Italy
Financial System Stability Assessment, including reports on the Observance of Standards and Codes on the following topics: Banking Supervision, Payment Systems, Insurance, Securities Regulation, Securities Settlement and Payment Systems, Monetary and Financial Policy Transparency, and Anti-Money Laundering and Combating the Financing of Terrorism

This paper discusses key findings of the Financial System Stability Assessment for Italy. The assessment reveals that Italy’s financial system is sound, and no major vulnerabilities that could cause systemic risks are identified. The deep restructuring of the banking sector in the 1990s has helped improve the efficiency and competition of the Italian banking industry. Most standard performance indicators are now broadly in line with those of other large European countries. Competition in the Italian banking sector has not yet been fully reflected in the pricing and quality of core services.

Abstract

This paper discusses key findings of the Financial System Stability Assessment for Italy. The assessment reveals that Italy’s financial system is sound, and no major vulnerabilities that could cause systemic risks are identified. The deep restructuring of the banking sector in the 1990s has helped improve the efficiency and competition of the Italian banking industry. Most standard performance indicators are now broadly in line with those of other large European countries. Competition in the Italian banking sector has not yet been fully reflected in the pricing and quality of core services.

I. Background

A. Macroeconomic Environment and Vulnerabilities

8. Following a lackluster growth performance in recent years, recovery is likely to be only gradual. GDP growth was weaker-than-expected in the third quarter (0.3 percent seasonally adjusted), raising questions about the strength and the durability of the recovery going forward. The staff now 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, under its excessive deficit procedures, the authorities’ plans to bring the deficit under the 3 percent of GDP ceiling by 2007.

9. The key potential macroeconomic vulnerability would be if the lackluster growth of recent years were to be followed by a continued protracted period of low growth. While historical data do not permit a meaningful quantification of the impact on the quality of the loan portfolio of such an event, it would ultimately be significant. In the near term, high public debt and fiscal instability will continue to pose a potential risk of widening interest rate spreads.

B. Key Features of Financial Sector Structure

10. The Italian financial sector is diversified and advanced. The banking sector remains a core funding source for the domestic economy (Figure 1). At end-June 2005, banking sector assets accounted for 66.5 percent of the financial system’s total assets (Table 1) and were equivalent to 175 percent of GDP (compared with 300 and 215 percent of GDP in Germany and France, respectively). In addition, banks control a substantial portion of both the insurance sector (about a third of total assets in the sector) and the asset management industry (about 86 percent of assets under management at end-2004). The banking sector has consolidated rapidly and the six largest Italian bank groups accounted for 55 percent of total assets at end-2004. However, Italian banks remain relatively small and further consolidation is to be expected. Since 1994, successive waves of privatization have drastically shrunk the share of bank assets majority-owned by the state or (nonprofit) foundations (Fondazioni) from 58 percent to 10 percent at end-2004 (Figure 2).

Figure 1.
Figure 1.

Key Features of Italy’s Banking Sector

Citation: IMF Staff Country Reports 2006, 112; 10.5089/9781451819984.002.A001

Source: EU Banking Structures (2004 ECB).
Figure 2.
Figure 2.

Restructuring of the Italian Banking Sector

Citation: IMF Staff Country Reports 2006, 112; 10.5089/9781451819984.002.A001

Source: EU Banking Structures (2005 ECB).
Table 1.

Financial System Structure (2000–2005)

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Sources: Bank of Italy, ISVAP, CONCOB, and COVIP.

Includes banks established as “Società per Azioni”, central credit and refinancing institutions.

Foreign controlled subsidiaries.

Banks with total assets above EUR 45 billions are mega banks, banks between EUR 20 and 45 billions are large, banks between EUR 7 and 20 billion are medium, and banks with total assets below EUR 7 billion are small.

Banks with total assets between 20 and 45 EUR millions.

Banks with total assets between 7 and 20 EUR millions.

Banks with total assets below 7 EUR millions.

Net asset values of pension funds’ portfolio allocation.

11. Asset management companies represent the second most important class of financial institutions with 16 percent of total assets, followed by insurance corporations (12 percent). Life insurance has grown very rapidly in recent years (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.

12. While Italy’s government bond market is the largest in Europe, its equity and corporate bond markets remain comparatively small. Government debt, which accounts for 106 percent of GDP, is held largely in the form of long-term debt, in a market that is among the most liquid in the world. The total capitalization of the equity markets managed by Borsa Italiana Group represents about 40 percent of GDP. Activity on these markets and on the Italian corporate debt market declined between 2000 and 2003, before rebounding in 2004.

C. Counterparties

13. The largest credit exposure of the banking system by far (60 percent) is to the corporate sector (Figure 3). The debt to equity ratio of the corporate sector rose to 97 percent in 2004 from 76 percent in 2000 and, while these ratios are broadly comparable to those of other large European countries, the corporate sector is likely to be the highest source of risk, in particular in a continued low growth environment. Banks’ exposure is quite diversified, with a few notable exceptions.

Figure 3.
Figure 3.

Exposure of Italian Banks to the Mortgage Market

Citation: IMF Staff Country Reports 2006, 112; 10.5089/9781451819984.002.A001

Source: EU Banking Structures (2004 ECB).

14. Provided interest rates do not rise sharply in the next few years, household credit markets provide a potentially stable revenue source with a relatively low risk exposure. Since 2000, banks have been focusing increasingly on developing the Italian household credit markets, driven by new mortgage loans for house purchases. Italy’s low household indebtedness (28 percent of GDP as compared to 57 percent for the EU-15 average) mitigates risk concerns in this segment (Table 2). Conditions would appear ripe for the development of new mortgage products, such as home equity credit lines.

Table 2.

Financial Soundness Indicators

(In percent and on an individual basis unless otherwise noted)

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Source: Bank of Italy and staff estimates.

Based on consolidated data.

Gross of deductions in participating entities and subordinated debts.

Nonperforming loans include doubtful loans.

Profit does not include change in the provision for general banking risks.

Net earnings include the net change in the fund for general banking risks; capital and reserves are calculated on a 13 month average.

Average overnight rate in December (June).

Current earnings (gross of interest expenses) to net interest expenses.

Special administration and private preemptive agreements.

Elaborations on data from Nomisma

15. Relative to other large countries, Italy’s banking sector exhibits a small overall risk exposure abroad (Figure 4). In line with most developed countries, most of its exposure is to other mature industrial countries (75 percent of total consolidated foreign claims). The exposure of Italian banks to emerging countries is strongly concentrated in Central and Eastern Europe, accounting for 16 percent of total consolidated foreign claims and 14 percent of consolidated profits at end-2004.

Figure 4.
Figure 4.

International Exposure for Selected Countries, 2004

Citation: IMF Staff Country Reports 2006, 112; 10.5089/9781451819984.002.A001

Source: BIS Consolidated International Banking Statistics.

D. Regulatory and Supervisory Framework

16. Regulation and oversight of financial markets are shared by six institutions. BI has extensive powers and responsibilities as the supervisor of the banking system and, until recently, the authority in charge of enforcing Italian antitrust laws in the banking sector. It is also responsible for supervising the financial markets that are relevant for monetary policy purposes, such as wholesale markets for government securities and interbank markets. All insurance undertakings, including mutual insurance companies, are supervised and regulated by ISVAP. Its responsibilities include the solvency of insurance companies, the sound development of the insurance sector, and transparency and fairness in customer relations. The Italian securities markets are supervised and regulated by the Italian Companies and Stock Exchange Commission (Consob). Pension funds are supervised by COVIP, the pension fund supervisory authority. Safeguarding competition is entrusted to the Antitrust Authority. The Italian Foreign Exchange Office (UIC) is responsible for anti—money laundering and combating terrorist financing.

17. A new Law on Savings was adopted at end-December 2005 to enhance the protection of investors. Drafted partly in response to the Parmalat case, the law includes new rules on corporate governance of the listed companies, minority shareholder rights, and the marketing and issue of corporate bonds, and allocates a more central role to Consob on securities markets. Reflecting recent amendments, the Law transfers the responsibility for regulating anticompetitive behavior to the Antitrust Authority while BI and the Antitrust Authority have been given shared responsibility for bank mergers and acquisitions. It also includes an additional set of reforms motivated by the public debate on the governance structure of BI. Concerns relating to the ownership and control of BI are discussed in more depth in Box 2, together with the reform proposals. The reforms adopted do not yet fully address staff concerns related to the need for clarity in the objective of BI, its ownership structure, and the role of the Board of Directors.

Ownership and Governance of Banca d’Italia

Governance structure

The BI governance structure is based on three bodies: the Directorate (composed of the Governor, the Director General and two Deputy Directors General), the General Meeting of Shareholders, and the Board of Directors. Prior to the adoption of Art.19 of the Savings Law, the Governor was entrusted with the formulation and implementation of all BI policies (including banking supervision) with the possibility of assigning specific responsibilities to the other members of the Directorate. The General Meeting of Shareholders elected the Board of Directors, which appointed and dismissed the Governor and the other members of the Directorate. The Board also established a Board Committee, with an advisory role, intervening on administrative matters upon the Governor’s request. According to Art.19 of the Savings Law, all the Governor’s non-ESCB responsibilities will henceforth be transferred to the Directorate (within which the Governor is attributed a casting vote). The BI Statute, further to the enactment of the Savings Law, should be revised within two months to provide the Board of Directors a role of internal oversight and control.

