## Executive Summary — Italy Financial Sector Assessment (CR06112) ## Source details **Canonical URL:** [Executive Summary — Italy Financial Sector Assessment (CR06112)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06112.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06112.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06112.pdf.json) --- ### Key findings - Italy’s financial system appears sound and no systemic vulnerabilities were identified. - High degree of conformity to supervisory and regulatory standards established by the Basel Committee, IAIS, IOSCO, FATF, and CPSS. - BI governance strengthened by recent reforms but implementation requires amendments to the BI statutes; key provisions remain to be specified. - Deep restructuring of the banking sector in the 1990s improved efficiency and competition; operational costs and nonperforming loans remain higher than peers. - Banks resilient to weak economic growth; stress tests suggest major banks’ capital buffers could absorb shocks in a low-growth/higher-euro-area-interest-rates scenario. - Insurance industry posted rapid premium growth and strong profitability; stress tests indicate several small life insurers are vulnerable but most vulnerable life insurers are bank-owned and estimated bank capital buffers appear to cover estimated solvency shortfalls. - Capital markets underdeveloped outside the government bond market; equity and corporate bond markets are comparatively small. ### Macroeconomic environment and vulnerabilities - GDP growth: "0.3 percent seasonally adjusted" in Q3 2005. - Staff projects GDP growth at "around zero in 2005" and "about 1½ percent in 2006". - Ecofin Council endorsed plans to bring the deficit under the "3 percent of GDP" ceiling by "2007". - Key macro vulnerability: protracted low growth could impair loan portfolio quality; high public debt and fiscal instability could widen interest rate spreads. ### Financial sector structure — key statistics - Total financial system assets (June 2005): "3,899.8" (€ bill.) — Banks: "2,594.9" (€ bill.) = "66.5 percent" of total assets. - Banking sector assets equivalent to "175 percent of GDP" (compared with "300" and "215 percent of GDP" in Germany and France, respectively). - Asset management companies: "16 percent" of total assets; Insurance corporations: "12 percent" of total assets. - Life insurance accounts for about "65 percent" of total insurance premiums; life insurance grew "more than 20 percent annually" in the early 2000s. - Six largest Italian bank groups accounted for "55 percent" of total assets at end-2004. - Since 1994, share of bank assets majority-owned by the state/foundations fell from "58 percent" to "10 percent at end-2004". - Government debt: "106 percent of GDP" held largely as long-term debt. - Total capitalization of equity markets managed by Borsa Italiana Group: about "40 percent of GDP". ### Banking sector resilience, performance and risks - Return on equity at end-2004: consolidated close to "10.7 percent"; six largest banking groups: "12.5 percent". - Cost-to-income ratio (2004): Italy "57.9 percent"; EU-15 average "63.7 percent". - Commission income at end-2004: "21 percent" of gross income. - Noninterest income stable at around "44 percent" since 2002. - Nonperforming and doubtful loans stabilized around "6.5 percent" of total loans since 2002 (peer average "2.9 percent"). - Under a standard "90-day past-due" classification NPL ratios would increase to "7.5 percent" from "6.8 percent" (BI preliminary June 2005 data). - If increased NPLs were provisioned at "40 percent", impact ≈ "20 percent of 2004 profits". - Capital ratios (largest six groups, 2000→2004): - Tier 1 capital ratio: "5.8 percent" → "7.3 percent". - Overall capital ratio: "8.7 percent" → "11.5 percent". - Household indebtedness: "28 percent of GDP" (Italy) vs "57 percent" EU-15 average. - Liquidity buffers decreased; liquidity stress test (Bank of Italy estimates): Number of banks with liquidity shortfall in the 1–7 days time-band: "82" — Share of assets: "22%". - Largest credit exposure: corporate sector — "60 percent". - Corporate sector debt-to-equity ratio rose to "97 percent" in 2004 from "76 percent" in 2000. ### Banking sector stress tests — summary (June 2005) - Scope: nine major banking groups accounting for "62 percent" of total bank assets; consolidated end-2004 balance sheets updated to end-June 2005. - Pre-Stress CAR (June 2005): Weighted Average "11.01"; Largest "8.78". - Selected Post-Stress CAR results (Post-Stress CAR shown): - Parallel increase in major interest rates: Post-Stress CAR Weighted Avg. "10.95"; Min. "8.71". - Rise and flattening of main yield curves: Post-Stress CAR "10.92"; Min. "8.72". - Fall in equity prices (30%): Post-Stress CAR "10.96"; Min. "8.64". - Euro depreciation against major currencies (15%): Post-Stress CAR "10.83"; Min. "8.72". - Sensitivity to Sovereign Risk: Post-Stress CAR "10.33"; Min. "8.77". - Sensitivity to credit risk (60% increase in PD, LGD 60%): Post-Stress CAR "10.71"; Min. "8.51". - Macroeconomic scenario (Oil to USD 85/bbl & −30% equity): Post-Stress CAR "10.60"; Min. "8.41". - Loss of economic value as percentage of bank capital — sensitivity to interest rate risk in the banking book: - Weighted Average: "−6.34" - Maximum loss: "−13.22" - VAR methodology (BI): 0.3 percent probability, 20-day holding period (VAR at 99.7, 20 days). Selected VAR 95th percentiles: - Interest Rate VAR 95th percentile: "45.18" - Equity VAR 95th percentile: "11.53" - Foreign exchange VAR 95th percentile: "19.82" ### Derivatives exposures — corporate sector - Largest banks hold about "90 percent" of derivative contracts in trading books. - Italian OTC derivatives market: "fifth largest in the world" in turnover. - Corporate derivative losses stress test: most severe shock (parallel decrease in the yield curve) causes maximum increase in average PD of "about 40 percent"; under that shock only "20 percent" of the firms will have a PD higher than "5 percent". - Tests are conservative and do not always account for hedging of on-balance-sheet positions. ### Insurance sector — performance, exposures and stress tests - Premium increases: about "12 percent" in both 2003 and 2004. - Market penetration: gross domestic premium income = "7.5 percent of GDP" in 2004 (EU average close to "9 percent"). - Total assets of insurance companies: "34.6 percent of GDP" in 2004. - Asset allocation: equities "about 12 percent"; fixed income "57 percent". - Life sector capitalization / total assets (1999–2004): "8.18", "7.88", "7.32", "6.71", "6.34", "5.88". - Life ROE (1999–2004): "8.69", "10.58", "7.54", "7.51", "8.83", "10.50". - Non-life combined ratio (1999–2004): "109.30", "106.70", "103.07", "98.74", "96.83", "95.69". - Insurance stress-tests (end-2004, 10 largest groups; >70% market share): - Life sector — Ante-shock solvency ratio Best/Average/Worst: "6.02 / 1.64 / 0.86". - Macroscenario: "5.61 / 1.52 / 0.69" — Number of companies with ratio < 1: "10" — Solvency shortfall/liabilities: "0.68". - Shock 1 (Tilt+): "6.06 / 1.64 / 0.80" — <1: "3" — Shortfall: "0.12". - Shock 2 (Shift+): "6.01 / 1.62 / 0.80" — <1: "4" — Shortfall: "0.36". - Nonlife sector — Ante-shock solvency ratio Best/Average/Worst: "7.56 / 3.14 / 1.04". - Macroscenario: "7.55 / 2.73 / 0.96" — Number with ratio < 1: "2" — Solvency shortfall/liabilities: "3.07". - Natural disaster after reinsurance: "7.58 / 3.13 / 1.04" — Number with ratio < 1: "–". - Conclusions: - Life sector most exposed to interest-rate and macro shocks. - A 70 bp shift: average solvency ratio declines from "2.05" to "1.98"; "3" companies (market share "2.2 percent") record solvency shortfall. - A 200 bp shift: estimated average solvency ratio "1.72"; "17" companies (market share about "46 percent") record shortfall; shortfall ≈ "0.37 percent" of (class C) technical provisions. - Adverse macro scenario: average solvency ratio falls from "2.05" to "1.77"; "7" companies (market share "13.7 percent") record shortfall. - Non-life sector resilient: macro scenario reduces average solvency ratio "3.35" → "2.92"; only "1" company records shortfall. - Most vulnerable life companies are bank-owned; parent banks’ capital pools materially mitigate apparent solvency shortfalls. ### Pension funds and asset management - Private pension funds cover less than "12 percent" of employed workforce. - Pension fund assets: about "€40bn" = "3 percent of GDP"; typical allocation: debt securities "46 percent", real estate "17 percent", mutual funds "13 percent", equities less than "10 percent". - TFR (Trattamento di fine rapporto): "6.91 percent" of gross salaries; about "€15bn" annually. - Recent legislative changes (July 2004) allow transfer of TFR to pension funds; implementation planned in "2008" (subject to further modification). ### Securities markets, payments and settlement systems - Government bond market: largest in Europe; MTS platform liquidity important. - Equity market capitalization (2003): "€488 billion"; number of listed companies: "219". - Annual turnover on MTS regulated markets for government bonds (2003): "€2,136 billion". - Monte Titoli: assessed as safe, sound and efficient; securities held in custody average: "€2.000 billion". - RTGS (Birel / New Birel): - Birel used by "600" financial institutions. - Payments settled (2001): "10.2 million" payments; (2002): "9.6 million". - Migration to New Birel completed in "January 2004"/by "May 2004". - Birel became domestic component of TARGET with EMU Stage III ("January 1999"). ### AML/CFT assessment — main findings and gaps - Italy’s AML/CFT system produced significant enforcement successes; law enforcement convictions ~ "600" cases per year; confiscation in 2004 over "€130 million". - UIC (FIU) technologically advanced but insufficient filtering limits effectiveness; almost "36,000" STRs received up to 2004; UIC AML department staff: "109". - Key gaps: - Preventive system not fully updated to revised FATF standard. - Need greater implementation of detailed CDD requirements. - Need more effective sanctions regime: current maximum fine for money laundering "€15,240". - Need to increase STRs by non-bank financial intermediaries and introduce an explicit legal obligation to report suspicions of terrorist financing. - Legal framework scattered across more than "60" laws/regulations; recommended consolidation and streamlining. - CDD thresholds and rules: - CDD mandatory for single/linked transactions of "€12,500" or more; wire transfers below "€12,500" currently exempt from CDD. - Archivio unico informatico (AUI) retention: data kept "ten years". - Recommendations include removing or lowering the "€12,500" threshold (suggested to "€1,000" or eliminate). ### Observance of standards and recommended actions (summary) - Assessments covered: BCP, CPSIPS, IAIS ICP, IOSCO, RSSS, IMF MFP Transparency Code, FATF AML/CFT. - Common recommended actions (selected): - BI governance and transparency: amend BI statute per Savings Law to clarify Board role and limit BI mandate to safeguarding financial system stability (omit "competitiveness"). - Banking sector: accelerate convergence to the "90-day past-due" impaired loans standard; enhance regulation of lending to related parties (definition, limits, reporting); provide legal protection to supervisory authorities and officers for good-faith actions; strengthen BI’s authority to remove unfit directors or senior officers. - Supervision and market oversight: increase number and scope of ISVAP on-site inspections; subject all insurance intermediaries operating in Italy to registration and direct supervision; include on-site inspections of markets and market operators by Consob and BI. - Corporate governance: mandate a majority of independent directors and require Board representation of minority shareholders. - Consumer protection and disclosure: strengthen disclosure of insurers' financial situations and risks; extend disclosure requirements to nonlisted debt instruments issued by banks. - AML/CFT: improve UIC filtering, provide UIC access to law enforcement information, consolidate legislation, increase STR quality and quantity, strengthen sanctions and supervisory inspections for non-prudential sectors. *Source: Executive Summary and excerpts from IMF staff Country Report (CR06112)* ### Executive Summary ...................................................................................................... ### Executive Summary ### Key findings - Italy’s financial system appears sound and no systemic vulnerabilities were identified. - The system’s strength is supported by a high degree of conformity to supervisory and regulatory standards established by the Basel Committee, IAIS, IOSCO, FATF, and CPSS. - The overall strong supervisory framework needs further improvements to governance provisions at the Bank of Italy (BI) as recognized by recent reforms; implementation will require amendments to the BI statutes. - The deep restructuring of the banking sector in the 1990s improved efficiency and competition, with significant reductions in state direct ownership and consolidation-driven cost reductions; however, operational costs and nonperforming loans remain higher than peers. - Banks have shown resilience to weak economic growth and appear able to withstand continued unfavorable macroeconomic scenarios; stress tests suggest major banks’ capital buffers could absorb the shocks associated with a low-growth/higher-euro-area-interest-rates scenario. - The insurance industry posted rapid growth in premiums and strong profitability; stress tests indicate a number of small life insurers are vulnerable, but most vulnerable life insurers are bank-owned and estimated bank capital buffers appear to cover estimated solvency shortfalls. - Capital markets are underdeveloped outside the government bond market; equity and corporate bond markets are comparatively small reflecting a relative lack of “equity culture,” a small number of big private corporations, predominance of family-owned SMEs, and marginal importance of certain institutional investor classes. ### Macroeconomic environment and vulnerabilities - GDP growth was weaker-than-expected in Q3 2005: "0.3 percent seasonally adjusted". - Staff projects GDP growth at "around zero in 2005", with a pick-up to "about 1½ percent in 2006". - Consumer price inflation is steady, in line with the euro zone average. - The Ecofin Council endorsed plans to bring the deficit under the "3 percent of GDP" ceiling by "2007". - Key potential macro vulnerability: a protracted period of low growth could significantly impair loan portfolio quality; high public debt and fiscal instability pose a potential risk of widening interest rate spreads. ### Financial sector structure (key statistics) - At end-June 2005, banking sector assets accounted for "66.5 percent" of the financial system’s total assets. - Banking sector assets were equivalent to "175 percent of GDP" (compared with "300" and "215 percent of GDP" in Germany and France, respectively). - Banks control about "a third" of total assets in the insurance sector and about "86 percent" of assets under management at end-2004. - The six largest Italian bank groups accounted for "55 percent" of total assets at end-2004. - Since 1994, successive waves of privatization reduced the share of bank assets majority-owned by the state or (nonprofit) foundations from "58 percent" to "10 percent at end-2004". ### Banking sector resilience and risks - Strengths: - Improved financial sector indicators, helped partly by the low interest rate environment. - Low household indebtedness limits risks. - Risks and vulnerabilities: - A macroeconomic scenario combining low growth and higher euro area interest rates would pose the biggest challenge for the banking sector. - Higher-than-average provisioning costs due to structurally higher nonperforming loans compared to other leading European countries, despite more lenient loan classifications. - Liquidity buffers in the banking sector have decreased and show some vulnerability to stress tests. - Limited regulation of lending to related parties raises uncertainty about the extent of connected lending in the banking sector. ### Insurance and pension sectors - The insurance industry has experienced rapid premium growth and strong recent profitability; prospects appear favorable. - Stress tests suggest several small life insurance companies are vulnerable to shocks. - Mitigants: most vulnerable life insurance companies are owned by banks; estimated bank capital buffers appear to cover estimated solvency shortfalls of stressed insurance companies. - Margins in the insurance industry are likely to shrink in coming years due to increased competition and a stricter regulatory regime. - Continued efforts to strengthen supervision and to promote better risk management practices in the industry are critical. ### Capital markets - Italy’s government bond market is the largest in Europe. - Equity and corporate bond markets are comparatively small, reflecting: - a relative lack of “equity culture”, - the small number of big private corporations, - predominance of family-owned SMEs, - marginal importance of certain institutional investor classes. - More developed capital markets would enhance diversity in financing sources and investment opportunities. ### Priority issues and policy recommendations (summary) - BI governance and transparency: - BI governance strengthened by reforms (appointment, revocation, term of office of Governor; term of Directorate; introduction of collegiality), but key provisions remain to be specified in BI statute amendments, including the role and composition of the Board of Directors and modalities of BI ownership transfer. - BI’s multiple objectives have been narrowed, with competition transferred to the Antitrust Authority; forthcoming BI statute revisions should clearly limit BI’s mandate to safeguarding financial system stability and omit the current reference to "competitiveness". - Banking sector: - Accelerate convergence to the "90-day past-due" criteria for impaired loans and probability of default (under the New Basel Capital Accord) and related provisioning requirements. - Apply a standard "90-day past due" definition of impaired loans to provide more meaningful information; this would imply a downward adjustment of measured profitability and possibly capital adequacy in some cases. - Enhance regulation of lending to related parties (definition, limit, reporting) to permit careful monitoring. - Continue close monitoring of banks’ liquidity risks and, if necessary, call for higher liquidity buffers. - Provide legal protection to supervisory authorities and officers for actions taken in good faith while discharging their duties. - Strengthen BI’s ability to promptly remove bank directors or senior officers who have become unfit. - Supervision and market oversight: - Increase both the number and scope of on-site inspections by ISVAP. - Subject all insurance intermediaries operating in Italy to registration and direct supervision. - Complement market contacts by formal on-site inspection of markets and market operators by Consob and BI. - Governance: - Strengthen minority shareholder rights by mandating a majority of independent directors and requiring that the Board of Directors include a representative of minority shareholders. - Consumer protection and disclosure: - Enhance monitoring of banks’ internal guidelines on marketing structured products to SMEs to ensure risks are appropriately disclosed. - Strengthen disclosure of the financial situation of each insurer and the risks to which it is subject. - Extend disclosure requirements to nonlisted debt instruments issued by banks. ### Box 1 — Main recommendations of the FSAP (selected actions) - BI governance and transparency: - Amend the BI statute in application of the Savings Law provisions to clarify the role of the Board of Directors in internal oversight and control and modify the ownership structure of BI. - Use the opportunity of amending the BI statute to clearly limit its objective to safeguarding the stability of the financial system, omitting the current reference to competitiveness. - Supervisory framework: - Accelerate the convergence to the "90-day past-due" criteria for impaired loans and probability of default (under the New Basel Capital Accord) and related provisioning requirements. - Enhance the comprehensiveness of bank regulation on lending to related parties, including its definition, limit and reporting requirement. - Continue to monitor closely banks’ vulnerability to liquidity risks and, if necessary call for higher liquidity buffers. - Provide legal protection to the supervisory authorities and their officers against lawsuits for actions taken in good faith while discharging their duties. - Strengthen BI’s ability to remove promptly bank directors or senior officers who may have become unfit for their duties. - Increase both the number and scope of on-site inspections by ISVAP. - Subject all insurance intermediaries operating in Italy to registration and direct supervision. - Complement market contacts by formal on site inspection of markets and market operators by Consob and BI. - Governance: - Strengthen the application of minority shareholder rights by mandating a majority of independent directors and requiring that the Board of Directors include a representative of minority shareholders. - Consumer protection: - Enhance the monitoring of bank’s internal guidelines on the marketing of structured products to small and medium size corporations to ensure that risks are appropriately disclosed. - Strengthen disclosure of the financial situation of each insurer and the risks to which it is subject. - Extend disclosure requirements to nonlisted debt instruments issued by banks. *Source: Executive Summary* ### 11. Asset management companies represent the second most important class of ### 11. Asset management companies