Italy's government has rethought its controversial windfall tax on banks after widespread criticism including from the European Central Bank, news agencies reported on Saturday.

Banks will be able to choose between paying the levy or boosting their non-distributable reserves – reserves which cannot be paid in dividends – by an amount equivalent to two and a half times the tax, according to a proposed amendment.

The amended text must be approved by parliament and could still change.

Prime Minister Giorgia Meloni's hard-right government announced last month it would levy a one-time 40-percent tax on banks' "surplus profits" netted as a result of the ECB's series of interest rate hikes over the past year.

The shock move spooked investors and sent shares in Italian banks plunging before the government watered down the plan, saying the new tax would be capped at 0.1 percent of a bank's assets.

In a legal opinion on September 13, the ECB warned the tax could weaken lenders' capital buffers and make them more vulnerable to future economic shocks. (AFP)