Ownership and control

Article 3 of the BI Statute permits entities supervised by BI to own its share capital. Banks are thus voting members of the General Meeting of Shareholders which effectively elect the Board of Directors and the Board Committee, and participate in the appointment of the Directorate. 1/ Article 3 of the BI Statute stipulates that the majority interest must be retained by public institutions. Since financial sector privatization, however, the majority of BI share capital is no longer held by public institutions (banks currently account for 84.2 percent). The authorities emphasized that this provision has been superseded by the privatization law. Notwithstanding the ownership structure, the authorities assured the staff that supervised entities could neither influence policy decisions nor have access to privileged information. The mission found that prior to the adoption of Art.19 of the Savings Law, the risk of conflicts of interest was paradoxically mitigated by the concentration of power in the hands of the Governor and the lack of any oversight role of the Board. 2/ The Savings Law now stipulates that 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 procedures for appointing the Directorate remain unchanged however. Although ownership will eventually be transferred to public entities, in the interim period between the enactment of an amended BI Statute with internal oversight responsibilities for the Board, and changes in the composition of the latter on account of the envisaged transfer of ownership, conflict of interest concerns remain.

Principles of reforms and assessment

The reforms, included 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 the compilation of minutes, the motivation of decisions and reporting to Parliament twice a year; 3/ and (v) changes to the mandate of the Governor and other members of the Directorate to 6-year, once-renewable staggered terms. Implementing these reforms will enhance transparency and accountability. However, key provisions are yet to be spelled out in the amendments to the BI Statute, including the role and composition of the Board of Directors, and the modalities of the transfer of ownership.

1/Subject to double-veto approval “by a decree of the President of the Republic acting on a proposal from the President of the Council of Ministers in agreement with the Minister of the Treasury after consulting the Council of Ministers” (Art. 19 of the BI Statute).2/Furthermore, a 1947 decree offered additional safeguards by precluding the influence of Board members in any of the matters under the competence of the ICCS (in bank supervision, stability, efficiency and competitiveness). Although the decree remains silent on supervised entities’ access to privileged information through their participation in Board meetings, any violations of the professional secrecy provisions of the Banking and Consolidated Laws would be sanctioned by the penal code.3/Previously, external oversight was neither legally mandated nor subject to pre-specified schedules. The Governor reported within ICCS deliberations and parliamentary hearings, whenever Parliament requested technical advice on subjects related to BI functions.

II. Strengths and Vulnerabilities

A. Banks

Recent performance and soundness

18. Despite the protracted period of low growth, the Italian financial system appears stable with improving results overall, albeit with some continuing challenges ahead. Restructuring has contributed to improvement in banks’ efficiency and asset quality. Low household indebtedness mitigates risk concerns in the retail sector and the low interest rate environment continues to sustain borrowers’ debt-servicing ability. While competition appears to have improved, costs remain high (compensated by high revenues) and challenges include generating stable sources of income, further restructuring and cost-cutting, and managing the high level of impaired loans and adequate provisions for credit losses.

19. Profitability indicators of the Italian banking sector continue to improve, arriving at levels close to the European average but further strengthening is needed. 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. In 2004, improvements in profitability have been achieved largely through a fall in asset value adjustment and a small progressive reduction in costs, whereas revenue growth has remained weak. In 2004 the cost-to-income ratio for Italian banks remained below the European average (57.9 percent in Italy as against 63.7 percent for the EU-15). But much remains to be done, especially to counterbalance the low revenue growth potential in the current low growth and low interest rate environment.

20. Revenue generating remains a key priority, as commission income continues to stagnate. Over the last decade, Italian banks relied increasingly on fee and commission income but by end-2004, at 21 percent of gross income this represented a share 5 percentage points lower than its peak in 2000. Overall, noninterest income to total income has remained stable at around 44 percent since 2002.

21. The deep restructuring of the banking sector in the 1990s, owing primarily to the almost complete privatization of the banking sector, has improved markedly the efficiency and competition of the Italian banking industry, but there is scope for further improvement. Standard performance and competition indicators suggest that Italian banks are now broadly in line with other large European countries. However, competition has not yet been fully reflected in the pricing of products and quality of services provided, reflecting limited contestability. The authorities are concerned that high switching costs hamper competition and 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 (albeit not a comprehensive coverage) appears to be one of the highest in Europe. Competition and efficiency issues are analyzed in detail in a selected issues paper “Italy—Assessing Competition and Efficiency in the Banking Sector,” issued as background to the Article IV discussions. Staff believes that improved efficiency and lower product pricing could help improve Italy’s growth potential.

22. The presence of foreign banks remains very limited in retail banking (Figure 5). So far, foreign takeovers have proven difficult to carry out, prompting scrutiny by the European Commission (and the Italian legal system). At end-2004, 7 percent of total bank assets were owned by foreigners. Although this is similar to the situation in some other large western European countries, no significant Italian bank or bank group is majority-owned by foreigners.1 Greater foreign ownership in the Italian retail banking sector would help strengthen efficiency.

Figure 5.
Figure 5.

Foreign Ownership of Italian Banks

Citation: IMF Staff Country Reports 2006, 112; 10.5089/9781451819984.002.A001

Source: EU Banking Structures (2005 ECB).

23. The quality of banks’ loan portfolios has significantly improved over the last few years, but the level of nonperforming loans remains high and is understated under current lenient loan classification system. After a sharp fall in the late 1990s, 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. (Figure 6).2 The prevailing classification system allows Italian banks to recognize impaired loans and the cessation of interest accrual later than in most other European countries. BI is taking measures to align its definition of impaired loans to international standards.3 According to surveys conducted by BI on the basis of preliminary June 2005 data, 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. This will reduce measured asset quality, which in turn will alter provisioning needs and thereby profitability figures. If the increased NPL were to be provisioned at 40 percent, the impact would be approximately equivalent to 20 percent of 2004 profits.

Figure 6.
Figure 6.

Selected FSIs in Large Developed Countries

Citation: IMF Staff Country Reports 2006, 112; 10.5089/9781451819984.002.A001

Sources: National authorities and IMF staff estimates.

24. Rising capital buffers mitigate banks’ vulnerability to external shocks and are broadly in line with other leading European countries. 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.

25. Despite their rapid development, securitization transactions had not until recently led to substantial reduction in risk exposures in banks’ balance sheets. Since the 1999 enactment of a securitization law and introduction of tax incentives, Italy’s securitization market has grown rapidly to rank as the second-largest in Europe. By 2004, bank loan securitization amounted to €85bn, €27bn of which related to NPL. It appears that since 2002 securitization transactions increasingly reflect funding purposes, as well as balance sheet and risk management objectives, suggesting that the market has further matured. However, the increasing use of more sophisticated products, such as synthetic securitizations, may also have introduced new risks in the system.

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. The largest Italian banks appear quite active in the sale of complex derivative products to corporate clients and consideration could be given to introduce capital charges for model risk for banks actively involved in structured products, in line with the recommendations in Basel II.4 The results of stress tests for a variety of shocks to derivative exposures of corporations indicate that the losses will only have 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), but only 20 percent of the firms will have a PD higher than 5 percent (see Figure 7 and section I of Appendix I for details).5 The results of the banking sector stress test indicate that the largest Italian banks can sustain a much larger increase in the PD. Nevertheless, supervision of bank derivative activities is key to ensure stability and minimize legal and reputational risks. BI and Consob supervisors need to closely monitor bank’s internal guidelines on the marketing of structured products and particular attention should be devoted to the practice of restructuring losing derivative positions by rolling them over into further structures, where the positions may be doubled.

Figure 7.
Figure 7.

Italy: Stress Test of Italian Corporation Derivatives Exposures

Citation: IMF Staff Country Reports 2006, 112; 10.5089/9781451819984.002.A001

Source: Bank of Italy. Shocks to the Euro-Curve include parallel shocks of +/- 100 b.p., Tilt+/-; s/t. rates +/- 110 b.p, m./t. rates i+/- 60 b.p. l./t rates =/- 40 b.p., and volatility shocks of +/-30 %.

Vulnerabilities and stress test results

27. Overall, the Italian banking system has low exposure to market and interest rate risk but liquidity buffers have decreased. 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. While the EU Banking Sector Stability Report indicates that this ratio remains in line with other European countries, some vulnerability to liquidity risk was identified by stress test results (see below).

28. Stress tests examined the impact of a variety of shocks on the nine major Italian banking groups accounting for 62 percent of total bank assets. The methodology for the stress tests was decided in consultation with IMF staff, and the tests were performed by both the banks and BI based on consolidated end-2004 balance sheets, yielding similar results, and updated by BI with data as of end-June 2005. The size of the shocks to assess market risk, sovereign risk, interest rate risk in the banking book and liquidity risk was in line with those applied in other FSAPs for Euro area countries, while the credit risk shock exceeded the largest historical shock in Italy. In addition, the stress tests assessed the impact of several adverse macroeconomic scenarios on the banking groups. (See section I of Appendix I for details).

29. Stress test results indicate that the major Italian banking groups are resilient to shocks, but that some smaller banks would be exposed to a liquidity shock. Even in the absence of profits, existing capital buffers are sufficient to absorb the shocks. The major Italian banks appear to be hedged to cope with market risk. The individual risk factors to which the Italian banks are more exposed are credit and sovereign risk (Table 3). Of the macro scenarios considered the oil shock that causes global slow down and resulting in a 30 percent decrease in global equity prices has the largest impact.6 The relatively low impact of stress tests is explained by the historically low impact on probabilities of default of similar shocks, on which the parameters of the exercise is calibrated. Historical relationships are not well suited to predict the impact of a prolonged period of low economic growth. Should low growth persist, the implications are likely to be more pronounced than that indicated by the current stress tests, especially through deterioration in the quality of lending to the corporate sector. That being said, these results were supported by VAR estimates conducted by BI on a system-wide basis.

