## 1itaea2020006 ## Source details **Canonical URL:** [1itaea2020006](https://www.imf.org/-/media/files/publications/cr/2020/english/1itaea2020006.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1itaea2020006.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1itaea2020006.pdf.json) --- ### Introduction and scope - Targeted review of selected aspects concerning the regulation and supervision of banks in Italy and their governance framework, carried out as part of the 2020 Italy Financial Sector Assessment Program (FSAP). - Review based on the regulatory framework in place and supervisory practices employed as of March 2019. - Focus on prudential regulation and supervision of less significant institutions (LSIs); significant institutions (SIs) were covered in the 2018 Euro Area FSAP. - Also reviewed AML/CFT and related party transactions, which apply to both SIs and LSIs. ### Market structure and key statistics (LSIs) - Banking sector composition (end-2017): - 113 banks belonging to 60 banking groups. - 347 stand-alone banks. - 78 branches of foreign banks. - Eleven banking groups held 74 percent of the total assets and were classified as SIs. - 289 institutions were mutual banks or banche di credito cooperativo (BCC). - 23 were popolari banks; remaining banks were joint stock companies (JSC). - Evolution of LSIs (number and assets): - Number of LSIs: Dec. 2015 — 472; Dec. 2016 — 436; Dec. 2017 — 386; Dec. 2018 — 361. - BCC counts: Dec. 2015 — 365; Dec. 2016 — 335; Dec. 2017 — 289; Dec. 2018 — 268. - LSIs’ Assets (in Euro Billion): Dec. 2015 — 549; Dec. 2016 — 547; Dec. 2017 — 542; Dec. 2018 — 519. - BCC assets (in Euro Billion): Dec. 2015 — 238; Dec. 2016 — 235; Dec. 2017 — 230; Dec. 2018 — 214. - Key prudential indicators (CET1, ROE, ROA): - CET1 Capital Ratio (in percent): 2015 — 15.3; 2016 — 16.0; 2017 — 16.8; Q2-2018 — 16.3. - JSC: 2015 — 14.3; 2016 — 15.5; 2017 — 17.5; Q2-2018 — 16.9. - Popolari Banks: 2015 — 15.4; 2016 — 15.4; 2017 — 15.4; Q2-2018 — 15.3. - BCC: 2015 — 16.6; 2016 — 16.7; 2017 — 16.4; Q2-2018 — 16.0. - ROE (in percent): 2015 — 1.4; 2016 — 1.7; 2017 — 1.9; Q2-2018 — 5.7. - JSC: 2015 — 4.7; 2016 — 4.6; 2017 — 2.3; Q2-2018 — 8.7. - Popolari Banks: 2015 — -3.7; 2016 — 0.6; 2017 — 2.1; Q2-2018 — -3.1. - BCC: 2015 — -0.3; 2016 — -0.3; 2017 — 1.2; Q2-2018 — 3.8. - ROA (in percent): 2015 — 0.1; 2016 — 0.2; 2017 — 0.2; Q2-2018 — 0.5. - JSC: 2015 — 0.5; 2016 — 0.4; 2017 — 0.3; Q2-2018 — 0.8. - Popolari Banks: 2015 — -0.4; 2016 — 0.1; 2017 — 0.1; Q2-2018 — -0.2. - BCC: 2015 — 0.0; 2016 — 0.0; 2017 — 0.1; Q2-2018 — 0.3. - Asset quality observation: - High NPL ratios and low profitability are key weaknesses; popolari sector weakest, followed by BCCs, then JSCs. ### Regulatory framework and BdI powers - TUB transposed CRD IV into national law; BdI obtained enhanced regulatory powers on prudential matters (capital, liquidity, risk management, governance, internal controls). - MEF retains powers that raise concerns: - Power to adopt decrees on suitability (fit and proper) requirements of major shareholders and corporate officers. - Power to put banks into compulsory administrative liquidation, acting on a proposal by the BdI. - Key recommendation: - Shift prudential topics (fit and proper criteria setting and compulsory administrative liquidation decisions) to supervisory authorities (BdI/ECB) or at least replace MEF exclusive powers with a formal consultation process with BdI. ### BdI independence, governance, and resourcing - Independence and governance: - BdI statute ensures autonomy; no public authority can veto BdI regulations or supervisory decisions; judicial review applies. - Governor term: six years, renewable once; appointment and deputy governors’ appointments via Presidential decrees following government proposals. - ECB recommendation: explicitly refer to the right of Deputy Governors to submit dismissal decisions to an independent court of law. - Budgeting and staffing: - Moving to a three-year budgeting process; no practical limitations on supervisory budgeting reported. - Supervisory expenditure totals (millions of Euros): TOTAL 2013 202.2; 2014 201.2; 2015 197.4; 2016 186.5; 2017 180.5. - BdI supervisory staff totals: Total Head Office 2015 697; 2016 730; 2017 724; August 2018 702. Total Branches 2015 496; 2016 500; 2017 499; August 2018 491. Total supervisory staff 2015 1,193; 2016 1,230; 2017 1,223; August 2018 1,193. - Low turnover rate of two percent over the last three years. - Organizational changes: - DGFSR reorganization: new Quality Assurance Division; SSM Coordination moved to Director General; 18 decentralized problem non-BCC LSIs moved under Banking Supervision 2 Directorate; mapping of 27 regional branches into 11 networks. ### Supervisory approach, SREP, and inspection practices - Risk-based proportional approach aligned with EBA SREP and broadly with SSM SREP. - SREP assessment areas: business model and profitability; internal governance and risk management; capital adequacy and risks to capital; liquidity and funding risks. - Priority classifications (as of Nov. 2018): nine HP, 63 medium-priority (MP), and 293 low-priority (LP) LSIs; excluding BCC sector: 8 HP, 34 MP, 53 LP. - Offsite supervision uses Finrep, Corep, Central Credit Register data, ICAAP, ILAAP, recovery plans, Tableau de Bord, internal control reports. - Onsite inspections: - Types: full-scope, targeted, follow-up, thematic, compliance. - Number of inspections: 2015 105; 2016 95; 2017 72; 2018 74; Planned 2019 46. - Full scope: 2015 92; 2016 74; 2017 58; 2018 24; Planned 2019 19. - Targeted/Thematic/Other: 2015 13; 2016 21; 2017 14; 2018 50; Planned 2019 27. - Limited use of thematic inspections: BdI conducted only two thematic inspections over the last three years (prior to the report). - Timeliness issues: inspection reports should be sent within 90 days but some communications took longer due to quality review processes. - Recommendations: - Streamline onsite inspection processes for timelier communication and remedial actions. - Increase thematic/targeted inspections and deep dives on governance, credit risk, and business models. - Further harmonize supervisory practices across BdI branches; periodic central teams to assist branch inspections. ### Cooperation with CONSOB and external auditors - MoU/protocols with CONSOB strengthened in June 2018; high-level and technical committees established. - Recommendations: - Enhance operational, bank-specific interaction with CONSOB and integrate CONSOB inputs into BdI risk assessments. - Grant BdI power to reject or rescind banks’ external auditors or obtain such actions from CONSOB. - Amend TUB to allow BdI to discuss more granular bank-specific issues with external auditors. ### Corrective actions, sanctions, and enforcement - Post-CRD IV enhancements: - BdI can sanction supervised entities and natural persons; pecuniary penalties increased from Euro 30,000 up to ten percent of entity’s total annual turnover; for natural persons from Euro 5,000 up to five million. - BdI can impose non-pecuniary measures, cease and desist orders, temporary bans up to three years, and remove board members. - Early-intervention and license withdrawal: - BdI can appoint temporary or special administrators; license withdrawal power vested exclusively in the ECB for SIs and LSIs, except liquidation via MEF decree upon BdI proposal. - Article 80 TUB empowers MEF to issue a decree ordering compulsory administrative liquidation on BdI proposal. - Observed practice: - Escalation of corrective measures has generally taken time due to systemic and contagion concerns; BdI historically favored market solutions (mergers, new shareholders). - Recommendations: - Consider timelier escalation of corrective measures for banks with unsustainable business models or persistent deterioration. - Amend banking law to shift the power of compulsory administrative liquidation from MEF to supervisory authorities with a proper consultation process. ### Credit risk, NPL management, and provisioning - BdI circular 285 and March 2019 implementation of EBA credit risk guidelines set requirements for credit risk management, classification, measurement, and reporting. - BdI issued January 2018 guidance on NPL management for LSIs, extending SSM expectations to LSIs; NPL task force reviews LSI NPL strategies. - Impact projection for a sample of 47 LSIs: - NPL ratio expected to decrease from 16.3 percent in June 2018 to 9.7 percent in December 2021. - BdI limitations and recommendations: - BdI does not have the power to require banks to adjust individual asset classifications or increase provisioning (BCP essential criterion 7 of CP 18). - Recommendation: grant BdI the power to require banks to adjust asset classification and increase provisioning levels. - Enhance BdI NPL guidance to align with EBA guidelines on management of non-performing and forborne exposures (October 2018). - Continue and increase supervisory deep dives and targeted inspections on classification, provisioning, and forbearance practices. ### Capital adequacy and Pillar 2 Requirements (P2R) - Capital framework based on CRR/CRD IV; BdI issues formal capital decisions for each LSI indicating Total SREP Capital Requirements (TSCR), Overall Capital Ratio (OCR), and where applicable Total Capital Demand (OCR + P2G). - Frequency of capital decisions: at least every year for high priority; two years for medium priority; three years for low priority. - Deviations from Basel relevant to LSIs: - SME concessionary risk weight (SME factor 0.7619) — capital relief amounting to 40 basis points CET1 based on authorities’ figures as of December 2017. - Concessions on residential mortgage loans and CET1 criteria for mutually-owned institutions beyond Basel flexibility. - P2R practice: - BdI reviews ICAAP and may replace unreliable ICAAP estimates with supervisory proxies; P2R linked to SREP scores and supervisory judgment. - Composition of P2R generally consistent with P1, but BdI can require P2R composed solely of CET1. - Recommendations: - Regularly monitor effects of EU deviations from Basel on LSIs’ capital ratios and positions. - Subject P2R add-on choice to additional criteria and ex-ante checks to ensure consistency and horizontal benchmarking across LSIs. ### Concentration risk and related party transactions - Concentration risk: - Managed through CRR large exposure rules and BdI circular 285 for sectoral/geographic concentrations; BdI treats concentration mostly as a subset of credit risk. - Some national discretions (Article 400(1)/(2), Article 493 CRR) may go beyond Basel standards. - Recommendation: BdI to issue more thorough concentration risk requirements; EU to align large exposures with Basel; supervisors to incorporate broader concentration dimensions. - Related party transactions: - BdI circular 263 defines related parties in four categories; requires internal procedures and independent director oversight; prudential limits on individual related party exposures exist, but no aggregate limit. - Individual related party exposure limits: non-financial related party limits up to 15 percent of equity depending on counterparty type; financial related party limits vary from five percent to 20 percent of equity on each related party and connected persons; consolidated application for groups. - No aggregate limit for all related parties; banks in groups may have a standalone 20 percent limit toward a single group of related parties. - Data trend: related party exposures to total risk-weighted assets decreased from 2.1 percent in March 2013 to 1.3 percent in December 2016; exposures exceeding prudential limits decreased from 60 to 7. - Recommendations: - Introduce an aggregate prudential limit for all related party exposures that is at least as strict as the single large exposure limit (25 percent of banks’ equity). - Review related party definition to include directors, senior management and key staff of affiliated companies as required under Basel Core Principles (CP 20 EC 1). - Remove higher standalone related party limits for banks that are part of a banking group; apply the same limits at standalone and consolidated levels. ### Operational risk, IT, cyber risk, and AML/CFT - Operational risk: - BdI circular 285 includes business continuity and ICT requirements; operational risk qualitative requirements are limited for banks using the basic indicator approach (majority of LSIs). - BdI has supervisory manual aligned with 2017 EBA ICT risk guidelines. - BdI resources on IT and cyber risk are limited; small IT supervision team and constrained skill mix. - Recommendation: enhance operational risk regulations and increase supervisory capacity on IT and cyber risk; perform inspections of concentrated IT outsourcing providers. - AML/CFT: - AML Law legislative decree no. 231/2007, amended by decree no. 90/2017; BdI power to adopt implementing regulations and perform inspections. - UIF established within BdI as