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Prudential regulation

i Relationship with the prudential regulator

The reach of the Bank of Italy's prudential supervision is extensive and penetrating. This widespread and strong supervisory regime managed to better mitigate the consequences of the financial crisis than was seen in many other countries, and encouraged significant capital increase transactions that led to an average increase of up to 13.2 per cent of the Common Equity Tier 1 ratio.

In implementing the CRD IV and CRR principles, the Bank of Italy exercised its discretionary power to further increase banks' minimum initial capital from €5 million (as provided by CRD IV) to €10 million (see Section III.iii) and exempt banks belonging to a group from holding the liquidity requirements individually (see Section III.iii).

Currently, the supervisory review process consists of the internal capital adequacy assessment process (ICAAP) carried out by banks under the responsibility of their corporate bodies; and the supervisory review and evaluation process (SREP), entrusted to the Bank of Italy for LSIs and to the ECB for SIs. Whereas the ICAAP mainly aims to quantify the capital needed to face the risks of banking business (including country and transfer risks) and set liquidity management measures accordingly, the purpose of SREP is to assess the suitability of these measures – both capital and organisational – and establish the necessary relevant corrective actions (limitations to the distribution of own funds' financial instruments, imposition of own funds' add-ons and divestment of assets).

Starting from the 2016 SREP process, in addition to the imposition of the own funds' add-on (Pillar 2 requirements), the supervisory authorities may also issue Pillar 2 guidance that, in the event of non-compliance, would lead to intensified supervision and bank-specific measures designed to reestablish a prudent level of capital.

The supervisory review process is carried out in compliance with the proportionality principle, under which corporate governance and risk management processes and mechanisms for identifying the amount of capital due for risk prevention must be proportionate to the features, business size and complexity of each bank. The frequency and intensity of SREP must take into account the systemic importance, features and any problematic issues of each institution.

In 2017, the provisions of Circular No. 285 of 17 December 2013 on the supervisory review process were amended with respect to, inter alia, early intervention measures, interest rate risks on banking books and the limitation of exposures towards shadow banking entities.

ii Management of banks

Rules governing management and remuneration in banks and banking groups according to CRD IV are set under the Supervisory Instructions, as amended in May 2014. These rules strengthen corporate governance by setting, inter alia, further qualitative requirements to be met by banks' directors, self-assessment processes of corporate bodies and ad hoc committees for larger banks, and introduce several limits to variable remuneration with regard to its amount and nature.

Corporate governance requirements

To ensure sound and prudent management and to achieve their business goals, Italian banks are required to:

  1. choose between three management structures:
    • a traditional system (the most common structure) encompassing a shareholders' meeting, a board of directors and an auditory board;
    • a monistic system, whereby the control committee is appointed within the board of directors; and
    • a dualistic system (adopted by only a few large Italian banks to date), which has a separate management board and supervisory board; and
  2. identify the bodies responsible for the three main prudential functions:
    • strategic supervision, which concerns the identification of the bank's targets and supervision over their satisfaction (by examining and resolving upon financial and business plans, and strategic transactions);
    • management (including the general director), which concerns the practical management of the bank to meet the targets set out by the strategic supervision body; and
    • internal control, which concerns the supervision of the regular performance of the administration activity, and the adequacy of the organisation and accounting systems of the bank to the bank's targets.

Banks are required to choose a management structure that is in line with their business and medium to long-term strategic goals, and that safeguards the effectiveness of the internal controls system. A specific assessment must be conducted on the structure's implementing costs to ensure their sustainability.

The composition of the corporate bodies (both executive and non-executive) must be adequate for the complexity and size of the business, and diversified as to age, gender, skills and experience. Each member is required to be fully aware of the powers and tasks ascribed; act in the interest of the institution, without being influenced by the shareholders; and fulfil professional requirements tailored to the bank's features. In August 2017, the MEF published for consultation a draft decree on suitability requirements of members of banks' corporate bodies and key function holders in order to finalise the CRD IV implementation and align the Italian framework to the 2017 ECB guide and EBA guidelines on fit and proper assessment. The draft decree significantly strengthens the existing standards of suitability and introduces new criteria to assess the suitability requirements (i.e., fairness, competence, collective suitability, independence of mind, time commitment and limits on the number of directorships).

The appointment procedure must also consider the interlocking ban, which prevents members from holding similar positions in competitor banking, financial or insurance undertakings or groups.

Corporate bodies are subject to a periodic self-assessment process aimed at verifying the proper qualitative and quantitative composition of each body, and encouraging the active participation of each director. The process is described in a report at the request of the Bank of Italy.

Further rules for larger banks (in terms of assets, size and complexity) are provided to ensure ad hoc committees (internal controls and risks, remuneration, appointments), and succession plans for the positions of chief executive officer and general director, to ensure business continuity and prevent economic and reputational effects.

