Prime Minister Silvio Berlusconi's Cabinet approved a draft law to reform Italy's financial regulatory system, leaving the Bank of Italy with an effective veto over banking mergers, ministers said yesterday.

The bill, drawn up following the multi-billion euro scandal at food group Parmalat, will now go for debate to parliament, which could take weeks or months to put it on the statute books.

Economy Minister Giulio Tremonti had originally proposed a radical overhaul of Italy's financial checks and balances that would have handed much of the Bank of Italy's regulatory powers to market watchdog Consob and the Antitrust Authority.

But in the event, at the request of Mr Berlusconi, the cabinet backed a watered-down version that means the central bank and Antitrust Authority will jointly decide on whether to allow mergers in the banking sector.

"If one of the two says 'no', then it is no. You will need two 'yes' votes," Foreign Minister Franco Frattini told reporters as he left the cabinet meeting.

The outcome represents a partial victory for Bank of Italy Governor Antonio Fazio, who has come under pressure from Mr Tremonti after the bank failed to spot balance sheet irregularities at Parmalat going back a decade.

This failure had left the door open for an attempt to limit the central bank's powers.

Ahead of yesterday's cabinet meeting, some ministers had expressed concern about the idea of clipping Mr Fazio's wings, saying a weakened Bank of Italy would leave Italy's clustered banking system open to foreign predators.

"Control of mergers and acquisitions must remain with the Bank of Italy. If not, it would expose our banks to the risk of aggression from foreign banking groups," European Affairs Minister Rocco Buttiglione was quoted as saying by newspapers.

Turning to another part of the reform, Mr Frattini said yesterday the government had decided to drop plans to increase prison terms for those found guilty of financial wrong-doing.

"As far as the sanctions are concerned the maximum term of 12 years remains in place but we are working to flesh out the details on what would constitute serious (financial) harm," he said, indicating that work on the text was still underway.

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