## wp17175

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### I. INTRODUCTION — key problems and context
- The Italian banking system suffers from weak profitability and generally poor asset quality.
- Return on equity (RoE) of Italian banks is among the lowest in the EU.
- Legacy asset quality:
  - nonperforming loans (NPLs) are very high at around 21 percent of GDP.
  - There were substantial write-downs in 2016.
- Banking sector structure (as of end-2016):
  - around 400 consolidated banking groups and about 200 subsidiaries.
- Data sources and caveats:
  - European Banking Authority (EBA) risk dashboard (198 European banks, 15 Italian) and European Central Bank’s consolidated banking database; comparability caveats noted.

### II. Recent legislative reforms affecting consolidation
- Popolare banks (BPs) — March 2015 measures:
  - Legislation required the 10 largest popolare banks (those with assets exceeding €8 billion) to be transformed into joint stock companies by end-2016.
  - Outcome by end-2016: All but two of the 10 BPs have converted into joint stock companies.
  - One merger completed: Banco Popolare and Banca Popolare di Milano in 2016, creating the third largest banking group in Italy.
  - Reform status: the reform is currently on hold owing to successful challenges in court (related to compensation of dissenting investors).
  - As of Q2 2016: there were 29 BPs in total; the 10 largest BPs with assets above €8 billion account for about 90 percent of the total assets of BPs.
  - Expected structural outcome once reforms are fully implemented: a more concentrated banking sector with around 140 consolidated banking groups.
- Mutual banks (BCCs) — February 2016 measures:
  - Mutual bank reform: the 355 smaller cooperative banks to consolidate under joint-stock (holding) companies with at least €1 billion in equity in 18 months starting November 2016 (time secondary legislation passed).
  - As of Q3 2016 there were 337 smaller cooperative banks (BCCs).
  - Plans under development to consolidate most BCCs into three cooperative banking groups with parent companies: Gruppo Bancario Iccrea, Cassa Centrale Banca and Cassa Centrale Raiffeisen.
  - Cohesion contract provisions and cross-guarantee system described; BCCs maintain full autonomy in customer relations.
- Foundations — April 2015 protocol:
  - Foundations were major shareholders in 23 percent of Italian banking assets in 2014.
  - Protocol set out self-regulating principles; 85 out of 86 existing foundations adhered.
  - Required changes include caps on indebtedness (10 percent of total assets), limits on single-entity exposure (one-third of total assets), bans on use of derivatives (except hedging), and required turnover of management bodies.
  - Disposal timelines for excess exposures as of 22 April 2015:
    - three years for listed financial instruments,
    - five years for non-listed financial instruments.
  - As of 2015, 42 foundations had more than one-third of their assets invested in one bank or banking group: 16 in listed banks and 26 in non-listed banks.
- Measures addressing asset quality also included changes to the insolvency and enforcement framework and state guarantees on certain types of NPL securities.

### III. HOW MUCH COULD BANK PROFITABILITY INCREASE FROM GREATER COST EFFICIENCY? — Data and methodology
- Sample and coverage:
  - Sample: 386 Italian credit institutions with data from S&P Global Market Intelligence, covering about 92 percent of system-wide assets.
  - According to BoI (2016), there were 462 LSIs in 2016 of which the sample covers 372; data are available on all 14 significant institutions.
  - Data year: 2015 annual data from S&P Global are used.
- Variables used or constructed from S&P Global:
  - net interest income/average assets, cost of funds, cost-income ratio, Capital Adequacy Ratio or CAR defined as ((Tier 1 capital +Tier 2 capital)/total risk-weighted assets), credit risk-weighted assets, fee and commission income/operating income, total gross loans, loan loss provisions/operating income, and net operating income.
- Profitability measure:
  - Net return on equity (RoE) based on net interest margins (NIMs), commissions/fee income, and operating expenses after accounting for firm-specific capitalization.
  - Net RoE formula (as described): (1−τ) × CAR_t / RWA_t̅̅̅̅̅̅̅̅ × ((net interest income_t + fees and commissions_t) / average assets_t × (1 − operating cost_t / net income_t) − LLP_t), where τ is the tax rate and LLP denotes reported provisioning.
  - Assumed tax rate: 35 percent for all banks.

