likely to originate in the corporate portfolio.

### Bank profitability
- Key drivers and trends:
  - Banks’ profitability has been dampened by structural and cyclical factors: low interest rates and low growth.
  - Contribution of net interest income (NII) to banks’ operating income declined significantly for all bank segments; banks increasingly relied on fee income.
  - Additional reductions in operating costs, particularly in small- and medium-sized banks, could support profitability enhancements.
  - Provisioning needs declined in 2017 compared to 2010; provisioning expenses rose between 2012 and 2014 then trended down.
- ECB TLTRO impact:
  - TLTRO provided substantial support to banks’ profitability; Italy’s banks are main users and benefit from a negative interest rate of -0.4 percent on TLTRO II borrowings.
  - September 2019: ECB launched TLTRO III ending in March 2021, each operation with a maturity of two years; TLTRO III will continue to support the banking system in the near term.
- Market cost of TLTRO replacement (end-2018 illustrative estimates):
  - If banks were to use funding mixtures, replacement costs could vary from 1–3 percent of banks’ equity on aggregate, but impact varies significantly by bank.
  - Cost could be passed-through to lending rates or mitigated by deleveraging (not considered in the analysis).
- Table 3: Illustrative estimates of annual market-based cost of an equivalent TLTRO (As of end-2018)
  - Prices of Funding (percent):
    - Retail funding: 0.4
    - ECB’s MRO: 0.0
    - Bond issuance (Long term bond) – low volatility period: 1.8
    - Bond issuance (Long term bond) – high volatility period: 4.2
  - Impact of Gross TLTRO Replacement (Percent of banks’ equity):
    - Retail funding: 0.5
    - ECB’s MRO: 0.0
    - Bond issuance (low volatility): 2.2
    - Bond issuance (high volatility): 5.2
  - Impact of Net TLTRO Replacement (Percent of banks’ equity) (TLTRO net of 50% of Banks’ Excess Reserves):
    - Retail funding: 0.4
    - ECB’s MRO: 0.0
    - Bond issuance (low volatility): 1.8
    - Bond issuance (high volatility): 4.2
  - Funding mix examples (impacts reported):
    - Funding Mix: 30 percent Retail, 30 percent MRO, 40 percent Bonds (low volatility): 1.3 (Gross) and 1.0 (Net)
    - Funding Mix: 30 percent Retail, 30 percent MRO, 40 percent Bonds (high volatility): 2.7 (Gross) and 2.2 (Net)
    - Funding Mix: 50 percent MRO, 50 percent Bonds (low volatility): 1.1 (Gross) and 0.9 (Net)
    - Funding Mix: 50 percent MRO, 50 percent Bonds (high volatility): 2.6 (Gross) and 2.1 (Net)
  - Note: Net estimates assume banks replace TLTRO liquidity by using half of their excess reserves and financing the rest.
- Market indicators:
  - Banks’ CDS spreads increased substantially in 2018, negatively impacting bond issuance prices; significant improvement in 2019 but spreads remain substantially above other European banks.
  - Charted CDS spreads show a broad range up to 500 bps for individual banks in Jan-17 to Jul-19 period.

### Bank liquidity
- Funding profile:
  - Retail deposits are largest source of stable funding: LSIs 59 percent and SIs 45 percent.
  - SIs’ funding is more diverse and includes central bank funding (13 percent) and unsecured funding from financial institutions (17 percent).
- Liquidity tests and reliance on TLTRO:
  - Liquidity stress tests (LCR, NSFR, and cashflow analyses) covered 11 SIs and 61 LSIs.
  - Aggregate liquidity is boosted by reliance on TLTRO which represents on average about 10 percent of banks’ total liabilities.
  - Tests highlight valuation risk due to concentration of liquid assets in Italian government securities; diversification by issuers, maturity and asset type would increase resilience.
  - High asset encumbrance ratios among some LSIs could hinder ability to tap wholesale funding markets.
- Table 4: LCR Stress Test Results (system-wide and by segment)
  - System-wide LCR: SIs 156% (baseline), Retail Scenario 92%, Wholesale Scenario 110%.
  - System-wide LCR: LSIs 229% (baseline), Retail Scenario 157%, Wholesale Scenario 189%.
  - Number of Banks w/ LCR<100%:
    - SIs: 0 (baseline), 9 (Retail), 1 (Wholesale).
    - LSIs: 1 (baseline), 10 (Retail), 7 (Wholesale).
  - Share of Group Assets (with LCR<100%):
    - SIs: 0% (baseline), 91% (Retail), 7% (Wholesale).
    - LSIs: 0.5% (baseline), 26% (Retail), 16% (Wholesale).
  - Liquidity shortfall (millions of euros):
    - SIs: 0 (baseline), 16,768 (Retail), 1,494 (Wholesale).
    - LSIs: 10 (baseline), 1,341 (Retail), 433 (Wholesale).
  - Liquidity shortfall (share of liabilities of failed banks):
    - SIs: 0.0% (baseline), 0.9% (Retail), 1.0% (Wholesale).
    - LSIs: 1.0% (baseline), 2.3% (Retail), 1.2% (Wholesale).
  - Retail scenario assumptions include: (i) 10 percent run-off rates for stable retail deposits and 15–20 percent for less stable retail deposits; (ii) 75 percent (40 percent) run-off rates for operational (non-operational) deposits not covered by Deposit Guarantee Scheme; (iii) 10 percent haircut on government securities for HQLA.
  - Wholesale scenario assumptions include: (i) 100 percent run-off for wholesale funding from other financial institutions; (ii) 50 percent run-off for operational and non-operational deposits not covered by Deposit Guarantee Scheme; (iii) 10 percent haircut on government securities for HQLA.
- Composition of liquid asset buffers:
  - General government items comprise 82 percent of the buffer of liquid assets of the LSIs and 67 percent of the SIs.

### Corporate sector vulnerabilities
- Overall conditions:
  - Favorable monetary conditions supported corporate balance sheet recovery, but vulnerabilities remain: the corporate sector has been deleveraging while profitability and investment have not yet recovered.
  - Construction and real estate sectors are most vulnerable, indicated by high shares of debt-at-risk and relatively low interest coverage ratios (ICRs).
  - Weak growth and elevated sovereign spreads that raise borrowing costs for corporates could create adverse feedback loops between the sovereign, corporate sector, and banks.
- Non-financial corporate stress test results:
  - Under the adverse macroeconomic scenario, combined profit and interest rate shocks would move the median interest coverage ratio and the share of firms (and debt)-at-risk close to levels seen in the 2008–09 and 2012 crises.
  - Improvement in corporate debt servicing capacity has been driven mainly by historically low interest rates; structural improvements in profitability have been insufficient.
  - Results are consistent with banking sector solvency stress tests where most losses emanate from corporate credit risk.