autonomous FIU since January 2008. - BdI developed a risk-based AML/CFT assessment model with UIF in 2016; inspections: 146 full-scope on LSIs and 23 targeted AML/CFT inspections in past three years. - Gaps: branch-level AML/CFT inspections may not be fully risk-based; AML/CFT findings not well integrated into overall supervisory risk assessments. - Recommendations: - Revisit approach to AML/CFT branch inspections and reallocate resources to targeted AML/CFT reviews or prudential inspections. - Better integrate AML/CFT findings into banks’ overall risk assessments. ### Bank governance, reforms (popolari, BCCs), and foundations - Popolari reform: - Decree Law 3/2015 (Law 33/2015): popolari banks with assets > Euro 8 billion required to convert into JSC by end-2016; implementation delays and legal challenges occurred. - Progress: eight out of ten large popolari banks converted within the deadline; two appealed; reform pending as of March 2019. - BCC reform and CBGs: - Decree Law n. 18/2016 created cooperative banking groups (CBGs); parent company net assets not less than Euro 1 billion; more than 60 percent of share capital held by BCCs in the group. - Cohesion contract and cross-guarantee scheme are core elements. - Progress as of March 2019: two CBGs approved and enrolled in banking group register in December 2018 and March 2019; other options and IPS arrangements pending definition. - Foundations: - Protocol with ACRI April 2015 to reduce single-exposure concentration to 33 percent of assets by 2020. - ACRI figures: foundations invest around 26.5 percent of total assets in banks. - MEF reports about ten foundations remain above the 33 percent threshold as of the protocol’s April 2020 deadline. - Distribution of foundations by ownership level (selected counts): - No shareholdings in spun-off banks: 2015 31; 2016 34; 2017 35; 2018 38. - Shareholdings > 50 percent: 2015 10; 2016 8; 2017 6; 2018 6. - Total Number of Foundations: 2015 88; 2016 88; 2017 88; 2018 87. - BdI governance requirements: - Circular 285 strengthened governance: separation of chair/CEO, minimum 25 percent independent directors, board committees for larger banks, prohibition on interlocking directorships. - Fit and proper framework concerns: - MEF retains power to adopt decrees on suitability; current decrees date from 1998. - Draft decree on corporate officers issued for public consultation in September 2017 but not finalized as of mission. - Recommendation: MEF should quickly issue the draft decree; BdI should be granted power to set fit and proper criteria given prudential nature. ### Main recommendations (selected, with responsible authorities and timing) - Amend the banking law to shift the power of putting banks under compulsory administrative liquidation from the MEF to supervisory authorities, with proper consultation with MEF. - Responsible Authorities: Italian Authorities; Timing*: ST. - Further oversee supervisory activities of BdI branches to ensure harmonization across locations. - Responsible Authorities: BdI; Timing*: I. - Perform more frequent deep dives and thematic/targeted inspections on governance, credit risk, and business models. - Responsible Authorities: BdI; Timing*: I. - Enhance interaction with CONSOB on external auditors and bank-specific issues. - Responsible Authorities: BdI, CONSOB; Timing*: ST. - Consider timelier escalation of corrective measures for banks with unsustainable business models or persistent deterioration. - Responsible Authorities: BdI; Timing*: I. - Review pillar 2 process and capital requirements to ensure consistency and horizontal benchmarking across LSIs. - Responsible Authorities: BdI; Timing*: C. - Align BdI NPL guidelines with EBA guidelines on non-performing and forborne exposures. - Responsible Authorities: BdI; Timing*: I. - Grant BdI power to require banks to adjust asset classification and increase provisioning levels. - Responsible Authorities: Italian Authorities; Timing*: I. - Introduce an aggregate prudential limit for all related party exposures at least as strict as the single large exposure limit. - Responsible Authorities: BdI; Timing*: ST. - Increase BdI supervisory capacity in relation to IT and cyber risk and inspect IT outsourcing firms. - Responsible Authorities: BdI; Timing*: ST / I. - Revisit AML/CFT branch inspections and reallocate resources to targeted AML/CFT reviews or prudential inspections. - Responsible Authorities: BdI; Timing*: I. - Quickly issue draft decree on fitness and propriety of corporate officers and revise decree on major shareholders; grant BdI power to issue fit and proper requirements. - Responsible Authorities: MEF; Italian Authorities; Timing*: I / ST. - Complete implementation of reform of large popolari banks (total assets of more than Euro 8 billion) and closely supervise new CBGs in first years. - Responsible Authorities: MEF, BdI, SSM; Timing*: I / ST. Note: * C= continuous; I (immediate)= within one year; ST= Short Term (within 1-2 years); MT= Medium Term (within 3-5 years). *Italic: Source — 1itaea2020006 (excerpt provided).* ### EXECUTIVE SUMMARY __________________________________________________________________________ 6 ### EXECUTIVE SUMMARY ### Introduction - Targeted review of selected aspects concerning the regulation and supervision of banks in Italy and their governance framework, carried out as part of the 2020 Italy Financial Sector Assessment Program (FSAP). - Review based on the regulatory framework in place and supervisory practices employed as of March 2019. - Focus on prudential regulation and supervision of less significant institutions (LSIs); significant institutions (SIs) were covered in the 2018 Euro Area FSAP. - Also reviewed regulatory and supervisory areas not covered by the wider EU regulatory framework, including AML/CFT and related party transactions, which apply to both SIs and LSIs. ### Regulatory Framework and BdI Powers - The overall banking and legal regulatory framework has been significantly enhanced since the last FSAP, particularly through transposition of the CRD IV into national law (TUB). - Enhancements include BdI regulatory powers in sanctioning supervised entities, removing banks’ board and senior management members, and increasing pecuniary sanctions. - Remaining concern: the banking law gives the Ministry of Economy and Finance (MEF) the power to put banks under compulsory administrative liquidation and to set a decree on fit and proper requirements of banks’ shareholders, board members and management. - Recommendation: these prudential topics should be left to the purview of the BdI. ### Supervisory Approach, Risk Assessment and Processes - BdI adopts a risk-based proportional approach to LSI supervision based on EBA guidelines for the SREP and broadly aligned with the SSM SREP approach. - Offsite assessment based on a thorough set of prudential reports and indicators covering banks’ main risk areas. - Onsite reviews thoroughly assess banks’ policies and risks and are well coordinated with offsite findings. - Areas for improvement: - Streamline onsite inspection processes to ensure timelier communication of supervisory findings and remedial actions. - Increase harmonization of supervisory processes across BdI’s branches, building on recent branch-level reform. - Enhance interaction with external auditors and cooperation with CONSOB; incorporate takeaways into banks’ risk profiles, leveraging recent revision of the general MoU and ongoing work on agreements with CONSOB. - Perform more frequent deep dives and thematic/targeted onsite inspections focused on key LSI weaknesses (bank governance, credit risk, business models). ### Corrective Actions and Sanctions - BdI’s enhanced corrective and sanctioning powers provide a better platform to address banking-sector weaknesses. - In practice, escalation of corrective measures has generally taken time because of concerns about systemic implications and contagion risk. - Recommendation: consider timelier escalation of corrective measures for banks with unsustainable business models or persistent deterioration in governance, asset quality, or capital levels. ### Credit Risk, Problem Assets and NPLs - BdI supervisory activities rightly focused on monitoring credit risk and problem assets; 2018 BdI guidelines on NPL management established more structured NPL reduction processes. - Supervisory recommendations: - Continue close supervision of LSIs’ credit risk, problem assets, and NPL reduction efforts. - Increase supervisory activities on credit risk and problem assets and take adequate corrective measures for imprudent credit risk management, insufficient provisioning, or undue forbearance. - Scrutinize banks’ NPL reduction plans regularly and provide more detailed guidance about loan classification and forbearance practices. - Make necessary refinements to align BdI NPL guidelines to the EBA guidelines on the management of non-performing and forborne exposures. - Grant the BdI the power to require banks to adjust asset classification and increase provisioning levels. ### Capital Adequacy and Pillar 2 Requirements (P2R) - Italian LSIs are subject to the EU capital framework, but some deviations from Basel may be relevant for LSIs. - BdI should regularly monitor effects of these deviations on LSIs’ capital ratios and positions. - BdI reviews banks’ ICAAPs and compares them with supervisory tools and proxies to determine P2R. - Recommendation: subject the choice of P2R add-ons to additional criteria and ex-ante checks to ensure better consistency and horizontal benchmarking across LSIs. ### Related Party Transactions - BdI has enhanced requirements and regulations for related party transactions, including extensive definitions and internal procedures to oversee related party transactions and limits on individual lending to related parties and connected persons. - Recommendation: set an aggregate prudential limit for all related party lending that is at least as strict as the single large exposure limit, in line with the Basel Core Principles. - A harmonized EU framework on related party transactions compliant with the Basel Core Principles would help establish a level playing field. ### Operational Risk, IT, Cyber, and AML/CFT - Operational risk management regulations should be improved; BdI resources and activities on IT and cyber risk should be increased. - Given many LSIs outsource IT systems to a small number of firms, BdI should perform inspections over these IT outsourcing firms to confirm they meet minimum IT security requirements. - BdI has enhanced AML/CFT regulations and supervisory practices; further efforts needed to better risk-based allocation of supervisory resources and to incorporate AML/CFT findings into banks’ risk assessments. - Recommendation: revisit approach to AML/CFT inspections at bank branch level and reallocate resources towards targeted AML/CFT reviews or prudential inspections. ### Bank Governance and Structural Reforms - Authorities passed significant reforms to enhance banks’ governance: reduction of foundations’ role, reform of popolari banks, and conversion of most banking cooperatives into cooperative banking groups (CBG). - Implementation status: - Reform of popolari banks implemented for eight out of the ten banks affected. - Reform of banking cooperatives is operational. - Popolari banks: cooperative nature, equal voting rights to all members, limits on ownership levels; shares can be listed and they have to allocate only 10 percent of profits to reserves. - BCCs/CBGs: BCCs comprise small entities, shares non-tradable and held by members, equal voting rights, ownership limits of Euro 50,000. - Recommendations: - Continue effective implementation of reforms. - MEF should quickly issue the draft decree on fitness and propriety of banks’ corporate officers and revise the decree on suitability of major shareholders. - Grant supervisory authorities the power to issue fit and proper requirements for banks’ shareholders and corporate officers, given the prudential nature of these requirements. - Complete implementation of reform of large popolari banks (i.e., with total assets of more than Euro 8 billion) and explore further ways to address problems of smaller popolari banks. - Closely supervise new CBGs during their first years of operations. ### Main Recommendations (extract from Table 1) - Amend the banking law to shift the power of putting banks under compulsory administrative liquidation from the MEF to the supervisory authorities, with a proper consultation process with the MEF. - Responsible Authorities: Italian Authorities - Timing*: ST - Further oversee supervisory activities of BdI’s branches to ensure maximum harmonization across all BdI locations, leveraging on the reform recently launched. - Responsible Authorities: BdI - Timing*: I - Perform more frequent deep dives and thematic and targeted inspections, particularly on key LSI weaknesses, including bank governance, credit