represent the second most important class of ### Financial system structure and market shares - Asset management companies account for 16 percent of total assets. - Insurance corporations account for 12 percent of total assets. - Life insurance has grown more than 20 percent annually in the early 2000s and accounts for about 65 percent of total insurance premiums at present. - Reinsurance activity is very limited. - Banks account for 66 percent of the financial system (2003). - Private pension system: 1 percent (2003). - Investment firms: 0.4 percent (2003). - Foreign UCITS: 4 percent (2003). ### Banking sector role and funding - Italian banks constitute a core funding source for the domestic economy. - Debt securities are not a major funding source: gross issues of debt securities by non-financial companies shown for 1999 and 2004 (EUR mill.) across Germany, Spain, France, Italy (figure reference). - Total capitalization of the equity markets managed by Borsa Italiana Group represents about 40 percent of GDP. - Government debt accounts for 106 percent of GDP and is held largely in the form of long-term debt. - Activity on equity and corporate debt markets declined between 2000 and 2003, before rebounding in 2004. ### Banking sector structure and consolidation - Structure of the banking system, 2004: Limited company banks 77%; Cooperative banks 11%; Mutual banks 5%; Branches of foreign banks 5%; Foreign controlled subsidiaries 2%. - Ownership of Italian banking system: active consolidation shown for 1994 (1,028 banks), 1999 (876 banks), 2004 (778 banks) with domestic M&A, EEA country M&A, and third country M&A components (figure reference). - At end-2004, 7 percent of total bank assets were owned by foreigners. - At end-2004, foreigners were majority owners in two medium-sized banks (total assets below €20 billion) and 13 small banks (total assets below €7 billion), accounting in total for only 2.5 percent of total bank assets. ### Counterparties and exposures - Largest credit exposure of the banking system is to the corporate sector: 60 percent. - Corporate sector debt to equity ratio rose to 97 percent in 2004 from 76 percent in 2000. - Banks’ exposure is diversified, with exceptions. - Low exposure of Italian banks to mortgage markets at end-2003 (in percent of GDP) shown in a comparative chart (Germany, Spain, France, Italy). - Italian banks' loans to the private sector, 1999-2004, include mortgage, consumer credit, and credit to non-financial corporations (figure reference). - Italian banks have most of their consolidated foreign claims to mature industrial countries: 75 percent. - Exposure to emerging countries is concentrated in Central and Eastern Europe: 16 percent of consolidated foreign claims and 14 percent of consolidated profits at end-2004. ### Households and retail credit - Household indebtedness is 28 percent of GDP in Italy as compared to 57 percent for the EU-15 average. - Since 2000, banks have been focusing increasingly on developing the Italian household credit markets, driven by new mortgage loans for house purchases. - Potential development of new mortgage products, such as home equity credit lines, noted if interest rates do not rise sharply. ### Regulatory and supervisory framework - Regulation and oversight of financial markets are shared by six institutions. - Bank of Italy (BI) supervises the banking system and wholesale markets relevant for monetary policy; had been authority enforcing antitrust laws in banking until recently. - ISVAP supervises and regulates all insurance undertakings, including mutual insurance companies. - Consob supervises and regulates Italian securities markets. - COVIP supervises pension funds (pension fund supervisory authority). - Antitrust Authority safeguards competition. - Italian Foreign Exchange Office (UIC) responsible for anti–money laundering and combating terrorist financing. - A new Law on Savings was adopted at end-December 2005 to enhance investor protection: includes rules on corporate governance of listed companies, minority shareholder rights, marketing and issue of corporate bonds, and allocates a more central role to Consob on securities markets. - Law transfers responsibility for regulating anticompetitive behavior to the Antitrust Authority while BI and the Antitrust Authority have shared responsibility for bank mergers and acquisitions. - Reforms adopted do not yet fully address staff concerns about clarity in the objective of BI, its ownership structure, and the role of the Board of Directors. ### Ownership and governance of Banca d’Italia (Box 2) - BI governance bodies: the Directorate (Governor, Director General, two Deputy Directors General), the General Meeting of Shareholders, and the Board of Directors. - Under Art.19 of the Savings Law, all the Governor’s non-ESCB responsibilities will be transferred to the Directorate (Governor has a casting vote). - The BI Statute should be revised within two months to provide the Board of Directors a role of internal oversight and control. - Article 3 of the BI Statute permits entities supervised by BI to own its share capital; banks currently account for 84.2 percent of BI share capital. - The Savings Law stipulates the Governor is appointed by Presidential decree upon nomination by the Council of Ministers and advice of the Board of Directors to the Council of Ministers. - The reforms in Art.19 of the Savings Law are based on five principles: - (i) reaffirmation of central bank autonomy, in line with ECB requirements; - (ii) transfer of BI ownership to public entities within three years, subject to a gradual decline in private voting rights; - (iii) enhanced collegiality, and the introduction of majority voting for decision-making by the Directorate; - (iv) increased reporting requirements through compilation of minutes, motivation of decisions and reporting to Parliament twice a year; - (v) changes to the mandate of the Governor and other members of the Directorate to 6-year, once-renewable staggered terms. - Key provisions remain to be spelled out in amendments to the BI Statute, including the role and composition of the Board of Directors, and the modalities of the transfer of ownership. ### Banks — strengths, vulnerabilities, and performance - Restructuring has contributed to improved efficiency and asset quality. - Challenges: generating stable sources of income, further restructuring and cost-cutting, managing high level of impaired loans and adequate provisions for credit losses. - At end-2004, return on equity rebounded to close to 10.7 percent on a consolidated basis and to 12.5 percent for the six largest banking groups. - Cost-to-income ratio for Italy in 2004: 57.9 percent; EU-15 average: 63.7 percent. - Commission income at end-2004: 21 percent of gross income, which is 5 percentage points lower than its peak in 2000. - Noninterest income to total income has remained stable at around 44 percent since 2002. - Nonperforming and doubtful loans have stabilized around 6.5 percent of banks’ total loans since 2002, compared with an average of 2.9 percent for Germany, France, Spain, the UK, and the U.S. - Under a standard 90-day past-due classification of impaired loans, NPL ratios would increase to 7.5 percent from 6.8 percent under the current classification (BI preliminary June 2005 data). - If the increased NPL were to be provisioned at 40 percent, the impact would be approximately equivalent to 20 percent of 2004 profits. - Between 2000 and 2004, the largest six bank groups increased their Tier 1 capital ratio from 5.8 percent to 7.3 percent and their overall capital ratio from 8.7 percent to 11.5 percent. - Italian banks’ reliance on overdraft facilities and lengthy judicial proceedings contribute to higher measured nonperforming loans. - BI is taking measures to align its definition of impaired loans to international standards; the Basel Committee granted Italy a five-year transition period to use a 180-day past-due definition for default. ### Foreign presence and competition - Presence of foreign banks in retail banking is very limited. - No significant Italian bank or bank group is majority-owned by foreigners (end-2004). - Greater foreign ownership in Italian retail banking is noted as a potential means to strengthen efficiency. - High switching costs may hamper competition; an investigation is being conducted in cooperation with the Antitrust Authority. - According to the 2005 World Retail Banking Report, the average price of basic banking services in Italy appears to be one of the highest in Europe. ### Securitization - Since the 1999 securitization law and tax incentives, Italy’s securitization market grew rapidly to rank as the second-largest in Europe by 2004. - By 2004, bank loan securitization amounted to €85bn, of which €27bn related to NPL. - Since 2002, securitization transactions increasingly reflect funding purposes as well as balance sheet and risk management objectives. - The increasing use of more sophisticated products, such as synthetic securitizations, may have introduced new risks in the system. *IMF staff report excerpt from the provided chapter content.* ### 26. Derivatives exposures do not appear to threaten the financial condition of Italian ### 26. Derivatives exposures do not appear to threaten the financial condition of Italian corporations, but might create legal and reputational risks for the banking system ### Derivatives exposures — main findings - The largest Italian banks are quite active in the sale of complex derivative products to corporate clients; Italian banks act mostly as dealers, holding about 90 percent of derivative contracts in their trading book. - The Italian over-the-counter (OTC) derivatives market is the fifth largest in the world in terms of turnover. - Stress tests for a variety of shocks to derivative exposures of corporations show losses have only a modest effect on the probability of default (PD). - The most severe shock, a parallel decrease in the yield curve, causes the maximum increase in the average PD (about 40 percent). - Under that shock, only 20 percent of the firms will have a PD higher than 5 percent. - The stress test performed is described as rather extreme and does not consider that derivatives might be hedging on-balance sheet exposures; the pattern of higher increases in PDs for interest rate declines suggests most derivatives positions are for hedging purposes. ### Policy recommendations and supervisory concerns (derivatives) - Consider introducing capital charges for model risk for banks actively involved in structured products, in line with the recommendations in Basel II. - Supervision of bank derivative activities is key to ensure stability and minimize legal and reputational risks. - BI and Consob supervisors need to closely monitor banks’ internal guidelines on the marketing of structured products. - Pay particular attention to the practice of restructuring losing derivative positions by rolling them over into further structures, where the positions may be doubled. ### Banking system vulnerabilities and stress-test overview - Overall exposures and liquidity: - Banking system exposures to foreign exchange and equity risks are well below five percent of capital. - Liquid assets in relation to short term liabilities has halved in the last five years. - Stress-test coverage and methodology: - Stress tests examined nine major Italian banking groups accounting for 62 percent of total bank assets. - Tests were performed on consolidated end-2004 balance sheets and updated with data as of end-June 2005. - Size of shocks for market, sovereign, interest rate in the banking book and liquidity were in line with other FSAPs for Euro area countries; the credit risk shock exceeded the largest historical shock in Italy. - Stress-test results — resilience and key exposures: - Major Italian banking groups are resilient to shocks; existing capital buffers are sufficient to absorb the shocks even in the absence of profits. - Individual risk factors with greater exposure are credit and sovereign risk. - Of the macro scenarios considered, the oil shock that causes global slow down and results in a 30 percent decrease in global equity prices has the largest impact. - This scenario corresponds to an estimated increase in the PDs of 83 percent, far exceeding the largest historical observation. - The relatively low impact of stress tests is attributed to historically low impacts on PDs used to calibrate the exercise; prolonged low growth could have more pronounced implications. - Liquidity vulnerabilities: - Stress tests indicated some banks (representing 22 percent of total bank assets) may not have appropriate liquidity buffers to sustain a liquidity shock. - Authorities noted these banks were mainly members of banking groups and would be covered by liquidity buffers in the parent bank; nevertheless, staff recommends monitoring liquidity buffers carefully and encouraging increases if necessary. ### Regulatory environment and structural issues (banks) - Compliance and supervisory quality: - A June 2003 detailed assessment of compliance with the Basel Core Principles found the Italian bank supervisory system to be of a high standard. - Progress on implementing key BCP recommendations has been slow; staff encouraged prompt convergence to a standard definition of impaired loans to raise transparency and cross-country comparability. - Connected lending and related-party lending: - Recommendation to introduce comprehensive regulations on lending to related parties: ICCS approved broad guidelines in July 2005, paving the way for more detailed BI regulations. - Only limited data is available on connected lending, raising uncertainty about its extent; BI is encouraged to regulate and monitor lending to related parties. - Basel II and model validation: - Large banks are at an advanced stage of preparation for adopting Basel II. - Two banks, accounting for roughly 30 percent of the system’s total assets, have had their market risk models validated by BI. - Eight banks identified as potential candidates for pre-validation of the internal ratings-based (IRB) approach; BI follows progress of five additional banks. - Accounting transition to IFRS: - Market participants expect some restatement of balance sheets with the transition to IFRS in 2005 but the overall impact on capital is uncertain. - Higher provisioning rates for nonperforming assets under IFRS are expected to translate into a negative impact on banks’ capital base because of the need to discount future income streams. - For many banks this effect may be balanced by the revaluation of real-estate property; stricter accounting for pension costs may affect some banks negatively. - Only a few Italian banks have provided quantitative data on IFRS impact; one bank resorted to capital injections in anticipation. ### Policy transparency and potential conflicts of objectives - Transparency practice: - The IMF Transparency Code is generally formally observed; BI disseminates information on policy developments and regulatory changes through its publications program. - There is little discussion of overall objectives, their linkages, and how they are being pursued; consideration should be given to publication of a financial stability report that could include these issues. - BI’s statutory objectives and potential conflict: - At the time of assessment, BI was by law assigned at least three broad objectives: maintaining the stability of the financial system, enforcing Italy’s antitrust laws, and promoting the efficiency and competitiveness of the banking sector. - Staff believe BI should not be promoting “competitiveness” and recommend changing the wording in the Banking Law. - BI’s joint responsibility for enforcing competition laws and maintaining financial stability might lead to potential conflicts (e.g., short-term stability concerns facilitating mergers without full competition assessment). - Such conflicts could be addressed by clear, transparent merger review procedures and compensatory antitrust measures where appropriate. - Institutional changes: - The newly enacted Savings Law transferred responsibility for regulating anticompetitive behavior to the Antitrust Authority. - BI and the Antitrust Authority have shared responsibility for authorizing bank mergers and acquisitions (BI on prudential grounds; the Antitrust Authority on competition grounds). - Effective implementation requires the Antitrust Authority to have clear decision-making processes, appropriate resources and expertise, and independence. - Role of ICCS: - The role of the ICCS in bank supervision makes it difficult to assess BI’s degree of operational independence on prudential issues. - ICCS remains the highest supervisory authority for issuing broad guidelines on prudential supervision and in the area of credit activities and the protection of savings. - Lack of clarity regarding ICCS’s role has delayed important supervisory regulations (e.g., connected lending). ### Insurance sector — recent performance and outlook - Performance and structure: - The Italian insurance industry posted premium increases of about 12 percent in both 2003 and 2004. - Capitalization levels remain strong; profitability is one of the highest in Europe. - Combined ratios dropped below 100 percent in 2003–04 for the first time in more than two decades. - Activity in the Italian nonlife sector carries relatively low risk profiles because certain risks (environmental and asbestos) have not affected the industry. - Market exposures and asset allocation: - Low exposures to equities (about 12 percent) and high exposures to fixed income securities (57 percent) in insurers’ portfolios. - Market size and prospects: - Italy is a relatively under-insured market; gross domestic premium income accounted for 7.5 percent of GDP in 2004, compared with an E.U. average of close to 9 percent. - Growth prospects are generally seen as favorable; margins may remain higher than in the rest of Europe for some time, and life sector industry should benefit medium term from the recently approved pension reform. - Challenges: - Margins likely to shrink due to increased competition and implementation of a stricter regulatory regime. - Nonlife profitability improvements could slow due to increased pressure from consumer associations and government to reduce tariffs. - Revenue diversification is important since most Italian insurers are exclusively domestic players. - Concerns about sale to retail investors of life insurance products with high fee structures and inadequate disclosure practices. - Competition may be hampered by rigid, vertically integrated distribution networks in which banks play a central role (about 70 percent of life insurance products are sold through bank networks). ### Insurance stress tests — findings - Coverage and methodology: - Stress tests applied to the balance sheets of the 10 largest insurance groups (as of end-2004), representing a market share of over 70 percent of premiums. - Assumptions consistent with those used in the parallel banking sector stress testing: domestic macroeconomic shock, range of interest rate shocks, and catastrophe risk. - Results: - A number of relatively small life insurance companies are vulnerable to shocks. - Life insurance companies are most exposed to adverse shocks; solvency may be particularly affected by an interest rate shock or adverse macroeconomic scenario. - Most vulnerable life companies are owned by banks and may benefit from the larger capital pool of their parent banking group. - Potential solvency shortfalls in bank-owned insurance companies are very small compared with amounts of capital available to banks. - In the nonlife sector, solvency levels seem unlikely to reach critically low levels due to relatively high current levels and the absence of significant exposures to catastrophic risk (especially after reinsurance). ### Insurance regulatory issues and recommendations - ISVAP supervision and forward-looking approach: - ISVAP has moved toward a more forward-looking, risk-based supervisory methodology and is preparing for Solvency II. - The legal framework is largely adequate, but legal protection of supervisors, independence of directors and licensing of intermediaries may need strengthening. - Supervisory practices to enhance: - Continue extensive off-site financial analysis and make it more forward-looking by requiring insurers to regularly perform stress testing and report results. - Increase on-site inspections significantly in breadth and frequency to support comprehensive risk assessments. - Increase inspections of insurance intermediaries, including those employed in nontraditional distribution systems. - Improve disclosure to consumers; increase disclosure of company-specific financial information (including by ISVAP) to support market discipline. - Institutional responsibilities for pension-related products: - ISVAP should supervise insurers selling pension products, and COVIP should monitor the transparency of pension products (including those sold by insurance companies) without imposing duplicate or conflicting supervisory requirements. *Source: IMF Staff Country Report excerpt.