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A view shows the logo of the European Central Bank (ECB) outside its headquarters in Frankfurt on March 16.HEIKO BECKER/Reuters

Italy will revisit a contested windfall tax on banks by giving lenders the option to boost their reserve buffers instead of paying the levy, government documents seen by Reuters showed.

Last month, Rome dealt a surprise blow to its lenders by imposing a one-off 40% tax on income derived from higher interest rates, after reprimanding banks for failing to reward deposits as the European Central Bank hiked official rates.

Bank shares tumbled before the economy ministry clarified it would not collect more than 0.1% of lenders' total assets.

The proposed changes, to be approved next week by the upper house of Parliament, the Senate, come after rebukes from the industry, international investors and the European Central Bank (ECB).

Frankfurt said last week the levy could make some lenders vulnerable to an economic downturn.

Under a government amendment, the tax targeting banks' net interest margin (NIM), a measure of profit resulting from the gap between lending and deposit rates, will be capped at 0.26% of risk-weighted exposures.

The new terms favour banks that hold a higher proportion of government bonds among their assets because they carry a zero risk weight.

Instead of paying the tax, banks can boost their non-distributable reserves by an amount equivalent to two and a half times the levy and setting that aside specifically in their accounts.

Such an option is expected to exempt cooperative banks from the tax, as they usually put aside a large part of their profits as reserves.

Lenders opting to boost capital can distribute it later on, but they would then have to pay the levy plus interest charged at the rate the ECB applies to lenders' deposits.

State auditors at the Treasury approved the latest version of the proposal on Saturday, a document showed, adding it would entail "a maximum tax limit equivalent to the previous one."

Prime Minister Giorgia Meloni earlier this month defended the rationale for the tax while leaving the door open to changes, provided proceeds remained unchanged at "just under" 3 billion euros ($3.2 billion).

Under the updated proposal, Italy will tax 40% of the NIM earned in 2023 if the margin has grown by 10% or more from 2021 levels. In the earlier version, the tax applied if NIM grows by at least 5% in 2022 and 10% in 2023 from 2021 levels.

Rome intends to use revenues from the levy to fund tax cuts and state guarantees on loans to small and medium-sized enterprises.

Italy’s antitrust body will monitor banks to make sure they don’t charge customers more for services to offset the levy, the amendment said.

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