A. Scope and Approach

1. This note presents a targeted review of selected aspects concerning the supervision of less significant banking institutions (LSIs) in Italy, as well as a review of banks’ governance. The review was carried out as part of the 2020 Italy Financial Sector Assessment Program (FSAP) and the findings and recommendations were based on the regulatory framework in place and the supervisory practices employed as of March 2019. They were also informed by insightful discussions with the Banca d’Italia (BdI) in Rome, the European Central Bank (ECB) in Frankfurt, and meetings held with banks, industry associations, audit firms, and other stakeholders and market participants in Rome and Milan during November–December 2018 and March 2019.

2. The mission focused on selected topics based on their macro-financial relevance, especially for LSIs, and on previously identified weaknesses in the Italian regulatory and supervisory framework. The main themes in relation to banking regulation and supervision included: the powers and responsibilities, independence, accountability and resourcing of the BdI; the supervisory approach and tools to assess banking risks and perform supervisory activities over LSIs; and the enforcement and sanctioning powers and practices of the BdI. This note also covers key aspects of the prudential framework, particularly in relation to capital adequacy, risk management, credit risk and problem loans, concentration risk and related party transactions, liquidity and funding risks, operational risk, and abuse of financial services. While the review of the prudential framework focused on LSIs, it also covered some regulatory and supervisory areas that are not governed by the wider EU regulatory framework such as the supervision of anti-money laundering and countering terrorism financing (AML/CFT) and related party transactions which apply to both significant banking institutions (SIs) and LSIs. The note also discusses the main recent reforms to enhance bank governance and the main future challenges and priorities, including on bank governance regulations and supervision.

3. The mission maintained close coordination with other FSAPs in the Euro Area. Many aspects of the legal and regulatory framework for LSIs in Italy are based on the European regulations and directives. Therefore, the mission built its analysis and review on the findings and recommendations of the 2018 Euro Area FSAP. It also maintained close coordination with recent and ongoing FSAPs in Euro Area countries.

4. The IMF team wishes to thank the authorities and private sector participants for their excellent cooperation. The BdI provided a partial self-assessment of compliance with the 2012 Basel Core Principles and responses to a complementary questionnaire. The ECB has also provided responses to a dedicated questionnaire. The authorities also provided examples of actual supervisory practices and assessments. The FSAP review team benefitted greatly from the inputs received and exchanges of views during meetings with supervisors, banks, industry associations and other market participants. The team would like to thank the authorities for their excellent arrangements that have greatly facilitated the work of the mission.

5. This note is structured as follows. The next two sections of this part discuss the market structure of LSIs in Italy, including a brief overview of their prudential indicators, and the institutional setting for banking regulation and supervision in Italy. The next part discusses the findings and recommendations in relation to banking regulation and supervision processes and practices, focusing on the LSI sector in Italy. The last part discusses the key features of the recent reforms to enhance banks’ governance, the main challenges and priorities ahead, and the related recommendations in this respect.

B. Market Structure

6. At the end of 2017 there were 113 banks belonging to 60 banking groups, 347 stand-alone banks and 78 branches of foreign banks operating in Italy. Eleven banking groups, holding 74 percent of the total assets of Italian banks, were classified as significant institutions (SIs) for the purposes of the European Single Supervisory Mechanism (SSM). 289 institutions were mutual banks or banche di credito cooperativo (BCC), 23 were popolari banks and the remaining banks were joint stock companies (JSC).

7. The LSI sector in Italy consists of banks with diverse legal forms but with a main focus on a traditional business model. LSIs include BCCs, popolari banks, as well as banks established as JSCs. Table 2 shows the evolution of the number of LSIs and their assets since 2015. A significant reduction in LSI numbers has been taking place over the past few years, which is mainly due to the consolidation in the sector, mainly BCCs. This consolidation has been driven by the weak situation faced by many LSIs, including BCCs. The vast majority of LSIs (95 percent in terms of the system’s assets) operate with a traditional banking business model.

^{Table 2.}

Italy: Evolution of LSIs in Number and Size

Source: Banca d’Italia.

^{Table 2.}

Italy: Evolution of LSIs in Number and Size

	Dec. 2015	Dec. 2016	Dec. 2017	Dec. 2018
Number of LSIs	472	436	386	361
- of which: BCC	365	335	289	268
LSIs’ Assets (in Euro Billion)	549	547	542	519
- of which: BCC	238	235	230	214

Source: Banca d’Italia.

View Table

^{Table 2.}

Italy: Evolution of LSIs in Number and Size

	Dec. 2015	Dec. 2016	Dec. 2017	Dec. 2018
Number of LSIs	472	436	386	361
- of which: BCC	365	335	289	268
LSIs’ Assets (in Euro Billion)	549	547	542	519
- of which: BCC	238	235	230	214

Source: Banca d’Italia.

8. The key financial and prudential indicators of the LSI sector show a number of weaknesses. These are due to the high NPL ratios and low profitability of the LSI sector. Table 3 and Figure 1 show the progress of the LSI sector’s key indicators over the last three years. While the capital ratios are well above the minimum requirements, a number of LSIs continue to have weak profitability and high NPL ratios. The more granular data show that the popolari sector has the weakest indicators relative to other LSIs, followed by mutual or BCC banks, then banks established as JSC.

^{Table 3.}

Italy: Capital and Profitability Ratios of the Italian LSI Sector

(in percent)

Source: Banca d’Italia.

^{Table 3.}

Italy: Capital and Profitability Ratios of the Italian LSI Sector

(in percent)

	2015	2016	2017	Q2–2018
CET1 Capital Ratio	15.3	16.0	16.8	16.3
Of which:
• JSC	14.3	15.5	17.5	16.9
• Popolari Banks	15.4	15.4	15.4	15.3
• BCC	16.6	16.7	16.4	16.0
ROE	1.4	1.7	1.9	5.7
Of which:
• JSC	4.7	4.6	2.3	8.7
• Popolari Banks	-3.7	0.6	2.1	-3.1
• BCC	-0.3	-0.3	1.2	3.8
ROA	0.1	0.2	0.2	0.5
Of which:
• JSC	0.5	0.4	0.3	0.8
• Popolari Banks	-0.4	0.1	0.1	-0.2
• BCC	0.0	0.0	0.1	0.3

Source: Banca d’Italia.

View Table

^{Table 3.}

Italy: Capital and Profitability Ratios of the Italian LSI Sector

(in percent)

	2015	2016	2017	Q2–2018
CET1 Capital Ratio	15.3	16.0	16.8	16.3
Of which:
• JSC	14.3	15.5	17.5	16.9
• Popolari Banks	15.4	15.4	15.4	15.3
• BCC	16.6	16.7	16.4	16.0
ROE	1.4	1.7	1.9	5.7
Of which:
• JSC	4.7	4.6	2.3	8.7
• Popolari Banks	-3.7	0.6	2.1	-3.1
• BCC	-0.3	-0.3	1.2	3.8
ROA	0.1	0.2	0.2	0.5
Of which:
• JSC	0.5	0.4	0.3	0.8
• Popolari Banks	-0.4	0.1	0.1	-0.2
• BCC	0.0	0.0	0.1	0.3

Source: Banca d’Italia.

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Asset Quality Ratio for LSIs

Citation: IMF Staff Country Reports 2020, 236; 10.5089/9781513552187.002.A001

Figures are in percentage terms and refer to loans to customers. End-2018 Figures are preliminary.Source: Banca d’Italia.

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9. A reform of the whole mutual banking sector and popolari banks has been taking place. A law was passed in 2015 to convert the largest Italian popolari banks (with total assets of more than Euro 8 billion) into JSC. Eight of the ten popolari banks above the size threshold converted into JSC while the remaining two are pending a legal review of the law. The law has also introduced some improvements in the legal framework applicable to popolari banks with total assets of less than Euro 8 billion. The reform of the BCC sector passed in 2016 envisaged that BCCs will have to join a cooperative banking group (CBG) established as a JSC. Two cooperative groups have been formed and are undergoing the process of becoming CBGs. They will be directly supervised by the ECB (one of the two is already supervised by the ECB) since they became SIs. The remaining 39 BCCs located in Alto Adige were given the option of establishing an institutional protection scheme (IPS).³ For a more thorough explanation of the reform and the two types of banking structures, see Boxes 1 and 2.

C. Institutional Setting

10. The relevant legislation, in particular the law on banking (Testo Unico Bancario or TUB) and the law on finance (Testo Unico della Finanza or TUF), establishes the competences of all the Italian financial authorities. These texts determine how the authorities exercise their powers also in the context of the European Union (EU). Furthermore, the Italian law defines the general principles for the cooperation and exchange of information among the Italian supervisory authorities as well as with other EU Member States, third countries authorities and the European Central Bank (ECB). The overall framework has been amended in recent years to implement the Directive 2013/36/UE (CRD IV) and to make the TUB consistent with the Single Supervisory Mechanism Regulation (SSMR).

11. The Italian competent authority for the banking sector is mainly the BdI. The Inter-ministerial Committee for Credit and Savings (ICCS)⁴ and the Minister for Economy and Finance also play some roles in the oversight of the banking sector. There are also other authorities responsible for the oversight of other financial sectors. These are: the Italian securities and market regulator (CONSOB), the Committee for the supervision of pension funds (COVIP), and the Institute for the Supervision of Insurance (IVASS).