* ### 47. Pension funds are small institutional investors in Italy, and recent reform ### 47. Pension funds are small institutional investors in Italy, and recent reform ### Pension funds and recent reform initiatives - Pension benefits are still primarily provided by the public pension system; private pension funds cover less than 12 percent of the employed workforce. - Italian pension funds are almost exclusively defined contribution schemes and generally invest their assets conservatively (a total of about €40bn, or 3 percent of GDP). - Typical asset allocation noted: debt securities 46 percent, real estate 17 percent, mutual funds 13 percent, and equities less than 10 percent. - Legislative changes approved in July 2004 include the possibility for employees to transfer their TFR (Trattamento di fine rapporto) to pension funds, which should help promote competition between private pension providers and stimulate the growth of pension funds and the asset management industries more broadly. - The TFR currently represents 6.91 percent of gross salaries, and about €15bn annually in aggregate. - Implementing the recent legislative changes would automatically channel TFR into private pension funds, unless employees explicitly decide otherwise. - However, the recent legislative changes are now planned to take effect only in 2008, and further modifications are possible before then. - The replacement rate provided by public pensions is estimated to gradually decline from about 70 percent at present, to 50 percent around 2050. ### Securities markets: structure and development - Italy’s equity markets are limited by a relative lack of “equity culture”, a small number of big private corporations, predominance of family-owned SMEs, and the marginal importance of certain institutional investor classes (such as pension funds). - Authorities have taken steps to: - introduce various market segments and improve market regulation to facilitate listing by small companies; - promote new indices to meet various investor needs. - The Italian corporate bond market remains underdeveloped; corporate scandals led to a further reduction in domestic bond issuance by Italian corporations in the early 2000s. - Some regulatory gaps that contributed to reduced issuance are being addressed in the Law on Savings. - The Italian government bond market is the largest and most liquid in Europe and has been a driving force of international capital market integration with the MTS platform. - MTS trading platform: - introduced in 1988 to increase liquidity and transparency in the Italian government bond market; - an estimated 70 percent of all euro zone government bonds are currently listed and traded on the MTS platform, offering standardized benchmarks for a wide range of fund managers and producers of financial instruments. - The liquidity of the secondary market for Italian government bonds reflects authorities’ efforts to issue a smaller number of benchmark instruments with greater outstanding amounts, while extending the overall duration of public debt. - The liquidity of the MTS market was tested on August 2, 2004, when a London-based market participant sold €12bn of euro government bonds (over half the size of average daily trading volumes) through the automated trading network in about 15 seconds; from a technical standpoint, the trading incident did not durably affect the functioning of the market (temporary limits on transaction size were removed after a few weeks). - An increased size and role of capital markets is desirable to provide the private sector with alternatives to bank financing and to support development of savings and investment opportunities for institutional investors and households. ### Securities market regulation, oversight and transparency - Assessment of IOSCO Objectives and Principles shows very strong securities market regulation and oversight. - Recent legislation has further strengthened Consob’s powers to investigate, supervise and enforce compliance, including by giving Consob and BI the authority to impose pecuniary sanctions. - Assessment of the IMF Transparency Code for securities regulation revealed a high degree of compliance. - Areas requiring further action: - Consob and BI should include markets and market operators in their on-site inspection plans. BI has indicated that inspections will be carried out as necessary on the basis of a recently adopted ad hoc methodology. - To strengthen supervision of the government securities market, Consob should ensure that information from the wholesale market is timely and effectively integrated with that from the retail market. - Disclosure requirements should be extended to nonlisted debt instruments issued by banks. ### Corporate governance and investor protection - An IMF staff study indicates the Italian corporate governance framework incorporates a high degree of investor protection, in some areas more stringent than international practice, but benefits are not always fully realized. - Factors limiting minority shareholder enforcement include highly concentrated ownership, cross-shareholdings, and pyramid structures. - The recently adopted law incorporating the EU market abuse directive has: - given Consob more resources; - augmented Consob’s power to act independently of the Minister of the Economy and Finance; - raised pecuniary sanctions. - Further recommended changes include: - mandating a majority of independent directors; - incorporating some provisions of the Preda (voluntary corporate governance) Code into regulatory requirements; - representing minority shareholders on the board. ### Payments, securities settlement, and crisis management (selected findings) - Payments and settlement: - A June 2003 assessment of Compliance with CPSS Core Principles for Systemically Important Payment Systems (CPSIPS) found high standards in payment system operation and oversight. - Migration to the new Birel RTGS system was completed in 2004 and most recommendations were addressed. Birel (together with the German system) has been chosen as the basis for developing the new unified euro area RTGS platform. - Assessment of CPSS/IOSCO Recommendations for Securities Settlement (RSSS) demonstrated that Italian securities clearing and settlement systems are safe, sound and efficient. - Monte Titoli (MT) has adequate procedures to monitor, identify and manage operational risk and intends to put in place proactive risk-management procedures and external audits of disaster recovery, business continuity and outsourcing arrangements. - Due to the de facto monopoly position of MT and Cassa di Compensazione e Garanzia, their common holding company, Borsa Italiana, indicated it would increase the number of independent Board members. - Systemic liquidity arrangements and emergency liquidity assistance (ELA): - BI maintains an element of institutional ambiguity in the provision of ELA to illiquid but solvent institutions; there is no ex ante specification of terms and conditions other than the use of collateral and the penalty rate slightly above market rates. - Uncertainty regarding granting of ELA and perceived reputational cost are believed to deter inappropriate reliance on ELA. - Recommendations include making BI’s role more transparent while precluding moral hazard, for example by disclosing that meeting pre-specified criteria is not a sufficient condition for support. - There is a presumption in favor of ex post disclosure, publishing aggregate terms and amounts, as in the latest cases of support in the early 1990s. - Since 1999 no bank has requested ELA. - A potential conflict of interest may arise from BI’s Asset Management Department’s privileged access to information on banks resorting to ELA, since it is entrusted with ELA decisions and is also responsible for handling the Bank’s portfolio investments; recent decisions to create a separate unit within the Department for ELA-related matters and to follow an investment strategy aimed at replicating a market index are moves in the right direction. - Bank resolution: - BI has extensive powers in bank resolution and liquidation procedures; the special administrator appointed by BI assumes all powers of the Board of Directors, including merger and acquisition negotiations. - Criteria underlying purchase and assumption decisions are unclear; authorities indicated competitive mechanisms were used, including, in at least one case, an informal auction to select the acquiring bank. - Shareholders approve the final decision but have limited recourse since only the special administrator may convene a shareholders’ meeting and determine items on its agenda. - Between 1990 and 2004, 94 banks were placed under special administration; of these, 30 were liquidated and 46 were merged with other banks. Since 1997, only small banks were under special administration. - Deposit insurance schemes (DIS): - Two funds operate: the Interbank Deposit Protection Fund (FITD) and the Mutual Banks Depositors Protection Fund (FDGCC). - Coverage of the two funds is significantly higher than required EU minima. - Contributions are subject to risk-based premia and charged on an ex post basis. - There is no presumption for back-up public financing should DIS resources prove insufficient, although this happened in two cases (in 1996 and 1997), with BI supplementing DIS resources on one occasion. - Between 1988 and 1997, the FITD intervened six times, in four of which it applied the purchase and assumption option. - The DIS evaluates options on a least-cost basis and may provide support interventions such as credits, guarantees and acquisitions of equity. *IMF Country Report: excerpt "47. Pension funds are small institutional investors in Italy, and recent reform" (source document provided).* ### 58. Italy’s comprehensive AML/CFT system has produced significant enforcement ### 58. Italy’s comprehensive AML/CFT system has produced significant enforcement successes against money laundering, but the complex legal framework needs consolidation and streamlining ### AML/CFT system — findings and gaps - The AML/CFT system has produced significant enforcement successes against money laundering. - The preventive system has generally not been updated to the latest FATF standard. - Key implementation gaps identified: - Need for greater implementation of the more detailed customer due diligence (CDD) requirements of the revised standard. - Need for a more effective sanctions regime. - Need to increase suspicious transaction reporting of non-bank financial intermediaries. - Need to introduce a legal obligation to report suspicious transactions related to terrorist financing. - The legal framework for nonfinancial businesses and professions urgently needs to be implemented. ### Financial Intelligence Unit (FIU) - The Financial Intelligence Unit has technologically advanced analytical capability but insufficient filtering limits its effectiveness. - The authorities are diligently working to close these gaps. ### Financial system structure (selected figures from Table 1, 2000–2005) - Total financial system assets (June 2005): 3,899.8 (€ bill.) — Percent of total assets: 100.0 - Banks total assets (June 2005): 2,594.9 (€ bill.) — Percent of total assets: 66.5 - Limited company banks (June 2005): 2,068.7 (€ bill.) — Percent of total assets: 53.0 - Branches of foreign banks (June 2005): 139.9 (€ bill.) — Percent of total assets: 3.6 - Insurance corporations (June 2005): 495.5 (€ bill.) — Percent of total assets: 12.7 - Life insurance (June 2005): 284.1 (€ bill.) — Percent of total assets: 7.3 - Nonlife insurance (June 2005): 27.3 (€ bill.) — Percent of total assets: 0.7 - Total number of employees (mem.), June 2005: 339,111 - Branches of domestic banks (June 2005): 30,554 ### Financial soundness indicators — banking (selected series from Table 2) - Regulatory capital to risk-weighted assets (Core set), 1999–2005: 10.5, 10.1, 10.4, 11.2, 11.4, 11.6, 11.6 - Regulatory Tier I Capital to risk-weighted assets (1999–2005): 9.3, 8.5, 7.8, 7.9, 8.2, 8.5, 8.8 - Nonperforming loans to total gross loans (1999–2005): 9.8, 7.8, 6.7, 6.5, 6.6, 6.5, 6.3 - Return on assets (1999–2005): 0.6, 0.7, 0.5, 0.4, 0.4, 0.6, 0.7 - Return on equity (1999–2005): 10.6, 12.9, 9.1, 6.4, 6.7, 10.7, 13.3 - Liquid assets to total assets (1999–2005): 10.6, 8.2, 7.4, 5.9, 5.5, 5.3, 5.6 - Household debt to GDP (1999–2005): 22.0, 22.8, 22.9, 24.3, 26.0, 28.1, 29.9 - Residential real estate prices (1990=100, deflated by CPI), 1999–2005: 98.1, 100.1, 104.6, 114.6, 123.5, 131.6, 139.5 - Residential real estate loans to total loans (1999–2005): 9.6, 10.3, 10.3, 12.0, 13.8, 15.7, 16.3 ### Banking sector stress tests — summary (June 2005, Table 3) - Pre-Stress CAR: 11.01 (Weighted Average), 8.78 (Largest) - Post-Stress CAR (selected scenarios): - Parallel increase in major interest rates 2/: Loss (–)/Gain (+) as % of June 2005 (annualized) after-tax profits: –5.7 (Weighted Average), –29.2 (Largest); Loss as percentage of capital buffer at June 2005 CAR: –2.0 (Weighted Average), –8.9 (Largest); Post-Stress CAR: 10.95 (Weighted Avg.), 8.71 (Min). - Rise and flattening of the main yield curves 3/: –8.7 (Weighted Average), –19.7 (Largest); –3.1, –7.4; Post-Stress CAR: 10.92, 8.72. - Fall in equity prices 4/: –4.3, –12.5; –1.53, –17.45; Post-Stress CAR: 10.96, 8.64. - Euro depreciation against major currencies 5/: –17.2, –36.7; –6.1, –14.2; Post-Stress CAR: 10.83, 8.72. - Sensitivity to Sovereign Risk 6/: –15.3 (Weighted Average), –178.0 (Largest); –6.2, –40.9; Post-Stress CAR: 10.33, 8.77. - Sensitivity to credit risk 7/: –24.3, –94.4; –9.8, –33.9; Post-Stress CAR: 10.71, 8.51. - Macroeconomic scenario (Rise in oil prices and fall in equity prices) 8/: –35.8, –144.7; –13.6, –46.9; Post-Stress CAR: 10.60, 8.41. - Dollar depreciation 9/: –17.9, –63.4; –8.5, –29.4; Post-Stress CAR: 10.75, 8.55. - Loss of economic value as percentage of bank capital — Sensitivity to interest rate risk in the banking book 10/: –6.34 (Weighted Average), –13.22 (Maximum loss). - Liquidity stress test (Bank of Italy estimates): Number of banks with liquidity shortfall in the 1–7 days time-band: 82 — Share of assets: 22%. ### Insurance sector — financial soundness indicators (selected, Table 4) - Life insurance: Capital / total assets (1999–2004): 8.18, 7.88, 7.32, 6.71, 6.34, 5.88 - Life insurance: Return on equity (ROE), 1999–2004: 8.69, 10.58, 7.54, 7.51, 8.83, 10.50 - Non-life insurance: Capital / total assets (1999–2004): 19.67, 19.89, 16.12, 16.04, 17.20, 17.64 - Non-life insurance: Combined ratio (1999–2004): 109.30, 106.70, 103.07, 98.74, 96.83, 95.69 - Life insurance: Net technical reserves / average net premiums received (3 yrs), 1999–2004: 443.27, 491.23, 492.15, 490.77, 502.28, 509.74 ### Insurance stress tests — summary (December 2004, Table 5) - Life sector — Ante shock solvency ratio (Best / Average / Worst): 6.02 / 1.64 / 0.86 - Macroscenario: 5.61 / 1.52 / 0.69 — Number of individual companies with ratio < 1: 10 — Solvency shortfall/liabilities: 0.68 - Shock 1 (Tilt+) 3/: 6.06 / 1.64 / 0.80 — Number with ratio < 1: 3 — Solvency shortfall/liabilities: 0.12 - Shock 2 (Shift +) 4/: 6.01 / 1.62 / 0.80 — Number with ratio < 1: 4 — Solvency shortfall/liabilities: 0.36 - Shock 3 (Tilt –) 5/: 5 / 5.95 / 1.66 / 0.85 — Number with ratio < 1: 6 — Solvency shortfall/liabilities: 0.16 - Shock 4 (Shift –) 6/: 5.98 / 1.67 / 0.85 — Number with ratio < 1: 5 — Solvency shortfall/liabilities: 0.07 - Nonlife sector — Ante shock solvency ratio (Best / Average / Worst): 7.56 / 3.14 / 1.04 - Macroscenario: 7.55 / 2.73 / 0.96 — Number with ratio < 1: 2 — Solvency shortfall/liabilities: 3.07 - Shock 2 (Shift +) 4/: 7.56 / 3.12 / 0.99 — Number with ratio < 1: 1 — Solvency shortfall/liabilities: 0.59 - Natural disaster before reinsurance: 7.56 / 3.01 / 1.02 — Number with ratio < 1: – — Solvency shortfall/liabilities: – - Natural disaster after reinsurance: 7.58 / 3.13 / 1.04 — Number with ratio < 1: – — Solvency shortfall/liabilities: – ### Assessments of standards and codes (Annex summary) - Summary assessments covered seven international standards and codes relevant for the financial sector: - Basel Core Principles for Effective Banking Supervision (BCP) - Core Principles for Systemically Important Payment Systems (CPSIPS) - IAIS Insurance Core Principles (ICP) - IOSCO Objectives and Principles for Securities Regulation - Securities Settlement and Payment systems CPSS-IOSCO (RSSS) - IMF Code of Good Practices on Transparency in Monetary and Financial Policies (MFP) - FATF Recommendations for Anti–Money Laundering and Combating the Financing of Terrorism (AML/CFT) - Assessment missions and timing (as reported): - IOSCO and CPSS-IOSCO assessments: mission to Italy from October 18 to November 3, 2004. - AML/CFT assessment: mission in April 2005. - ICP and MFP assessments: mission July 6–20, 2005. - Sources for assessments included self-assessments by supervisory authorities, reviews of laws/regulations/policies, interviews with supervisory authorities, meetings with the Ministry of Finance, Bank of Italy and other authorities and independent bodies, and meetings with financial sector firms and associations. *Source: _cr06112 - 58. Italy’s comprehensive AML/CFT system has produced significant enforcement* ### 59. Since 1990, the Italian banking system has undergone a significant consolidation ### _cr06112 - 59. Since 1990, the Italian banking system has undergone a significant consolidation ### Overview and structural changes since 1990 - Successive waves of privatization have significantly shrunken the share of state ownership via (nonprofit) foundations (Fondazioni) participation in the banks’ capital. - Market discipline has improved with greater transparency regarding ownership structure and reduction in cross-shareholdings. - Shareholders are required to disclose the existence and content of private agreements to BI; for listed banks, this information is also disclosed to the public. - There are a few cases where cross-shareholdings allow a group of Fondazioni to control jointly more than 50 percent of a bank’s capital. ### Insolvency regimes and crisis frameworks - The corporate insolvency regime results in lengthy and costly judicial proceedings and slow realization of collateral. - The government had proposed legal reform aimed at simplifying legal proceedings and maximizing the value of the distressed enterprise through restructuring; this reform was approved in December 2005. - The insolvency regime for banks, based on administrative procedures led by BI, is fast and efficient, supported by deposit insurance and a framework for public intervention to limit systemic stress. ### General preconditions for effective banking supervision - The legal framework defines general principles for bank and nonbank financial intermediaries; detailed technical rules are deferred to secondary legislation. - BI (Banca d’Italia) has extensive powers and responsibilities as banking supervisor and supervises financial markets relevant for monetary policy (e.g., wholesale markets for government securities and interbank markets). - All Italian agencies are legally required to cooperate through formal and informal contacts and may not invoke official secrecy against one another. - BI has signed a protocol with ISVAP establishing formal mutual cooperation procedures. - BI conducts supervisory policies transparently while preserving confidentiality; it publishes principles and criteria of its supervisory activity and specifies time limits and responsible persons for administrative procedures. ### Transparency, disclosure, and corporate governance - A key challenge is strengthening transparency and disclosure of banks’ balance sheets, income statements, and corporate governance practices. - Banks disclose a highly detailed set of data to BI for micro- and macro-prudential surveillance; listed banks disclose extensive information to markets. - Further efforts to facilitate cross-country comparisons and investor analysis would enhance market discipline. ### Main findings on compliance with Basel Core Principles (BCPs) - Italy has a high overall level of compliance with the Core Principles, though some legal amendments were required at the time of assessment. - BI conducts comprehensive off-site monitoring integrated with on-site inspections. - Inspection cycle: small banks inspected on a three-year cycle; large banks previously at longer intervals (not more than six years). - BI is increasingly using focused and thematic inspections to shorten the cycle; the inspection cycle for large banks has recently been shortened to no longer than three years when thematic inspections are included. - Specific concerns and recommendations: - Loan impairment recognition and cessation of interest accrual appear to be recognized later in Italy relative to other G7 practices. - Italy opted for a five-year transition period to use a 180-day past-due definition for impaired loans (as opposed to the standard “more than 90 days past-due” criteria), as permitted in the EU Capital Requirements Directive. - Lack of a comprehensive definition of “connected lending or lending to related parties” in banking law; recommendation to issue comprehensive regulation addressing definition, overall limits, and reporting. - Supervisory authority lacks sufficiently clear legal authority to require expeditious change in board/management composition when incumbents no longer meet “fit and proper” criteria. - BI should review how to derive greater benefit from external auditors’ work and seek authority to revoke external auditors’ appointments when performance is deficient and to set audit standards/scope. - Mission discussions suggested the system delayed recognition of impaired loans and suspension of income recognition; adoption of IFRS in 2005 would help alignment. - BI has broad remedial powers but lacks specific provision to require subsequent removal of a director or senior officer who becomes unfit. - Cross-border cooperation: BI has memoranda of understanding with many foreign supervisors; coordination for foreign banks operating in Italy is adequate; regulatory framework for consolidated supervision is satisfactory. ### Key statistics and timelines preserved from the assessment - More than 50 percent: instances where a group of Fondazioni jointly control a bank’s capital. - Five-year transition period to use a 180-day past-due definition for impaired loans. - 180-day and 90-day past-due criteria explicitly retained in discussion. - Inspection cycles: three-year cycle for small banking institutions; not more than six years previously for large banks; shortened to no longer than three years when including thematic inspections. - Date