THE SHARE OF OUTSTANDING LOANS BY NBFCS VIS-A-VIS THE

OUTSTANDING LOANS BY BANKS IN ITALY - FINANCIAL ASPECTS

(Term paper towards partial fulfillment of project in the subject of Corporate Finance
Law, Policy and Practice)
Submitted by Submitted to
Amritambu Satyarthi (Roll no. 811)

Anusha Nagoji (Roll no. 813)

Aratrika Chakraborty (Roll no. 814)

Diva Devarsha Srivastava (Roll no. 822)

Mohit Maheshwari (Roll no. 828)

N. S. Tanvi (Roll no. 829)
Dr. Rituparno Das
Mr. Prateek Deol
Faculty of Law and policy sciences




NATIONAL LAW UNIVERSITY, JODHPUR
OCTOBER, 2014

(Number of words: 11280)
1

CONTENT

Content .......................................................................................................................................1
Introduction ................................................................................................................................4
Italy: An Economic Overview .................................................................................................4
Commercial Banks in Italy ......................................................................................................4
STRUCTURE OF THE ITALIAN BANKING SECTOR: THE MAIN PLAYERS .................7
ITALIAN FINANCIAL SITUATION .....................................................................................7
Actions needed in the Italian Financial Sector .........................................................................8
REGULATIONS FOR NON BANKING FINANCIAL INSTITUTIONS IN ITALY ..................9
The Italian Non-Financial Sector ........................................................................................... 10
Italys New Rules to Facilitate Direct Lending ...................................................................... 10
Regulatory Changes .............................................................................................................. 11
Lending Deregulation ........................................................................................................ 11
Insurance Companies......................................................................................................... 11
Securitization SPVs ........................................................................................................... 12
Exemption from withholding tax ........................................................................................... 12
Substitutive tax on loan transfers ........................................................................................... 13
Issue of Bonds ................................................................................................................... 14
Possible Further Measures ................................................................................................. 14
2

Loans by NBFIs .................................................................................................................... 15
Banking and grant of loans in Italy ............................................................................................ 15
REGULATORY ARCHITECTURE: OVERVIEW OF BANKING REGULATORS AND KEY
REGULATIONS....................................................................................................................... 16
RECENT REGULATORY DEVELOPMENTS ........................................................................ 17
BANK GOVERNANCE AND INTERNAL CONTROLS ........................................................ 19
Distinction between control and management functions of bank ............................................ 20
Loans by banks and NBFCs .................................................................................................. 23
Regulatory Requirements for Mortgage Lending ................................................................... 24
New lending opportunities in Italy for non-bank lenders ........................................................ 26
Paving the way for lending by debt funds .......................................................................... 26
Exemption from withholding tax ....................................................................................... 27
Substitutive tax on loan transfers ....................................................................................... 28
Investing in Non-Performing Loans in Italy ........................................................................... 29
NPL portfolios ................................................................................................................... 29
A window of opportunity................................................................................................... 29
Outstanding loans in Italy .................................................................................................. 30
COMPARISON OF OUTSTANDING LOANS BY NBFCs AND BANKS .............................. 31
Reasons for rise in Non-Banking Financial lending ............................................................... 33
Distinction between loans provided by Non-Banking Financial Institutes and loans by Banks
.............................................................................................................................................. 34
3

Conclusion ................................................................................................................................ 36
BIBLIOGRAPHY ..................................................................................................................... 37



4

INTRODUCTION
ITALY: AN ECONOMIC OVERVIEW
The global financial crisis didnt spare Italy. Economic and political turmoil over recent years
has put the country and wider Eurozone at risk. The macroeconomic environment has negatively
affected the countrys public finances, with the deep recession and the complex financial
situation presenting Italian governments with a series of problems. Despite interventions from
both the Italian government and European institutions, public debt has escalated substantially in
the last five years and the situation remains critical.
During the second half of 2011, the government passed a series of three austerity plans to
balance its budget and decrease public debt:
June 2011 Italy approved the first austerity package of US$68 billion, which was meant to
reassure the international financial markets and reduce the Italian budget deficit.
September 2011 Silvio Berlusconis US$74 billion new package was approved by the Italian
Parliament to reduce the deficit.
December 2011 The Senate voted for Mario Montis austerity plan of US$39 billion, which
aimed at mitigating the debt with actions such as spending cuts, tax rises, and pension reform.
European Central Bank (ECB) intervention to help financial institutions at both the European
and the Italian level has put a lot of pressure on the country.4
By the end of 2012, Italian banks had borrowed 268 billion from the ECB. This funding may
have helped prevent Italian banks from going bust, but risks remain very high as profits remain
low and the quality of loans is still deteriorating.
COMMERCIAL BANKS IN ITALY
According to the Bank of Italy, there were 841 banks in the country at the turn of the 21st
century, one third of them being in banking groups. The statistical data demonstrates that 240
banks have been incorporated as stock-exchange-listed companies, these accounting for about
5

eighty percent of the sectors total assets, while the shares of savings banks and mutual banks are
respectively 12 percent and 4.4 percent of the assets.
1

Historically, the Italians can be proud of having the oldest bank in the world. Monte dei Paschi di
Siena (locally named Il Monte) has been a banking institution since 1472, twenty full years
before Christopher Columbus discovered America! Interestingly enough, the oldest bank in the
world was originally formed as a charity granting loans for the poor in Siena and benefiting the
citys economy. Today, the bank is a part of MPS Group (publicly traded as BIT, BMPS)
2
,
which holds the largest share of the domestic market. The bank has 32,870 officials working in
over 1,900 branches throughout Italy and in the some of the worlds biggest financial centers.
Through its subsidiaries (MPS Finance, Banca Toscana, and Antonveneta), Il Monte has
developed a wide range of banking activities, including everyday banking solutions, bank loans,
asset management, insurance and investment banking. After the acquisition of Banca
Antonveneta in 2007-2008, Monte dei Paschi di Siena became Italys third largest bank
after UniCredit and Intesa Sanpaolo.
UniCredit SpA (stock exchange symbols FWB: CRI, BIT: UCG) is the largest banking group
based in Italy (headquartered in Milan) and one of the ten largest groups in the world. UniCredit
Group started its existence in 1473, just a year after the establishment of Il Monte, as Intesa
Sanpaolo, then in 1870 it changed to Banca di Genova and subsequently to Credito Italiano
(1895). Today, the organization has 177,571 employees and a network of offices in twenty-two
countries across Europe, serving more than forty million costumers. To their individual clients,
the devoted team of UniCredit Group is proud to offer a rich variety of everyday banking
services such as current and savings accounts, credit and debit cards, consumer and mortgage
loans, online banking solutions, and insurance services, while the business clients of the bank
may choose from a set of tailored banking solutions, including investment advisory and
management, asset management, assistance on EU projects application, project financing, and
direct banking solutions. The corporate and institutional clients of UniCredit are offered risk

1
E. Polovedo, 2011, Italy approves an austerity package, The New York Times.
http://www.nytimes.com/2011/07/01/world/europe/01italy.html

2
Id.
6

management solutions, business loans, realty investment solutions, merger and acquisition
advisory, etc.
Intesa Sanpaolo Group (listed on the Italian Stock Exchange as ISP) is the second strongest
player in Italys banking sector. Headquartered in Turin, Italy, the group started its existence
after the merger of Banca Intesa and Sanpaolo IMI in 2007. ISP now has over 108,000
employees, working in a network of offices in Italy, Central and Eastern Europe, and the
Mediterranean region. Banca Intesa S.p.A. has developed its activities in four main business
areas. The banks retail banking business serves individual clients, small and medium-sized
businesses, as well as non-profit organizations, offering them a package of integrated banking
services, including investment banking and advisory, wealth management, business projects
financing and industrial loans, while the corporate division of Banca Intesa caters for the
interests of large corporations, financial institutions and institutional clients, offering them
merger and acquisition advisory, asset management, capital market and merchant banking, etc
3
.
Banca Nazionale del Lavoro is the sixth largest bank in Italy. The bank was founded in 1913 in
Rome. The structure was nationalized in 1929 and then went private again in 1998. The bank
existed independently until it was acquired by Frances BNP Paribas in 2006.
Banca Popolare di Milano, listed as PMI, is Italys second corporate bank (the first being Banca
Popolare di Lodi). Founded in 1865 in Milan, the bank has about 8,000 officials and a network in
710 branches in Italy and abroad. The groups one and a half million clients can choose among a
large selection of banking services and solutions, including online banking and everyday banking
solutions, property management and brokerage, mutual funds management, and
merchant banking.
As a whole, the banking sector in Italy has been hard hit by the global economic crisis.
According to a 2009 report of the International Monetary Fund, Ireland is the only economy in
the Eurozone that is currently doing worse than Italy.