Table 3.

Summary Results for Banking Sector Stress Tests, June 2005—Top Down

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Source: Bank of Italy

Risk-weighted capital adequacy ratio, NOT allowing for losses to be covered first by before-tax profits.

EUR, USD and JPY interest rates increase by 70, 65, and 60 b.p. respectively.

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.

A 30 percent decrease in the equity prices.

A 15 percent depreciation in the EUR against the USD and JPY, respectively.

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.

A 60 percent increase in the probability of default of all credit exposures, except interbank exposures.

The price of oil increase to 85 USD per barrel and global equity prices decline by 30 percent.

Sustained 20 percent depreciation of the USD with respect to the major currencies.

EUR interest rates increase by 200 b.p.

Interest rates for T-bills increase as in 4/. Withdrawal rate of interbank and consumer deposits increases to 40 percent and 15 percent respectively.

30. Stress tests indicated that, some banks (representing 22 percent of total bank assets) may not have appropriate liquidity buffers to sustain a liquidity shock. The authorities emphasized that these banks were mainly members of banking groups and would be covered by liquidity buffers in the parent bank. Nevertheless staff believes that liquidity buffers should be monitored carefully and banks encouraged to increase them, if necessary.

Regulatory issues

31. A June 2003 detailed assessment of compliance with the Basel Core Principles for Effective Banking Supervision (BCP) found the Italian bank supervisory system to be of a high standard. Because of its timing, the assessment could not take into account information revealed in the context the current high profile bank take-over attempts. Some of the alleged actions, if proven, would indicate a need for greater vigilance in encorcing the overall strong supervisory framework. Also, progress on implementing key BCP recommendations has been slow, and the staff encouraged the authorities to promptly converge to a standard definition of impaired loans, as this would greatly raise transparency and cross-country comparison of banks’ financial accounts. Regarding the recommendation to introduce comprehensive regulations on lending to related parties, the staff notes that the ICCS approved broad guidelines in July 2005, paving the way for more detailed BI regulations. Only limited data is available, raising uncertainty about the extent of connected lending. The staff welcomes the opportunity for BI to regulate lending to related parties and monitor the potentially negative impact of such lending on the quality of banks’ balance sheets.

32. The large banks are at an advanced stage of preparation for adopting Basel II requirements. Two banks, accounting for roughly 30 percent of the system’s total assets, have already had their market risk models validated by BI and a few more banks are in the process of submitting their models. Eight banks have been identified as potential candidates for the pre-validation of their internal ratings-based (IRB) approach to capital adequacy and BI follows closely the progress of five additional banks. Most of these banks are already using internal rating systems in the credit evaluation process of corporate customers.

33. Market participants expect some restatement of balance sheets with the transition to IFRS in 2005 but the overall impact on capital is uncertain.7 The 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.8 For many banks, this effect will be balanced by the revaluation of real-estate property. Stricter accounting for pension costs may also affect some banks negatively. So far, only a few Italian banks have provided quantitative data on the impact of IFRS adoption on their equity and income; one bank has resorted to capital injections in anticipation of the changes.

Policy transparency and potentially conflicting objectives

34. The IMF Transparency Code is generally formally observed, but clarifying broad policy objectives would further strengthen the transparency of banking supervision. Information on policy developments and regulatory changes is disseminated on a timely basis through the BI publications program. However, there is little discussion of the overall objectives, their linkages, and the manner in which they are being pursued. Consideration should be given to the publication of a financial stability report, which could include these issues.

35. At the time of the assessment, BI was by law assigned at least three broad objectives, namely maintaining the stability of the financial system, enforcing Italy’s antitrust laws, and promoting the efficiency and competitiveness of the banking sector. While the authorities indicated that, staff believe that BI should not be promoting “competitiveness” and recommend that the wording should be changed in the Banking Law.

36. BI’s joint responsibility for enforcing competition laws and maintaining the stability of the financial system might lead to a potential conflict. For example, short-term stability concerns might induce BI to facilitate the merger of a weak bank without considering the long-term competition implication. Such a conflict, however, could be addressed in several ways, including by imposing compensatory antitrust measures on the merging bank. Thus, provided merger reviews are supported by clear and transparent implementation procedures and adequate accountability mechanisms, competition and stability objectives are not necessarily inconsistent, as supported by the literature.9

37. In an effort to improve transparency and accountability, the newly enacted Savings Law has transferred responsibility for regulating anticompetitive behavior to the Antitrust Authority. In the area of merger reviews, BI and the Antitrust Authority have been given shared responsibility for authorizing bank mergers and acquisitions (BI on prudential grounds and the Antitrust Authority on competition grounds). For a successful implementation, the Antitrust Authority must have in place a clear and transparent decision-making process, appropriate resources and expertise to analyze the merger impact on competition, and utmost independence in forming its opinion. In the cases where BI may recommend a merger for stability purposes, the Antitrust Authority should be entitled to authorize concentrations on stability grounds, with compensatory measures if necessary.

38. The role of the ICCS in bank supervision makes it difficult to assess BI’s degree of operational independence on prudential issues. While policy formulation and implementation are vested solely in the Governor (now, the Directorate), the 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.10 Although the 2003 BCP detailed assessment found BI to be operationally independent in day-to-day supervisory and regulatory activities, it also noted that the lack of clarity regarding the role of ICCS in bank supervision made it difficult to assess whether BI had full operational independence over supervisory policies and processes. For example, important supervisory regulations have been significantly delayed by the ICCS, as evidenced in the case of connected lending.

B. Insurance and Pension Sectors

Recent performance and soundness

39. The Italian insurance industry has posted rapid growth rates and strong profitability in recent years. The sector experienced premium increases of about 12 percent in both 2003 and 2004. Capitalization levels remain strong, profitability is one of the highest in Europe, and combined ratios11 have dropped below 100 percent in 2003-04 for the first time in more than two decades (Table 4). Compared with other countries, activity in the Italian nonlife sector carries relatively low risk profiles because certain specific risks, such as environmental and asbestos risks, have not affected the industry.

Table 4.

Insurance Sector Financial Soundness Indicators, 1999–2004

(In percent unless otherwise noted)

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Source: ISVAP

40. Prospects for the Italian insurance sector appear favorable in many respects. Italy is a relatively under-insured market, and growth prospects for the insurance industry are generally seen as favorable.12 Margins may still remain higher than in the rest of Europe for some time, and the life sector industry should cover this medium term benefit from the recently approved pension reform. In addition, the traditionally conservative investment strategies of Italian insurance companies, as reflected in low exposures to equities (about 12 percent) and high exposures to fixed income securities (57 percent), should continue to insulate insurance companies from market volatility.

41. However, there are some significant challenges ahead for the industry. Margins are likely to shrink in the coming years, including as a result of increased competition and the implementation of a stricter regulatory regime. In the nonlife sector, for example, the recent profitability improvements should slow down due to increased pressure from consumer associations and from the government to reduce tariffs (following their strong increase in recent years). Revenue diversification will therefore be an important objective and challenge for most insurance companies, especially since most Italian insurers are exclusively domestic players.

42. Against this background, continued efforts to strengthen supervision, and to promote better risk management practices in the industry, are critical. ISVAP has undertaken increasing efforts to strengthen its risk-based approach to supervision and to promote internal controls, reflecting in particular changes in international regulatory frameworks, including at the European level and in anticipation of the Solvency II framework implementation. Such efforts are particularly important for the smaller insurance companies, where risk management and risk-based capital management are not widespread.

43. The need to strengthen competition, transparency and product control has also attracted greater attention from a consumer protection perspective. Concerns have emerged regarding the sale to retail investors of life insurance products with high fee structures and in a context of inadequate disclosure practices. More broadly, competition in the insurance market may be hampered by the rigid, vertically integrated structure of distribution networks, in which banks play a central role.13 Recent reforms, including the new circular on life insurance disclosure and, more broadly, the Law on Savings, are expected to address some of these shortcomings, including through a clearer division of responsibilities between regulatory agencies in these areas. In particular, ISVAP should be able to supervise insurers selling pension products, and COVIP to monitor the transparency of pension products (including those sold by insurance companies) without imposing duplicate or conflicting supervisory requirements on insurance companies.

Stress test results

44. The stress tests assessed the impact of a variety of shocks on major Italian insurance groups (Table 5 and Section II of Appendix I). They were applied to the balance sheets of the 10 largest insurance groups in Italy (as of end-2004), representing a market share of over 70 percent of premiums. Stress test assumptions were chosen to be consistent with those used in the parallel stress testing of the Italian banking sector. Specifically, the resilience of the insurance sector was assessed against a domestic macroeconomic shock, a range of interest rate shocks (interest rate risk being by far the main market risk for Italian insurance companies), and catastrophe risk.

Table 5.

Summary Results for Insurance Stress Tests

(December 2004)

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The solvency shortfall/liabilities ratio is the average shortfall of companies with shortfalls divided by their average liabilities.

The three companies with initial solvency ratio <1 have been recapitalized.