Specific provisions to align the special rules on CCBs with the rules on cooperative banking groups were introduced in the Supervisory Instructions, concerning, among other things capital structure and shareholder categories, articles of association and extraordinary transactions, and territorial competence.

Finally, as a result of the amendments to the Banking Act under Legislative Decree No. 72 of 12 May 2015, the Bank of Italy has the power to remove corporate bodies from office when the sound and prudent management of a bank is compromised.

Remuneration policies

The management body is in charge of setting remuneration policies in line with the risk appetite and long-term interests of a bank, and coherent with its capital and liquidity ratios. Incentive mechanisms that may lead to breaches of the regulations or the taking of large risks are forbidden.

To this end, the Supervisory Instructions, as amended in October 2018 to meet the CRD IV provisions and the recommendations issued by the EBA and FSB policies, state that, among other things:

  1. the ratio between fixed and variable remuneration cannot exceed 100 per cent. The ratio may be increased up to 200 per cent if so provided in the by-laws and approved by a shareholders' resolution with a qualified quorum. The latter must be based on a proposal made by the strategic supervision body outlining the concerned personnel, the rationale of the decision and its compatibility with the prudential rules;
  2. at least 50 per cent of the variable component must consist of shares or equivalent ownership interest, which in any case the Bank of Italy can prohibit, depending on the bank's specific status;
  3. malus and clawback arrangements also apply to the incentives due or paid to personnel who contributed to significant losses for a bank or customers, acted fraudulently, or acted contrary to laws, regulatory or statutory provisions or ethics codes; and
  4. remuneration and incentive clauses that do not comply with EU and local regulations are void and automatically replaced by the parameters set out by these regulations.

Banks apply the above requirements in accordance with their features, size and complexity of business, based on their classification as major, middle or minor banks. Major banks must fully comply with the remuneration rules, whereas middle and minor banks benefit from some exemptions.

As to the amendments to the Supervisory Instructions on remuneration issued by the Bank of Italy in October 2018 to align the Italian regulatory framework with the EBA guidelines of December 2015, the new key provisions concern, among other things:

  1. the definition of fixed remuneration;
  2. the inclusion of carried interest payments in variable remuneration;
  3. amendments to the procedure to identify staff whose work has a material impact on the bank's risk profile; and
  4. the inclusion, under specific conditions, of golden parachutes in the calculation of the ratio between the fixed and variable components of remuneration.

As a result of the new rules, Italian banks are now required to review their remuneration policies by no later than the date of approval of the 2018 financial statements, with particular focus on the variable component, to avoid reducing their capital bases and to ensure that a sound capital structure is maintained.

iii Regulatory capital and liquidity

Italian banks must hold regulatory capital at least equal to the minimum capital necessary to be authorised to exercise their activity (€10 million, except for cooperative banks, for which the minimum capital required is €5 million). This capital must consist of:

  1. 4.5 per cent of Common Equity Tier 1 ratio;
  2. 6 per cent of Tier 1 ratio (a favourable tax regime applies to additional Tier 1 items);
  3. 8 per cent of total capital ratio; and
  4. any additional capital requirements imposed under the SREP (see subsection i).

Additional requirements are:

  1. liquidity coverage ratio (100 per cent);
  2. leverage ratio (3 per cent based on the Basel Committee's framework, not yet implemented as a minimum requirement); and
  3. buffers, as follows:
    • capital conservation buffer: 2.5 per cent; 
    • countercyclical capital buffer: from zero to 2.5 per cent; to date, the Bank of Italy has maintained the countercyclical capital buffer rate (for exposures to Italian counterparties) at zero;
    • global systemically important institution (G-SII) buffer: only one Italian bank (UniCredit) has been identified as a G-SII, and must maintain a capital buffer of 1 per cent; and
    • other systemically important institution (O-SII) buffer: three Italian banking groups – UniCredit, Intesa and Banco BPM – have been identified as O-SIIs and will have to achieve a buffer of 1, 0.75 and 0.25 per cent, respectively, by 2022 (the buffer from 1 January 2019 to 1 January 2020 is 0.06 for Banco BPM, 0.38 per cent for Intesa; and 0.50 per cent for Unicredit).

    Italian banks belonging to a banking group are exempted from the application of the liquidity coverage requirement on an individual basis, while banking groups – subject to certain conditions – are exempted from calculating the leverage ratio of exposures to entities that belong to the same group and are incorporated in Italy.

    In accordance with the ECB recommendations of December 2018, banks that meet the above regulatory capital requirements can conservatively distribute net profits in dividends, with the aim of continuing to fulfil all requirements even if economic and financial conditions worsen. Conversely, failure to comply with the above thresholds will prevent institutions from carrying out any such distribution.