12. Following the entry into force of the SSM, banking supervisory powers are split between the ECB and the National Competent Authorities (NCAs), the BdI in Italy’s case, respectively on SIs and LSIs. For what relates to licensing and acquisitions of qualifying holdings, the ECB is the competent authority for all banks: the BdI is the “entry point” of all notifications and is responsible for their first assessment, as well as for submitting to the ECB specific proposals regarding the possibility to grant authorizations or not. The NCAs plan and carry out their ongoing supervisory activities using their own resources and decision-making procedures. Additionally, NCAs perform supervision in areas that are not covered by the SSM Regulation. The ECB is entrusted with an oversight responsibility to ensure that the supervisory activities carried out by NCAs for LSI supervision are in line with high supervisory standards, also with a view to fostering consistency of supervisory outcomes within the SSM.

13. Pursuant to the TUB, the ICCS is the authority responsible for “high-level supervision”. However, this does not involve the exercise of any power of intervention in respect to banks and banking groups, given that the TUB limits the functions of the ICCS to the issuance of guidelines (following a proposal by the BdI) on transparency and consumer protection and few other topics (e.g., collection of savings by non-banking entities). When the TUB provides so, the ICCS provides guidelines that serve as a basis for the BdI detailed regulations.⁵

14. The Ministry of Economy and Finance (MEF) plays also some roles of prudential dimension. The MEF has the power to adopt decrees on the suitability requirements of major shareholders and managers (fit and proper requirements) and on some organizational aspects of CBGs. It is also vested with the power to put banks and companies belonging to banking groups into compulsory administrative liquidation, acting on a proposal by the BdI, as well as to approve the decision of the BdI to initiate the resolution of banks and companies belonging to banking groups. The MEF is also mainly involved when transparency and consumer protection issues are concerned and in case of non-banking intermediaries

A. Supervisory Objectives, Powers, Independence and Resources

Resources

25. The BdI employs an internal budgeting process that allows a good level of autonomy in setting the amount of funds needed to perform its activities. Based on a guidance given by the Senior Deputy Governor, the organizational units of the various functions, including the supervisory functions, propose a budget request for the following year. The heads of general directorates are also involved in planning staff resources by formulating their needs on a yearly and more medium-term basis to both the Human Resources Directorate and an advisory committee. These needs are evaluated and decided upon by the BdI Governing Board. The discussions with supervisors did not reveal any practical limitations on supervisory budgeting and resourcing. However, as mentioned above, the BdI statute gives the board of directors the powers to approve staffing levels and the annual budget. The BdI is in the process of moving into a three-year budgeting process which would allow a better medium-term budget visibility and planning.

Table 4.

Italy: Employed Supervisory Resources Based on Full Cost Figures

(Figures are in millions of Euros)

Source: Banca d’Italia.

Table 4.

Italy: Employed Supervisory Resources Based on Full Cost Figures

(Figures are in millions of Euros)

	2013		2014		2015		2016		2017
	SI	LSI	SI	LSI	SI	LSI	SI	LSI	SI	LSI
Offsite Supervision	14.6	68.3	9.6	59.3	19.8	70.3	21.7	62.7	21.7	62.5
Onsite Supervision	28.9	48.9	9.7	37.2	21.8	42.1	21.2	41.4	22.5	31.9
Horizontal Activities	33.8		75.0		29.8		24.1		25.6
Crisis Management	1.2		0.2		0.5		0.5		0.8
Statistics	6.4		7.1		7.5		8.1		7.5
SSM Macro-prudential tasks	n/a		3.2		5.6		6.8		8.0
TOTAL	202.2		201.2		197.4		186.5		180.5

Source: Banca d’Italia.

View Table

Table 4.

Italy: Employed Supervisory Resources Based on Full Cost Figures

(Figures are in millions of Euros)

	2013		2014		2015		2016		2017
	SI	LSI	SI	LSI	SI	LSI	SI	LSI	SI	LSI
Offsite Supervision	14.6	68.3	9.6	59.3	19.8	70.3	21.7	62.7	21.7	62.5
Onsite Supervision	28.9	48.9	9.7	37.2	21.8	42.1	21.2	41.4	22.5	31.9
Horizontal Activities	33.8		75.0		29.8		24.1		25.6
Crisis Management	1.2		0.2		0.5		0.5		0.8
Statistics	6.4		7.1		7.5		8.1		7.5
SSM Macro-prudential tasks	n/a		3.2		5.6		6.8		8.0
TOTAL	202.2		201.2		197.4		186.5		180.5

Source: Banca d’Italia.

26. Based on the full cost figures provided by the BdI, the expenditures spent on supervision of LSIs has decreased particularly in 2017. However, based on discussions with the BdI, one of the drivers mentioned behind the decrease in supervisory expenses over the last years is the consolidation taking place in the sector and the decrease in the number of LSIs. The budgetary process is mainly driven by the guidance of the governing board and the input of the various financial supervision and regulation directorates. The discussions with stakeholders during the mission did not reveal pressures on supervisory cost and budgeting either from the BdI’s BoD nor indirectly from the treasury.

27. The BdI’s supervisory activities are carried out by the Directorate General for Financial Supervision and Regulation (DGFSR) at the BdI’s Head Office in Rome and by its branch network.⁹ The DGSFR is composed of seven Directorates with the following responsibilities:

• Banking Supervision 1 Directorate: helps define supervisory interventions for the Italian or foreign banking groups in Italy subject to the direct supervision of the ECB. It monitors the technical situation and carries out supervisory interventions at non-European bank branches and at banking groups and banks that are not subject to the direct supervision of the ECB;

• Regulation and Macroprudential Analysis Directorate: draws up proposals for the Governing Board and implements strategic guidelines on regulation, international cooperation, balance sheets and statistical reporting. It also has various roles in relation to developing methods of financial analysis, produces risk analysis reports, manages the information systems of the directorate general and carries out supervisory macroprudential stress test;

• Banking Supervision 2 Directorate: monitors and carries out supervisory interventions at banks and banking groups not subject to the direct supervision of the ECB; it also coordinates the supervisory activities performed by BdI’s branches.

• Financial Supervision Directorate: supervises the non-bank financial intermediaries;

• Inspectorate Directorate: conducts inspections of banking groups and banks, non-bank financial intermediaries and the other entities subject by law to forms of control by the BdI, including inspections;

• Consumer Protection and Anti-Money Laundering Directorate: conducts verifications, for prudential purposes, concerning usury, money laundering and terrorist financing; and

• Supervisory Institutional Relation Directorate: liaises with judicial authorities, other national authorities and investigative bodies. It also monitors communications of relevance for supervisory purposes and manages the information systems of the Directorate General. It carries out tasks connected with access to the market and irregularities detected in the course of supervision. The Directorate also monitors development of financial innovation and provides the secretariat to the ICCS.

28. The DGFSR has been undergoing a reorganization since end-2018. The main changes are the following:

• Creating a new Quality Assurance Division reporting to the Director General to improve supervisory processes and promote best supervisory practices.

• Moving the SSM Coordination division from the Banking Supervision 1 Directorate to put it under the Director General, with the aim to facilitate cooperation and information sharing within the Directorate to support the participation in the SSM decision-making bodies.

• Putting 18 decentralized problem non-BCC LSIs (i.e., supervised by BdI branches) under the supervision of the Banking Supervision 2 Directorate, with the objective to guarantee that detected critical issues are rapidly reported to the appropriate level of responsibility and timely actions taken. Seven banks were moved since November 2018 and the 11 remaining banks were moved at end March 2019; the need for eventual further moves will be assessed on a semi-annual basis.

• Putting the two newly formed CBGs under the direct supervision of Banking Supervision 1 Directorate since they will become SIs.

• Establishing 11 networks of branches and mapping the 27 BdI regional branches into these networks. The networks will act as a “polo”-leader, i.e., as the reference point and main interlocutor for the affiliated branches. They will assist in defining supervisory activities with HQ and the affiliated BdI branches and they will be responsible for implementing the operational plan and monitoring its execution.

29. The BdI has maintained an overall steady level of supervisory staffing resources for the last four years. While there was a slight decrease in the staffing of some divisions particularly in the last two years, this does not seem to have impacted the supervisory resources for LSIs. The low turnover rate of two percent over the last three years is another indicator of the stability in supervisory staffing resources. The BdI sees no difficulties in attracting qualified staff since it hires only young people at basic levels and can select them, through public competitive exams, from a wide number of very qualified candidates.

30. The BdI has rules and procedures on conflict of interest and post-employment for staff. New rules on avoidance of conflict of interest for staff have been adopted in 2017. These rules aim to prevent the misuse of insider information and avoid conflict of interest arising from private financial circumstances or investments. Specific procedures were also set to manage and deal with situations of conflicts of interest. In 2015, a decree of the prime minister set rules governing post-employment restrictions for the senior management of BdI and IVASS. These rules stipulate that members of the BdI governing board and senior managers performing supervision can’t assume, directly or indirectly, partnerships, consulting or employment with regulated or supervised entities for the two years following the termination of the office or the employment. The BdI code of conduct stipulates that all staff should continue to avoid any conflict of interest that could arise from any new private or professional activities during the first year after the end of the employment relation with the Bank.

31. The BdI has enhanced the conditions for protecting its staff against the costs of defending their actions or omissions while discharging their duties in good faith. According to the Law no. 262 of 2005, the BdI and the components of its governing bodies and employees are only responsible for gross negligence and for acts committed intentionally. The BdI internal rules provide reimbursement for legal expenses incurred by the BdI’s employees but only after the conclusion of the proceeding. This was considered an unfavorable treatment based on the previous FSAP since it meant that the employees would have to personally bear the costs of defending their actions at a time when the BdI faces frequent legal challenges and the judicial proceedings may take a very long time before being concluded. As a solution, the BdI introduced changes to its internal circular allowing its employees to ask for advance payments in order to cover the costs of defending their actions.