Shock 1: rise and flattening (increase in short term interest rate of 110 bp, in medium term interest rate of 60 bp, and in long-term interest rate 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, in medium term interest rate of 60 bp, and in long-term interest rate of 40 bp);

Shock 4: parallel downward shift of 70 bp.

45. Stress test results suggest that a number of relatively small life insurance companies are vulnerable to shocks. Life insurance companies appear as the most exposed to adverse shocks, and their solvency may be particularly affected by an interest rate shock or by an adverse macroeconomic scenario. However, most of the vulnerable life insurance companies are owned by banks and, in case of shock, may benefit from the larger pool of capital available to their parent banking group. Indeed, the stress tests results also indicate that the potential solvency shortfalls in bank-owned insurance companies are very small compared with the amounts of capital available to banks, mitigating concerns about risks arising from the potential impact of correlated shocks across the financial system. As a result, only a limited number of relatively small life insurance companies appear vulnerable. In the nonlife sector, solvency levels seem unlikely to reach critically low levels due to their relatively high-level at present, and to the absence of significant exposures to catastrophic risk (especially once the impact of reinsurance is taken into account).

Regulatory issues

46. In recent years, ISVAP has moved toward a more forward-looking approach to supervision, working toward the full implementation of a risk-based supervisory methodology and promoting better risk management practices by insurers. Further changes are ahead, such as the implementation of Solvency II, which ISVAP has been actively involved in developing. The legal framework for supervision of the insurance sector is largely adequate, but legal protection of supervisors, independence of directors and licensing of intermediaries may need to be strengthened.14 ISVAP conducts extensive off-site financial analysis which it should continue to make more forward-looking, for example, by requiring insurers to regularly perform stress testing and report the results. On-site inspections of insurers should be increased significantly, both in breadth and frequency, supporting more comprehensive risk assessment processes. Inspections of insurance intermediaries should be more frequent and extended to include those employed in nontraditional distribution systems. Efforts to improve disclosure to consumers are commendable and should enhance the competitive environment. Increased disclosure of company-specific financial information, including by ISVAP, would support market discipline.

Role of pension funds

47. Pension funds are small institutional investors in Italy, and recent reform initiatives that would stimulate their growth will not be implemented before 2008. Pension benefits are still primarily provided by the public pension system, as private pension funds cover less than 12 percent of the employed workforce.15 Italian pension funds are not a source of solvency concerns as they are almost exclusively defined contribution schemes, and generally invest their assets conservatively (a total of about €40bn, or 3 percent of GDP).16 Legislative changes approved in July 2004 include the possibility for employees to transfer their TFR (Trattamento difine rapporto) to pension funds. This should help promote competition between private pension providers and stimulate the growth of pension funds and the asset management industries more broadly.17 However, the recent legislative changes are now planned to take effect only in 2008, and further modifications are possible before then.

C. Capital Markets

Securities markets

48. The limited development of Italy’s equity markets reflects the relative lack of “equity culture” in Italy, the small number of big private corporations and the predominance of family-owned SMEs in the economy, as well as the marginal importance of certain institutional investor classes (such as pension funds). The authorities have made efforts to (i) introduce various market segments and to improve market regulation in order to facilitate listing by small companies, and (ii) promote new indices to meet various investor needs. Similarly, the Italian corporate bond market (also managed by Borsa Italiana) remains underdeveloped, and corporate scandals led to a further reduction in domestic bond issuance by Italian corporations in the early 2000s. Some regulatory gaps that contributed to this trend are being addressed in the Law on Savings.

49. In contrast, 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. The liquidity of the secondary market for Italian government bonds reflects the authorities’ efforts to issue a smaller number of benchmark instruments with greater outstanding amounts, while extending the overall duration of public debt. MTS, the trading platform introduced in 1988 with the initial objective of increasing liquidity and transparency in the Italian government bond market, evolved into a model adopted by a number of European and other countries. 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.18

50. An increased size and role of capital markets in the economy is desirable, to provide the private sector with alternatives to bank financing. Deeper capital markets would also support the further development of savings and investment opportunities for both institutional investors and households.

Securities market regulation, oversight and transparency

51. The assessment of IOSCO Objectives and Principles shows very strong securities market regulation and oversight. Moreover, recently enacted legislation has further strengthened Consob’s powers to investigate, supervise and enforce compliance with the regulatory framework, including by giving Consob and BI the authority to impose pecuniary sanctions. The assessment of the IMF Transparency Code for securities regulation revealed a high degree of compliance. A few areas still require action, in particular:

  • 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. Furthermore, to strengthen the 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

52. An IMF staff study of the Italian corporate governance framework indicates that it incorporates a high degree of investor protection, in some areas more stringent than international practice, but its benefits are not always fully realized.19 In particular, highly concentrated ownership, cross-shareholdings, and pyramid structures make it difficult for minority shareholders to implement or enforce the rights that they are given by law. The recently adopted law incorporating the EU market abuse directive has addressed some of these issues by giving Consob more resources, augmenting its power to act independently of the Minister of the Economy and Finance, and raising pecuniary sanctions. Other areas where further changes are recommended include mandating a majority of independent directors, incorporating some of the provisions of the Preda (voluntary corporate governance) Code into regulatory requirements, and representing minority shareholders on the board.

III. Infrastructure and Crisis Resolution

A. Payments and Securities Settlement Systems

53. 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.20 The migration to the new Birel RTGS system was completed in 2004 and most of the recommendations were addressed. Birel (together with the German system) has been chosen as the basis for developing the new unified euro area RTGS platform.

54. The 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. It intends putting in place proactive risk-management procedures and externally auditing its procedures and arrangements for disaster recovery and business continuity and for the outsourcing IT company. Due to the de facto monopoly position of both MT and Cassa di Compensazione e Garanzia in the Italian financial market, their common holding company, Borsa Italiana, has indicated that it would increase the number of independent Board members.

B. Crisis Management and Safety Nets

Systemic liquidity arrangements

55. BI maintains an element of institutional ambiguity in the provision of emergency liquidity assistance (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 the granting of ELA and the perceived reputational cost are believed to deter banks from relying inappropriately on ELA. BI’s role could be made more transparent, while precluding moral hazard, 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 in charge of ELA-related matters, and to follow an investment strategy aimed at replicating a market index, represent moves in the right direction.

Bank resolution mechanism

56. BI has extensive powers in bank resolution and liquidation procedures. The special administrator appointed by the BI assumes all powers of the Board of Directors, including merger and acquisition negotiations. The criteria underlying purchase and assumption decisions are unclear; the authorities indicated that competitive mechanisms were used, including, in at least one case, through 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

57. Italian banks benefit from relatively generous deposit insurance schemes (DIS) which have worked well under BI surveillance. Coverage of the two funds in operation (the Interbank Deposit Protection Fund or FITD and the Mutual Banks Depositors Protection Fund or FDGCC) 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.

C. AML/CFT

58. Italy’s comprehensive AML/CFT system has produced significant enforcement successes against money laundering, but the complex legal framework needs consolidation and streamlining. The preventive system has generally not been updated to the latest FATF standard and requires greater implementation of the more detailed customer due diligence (CDD) requirements of the revised standard, more effective sanctions regime, the increase of suspicious transaction reporting of non-bank financial intermediaries and the introduction of a legal obligation to report suspicious transactions related to terrorist financing. The legal framework for nonfinancial businesses and professions urgently needs to be implemented. The Financial Intelligence Unit has technologically advanced analytical capability but insufficient filtering limits its effectiveness. The authorities are diligently working to close these gaps.

ANNEX: Observance of Financial Sector Standards and Codes-Summary Assessments

The annex contains summary assessments of seven international standards and codes relevant for the financial sector. The assessments have helped to identify the extent to which the supervisory and regulatory framework is adequate to address the potential risks in the financial system. The following detailed assessments of financial sector standards were undertaken:

  • The Basel Core Principles for Effective Banking Supervision (BCP), by Keith Bell (Consultant) and Ms. Maria Nieto (Bank of Spain);

  • The Core Principles for Systemically Important Payment Systems (CPSIPS), by Peter Allsopp (Consultant);

  • The IAIS Insurance Core Principles (ICP), by Michael Hafeman (Consultant);

  • The IOSCO Objectives and Principles for Securities Regulation, by José Manuel Portero (Spanish CNMV);

  • The Securities Settlement and Payment systems CPSS-IOSCO (RSSS), by Elias Kazarian (IMF-MFD);

  • The IMF Code of Good Practices on Transparency in Monetary and Financial Policies (MFP), by Marie Thérèse Camilleri (IMF-MFD) in the context of the Basel Core Principles for Effective Banking Supervision and Core Principles for Systemically Important Payment Systems and Laurent Bouscharain (IMF-MFD) in the context of the IOSCO Objectives and Principles for Securities Regulation; and

  • The FATF Recommendations for Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT), by Jean-Fran’s Thony (LEG), team leader; Richard Lalonde (MFD); Nadine Schwarz (LEG); Maud Börink (MFD); and Michael DeFeo (LEG Consultant).

The IOSCO and CPSS-IOSCO assessments were carried out during a mission to Italy from October 18 to November 3, 2004, the AML/CFT assessment was conducted during a mission in April 2005 and the ICP and MFP assessments were carried out during a mission July 6–20, 2005. All the assessments were based on the laws, regulations, policies and practices in place at the time the assessments were made.

The Core Principles for Systemically Important Payment Systems (CPSIPS) and the Basel Core Principles for Effective Banking Supervision (BCP) were conducted in, respectively, March and April 2003 (the reports are available at www.imf.org).