    For banking groups, compliance with the regulatory capital requirements is supervised by (1) 'Banking Supervision Desk I', with reference to banking groups subject to ECB direct supervision; and (2) 'Banking Supervision Desk II' and Bank of Italy branches, in respect of banking groups other than those under (1). Both Desks have extensive powers that mainly result in the supervision of national and transnational groups on a consolidated basis, analysis of risks and management of administrative proceedings.

    In the context of the prudential regulations, a key role is ascribed to management of the liquidity risk, both as a funding liquidity risk and market liquidity risk. To prevent these risks, Italian banking groups, Italian banks not belonging to a group and Italian branches of non-EU banks (the latter according to the proportionality principle) are mainly required to identify and measure their exposure to a liquidity risk, establish a liquidity risk's tolerance threshold and carry out stress tests to assess the adequacy of the liquidity reserves on an ongoing basis.

    iv Recovery and resolution

    Italy implemented the BRRD through Legislative Decrees No. 180 and No. 181 of 16 November 2015, which set out the BRRD regime and updated the Banking Act and Financial Act accordingly. A few days after implementation of the BRRD, four banks that jointly covered approximately 1 per cent of Italian deposits were placed under resolution, in accordance with a programme issued by the Bank of Italy as resolution authority, which provided for:

    1. the full write down of the banks' shares and subordinated bonds for overall amounts that exceeded €1 billion and €500 million, respectively;
    2. the setting up of four bridge institutions with new corporate bodies and capital ratios;
    3. the assignment of the rights, assets and liabilities in force as at the resolution date to the bridge institutions, with the exclusion of the written-down shares and bonds;
    4. the transfer of NPLs from the bridge institutions to an asset management vehicle.

    As a result of the resolution programme, the four bridge institutions restarted banking business and again played a key role in the local economy, supporting small and medium-sized regional enterprises. Furthermore, the government set specific measures to restore the written-down subordinated bondholders.

    After short postponements of the deadline for the sale of the bridge institutions, between January and March 2017, three banks were sold for a symbolic purchase price to UBI and one to BPER Banca SpA at the end of a competitive bid process that lasted a year.

    In addition to the BRRD implementing regulations, Italian banks are still subject to the existing local regime. This regime provides for the following proceedings, depending on the nature of the crisis affecting the bank in question:

    1. special administration: a short-term temporary measure aimed at verifying the possibility of restoring adequate capital buffers, and sound organisation and business conditions when the infringements in the bank's management, the breaches of the applicable regulations or the losses are serious but not irrevocable (as of January 2019, two banks are under special administration); and
    2. compulsory administrative liquidation: to be applied when a crisis appears to be irreversible and the conditions for resolutions are not fulfilled, and which is a direction to close down a bank and allow the competent court that handles the process to satisfy most of the creditors of that bank.

    After having applied for a precautionary recapitalisation under Law Decree No. 237 of 23 December 2016, in July 2017 MPS completed a total recapitalisation of €8.8 billion covered through burden-sharing and the state's subscription of newly issued MPS shares. As a result, the state currently holds 68.2 per cent of MPS's share capital.

    In the same year, Banca Popolare di Vicenza and Veneto Banca also applied for a precautionary recapitalisation, but did not obtain authorisation from the European Commission. In June 2017, the two banks were placed under compulsory administrative liquidation after the ECB declared the two banks as failing or likely to fail. In this case, the BRRD framework was not applied as the Single Resolution Board concluded that resolution action was not warranted in the public interest. The banking businesses of the two banks (along with some of their assets, liabilities, goods, rights and legal relationships) were acquired by Intesa for a symbolic purchase price; NPL subordinated bonds, shareholdings and other legal relationships were excluded from the acquisition.

    With the 2018 Budget Law, the government set specific measures to further restore subordinated bondholders – and in this case, also shareholders – of banks placed under compulsory administrative liquidation between 16 November 2015 and 1 January 2018 that had suffered financial losses due to violation of fairness and transparency duties.

    In January 2019, Banca Carige was placed under special administration by the ECB. Furthermore, to encourage the recapitalisation of the bank and the reduction of its NPLs, the government issued Law Decree No. 1 of 8 January 2019 (converted into Law No. 16 of 8 March 2019), which allows Banca Carige to obtain a state guarantee on newly issued liabilities and loans granted by the Bank of Italy at its discretion, and apply for a precautionary recapitalisation.

    In line with recent amendments to the BRRD, the Banking Act was amended by Law No. 205 of 27 December 2017 to introduce a new class of unsecured debt instruments, which rank in an intermediate position between senior and subordinated liabilities in the insolvency hierarchy.