risk, and business models. - Responsible Authorities: BdI - Timing*: I - Enhance interaction with CONSOB to discuss bank-specific issues and findings related to external auditors, building on the recent revision of the MoUs. - Responsible Authorities: BdI, CONSOB - Timing*: ST - Consider timelier escalation of corrective measures for banks with unsustainable business models and those whose situation shows persistent deterioration (e.g., governance, asset quality, or capital levels). - Responsible Authorities: BdI - Timing*: I - Review banks’ pillar 2 process and capital requirements to ensure better consistency and horizontal benchmarking in applying P2R across all LSIs. - Responsible Authorities: BdI - Timing*: C - Make necessary refinements to align BdI NPL guidelines to the EBA guidelines on management of non-performing and forborne exposures. - Responsible Authorities: BdI - Timing*: I - Grant BdI power to require banks to adjust asset classification and increase provisioning levels. - Responsible Authorities: Italian Authorities - Timing*: I - Continue monitoring implementation of banks’ NPL plans and further scrutinize plans for reliability and ambitiousness. - Responsible Authorities: BdI - Timing*: C - Introduce an aggregate prudential limit for all related party exposures that is at least as strict as the single large exposure limit. - Responsible Authorities: BdI - Timing*: ST - Increase BdI supervisory capacity in relation to IT and cyber risk. - Responsible Authorities: BdI - Timing*: ST - Perform inspections over IT outsourcing firms to ensure they are subject to minimum IT security requirements. - Responsible Authorities: BdI - Timing*: I - Revisit approach to AML/CFT inspections conducted by the BdI over banks’ branches and use these resources for more targeted AML/CFT reviews or prudential inspections. - Responsible Authorities: BdI - Timing*: I - Quickly issue the draft decree on fitness and propriety of banks’ corporate officers and revise the decree on suitability of major shareholders. - Responsible Authorities: MEF - Timing*: I - Grant supervisory authorities the power to issue fit and proper requirements for banks’ shareholders and corporate officers. - Responsible Authorities: Italian Authorities - Timing*: ST - Complete implementation of reform of large popolari banks (total assets of more than Euro 8 billion) and continue to explore ways to address smaller popolari banks. - Responsible Authorities: MEF, BdI - Timing*: I - Closely supervise the new CBGs during their first years of operations to ensure challenges are successfully overcome. - Responsible Authorities: SSM, BdI - Timing*: ST Note: * C= continuous; I (immediate)= within one year; ST= Short Term (within 1-2 years); MT= Medium Term (within 3-5 years) *Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1itaea2020006.pdf* ### 2. The mission focused on selected topics based on their macro-financial relevance, ### 2. The mission focused on selected topics based on their macro-financial relevance, especially for LSIs, and on previously identified weaknesses in the Italian regulatory and supervisory framework. ### Mission focus and scope - Main themes in relation to banking regulation and supervision: - Powers and responsibilities, independence, accountability and resourcing of the BdI. - Supervisory approach and tools to assess banking risks and perform supervisory activities over LSIs. - Enforcement and sanctioning powers and practices of the BdI. - Prudential framework topics covered (focus on LSIs, with some measures applying to SIs and LSIs): - Capital adequacy. - Risk management. - Credit risk and problem loans. - Concentration risk and related party transactions. - Liquidity and funding risks. - Operational risk. - Abuse of financial services. - AML/CFT supervision and related party transactions covered for both SIs and LSIs. - Mission coordination and inputs: - Built on findings and recommendations of the 2018 Euro Area FSAP. - Maintained close coordination with recent and ongoing FSAPs in Euro Area countries. - BdI provided a partial self-assessment of compliance with the 2012 Basel Core Principles and responses to a complementary questionnaire. - The ECB provided responses to a dedicated questionnaire. - FSAP review team engaged supervisors, banks, industry associations and other market participants. ### Market structure of LSIs and key statistics - Banking sector composition (end-2017): - 113 banks belonging to 60 banking groups. - 347 stand-alone banks. - 78 branches of foreign banks. - Eleven banking groups, holding 74 percent of the total assets of Italian banks, were classified as significant institutions (SIs) for the purposes of the European Single Supervisory Mechanism (SSM). - 289 institutions were mutual banks or banche di credito cooperativo (BCC). - 23 were popolari banks. - The remaining banks were joint stock companies (JSC). - LSI sector characteristics: - LSIs include BCCs, popolari banks, and banks established as JSCs. - The vast majority of LSIs (95 percent in terms of the system’s assets) operate with a traditional banking business model. - Consolidation has significantly reduced LSI numbers, mainly among BCCs, driven by weak situations faced by many LSIs. - Evolution of LSIs in number and size (Table 2): - Number of LSIs: Dec. 2015 — 472; Dec. 2016 — 436; Dec. 2017 — 386; Dec. 2018 — 361. - - of which: BCC: Dec. 2015 — 365; Dec. 2016 — 335; Dec. 2017 — 289; Dec. 2018 — 268. - LSIs’ Assets (in Euro Billion): Dec. 2015 — 549; Dec. 2016 — 547; Dec. 2017 — 542; Dec. 2018 — 519. - - of which: BCC assets (in Euro Billion): Dec. 2015 — 238; Dec. 2016 — 235; Dec. 2017 — 230; Dec. 2018 — 214. - Source: Banca d’Italia. - Key financial and prudential indicators (Table 3): - CET1 Capital Ratio (in percent): - 2015 — 15.3 - 2016 — 16.0 - 2017 — 16.8 - Q2-2018 — 16.3 - Of which: - JSC: 2015 — 14.3; 2016 — 15.5; 2017 — 17.5; Q2-2018 — 16.9 - Popolari Banks: 2015 — 15.4; 2016 — 15.4; 2017 — 15.4; Q2-2018 — 15.3 - BCC: 2015 — 16.6; 2016 — 16.7; 2017 — 16.4; Q2-2018 — 16.0 - ROE (in percent): - 2015 — 1.4 - 2016 — 1.7 - 2017 — 1.9 - Q2-2018 — 5.7 - Of which: - JSC: 2015 — 4.7; 2016 — 4.6; 2017 — 2.3; Q2-2018 — 8.7 - Popolari Banks: 2015 — -3.7; 2016 — 0.6; 2017 — 2.1; Q2-2018 — -3.1 - BCC: 2015 — -0.3; 2016 — -0.3; 2017 — 1.2; Q2-2018 — 3.8 - ROA (in percent): - 2015 — 0.1 - 2016 — 0.2 - 2017 — 0.2 - Q2-2018 — 0.5 - Of which: - JSC: 2015 — 0.5; 2016 — 0.4; 2017 — 0.3; Q2-2018 — 0.8 - Popolari Banks: 2015 — -0.4; 2016 — 0.1; 2017 — 0.1; Q2-2018 — -0.2 - BCC: 2015 — 0.0; 2016 — 0.0; 2017 — 0.1; Q2-2018 — 0.3 - Source: Banca d’Italia. - Asset quality observations: - High NPL ratios and low profitability are key weaknesses in the LSI sector. - Popolari sector has the weakest indicators relative to other LSIs, followed by BCCs, then JSCs. ### Reforms affecting popolari and BCCs - Popolari banks reform (Box 1): - Main feature: popolari banks operate according to a cooperative nature, equal voting rights to members (one head one vote), and limits of one percent of capital on ownership rights (larger amounts allowed for institutional investors). They must allocate only ten percent of profits to reserves. - Reform component: Decree Law 3/2015 (converted into Law 33/2015) required popolari banks with assets of more than Euro 8 billion to convert into JSC by end-2016; law introduced improvements for popolari banks with assets less than Euro 8 billion. - Progress: - Eight out of ten large popolari banks converted into JSC within the deadline; two appealed the reform. - The Constitutional Court published its decision in May 2018 confirming constitutionality and rejecting illegitimacy issues. - Decree law 91/2018 set end-2018 for completion; subsequent legal actions and decree law 119/2018 as converted into law 136/2018 postponed completion to end-2019. - Reform still pending as in March 2019. - BCC reform (Box 2): - Main features of BCCs: shares non-tradable held only by members; must allocate three-quarters of profits to reserves; equal voting rights (one head one vote); limits on ownership rights of Euro 50,000. - Reform component: Decree Law n. 18/2016 (converted into law in April 2016) introduced cooperative banking groups (CBGs) and required BCCs to join CBGs. CBG composition: - (i) a parent company formed as a JSC authorized to engage in banking, majority capital held by BCCs and exercising management and coordination; - (ii) the BCCs in the contract; and - (iii) other banks and ancillary services undertakings controlled by the parent company. - CBG requirements: - Net assets of the parent company should not be less than Euro 1 billion. - More than 60 percent of share capital should be held by the BCCs belonging to the group. - The parent entity shall provide access to interbank markets and operational, accounting, technology and infrastructure services. - CBG elements: - Cohesion contract: contractual agreement ensuring unity of strategic direction and internal control, binding instructions from parent entity, parent exercise of control and intervention proportionate to risk. - Cross-guarantee scheme: parent and affiliates jointly liable for liabilities of participating banks within limits; mutual financial support to ensure solvency and liquidity. - Progress: - Three CBGs were to be formed; at end-2018 the government allowed one BCC group the option to create a CBG or establish an IPS. - Remaining 39 BCCs (located in Alto Adige) were given the option of establishing an IPS. - As of March 2019, terms and conditions of the new IPS not yet defined; two CBGs approved and enrolled in the banking group register in December 2018 and March 2019; next step was comprehensive assessment for ECB supervision. ### Institutional setting for banking regulation and supervision - Legal framework: - Testo Unico Bancario (TUB) and Testo Unico della Finanza (TUF) establish competences of Italian financial authorities and determine how powers are exercised in the EU context. - Italian law defines principles for cooperation and exchange of information among Italian supervisory authorities, other EU Member States, third country authorities and the ECB. - The framework has been amended to implement Directive 2013/36/UE (CRD IV) and to make TUB consistent with the Single Supervisory Mechanism Regulation (SSMR). - Relevant authorities and roles: - BdI (Banca d’Italia): main competent authority for the banking sector. - Inter-ministerial Committee for Credit and Savings (ICCS) and the Minister for Economy and Finance (MEF) play oversight roles. - Other sector regulators: CONSOB, COVIP, IVASS. - SSM division of responsibilities: - Banking supervisory powers split between the ECB (for SIs) and National Competent Authorities (NCAs) — BdI for LSIs. - For licensing and acquisitions of qualifying holdings the ECB is competent authority; BdI is the “entry point” for notifications and first assessment and submits proposals to the ECB. - NCAs plan and carry out ongoing supervisory activities using their resources and procedures and perform supervision in areas not covered by the SSM Regulation. - ECB has oversight responsibility to ensure NCA supervisory activities for LSIs align with high supervisory standards and foster consistency of supervisory outcomes within the SSM. - ICCS: - Pursuant to the TUB, ICCS responsible for “high-level supervision” but limited to issuance of guidelines (following BdI proposals) on transparency, consumer protection and few other topics; ICCS does not exercise intervention powers over banks. - ICCS regulatory scope significantly revised with transposition of CRD IV and SSM framework; ICCS no longer involved in regulation of prudential matters; BdI endowed with regulatory powers on prudential issues (capital, liquidity, risk management, governance, internal controls). - Ministry of Economy and Finance (MEF) powers: - Power to adopt decrees on suitability requirements of major shareholders and managers (fit and proper requirements) and on some organizational aspects of CBGs. - Power to put banks and companies belonging to banking groups into compulsory administrative liquidation, acting on a proposal by the BdI. - Power to approve BdI decisions to initiate resolution of banks and companies belonging to banking groups. - Involvement in transparency and consumer protection issues and in case of non-banking intermediaries. ### Supervisory objectives, powers and mandates - Objectives defined in legislation: - TUB: national credit authorities (BdI, ICCS, MEF) exercise powers with regard to: - (i) sound and prudent management of supervised institutions; - (ii) financial system stability, efficiency and competitiveness; - (iii) compliance of supervised institutions with laws and regulations. - TUF objectives of supervisory activities: - (i) safeguarding of faith in the financial system, its stability, competitiveness and correct operation; - (ii) protection of investors; - (iii) observance of financial