## 1. Financial Sector Structure, 1992–2002 ## Source details **Canonical URL:** [1. Financial Sector Structure, 1992–2002](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04133.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04133.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04133.pdf.json) --- ### Assessment and methodology - On-site assessment of Italy’s compliance with the Basel Core Principles for Effective Banking Supervision (BCPs) conducted June 16–27, 2003. - Assessment team: Mr. Keith Bell and Ms. Maria Nieto (IMF-led mission). - Overall supervisory observance: compliant with 24 of the 30 BCPs. - Inputs to assessment: - self-assessment by Italian authorities (March 2002); - interviews with senior BI officials and technical teams; - laws, regulations, supervisory documentation; meetings with MoE, ISVAP, Consob, market participants, financial institutions, industry associations, accounting/auditing professions. - Methodology: Core Principles Methodology (Basel Committee, October 1999); based on legislation in force at time of assessment; proposed reforms after mission not addressed. ### Institutional and market structure (1990–2002) - Consolidation and counts: - Number of banks: 1,100 in 1990 → 814 in 2002 (fall of 26 percent). - Mergers and acquisitions: 583 between 1990 and 2002. - 2002 institutional composition (shares of total bank assets): - 253 commercial banks (representing 80 percent of total bank assets); - 461 mutual banks (5 percent of total bank assets); - 40 cooperative banks (11 percent of total bank assets); - 60 branches of foreign banks (4 percent of total bank assets). - Other financial institutions (2002): - 158 securities firms; - 142 asset management companies; - 316 supervised financial companies. - Group concentration (2002): - Groups represented 87 percent of total bank assets; - Top three Italian bank groups: 38 percent of total bank assets; - Top five Italian bank groups: 52 percent of total bank assets. ### Ownership, funding, and sector linkages - Funding structure: - Households hold 70 percent of their liabilities in the form of short-, medium- and long-term bank loans. - Firms hold less than one third of their liabilities in bank loans; around 50 percent of firms’ liabilities are held in shares. - Indebtedness: - Household indebtedness (percent of GDP): 1996 = 19 percent; 2002 = 24 percent. - Corporate total debt to equity: 1996 = 103.4; 2000 = 56.2; 2002 = 68.9. - Holdings of Italian securities (2002): - Italian corporate bonds held by private investors: 95 percent. - Italian government securities held by private investors: 45 percent; nonbank residents: 43 percent; domestic banks: 9 percent. - State ownership: - 1992: state or foundations controlled 66 percent of total bank assets. - 2002: state ownership shrank to 10 percent of total bank assets. - As of end August 2003: Fondazioni lost control in all large bank groups; own majority in only 18 small banks representing less than 4 percent of total bank assets. - Regulatory actions on Fondazioni: - Deadlines and scope modified by decree and appeals; deadlines postponed to December 2004 and extended in August 2003 to December 2005; small Fondazioni with assets below €200 million exempted from compulsory divestment. - Bancassurance and insurance sector (end-2002): - Banks had equity holdings in 74 insurance companies (controlled 32); - Insurance companies held interests in 32 Italian banks (controlling interests in seven small banks representing 0.4 percent of total bank assets). - Total life insurance premium: €26.5 million in 1998 → €55 million in 2002 (representing 4.4 percent of GDP). - Life insurers’ investments: up to 92 percent in bonds and less than one percent in real estate. - Re-insurance: 4.4 percent of total life insurance premium. - Distribution channel (BI survey): in 2002, 80 percent of new life insurance premiums collected through banks’ branches. ### Financial Soundness Indicators (selected, 1996−2002) - Capital adequacy (consolidated): - Regulatory capital to risk-weighted assets: 1996 = 12.2; 1997 = 11.4; 1998 = 11.3; 1999 = 10.6; 2000 = 10.1; 2001 = 10.4; 2002 = 11.2. - Regulatory tier I capital to risk-weighted assets: 1996 = 10.5; 1997 = 9.7; 1998 = 9.4; 1999 = 8.6; 2000 = 7.8; 2001 = 7.8; 2002 = 8.2. - Asset quality: - Nonperforming loans to total gross loans: 1996 = 13.9; 1997 = 12.6; 1998 = 11.8; 1999 = 9.8; 2000 = 7.8; 2001 = 6.7; 2002 = 6.5. - Nonperforming loans net of provisions to capital: 1996 = 64.4; 1997 = 58.4; 1998 = 51.1; 1999 = 38.9; 2000 = 30.1; 2001 = 26.8; 2002 = 25.0. - Loan sectoral distribution to total loans (selected, percent): - General government: 1996 = 9.0; 2002 = 5.3. - Financial corporations: 1996 = 11.4; 2002 = 14.6. - Nonfinancial corporations and sole proprietorships: 1996 = 63.3; 2002 = 59.1. - Consumer households: 1996 = 16.3; 2002 = 21.0. - Profitability: - Return on assets: 1996 = 0.2; 1997 = 0.1; 1998 = 0.5; 1999 = 0.6; 2000 = 0.8; 2001 = 0.6; 2002 = 0.5. - Return on equity: 1996 = 0.3; 1997 = 1.5; 1998 = 7.4; 1999 = 9.6; 2000 = 11.5; 2001 = 8.8; 2002 = 6.2. - Income composition and costs: - Interest margin to gross income: 1996 = 75.7; 1997 = 71.6; 1998 = 60.6; 1999 = 55.0; 2000 = 52.2; 2001 = 52.3; 2002 = 56.7. - Noninterest expenses to gross income: 1996 = 66.8; 1997 = 68.8; 1998 = 60.8; 1999 = 60.8; 2000 = 55.9; 2001 = 55.3; 2002 = 59.8. - Liquidity: - Liquid assets to total assets: 1996 = 13.3; 2002 = 7.8. - Liquid assets to short-term liabilities: 1996 = 43.4; 2002 = 23.4. - Market risk and positions: - Net open position in foreign exchange to capital (consolidated): 1997 = 5.9; 2002 = 3.9. - Gross asset position in financial derivatives to capital: 1996 = 21.6; 2002 = 46.8. - Gross liability position in financial derivatives to capital: 1996 = 21.5; 2002 = 44.9. - Trading and personnel: - Trading income to total income: 1996 = 10.5; 2002 = 2.1. - Personnel expenses to noninterest income: 1996 = 64.0; 2002 = 54.6. - Lending spreads (average new loans): - Household lending spread: 1996 = 5.0; 2002 = 3.0. - Corporate lending spread: 1996 = 2.9; 2002 = 2.1. - Customer deposits and bonds to total (noninterbank) loans: 1996 = 127.1; 2002 = 103.7. - Foreign currency indicators (percent): - Foreign currency-denominated loans to total loans: 1996 = 8.3; 2002 = 4.2. - Foreign currency-denominated deposits to total deposits: 1996 = 3.3; 2002 = 4.7. - Nonbank sector size: - Nonbank assets to total financial system assets: 1996 = 21.3; 2002 = 34.6. - Nonbank assets to GDP: 1996 = 39.8; 2002 = 85.5. - Household sector: - Household debt to GDP - Italy: 1996 = 18.6; 2002 = 24.1. - Household debt service and principal payments to income: 1996 = 1.8; 2002 = 1.7. - Real estate: - Residential real estate prices (1990=100, deflated by CPI): 1996 = 97.9; 2002 = 106.9. - Residential real estate loans to total loans: 1999 = 7.5; 2002 = 10.3 (alternate row shows 12.0 for 2002). - Commercial real estate loans to total loans: 1996 = 9.5; 2002 = 6.9. ### Observed resilience and challenges - BI analytical work and stress tests indicate high degree of resilience to macroeconomic shocks. - Key ongoing challenges identified: - managing high level of nonperforming loans; - maintaining adequate provisions for credit losses; - sustaining cost-cutting and restructuring efforts. ### Asset quality, credit exposures, and capital adequacy (highlights) - Nonperforming loans net of provisions to capital: fell to 25 percent in 2002 from 64 percent in 1996 but remains high relative to other European countries. - Non-performing loans (“sofferenze”) and Substandard Loans (“incagli”): account for 3 percent of banks’ assets. - Nonperforming loans to total loans: fell from 14 percent in 1996 to 6.5 percent in 2002, partly due to tax incentives and securitization. - Credit exposure breakdown (2002): - Nonfinancial sector: 59 percent; - Household sector: 21 percent; - Financial sector: 15 percent; - Government sector: 5 percent. - Capital increases (largest 14 bank groups, 2000–2002): - Tier 1 capital ratio: 5.4 percent → 6.1 percent. - Overall capital ratio: 8.7 percent → 10.3 percent. - System solvency ratio: 12 percent in 1994; 10.1 percent in 2000; 11.2 percent in December 2002. - BI target outcomes (2001–2002): number achieving Tier 1 target of 6 percent rose from four to seven; number achieving overall capital target of 10 percent remained at six. ### Costs, income and structural pressures - Non-interest expenses to gross income: 1996 = 67 percent; 2001 = 55 percent; 2002 = 60 percent (increase attributed to poor financial markets and slower commission income). - Net interest income trend: declined generally since 1996. - Operating profits: fell by 7.5 percent in 2002. - Return on equity: 6.2 percent in 2002. - Branch network: 26,300 in 1998 → 29,900 in 2002 (most branches are small). - Structural implication: low interest rate environment with sticky deposit rates implies further margin pressure unless operating costs fall sharply or productivity increases; consolidation to achieve critical mass judged important. ### BI monitoring, surveillance and stress testing - Central Credit Registry (CCR) records: - customer loans above €75,000 and all bad debts; - sample interest rates covering ~70 percent of all short-term loans. - BI matches CCR data with Company Account Data Service (40,000 firms) and Cerved Data Service (500,000 firms). - PATROL rating methodology covers five components: capital adequacy, asset quality, organization, profitability, liquidity; overall rating derived with qualitative input. - Macroprudential monitoring includes credit, market, country, and interest rate risk with “bottom-up” approach, one-year default probability (PD) estimates, model simulations, and yearly stress tests. - Credit risk stress tests include: - (i) direct effects of macro shocks similar to 1993–94 corporate deterioration; - (ii) consistency checks between loan interest rate differentials and regulatory capital cost by risk category under Basel II; - (iii) probability of downgrade in PATROL rating. - BI intends to extend macroeconomic model to incorporate real–financial linkages. - Model validation: two banks (accounting for ~30 percent of system assets) had market risk models validated by BI; additional banks in process. ### Basel II, IAS transition, securitization, and credit risk management - Italy allowed five-year transition to use 180-day past-due default definition (instead of 90 days) under Basel II, reflecting local credit-granting and loan recovery specifics. - Large banks advanced in Basel II and IAS preparation with BI and ABI support; BI works with major banks to strengthen data systems and credit processes for IRB adoption. - Securitization monitored comprehensively through extensive reporting; BI’s approach allows accurate capital assessment for securitizations and facilitates Basel II treatment. ### Insurance and securities supervision (summary) - ISVAP: autonomous public institution since 1998; supervises solvency, sector development, transparency and customer fairness; conducts off-site and on-site exams; challenges include consolidated supervision and prevention of cross-sectoral regulatory arbitrage. - Consob: supervises securities market transparency, disclosure by listed companies, prospectus accuracy, auditors’ compliance; investigates insider dealing and market manipulation. ### Basel Core Principles (BCPs) assessment — summary findings - Grouping: BCPs grouped into preconditions, licensing/structure, prudential regulations, ongoing supervision, information requirements, formal powers, cross-border banking. - Overall observance: - Compliant with 24 BCPs; - Largely compliant with 5 BCPs: BCP 8 (Loan Evaluation and Loan-Loss Provisioning); BCP 10 (Connected Lending); BCP 14 (Internal Control Audit); BCP 19 (Validation of Supervisory Information); BCP 21 (Accounting Standards); - Non-compliant with 1 BCP: BCP 1(5) (Legal Protection for Supervisors). - Key prudential concerns and recommendations summarized below. ### Key prudential concerns and recommendations (selected) - Loan classification and provisioning: - Impairment recognition and cessation of interest accrual appear later in Italy than in other G–7 countries. - Recommendation: BI to consider revising supervisory instructions on loan classification to align more closely with G–7 practice and provide further guidance on provisioning policies; issue administrative guidelines pending legislative changes. - Connected lending: - No comprehensive definition or limits on connected lending; no statutory/regulatory requirement that exposures to connected parties be on market terms. - Recommendation: authorities strongly recommended to issue comprehensive regulation on connected lending covering definition, overall limits, and reporting to the BI. - Internal controls and supervisory powers: - Supervisory authority lacks clear legal authority to require expeditious change in board/management composition when incumbents no longer meet “fit and proper” criteria. - Recommendation: consider amending 1993 BL to legally empower BI to remove unfit directors/officers expeditiously. - External audit and validation: - BI should review means to derive greater benefit from external auditors’ work; consider authority to revoke external auditors’ appointment and to establish audit scope/standards. - Noted that 166 out of 814 banks are required to have accounts audited (as of December 2002); about 180 voluntarily audited; ~470 banks do not produce audited financial statements (mostly very small). Banks subject to external audit account for over 90 percent of system assets. - Insolvency and loan recovery: - Corporate insolvency regime: legal proceedings 6 to 7 years; recovery rates around 38 percent gross of legal fees; private out-of-court arrangements: 2 years horizon and 70 percent recovery of unsecured assets. - Recommendation: significant legal