## cr1870 ## Source details **Canonical URL:** [cr1870](https://www.imf.org/-/media/files/publications/cr/2018/cr1870.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr1870.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr1870.pdf.json) --- ### EXECUTIVE SUMMARY — INTRODUCTION - Framework for supervision of banks, insurance companies and FCs in Belgium fundamentally revamped since the 2013 FSAP. - The Single Supervisory Mechanism (SSM) is directly responsible for the supervision of over 90 percent of the Belgian banking sector assets. - Key legislative and institutional changes: - New national banking and insurance laws; transposition of BRRD and amendments to FICOD; implementation of Solvency II; NBB designated as macroprudential authority. - 2018 FSAP analysis based on regulatory framework and supervisory practices as of September 2017. - Focus areas: supervisory resources; implementation of Solvency II; resolution and crisis management of large/complex insurance groups; special attention to financial conglomerates (FCs) per Joint Forum Principles (JFP). ### IMPROVEMENTS SINCE 2013 FSAP - Regulatory framework substantially strengthened since 2013 FSAP. - Institutional actions include: - Establishment of SSM increasing intrusiveness and forward-looking supervision for banks. - NBB designated macroprudential authority and issuance of new national laws. ### MARKET STRUCTURE — KEY METRICS - Belgian financial system: relatively large, concentrated and interconnected. - Banking sector: - Total banking sector assets were around 250 percent of GDP in 2016. - Four banking groups represent over 80 percent of consolidated system assets. - Number of credit institutions: 108 (2011) and 90 (2016). - Loans account for approximately 60 percent of banking system assets. - Mortgage loans increased about 5.5 percent from end-2015 to end-2016 and comprise approximately 18 percent of total assets. - Household deposits: about 36 percent of total liabilities at end-2016. - Insurance sector: - Three large insurers (KBC, Belfius and Argenta) account for 20 percent of total assets of the insurance industry. - 92 percent of industry assets are held by composite insurers; pure life companies hold 3 percent and non-life companies hold 5 percent (end 2016). - Majority of investments: government securities — about 69 percent of life sector assets, 59 percent of non-life sector assets, and 50 percent of composite insurers’ assets. - Life insurance premiums declined from EUR 25 billion to EUR 15 billion since 2005; net profit dropped from EUR 2.4 billion (2012) to EUR 1 billion (2016). ### A. BANKING SUPERVISION — FINDINGS - SSM responsibility: over 90 percent of Belgian banking sector assets; supervision more intrusive, forward-looking, and effective. - NBB enhanced supervision of Less Significant Institutions (LSIs), aligning practices with those applied to Significant Institutions (SIs) with proportionality. - Key financial soundness indicators (selected, 2010–2016:Q3): - Regulatory Capital to Risk-Weighted Assets: 19.3 (2010), 18.5 (2016:Q3) - Regulatory Tier 1 Capital to Risk-Weighted Assets: 15.5 (2010), 15.9 (2016:Q3) - Non-performing Loans to Total Gross Loans: 2.8 (2010), 3.5 (2016:Q3) - Non-performing Loans Net of Provisions to Capital: 14.2 (2010), 19.9 (2016:Q3) - Return on Assets: 0.5 (2010), 0.7 (2016:Q3) - Return on Equity: 10.6 (2010), 10.2 (2016:Q3) - Liquid Assets to Total Assets: 32.5 (2010), 33.2 (2016:Q3) - Liquid Assets to Short Term Liabilities: 75.7 (2010), 57.8 (2016:Q3) - Belgian banks’ end 2016 average Tier 1 and total capital ratios: 15.7 and 18.8 percent; EU averages: 15.5 and 18.5 percent. - Basel III phasing to 2019 not expected to substantially lower these figures. - Non-performing loans declined to 3.5 percent of total loans at 2016: Q3. ### A. BANKING SUPERVISION — SELECTED RECOMMENDATIONS - Continue enhancing reliability and consistency of internal models (NBB/SSM) — Timing: C; Priority: H. - Play a more active role in assessing loan classifications to ensure prudent provisioning practices (NBB/SSM) — Timing: C; Priority: H. - Strengthen regulation and monitoring of transactions with related parties (NBB/SSM) — Timing: ST; Priority: H. - Enhance risk management and control functions by strengthening board supervisory role (NBB/SSM) — Timing: I; Priority: M. - Continue efforts to enhance banks’ and FCs’ data quality and reporting (NBB/SSM) — Timing: C; Priority: M. - Ensure off-balance sheet activities, including SPEs, are brought within group-wide supervision (NBB/SSM) — Timing: MT; Priority: H. ### INTERNAL MODELS — OBSERVATIONS & ACTIONS - Major banks extensively use internal models; models tend to produce substantially lower capital requirements than standardized approaches. - Low default rates in bank databases generate particularly low risk weights. - Targeted review of internal models launched by SSM entered execution in 2017; planned completion by 2019. - Recommended actions: - Sound execution of targeted review and improved ongoing model monitoring to reduce unwarranted variability of RWAs. - Enforce strong board oversight of models; banks to adopt robust model risk management frameworks. ### ASSET CLASSIFICATION, PROVISIONS & AUDIT - Belgian authorities have issued limited supervisory guidance on asset classification and provisioning beyond accounting standards. - Supervisors face limitations: cannot directly instruct banks to change individual asset classifications outside accounting standards; rely heavily on external auditors. - Recommendations: - Supervisors should play a more active role in assessing loan classification and provisioning. - Consider more granular regulatory requirements for credit risk exposures and stronger policies on auditor rotation to strengthen independence. ### CAPITAL BUFFERS & MORTGAGE ADD-ON - Mortgage risk-weight add-on: until May 27, 2017 a 5-percentage point add-on to IRB mortgage risk weights applied; regulation expired end-May; banks advised to continue using former requirement to calculate RWAs while proposals discussed. - CRD capital buffers (Articles 128-135): - CCB: set at 1.25 percent of RWAs (until end 2017). - CCyB: currently 0 percent for exposures in Belgium. - G-SII buffer: applies to G-SIIs. - O-SII buffer: actual values from January 1, 2018 presented in Table 4; current values are 1 percent for institutions in highest bucket and 0.5 percent for lower bucket. Examples: - BNPP Fortis | 2 | 1.5 - KBC Group | 2 | 1.5 - Euroclear | 1 | 0.75 - Systemic risk buffer: currently not applied in Belgium. - Pillar 2: ECB can require capital in excess of Pillar 1; Pillar 2 add-on comprises binding Pillar 2 requirement and nonbinding Pillar 2 guidance. ### TRANSPOSITIONAL/WAIVER ISSUES - Proposed EC legislative proposal (23 November 2016) to expand waivers from capital and liquidity requirements to subsidiaries in other member states; would allow waivers if parent commits to support subsidiary and collateralizes at least half of guarantee. - FSAP view: during transition to full banking union, prudential requirements and supervision at national level remain important; changes should be gradual and mindful of member-state financial stability. ### B. INSURANCE SUPERVISION — FINDINGS - Insurance sector risk profile evolving under low interest rates; some insurers shift toward asset management-type products, reducing interest rate risk but increasing liquidity risk. - Brexit has prompted reallocation of reinsurance business to Belgium. - Industry relies partially on lower-quality forms of capital, including subordinated loans from parent banks and unrecognized gains (Value in Force). - Use of Volatility Adjustment (VA) may have led to overstatement of solvency; application of VA increased unrestricted Tier 1 and improved SCR ratios by 25 percent as of end-2016. - Solvency II implementation lowered SCR compared to Solvency I; average SCR ratio: 134 percent for life insurers and 177 percent for composite insurers. - Only one insurer uses the Solvency II transitional measure for technical provisions; 19 insurers use the VA. - NBB faces resource and staffing challenges as industry size and complexity increase. ### B. INSURANCE SUPERVISION — SELECTED RECOMMENDATIONS - Engage with industry to gradually improve quality of capital (NBB) — Timing: ST; Priority: M. - Seek to impose measures to address increasing liquidity risk, considering policyholder protection (NBB) — Timing: ST; Priority: H. - Consider imposing more detailed reporting on insurers with large mortgage exposures (NBB) — Timing: ST; Priority: M. - Continue analyzing reinsurance business growth and enhance supervisory resources as needed (NBB) — Timing: C; Priority: H. - Strive to retain staff with high expertise in Solvency II implementation (NBB) — Timing: C; Priority: H. ### SOLVENCY II — VALUATION, CAPITAL QUALITY & MEASURES - Solvency II valuations: assets mark-to-market; technical provisions = best estimate + MOCE (cost of capital method at 6 percent). - Flashing Light provision: total amount EUR 7.6 billion at end-2016; provision led to EUR 4.6 billion additional provisions in 2013–2015 when no exemptions granted. - LAC_DT cap adjustments: NBB issued guidance capping LAC_DT to net DTL in 2016; 2017 circular allowed projections up to five years with new cap; NBB monitoring outliers. - Internal models for insurers: few approvals; Internal Models Supervision unit enforces rigid calibration and use tests; some subsidiaries required to use standard formula. - LTG/transitional measures: many firms (19) use VA; only one small insurer uses transitional measures; average SCR with LTG measures 175 percent as of end-2016; would fall to 149 percent without LTG measures. - VA increased SCR ratios by 25 percent in stable market conditions; capital resources from VA may not meet ICP quality/suitability criteria. ### INSURANCE — ENTERPRISE RISK MANAGEMENT & ORSA - Solvency II required significant ERM improvements: ORSA with board commitment; NBB reviews ORSA and links outcomes to a scorecard. - NBB designated three insurance groups as domestic systemically important insurers (D-SIFIs) and applies enhanced supervision. ### INTERLINKAGES & UNIT-LINKED PRODUCTS - Unit linked products (class 23) value over EUR 30 billion — about 10 percent of overall insurance sector assets and 14 percent of premiums. - Unit linked investments often flow into group asset managers or parent banks; many invested into internal collective investment schemes not always subject to UCITS requirements. - NBB and FSMA analyzing interconnectedness; possible regulatory enhancements include concentration limits for assets of unit linked products. ### LIQUIDITY RISK & INDUSTRY RESPONSES - Life insurers shortened minimum guarantees to 8 years; buy-backs reduced legacy portfolios (example: total buy-back amount reached EUR 7 billion). - NBB considering minimum requirements on surrender value calculation (charges/market value adjustments) for new policies. - NBB monitoring liquidity: most insurers have liquid assets > 3 times liquid liabilities; all insurers’ liquid assets exceed liquid liabilities. ### C. FINANCIAL CONGLOMERATES (FCs) — FINDINGS - Three banking-led FCs in Belgium; banking entities of the three FCs account for 42 percent of banking sector assets and 20 percent of insurance sector assets. - FCs offer bancassurance synergies but complex legal structures complicate risk management, supervision and resolution. - Supervisory practices for collecting data and analyzing intra-group transactions and concentration risk are limited and not harmonized. - SSM Supervisory Manual provides limited insight beyond regulatory requirements for FCs. ### C. FINANCIAL CONGLOMERATES — KEY RISKS & REGULATORY ARBITRAGE - Danish Compromise (CRR Articles 49 and 471) allows risk-weighting investments in insurance subsidiaries at 370 percent rather than deduction, lowering capital requirements relative to deduction. - Consequences: - Incentives for regulatory arbitrage: shifting low risk-weighted assets (e.g., mortgage loans) to insurers or transferring illiquid/high-risk assets to insurers. - No FC-level Pillar 1 liquidity or leverage requirement; asymmetric liquidity regime between banking and insurance sectors. - Intragroup transactions can create large intragroup concentrations and liquidity provision from insurance to banks. - Off-balance sheet activities and SPEs often remain outside group-wide supervision due to legal definition constraints. ### C. FINANCIAL CONGLOMERATES — SELECTED RECOMMENDATIONS - Seek legislative changes to enhance supervisory authority over holding companies and flexibility in defining supervisory perimeter (NBB/SSM) — Timing: MT; Priority: M. - Set supervisory expectations for FC governance and integrated risk management (NBB/SSM) — Timing: ST; Priority: H. - Enhance data collection to monitor risk concentration and intra-group transactions by implementing Regulation 2015/2303 (NBB/SSM) — Timing: ST; Priority: H. - Provide additional guidance in SSM Supervisory Manual concerning supplementary supervision (SSM) — Timing: ST; Priority: H. - Establish supervisory approach to monitor liquidity risk at FC level, reflecting banking and insurance differences (NBB/SSM) — Timing: MT; Priority: M. - Monitor risk of regulatory arbitrage between insurance and banking sectors (NBB/SSM) — Timing: I; Priority: H. - Bring off-balance sheet activities, including SPEs, within scope of group-wide supervision and develop processes for consolidation determinations. ### FC SUPERVISION — PRACTICAL TOOLS & GAPS - FICOD shortcomings: MFHCs are unregulated entities with limited powers; no unified point of entry for supplementary supervision; FC definition is prescriptive and static; no EU-wide recovery/resolution framework directly for FCs; lack of harmonized reporting templates. - BL (Belgian Banking Law) improvements: Articles 164–219 introduce consolidated and supplementary supervision; Article 170 extends consolidated provisions to MFHC level when conditions met; Articles 183, 188 and 213 enhance information and scope. - Reg 2015/2303 supplements FICOD with detailed definitions and reporting requirements for intragroup transactions and concentration, but not fully implemented in practice. ### RECOVERY, RESOLUTION & CRISIS MANAGEMENT - Insurance law provides recovery measures: suspension of redemptions, prohibition of dividends, requiring additional reserves, requiring risk reductions, imposing liquidity rules; NBB can suspend business, replace management, and order transfer of assets and liabilities. - Policyholders are highest class of creditors in insolvency; three guarantee funds exist but are small. - Recovery and resolution plans: - Formal recovery and resolution plans not required for insurance groups generally. - NBB conducted pilot solo recovery plans and developed recovery plan for a large insurer; insurance operations not yet fully incorporated into FC-level recovery/resolution plans. - Recommendations: - Ensure systemically important insurance groups have robust recovery/contingency plans. - For insurance groups in bank-led FCs, incorporate insurance subsidiaries into group recovery plans. - Other insurers should develop contingency plans based on ORSA and reverse stress testing. ### SUPERVISORY PRACTICE — SSM, JSTs, AND NBB - Day-to-day supervision performed by JSTs comprising ECB and NBB staff under an ECB coordinator. - SREP pillars: (i) business model and profitability; (ii) internal governance and risk management; (iii) risks to capital; (iv) risks to liquidity and funding. - LSI on-site inspection minimum frequencies: - High priority LSIs: 1 inspection / year - Medium priority LSIs: 1 inspection / 4 years - Low priority LSIs: 1 inspection / 7 years - Operational outcome: approximately 5-6 inspections for LSIs per year. - NBB defines domestic priorities and Minimum Engagement Levels (MELs) for LSIs and organizes monitoring via multidisciplinary teams. ### ADDITIONAL RECOMMENDATIONS & SUPERVISORY PRIORITIES - Strengthen board engagement: include regular meetings with full board, not only with individual board members. - Improve risk data aggregation and reporting: adopt BCBS principles and ECB developments; address aging IT systems and legacy infrastructure. - Enhance monitoring of intragroup transactions and consider quantitative limits if principle-based approach fails. - Develop clearer expectations for integrated FC risk management: define risk appetite, governance, FC-wide stress testing, risk data aggregation, and recognition of diversification. - Incorporate Regulation 2015/2303 guidance into supervisory practice for intragroup transactions and concentration risk. - The SSM and NBB should develop a robust supervisory approach for FC-level liquidity risk, including analysis of intragroup transactions and potential limits. *Source: cr1870 - EXECUTIVE SUMMARY and selected excerpts (Technical note, based on regulatory framework and supervisory practices as of September 2017).* ### EXECUTIVE SUMMARY __________________________________________________________________________ 6 ### EXECUTIVE SUMMARY ### INTRODUCTION - The framework for the supervision of banks, insurance companies and FCs in Belgium has been fundamentally revamped since the 2013 FSAP. - The Single Supervisory Mechanism (SSM) is directly responsible for the supervision of over 90 percent of the Belgian banking sector assets. - New national banking and insurance laws have been issued, the Bank Recovery and Resolution Directive (BRRD) and amendments to Financial Conglomerate Directive (FICOD) have been transposed, Solvency II has been implemented, and the National Bank of Belgium (NBB) has been designated as the macroprudential authority. - The 2018 FSAP analysis was based on the regulatory framework in place and supervisory practices employed as of September 2017 and drew on review of regulations, meetings with NBB and ECB, responses to self-assessments and questionnaires, and meetings with banks, insurers, audit firms, and industry associations. - The note focuses on: i) key vulnerabilities identified in the previous FSAP regarding supervisory resources; ii) the implementation of the Solvency II requirements; and iii) resolution and crisis management of large and complex insurance groups. - Special attention is devoted to financial conglomerates (FCs) and their challenges for group-wide capital adequacy, conflicts of interest, contagion, concentration and other risks, requiring supplementary supervision in line with the Joint Forum Principles (JFP). ### IMPROVEMENTS SINCE 2013 FSAP - The regulatory framework for Belgian financial institutions has been strengthened substantially since the 2013 FSAP. - Implementation actions and institutional changes include: - New national banking and insurance laws. - Transposition of BRRD and amendments to FICOD. - Implementation of Solvency II. - NBB designated as the macroprudential authority. - Establishment of the SSM, increasing intrusiveness and forward-looking supervision for banks. ### BANKING SUPERVISION — KEY OBSERVATIONS AND RECOMMENDATIONS Findings: - The SSM is responsible for over 90 percent of Belgian banking sector assets and has made supervision more intrusive, forward looking, and effective. - NBB has enhanced supervision of less significant institutions (LSIs) by aligning practices with those applied to significant banks, with proportionality considerations. Recommendations (selected, with responsible authorities and timing/priority as in Table 1): - Continue enhancing the reliability and consistency of internal models used to calculate regulatory capital. (NBB/SSM) — Timing: C; Priority: H - Play a more active role in assessing loan classifications to ensure prudent provisioning practices. (NBB/SSM) — Timing: C; Priority: H - Seek to strengthen the regulation and monitoring of transactions with related parties. (NBB/SSM) — Timing: ST; Priority: H - Continue efforts to enhance the risk management and control functions by strengthening the role of the board in its supervisory function. (NBB/SSM) — Timing: I; Priority: M - Continue efforts to enhance banks’ and FCs’ data quality and reporting. (NBB/SSM) — Timing: C; Priority: M - Ensure that off-balance sheet activities, including SPEs, are brought within the scope of group-wide supervision. (NBB/SSM) — Timing: MT; Priority: H Specific thematic guidance: - Transition to the banking union: maintain sufficient capital in cross-border subsidiaries until a common deposit insurance scheme and a common fiscal backstop for systemic events are in place; any changes to prudential requirements and supervision focus should be gradual and mindful of member-state financial stability. - Internal models: the targeted review of internal models launched by the SSM entered execution in 2017; continue improving model monitoring to reduce unwarranted variability of risk weighted assets and increase bank board involvement in model oversight. - Loan classification and provisioning: loan valuation and provisioning have been driven by accounting norms; ECB-issued guidelines introduce prudential considerations but their impact is expected to be limited; supervisors should play a more proactive role in assessing banks’ treatment of assets. - Related party transactions: the legal definition in Belgium is too narrow; broaden the definition of related parties and related transactions, and require banks to establish stronger policies and processes to identify them. - Off-balance sheet activities: Special purpose entities (SPE) should be brought within supervision scope; supervisors should develop processes to determine full or proportional consolidation for regulatory purposes and consider the overall nature of relationships beyond traditional control criteria; stress tests and scenario analyses should consider all relevant off-balance sheet activities. ### INSURANCE SUPERVISION — KEY OBSERVATIONS AND RECOMMENDATIONS Findings: - The insurance sector’s risk profile is changing in response to low interest rates; some insurers have shifted from traditional insurance products to asset management-type products, reducing interest rate risk but increasing liquidity risk. - Brexit has prompted reallocation of reinsurance business to Belgium, posing additional challenges. - The industry partially relies on relatively low-quality forms of capital, including subordinated loans from parent banks and unrecognized gains on new insurance products with flexibility of surrender. - Use of volatility adjustments (VA) may have led to an overstatement of insurers’ solvency. - The industry meets Solvency II requirements, but capital quality concerns remain. - NBB faces resource and staffing challenges as industry size and complexity increase. Recommendations (selected, with responsible authorities and timing/priority as in Table 1): - Engage with the insurance industry to gradually improve the quality of capital. (NBB) — Timing: ST; Priority: M - Seek to impose appropriate measures to address increasing liquidity risk of the sector, with due consideration of policyholders’ protection and benefits. (NBB) — Timing: ST; Priority: H - Consider imposing more detailed reporting requirements on insurers with large exposures to mortgage loans. (NBB) — Timing: ST; Priority: M - Continue analyzing the business growth of reinsurance operations and enhance supervisory resources as