### III. Scenario analysis assumptions
- Two scenarios considered:
  - (i) Cyclical recovery:
    - Assumes cyclical recovery continues in line with the Spring 2017 WEO projections.
    - Benchmark short-term interest rate rises by 50 basis points.
    - NIM is assumed to improve by 25 basis points (using historical elasticity for Italy).
    - Provision expenses (in percent of total operating income) halve for each bank within the next five years, assuming recovery proceeds as expected in the Spring 2017 WEO submissions.
    - Average growth is projected to be below 1 percent during the period 2017–22.
  - (ii) Structural reform:
    - Assumes cost-to-income ratio for each bank declines to the median cost-to-income ratio of Italian banks in the sample that enjoyed healthy profitability (above 10 percent) in 2015, except for banks already below that benchmark.
    - This cost-to-income ratio would be 52 percent, approximately the same as the EU median cost-to-income over the last three years based on the EBA sample.
- Bank RoE buckets for each scenario:
  - Net RoE > 10 percent (healthy)
  - 8% ≤ Net RoE ≤ 10% (challenged)
  - Net RoE < 8% (weak)
- Rationale for thresholds:
  - Linked to cost of equity capital estimated between 8 and 10 percent.
  - Mohaddes and others (2017) estimate a tipping point for NPL reduction at 3 percent nominal GDP growth (or 1.2 percent real); years with nominal growth just above 3 percent were associated with RoE above 10 percent.

### III. Results — profitability and cost efficiency
- Cross-sample findings:
  - The vast majority of Italian banks are suffering from weak profitability according to S&P Global 2015 data.
  - Continuation of the modest cyclical recovery will strengthen system profitability but is unlikely to restore large parts of the system to healthy profitability; the banking system will remain vulnerable to adverse shocks.
  - Enhancing operational efficiency and aligning cost-to-income ratios to the best performing Italian banks or the European median will have a significant impact on profitability.
    - Even under structural reform (cost-to-income ratios aligned to benchmark), more than 50 percent of the banking system is still challenged or weak.
  - Other factors, notably the high stock of legacy NPL assets, also need to be addressed to restore widespread healthy profitability.
  - Further cuts in operational costs may be needed for the remaining banks with weak profitability metrics, accounting for about one-fifth of the system.
- Implications for NPL policy:
  - To secure the effectiveness of recent NPL guidance by the SSM, supervisors need to ensure NPL reduction strategies and targets are ambitious and credible.
  - Sizeable NPL sales planned in the coming year need implementation and backing by strong and credible restructuring plans.
  - Complementary measures include advancing insolvency and enforcement reforms and facilitating distressed debt markets.

### IV. Is there room for consolidation to achieve efficiency gains?
- Structure and concentration:
  - Italy had 635 credit firms as of Q2 2016, of which more than half are small cooperative (mutual) banks.
  - Market shares of the five largest credit institutions account for about 40 percent.
  - Herfindahl index is among the lowest in euro area countries.
- Scope for M&As and consolidation:
  - Fragmentation and overcapacity suggest room for M&As, accompanied by downsizing and cost cutting to generate efficiency gains while remaining within “too-big-to-fail” considerations.
  - Empirical evidence is mixed:
    - Many studies fail to find significant evidence that M&As yield economies of scale and cost savings, especially domestically.
    - Cross-border M&As fare somewhat better.
  - Consolidation may harm small business lending in the short term, underscoring the importance of alternative financing channels.
  - Total M&A activity declined significantly in 2013–17 in both number and value versus pre-crisis trends; most transactions have been domestic; cross-border deal share declined further with the crisis.
- Limitations and necessary complementarities:
  - Profitability gains cannot come solely from M&As; growth-enhancing structural reforms and active NPL resolution are also needed.
  - A careful, case-by-case analysis of synergies and viability is required given mixed cross-country experiences.