The assessments were based on several sources including:

  • Self-assessments by the supervisory authorities;

  • Reviews of relevant legislation, regulations, policy statements and other documentation;

  • Detailed interviews with the 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.

Summary Assessment of Compliance with the Basel Core Principles for Effective Banking Supervision and Transparency of Banking Supervision21

Institutional and Macro Prudential Setting, Market Structure—Overview

59. Since 1990, the Italian banking system has undergone a significant consolidation and 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 the greater transparency regarding the ownership structure of banks and the 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 still a few cases where cross-shareholdings allow a group of Fondazioni to control jointly more than 50 percent of a bank’s capital.

60. The Italian corporate insolvency regime results in lengthy and costly judicial proceedings, and a slow realization of collateral in the event of borrowers’ default. The government at the time of the assessment had proposed a legal reform aimed at simplifying legal proceedings and maximizing the value of the distressed enterprise through restructuring, which was approved in December 2005. In contrast, 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 designed to prevent the distress in one bank resulting in systemic stress.

General Preconditions for Effective Banking Supervision

61. The legal framework adequately defines the general principles governing the activity of both bank and nonbank financial intermediaries. Detailed technical rules are deferred to secondary legislation, allowing for prompt adjustments to the evolving needs of financial intermediaries and markets. BI has extensive powers and responsibilities as the supervisor of the banking system. It is also responsible for supervising the financial markets that are relevant for monetary policy purposes, such as 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, the insurance sector supervisory authority, establishing a formal procedure for mutual cooperation between the two institutions on matters of common interest.

62. BI conducts its supervisory policies transparently, with adequate confidentiality considerations to preserve both the effectiveness of its actions and the market sensitivity of information regarding individual financial institutions. BI makes public the principles and criteria of its supervisory activity; establishes the time limits for the adoption of measures; and specifies the persons responsible for each administrative procedure.

63. A key challenge is to continue to strengthen the transparency and disclosure of banks’ balance sheets and income statements as well as corporate governance practices. Banks already disclose a highly detailed set of data to BI, which uses this information both for micro- and macro-prudential surveillance purposes. In addition, listed banks are required to disclose a large body of information to the markets. Further efforts in facilitating cross-country comparisons and investors’ analysis of this information would contribute to enhance market discipline.

Main findings

64. Italy has a high overall level of compliance with the Core Principles. Nonetheless, some legal amendments are required to reach full compliance and, at the time of the assessment in some areas, it would have been beneficial if tighter and more specific prudential guidance was provided to banks. BI conducts a comprehensive, sophisticated, and continuous process of off-site monitoring, closely integrated with a cycle of thorough on-site inspections. The cycle of on-site inspections is long; for small banking institutions, inspections are conducted on a three-year cycle and at longer intervals (not more than six years) for large banks. In line with the rapid developments in the scope and complexity of the banking industry, BI is increasingly relying on focused and thematic inspections, thereby shortening the inspection cycle.

Objectives, Autonomy, Powers, and Resources (CP 1)

65. There is a generally appropriate body of banking laws and regulations. Broad guidelines on prudential supervision in the area of credit activities and the protection of savings are issued by the Inter-Ministerial Committee on Credit and Savings (ICCS). This makes it difficult to assess whether supervisory polices, plans, and processes are entirely independent from the government. In practice, however, BI takes the initiative in recommending regulatory and supervisory policy and has operational independence on day-to-day application of supervisory methods, once broad guidelines have been approved by the ICCS. The BI supervisory program is supported by adequate enforcement powers. In addition to fostering the overall stability of the financial system, BI has the legal responsibility to enforce Italy’s antitrust laws22 and promote the efficiency and competitiveness of the banking sector. One particular concern is that the law does not provide legal protection to its supervisors against court proceedings stemming from measures adopted in the performance of their functions in good faith.

Licensing and Structure (CPs 2–5)

66. The licensing regime is well developed and appropriate, as is the process for review of change in ownership of significant shareholdings in banks. BI complies with the Essential Criterion concerning fit and proper test for proposed directors and senior management at the initial authorization for a bank to commence business. Regulations adequately define the types of acquisitions and investments in which BI’s approval is needed. BI has the power to prohibit acquisitions of holding banks, financial and insurance companies if such initiatives are likely to limit or impede the effective performance of supervision on a consolidated basis.

Prudential Regulations and Requirements (CPs 6–15)

67. The supervisory regime would be strengthened by the promulgation of more stringent criteria for the classification of impaired loans and for the definition of or limits on “connected lending or lending to related parties.” In comparison to practices in other G7 countries, loan impairment and cessation of interest accrual appears to be recognized later in Italy. Italy has 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. Another particular concern is the lack of a comprehensive definition of “connected lending or lending to related parties” in the banking law. It is strongly recommended that the authorities issue a comprehensive regulation on connected lending to address its definition, overall limits, and reporting.

68. The supervisory and regulatory framework to ensure sound internal controls and risk management systems and to control money laundering are satisfactory, with the caveat that the supervisory authority lacks sufficiently clear legal authority to require expeditious change in the composition of a bank’s board of directors and management whenever an incumbent no longer meets “fit and proper” criteria.

Methods of Ongoing Supervision (CPs 16–20)

69. There is a well-structured off-site analysis function based on very detailed statistical data requirements, frequent contacts with banks’ management and staff, and smooth integration with the on-site analysis. BI does not rely on external auditors for the purpose of on-site inspections. The cycle of on-site inspections is long; taking into account thematic inspections, the inspection cycle for large banks has recently been shortened to no longer than three years, as in the case of the small banks. BI should review the means by which it may derive greater benefit from the work of external auditors in the execution of its own mandate. In addition, revising the banking law would be desirable, so as to obtain the authority to revoke the appointment of the external auditors of a bank when their performance is deficient and to establish the standards of banks’ external audits and the scope of bank’s audit programs. In the light of the rapid changes in the banking industry and risk management techniques, BI should continue to keep the adequacy of resources under review.

Information Requirement (CP 21)

70. The mission’s discussions with banks’ managers suggested that the system in use delayed the recognition of impaired loans and the suspension of recognition of income from these loans. As noted above (paragraph 69), Italian banks will have a transition period of five years to move to the Basel II “default” definition. The adoption of the new IFRS in 2005 will also help align loan-loss recognition with international practices.

Formal Powers of Supervisors (CP 22)

71. A broad range of remedial powers is provided by law to BI, including explicit requirements to take prompt action in cases of insolvency. The power of BI derives from a flexible and comprehensive set of notification and corrective action procedures, effective bank resolution procedures, and sound enforcement powers. One shortcoming is the lack of specific provision for BI to require subsequent removal of a director or senior officer who may have become unfit (see also paragraph 9 above).

Cross-Border Banking (CPs 23–25)

72. BI has established close cooperation, including memoranda of understanding, with many foreign supervisory authorities responsible for the foreign operations of Italian banks. Coordination with foreign supervisors to cover operations in Italy by foreign banks is also adequate. The regulatory framework for globally consolidated supervision over internationally active banking groups is satisfactory.

Table 6.

Action Plan to Improve Compliance with the Basel Core Principles23

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Developments subsequent to the assessment

73. The authorities have addressed some of the recommendations highlighted in Table 1. Following-up on these and other BCP recommendations would further strengthen the effectiveness of BI’s framework for bank supervision.

74. Regarding the recommendation to align Italy’s criteria for impaired loans to international standards (BCP 8 and 21), BI introduced a new reporting requirement for banks to monitor the impact of moving to a 180-day (ultimately 90-day) past-due definition for impaired loans. On the basis of such reports, the ratio of effective nonperforming loans (i.e., 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. According to the new accounting regulation, banking groups and individual banks are required to classify in their financial statements as of December 31, 2005, the 180-day past-due loans as impaired loans and to provision these in line with IFRS (consolidated) and national GAAP (individual). At the latest by 2011, banks will have to converge from the 180-day to the standard 90-day past due criteria for impaired loans, in line with the definition of default applied under Basel II.24 The staff encourages the authorities to speed up the process, as this would greatly raise transparency and cross-country comparison of banks’ financial accounts.

75. The authorities have also made some progress in addressing the lack of regulation on lending to related parties (BCP 10). In July 2005, the ICCS approved a guideline on connected lending and entrusted BI with issuing a more detailed regulation in this area. The Savings Law is consistent with the ICCS guidelines. 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. BI has prepared a draft regulation implementing the ICCS guideline, which will be issued for consultation shortly. The staff welcomes the opportunity for BI to regulate lending to third parties and address the risks associated with such lending.

76. The supervisory authority and their officers continue to be liable to legal procedures stemming from measures adopted in good faith in the performance of their functions (BCP 1.5); Italian compliance with this BCP can only be achieved by amending the laws, which is not within the powers of BI. BI continues to lack the legal power to remove expeditiously bank directors or senior officers who may have become unfit for their duties (BCP 14), even if BI officials feel that moral suasion can be a sufficiently effective tool to achieve this aim. Similarly, limited progress has been made toward granting BI the authority to remove bank external auditors when their performance is deficient (BCP 19). The authorities noted that a forthcoming EU directive will extend the scope of mandatory external bank audits. Given that Consob will be managing the auditors’ registry, Consob would have the legal power to remove unfit auditors. However, to ensure that deficient external auditors are removed promptly from their audit responsibilities, BI supervisors need to cooperate closely with Consob whenever the performance of an external auditor appears to be no longer satisfactory.