framework changes needed to reduce cost/time of loan recovery and contain LGD. - Deposit insurance (IDPF): - Coverage: up to €103,291 per depositor (EU Directive minimum €20,000). - Member commitment: ranges between 0.4 percent and 0.8 percent of total reimbursable funds (or of €332 billion). - IDPF funded ex-post; IDPF interventions limited to when bank under special administration; IDPF has been activated in six cases since creation. ### BI Recommended Action Plan (selected principles and actions) - BCP 1.5 (Legal protection): consider legislative amendments to provide legal protection to supervisors and officers for acts in good faith. - BCP 8 (Loan evaluation/provisioning): align rules over time with 90-day past-due practice; revise instructions to better align provisioning with estimated portfolio losses. - BCP 10 (Connected lending): issue comprehensive regulation on connected lending (definition, limits, reporting). - BCP 14 (Internal control/audit): consider amending 1993 BL to empower BI to remove unfit directors/senior officers. - BCP 19 (Validation of supervisory information): derive greater benefit from external auditors; expand mandatory audit coverage; consider power to revoke external auditors and set audit scope/standards; review resource adequacy. - BCP 21 (Accounting standards): linked to BCP 8 recommendation. ### Authorities’ response (summary) - BI considers assessment recognizes high compliance and effectiveness of supervisory system; commits to take steps to meet recommendations. - BI notes some changes require legislative amendments or ICCS guidance; BI has already initiated steps toward more objective loan classification criteria consistent with Basel II and argues CCR data mitigates late downgrading. - BI does not agree that existing classification criteria necessarily overestimate bank income. ### BI empirical points on interest recognition and provisioning - All interest on bad loans is considered interest on arrears and is effectively totally provisioned. - For sub-standard loans, banks estimate recoverable amount; amounts in excess are provisioned. - For other past-due loans, “penalty interest” provisioned largely (70 percent per survey covering 80 percent of banks by assets); 80 percent of “other past-due loans” become current within one year. *Source: IMF staff assessment based on documentation and Bank of Italy data contained in the chapter “1. Financial Sector Structure, 1992–2002.”* ### 1. Financial Sector Structure, 1992–2002............................................................................... ### 1. Financial Sector Structure, 1992–2002 ### Assessment and methodology - On-site assessment of Italy’s compliance with the Basel Core Principles for Effective Banking Supervision (BCPs) was conducted June 16–27, 2003 by Mr. Keith Bell and Ms. Maria Nieto as part of an IMF-led mission. - The supervisory system achieved full compliance with 24 of the 30 BCPs. - The Banca d’Italia (BI) performs comprehensive off-site monitoring integrated with a cycle of on-site inspections: - Small banking institutions without significant weaknesses: inspections on a three-year cycle. - Large banks: inspection cycle not more than six years historically; recently shortened (including thematic inspections) to no longer than three years for large bank groups. - Areas recommended for further regulatory strengthening include: - loan evaluation and loan-loss provisioning, - connected lending, - legal protection of supervisors. - Assessment inputs included: - a self-assessment prepared by the Italian authorities in March 2002; - interviews with senior BI officials and technical teams; - laws, regulations, and documentation on supervisory framework and financial sector structure; - meetings with MoE, ISVAP, Consob, market participants, financial institutions, industry associations, and accounting/auditing professions. - The assessment follows the Core Principles Methodology (Issued by the Basel Committee, October 1999) and is based on legislation in force at the time of assessment. Proposed reforms initiated after the mission but before final publication were not addressed. ### Institutional and market structure overview - Consolidation since 1990: - Number of banks fell by 26 percent from 1,100 in 1990 to 814 in 2002. - 583 mergers and acquisitions took place between 1990 and 2002. - 2002 institutional composition: - 253 commercial banks (representing 80 percent of total bank assets); - 461 mutual banks (5 percent of total bank assets); - 40 cooperative banks (11 percent of total bank assets); - 60 branches of foreign banks (4 percent of total bank assets). - Other financial institutions in 2002: - 158 securities firms; - 142 asset management companies; - 316 supervised financial companies. - Group concentration (2002): - Groups represented 87 percent of total bank assets; - Top three Italian bank groups accounted for 38 percent of total bank assets; - Top five Italian bank groups accounted for 52 percent of total bank assets. ### Ownership, funding, and sector linkages - Banks as core funding source: - Households hold 70 percent of their liabilities in the form of short-, medium- and long-term bank loans. - Firms hold less than one third of their liabilities in bank loans; around 50 percent of firms’ liabilities are held in shares. - Household and corporate indebtedness: - Household indebtedness (percent of GDP) rose from 19 percent in 1996 to 24 percent in 2002. - Corporate sector leverage (debt as a percent of equity) fell from 103 percent in 1996 to 56 percent in 2000, then rose to 69 percent in 2002. - Holdings of Italian securities: - Italian corporate bonds are held primarily by private investors (95 percent). - Italian government securities are held by private investors (45 percent), nonbank residents (43 percent) and domestic banks (9 percent). - State ownership reduction: - In 1992 banks controlled by the state or by foundations accounted for 66 percent of total bank assets. - By 2002 state ownership shrank to 10 percent of total bank assets. - As of end August 2003, Fondazioni have lost control in all large bank groups and own a majority stake in only 18 small banks representing less than 4 percent of total bank assets. - Regulatory actions affecting Fondazioni: - Government measures required sale or management constraints for majority shareholdings and board appointment limitations; deadlines and scope were modified by decree and appeals (deadlines postponed to December 2004 and extended in August 2003 to December 2005; small Fondazioni with assets below €200 million exempted from compulsory divestment). - Bank income diversification and bancassurance: - At the start of the 1990s, over 75 percent of banks’ gross income came from deposit-taking and lending; ten years later net interest income accounted for 52 percent of gross income. - Cross-linkages with insurance mainly via commercial agreements allowing banks to sell standard life insurance products; creation of major bancassurance groups had not occurred by end-2002. - End-2002: banks had equity holdings in 74 insurance companies (controlled 32); insurance companies held interests in 32 Italian banks (controlling interests in seven small banks representing 0.4 percent of total bank assets). - Life insurance industry growth: - Total premium rose from €26.5 million in 1998 to €55 million in 2002, representing 4.4 percent of GDP. - End-2002: 202 insurance companies operating (life and nonlife), eight incorporated abroad, ten listed. - Life insurers’ investments: up to 92 percent in bonds and less than one percent in real estate. - Re-insurance accounts for 4.4 percent of total life insurance premium. - Distribution channel for life insurance (BI survey): - In 2002, 80 percent of new life insurance premiums were collected through banks’ branches. ### Financial Soundness Indicators (FSIs), 1996−2002 (selection of reported indicators) - Capital adequacy (consolidated): - Regulatory capital to risk-weighted assets: 1996 = 12.2; 1997 = 11.4; 1998 = 11.3; 1999 = 10.6; 2000 = 10.1; 2001 = 10.4; 2002 = 11.2. - Regulatory tier I capital to risk-weighted assets: 1996 = 10.5; 1997 = 9.7; 1998 = 9.4; 1999 = 8.6; 2000 = 7.8; 2001 = 7.8; 2002 = 8.2. - Asset quality: - Nonperforming loans to total gross loans: 1996 = 13.9; 1997 = 12.6; 1998 = 11.8; 1999 = 9.8; 2000 = 7.8; 2001 = 6.7; 2002 = 6.5. - Nonperforming loans net of provisions to capital: 1996 = 64.4; 1997 = 58.4; 1998 = 51.1; 1999 = 38.9; 2000 = 30.1; 2001 = 26.8; 2002 = 25.0. - Loan sectoral distribution to total loans (selected): - General government: 1996 = 9.0; 1997 = 8.8; 1998 = 8.0; 1999 = 7.6; 2000 = 6.4; 2001 = 5.8; 2002 = 5.3. - Financial corporations: 1996 = 11.4; 1997 = 12.7; 1998 = 12.5; 1999 = 13.0; 2000 = 14.5; 2001 = 14.7; 2002 = 14.6. - Nonfinancial corporations and sole proprietorships: 1996 = 63.3; 1997 = 61.7; 1998 = 61.3; 1999 = 59.4; 2000 = 59.2; 2001 = 59.3; 2002 = 59.1. - Consumer households: 1996 = 16.3; 1997 = 16.8; 1998 = 18.2; 1999 = 20.0; 2000 = 19.9; 2001 = 20.2; 2002 = 21.0. - Large exposures to capital (consolidated): 1996 = 63.7; 1997 = 66.5; 1998 = 44.7; 1999 = 66.1; 2000 = 66.9; 2001 = 66.8; 2002 = 60.2. - Profitability: - Return on assets: 1996 = 0.2; 1997 = 0.1; 1998 = 0.5; 1999 = 0.6; 2000 = 0.8; 2001 = 0.6; 2002 = 0.5. - Return on equity: 1996 = 0.3; 1997 = 1.5; 1998 = 7.4; 1999 = 9.6; 2000 = 11.5; 2001 = 8.8; 2002 = 6.2. - Income composition and costs: - Interest margin to gross income: 1996 = 75.7; 1997 = 71.6; 1998 = 60.6; 1999 = 55.0; 2000 = 52.2; 2001 = 52.3; 2002 = 56.7. - Noninterest expenses to gross income: 1996 = 66.8; 1997 = 68.8; 1998 = 60.8; 1999 = 60.8; 2000 = 55.9; 2001 = 55.3; 2002 = 59.8. - Liquidity: - Liquid assets to total assets: 1996 = 13.3; 1997 = 11.8; 1998 = 12.9; 1999 = 11.3; 2000 = 8.9; 2001 = 8.7; 2002 = 7.8. - Liquid assets to short-term liabilities: 1996 = 43.4; 1997 = 36.9; 1998 = 37.2; 1999 = 34.0; 2000 = 27.1; 2001 = 26.0; 2002 = 23.4. - Market risk and positions: - Net open position in foreign exchange to capital (consolidated): 1997 = 5.9; 1998 = 5.2; 1999 = 4.4; 2000 = 5.6; 2001 = 4.9; 2002 = 3.9. - Gross asset position in financial derivatives to capital: 1996 = 21.6; 1997 = 31.3; 1998 = 31.3; 1999 = 25.6; 2000 = 36.8; 2001 = 50.8; 2002 = 46.8. - Gross liability position in financial derivatives to capital: 1996 = 21.5; 1997 = 31.9; 1998 = 32.7; 1999 = 25.1; 2000 = 25.2; 2001 = 37.0; 2002 = 44.9. - Trading and personnel: - Trading income to total income: 1996 = 10.5; 1997 = 8.8; 1998 = 9.1; 1999 = 5.1; 2000 = 3.9; 2001 = 3.5; 2002 = 2.1. - Personnel expenses to noninterest income (selected): 1996 = 64.0; 1997 = 62.1; 1998 = 60.4; 1999 = 58.4; 2000 = 56.3; 2001 = 54.5; 2002 = 54.6. - Lending spreads (average new loans): - Household lending spread: 1996 = 5.0; 1997 = 4.4; 1998 = 3.1; 1999 = 3.1; 2000 = 3.0; 2001 = 3.3; 2002 = 3.0. - Corporate lending spread: 1996 = 2.9; 1997 = 2.0; 1998 = 1.4; 1999 = 2.2; 2000 = 2.3; 2001 = 2.2; 2002 = 2.1. - Customer deposits and bonds to total (noninterbank) loans: 1996 = 127.1; 1997 = 120.0; 1998 = 116.4; 1999 = 107.8; 2000 = 100.3; 2001 = 100.0; 2002 = 103.7. - Foreign currency indicators: - Foreign currency-denominated loans to total loans: 1996 = 8.3; 1997 = 9.4; 1998 = 9.1; 1999 = 5.9; 2000 = 6.1; 2001 = 5.5; 2002 = 4.2. - Foreign currency-denominated deposits to total deposits: 1996 = 3.3; 1997 = 4.3; 1998 = 4.3; 1999 = 4.1; 2000 = 4.5; 2001 = 4.5; 2002 = 4.7. - Nonbank financial institutions and system size: - Nonbank assets to total financial system assets: 1996 = 21.3; 1997 = 26.2; 1998 = 34.4; 1999 = 37.4; 2000 = 36.9; 2001 = 36.6; 2002 = 34.6. - Nonbank assets to GDP: 1996 = 39.8; 1997 = 53.2; 1998 = 76.7; 1999 = 92.3; 2000 = 92.3; 2001 = 89.8; 2002 = 85.5. - Corporate sector indicators: - Total debt to equity: 1996 = 103.4; 1997 = 86.9; 1998 = 73.4; 1999 = 57.2; 2000 = 56.2; 2001 = 65.9; 2002 = 68.9. - Number of applications for protection from creditors (Special administration and private preemptive agreements): 1999 = 1,255; 2000 = 1,164; 2001 = 571; 2002 = 605; (note table shows 883 in a later column). - Household sector: - Household debt to GDP - Italy: 1996 = 18.6; 1997 = 19.0; 1998 = 19.8; 1999 = 22.0; 2000 = 22.8; 2001 = 22.9; 2002 = 24.1. - Household debt service and principal payments to income (selected years): 1996 = 1.8; 1997 = 1.7; 1998 = 1.6; 1999 = 1.3; 2000 = 1.8; 2001 = 1.9; 2002 = 1.7. - Real estate markets: - Residential real estate prices (1990=100, deflated by CPI) — Residential: 1996 = 97.9; 1997 = 98.5; 1998 = 94.6; 1999 = 92.3; 2000 = 93.6; 2001 = 98.3; 2002 = 106.9. - Residential real estate loans to total loans (selected): 1999 = 7.5; 2000 = 8.3; 2001 = 9.6; 2002 = 10.3; another entry shows 12.0 for 2002 in a separate row. - Commercial real estate loans to total loans: 1996 = 9.5; 1997 = 8.6; 1998 = 8.3; 1999 = 7.6; 2000 = 7.0; 2001 = 6.8; 2002 = 6.9. ### Observed resilience and challenges - BI analytical work and stress tests suggest a high degree of resilience of the Italian banking system to possible macroeconomic shocks. - Mission did not perform an independent assessment of sector soundness; BI FSIs and model simulations indicate key challenges: - managing the high level of nonperforming loans, - maintaining adequate provisions for credit losses, - sustaining cost-cutting and restructuring efforts. *Source: IMF staff assessment based on documentation and Bank of Italy data contained in the chapter “1. Financial Sector Structure, 1992–2002.”