needed. (NBB) — Timing: C; Priority: H - Strive to retain staff with high expertise in the implementation of Solvency II. (NBB) — Timing: C; Priority: H Specific thematic guidance: - Evolving risk profiles: NBB should be ready to deploy prudential measures to mitigate liquidity risk, retain highly-qualified staff, and enhance resources as the industry grows in size and complexity. - Quality of capital: proactively engage the industry to gradually improve capital quality and address vulnerabilities from subordinated loans and redemption risk associated with surrender-flexible products; assess the impact of volatility adjustments (VA) on reported solvency. ### FINANCIAL CONGLOMERATE SUPERVISION — KEY OBSERVATIONS AND RECOMMENDATIONS Findings: - Financial conglomerates (FCs) are prevalent in the Belgian financial sector; supplementary supervision is necessary to address group-wide risks. - Supervisory expectations on governance should be heightened and oversight of key prudential requirements strengthened. - Supervisory practices for collecting data and analyzing intra-group transactions and concentration risk are limited and not harmonized. - The SSM Supervisory Manual provides limited insight beyond regulatory requirements for FCs. Recommendations (selected, with responsible authorities and timing/priority as in Table 1): - Seek legislative changes to enhance supervisory authority over holding companies and flexibility in defining the supervisory perimeter. (NBB/SSM) — Timing: MT; Priority: M - Set supervisory expectations for FC governance and integrated risk management. (NBB/SSM) — Timing: ST; Priority: H - Enhance data collection to monitor risk concentration and intra-group transactions by implementing Regulation 2015/2303. (NBB/SSM) — Timing: ST; Priority: H - Provide additional guidance in the SSM Supervisory Manual concerning supplementary supervision. (SSM) — Timing: ST; Priority: H - Enhance disclosure by the FCs that do not deduct participations in insurance subsidiaries. (NBB/SSM) — Timing: I; Priority: M - Establish a supervisory approach to monitor liquidity risk at FC level, reflecting differences in banking and insurance. (NBB/SSM) — Timing: MT; Priority: M - Monitor risk of regulatory arbitrage between insurance and banking sectors. (NBB/SSM) — Timing: I; Priority: H Specific thematic guidance: - Policies for governance, risk management, and capital and liquidity requirements: define best practices and provide further guidance beyond the SSM Supervisory Manual to support effective FC supervision. - Intra-group transactions and concentration risk: develop guidance on evaluating FC intra-group transactions to determine economic purpose and identify transfers of sub-quality assets at book value between affiliates to avoid loss recognition; emphasize monitoring of reputational and other transmission channels even where supplementary supervision is waived. *Italic source attribution line below.* *Source: cr1870 - EXECUTIVE SUMMARY (Technical note, based on regulatory framework and supervisory practices as of September 2017).* ### 5. The IMF mission thanks the authorities and private sector participants for their ### 5. The IMF mission thanks the authorities and private sector participants for their ### Acknowledgements and cooperation - The FSAP team benefitted from inputs and exchanges of views during meetings with supervisors and market participants. - The team thanks NBB and ECB staff for professionalism, spirit of cooperation, and for making enormous efforts to respond to requests and overcome logistical challenges. ### Market structure — overview - The Belgian financial system is relatively large, concentrated, and interconnected with the rest of the world. - Total banking sector assets were around 250 percent of GDP in 2016. - Strong presence of foreign-owned institutions. - Insurance sector embedded in a predominant bancassurance model dominated by a few financial conglomerates (FCs). ### A. Banking sector — structure and key metrics - System concentration: - Four banking groups represent over 80 percent of consolidated system assets. - In 2016 there were 90 credit institutions operating in Belgium (versus 108 in 2011). - Table 2 (Credit Institutions in Belgium) — Institutions by type, 2011 and 2016: - Credit institutions governed by Belgian law with Belgium majority shareholding: 20 (2011), 15 (2016) - Credit institutions governed by Belgian law with foreign majority shareholding: 27 (2011), 19 (2016) - EU member states: 20 (2011), 11 (2016) - Other States: 7 (2011), 8 (2016) - Belgian branches of foreign credit institutions: 61 (2011), 56 (2016) - EU member states: 52 (2011), 48 (2016) - Other States: 9 (2011), 8 (2016) - Total: 108 (2011), 90 (2016) - Source: NBB Financial Stability Report 2017. - Asset composition and liabilities: - Loans account for approximately 60 percent of banking system assets. - Mortgage loans increased about 5.5 percent from end-2015 to end-2016 and comprise approximately 18 percent of total assets. - Household deposits accounted for about 36 percent of total liabilities at end-2016. - Financial soundness and resilience: - Non-performing loans declined to 3.5 percent of total loans at 2016: Q3. - Liquid assets to short-term liabilities ratio stands at 57.8 (2016: Q3). - Profitability has recovered and migration to Basel III standards is well under way. ### Key financial soundness indicators (selected, 2010–2016:Q3) - Regulatory Capital to Risk-Weighted Assets: 19.3 (2010), 18.5 (2016:Q3) - Regulatory Tier 1 Capital to Risk-Weighted Assets: 15.5 (2010), 15.9 (2016:Q3) - Non-performing Loans Net of Provisions to Capital: 14.2 (2010), 19.9 (2016:Q3) - Non-performing Loans to Total Gross Loans: 2.8 (2010), 3.5 (2016:Q3) - Sectoral Distribution of Total Loans: Residents: 47.6 (2010), 62.6 (2016:Q3) - Sectoral Distribution of Total Loans: Nonresidents: 52.4 (2010), 37.4 (2016:Q3) - Return on Assets: 0.5 (2010), 0.7 (2016:Q3) - Return on Equity: 10.6 (2010), 10.2 (2016:Q3) - Liquid Assets to Total Assets (Liquid Asset Ratio): 32.5 (2010), 33.2 (2016:Q3) - Liquid Assets to Short Term Liabilities: 75.7 (2010), 57.8 (2016:Q3) - Net Open Position in Foreign Exchange to Capital: 3.3 (2010), 1.9 (2016:Q3) - Source: IMF Financial Soundness Indicators Database. ### B. Insurance sector — structure, risks, and trends - Market structure and concentration: - Industry characterized by a few FCs and concentrated ownership. - Three large insurers (KBC, Belfius and Argenta) belong to FCs led by banks and account for 20 percent of total assets of the insurance industry. - 92 percent of industry assets are held by composite insurers; pure life companies hold 3 percent and non-life companies hold 5 percent (as of end 2016). - Unless otherwise noted, data on the insurance sector below refer to composite insurers. - Asset allocation and home bias: - Majority of life and non-life investments consist of government securities: about 69 percent of life sector assets, 59 percent of non-life sector assets, and 50 percent of composite insurers’ assets. - Belgium and France account for about 60 percent and 10 percent of the sovereign portfolio, respectively. - No clear trend toward allocations to euro area periphery countries or lower credit corporate bonds over last five years. - Allocation in government bonds increased from 45 percent (end 2014, book value) to 50 percent (end 2016, market value), partly due to mark-to-market gains. - Investment behavior and search for yield: - No industry-wide sign of search for yield, though some groups are increasing investments in less liquid assets such as mortgage loan portfolios typically acquired from banks within the same FC. - Guaranteed rates, product mix, and returns: - Life insurers have reduced guaranteed rates gradually; average guaranteed rate is still around 3 percent while the long-term interest rate is less than 1 percent. - Some insurers stopped selling saving-type products, shifted toward protection products, proposed decreasing guaranteed rates to invest more in equities, and encouraged policyholders to shift to unit-linked products. - Duration mismatch and ALM gap: - Small and medium-sized insurers still have a sizable duration mismatch and remain exposed to interest rate risk; their ALM gap has not narrowed in recent years. - Large insurers have reduced the ALM gap significantly: industry average ALM gap was more than 4 years in 2015 and reduced to less than 1 year (recent), lowering sensitivity to further decreases in long-term rates. - However, reduced ALM gap and new product flexibility increase liquidity risk due to greater surrender flexibility and derivative-related margin and collateral needs. - Solvency and capital: - Solvency II implementation lowered solvency capital requirements (SCR) compared to Solvency I, particularly for life insurers. - Some smaller insurers were undercapitalized in 2014 under Solvency II SCR specifications at that time; NBB efforts improved weak companies’ solvency. - Average SCR ratio: 134 percent for life insurers and 177 percent for composite insurers. - Only one insurer is using the Solvency II transitional measure for technical provisions; 19 insurers are using the VA (volatility adjustment). - Premiums and profitability: - Life insurance premiums declined from EUR 25 billion to EUR 15 billion since 2005. - Declining trend accelerated from 2012 by 7 percent annually. - Net profit of sector dropped from EUR 2.4 billion (2012) to EUR 1 billion (2016). - Tax context: tax on life insurance premiums introduced in 2005 (1.1 percent) and increased to 2 percent in 2015; tax on other financial products will be increased in 2017 (noted as potential positive impact). ### C. Financial conglomerates (FCs) — role, benefits, and supervisory challenges - Role and market share: - There are three large FCs, all led by banks, with asset management and insurance subsidiaries active in life and non-life activities. - Banking entities of the three FCs account for 42 percent of banking sector assets and 20 percent of insurance sector assets. - Synergies and business model: - FCs benefit from marketing and distribution synergies; cross-selling of banking and insurance products is important. - Bancassurance model provides distribution channel and fee income for banks. - Risks and structural challenges: - Complex group legal structures complicate risk management, supervision, and resolution. - Intragroup transactions between banking and insurance entities have increased as FCs enhance business integration. - Risk management practices differ across sectors; full integration of group-level risk management and control functions is not yet achieved. - Fragmented regulatory frameworks across banking, securities, and insurance can create regulatory arbitrage opportunities through intragroup transactions despite Solvency II improving consistency of capital requirements. ### Institutional setting — supervisory responsibilities, objectives, and powers - Twin peaks supervisory model (since April 1, 2011): - NBB and Financial Services and Markets Authority (FSMA) assumed responsibilities of former CBFA. - NBB: micro- and macro-prudential supervision of banks, insurance companies, and stock-broking firms. - FSMA: supervision of management companies for UCITS, asset management companies, investment advisers, market supervision (including issuance of public financial instruments), and rules of conduct. - Single Supervisory Mechanism (SSM) and national roles: - With SSM implementation, direct supervision of credit institutions is performed by ECB for significant institutions (SIs) and by NBB for less significant institutions (LSIs) as defined in the SSM Regulation and Articles 3 