3
BBC News, Italy senate passes Montis austerity package. http://www.bbc.co.uk/news/world-europe-16301956,
2011

7

STRUCTURE OF THE ITALIAN BANKING SECTOR: THE MAIN PLAYERS
The gap between the top 10 players in the Italian banking sector market and the remaining banks
is extremely wide. According to the European Banking Federation, Italy is home to the fourth
largest banking market in Europe (after Germany, the UK, and France) with total asset value
estimated at 4,042 billion at the end of 2011. This accounts for approximately 9% of total
European banks assets, with the main players being Unicredit, Intesa San Paolo, and Monte dei
Paschi di Siena.Italy has up to 72 foreign financial institution subsidiaries and banks among
which, two figure in the top 10 Italian banking groups. The largest entities are BNL (part of BNP
Paribas), Cariparma (part of Credit Agricole), and Deutsche Bank. Other banks usually have a
single branch representation or subsidiary, providing investment banking/corporate finance
services.
ITALIAN FINANCIAL SITUATION
Before the 1990s, the state owned more than 70% of Italys banking assets, but a wave of
privatisations changed the scene. Since 2006, the global economy has gone through three
different phases of the financial downturn: first, the subprime mortgage crisis; second, the near-
collapse of financial institutions which started with the Lehman Brothers bankruptcy; and
finally, the ongoing debt crisis.
The first phase of the crisis did not hit the Italian market thanks to its traditional commercial
banking business model. The impact on personal lines was limited, as the Italian population
doesnt have a culture of high personal debt.
However, phase two didnt follow suit. The crisis started impacting Italian financial institutions
and as a result, between 2008 and 2010, Italian banks suffered losses (devaluation and loss of
credit) equivalent to around 38 billion.
4

As the financial market worsened around Europe, Italian banks lost their credibility, accumulated
more debts, suffered downgrading by Standard & Poors, and faced increased constraints on

4
Id.
8

accessing government funds and foreign markets.
5
Moreover, the gloomy picture has been made
worse by the political instability and the scandals that hit many financial institutions.
In early 2012, the ECB started its Long-Term Refinancing Operation (LTRO), from which
Italian banks benefited around 250 billion, which was mainly used to acquire government
bonds. This arrangement seems to be temporary and not sufficient to recover from the deep crisis
that affected the Italian financial sectors. Further solutions are necessary for a long-term
stability.
ACTIONS NEEDED IN THE ITALIAN FINANCIAL SECTOR
The Bank of Italy is the central bank of the Republic of Italy and is part of the European System
of Central Banks (ESCB) and also the Eurosystem. The Bank is working to enhance Italian
financial sector efficiency and flexibility by reaching economic stability, cutting costs within the
financial institutions, increasing banks transparency, and providing less rigid financial solutions
to stimulate growth.
6

These actions are needed and seem to provide some relief to the heavily indebted financial
institutions. For example, Italian banks, as of January 2013, held circa 350 billion of Italian
debt, a number that has rocketed in the last couple of years. A slow and slight improvement in
the banking system has been registered in the past year.
Even if 2013 seemed to be slightly better, last year the top 10 Italian banks incurred financial
losses of approximately 1 billion, a figure that will present the market with a tough challenge.
7



5
ECB funding to Italian banks fall in March, Reuters. http://uk.reuters.com/, 2013 article/2013/04/08/italy-banks-
ecbidUKL5N0CV14H20130408
6
V. Proskurovska, 2012, European Banking Sector Data and facts 2012. http://www.ebf-
fbe.eu/uploads/FF2012.pdf
7
Id.
9

REGULATIONS FOR NON BANKING FINANCIAL INSTITUTIONS IN ITALY
In Italian legislation, banking activity consists in the dual task of accepting deposits and other
repayable funds from the public, and of exercising of credit. Banks accept repayable savings and
liquid funds in the form of deposits and in other forms. In keeping with European legislation,
banks can also engage in any other financial activity excluding those reserved to non-bank
entities. Thus, the Italian financial system is dominated by banks. Banks balance sheets reflect
their traditional banking model of providing loans with customer funding. The expanded ECB
monetary policy framework has also contributed to shielding Italian banks against market
shocks.
8

Part of the difficulty of assessing the impact of Non Banking Financial Institutions (NBFIs) on
financial stability is the wide range of institutions involved. The sector of NBFIs is defined as
including insurance undertakings, pension funds and other financial intermediaries (OFIs). The
latter group includes financial institutions engaged in the securitisation of assets, securities and
derivatives dealers (operating on own account) and specialised financial institutions (e.g., hedge
funds, venture capital firms, etc.).
All financial institutions and quasi-institutions which are principally engaged
in financial intermediation by incurring liabilities in forms other than currency,
deposits and/or close substitutes for deposits from institutional units other than
monetary financial institutions, or insurance technical services.
9

Sergio (1996)10 in a study of non-performing loans in Italy found evidence that, an increase in
the riskiness of loan assets is rooted in a banks lending policy adducing to relatively unselective
and inadequate assessment of sectorial prospects. Interestingly, this study refuted that business
cycle could be a primary reason for banks NPLs. It takes a different approach than the solvency
and liquidity stress tests by assessing the financial soundness of the main borrowers of the
Italian banking systemhouseholds and the non-financial corporate sectorand quantifying the

8
Italy: Financial System Stability Assessment, IMF Country Report No. 13/300, September 2013
9
Other financial intermediaries, insurance undertakings and pension funds as defined in Council Regulation (EC)
No 2223/96 will be considered in this study. Alternative definitions, if used due to data limitations, will be referred
to explicitly.
10
Sergio, M.,(1996). Non-performing bank loans: Cyclical patterns and sectoral risk. Review of Economic
Conditions in Italy.
10

potential impact from macroeconomic shocks. It relies on various sources of information,
including aggregate statistics and more granular information from household surveys and
corporate balance sheet databases.
11

THE ITALIAN NON-FINANCIAL SECTOR
In Europe, a wide range of non-bank institutions have the potential to act as direct lenders to
mid-market companies. The most obvious are insurers and pension funds, but sovereign wealth
funds and hedge funds could also be attracted to this market. European non-bank institutions
could also lend direct to larger mid-market companies without a formal credit rating, as in a US
private placement or a German Schuldschein loan. Standard & Poors launch of a service
offering creditworthiness opinions to mid-market companies is an indicator of the potential
growth in this area. The debt burden of the corporate sector is moderate, but leverage is high.
Corporate balance sheets, made fragile by the prolonged recession, are weighed down by a
historically high level of debt in relation to both value added and equity. Leverage has increased
during the crisis, though mostly reflecting a decline in the value of equity. On average, Italian
firms leverage is among the highest in the euro area. SMEs are more highly leveraged than other
firms.
ITALYS NEW RULES TO FACILITATE DIRECT LENDING
On June 24, 2014, the Italian Government adopted Law Decree no. 91 (the Decree)
12
that,
among other things, introduced various measures aimed at stimulating the Italian economy. This
memorandum outlines some of the measures contained in the Decree designed to increase the
availability of non-bank debt financing to Italian companies and lifting certain tax obstacles to
the access by non-listed companies to the international debt capital markets. Decree 91 amends
the definition of Undertaking for Collective Investment ("UCI") to include those who invest in
credit, including credit made available by utilisation of the UCIs' own assets.