* ### 14. Despite significant improvements over the last few years, the quality of banks’ ### 14. Despite significant improvements over the last few years, the quality of banks’ ### Asset quality and credit exposures - The ratio of nonperforming loans net of provisions to capital fell to 25 percent in 2002 from its record high of 64 percent in 1996, but remains high relative to other European countries. - Non-performing loans (“sofferenze”) and Substandard Loans (“incagli”) account for 3 percent of banks’ assets. - Partly due to tax incentives and securitization, the ratio of nonperforming loans to total loans fell from its record high of 14 percent in 1996 to 6.5 percent in 2002. - Securitization has allowed some Italian banks to reduce the level of problem loans and better manage credit risk. - Credit exposure of the banking system in 2002: - Nonfinancial sector: 59 percent - Household sector: 21 percent - Financial sector: 15 percent - Government sector: 5 percent - Risk factors noted: continuing slow economic growth in Italy and abroad, and increasing corporate indebtedness (Corporate sector debt-to-equity ratio increased to 69 percent in 2002 from 56 percent in 2000) could pressure loan portfolio quality. ### Capital adequacy and solvency - In response to BI calls, between 2000 and 2002 the largest 14 bank groups increased: - Tier 1 capital ratio from 5.4 percent to 6.1 percent - Overall capital ratio from 8.7 percent to 10.3 percent - The solvency ratio of the banking system: - 12 percent in 1994 - 10.1 percent in 2000 - 11.2 percent in December 2002 - BI encouraged 14 largest bank groups in 2001 to reach capital adequacy targets of 6 percent for Tier 1 ratios and 10 percent for overall capital ratios; in 2002, the number achieving target values rose from four to seven for core capital and remained at six for overall capital. ### Costs, income, profitability, and operational structure - Since mid-1990s banks reduced operating expenditures; non-interest expenses to gross income: - 67 percent in 1996 - 55 percent in 2001 - 60 percent in 2002 (increase due to poor financial markets and slower commission-related income) - Net interest income declined generally since 1996. - Operating profits fell by 7.5 percent in 2002. - Return on equity declined to 6.2 percent. - Branch network: number of bank branches increased from 26,300 in 1998 to 29,900 in 2002; most branches are small. - In a low interest rate environment with sticky deposit rates, further falls in interest rates would primarily reduce interest rate margins; mitigating this requires sharp reduction in operating costs or increased productivity. ### Consolidation and structural change - Prospects for costs and income, combined with structural changes, create pressures for further consolidation. - Achieving critical mass is identified as a key factor for banks to face future industry challenges. ### BI monitoring, microprudential and macroprudential surveillance - BI has a highly comprehensive reporting system requiring detailed data domestically and for foreign branches, on individual and consolidated bases. - Central Credit Registry (CCR) records detailed monthly information on: - customer loans above a certain amount (€75,000) - all bad debts - interest rates on individual loans for a sample covering approximately 70 percent of all short-term loans - BI matches CCR credit information with financial statements from private databases: - Company Account Data Service: balance sheet and income statements for 40,000 medium-and large-sized nonfinancial corporations - Cerved Data Service: slightly less detailed information for 500,000 nonfinancial institutions - Microprudential monitoring: - PATROL rating methodology covers five components: capital adequacy, asset quality, organization, profitability, and liquidity; an overall rating is derived from these plus qualitative information. - Macroprudential monitoring: - BI examines credit risk, market risk, country risk, and interest rate risk using a “bottom-up” approach. - For credit risk, BI monitors bad loans and sectoral exposures and estimates one-year default probabilities (PDs) over one business cycle for corporate borrowers; conducts model simulations and yearly stress tests. - For interest rate risk, BI conducts periodic stress tests according to the standard Basel procedure, estimating economic loss as a share of regulatory capital for a shift in the yield curve (from 100 b.p. to 60 b.p.). - BI measures market risk exposures continuously and assesses country risk quarterly. ### Stress testing and model validations - BI conducts three types of tests in credit risk work: - (i) direct effects on banks’ balance sheets of a macroeconomic shock similar to Italy’s 1993–94 corporate deterioration; - (ii) consistency between loan interest rate differentials and the cost of regulatory capital by risk categories and borrowers’ size as implied by Basel II; - (iii) probability of a bank being downgraded in PATROL (CAMEL) rating. - BI intends to extend its macroeconomic model to incorporate linkages between the real sector and financial sector for credit risk impact. - Two banks, accounting for roughly 30 percent of the system’s total assets, have had their market risk models validated by the BI; a few more banks are in the process of submitting models. ### Basel II, IAS transition, and credit risk management - Preparations for Basel II and adaptations for new IAS have pushed strengthening of credit risk management. - Large banks are at an advanced stage of Basel II and IAS preparation, supported by BI and ABI. - Reflecting Italian credit-granting and loan recovery specifics, Italy was allowed a five-year transition to use 180-day past-due as the basis for estimating default rates instead of the 90-day past-due criteria in Basel II; this transition provides time to align credit practices, monitoring, and loan recovery with international practices. - BI works with major banks to strengthen data systems and credit processes to adopt the IRB approach; most large banks are already using internal rating systems for corporate credit evaluation. - Securitization is monitored comprehensively via extensive reporting requirements; BI’s regulatory approach allows accurate assessment of capital requirements for securitizations and facilitates Basel II adoption on securitization. ### Insurance and securities supervision - ISVAP supervises all insurance undertakings; since 1998 it is a fully autonomous public institution. - ISVAP responsibilities: solvency of insurance companies, sound development of insurance sector, transparency and fairness in customer relations. - ISVAP conducts off-site (annual accounts and market data) and on-site examinations; it can propose sanctions to the Ministry of Production Activities and impose them. - Major supervisory challenges: implementation of supervision on a consolidated basis; prevention of cross-sectoral regulatory arbitrage; adoption of risk management techniques for new financial products such as securitization operations. - ISVAP notes insurance companies are not yet major sellers of credit risk insurance through Special Purpose Vehicles (SPVs). - Consob supervises and regulates the securities market to ensure transparency, full and accurate disclosure by listed companies, prospectus accuracy, and compliance by auditors; it investigates insider dealing and market manipulation. Consob manages operating expenses autonomously; annual accounts audited by State Audit Office. ### Basel Core Principles (BCPs) assessment — summary findings - The 30 BCPs are grouped into seven categories: preconditions for effective supervision (BCP 1(1)–1(6)); licensing and structure (BCPs 2–5); prudential regulations and requirements (BCPs 6–15); methods of ongoing supervision (BCPs 16–20); information requirements (BCP 21); formal powers of supervisors (BCP 22); cross-border banking (BCPs 23–25). - Overall observance: - Compliant with 24 BCPs - Largely compliant with 5 BCPs (BCP 8 Loan Evaluation and Loan-Loss Provisioning; BCP 10 Connected Lending; BCP 14 Internal Control Audit; BCP 19 Validation of Supervisory Information; BCP 21 Accounting Standards) - Non-compliant with 1 BCP (BCP 1(5) Legal Protection for Supervisors) - Preconditions and institutional arrangements: - Broad objectives and responsibilities of credit authorities are set in legislation; ICCS issues broad guidelines; BI has operational independence for day-to-day supervisory methods (BCP 1(1), BCP 1(2)). - BI has legal responsibility to promote competition and foster financial stability (1993 BL, Art.5(1)). - BI’s supervisory program covers on- and off-site prudential supervision of deposit-taking institutions and other financial companies, transparency controls, promotion of competition, and cooperation with judicial authorities to prevent financial crime (BCP 1(2)). - Legal framework for entry of credit institutions and enforcement powers of supervisors is satisfactory (BCP 1(3), BCP 1(4)); coordination among BI, ISVAP, Consob, COVIP, and UIC is required and MoUs exist for cross-border information exchange (BCP 1(6)). - The system lacks legal protection for supervisors against court proceedings for measures adopted in good faith; BI’s practice to cover legal defense costs is not equivalent to statutory legal protection (BCP 1(5)). ### Key prudential concerns and recommendations - Loan classification and provisioning: - Impairment recognition and cessation of interest accrual appear later in Italy than in other G–7 countries; BI guidance on classification of ‘substandard loans’ leaves scope for banks to overstate performing loans and income, though CCR monitoring mitigates this. - On-site inspections (cycle up to six years for large banks, three years if thematic inspections counted) often lead to BI downward re-classification of loans. - Recommendation: BI may consider revising supervisory instructions on loan classification to align more closely with G–7 practice and provide further guidance on provisioning policies. - BI acknowledges need for more stringent objective criteria for classification of impaired loans, notably “substandard” loans. - Connected lending: - No comprehensive definition or limits on connected lending; discretion is granted to supervisors only in large exposure contexts. - No statutory or regulatory requirement that exposures to connected or related parties be granted on market terms; no special reporting or limits except within large exposure rules. - Authorities are strongly recommended to issue comprehensive regulation on connected lending covering definition, overall limits, and reporting to the BI. - Internal controls and supervisory powers: - Supervisory framework for internal controls and risk management satisfactory, but supervisory authority lacks clear legal authority to require expeditious change in board/management composition when incumbents no longer meet “fit and proper” criteria. - Securitization oversight: - BI monitors securitization comprehensively with extensive reporting; approach allows accurate capital assessment and facilitates Basel II securitization treatment. *Source: IMF staff report text (excerpt)._cr04133 - 14. Despite significant improvements over the last few years, the quality of banks’* ### 34. The information available to the supervisor for monitoring and early detection ### _cr04133 - 34. The information available to the supervisor for monitoring and early detection ### Supervisory information, on‑site and off‑site monitoring - Integrated on-site inspections and off-site analysis (BCP 16), detailed statistical data requirements (BCP 18), and frequent contact with banks’ management and staff (BCP 17) enable the BI to remain well informed on banks’ financial condition and management quality. - The BI can request auditors to examine specific aspects of banks’ financial accounts but does not rely on external auditors for on-site inspections (BCP 19). - On-site inspection cycle: - Small banking institutions without significant weaknesses: inspections on a three-year cycle. - Large banks: inspections previously at longer intervals (not more than six years), recently shortened to no longer than three years when thematic inspections are taken into account. - Recommendation: BI should review means to derive greater benefit from external auditors’ work, including revising the 1993 BL to obtain authority to revoke external auditors’ appointment and to establish standards for external audits and scope of bank audit programs. - BI should continue to keep the adequacy of resources under review in light of rapid changes in the banking industry and risk management technology. ### External audit coverage and supervisory reporting - No requirement for banks that do not issue securities listed on a regulated exchange to have external auditors validate key supervisory reports, aggregates, or full financial statements. - Current audit coverage (as of December 2002): - 166 out of 814 banks are required to have their accounts audited (banks with securities listed on a regulated exchange and banks controlled by them). - About a further 180 banks have accounts audited on a voluntary basis. - Approximately 470 banks do not produce audited financial statements (mostly very small). - Asset concentration: - Banks subject to external audit account for over 90 percent of the system’s total assets. - Regulatory change noted: - The current requirement for audit of accounts by external auditing firms is to be further expanded in January 2004. - Disclosure requirement: Supervisory instructions require banks to disclose loans and guarantees granted to General Managers, members of the Board of Directors and Board of Statutory Auditors. ### Inspection methodologies and thematic work - For large banks, BI may extend the use of statistical sampling methodologies for evaluating credit risk of homogeneous loan categories (currently applied only to consumer credit banks) to ensure statistically representative assessment of credit risk. - Scope for thematic inspections could be expanded. ### Accounting standards and loan‑loss recognition (BCP 21) - Accounting rules and regulations are in line with EU Directives. - Mission’s discussions indicate the system in use delays recognition of impairment and suspension of income recognition from impaired