references: - Assessment conducted in June 2003. - Savings Law (No. 262 of December 28, 2005) referenced. - New accounting regulation requires classification as of December 31, 2005 of 180-day past-due loans as impaired loans. - At the latest by 2011, banks must converge from 180-day to 90-day past-due criteria. - RTGS system Birel launched in 1997; replaced by New Birel in January 2004. - Historical: BI responsibility for clearing since 1926; new procedures from 1991 to settle most interbank transactions in central bank money. - Nonperforming loans ratio projection: - Ratio of effective nonperforming loans (positions past-due or overdrawn continuously for more than 90 days) to total loans would rise from 6.8 percent to 7.5 percent at end-June 2005 under the monitoring reports for moving to 180-day/90-day definitions. - Banking sector concentration and related-party exposures: - Based on the 14 largest Italian banks (accounting for 75 percent of total banking assets), about 10 related parties’ positions would exceed the highest threshold set by the ICCS, for an overall amount of around 9 billion euros. ### Action Plan highlights (selected recommended actions from Table 6) - BCP 1.5 Legal protection - Introduce legislative amendments to provide legal protection to the supervisory authority and its officers against legal action stemming from measures adopted in good faith. - BCP 8 Loan Evaluation and Loan-Loss Provisioning - During the transitional period allowed by Basel II for Italy to use 180 days past due, modify rules/procedures to conform in due course to the widely accepted international practice of 90 days past due. - Revise instructions to better align provisioning with estimated loan-portfolio losses. - BCP 10 Connected Lending - Issue comprehensive regulation on connected lending addressing definition, overall limits, and reporting. - BCP 14 Internal Control and Audit - Amend banking law and regulations to empower BI to remove expeditiously bank directors or senior officers who have become unfit. - BCP 19 Validation of Supervisory Information - Review means to derive greater benefit from external auditors’ work (e.g., money laundering areas). - Amend banking law to obtain power to revoke bank external auditors when performance is deficient and to establish scope and standards for external audits. - Continue reviewing adequacy of staff resources. - BCP 21 Accounting Standards - See recommendation on loan evaluation in BCP 8 above. ### Developments subsequent to the assessment - Authorities addressed some recommendations from Table 6; follow-up would further strengthen BI’s supervision. - BI introduced a new reporting requirement to monitor the impact of moving to a 180-day (ultimately 90-day) past-due definition. - Based on such reports, effective nonperforming loans ratio would rise from 6.8 percent to 7.5 percent at end-June 2005. - New accounting regulation requires classification in financial statements as of December 31, 2005 of 180-day past-due loans as impaired and provisioning in line with IFRS (consolidated) and national GAAP (individual). - Convergence from 180-day to 90-day by 2011 at the latest; staff encourages speeding up this process. - Progress on connected lending (BCP 10): - July 2005 ICCS approved a guideline on connected lending and entrusted BI to issue a detailed regulation; Savings Law consistent with ICCS guidelines. - Based on the 14 largest banks (75 percent of assets), about 10 related parties’ positions would exceed the highest ICCS threshold for around 9 billion euros. - BI prepared a draft regulation implementing the ICCS guideline, to be issued for consultation shortly. - Outstanding issues: - Supervisory authority and officers remain liable to legal procedures for measures adopted in good faith (BCP 1.5); legal amendment required for compliance. - BI still lacks legal power to remove expeditiously unfit bank directors or senior officers (BCP 14). - Limited progress on granting BI authority to remove external auditors when performance is deficient (BCP 19); forthcoming EU directive expected to extend mandatory external bank audits and Consob will manage auditors’ registry, with power to remove unfit auditors—requiring cooperation between BI and Consob. ### Authorities’ response (BI) - BI considers the assessment recognizes a high degree of compliance with the BCPs and highlights positive features: adequacy of prudential regulations, effectiveness of controls, fruitful interaction between on- and off-site methods, and flexible supervisory tools. - IMF recommendations aligned with BI’s ongoing considerations, including legal protection for supervisors and comprehensive regulation on lending to related parties. - BI committed to issuing supervisory regulation in 2006 to comply with July 2005 ICCS resolution and the Savings Law. - BI contends that observations on BCPs 14 and 19 do not imply the existing framework prevents BI from achieving BCP goals, though initiatives will be taken to address issues by competent authorities. - On BCPs 8 and 21, BI has defined more objective criteria for classification of impaired loans consistent with most G-10 countries and will amend supervisory regulations per the New Capital Accord time frame to achieve 90-day classification; BI disagrees that existing criteria overestimate banks’ income and argues reclassification dynamics offset such income over time. ### Summary assessment of the RTGS payment system (Birel / New Birel) - Assessment covered compliance of the Italian RTGS system Birel (replaced by New Birel) with CPSS Core Principles for Systemically Important Payment Systems; assessment conducted June 16–27, 2003. - Methodology followed Guidance Note prepared in August 2001 and was aided by a comprehensive BI self-assessment. - Institutional/market structure: - BI has legal responsibility for clearing procedures since 1926. - From 1991, procedures ensured most interbank transactions settled in central bank money rather than bilateral correspondent accounts. - RTGS system Birel launched in 1997; since 1998 all types of domestic high-value payments settled through the system. - Birel was replaced by New Birel in January 2004. *Source: IMF staff assessment as presented in the referenced PDF chapter/section.* ### 85. With the start of Stage III of European Monetary Union (EMU) in ### _cr06112 - 85. With the start of Stage III of European Monetary Union (EMU) in ### Integration with EMU / TARGET - With the start of Stage III of European Monetary Union (EMU) in January 1999, Birel became the domestic Italian component of the EU-wide RTGS system, TARGET. - Procedures and policies relating to Birel must comply with relevant decisions of the European Central Bank (ECB). - Availability and circulation of liquidity—cash or collateral—in Birel must be considered in the context of real-time cross-border links between Birel and the RTGS systems of other EU countries (both inside and outside the Euro-zone). ### Birel system description and usage - Birel is used by 600 financial institutions holding RTGS accounts with BI. - No minimum amount is required for a payment through Birel; it handles time-critical low-value payments as well as large-value transfers and payments in settlement of securities transactions. - In terms of total volume of transactions settled: - 2001: 10.2 million payments (Birel ranked second among EU RTGS systems). - 2002: 9.6 million payments (Birel ranked second among EU RTGS systems). - In terms of total value of transactions settled: - Birel ranked 5th in both 2001 and 2002. - Payment flows in Birel are concentrated in a relatively small number of banks. ### Operation, transparency, and oversight - Birel is operated and overseen by BI within TARGET rules, procedures and guidelines issued by the ECB. - BI’s policies, procedures and practices for Birel are open and transparent and widely circulated through publications and ongoing contact with users. - BI publishes regular reports on Birel’s operation and on volume and value of payments. ### Observance of CPSS Core Principles and main findings (selected) - Legal basis (CP 1) - Birel’s legal basis derives from: the Statute of the European System of Central Banks and ECB rules/regulations/guidelines (as incorporated into Italian law); domestic Italian legislation relating to BI; Italian Civil Code; insolvency and corporate law. - Potential conflict of law exists for branches in Italy of banks incorporated outside the European Economic Area (EEA). BI and other TARGET central banks initiated a legal project analyzing conflicts for participants outside the European jurisdiction. - Continuing uncertainties exist, in the absence of an expected Decree, about the validity of electronic instructions to make payments in Birel. - Understanding and management of risks (CPs 2–3) - Members can fully understand the financial risks; risks are set out in the BI Membership Agreement and Guide and through contacts with BI. - Credit risks arise principally from BI’s provision of intraday liquidity against collateral; there may be a slight credit risk for BI in realizing collateral taken from certain banks incorporated outside the EEA. - Liquidity risks for members are effectively managed by: real-time information on payment flows; queuing and optimization mechanisms; availability of intraday liquidity from BI supplementing compulsory monetary reserves. - Final settlement (CPs 4–5) - Birel provides real-time immediate finality as an RTGS system; it is not a multilateral netting system. - Assets for settlement (CP 6) - Birel settles in central bank money. - Security, operational reliability and contingency (CP 7) - Security and reliability requirements are set within the ECB framework for national TARGET components; annual risk assessments of compliance use ECB guidelines. - Business Continuity, Contingency and Information Security plans/procedures are regularly reviewed with main users. - Steps are in hand to achieve system-wide Service Level Agreements among BI, member banks and service providers, though not yet fully achieved. - Practicality and efficiency (CP 8) - Birel meets key RTGS requirements of speed, cost, practicality, and user relevance; end-to-end times are well within TARGET and BI guidelines. - Pricing policy seeks over time to recover through fees and message charges 80 – 85% of the system’s operational, development and overhead costs, with the balance regarded as a public good contribution. - Participation criteria (CP 9) - Access criteria are those laid down by the ECB for every national TARGET component. - Governance (CP 10) - Governance of Birel falls within BI’s overall governance; the Area for Payment Systems and Treasury Operations (APSTO) and the Payment Systems Department (PSD) manage Birel. - PSD’s work is audited by BI’s Internal Audit Department, reporting to BI’s Directorate and top management of the ECB. - PSD maintains coordination with Birel members through working groups, specialized meetings and questionnaires. - A clear separation of operation and oversight could be considered: PSD operating Birel and setting policies; PSOO overseeing compliance with international standards and best practice. - Central bank responsibilities (A–D) - Responsibility A: BI has defined and publicly disclosed payment system objectives in various publications. - Responsibility B: Birel complies, in full or broadly, with all the Core Principles. - Responsibility C: No privately-operated SIPS in Italy currently; BI should monitor flows through “Group Settlement Arrangements” for concentration risk. - Responsibility D: BI cooperates with ECB and other EU central banks via MOUs; no arrangements were in place for cooperation and exchange of information with home country central banks or banking supervisors of Birel members incorporated outside the EEA. ### Recommended actions (Table 8 selected items) - Legal foundation - BI should, by agreement with the ECB, obtain satisfactory Capacity Opinions and Country Opinions for the 14 Birel participants incorporated outside the EEA, or exclude from participation any banks from whom satisfactory Opinions are not obtained. - BI should seek issuance of a Decree covering technical rules on standards of security, authenticity and integrity for electronic processing of payment instructions in Birel and New Birel. - Understanding and management of risks - BI should ensure every bank that will become an Indirect Participant in New Birel is fully aware of risks incurred through appointing a Direct Participant to handle its New Birel receipts. - Security, operational reliability and contingency - BI should consider concentration risks and operational vulnerabilities from outsourcing payment system functionality to a limited set of service providers and from the use of “Group Settlement Agents.” - BI should clarify whether formal and monitorable Service Level Agreements have been signed between each participant in Birel (and New Birel) and every service provider on whom end-to-end RTGS performance depends. - Criteria for participation and Central Bank Responsibilities C and D - BI (via PSD and PSOO) should closely monitor developments in the 2-tier access system for New Birel to detect changes adversely impacting system integrity or efficiency. - BI should put in place arrangements for cooperation and exchanges of information with the 7 central banks and banking supervisors of Birel participants incorporated in non-EU countries. ### Authorities’ response and implementation status - Migration to the new Birel RTGS system was completed by May 2004; BI considers all recommendations addressed except some marginal aspects. - New Birel formed the basis (along with German and French systems) for developing the new unified RTGS platform for the euro area. - Non-EU direct participants in new Birel were reduced from fourteen to three; Capacity Opinions and Country Opinions have been obtained and assessed by the Bank’s Legal Department as fully satisfactory, concluding no conflict of jurisdiction vis-à-vis the country (U.S.) where the three banks are incorporated. - The need for a decree on technical rules for electronic processing was significantly reduced following amendment (legislative decree No. 82 of 7 March 2005) to law No.445 of 2000 that called for issuance of such a decree. - BI amended New Birel rules to introduce a warning for indirect participants about risk exposure vis-à-vis their direct participants. - Banks have been required to sign Service Level Agreements with service providers; outsourcing risks are monitored by an ad hoc business continuity working group including BI functions, major banks, market infrastructures, public utilities and service providers. - Concentration risk monitoring: first quarter of 2004 (near completion of migration) payment shares: - First five banking groups: 45.2 percent (new Birel) vs 42.4 percent (same period previous year in old Birel). - First ten banking groups: decreased from 76.6 percent (old Birel) to 72.5 percent (new Birel). - Conclusion: launch of new Birel did not increase concentration of payments among intermediaries. - BI entered into an agreement on information sharing with the U.S. Federal Reserve. - Separation of operations and oversight: PSD functions report to separate Senior Managers within the Department; ad hoc ECB assessment found no evidence of conflict of interest. ### Insurance sector (selected summary points from assessment) - Assessment covers observance of IAIS Insurance Core Principles (ICP), using ICP dated October 2003; mission conducted July 5–20, 2005; assessment based on circumstances and practices at that time. - Insurance sector performance and structure: - Premium increases of about 12 percent in both 2003 and 2004. - Market penetration: gross domestic premium income accounted for 7.5 percent of GDP in 2004 (EU average close to 9 percent). - Total assets of insurance companies: 34.6 percent of GDP in 2004. - Licensed domestic companies at year-end 2004: 76 life, 81 non-life, 19 composite, and 3 reinsurers; plus 67 branches of foreign companies (primarily non-life). - Concentration (2004, life): largest five life companies accounted for 47 percent of life premiums; largest ten accounted for 65 percent. - Concentration (2003, groups): five largest groups accounted for 53 percent of life premiums and 67 percent of non-life premiums. - Distribution channels (2004): - Banks and post offices: 59 percent of life insurance sales. - Agency channel: about 30 percent of life sales and 88 percent of non-life sales. - Profitability (2004): - Overall return on equity for life business: 10.5 percent. - Combined ratio for non-life declined from 109 percent in 1999 to 96 percent in 2004. - Return on equity (overall non-life): 13.4 percent in 2004. - Supervisor: ISVAP (Istituto per la Vigilanza sulle Assicurazioni Private e di Interesse Collettivo), an independent authority with a Board of Directors funded by a levy on premiums. - ISVAP has moved toward a forward-looking, risk-based supervisory methodology and is active in Solvency II implementation; industry has generally noticed and largely supports the change in approach. *Source: _cr06112 - 85. With the start of Stage III of European Monetary Union (EMU) in* ### 102. The level of observance of the ICP in Italy is good, with the legislative and ### The level of observance of the ICP in Italy is good, with the legislative and ### Conditions for effective insurance supervision - Italy largely meets the conditions necessary for effective insurance supervision. - The harmonization of accounting standards and the development of an alternative dispute resolution mechanism would enhance these conditions. - Recommended clarifications: - The responsibilities for the supervision of pension products should be clearly defined to support ISVAP’s ability to conduct prudential supervision of insurers selling such products, while avoiding duplication or conflict of supervisory requirements. - The accounting and supervisory reporting requirements applicable to insurers under Italian GAAP should be harmonized with IFRS as far as possible. - A specialized alternative dispute resolution mechanism, such as an independent ombudsman, should be established to deal with complaints of insurance consumers (or all financial sector consumers). ### The supervisory system (ISVAP) - Findings and recommended actions: - ISVAP should explicitly communicate the principal objectives of insurance supervision and explain how its plans and activities support these objectives. - Both the board of directors and staff of ISVAP should be protected against lawsuits for actions taken in good faith while discharging their duties. - ISVAP should establish and enforce a code of conduct that includes a prohibition on dealing in shares and investing in companies subject to ISVAP’s supervision. - ISVAP should develop criteria for assessing the overall risk of an insurer and define the nature of supervisory action corresponding to various levels of risk, and communicate this information to the industry. - ISVAP should exchange information with relevant supervisors outside of the EU/EEA. - Additional supervisory enhancements noted: - Consistent with a move to a more risk-focused approach, ISVAP should develop criteria for assessing overall insurer risk and define supervisory actions for various risk levels. - Greater sharing of information with other supervisors, particularly those responsible for other parts of the Italian financial sector and insurance supervisors outside the European Union, would improve observance. ### The supervised entity (insurers and governance) - Recommended legislative and supervisory changes: - Amend legislation to require that all senior management of an insurer meet fit and proper requirements. - Fit and proper requirements should be defined and applied more broadly. - Require that all insurers conform to all of the corporate governance requirements applicable to listed companies. - Amend legislation to provide for legal protection from liability for those parties required to report concerns to ISVAP, in respect of such reporting. - ISVAP should strengthen its off-site and on-site assessment of insurers’ corporate governance practices. - ISVAP should strengthen its off-site assessment of internal controls by routinely reviewing internal audit plans and reports, as well as reports of the board of statutory auditors. - ISVAP should meet regularly with the head of the internal audit function, the appointed actuary, the external auditor, the auditing actuary and the board of statutory auditors to obtain information regarding the effectiveness of internal controls. Legislation should be amended to enable such meetings to take place on a confidential basis, without management present, and the persons involved should have legal protection from liability for providing information to ISVAP. ### Ongoing supervision - Current recommendations and changes: - ISVAP’s on-site inspections should assess not only compliance with requirements but the effectiveness of an insurer in identifying and managing its risks. - ISVAP should significantly increase both the number and scope of its on-site inspections, and should provide advance notice of its inspections, except in cases of specific compliance concerns. - On-site inspections should assess not only compliance with requirements but the effectiveness of risk management. - ISVAP’s market analysis process should include regular meetings and cooperation in quantitative analyses with the other Italian financial sector supervisors and regular meetings with various industry and professional associations. Results should be communicated widely within ISVAP. - Amend legislation to provide that no breach of fitness or propriety requirements will be automatically disregarded after three years have passed. - ISVAP should systematically exchange quantitative and qualitative information with relevant Italian supervisory