Italy Takes Fast Track in Modernizing Banking System

Despite being one of the staunchest supporters of European unity, Italy had been slow to enact legislation designed to bring its economic system into line with those of its European Community neighbors.

But in recent months, the Italian government has broken out of its snail-like pace and passed a flurry of major economic legislation that has propelled the country further down the road to unification.

From a complete overhaul of the banking system to a major restructuring of the stock market, Italy has taken steps that go beyond simple compliance with the EC directives handed down in Brussels. It has also prepared itself for the heightened competition that is sure to be a hallmark of unification.

All these moves have had major implications for Italian banks.

Exchange Controls Scrapped

One of the most important economic maneuvers came when Italy scrapped all remaining exchange controls. The lifting of restrictions brought the country into line with its EC partners and paved the way for banks to offer a host of new services.

For the first time, Italian bank customers were free to hold unlimited amounts of money in domestic accounts denominated in U.S. dollars, Swiss francs, German marks, or any other foreign currency. Barriers were also removed to opening accounts in foreign banks and buying foreign securities, while corporations can now seek to borrow money abroad on more favorable terms.

In its annual report on the state of the economy, published last month, Bank of Italy, the nation's central bank, said the lifting of restrictions had an extraordinary effect on both inflows and outflows of capital.

The foreign branches of Italian banks reported a nearly threefold increase in deposits from Italian residents in the 12 months ended in December 1990. During the same period, the amount of foreign currency held by Italian residents at national banks increased by 41%.

But the Bank of Italy report pointed out that direct Italian investment abroad is still significantly lower than that of any other major industrialized nation. This helped allay fears that eased exchange restrictions would result in major capital flight and subsequent rises in domestic interest rates.

Amato Bill Opened Door

Italy witnessed the passage of another major economic reform in July when Parliament approved the now familiar Amato bill, legislation that opened the door for a major overhaul of the country's state-dominated banking system.

Named after former Treasury Minister Giuliano Amato, who first introduced the legislation, the law encourages the flow of private capital into a system where two-thirds of the banks are state-controlled. Under terms of the new law, a bank can now float up to 49% of its equity on the stock market.

Several banks have either made the transformation to joint stock companies or are in the process of doing so. The list includes such notable names as Banco Nazionale de Lavoro, Banco di Napoli, and the Rome-based investment banking group IMI.

But the Amato law's impact on Italian banking does not end there.

Working on the assumption that bigger is better, the law also was aimed at encouraging bank mergers, in an effort to consolidate a system that is dominated by about 1,000 players.

Tax Incentives for Mergers

The legislation outlines terms by which the government will give tax incentives to banks that decide to tie the knot. The tax break is based on the difference in net assets between the merged entity and the biggest of the two partners.

Already Italy's second-biggest savings bank, Cassa di Risparmio di Roma, has rushed to take advantage of the new legislation. After acquiring Banco di Santo Spirito in 1989, Cassa di Risparmio agreed last October to merge with Banco di Roma, making the combined banking group the country's largest, with total assets of about 135 trillion lira ($108 billion).

Several more banks are following suit. Credito Italiano; Banca Commerciale Italiana, or BCI; Cassa di Risparmio delle Provincie Lombarde, or Cariplo; Banca Nazionale del Lavoro, or BNL; and Istituto Mobiliare Italiano, or IMI, are all considered prime merger candidates.

The central bank, whose approval is required for any merger, has applauded the new legislation.

In his annual report, the governor of the Bank of Italy, Carlo Azeglio Ciampi, described the legislation as one of the means by which Italy can best prepare for the single European market.

|An Effective Instrument'

"The first application [of the Amato bill] serves as proof that the law...offers an effective instrument for restructuring and concentrating the institutions within the banking system," Mr. Ciampi said.

Just a month after the Amato law took effect, Parliament passed another piece of sweeping economic legislation, this time aimed at reforming the stock market.

The law, first proposed five years ago, replaced antiquated legislation dating from 1913; it was aimed at making the Milan bourse more competitive with other international stock markets. But though the reform plan was years in the making, its approval in December came only after months of political wrangling.

The bill provides for creating a new type of financial institution: Societa di Intermediazione Mobiliare, or SIMs. By next year, equity transactions will be handled through these so-called securities intermediaries.