and 134 of the Banking Law (BL). - FSMA supervises compliance with rules of conduct applicable to all financial institutions. - NBB acts as the Belgian National Competent Authority (NCA) within the SSM; a cooperation protocol between NBB and FSMA was concluded on March 14, 2013. - NBB issues circulars describing supervisory objectives, interpretation of legal framework, and expectations; NBB discloses supervisory tasks and description of the SSM on its website. - EU-level responsibilities and national implementation: - Article 4 of the Capital Requirements Directive (CRD) IV requires member states to ensure competent authorities assess compliance with CRD IV and the Capital Requirements Regulation (CRR). - CRD IV, BRRD, and EBA guidelines provide a framework for supervisory powers and delegate authority to member states to ensure national laws enable supervisors to set and enforce prudential standards. - Banking Law (BL) and consolidated supervision: - BL implements and sets framework for compliance with EU laws and coordination with ECB through the SSM. - Articles 15 and 134 (2) of BL require supervisors to consider capacity to achieve developmental objectives and potential effects of supervisory decisions on stability of financial systems of other member states concerned. - 2014 revisions to BL introduced a new chapter on consolidated and supplementary supervision (Articles 164–219) reflecting FICOD: - Integrates references to CRR (Pillar 1 and 3) and CRD IV (Pillar 2). - Eliminates differentiated supervisory treatment between groups headed by a financial holding company (FHC) or a credit institution (consolidated supervision) and groups headed by a mixed financial holding company (MFHC) (previously only supplementary supervision under FICOD). - Consolidated supervision may be applied at the top level whether the FC is headed by a MFHC, FHC, credit institution, or insurance company. - Revisions address supervisory authority’s ability to request data and information from mixed activity holding companies (MAHCs) necessary to exercise supervisory role. *Source: IMF staff, "BELGIUM" (excerpts from CR1870 PDF).* ### 29. Article 170 of BL extends application of all provisions based on the consolidated ### Article 170 of BL extends application of all provisions based on the consolidated position of the FHC to the level of a MFHC ### Scope and effect of Article 170 - Article 170 applies when: i) banking sector is the most important of the FC, ii) at least one of the subsidiaries is a credit institution, and iii) the supervisory authority exercises both the consolidated supervision and the supplementary conglomerate supervision. - Effect: eliminates the need for supervisory authorities to choose between consolidated supervision or supplementary supervision at the MFHC level, enabling implementation of both and broadening the supervisory scope. ### Independence, accountability, and legal protection of NBB - Governor appointment and dismissal: - Governor is appointed by the King for a five-year term. - Dismissal only if he/she no longer fulfils the conditions required for the performance of his/her duties or if he/she has been guilty of serious misconduct (Article 23 of the NBB Organic Law). - The Royal Decree removing the Governor is a public document and states the reasons for removal; therefore, reasons for dismissal are disclosed. - Staffing: - ECB requested in 2015 that the NBB increase its joint supervisory team (JST) contribution to 37, a level that the NBB has met. - Demand for onsite inspections and internal model investigations (IMI) has required strengthening of NBB resources. - Turnover is very low and an additional number of staff positions will be filled. - Independence and governance: - NBB has operational and financial independence to carry out supervisory tasks without political interference. - Article 22 of the NBB Organic Law states that the Minister of Finance does not have the right to supervise NBB transactions nor to oppose implementation of any measure contrary to the law, the Statutes or the interests of the State. - Oversight is provided by the Chamber of Representatives; the Governor sends an annual report to that body. - Additional independence layer: integration of banking supervision with the ECB in the SSM. - Legal protection for supervisory staff: - Article 12bis, § 3: “the NBB, the members of its bodies and the members of its staff shall not bear civil liability for their decisions, acts and conduct in the exercise of the legal tasks of the NBB, save in the event of fraud or gross negligence”. ### Interaction with ECB/SSM and other agencies - SSM operation: - The SSM has been in operation since November 2014. - Credit institutions categorized as significant (SI) and directly supervised by the ECB or LSI and directly supervised by the NCAs under ECB oversight. - Factors for SI/LSI designation include: size, importance to the economy of the Union or any member state of the euro area, and significance of cross-border activities (per SSM Regulation and SSM Framework Regulation). - ECB supervisory powers (selected): - Carry out off-site supervision in accordance with Article 4 of SSM Regulation. - Adopt supervisory measures in accordance with Articles 16 and 18 of SSM Regulation. - Conduct on-site inspections and general investigations in accordance with Articles 11 and 12 of the SSM Regulation and Articles 143 to 146 of the SSM Framework Regulation. - JST and supervisory model: - Day-to-day supervision performed by a JST comprising staff from the ECB and the NBB under an ECB coordinator. - Consolidated-level supervision performed by JST with high involvement by ECB and NCA staff. - Solo/sub-consolidated supervision follows same model as consolidated supervision. - LSI supervision can be influenced by the ECB via Article 6(5) of SSM Regulation (e.g., issuing regulations, guidelines, general instructions). - Cross-sector and EU-level cooperation: - Legal framework grants powers for cooperation, coordination, and information sharing to facilitate group-wide supervision. - Within the EU, cooperation among sector supervisors is governed by the Directive on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a FC (FICOD). ### Supervisory approach and techniques (SSM SREP, NBB practices) - SREP and scope: - The ECB carries out SREP for SIs at consolidated, sub-consolidated and single-entity levels unless waived under Articles 7, 8, and 10 of the CRR. - SSM SREP based on EBA guidelines (EBA/GL/2014/13) and applied proportionately. - Four pillars of SSM SREP: - (i) business model and profitability assessment; - (ii) internal governance and risk management assessment; - (iii) risks to capital; - (iv) risks to liquidity and funding. - Outcomes and linkage: - Assessments result in an overall SREP assessment that underpins supervisory actions, including capital or liquidity adequacy decisions and other qualitative or quantitative measures. - Direct link between supervisory assessment, necessary supervisory measures, and the supervisory examination program (SEP). - Planning and execution: - Article 99 of CRD IV requires annual supervisory assessment program including plan for activities and resources, identification of institutions for enhanced supervision, and plan for onsite examinations. - SEP covers off-site ongoing supervision and on-site missions in line with available resources. - In-depth reviews conducted through on-site reviews (inspection or IMI); inspection teams are organizationally independent but cooperate closely with JST. - Final supervisory decisions taken by the Supervisory Board and the Governing Council of the ECB. - SI categorization and supervisory engagement: - SIs grouped into five categories; grouping reflects potential impact of resolution on financial stability and intrinsic riskiness. - Categorization updated annually or on developments (e.g., purchase of another bank). - Impact assessment uses size, complexity and geographical diversification, substitutability, interconnectedness, and implicit groups (as in FSB SIFI context). - Supervisory engagement varies by category in supervisory expectations and resources (especially JST resources). - LSI supervision by NBB: - NBB defines domestic priorities for LSI supervision annually for the following 12 to 18 months. - NBB adopts minimum engagement levels (MELs) for standard activities and defines individual SEPs for high priority LSIs and aggregated SEPs for non-high priority LSIs. - Through SREP for LSIs, the NBB identifies weaknesses requiring prudential action; SREP fosters dialogue with institutions. - Monitoring organized under multidisciplinary supervision teams with roles for financial analysts (mainly off-site), institutional specialists (mainly off-site), and inspection teams (mainly on-site). - NBB categorization criteria merge concepts from the BL and the SSM Regulation; categories: high priority LSIs (category 4), medium priority LSIs (category 3), low priority LSIs (categories 1 and 2). ### LSI on-site inspection minimum frequencies and monitoring - Minimum frequency for on-site inspections: - High priority LSIs: 1 inspection / year - Medium priority LSIs: 1 inspection / 4 years - Low priority LSIs: 1 inspection / 7 years - EU (non SSM) branches: no minimum frequency, event driven. - Operational outcome: - This leads to approximately 5-6 inspections for LSIs per year. - Anti-money laundering inspections are not included in these MELs; they are based on a separate risk analysis and planning. - Ongoing monitoring MEL includes: - Annual reviews of financial information and audit reports; - Analysis of internal risk management reports, recovery plans, Internal Capital Adequacy Assessment Process (ICAAP); - Meetings with senior management, directors, internal and external auditors; - Risk assessment updates and SREP; - Early warning system (Quick Look Tool) identifies outliers based on financial ratios and trend analysis. ### Capital adequacy framework and key statistics - Basel III implementation and Belgian bank capital ratios: - Belgian banks’ end 2016 average Tier 1 and total capital ratios: 15.7 and 18.8 percent. - EU average capital ratios: 15.5 and 18.5 percent. - Full implementation of Basel III being phased in until 2019 is not expected to substantially lower these figures. - Capital requirements application: - Capital requirements imposed on solo and consolidated bases. - CRR requires each individual institution to meet capital adequacy requirements on an individual basis even if part of a group. - CRR allows NBB to waive solo capital adequacy requirements where parent and subsidiaries established in Belgium (CRR, Article 7); NBB has never applied this option. - Material deviations from Basel standards in EU implementation (RCAP findings) relevant to Belgium: - Investment in insurance subsidiaries: CRR allows, if conditions met, investments to be risk-weighted at 370 percent instead of deduction required by Basel III (Article 49, paragraph 1 and Article 471 of the CRR). - Exposures to SMEs: transitional provision in CRR multiplies capital requirements for SME exposures by factor 0.7619 corresponding to ratio between 8 percent and 10.5 percent. - Credit valuation adjustment (CVA) risk: CRR allows exemption from CVA risk capital charge for transactions between EU banks and “CVA exempted entities”. - NBB-specific capital regulation adjustments: - Gradual elimination of possibility for IRB banks to use the standardized approach for sovereign exposures; phased implementation from 2014 to 2018 with application percentages by year (20 percent in 2014, 40 percent in 2015, 60 percent in 2016, 80 percent in 2017 and in 2018 100 percent). - NBB