### V. How to make consolidation successful — policy recommendations
- Supervisory encouragement and oversight of consolidation:
  - Supervisors should take a proactive stance and rigorously challenge:
    - Capital adequacy: ensure emerging banks have adequate capital via ex ante diagnostics or asset quality reviews.
    - New bank business models: test credibility of income and cost assumptions and resilience to liquidity and asset quality shocks.
    - New bank consolidation programs: require granular, ambitious, and credible targets for centralizing risk management, IT, branch/staff rationalization.
    - Governance arrangements: ensure boards and executive committees are staffed with well qualified and experienced people and contain assertive independent directors.
- Address structural rigidities limiting efficiency gains:
  - Labor market rigidities: Jobs Act applies to new contracts and may limit workforce reductions; costly early retirement packages are common.
  - Italian authorities have allocated €500 million over the next three years to help commercial banks finance early retirement schemes.
  - Banks remain responsible for delivering on cost rationalization plans and ambitious labor cost cutting targets.
  - Trade union estimate: FABI expects 16,000 banking jobs will be cut by 2020 of which 9,000 are expected to be early retirement.
- Resolve governance issues and challenge vested interests:
  - Evidence suggests politically connected banks may display higher net interest revenues, lower loan quality, and lower efficiency.
  - Close legislative gaps in Italy’s implementation of the EU fit and proper rules (CRD‑IV); apply 2015 EBA and 2016 ECB guidance in full.
  - Consider a deep review of bank governance: composition and competence of boards, time limits on board participation, requirement for independent chairs of sub-committees, and thematic reviews of related party lending.
  - Planned or ongoing measures: adoption of fit and proper requirements at national level (draft decree prepared); SSM/ECB adopting evaluation criteria on board composition, competence, and political independence.
- Facilitate cross-border consolidation where beneficial:
  - Cross-border M&As can reduce fragmentation, enhance risk pooling, and weaken the country-banking system risk nexus.
  - Obstacles include political/regulatory barriers, national ring-fencing tendencies, legal aspects, and cultural barriers.
  - There may be a role for EU-level policies to facilitate a level playing field for cross-border M&As.

### VI. Conclusion — synthesis of findings
- Fragmentation and heterogeneity:
  - The Italian banking system is fragmented with large heterogeneity across banks: some have above EU average profitability and lower cost-to-income ratios, but most banks are weak.
  - Large dispersion in profitability and cost efficiency exists within and across bank types.
- Need for simultaneous actions:
  - Operational efficiency gains are needed, alongside balance sheet cleanup.
  - Bottom-up analysis of 386 banks suggests cyclical recovery improves profitability but operational efficiency gains are necessary to restore large parts of the system to healthy profitability.
  - Even if all banks achieve cost-to-income ratios in line with the EU median (52 percent), significant parts of the sector remain challenged or weak due to legacy NPLs and other drag factors.
- Role of consolidation:
  - Consolidation can contribute to efficiency gains but is not a panacea.
  - M&As should be part of a comprehensive strategy including growth-enhancing reforms and active NPL resolution.
  - UniCredit has begun capital raising and NPL reduction efforts; it remains to be seen whether others follow.
  - Given mixed international evidence, careful viability and synergy analysis is essential for each M&A case.
- Cross-country experience policy lessons:
  - Enhance governance, tackle vested interests, strengthen supervisory oversight, take prompt corrective action, and address structural rigidities to maximize efficiency gains from consolidation.

*Source: wp17175.*

### References .............................................................................................................

### wp17175 - References

### I. INTRODUCTION — key problems and context
- The Italian banking system suffers from weak profitability and generally poor asset quality.
- Return on equity (RoE) of Italian banks is among the lowest in the EU.
- Legacy asset quality challenge: nonperforming loans (NPLs) are very high at around 21 percent of GDP, although they have declined marginally recently.
- There were substantial write-downs in 2016.
- As of end-2016, the banking sector structure: around 400 consolidated banking groups and about 200 subsidiaries.
- Data sources cited: European Banking Authority (EBA) risk dashboard (198 European banks, 15 Italian) and European Central Bank’s consolidated banking database; caveats noted on comparability.