Table 5.

Italy: Evolution of the BdI Supervisory Staffing Resources

Source: Banca d’Italia.

Table 5.

Italy: Evolution of the BdI Supervisory Staffing Resources

Directorates	2015	2016	2017	August 2018
Banking Supervision 1	122	128	135	123
Regulation and Macroprudential Analysis	89	99	99	96
Inspectorate	187	184	177	173
Financial Supervision	73	69	57	55
Banking Supervision 2	71	78	73	73
Consumer Protection and Anti-Money Laundering	49	57	65	65
Financial Supervision Coordination and External Relations	106	115	118	117
Total Head Office	697	730	724	702
Total Branches	496	500	499	491
Total Number of BdI Supervisory Staff	1,193	1,230	1,223	1,193

Source: Banca d’Italia.

View Table

Table 5.

Italy: Evolution of the BdI Supervisory Staffing Resources

Directorates	2015	2016	2017	August 2018
Banking Supervision 1	122	128	135	123
Regulation and Macroprudential Analysis	89	99	99	96
Inspectorate	187	184	177	173
Financial Supervision	73	69	57	55
Banking Supervision 2	71	78	73	73
Consumer Protection and Anti-Money Laundering	49	57	65	65
Financial Supervision Coordination and External Relations	106	115	118	117
Total Head Office	697	730	724	702
Total Branches	496	500	499	491
Total Number of BdI Supervisory Staff	1,193	1,230	1,223	1,193

Source: Banca d’Italia.

B. Supervisory Approach, Processes, and Cooperation

33. The BdI plans its supervisory activities over LSIs and allocates its resources on an annual basis according to a set of key priorities that take into account the risks to which LSIs are exposed and their weaknesses. The supervisory process is outlined in BdI circular 269 and the overall planning process is based on the ECB joint supervisory standard on supervisory planning. The planning consists in three phases: strategic planning, operational planning, and monitoring. The supervisory priorities for LSIs for 2016–2018 have identified business models and profitability, credit risk, and internal governance and risk controls as key risks. These priorities seem very relevant given the main risks Italian LSIs are exposed to. Most of these issues remain on the BdI priority list for LSI supervision in 2019.

34. The BdI applies a risk-based approach to the supervision of LSIs. While the BdI has started applying the SSM LSI SREP methodology for HP LSIs, the risk assessment framework that is being applied to non-high priority (non-HP) LSIs is highly similar to the SSM approach. The BdI risk assessment framework focuses on relevant risks and controls and provides for supervisory discretionary judgment in assigning risk scores. It is applied on solo LSIs and on LSI consolidated groups and includes the following areas of assessment: (i) business model and profitability, (ii) internal governance and risk management, (iii) capital adequacy and risks to capital, and (iv) liquidity and funding risks. The assessment of risks ranges from 1 (best) to 4 (worst) and is based on a mix of quantitative and qualitative assessments. The evaluation of net risk results from the combination of the assessment of risk exposures and indicators on one side and risk controls and mitigants on the other side.¹⁰ Supervisory judgment is applied at several phases of the assessment based on the supervisors’ perception of the risks. The indicators used to assess risks are often based on peer group analysis, which allows to differentiate between banks with different characteristics (like business models, legal structure, size, etc.).

35. The BdI has started applying the SSM SREP methodology for HP LSIs starting from SREP 2018 and will extend it to all LSIs over the coming years. The transition should be smooth given that the BdI approach is similar to SSM LSI SREP methodology in various aspects.¹¹ While the SSM LSI SREP methodology provides for a harmonized assessment of LSIs across the Euro Area, some aspects related to flexibility and local context may be foregone. However, some flexibility can be restored through a constrained and justified application of supervisory judgment. Based on that, the BdI decided to make use of its own risk assessment tools by including in its implementation of the SSM LSI SREP all the instances where the data reported and stored at national level allow additional and relevant information. The BdI believes that this will allow its supervisors to take into account national specificities and additional relevant information in the process of applying their supervisory judgment when overriding the risk scores. In addition, the SSM LSI SREP approach does not provide the proper tools and flexibility for a differentiated assessment for LSIs with specialized business models. While the relative size of these LSIs is still small, they are increasingly growing and may deserve a more adapted risk assessment methodology.

36. Proportionality is embedded in the supervisory approach of the BdI which includes a mix of offsite and onsite activities. Circular 269 classifies the LSIs in four classes of priority (very high, high, medium, and low) based on their impact and risk. Excluding the very high priority entities (which represent SIs for the ECB and other systemically important institutions based on the BdI classification), the three other categories of entities align with the ECB methodology for LSI prioritization.¹² Based on this classification, the BdI defines minimum engagement levels (MEL) for its supervisory activities setting minimum levels for frequency, scope, and granularity of control during its assessment process. The supervisory activities are laid down in operational plans or supervisory examination programmes (SEP). It is worth mentioning that some banks that have a regional presence are supervised at a decentralized level by supervisors in the BdI branches.

37. The off-site or ongoing supervisory function assesses the bank’s performance and prudential indicators. The data periodically submitted by banks (e.g., Finrep, Corep and non-harmonized reporting) represent one of the bases for prudential analysis and monitoring activities, which also benefit from other sources of information regularly reported to the BdI (e.g., those included in the central credit register data warehouse). Furthermore, the supervisory activities encompass an assessment of the financial statements and audit reports, the ICAAP and ILAAP, recovery plans, and the quarterly report (Tableau de Bord) as well as the annual report of the internal control functions. The offsite assessment takes also into account the information gathered during the meetings regularly held with the banks. This analysis aims to assess compliance with the prudential limits and requirements. It also allows to evaluate the level and evolution of the banks’ exposure to relevant risks as part of the SREP and to monitor the evolution of a set of predefined early warning indicators, in order to promptly intercept any evidence of potential banking distress.

38. The BdI has a structured process for planning onsite inspections but more integration is needed across various BdI’s supervisory functions. Onsite inspections are mainly planned based on the inputs received from the offsite assessment. The frequency of on-site inspections depends on the institution’s risk assessment and the time passed since the last inspection. However, the inspection plan is an aggregate of several components that are not always well coordinated and integrated. The inspection needs for centrally inspected institutions are defined based on an interaction between the BdI’s central offsite and onsite functions. For those institutions that are supervised by the BdI branches, the inspection plan is defined by the local branch itself under the coordination of the Inspectorate directorate. This component is then added to the overall inspection plan.¹³ A review of the inspection plan reveals cases where some decentralized institutions have not been subject to an inspection for a very long time (beyond the SEP defined in the BdI’s supervisory approach). This illustrates the need to better oversee the supervisory and inspection planning processes and frequency of onsite inspections for decentralized institutions to ensure that the BdI’s supervisory practices are well harmonized across various BdI locations and branches.¹⁴

39. The reorganization that the BdI has been implementing for its DGFSR is a step in the right direction to better oversee and coordinate the BdI branches’ supervisory practices. While the main current change is to move the decision-making functions for a set of decentralized problem banks to the central BdI supervisory functions, a more comprehensive process aiming at more harmonized supervisory practices and processes at the level of branches compared to the central functions is desirable.¹⁵ The process of organizing branches into 11 networks may help in addressing this issue but the effectiveness of this very recent step remains to be seen. The authorities could also consider the benefits of letting the BdI head office teams, on a periodic basis, perform (or assist in) some inspections traditionally done by the branches depending on the criticality of the inspection theme or the entity being inspected. This approach can further strengthen oversight over the branches’ supervision activities and foster harmonization of supervisory practices.

40. The BdI conducts various types of onsite inspections. BdI’s inspections range from full-scope inspections (particularly for small or decentralized institutions) to targeted inspections (particularly for higher priority LSIs). The BdI also performs follow-up inspections to monitor the progress in implementing corrective measures. It also conducts other types of inspections such as thematic inspections or compliance inspections (focused on compliance with AML/CFT requirements or consumer protection issues).

41. While the BdI has recently increased its targeted inspections, the use of thematic inspections and the performance of deep dives have been limited. The BdI has conducted only two thematic inspections over the last three years, one focused on consumer protection and AML/CFT and the other focused on credit risk and IT systems for cooperative banks in preparation for the establishment of the CBG. Table 6 shows the distribution of onsite inspection over the last four years.¹⁶ The level of targeted inspections focused on the BdI’s key supervisory priorities (governance, credit risk, and business models) has been very low until 2018. A higher use of thematic reviews and the performance of more targeted inspections and deep dives on the main supervisory priorities and LSI weaknesses could enhance the BdI’s inspection mix and enable it to better deal and benchmark common weaknesses and gaps in the banking sector.

^{Table 6.}

Italy: Onsite Inspections Performed / Planned by the BdI over LSIs

Source: Banca d’Italia.

^{Table 6.}

Italy: Onsite Inspections Performed / Planned by the BdI over LSIs

Year			2015	2016	2017	2018	Planned 2019
Number of inspections			105	95	72	74	46
- Full scope			92	74	58	24	19
- Targeted, Thematic, and other			13	21	14	50	27
	Of which focused on:
		■ Credit Risk	2	6	1	30	-
		■ Governance	2	4	-	3	2
		■ Operational Risk	3	-	2	4	2
		■ Consumer Protection	5	6	3	-	2
		■ AML/CFT	-	-	6	7	7
		■ Business Model and Profitability	-	-	1	-	6
		■ Others	1	5	1	6	8

Source: Banca d’Italia.