regulation. - For investment services: - BdI responsible for risk containment, asset stability, and sound and prudent management of intermediaries. - CONSOB responsible for transparency and correctness of conduct. _Italic: IMF mission note prepared by Rachid Awad (IMF) — extract provided in the source content._ ### 16. The BdI is the primary authority responsible for the prudential supervision of banks ### 16. The BdI is the primary authority responsible for the prudential supervision of banks ### Scope of supervisory responsibilities and other authorities - The BdI is the primary authority responsible for the prudential supervision of banks and banking groups (within the limits and in accordance with the SSM rules). - Under the TUB (Articles 53 and 67) and CRD IV transposition, the BdI is empowered to issue general regulations on: - capital adequacy, risk containment, permissible holdings, governance, disclosures, remuneration policies, connected lending and other transactions with related parties. - The ICCS: - Scope of regulatory powers significantly narrowed following transposition of the European framework. - According to the TUB (art. 2), ICCS is still deemed the highest supervisory authority for credit and the protection of savings. - ICCS can receive and decide on complaints filed by parties having an interest in a measure adopted by the BdI in the performance of the supervisory functions conferred to it by the TUB. - Based on discussions with the authorities, the ICCS has not played any role in this respect practically. - ICCS issues guidelines, following a proposal by the BdI, on transparency and consumer protection and other topics, such as collection of funds on a public basis. - The MEF: - Power to adopt decrees on the suitability and fit and proper requirements of major shareholders and corporate officers, after consultation with the BdI. - Current decrees date from 1998 and set very limited requirements on fitness and propriety of corporate officers and major shareholders. - A draft decree to replace the one applicable to corporate officers has been prepared but has been in discussion for many years without being finalized or passed. - Power to put banks and companies belonging to banking groups into compulsory administrative liquidation, acting on a proposal by the BdI, and to approve the BdI decision to initiate resolution of banks and companies belonging to banking groups. ### Key recommendation on legal clarity and allocation of powers - Clarify further in the TUB the role of the ICCS and MEF in relation to prudential supervisory issues and ensure their role does not interfere with BdI prudential powers. - Reflect the limited practical scope of the ICCS role in banking law and clarify its exact role in deciding on supervision-related complaints. - Recognize that the MEF role in setting fit and proper criteria may limit BdI’s ability to upgrade these criteria without undue political influence. - Recognize that MEF powers to decide on compulsory administrative liquidation may limit the ECB’s ability in withdrawing bank licenses. - Authorities are encouraged to consider shifting powers (fit and proper criteria setting and compulsory administrative liquidation decisions) to supervisory authorities and replacing them with a thorough consultation process between the BdI and MEF to ensure relevant aspects are still discussed with the MEF. ### Independence of the BdI - The BdI has a high level of operational independence in exercising prudential and supervisory responsibilities. - BdI statute: BdI and members of its decision-making bodies shall act autonomously and independently and may not seek or accept instructions from other public or private sector entities. - No public authority empowered to influence, veto, overcome or void BdI regulations or supervisory decisions; judicial review applies if decisions are against the law (Article 24 of the Italian constitution). - Governance structure and appointments: - BdI ownership historically composed mainly of banks and insurance firms; capital held by 70 banks, ten insurance firms, 11 social security institutions, 21 foundations and eight pension funds. - BoD: Board of Directors chaired by the BdI Governor and composed of thirteen directors appointed by the shareholders’ meeting. - Governing Board: Governor, Senior Deputy Governor, and three Deputy Governors. - Governor appointment: term of six years (possibly renewed only once) by decree of the President of the Republic, acting on a proposal from the President of the Council of Ministers, following a Council of ministers resolution and after hearing the opinion of the BdI’s BoD. - Deputy governors: appointment, reappointment and removal approved by decree of the President of the Republic, acting on a proposal from the President of the Council of Ministers in agreement with the MEF after consulting the Council of Ministers. - Dismissal and review: - Removal of Governor, Senior Deputy Governor, and Deputy Governors per cases in Article 14(2) of the Statute of the ESCB (no longer fulfill conditions or guilty of serious misconduct). - ECB opinion (CON/2014/19): members of the Governing Board, other than the Governor, must have the right to submit any decision to dismiss them to an independent court of law; ECB advised to refer to such a right of review in the BdI statute for legal certainty. - Potential indirect constraints: - Statute (Article 19) gives BoD responsibilities that may indirectly impact BdI functions: (i) determining staffing levels, appointing and dismissing employees, (ii) approving annual expenditure budget, (iii) adopting resolutions regarding general organizational structure. - BdI clarified separation in practice: BoD acts on proposals from the Governing Board after preparatory approvals by the Governing Board; separation applied to all BoD administrative functions, which has not practically impacted BdI’s ability to perform institutional public functions. ### Resources, budgeting, and supervisory organization - Budgeting and resource planning: - BdI employs an internal budgeting process with guidance from the Senior Deputy Governor; organizational units propose budget requests; heads of general directorates plan staff resources yearly and medium-term; needs evaluated and decided by the BdI Governing Board. - BdI is moving to a three-year budgeting process to allow better medium-term visibility and planning. - Discussions did not reveal practical limitations on supervisory budgeting and resourcing; no reported pressures from BoD or indirectly from the treasury. - Supervisory expenditure trends (full cost figures provided by BdI; Figures are in millions of Euros): - Table 4 totals and selected entries: - TOTAL (years): 2013 202.2; 2014 201.2; 2015 197.4; 2016 186.5; 2017 180.5. - Offsite Supervision (SI LSI): 2013 14.6 68.3; 2014 9.6 59.3; 2015 19.8 70.3; 2016 21.7 62.7; 2017 21.7 62.5. - Onsite Supervision (SI LSI): 2013 28.9 48.9; 2014 9.7 37.2; 2015 21.8 42.1; 2016 21.2 41.4; 2017 22.5 31.9. - Horizontal Activities: 33.8 75.0 29.8 24.1 25.6. - Crisis Management: 1.2 0.2 0.5 0.5 0.8. - Statistics: 6.4 7.1 7.5 8.1 7.5. - SSM Macro-prudential tasks: n/a 3.2 5.6 6.8 8.0. - Observation: expenditures on supervision of LSIs decreased particularly in 2017; BdI attributes this in part to consolidation and a decrease in the number of LSIs. - Supervisory structure and directorates (DGFSR responsibilities): - DGFSR operates at Head Office in Rome and via branch network. - Seven directorates and responsibilities: - Banking Supervision 1 Directorate: defines supervisory interventions for Italian or foreign banking groups in Italy subject to direct ECB supervision; monitors technical situation and carries out supervisory interventions at non-European bank branches and at banking groups and banks not subject to direct ECB supervision. - Regulation and Macroprudential Analysis Directorate: draws up proposals for the Governing Board; implements strategic guidelines on regulation, international cooperation, balance sheets and statistical reporting; develops methods of financial analysis; produces risk analysis reports; manages directorate information systems; carries out supervisory macroprudential stress tests. - Banking Supervision 2 Directorate: monitors and carries out supervisory interventions at banks and banking groups not subject to direct ECB supervision; coordinates supervisory activities performed by BdI branches. - Financial Supervision Directorate: supervises non-bank financial intermediaries. - Inspectorate Directorate: conducts inspections of banking groups and banks, non-bank financial intermediaries and other entities subject to BdI control. - Consumer Protection and Anti-Money Laundering Directorate: conducts verifications for prudential purposes concerning usury, money laundering and terrorist financing. - Supervisory Institutional Relation Directorate: liaises with judicial authorities, other national authorities and investigative bodies; monitors communications relevant for supervisory purposes; manages directorate information systems; handles market access tasks and irregularities; monitors development of financial innovation; provides secretariat to the ICCS. - DGFSR reorganization since end-2018 (main changes): - Creation of a new Quality Assurance Division reporting to the Director General to improve supervisory processes and promote best practices. - Moving the SSM Coordination division from Banking Supervision 1 Directorate to the Director General to facilitate cooperation and information sharing and support participation in SSM decision-making bodies. - Moving 18 decentralized problem non-BCC LSIs (supervised by BdI branches) under Banking Supervision 2 Directorate to ensure critical issues are rapidly reported and timely actions taken; seven banks moved since November 2018 and 11 remaining banks moved at end March 2019; further moves assessed on a semi-annual basis. - Putting two newly formed CBGs under direct supervision of Banking Supervision 1 Directorate since they will become SIs. - Establishing 11 networks of branches and mapping 27 BdI regional branches into these networks; networks act as “polo”-leader, assist in defining supervisory activities with HQ and affiliated branches, and will implement and monitor operational plans. - Staffing levels and trends (Table 5: Evolution of the BdI Supervisory Staffing Resources; Source: Banca d’Italia): - Directorates — head office counts by year: - Banking Supervision 1: 2015 122; 2016 128; 2017 135; August 2018 123. - Regulation and Macroprudential Analysis: 2015 89; 2016 99; 2017 99; August 2018 96. - Inspectorate: 2015 187; 2016 184; 2017 177; August 2018 173. - Financial Supervision: 2015 73; 2016 69; 2017 57; August 2018 55. - Banking Supervision 2: 2015 71; 2016 78; 2017 73; August 2018 73. - Consumer Protection and Anti-Money Laundering: 2015 49; 2016 57; 2017 65; August 2018 65. - Financial Supervision Coordination and External Relations: 2015 106; 2016 115; 2017 118; August 2018 117. - Totals: - Total Head Office: 2015 697; 2016 730; 2017 724; August 2018 702. - Total Branches: 2015 496; 2016 500; 2017 499; August 2018 491. - Total Number of BdI Supervisory Staff: 2015 1,193; 2016 1,230; 2017 1,223; August 2018 1,193. - Observations: - BdI maintained an overall steady level of supervisory staffing resources for the last four years. - Slight decreases in staffing in some divisions in the last two years did not seem to have impacted supervisory resources for LSIs. - Low turnover rate of two percent over the last three years indicates staffing stability. - BdI reports no difficulties in attracting qualified staff; hires young people at basic levels via public competitive exams. ### Staff conduct, protections, and post-employment rules - Conflict of interest and post-employment: - New rules on avoidance of conflict of interest for staff adopted in 2017 to prevent misuse of insider information and avoid conflicts arising from private financial circumstances or investments; specific procedures set to manage conflicts. - 2015 prime minister decree sets post-employment restrictions for BdI and IVASS senior management performing supervision: cannot assume partnerships, consulting or employment with regulated or supervised entities for the two years following termination of office or employment. - BdI code of conduct: staff should avoid conflicts of interest that could arise from any new private or professional activities during the first year after the end of employment with the Bank. - Legal defence protections: - Under Law no. 262 of 2005, BdI and components of its governing bodies and employees are only responsible for gross negligence and intentional acts. - BdI internal rules provide reimbursement for legal expenses incurred by employees but only after conclusion of the proceeding; previously considered unfavorable as employees would have to personally bear defence costs during