### II. Recent legislative reforms affecting consolidation
- Timeline and measures:
  - March 2015: legislation required the 10 largest popolare banks (those with assets exceeding €8 billion) to be transformed into joint stock companies by end-2016.
  - February 2016: reforms to smaller cooperative (mutual) banks.
  - April 2015: changes to the governance of foundations (Box 1 referenced).
  - Mutual bank reform: the 355 smaller cooperative banks to consolidate under joint-stock (holding) companies with at least €1 billion in equity in 18 months starting November 2016 (time secondary legislation passed).
- Status and impacts:
  - One merger completed: Banco Popolare and Banca Popolare di Milano in 2016, creating the third largest banking group in Italy.
  - As of Q2 2016, there were 29 BPs in total. The 10 largest BPs with assets above €8 billion account for about 90 percent of the total assets of BPs.
  - The original deadline to complete the popolare transformations was end-2016; eight of the ten largest popolare banks already underwent the transformation to joint stock companies.
  - The reform is currently on hold owing to successful challenges in court, related to compensation of dissenting investors.
  - Expected structural outcome once reforms are fully implemented: a more concentrated banking sector with around 140 consolidated banking groups.
- Measures addressing asset quality also included changes to the insolvency and enforcement framework and state guarantees on certain types of NPL securities.

### III. The case for more banking sector efficiency in Italy — findings on costs and profitability
- Cost and profitability observations:
  - Italian banks have among the highest structural costs among advanced European countries when costs are standardized by total assets.
  - Italian banks spent 2 percent of their assets as operating expenses in 2015, which is significantly above the spending in the other large economies in the euro area, Germany, France, and Spain.
  - When costs are standardized by total operating income, Italian banks are comparable to other large economies such as France and Germany.
  - Cost-to-income ratios for Italian banks are significantly above the EU median.
- Drivers of high costs:
  - Business model: a larger part of assets devoted to lending to households and firms than in other countries.
  - Relatively high number of branches per capita.
  - Personnel expenses.
- Progress to date:
  - Since the beginning of the crisis, branches and headcounts in Italy have decreased by about 10 percent between 2008 and 2015.

### IV. Heterogeneity within the Italian banking system
- There is significant heterogeneity across Italian banks:
  - Some banks have above EU average profitability ratios and lower cost-to-income ratios than the EU average.
  - Other banks are lagging behind (reference to Figure 2).
- Implication: potential efficiency gains may be unevenly distributed and depend on bank-specific characteristics.

### V. Scope and structure of the paper (as presented)
- The paper examines:
  - Whether there is a case for efficiency gains in Italy by comparing Italian banks with European peers and assessing heterogeneity within Italy (Section II).
  - Potential gains in profitability from greater cost efficiency (Section III).
  - Whether bank consolidation can help achieve needed efficiency gains; critical review of the literature on bank consolidation and lessons learned (Section IV).
  - How to make the ongoing consolidation process in Italy as efficient as possible to maximize potential benefits (Section IV continuation).
  - Conclusions (Section V).

*Source: wp17175 - References (excerpts provided).*

### Appendix Figure A1). Both large and small banks suffer from low profitability and high

### III. HOW MUCH COULD BANK PROFITABILITY INCREASE FROM GREATER COST EFFICIENCY?

### Data and Methodology
- Sample: 386 Italian credit institutions with data from S&P Global Market Intelligence, covering about 92 percent of system-wide assets.
- Coverage details: According to BoI (2016), there were 462 LSIs in 2016 of which the sample covers 372; data are available on all 14 significant institutions.
- Data year: 2015 annual data from S&P Global are used.
- Variables used or constructed from S&P Global: net interest income/average assets, cost of funds, cost-income ratio, Capital Adequacy Ratio or CAR defined as ((Tier 1 capital +Tier 2 capital)/total risk-weighted assets), credit risk-weighted assets, fee and commission income/operating income, total gross loans, loan loss provisions/operating income, and net operating income.
- Profitability measure: net return on equity (RoE) based on net interest margins (NIMs), commissions/fee income, and operating expenses after accounting for firm-specific capitalization.
- Net RoE formula (as described): (1−τ) × CAR_t / RWA_t̅̅̅̅̅̅̅̅ × ((net interest income_t + fees and commissions_t) / average assets_t × (1 − operating cost_t / net income_t) − LLP_t), where τ is the tax rate and LLP denotes reported provisioning.
  - Assumed tax rate: 35 percent for all banks.

