Several UK-based investment banks have been accused of mis-selling financial products to Italian cities and regions.
Nomura, UBS and Deutsche Bank are among those accused by Italian prosecutors of mis-selling derivatives in deals worth 35bn euros (£28bn).
The banks deny wrongdoing, but refused to comment further because the matter is now before the Italian courts.
BBC Newsnight discovered that London's financial watchdog was made aware of the mis-selling, but failed to act.
Now those Swap derivatives look as if they could further damage the entire Italian economy - the third largest in the eurozone.
Sicily has already needed a 400m-euro bailout from the federal government in Rome, which itself may soon need aid from its eurozone partners to stay financially afloat.
On Monday, official figures revealed that the Italian economy, which has contracted for the past four quarters, shrank by 0.8% between April and June, slightly more than previously estimated.
Between 1997 and 2007, dozens of Italian cities and regions borrowed 111bn euros from London-based investment banks - the repayments of which were funded by a type of derivative called a Swap
Although these Swap deals appeared to offer attractive interest rates, in reality the regions had unwittingly placed their own taxpayers on the hook for complex derivative bets which would end up costing them far more than expected.
"The banks didn't provide sufficient information to local authorities on the risk they were taking," according to Claudi Gatti, an investigative journalist with Il Sole 24 Ore who unearthed the mis-selling.
"So the authorities felt they were getting money for free. But the banks were making huge profits. They were encouraging the authorities to take major risks so that they [the banks] could make tens of millions of euros of profits for each contract."
The banks believe they were transparent in their dealings and that customers were made aware of the risks involved.
Even though whistleblowers made the Financial Services Authority (FSA) aware that London-based banks, which it regulates, may have been mis-selling complicated derivatives to Italian local authorities, it refused to act.
"In terms of surveillance I saw no intervention by the FSA into any London-based banks," Milan's chief prosecutor Alfredo Robledo told Newsnight.
Mr Robledo did act, though, when he suspected mis-selling by London-based banks such as UBS, Deutsche Bank and JP Morgan.
They simply ignored Mr Robledo until, that is, he locked their employees out of their Italian offices in 2009.
However, they settled with Milan this year, tore up the offending Swap contracts and paid the city almost 500m euros.
"The banks threaten to take their capital out of countries if regulation comes in. But we need regulation as these banks are plundering society," Mr Robledo said.
The London-based banks who were accused of mis-selling Swaps to Italian local authorities now face numerous civil and criminal proceedings by multiple Italian cities.
Some banking insiders did voice concern about derivative sales in Italy.
The BBC spoke to one such whistleblower who wrote to the FSA on numerous occasions with his concerns about behaviour at his then-investment bank.
The FSA refused to act on the information and even requested that the whistleblower never contact them again.
Furthermore, Newsnight can reveal that not a single UK-based bank has ever been punished for firing a whistleblower within its ranks - even though these individuals are protected in law since the Public Interest Disclosure Act 1998 came into force.
When Newsnight approached the FSA for a response it said it would not comment on individual cases, but acknowledged that no bank had ever been sanctioned in such circumstances.
According to our whistleblowing source, who has been asked to give evidence to the new Parliamentary Committee on Banking Standards, set up in the wake of the Libor scandal in June, banks tend to take a very dim view of employees who break ranks.
"No risk manager wants to admit that he didn't do his job. So an unholy alliance of mutual self-interest kicks in," the source, who asked to remain anonymous, said. "So they'll do anything to bad-mouth a whistleblower as an underperformer. They have a 100% success record."
Watch Newsnight's full report at 10.30pm on 11 September 2012 on BBC Two, then afterwards on the BBC iPlayer.