potentially very long proceedings. - BdI introduced changes to its internal circular allowing employees to ask for advance payments to cover the costs of defending their actions. *Source: 1itaea2020006 - 16. The BdI is the primary authority responsible for the prudential supervision of banks* ### 32. The BdI has broad prudential powers, a high level of independence, and a reasonable ### 1itaea2020006 - 32. The BdI has broad prudential powers, a high level of independence, and a reasonable ### Independence, legal powers, and governance recommendations - Findings: - "The BdI has broad prudential powers, a high level of independence, and a reasonable autonomy over its resources and budgeting." - Recommended legal and governance actions: - Banking law amendments: - (i) "clarify the exact role of the ICCS and remove any overlapping or oversight role that interferes with the BdI prudential mandate," - (ii) "remove the power of the MEF to put banks under compulsory administrative liquidation and replace it with a consultation process between the prudential supervisor (the ECB/ The BdI) and the MEF." - Consider amending the BdI statute to: - "Grant further autonomy to the BdI’s Governing Board in areas linked with its institutional responsibilities such as determining staffing levels, appointing and dismissing employees, approving the annual expenditure budget, and adopting resolutions concerning the organizational structure of the BdI." - "Implement the ECB recommendation of explicitly referring to the right of the BdI’s Deputy Governors to submit any decision to dismiss them to an independent court of law." ### Supervisory approach and planning for LSIs - Findings on planning and priorities: - Supervisory planning is based on BdI circular 269 and ECB joint supervisory standard on supervisory planning; three phases: strategic planning, operational planning, and monitoring. - "The supervisory priorities for LSIs for 2016-2018 have identified business models and profitability, credit risk, and internal governance and risk controls as key risks." - "Most of these issues remain on the BdI priority list for LSI supervision in 2019." - Risk-based approach and SREP methodology: - BdI applies a risk-based approach; started applying the SSM LSI SREP methodology for HP LSIs and uses a highly similar framework for non-HP LSIs. - Assessment areas: (i) "business model and profitability," (ii) "internal governance and risk management," (iii) "capital adequacy and risks to capital," and (iv) "liquidity and funding risks." - Risk assessment scoring: - Scores range from 1 (best) to 4 (worst). - Evaluation combines assessment of risk exposures/indicators and risk controls/mitigants. - Supervisory judgment is applied at several phases and allows discretionary adjustment ("(+/-1)"). - BdI started applying the SSM SREP methodology for HP LSIs from "SREP 2018" and plans to extend to all LSIs. - Concerns: SSM LSI SREP may reduce flexibility for local context and for LSIs with specialized business models; BdI intends to include national data and use supervisory judgment to account for specificities. - Prioritization and proportionality: - Circular 269 classifies LSIs into four priority classes: "very high, high, medium, and low." - Excluding very high priority entities, the other three categories align with ECB methodology. - Minimum engagement levels (MEL) defined for frequency, scope, and granularity of control. - Decentralized supervision: some regional banks supervised by BdI branches. - LSI prioritization counts (as of November 2018): - "nine HP, 63 medium-priority (MP), and 293 low-priority (LP) LSIs." - "Excluding the BCC sector, there are 8 HP, 34 MP, and 53 LP LSIs." ### Off-site supervision, data sources, and early warning - Off-site function: - Uses periodic supervisory data submissions (Finrep, Corep, non-harmonized reporting) and central credit register data warehouse. - Assesses financial statements, audit reports, ICAAP, ILAAP, recovery plans, Tableau de Bord (quarterly report), and annual internal control reports. - Purpose: assess compliance with prudential limits, monitor exposure evolution, and track predefined early warning indicators to "promptly intercept any evidence of potential banking distress." ### Onsite inspections: planning, execution, and effectiveness - Planning and coordination: - Onsite inspections planned mainly from offsite assessment inputs; frequency depends on risk assessment and time since last inspection. - Inspection plan aggregates components defined centrally and by branches; coordination gaps exist. - Review found some decentralized institutions had not been inspected "for a very long time (beyond the SEP defined in the BdI’s supervisory approach)." - Reorganization of DGFSR and branch network into 11 networks aims to improve harmonization; effectiveness remains to be seen. - Suggestion: periodic central BdI head office teams perform or assist in branch inspections for critical themes/entities. - Types and mix of inspections: - BdI conducts: full-scope inspections, targeted inspections, follow-up inspections, thematic inspections, compliance inspections. - Use of thematic inspections and deep dives has been limited; "BdI has conducted only two thematic inspections over the last three years." - Table of onsite inspections (BdI over LSIs): - Year: 2015 | 2016 | 2017 | 2018 | Planned 2019 - Number of inspections: 105 | 95 | 72 | 74 | 46 - - Full scope: 92 | 74 | 58 | 24 | 19 - - Targeted, Thematic, and other: 13 | 21 | 14 | 50 | 27 - Of which focused on: - Credit Risk: 2 | 6 | 1 | 30 | - - Governance: 2 | 4 | - | 3 | 2 - Operational Risk: 3 | - | 2 | 4 | 2 - Consumer Protection: 5 | 6 | 3 | - | 2 - AML/CFT: - | - | 6 | 7 | 7 - Business Model and Profitability: - | - | 1 | - | 6 - Others: 1 | 5 | 1 | 6 | 8 - Operational practices and timing: - Inspections are performed on a surprise basis, limiting ex-ante interaction with institutions; pre-inspection notes are prepared but surprise inspections constrain preparatory dialogue. - Inspection findings summarized in reports presented to bank management/board; post-inspection letters issued when necessary. - "Inspection report should be sent to the bank within 90 days of the finalization of the inspection," but some communications took longer, partly due to extensive quality review and post-mission decision processes. - Efficiency recommendations: - Increase thematic reviews, targeted inspections, and deep dives on supervisory priorities (governance, credit risk, business models). - Streamline quality review and post-mission processes to ensure timely communication and remedial action. ### Cooperation with CONSOB and external auditors - Existing cooperation: - BdI signed MoU/protocols with CONSOB since 2007; master agreement in June 2018 strengthened cooperation. - Two committees established: high-level strategic committee (met twice in 2018) and technical committee (met three times in 2018). - Opportunities to enhance cooperation: - Move from strategic-level interaction to more operational, bank-specific discussion and monitoring to better integrate CONSOB inputs into BdI risk assessments and supervisory activities. - Use revised MoU and ongoing agreements to operationalize cooperation. - External auditors oversight gap: - BdI currently "does not have the power to reject or rescind the appointment of banks’ external auditors." - Interim mitigation: cooperation with CONSOB to obtain information on CONSOB’s assessment of external auditors and to provide BdI feedback to CONSOB. - A more robust solution: grant BdI powers to reject or rescind banks’ external auditors or to request such action from CONSOB. - Interaction with external auditors: - BdI meets at least twice a year with Assirevi to discuss accounting issues; meetings do not cover bank-specific auditor issues due to TUB professional secrecy constraints. - Authorities are "currently working on addressing this constraint" to allow more operational cooperation. *Source: IMF staff summary of the BdI supervisory review and recommendations.* ### 47. The BdI has a well-balanced supervisory approach and risk-based processes, which can ### 1itaea2020006 - 47. The BdI has a well-balanced supervisory approach and risk-based processes, which can ### Enhancements to BdI supervisory approach and risk-based processes - Continue efforts (building on the recent reorganization of the banking supervision department) to further oversee the supervisory activities of BdI’s branches to ensure maximum harmonization of supervisory processes and practices across all BdI’s locations. - Perform more frequent deep dives and increased thematic and targeted inspections, particularly on key LSI weaknesses, including bank governance, credit risk, and business models. - Review routine inspection processes to allow a prior notification to banks about inspection missions 18 and look into ways to streamline / reduce inspection durations and the time spent to communicate supervisory findings, while ensuring a high quality of its work. - Supervisory authorities should consider the need to review the current supervisory risk assessment methodology to better cater for the risks and activities of LSIs with specialized business models. - Footnote 18: "This should not preclude the BdI from conducting surprise inspections where this is deemed more appropriate or in exceptional cases." ### Coordination with CONSOB and banks’ external auditors - Enhance interaction with CONSOB to ensure more frequent discussion of bank-specific risks and issues, and to share information and views about the work of banks’ external auditors (building on the recent revision of the MoUs). - Grant the BdI powers to reject or rescind banks’ external auditors or to request such rejection or rescindment from CONSOB. - Better integrate the input received from CONSOB in the BdI’s assessment of banks’ risks. - Amend the TUB to allow the BdI to discuss more granular bank-specific issues and concerns with banks’ external auditors. ### Corrective actions and sanctions — current powers and practices - Improvements following transposition of CRD IV into national law include: - Ability to sanction not only natural persons but supervised entities as well. - Application of both pecuniary and non-pecuniary measures compared with the ability to apply only pecuniary measures previously. - Increase in pecuniary penalties that can be applied to supervised entities from Euro 30,000 up to ten percent of the entity’s total annual turnover, and for natural persons from Euro 5,000 up to five million. - As alternative to fines, the BdI can impose cease and desist orders on supervised entities or a temporary ban from exercising managerial functions in supervised entities for up to three years. - Power to remove one or more board members of banks (including the general director) or the collective removal of a bank’s board members. - Corrective and early-intervention measures BdI can require or impose: - Stricter prudential measures (including capital add-ons). - Ban on conducting specific operations. - Restrictions on dividend payment and remuneration. - Removal of one or more members of the management or control bodies of an institution. - Activation of one or more arrangements of a bank’s recovery plan, debt restructuring, or implementing changes to the business models or legal / operational structure. - Limits and procedures related to license withdrawal and administration: - BdI can appoint temporary or special administrators and an oversight committee to replace management or control bodies; appointment of special administrators is for one year and can be renewed. - Power to withdraw banking licenses is vested exclusively in the ECB for SIs as well as LSIs. The ECB can exercise this right if: - (i) the conditions for granting the banking license are no longer fulfilled; - (ii) the banking license was obtained through false statements; - (iii) the bank has not made use of the license within 6 months; or - (iv) the bank has been put into a liquidation procedure (compulsory administrative liquidation) upon the BdI proposal. - Article 80 of the TUB empowers the MEF, based on a proposal from the BdI, to issue a decree ordering the compulsory administrative liquidation of a bank — a limitation to BdI’s powers in this latter case. - Use of supervisory guidance and interaction with ECB: - Circular 269 provides criteria and procedures for preventive and corrective actions; imposition of corrective measures is usually the result of negative SREP results (score of 3 or 4), critical onsite inspection findings, or other deteriorating conditions related to capital, liquidity, credit quality and profitability. - Financial deterioration reporting set by the ECB: institutions that breach a fixed set of thresholds based on key solvency and performance indicators are followed up and discussed more closely with the ECB. - BdI uses a mix of moral suasion and formal