Authorities’ response

77. BI considers that the assessment recognizes the high degree of compliance of the Italian supervisory system with the Basel Core Principles. The assessment highlights a number of very positive features of the Italian supervisory framework, such as the adequacy of prudential regulations, the effectiveness of controls, achieved, inter alia, thanks to the fruitful interaction between on- and off-site methods and to the flexible and wide-ranging supervisory tools.

78. The interaction with the IMF mission has stimulated BI’s own considerations on a number of issues related with the subjects covered during the assessment.

79. On a number of issues the IMF recommendations and findings back up some strands of work to which BI had already began to devote consideration, such as: the importance of providing legal protection to the supervisory authority and its officers against the possibility of legal action by third parties in response to measures adopted in good faith in the performance of their functions; the issuance of a comprehensive regulation on lending to related parties in order to address more thoroughly, in addition to the existing provisions in the context of large exposures, the issues of definition and overall limits. In 2006, BI will issue the supervisory regulation to comply with the July 2005 ICCS resolution and the Savings Law.

80. BI believes that the observations of the IMF mission on BCPs 14 (Internal control and audit) and 19 (Validation of supervisory information), although grounded in principle, do not imply that the existing framework does not allow BI to fully achieve the goals laid down in the BCPs. However, initiatives will be taken in order for the issues to be addressed by the competent authorities.

81. On BCPs 8 (Loan Evaluation and Loan-Loss Provisioning) and 21 (Accounting Standards) BI has tackled the issues by defining more objective criteria for the classification of impaired loans in line with the prevailing practices in most G-10 countries. Supervisory regulations will be amended consistently with the time frame envisaged by the New Capital Accord in order to achieve the standard 90-day past-due loan classification. However, BI does not agree with the IMF view that the existing classification criteria may determine an overestimation of income of Italian banks. As a significant share of “past-due loans” (other than bad and substandard) become current again within one year, this implies that such provisions tend to offset interest on the 20 percent of loans that eventually will be classified as bad loans or substandard loans.

Summary Assessment of Observance of the Core Principles for Systemically Important Payment Systems (CPSIPS)

General

82. The present document is the summary assessment of compliance of the Italian RTGS system, Birel (which has now been replaced by New Birel) with the CPSS Core Principles for Systemically Important Payment Systems. The assessment was conducted during the period June 16–27, 2003. The assessment was based on detailed discussions with officials from relevant departments of BI, and with representatives of commercial banks, banking associations, and the Interbank Company for Automation.

83. The methodology used for the assessment followed the Guidance Note prepared in August 2001. It was greatly helped by a comprehensive self-assessment that had been prepared by BI.

Institutional and market structure

84. Since 1926 BI has had by law the responsibility for providing the clearing procedures for settlement of interbank payments and securities transactions. From 1991, new procedures have ensured that most interbank transactions would be settled in central bank money through the clearing system, rather than as hitherto through banks’ bilateral correspondent accounts. In 1997 the RTGS system, Birel, was launched, and since 1998 all types of domestic high-value payments have been settled through the system (which was replaced by New Birel in January 2004).

85. 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. Therefore, procedures and policies of or relating to Birel have to comply with relevant decisions of the European Central Bank. Similarly issues relating to the functioning of Birel, and in particular to the availability and circulation of liquidity—cash or collateral—in the system, have to be considered in the context of the real-time cross-border links between Birel and the RTGS systems of other EU countries (both inside and outside the Euro-zone).

86. Birel is used by 600 financial institutions holding RTGS accounts with BI. (This number is reducing as a result of both consolidation within the Italian banking sector and the progressive introduction of New Birel.) There is no minimum amount for a payment to be made through Birel, so that it handles time-critical low-value payments as well as large-value transfers and payments in settlement of securities transactions. In terms of the total volume of transactions settled, Birel ranked second among EU RTGS systems in both 2001 (10.2 million payments) and 2002 (9.6 million); in terms of the total value, it ranked 5th in each year. The flows of payments in Birel are concentrated in a relatively small number of banks.

Effective payment system oversight

87. Birel is operated and overseen by BI, in the context of TARGET rules, procedures and guidelines issued by the ECB. The policies, procedures and practices of BI in respect of Birel are open and transparent; they are widely circulated through a series of publications and through close and continuing contacts with the system’s users. BI publishes regular reports on the operation of Birel, and on the volume and value of payments through the system.

Main findings—Summary

Table 7.

Main Findings of Assessment of Observance of CPSS Core Principles for Systemically Important Payment Systems and of Central Banks’ Responsibilities

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Table 8.

Actions to Improve Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPSIPS—Birel

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Authorities’ response and next steps

88. The migration to the new Birel RTGS system was completed by May 2004, and BI considers that all the recommendations contained in the assessment were addressed except for some marginal aspects. Birel (together with the German and French systems) has been chosen as the basis for developing the new unified RTGS platform for the euro area.

89. In new Birel the non-EU banks directly participating in the system are three instead of fourteen and legal opinions (Capacity Opinions and Country Opinions) have been obtained; they have been assessed by the Bank’s Legal Department that found them fully satisfactory and therefore concluded that no conflict of jurisdiction arises vis-à-vis the country (U.S.) where the three banks are incorporated.

90. Regarding the recommendation that a decree should be issued covering the technical rules for electronic processing, the need was significantly reduced following the amendment (with the legislative decree No. 82 of 7 March 2005) to law No.445 of 2000 that called for the issuance of such a decree.

91. As to the understanding and management of risk, BI has already amended the rules of new Birel in order to introduce a warning for indirect participants regarding their risk exposure vis-à-vis the respective direct participants, in case they opt for such form of participation in the system.

92. Concerning the recommendation to ensure that Service Level Agreements are in place between direct participants and service providers, banks have been required to sign such agreements. In addition, the risks stemming from the outsourcing of important elements of the payment system functionality to a few service providers are monitored by an ad hoc working group on business continuity, which covers the entire national marketplace. Indeed, both representatives from the Bank’s competent functions and critical players (such as major banks, market infrastructures, public utilities and service providers) participate.

93. As regards the recommendation to keep a close watch on the developments in the 2-tier system for access, as a part of the infrastructure of new Birel and to consider carefully the concentration risks that may arise in respect of the use of ‘Group Settlement Agents’ acting on behalf of members of a group of banks, it is to be pointed out that in the first quarter of 2004 (when the participants’ migration process was almost completed) the share of the payments settled by the first five banking group in the new Birel (that provides for the 2-tier structure for access) amounted to 45.2 percent compared to 42.4 percent in the correspondent period of the previous year in the old Birel (which only provided for direct access). In the same periods, the share of the payments settled by the first ten banking groups even decreased from 76.6 percent to 72.5 percent. This clearly shows that the launch of new Birel did not increase the concentration of payments among intermediaries.

94. As regards the recommendation concerning responsibility D, BI has entered into an agreement on information sharing with the U.S. Federal Reserve for information sharing.

95. Regarding the possibility of transferring the responsibility for compliance of the Italian RTGS system with the Core Principles from the Payment Systems Department (PSD) to the Payment System Oversight Office, the authorities noted that the separation of operations and oversight within the PSD had been strengthened by the reporting of each function to a separate Senior Manager within the Department. According to an ad hoc assessment carried out at the ECB level, no evidence of conflict of interest has been found.

Summary Assessment of IAIS Insurance Core Principles (ICP)

General

96. This report summarizes the results of an assessment of the observance of the Insurance core principles (ICP) of the International Association of Insurance Supervisors (IAIS) in Italy. Insurance is supervised in Italy by the Supervisory Authority for Private Insurance Undertakings and Insurance Undertakings of Public Interest (Istituto per la Vigilanza sulle Assicurazioni Private e di Interesse Collettivo—ISVAP). ISVAP is responsible for prudential and market conduct supervision of insurance companies and intermediaries. This assessment was done in the context of the IMF and World Bank Financial Sector Assessment Program (FSAP), using the ICP dated October 2003. This assessment was conducted during a mission to Italy July 5–20, 2005, and is based on the circumstances in place and the practices used at that time. Although Italy is undergoing significant changes in its insurance supervisory processes and Parliament is considering changes in legislation relevant to insurance supervision, prospective changes have not been considered in the assessment. The report includes recommendations for strengthening the supervision of insurance.

97. Major sources of information used for the assessment included ISVAP’s answers to the questionnaire submitted by the IMF prior to the mission, a comprehensive self assessment carried out by ISVAP, ISVAP’s annual report, translations of various circulars issued by ISVAP, supplemented by publications of industry associations and ratings agencies. Extensive meetings were held with management and staff of ISVAP to discuss each of the criteria within the ICP. In addition, meetings were held with representatives of a wide range of industry and professional organizations. All concerned gave willingly of their time and were cooperative, and this added significantly to the effectiveness of the assessor.