### Scenario analysis assumptions
- Two scenarios considered:
  - (i) Cyclical recovery:
    - Assumes cyclical recovery continues in line with the Spring 2017 WEO projections.
    - Benchmark short-term interest rate rises by 50 basis points.
    - NIM is assumed to improve by 25 basis points (using historical elasticity for Italy).
    - Provision expenses (in percent of total operating income) halve for each bank within the next five years, assuming recovery proceeds as expected in the Spring 2017 WEO submissions.
    - Average growth is projected to be below 1 percent during the period 2017–22.
  - (ii) Structural reform:
    - Assumes cost-to-income ratio for each bank declines to the median cost-to-income ratio of Italian banks in the sample that enjoyed healthy profitability (above 10 percent) in 2015, except for banks already below that benchmark.
    - This cost-to-income ratio would be 52 percent, approximately the same as the EU median cost-to-income over the last three years based on the EBA sample.
- Bank RoE buckets for each scenario:
  - Net RoE > 10 percent (healthy)
  - 8% ≤ Net RoE ≤ 10% (challenged)
  - Net RoE < 8% (weak)
- Rationale for thresholds:
  - Linked to cost of equity capital estimated between 8 and 10 percent.
  - Mohaddes and others (2017) estimate a tipping point for NPL reduction at 3 percent nominal GDP growth (or 1.2 percent real); years with nominal growth just above 3 percent were associated with RoE above 10 percent.

### Results — Profitability and Cost Efficiency
- Key cross-sample findings:
  - The vast majority of Italian banks are suffering from weak profitability according to S&P Global 2015 data.
  - While a continuation of the modest cyclical recovery will strengthen system profitability, it is unlikely to restore large parts of the system to healthy profitability; the banking system will remain vulnerable to adverse shocks.
  - Enhancing operational efficiency and aligning cost-to-income ratios to the best performing Italian banks or the European median will have a significant impact on profitability.
    - Even under structural reform (cost-to-income ratios aligned to benchmark), more than 50 percent of the banking system is still challenged or weak.
  - Other factors, notably the high stock of legacy NPL assets, also need to be addressed to restore widespread healthy profitability.
  - Further cuts in operational costs may be needed for the remaining banks with weak profitability metrics, accounting for about one-fifth of the system.
- Implications for NPL policy:
  - To secure the effectiveness of recent NPL guidance by the SSM, supervisors need to ensure NPL reduction strategies and targets are ambitious and credible.
  - Sizeable NPL sales planned in the coming year need implementation and backing by strong and credible restructuring plans.
  - Complementary measures include advancing insolvency and enforcement reforms and facilitating distressed debt markets.

### Is there room for consolidation to achieve efficiency gains?
- Structure and concentration:
  - Italy had 635 credit firms as of Q2 2016, of which more than half are small cooperative (mutual) banks.
  - Market shares of the five largest credit institutions account for about 40 percent.
  - Herfindahl index is among the lowest in euro area countries.
- Scope for M&As and consolidation:
  - Fragmentation and overcapacity suggest room for M&As, accompanied by downsizing and cost cutting to generate efficiency gains while remaining within “too-big-to-fail” considerations.
  - Empirical evidence is mixed: many studies fail to find significant evidence that M&As yield economies of scale and cost savings, especially domestically; cross-border M&As fare somewhat better.
  - Consolidation may harm small business lending in the short term, underscoring the importance of alternative financing channels.
  - Total M&A activity declined significantly in 2013–17 in both number and value versus pre-crisis trends; most transactions have been domestic; cross-border deal share declined further with the crisis.
- Limitations and necessary complementarities:
  - Profitability gains cannot come solely from M&As; growth-enhancing structural reforms and active NPL resolution are also needed.
  - A careful, case-by-case analysis of synergies and viability is required given mixed cross-country experiences.