*Source: IMF staff compilation from the provided chapter content.*

### 24.      The insurance sector fared well in the 2018 EIOPA stress test. Assets and liabilities of the

### 24.      The insurance sector fared well in the 2018 EIOPA stress test. Assets and liabilities of the

### Insurance sector stress-test findings
- Assets and liabilities of the Italian insurance sector have different characteristics compared to other European countries.
- On the assets side:
  - 39 percent of assets held by 12 Italian entities in the scope of the EU-wide stress test are invested in Government bonds (mostly Italian), as compared to an average of 24 percent for Europe.
  - Considering the whole Italian insurance sector, investments in sovereign bonds constitute 48 percent of total assets.
- On the liabilities side:
  - Duration at 7 years is much shorter than the EU average and is well matched with asset duration.
  - A lower interest rate would have a limited impact on Italian insurers due to this duration matching.
- EIOPA stress test conclusions:
  - The Italian insurance sector is more vulnerable to the “upward shift in the yield curve” scenario mainly due to exposure to sovereign bonds and the lapse risk associated with the life business.
  - The results suggest that the Italian insurers included in the test are sufficiently capitalized.
- IVASS sensitivity analysis and follow-up:
  - Solvency ratios of several insurers (on solo basis) would fall below the 100 percent threshold under a more severe interest rate shock that involves an increase in Italian sovereign spreads to above 399 basis points.
  - The sector as a whole remains adequately capitalized, with an average solvency ratio around 150 percent.
  - Based on these results, IVASS asked the vulnerable insurers to mitigate the risk of their portfolios and repeat the stress test at the end of 2018.
  - While the 2018 year-end stress test results were not yet available at the time of the FSAP visit, the solvency position of the affected insurers had improved at the end of 2018.

### Interconnectedness and cross-sector contagion risk
- Domestic interbank contagion is limited due to small interbank exposures.
- Flow-of-funds analysis indicates significant cross-sectoral contagion risk owing to:
  - growing cross-sectoral exposures;
  - significant exposure of banks, nonbanks (particularly insurance firms) and foreign investors to the government bond market;
  - indirect links of households to sovereign risk intermediated through the financial system;
  - important direct links of banks, households and nonresidents to corporate debt.
- Cross-border linkages:
  - Linkages, especially with Europe, are high, and external shocks are becoming increasingly relevant to the Italian financial system.
  - Italian stock markets, bank returns, and sovereign CDS spreads have historically been net shock transmitters to other countries, but their importance as net shock originators declined since May 2018.
  - Italian financial system has become more sensitive to external shocks as foreign investors have been selling Italian securities while domestic residents have continued to build their net foreign asset position.

### Macroprudential policy recommendations
- Formalize framework by establishing a national macroprudential policy authority:
  - Existing coordination arrangements do not provide ways to resolve eventual differences across agencies.
  - A national macroprudential policy authority would make recommendations under a “comply or explain” mechanism.
  - Given BdI’s mandate and experience, BdI should play a leading role.
- Enhance macroprudential toolkit by incorporating:
  - the Systemic Risk Buffer (SyRB);
  - borrower-based measures such as loan-to-value (LTV) and debt service-to-income (DSTI) ratios.
- Surveillance and assessment:
  - BdI’s surveillance is state-of-the-art, and IVASS conducts macroprudential surveillance for the insurance sector.
  - The Financial Stability Report (FSR) could be complemented by regular discussions of systemic risk that consider interconnections from large sovereign exposures.
  - Regular incorporation of tests assessing resilience of the Italian banking sector to Italy-specific risks would complement EBA stress tests.
- Prudential policies to moderate the sovereign-bank nexus:
  - Encourage banks to diversify sovereign holdings and build capital buffers that incorporate the risk from sovereign debt holdings.
  - Possible approaches: carefully calibrated SyRB, Pillar II supervisory measures, positive risk weights for sovereign exposures, capital surcharges for concentration of exposures.
  - Monitor non-banks’ exposures to the sovereign and explore options for non-banks, particularly the insurance sector, if concentration grows.
  - Implement policies with a gradual phase-in to minimize market disruptions.
- O-SII buffers:
  - Evaluate adequacy of current O-SII buffers; both fully-loaded and transitional buffers of Italian O-SIIs are at the lower end of European peers.
  - If review indicates need, consider raising buffers with an adequate phase-in period to allow organic accumulation and avoid procyclicality.

### Banking regulation and supervision recommendations
- Legal and regulatory enhancements:
  - Transposition of CRD IV and banking law (TUB) enhanced BdI regulatory powers, including sanctioning supervised entities and increasing pecuniary sanctions.
- Further powers transfer:
  - Some powers currently with the Ministry of Economy and Finance (MEF), such as compulsory administrative liquidation and fit and proper requirements for banks’ shareholders, board members and management, should be under BdI purview given their prudential nature.
- Supervision of LSIs and SIs:
  - BdI applies a risk-based proportional approach to LSIs; SIs are supervised by the ECB.
  - BdI’s LSI SREP approach is broadly aligned with the SSM SREP approach; transition to SSM LSI SREP methodology should be smooth.
  - BdI has structured planning for supervisory activities focused on main weaknesses in the LSI sector; offsite and onsite assessments are thorough and coordinated.
- Enhancements to supervisory processes:
  - Streamline inspection processes to ensure more timely communication of findings and remedial actions.
  - Increase harmonization of supervisory processes across BdI branches.
  - Conduct more periodic deep dives and targeted thematic inspections on governance and business models.
  - Enhance interaction with banks’ external auditors and cooperation with CONSOB; incorporate findings into banks’ risk assessments.
- Escalation of corrective actions:
  - More timely escalation of corrective measures for problem LSIs with persistent weaknesses is needed to prevent worsening of capital, profitability, or governance.
- Credit risk and problem assets supervision:
  - Expand supervisory activities related to credit risk and problem assets, including targeted reviews and deep dives.
  - Take adequate corrective measures in case of imprudent credit risk management, insufficient provisioning, or undue forbearance.
- Pillar 2 requirements (P2R) approach:
  - Regularly monitor effect of deviations in the EU capital framework from Basel requirements on LSIs’ capital ratios.
  - Given extensive use of supervisory judgment and proxies, apply additional criteria and ex-ante checks to ensure consistency and horizontal benchmarking in applying P2R across LSIs.
- Related party lending:
  - Tighten the overall prudential limit for related party lending and set an aggregate limit on all related party lending as strict as the large exposure limit in Basel Committee standards.
- Other risk areas:
  - Improve regulations on operational risk management.
  - Increase BdI resources and activities on IT and cyber risk; perform inspections over third-party IT providers to confirm minimum IT security requirements.
  - Continue enhancing AML/CFT regulations and ensure better risk-based allocation of supervisory resources and incorporation of AML/CFT findings in banks’ risk assessments.

### NPL resolution and supervisory oversight
- Supervisory oversight has led banks to develop meaningful NPL management plans with NPL reduction targets.
- Bank supervisors set up dedicated task forces to review and challenge banks’ strategies and intensified reporting and monitoring of progress against targets.
- NPL reduction plans vary across banks; more profitable and better capitalized banks plan more aggressive reductions.
- Supervisors should continue robust challenge of banks’ strategies and ambition of their NPL reduction targets.

*Source: IMF staff report content provided in the input.*

### 44.      Banks’ plans to reduce NPLs are heavily reliant on disposals and write-offs. On aggregate,

### Banks’ plans to reduce NPLs are heavily reliant on disposals and write-offs.

### NPL reduction plans and operational constraints
- Banks’ projected volumes of NPL cures and internal workouts are almost matched by the new inflow of NPLs.
- Long delays with insolvency and enforcement procedures and banks’ internal capacity constraints limit cures and workouts.
- Banks expect to reduce NPL levels mainly through sales and write-offs.
- Banks’ NPL disposal targets have been achieved or exceeded to date and disposals currently planned appear achievable in the current liquid market environment.