11
Technical Note On The Financial Situation Of Italian Households And Non-Financial Corporations And Risks To
The Banking System, IMF Country Report No. 13/348, December 2013
12
The Decree was published in the Official Gazette on June 25, 2014, date as of which it is effective. It will have to
be converted into law by Parliament within 60 days, otherwise it will lapse on a retroactive basis. Amendments to
the Decree could be passed during the conversion process.
11

REGULATORY CHANGES
Lending Deregulation
In Italy lending activity (including issuance of guarantees) has been traditionally reserved to
banks and those financial intermediaries enrolled in a specific register held by the Bank of Italy
that are subject to regulatory and prudential provisions broadly mirroring those applicable to
banks (the 106 Intermediaries).
13

In order to facilitate Italian companies access to non-bank debt financing, the Decree expanded
the scope of the entities that are allowed to carry out lending in Italy by including Italian
insurance companies and Italian securitization vehicles (Securitization SPVs).
14

Insurance Companies
With respect to insurance companies, the Decree directly amends Art. 106 of the Italian Banking
Act in order to add a specific carve-out from the general prohibition on lending activity for any
lending (other than the issuance of guarantees) carried out by Italian insurance companies other
than to natural persons and so-called micro-enterprises.
15

The regime applicable to the abovementioned lending activity will be specified by implementing
regulations to be issued by the competent authorities. Specifically, the Italian banking regulator
(Banca dItalia) has been given authority to identify the reporting requirements applicable to
Insurance companies engaged in lending as well as the manner of their inclusion in the Italian
centralized credit risk database (Centrale dei rischi). Similarly, the Italian insurance regulator
(IVASS) has been authorized to establish limits and conditions applicable to such lending by
insurance companies in accordance with the following principles:
borrowers will be selected by a bank or a 106 Intermediary; such entities should retain a
significant economic interest in the transaction;

13
See Art. 106 and ff. of Legislative Decree No. 385 of September 1, 1993 (the Italian Banking Act)
14
Securitization SPVs are established under Art. 3 of Law No. 130 of April 30, 1999 (the Securitization Law).
15
As defined by EU Commission Recommendation 2003/361/EC
12

- the insurance company will be adequately capitalized and have an internal control and
risk management system which allows the insurance company to manage the risks
typically related to the lending activity.
Securitization SPVs
The Decree also contains provisions enabling Securitization SPVs to carry out lending in Italy,
other than vis--vis natural persons or micro-enterprises.
16

The Decree further specifies the conditions applicable to such lending by Securitization SPVs.
Like for insurance companies, banks or 106 Intermediaries must select the borrowers and retain a
significant interest in the transaction. In addition, the Decree provides that the securities issued
to finance such lending may be purchased only by qualified investors.
17
It is not clear whether
the restriction on identity of the initial purchasers also entails a restriction on re-sales to entities
other than qualified investors.
EXEMPTION FROM WITHHOLDING TAX
The new rules also include striking developments in the rules on taxation of loans to Italian
borrowers, which may have even more of an immediate effect in practice.
By way of background, Italian withholding tax is generally levied at 26% of the amount payable
by way of interest or financial remuneration, after subsequent increases from 12.5% and then
from 20% over the last few years. This rate is subject to any treaty against double taxation
between Italy and the lenders' home jurisdiction.
The good news is that Decree 91 exempts from withholding tax interest and other proceeds
having a financial nature payable in respect of medium to long term loans (i.e. loans for a term in
excess of 18 months) by Italian borrowers to (i) credit institutions based in a EU Member State,
(ii) insurers regulated under the law of a EU Member State, or (iii) UCIs which are not leveraged

16
Somewhat confusingly, instead of introducing a further carve-out in Art. 106 of the Italian Banking Act, where the
general prohibition is contained, the Decree amends the Securitization Law to provides that Securitization SPVs are
allowed to carry such lending.
17
The definition of qualified investor mirrors that of professional client provided for under the MiFID regime
and includes, among others, banks, investment firms, insurance companies, collective investment undertakings,
pension funds, broker dealers and other institutional investors as well as large corporations.
13

funds and are organised in a EU Member State or a EEA State included in the Finance Ministry's
white list.
SUBSTITUTIVE TAX ON LOAN TRANSFERS
Imposta sostitutiva is the incentive tax regime available for medium-long term loans documented
in Italy, and consists of a one-off levy payable on utilisation or availability of credit facilities, at
the rate of 0.25% of the principal amount of the facility.
It is called a "substitutive" tax because, where it is payable, the credit and security documents are
exempt from registration and other indirect taxes. The measure is beneficial for secured
transactions, which, depending on the circumstances, may trigger registration tax at 0.5% of the
amount of the secured claims for each security document, or mortgage tax in respect of land or
property charges, at 2% of the amount of the secured claims. It is a one-off tax because it will
cover subsequent amendments, restatements and adjustments to the finance documentation but,
so far, not the transfer of the lenders' rights thereunder or the contractual relationship as a whole.
However, Decree 91 provides that the regime will now also cover post-closing transfers of the
loans, as well as the related security and contract documentation. Previously, the unavailability
of imposta sostitutiva for such loan transfers had meant that the transfer of a secured loan would
trigger substantial tax burdens, in form of all the indirect taxes payable on the security interests
under the ordinary regime. This development is another important contribution to the
improvement of the liquidity of the Italian market, at a time when Italian credit institutions are
pressed to sell on their loans for supervisory capital concerns, as well as to release capacity for
fresh lending.
18

Whilst these new developments mark a significant step forwards towards a more efficient and
liquid Italian loans market, it remains to be seen how the market will react. It would appear that
opening up the loan markets to non-bank Lenders may well encourage the development of
alternative financing structures for Italian borrowers, including unitranche transactions.

18
Supra at 3
14

Issue of Bonds
19

Other measures have also been taken to encourage the issuance of bonds by non-listed
companies, and in particular private placements (non-listed bonds subscribed by qualified
investors). In fact, Article 21 of the Decree extends the application of the so-called 239
regime[1] to non-listed bonds if they are held by one or more qualified investors (as defined by
the Italian Financial Act in line with the Prospectus Directive), the listing of bonds being no
longer a requirement in order to benefit from such a favorable regime.
In addition, a blanket exemption from withholding tax will apply to private placements where the
bonds are subscribed by domestic or European investment funds or Italian securitisation vehicles
provided that the following conditions are met: (i) at least 50% of their assets are invested in
such bonds; and (ii) the units of the investment fund (or the bonds issued by the securitisation
vehicles) are fully owned by qualified investors.
Possible Further Measures
In our view there are at least three items which are missing from the described picture. The first
item is real estate investment funds, where legislation has rapidly evolved in past years, but is
still linked to views on the real estate business which are now too formal and traditional in
respect of what a post-crisis market expects.
The Italian government has in fact promised to investors that a reform on real estate funds and
the real estate market will be enacted soon. The second item relates to the granting of loans by
investment funds. As mentioned, a reference to the right of Italian closed investment funds to
grant loans is made in the Decree even though a more explicit legislative coordination would be
invaluable. In this respect, it is also worth mentioning that the financial intermediaries
regulation framework is still awaiting implementing measures. Hopefully, this will be the
occasion to coordinate the relevant legal frameworks.
Till now as we know that various financial institutions have provided loans in Italy. For instance,
ICG made its first investment in Italy by providing a mezzanine loan for acquisition finance of

19
Italy Introduces Measures To Facilitate Alternative Funding, July 07, 2014; Available at
http://www.paulhastings.com/publications-items/details/?id=b185e169-2334-6428-811c-ff00004cbded
15