### How to make consolidation successful — policy recommendations
- Supervisory encouragement and oversight of consolidation:
  - Supervisors should take a proactive stance and rigorously challenge:
    - Capital adequacy: ensure emerging banks have adequate capital via ex ante diagnostics or asset quality reviews.
    - New bank business models: test credibility of income and cost assumptions and resilience to liquidity and asset quality shocks.
    - New bank consolidation programs: require granular, ambitious, and credible targets for centralizing risk management, IT, branch/staff rationalization.
    - Governance arrangements: ensure boards and executive committees are staffed with well qualified and experienced people and contain assertive independent directors.
- Address structural rigidities limiting efficiency gains:
  - Labor market rigidities: Jobs Act applies to new contracts and may limit workforce reductions; costly early retirement packages are common.
  - Italian authorities have allocated €500 million over the next three years to help commercial banks finance early retirement schemes.
  - Banks remain responsible for delivering on cost rationalization plans and ambitious labor cost cutting targets.
  - Trade union estimate: FABI expects 16,000 banking jobs will be cut by 2020 of which 9,000 are expected to be early retirement.
- Resolve governance issues and challenge vested interests:
  - Evidence suggests politically connected banks may display higher net interest revenues, lower loan quality, and lower efficiency.
  - Close legislative gaps in Italy’s implementation of the EU fit and proper rules (CRD‑IV); apply 2015 EBA and 2016 ECB guidance in full.
  - Consider a deep review of bank governance: composition and competence of boards, time limits on board participation, requirement for independent chairs of sub-committees, and thematic reviews of related party lending.
  - Planned or ongoing measures: adoption of fit and proper requirements at national level (draft decree prepared); SSM/ECB adopting evaluation criteria on board composition, competence, and political independence.
- Facilitate cross-border consolidation where beneficial:
  - Cross-border M&As can reduce fragmentation, enhance risk pooling, and weaken the country-banking system risk nexus.
  - Obstacles to cross-border M&As include political/regulatory barriers, national ring-fencing tendencies, legal aspects, and cultural barriers.
  - There may be a role for EU-level policies to facilitate a level playing field for cross-border M&As.

### Conclusion — synthesis of findings
- The Italian banking system is fragmented with large heterogeneity across banks:
  - Some Italian banks have above EU average profitability and lower cost-to-income ratios, but most banks are weak.
  - Large dispersion in profitability and cost efficiency exists within and across bank types.
- Operational efficiency gains are needed, alongside balance sheet cleanup:
  - Bottom-up analysis of 386 banks suggests cyclical recovery improves profitability but operational efficiency gains are necessary to restore large parts of the system to healthy profitability.
  - Even if all banks achieve cost-to-income ratios in line with the EU median (52 percent), significant parts of the sector remain challenged or weak due to legacy NPLs and other drag factors.
- Consolidation can contribute to efficiency gains but is not a panacea:
  - M&As should be part of a comprehensive strategy including growth-enhancing reforms and active NPL resolution.
  - UniCredit has begun capital raising and NPL reduction efforts; it remains to be seen whether others follow.
  - Given mixed international evidence, careful viability and synergy analysis is essential for each M&A case.
- Cross-country experience underscores the need to enhance governance, tackle vested interests, strengthen supervisory oversight, take prompt corrective action, and address structural rigidities to maximize efficiency gains from consolidation.