### Complex features of legacy NPL portfolio and supervisory recommendations
- Over 40 percent of banks’ current NPL gross stock is categorized as ‘unlikely to pay’ (UTP), reflecting continued efforts to rehabilitate a large volume of distressed enterprises.
- Successful rehabilitation is challenging due to multi-creditor issues and may require financial and operational restructuring, change of business model, and supply of fresh credit.
- Supervisory recommendations:
  - Conduct targeted diagnostics using a representative sample of enterprises to ensure unviable firms are not granted unsustainable forbearance.
  - Consider partnering with one or more specialist firms for a one-off, limited-term project to identify existing balance sheet vulnerabilities and build the methodological approach for future on-site challenge.
  - Use eventual findings of the SSM’s asset quality review of the two new banking groups (formed by cooperative banks) to inform supervision of the rest of the LSIs, particularly on classification and provisioning of NPLs.

### Calendar-based provisioning and provisioning expectations
- Measures to recognize losses on deeply delinquent loans using a calendar-based approach are welcomed.
- ECB and EU initiatives to introduce calendar-based provisioning will:
  - Incentivize banks to quickly restructure realistically rehabilitatable cases.
  - Ensure recognition of recovery costs for borrowers that cannot be rehabilitated.
  - Encourage banks slow in reducing NPLs to act more quickly.
- Recommendation: BdI should consider extending the SSM’s approach setting expectations for the gradual path to full provisioning on existing NPL stocks to LSIs with high NPLs.

### Guidance to LSIs on NPL management
- Existing 2018 NPL guidance to LSIs sets expectations for formal policies on asset classification, forbearance, and valuation.
- Suggested additions to guidance:
  - Practical examples of when forbearance is appropriate.
  - Expectations on forbearance decisions and controls when applying multiple forbearance measures.
  - Application of time constraints on any forbearance granted.
  - Examples of when loans should be valued using a going versus gone-concern valuation approach.
  - Constraints on collateral valuation methodology.
- Note: Elements of recently-issued EBA guidelines on the management of nonperforming and forborne exposures could be used as a starting point.

### Legal aspects of NPL resolution: judicial delays and reforms
- Judicial enforcement and insolvency durations:
  - Average time for judicial enforcement of secured claims is 5 years.
  - Insolvency takes around 7 years.
- Long delays are driven by lengthy in-court processes, courts’ lack of resources, and accumulated case backlogs, with high heterogeneity from court to court.
- Recent reforms (including the 2019 insolvency law) are positive but require substantial implementation efforts:
  - Strengthen regulation of insolvency administrators.
  - Fine-tune the early warning mechanism.
  - Improve efficiency of liquidation processes.
  - Consider consolidation of creditor priorities and reform of special regime for large enterprises.
  - Legislative changes to provide greater legal certainty and flexibility for out-of-court foreclosure mechanisms are warranted.

### Institutional and judicial reform priorities
- Enhance effectiveness of the judicial system to benefit asset recovery in debt enforcement and insolvency cases.
- Structural improvements and internal court administration enhancements are necessary.
- Judicial reform should focus on:
  - Ensuring adequate resources and expertise across the court system.
  - Strengthening specialization of judges in commercial and insolvency matters.
  - Expanding competence of enterprise courts to include most commercial and insolvency cases.

### Bank governance reforms and supervisory actions
- Recent reforms: reduction of foundations’ role, reform of popolari banks, consolidation of mutual banks into mutual banking groups.
- Implementation status and next steps:
  - Reform of popolari banks implemented for eight out of the ten banks affected.
  - Reform of banking cooperatives put into effect in early 2019.
  - Key near-term actions: Ministry of Economy and Finance should issue draft decree on fitness and propriety of banks’ corporate officers and revise decree on suitability of major shareholders.
  - Perform more targeted and thematic supervisory activities on bank governance.
  - Explore actions for smaller popolari banks ranging from legal reform analogues to creation of joint arrangements in the form of IPS or groups, coupled with stronger supervisory measures for persistently weak popolari banks.

### Insurance regulation and supervision
- Solvency II implementation:
  - IVASS has fully incorporated Solvency II requirements into laws and regulations.
  - New framework addressed most regulatory weaknesses identified in the 2013 FSAP and improved corporate governance and risk management.
  - Risk-based capital framework incentivized life insurers toward capital-light products like unit-linked products.
- Remaining needs:
  - Address independence and resource adequacy of IVASS.
  - Review and justify staffing requirements (staff strength capped by legislation) and amend legislation if necessary.
  - Review powers that currently rest with the Minister for Economic Development in areas of: (a) fit-and-proper assessment criteria; (b) power to withdraw licenses directly; (c) approving winding-up of insurers.

### Investor protection and conduct supervision in securities markets
- Mis-selling allegations of subordinated bank bonds have hindered crisis management and limited loss-absorbing capacity of subordinated instruments.
- Regulatory response:
  - MiFID II and related measures have reduced holdings of subordinated debt instruments.
  - Supervisors should continue to monitor sales of instruments subject to burden sharing or bail-in to retail investors and assess adequacy of post-issuance procedures.
  - Investor compensation should be used only where there is clear evidence of mis-selling.
- On-site inspection regime:
  - Supervisory framework can be improved by more frequent on-site inspections.
  - Recommendation: institute a reasonable supervisory cycle in which all regulated entities are subjected to an on-site inspection.

### Financial integrity and AML/CFT
- Italy has a well-developed legal and institutional AML/CFT framework with improvements needed.
- May 2017 legislative decree upgraded the legal framework.
- Progress in technical compliance includes: requirements for risk-based approach, preventive measures by financial institutions, AML/CFT supervision, and sanctions regime.
- BdI’s AML/CFT supervision informed by a risk rating process covering inherent ML/TF risk and mitigating measures.
- Recommended continuing efforts:
  - Enhance tools for risk-based AML/CFT supervision, especially on non-banking institutions.
  - Ensure dissuasive and proportionate sanctions on financial institutions and individuals in a timely manner.
  - Promote robust and consistent due diligence on beneficial owners.

### Crisis management and safety nets: priorities and recommendations
- Priority: reinforce crisis management framework despite substantial strengthening since the 2013 FSAP.
- Remaining needs:
  - Enhance institutional framework and refine resolution planning for LSIs with systemic risk potential.
  - Greater focus on loss allocation to unsecured and uninsured creditors and further strengthen the two DGSs.
  - Medium-term: Banking Union-level reforms needed to reduce dichotomy between resolution and liquidation and enable a unified regime under SRB.
- Contingency planning and institutional roles:
  - Institutional responsibilities are clearly assigned with BdI as central node.
  - Recommendation: establish a formal crisis management committee to periodically review preparedness and coordinate policy responses and communications.
  - Limit Minister of Economy and Finance’s role in resolution and liquidation to cases with direct fiscal impact or system-wide financial stability implications to strengthen BdI’s operational independence.
- Use of special administration:
  - Special administration has been used to rehabilitate distressed banks and facilitate M&A and asset/liability transfers.
  - Recommendation: use special administration only in exceptional circumstances; BdI should be ready to initiate more decisive actions if rehabilitation prospects remain elusive.
- Operational capacity for bank resolution:
  - BdI’s Resolution and Crisis Management Unit benefits from direct reporting, competent staff, adequate budget, and access to supervisory information.
  - Recommendation: finalize internal policies and manuals and conduct periodic crisis simulations.
- Loss-absorbing capacity and loss allocation:
  - Key priority: establish additional loss absorbing capacity to allow allocation of losses to unsecured and uninsured creditors.
  - Recent resolutions and liquidations have often avoided allocating losses to unsecured and uninsured creditors due to systemic concerns, generating taxpayer and banking system costs.
  - Recommendation: continue efforts to build loss absorbing capacity, with consideration of LSIs for which a resolution strategy is foreseen; limit use of public funds to exceptional events that could undermine system-wide financial stability.
- Emergency Liquidity Assistance (ELA):
  - Operational readiness for ELA has been confirmed, but framework can be strengthened.
  - Recommendations:
    - Review policies and procedures for (re)confirming bank solvency and viability at time of an ELA request.
    - Review disclosure practices by the Eurosystem to minimize premature signaling of ELA operations.
    - Further consider availability of central bank liquidity support during resolution and associated risk mitigants (e.g., government indemnities).
- Deposit Guarantee Schemes (DGSs):
  - Recommended changes:
    - Remove ‘active’ bankers from Boards to strengthen operational independence.
    - Eventually shift DGSs into the public sector to align more closely with IADI Core Principles (e.g., exchange of supervisory information, participation in contingency planning, public sector backstop, legal protection for staff and management).
    - The introduction of an ex ante funding mechanism is welcome but current funding targets—while in line with minimum EU requirements—may not provide sufficient resources for dealing with potential failure of a large LSI or series of smaller simultaneous failures; backstop arrangements remain important.
  - Use of DGSs for preventive measures:
    - Should be avoided as much as possible due to moral hazard and risks.
    - If used, should be exceptional with strong prospects for successful rehabilitation and long-term viability.
  - Historical interventions:
    - Between 1997 and 2014, the FGD conducted 52 ‘preventive interventions’, while the FITD has conducted five such interventions (including three in 2019 that are still in train, i.e., Banca del Fucino, Banca Carige and Banca Popolare di Bari).
    - Ten banks that benefited from preventive interventions by the FGD received two rounds of support, while nine (including two from the afore-mentioned group of ten) could not be recovered and were eventually placed into liquidation.