Institutional and macroprudential setting—overview

98. While the insurance sector in Italy experienced strong growth in 2003 and 2004, with premium increases of about 12 percent in both years, Italy remains relatively under-insured. Market penetration is low, with gross domestic premium income accounting for 7.5 percent of GDP in 2004, compared to the EU average of close to 9 percent. The total assets of the insurance companies amount to 34.6 percent of GDP in 2004. At year-end 2004, licensed domestic insurance companies included 76 life insurance companies, 81 non-life insurance companies, 19 companies licensed for both life and non-life insurance (composite companies) and 3 reinsurers. In addition, 67 branches of foreign companies were licensed to operate, primarily in the non-life sector. The industry is relatively concentrated, with the largest five and the largest ten life companies, respectively, accounting for 47 percent and 65 percent of the sector’s total insurance premiums in 2004. The largest five and the largest ten non-life companies, respectively, wrote 41 percent and 61 percent of the premiums in the same year. Insurers are frequently members of groups, with the five largest groups accounting for 53 percent of life premiums and 67 percent of non-life premiums in 2003. Banks and post offices are the predominant life insurance distribution channel, accounting for 59 percent of sales in 2004. The agency distribution channel also remains important, accounting for about 30 percent of life insurance sales and 88 percent of non-life insurance sales in 2004. Financial advisors account for most of the remaining life insurance sales, with brokers handling the balance of the non-life sales, focusing on the medium to large commercial risks.

99. Life insurance products are predominantly savings-oriented, and include traditional and unit-linked policies. Legislation currently under consideration is expected to expand the opportunities for the sale of the life insurance to fund supplemental individual pensions. The life insurance business has been profitable, with an overall return on equity of 10.5 percent in 2004. Motor insurance is the predominant non-life product, accounting for almost 60 percent of the non-life premiums written. Motor insurance claims costs have been increasing rapidly, but premiums have kept pace. Both motor insurance and other non-life products have been profitable in recent years, with the overall combined ratio having declined steadily from 109 percent in 1999 to 96 percent in 2004. Return on equity was 13.4 percent in 2004.

100. The supervisor for the insurance sector is ISVAP, an independent supervisory authority with a Board of Directors, funded by a levy on premiums.

Main findings

101. Insurance supervision in Italy occurs within a legal framework that incorporates the relevant EU Directives. In recent years, ISVAP has moved toward a more forward-looking approach to supervision, working toward the full implementation of a risk-based supervisory methodology and promoting better risk management practices by insurers. This change in approach has clearly been noticed by the industry and, for the most part, appears to have its support (in principle, although not always on the specifics). Further changes are ahead, such as the implementation of Solvency II, which ISVAP has been actively involved in developing.

102. The level of observance of the ICP in Italy is good, with the legislative and supervisory initiatives that are currently being pursued holding the potential to further improve the level of observance in the coming years. In some areas, where frameworks are in place, it has been recommended that implementation be strengthened, e.g., by increasing the frequency and scope of on-site inspections of both insurers and intermediaries. In other cases, the legal framework should be strengthened, e.g., legal protection should be provided for those involved in the supervisory process, and governance requirements and disclosure requirements for insurers that are not subject to the requirements applicable to listed companies should be strengthened.

Conditions for effective insurance supervision

103. 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.

The supervisory system

104. Both the board of directors and staff of ISVAP should be protected against lawsuits for actions taken in good faith while discharging their duties. Consistent with its move to a more risk-focused approach, 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. While ISVAP actively exchanges information with other EU/EAA insurance supervisors, 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

105. Broadening the application of fit and proper and corporate governance requirements, strengthening the assessment of corporate governance and internal controls, along with legislative changes to help ensure the flow of information from those involved in the control process, would improve observance.

Ongoing supervision

106. ISVAP’s on-site inspections should seek to assess not only compliance with requirements but the effectiveness of an insurer in identifying and managing its risks. Significantly increasing both the number and scope of the on-site inspections, and providing advance notice of most inspections, would facilitate more forward-looking and effective supervision.

Prudential requirements

107. ISVAP is actively involved in international standard setting initiatives, such as Solvency II. It has also taken steps to require insurers to perform stress testing. The ability of ISVAP to assess the financial condition of insurers and to 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.

Markets and consumers

108. 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 would be appropriate, e.g., to ensure that information is easily available to interested parties.

Anti—money laundering, combating the financing of terrorism

109. More frequent inspection of controls by ISVAP is recommended, along with explicit guidance to emphasize the need for foreign branches and subsidiaries of Italian insurers to observe AML/CFT measures.

Table 9.

Action Plan to Improve Observance of IAIS Insurance Core Principles

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Authorities’ response to the assessment

110. We would like to pay tribute to the International Monetary Fund for the fruitful discussions held during the assessment and the recommendations made, which will help to improve the effectiveness of insurance supervision in Italy.

111. ISVAP welcomes the IMF’s support to the efforts undertaken to strengthen Italian insurance supervision according to an approach that is more and more forward-looking and risk-based, and to increase the standards relating to risk management and insurance undertakings’ internal controls, in line with the developments of the Solvency II Project.

112. ISVAP is carefully assessing the recommendations by the IMF. The pre-requisites which will be necessary to carry out some of them have been already defined, especially as regards the two ISVAP circulars on the system of internal controls and risk management and on passive reinsurance; in other cases the carrying out of such recommendations is subject to objective limits set by the legislation in force, but it is now possible in 2006, with the entry into force of the New Insurance Code, which will also extend ISVAP’s powers.

113. Moreover, as regards certain recommendations, ISVAP is already working on drawing up measures for their implementation, like the code of conduct for staff and the reinforcement of its own supervisory function, also in the light of the innovations contained in said Code, which extends ISVAP’s supervision to all insurance intermediaries and introduces the possibility for ISVAP to have recourse to Guardia di Finanza (the Financial Police).

114. Finally, as regards other recommendations, the expected benefits from the introduction of the proposed improvements will be examined in the light of a comparison between costs and benefits of regulation and supervision.

Summary Assessment of Implementation of the IOSCO Objectives and Principles of Securities Regulation

General

115. An assessment of implementation of the IOSCO Principles was carried out as part of the first FSAP mission, between October 18 and November 3, 2004, by José Manuel Portero.

116. The assessment was carried out using IOSCO Assessment Methodology (the Methodology), adopted by IOSCO in October 2003. The assessment relied on a detailed self-assessment completed by Consob and BI, in-depth interviews with Consob, BI and the Ministry of Economy and Finance staff, interviews with market participants and industry associations, and a review of key pieces of legislation.

Institutional setting and market structure

117. The Italian securities market, as other European markets, is a bank dominated industry. In 2003, there were 710 banks and 131 investment firms, mostly controlled by Italian banks and Italian financial groups, authorized to carry out investment services from the reception and transmission of orders to dealing on their own account and providing underwriting services.25 Additionally 153 asset management companies, mostly controlled by Italian banks, and 1556 CIS were registered, including open-end mutual funds, close-end private equity funds, closed-end real estate funds and hedge funds, with a total of €403.722 million assets under management.26

118. In 2003, three market operators were authorized to manage regulated markets: the Borsa Italiana Spa (the Italian Stock Exchange), which is mostly owned by Italian banks, MTS SpA, whose control has recently been transferred to Euronext and Borsa Italiana27 and Tlx SpA, which is fully owned by Italian banks.

119. The Italian Stock Exchange, which had 128 members in 2003, manages the following markets: three regulated equity markets (MTA, Mercato Expandi and MTAX, which replaced the segment previously known as Nuovo Mercato); one market for funds (MTF); a derivative market (IDEM); a securitized derivatives market (SeDex) and two fixed-income markets (MOT for government securities and corporate bonds and EUROMOT, for Eurobonds and Asset Backed securities). In 2003, the Italian Stock Exchange had a total market capitalization of €488 million, €475 million corresponding to the MTA market, with 219 Italian companies listed. A total of €12,524 million in equity were issued (9,868 from IPO’s) in that market in 2003. In 2003 total turnover for the MOT market was €142 billion, €133 billion corresponding to government bonds. Total turnover for EUROMOT market was €4 billion.28

120. MTS manages the wholesale government bonds market (MTS), a multidealer to client Internet-based government bond wholesale market (BondVision) and MTS Corporate wholesale (dealing on corporate bonds, ABS and quasi-government bonds). In 2003 turnover for the MTS/cash segment market was €2,136 billion and of €12,464 billion for the MTS/repo segment. Turnover in the BondVision was €149 billion.29

121. Tlx manages the TLX market where corporate bonds, Italian and EU government bonds and funds and equity linked securities are traded. In 2003 total turnover was €2 billion.30

122. Both the central depository (Monte Titoli) and the clearing house (Cassa di Compensazione e Garanzia SpA) are mostly owned by the Italian Stock Exchange.

Description of the regulatory structure

123. The 1998 Consolidated Law of Financial Intermediation (Consolidated Law) sets out the institutional framework for the regulation and supervision of the Italian securities market. Under this Law, Consob has responsibility for market efficiency and transparency, proper conduct of business by intermediaries and investor’s protection, while BI is responsible for prudential supervision and financial stability of intermediaries. It also has direct responsibility for the supervision of wholesale markets in government securities, although Consob is responsible for the regulation and supervision of market abuse in that market.

124. The main provisions governing Consob are set out in Law 216/1974 as amended in the Consolidated Law. BI’s organization and competences are comprised in different legal sources: its bylaws ratified by Royal Decree 1067/1936 as amended, the Consolidated Law on Banking (Legislative Decree 385/1993 Consolidated Law on Banking) and the Consolidated Law. The Consolidated Law was recently amended by Law no. 62/2005, which implemented the Market Abuse Directive.31 Most of the changes needed to transpose the European Directives into the Italian legal framework have already been introduced; however, some are still needed to harmonize it with the Prospectus Directive.32

General preconditions

125. The IOSCO Principles list a number of preconditions to effective securities regulation. These include the appropriateness of legal, tax and accounting framework within which the securities market operate, the effectiveness of procedures for the efficient resolution of problems in the securities market, and the soundness of macroeconomic policies (those aspects that could affect the operations of the securities market). These preconditions appear to be in place in Italy.