loans. - Transition and standards: - Italian banks will have a transition period of five years to move to the Basel II “default” definition. - Adoption of the new IAS in 2005 (in particular IAS 39) will help align loan‑loss recognition with international practices. ### Formal enforcement powers (BCP 22) - BI’s enforcement capacity is adequate (BCP 22). - BI’s power derives from a flexible and comprehensive set of notification and corrective action procedures, effective bank resolution procedures, and sound enforcement powers. ### Cross‑border banking supervision (BCPs 23‑25) - Prudential regulations for banking groups are in line with established best practices. - Close cooperation between BI and foreign regulators supports sound cross‑border financial activities. - Regulatory framework for globally consolidated supervision over internationally active banking groups is satisfactory (BCP 23). - Coordination with foreign supervisors for foreign operations by Italian banks (BCP 24) and operations in Italy by foreign banks (BCP 25) is adequate. ### Institutional context and general preconditions - Structural changes in the past five years included creation of the European Monetary Union and introduction of the Euro in 1999. - With Monetary Union launch, BI became part of the Eurosystem comprising the European Central Bank (ECB) and the 12 national central banks (NCBs) of the Monetary Union; as a member of the European System of Central Banks (ESCB), BI no longer conducts independent monetary policy. - BI responsibilities include managing foreign exchange assets and performing government treasury functions. - Primary laws: - The 1993 BL and the 1998 Consolidated Law on Financial Intermediation (CLFI) define general principles governing bank and nonbank financial intermediaries; detailed technical rules are deferred to secondary legislation. ### Insolvency regime, loan recovery, and loss given default - Italian corporate insolvency regime: - Lengthy judicial proceedings: bankruptcy procedures lasting 6 to 7 years. - Costly recovery proceedings: approximately 2 percent of total operating expenses. - Low recovery rates: around 38 percent of total amount owed, gross of legal fees. - Private out‑of‑court arrangements: - Shorter settlement horizon: 2 years versus 6 to 7 years for legal procedures. - Higher recovery rate: 70 percent of total unsecured assets versus 20 percent in legal procedures. - Lack legal protection if borrower later declared bankrupt. - ABI issued a code of practice in 2000 to promote private agreements. - Recommendation: Significant changes in the legal framework for corporate insolvency would be needed to reduce cost and time of loan recovery and to contain loss given default (LGD). - Insolvency regime for individual banks: - Based on administrative procedures led by the BI, described as fast and efficient, supported by deposit insurance and a framework for public intervention to prevent systemic stress. ### Bank resolution procedures and coordination - BI determines intervention type and transmits proposals to the Minister of the Economy and Finance. - For compulsory administrative liquidation (CAL) proposals, BI’s Banking and Financial Supervision Department (BFS) coordinates with other BI departments to prepare crisis management measures prior to proceedings. - Coordination steps include: - Payment System Department: ascertains direct counterparty status in Italian payment system. - Monetary and Exchange Department: ascertains direct counterparty status in monetary operations. - Market Oversight Office: ascertains direct counterparty status in Italian markets. - Relevant deposit insurance scheme informed about BI’s proposed intervention. - “International Contact Point” within BI payment system notified for cross‑border payment minimization. - After ministerial decree validating BI’s proposal, BI appoints the special body or liquidating body and notifies relevant parties (Consob, Monte Titoli, Casse di Compensazione e Garanzia, deposit insurance schemes, International Contact Point). ### Deposit insurance (IDPF) and member obligations - Coverage and scope: - Depositors in all banks incorporated under Italian law (total of 297 institutions), except mutual banks, are protected by the Italian Interbank Deposit Protection Fund (IDPF). - EU Directive 94/19 minimum coverage: €20,000 per depositor. - Italy’s IDPF coverage: up to €103,291 per depositor. - IDPF interventions: - Can pay off depositors, cover shortfalls in transfer to a third party, or provide credits, guarantees, and equity acquisitions. - Such interventions can only be initiated when a bank is put under special administration. - Funding and member commitments: - IDPF funded by surviving banks, charged on an ex‑post basis, a risk‑adjusted premium based on size of protected funds and portfolio risk. - Members’ commitment ranges between 0.4 percent and 0.8 percent of total reimbursable funds (or, between 0.4 percent and 0.8 percent of €332 billion). - Usage history: - Since creation, IDPF has been activated in only six cases. - IDPF has suspended a member’s voting right in only two cases and has never expelled a member. - BI has used public funds to substitute or complement IDPF coverage in past crises (resolution of December 23, 1986 of the ICCS and law 588/96). - Noted concern: relatively generous coverage and guarantee/credit facilities may need further revision in light of growing consolidation in the banking industry. - IDPF supervisory powers: - IDPF does not have supervisory powers; monitors members via financial ratios and can impose four types of sanctions (suspend voting rights, remove representative, impose pecuniary sanctions, exclude member subject to prior BI agreement). ### Transparency and publication - BI conducts supervisory policies with a high degree of transparency while preserving confidentiality for effectiveness and market sensitivity. - BI publishes: - Principles and criteria of supervisory activity. - Time limits for adoption of measures and responsible persons for administrative procedures. - An annual report on supervisory activity and continuous information on the state of the Italian banking and financial system. - An abridged version of BI’s annual report is available in English in hard copy and on the BI’s web site. *Source: IMF staff report section titled "The information available to the supervisor for monitoring and early detection" (extracted text).* ### 50. Prospective changes in transparency and disclosure framework for banking will ### _cr04133 - 50. Prospective changes in transparency and disclosure framework for banking will ### Strengthening market discipline through transparency and disclosure - Banks already disclose a highly detailed set of data to the BI, which uses this information for micro- and macroprudential surveillance purposes. - Listed banks are required to disclose a large body of information to the markets. - Key challenge: continue to strengthen the transparency and disclosure of banks’ balance sheets and income statements as well as corporate governance practices. - Further efforts to facilitate cross-country comparisons and investors’ analysis of disclosed information would contribute to enhancing market discipline. - Market disclosure requirements for banks are currently governed by BI regulations issued following EC Directives in 1992. - Major changes are in process to: - implement IAS by 2005, and - implement the prospective changes under Pillar III of Basel II. - Although a range of Financial Soundness Indicators (FSIs) and their analysis are presented in the BI’s Annual Report and other publications, a more systematic dissemination of the BI’s macro-prudential surveillance and financial stability analysis could also contribute to making market discipline more effective. ### Assessment framework for observance of the BCPS (Principle-by-Principle) - The assessment of each principle is made on a qualitative judgment basis using five categories: compliant, largely compliant, materially non-compliant, non-compliant, and not applicable. (Paragraph 51) - Definitions of assessment outcomes: (Paragraph 52) - compliant: whenever all essential criteria are generally met without any significant deficiencies. - largely compliant: whenever only minor shortcomings are observed, which do not raise any concerns about the authority’s ability and intent to achieve full compliance within a prescribed period of time. - materially non-compliant: whenever, despite progress, the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. - non-compliant: whenever no substantive progress toward compliance has been achieved. - not applicable: whenever the BCP does not apply given the legal, structural, or institutional features of a country. *Source: _cr04133 - 50. Prospective changes in transparency and disclosure framework for banking will* ### 53. For each principle there is a descriptive part, which sets out the pertinent laws, ### _cr04133 - 53. For each principle there is a descriptive part, which sets out the pertinent laws, ### Overview - Content covers Table 4: Detailed Assessment of Compliance with the Basel Core Principles for Effective Banking Supervision, focusing on Principle 1 (Objectives, Autonomy, Powers, and Resources) and beginning of Principles 2 and 3. - Describes Italy’s legal and institutional framework for banking supervision, the role and powers of the Banca d’Italia (BI), interagency cooperation, crisis procedures, resource and staffing arrangements, and assessments of compliance for specific subprinciples. ### Principle 1 — Objectives, Autonomy, Powers, and Resources: institutional framework and mandates - BI, ISVAP, and Consob are the three main agencies for supervision: BI (banking industry); ISVAP (insurance); Consob (securities), with joint roles for securities (1998 CLFI). - Primary laws cited: 1993 Banking Law (Legislative Decree 385 of September 1, 1993) (1993 BL) and 1998 Consolidated Law on Financial Intermediation (Legislative Decree 58 of February 24, 1998) (1998 CLFI). - Credit authorities identified in 1993 BL, Art. 1(a): (a) BI; (b) Interministerial Committee for Credit and Savings (ICCS); (c) Minister of the Economy and Finance (MEF) (who also serves as Chairman of the ICCS). - Credit authorities’ stated objectives (1993 BL, Art. 5(1)): (a) the sound and prudent management of institutions subject to supervision; (b) compliance of supervised institutions with legislative provisions concerning credit; and (c) the overall stability, efficiency and competitiveness of the financial system. - Regulatory architecture: general principles set in primary legislation; detailed technical provisions via secondary legislation (ICCS resolutions, MEF regulations, BI regulations and supervisory instructions, Consob regulations). EU membership requires incorporation of EU Directives. - ICCS composition (1993 BL, Art 2(1)): five ministers (MEF Chairperson; Ministers for Agricultural, Food and Forestry Policies; Industry; Infrastructure; European Affairs). BI Governor attends; BI provides Secretariat (1993 BL, Art 2(4)). ICCS issues broad guidelines on prudential supervision; BI takes initiative and has operational independence for day-to-day application. ### Principle 1(1) — Clear responsibilities and objectives; assessment Findings: - BI’s objectives and responsibilities set out in 1993 BL and 1998 CLFI. - BI responsible for banking supervision based on prudential returns, regulatory powers and inspections (1993 BL, Arts. 51 through 69). - BI issues regulations concerning capital adequacy, risk limitation, permissible holdings, administrative and accounting procedures and internal controls (1993 BL, Arts. 53(1) and 67(1)); issues regulations and supervisory instructions on its own authority (1993 BL, Art. 4(1)); publishes principles and criteria of supervisory activity (1993 BL, Art. 4(2)) and grants first authorization to conduct banking (1993 BL, Art. 14). - Publication rules: BI Bulletin (1993 BL, Art. 8(1)); resolutions of the ICCS and MEF general measures in Gazzetta (1993 BL, Art. 8(2)); BI general measures published in Gazzetta when scope extends beyond supervised entities. - Ufficio Italiano dei Cambi (UIC) chaired by BI Governor; checks AML compliance pursuant to Law 197/1991. - BI and Consob share supervisory responsibilities for banks providing investment services (1998 CLFI, Arts. 5(2) and 5(3)); coordination and notification requirements (1998 CLFI, Arts. 5(4), 5(5), and Art.10(2)). - Cooperation provisions among BI, Consob, COVIP, ISVAP and UIC; may not invoke professional secrecy against each other (1993 BL, Art. 7(5); 1998 CLFI, Art. 4(1)). MoUs: BI–UIC (1992); BI–ISVAP (2001); BI–Consob (1997 renewed in 2001). - Crisis procedures in 1993 BL: provisional management by BI for up to two months (1993 BL, Art. 76); special administration duration one year unless otherwise (1993 BL, Art. 70(5)); Minister of the Economy and Finance may decree dissolution of administrative/control bodies acting on BI proposal; Compulsory Administrative Liquidation (CAL) procedures and BI powers during liquidation (1993 BL, Arts. 80–93). BI coordinates with mandatory depositor guarantee schemes (1993 BL, Art. 96-ter; Art. 96(1); Art. 96-bis). Assessment: - COMPLIANT Comments: - 1993 BL and 1998 CLFI establish clear powers and tasks; BI takes operational initiative and independence in practice; BI has legal responsibility to promote competition (1993 BL, Art. 5(1)). - BI has a wide-ranging supervisory program including prudential supervision, transparency controls (non-investment services), promotion of competition, and cooperation with judicial authorities (including prevention of financial crime). ### Principle 1(2) — Operational independence and adequate resources Findings: - BI’s governance: Statuto della Banca d’Italia (SDBI) — General Meeting of Shareholders, Board of Directors, Board of Auditors, Governor (SDBI, Art. 5). - Shareholders restricted to commercial banks, social security institutions, insurance companies and, pursuant to Art. 27 of Legislative Decree of May 17, 1999, Banking Foundations; majority interest must be retained by public institutions or by companies with majority voting shares held by public institutions (SDBI, Art. 5)). BI’s shareholders currently include supervised banks. - Board of Directors composition: Governor as Chairman plus 13 Directors elected by local shareholders meetings; directors’ term 5 years and eligible for re-election (SDBI, Art. 17). Persons holding political office cannot be Directors (SDBI, Art. 59 and 60). - Governor: represents BI, presides over governing bodies, responsible for banking and financial markets supervision; term of office is indefinite. ECB view: Governor’s mandate aligns with ECB statute insofar as “indefinite” interpreted as “in excess of five years”; dismissal only for reasons in Art. 14(2) of ECB statute and appealable to European Court of Justice. - Incompatibility rules: Directorate, Central Managers, Branch Managers and other employees may not belong to other credit institutions, engage in commerce, carry out stock exchange transactions or be directors/auditors of any company (SDBI, Art. 59). Staff bound by official secrecy. - Organizational committees: three Interdepartmental Committees for Central Banking Activities; Banking and Financial System; Internal Management. BFS budget is component of BI budget; revenues primarily from seigniorage and investment income. - IT and data resources: access to Central Credit Registry (CCR), Company Accounts Data Service (CADS), Fitch IBCA archives, supervisory archives. - BFS staffing: organized across four Divisions: (a) Competition, Regulation, and General Affairs; (b) Banking Supervision; (c) Financial Supervision; and (d) Supervision Inspectorate. BFS provides 13 staff to ICCS Secretariat. - Staffing numbers: On June 27, 2003, BFS staff numbered 1,064, including 540 staff employed in the 95 branches of the BI. - Recruitment and training: entry-level personnel with undergraduate and often graduate degrees; salary scales competitive at entry level; in-house training and funding for external courses/degrees; on-the-job examiner training. - Supervisory coverage and inspection cycles: BI supervises approximately 1,430 credit institutions and investment firms; off-site monitoring advanced; on-site inspections of large institutions proceed on a six-year cycle; taking thematic inspections into account frequency is three years; smaller institutions examined on a three-year cycle. Assessment: - COMPLIANT Comments: - ICCS issues broad guidelines, which may complicate full independence perception; in practice ICCS and MEF do not have direct operational involvement. Privatization in 1990s reduced government ownership conflicts. No evidence of interference in staffing. Funding arrangements do not undermine independence. Indefinite Governor term interpreted by ECB as acceptable. ### Principle 1(3) — Authorization and ongoing supervision Findings: - Authorization conditions (1993 BL, Art. 14(1)) include: (i) satisfactory corporate form and by-laws; (ii) registered and head offices in Italy; (iii) adequate initial capitalization; (iv) satisfactory plan of operations; (v) shareholders (each above a quantum ownership threshold) meeting integrity requirements set by MEF regulation (1993 BL, Arts. 25(1) and 25(2)); (vi) management meeting experience and integrity requirements specified by MEF regulation (1993 BL, Art. 26(1)); and (vii) absence of close links that would prevent effective supervision. BI must refuse authorization if sound and prudent management is not ensured (1993 BL, Art. 14(2)). - BI authorizes branches and operations in non-EU member states (1993 BL, Arts. 15(2), 16(2), 15(4), 16(4)); first branch of a non-EU bank in Italy requires decree of MEF in agreement with Minister of Foreign Affairs in consultation with BI (1993 BL, Art. 14(4)). - BI authorizes provision of investment services by banks and registered financial intermediaries (1998 CLFI, Art. 19(4); 1993 BL, Arts. 1(2)(g) and 106). BI consults Consob and may authorize asset management companies and SICAVs subject to conditions (1998 CLFI, Arts. 34(1) and 43(1)). - BI regulation-making powers extensive under 1993 BL; some regulations require ICCS resolutions (e.g., EU-member banks activities not subject to mutual recognition (1993 BL, Art. 17); authorization to hold prescribed voting capital levels (1993 BL, Art. 19(9)); prudential supervision (1993 BL, Arts. 53, 67 and 107(2))). BI issues general regulations on capital adequacy, risk limitation, permissible holdings and internal controls. - Revocation of authorization and CAL: Minister of the Economy and Finance declares revocation on BI proposal in cases of exceptionally serious contravention or losses (1993 BL, Art. 80(1)). Similar powers for asset management companies and SICAVs under 1998 CLFI, Art. 57(1). - Reporting requirements: banks must send BI periodic returns and other requested figures/documents (1993 BL, Art. 51(1)); financial intermediaries similar reporting (1993 BL, Art. 107(3)). BI’s information requirements communicated during authorization and when changes occur (1993 BL, Art. 4(2)). - Consolidated supervision: BI may request relevant information from all companies in scope (1993 BL, Arts. 65(1) and 66)); custodial and monetary penalties for misrepresentation (1993 BL, Art. 134). - BI and Consob powers to require data and documents from authorized persons and external auditors (1998 CLFI, Art. 8(1)). Assessment: - COMPLIANT Comments: - BI empowered to verify legal, technical and management conditions at authorization and subsequently; BI may propose withdrawal of authorization within CAL procedure; legislation requires transparency and allows administrative setting of prudential rules, though some ICCS resolutions are required before BI can issue certain regulations. ### Principle 1(4) — Powers to address compliance and safety and soundness Findings: - Supervision facets under 1993 BL: (a) regular data reporting; (b) special reporting by boards of auditors and external auditors to alert BI (1993 BL, Arts. 52(1)(2) and 61(5)); (c) development/issuance of prudential regulations (1993 BL, Arts. 53(1)(2)(4) and 67); (d) on-site inspections (1993 BL, Arts. 54 and 68); (e) imposition of remedial measures including sanctions (1993 BL, Arts. 53(3), 70, 76 and 80). - BI allowed to convene administrative and control authorities of a bank and demand remedial action (1993 BL, Art. 53(3)(a)(b)(c)). - Legislation contemplates total transparency of banks’ affairs vis-à-vis BI and significant rule-making powers. Assessment: - COMPLIANT Comments: - BI can apply qualitative judgment and has full access to banks’ files; range of sanctions up to revocation of authorization with MEF approval. ### Principle 1(5) — Legal protection for supervisors Findings: - No legal protection for BI and its officers against legal action resulting from measures adopted in good faith. - As practice, BI pays defense costs of staff members where actions were legitimate and pays its own legal costs. Assessment: - NON-COMPLIANT Comments: - Payment of defense costs/legal fees does not amount to proper legal protection; legal amendments required. ### Principle 1(6) — Information sharing and confidentiality Findings: - All supervisory data obtained by BI covered by ‘professional secrecy’ (1993 BL Art. 7); exceptions: MEF (as Chairman of ICCS), judicial authorities for investigations/proceedings regarding crimes (1993 BL Art. 7(1)), and other national financial sector supervisory authorities. - BI, Consob, COVIP, ISVAP and UIC required to cooperate and exchange information (1993 BL Art. 7(5); 1998 CLFI Art. 4(1)); may not invoke professional secrecy against each other. - BI may cooperate and exchange information with EU-member state supervisors (1993 BL, Art. 7(6)) and, under appropriate agreements, non-EU supervisors (1993 BL, Art. 7(7)); information received may be transmitted to other Italian supervisors unless denied by supplying authority; transmission to third parties only with explicit consent of supplying authority. - Similar rules for BI and Consob cooperation regarding investment services (1998 CLFI, Arts. 4(2), 4(3), 4(4)). - Cooperation formalized in MoUs; exchange of letters with some major non-EU states; procedures established for inspections of branches of home-country banks in host jurisdictions. Assessment: - COMPLIANT Comments: - Well-developed framework for cooperation and information sharing domestically and with foreign homologues. BI may refuse requests for confidential information; exceptions exist for MEF and judicial authorities. ### Principle 2 — Permissible Activities (summary) Findings: - 1993 BL defines bank as undertaking authorized to engage in fund raising on a public basis and the granting of credit (Arts. 1(1)(b) and 10(1)). - Banks may engage in financial activities subject to mutual recognition per Second European Banking Directive and in related/instrumental activities (1993 BL, Arts 1(2)(f) and 10(3)); may not engage directly in collective asset management and insurance business (1993 BL, Arts. 10(2) and 11(2)). - Corporate name and corporate purpose restricted and examined by BI at formation and by-law amendments; name must not be confusing. - Use of words banca, banco, credito, risparmio or deceptive foreign-language equivalents prohibited to non-banks (1993 BL, Art. 133(1)); violators subject to administrative sanctions (1993 BL, Art. 133(3)). - Fund-raising on a public basis prohibited to persons other than banks (1993 BL, Art. 11(2)); violators face penal sanctions (1993 BL, Art. 130). Assessment: - COMPLIANT Comments: - Bank name and permitted activities clearly defined in law consistent with European model; deposit-taking restricted exclusively to banks. ### Principle 3 — Licensing criteria (beginning) Findings (introductory): - Licensing (banking authorization) granted by BI provided 1993 BL (Art. 14(1)) requirements and BI supervisory instructions are satisfied. - Licensing process should include assessment of ownership structure, directors and senior management, operating plan, internal controls, projected financial condition and capital base; for foreign parent, prior consent of home supervisor should be obtained (principle statement). - Text cuts off after introduction to licensing criteria and before detailed list of BI supervisory instructions. Assessment: - (Assessment for Principle 3 not concluded in provided extract.) *Source: Table 4. Detailed Assessment of Compliance with the Basel Core Principles for Effective Banking Supervision (excerpts) — Italy, as presented in the supplied chapter excerpt.* ### 1. the legal form adopted must be that of a società per azioni (joint stock company) or società ### 1. the legal form adopted must be that of a società per azioni (joint stock company) or società ### Legal form and location - The legal form adopted must be that of a società per azioni (joint stock company) or società cooperativa per azioni a responsabilità limitata (joint stock cooperative limited liability company). - The registered office and head office must be located in Italy. ### Paid-up capital requirements - The paid-up capital must be at least €6.3 million and €2 million for banche di credito cooperativo (mutual banks). - (Directive 2000/12/EC requires €5 million for the general operation of banks and €1 million for minor banks). ### Program of initial operations (submission requirements) - A program of initial operations must be submitted, together with the instrument of incorporation and the by-laws. In particular, the program must indicate: - the sectors of activity, operations, and services in which the bank intends to engage; - the bank’s technical, organizational, and geographical structure; its procedures for internal controls; and the characteristics of its information system; - the forecast budgets for the first three years. ### Shareholder integrity and authorization requirements - The shareholders (direct or indirect) must satisfy the integrity requirements established by statutory and regulatory provisions (ICCS Resolution dated April 19, 1993; 1993 BL, Art. 25 (1); and Ministerial Decree 144/1998). Also, the requirements for authorization to hold shares of banks must be satisfied. In particular, the applicant must submit the following: - a list of the bank’s shareholders (direct or indirect), together with the proportionate interest of each and, for indirect shareholdings, the identity of the beneficial shareholder(s); - information on the origin of the funds for the initial subscription of capital; and - documentation showing that persons directly or indirectly holding more than 5 percent of the voting capital or control of the bank satisfy the integrity requirements and attesting to their quality. ### Requirements for persons in administrative, managerial, or control functions - The persons performing administrative, managerial or control functions must satisfy the experience and integrity requirements (1993 BL, Art. 26; Ministerial Decree 161/1998). - The experience requirement must be satisfied by all persons performing administrative or managerial functions in banks formed as joint stock companies or banche popolari (cooperative banks) and by chairmen and general managers of mutual banks. - The general manager and managing director must in all cases satisfy a specific requirement of managerial experience in the fields of banking, finance, securities and insurance. - In verifying satisfaction of the requirements, the applicant company’s board of directors must verify that the previous experience of the appointees to the offices of general manager, managing director, and board chairman are consistent with the specific management and operating needs of the bank. - With regard to the integrity requirement, corporate office may not be held by persons who, for example, have been subjected to preventive measures by the judicial authorities or sentenced to a term of imprisonment of at least one year or two years for the crimes indicated in Ministerial Decree 161/1998. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04133.pdf* ### 7. Close links must not exist between the bank or the components of the grou ### _cr04133 - 7. Close links must not exist between the bank or the components of the grou ### Banking authorization: evaluation and grounds for denial - The evaluation for authorization is conducted using ordinary supervisory criteria and rules for banking, including ownership structures, requirements for corporate officers, capital adequacy, internal controls, and investment services. - Instruments used: requests for information from other authorities; requests for additions/amendments to programs of operations; meetings with promoters of new banks; on-site inspections. - Authorization denied when application reveals shortcomings precluding sound and prudent management. Most frequent causes of denial: - inadequate capital base; - deficiencies in the program of operations; - record of criminal conviction or investigation of major shareholders; - negative results of inspections of financial companies applying to become banks. - The BI verifies that no close links exist between the bank (or group components) and other persons that would prevent effective exercise of supervisory functions; assessments include group configuration, transparency of ownership, location of components, adequacy of supervision of foreign components, and BI’s ability to perform consolidated supervision. - Shareholder suitability based primarily on documentation attached to application; BI may use confidential information from other public authorities and foreign supervisors. - Shareholders may be required to offer specific commitments to safeguard sound and prudent management. - The BI scrutinizes criminal records of shareholders even where shareholdings are below the first prescribed threshold, i.e., 5 percent of voting capital. ### Fit and proper of corporate officers - Compliance with integrity and experience requirements initially verified by board of directors; board transmits minutes and documentation to BI. - BI conducts its own assessment and may declare disqualification of the officer concerned and act in lieu of the board where grounds exist. - Meetings with proposed officers assess knowledge of operations and organization in the program of operations. - BI verifies the program of operations: must fully describe business plan and strategy and be based on principles of sound and prudent management. - BI assesses proposed corporate governance system via company rules, by-laws, and shareholders’ agreements; examines composition, functioning, tasks and responsibilities of corporate bodies. - Information systems must be adequate to control the bank’s business and satisfy supervisory reporting requirements. - Technical report requirement: forecast budgets for the first three financial years are evaluated for capacity to maintain profitability and comply with prudential rules during start-up. - BI may request changes in governance, corporate structure, internal controls, or business plan and/or increases in initial capital when necessary. - Authorization may be revoked where authorization was granted on the basis of false information; revocation may follow general law or pursuant to 1993 BL (Art. 80(1)) leading to liquidation on grounds of exceptionally serious administrative irregularity. - Assessment: COMPLIANT. Comment: BI complies with Essential Criterion on fit and proper tests at initial authorization; no specific provision for subsequent removal of a director or senior officer who may become unfit (issue noted in BCP 14 assessment). ### Ownership, transfers, and notification thresholds (Principle 4) - BI prior authorization required when acquisition results in ownership interest of more than 5 percent of voting capital or results in control (1993 BL, Arts. 19(1), (3) and 22); thresholds also at 10, 15, 20, 33 and 50 percent (1993 BL, Art. 19(1)). - Notified percentages calculated on all voting shares; indirect acquisitions require requests by company at top of shareholding chain and direct holder. - BI decides within sixty days of receipt of application; time limit may be suspended or interrupted in specified cases. - For foreign acquirer, prior consultation with competent authorities of acquirer’s state. - BI may deny authorization where requirements not satisfied; authorization may be suspended or revoked where conditions cease to be satisfied (1993 BL, Art. 19(5)). - Voting rights attached to shares lacking authorization may not be exercised (1993 BL, Art. 24(1)); omission of notification may prevent exercise of voting rights. - BI may establish lower percentage thresholds for notification where capital widely distributed. - Mandatory notification of agreements governing possible concerted exercise of voting rights; BI may suspend voting rights of parties where concerted exercise jeopardizes sound and prudent management (1993 BL, Art. 20(3)). - Trust companies acting as shareholders must identify beneficiaries at BI’s request (1993 BL, Art. 21(3)). - Assessment: COMPLIANT. Comment: supervisory instructions introduce concept of "significant shareholder" as person holding at least 5 percent of voting capital or control. New company law (entering into force in January 2004 in source) noted to make disclosure of shareholder agreements compulsory for firms with more than 200 shareholders (comment only as in source). ### Investment criteria (Principle 5) - BI regulations govern acquisition of shareholdings by banks and banking groups (1993 BL, Art. 53(1)(b)(c); Art. 67(1)(b)(c)). - Prior authorization required for holdings in banks, financial companies, insurance companies when interest exceeds thresholds: 10, 20 and 50 percent of investee voting capital and any percentage involving control, or 10 percent of investor’s supervisory capital. - Equity investments in instrumental companies always subject to prior authorization. - Holdings in non-financial companies may be acquired without authorization but subject to quantitative limits: - each such investment may not exceed 3 percent of the investor’s supervisory capital; - total of such investments may not exceed 15 percent of the investor’s supervisory capital; - maximum permissible holding generally 15 percent of investee company’s share capital, with specified exceptions for small investments; - banks/groups satisfying particular size/operations requirements may be authorized on a general basis to comply with less stringent limits. - General quantitative limits for banks: - book value of real estate and participations may not be greater than the bank’s supervisory capital; - total of investments in insurance companies limited to 40 percent of consolidated supervisory capital or of supervisory capital in the case of an unaffiliated bank (60 percent of supervisory capital in the case of banks belonging to banking groups). - BI may prohibit acquisitions likely to limit or impede effective consolidated supervision. - Authorization granted after evaluation of technical and organizational situation, compatibility with acquirer’s overall strategy, impact on capital requirements, availability of financial resources, and internal controls. - Banks and groups must report every three months equity interests exceeding 2 percent of investee company’s capital, 0.5 percent of supervisory capital, or €5 million. - Assessment: COMPLIANT. ### Capital adequacy (Principle 6) - Arts. 53 and 67 of 1993 BL empower BI to issue general regulations concerning capital adequacy and limitation of risk for individual banks and groups. - BI issued specific provisions on calculation of supervisory capital, solvency ratio, market risks and large exposures on solo and consolidated basis; rules conform with Basel Accord July 1988, January 1996 Amendment, and EU legislation. - National regulation more stringent than EU Directive due to two deductions from own funds: (a) minimum level of provisions for country risk, and (b) net potential capital loss on financial fixed assets. - Reporting: banks transmit quarterly reports on supervisory profiles; holding companies transmit half-yearly consolidated reports (except large exposures quarterly). - Governing bodies must evaluate at least twice a year consistency of business growth with supervisory capital. - BI may set requirement higher than minimum for elements of accentuated risk (loan quality, concentration, liquidity of loan portfolio, organizational adequacy); in groups may adopt measures if minority interests condition balance sheet position. - Supervisory instructions require efficient internal controls permitting evaluation of capital adequacy relative to underlying risks; BI ascertains adequacy by meetings, on-site inspections, and questionnaires/self-evaluations. - Assessment: COMPLIANT. Comment: in 2001 BI required 14 largest banking groups to submit plans for achieving capital adequacy targets higher than regulatory minimums. ### Credit policies (Principle 7) - Boards approve strategic guidelines and lending policies; senior management establishes methods for measuring credit risk and monitoring, with board knowledge and approval. - Supervisory instructions require internal rules governing entire lending process (origination, credit-granting, monitoring, revision, actions on non-performing loans), periodic revision. - Loan documentation requirements: adequate evaluation of applicant’s creditworthiness, correct loan pricing, consistency between loan amount, technical form and project financed, identification of borrower’s characteristics and dealings with the bank. - Delegations of lending authority must be approved by board resolution; delegating person informed periodically of use of delegations. - Operating units’ tasks for monitoring credits established by internal rules including procedures and time limits for non-performing loans. - Banks must maintain accurate exposure pictures for each customer or group of connected clients and have adequate information systems. - Controls verified via off-site supervision (organizational analysis, meetings using questionnaire) and inspections (direct access to customer records). - Supervisory rules and Civil Code/1993 BL measures aim to prevent conflicts of interest, with special procedures for lending to persons in administrative/managerial/control functions (Art. 136 1993 BL). - BI has full access to loan portfolio information (Art. 51 1993 BL); uses supervisory returns and CCR data (CCR records exposures exceeding €75,000). - Assessment: COMPLIANT. ### Loan evaluation and loan-loss provisioning (Principle 8) - Loan valuation rules in Legislative Decree 87/1992: loans valued at estimated realizable value in annual accounts; realizable value calculated taking into account market prices, borrowers’ solvency, and country risk. - Standard value-adjustment coefficients allowed for homogeneous categories and country risk; substantial loans require case-by-case valuation. - BI supervisory instructions (Circular 49 of February 8, 1992) require classification as performing or non-performing with four sub-groups: - (i) Bad debts (sofferenze): serious non-temporary difficulty or insolvency or subject to insolvency proceedings. - (ii) Substandard loans (incagli): “situation of difficulty likely to be eliminated within a reasonable period” including conditions where at least 7 monthly installments are past due for loans >36 months (or 5 for ≤36 months), or equivalent quarterly/half-yearly/annual thresholds, and overdue amounts equal at least 20 percent of exposure; includes claims on companies under supervised administration. - (iii) Loans being restructured: borrower indebted to plurality of banks applying for consolidation within last twelve months. - (iv) Restructured loans: moratorium and renegotiation at lower-than-market interest rates. - Interest accrual and provisioning: - Full provision made going forward for interest once loan classified as bad debt. - All interest on bad loans considered interest on arrears and effectively totally provisioned. - Sub-standard loans: bank estimates recoverable amount; sums in excess are provisioned. - Other past-due loans: “penalty interest” largely provisioned (70 percent of such interest per survey covering 80 percent of banks by assets) but contractual interest continues to accrue to income. - BI may require deduction of provisioning shortfalls from regulatory capital or impose higher-than-minimum capital requirements. - Banks must review loan classification at least half-yearly. - BI assesses reliability of classifications using supervisory statistics and CCR; on-site inspectors examine files on a large sample (including riskiest positions). - Assessment: LARGELY COMPLIANT. Comments and recommendations: - Compared with other G–7 countries, impairment recognition and cessation of interest accrual appear recognized later in Italy; criteria defining “substandard loans” allow scope to overstate performing loans and income. - Writing off nonperforming loans may take years; unpaid contractual interest continues to accrue to income, overstating income. - BI should consider revising supervisory instructions on loan classification to align more closely with G–7 practices and better align provisioning with estimated losses of loan portfolio. - Pending changes, BI could issue administrative guidelines to reinforce implementation of provisioning policies. - Basel Committee granted Italy a five-year transition period allowing a 180-day past-due default criteria as an exception to 90 days (context in new Basel Capital Accord April 2003). - Securitization (law in 1999) used by banks to remove loans from balance sheets; BI monitors through prudential reporting. ### Large exposures (Principle 9) - Client definition includes single person or group of connected clients; group of connected clients defined by legal control or economic interconnection. - Exposure equals sum of on- and off-balance-sheet claims weighted by factors similar to solvency ratio. - Limits: - total amount of large exposures (exposures equal to 10 percent or more of supervisory capital) must be within eight times supervisory capital (overall limit); - each exposure must be within 25 percent of supervisory capital (individual limit); - more restrictive for significant shareholders and companies where bank is significant shareholder: individual limit equal to 20 percent of supervisory capital. - Each single bank in a banking group subject to individual limit equal to 40 percent of its supervisory capital. - BI may set more stringent individual and overall limits where banks/groups show profiles of accentuated risk. - Banks required to have organizational procedures to ensure compliance; holding company board charged with periodic review of large exposures and loans to connected persons. - Banks required to report large exposures quarterly on solo and consolidated basis. - Assessment: COMPLIANT. ### Connected lending (Principle 10) - Supervisory instructions define connected persons: significant shareholder (directly/indirectly holds at least 15 percent of capital or control) and companies with significant shareholdings (bank holds at least 20 percent or control). Companies belonging to banking group or consolidated are excluded. - Legal and supervisory framework includes: - Art. 136 of 1993 BL: special procedure for persons performing administrative/managerial/control functions contracting obligations with the bank — requires unanimous administrative body resolution and favorable vote of all members of control body, with the concerned officer abstaining; penal sanctions for violations. - Civil Code Art. 2391 and company law reforms require directors to disclose interests and abstain where required. - Supervisory instructions require ad hoc procedures to prevent conflicts for loans to employees and managers; principle that such loans be approved at a level higher than borrower. - Controls on significant shareholders upstream at acquisition stage; BI may require shareholder declarations to respect bank autonomy. - Limits and reporting on connected lending are those in large exposures regulation; no comprehensive law/regulation requiring exposures to connected/related parties be on market terms. - Assessment: LARGELY COMPLIANT. Recommendation: authorities strongly recommended to issue comprehensive regulation on connected lending to address definition, overall limits, and reporting to BI. ### Country risk (Principle 11) - Banks must monitor country risk; provisioning against unsecured loans to counterparties in countries subject to country risk not smaller than amounts calculated under supervisory rules. - Countries where system exposure exceeds €12.5 million classified into 6 risk classes, corresponding to asset adjustment factors between 15 and 60 percent. - Classification based on score from market indicators, macroeconomic indicators, performance indicators, and exceptional factors. - Trade credits considered at 15 percent of face value in value adjustments. - Banks with exposure smaller than €200 million may opt for simplified method (standard adjustment of 30 percent) instead of analytical method. - Shortfalls in provisions deducted from supplementary capital; ordinary tax deductibility rules apply for allocations referring to credits to private nonbank counterparties. - Countries’ risk scores and adjustment factors re-evaluated every six months; economic/financial conditions reviewed quarterly for vulnerability. - Banks send two reports on foreign exposure: unsecured credits to countries at risk (every six months, individual and consolidated), and country-level information for statistics (units in Italy monthly; branches/subs abroad quarterly). - Assessment: COMPLIANT. ### Market risks (Principle 12) - BI issued regulations on capital adequacy, administrative and accounting procedures and internal controls for market risks under Arts. 53 and 67 of 1993 BL. - Banks/groups must have information systems for constant monitoring of securities and FX exposure; shared methods of measuring exposures; detailed system of limits; management information for senior management; effective internal auditing. - Capital requirement against market risks defined in accordance with 1996 Amendment to Capital Accord and EU directives, covering: - trading book (position, settlement, counterparty, concentration risk); - whole balance sheet (foreign exchange risk and position risk on commodities). - Banks may use internal model validated by BI as alternative to standardized model. - BI validates models (qualitative organizational standards and quantitative restrictions), requires stress testing and back testing; validation effected by BI specialists with documentation analysis and on-site verification. - BI may set a multiplier larger than 3 for calculation of necessary regulatory capital to cover market risk if compliance unsatisfactory. - Larger banking groups asked to adopt validated internal models promptly. - Assessment: COMPLIANT. ### Other material risks and integrated risk management (Principle 13) - BI regulations address internal control systems and exposure to interest rate risk (Arts. 53 and 67 1993 BL). - Supervisory instructions require board of directors to be aware and approve procedures to identify, measure and manage different risks; banks must have internal risk management systems covering credit, market, interest rate, liquidity, operational, legal and settlement risk. - For complex banks, measurement and integrated control functions must be separate and independent. - Liquidity risk rules on maturity transformation applied on solo and consolidated basis; annual accounts must include maturity distribution of on- and off-balance-sheet assets and liabilities. - BI uses supervisory statistics for residual maturities, interest rate revision dates, currencies to establish indicators for liquidity, interest rate and exchange rate risk; BI sends quarterly data flow for reference. - BI checks operational risk procedures and is preparing guidance on IT security/contingency planning; has guidance on outsourcing. - BI may set specific capital cover for pronounced risk elements; does not currently require capital against operational risk but planning to do so in Basel II implementation; banks consortium initiated database on event losses. - Assessment: COMPLIANT. ### Internal control and audit (Principle 14) - Internal controls defined in supervisory instructions as set of rules, procedures and structures ensuring effectiveness, asset preservation, reliable accounting, and conformity with laws and policies. - Internal controls comprise line controls, risk management controls (independent of production), and internal audit function. - Board of directors must approve risk management strategies, organizational structure and verify management’s adoption of adequate controls; audit committees may be established. - Board of auditors checks regular functioning of organizational areas, may use internal audit. - BI evaluates adequacy of internal controls via documentation review and meetings; checks composition of board and senior management, separation of responsibilities, reporting systems, mapping of risks, adequacy of back-office, and internal audit autonomy and planning. - BI requires internal audit to report to audit committee and gives supervisors access to reports. - Assessment: LARGELY COMPLIANT. Comment: legal authority to require expeditious removal of unfit directors/managers considered insufficient; amendment of 1993 BL recommended to provide more qualitative “fit and proper” and legal power for supervisor to require removal. ### Money laundering (Principle 15) - Anti-Money-Laundering Law (Law 197/1991 as amended by Legislative Decree 153/1997) sets strict requirements on customer identification, recording data in computerized data banks, and reporting suspicious transactions; UIC (Italian Foreign Exchange Office) is financial intelligence unit. - BI issued “Operating instructions for identifying suspicious transactions” covering anomaly indicators and guidance for new distribution channels (Internet), staff training, anti-money-laundering officer appointment and responsibilities, and reporting procedures to UIC. - UIC and BI check compliance via requests for information and on-site controls. - Assessment: COMPLIANT. ### On-site and off-site supervision (Principle 16) - BI uses monthly statistical reporting, regularly transmitted non-quantitative information, and ad hoc data for evaluations. - Annual general report on off-site supervision with priorities; off-site analysis supplemented by meetings with corporate officers. - On-site activity conducted based on annual plan informed by off-site priorities; Guide for Banking Supervision and Guide for Bank Inspection provide methodologies. - Off-site model PATROL (analogous to CAMEL) evaluates capital adequacy, profitability, risk, liquidity and organization with scores; computer procedures support analysts. - Inspections examine entire bank situation, focusing on governance, quantification of significant risks (credit given high priority), and reliability of accounting data. - On-site and off-site coordinated via committees; inspection results integrated with off-site assessments. - Inspection cycles: for small institutions without significant weaknesses, inspections every three years; longer intervals (currently not more than six years) for large banks—recently shortened to no longer than three years including thematic inspections. - BI legally required to treat supervisory information as confidential (Art. 7 1993 BL); rights to access records of boards of auditors and external auditors under conditions (Art. 52(2)). - Assessment: COMPLIANT. Comment: supervisory procedures subject to BI internal auditors; no explicit procedures noted to assess effectiveness of on-site/off-site functions and address identified weaknesses. ### Bank management contact (Principle 17) - Meetings with bank management provided for by 1993 BL (Art. 53); general meetings with corporate officers on strategy and sectoral meetings on specific operations. - Meetings used to prevent deterioration, verify officers’ grasp of problems, obtain commitments formalized by letter, and monitor implementation (e.g., mergers/acquisitions). - Banks must notify substantive changes under Title II 1993 BL; boards of auditors and external auditors obliged to inform BI of breaches (Art. 52). - Assessment: COMPLIANT. ### Off-site reporting and consolidated reporting (Principle 18) - Art. 51 1993 BL requires banks to send periodic reports and financial statements to BI as established by BI. - Consolidated supervision empowered by Art. 61 1993 BL; holding companies transmit consolidated reports and sub-consolidated data (1993 BL Arts. 65 and 66). - Responsibility for correctness of reports rests with board of directors, board of auditors, general manager and chief accountant; attestation letter required from chairman of board, chairman of board of auditors and general manager. - Computerized BI checks and on-site checks validate accuracy; administrative fines (Art. 144) and penal sanctions (Art. 134) apply for errors or willful wrong information. - Frequency and timing: supervisory report data generally transmitted within the 25th day of month following reference date; BI transmits data to ECB within the twelfth working day after the reference date. - Assessment: COMPLIANT. ### Validation of supervisory information (Principle 19) - BI empowered to carry out inspections of individual banks and groups (Arts. 54 and 68 1993 BL); inspections verify reliability of periodic data and internal systems. - BFS Department staffing and inspectorate noted: Supervision Inspectorate 188 persons; other divisions: Competition/Regulation/General Affairs 119, Banking Supervision 129, Financial Supervision 75; 540 persons in BI branches available for on-site inspections. - Inspection plans based on off-site analysis; inspection cycles: small banks 3-year cycle; large banks inspections last average 5-6 months with teams of up to 10–12 inspectors; thematic inspections used. - Inspection reports have an open part delivered to bank and confidential assessment; banks required to respond within 30 days and take remedial action. - External audit role: law does not delegate facets of on-site inspection to external auditors; BI has legal right to access records submitted to boards and external auditors (Art. 52). - For many small banks (~470 out of 814 as of December 2002) there is no external audit requirement; banks subject to external audit account for over 90 percent of system’s total assets; scope of mandatory audit to be expanded January 2004 (as stated in source). - BI lacks power to revoke appointment of external auditors or set scope/standards for external audits of banks; Consob has such powers for listed banks. - Assessment: LARGELY COMPLIANT. Recommendations: - BI should review means to derive greater benefit from external auditors’ work given strong reliance on off-site analysis and limitations in inspection frequency. - Consider authority to revoke external auditors when performance deficient and to set scope/standards for bank external audits. - For credit risk assessment in large banks, consider extending statistical sampling methodologies for homogeneous loan categories and expand thematic inspections. ### Consolidated supervision (Principle 20) - 1993 BL defines banking groups; groups must be registered with BI; holding