*Source: IMF staff analysis of S&P Global Market Intelligence and related IMF and ECB material as presented in wp17175.*

### Box 1. Recent Reforms to Support Banking System Consolidation

### Box 1. Recent Reforms to Support Banking System Consolidation

### Banche Popolare (BPs, March 2015)
- BPs account for about 14 percent of the banking system.
- Pre-reform governance features:
  - Equal voting rights to all members (one member-one vote).
  - Restrictions on ownership rights (1 percent of capital with larger amounts permitted for institutional investors).
  - Limits on proxy voting.
  - These restrictions hindered market diligence, banks’ capacity to raise capital from outside sources, and made it difficult to change governance structures or replace poorly performing managers.
  - Cooperative ownership restrictions made it virtually impossible to attract strategic investors because they could not acquire management control.
- March 2015 reform measures for BPs with total assets exceeding €8bn:
  - Removed (i) one vote per head and (ii) limitations on the size of individual shareholdings.
  - Banks were granted until end-2016 to transform into joint stock companies.
  - Outcome by end-2016: All but two of the 10 BPs have converted into joint stock companies.
  - Resulted in the merger between Banco Popolare and Banca Popolare di Milano, completed in 2016, creating the third largest banking group in Italy.
  - Note: the reform is currently on hold due to successful challenges in court by dissenting investors.

### Mutual banks (BCCs, February 2016)
- As of Q3 2016 there were 337 smaller cooperative banks (BCCs).
- Reform requirements:
  - Smaller cooperative banks must consolidate under joint-stock (holding) companies with at least €1 billion in equity in 18 months starting November 2016 (the time the secondary legislation was passed).
- Consolidation plans:
  - Plans under development to consolidate most BCCs into three cooperative banking groups.
  - Parent companies should be Gruppo Bancario Iccrea, Cassa Centrale Banca and Cassa Centrale Raiffeisen.
  - Parent company will exercise coordination and develop guidelines towards BCCs based on a cohesion agreement.
- Cohesion contract provisions:
  - Sets out the parent company’s powers to direct and coordinate BCCs belonging to the group, proportional to their risk level and admission requirements.
  - If a BCC breaches strategic orientation and operational objectives, the parent may adopt corrective measures and impose sanctions, including removing and replacing management boards of the BCC and expelling it from the group.
- Operational arrangements:
  - BCCs will maintain full autonomy in their relationship with end customers.
  - There will be common risk management and internal control systems for assessment, prevention, and monitoring of all risks.
  - A cross-guarantee system will be established.

### Foundations (April 2015)
- Context and challenges:
  - Bank ownership by foundations (private, non-profit entities without shareholders and subject to political influence) raised corporate governance challenges and limited opportunities for domestic and international strategic and financial investors (Jassaud, 2014).
  - In 2014, foundations were major shareholders in 23 percent of Italian banking assets through participations in 20 percent or more of bank capital.
  - In several large banks, foundations controlled bank boards with an even smaller share of ownership, often through shareholders’ agreements.
- April 2015 protocol:
  - The Italian Ministry for the Economy and Finance and the Association of Banking Foundations and Saving Banks signed a protocol setting out self-regulating principles applicable to Italian banking foundations on issues including asset management policies and corporate governance.
  - Almost all existing foundations adhered to the protocol: 85 out of 86.
- Required changes and limits:
  - Foundations will implement the protocol principles by amending their by-laws.
  - Principles include:
    - Policies for a prudent asset management.
    - A cap on total indebtedness (i.e., 10 percent of total assets).
    - A ban on the use of derivative instruments (other than those entered into for hedging purposes or without any risk of losses).
    - Corporate governance principles (e.g., required turn-over of management bodies).
  - Exposure limits:
    - Each foundation may not invest, directly or indirectly, more than one-third of its total assets on any single entity or group of entities.
    - Any foundation with investments exceeding the one-third limit as of 22 April 2015 is required to dispose of the excess within the next few years:
      - three years in the event of listed financial instruments, or
      - five years in the event of non-listed financial instruments.
  - As of 2015, 42 foundations had more than one-third of their assets invested in one bank or banking group:
    - 16 are in listed banks and 26 are in non-listed banks.

*Source: wp17175 - Box 1. Recent Reforms to Support Banking System Consolidation*

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_Source: https://www.imf.org/-/media/files/publications/wp/2017/wp17175.pdf_