regulation immediately implements some CRR options for new capital definition items (e.g., goodwill and negative results for the current year fully deducted from own funds per Article 22 of the NBB Regulation of March 4, 2014). - Non-risk based capital (gearing/leverage) requirement in Belgium: - Belgium maintains a long-standing gearing ratio; minimum own funds requirement calculated as: - 6 percent of liabilities ≤ €25 million, plus - 4 percent of liabilities > €25 million and ≤ €125 million, plus - 3 percent of liabilities > €125 million and ≤ €250 million, plus - 2.5 percent of liabilities >€250 million and ≤ €1.250 million plus - 2 percent of liabilities > €1.250 million. - The ratio is more constraining than fully-loaded risk based capital requirements (including buffers) only for a limited number of banks. *International Monetary Fund — cr1870 (excerpt provided)* ### 58. The NBB requires banks to voluntarily maintain higher capital requirements for ### The NBB requires banks to voluntarily maintain higher capital requirements for ### Mortgage risk-weight add-on - Until May 27, 2017 the regulatory framework imposed a 5-percentage point add-on to the risk weights for mortgages backed by real estate calculated by banks using the IRB approach. - The add-on meaningfully increased capital requirements, considering that the average risk weight calculated by the IRB banks is around 10 percent. - The add-on aimed to mitigate potential risks arising from the Belgian real estate sector given sustained housing price increases combined with a progressive build-up of households’ debt. - At the end of May, the regulation imposing the additional requirement expired. - While new proposals are being discussed, banks have been advised to continue using the former requirement to calculate their risk weighted assets. ### Capital buffers - The CRD establishes five different types of capital buffers (Articles 128-135): - CCB. The CCB is currently set at 1.25 percent of risk-weighted assets (until end 2017). It is being phased in according to the international timeline and applies to all SIs and LSIs. - Countercyclical Capital Buffer (CCyB). The CCyB is currently set at zero percent for exposures in Belgium, but its final value depends on the CCyB ratios established in the jurisdictions where the bank operates. The CCyB applies to all SIs and LSIs. - Global Systemically Important Institution (G-SII) buffer. The G-SII follows the Basel methodology for the Global Systemically Important Banks (G-SIBs). Some banks operating in Belgium such as BNP Paribas, ING Bank and The Bank of NY Mellon are classified as G-SIIs and are subjected to the applicable capital surcharge. - Other Systemically Important Institution (O-SII) buffer. Banks are identified as O-SIIs according to their size, importance for the economy of the EU and Belgium, significance of cross-border operations and interconnectedness. Each O-SII is allocated into one of two buckets according to their degree of systemic importance. The CRD allows authorities to require an O-SII buffer of up to 2 percent. The actual levels of the Common Equity Tier 1 (CET1) capital surcharges are presented in Table 4. - Systemic risk buffer. It is designed to mitigate long term non-cyclical systemic or macroprudential risks not covered by the CRR. It is currently not applied in Belgium. - Table 4. Belgium: O-SII Capital Buffer (From January 1, 2018. Current values are 1 percent for institutions in the highest bucket and 0.5 percent for the lower bucket): - O-SII Bucket | O-SII buffer rate, percent - BNPP Fortis | 2 | 1.5 - KBC Group | 2 | 1.5 - Belfius Bank | 2 | 1.5 - ING Belgium | 2 | 1.5 - Euroclear | 1 | 0.75 - The Bank of New York Mellon | 1 | 0.75 - Axa Bank Europe | 1 | 0.75 - Argenta | 1 | 0.75 - The capital buffers should be met with CET1. - The CCyB, G-SII, O-SII and systemic risk buffer extend the CCB. Only the highest buffer among the G-SII, O-SII and systemic risk buffer are applied at a consolidated, sub-consolidated and solo basis. ### Internal models - Major banks in Belgium make extensive use of internal models to calculate capital requirements. - Internal models tend to require substantially less capital than the standardized approaches. - In Belgium, the low default rate reflected in the databases of banks generates particularly low risk weights in comparison with other European countries. - Internal models for credit risk are the most used, including by seven SIs and two LSIs. - After the establishment of the SSM the responsibility for model approval is split between the SSM and the NBB, depending on the bank, but no bank has been authorized to use advanced approaches recently. The last authorization to use the advanced IRB approach was granted in 2013. - Any material change to an approved internal model needs prior permission by the competent authority. - Table 5. Belgium: Use of Internal Model Approaches by Belgian Banks (Source: NBB): - Systemic Institutions (SIs): - KBC Group: Internal Models for Credit Risk (IRB) Yes; Internal Models for Market Risk Yes; Internal Models for Operational Risk (AMA) No - Belfius Banque: Yes; Yes; No - Dexia Group: Yes; Yes; No - Investar: Yes; No; No - Axa Bank Europe: Yes; No; No - BNP Paribas Fortis: Yes; Yes; Yes - ING Belgium: Yes; Yes; Yes - Less Systemic Institutions (LSIs): - Euroclear: Yes; No; Yes - Crelan: Yes; No; No ### Pillar 2 add-ons and SREP - The ECB has the power to require institutions to hold capital in excess of the Pillar 1 requirements set out in CRR (Article 16(2)(a) of the SSMR). - The SREP is composed of the risk assessments, ICAAP and ILAAP reviews and Pillar 2 quantifications, which include stress tests. - Final SREP conclusions can include corrective measures and additional capital and/or liquidity requirements. - The capital decision takes the form of a Pillar 2 capital add-on. The Pillar 2 add-on is composed of a Pillar 2 requirement and a Pillar 2 guidance: - A Pillar 2 requirement is binding and expected to be observed at all times. Its breach affects the maximum distribution of a bank’s profits. - The Pillar 2 guidance is nonbinding, does not affect profit distributions and is based on the results of the supervisory stress tests. - Independent Pillar 2 assessments and decisions are taken for material subsidiaries. Supervisors can impose the same or differentiated Pillar 2 requirements on consolidated, sub-consolidated and individual levels. - Large Belgian subsidiaries of SSM banking groups (BNPP Fortis, ING Belgium) are subject to a SREP decision including a Pillar 2 requirement and a Pillar 2 guidance. This is not the case for small subsidiaries due to their lack of materiality within the group. ### Prudential requirements for bank subsidiaries and proposed CRR waivers - The European Commission published on November 23, 2016 a legislative proposal that would expand waivers from capital and liquidity requirements to subsidiaries located in a different member state than the parent entity. - The proposal argues that requiring subsidiaries to comply with capital and liquidity requirements on an individual basis may prevent groups from managing resources efficiently at group level and would facilitate pooling of capital and liquidity at the group level. - In practice, the proposed waivers mean individual banks within the group may not have to meet minimum capital and liquidity requirements if conditions are met: - The competent authority supervising parents established in a member state within the banking union (the ECB) would be able to waive the application of own funds and liquidity requirements for subsidiaries located in other member states than the parent if they are included in the consolidated requirements. - To safeguard host countries, the capital waiver would only be granted if the parent commits to supporting its subsidiaries for the whole amount of the waived requirement and the guarantee is collateralized for at least half of the guaranteed amount. - The same waivers would be available as an option, and only if the competent authority of both the parent company and the subsidiary agree, for banking groups that include EU parent companies and/or subsidiaries outside the banking union. - Cross border waivers for liquidity requirements are already allowed by Article 8 (3) of the CRR. As the competent authority responsible for granting this waiver, the ECB has issued a guideline where it establishes a minimum Liquidity Coverage Ratio of 75 percent for systemically important subsidiaries. - The ECB is working on a recommendation to the EC for additional prudential safeguards and technical modifications to address potential financial stability concerns resulting from the waiver mechanism, particularly for systemically important subsidiaries. - The FSAP team’s view: - Supports the single market, but during the transition to a full banking union considers that prudential requirements and adequate supervision at the national level remain important for financial stability. - Recommends that any changes to capital, liquidity or governance requirements or the intensity of supervision be made gradually and be mindful of financial stability in individual member states, especially for systemically important subsidiaries. - The proposed waivers will be discussed further as part of the upcoming euro area FSAP. ### Recommendations on internal models and model governance - The relatively heavy reliance on internal models for regulatory capital requires strong oversight by banks’ boards and supervisors. - The targeted review of internal models launched by the SSM is assessing banks’ compliance with regulatory requirements and the reliability of the models currently authorized for capital requirements calculation. - The targeted review project entered the execution phase in 2017. It is planned to be completed by 2019. - Key supervisory and bank actions recommended: - Sound execution of the targeted review and continued efforts to improve ongoing model monitoring to reduce unwarranted variability of RWAs. - Supervisors should enforce strong oversight of the models by banks’ boards. - Banks should have an appropriate model risk management framework, including effective model governance, a risk control function, a validation function and internal audit as a third line of defense. ### Credit risk framework and supervisory practices - The BL (Annex I) requires institutions to have internal procedures to assess the credit risk associated with risk positions on different debtors, securitizations, securities and the entire portfolio, and these procedures should not rely solely on external ratings. - Additional BL requirements include: - Clear procedures for approval, amendment, extension and refinancing of credits and sound and clearly defined criteria for granting credit. - Appropriate systems for the management and continuous monitoring of the loan portfolios and risk positions to which credit risk is linked. - Appropriate diversification of credit portfolios, considering the overall credit strategy. - The requirements for credit risk management are verified through on-site inspections and reports from management and from accredited auditors in the context of SREP (BL, Article 148). - The BL grants authorities full access to information in the credit and investment portfolio and to bank officers. - The law requires institutions to conduct stress tests that are considered during the SREP evaluation. ### Problem assets, provisions and reserves - NPLs in Belgium are relatively low. NPLs have declined during the last two years and accounted for 3.4 percent of the total loans at the end of 2016. - The result of the 2014 SSM asset quality review has not