companies treated as banks when financial companies (Arts. 62, 63). - BI must approve group structure changes and may exclude companies likely to prevent effective consolidated supervision. - BI supervises on solo and consolidated basis banks, financial companies and instrumental companies; close cooperation with ISVAP for insurance companies in groups. - BI can require information and on-site inspections across group; may include companies not in group where material for stability. - Assessment: COMPLIANT. ### Accounting standards and external audit (Principle 21) - BI empowered to issue regulations on administrative/accounting procedures and internal controls (1993 BL Art. 53(1)(d)); supervisory instructions require recording of every transaction in adequate detail and reliable information systems. - Responsibility for supervisory returns rests with board of directors, board of auditors, general manager and chief accountant. - BI computerized checks data; board of auditors and on-site inspections verify record accuracy. - For listed banks and unlisted companies they control, auditing firms verify account keeping and compliance (1998 CLFI Arts. 155 and 165). For unlisted banks, board of auditors responsible (Art. 2403 Civil Code). - Auditors must notify BI of acts/facts constituting serious violations or that jeopardize the undertaking (1993 BL Art. 52(2)); board of auditors likewise obliged (Art. 52(1)). - Consob supervises registered auditing firms for listed companies and may impose disciplinary measures; BI has no similar power to revoke external auditors’ appointments. - Legislative Decree 87/1992 and BI supervisory instructions set valuation principles and technical forms for annual accounts; Circular 49 criteria for loan classification described earlier. - Assessment: LARGELY COMPLIANT. Comments: - Combined effect of loan classification tests may delay recognition of impairment versus other G–7 countries; prudential accounting rules for loan classification may not present true representation of bank condition. - BI may consider revising supervisory instructions on loan classification and provide further guidance on provisioning policies. - Transitional allowance under Basel II: 180-day past-due criterion for Italy for five-year period noted in source. ### Remedial measures and crisis procedures (Principle 22) - BI has graduated powers to intervene and correct problems, including convening governing bodies, sending analysis letters requesting action plans, proposing measures, imposing more stringent requirements, and proposing pecuniary administrative sanctions (Art. 144). - BI can prohibit new business or order closure of branches (Art. 78). - For serious violations or administrative irregularities, Minister of Economy and Finance can place bank in Special Administration; BI appoints special administrators to run bank and restore sound management; BI may appoint provisional special administrators for up to two months in emergencies. - For irreversible crises or exceptionally serious irregularities, Compulsory Administrative Liquidation (CAL) may be ordered; BI directs procedure, often disposing assets/liabilities to another bank. - BI coordinates closely with private-law deposit guarantee schemes funded by participating banks to facilitate deposit repayment and disposal of assets/liabilities. - Assessment: COMPLIANT. Historical note in source: In 2001, five Special Administration procedures and four CALs; in 2002, seven Special Administration procedures and one CAL (mostly small mutual banks). ### Global consolidated, host country and foreign establishments supervision (Principles 23–25) - BI supervises entire activities of banking groups including foreign branches and subsidiaries (1993 BL Arts. 59, 60, 61). - BI can prohibit setting up foreign establishments, set limits on operations, or order disposal where host-country framework inadequate. - BI evaluates and inspects foreign networks on consolidated basis and requires annual reports on foreign checks; may perform on-site inspections of foreign establishments and meet with host supervisors. - Cooperation agreements and MoUs exist with many countries; EU rules on mutual recognition and home-country control apply for branches in EU/EEA; bilateral agreements in place with many EU member states and major non-EU countries. - For branches of non-EU banks, BI assesses adequacy of home-country supervision, reciprocity, and information exchange; prior agreement of home-country supervisor and declarations on capital adequacy and organizational adequacy required. - BI may exempt branches of non-EU banks from certain prudential rules if home-country supervision equivalent; branches from G–10 countries are expressly excluded from rules on individual solvency ratios and individual capital charges for market risks. - Assessment: COMPLIANT. ### Summary compliance and key operational figures (as given in source) - BI decision time limit for authorization: BI decides within sixty days of receipt of application for authorization. - Reporting and thresholds referenced in source: - 5 percent voting capital threshold for initial shareholder scrutiny; - Ownership notification thresholds: 5 percent, 10 percent, 15 percent, 20 percent, 33 percent, 50 percent; - Banks report equity interests every three months when exceeding any of: 2 percent of investee capital; 0.5 percent of supervisory capital; or €5 million; - CCR records exposures exceeding €75,000; - Country exposure classification threshold: countries where system exposure exceeds €12.5 million are classified into 6 risk classes (asset adjustment factors between 15 and 60 percent); - Simplified country-risk method available to banks with exposure smaller than €200 million (standard adjustment 30 percent); - Large exposures defined: exposures equal to 10 percent or more of supervisory capital are "large exposures"; overall large exposure limit within eight times supervisory capital; individual exposure limit 25 percent of supervisory capital; individual limit to connected persons 20 percent; single bank in group individual limit 40 percent of its supervisory capital; - Interest provisioning practice: survey covering 80 percent of banks by volume of assets indicates 70 percent provisioning of penalty interest on other past-due loans. - Assessments appearing in the source include repeated COMPLIANT ratings for many Principles and LARGELY COMPLIANT for Principles 8, 10, 14, 19 and 21 where issues and recommendations are noted. *Source: _cr04133 - 7. Close links must not exist between the bank or the components of the grou (IMF staff report content provided in the prompt)* ### 1. Objectives, Autonomy, Powers, and Resources ### 1. Objectives, Autonomy, Powers, and Resources ### Overall assessment and context - The BI conducts a comprehensive, sophisticated, continual process of off-site monitoring, well integrated with a cycle of thorough, although less frequent, on-site inspections. - Observance of the Basel Core Principles for Effective Banking Supervision is at a high level; areas lacking total compliance are identified with recommended actions for the BI’s consideration. - Given current resources, the BI’s inspection cycle is 3- to 6-year. ### Recommended Action Plan (selected principles with recommended actions) - BCP 1.5. Legal protection - The authorities should give consideration to amendments to the legislation to provide legal protection to the supervisory authority and its officers against the possibility of legal action stemming from measures adopted in good faith in the performance of their functions. - BCP 8. Loan Evaluation and Loan-Loss Provisioning - During the transitional period allowed by Basel II for the case of Italy to use less stringent 180 days past due requirements, rules and procedures should be modified to conform in due course to the widely accepted international practice of 90 days past due. - The BI may wish to consider, in the exercise of its regulatory powers (1993 BL Art. 53), revising the applicable instructions so as to better align provisioning with the estimated losses of the loan portfolio of the banking system so that banks can better withstand a sudden deterioration in credit conditions. Some market participants would welcome this initiative. - BCP 10. Connected Lending - The BI is strongly recommended to consider the issuance of a comprehensive regulation on connected lending to address the issues of definition, overall limits, and reporting. - BCP 14. Internal Control and Audit - The authorities should consider amending the 1993 BL and applicable regulations to legally empower the BI to remove expeditiously those banks directors or senior officers who may have become unfit for their duties. - BCP 19. Validation of Supervisory Information - Given its current level of resources, and the related factor of its 3- to 6-year inspection cycle, the BI should review the means by which it may derive greater benefit from the work of external auditors in specific areas (e.g., money laundering) in the execution of its own mandate. - The BI should review the status of some banks, albeit extremely small institutions, which are not subject to external audit. - The BI should consider revising the 1993 BL so as to obtain the power to revoke the appointment of a bank’s external auditors when their performance is deficient and to provide it with the authority to establish the scope and standards to be achieved in banks’ external audits. - In light of the rapid changes in the banking industry and risk management technology, the BI should continue to keep the adequacy of resources under review. - BCP 21. Accounting Standards - See recommendation on loan evaluation in BCP 8 above. ### Authorities’ response — summary - The BI considers the assessment recognizes the high degree of compliance of the Italian supervisory system with the Basel Core Principles, highlighting adequacy of prudential regulations and effectiveness of controls due to interaction between on- and off-site methods and flexible supervisory tools. - The BI states commitment to take necessary steps to meet the IMF’s recommendations, noting some actions will require amendments of existing laws (BCP 1.5) and issuance of guidelines by the ICCS (BCP 10). - The BI views observations on BCP 14 (Internal control and audit) and BCP 19 (Validation of supervisory information) as grounded in principle but not implying the existing framework prevents the BI from achieving BCP goals; initiatives will be taken and addressed by competent authorities. - On BCP 8 (Loan Evaluation and Loan-Loss Provisioning) and BCP 21 (Accounting Standards) the BI has already taken steps toward defining more objective criteria for classification of impaired loans in line with prevailing practices in most G-10 countries; amendments to supervisory regulations will be consistent with the time frame envisaged by the New Capital Accord (Basel II). - The BI does not agree with the IMF’s view that existing classification criteria may determine an overestimation of income of Italian banks. ### Authorities’ specific comments on recommendations - BCP 1.5 and 10 - The BI noted it is not empowered to act on its own authority, but requires either amendments of the BL or the issuance of specific guidelines by the ICCS; the BI will approach competent authorities. - BCP 14 - Although the law does not formally provide authority to require changes in board composition and management, the BI can rely on a wide scope of enforcement tools, including the power to order a special meeting of shareholders with a predetermined agenda and to put the bank under special administration if required. - BCP 19 - Under Italian commercial law, the board of statutory auditors, primarily responsible for validation of supervisory information, carries out the same task that is discharged by external auditors in jurisdictions without such a body. - Banks subject to external audit account for over 90 percent of the system’s total assets. - The requirement for audit of accounts by external auditing firms is to be further expanded as a result of the entry into force of the new company law in January 2004. - The BI will give due consideration to the IMF recommendation to extend the BI’s power to revoke the appointment of banks’ external auditors, noting such extension entails amendments to existing laws. - BCP 8 and 21 - The BI acknowledges the need for more stringent objective criteria for classification of impaired loans, notably regarding “substandard” loans, and has already taken steps to align loan classification criteria with practices in other industrialized countries; this will be advanced in accordance with Basel II. - The BI notes the Central Credit Registry data is a mitigating factor, driving banks to downgrade loans from the “performing status”. ### BI’s empirical points on interest recognition and provisioning 1. All interest on bad loans is considered interest on arrears and is effectively totally provisioned for, even though part of it is actually recovered. 2. As for sub-standard loans, banks make an estimate of the recoverable amount; all sums due (for capital and interest) in excess of this amount are provisioned. 3. As regards other past-due loans, while “contractual” interest accrues to income, “penalty interest” is to a very large extent provisioned for (70 percent of such interest, according to a survey covering 80 percent of banks by volume of assets). Considering that 80 percent of “other past-due loans” become current again within one year, this implies that such provisions tend to offset interest on the 20 percent of loans that eventually will be classified as bad loans or sub-standard loans. *Source: IMF assessment section "1. Objectives, Autonomy, Powers, and Resources" and associated Recommended Action Plan and Authorities’ Response.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04133.pdf_