*Italic source attribution: IMF Country Report — Italy (excerpt).*

### Appendix I. Key Figures

### Appendix I. Key Figures

### Output
- Real GDP Growth by year: 2015 0.8, 2016 1.3, 2017 1.7, 2018 0.8, 2019 0.2, 2020 0.4, 2021 0.7
- Potential Output Growth by year: 2015 0.1, 2016 0.3, 2017 0.4, 2018 0.3, 2019 0.3, 2020 0.4, 2021 0.4
- Output Gap by year: 2015 -3.4, 2016 -2.5, 2017 -1.2, 2018 -0.7, 2019 -0.8, 2020 -0.8, 2021 -0.5

### Employment
- Unemployment by year: 2015 11.9, 2016 11.7, 2017 11.3, 2018 10.6, 2019 10.0, 2020 10.1, 2021 10.0

### Prices
- CPI Inflation (end) by year: 2015 0.1, 2016 -0.1, 2017 1.3, 2018 1.2, 2019 0.6, 2020 0.9, 2021 1.1

### General Government Finances (percent of GDP)
- Revenue by year: 2015 47.8, 2016 46.6, 2017 46.2, 2018 46.2, 2019 46.6, 2020 46.6, 2021 46.5
- Expenditure by year: 2015 50.3, 2016 49.0, 2017 48.7, 2018 48.4, 2019 48.7, 2020 49.0, 2021 48.8
- Fiscal Balance by year: 2015 -2.6, 2016 -2.4, 2017 -2.4, 2018 -2.2, 2019 -2.1, 2020 -2.4, 2021 -2.3
- Public Debt by year: 2015 135.3, 2016 134.8, 2017 134.1, 2018 134.8, 2019 135.7, 2020 136.1, 2021 135.7

### Money and Credit
- Credit to the Private Sector (percent of GDP) by year: 2015 24.9, 2016 24.1, 2017 22.8
- Household Debt (percent of GDP) by year: 2015 56.1, 2016 55.5, 2017 54.0
- Household Saving Ratio by year: 2015 11.2, 2016 12.2, 2017 11.8, 2018 12.6, 2019 12.9, 2020 12.8, 2021 12.8
- Non-financial Sector Debt (percent of GDP) by year: 2015 270.6, 2016 264.9, 2017 259.8

### Balance of Payments (percent of GDP)
- Current Account (percent of GDP in USD) by year: 2015 1.4, 2016 2.6, 2017 2.7, 2018 2.6, 2019 2.9, 2020 3.0, 2021 2.9
- Gross Official Reserves (percent of GDP) by year: 2015 7.3, 2016 7.6, 2017 7.3, 2018 7.6
- Gross External Debt (percent of GDP in USD) by year: 2015 125.5, 2016 122.9, 2017 122.1, 2018 120.9, 2019 121.8, 2020 120.8, 2021 120.3

### Exchange Rate
- Real Effective Exchange Rate Index (avg of period) by year: 2015 95.0, 2016 95.4, 2017 95.5, 2018 97.9

### Memorandum Items
- Nominal GDP (billions of Euros) by year: 2015 1,655.4, 2016 1,695.6, 2017 1,736.6, 2018 1,765.4, 2019 1,779.0, 2020 1,805.7, 2021 1,837.3
- Average Exchange Rate (per US dollor) by year: 2015 0.9, 2016 0.9, 2017 0.9, 2018 0.8, 2019 0.9, 2020 0.9, 2021 0.9
- House Price Index by year: 2015 100.0, 2016 100.3, 2017 99.2
- Population (millions) by year: 2015 60.8, 2016 60.7, 2017 60.6, 2018 60.5, 2019 60.7, 2020 60.7, 2021 60.7

### Financial Soundness Indicators for the Banking Sector (selected series)
- Regulatory Capital to Risk-Weighted Assets by year: 2012 13.4, 2013 13.7, 2014 14.3, 2015 14.8, 2016 13.8, 2017 16.7, 2018 16.1, 2019 16.5
- Regulatory Tier 1 Capital to Risk-Weighted Assets by year: 2012 10.5, 2013 10.6, 2014 11.9, 2015 12.3, 2016 11.3, 2017 14.3, 2018 13.8, 2019 14.4
- Non-performing Loans Net of Provisions to Capital by year: 2012 79.7, 2013 89.9, 2014 93.4, 2015 89.0, 2016 85.2, 2017 58.0, 2018 40.1, 2019 37.3
- Non-performing Loans to Total Gross Loans by year: 2012 13.7, 2013 16.5, 2014 18.0, 2015 18.1, 2016 17.1, 2017 14.4, 2018 8.4, 2019 8.1
- Sectoral Distribution of Total Loans: Residents by year: 2012 75.5, 2013 75.7, 2014 75.3, 2015 74.3, 2016 76.9, 2017 75.5, 2018 75.5, 2019 74.6
- Sectoral Distribution of Total Loans: Deposit-takers by year: 2012 2.6, 2013 2.7, 2014 2.5, 2015 2.5, 2016 2.3, 2017 2.5, 2018 2.9, 2019 2.3
- Sectoral Distribution of Total Loans: Central bank by year: 2012 1.1, 2013 0.8, 2014 0.6, 2015 0.8, 2016 2.8, 2017 4.3, 2018 3.6, 2019 3.9
- Sectoral Distribution of Total Loans: Other financial corporations by year: 2012 6.0, 2013 6.1, 2014 6.6, 2015 7.4, 2016 7.7, 2017 7.6, 2018 8.1, 2019 7.7
- Sectoral Distribution of Total Loans: General government by year: 2012 2.6, 2013 2.5, 2014 2.4, 2015 2.0, 2016 1.9, 2017 1.5, 2018 1.5, 2019 1.4
- Sectoral Distribution of Total Loans: Nonfinancial corporations by year: 2012 37.2, 2013 36.8, 2014 36.8, 2015 35.4, 2016 34.6, 2017 32.3, 2018 31.3, 2019 30.7
- Sectoral Distribution of Total Loans: Other domestic sectors by year: 2012 25.9, 2013 26.9, 2014 26.5, 2015 26.2, 2016 27.6, 2017 27.3, 2018 28.0, 2019 28.5
- Sectoral Distribution of Total Loans: Nonresidents by year: 2012 24.5, 2013 24.3, 2014 24.7, 2015 25.7, 2016 23.1, 2017 24.5, 2018 24.5, 2019 25.4
- Return on Assets (ROA) by year: 2012 -0.1, 2013 -0.8, 2014 -0.2, 2015 0.3, 2016 -0.5, 2017 0.6, 2018 0.5, 2019 0.3
- Return on Equity (ROE) by year: 2012 -0.9, 2013 -11.5, 2014 -2.8, 2015 3.4, 2016 -7.7, 2017 7.5, 2018 6.1, 2019 3.9
- Interest Margin to Gross Income by year: 2012 53.8, 2013 49.1, 2014 50.4, 2015 47.7, 2016 48.4, 2017 48.2, 2018 49.6, 2019 49.5
- Non-interest Expenses to Gross Income by year: 2012 62.6, 2013 59.1, 2014 63.5, 2015 64.2, 2016 73.9, 2017 69.3, 2018 65.7, 2019 66.2
- Liquidity Assets to Total Assets by year: 2012 14.6, 2013 16.6, 2014 16.6, 2015 16.0, 2016 17.3, 2017 16.1, 2018 15.7
- Liquidity Assets to Short-term Liabilities by year: 2012 89.7, 2013 105.5, 2014 93.1, 2015 84.4, 2016 83.9, 2017 76.1, 2018 77.1
- Foreign-Currency-Denominated Liabilities to Total Liabilities by year: 2012 7.1, 2013 7.9, 2014 7.9, 2015 7.3, 2016 7.5, 2017 7.3
- Large Exposures to Capital by year: 2012 210.3, 2013 205.6, 2014 249.6, 2015 211.9, 2016 225.0