corrective actions; formal measures are decided by the BdI governing board, with consultation with the ECB for problem banks (particularly those "in financial deterioration" based on ECB triggers). - BdI historically preferred market solutions (mergers, new shareholders) for persistent weaknesses; recommendation to consider more decisive and timelier escalation of corrective measures for banks with structural weaknesses and persistent deterioration (e.g., capital levels, operational efficiency, governance). ### Corrective actions — Recommendations (from the source) - Amend the banking law to shift the power of putting banks under compulsory administrative liquidation from the MEF to the supervisory authorities, subject to a proper consultation process with the MEF. - Increase the BdI’s use of formal corrective measures and timely escalate these measures to more effectively address problem LSIs with persistently deteriorating conditions. ### Capital adequacy — framework and practices - Capital requirements are based on the EU prudential framework (CRR/CRD IV); requirements apply equally to the LSI sector. - Since 2015, BdI formulates a formal capital decision for each LSI indicating: - (i) the Total SREP Capital Requirements (TSCR) ratio that includes Pillar 1 (P1) and Pillar 2 Requirements (P2R) and has to be met at all times; - (ii) the Overall Capital Ratio (OCR), that includes P1, P2R and the capital conservation buffer; 19 - (iii) in case needed a Total Capital Demand, that is equal to the sum of OCR and Pillar 2 Guidance (P2G), where P2G is a non-legally binding requirement which, if not met, does not entail specific intervention measures. - Basel Committee RCAP 2014 assessment of EU legislation compliance with Basel: - Assessed as “materially non-compliant” overall in 2014. - Found “compliant” on: scope of application, transitional arrangements, capital buffers, internal models approach for market risk, operational risk, supervisory review process and disclosure requirements. - Rated “largely compliant” for: definition of capital, standardized approach for credit risk, securitization framework, and standardized approach for market risk. - “Materially non-compliant” rating assigned for the IRB approach for credit risk. - “Non-compliant” rating assigned for the counterparty credit risk framework (calculation of the CVA capital charge). - Relevant deviations for Italian LSIs: - Some deviations in IRB approach are less relevant because Italian LSIs (apart in one case) apply the standardized approach. - Other deviations relevant to LSIs include the concessionary risk weight extended to SME exposures, 20 the treatment of residential mortgage loans, and concessions from the CET1 criteria for mutually-owned institutions that go beyond permissible flexibility under the Basel standard. - BdI application of P2R and capital decisions: - BdI applies pillar 2 capital add-ons as part of the SREP capital decision process. - Frequency of capital decisions depends on prioritization level: at least every year for high priority; two years for medium priority; three years for low priority. - Starting point for the capital decision is the capital needs provided by each institution’s ICAAP; if ICAAP estimates are not deemed reliable, they are replaced by supervisory proxies. - Determination of the P2R add-on is related to the overall SREP score; Circular 269 describes the P2R methodology. Supervisory discretion is applied depending on the overall risk profile. Composition of P2R is usually consistent with P1 requirements, 21 but the BdI can require that P2R be composed solely of CET1 depending on the situation. - Use of supervisory proxies involves thorough supervisory judgment; recommendation to introduce more guidance and consistency checks in the application of these proxies to ensure better consistency and horizontal benchmarking in applying P2R across LSIs. P2R should take into account a forward-looking perspective of banks’ situations, including governance, business model, and asset quality. - Footnote 19: "OCR is relevant for the calculation of maximum distributable amount and, if it is not met, a capital conservation plan has to be submitted by banks." - Footnote 20: "Based on the CRR, capital requirements for credit risk on exposures to SMEs, both in the EU and abroad, are multiplied by a factor of 0.7619. This provision, applicable to SME exposures under both the Standardized and IRB approach, was considered as a material deviation from the Basel standard according to the 2014 RCAP. Based on the authorities’ figures, the capital relief (in terms of CET1) stemming from the application of the SME factor amounts to 40 basis points based on SME exposures reported by Italian banking groups as of December 2017." - Footnote 21: "56 percent CET1, 75 percent T1, and 100 percent TCR." ### Capital adequacy — Recommendations (from the source) - Regularly monitor the effect of the deviations in the EU capital framework from the Basel standards on LSIs’ capital ratios and positions. In line with the 2018 Euro Area FSAP recommendations, the EU authorities should also work on conforming the capital adequacy requirements of the CRR and CRD IV to the Basel standards. - BdI supervisors should ensure that the application of P2R in banks’ capital decisions are subject to thorough criteria as well as various benchmarking and checks to promote more consistency in the application of supervisory judgment. ### Credit risk, problem assets and provisioning — regulatory and supervisory practices - BdI regulations include thorough requirements about credit risk management policies and processes. Circular 285 requires banks and banking groups to comply with specific requirements on the measurement, monitoring, management, and reporting of credit risk, and defines tasks and responsibilities of governing bodies in setting risk appetite, strategy, policies, and operating limits. - Supervision of credit risk is a key supervisory priority. Recent increases in onsite inspections targeted over credit risk, in addition to full scope inspections where credit risk is a main focus. - BdI inspectors perform quantitative assessments by sampling banks’ credit portfolios to check classification and valuation alignment with applicable requirements and submit lists of loans with revised classification assessment and provision adjustment, which banks usually take on board. - Offsite supervisors monitor credit risk indicators within the SREP process, supported by IT tools and granular data through the Central Credit Register, allowing cross comparisons between banks’ valuations. Specific reviews are performed when needed for preliminary assessment of NPL classification and provisioning issues, discussed with banks to identify appropriate actions. - BdI engagement with IFRS 9 implementation: - BdI teams have been thoroughly engaged with banks, audit firms, and CONSOB to monitor IFRS 9 implementation. - BdI participated in SSM and EBA initiatives and extended EBA and SSM exercises to an additional sample of LSIs in the first half of 2017. - BdI collected data in 2018 on the actual impact of IFRS 9 on the entire Italian banking system; preliminary BdI estimates in 2018 showed an average reduction of 131 bps in the CET1 ratio (without considering the impact of the transitional arrangements provided in the EU regulation). - Loan classification and provisioning framework: - BdI circular 285 sets obligations of banks’ boards for criteria on classification, measurement and management of non-performing exposures (NPEs), determines recovery value criteria and clarifies risk control function responsibilities. - Definition of NPEs is based on the EBA ITS on Supervisory Reporting (Implementing Regulation EU No 680/2014) and on Article 178 of the CRR. - BdI implemented in March 2019 the EBA guidelines on credit institutions’ credit risk management practices and accounting for expected credit losses in the national regulatory framework. - NPL management guidance and implementation: - January 2018 BdI guidance on management of NPLs for LSIs extended some supervisory expectations from the SSM NPL Guidance for SIs to Italian LSIs. - Guidance urges banks to adopt formal strategies to optimize NPL management by maximizing current value of recoveries; develop short and medium to long-term operational plans (roughly 1 and 3/5 years) with targets and actions; provides guidelines on governance, operational arrangements, treatment of forbearance measures, criteria for loan classification, value adjustments and write-offs, and valuation of real estate collateral. - BdI established a dedicated task force to assess and review NPL strategies submitted by high NPL LSIs for reliability and ambitiousness. Based on these plans, the NPL ratio for a sample of 47 LSIs is expected to decrease from *Italic: Source — 1itaea2020006 (excerpt provided).* ### 16.3 percent in June 2018 to 9.7 percent in December 2021. While the BdI found the targets set i ### 1itaea2020006 - 16.3 percent in June 2018 to 9.7 percent in December 2021. While the BdI found the targets set i ### Non-performing loans (NPL) management and BdI guidance - The BdI found the targets set in the NPL strategies overall relevant; some banks were requested to amend plans. A second round of plan updates was scheduled for March 2019 and an annual update will take place going forward. - Chapter 5 and 6 of the BdI Guidelines for NPL management for Italian LSIs report the main indications of the corresponding chapters (5 and 6) of the SSM Guidance, requiring banks to refer to the SSM Guidance for details. - The BdI does not have the power to require banks to adjust their classifications of individual assets or increase provisioning levels in line with the requirements of BCP (essential criterion 7 of CP 18). - The BdI indicates banks usually take on board findings related to loan classification and provisioning during review of loan files by BdI inspectors and supervisors; noncompliance may lead to a pillar 2 capital add-on. - The BdI guidance on management of NPLs by LSIs is concise and urges banks to: - assess the financial situation of debtors when forbearance measures are considered, - adopt forbearance policies that identify the best solutions, - monitor the effectiveness of forbearance measures. - The BdI’s guidelines include references to SSM guidance for operational details, but are not detailed enough particularly regarding forbearance measures and processes, collateral valuation, and impairment triggers. - It would be useful to enhance BdI guidance with more details on indications for viability and timeline of forbearance measures and main elements of a sound forbearance process, as outlined in the EBA guidelines on management of non-performing and forborne exposure issued in October 2018. ### NPL-related recommendations - The BdI should further align its NPL guidelines to the EBA guidelines on the management of non-performing and forborne exposure, with a view to outlining more detailed criteria and indications about: - sound forbearance measures and processes, - NPE recognition (including indications on classifying exposures as unlikely-to-pay (UTP), treating forborne exposures both in performing and non-performing status, and reclassification of NPEs), - NPE impairment and write-offs. - The BdI should be given the right to require banks to adjust their asset classification and increase provisioning levels. - Note: The EU agreed new rules on calendar-based provisioning in April 2019 setting minimum loss coverage levels for banks’ secured and unsecured NPLs depending on time lapse since classification as non-performing and type of collateral. The rules are effective for all new loans issued after publication of the new requirements which will set out mandatory requirements (pillar 1 requirements) for all EU banks (both SIs and LSIs). - The BdI supervisory teams should continue and increase supervisory activities focused on credit risk and problem assets by: - performing more targeted inspections and deep dives into banks’ credit risk management practices, particularly focusing on adequacy of bank asset classification and provisioning, and viability and prudence of forbearance practices; - continuing monitoring implementation of banks’ NPL plans (through regular follow-up during the year) and further scrutinizing banks’ NPL plans for reliability and ambitiousness. ### Concentration risk framework and BdI regulations - Regulations on management of concentration risk consist of applicable EU regulations and directives, EBA guidelines, and BdI circular 285. - Requirements for concentration risk from exposures to individual counterparties or groups of connected counterparties are set in the CRR; other concentration risks (economic sectors, geographic regions) are included in BdI circular 285 based on CRD IV and EBA guidelines. - BdI circular 285 requires banks to have internal control systems to manage and