View Table

^{Table 6.}

Italy: Onsite Inspections Performed / Planned by the BdI over LSIs

Year			2015	2016	2017	2018	Planned 2019
Number of inspections			105	95	72	74	46
- Full scope			92	74	58	24	19
- Targeted, Thematic, and other			13	21	14	50	27
	Of which focused on:
		■ Credit Risk	2	6	1	30	-
		■ Governance	2	4	-	3	2
		■ Operational Risk	3	-	2	4	2
		■ Consumer Protection	5	6	3	-	2
		■ AML/CFT	-	-	6	7	7
		■ Business Model and Profitability	-	-	1	-	6
		■ Others	1	5	1	6	8

Source: Banca d’Italia.

42. While the BdI has well established onsite inspection processes, some practices can be streamlined to enhance the efficiency of onsite inspections. Onsite supervision visits are planned, and their findings are followed-up in coordination with the off-site supervision function. Pre-inspection notes are prepared before the start of inspections where onsite and offsite analysts work together to define the scope of the inspections and its main areas of focus. However, the BdI teams still perform all inspections on a surprise basis which do not allow an ex-ante interaction with inspected institutions. Such interaction could enable a better preparation ahead of inspection missions and a more efficient use of inspection time. The inspection findings are well summarized in the inspection report that is presented by the head of the mission to the management and supervisory bodies of the bank. When deemed necessary, a post-inspection letter is communicated to the bank outlining the recommendations or the measures that the bank needs to take to address the findings. The offsite supervisors follow-up on the bank’s implementation of the remedial measures. While the inspection report should be sent to the bank within 90 days of the finalization of the inspection, a review of the current practices reveals some cases where the communication of the inspection findings was longer. While this could be mainly attributed to the extensive quality review process in addition to post-mission processes and actions,¹⁷ more streamlining is possible to ensure that inspection findings are communicated, and remedial actions are set on a timely basis.

43. The BdI has signed an MoU and established cooperation mechanisms with other domestic supervisory agencies, including CONSOB. The TUF requires the BdI and CONSOB to sign a protocol of understanding to coordinate their supervisory duties and exchange information on irregularities. This protocol was signed in 2007 and was later complemented by various cooperation agreements on specific aspects. In June 2018, the BdI and CONSOB signed a master agreement to strengthen their cooperation and collaboration. Two committees were established to facilitate coordination. The first is a high-level strategic committee that met twice in 2018 discussing general supervisory issues with no specific agenda. The second is a technical committee that has a lower level composition. It met three times in 2018 and discussed various supervisory issues on LSIs and the credit cooperative reform.

44. A more operational cooperation with CONSOB and a better integration of the inputs received from such cooperation could enhance the BdI’s supervisory processes. While there are cooperation agreements and mechanisms with CONSOB, the cooperation could be enhanced, at the operational level, to ensure more frequent discussion and monitoring of bank-specific issues and concerns. In addition, the supervisory process should ensure that the inputs received from such cooperation with CONSOB are adequately incorporated in the BdI’s risk assessment of banks and supervisory activities. These enhancements could leverage on the recent revision of the general MoU and the ongoing work on the other agreements with CONSOB.

45. While the BdI’s cooperation with CONSOB could also cover the oversight of external auditors, the BdI should be given more powers related to banks’ external auditors. In fact, the BdI does not have the power to reject or rescind the appointment of banks’ external auditors. As an interim measure to make up for this gap, the cooperation with CONSOB on this aspect could be useful. Such enhanced cooperation could allow the BdI to get more information about CONSOB’s assessment and views of banks’ external auditors, which would be useful for the BdI in determining the extent of reliance on the work of the respective external auditors. In addition, this cooperation could enable the BdI to give CONSOB feedback about any gaps related to a bank’s external auditor’s work, which would help in taking actions against that external auditor by CONSOB. However, a more effective and legally robust solution would entail granting the BdI powers to reject or rescind banks’ external auditors or to request such rejection or rescindment from CONSOB.

46. On the other hand, the cooperation between the BdI and banks’ external auditors is still very general and does not rise to an operational level to discuss bank-specific issues. The BdI meets, at least twice a year, with the representatives of the Italian external auditors’ association (Assirevi) to discuss the current accounting issues and their prudential implications and to ensure the consistent application of the accounting and disclosure standards in banks’ financial statements. However, the BdI does not meet with external auditors to discuss bank-specific issues and concerns. This could be a useful tool to better inform the BdI’s about banks’ risks and weaknesses. This is currently not permitted by the TUB due to professional secrecy requirements, but the authorities are currently working on addressing this constraint.

C. Corrective Actions and Sanctions

49. The corrective and sanctioning powers of BdI have been significantly enhanced following the transposition of the CRD IV in the national legal framework. This has helped address many deficiencies found in the BCP assessment during the previous FSAP. Some of the main improvements are the following:

• The ability to sanction not only natural persons but supervised entities as well.

• The application of both pecuniary and non-pecuniary measures compared with the ability to apply only pecuniary measures previously.

• The increase in pecuniary penalties that can be applied to supervised entities from Euro 30,000 up to ten percent of the entity’s total annual turnover, and for natural persons from Euro 5,000 up to five million. As alternative to fines, the BdI can impose cease and desist orders on supervised entities or a temporary ban from exercising managerial functions in supervised entities for up to three years.

• The power to remove one or more board members of banks (including the general director) or the collective removal of a bank’s board members.

50. The BdI can impose or require the supervised entity, whether it is an LSI or companies belonging to LSI banking groups, to take a series of corrective measures to ensure the sound and prudent management of the entity or the group. These measures include stricter prudential measures (including capital add-ons), ban on conducting specific operations, restrictions on dividend payment and remuneration, as well as the removal of one or more members of the management or control bodies of an institution. In addition, the BdI can apply early intervention measures in case of current or prospective infringement of prudential requirements. These can include the activation of one or more arrangements of a bank’s recovery plan, debt restructuring, or implementing changes to the business models or legal / operational structure.

51. The BdI can apply more severe corrective measures but the power to withdraw a banking license remains, at least in theory and in some cases, limited. The BdI has the power to appoint temporary or special administrators and an oversight committee to replace the management or control body of the supervised entity. The appointment of special administrators is for one year, but their term can be renewed, if needed. The power to withdraw banking licenses is vested exclusively in the ECB for SIs as well as LSIs. The ECB can exercise this right if: (i) the conditions for granting the banking license are no longer fulfilled; (ii) the banking license was obtained through false statements; (iii) the bank has not made use of the license within 6 months; or (iv) the bank has been put into a liquidation procedure (compulsory administrative liquidation) upon the BdI proposal. There is a limitation to BdI’s powers in this latter case since article 80 of the TUB empowers the MEF, based on a proposal from the BdI, to issue a decree ordering the compulsory administrative liquidation of a bank.

52. The BdI’s guide to supervisory activities (Circular 269) provides criteria and procedures for preventive and corrective actions that the BdI supervisors apply with flexibility and judgment depending on each case. Usually, the imposition of corrective measures is the result of negative SREP results (score of 3 or 4), critical onsite inspection findings, or other situations where the bank is in a deteriorating condition that reaches or is likely to reach levels that may require early intervention measures, mainly in relation to capital, liquidity, credit quality and profitability. There is an increased interaction with the ECB for problematic bank situations. For this purpose, a financial deterioration reporting was set by the ECB whereby institutions that breach a fixed set of thresholds based on key solvency and performance indicators are being followed up and discussed more closely with the ECB.

53. The BdI can address weaknesses and problems in banks by using a mix of both moral suasion and formal corrective actions. The first course of action is to have an informal dialogue with the credit institution to address the problems and use of strong moral suasion in order to push the bank to autonomously address its weaknesses in a prompt and efficient way. The second is to take formal corrective supervisory measures which are decided upon by the BdI governing board although very few measures, involving a low degree of discretion, may be delegated to lower levels. There is also consultation with the ECB on the courses of action to adopt for problem banks, particularly those that are reported as “in financial deterioration” based on the ECB triggers. This also happens in the context of ex-ante notifications by NCAs on material supervisory procedures and draft decisions regarding HP LSIs, in line with the SSM framework regulation and the supervisory manual.

54. The BdI’s approach to weak and problem banks has been relying on exploring all the possible moral suasion efforts and other informal supervisory measures to address the situation before proceeding into stronger interventions. The BdI has also resorted to stronger corrective measures in selected cases but the escalation of these measures takes some time, since the BdI evaluates the implications associated with taking and escalating corrective measures particularly in the current context where contagion and reputational risks are very high. The BdI’s preference to date was to resort to market solutions (such as mergers, new shareholders, etc.) to address the situation of banks with persistent weaknesses. Going forward, with the bolstering of the banking system in recent years, the BdI’s approach to problem banks should consider more decisive and timelier escalation of corrective measures to address banks with structural weaknesses and persistent deterioration (e.g., in relation to capital levels, operational efficiency, governance) so that weaknesses do not persist or even become exacerbated if not dealt with in a timely manner.

D. Capital Adequacy

56. Capital requirements are based on the EU prudential framework. The requirements established by the CRR for calculating capital requirements, the qualifying components of capital, and the deductions from own funds apply equally to the LSI sector. Since 2015, the BdI formulates a formal capital decision for each LSI indicating: (i) the Total SREP Capital Requirements (TSCR) ratio that includes Pillar 1 (P1) and Pillar 2 Requirements (P2R) and has to be met at all times; (ii) the Overall Capital Ratio (OCR), that includes P1, P2R and the capital conservation buffer;¹⁹ and (iii) in case needed a Total Capital Demand, that is equal to the sum of OCR and Pillar 2 Guidance (P2G), where the latter is a non-legally binding requirement which, if not met, does not entail specific intervention measures.