had a significant impact on the general level of provisions of most Belgian banks. - The regulatory framework for problem assets, provisions, and reserves consists of two layers: accounting and prudential. - Accounting layer: requirements on the valuation and presentation of assets and liabilities for both general purpose financial statements and prudential returns. - Prudential layer: additional provisions on the management of credit risk and the solvency treatment of problem assets, provisions, and reserves. - Reporting standards: - Both SIs and LSIs should report in accordance with the Belgian Generally Accepted Accounting Principles (BGAAP) on an individual basis and International Financial Reporting Standards (IFRS) on consolidated terms. - The European financial reporting (Finrep) follows, on an individual basis, the national accounting rules (BGAAP) unless the institution has requested and obtained a special agreement from the ECB (SI) or the NBB (LSI) to prepare its Finrep solo reporting based on IFRS. - Loan-loss provisions are established in accordance with accounting standards. IAS 39, and after January 1, 2018, IFRS 9, lays down the principles for impairment recognition for banks under a consolidation obligation, which prepare their consolidated financial statements in accordance with IFRS. - BGAAP distinguishes two classes of problem assets: “loans with uncertain outcome” and “doubtful loans” and requires a forward-looking approach for realistic repayment and recovery expectations: - “Doubtful” loans require individual (specific) provisions in the expectation that there will not be full payment of the outstanding principal and interest. - “Uncertain” loans are assigned provisions for the part considered uncertain. - The prudential framework sets additional requirements for problem assets aiming to reinforce governance mechanisms, information systems, and procedures. The BL requires banks to have appropriate systems that include detection and management of problem loans. SREP guidelines require management body approval of credit risk policies, clear formalization, communication and consistent application across institutions. - Review of loan classification and provisioning is entrusted to external auditors. Accredited external auditors must provide an opinion to the supervisor on the correctness of the annual accounts and the prudential reporting of the banks on a semiannual basis. - Auditor rotation and independence: - Article 17 of the EU Audit Regulation imposes a maximum term of ten years for auditors of public interest entities, with exceptions (extension to 24 years when a college is formed). - Article 133 of the Belgian Companies Code: auditors are appointed for renewable terms of 3 years, with a maximum of nine years, extendable to 24 years in case a college is established after the initial nine years. *Source: IMF Staff report content provided in the supplied material.* ### 79. Belgian authorities have issued limited supervisory guidance on asset classification ### 79. Belgian authorities have issued limited supervisory guidance on asset classification ### Supervisory guidance on asset classification and provisioning - Belgian authorities have issued limited supervisory guidance on asset classification and provisioning beyond the accounting standards. - As most European countries with low NPL ratios, Belgium has not issued substantial guidance to banks on issues such as NPL recognition and classification, classification of forborne exposures, impairment triggers, provisioning, write-offs or accrued interest. - Banks are mostly expected to follow accounting standards. ### ECB guidance on non-performing loans (NPLs) - The ECB published guidance on NPLs detailing supervisory expectations for the treatment of NPLs; applicable to all SIs supervised directly under the SSM. - The guidance includes supervisory expectations regarding banks’ policies, systems and procedures for the recognition of NPLs and the impairment measures including provisions and all the elements of the management of problem assets. - The guidance is applicable considering the principle of proportionality and respecting accounting differences across countries. - It provides elements to harmonize definitions and supervisory reports across countries and gives some best practice examples to reduce diversity in implementation. - The guidance does not have a prescriptive nature and does not provide accounting requirements, but describes practices that may be applied within existing accounting frameworks. - Footnote reference in source: 28 https://www.bankingsupervision.europa.eu/ecb/pub/pdf/guidance_on_npl.en.pdf ### Supervisory review and limitations - Supervisors review the overall framework for problem assets and provisions within the SREP. - SREP guidelines require competent authorities to ensure the credit risk framework enables the institution to differentiate between different levels of borrowers and to determine the level of provisions and credit valuation adjustments required to cover expected and incurred losses. - External auditor reports are considered in this process. - Supervisors face important limitations when requiring banks to hold appropriate amounts of provisions: - Asset classification and provisioning are mainly driven by accounting standards. - The NBB and the SSM cannot directly instruct Belgian banks to adjust their classifications of individual assets, nor to increase their levels of provisions and reserves. - Supervisory powers allow the ECB to influence provisioning policy within the limits of accounting standards and to require credit institutions to apply specific adjustments (deductions, filters or similar measures) to own funds calculations where the accounting treatment is considered not prudent from a supervisory perspective. ### Recommendations on asset classification and provisioning - Supervisors should play a more active role in assessing loan classification to ensure prudent provisioning practices. - Belgian supervisors have traditionally viewed loan valuation as an accounting function and relied heavily on external auditors to assess the correctness of provisioning amounts. - The ECB “Guidance to banks on non-performing loans” helps introduce prudential considerations and narrow bank management’s judgement but its non-rule nature has limits. - Continue regulatory efforts to ensure appropriate prudential treatment of problem assets and complement them with more intrusive supervisory reviews. - EBA Guidelines on SREP require competent authorities to pay particular attention to the adequacy of the classification of credit exposures and assess the impact of potential misclassification. - In practice, cases where the supervisor directly tests a bank’s treatment of assets to identify independently material circumvention of classification and provisioning standards are not common. - The credit risk framework could be further enhanced by introducing more granular regulatory requirements: - Require that credit risk exposures that are especially risky or otherwise not in line with the mainstream of the bank’s activities be decided by the bank’s board or senior management (BCP17.6). - Require banks to have policies and processes to monitor the total indebtedness of entities to which they extend credit (BCP 17.4). - Authorities could consider reducing the maximum period of engagement of external auditors before mandatory rotation. - Periods defined in the Companies Code: maximum of 9 years, extendable to 24 years in case a college is established after the initial 9 years, might be excessively long to ensure auditor independence. ### Concentration risk and large exposures - Regulatory framework focuses on concentration risk from exposures to individual counterparties or groups of connected counterparties. - Banks required to have procedures and internal control mechanisms for identifying, managing, monitoring, reporting and recording large exposures (exposures equal to or in excess of 10 percent of the institutions’ eligible capital). (CRR, Article 393) - SSM Supervisory Manual requires institutions under direct supervision to have a concise and practical definition of credit concentration; SREP guidelines require supervisors to identify and measure credit concentration risk including single name, sectoral, geographical, product and collateral concentrations. - Gaps in the framework: - No explicit requirement for banks to have policies/processes providing a bank-wide view of sources of concentration risk, including markets, asset classes, collateral and currencies (CP 19.1). - No specific requirement that all material concentrations be reviewed and reported to the bank’s supervisory board (CP 19.3). - Law does not provide supervisors discretion in applying the definition of a “group of connected counterparties” on a case by case basis (CP 19.5). - Large exposure limits aligned broadly with international standards (CRR, Articles 389, 395 and 403). - Definition includes both on- and off-balance-sheet items. - Exposure is a large exposure where value is equal to or exceeds 10 percent of institution’s eligible capital. - A bank may not incur exposure to a client or group of connected clients higher than 25 percent of its eligible capital. - Exceptions that may weaken the limit: - If the counterparty is a credit institution or investment firm, the limit is 100 percent of the bank’s eligible capital or EUR 150 million, whichever is higher, when the reporting institution’s eligible capital is lower than EUR 600 million. - Other relevant exceptions apply, such as for some off-balance sheet facilities. - Some exemptions under national discretion are not compliant with the international standard (CRR, Article 400(2)); the ECB opted to exercise a number of these exemptions. - Exposures of Belgian banks to parent undertakings and sister institutions are limited: - NBB implemented CRR options maintaining a system of intra-group concentration limits for SIs and LSIs (discretion foreseen in CRR Article 493(3)(c)). - Rules limit up-and-sideways intra-group exposures from Belgian banks to foreign parent companies and their subsidiaries to 100 percent of eligible regulatory capital. - Exposures to subsidiaries of Belgian banks are not limited. ### Transactions with related parties - Banks required to make credit decisions free of conflicts of interest. - Belgian BL requires credit institutions to have sound organizational structures and effective procedures for prevention of conflicts of interest; NBB Governance Manual requires a comprehensive policy to identify and prevent conflicts of interest. (BL, Article 72) - Legal provisions are insufficient for a comprehensive prudential framework for transactions with related parties: - Specific provisions (Article 72 of the BL) limited to loans, credits and guarantees and do not include other transactions such as service contracts, asset purchases and sales, construction contracts, lease agreements, derivative transactions and write-offs. - Definition of related party is narrow and does not include other institutions of the broad economic group (only the parent undertaking) and does not allow supervisors discretion in applying the definition. - No requirement that related party exposures be monitored and controlled separately and in aggregate by the bank. - Recommendation: widen the definition of related parties and covered transactions; require banks to establish stronger policies and processes to identify them; and more actively monitor these transactions. ### Risk management, internal controls and audit - Belgium follows the three-lines-of-defense model: - First line: commercial and business units (including front office) responsible for identifying risks and observing procedures and limits. - Second line: control functions (risk management and compliance) ensure risks are identified and managed according to policies and procedures. - Third line: internal audit monitors compliance by first and second lines. - Control functions must have sufficient authority, status and resources and be independent from operational functions. - Persons responsible may report directly, if necessary through the risk committee, to the board. - Head of control functions may only be removed by the board after previous notification to the supervisory authority. - Management committee must provide the board, the accredited statutory auditor and the supervisory authority a report on the effectiveness of the organizational structure and measures taken to tackle any non-conformity. - Risk management framework requirements: - CRD and EBA guidelines require an appropriate risk management framework commensurate with the risk profile, including clear organizational structure and effective processes to identify, manage, monitor and report all relevant risks. - Belgium transposed EU directives into national law and NBB issued circulars transposing EBA guidelines into Belgian legislation. - Board responsibilities: - Board must determine risk tolerance and closely monitor risk profile (BL, Article 57). - Approve and regularly review strategies and policies on taking, managing, monitoring, and mitigating risks. - Devote a great proportion of activity to supervision of management of significant risks including valuation of assets and use of external ratings and internal models. - Ensure sufficient resources allocated to risk management activities; establish a risk committee within the board. - Regulation requires reporting mechanisms providing timely and appropriate risk information to the board and relevant units. (NBB Governance Manual) - Structure of the board (management body): - Three functions: policy, management, supervisory. - Division between senior management (management committee, executive members) and supervisory function (non-executive members); general policy function entrusted to the governing body as a whole. - Specialized advisory committees recommended: audit, risk, remuneration, nomination; composed of non-executive members. - Non-executive majority on board; chairman cannot chair the management committee. - Chief Risk Officer (CRO) must be an executive member of the management committee. - Head of risk management cannot exercise any other function except, subject to supervisory approval, the compliance function. - SREP assesses adequacy of internal governance and risk management across: - Internal governance framework (including risk management, internal auditing, compliance), - Risk management framework and risk culture, - Risk infrastructure, internal data and reporting. - Assessment includes monitoring of risk exposures, need for risk mitigation, and adequacy of internal policies, organization and limits. - Supervisors assess whether senior management and the board have necessary knowledge and information to understand risks being taken. - Supervisory assessment of risk appetite framework: - Reviews whether mechanisms ensure alignment of risk appetite, risk management strategy, and business strategy and their embedding in decision-making and operations. - Board required to ensure risk appetite translates into clear incentives and constraints for business lines. - Risk appetite should cover activities outside direct control including subsidiaries and third-party outsourcing suppliers. - Supervisory review of ICAAP/ILAAP: - Supervisors review annually the board’s and senior management’s role in approving the ICAAP/ILAAP and their role in capital planning, strategy and risk appetite setting. - ICAAP/ILAAP assumptions and methodology expected to be reasonably understood and discussed. - Risk data and reporting improvements: - NBB finalizing a new circular establishing a framework for risk data aggregation and reporting, expected to incorporate BCBS “Principles for effective risk aggregation and risk reporting” and ECB developments. - ECB conducting a thematic review as part of SSM priorities for 2016–17 to assess compliance with BCBS principles on data aggregation and reporting. - Supervisors have tested banks’ capability to aggregate risk data rapidly by making occasional requests with short deadlines. - Recovery and contingency planning: - Banks required to develop and maintain recovery and contingency plans. - Recovery plans should include a range of recovery options, conditions and procedures for timely implementation, scenarios of severe macroeconomic and financial stress, and a framework of indicators identifying trigger levels for decision-making on recovery actions. - ECB and NBB assess whether proposed arrangements are likely to restore viability and whether conditions for implementation are reasonable. - All banks need to maintain recovery plans; obligations of small non-complex firms are simplified. - Banks should keep contingency and business continuity plans ensuring ongoing operation and limiting losses in severe business disruption. *Source: cr1870 - 79. Belgian authorities have issued limited supervisory guidance on asset classification* ### 102. Supervisors require banks to have a stress-testing program and demonstrate how they ### cr1870 - 102. Supervisors require banks to have a stress-testing program and demonstrate how they ### Stress testing and banks' internal assessment - Supervisors require banks to have a stress-testing program and demonstrate how they use its outcomes for risk management and internal capital and liquidity assessment. - Banks are supposed to follow the EBA guidelines on stress testing. - Supervisors periodically assess: - the frequency of the tests, - their integration with the overall risk management framework, - whether the results are reported to the board. - Supervisors also assess: - if assumptions and scenarios are regularly reviewed and updated, - if different horizons are implemented (institution specific, market wide and possible combinations), - if the stress testing has an impact on individual level as well as on the group wide position. - The NBB also expects LSIs to develop, in the course of their ICAAP/ILAAP, rigorous stress testing exercises. ### Compliance function - The BL requires all banks to establish an independent compliance function in accordance with international standards. - The compliance function is responsible for monitoring compliance with the legal and regulatory rules on integrity and conduct applicable to credit institutions. - The compliance function is expected to prevent the credit institution from suffering consequences—in particular, a loss of reputation or credibility—of non-compliance with legal and regulatory provisions or with ethical rules applicable to banks. - Legal provisions are complemented by a circular postulating several principles detailing supervisors’ expectations on governance, reporting and resources; the principles are applied proportionally. - Supervisors assess compliance with the legal provisions via on-site and off-site examinations. ### Strengthening control functions and governance - The NBB and EBA have proposed regulatory changes to further strengthen control functions: - The NBB, together with the FSMA, is further developing the “fit and proper” criteria for compliance officers, which includes an examination for candidate compliance officers; mandating the board to define an appropriate integrity policy; and requiring a specific yearly reporting by the board to the supervisor on the evaluation of the compliance function. - The EBA launched in October 2016 a public consultation on its revised guidelines on internal governance, placing more emphasis on the duties and responsibilities of the board in its supervisory function on risk oversight and improving the status of the risk management function. ### Internal audit - Internal audit requirements are aligned with international standards. - The BL requires credit institutions to establish an independent audit function covering all the institution’s operations and entities, including in the case of outsourcing. - The internal audit function should report directly to the board, where applicable through the audit committee, and should keep the management committee or the senior management informed about its findings. - Supervisors assess compliance with legal and regulatory requirements on an on-going basis within the Internal Governance and Risk Management Assessment part of the SREP. ### Recommendations on governance, board engagement, and data - Efforts to strengthen the risk management and control functions should continue; inspections show room to further enhance standards by strengthening the role of the board in its supervisory function (paragraph 106). - Regular meetings with the full board should form an integral component of supervision practices: - Meetings with key individual members of the board (CEO, CRO) are frequent, but meetings with the full board are not part of the standard supervisory practice. - Annual meetings with the full board (including non-executive independent directors) would help the supervisor assess the role of the board in overseeing management (paragraph 107). - Risk data aggregation and reporting need continued attention: - Supervisors have found weaknesses in data quality across Belgian banks and FCs. - Issues arise from aging IT infrastructure, legacy systems, and lack of harmonized IT policies across multiple legal entities. - Standards for data aggregation and the need for a bank-wide view of risk should continue to be enforced by supervisors (paragraph 108). ### Insurance supervision — Supervisory approach and resources - The 2013 FSAP highlighted the importance of having adequate resources to effectively discharge supervisory mandates, especially with Solvency II and cross-border groups. - In 2012, staff allocated to Insurance Supervisory Resources comprised around 50 full-time-equivalents (FTE). - Key tasks included close monitoring of distressed insurers; enhanced supervision of nine insurance groups (six complex); and resource-intensive implementation of Solvency II. - Early adoption of key Solvency II requirements enabled industry to meet higher capital requirements without relying on the 16-year transitional measures. - NBB identified troubled insurers early and applied intrusive supervision to improve solvency positions. - Industry actions included lowering guaranteed rates of saving products, shortening the period of guarantees (to eight years or even shorter for the majority of products), reducing the ALM gap, and encouraging policyholders to surrender contracts with the highest guaranteed interest rates. - Thanks to those efforts, most of the industry meets the Solvency II capital standards without relying on transitional measures. - The NBB improved resources and expertise via early adoption and well-prepared implementation of Solvency II: - Resources expanded gradually with effective training programs and sufficient training budgets. - NBB retained highly-trained staff and hired experts from industry; senior management commitment and reasonable compensation aided retention. ### Brexit impact (Box 2) — supervisory implications - Brexit uncertainties push internationally active insurance groups to relocate to EU member states; Solvency II allows cross-border diversification and consistent regulatory framework. - Uncertainties raise concerns for reinsurance groups (e.g., Lloyds) on access to EU policyholders, recognition of reinsurance contracts, and