authorities, where an insurer is a member of a group that operates in the other sectors. ### Prudential requirements - Current status and recommended actions: - ISVAP is actively involved in international standard setting initiatives, such as Solvency II, and has taken steps to require insurers to perform stress testing. - The ability of ISVAP to assess financial condition and take early action could be improved by making regular use of the results of the stress tests and by establishing and communicating solvency control levels. - Specific recommended actions: - The draft circular on reinsurance should be finalized and implemented with high priority. - Amend legislation to extend the requirement for an appointed actuary to all non-life classes of business. - ISVAP should require each insurer to have an overall strategic investment policy and provide guidance regarding the main elements to be addressed therein. - ISVAP should establish and communicate a solvency control level in excess of the minimum solvency margin. - ISVAP should regularly review the results of the stress testing undertaken by insurers, as well as their contingency plans. ### Markets and consumers - Key measures and recommendations: - The new insurance code should strengthen the basis for the supervision of insurance intermediaries. - Disclosure practices are expected to improve with the move to IFRS, although further action is appropriate to ensure information is easily available to interested parties. - Recommended actions: - Adopt the new insurance code and implement its provisions on insurance intermediation with high priority. These provisions should require that all insurance intermediaries operating in Italy be subject to registration and direct supervision, and that the conditions of registration include demonstration, through examination, of adequate insurance expertise. - Amend legislation to clarify ISVAP’s power to require insurers to disclose information on their financial situation and the risks to which they are subject and to require all insurers to make their annual audited financial statements easily available. - ISVAP should publish, on an entity-specific basis, some of the information provided to it by insurers in the supervisory returns. Amend legislation, as necessary, to facilitate such publication. ### Anti–money laundering and combating the financing of terrorism (AML/CFT) - Findings and recommendations: - More frequent inspection of controls by ISVAP is recommended. - Explicit guidance should emphasize the need for foreign branches and subsidiaries of Italian insurers to observe AML/CFT measures. - Recommended actions: - ISVAP should significantly increase the frequency of its on-site inspections of both insurers and intermediaries regarding AML/CFT. - Amend legislation to make ISVAP a member of the FSC. ### Table 9 — Action Plan to Improve Observance of IAIS Insurance Core Principles (high-level summary) - Conditions for effective insurance supervision (CP 1): - Clarify pension product supervisory responsibilities to support ISVAP’s prudential supervision. - Harmonize Italian GAAP accounting and supervisory reporting requirements with IFRS as far as possible. - Establish a specialized alternative dispute resolution mechanism, such as an independent ombudsman. - The supervisory system (CP 2–5): - Communicate principal objectives of insurance supervision and how plans support them. - Provide legal protection for ISVAP board and staff acting in good faith. - Establish and enforce code of conduct for ISVAP staff (including investment prohibitions). - Develop insurer risk assessment criteria and supervisory actions by risk level. - Exchange information with relevant supervisors outside the EU/EEA. - The supervised entity (CP 6–10): - Require all senior management to meet fit and proper requirements and apply those requirements broadly. - Require insurers to conform to corporate governance requirements applicable to listed companies. - Provide legal protection for those reporting concerns to ISVAP. - Strengthen off-site and on-site assessment of corporate governance and internal controls; enable confidential meetings with control function heads and provide legal protection for them. - Ongoing supervision (CP 11–17): - Include regular cross-supervisor quantitative analysis and industry engagement in market analysis. - Increase number and scope of on-site inspections and provide advance notice except for specific concerns. - Assess effectiveness of risk management during on-site inspections. - Amend legislation on time limits for disregarding breaches of fitness/propriety. - Systematically exchange supervisory information with other Italian authorities for group insurers operating across sectors. - Prudential requirements (CP 18–23): - Finalize and implement the draft circular on reinsurance. - Extend appointed actuary requirement to all non-life classes. - Require insurers to have overall strategic investment policies and provide guidance. - Establish and communicate solvency control levels above the minimum solvency margin. - Regularly review insurers’ stress test results and contingency plans. - Markets and consumers (CP 24–27): - Adopt and implement the new insurance code with priority for intermediation provisions, registration and examination requirements. - Clarify ISVAP’s disclosure powers and require insurers to make audited financial statements easily available. - Publish entity-specific supervisory return information, amending legislation as needed. - AML/CFT (CP 28): - Significantly increase frequency of on-site AML/CFT inspections of insurers and intermediaries. - Amend legislation to make ISVAP a member of the FSC. ### Authorities’ response and implementation stance - Acknowledgements and intentions: - ISVAP welcomes the IMF’s recommendations and support to strengthen Italian insurance supervision toward a more forward-looking and risk-based approach in line with Solvency II developments. - ISVAP is carefully assessing the IMF recommendations. - Pre-requisites for some recommendations have been defined, particularly two ISVAP circulars on the system of internal controls and risk management and on passive reinsurance. - Some recommendations are subject to objective limits set by legislation in force, but with the entry into force of the New Insurance Code in 2006, it will be possible to extend ISVAP’s powers. - ISVAP is working on measures such as a code of conduct for staff and reinforcement of its supervisory function; the New Insurance Code extends ISVAP’s supervision to all insurance intermediaries and introduces the possibility for ISVAP to have recourse to Guardia di Finanza (the Financial Police). - For other recommendations, ISVAP will examine expected benefits in the light of a comparison between costs and benefits of regulation and supervision. *Source: IMF assessment text contained in the provided content unit.* ### 131. Public offerings are subject to previous authorization based on disclosure of ### _cr06112 - 131. Public offerings are subject to previous authorization based on disclosure of ### Disclosure, prospectus and issuer reporting - Public offerings are subject to previous authorization based on disclosure of relevant information, through a prospectus. - Periodic reporting as well as disclosure of material information is mandatory. - At the time of the assessment, those requirements did not apply to nonlisted debt instruments issued by banks. 33 - Significant holdings as well as insider holdings are subject to disclosure requirements. - Equal treatment provisions are in place, including mandatory tender offers in certain circumstances. - Note: 33 This was rectified by the Savings Law of December 28, 2005. ### Accounting and auditing - Accounting and auditing standards are of internationally acceptable quality. - The use of IFRS is mandatory for the consolidated accounts of listed companies as of January 1, 2005. - Consob has powers to review the quality of auditor’s work and has done so through an inspection program. - Consob can request disclosure of additional information and ask issuers to restate their financial statements. - If the issuer does not comply with Consob’s request, Consob can sue the issuer before the Civil Court. ### Principles related to collective investment schemes - Regulation of collective investment schemes is well developed. - Both the asset manager and the CISs are subject to licensing. - Licensing criteria for asset management companies (AMCs) include capital adequacy, integrity and experience requirements for control functions, and adequacy requirements for management procedures. - AMCs are subject to periodic reporting. - CISs face similar information requirements as issuers: mandatory prospectus, periodic and material events disclosure requirements. - Rules exist on legal form and structure, custody and net asset value calculations. - AMCs and CISs are subject to inspections by Consob and BI. ### Principles related to market intermediaries - Investment firms are subject to licensing based on requirements including capital adequacy and adequacy of internal controls and management systems. - Market conduct rules apply; periodic reporting is mandatory. - Both BI and Consob conduct inspections on financial intermediaries. - There is a process for winding up firms and an investor’s compensation scheme. ### Principles related to secondary markets and supervision - Secondary markets are subject to licensing with criteria including capital adequacy, integrity and experience for control functions, and conformity of rules with community law. - Regulations promote transparency of trading and aim to ensure proper management of large exposures, default risks, and market disruption. - The supervisory approach relies on mechanisms such as direct access to trading systems, reporting obligations on market operators and visits, but does not include on-site inspections as a routine supervision tool. - Consob conducts real time surveillance of the regulated markets it authorizes; BI conducts real time surveillance for the government bonds wholesale market. ### Actions to Improve Implementation of the IOSCO Objectives and Principles of Securities Regulation (summary) - Principles for the regulator: Recommendations regarding legal protection of BI staff are included in the BCP Assessment. - Principles for enforcement of securities: 1. On site inspections of market operators and regulated markets should be included in Consob’s and BI’s inspection plans. 2. Transparency regarding investor’s complaints would be enhanced with a separate an extensive report on activities performed by Consob. - Principles for issuers: Full prospectus requirements as provided in the Prospectus Directive (2003/71EC) should be applied to nonlisted debt instruments issued by banks. 1/ - 1/ This was addressed by the Savings Law. - Principles for market intermediaries: Consob should consider enhancing monitoring of market intermediaries to ensure compliance with suitability and information disclosure requirements, within the limits of the MIFID Directive. - Principles for secondary markets: On site inspections of both market operators and regulated markets should be conducted by Consob and BI. ### Authorities’ response to the assessment (Consob and BI) - BI and CONSOB contend that Principles 10 and 26 have been fully implemented. - They argue that routine annual on-site inspections of market operators have not been necessary given: - direct access to trading system information (Consob for all markets; BI for wholesale government bonds market), - periodic information required from market operators, including annual accounts and an annual report on internal control issues. - Consob and BI interpret IOSCO Principle 8 (Methodology Key question 3) as permitting the regulator to choose a mix of supervisory tools to perform surveillance; on-site inspections are not required on an annual basis if the regulator has the power to perform them when necessary. - Consob and BI routinely supervise through: - direct supervision of trading and market member behavior, - powers under Article 74 paragraph 3 (Consob) and Article 76 paragraph 1 (BI) to adopt urgent measures and act in place of the market management company, - regular visits to market operators (twice per month) and contacts with staff, - receipt of periodic reports on organizational risk management and technological infrastructure prepared by external auditors, - advance receipt of board meeting agendas and the power to request items be included, - Consob’s approval requirement for market rules. - Historically, after privatization of market operators in 1996, Consob performed 2 on-site inspections pursuant to Article 74 paragraph 2 of the Consolidated Law on the Italian Stock Exchange. - BI has statutory powers to conduct on-site inspections of wholesale government bond market operators; inspections will be carried out as necessary based on a recently adopted methodology applicable to other market infrastructures. - Consob receives and stores transaction data for the wholesale government securities market for analysis to identify possible market abuse and conducts real time monitoring of the retail market for government securities as an additional input for detecting price formation problems. ### Summary assessment of Monte Titoli (MT) against CPSS/IOSCO Recommendations for Securities Settlement Systems General and scope - Assessment undertaken in the context of the IMF Financial Sector Assessment Program (FSAP) exercise for Italy in October 2004. - Covers Monte Titoli (MT) and the Cassa di Compensazione e Garanzia (CC&G). - CC&G is assessed only against Recommendation 4 on CCP in this assessment. Institutional and market structure (key statistics) - Equity market capitalization: €488 billion in 2003. - Number of listed companies: 219. - Equity issued in 2003: €12,524 million (9,868 from IPOs). - Annual turnover on MTS regulated markets for government bonds: €2,136 billion in 2003. - Annual turnover on BondVision: €149 billion in 2003. - As of end-2003, CC&G daily average transactions: 70.365 for derivatives and 307,773 for equities. - At end-2003, CC&G had 140 members; largest 15 members account for 75 percent of all clearing activities. - As of end March 2004, MT had 471 participants in the CSD and 143 participants in the settlement systems. - Largest 15 members account for 90 percent of total settlement instructions. - Securities held in custody average: €2.000 billion. - Value of all transactions settled in MT between January and October 2004: €39.360 billion; number of transactions: 17 million. Main finding - The assessment demonstrates that MT is safe, sound, efficient and reliable and observes the CPSS/IOSCO Recommendations for Securities Settlement Systems. Legal risk (Recommendation 1) - Clearing and settlement activities are governed by a consistent set of laws, regulations and instructions. - Important laws include: - “Legislative Decree 58/59 on consolidation Law on Financial Intermediation,” - “Legislative Decree 213/98 on the Euro introduction,” - “Legislative Decree 210/2001 on Settlement Finality Directive,” - “Legislative Decree 170/2004 on Financial Collateral Arrangement.” - Legal framework supports enforceability of transactions, protection of customer assets, immobilization and dematerialization, netting, securities lending, and delivery versus payment. - Adequate rules exist for participant default and effective use of collateral. - There is no zero-hour rule in Italy. Pre-settlement risk (Recommendations 2–5) - Straight-through processing (STP) allows electronic confirmation between direct market participants on the trading day. - Indirect participants’ transactions can be confirmed on the settlement day if they have an account with MT. - Settlement timing varies between same-day settlement and up to three days for traded securities. - For exchange-traded securities, timely settlement is guaranteed through use of a central counterparty (CCP). - MT provides an automated securities lending facility with a sound legal basis. Settlement risk (Recommendations 6–10) - MT operates both net settlement and real-time gross-settlement (RTGS) systems, allowing intraday and real time settlement finality. - Both netting and RTGS systems settle on a delivery versus payment (DVP) basis in central bank money. - Net settlement batch is activated only after checking availability of securities and cash; transactions lacking assets are excluded from the net batch. - Automated collateralization mechanism and securities lending facility reduce settlement failure. - Mandatory use of CCP for transactions traded in the equity market reduces counterparty risk. - The level of end-of-day failure is slightly higher in terms of value of transactions while low in terms of volume. - To reduce settlement failures to insignificant levels in value, MT may consider strengthening stress testing by analyzing various scenarios for the uncovered cash positions and fine-tuning adjustment of the optimization algorithm. Operational risk (Recommendation 11) - MT has procedures to monitor, identify, and manage operational risk; issues are handled by senior managers and checked by the managing director. - Written documentation exists for contingency scenarios. - A “live” secondary site allows resumption of operations within a short period in case of primary site malfunction. - Recommendations: - Put in place a proactive risk analysis methodology and include market participants in full back testing. - Carry out external audit of procedures and arrangements for disaster recovery and business continuity and for procedures used by the outsourcing company. - BI and Consob may consider issuing regulation allowing direct access to the service provider (SIA) that operates MT’s IT platform to verify disaster recovery and business continuity measures. Custody risk (Recommendation 12) - All traded securities are issued in dematerialized form. - Legislative decrees and BI and Consob regulations require MT and custodians to completely segregate their own securities holdings from customers’. - Custodians must reconcile daily holdings within their systems with accounts at MT. - Securities account balances are subject to external audits. Other issues (Recommendations 13–19) - Governance arrangements are designed to fulfill public interest requirements and to promote owner and user objectives. - Due to MT’s de facto monopoly in settlement and custody activities, it is advisable to increase the number of independent directors on MT’s Board. - MT’s operations are cost-effective in meeting user requirements. - Roles and responsibilities of BI and Consob in clearing and settlement are clearly defined and cooperation is regular (information exchange, joint instructions, on-site supervision). - All links established by MT are free of payment (FOP) and used mainly as collateral for monetary policy operations; MT carried out risk analysis covering legal soundness, customer protection, finality and operational reliability. Table 11 — Recommended actions (highlights) - Recommendation 5: MT should accelerate development of standardized documentation for the securities lending facility. - Recommendation 9: MT may strengthen stress testing for uncovered cash positions and fine-tune the optimization algorithm to reduce end-of-day failures in value. - Recommendation 11: Recommended that MT: - Carry out full-back testing including market participants; - Develop and implement a proactive risk analysis methodology; - Carry out external audit of disaster recovery and business continuity procedures; - Carry out external audit of SIA’s contingency plans and back-up facilities. - BI and Consob may consider regulation allowing direct access to SIA to verify disaster recovery and business continuity. - Recommendation 13: Increase the number of independent directors at the Board of MT due to its de facto monopoly in settlement and custody activities. *Source: _cr06112 - 131. Public offerings are subject to previous authorization based on disclosure of* ### 160. The Italian authorities (IA—BI and Consob) contend that Recommendation 11 has ### _cr06112 - 160. The Italian authorities (IA—BI and Consob) contend that Recommendation 11 has ### IA—BI and Consob response on Recommendation 11 - On December 3, 2005, Monte Titoli (MT) conducted a Disaster Recovery Plan (DRP) test with extensive involvement of participants and other market infrastructures; the results of the DRP test will be timely disclosed to the IMF staff as soon as available. - MT’s risk analysis framework has been fully successful in “proactively” preventing the materialization of any kind of risks even in the delicate phases of the implementation of services and procedures very complex and totally new. - An external audit on the MT Business Continuity Plan and Procedures and on SIA’s contingency plans and back-up facilities is being carried out and is expected to be completed shortly; if requested, BI would inform the IMF staff of the main findings of the audit report. - BI is consulting supervised entities on new guidelines for managing and controlling risks arising from outsourced activities; these guidelines explicitly state that the authorities should be allowed to exercise their supervisory powers also with regard to the outsourced activities. ### Summary assessment — Transparency in Banking Supervision (General) - Broad objectives are defined in the 1993 Banking Law: sound and prudent management of supervised institutions, and the overall stability, efficiency and competitiveness of the financial system. - Institutional framework and relationships between financial agencies are defined in the 1993 Banking Law and the 1998 Consolidated Law. - BI has established a structured and comprehensive public information system for timely dissemination of data and information on policy developments and regulatory changes. - Internal