Banks' Use of SIMs

SIMs established before the end of 1992 must include one of the nation's 220 government-authorized brokers. But after that date, banks and other financial institutions will be free to set up their own solo ventures.

Analysts expect that half of all SIMs will eventually be operated by banks, while the rest will most likely be either joint ventures among existing brokers or independent operations by some of the largest firms.

Lawmakers followed up their well-received reform of the Italian stock market by passing an unpopular capital gains tax in March.

The tax was only aimed at individual investors because the capital gains of companies and institutional investors are already taxed as part of their corporate earnings.

But the proposal triggered a series of strikes by Milan floor traders, who opposed the complicated collection process even more than the tax itself. Banks joined in blasting the new plan, while investors who were facing uncertainty about how their gains would be taxed opted to invest in Italian blue chips on the London market.

First outlined in September by Finance Minister Rino Formica as part of the 1991 budget package, the legislation was amended three times before being enacted.

A Choice of Taxes

The final version gave investors the choice of being taxed one of two ways: either by paying a 25% tax on net capital gains, adjusted for inflation, or by paying a 15% tax on a hypothetical gain, based on shares' performance in the nine months before the sale.

Investors are required to make their choice at the time they sell the stock.

Lawmakers rounded out their stock market reform last month by passing legislation that banned insider trading. While the government's first attempt to limit the use of privileged information had also been long in the making, it was held up because the law on SIMs had to be passed first in order to define precisely who would come under the new ban on insider trading.

Warning from Treasury

Despite the sweeping reform of the banking system and stock market, much needs doing if Italy is to catch up with its EC neighbors.

In its annual letter to the Italian Treasury Ministry, the International Monetary Fund warned that, unless Italy curbs its rampant public spending, monetary union may be hampered.

"It seems inconceivable that a country that has supported EMU (European monetary union) so actively and has participated in all the major steps of the construction of Europe would be excluded from the group of countries progressing to the next phase of EMU or find itself accused of delaying monetary unification," the report said.

"If progress is too slow in the two key areas of public finance and wage-price moderation, it will be difficult to meet the deadline of 1994" for the next phase of economic union.

The reason for the IMF's warning was clear.

Last year, Italy's budget deficit totaled 11% of gross domestic product and accounted for more than half of all government borrowing within the EC.

Enormous Debt Burden

Italy's total public debt is well over 1,000 trillion lire ($800 billion) and matches the country's gross domestic product. In contrast, U.S. government debt is 54% of GDP.

Shortly after the IMF issued its warning, squabbling over how to reduce the budget deficit brought down the coalition led by Prime Minister Giulio Andreotti - the country's 49th postwar government.

After Mr. Andreotti managed to get another coalition together to form his seventh government, discussions began in earnest about long-term solutions.

Over the long run, cost-cutting plans include limiting public-sector wage increases to the rate of inflation for a certain period of time, gradually raising the retirement age from 60 to 65, and getting employees to shoulder more of the burden of financing the country's generous pensions.

Politics Hobbles Reform

But with elections scheduled next year, the government opted to put off controversial reform of the national pension scheme and settled instead for emergency cost-cutting and revenue-raising measures designed to rim 14 trillion lire ($1 billion) off this year's deficit.

The emergency revenue-raising package passed last month mainly applies to luxury goods, raising taxes on such things as mobile telephones, private airplanes, allterrain vehicles, and big-cylinder motorcycles. The government also levied a 30,000 lire tax on credit cards held with Italian banks.

But no matter how much the government does to improve the ailing economic system, some observers see only feeble attempts to bandage a festering wound. Curing the nation's ills, they contend, will take major surgery.

Moving in that direction, Mr. Andreotti has promised to put constitutional reform at the top of his new government's agenda.

A Presidential Republic?

One proposal made so far is that a national referendum be held to replace the country's current pure form of proportional representation with a presidential republic aimed at creating clear-cut parliamentary majorities. And in good news for the country's bankers, Mr. Andreotti has also proposed a "fast track" for all economic legislation.

Whether anything new will come of the proposals is anybody's guess, but Italians are taking heart at the fact that at least things seem to be moving in the right direction.

Ms. Cirulli is an American freelance journalist based in Rome, who specializes in business topics. She has contributed to Newsweek magazine, the Journal of Commerce, and the Associated Press.

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