### Risk Assessment Matrix — Key Risks, Likelihoods, and Expected Impacts
- Sharp rise in risk premia that exposes financial vulnerabilities
  - Overall Level of Concern: Medium
  - Relative Likelihood: High
  - Expected Impact if Materialized:
    - Tighter financial conditions, higher debt service and financial risks.
    - Weakening of bank balance sheets and solvency positions.
    - Potential loss of market confidence, concerns over fiscal sustainability.
    - Recovery cannot be supported by financial sector.
- Weak domestic demand due to low productivity and a failure to fully address crisis legacies and undertake structural reforms
  - Overall Level of Concern: High
  - Relative Likelihood: High
  - Expected Impact if Materialized:
    - Slower output growth, slow-down in potential output.
    - Lower growth weakening public debt sustainability.
    - Weaker investment and persistent long-term employment further damaging private balance sheets, leading to further formation of NPLs.
- Weaker-than-expected global growth
  - Overall Level of Concern: Low/High
  - Relative Likelihood: (noted as) Idiosyncratic factors in the U.S. (low), Europe (high), China (high), and other large emerging markets feed off each other to result in a synchronized and prolonged growth slowdown.
- Rising protectionism and retreat from multilateralism
  - Overall Level of Concern: High
  - Expected Impact if Materialized:
    - (General adverse effects on investment, productivity and growth noted.)
- An increase in Italy-specific risk premia and a widening of spreads relative to other Euro-area sovereigns, due to continued political uncertainty
  - Overall Level of Concern: Medium
  - Relative Likelihood: High
  - Expected Impact if Materialized:
    - Higher borrowing costs for the government, with little support from the ECB as the rest of the Euro Area emerges from the crisis.
    - Large losses on bank balance sheets due to their sovereign exposures, leading to deleveraging and exacerbating the downturn.
    - Higher borrowing costs for the private sector, as banks shift higher costs to customers.
- Coronavirus outbreak causes widespread and prolonged disruptions to economic activity and global spillovers through tourism, supply chains, containment costs and confidence effects on financial markets
  - Overall Level of Concern: Medium
  - Relative Likelihood: High
  - Expected Impact if Materialized:
    - Weaker sentiment triggering volatility in financial markets.
    - Risks for investment, productivity, and long-term growth.

*Source: Haver, IMF FSI database, WEO database, and IMF staff estimates.*

### Appendix III. Stress Tests Scenario and Matrix

### Appendix III. Stress Tests Scenario and Matrix

### Adverse Scenario Calibration (Table A3.1)
- Scenario label: Italy: FSAP ST Adverse Scenario — Deviation from the baseline (in percentage points; unless specified otherwise).
- Adverse Scenario deviations by year:
  - Real GDP: 2019 -3.4, 2020 -6.9, 2021 -7.2
  - Policy interest rates: 2019 0.1, 2020 0.1, 2021 0.0
  - Short-term money market rate: 2019 0.8, 2020 1.1, 2021 0.9
  - Spread of short-term money market rate: 2019 0.7, 2020 1.0, 2021 0.9
  - Long-term government bond yield: 2019 1.3, 2020 1.8, 2021 1.5
  - Real effective exchange rate appreciation (-)/depreciation (+): 2019 8.0, 2020 12.7, 2021 12.3
  - Nominal exchange rate appreciation (-)/depreciation (+): 2019 7.7, 2020 11.5, 2021 10.4
  - Inflation rate (CPI): 2019 -0.3, 2020 -1.2, 2021 -0.9
  - Unemployment rate: 2019 1.1, 2020 3.4, 2021 4.5
- Memo (growth figures preserved exactly):
  - Baseline Real GDP growth (in percent): 2019 0.0, 2020 0.9, 2021 0.7
  - (Adverse) Real GDP growth (in percent): 2019 -3.4, 2020 -2.7, 2021 0.3
  - Cumulative real GDP growth (from 2018): 2019 -3.4, 2020 -6.0, 2021 -5.7
- Severity: deviation of growth from baseline in multiples of standard deviation of historical growth volatility:
  - Year values: 1.8, 2.1, 1.6

### Baseline and Adverse Scenario Calibration (Table A3.2)
- Tabulated projections (in percent; unless specified otherwise). Values listed per indicator for Baseline (2019, 2020, 2021) and Adverse (2019, 2020, 2021):
  - Real GDP Growth: Baseline 0.0, 0.9, 0.7; Adverse -3.4, -2.7, 0.3
  - Policy interest rate: Baseline 0.0, 0.2, 0.3; Adverse 0.1, 0.3, 0.3
  - Short-term money market spread: Baseline 0.0, 0.0, 0.0; Adverse 0.8, 1.1, 0.9
  - Long-term government bond yield: Baseline 3.5, 3.8, 4.0; Adverse 4.8, 5.5, 5.5
  - Nominal exchange rate app(-)/dep(+): Baseline 0.0, 0.0, 0.0; Adverse 7.7, 5, 0.4
  - Inflation rate (CPI): Baseline 0.8, 1.4, 1.6; Adverse 0.5, 0.2, 0.7
  - Unemployment rate: Baseline 10.8, 10.6, 10.4; Adverse 11.9, 14.0, 14.9