57. The compliance of the EU legislation with the Basel capital framework has been assessed as “materially non-compliant” by the Basel Committee under its RCAP in 2014. The EU framework was found “compliant” in terms of scope of application, transitional arrangements, capital buffers, internal models approach for market risk, operational risk, supervisory review process and disclosure requirements. It was rated “largely compliant” for definition of capital, standardized approach for credit risk, securitization framework, and the standardized approach for market risk. But deviations were observed as explained below. A “materially non-compliant” rating was assigned for the IRB approach for credit risk and a “non-compliant” rating was assigned for the counterparty credit risk framework (calculation of the CVA capital charge).

58. While some deviations highlighted in the Basel RCAP may be less material for Italian LSIs, others are quite relevant. Some material deviations found in the IRB approach to credit risk is not relevant to Italian LSIs since—apart in one case—they all apply the standardized approach. However, other deviations could also be very relevant for Italian LSIs such as the concessionary risk weight extended to SME exposures,²⁰ the treatment of residential mortgage loans, and the concessions from the CET1 criteria for mutually-owned institutions that go beyond the permissible flexibility under the Basel standard.

59. The BdI applies pillar 2 capital add-ons as part of the SREP capital decision process. The frequency of capital decisions depends on the prioritization level of each institution (at least every year for high priority; two years for medium priority; three years for low priority). The starting point for the capital decision is the capital needs provided by each institution’s ICAAP. If these estimates are not deemed reliable, they are replaced by supervisory proxies.

60. The determination of the P2R add-on is also related to the overall SREP score of the institution. Circular 269 describes the methodology for the determination of the P2R add-on. The starting point for quantifying P2R is to challenge the ICAAP reports through supervisory proxies. In addition, supervisory discretion is applied depending on the overall risk profile of the institution. . The composition of P2R is usually consistent with P1 requirements,²¹ but the BdI can require that P2R be composed solely of CET1 depending on the situation of the institution.

61. The use of supervisory proxies which involve thorough supervisory judgement in applying P2R could be enhanced by introducing more guidance and consistency checks in the application of these proxies. The BdI supervisors have a detailed process for reviewing banks’ ICAAPs and comparing them with their own supervisory tools and proxies to determine P2R. However, supervisory proxies involve a range of add-ons that are applied based on an extensive use of supervisory judgment. While this is a sound approach, the choice of the proper add-on could be subject to additional criteria and ex-ante checks to ensure better consistency and horizontal benchmarking in applying P2R across LSIs. It is also important to ensure that P2R is calculated in a way that takes into account a forward-looking perspective of banks’ situations, including governance, business model, and asset quality.

E. Credit Risk, Problem Assets and Provisioning²²

63. The regulations issued by the BdI include thorough requirements about credit risk management policies and processes. Circular 285 requires banks and banking groups to comply with specific requirements on the measurement, monitoring, management, and reporting of credit risk. These requirements establish the tasks and responsibilities of the banks’ governing bodies in defining and approving the banks’ risk appetite and profile, determining credit and counterparty risk strategy and policies, and managing these risks. They also require banks’ risk management functions to monitor and control banks’ credit risk exposures and ensure that they remain within the risk policies and the operating limits set out by the banks’ board of directors.

64. Supervision of credit risk continues to be one of the key supervisory priorities of the BdI. The BdI has recently increased its onsite inspections targeted over credit risk, in addition to the full scope inspections where credit risk is also a main focus. In addition to assessing banks’ credit risk management and compliance with the related regulations and guidelines, the BdI’s inspectors perform quantitative assessment to assess the credit risk profile of the bank. In this regard, the BdI inspectors assess a sample of the bank’s credit portfolio to check if a bank’s classification and valuation are in line with the applicable requirements and submit to the bank a list of loans containing the revised classification assessment and provision adjustment, which the bank usually takes on board. Offsite supervisors also monitor closely the credit risk indicators of banks in the context of the SREP process. They are supported by a wide set of information processed with specific IT tools as well as granular data through the Central Credit Register, which allows for cross comparisons between banks’ valuations. Specific reviews are performed when needed to do some preliminary assessment of NPL classification and provisioning issues, which are then discussed with banks to identify the appropriate course of action.

65. The BdI teams have been also thoroughly engaged in the IFRS 9 implementation process by Italian banks and LSIs. The BdI held meetings with banks, audit firms, and CONSOB to monitor the process of IFRS 9 implementation. The BdI supervisors have been also actively participating in initiatives carried out by the SSM and the EBA in the context of IFRS 9 implementation. The BdI has also extended the EBA and SSM exercises to an additional sample of LSIs in the first half of 2017. The BdI has been collecting data in 2018 on the actual impact of IFRS 9 on the entire Italian banking system. Preliminary BdI estimates in 2018 showed an average reduction of 131 bps in the CET1 ratio (without considering the impact of the transitional arrangements provided in the EU regulation).

66. The regulations and requirements covering loan classification and provisioning generally follow EU regulations or the BdI’s own regulations and circulars. BdI circular 285 sets in general terms the obligations of banks’ boards in determining criteria for the classification, measurement and management of non-performing exposures (NPEs). It sets general criteria for determining the recovery value of NPEs and clarifies the responsibility of the bank’s risk control function in overseeing the whole process. The definition of (NPEs is based on the EBA ITS on Supervisory Reporting (Implementing Regulation EU No 680/2014) and on the Article 178 of the CRR. The BdI has also implemented in March 2019 the EBA guidelines on credit institutions’ credit risk management practices and accounting for expected credit losses in the national regulatory framework.

67. In an effort to push banks further to reduce their high stock of NPLs, the BdI has issued in January 2018 a guidance on the management of NPLs for LSIs in Italy. The BdI guidance extended to Italian LSIs some of the supervisory expectations set out in the SSM NPL Guidance for SIs.²³ The guidance urges banks to adopt a formal strategy for optimizing NPL management by maximizing the current value of recoveries. It also asks banks to develop short and medium to long-term operational plans (of roughly 1 and 3/5 years) for managing NPLs, setting out the targets for closing out positions and the actions to attain them. The guidance also included guidelines on the governance and operational arrangements for NPL management, treatment of forbearance measures, criteria for loan classification, value adjustments and write-offs, and the valuation of real estate collateral.

68. The BdI has reviewed the NPL strategies submitted by high NPL LSIs. The BdI has established a dedicated task force to assess and review these plans for reliability and ambitiousness. Based on these plans, the NPL ratio for a sample of 47 LSIs is expected to decrease from 16.3 percent in June 2018 to 9.7 percent in December 2021. While the BdI found the targets set in the NPL strategies overall relevant, it requested some banks to amend the plans. The second round of the plan updates was scheduled for March 2019 and an annual update will take place going forward.

69. Additional powers should be granted to the BdI in relation to loan classification and provisioning requirements. The BdI does not have the power to require banks to adjust their classifications of individual assets or increase provisioning levels in line with the requirements of BCP (essential criterion 7 of CP 18). The BdI has indicated that banks usually take onboard the findings related to loan classification and provisioning in the course of the review of loan files performed by the BdI’s inspectors and supervisors. If banks do not comply, the BdI may impose a pillar 2 capital add-on.

70. The NPL guidelines issued by BdI represent a step in the right direction to promote more active NPL management by Italian LSIs, but they are not detailed enough particularly in relation to forbearance measures and processes. The BdI guidance on the management of NPLs by LSIs is concise. It urges banks to assess the financial situation of debtors when forbearance measures are being considered, adopt forbearance policies that identify the best solutions, and monitor the effectiveness of forbearance measures. While the BdI’s guidelines include references to the related SSM guidance for operational details, incorporating prescriptive expectations in the BdI guidelines would ensure a more consistent approach by banks and supervisory teams, particularly in relation to forbearance, collateral valuation, and impairment triggers. It would also be useful to enhance the BdI’s guidance on the management of NPLs by including more details on the indications for the viability and the timeline of forbearance measures and the main elements of a sound forbearance process, as outlined in the EBA guidelines on the management of non-performing and forborne exposure issued in October 2018.

F. Concentration Risk and Related Parties

73. The regulations on the management of concentration risk consist of the applicable EU regulations and directives and the EBA guidelines as well as the BdI circular 285. The requirements for concentration risk resulting from exposures to individual counterparties or groups of connected counterparties are set in the CRR. However, other types of concentration risks, e.g., in economic sectors and geographic regions, are included in the BdI circular 285, based on the provisions in the CRD IV and the EBA related guidelines.

74. The BdI regulations include few requirements on how banks should establish policies and manage concentration risk. The circular requires banks to have internal control systems that ensure the management and control of concentration risks through exposure to: (i) single counterparties and groups of counterparties; (ii) counterparties in the same industry, economic sector, or geographic region; and (iii) counterparties whose financial performance depends on the same business or exposures having common credit risk mitigation techniques. The BdI does not have explicit provisions requiring a bank’s risk management policies and processes to establish thresholds for acceptable concentrations of risk reflecting the bank’s risk profile, risk appetite, and its capital strength. The BdI circular contains instead general provisions on the need for banks to establish risk management policies and risk tolerance thresholds.

75. The BdI supervisors examine banks’ concentration risk policies and exposures. The BdI receives data on concentrated risk exposures from both SIs and LSIs which allow it to monitor and track various forms of concentration risk exposures in banks’ portfolios. In addition, the BdI onsite inspectors examine banks’ concentration risk policies and exposures as part of their targeted and full scope inspections in banks. In addition, a thorough assessment of banks’ concentration risk is made as part of the SREP based on a review of the banks’ ICAAP reports. However, the BdI supervisors still look at concentration risk as a subset of credit risk without examining other types of concentration risk.