Instrumentation Laboratories to support Citicorp Italia/CH Werten. Aart from that SMEs also
seem to have been turning to retail bonds to raise money. Known as mots, these bonds are well
established in Italy, where they have traded on Milans Borsa Italiana since 1994.
20

LOANS BY NBFIS
Loan assets expanded relatively significantly in 2006. Short-term loan assets expanded more
than long-term loan assets on a proportionate basis. However, this occurred more due to
valuation changes than active loan expansion activity by NBFIs. The key consequence of the
crisis on loan assets was a reduction in asset growth.
21

BANKING AND GRANT OF LOANS IN ITALY
The modern Italian banking system has its origins in the 80s. During these years, two important
innovations were introduced.
The first was the change in the attitude to banking supervision. Under the new model, Italian
authority had the power to deny authorization for the opening of banks if it deemed that a new
bank was not necessary to satisfy market needs. For the same reasons, banks did not have the
power to decide their territorial expansion independently, as the opening of new offices was also
subordinated to Bank of Italys discretionary approval. This authority to control market structure
has been repealed in the current new model.
The second innovation was the privatization of banking sector that started with the so-called
Amato law (i.e. Law 218/1990). Indeed, until then, the most important Italian banks were
directly or indirectly state controlled as it was commonly felt that that banking activity had to be
regarded as an activity of public interest.
Since the 90s the banking system has undergone significant changes, most of which have been
introduced also as a consequence of legislation of European Union (EU). The ban on banks
acquiring shareholding above given thresholds, in companies operating in the

20
Alternative Capitals Critical Role in Rebuilding Europes Economy for the Long Term, May 15, 2014; Available
at http://www.kkr.com/sites/default/files/KKR-1404-Alternative-Capital-Europe.pdf
21
Non-bank financial institutions: Assessment of their impact on the stability of the financial system, Economic
Papers 472, November 2012; Available at
http://ec.europa.eu/economy_finance/publications/economic_paper/2012/pdf/ecp472_en.pdf
16

commercial/industrial sectors, has been abolished. Today the Italian supervisory model is based
on three pillars of Basel II, and bank of Italy has made efforts to simplify the administrative
proceedings governing banking activities. In order to improve competition in the financial sector,
a ban on interlocking directorships among financial entities who are competitors have been
introduced.
Banking regulation is influenced by the directives and regulations of EU, and by the standards
adopted by the Basel Committee and the Financial Stability Board/Forum. In this context, the
Italian authorities have been favorable to the principle that the financial industry should be able
to adopt suitable self-regulation. This attitude helped the banking system absorb the first
financial crisis in 2007-08 with the Lehman Brothers insolvency.
REGULATORY ARCHITECTURE: OVERVIEW OF BANKING REGULATORS AND
KEY REGULATIONS
The fundamental source of law governing banking activity is the legislative decree No. 385/1993
(i.e the consolidated law on banking) which lays down the architecture of the system by
regulating: (i) bodies responsible for supervising and regulating banks and other entities
operating in the banking system, (ii) entities operating the banking system; (iii) provision of
banking services; and (iv) banking crisis management.
The main authorities in charge of banking regulation are the CICR (i.e. Interdepartmental
Committee for credit and savings), the ministry of economy and finance (MEF) and bank of
Italy. Just like the MEF, the CICR is also a political body which rules, after having reviewed the
bank of Italys proposals. Bank of Italy is the supervising authority for banks and other entities
operating in the banking system.
The rules implementing the provisions of the Consolidated law on banking are contained in the
CICRs resolutions, in the MEFs decrees, and in a large number of regulations issued by the
Bank of Italy. The hierarchy between such sources of laws are: the CICR resolutions and MEF
decrees must be compliant with the provisions of Consolidated law on banking, whilst bank of
Italys regulations must be compliant with all. The following is the distribution of regulatory
powers:
17

a) CICR: (i) cases where deposit taking activities do not constitute banking activities (ii)
banking services which are subject to publicity content and advertising; (iii) criteria to
be complied with when determining the amount of commission to be payable on
facilities and overdrafts; (iv) content and means of periodic communication to clients,
etc.
b) MEF: It has powers in the management of bank crises and it regulates inter alia, (i)
requirements of reputation that must be owned by the shareholders of banks and (ii)
requirements of reputation, experience and independence that must be owned by the
executives of the bank
c) Bank of Italy: on the basis of guidelines issued by the CICR, it regulates (i)
authorization proceedings for acquisition of direct and indirect shareholdings in banks,
(ii) issuance of bonds by banks, (iii) maximum amount of mortgage loans and content of
relevant contracts; (iv) capital adequacy and risk containment of banks; (v) corporate
governance, internal control systems, remuneration and incentive system of banks (vi)
operation on conflict of interest; (vii) definition of banking group, etc.

Amongst the most important regulations that have been adopted by the Bank of Italy in relation
to banks, the following can be mentioned:
Circular no. 229 of 1999 containing supervisory instructions for banks as amended
from time to time.
Circular no. 263 of 2006 containing the new provision on prudential supervision for
banks
Regulation on transparency requirements applicable to banking services
RECENT REGULATORY DEVELOPMENTS
Since 2004 Italian corporate law has contemplated three different governance and supervision
structures that stock corporations may choose from and adopt in their by-laws:
(i) The traditional Italian model, comprising a board of directors and a board of statutory auditors
(collegio sindacale) composed of independent members performing oversight functions;

18

(ii) A one tier model, consisting of a board of directors, including a management audit committee
(comitato per il controllo sulla gestione) composed of a majority of independent directors; and
(iii) A two tier model comprising a supervisory board (consiglio di sorveglianza) and a
management board.
In March 2008, the Bank of Italy issued a supervisory regulation regarding banks internal
organization and corporate governance (the New Regulation),1 which implements the general
guidelines set forth by Decree No. 200 of the Minister of Economic Affairs of August 2004 (the
Treasury Decree) on the principles to be followed by banks and other financial intermediaries
adopting governance systems alternative to the traditional one.2 In line with better regulation
standards, the New Regulation is divided into general principles and implementing guidelines.
The principles set forth the organizational and governance goals that banks are free to achieve in
the manner they choose depending on their characteristics, whilst the guidelines are intended to
facilitate the implementation of the general rules in specific areas.
The New Regulation applies to both banks and bank holding companies (capogruppo)
incorporated in Italy and sets forth the essential features that a bank or bank holding company
22

(hereinafter, collectively referred to as banks) must adopt in its corporate governance system to
ensure the sound and prudent management of the bank.
The New Regulation uses the concepts of (i) strategic supervision, (ii) management, and (iii)
control to identify the functions with which corporate bodies or their members need to be
entrusted. This approach focuses on the powers and duties that are relevant for supervisory and
corporate law purposes.
The New Regulation seeks primarily to draw a clear distinction between the control and
management functions and clearly define each of them. In particular, the New Regulation
addresses those situations where, depending on the governance system implemented in a banks
by-laws, the same (management or control) function is performed by more than one corporate

22
Bank holding companies are, in particular, responsible for the overall consistency of the corporate governance at a
group level and the creation of adequate connections between bodies, areas and functions (control functions in
particular) at the various group member companies.
19

body, or a single corporate body performs various functions. Indeed, the confusion generated by
such situations could jeopardize a banks sound and prudent management.
The principles set forth by the New Regulation are particularly relevant for the two tier
governance system (as outlined in the Italian Civil Code), in which the risk of overlaps between
the governing bodies is particularly acute.
BANK GOVERNANCE AND INTERNAL CONTROLS
According to the New Regulation, banks shall choose the corporate governance model which is
most likely to ensure the efficiency of operations and the effectiveness of controls, taking into
account the costs involved in each model. The choice should be made on the basis of a self-
assessment process, considering:
(i) The banks ownership structure and its recourse to the equity capital markets;
(ii) The banks size and the complexity of its operations;
(iii) The banks medium- and long-term strategic objectives; and, if applicable,
(iv) The organizational structure of the group to which the bank belongs.
23

Banks will have to (a) adopt, by June 30, 2009, (b) update upon the occurrence of any
significant organizational change, and (c) file, upon request, with the Bank of Italy, a corporate
governance plan,
24
. The corporate governance plan will need to be approved by the corporate
body in charge of the strategic supervision function and adopted with the favorable opinion of
the body entrusted with the control function.