Main findings

Principles related to the regulator

126. Two autonomous agencies, Consob and BI, share the responsibility for the regulation and supervision of the Italian securities market. Since 1997 there has been a protocol governing the terms of their cooperation, which was recently made public. Both agencies have been given broad powers to carry out their mandates and seem to be exercising them in an adequate manner. Although Consob’s budget is funded partly by the state budget and has a legal ceiling on its staff number, at this time both BI and Consob seem to operate within an appropriate budget and sufficient resources. Liability of Consob’s staff is limited to cases of serious/gross negligence, fraud, deceit or willful wrong. There is no specific law offering legal protection to BI staff and its officers against the possibility of legal action resulted from actions adopted in good faith in the exercise of their supervisory functions. Both agencies are subject to accountability provisions, including, annual reporting, judicial review, and conduct rules.

Principles of self regulation

127. There are no self-regulatory organizations in the Italian securities market.

Principles related to compliance and enforcement

128. Consob and BI have all the necessary powers to carry out investigations and inspections and have done so on a regular basis. However, the Italian supervisory approach toward market and market operators has relied on different mechanisms such as direct access to the trading systems, reporting obligations on market operators and visits to market operators, but it does not include on site inspections as a routine tool of supervision. Consob conducts real time surveillance of the regulated markets it authorizes, while BI conducts it for the government bonds wholesale market.

129. Both agencies also have broad powers to enforce securities provisions in the area of their competence. These include precautionary and remedial measures as well as the imposition of administrative sanctions.

Principles related to information sharing

130. The Consolidated Law requires Consob and BI to cooperate effectively, both at the internal and external level. No external approval is needed to exchange information with foreign counterparties and both agencies are legally empowered to use their powers at the request of foreign counterparties. There is no limitation with respect to the provision of unsolicited assistance. Internally, Consob has signed protocols with BI and the anti—money laundering authority. Externally, Consob is signatory of both CESR and IOSCO’s MOU and BI is signatory of CESR MOU. Both authorities have signed bilateral MOUs. Moreover, due to the agreement between the Italian and the French Central Counterparties Consob and BI have jointly signed an MOU with the French authorities competent for clearing and settlement.

Principles related to issuers

131. 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 also mandatory. However, 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. There are equal treatment provisions in place, including mandatory tender offers in certain circumstances.

132. 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. In addition, Consob can request disclosure of additional information and ask issuers to restate their financial statements. In case the issuer does not comply with Consob’s request, Consob can sue the issuer before the Civil Court.

Principles related to collective investment schemes

133. Regulation of collective investment schemes is well developed. Both the asset manager and the CISs are subject to licensing. The criteria for licensing asset management companies (AMCs) include capital adequacy, as well as integrity and experience requirements for control functions and adequacy requirements for management procedures. AMCs are subject to periodic reporting. CISs are subject to similar information requirements as issuers: mandatory prospectus, as well as periodic and material events disclosure requirements. There are rules in place to deal with 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

134. Investment firms are subject to licensing based on the fulfillment of a set of requirements that include capital adequacy, as well as the adequacy of internal controls and management systems. They are also subject to market conduct rules. 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

135. Secondary markets are subject to licensing based on the fulfillment of a set of criteria that include capital adequacy, integrity and experience requirements for control functions and conformity of its rules with community law. Regulations are in place that promote the transparency of trading and also which aim to ensure proper management of large exposures, default risks, and market disruption. The Italian supervisory approach toward market and market operators has relied on different mechanisms such as direct access to the trading systems, reporting obligations on market operators and visits to market operators, but it does not include on site inspections as a routine tool of supervision. Consob conducts real time surveillance of the regulated markets it authorizes, while BI conducts it for the government bonds wholesale market.

Table 10.

Actions to Improve Implementation of the IOSCO Objectives and Principles of Securities Regulation

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This was addressed by the Savings Law.

Authorities’ response to the assessment

136. BI and CONSOB contend that Principles 10 and 26 have been fully implemented.

137. They consider that, so far, planning routine on site inspections on the market operator on an annual basis has not been necessary to ensure effective supervision of markets and market operators. Both Consob—for all markets—and BI—for the wholesale government bonds market—have direct access to the information on the trading systems, which is complemented by the periodic information that market operators have to send to them, and that includes annual accounts, as well as an annual report on internal control issues.

138. In the view of Consob and BI, IOSCO Principle 8, as specified by the Methodology Key question 3), requires that the regulator is able to perform “surveillance” on the markets (which is defined under Principle 25) and leaves it to the regulator to decide which mix of supervisory tools should be used. IOSCO Principles (see Principle 26) do not require that on-site inspections of market operators be included in an annual plan of supervision (it is sufficient to have the power to perform inspections if necessary). The Principles require that mechanisms are in place (key question 1) which allow for a surveillance program of the trading or of the trading system and of the behavior of the intermediaries. Principle 28 (key Question 2) requires that the system provides (among the different methods listed) a combination which ensures the correct monitoring and detection of possible market abuse.

139. By directly supervising the trading on the market and the behavior of the market members (including through checks on their trading strategies and their positions) Consob and BI—for the wholesale government bonds markets—can identify any anomalies or inability of the market operator to maintain orderly trading on the platform. It should also be recalled that pursuant to Article 74 paragraph 3, in cases of necessity and as a matter of urgency Consob can adopt all necessary measures acting in the place of the market management company; the same powers are attributed to BI with regard to the wholesale government bonds market (Article 76, paragraph 1).

140. In addition, Consob and BI make regular use of other mechanisms for continuous monitoring, such as regular visits to market operators (twice per month) and contacts with the staff of market operators to keep informed of market’s developments; the company has also been providing the authorities with periodic reports required by the Supervisory Instructions on organizational risk management and technological infrastructure made by external auditors. Furthermore the authorities receive in advance the agenda of the board’s meetings and have the power to ask that items be included in it. Also, Consob has to approve the rules of the market.

141. However, it should be noted that following the privatization of the market operators in 1996, Consob has performed to date 2 on site inspections pursuant to Article 74 paragraph 2 of the Consolidated Law on the Italian Stock Exchange.

142. BI has statutory powers to conduct on-site inspections on the operators of wholesale markets on government bonds. Inspections will be carried out, as necessary, based on a methodology that has been recently adopted and is applicable also to other market infrastructures. This methodology aims at integrating the information received with an appraisal of the reliability and effectiveness of organizational structure, systems and procedures and internal controls.

143. Finally, the authorities consider that the system in place for the supervision of the wholesale government securities market is effective also on the issues of market manipulation and investor’s protection. Consob receives all the data on the transactions performed in this market and stores it in its database so that it can be analyzed to identify possible market abuse. In addition, Consob conducts real time monitoring of the retail market for government securities, which constitutes an additional input fur the purposes of detecting problems in price formation in the government bonds market.

Summary Assessment of the Observance of Monte Titoli of the CPSS/IOSCO Recommendations for Securities Settlement Systems

General

144. This assessment of the Italian securities clearing and settlement systems was undertaken in the context of the IMF Financial Sector Assessment Program (FSAP) exercise for Italy in October 2004. It covers Monte Titoli (MT) and the Cassa di Compensazione e Garanzia (CC&G).

145. Prior to the mission, the Italian authorities—BI (BI) and Consob—conducted a comprehensive and very clear self-assessment. The Italian authorities were fully cooperative and all relevant documentation to fulfill the assessment of the securities settlement was provided on time and without difficulties. The mission benefited also from meetings with market participants arranged by the Italian authorities.

Scope of the assessment

146. The assessment covers MT as the central securities depository (CSD) and the securities settlement systems (SSS) for a broad range of securities, such as government bonds, corporate bonds, equities and derivatives traded in regulated markets and OTC financial instruments. The assessment also covers the CC&G, the central counterparty (CCP) in Italy, which clears both equities and bonds, as covered in the CPSS/IOSCO Recommendations for Securities Settlement Systems. Consequently, CC&G is assessed only against Recommendation 4 on CCP, which mainly deals with the cost and benefit of introducing a CCP. The Italian authorities may consider assessing CC&G against the new CPSS/IOSCO Recommendations for Central Counterparties, which cover broader aspects of CCP activities.

Institutional and market structure

147. The capital markets in Italy are well developed and diversified. In terms of capital markets capitalization, the size of the equity market was €488 billion in 2003 and the number of listed companies was 219. A total of €12,524 million in equity were issued (9,868 from IPOs) in that market in 2003. However, compared to other European equity markets and taking into account that the Italian economy is the third largest in Europe, the size and activities in the equity market are still modest. The securities debt markets are relatively large in Italy. MTS manages the government market (MTS) and a multidealer to client Internet-based government bond wholesale market (BondVision). The annual turnover of trades taking place on the MTS regulated markets for government bonds was €2,136 billion in 2003 and the figure for BondVision was €149 billion.

148. The Borsa Italiana is a private company owned mainly by the Italian banking community. It manages and organizes the trades on the regulated markets for equities, traded derivatives, government securities, corporate bonds and asset backed securities. However, the bulk of government securities are traded on the MTS, which is also a private owned company.

149. The CC&G is the Italian CCP that clears both derivatives and cash instruments. It is owned, up to 86 percent, by Borsa Italiana. The daily average number of transactions was 70.365 fo