### Scenario Comparisons and Stylized Features (Figure A3.1)
- Key comparative observations:
  - "The overall loss of output is similar to what was experienced during the GFC... however, the adverse scenario is less V-shaped."
  - "Unemployment starting point higher than prior to the GFC"
  - "Increase in LT bond yields partly due to the baseline."
  - "IMF adverse scenario more U-shaped than EBA."
  - "The adverse scenario includes a sharp increase in bond spreads relative to bunds."
- Selected indexed and rate snapshots shown (preserve plotted values as presented):
  - Real GDP under Stress Scenarios, 2018-21 (2018 = 100): sample plotted points include 100.1, 101.0, 101.7, 100.0, 96.7, 94.1, 94.4, 98.9, 93.5, 95.1
  - Real GDP Growth under Stress Scenarios, 2018-21 (In percent): sample plotted points include 0.1, 0.9, 0.7, 0.9, -3.3, -2.7, 0.3, 1.5, -1.1, -5.5, 1.7
  - Unemployment Rate under Stress Scenarios, 2018-21 (In percent): sample plotted points include 10.7, 10.5, 10.4, 10.6, 11.8, 14.0, 14.9, 6.1, 6.7, 7.7, 8.3
  - LT government bond yields under Stress Scenarios, 2018-21 (In percent): sample plotted points include 3.5, 3.8, 4.0, 3.0, 4.8, 5.5, 5.5, 5.4, 5.5, 4.3, 3.3
  - Real GDP Growth: EBA(2018) vs IMF scenario (In percent): sample plotted points include 0.1, 0.9, 0.7, 1.4, 1.3, 1.3, -3.3, -2.7, 0.3, -0.6, -1.5, -0.6
  - LT government bond spreads relative to Bunds (In percent): sample plotted points include 3.2, 3.3, 3.5, 4.9, 5.8, 5.6, 2.8, 3.9, 2.7, 2.2, 2.3, 2.5

### Projected Default Rates (Figure A3.2)
- General statement: "Default rates rise as growth slows down and unemployment and interest rates increase."
- Series displayed (sources: Banca d’Italia; and IMF staff calculations):
  - Large Firms: plotted Baseline, Adverse, Fitted series (historical range plotted between 3/1/2006 and 12/1/2021)
  - SME: plotted Baseline, Adverse, Fitted series (historical range plotted between 3/1/2006 and 12/1/2021)
  - Consumer Loans: plotted Baseline, Adverse, Fitted series (historical range plotted between 3/1/2006 and 12/1/2021)
  - Mortgage: plotted Baseline, Adverse, Fitted series (historical range plotted between 9/1/2006 and 9/1/2021)
  - Financial Institution: plotted Baseline, Adverse, Fitted series (historical range plotted)
- Chart axes sample tick values preserved as presented:
  - Ranges shown include 0, 0.5, 1, 1.5, 2, 2.5, 3, 3.5, 4, 4.5, etc., depending on loan type.

### Stress Testing Matrix (STeM) — Banking Sector: Solvency Stress Test (Table A3.3, sections 1–5)
- Institutional perimeter and data:
  - Exercise: Top-Down by FSAP team.
  - Institutions included: Nine SIs in the sample and select LSIs (62 institutions). LSIs are only subject to sensitivity analysis.
  - Market share: Total coverage is around 78 percent, with 69 percent for SIs and 9 percent for LSIs.
  - Data and baseline date:
    - Latest data: December 2018 for SIs and June 2018 for LSIs.
    - Supervisory data: balance sheet information, COREP and FINREP, Short Term Exercise (STE), Expected Default Frequency sourced from Moody’s Analytics and large exposure (LE) templates provided by the authorities.
    - Additional supervisory information: non-performing loans by portfolio, PDs by portfolio (excluding consumer loans) from credit register, PDs for consumer loans from CRIF, details of funding and lending rate by type of asset and funding portfolios.
    - Transparency templates for banks in the 2018 EBA stress test sample and equivalent data for banks not in the EBA sample but which underwent a similar stress test by ECB.
    - Market and publicly-available data.
    - Scope of consolidation: banking activities of the consolidated banking group for banks having their headquarters in Italy.
    - Coverage of sovereign and non-sovereign securities exposures: fair value accounts (FVTPL and FVTOCI) and valued respectively at amortized cost (AC).
- Channels of risk propagation and methodology:
  - FSAP team satellite models and methodologies.
  - Balance-sheet regulatory approach.
  - Baseline and adverse scenario use fully load IFRS 9 capital ratios (capital ratios reflect banks capital ratios as if transitional arrangement for IFRS 9 had not been applied).
  - Market risk treated as an add-on component, with a separate calibration; impacts both capital resources (via profit and loss or OCI) and capital requirements (RWA).
  - Losses for securities portfolios based on duration approach.
  - Equities and associated hedges: floor as set by the EBA methodology: ∆Eq = 1.5*(-0.20%(Eq^Long + Eq^Short))
  - IRB portfolios: provisions calculated for mortgage, financial institution, corporate large firms, corporate SMEs, and consumer loans.
  - Expected losses = product of projected point-in-time PDs and LGDs, and projected exposure at defaults.
  - Point-in-time (PiT) PDs projected using regression models with macro variables as independent variables. PDs used for provisioning are PiT; PDs used to project RWAs are TTC.
  - Credit risk for standardized exposures estimated by projecting new flows of NPL using PD projection.
  - PiT LGD based on historical recovery rates of NPLs from internal workout and disposal. Same PiT LGD used for baseline and adverse scenario.
  - Credit risk for fixed-income instruments differentiates between amortized cost (AC) and fair value holdings. Credit risk of fair value holdings embedded in market risk methodology; AC securities provisions calculated for any increase in credit risk associated with a security.
- Stress test horizon:
  - 2018Q4–2021Q4 (3 years)
- Tail shocks and sensitivity analysis:
  - Baseline scenario based on the April 2019 WEO macroeconomic projections.
  - Adverse scenario designed using staff’s Global Macrofinancial Model (GFM) and feature key risks discussed in the RAM.
  - Single-factor sensitivity tests include:
    - Concentration risk for SIs (top 3 to 5 exposures assumed to fail).
    - Three-factor shocks for LSIs: interest rate risks (IRRBB), decrease in the prices of sovereign bonds, credit losses associated with asset quality deterioration.
    - Sensitivity analysis on the increase in the RWA of SME loans (SIs only).
- Risks and behavioral assumptions:
  - Risks covered: credit, market (equity, exchange rate and interest rate risks), sovereign (repricing and spread risks) and funding risks, and interest rate risk on the banking book; concentration risks by sensitivity analysis.
  - Behavioral adjustment:
    - Quasi-static approach for balance sheet growth: asset allocation and composition of funding remain the same; balance sheet grows in line with nominal GDP path; floor of zero percent growth to prevent deleveraging (constraint binding in adverse scenario).
    - Projecting RWAs: standardized and IRB portfolios differentiated; standardized RWA change due to balance sheet growth, new provisions, exchange rate movements, conversion of off-balance sheet items; IRB portfolios use projected through-the-cycle PDs to calculate new average risk weights.
    - Interest income from non-performing loan is not accrued.
    - Banks assumed not to issue new shares or make repurchases during the stress test horizon.
    - Dividends assumed to be paid out at 30 percent of current period net income after taxes (only if net income is positive) by banks in compliance with supervisory capital requirements.
- Regulatory and market-based parameters and reporting:
  - Calibration of risk parameters based on IMF staff credit models; satellite models project PiT PDs by portfolio; PiT PDs sourced from credit register at system-wide level (consumer loans PDs from CRIF); TTC PDs estimated using average PDs over 8 quarters.
  - For exposures outside Italy, satellite models used for corporate, mortgage, and consumer loans for certain countries; Moody’s EDF data used to project PDs.
  - Regulatory/accounting and market-based standards:
    - National regulatory framework.
    - Basel III regulatory minima on CET1 (4.5 percent) and include any requirements due to systemic buffers for three other systemically important institution (O-SII).
    - Evaluated total capital adequacy ratio against 8 percent level, Tier 1 capital ratio against 6 percent benchmark, and leverage ratio against 3 percent Basel III minimum requirement.
    - Same hurdle rate used for baseline and adverse scenario. Hurdle rates do not include capital conservation and capital countercyclical buffers as well as pillar 2 requirement.
    - For sensitivity test of LSIs, established hurdle rate is 7   percent CET1 ratio.
    - Banks that end the stress test horizon with a capital level or a leverage ratio below the relevant hurdle rates are considered to have failed the test.
  - Output presentation:
    - Results reported using charts and tables: evolution of capital ratios for system as a whole; LSIs reported by regional groups.
    - Outputs include impact of different result drivers, profit components, losses due to realization of different risk factors; capital shortfall as sum of individual shortfalls; shortfall in euros and in percent of nominal annual GDP; number of banks and corresponding percentage of assets below regulatory minimum (or below the minimum leverage ratio).