23
According to the Speech, Once the rules have been issued, banks will be expected to make, in accordance with
the principle of proportionality, a detailed self-assessment to verify the compliance of their corporate governance
systems with the new rules. A suitable transition period will allow intermediaries [i.e., banks] to make any
adjustments that may prove necessary.
24
In its paper illustrating the outcome of the public consultation on the draft New Regulation (the Paper) the Bank
of Italy clarified that each bank is free to decide whether to publish in whole or in part the corporate governance plan
or classify it as confidential and deliver it only to Bank of Italy. See http://www.bancaditalia.it/
vigilanza/banche/documcons/consnorm/resoconto_040308.pdf.
20

Each banks corporate governance plan will need to detail (i) the reasons why the corporate
governance model chosen by the shareholders is the most suitable to ensure efficient
management and control, and (ii) the choices made with respect to the organizational structure of
the bank (e.g., tasks, powers and composition of the governing bodies; delegated powers;
accounting audit system; incentive and remuneration schemes; and information flows),
shareholders rights (e.g., withdrawal rights and quorums for shareholders meetings to vote on
resolutions and for challenging shareholders or board resolutions), financial structure (e.g.,
classes of shares and limits to their transfer, other equity-like securities, and segregated assets),
and procedures for handling conflicts of interest (e.g., related-party transactions, directors
obligations).
For banking groups, the plan prepared by the group parent company (capogruppo) will have to
illustrate the measures adopted to ensure the adequacy of the management and control systems
and the organizational choices made with respect to the banks belonging to the banking group.
Group holding companies will need to detail the measures in place to ensure the interaction
between the corporate bodies and functions of the various companies making up their group, in
particular as regards the control systems. Banks belonging to banking groups are exempted from
drafting a corporate governance plan if their organizational choices are reflected in the plan of
their group parent company.
25

DISTINCTION BETWEEN CONTROL AND MANAGEMENT FUNCTIONS OF BANK
The Bank of Italy has articulated a number of innovative positions with respect to the internal
corporate governance of Italian banks, in particular when they adopt the two tier governance
system. The level of detail and the prescriptive nature of the provisions concerning the internal
organization and powers of banks corporate bodies have been criticized by commentators

25
The corporate governance plan also needs to be filed at the time of (i) the establishment of a bank, and (ii) a
change of the existing corporate governance model. Mutual banks (banche di credito cooperativo) adopting the
standard by-laws prepared by their association and reviewed by the Bank of Italy will not be required to prepare a
corporate governance plan.
21

because of certain significant restrictions imposed on banks ability to fully implement the
governance systems provided for under the Italian Civil Code.
26

The New Regulation requires that, where the strategic supervision and management functions are
assigned to different bodies, the tasks and responsibilities of each body be clearly identified, with
(i) the strategic supervision body being responsible for deciding the banks strategy and
monitoring its implementation, and (ii) the management body being in charge of the banks
management.
27

Similarly, the New Regulation requires that a clear distinction be drawn between powers and
roles of the individuals within the corporate bodies to which both supervisory and management
functions are entrusted. In particular, the chairman of the board of directors is supposed to have a
key role in fostering debate within the board and ensuring an adequate balance of powers in a
manner consistent with his or her duty to organize the work of the board and guarantee that the
board members receive an adequate information flow.
The New Regulation requires that a similar function be vested in banks that adopt the two tier
model in the chairman of the body in charge of strategic supervision. If the strategic function
has been entrusted to the supervisory board, the chairman of the supervisory body must ensure a
neutral stance among the functions attributed to him or her, so as to guarantee their objective and
impartial integration (see below regarding the means to ensure neutrality).
28



26
The Bank of Italy in its Paper addresses these criticisms, stating that it has been delegated sufficient powers (by
the Italian Banking Act and Treasury Decree No. 200 of 2004) to enable it to influence, in the interest of the sound
and prudent management principle, the contents of bank by-laws, including by way of restricting the choices granted
to companies by the Civil Code.
27
In the Speech, the Governor confirmed the rationale for this provision: The supervisory board can combine and
in fact usually does combine guidance functions, typical of the shareholders meeting, strategic supervision
functions, vested in the board of directors, and control functions, characteristic of the board of auditors
28
For example, the Chairman of the Supervisory Board of Mediobanca Banca di Credito Finanziario S.p.A.,
despite being empowered by the current by-laws of the bank to participate in the meetings of the banks
Management Board (the bank adopted the two tier system in June 2007), has informally agreed with the Bank of
Italy that he would delegate such power to another member of the Supervisory Board, who is also President of the
banks Internal Audit Committee.
22

In order to implement such principles, the New Regulation requires, inter alia:
(i) That the scope of delegated powers of the members of the management body be set out in a
clear and precise fashion, especially with regard to quantitative limits, as well as the manner in
which such powers should be exercised;
(ii) That certain activities in addition to those set forth by the Italian Civil Code not be
delegated to individual members or committees (e.g., strategic guidelines and transactions,
preparation of business and financial plans and appointment of the general manager, amendment
of key internal policies, choice of the head of internal control and compliance functions);
(iii) That the simultaneous presence within a board of directors of an executive committee and
one or more chief executive officers be justified by the size and complexity of the banks
operations;
(iv) That the chairman of the board of directors and, in the two tier model, the chairman of the
management board when the supervisory board does not perform the strategic supervision
function, have a non-executive role and not be involved, even de facto, in the current business of
the company, except for exceptional circumstances, and provide a balance of power vis--vis the
CEO or other executive directors; and
(v) That the entrustment to the supervisory board of strategic supervision not lead to the
involvement of the supervisory board in the management of the bank, thus changing its nature as
a control body and limiting the independence of the management body.
29




29
The New Regulation provides for a number of measures to be included in the by-laws of banks that have adopted
the two tier system in order to ensure an adequate balance between the strategic and management functions. In
particular, the New Regulation and the Paper require that banks by-laws, among other things:
(i) clearly set out the functions of the supervisory and management boards, respectively, and exclude the possibility
of expanding such functions on a case-by-case basis, (ii) identify the nature and content of the decision-making
powers entrusted to the supervisory board, compared to the powers entrusted to the management board, and (iii) set
out the key strategic transactions in connection with which the supervisory board may formulate its guidelines to the
management board.
23

LOANS BY BANKS AND NBFCS
The laws on banking and credit matters have been brought together in Legislative Decree
385/1993, as amended, generally known as the Consolidated Law on Banking. This law
establishes principles and assigns powers; it lays down the basic rules and defines the tasks of the
credit authorities (the Interministerial Committee for Credit and Savings, the Ministry for the
Economy and Finance and the Bank of Italy). In particular, it assigns the power to issue
secondary legislation on technical matters and interventions of a prudential nature.
The laws on financial matters have been brought together in Legislative Decree 58/1998, as
amended, generally known as the Consolidated Law on Finance. Other important rules for the
organization, powers and functioning of the Bank of Italy and of other supervisory authorities are
contained in the articles 19 to 29 of the Law 262/2005 ("Measures for the protection of savings
and discipline of the financial markets").
Total bank assets in Italy stand at a relatively modest 2.6 times GDP, compared with 3.2 times in
the whole of the euro area. Italian banks generally shunned the sorts of toxic financial
instruments that brought down banks in America and Germany. And the country has not
experienced a housing bust on a par with that in Ireland or Spain.
Yet for all their sobriety, Italian banks are struggling amid a mountain of bad debts from Italian
businesses, big and small. These are rising by about 20% a year and now stand at more than 8%
of all bank loans, or almost 17% of GDP. The euro-area average is 11%, although Italy uses a
slightly stricter definition of souring loans.
The main culprit is Italys economy, which has been shrinking for more than two years. In
addition, a slow legal system makes it difficult for creditors to recover money owed to them. In
many cases banks simply keep on extending loans to firms that have no hope of repaying them.
Alberto Gallo of Royal Bank of Scotland reckons that some 30% of Italian firms owe five times
or more than their annual earnings before interest, tax, depreciation and amortisation, a ratio that
would make a private-equity firm blush
Italys bankers are also contributing to a dangerous downward spiral by withholding credit from
firms that are growing. Faced with the prospect of large write-offs, bankers are generally
24

retreating from risk. Holdings of government bonds as a portion of total assets are among the
highest in Europe. This leaves Italian banks dangerously susceptible to a sudden jump in yields
on Italian government debt.
30