76. The limits on exposures to single or groups of connected counterparties for LSIs are based on the CRR provisions, which are broadly but not exactly aligned with the Basel large exposure standard. As outlined in the 2018 Euro Area FSAP, some exceptions under article 400 (1) of the CRR seem to go beyond the Basel framework, such as the treatment of some off-balance sheet contingent facilities and the definition of eligible capital.²⁵ The deviation in the definition of eligible capital may be less material for Italian LSIs that rely more on Tier 1 capital. In addition, the exemptions under national discretions provided by Article 400 (2) of the CRR may not be compliant with the Basel regime. It is worth noting that Italy has adopted those discretions allowed in article 400 (2) and the discretions under article 493 of the CRR.²⁶

77. While there is no EU-wide framework regulating related party transactions and exposures, Italy has made significant progress in this aspect since the previous Italy FSAP. The regulatory framework governing related parties is not new. It entered into effect just before the previous FSAP but there was no sufficient evidence back then to assess its effective implementation in practice. While this framework represents a major improvement from the old framework that existed in 2011, there are still few gaps where the framework could be enhanced.

78. The BdI circular 263 establishes a thorough definition of a banks’ related parties. The related parties are divided into four categories: (i) officers performing administrative, management and monitoring functions in a bank; (ii) participants holding at least ten percent of the bank or who can exercise control, joint control, or significant influence over the bank; (iii) persons, other than participants, empowered to appoint members of the bank’s management or supervisory board on the basis of any concluded agreements; and (iv) companies or firms on which a bank or its subsidiary exerts control or significant influence. The regulation also defines a set of connected persons to the related party.²⁷ Any related party and its connected persons must be considered a single entity. The BdI is also empowered to identify additional related parties beyond the definition on a case by case basis. While the definition is quite extensive, it does not appear to include the directors, senior management and key staff of a bank’s affiliated companies, as required under the definition established by CP 20 EC 1. In addition, the definition may need to be reviewed in light of the reform of the BCC sector (either in the form of CBGs or IPS) to ensure that it continues to properly capture all related parties across the group.

79. The BdI circular requires banks to implement thorough procedures to avoid conflict of interest in related party transactions. These procedures empower the bank’s independent directors to oversee related party transactions. The procedure introduced additional elements such as special disclosures and reporting obligations to shareholders and to the body in charge of the control function, and implementation of internal policies on conflict of interests. Independent directors are involved in each transaction at both the preliminary stage and in the deliberative process, but their role is to issue a non-binding advice. The TUB also provides that shareholders and board members shall not take part in deliberations in which they have a conflict of interest.

80. Prudential limits have been established on individual related parties but not on all related party exposures. The TUB provides the BdI with the power to set general conditions and limits in the case of transactions with related parties and to establish specific conditions and limits when it identifies conflicts of interest in transactions with related parties. The limits differ depending on whether the related party is financial or non-financial. Exposures to each non-financial related party and its respective connected persons are limited to five percent of equity for banks’ officers and shareholders with significant influence or control powers, 7.5 percent for other shareholders, and 15 percent in all other cases. For exposures to other related parties (financial), the limit varies from five percent to 20 percent of equity on each related party and its respective connected persons. Those limits are applied at the consolidated level for banking groups. However, there is no limit applied for all the related parties of a bank. In addition, for banks that are part of a banking group, they can have, on a standalone basis, a higher 20 percent limit toward a single group of related parties irrespective of their financial or non-financial nature. Furthermore, the BdI regulation requires banks to adopt internal controls and policies to define their risk appetite regarding exposures to related parties, also in terms of the maximum amount of all related party lending deemed acceptable in relation to their own funds. Finally, the BdI has the power to impose more stringent prudential limits (including at aggregate level), and other conditions, on a case-by-case basis.

81. The BdI data and assessment show a reduction in related party exposures. An ex-post assessment was performed by the BdI focusing, among others, on the: (i) the evolution of the size and characteristics of the exposures to related parties since 2013; (ii) the respect of prudential limits; and (iii) the frequency and the characteristics of the material related party transactions. The evaluation showed that the share of related party exposures to total risk-weighted assets has decreased from 2.1 percent in March 2013 to 1.3 percent in December 2016 and that the number of exposures exceeding the prudential limit has decreased from 60 to 7. The assessment also showed that the material related transactions were concluded at market conditions in 89 percent of the cases (99 percent by size).

G. Liquidity Risk

84. Italian LSIs are subject to the EU LCR regulation which establishes the LCR as a minimum pillar 1 requirement. The EU LCR framework was subject to a RCAP review by the BCBS in 2017, which found the EU LCR framework overall largely compliant with the Basel LCR standard, but with some deviations, especially in the definition of HQLA. The treatment of certain inflows is also less stringent than under Basel LCR standard while it is the opposite for some outflows. The BdI has exercised the options and discretions available in the CRR. As per the current EU framework, Italian banks are not currently subject to a binding net stable funding ratio (NSFR).²⁸

85. The BdI regulations include very thorough liquidity risk management requirements that are usually assessed in the context of the SREP process and the ILAAP requirements. Italy has transposed the liquidity qualitative requirements listed in Article 86 of CRD IV in the BdI circular 285. As such, banks are required to formalize their policies for the governance of liquidity risk and implement an effective process for its management. They are also requested to set their liquidity risk tolerance level and identify and measure liquidity risk on a forward-looking basis. Banks are also required to define a contingency funding and recovery plan (CFRP) to address extreme negative funding conditions and identify the necessary remedial actions in case of liquidity strains.

86. Supervision of banks’ liquidity risk is performed by both offsite and onsite teams in the context of SREP. The ongoing evaluation of banks’ liquidity risk profile is based on a specific methodology defined in the BdI supervisory guide while the assessment is performed in accordance with the SSM LSI SREP Methodology for HP LSIs, and with BdI supervisory guide, for non-HP LSIs. Based on the BdI methodology, the final score attributed to the liquidity risk profile results from the combination of a quantitative analysis and of a qualitative assessment. This entails analyzing the bank’s risk exposure by using the LCR and an indicator of the stability of funding which proxies the NSFR of the Basel Committee. These indicators are complemented by additional data on funding gap, asset encumbrance, and funding structure. Then a qualitative assessment of the bank’s liquidity risk management framework is performed. A liquidity risk score is calculated after combining the qualitative and the quantitative assessment, based on which supervisory actions are determined. From an onsite perspective, banks’ liquidity is usually assessed during full-scope missions to ensure that the liquidity risk framework is fully integrated within the risk management process and covers all the elements required by the regulation.

87. In addition, a subset of Italian LSIs is required to report more frequent information on their liquidity positions and sources which are monitored and assessed by BdI supervisors. Since the global financial crisis in 2007, the BdI has requested all large and medium-sized banking groups and a selected number of small banks to report their counterbalancing capacity with a weekly frequency together with projected contractual maturities over a three-month period (monitoring frequency can be increased to daily at times of systemic or idiosyncratic stress) and detailed information about their central bank eligible assets (composition, level of encumbrance).²⁹ Data are discussed on a weekly basis with the bank; more frequent contacts are held if necessary. Starting from May 2016, the BdI also receives on a fortnightly basis further information for the most relevant Italian LSIs regarding their estimates about additional sources of liquidity, funding composition, deposit concentration, and the interbank position. These data may result in informal requirements for institutions.

88. The recent implementation of ILAAP requirements allows a more thorough assessment of banks’ liquidity risk management and exposures but more is needed to enhance this exercise and make it more useful for supervisory purposes. Since end-June 2018, Italian LSIs have started submitting their first ILAAP report in line with the EBA guidelines and the BdI regulation. The first-time assessment has focused on the extent to which banks have complied with the supervisory requirements. The experience with ILAAP reports is still nascent. Future supervisory activities should focus on how to enhance the quality and completeness of the ILAAP reports submitted by LSIs and how to enhance its use and integrate it further in the supervisory process.

H. Operational Risk

90. While the BdI regulations include thorough requirements on banks’ business continuity and information systems, the general requirements on operational risk management are rather thin. The circular 285 establishes thorough requirements on the overall risk management and the role of the management body in its supervisory function to define the risk tolerance threshold, the risk appetite framework and the risk governance policies. The circular includes an annex, a part of which is dedicated to operational risk. This annex mentions that the provisions on the governance and management of operational risk are set out in Part three, Title III of the CRR. However, the CRR includes some qualitative aspects to operational risk depending on the approach used by banks to compute the operational risk capital charge. The CRR does not include detailed operational risk management requirements for banks adopting the basic indicator approach to operational risk, which is the case for most Italian LSIs. Based on that and taking into account the developments in the international and EU regulatory framework, it would be useful to further enhance the circular 285 by including more thorough requirements in relation to the overall management of operational risk.

91. The BdI regulatory requirements include thorough requirement on banks’ business continuity plans and information systems. The BdI has developed its supervisory manual related to business continuity and disaster recovery in line with the 2017 EBA guidelines on the assessment of information and communication technology (ICT) risk. In addition, the BdI circular 285 requires banks to develop plans that contain the principles, objectives and description of the procedures for managing the business continuity of critical business processes. The circular defines the main or minimum elements of banks’ business continuity plan and sets related reporting requirements to the BdI. The BdI regulations also lay out the minimum requirements for a bank’s outsourcing policy and require that the bank’s outsourced activities be consistent with the banks’ policy.