control concentration risks through exposure to: - (i) single counterparties and groups of counterparties; - (ii) counterparties in same industry, economic sector, or geographic region; - (iii) counterparties whose financial performance depends on same business or exposures having common credit risk mitigation techniques. - The BdI does not have explicit provisions requiring banks’ risk management policies to establish thresholds for acceptable concentrations reflecting bank’s risk profile, risk appetite, and capital strength; circular contains general provisions on need to establish risk management policies and risk tolerance thresholds. - BdI supervisors examine banks’ concentration risk policies and exposures; BdI receives data on concentrated risk exposures from SIs and LSIs and onsite inspectors examine concentration risk policies as part of inspections. A thorough assessment of concentration risk is made as part of SREP based on ICAAP reviews. However, BdI supervisors still view concentration risk as a subset of credit risk without examining other types. - Limits on exposures to single or groups of connected counterparties for LSIs are based on CRR provisions, broadly but not exactly aligned with Basel large exposure standard. Some exceptions under article 400 (1) of CRR seem to go beyond Basel framework (treatment of some off-balance sheet contingent facilities and definition of eligible capital). - The deviation in definition of eligible capital may be less material for Italian LSIs that rely more on Tier 1 capital. Exemptions under national discretions provided by Article 400 (2) of CRR may not be compliant with Basel regime. Italy has adopted discretions allowed in article 400 (2) and discretions under article 493 of the CRR. - Related party framework has progressed since previous FSAP but gaps remain. - BdI circular 263 establishes a thorough definition of banks’ related parties divided into four categories: - (i) officers performing administrative, management and monitoring functions in a bank; - (ii) participants holding at least ten percent of the bank or who can exercise control, joint control, or significant influence; - (iii) persons, other than participants, empowered to appoint members of management or supervisory board based on concluded agreements; - (iv) companies or firms on which a bank or its subsidiary exerts control or significant influence. - Regulation defines connected persons to related party; any related party and its connected persons must be considered a single entity. BdI can identify additional related parties case by case. - The definition does not appear to include directors, senior management and key staff of a bank’s affiliated companies, as required under CP 20 EC 1; definition may need review in light of reform of the BCC sector. - Circular requires banks to implement procedures to avoid conflict of interest in related party transactions; independent directors oversee related party transactions and issue non-binding advice. TUB provides shareholders and board members shall not take part in deliberations where they have a conflict of interest. - Prudential limits established on individual related parties but not on aggregate related party exposures: - Exposures to each non-financial related party and its connected persons: limited to five percent of equity for banks’ officers and shareholders with significant influence or control powers, 7.5 percent for other shareholders, and 15 percent in all other cases. - For exposures to other related parties (financial), the limit varies from five percent to 20 percent of equity on each related party and its connected persons. - Those limits are applied at consolidated level for banking groups. - No aggregate limit applied for all related parties of a bank. - For banks part of a banking group, they can have, on a standalone basis, a higher 20 percent limit toward a single group of related parties irrespective of financial or non-financial nature. - BdI regulation requires banks to adopt internal controls and policies to define risk appetite regarding exposures to related parties, including maximum amount of all related party lending deemed acceptable in relation to own funds. - BdI has power to impose more stringent prudential limits (including at aggregate level) and other conditions on a case-by-case basis. - BdI data and assessment show reduction in related party exposures: - Share of related party exposures to total risk-weighted assets decreased from 2.1 percent in March 2013 to 1.3 percent in December 2016. - Number of exposures exceeding prudential limit decreased from 60 to 7. - Material related transactions were concluded at market conditions in 89 percent of cases (99 percent by size). ### Concentration risk and related party recommendations - The BdI and EU regulatory requirements should be further aligned with Basel core principles and standards, and supervisory practices should entail a broader concept of concentration risk. Recommended actions: - The BdI should issue more thorough requirements in relation to concentration risk policies and management by banks. - The EU should amend the rules on large exposures to ensure a closer alignment with the Basel standard, in line with the recommendation made in the Euro Area BCP DAR. - The BdI supervisors should take into account potential impact of deviations from the Basel regime in their bank risk assessment and closely monitor the risk concentration these deviations may incentivize. - The BdI supervisory approach and requirements should incorporate all dimensions of concentration risks rather than only those linked to credit risk. - BdI should further enhance its regulation and prudential framework on related party exposures and align it with international standards. Recommended actions: - The BdI should introduce an aggregate prudential limit for all related party exposures that is at least as strict as the single large exposure limit (25 percent of banks’ equity). - The BdI should review the definition of related parties and their connected persons to include the directors, senior management and key staff of a bank’s affiliated companies, as required under Basel Core Principles (CP 20 EC 1). - The BdI should revise the higher related party exposure limit allowed for banks that are part of a banking group and subject the standalone position of these banks to the same limits applied for the consolidated position of banking groups. ### Liquidity risk framework for Italian LSIs - Italian LSIs are subject to the EU LCR regulation which establishes the LCR as a minimum pillar 1 requirement. - The EU LCR framework was subject to a RCAP review by the BCBS in 2017, which found the EU LCR framework overall largely compliant with the Basel LCR standard, but with some deviations, especially in the definition of HQLA. The treatment of certain inflows is also less stringent than under Basel LCR standard while it is the opposite for some outflows. - The BdI has exercised the options and discretions available in the CRR. - As per the current EU framework, Italian banks are not currently subject to a binding net stable funding ratio (NSFR). - BdI regulations include very thorough liquidity risk management requirements usually assessed in context of SREP and ILAAP. Italy has transposed liquidity qualitative requirements listed in Article 86 of CRD IV in the BdI circular. *Italic: Content derived from 1itaea2020006 - 16.3 percent in June 2018 to 9.7 percent in December 2021. While the BdI found the targets set i* ### 285. As such, banks are required to formalize their policies for the governance of liquidity risk and ### 1itaea2020006 - 285. As such, banks are required to formalize their policies for the governance of liquidity risk and ### Liquidity Risk: supervisory framework and practices - Banks are required to formalize policies for the governance of liquidity risk, implement an effective management process, set liquidity risk tolerance level, identify and measure liquidity risk on a forward-looking basis, and define a contingency funding and recovery plan (CFRP). - The European Council approved the reformed banking package in June 2019, including CRR2 and CRD V; as per this package which became applicable on June 28, 2019, the NSFR becomes a binding requirement. - Supervision of banks’ liquidity risk is performed by both offsite and onsite teams in the context of SREP (paragraph 86). - Ongoing evaluation of banks’ liquidity risk profile: - Based on a specific methodology defined in the BdI supervisory guide; assessment performed in accordance with the SSM LSI SREP Methodology for HP LSIs, and with BdI supervisory guide for non-HP LSIs. - Final liquidity risk score results from combining a quantitative analysis and a qualitative assessment. - Quantitative analysis uses the LCR and an indicator of the stability of funding which proxies the NSFR of the Basel Committee, complemented by data on funding gap, asset encumbrance, and funding structure. - A qualitative assessment of the bank’s liquidity risk management framework is combined with quantitative indicators to produce a liquidity risk score that determines supervisory actions. - Onsite assessment: liquidity is usually assessed during full-scope missions to ensure integration within risk management and regulatory coverage. - Enhanced reporting for a subset of Italian LSIs (paragraph 87): - Since the global financial crisis in 2007, BdI has required large and medium-sized banking groups and selected small banks to report counterbalancing capacity weekly together with projected contractual maturities over a three-month period (monitoring frequency can be increased to daily at times of systemic or idiosyncratic stress) and detailed information about central bank eligible assets (composition, level of encumbrance). - Data are discussed on a weekly basis with the bank; more frequent contacts as necessary. - Starting from May 2016, BdI receives on a fortnightly basis further information for the most relevant Italian LSIs on estimates about additional sources of liquidity, funding composition, deposit concentration, and the interbank position; these data may result in informal requirements for institutions. - ILAAP implementation (paragraph 88): - Since end-June 2018, Italian LSIs have started submitting their first ILAAP report in line with the EBA guidelines and the BdI regulation. - First-time assessment focused on extent of compliance with supervisory requirements; experience with ILAAP reports is nascent. - Future supervisory activities should focus on enhancing the quality and completeness of ILAAP reports and integrating them further into the supervisory process. ### Liquidity Risk: recommendations - The BdI should continue enhancing its assessment of LSIs’ liquidity positions and risk management by requiring banks to further enhance their ILAAP reports to use them as a reliable basis for liquidity risk assessment. - The EU framework should conform the LCR rules to the Basel standard, as recommended by the 2018 Euro Area FSAP. ### Operational Risk: regulatory framework and supervisory practice - BdI regulations include thorough requirements on banks’ business continuity and information systems, while general requirements on operational risk management are rather thin (paragraph 90). - Circular 285 establishes requirements on overall risk management and the role of the management body; an annex is dedicated to operational risk and references Part three, Title III of the CRR. - CRR includes qualitative aspects to operational risk depending on the approach used to compute the operational risk capital charge; CRR does not include detailed operational risk management requirements for banks adopting the basic indicator approach (the case for most Italian LSIs). - BdI has developed a supervisory manual related to business continuity and disaster recovery in line with the 2017 EBA guidelines on the assessment of ICT risk; circular 285 requires banks to develop business continuity plans with defined minimum elements and reporting requirements (paragraph 91). - BdI offsite and onsite teams assess operational risk within SREP: - Offsite assessment uses annual reports on internal controls, risk management and outsourced functions, annual ICAAP reports, and quarterly internal control function reports (Tableau de Bord). - Onsite assessment of operational and IT risks is primarily through full-scope inspections; BdI has not recently done targeted or thematic inspections focused on operational and IT risk (paragraph 92). - ICT assessment focuses on governance of the ICT function, ICT risk management structure, ICT risk control, and verification of ICT outsourcing arrangements against bank strategy and risk tolerance. - BdI resources on IT and cyber risk are very limited relative to the breadth of activities (paragraph 93): - Small team of IT supervisors involved in policy development on ICT, onsite inspections