Meanwhile, the number of companies saying that access to finance is their biggest problem has
been increasing over the past two years, even as it has been falling in places such as Germany.
Some members of Confcommercio, a business association, have had their overdraft limits halved
overnight. It reckons only about 10% of members applied for loans last year; only a quarter of
those applications were approved. For the economy as a whole lending to non-financial firms fell
by almost 9% over the two years to December, according to the European Central Bank (ECB).
For the minority of small Italian firms that do manage to get finance, the rates they pay are about
two percentage points higher than those charged to firms elsewhere in the euro area. That is
partly due to the risks involved in lending to firms in a sluggish economy. But it is also a
reflection of Italys dysfunctional banks, many of which also struggle to borrow money from
bond investors or in capital markets. One measure of this is the reliance on the ECBs Long-
Term Refinancing Operations (LTRO), an emergency source of funding put in place when it
seemed the euro area might break up. Fitch, a ratings agency, points out that last year Italy
overtook Spain to become the largest user of LTRO funding.
There is some hope of change. The ECBs impending inspection of the balance-sheets of banks
across the euro area is prompting some to write down bad debts and raise capital now, to avoid
humiliation. Intesa and Unicredit, Italys two biggest banks, earlier this year posted combined
losses of almost 19 billion ($25 billion) in part due to write-downs. In April they struck a deal
to pool some of their bad debts and have them managed by KKR, an American private-equity
firm
31

REGULATORY REQUIREMENTS FOR MORTGAGE LENDING
The regulatory requirements for mortgage lending promulgated by the bank of Italy and
emanating from basel II recommendations. The rules for prudential vigilance apply to the

30
GIOVANNI LEGORANO , Loans Sour for Italy's Banks, The Wall street journal, Nov. 13, 2013
31
Investing in Non-Performing Loans in Italy: latest trends and investment opportunities, available at
http://www.gop.it/doc_pubblicazioni/339_7qiu886bf6_ita.pdf
25

screening process for new loans and the procedures for monitoring existing mortgage exposures.
In particular, the rules focus on the operational limits (i.e., the loan-to-value ratio) and the
acceptance of mortgages as credit risk mitigation instruments. As in the U.S., the term real estate
mortgage loan (credito fondiario) refers to a written loan agreement securitized by a mortgage on
a real property used as collateral for borrowed funds. Such a loan enjoys privileged tax and
regulatory treatments due to the social relevance of property investments. The purpose of the
borrowed funds is to buy, build or renew a real property .In order to be classified as a real estate
mortgage, thepromissory note must contain the following provisions:
a.Maturity: The loan must have a medium- or long-term maturity (i.e., have an average duration
of more than 18 months). With residential mortgages, the amortization term is usually between
eight and 30 year.
b.Mortgage: A so-called first grade or senior mortgage is a pledge of property as collateral for
the payment of the debt. Subordinated liens may also be accepted, but the loan-to-value ratio
stated for regulatory purposeswhich defines the maximum credit amountmust be calculated
considering both the amount of the new loan to be granted and the residual amount of any
previous mortgage.
c. Loan-to-Value Ratio: As described in detail next, the maximum loan amount is set by the
Central bank as a percentage of the current market value of the real estate pledged as collateral
for the loan. Additional securities may lever the loan-to-value ratio under specific circumstances.
If these provisions are fulfilled, the mortgage loan enjoysas a medium- to long-term loana
reduced substitute tax of 0.25 percent calculated on the borrowed amount; the substitute tax
is levied in place of the ordinary, higher indirect taxes related to the cadastral (land) register and
mortgage taxes. In addition to other favorable legal standards, mortgages pledging property are
not subject to bankruptcy claw-back actions if they have been recorded at least 10 days prior to
the bankruptcy declaration of the mortgagor. Also, a mortgage holder cannot terminate the loan
26

agreement and initiate foreclosure unless the borrower fails seven times, at several points in time,
to make interest and principal payments when due under the promissory note.
32

NEW LENDING OPPORTUNITIES IN ITALY FOR NON-BANK LENDERS
The Italian government recently published long awaited legal reforms, designed to improve the
competitiveness of Italian businesses and the economy in general: Law Decree No. 91/2014 of
24 June 2014 ("Decree 91") is now in full force and effect after publication on 20 August 2014
of the conversion law No. 116 of 11 August 2014.
The reforms include some of the boldest changes seen by the Italian loan market for years, and
are expected to facilitate credit conditions and to diversify the offering from foreign investors
and non-bank lenders.
However, at this stage there remains substantial uncertainty on the wider implications of the new
measures, and it will be interesting to see how these measures will be implemented.
Paving the way for lending by debt funds
Decree 91 amends the definition of Undertaking for Collective Investment ("UCI") to include
those who invest in credit, including credit made available by utilisation of the UCIs' own assets.
This change in law dovetails with the Finance Ministry's proposed new regulation on criteria for
investment by UCIs, mandated under article 39 of Legislative Decree 24 February 1998 No. 58
(the "Finance Act"), by way of implementation in Italy of Directive 2011/61/EU (AIFMD).
UCIs are now permitted to engage in lending in Italy subject to the conditions set out in the draft
Bank of Italy Regulation on Collective Investment Schemes. Amongst other things, the new
rules require UCIs investing in credit receivables to participate in the Bank of Italy's Centrale dei
Rischi, the Bank's central credit information system, and the Bank of Italy may require the
information flow with theCentrale dei Rischi to be intermediated by a licensed bank or registered
financial institution. It is expected that, to engage in direct lending, UCIs will be required to put
in place appropriate mechanisms and models for the evaluation and managment of credit risk.

32
MASSIMO BIASIN; AND HALBERT C. SMITH, CRE EMERITUS, The Valuation of Mortgage Security by
Italian Banks
27

Certain additional limitations will also apply which we will be able to expand upon once the
results of the relevant open consultations are known. It would also appear that additional
conditions may still be enacted because certain aspects relating to how such financings will be
regulated have not yet been addressed in full.
In particular the definition of UCIs in the Finance Act does not contain any jurisdictional
limitations on where a UCI should be organised in order to be a permitted lender. As a result, the
requirements for foreign UCIs are unclear. Initial views suggest that EU UCIs authorised to lend
in their home jurisdiction are permitted to carry out this activity in Italy as well if the Alternative
Investment Fund Manager (AIFM) is passported into Italy, even though such requirement is not
expressly stated. Accordingly we recommend that until the specific rules and common practice
are established, any AIFM should engage in preliminary consultations with the Bank of Italy
before making any significant Italian loan investments.
Exemption from withholding tax
The new rules also include striking developments in the rules on taxation of loans to Italian
borrowers, which may have even more of an immediate effect in practice.
By way of background, Italian withholding tax is generally levied at 26% of the amount payable
by way of interest or financial remuneration, after subsequent increases from 12.5% and then
from 20% over the last few years. This rate is subject to any treaty against double taxation
between Italy and the lenders' home jurisdiction. As a result, in the past fronting bank and other
financial structures have been commonly used to facilitate non-Italian lenders advancing funds to
an Italian borrower in order to structure around the application of Italian withholding tax.
The good news is that Decree 91 exempts from withholding tax interest and other proceeds
having a financial nature payable in respect of medium to long term loans (i.e. loans for a term in
excess of 18 months) by Italian borrowers to
(i) credit institutions based in a EU Member State,
(ii) insurers regulated under the law of a EU Member State, or
28