### Stress Testing Matrix (STeM) — Banking Sector: Liquidity Stress Test (Table A3.3)
- Institutional perimeter and data:
  - Exercise: Top-Down by FSAP team.
  - Institutions included: All SIs (11) and select LSIs (62 institutions). LSIs only subject to sensitivity analysis.
  - Market share: Total coverage around 82 percent, with 74.1 percent for SIs and 8 percent for LSIs.
  - Data and baseline date:
    - Latest data: October 2018 for SIs and end-June 2018 for LSIs.
    - Source: supervisory data (LCR, NSFR and ALMM Maturity Ladder template).
    - Scope of consolidation: banking activities of the consolidated banking group for banks having their headquarters in Italy.
- Methodology and risk channels:
  - Basel III LCR and NSFR, cash-flow based liquidity stress test using maturity buckets by banks, incorporating contractual and behavioral assumptions about combined interaction of funding and market liquidity and different levels of central bank support.
  - Liquidity test in total currency.
  - Liquidity test for large depositors’ withdrawals.
- Risks and buffers:
  - Risks: Funding liquidity, Market liquidity, Counterparty/depositor concentration risk (withdrawal of top 1, 3 and 5 depositors).
  - Buffers: Counterbalancing capacity, including liquidity obtained from markets and/or central bank facilities; expected cash inflows included in cash-flow based and LCR-based analysis.
- Tail shocks (size and calibration):
  - Run-off rates calibrated to reflect system-wide deposit runs and dry-up of unsecured wholesale and retail funding, with additional run-off for non-resident deposits, calibrated following historical events, recent international experience and IMF judgment.
  - Retail scenario key assumptions:
    - 10 percent run-off rates for stable retail deposits and 15–20 percent for less stable retail;
    - 75 percent (40 percent) run-off rates for non-operational (operational) deposits not covered by Deposit Guarantee Scheme;
    - 10 percent haircut on government securities for calculation of HQLA.
  - Wholesale scenario key assumptions:
    - 100 percent run-off rates for wholesale funding from other financial institutions;
    - 50 percent run-off rates for operational deposits not covered by Deposit Guarantee Scheme;
    - 50 percent run-off by non-operational deposits not covered by Deposit Guarantee Scheme;
    - 10 percent haircut on government securities for calculation of HQLA.
  - Liquidity shocks simulated for 1–month for both LCR and cash-flow based approaches, and 5–day and 3–months for cash-flow based approach.
  - Haircuts of HQLA calibrated consistent with market shock for investment securities and money market instruments in solvency stress test.
- Regulatory standards and output:
  - Regulatory standards consistent with Basel III (LCR and NSFR).
  - Output presentation includes liquidity ratio or shortfall by groups of banks and aggregated (system wide), and number of banks that still can meet or fail their obligations.

### Stress Testing Matrix (STeM) — Bank and Non-bank Sector: Contagion Analysis (Table A3.3)
- Institutional perimeter and data:
  - Institutions included: All SIs (11) and select LSIs (62 institutions).
  - Market share: Total coverage around 82 percent, with 74.1 percent for SIs and 8 percent for LSIs.
  - Data and baseline date:
    - Supervisory as of end-June 2018; market data.
    - BIS consolidated banking statistics.
    - Flow-of-funds quarterly data (2008Q1–2018Q1) for cross-sectoral linkages analysis.
- Methodology and channels:
  - Balance-sheet model: Interbank and cross-border network model by Espinosa-Vega and Solé (2010).
  - Market-based model: Diebold-Yilmaz (2014) generalized forecast variance decomposition approach.
- Tail shocks and default thresholds:
  - Pure contagion: hypothetical default of institutions.
  - Default threshold: banks would default if their CET1 capital ratios fall below 4.5 percent (regulatory minimum).
- Outputs and reporting format:
  - Number of undercapitalized institutions in distress.
  - Capital shortfall systemwide, by bank and by group: contagion and vulnerability scores.
  - Amplification and cascade effects, direction and size of spillovers within the network.
  - Net spillovers due to interconnectivity (market-based).
  - Market-based analysis: Varian Decomposition (spillover contribution to equity prices).

*Source: Appendix III. Stress Tests Scenario and Matrix — IMF staff (Italy FSAP ST materials as presented in the provided content).*

### Appendix IV. Status of Key Recommendations of the 2013 FSAP

### Appendix IV. Status of Key Recommendations of the 2013 FSAP

### Banking
- Issue prudential guidance to ensure a minimum level of harmonization in loan loss provisions and write-off practices [BI] — Partially Implemented
  - European Council’s package of proposals on NPLs (March 2018) includes a Regulation amending the CRR, introducing common minimum coverage levels for newly originated loans that become non-performing. If a bank does not meet the applicable minimum level, deductions from its own funds would apply. Proposal currently under discussion in the Council and the European Parliament.
- Amend law to ensure effective oversight of banking foundations by the MEF, require the largest foundations to publish audited financial statements, have an asset allocation policy aimed at diversification, and impose leverage limits [MEF/Parliament] — Partially Implemented
  - April 2015: MEF, ACRI and Foundations signed a MOU forbidding foundations from investing more than 33 percent of their equity in any single asset class. Foundations reduced their stakes in Italian banks substantially, mostly due to capital dilution, resulting in most foundations now being minority shareholders.
- Amend regulation to require that related-party transactions do not carry more favorable terms relative to those with unrelated parties, and that board members with conflicts of interest are excluded from the decision [BI/MEF] — Implemented
  - Article 53 of the consolidated law on banking (TUB) provides that bank shareholders and board members must abstain from decisions in which they have a conflicting interest. BdI regulation provides rules and principles to ensure related party transactions occur at fair terms and do not affect company interests.
- Gradually increase the tax deductibility of bank provisions in the same tax year [MEF/Parliament] — Implemented
  - Tax deductibility of loan losses: from 18 years before 2013 to 5 years since 2013 to 1 year since 2015, to allow for complete write-off of current stock of deferred tax assets (DTAs).
  - Impact largely superseded by switch to IFRS9, which resulted in substantial increases in banks’ provisioning coverage ratios—from 50 percent in Dec 2017 to 55 percent in Jun 2018, compared to 48 percent for SSM banks on average.
- Monitor closely the implementation of the restructuring plan for Monte dei Paschi di Siena and prepare contingency measures if plan targets are not reached [MEF/BI] — Partial Implementation
  - Bank is directly supervised by the SSM. End of 2016: bank requested precautionary recapitalization by the Italian Government, excising Article 32(4) of EU BRRD. July 2017: Ministry of Economy and Finance became MPS’s majority shareholder. Bank began a restructuring process and disposed its NPL portfolio via securitization involving the Atlante II fund in July 2018 (see Appendix V actions).