for SIs (as part of SSM) and for LSIs, and international activities on IT and cyber risk. - BdI IT department sometimes provides additional resources; availability and skill mix are not always sufficient. - Concentration of IT outsourcing among a small number of providers, but BdI has not done thematic or targeted IT inspections of those providers (paragraph 94); BdI has power to inspect these firms. ### Operational Risk: recommendations - The BdI should enhance its regulations on operational risk management by including more detailed requirements. - The BdI is advised to increase its supervisory capacity in relation to IT and cyber risk. - Given concentration of IT outsourcing, the BdI should perform inspections over these providers to ensure minimum IT security requirements, in line with recently adopted inspection plans. ### Financial Integrity (AML/CFT): legal framework and supervisory arrangements - AML Law set out in legislative decree no. 231/2007; amended in May 2017 by legislative decree no. 90 transposing Directive (EU) 2015/849 (paragraph 96). - Decree confirmed BdI power to adopt implementing regulations on customer due diligence (CDD), record keeping, and internal controls; BdI can request documents and carry out inspections. - On March 26, 2019, the Bank of Italy published provisions on organization, procedures and controls aimed at preventing use of supervised entities for ML/TF. - UIF (Unità di Informazione Finanze) is Italy’s Financial Intelligence Unit, established within BdI as autonomous and operationally independent since January 2008 (paragraph 97). - UIF receives and analyzes suspicious transaction reports (STRs) from all obliged entities and conducts inspections to check adequacy of STR identification and reporting procedures. - Cooperation between BdI supervisory function and UIF is mandated by AML law and facilitated by a 2009 MoU; BdI reports suspicious transactions and relevant supervisory findings to UIF (paragraph 98). - BdI AML internal controls regulation requires well-documented CDD processes, a dedicated AML function integrated within corporate control, and enhanced CDD for correspondent accounts only with non-EU respondent institutions (paragraph 99). - Supervision of AML/CFT performed by BdI Consumer protection and AML directorate: - In 2016 BdI developed, with UIF, a new risk-based AML/CFT assessment model for the banking sector that produces a final score using a combined qualitative-quantitative approach (paragraph 100). - Inspections are performed during full-scope inspections or via targeted AML/CFT inspections; banks sampled by size, date of previous inspection, and off-site risk assessment (paragraph 101). - In the past three years, BdI carried out 146 full scope inspections on LSIs and 23 targeted AML/CFT inspections, out of which 12 SIs and 11 LSIs. - Number of inspections has decreased over the last three years, attributed to consolidation of LSIs and increased inspections of other financial intermediaries; inspections led to significant findings and application of sanctions or corrective measures. ### Financial Integrity: supervisory gaps and recommendations - Gaps noted: - Branch inspections for AML/CFT are still performed by BdI branches and are partly covered by overall BdI inspection plan; selection uses risk indicators but may not be fully aligned with a risk-based approach centered on each supervised entity’s overall ML/TF risk assessment (paragraph 102). - AML/CFT directorate work and findings are not well integrated into the overall supervisory process. - Recommendations (paragraph 103): - Revisit approach to AML/CFT inspections in banks’ branches and use these resources for more targeted AML/CFT reviews or more prudential inspections over banks. - Better integrate AML/CFT supervisory work and findings in the supervisory process and in the overall risk assessment of banks. ### Bank governance: reforms and context - Authorities have passed reforms and regulatory actions to enhance governance of Italian banks, targeting special ownership structures (foundations), BCCs, and popolari banks; some reforms are ongoing and challenging to execute (paragraph 104). - BdI regulations on bank governance have been significantly enhanced, raising the bar for governance practices; implementation needs close monitoring to ensure objective achievement. - Historical role of banking foundations (paragraph 105): - Foundations were key shareholders following 1990s privatizations, acting as stable long-term shareholders and supporting recapitalization after the GFC. - Foundations have had peculiar governance structures, weak internal accountability, little oversight (especially after a 2003 Constitutional Court decision that curtailed MEF authority), non-uniform accounting rules, and non-transparent appointment of governing bodies. *ITALY INTERNATIONAL MONETARY FUND* ### 106. New features for foundations’ investments in entities, including banks, were set i ### 106. New features for foundations’ investments in entities, including banks, were set i ### Background and reforms affecting foundations and banks - A protocol agreement was signed in April 2015 between the Association of Banking Foundations and Savings Banks (ACRI), that represents 85 associated members, and the MEF that is responsible for supervising the foundations. - Based on the protocol, foundations committed to take measures with the main aim to diversify their portfolio, limit their risks and improve their asset management strategy, and enhance some governance aspects. - The protocol requires that foundations should reduce their direct or indirect exposure to a single person or entity to 33 percent of their assets by 2020. - Foundations were created in the 1990s during bank privatization; they are private legal entities intended to pursue public interest or socially-oriented activities. ### Current ownership and investment concentration (findings) - While the role of foundations has been decreasing, they still have significant shareholdings in 11 banks. - Based on ACRI figures, foundations now invest around 26.5 percent of their total assets in banks, which is below the 33 percent limit stipulated in the protocol agreement with the MEF. - According to the MEF, about ten foundations remain above the 33 percent threshold as of the protocol’s April 2020 deadline. - Most foundations now hold minority shares in banks, though about six foundations still have control ownership. - Table 7 (distribution of number of foundations by ownership level in their spun-off banks) — key rows and counts: - Foundations that have no shareholdings in their spun-off banks: 2015: 31; 2016: 34; 2017: 35; 2018: 38 - Foundations that have shareholdings <50 percent: 2015: 47; 2016: 46; 2017: 47; 2018: 43 - Shareholdings less than 5 percent: 2015: 27; 2016: 30; 2017: 34; 2018: 33 - Shareholdings between 5 and 20 percent: 2015: 10; 2016: 8; 2017: 5; 2018: 5 - Shareholdings between 20 and 50 percent: 2015: 10; 2016: 8; 2017: 8; 2018: 5 - Foundations that have shareholdings > 50 percent: 2015: 10; 2016: 8; 2017: 6; 2018: 6 - Total Number of Foundations: 2015: 88; 2016: 88; 2017: 88; 2018: 87* - (*) The decrease in the number is due to a merger between a large and a small foundation in Northern Italy. - Source cited in table: ACRI Annual Reports and Data. ### Related governance and structural bank reforms - Reform of the popolari banks: - Caps on ownership and restriction on voting rights (one head one vote) weakened governance and affected ability to attract outside capital. - Conversion of the largest popolari banks (total assets of more than Euro 8 billion) into joint stock companies eased governance challenges and allowed easier access to financial markets and mergers. - Eight of the ten popolari banks above the Euro 8 billion threshold converted into JSC; for the remaining two, a legal review by the European court of Justice is pending. - Transformation of the BCC sector into CBGs: - Intended to address profitability and viability issues stemming from small, local nature of BCCs. - Group structure and cross-guarantee scheme expected to raise efficiency and allow weaker BCCs to adapt business models or face corrective actions by the parent. - Implementation challenges include governance specificities, central role and capability of the parent, potential contagion from parent weaknesses, IT and process integration, convergence to common standards, and centralization of risk management and internal control systems. - Bank governance regulatory upgrades by BdI: - BdI circular 285 significantly upgraded in 2014 on governance-related aspects. - Requirements: clear allocation of tasks between management and supervisory bodies; balance of powers between executive and non-executive directors; composition of supervisory and management bodies; integrity and effectiveness of internal controls. - Proportionality aspects introduced for different bank sizes and sophistication. - Strict rules on separation between chairperson and CEO roles, board size, and a minimum percentage (25 percent) of independent directors. - For larger banks, three major board-level committees (remuneration, risk, and nomination) must be established and composed of non-executive directors, the majority of whom should be independent. - A legislative ban was introduced for interlocking directorships across financial sector entities. ### Remaining challenges and supervisory priorities - Fit and proper requirements: - Current limited requirements for fitness and propriety of banks’ major shareholders and corporate officers; power to set these criteria rests with the MEF according to the TUB. - Existing corporate officer criteria based on Ministerial Decree 161 of March 18, 1998; narrow requirements on professional and integrity aspects. - Decree 144 of 1998 exists for suitability of major shareholders but requirements are few and mainly related to conviction. - MEF prepared a draft decree on fit and proper requirements for corporate officers issued for public consultation in September 2017; last available version establishes integrity, good repute, professional experience and competence criteria, independence requirements, time availability and limits on multiple positions. - Draft decree had a fairly long process before issuance at the time of mission; accelerating issuance is essential. - Recommendation to consider granting BdI the power to set fit and proper criteria for shareholders and corporate officers given the clear prudential dimension; with possible consultation with MEF and Council of State for significant changes. - Supervisory enforcement and targeted activities: - Despite reforms, many LSIs still face governance weaknesses (board composition, qualifications and suitability of significant shareholders and board members, and risk culture). - Need to better enforce governance requirements and be ready to take stronger measures in case of persistently poor governance practices. - More focused and increased supervisory activities on governance suggested, including targeted inspections or thematic reviews on the governance of the LSI sector. - Popolari and BCC follow-up: - Complete implementation of the popolari bank reform if European court of Justice review allows; additional actions for smaller popolari banks (total assets less than Euro 8 billion) should be explored—encourage pooling, IPS-like arrangements, mutual services or platforms, and joint liquidity support. - Close supervision of new CBGs, particularly in early years, focusing on governance of the parent, ability to steer affiliated BCCs, early warning systems, and potential individual-level supervisory controls on BCCs in the first years. ### Recommendations (explicit) - The MEF should continue monitoring the compliance with the protocol agreement with ACRI and enforce its effective implementation by foundations. - The MEF should quickly issue the draft decree on the fitness and propriety of banks’ corporate officers and review the decree on the suitability requirements of major shareholders. In addition, the BdI should be granted the power to issue such requirements given their prudential nature. - The reform of the large popolari banks should continue and Italian authorities should continue to explore ways to address problems and push for solutions for the smaller popolari banks, as outlined earlier in this note. - The supervisory authorities (ECB, BdI) should closely supervise the new CBGs during their first years of operations to ensure that the challenges associated with the reform are successfully overcome. - The BdI should increase its focused supervisory activities on bank governance, such as performing more targeted inspections or thematic reviews, and take timely and adequate measures in case of persistent governance weaknesses. *Source: IMF staff report excerpt provided in the content unit.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1itaea2020006.pdf_