governance arrangements, publication of audited financial statements, and statutory provisions governing conflict of interest and staff conduct provide assurances of integrity. - Transparency could be further consolidated by: - more specifically explaining the broad objectives of stability, efficiency and competitiveness and openly discussing potential tradeoffs; - more extensive discussion of progress achieved in meeting these objectives; - disclosing practical modalities for cooperation and the type of information exchanged with other agencies. ### Main findings summary — Banking Supervision - Clarity of roles, responsibilities, and objectives: - Roles, responsibilities, and objectives are set out in the legal framework; the 1993 Banking Law states supervisory objectives. - Organization, jurisdiction and responsibilities of BI are established in its Statute. - Recommendation: strengthen transparency by explaining BI objectives in more depth and disclosing criteria for dismissal of heads and members of governing bodies. - Open process for formulating and reporting: - Financial reporting requirements are disclosed to supervised entities; BI engages in two-way communication on significant changes. - BI reports periodically on international developments and implications. - Formal procedures for cooperation and exchange of information are articulated legally, but practical conduct of exchanges was not fully disclosed at the time of the assessment. - Public availability of information: - Extensive information is publicly available: supervisory bulletin, Annual Report, periodic statistical bulletins, databases accessible via the Internet. - Financial statements published monthly and annually; deposit insurance information in the BI Annual Report. - Presumption toward aggregate ex post disclosure of lender-of-last-resort liquidity assistance. - Accountability and assurances of integrity: - Accountability through reporting, ICCS deliberations and parliamentary hearings (no pre-specified schedule). - At time of assessment, responsibilities for policy formulation and implementation were vested solely in the Governor. - Financial statements audited and fully disclosed; BI has standards on conduct and conflict of interest. - BI legal framework did not offer legal protection to banking supervisors in the conduct of their duties (at time of assessment). ### Plan of Action (selected entries) - 5.1.1 The broad objective(s) of financial agencies should be publicly disclosed and explained. - Recommendation: BI publicly disclose and further explain objectives of stability, efficiency and competitiveness. - 5.1.4 Procedures for appointment, terms of office, and general criteria for removal of heads and members of governing bodies should be publicly disclosed. - Recommendation: BI publicly disclose applicability of Article 14.2 of the ESCB Statute regarding dismissal of the Governor and general criteria for removal of heads and members; BI amended on-line pamphlet “le persone e l’organizzazione.” The Savings Law now explicitly mentions Art. 14.2 of the ECSB statutes for the Governor’s dismissal procedures. - 6.1.5 Formal procedures for information sharing and consultation between financial agencies should be publicly disclosed. - Recommendation: BI publicly disclose details on protocols defining practical modalities of cooperation and actual procedures for information sharing. Further to this recommendation, the MOU governing cooperation and exchange of information between BI and Consob was made public on the Web sites of the two institutions. ### Authorities’ response (BI) - BI notes the assessment’s recognition of a very high degree of compliance with the IMF MFP Transparency Code. - Positive features highlighted by the assessment: - extensive information via Annual Report, publication of general measures in the Gazzetta Ufficiale della Repubblica Italiana and Bollettino di vigilanza, wide-ranging statistical program, frequent Parliamentary hearings and speeches; - cooperation with domestic and foreign financial agencies via exchange of information and coordinated action (MOUs with Consob and ISVAP available on Web sites); - practice of public consultation with market participants on significant regulatory changes. - Practice 5.1.1: - The Annual Report contains a section (about. 100 pages in length) on criteria, methods and results of supervisory activities, fulfilling accountability obligations of the 1993 Banking Law. - Objectives were explained initially in the 1993 Annual Report; subsequent reports (e.g., 2003, 2004) regularly discuss supervisory issues and regulatory changes such as implementation of Basel II and IAS/IFRS. - The Savings Law provides for half-yearly reporting to both Parliament and Government. - BI is studying the possibility of issuing a new report on the evolution of the Italian banking and financial system and regulatory/supervisory issues. - On objectives in Article 5 of the Consolidated Law on Banking (1993): legislators deemed objectives strictly complementary; BI shares the view that competition supports efficiency and stability. - On dismissal procedures: - Article 19.8 of the Savings Law established new procedures for appointment and dismissal of the Governor referring to article 14.2 of the ESCB/ECB Statute. - BI Statute provides for appointment and dismissal of the Director General and two Deputy Directors General; principles and criteria for dismissal specified in general administrative law and case law. - EMI and ECB Convergence Reports and ECB opinion imply safeguards against arbitrary dismissal in the ESCB/ECB Statute apply to Director General and Deputies performing ESCB-related tasks. - The Savings Law has attributed responsibilities for policy formulation and implementation to the whole Directorate. ### Transparency of Payment System Oversight - General observations: - BI’s oversight characterized by high levels of transparency, clarity in EU-wide institutional framework, and active disclosure of policy developments. - 1993 Banking Law statutory mandate redefined in BI’s 2004 Oversight Provisions, setting objectives: financial, market and systemic stability; competitive and fair markets; client asset protection; regulatory enforcement. - Active communication policy includes publications and reporting program; White Paper (1997) explains institutional framework and guiding principles; White Paper (1999) analyzes methods of intervention and areas of interest. - Process and public availability: - BI routinely discloses progress toward policy objectives and engages in two-way communication with markets. - Strategic, operational and technical papers inform and informally consult market operators on major reforms in payment clearing and settlement systems. - Financial statements are publicly disclosed on a preannounced schedule (do not single out policy functions). - Information on payment system oversight provided through speeches by BI and ECB representatives, generally posted on relevant Web sites. - Accountability and integrity: - Accountability upheld through regular reports, parliamentary hearings, and Eurosystem-level financial reporting rules and ECB communications policy. - BI Statute includes rules on conflicts of interest and staff conduct; BI pamphlet on functions and organization discloses the existence of an Internal Inspectorate. - Plan of Action (selected entry): - 5.1.4 Procedures for appointment, terms of office, and general criteria for removal of heads and members should be publicly disclosed. - Recommendation: BI publicly disclose applicability of Article 14.2 of the ESCB Statute regarding dismissal of the Governor and general criteria for removal; the recently adopted Savings Law explicitly mentions Art. 14.2 of the ECBS Statute for the Governor’s dismissal procedures. *Source: IMF staff report content provided in the supplied PDF text.* ### 181. BI considers that the assessment recognizes the high degree of transparency which ### _cr06112 - 181. BI considers that the assessment recognizes the high degree of transparency which ### Payment system oversight transparency - BI considers that the assessment recognizes the high degree of transparency which characterizes the policy for payment system oversight. - Interaction with IMF representatives was "very fruitful" and discussions highlighted issues expected to positively influence future behavior of the agency. - Institutional framework (point 5.1): BI has recently approved new legislation implementing a number of changes in the management of BICOMP, the retail payment system managed by BI itself. - Publication and disclosure: - The new legislation—together with an explanatory note—will be published on the Gazzetta Ufficiale della Repubblica italiana and on the BI’s Web site to enhance public awareness of oversight objectives and institutional decisions. - The draft provisions together with the opinion released by the ECB are already available on the ECB Web site. ### Transparency of Securities Regulation — General - Objectives and responsibilities of Consob and BI, and modalities of cooperation between them, are clearly established in the 1998 Consolidated Law. - An area for improvement: further clarity on practical modalities of exchanging information with other domestic institutions. - Regulatory framework is publicly disclosed and explained via: - Comprehensive publications program. - Multi-faceted communication strategy including educational efforts and officials’ public speeches. - Presumption in favor of consulting securities market participants. - Accountability mechanisms: - Regular reporting and testimony before the Ministry of Economy and Finance and/or Parliament. - Internal governance arrangements, audited financial statements and rules on staff conduct. ### Main findings summary — securities regulation - Clarity of roles, responsibilities, and objectives of financial agencies (paragraph 183): - Broad objectives and institutional framework of Consob and BI in securities regulation are defined in the 1998 Consolidated Law. - Responsibilities and broad modalities of accountability are set out in the law. - Consob: terms and mandates of the head and members of governing bodies are publicly disclosed; Consob submits an annual report to the Ministry of Economy and Finance (subsequently presented to Parliament) and presents activity and sectoral prospects to market participants. - BI: at the time of the assessment, BI suffered from a lack of clarity of the grounds for dismissal. (See paragraph 175 regarding dismissal of the Governor of BI.) - Open process for formulating and reporting of financial policies (paragraph 184): - Securities regulatory policies are carried out in a transparent manner by Consob and BI. - Clarity of information exchange and consultation between them and other domestic financial agencies could be improved. - Protocols that define practical modalities of cooperation and information sharing were not made public at the time of the assessment. - Both Consob and BI engage in two-way communication with market participants; significant policy changes are disclosed and usually preceded by consultation. - Public availability of information on financial policies (paragraph 185): - Information provided through annual publications posted on Consob and BI Web sites. - Supplemented by weekly notes for Consob and the Monthly Bulletin of BI. - Consob pursues investor education and publishes information on persons holding significant shares in listed Italian companies. - BI maintains and disseminates an extensive database on activities of market operators in wholesale markets for government securities and management companies in post trading. - Accountability and assurances of integrity by financial agencies (paragraph 186): - Consob and BI regularly report to a designated public authority. - Internal governance, auditing arrangements and rules on staff conduct provide assurance of integrity. - Consob: budget and financial statements made public on Consob’s Web site and in the Official Journal. - BI: publishes audited financial statements with information on revenues and expenses, but these cover all BI activities and do not distinguish its capacity as securities regulator. ### Table 14 — Plan of Action to Improve Observance of IMF MFP Transparency Code Practices — Securities Regulation (selected recommended actions) - V. Clarity of Roles, Responsibilities and Objectives of Financial Agencies Responsible for Financial Policies - Reference Principle 5.1.4: "Where applicable, the procedures for appointment, terms of office, and any general criteria for removal of the heads and members of the governing bodies of financial agencies should be publicly disclosed." - Recommended Action: It was recommended that BI publicly disclose the applicability of Article 14.2 of the ESCB Statute as regards the dismissal of the Governor and the general criteria for removal of the heads and members of the governing bodies in the absence of such provisions in the BI Statute. - Implementation note: The recently adopted Savings Law explicitly mentions Art. 14.2 of the ECSB Statute for the Governor’s dismissal procedures. - VI. Open Process for Formulating and Reporting Financial Policies - Reference Principle 6.1.5: "Where applicable, formal procedures for information sharing and consultation between financial agencies (including central banks), domestic and international should be publicly disclosed." - Recommended Action: It was recommended that BI publicly disclose the details on protocols that define the practical modalities of cooperation between domestic financial agencies, and the actual procedures that are followed for information sharing. - Implementation note: Further to this recommendation, the MOU governing the cooperation and exchange of information between BI and Consob was made public on the Web sites of the two institutions. ### Authorities’ response (paragraph 187) - BI and Consob consider that the assessment recognizes a very high degree of compliance of the Italian supervisory system with the IMF Code of Good Practices on Transparency in Monetary and Financial Policies (MFPT Code). - The assessment shows that the objectives and responsibilities of the two supervisory authorities and the modalities of cooperation between them are clearly established in the 1998 Consolidated Law. - The regulatory framework is publicly disclosed and explained. ### SUMMARY ASSESSMENT OF OBSERVANCE OF STANDARDS AND CODES — AML/CFT - Introduction (paragraphs 188–189): - Report prepared by a team composed of staff of the Fund and an expert under the supervision of Fund staff using the AML/CFT Methodology 2004.39 - The report summarizes observance with the FATF 40 Recommendations 2003 and 9 Special Recommendations on Combating the Financing of Terrorism (CFT) and provides recommendations to strengthen observance. - Views expressed are those of the assessment team and do not necessarily reflect the views of the government of Italy or the Board of the IMF. - Information and Methodology Used for the Assessment (paragraph 190): - Fund staff reviewed institutional framework, laws, regulations, guidelines and other requirements, and regulatory and other systems in place to deter money laundering and the financing of terrorism through financial institutions and DNFBPs. - Assessment based on information available at the time of the on-site visit by the team April 4–19, 2005, and immediately thereafter. - Main Findings (paragraphs 191–207): - 191: Italy has a comprehensive AML/CFT system set up initially in 1991 and updated a number of times. - Law enforcement efforts against money laundering have been quite successful: almost 600 cases lead to conviction every year. - Based on three different systems of confiscation of criminal assets, law enforcement confiscated over €130 million in criminal proceeds in 2004. - 192: The financial intelligence unit, the Ufficio Italiano dei Cambi (UIC), has an advanced system of computerized data collection. - Insufficient filtering at the level of the UIC limits the effectiveness of the system, and does not allow for an immediate feedback to the reporting entities. - 193: The AML/CFT preventive system is quite sophisticated but has generally not been updated to reflect the revised FATF standard and the 2001 EU Directive on Money Laundering. - High degree of awareness and broad implementation of AML/CFT preventive measures within the financial sector. - Good cooperation between supervisory authorities. - 194: Supervisory challenges and priorities: - i) implement the more detailed customer due diligence (CDD) requirements of the revised standard; - ii) increase levels of suspicious transaction reporting of non-bank financial intermediaries and introduce a legal obligation to report transactions suspected of being related to terrorist financing; - iii) increase on-site inspection efforts and resources for the securities and insurance sectors, Bancoposta and non-prudentially supervised entities; - iv) ensure the application of a more effective sanctions regime. - 195: Authorities are paying attention to implementing the revised standard and strengthening the AML/CFT regime. - Existing AML/CFT legal framework is very complex and would gain in clarity and effectiveness if consolidated in a single instrument. - Legal framework for DNFBPs, adopted in 1999 and 2004, urgently needs implementation via finalizing draft regulations. - A law to ratify the Palermo convention is under consideration by parliament. - Provisions to strengthen the terrorist asset freezing regime are to be adopted soon, according to the authorities. - Supervisory resources are being increased for the securities sector. - 196: General situation of money laundering and terrorist financing risks: - Italy has historically suffered from a high rate of criminality, organized violence and penetration of political and economic life by organized crime groups. - Diversion of funds from public contracts by groups like the Sicilian Mafia remains a law enforcement concern. - Laundered funds are often invested in properties and enterprises in north and central Italy. - Italy has one the highest cash payment ratios in Europe; tax fraud in sectors such as real estate provides a favorable environment to money laundering. - 197: Terrorist financing is considered a risk among large communities of legal and illegal immigrants; Italy has been under specific terrorist threats since the war in Iraq. - 198: Overview of the financial sector and DNFBPs: - Financial sector characterized by a wide range of service providers; banking sector remains a core source of funding. - UIC has primary responsibility for AML/CFT supervision of prudentially regulated financial institutions, exercised in collaboration with: - Bank of Italy (BI) — prudential supervisor for banks, Bancoposta, and securities and asset management firms; - Commissione Nazionale per le Società e la Borsa (Consob) — market conduct supervisor for securities and asset management firms; - Istituto per la Vigilanza sulle Assicurazione Private e di Interesse Collettivo (ISVAP) — supervisor of insurance companies and brokers. - Guardia di Finanza (GdF) — financial police responsible for monitoring non-prudentially supervised entities, including bureaux de change and money transfer agents. - 199: Most important DNFBPs to be included: lawyers, notaries, accountants, real estate agents, dealers in gold, and casinos. - Legislation adopted bringing these professions within scope of AML law, but further implementing regulations required. - AML/CFT supervisory authorities have not been designated for these businesses and professions. - 200: Legal measures and penalties: - Money laundering offence extends to proceeds from any crime committed intentionally; does not extend to the author of the predicate offence ("self-laundering"). - Money laundering punished by 4 to 12 years of imprisonment, and by fines of a maximum of €15,240. - No penal liability for legal persons; system of administrative liability for some penal offences committed by legal persons includes financing of terrorism but not money laundering at present. - 201: Definition of terrorist financing is not fully consistent with existing standards; some key elements not defined and it does not extend to individual acts of terrorism. - A law adopted on July 31, 2005, extended the definition of terrorist actions by adding two new offences: enlisting and training with the objective of terrorism. - 202: Confiscation framework: - Threefold approach: traditional conviction-based confiscation; system based on alleviation of burden of proof for convicted persons who cannot justify origin of assets; preventive system for assets in possession of persons belonging to mafia-type organizations. - Law enforcement agencies provided with legal means to identify, trace and seize criminal and terrorist assets; statistics illustrate efficiency of the system. - 203: Implementation of UN Security Council decisions on freezing terrorist assets via EU Regulations and national mechanisms. - Preventive system of seizure and confiscation of mafia-type assets extended to national and foreign suspected terrorists. - Financial Security Committee (FSC) coordinates implementation and decides submission to the UN of names of suspected terrorists: to date names of 67 individuals and 15 entities have been submitted. - Process of freezing of non-financial assets should be improved. - 204: UIC operations and outputs: - UIC has carried out FIU functions since 1997 as an instrumental entity of BI. - Until 2004, the UIC has received around 36,000 suspicious transaction reports (STRs). - AML department of the UIC is composed of 109 personnel; one of its functions is to collect, analyze and disseminate STRs. - UIC uses an elaborate computerized system to analyze aggregate data sent by reporting entities; system does not include law enforcement information other than