### Financial Sector Oversight
- Expand the definition of fit and proper for bank and investment service providers (ISP) directors so that adverse regulatory judgments can be taken into consideration [MEF/Parliament] — Not Implemented
  - Some strengthening in TUB, but criteria still based on an old MEF decree currently being revised.
- Clarify in supervisory guidance for licensing that the assessment of financial suitability of major shareholders should include the capacity to provide additional capital [BI] — Implemented
  - Based on SSM framework regulation, ECB is the competent authority for licensing of credit institutions. BdI Circular No. 285 provides that ECB and BdI assess quality and financial soundness of significant shareholders, including capacity to provide additional capital resources in the first years of operation or in stressful situations.
- Adopt a dedicated group supervisory approach for the nationally significant insurers [IVASS] — Implemented
  - IVASS, as group supervisor, coordinates supervisory colleges and establishes coordination arrangements on organization of work, cooperation, and exchange of information during ongoing supervision and crises.
- Increase use of onsite inspections of ISPs, including asset managers [CONSOB, BI] — Not Implemented
  - Frequency of inspections remains low. Instituting a supervisory cycle of between 2–3 years for on-site inspections and dedicating additional resources to supervision is recommended.
- Amend law to empower BdI and CONSOB to impose fines not only on individuals but also on financial sector entities and raise the ceiling for sanctions [MEF] — Implemented
  - Legislative Decree No. 72 of 2015 (transposing CRD IV) revised sanctioning framework, granting supervisors a wide set of sanctioning powers and increasing amounts of pecuniary sanctions. TUB Article 144 provides that pecuniary administrative sanctions can be applied also to banks as corporate entities.
- Amend law to enable supervisors to remove individual board members, officers, and auditors of financial institutions [MEF/Parliament] — Partially Implemented
  - Legislative Decree No. 72 of 2015 amended TUB to provide supervisor power to remove board members and officers of credit institutions. BdI has no powers vis-à-vis banks’ external auditors who are subject to CONSOB oversight.
- Introduce risk sensitivity in the current solvency framework for insurers in anticipation of the EU implementation of Solvency II [IVASS] — Implemented
  - EU-wide implementation of Solvency II introduced elements of risk sensitivity into the solvency framework for the Italian insurance sector.

### Financial Safety Nets
- Provide a statutory basis and detailed guidelines for RRPs to be prepared by all systemically important banks [MEF, BI] — Implemented
  - Recovery and resolution planning requirements introduced via Legislative Decrees 180 and 181 transposing the EU Bank Recovery and Resolution Directive into Italian law (effective November 16 2015, except bail-in tool implemented January 1, 2016).
- Adopt depositor preference, expand resolution tools to include bail-in, bridge bank powers and recapitalization/transfer powers, selectively transfer assets and liabilities, and trigger these at an early juncture when the firm is no longer viable [MEF, BI] — Implemented
  - Addressed via transposition of the EU Bank Recovery and Resolution Directive. Note: as of January 1, 2019, all deposits (including those not covered by depositor preference in the BRRD) rank senior to other unsecured debt.
- Amend the deposit guarantee framework to provide for ex ante funding, with a back-up credit line from the MEF, and remove active bankers from the board and executive committees of deposit guarantee schemes [MEF, BI] — Partially Implemented
  - Ex ante funding requirements introduced in 2016 via transposition of the EU DGS Directive (Legislative Decree 30). The two schemes continue to operate as private sector consortia with boards comprised of senior executives of affiliated banks.

### Appendix V. Main Measures to Strengthen the Banking System
- Initiatives to strengthen governance, facilitate capitalization and NPL disposals, and increase sector efficiency:
  - The popolari banks reform converted eight of the ten largest cooperative banks into joint stock companies, improving corporate governance and facilitating banking capitalization.
  - The BCC banks reform merged the majority of the 280 small cooperatives into two new banking groups; some remaining cooperatives are in the process to form one institutional protection scheme.
  - Foundations’ role in banks: MEF signed in 2015 an MoU with the association of banking foundations and Savings banks setting concentration limits on foundations’ investments in single entities and some governance aspects; foundations’ role in banks was significantly reduced.
  - Introduction of Garanzia Cartolarizzazione Sofferenze (GACS), a state guarantee of the senior tranches of banks’ securitization operations to facilitate removal of NPLs. This time-bound scheme has been extended multiple times since early 2016.
- Regulatory and supervisory initiatives to raise prudential standards and improve asset quality:
  - 2014 EBA definition of Non-performing Exposures and forbearance (NPEs) and 2018 EBA guidelines on disclosure of non-performing and forborne exposures.
  - 2014 ECB Comprehensive Assessment: asset quality review and solvency stress test applied to largest Italian banks that became under direct SSM supervision.
  - Adoption of EU 2016/867, the AnaCredit Regulation on collection of granular credit and credit risk data and related amending decision on preparatory measures by the European System of Central Banks.
  - SSM guidance to banks on management of non-performing exposures provides qualitative guidance and supervisory expectations for provisioning of NPLs (2017/2018).
  - EU Council’s 2017 Action Plan: includes prudential backstop for minimum loan loss provisioning; EBA guidance (2018) on NPL management; enhanced asset quality and NPL disclosure requirements; guidelines for loan tapes monitoring; standardized data for NPLs and NPL transaction platforms; approach to foster secondary markets for NPLs.
  - BdI Guidance on management of non-performing exposures for Italy’s LSI explains supervisory expectations for LSIs (2018).
  - EBA Guidance on nonperforming and forborne exposures requires institutions with a gross NPL ratio above 5 percent to establish NPL reduction strategies and governance/operational requirements to support them (2018).
- Actions to address weak banks:
  - November 2015: Four small banks (Banca delle Marche, Banca Populare dell’Etruria e del Lazio, Cassa de Risparmio di Ferrara and Cassa di Risparmio della Provincia di Chieti) were resolved by transferring “healthy parts” to bridge banks and moving troubled assets to a bad bank.
  - June 2017: Two SI (Veneto Banca and Banca Popolare di Vincenza) were liquidated under compulsory administrative liquidation; liquidation aid approved by the European Commission.
  - July 2017: European Commission approved precautionary recapitalization of Monte dei Paschi di Siena following negative stress test results; bank disposed its NPL portfolio via securitization involving the Atlante II fund in July 2018.
  - April 2018: Italian government notified a scheme for liquidation of small banks (assets below EUR 3 billion) to the European Commission; scheme allows transfer of (part of) failing banks’ assets and liabilities to an assuming bank under national insolvency proceedings with financial support on a least cost basis (as needed) from the responsible deposit protection scheme. Banca di Sviluppo Economico (Banca Base) subsequently liquidated under the scheme.
  - January 2019: ECB put Banca Carige under special administration after majority of Board members resigned. A decree law was issued to provide a state guarantee for future bond issuances and capital raising efforts are in train.
- Enhancements to legal framework for distressed corporate debt recovery:
  - Reforms to the judicial foreclosure process (2015–2016) aimed at reducing foreclosure time, improving auction processes, and introduction of out-of-court enforcement on real estate collateral (“patto Marciano” 2016).
  - New Insolvency Law adopted in January 2018 harmonized insolvency framework and provided additional incentives to early restructuring.

*Appendix IV. Status of Key Recommendations of the 2013 FSAP — content unit 1itaea2020002*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1itaea2020002.pdf_