92. The BdI offsite and onsite supervisory teams assess various elements of banks’ operational risk management frameworks. The assessment of operational risk is done in the context of the SREP. From the offsite perspective, it is based on various documents required from banks such as the annual reports on internal controls, risk management and outsourced functions, annual ICAAP reports, and the quarterly banks’ internal control function reports (Tableau de Bord). Based on the banks’ business model and the level of their exposure, supervisory interventions can be made. The onsite assessment of operational and IT risks is primarily made through the full-scope inspections since the BdI has not done recently targeted or thematic inspections focused on operational and IT risk. The BdI supervisory teams assess ICT issues by focusing on the governance of the ICT function, ICT risk management structure, and ICT risk control. The BdI teams also verify whether the ICT outsourcing arrangements made by the bank are in line with the bank’s strategy and risk tolerance.

93. The BdI resources on IT and cyber risk are very limited relative to the breadth of activities that those teams are involved in. The small team of IT supervisors are involved in policy development on ICT. They are also involved in onsite inspections for SIs as part of the SSM and for LSIs. In addition, they are involved in international activities on IT and cyber risk. The BdI supervisory team sometimes gets additional resources from the BdI IT department. The authorities indicated that the BdI IT department possesses significant IT skills and their utilization in inspection contributed in a highly valuable way to the effectiveness of the investigations. However, these resources are not always available and may not always possess the proper mix of skills usually required from IT supervisors.

94. While a large number of Italian LSIs have outsourced their IT functions to a small number of firms and providers, the BdI has not done thematic or targeted IT inspection for those providers. Given this concentration in IT outsourcing activities, inspections over the few IT providers is essential to check the ICT systems and security of those firms and ensure they do not pose significant risks to the LSI sector. The BdI has the power to inspect these firms. Such inspections would also allow the BdI to better streamline the use of its resources.

I. Financial Integrity

96. The AML legal framework has been extensively amended in 2017 to transpose the fourth AML directive. The Italian AML legal framework (AML Law) is set out in legislative decree no. 231/2007. It was amended in May 2017 by legislative decree no. 90, transposing the Directive (EU) 2015/849. The Decree has confirmed the power of the BdI to adopt implementing regulations regarding customer due diligence (CDD) requirements, record keeping obligations and internal controls. In order to verify the adequacy of the AML organizational and procedural arrangements set up by banks and their overall compliance with AML obligations, the BdI has the power to request documents, acts and any other useful information from banks, and to carry out inspections. On March 26, 2019, the Bank of Italy published the provisions on organization, procedures and controls aimed at preventing the use of supervised entities for ML/TF purposes.

97. Unità di Informazione Finanze (UIF) is Italy’s Financial Intelligence Unit, established within the BdI as an autonomous and operationally independent unit since January 2008.³⁰ The UIF carries out controls, also through inspections, to ascertain compliance with the AML provisions in relation to suspicious transaction reporting and omitted reporting, as well as communications to UIF provided by the AML Law, also relying upon collaboration with the Currency Police Special Unit of Guardia di Finanza. The UIF exercises the key functions of receiving and analyzing suspicious transaction reports (STRs) received from all obliged entities (banks, financial intermediaries, professionals, non-financial operators). The UIF conducts general inspections on subject entities to check about the adequacy of the procedures for identifying and reporting STRs.

98. Cooperation between the BdI supervisory function and UIF is mandated by the AML law and facilitated by a Memorandum of Understanding (MoU). The AML Law (article 12, para. 1) requires all the competent authorities (including supervisory authorities and the UIF), relevant administrations and bodies, the Judicial Authority and investigating bodies to jointly cooperate to identify circumstances that can help prevent the use of the financial and economic system for money laundering or terrorist financing purposes. In that aim, the BdI and UIF have signed an MoU in 2009 detailing the information sharing and cooperation arrangement. Based on this MoU, the BdI reports to the UIF suspicious transactions and other relevant findings as a result of its supervisory activities. Based on the discussions with both the BdI and the UIF, cooperation and information sharing seem to work smoothly in line with the signed MoU.

99. The BdI regulation on AML internal controls include thorough requirements and provisions pertaining to banks’ AML/CFT policies and processes. The BdI regulation requires banks to have well documented CDD processes that are communicated to all staff and fully integrated into the banks’ overall risk management. A dedicated AML function should be created and integrated within the corporate control. In addition, the BdI has invited banks, since 2015, to conduct a self-assessment exercise to identify and assess their ML/TF risks and evaluate their internal AML structure and safeguards. The AML law establishes also requirements in relation to determining politically exposed persons (PEP), getting the necessary authorizations for dealing with PEPs and monitoring the relationship with them. The BdI requires credit institutions to establish enhanced CDD procedures with respect to correspondent accounts only with non-EU respondent institutions.

100. The supervision of AML/CFT is performed by the BdI Consumer protection and AML directorate. For offsite supervision, the BdI has developed in 2016, in collaboration with the UIF, a new risk-based AML/CFT assessment model for the banking sector. This system allows BdI supervisors to conduct an AML/CFT risk assessment of the supervised entities and guide supervisory activities and interventions. This model is based on existing databases, collecting data and information stemming from supervisory reporting, as well as AML compliance findings of the supervised entities. It evaluates the adequacy of banks’ AML/CFT safeguards and produces a final score using a combined qualitative-quantitative approach.

101. The inspections of banks’ AML/CFT frameworks and risks is performed during full scope inspections or via targeted AML/CFT inspections if required by the competent off-site supervisory units. Banks are sampled on the basis of size, date of previous inspection and off-site overall risk assessment. The analysis of AML/CFT profile is based on a methodology (included in the Guide circ. 269 Part III) which is focused on the adequacy of organizational structure, procedures and internal controls of the bank. Inspections also aim at verifying compliance with the regulatory provisions. In the past three years, the BdI carried out 146 full scope inspections on LSIs and 23 targeted AML/CFT inspections, out of which 12 SIs and 11 LSIs. The number of inspections has been decreasing over the last three years but the BdI attributes this trend to the consolidation process of Italian LSIs on one hand, and to the increase in the number of inspections on other financial intermediaries, on the other hand. Nevertheless, these inspections had led to a significant number of findings and the BdI was able to apply sanctions or corrective measures over concerned institutions.

102. While the BdI has enhanced its regulations and supervisory practices on AML/CFT, further efforts are needed to better use its supervisory resources and incorporate AML/CFT findings in banks’ risk assessment. The BdI sanctions have been increased following the transposition of the fourth EU AML directive. In addition, the BdI has adopted a risk-based model to the assessment and follow-up of AML/CFT issues. However, supervisors in BdI’s branches still perform onsite assessments of AML/CFT practices in banks’ branches. The BdI believes that this approach allows it to have a better assessment of AML/CFT risks from a practical perspective. However, these inspections are performed by the branches and are in part covered by overall BdI inspection plan. While these inspections are selected using risk indicators (e.g., anomalies on the use of cash, anomalies in suspicious transaction reporting, etc.), this approach to inspection of banks’ branches do not seem to be fully in line with the move of the BdI to a risk-based approach to AML/CFT supervision, which should be based on the overall ML/TF risk assessment of the supervised entity. It would be better if these supervisory resources could be allocated to increasing the number of targeted AML/CFT inspections or to the overall inspection resources and activities that the BdI performs. In addition, the work and the findings of the AML/CFT directorate are still not well integrated in the overall supervisory process. Therefore, the BdI should consider ways to further take into account its AML/CFT findings in its supervisory assessment of banks, in the context of the SREP process.

A. Key Actions and Reforms to Enhance Banks’ Governance

104. The authorities have passed a series of reforms and regulatory actions in the last years to enhance the governance of Italian banks. These reforms aimed at enacting changes in banks that have special ownership structure, like banks that have significant or major ownership by foundations, or those that have particular legal forms, such as BCCs or popolari Banks. Some of these reforms are ongoing and have been challenging to execute. While it is still too early to assess their impact, these reforms have already created some positive changes in the current banking environment. In addition, the BdI regulations on bank governance have been significantly enhanced and raised the bar for banks’ governance practices. However, the implementation of these reforms and regulations need to be closely monitored and assessed by the authorities to ensure that they are achieving their objective of strengthening banks’ governance and capital positions.

105. Historically, banking foundations were key shareholders of Italian banks. They have been a distinctive feature of the Italian banking system and played a critical role in bank privatization in the 1990s.³¹ Following that, they became stable long-term shareholders of banks, in many cases spurring them to expand and modernize. Foundations supported the recapitalization efforts of banks after the GFC. But at the same time, foundations had a peculiar governance structure, weak internal accountability, and little oversight (especially after a 2003 Constitutional Court decision that curtailed the authority of the MEF to supervise them). They do not follow uniform accounting rules, and the appointment of their governing bodies is not always transparent.

106. New features for foundations’ investments in entities, including banks, were set in 2015. A protocol agreement was signed in April 2015 between the Association of Banking Foundations and Savings Banks (ACRI), that represents 85 associated members, and the MEF that is responsible for supervising the foundations. Based on the protocol, the foundations committed to take measures with the main aim to diversify their portfolio, limit their risks and improve their asset management strategy, and enhance some governance aspects.³² A particular aspect of this protocol is the provision that foundations should reduce their direct or indirect exposure to a single person or entity to 33 percent of their assets by 2020. This means that foundations that have a concentrated ownership in banks, for example, have to reduce their stake to be within the limits set in the protocol agreement.

107. While the role of foundations has been decreasing over the years, they still have significant shareholdings in 11 banks. Table 7 shows the distribution of the number of foundations by their ownership levels in their spun-off banks. Most of the foundations have now minority shares in banks. However, about six foundations still have control ownership. This decrease may be due on one hand to the protocol signed with the MEF and also to the move or need of some banks to increase capital which has diluted the shares owned by foundations. Based on ACRI figures, foundations now invest around 26.5 percent of their total assets in banks, which is below the 33 percent limit stipulated in the protocol agreement with the MEF. However, according to the MEF, there remains about ten foundations that are above the threshold, knowing that the deadline is in April 2020.