criminal records. - UIC required by law to send almost all STRs to the Anti-Mafia Investigative Directorate (DIA) and the GdF for further consideration. - Insufficient filtering at the UIC limits effectiveness and does not allow immediate feedback to reporting entities; guidance to reporting entities and general information through public annual reports is limited. - 205: Law enforcement and prosecution: - State Police, GdF and Carabinieri collaborate under coordination of the Ministry of Interior. - National Anti-Mafia Directorate (DNA) and DIA provide expertise and coordination for anti-mafia efforts. - These bodies are adequately staffed and empowered with advanced legal powers. - Italy has a record of prosecutions in money laundering cases (around 600 per year). - Number of prosecutions limited to some 29 convictions for promoting, managing or financing terrorism in the period 2000-2004. - New law of July 31, 2005, strengthens investigative powers in terrorism matters aiming to improve prosecutions and convictions. - 206: Cross-border cash controls: - Italy established a system of declaration of cross-border transportation of funds, even by mail. - Customs Agency and GdF implement these measures and forward declarations and suspicious information to the UIC for analysis. - These agencies seize on average per year more than €25 million as a result of these types of violations or suspicions. - 207: Preventive measures — financial institutions: - Sectoral coverage under AML/CFT requirements is comprehensive and the authorities have not exempted any sectors on the basis of risk. - In some instances sectoral coverage has gone beyond the standard (e.g., tax collection agencies). *Source: _cr06112 - 181. BI considers that the assessment recognizes the high degree of transparency which* ### 208. Financial institutions are required to collect and record a wide range of ### _cr06112 - 208. Financial institutions are required to collect and record a wide range of ### Customer due diligence (CDD) requirements - CDD is required for any person who: - opens/changes/closes a business relationship, or - carries out a single transaction, or several linked transactions of €12,500 or more. - The identifying details of the person on whose behalf the transaction is carried out must be recorded. - A transaction cannot be executed if the financial institution cannot satisfactorily complete CDD. - CDD is not required for occasional transactions below a €12,500 threshold that are wire transfers. - Financial institutions must collect and record a wide range of customer identification data. ### Decalogo (BI “Operating Instructions for identifying suspicious transactions”) and customer profiling - Issued in February 1993 and updated in 1994 and 2001; legally binding on all reporting entities. - Instructs intermediaries to acquire a “thorough knowledge of the customer” to establish risk profiles and expected account operation. - For customers that are legal persons, there are no specific legal or regulatory requirements to: - verify that the person purporting to act on behalf of the legal person is so authorized, or - verify the legal status of the legal person. - Decalogo requires development of detailed customer profiles, review of account operations against profiles, and recording findings concerning anomalous transactions even if no STR was filed with the UIC. - Decalogo calls for precautionary measures with respect to electronic money and “distance banking,” but: - there are no requirements for enhanced due diligence for higher risk categories (e.g., PEPs), and - there are no provisions allowing discretion to apply simplified due diligence. ### Ownership, control, and trusts - AML Law requires identification of any person on whose behalf a transaction is carried out, but: - there is no specific requirement to take reasonable measures to understand the ownership and control structure of a customer that is a legal person, or to determine the natural persons who ultimately own or control the customer. - No requirement regarding the identification of the settlor, trustee and beneficiaries where financial institutions accept trusts established abroad or in Italy under foreign legislation. ### Anonymous accounts, bearer passbooks, and ongoing due diligence - Anonymous accounts are not permitted. - Credit institutions and Bancoposta provide bearer passbook accounts, provided the balance is €12,500 or less. - CDD must be carried out upon issuance and upon closure, and, according to industry guidance and civil law principles, for any transaction at lower thresholds. - Passbooks can be transferred anonymously between issuance and closure without limitation. - Mission notes no evidence of secondary market trading of passbooks for criminal purposes; neither STRs nor border controls have detected such trading to date. - Anonymous transferability poses a significant challenge for ongoing due diligence over the life of the business relationship. ### Reliance on third parties for CDD - Financial institutions may rely on third parties to conduct CDD but retain ultimate responsibility. - They must collect identification data from the third party and ascertain that the third party has its head office in an FATF member country or certify that its foreign branch complies with the FATF standard. - This does not fully satisfy FATF requirements that financial institutions take adequate steps to satisfy themselves that copies of identification data can be readily obtained from the third party or that the third party be regulated and supervised in accordance with FATF Recommendations. ### Archivio unico informatico (AUI) and wire transfer originator information - All entities subject to CDD requirements must file in a single computerized database, the archivio unico informatico (AUI), all information pertaining to the opening and the closing of an account, as well as transactions above €12,500, and must maintain these data for a period of ten years. - Financial institutions are not required to include originator information on wire transfers nor to have procedures to deal with incoming transfers with incomplete originator information. ### Suspicious transaction reporting (STRs) and UIC operations - Every transaction that leads to belief that proceeds might be derived from intentional crime must be reported to the UIC, where possible before carrying out the transaction. - Banks are the main reporting institutions responsible for almost 90 per cent of all STRs. - Cash withdrawals and deposits make up 40 per cent of the reported transactions. - Frequency of reporting by non-bank financial intermediaries is disproportionately low. - Systematic feedback is not provided to reporting entities. - Since 2001, some 2000 STRs have been filed with the UIC in respect to CFT. - UIC’s mandate extends to combating the financing of terrorism, but the reporting obligation does not formally extend to CFT; circulars require such reporting, but the reporting obligation should be based on explicit legal provision rather than a circular. ### Internal controls, training, and preventive measures - AML Law requires financial institutions to establish adequate internal controls and provide training for staff; the Decalogo provides more detailed guidance. - Internal control requirements are generally well developed and implemented for prudentially supervised financial institutions; they are far less well developed and implemented in other sectors. - Measures to ensure integrity of financial institutions are generally appropriate; enforceable guidelines issued by nearly all supervisory authorities apply to all reporting entities in the case of the Decalogo and UIC guidance. - Little guidance is provided for identifying suspicious transactions possibly linked to terrorist financing. ### Correspondent banking, shell banks, and interbank exemptions - The Banking Law effectively precludes establishment of a shell bank in Italy. - No CDD provisions exist for banks regarding establishment of (cross-border) correspondent banking relationships, including with shell banks. - Financial institutions are not prohibited from establishing relations with respondent foreign financial institutions that permit their accounts to be used by shell banks. - Exemptions from CDD requirements extend to cross-border interbank transactions, regardless of whether the customer bank is located in a country that effectively implements the FATF Recommendations. ### Supervision, inspections, and sanctions - UIC has overall responsibility for supervising AML/CFT compliance of prudentially supervised intermediaries, in collaboration with BI, Consob, ISVAP; GdF supervises non-prudentially supervised entities. - Coordination and cooperation effected through MOUs; in practice there is extensive cooperation. - Supervisors of prudentially supervised intermediaries are appropriately structured and have appropriate powers; taken together AML/CFT supervision of these intermediaries is consistent. - Supervisory approach for non-prudentially supervised entities is not on par with prudentially supervised ones. - Resources and efforts for AML/CFT supervision and on-site inspections in securities and insurance sectors, Bancoposta and non-prudentially supervised financial entities are insufficient. - Consob has recently been given a significant increase in resources, some earmarked for on-site inspections of the securities sector. - Sanctions regime: - Does not appear to be as effective, proportionate and dissuasive as it should be and is relatively complex. - Application of sanctions is heavily skewed toward violations in record-keeping and requirements not covered by FATF Recommendations (e.g., controls on cash transfers). - Few sanctions imposed on failures to report suspicious transactions and deficiencies in internal controls. - There are no sanctions for deficiencies in internal controls and training for non-prudentially supervised entities. ### Money transfer providers - UIC registers money transfer providers; either the UIC or the GdF supervises them for AML/CFT compliance. - UIC inspects providers authorized to execute cash transactions over €12,500; GdF focuses mainly on illegal providers. - Recommendation: review inspection policies to ensure all money transfer agents and subagents are adequately monitored for AML/CFT compliance. ### Designated Non-Financial Businesses and Professions (DNFBPs) - Italy has brought a long list of DNFBPs within the remit of the AML law, but required implementing regulations have not yet been promulgated; DNFBPs are effectively not yet covered by the AML/CFT regime. - Authorities expect implementing regulations to come into force before the end of 2005. - Guidelines have not been issued for the DNFBPs. - AML law does not extend to independent legal professionals, internet casinos, dealers in precious stones and dealers in (other) precious metals. - No supervisor has yet been designated for DNFBPs, nor have additional supervisory capacity and resources been arranged. - Lawyers, notaries and accountants have national and regional professional orders with a general supervisory role; national orders have been consulted regarding implementing regulations. ### Legal persons, trusts, and non-profit organizations (NPOs) - Listed joint stock companies may issue nominative and bearer shares and are required to publish lists of shareholders and persons who hold rights on securities. - Use of bearer shares is limited to specific circumstances; authorities state shares are subject to dematerialization and are de facto no longer anonymous. - Italian legislation does not specifically provide for legal arrangements such as trusts. - Foreign trusts may be handled by financial intermediaries, but there are no legal requirements in respect of foreign trusts; application by analogy of CDD provisions would not be sufficient to meet the standard. - Measures related to NPOs: - BI issued operating guidelines requiring intermediaries to pay special attention to relationships with NPOs and report suspicions to the UIC. - A special fiscal category, Organizzazioni non-lucrative di utilità sociale (ONLUS), was introduced. - The ONLUS Agency, created in 2000, and the Tax Revenue Agency oversee and inspect all NPOs. ### International cooperation and legislative consolidation - Italy is party to most international relevant AML/CFT instruments except for the Palermo Convention, whose ratification has been pending in parliament since 2003. - An extensive network of international cooperation agreements exists; Italy is an active and cooperative international criminal justice partner. - UIC has adequate powers for international cooperation and can legally provide spontaneous information to counterparts. - Legal framework for AML/CFT is scattered in more than 60 relevant laws and regulations, plus circulars and guidance. - Mission strongly recommends consolidation and streamlining of pertinent legislation in a unified text to improve clarity and effectiveness. ### Summary assessment, key findings and recommended actions (selected) - Overall, Italy’s AML/CFT framework is comprehensive and contributes to maintaining integrity of the financial system; it achieves a satisfactory degree of compliance with most of the FATF 40+9. - Law enforcement efforts against money laundering have been successful. - The efficiency of the financial intelligence unit is hampered by limitations in the processing of STRs; recommendation highlights include: - UIC should improve its filtering function and send to police authorities only STRs where suspicion can be substantiated. - UIC should be granted access to law enforcement information during analysis and be provided more human resources for STR analysis. - A system-wide evaluation of STR quality and UIC analysis effectiveness is recommended. - Criminalization and confiscation recommendations (selected from Table 15): - Provide penal liability of legal persons by law or add money laundering to offences for which administrative liability can be sought; increase deterrent sanctions. - Increase maximum fines for money laundering (current maximum €15,240 is far too limited). - Consider criminalizing self laundering. - Clarify definition of assets to include indirect proceeds of crime. - Broaden definition of assets subject to confiscation to include indirectly derived proceeds and consider confiscation of assets of equivalent value. - Consider an agency to manage and dispose of seized and confiscated assets for AML and CFT. - Terrorist financing recommendations (selected): - Make definition of the offence consistent with the 1999 convention or define “financing” to include types of funds and assets; include financing of “individual” terrorists. - Extend more deterrent sanctions in administrative liability of legal persons. - Institute a notification system to inform banks of list updates, enhance monitoring of freezing measures, apply sanctions for violations, and institute procedures to protect bona fide third parties. - Supervisory and law enforcement recommendations: - Authorities should review effectiveness of law enforcement and prosecution strategies and action. - More effort needed by supervisors to ensure effective implementation of legal framework by reporting entities. - Increase resources and on-site inspection effort for securities, insurance, Bancoposta and non-prudentially supervised entities. *Source: _cr06112 - 208. Financial institutions are required to collect and record a wide range of* ### 3. Preventive Measures–Financial ### 3. Preventive Measures–Financial Institutions ### Customer due diligence, including enhanced or reduced measures (R.5 to 8) - Authorities should expand CDD requirements in line with the revised FATF Recommendations in the following areas: - Expand in law or regulation the circumstances where CDD must be carried out, in particular for: the identification of occasional transactions that are wire transfers below the €12,500 threshold. - Consider making explicit the requirement to identify and verify the identity of any customer when there is a suspicion of money laundering or terrorist financing. - Establish in law or regulation a requirement to verify that the person purporting to act on behalf of the customer is so authorized. - Require financial institutions to verify the legal status of a customer that is a legal person. - Introduce specific requirements in law or regulation for financial institutions to take reasonable measures to understand the ownership and control structure of a legal person and to determine who are the natural persons that ultimately own or control the customer. - Set out in law or regulation the requirement in the Decalogo for conducting ongoing due diligence. - Limit the exemption from CDD in the case of customers that are banks or branches abroad to those located in jurisdictions that effectively implement the FATF recommendations. - Extend specific requirements to identification and verification of the settlor, trustee or person exercising effective control over trusts and the beneficiaries. - Require enhanced due diligence in higher risk situations, e.g., for non-resident customers, private banking, legal persons and arrangements such as trusts or for companies that have nominee shareholders or shares in bearer form. - Clarify the timing of verification of identity. - Require full identification and recording of persons to whom a bearer passbook is transferred. - Introduce additional specific requirements for the identification of PEPs and senior management approval for establishing a business relationship with a PEP. - Introduce additional specific requirements regarding procedures for the opening and operation of cross-border correspondent banking relationships, notably with respect to: - gathering information on the respondent, - assessing its AML/CFT controls, - obtaining senior management approval before establishing new correspondent relationships, - documenting respective responsibilities, - ensuring, with respect to payable-through accounts, that the respondent has verified the identity of and performs ongoing due diligence regarding subaccount holders and is able to provide customer identification upon request of the correspondent. - Enshrine the documentary evidence required for verification of identity in law or regulation. ### Third parties and introduced business (R.9) - Introduce the following additional requirements: - Financial institutions should satisfy themselves that copies of identification data and other relevant information relating to CDD requirements will be made available from the third party upon request without delay. - Beyond obtaining head office certification, financial institutions should be required to obtain from the third party located abroad a copy of its customer acceptance and ongoing CDD policies and satisfy themselves that the third party is regulated and supervised in accordance with FATF Rec. 23, 24 and 29. ### Record keeping and wire transfer rules (R.10 & SR.VII) - Recommendations: - Consider removing the €12,500 threshold for the recording in the AUI transactions conducted on an account. - Introduce requirements to ensure that complete originator information is included in outgoing wire transfers and that beneficiary financial institutions adopt effective risk-based procedures for identifying and handling wire transfers that are not accompanied by account number and address information. - Lower the threshold of €12,500 at or above which customer identification and record keeping is required to €1,000 or eliminate it altogether as is envisaged in the forthcoming EU regulation. ### Monitoring of transactions and relationships (R.11 & 21) - Recommendations: - Ensure there are effective means to enforce the provisions of the Decalogo with respect to financial intermediaries that are not subject to prudential supervision. - Extend requirements to pay special attention to business relationships and transactions with persons from any country which does not or insufficiently apply the FATF recommendations. ### Suspicious transaction reports and other reporting (R.13-14, 19, 25 & SR.IV) - Recommendations and observations: - Introduce a specific requirement for the reporting of transactions suspected of being related to or to be used for terrorism, terrorist acts or by terrorist organizations, or those who finance terrorism. Note: under the Italian legislation, terrorist financing is a predicate offence to money laundering and is therefore technically included in the reporting requirements set out in the law; Special Recommendation IV nevertheless calls for a direct mandatory obligation to report suspicions of terrorist financing. - Reporting requirement is not effectively being implemented by bureaux de change, the postal bank, stockbrokers, investment companies, trust companies and insurance companies; respective supervisory authorities should review this more closely as part of their on-site inspections and consider additional outreach and guidance. - While the suspicious transaction reporting requirement applies to all transactions regardless of threshold, the usage of GIANOS in the banking and other sectors (including the application of transactions thresholds) should be reviewed to ensure it is used as a complement rather than a substitute for ongoing vigilance. - Ensure effective means to enforce the provisions of the Decalogo with respect to financial intermediaries not prudentially supervised. - Review the scope of the legal protection from criminal and civil liability associated with the reporting of suspicious transactions and clarify in law that it is restricted to only those persons who report in good faith. - Introduce an explicit prohibition to disclose the fact that a report has been made to the UIC or the fact that the UIC has requested additional information. - The UIC should provide reporting entities with systematic feedback in the form of