(iii) UCIs which are not leveraged funds and are organised in a EU Member State or a
EEA State included in the Finance Ministry's white list.
This development should facilitate syndication and secondary market transactions, as before now
borrowers have been understandably reluctant to allow (or bear the increased costs ensuing from)
inclusion of foreign credit institutions.
33

Substitutive tax on loan transfers
Imposta sostitutiva is the incentive tax regime available for medium-long term loans documented
in Italy, and consists of a one-off levy payable on utilisation or availability of credit facilities, at
the rate of 0.25% of the principal amount of the facility.
It is called a "substitutive" tax because, where it is payable, the credit and security documents are
exempt from registration and other indirect taxes.
The measure is beneficial for secured transactions, which, depending on the circumstances, may
trigger registration tax at 0.5% of the amount of the secured claims for each security document,
or mortgage tax in respect of land or property charges, at 2% of the amount of the secured
claims.
34

It is a one-off tax because it will cover subsequent amendments, restatements and adjustments to
the finance documentation but, so far, not the transfer of the lenders' rights thereunder or the
contractual relationship as a whole.
However, Decree 91 provides that the regime will now also cover post-closing transfers of the
loans, as well as the related security and contract documentation. Previously, the unavailability
of imposta sostitutiva for such loan transfers had meant that the transfer of a secured loan would
trigger substantial tax burdens, in form of all the indirect taxes payable on the security interests
under the ordinary regime.

33
Carlo Massini, Jeffery Greenbaum and Fulvia Astolfi, Hogan Lovells ,New lending opportunities in Italy,
particularly for non-bank lenders, Italy, September 11 2014

34
Ibid
29

This development is another important contribution to the improvement of the liquidity of the
Italian market, at a time when Italian credit institutions are pressed to sell on their loans for
supervisory capital concerns, as well as to release capacity for fresh lending.
INVESTING IN NON-PERFORMING LOANS IN ITALY
NPL portfolios
Latest trends and opportunities According to the most recent data released by the Bank of Italy,
non-performing loans (NPL) in the balance sheets of Italian banks totaled around Euro 160
billion in January 2014, rising nearly by 25% compared to a year ago. The factors leading to this
increase depend mainly on the contraction of gross domestic product and in the increase of the
unemployment rate.Italian banks are now addressing the issue with more decision, due to the
upcoming asset quality reviews and stress tests operated by the European Central Bank. During a
recent speech in front of the Italian Banking Association (ABI), the Governor of the Bank of
Italy, Mr. Ignazio Visco, stressed that NPLs are still very heavy on national banks balance
sheets and it is therefore necessary an intervention on several grounds. On one hand, banks need
to continue to raise financial hedges and to allocate funds proportionally to the risk degree of the
assets owned; on the other, they need to make internal management procedures more effective or
otherwise make use of operators specialized in the recovery of problematic loans. Some of them
will have to sell at least part of their NPL portfolios to investors.
But if the large amounts of NPLs in the Italian banks balance sheets constitutes an issue for the
banks, at the same time they represent a very attractive opportunity for investors. Italian banks
have been very cautious and relatively few transactions have taken place in Italy compared to the
aggregate size of NPLs. Other European countries, notably Spain and Ireland, have been much
faster in tackling the issue. Now it seems it is Italys much awaited turn. In fact, after a calm
period of several years, more and more funds and specialized investors are now becoming active
on Italian NPL portfolios.
A window of opportunity
Due to the banks need to sell their distressed credit portfolios in order to get fresh liquidity and
comply with the banking authorities requirements, it is now possible for investors to buy NPL
30

portfolios at a fraction of their face value. Prices have been very low until now, due to the
negative evaluations of Italys economy by international investors and rating agencies. Now
prices negotiated for portfolios are going up, reflecting an improvement of Italian economys
perception. Clearly the discount rate to be applied is becoming more negotiated, as the vendors,
due to the increasing market demand, are gaining negotiating power. Still, the aggregate size of
NPL portfolios to be sold is such that the market should still remain attractive for some time.
Inviting opportunities can still be found in different categories, such as consumer loans,
corporate loans and asset-backed loans. Another category to be looked at is past-due receivables
guaranteed by the state or other governmental entities
Outstanding loans in Italy
Italian banks' bad loans started to decline as a proportion of overall lending in the first quarter of
this year, although they are still rising in absolute terms, the Bank of Italysaid on Friday.
"The deterioration in banks' loan asset quality has eased," the central bank said in its twice-yearly
Financial Stability Report.
"The flow of new bad debts as a ratio to outstanding loans stabilised in the fourth quarter of 2013
and preliminary data indicate that in the first quarter of 2014 it declined," the report said.
"However, the volume of non-performing loans is still growing."
35

A gradual easing of credit contraction and the decline in net non-performing loans (NPLs) are
among several signs that Italy is gradually emerging from a two-year long recession.
Italian banking association ABI said last month that net NPLs had fallen to 78.2 billion euros
(64.43 billion pounds) in February from 79.2 billion euros in January.
Gross NPLs topped 162 billion euros in February, ABI said, up from 160.4 billion.

35
Italian banks' bad loan problem is easing - central bank, Reuters, May 2 , 2014
31

The Bank of Italy report said Italian banks are gradually repaying the money they borrowed from
the European Central Bank during the height of the euro zone debt crisis, but at a slower rate
than elsewhere in the currency bloc.
Last month 38 of the 112 Italian counterparties that had taken part in the ECB's 3-year
refinancing operations had paid back 79 billion euros, or 31 percent of the original borrowing,
compared with 62 percent in the other euro zone countries, the Bank of Italy said on Friday.
COMPARISON OF OUTSTANDING LOANS BY NBFCS AND BANKS
A bank is an organization that accepts customer cash deposits and then provides financial
services like bank accounts, loans share trading account, mutual funds, etc. A NBFC (Non
Banking Financial Company) on tthe other hand is an organization that does not accept cash
deposits but provides all financial services except bank accounts. The key points of difference
between the two are:-
a) While a bank directly interacts with customers, NBFCs interact with banks and governments.
b) A bank indulges in a number of activities relating to finance with a range of customers,
NBFCs on the other hand are mainly concerned with the term loan needs of large enterprises.
c) While a bank deals with both internal and international customers, NBFCs are mainly
concerned with finances of foreign companies.
d) While a banks main interest is to help in business transactions and savings/ investment
activities on the other hand NBFCs main interest is in stabilization of the currency.
There is significant difference between the interest rates of banks and NBFCs.
Compared to the peak of EUR 4.6 trillion reached at the beginning of 2009, the volume of
outstanding loans has decreased by more than 9% to EUR 4.2 trillion in the Euro area till
October 2013.
36
On balance, the reporting euro area banks have further tightened their credit
standards to non-financial corporations (NFCs). As stricter regulations were being applied by

36
Helmut Kraemer- Eis, Salome Gvetadze, European Small Business Finance Outlook, European Investment Fund
(December 2013)
32

banks of Europe there was a surge in non banking financial corporations especially in Italy.
Since these NBFCs were involved in high amount of lending there has been a steady decline in
the amount of STRs(Suspicious Transaction Reports) filed by banks has mostly as a result of the
surge in the STRs filed by the Italian Post Office and by Non-Banking Financial Companies.
37

These reports are indicators of more outstanding loans being provided by NBFCs in recent years
as compared to Italian Banks.
The surge in NBFCs in Italy has led to more lending to Small and Medium Sized Enterprises
(SMEs). Loans are increasingly being granted not by banks but by alternate providers of finance
in Italy and other European Union countries as banks in Italy and other countries of Europe are
not feeling robust unlike the banks of United States.
38
Banking industry of Italy and other
European countries has been influenced by impressive growth of US business development
companies (BDCs) which now boasts assets in excess of $1.2 trillion- at the last count in summer
2013.
39
Now European banking industry and Italian banking industry is trying to replicate the
model by boosting companies access to credit, especially for smaller groups for whom access to
bond markets, or even pooled vehicles such as collateralised loan obligations is tough. Frances
Tikehau, a fast expanding alternative finance boutique, is looking at just such an initiative in its
domestic market. In Italy, meanwhile, Andrea Beltratti- an academic and former chairman of
Intesa Sanpaolo- is plotting something similar.
40
While this may be beneficial for the economy it
has also accounted for outstanding loans to a great extent in the Italian market.
A further sign of an appetite for financial risk is the willingness of investors to buy loans with
minimal protection in the case of a deterioration in the debtors financial positionso-called
covenant-lite loans. More than half of loans sold by non-bank lenders in January 2014 were
covenant-lite, the highest proportion ever.
41
This again has led to an increase in outstanding loans
by NBFCs.