108. The reform of the foundations is in line with the recommendations made in the context of the previous Italy FSAP. The previous FSAP recommended that the legal framework of the foundations be revised to ensure minimum standards of transparency and financial reporting, diversified investments and caps on leverage, stronger corporate governance arrangements (such as term limit for foundation members and a cooling-off period between a political office and foundation position), and robust oversight by the MEF or a new entity over the foundation with adequate sanctioning powers. The provisions of the protocol agreement would respond to most of these recommendations, if properly implemented. However, the key remaining issue is the extent to which the MEF can enforce a protocol agreement that is based on the will of the two parties to implement it. While the MEF receives reports from foundations and monitors the progress in the implementation of the protocol, the lack of enforcement powers does not allow for proper incentives to timely implement the reform.

109. The reform of the popolari banks was also a main tool to strengthen the position of these banks (see Box 1 for the main features of this reform). The caps on ownership and the restriction on voting rights (one head one vote) weakened the governance mechanisms of the large popolari banks and impacted their ability to attract outside capital, particularly in times of stress when capital is most needed. The conversion of the largest popolari banks (i.e., with total assets of more than Euro 8 billion) into joint stock companies has eased the governance challenges faced by these banks and allowed them to tap financial markets to raise capital in a much easier way or to carry out mergers that would have been difficult to execute.

^{Table 7.}

Italy: Distribution of the Number of Foundations by Ownership Level in Their Banks

(*) The decrease in the number is due to a merger between a large and a small foundation in Northern Italy. Source: ACRI Annual Reports and Data.

^{Table 7.}

Italy: Distribution of the Number of Foundations by Ownership Level in Their Banks

			2015	2016	2017	2018
- Foundations that have no shareholdings in their spun-off banks			31	34	35	38
- Foundations that have shareholdings <50 percent			47	46	47	43
	Of which:
		Shareholdings less than 5 percent	27	30	34	33
		Shareholdings between 5 and 20 percent	10	8	5	5
		Shareholdings between 20 and 50 percent	10	8	8	5
- Foundations that have shareholdings > 50 percent			10	8	6	6
		Total Number of Foundations	88	88	88	87*

(*) The decrease in the number is due to a merger between a large and a small foundation in Northern Italy. Source: ACRI Annual Reports and Data.

View Table

^{Table 7.}

Italy: Distribution of the Number of Foundations by Ownership Level in Their Banks

			2015	2016	2017	2018
- Foundations that have no shareholdings in their spun-off banks			31	34	35	38
- Foundations that have shareholdings <50 percent			47	46	47	43
	Of which:
		Shareholdings less than 5 percent	27	30	34	33
		Shareholdings between 5 and 20 percent	10	8	5	5
		Shareholdings between 20 and 50 percent	10	8	8	5
- Foundations that have shareholdings > 50 percent			10	8	6	6
		Total Number of Foundations	88	88	88	87*

(*) The decrease in the number is due to a merger between a large and a small foundation in Northern Italy. Source: ACRI Annual Reports and Data.

110. The transformation of the BCC sector into CBGs is also another positive development that could address the current difficult situation of the sector (see Box 2 for the main features of this reform). Given their small and very local nature, the BCCs have been facing profitability issues that impacted the viability and business model of many of them. This has led to a significant consolidation of the BCC sector over the last few years (see Table 2). In addition, the caps on ownership and the restriction on voting rights also raised many governance challenges that added to their problems. The group structure would allow the BCCs to raise their efficiency levels. The cross-guarantee scheme could also act as a mechanism to allow the weakest BCCs to take timely action to change or enhance their business models or to face corrective actions by the parent.

111. In addition to the above reforms, the BdI has upgraded banks’ governance requirements and aligned them further with international standards and best practices. The BdI circular 285 was significantly upgraded in 2014 on governance-related aspects. The requirements focused on the clear allocation of tasks between the management and supervisory bodies, the balance of powers between executive and non-executive directors, the composition of the supervisory and management bodies, and the integrity and effectiveness of internal controls. Some proportionality aspects were also introduced to cater for different bank sizes and sophistication. Strict rules were included on the separation between the role of the chairperson and the CEO, the size of the board, and a minimum percentage (25 percent) of independent directors. For larger banks, three major board-level committees (remuneration, risk, and nomination) must be established and composed of non-executive directors, the majority of whom should be independent. A legislative ban was also introduced for interlocking directorships across financial sector entities.

B. Remaining Challenges and Priorities Ahead

112. A key challenge to enhancing bank governance in Italy is the current limited requirements for the fitness and propriety of banks’ major shareholders and corporate officers. As outlined earlier in this note, the power to set these fit and proper criteria rests with the MEF according to the TUB. The current criteria for corporate officers are based on a 1998 decree³³ that sets narrow requirements in relation to professional and integrity requirements. With the current decree, supervisors face challenges in enforcing reputation, time commitment, experience, and conflict of interest issues. There is another decree³⁴ for the suitability of major shareholders but the requirements are also very few, mainly related to conviction of the person, without much discussion of reputation or other integrity issues.

113. The MEF has prepared a draft decree for the fit and proper requirements of corporate officers that has been in discussion for years but has not been issued yet. The draft decree was issued for public consultation back in September 2017. The last available version of the draft decree establishes thorough fit and proper criteria for banks’ corporate officers. It establishes integrity, good repute, professional experience and competence criteria, independence requirements, time availability and limits on multiple positions. Based on the discussion with the MEF at the time of the mission, it seemed that the draft decree still had a fairly long process before being issued. It is therefore essential to accelerate the process of issuing this draft decree.

114. In addition, the authorities should consider granting the BdI the power to set fit and proper criteria for banks’ shareholders and corporate officers. The rationale for granting the MEF the powers to set these fit and proper criteria was because these are issues that can impact the personal rights of people, which could be sensitive and needs to be handled by the MEF, with the advice of the Council of State. However, these criteria have a clear prudential dimension which fall under the mandate of the BdI. In addition, the current two decrees for banks’ shareholders and corporate officers are more than 20 years old and the current process to amend one of them has been taking many years now and is not expected to be completed soon. Therefore, subjecting the setting of these criteria to a political process can hinder the ability of the BdI to timely introduce needed changes, which could have implications for financial sector stability. Granting this power to the BdI, with a possible consideration of a consultation process about significant changes in the regulations with the MEF and the Council of State if needed, could be a better option to ensure that the banking sector governance is continuously and timely enhanced in line with international standards.

115. While the BdI requirements on bank governance were upgraded, the topic remains on the list of key supervisory priorities, which signals the need for more pointed activities. Despite the governance reforms, many LSIs still face governance weaknesses (including in relation to board composition, qualifications and suitability of the significant shareholders and board members, and risk culture). This indicates the need to better enforce the governance requirements and be ready to take stronger measures in case of persistently poor governance practices. A more focused and an increased level of supervisory activities on governance may help in better informing supervisory actions. These activities could translate into more targeted inspections or thematic reviews on the governance of the LSI sector going forward.

116. The reform of the popolari banks should be fully implemented and additional supervisory actions or reforms should be explored to address weaknesses in the remaining popolari sector. The reform of the large popolari banks has been largely completed: eight of the ten popolari banks above the size threshold (total assets above Euro 8 billion) converted into JSC while, for the remaining two, a legal review by the European court of Justice is pending. In case the outcome of such review is in favor of the reform, the implementation of the reform should be completed quickly. Additional actions need to be envisaged in relation to the remaining popolari banks (i.e., the popolari banks with total assets of less than Euro 8 billion), particularly those in a weak situation. The move by some of them to pool their efforts and create synergies should be encouraged. This could be ultimately through the creation of some form of joint arrangement, such as an IPS, to benefit from mutual services or platforms and ultimately some joint liquidity support. This would help smaller popolari banks address business model weaknesses and reduce their NPLs, among other issues. However, this should be accompanied by a closer supervisory scrutiny of weak popolari banks and stronger supervisory measures for those with governance or other structural problems.

117. The reform of the BCCs through their transformation into CBGs is an innovative way to address their weaknesses, but the successful implementation of this reform could face several challenges. First, the CBGs show some specificities in their governance structure since BCCs participate in the parent and are represented in the parent’s board on one hand and they are subjected to the parent’s steering and coordination power on the other hand. While there are specific checks and balances to address conflicts resulting from this situation, implementation might prove to be difficult. Another challenge is related to the central role played by the parent and the high reliance on the parent to steer the whole group, which would require a capability of the parent to quickly gain effectiveness in its new function (which also involves a change in the mindset). In addition, any weaknesses or problems at the parent level or a lack in its ability to steer the group may impact all the BCCs in the group and could create more severe implications. Finally, the execution process is challenging, particularly the integration of IT systems and processes, the convergence into common standards and practices, and the centralization of risk management and internal control systems.

118. Given these challenges, a close supervision should be performed over the new CBGs, particularly in their first years of operations. The supervisory themes should be focused on the above-mentioned challenges to ensure that the reform is working as intended. Particular importance should be given to the governance of the parent and its ability to steer the affiliated BCCs, assess their risks, and take corrective actions vis-à-vis risky or weak BCCs. In addition, the early warning systems of the BCCs should be regularly reviewed to assess their relevance and reliability. In this respect, it may be useful to consider the merits of performing a specific set of individual-level supervisory controls on the BCCs (at least in the first years), which could also help in assessing the adequacy of the early warning system at the parent level.