statistics and typologies, for instance by means of a periodic newsletter or an annual report. ### Internal controls, compliance, audit and foreign branches (R.15 & 22) - Recommendations: - Introduce requirements for adequate screening procedures for hiring employees. - Develop more detailed guidance on how financial intermediaries other than prudentially supervised financial institutions should organize themselves to comply with AML/CFT requirements. - Introduce additional requirements to further ensure that AML/CFT principles are implemented by branches and majority-owned subsidiaries located abroad, including: - extending requirements to foreign branches of other financial institutions (such as insurance companies and securities firms) and to majority-owned subsidiaries of financial institutions located abroad, - requiring foreign establishments of Italian financial institutions to notify competent authorities when they cannot comply. ### Shell banks (R.18) - Recommendations: - Prohibit financial institutions from entering into or continuing correspondent banking relationships with shell banks and from establishing relations with respondent foreign financial institutions that permit their accounts to be used by shell banks. - Consider a clearer prohibition on the establishment of shell banks. ### The supervisory and oversight system–competent authorities and SROs (R. 17, 23, 29 & 30) - Findings and recommendations: - Supervisory authorities of prudentially regulated financial institutions are appropriately structured and have appropriate powers to ensure compliance with prudential and market conduct requirements. - Assess the effectiveness of AML/CFT supervision of non-prudentially supervised financial intermediaries to ensure more comprehensive, systematic and uniform inspections for all financial intermediaries. - Increase resources and efforts directed to AML/CFT supervision and on-site inspections with respect to the securities and insurance sectors as well as financial intermediaries registered under Article 106 of the Banking Law. - Where possible, increase the frequency of on-site inspections of foreign branches and subsidiaries of Italian financial intermediaries. - Pay more attention to Bancoposta given its considerable importance as a provider of financial services, particularly following its introduction of new procedures and internal controls and now that BI has recently been granted supervisory authority over it. - Address gaps in supervision notably with respect to independent distributors working with or on behalf of insurance undertakings (i.e., financial salespersons, subagents and brokers); increase supervisory efforts on a risk basis and continue plans to expand registration requirements and ensure requisite professional qualifications and integrity. - Amend the law to clarify the sanctions framework and ensure it is effective, proportionate and dissuasive; render the financial institutions (i.e. legal persons) separately liable for all violations of the AML/CFT requirements; extend the range of sanctions to include sanctions for deficiencies in internal controls and training, particularly for financial intermediaries that are not prudentially supervised. ### AML/CFT Guidelines (R.25) - Recommendations: - Develop additional specific guidance to assist in identifying suspicious transactions possibly linked to terrorist financing. - Develop guidance to DNFBPs to assist them in identifying suspicious transactions. - Provide positive feedback to financial institutions on their STRs. - Publish periodic reports on trends and typologies. ### Ongoing supervision and monitoring (R.23, 29 & 32) - Recommendations (reinforcing prior points): - Assess the effectiveness of AML/CFT supervision of non-prudentially supervised financial intermediaries to ensure more comprehensive, systematic and uniform inspections for all financial intermediaries. - Increase resources and efforts directed to AML/CFT supervision and on-site inspections with respect to the securities and insurance sectors as well as financial intermediaries registered under Article 106 of the Banking Law; where possible increase frequency of on-site inspections of foreign branches and subsidiaries. - Pay more attention to Bancoposta following its introduction of new procedures and internal controls now that BI has been granted supervisory authority over it. - Address supervision gaps with respect to independent distributors working with or on behalf of insurance undertakings and continue plans to expand registration requirements and ensure requisite professional qualifications and integrity. - Maintain more systematic statistics regarding requests for assistance made or received by supervisors including whether the request was granted or refused. ### Money value transfer services (SR.VI) - Recommendation: - Review inspection policies with regard to money transfer agents and subagents and ensure the whole sector is adequately monitored and complies with the AML/CFT requirements. --- *Italicized: Authorities’ Response to the Assessment and related commentary as provided in the source.* ### 237. The market risk shocks applied are in line with shocks applied in other Euro ### 237. The market risk shocks applied are in line with shocks applied in other Euro area countries. ### Market risk shocks and VAR - Market risk shocks applied are in line with shocks applied in other Euro area countries. - BI calculated losses due to changes in market prices using a parametric Value-at-Risk approach (VAR) under conservative assumptions: - 0.3 percent probability of the shock - 20-day holding period - BI Value-at-Risk estimates (VAR at the 99.7 level of confidence, 20 days holding period): - Interest Rate: Banks with VAR >100%: 7; VAR 95th percentile: 45.18; Banks with VAR >100% (VAR over capital buffer): 2; VAR 95th percentile (over capital buffer): 5.21 - Equity: Banks with VAR >100%: 3; VAR 95th percentile: 11.53; Banks with VAR >100% (over capital buffer): 2; VAR 95th percentile (over capital buffer): 1.37 - Foreign exchange: Banks with VAR >100%: 4; VAR 95th percentile: 19.82; Banks with VAR >100% (over capital buffer): 1; VAR 95th percentile (over capital buffer): 4.4 ### Credit risk shock and methodology - Credit risk shock parameters and assumptions: - 60 percent increase in the probability of default (PD), larger than the largest historical observation of 54 percent increase in PD in 1993. - Loss given default (LGD) assumed at 60 percent for the whole portfolio. - Exposure at default equal to the drawn amount of the performing loan portfolio plus 75 percent of the undrawn credit lines. - The assumed LGD of 60 percent is consistent with loan loss provisions in the largest banking groups and higher than the average 40 percent LGD reported by G-10 countries in the QIS3 study of the Basel Committee. - Top-down PD definition: measured as the flow of new bad debts over the stock of performing loans in the previous period. - BI also performed a credit risk sensitivity analysis over the balance sheet of the whole banking system following the same methodology. - Note on PD definition: Because data on the flow of doubtful loans (incagli) are unavailable, the definition of PD in the top-down approach is narrower than the one used by banks. Banks used a lower LGD, around 40 percent on average, based on their internal information on guarantees. ### Sovereign risk stress tests - Stress tests were performed on exposures to “developing or transitioning countries.” - Top-down approach: - Countries assigned a rating and a pre-shock PD derived from Moody’s default statistics for corporate firms. - Assumed LGD for sovereign exposures: 80 percent. - Bottom-up approach: banks used their own internal ratings. ### Macroeconomic scenario simulations and effects (two-year horizon) - BI simulated adverse macroeconomic scenarios with its macro econometric model; shocks generated deviations from a baseline projection over a two-year horizon and produced: - (i) after-shock PD for the lending portfolio - (ii) after-shock operating profits using econometric models - Table 16 — Effect of macro scenarios after two years (deviations/levels and percentage changes): - Scenario 1: Oil price increases to USD 85 per barrel and global equity prices decline by 30 percent - Scenario 2: USD depreciates 20 percent with respect to EUR due to loss of confidence in the currency - Scenario 3: Large corporate defaults in Italy trigger a 200 b.p. increase in credit spreads and a 35 percent decline in Italian equity prices - Effect of shocks in macroeconomic variables (Effects after two years) - Output GAP 1/: Scenario1: -1.87; Scenario2: 0.01; Scenario3: -1.54 - Short-term interest rate (in p.p.) 2/: Scenario1: 2.0; Scenario2: 2.0; Scenario3: 2.0 - Inflation 2/: Scenario1: 1.98; Scenario2: 1.37; Scenario3: 1.62 - Effect on banks’ operating profits and PD (percentage changes after two years) - Banks operating profits: Scenario1: -5.8; Scenario2: 17.2; Scenario3: -11.2 - Probability of Default (PD): Scenario1: 83; Scenario2: 52; Scenario3: 71 - Source: Bank of Italy. - Notes: 1/ Deviation with respect to baseline projection. 2/ Levels. ### Interest rate risk sensitivity (banking and trading books) - Banks performed sensitivity analysis for interest rate risk on the banking book; BI performed it on both banking and trading books. - Bottom-up: cash flows mapped into time buckets; impact of interest rate fluctuations on present value calculated under stress scenarios. - Top-down: modified duration approach with duration parameters computed based on prevailing interest rates; convexity factor applied. - Treatment of sight and saving deposits differs: - Top-down: sight and saving deposits exceeding assets in the first maturity bucket are proportionally distributed in other time buckets up to one year according to length in months of the funding period. - Bottom-up: banks used different assumptions based on historical internal information. - Economic value of losses due to interest rate increases was within Basel Committee limits (i.e., 20 percent of bank capital). - Loss of economic value as percentage of bank capital — sensitivity to interest rate risk in the banking book: - Weighted Average: -6.34 - Maximum loss: -13.22 ### Liquidity stress testing - BI assessed liquidity position of over 700 banks under a liquidity stress scenario similar to those applied in other Euro area countries. - Off-site monitoring methodology: allocate assets and liabilities to time bands by residual maturity; a bank is vulnerable when mismatches in the first maturity bracket (up to one week) cannot be covered with liquid assets. - Liquid assets include: - cash and T-bills - assets eligible for access to collateralized ECB standing facilities - temporarily available unencumbered securities stemming from reverse repos (both with a 30 percent haircut) - 10 percent of sight loans - Liquidity stress test (BI estimates): - Number of banks with liquidity shortfall in the 1-7 days time band: 82 - Share of assets: 22% ### Derivative positions of Italian corporations - BI assessed resilience of Italian corporations to losses in derivative exposures by asking two largest market players to reprice positions for a sample of corporations; exercise included interest rate and volatility shocks. - Increase in each firm’s PD from derivative losses calculated using a BI micro econometric model. - Sample: - Total firms selected: 2000 (396 small, 788 medium, 816 large) - Selection weighting reflected end-June 2005 credit registry exposures. - Within each class, 50 percent chosen for largest absolute exposure, 50 percent for largest relative exposure. - Sample divided between two banks (each reported on 1000 firms). - Results provided for 1762 firms (others did not have exposure to risk factors considered). - These 1762 firms account for 28 percent of total derivative exposures of the corporate sector and 4 percent of total credit to the corporate sector. ### Banking sector stress test results (June 2005 Update — Top Down) — selected entries - Pre-Stress CAR: 11.01 8.78 - Post Stress CAR (selected sensitivities; figures: Loss as percentage of June 2005 (annualized) after-tax profits; Largest Loss; Weighted Avg. CAR; Min. CAR): - Parallel increase in major interest rates 2/: -5.7; -29.2; 10.95; 8.71 - Parallel decrease in major interest rates 3/: +5.7; 0.0; 11.01; 8.78 - Rise and flattening of the main yield curves 4/: -8.7; -19.7; 10.92; 8.72 - Fall and steepening of the main yield curves 5/: +4.0; 0.0; 11.01; 8.78 - Rise in main medium-term rates 6/: -0.9; -4.0; 11.00; 8.75 - Fall in main medium-term rates 7/: +0.9; 0.0; 11.01; 8.78 - Fall in equity prices 8/: -4.3; -12.5; 10.96; 8.64 - Euro appreciation against major currencies 9/: +17.2; +1.9; 11.01; 8.78 - Euro depreciation against major currencies 10/: -17.2; -36.7; 10.83; 8.72 - Rise in financial market volatility 11/: -1.0; -15.1; 11.01; 8.78 - Decrease in financial market volatility 12/: +1.0; -4.1; 11.01; 8.78 - Sensitivity to Sovereign Risk 13/: -15.3; -178.0; 10.82; 8.77 - Sensitivity to credit risk 14/: -24.3; -94.4; 10.71; 8.51 - Macroeconomic scenario tests: - Rise in oil prices and fall in equity prices 15/: -35.8; -144.7; 10.60; 8.41 - Dollar depreciation 16/: -17.9; -63.4; 10.75; 8.55 - Domestic confidence shock 17/: -32.6; -137.7; 10.66; 8.47 - VAR over after tax profits / VAR over capital buffer: see BI Value-at-Risk estimates above. - Loss of economic value as percentage of bank capital — sensitivity to interest rate risk in the banking book: - Weighted Average: -6.34 - Maximum loss: -13.22 - Banks with liquidity shortfall in the 1-7 days time band: - Number of banks: 82 - Share of assets: 22% - Footnotes / scenario definitions (selected): - 2/ EUR, USD and JPY interest rates increase by 70, 65, and 60 b.p. respectively. - 3/ EUR and USD interest rates decrease by 70, and 40 b.p. respectively. - 4/ EUR short-term, medium-term, and long-term interest rates increase by 110, 60 and 40 b.p. respectively. USD interest rates increase by 100, 50, and 30 b.p., while JPY interest rates increase by 100, 40, and 30. - 8/ A 30 percent decrease in the equity prices. - 9/ A 15 percent appreciation in the EUR against the USD and JPY, respectively. - 10/ A 15 percent depreciation in the EUR against the USD and JPY, respectively. - 13/ A three-notch downgrade of claims on emerging markets countries that comprise at least 50 percent of banks’ total exposure to emerging market, and a two-notch deterioration applied to all others. - 14/ A 60 percent increase in the probability of default of all credit exposures, except interbank exposures. - 15/ The price of oil increase to 85 USD per barrel and global equity prices decline by 30 percent. - 16/ Sustained 20 percent depreciation of the USD with respect to the major currencies. - 17/ Italian corporate spreads increase by 200 b.p. and Italian equities decline by 35 percent. - 18/ VAR at the 99.7 level of confidence, 20 days holding period. - 19/ EUR interest rates increase by 200 b.p. - 20/ Interest rates for T-bills increase as in 4/. Withdrawal rate of interbank and consumer deposits increases to 40 percent and 15 percent respectively. ### Insurance sector — overall methodology and participation - Bottom-up exercise coordinated by ISVAP and conducted by Italian insurance companies using their internal models. - Stress tests on balance sheet exposures as of end-December 2004. - Ten Italian insurance groups participated, representing a market share of over 70 percent as of end-2004. - Sample composition: five domestically owned groups, two foreign-owned groups, two companies fully owned by Italian banking groups, one state-owned company. - Tests performed at the level of 59 individual companies owned by the ten groups (37 in the life sector). ### Insurance sector — assumptions and stress scenarios - Macroeconomic scenario assessed: - Domestic confidence crisis triggered by large corporate failures in Italy, resulting in: - (i) a 35 percent decline of domestic equity prices or, alternatively, the maximum decline in annual stock prices during the last 20 years - (ii) a 200-bp increase in corporate credit spreads - Tests assessed effects on both asset and liability sides due to possible policy lapses leading to: - (i) outflows of cash (payments to policyholders) - (ii) decreases in premium inflow and invested funds - Market risk — interest rate sensitivity shocks applied (bottom-up): - Shock 1: rise and flattening — increase in short-term interest rate of 110 bp, medium-term of 60 bp, long-term of 40 bp - Shock 2: parallel upward shift of 70 bp - Shock 3: fall and steepening — decrease in short-term interest rate of 110 bp, medium-term of 60 bp, long-term of 40 bp - Shock 4: parallel downward shift of 70 bp - Top-down rough calculation for life companies: parallel upward shift of 200 bp estimated by multiplying impact of 70 bp upward shift by 3 on bond portfolio and by 3.5 on additional provisions. - Catastrophic events: modeled as damage twice as large as the worst previous experience defined by non-life companies; test included impact before and after reinsurance and required increase in loss ratio to wipe out residual excess solvency margin. ### Insurance sector — results presentation and implementation issues - Impact measured through changes in solvency ratio (available solvency margin / required solvency margin). - Results provided at group and individual company levels; two calculations of available solvency margin: - (i) regular forms of capital - (ii) regular capital plus (a) unrealized net gains from asset valuation under current accounting rules and (b) one half of unpaid equity capital - Implementation issues affecting accuracy and interpretation: - Tests conducted on a legal-entity basis, preventing assessment of potential double-counting of capital ("double gearing") at group level. - Some companies did not fully implement all parts of the tests: - Some companies did not include unit- and index-linked life insurance contracts (represent about 35 percent of technical provisions in the life industry), despite these contracts having a minimal capital requirement (between 0 and 1 percent). - Some companies assumed policy lapses would be negligible and did not account for their impact on mathematical provisions and realized capital gains. *Source: IMF staff summary of Bank of Italy and ISVAP stress-testing exercises as presented in the cited document.* ### Conclusions ### Conclusions ### Life sector: exposure to interest-rate and macro shocks - The life insurance sector is the most exposed to adverse shocks. - Interest-rate shocks: - A 70 bp shift would lead to a decline in the average solvency ratio from 2.05 (before the shock) to 1.98, with three companies (out of 37 in the life sector) representing a market share of 2.2 percent of total technical provisions, recording a solvency shortfall. - A 200 bp shift may drop the solvency ratio to an estimated 1.72, with 17 companies representing a market share of about 46 percent, recording a solvency shortfall. However, this shortfall would represent only 0.37 percent of (class C) technical provisions. - Adverse macroeconomic scenario: - This scenario would lead to a decline in the average solvency ratio from 2.05 to 1.77, with seven companies recording a solvency shortfall, representing a market share of 13.7 percent of total technical provisions. ### Non-life sector: resilience and limited vulnerabilities - Solvency levels in the non-life sector seem very unlikely to reach critically low levels. - Macroeconomic scenario impact: - The macroeconomic scenario reduced the average solvency ratio from 3.35 (before the shock) to 2.92, with only one company (out of 22 in the non-life sector) recording a solvency shortfall. - Catastrophe/natural-disaster shock: - The proposed catastrophe shock reduced the average solvency ratio only to 3.23, and no company recorded a solvency shortfall. - Once the impact of reinsurance is taken into account, the average solvency ratio appears unaffected by the natural-disaster shock. ### Bank ownership and group-level considerations - Bank ownership of life insurers materially affects solvency assessment: - Parent banking groups generally allocate only a minimum level of capital to insurance subsidiaries, sufficient to meet the required solvency margin. - In case of shock, bank-owned insurers may benefit from the larger pool of parent-bank capital, reducing their apparent insolvency risk despite low subsidiary solvency ratios. - Illustration: - Of the 17 companies that may record a shortfall in the case of a 200 bp upward shift in the yield curve, 12 are owned by banks, representing a market share of about 38 percent of total technical provisions. - Authorities’ aggregation: - BI and ISVAP aggregated banking and insurance stress tests institution by institution to assess group-level capital adequacy; although no quantified group-level material was provided, authorities indicated the potential solvency shortfalls in the insurance sector are very small compared with the amounts of capital available to parent banks. ### Overall assessment and systemic risk conclusion - Only a limited number of relatively small life insurance companies appear vulnerable, suggesting the insurance sector is resilient to shocks. - Specifically: - Only five life insurance companies owned by insurance groups (i.e., not by bank groups), representing a market share of less than 5 percent, would record a solvency shortfall under the most adverse circumstances (a 200-bp upward shift in the yield curve). - Such a shortfall would represent 0/14 percent of (class C) technical provisions. - Conclusion: - These results tend to indicate that systemic risks are very limited in the Italian insurance sector, although the results should be interpreted with a degree of caution. *Source: _cr06112 - Conclusions* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06112.pdf_