37
Italy FATF Mutual Evaluation(February 2011), available at http://www.fatf-
gafi.org/media/fatf/documents/reports/mer/First_Biennial_Update_Feb2011_Italy.pdf
38
http://www.ft.com/intl/cms/s/0/146eb00c-7c69-11e3-9179-00144feabdc0.html#axzz3GSjBoXCZ
39
Ibid.
40
Supra Note 3
41
http://www.economist.com/news/briefing/21575773-central-banks-have-cushioned-developed-worlds-economy-
difficult-period-they-have-yet
33

Non-bank lending need not constitute a direct challenge to European banks. There are increasing
signs that banks are willing to work with a range of alternative lenders to meet their clients
needs and relieve the strain on their own balance sheets. In our view, the potential benefits to
both borrowers and lenders are compelling.
REASONS FOR RISE IN NON-BANKING FINANCIAL LENDING
European small and medium-sized businesses were increasingly wishing to invest for future
growth, but European banks remained under pressure to reduce their levels of leverage. Raising
capital or restructuring liabilities was not enough to prevent the banks from reducing net new
lending. As a result many non banking corporations were created to fill the void in the lending
market.
42

Institutions with capital to invest were increasingly interested in the possibilities of direct
lending. Hence many non- banking institutes mushroomed in Italian markets which lend loans to
small and medium sized companies alongside commercial banks.
43

Demand for credit among European SMEs kept growing as the regions economies recovered
after recession. The Italian lending market needed to expand capacity as firms were seeking to
meet rising customer demand. Demand for credit received an additional boost from the hangover
of the credit boom that ended in 2008. A large proportion of the credit raised by European SMEs
between 2004 and 2007 is due to be refinanced by 2017, but many of the markets which were the
source of this finance are either closed or operating at reduced capacity. Unfortunately as
European businesses demand for credit increased, European banks ability to lend declined.
European banks have been under pressure to reduce balance sheet leverage since 2008, and this
trend is likely to continue for several years. Italian firms struggled to fill this gap using other
existing sources of credit.
Boom in small to medium scale enterprises in Europe and Italy attracted many non banking
financial institutes such as insurers, pension funds, sovereign wealth funds and hedge funds to

42
Increasing European SME Access to Credit with Non- bank Lenders, PwC (April 2014), available at
http://www.pwc.com/en_GX/gx/banking-capital-markets/pdf/pwc-increasing-european-sme-access-to-credit-with-
non-bank-lenders.pdf
43
Ibid.
34

European market. Wide range of non banking institutions had the potential to act as direct
lenders to mid-market companies.
DISTINCTION BETWEEN LOANS PROVIDED BY NON-BANKING FINANCIAL INSTITUTES AND
LOANS BY BANKS
Following are some points of distinction between loans provided by NBFCs and loans provided
by Banks
44

1. Italian and European non bank institutes can lend loans to large mid market companies
without a formal credit rating. Same is not true for Italian and European banks which can lend
loans to companies with a formal credit rating.
2. While Italian banks face tough regulatory capital requirements, there are no such tough
regulatory measures on non banking institutes and they are likely to get more risk adjusted
returns than for banks.
3. European and Italian Non-bank institutions do not have the treasury functions to provide
revolving credit facilities and assets with fixed duration offer the best fit while lending loans.
Italian Banks on the other hand do have treasury functions to provide revolving credit facilities
while lending loans.
4. Non banking financial institutions (NBFIs) lend loans of high amount with a typical loan
falling somewhere between 10m and 50m. Below that band, loans are too small to attract non
bank institutions, on the other hand banks provide loans at all kinds of amounts.
5. Non-bank institutions acting as lenders lack the right supporting structures and capabilities.
Generally such institutions lack in-house lending facilities and credit risk management expertise
which are there with banks. NBFIs outsource loan administration and other back office work to a
third party service provider.

44
Supra Note 7
35

6. Non banking financial institutions are more likely to face problem of outstanding loans as
European and Italian regulators are clearly sensitive to levels of leverage among non-bank
institutions. Such lack of regulatory measures is not there with the banks.
7. Non bank lenders are usually willing to lend for a fixed period. Such limitations are not there
on banks which are better able to manage revolving credit. However some banks also prefer to
retain short term lending for the opportunity it offers to cross-sell services such as foreign
exchange, cash management and trade finance.
8. Italian NBFIs as compared to banks are found to have better exposure to small and medium
enterprises while lending loans.
We believe that co-lending, where banks and non-banks lend alongside each other, represents the
most promising model for non-bank lending. In most cases, commercial banks will retain the
primary customer relationship and continue to provide less capital intensive products and
services. However private banks and investment banks could also use non-bank lending partners
to meet their customers credit needs without using up precious capital. For banks, the effect
would be to move their corporate lending function closer to a debt capital markets model.
Since recession in 2008 the capabilities of banks have been reduced to a great extent.
Henceforth, it is the present need of the hour for non banking institutes to go mainstream and
provide high amount lending in order to revive the economy again. The fact is that lending to
non-financial companies in Europe has increased last year. According to new data from Allen &
Overy, the law firm, new loans were up globally by an average of 30 per cent.
US non banking financial institutes have thrived in recent years. The Italians are trying to
emulate the same model. However there are a few caveats to heed.
First, the US structures in place for 30 years have only thrived thanks to generous tax breaks.
If a European BDC (business development companies) industry is to take off, politicians would
probably need to grant it similar concessions. Second, regulators must find a way to monitor the
sector. Despite its vast size in the US, it is obscure and only lightly supervised.
36

CONCLUSION
Italian banks' bad loans started to decline as a proportion of overall lending in the first quarter of
this year, although they are still rising in absolute terms, the Bank of Italy said on Friday. The
deterioration in banks' loan asset quality has eased. the central bank said in its twice-yearly
Financial Stability Report.
The flow of new bad debts as a ratio to outstanding loans stabilised in the fourth quarter of 2013
and preliminary data indicate that in the first quarter of 2014 it declined. the report said.
However, the volume of non-performing loans is still growing.
A gradual easing of credit contraction and the decline in net non-performing loans (NPLs) are
among several signs that Italy is gradually emerging from a two-year long recession. Italian
banking association ABI said last month that net NPLs had fallen to 78.2 billion euros (64.43
billion pounds) in February from 79.2 billion euros in January.
Gross NPLs topped 162 billion euros in February, ABI said, up from 160.4 billion. The Bank of
Italy report said Italian banks are gradually repaying the money they borrowed from the
European Central Bank during the height of the euro zone debt crisis, but at a slower rate than
elsewhere in the currency bloc.
Last month 38 of the 112 Italian counterparties that had taken part in the ECB's 3-year
refinancing operations had paid back 79 billion euros, or 31 percent of the original borrowing,
compared with 62 percent in the other euro zone countries, the Bank of Italy said.

37

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