the use of internal models post-Brexit. - Large reinsurance players are planning EU subsidiaries; Lloyds announced establishment of a new EU subsidiary in Brussels in March 2017. - The NBB would be responsible for supervising a number of new subsidiaries with complex reinsurance risks; NBB hired four new experts and will transfer four experts internally, coordinating closely with the UK PRA. ### Insurance supervision — Recommendations on staffing and retention - The NBB should continue to analyze the business growth of reinsurance operations and enhance its resources as needed (paragraph 112). - Reinsurance companies are more interconnected and exposed to complex risks; depending on Brexit outcomes, Belgian operations could become significant and systemically important. - The NBB should strive to retain the current staff with substantial knowledge of Solvency II (paragraph 113). - Solvency II requires experts for continuous model validation, improvement of data submission, and guidance for proper implementation (including calculation of best estimate loss absorption capacity of deferred taxes (LAC_DT)). - Current NBB staff obtained deep knowledge during implementation and are difficult to replace; senior management engagement and reasonable compensation help retention. ### Solvency requirements — valuation of assets and liabilities - Insurance assets and liabilities are valued consistently with observable market data for solvency purposes. - Assets generally valued at mark to market. - Technical provisions valued with the best estimate (probability-weighted average of future cash flows taking account of the time value of money), plus Margin Over Current Estimate (MOCE) derived from the cost of capital method with 6 percent as the cost of capital. - Best estimate is discounted by the relevant risk-free interest rate term structure derived from EIOPA. - NBB communicated not to rely on transitional arrangements under Solvency II and encouraged insurers to improve solvency positions before implementation. - Upon NBB approval, use of transitional measures allowed for existing insurance liabilities at the end of 2016; only one company permitted to use the transitional measures. - For general-purpose accounting (BGAAP), assets and liabilities are still valued mainly at amortized cost; assets backing technical provisions are valued at mark to market, except for sovereign bonds. - NBB introduced the Flashing Light provision: - NBB can provide an exemption from the Flashing Light provision upon insurer’s request; no exemptions granted in 2013, 2014 and 2015, resulting in EUR 4.6 billion additional provisions. - The total amount of Flashing Light provisions at the end of 2016 amounted to EUR 7.6 billion. - Interactions between Solvency II valuation, BGAAP valuation, and tax treatment make determination of some asset and liability values complex (deferred tax assets, deferred tax liabilities (DTL), and LAC_DT). - NBB issued additional guidelines capping the LAC_DT to the net DTL in 2016. - In 2017, a new circular allowed going beyond the cap of net DTL; a new cap was defined taking into account the financial position of the undertaking and limiting projections of future profits to maximum five years. - NBB continues to monitor closely and has identified a few outliers. ### Solvency requirements — capital resources and requirements - The NBB has approved only a few insurance groups to use internal models for solvency purposes. - NBB has one centralized unit (Internal Models Supervision) for internal model validation across banks, investment firms and insurers. - Unit imposes rigid requirements (including statistical quality test, calibrating test and use test); EU joint model validations with home and host supervisors aided robustness. - NBB required some Belgian subsidiaries of large groups whose internal models were approved by home authorities to use the standard formula. - Belgian insurers depend on lower quality capital instruments: - Subordinated loans and other lower quality instruments were issued before Solvency II; some firms use the 10-year transition period provided in Solvency II. - Part of unrestricted Tier I capital relies on unrecognized gains from future premiums (so called Value in Force). - Low quality capital instruments may trigger reputational risk to the industry’s overall loss absorption capacity in the next market turmoil. - Insurers using long-term guarantee (LTG) measures are subject to close oversight by the NBB: - Adjustment measures for LTG business and transitional measures over 16 years from January 2016 to January 2032 allowed upon NBB approval. - NBB imposed stringent conditions on transitional measures; only one small insurer is using them. However, many insurers (19) use the VA. - Average SCR ratio with LTG measures was 175 percent as of the end 2016; the ratio would fall to 149 percent without LTG measures. - The application of VA may have led to an overstatement of insurers’ solvency: - VA stabilizes capital resources and is set by EIOPA. - Application of VA increased unrestricted Tier I and improved SCR ratios by 25 percent as of the end of 2016, when the market was stable and the VA was supposed to be immaterial. - Capital resources resulting from VA do not meet the quality and suitability criteria (such as availability and permanence) described in the ICP. ### Enterprise risk management and ORSA - Implementation of Solvency II required significant improvement of enterprise risk management. - ICP16 requires identification and measurement of all material risks, documentation of policies, feedback loops and an annual Own Risk and Solvency Assessment (ORSA) with clear commitment by the board and senior management. - NBB reviews the process and financial condition, including ORSA report, of each insurer and links the outcome to a scorecard. *Source: IMF Financial Sector Assessment — Belgium (selected excerpts).* ### 122. The requirements of Solvency II are based on the Prudent Person Principle (PPP) and ### cr1870 - 122. The requirements of Solvency II are based on the Prudent Person Principle (PPP) and ### Solvency II framework and investment constraints - Solvency II requirements are based on the Prudent Person Principle (PPP) and do not prescribe quantitative limits on investments. - Insurers may invest only in assets and instruments for which they can properly identify, measure, monitor, manage, control and report the underlying risks. - Use of derivative instruments is allowed only if they contribute to a reduction of risks or facilitate efficient portfolio management. - Most insurers are not actively using derivatives; a few groups use them for hedging and yield enhancing purposes. - Some insurers in financial conglomerates (FCs) have engaged in intragroup transactions with parent banks through deposits, repos, securities lending and participations in mortgage loans. ### Capital quality and Value in Force (VIF) - The NBB lacks concrete figures of how much of unrestricted Tier I is composed of Value in Force; rough estimation based on B-GAAP suggests it could reach more than 10 percent of the insurance liabilities. - A significant portion of Tier I may rely on future unrealized gain from existing policies. - Belgian insurers face high redemption risk, increasing the exposure of Value in Force to higher risk. ### Interlinkages with banks and asset management (Box 3) - The insurance sector’s contribution to systemic risk has increased since the financial crisis, with greater commonalities in exposure to aggregate risk across financial sectors. - Business model shift toward asset management type products increases interconnectedness with banks and asset management industry. - Value of unit linked products (“class 23”) has reached over EUR 30 billion, about 10 percent of overall insurance sector assets and 14 percent of premiums. - Premiums for unit linked products are typically invested into group asset management entities or deposited with the parent bank. - Investments of unit linked products are partially exempted from Solvency II capital charges and thus have relatively higher allocation to risky assets. - Majority of investments are into collective investment schemes, mainly equity or mixed funds, often internal funds that may not be subject to UCITS regulatory requirements and thus exempted from investment, leverage, liquidity, concentration, use of derivatives and other requirements. - Insurers should provide clear investment mandates and limits to protect policyholders of those products. - In FCs, insurers use group entities extensively, creating large intragroup concentration: excess cash is deposited with banks or money market funds operated by the group asset manager; derivative transactions for internal funds tend to be conducted with the group bank; structured notes are often issued by SPVs or financing companies sponsored by the parent bank. - Some insurers offer “structured class 23 contracts” with synthetic guarantees and automatic rebalancing; in a sudden market crash rebalancing may fail and policyholders may suffer losses, generating reputational and legal risk. - Automatic allocation mechanisms may exaggerate market volatility by following market directions (buy when markets move up and sell when markets move down). - NBB is working with FSMA to analyze risks from interconnectedness and has found the need for possible regulatory enhancements such as concentration limits for assets of unit linked products. ### NBB supervision, designation of D-SIFIs, and macroprudential authority - The NBB established a methodology to identify systemically important insurance groups; three insurance groups have been designated as domestic systemically important insurers (D-SIFIs). - The designated D-SIFIs belong to bank-led conglomerates and are subject to enhanced supervision: higher allocation of staff, additional reporting requirements, and close monitoring. - The NBB has the power to impose macroprudential measures on the entire financial sector, including insurance. - The NBB analyzed sector-wide risks and imposed banking macroprudential measures (increasing the risk weight for mortgage loans by IRB banks by 5 percent) that currently exempt insurers even if part of the banking group, creating potential for regulatory arbitrage via shifting mortgage portfolios to insurance subsidiaries. - Monitoring intragroup transactions is essential. ### Measures against prolonged low interest rates (Box 4) and industry responses - NBB coordinated to reduce maximum guaranteed interest rates: maximum guaranteed rate was up to 4.75 percent in the late 1990s, reduced to 3.75 percent in July 1999 and to 2 percent in February 2016. - The 2003 law on the supplementary pension system set minimum interest rates: 3.25 percent to employers and 3.75 percent to employees until January 2016; reduced to 1.75 percent thereafter. - Flashing Light Provision (introduced in 2011 under BGAAP) requires gradual buildup of additional technical provisions over 10 years; discount rate calibrated at 80 percent of the average yield over the last five years of the ten-year Belgian sovereign bonds. - Total reserved amount in the Flashing Light provision reached EUR 7.6 billion as of end-2016. - NBB has not granted exemptions from the provision in 2013, 2014 and 2015, encouraging life insurers to reduce guaranteed rates. - Insurers shortened length of minimum guarantees to 8 years from premium payment; legacy portfolios with long-term high guarantees remain but current liabilities do not provide guarantees for future premium payments. - Solvency II transitional measures allow use of Solvency I discounting rates over 16 years upon NBB approval; NBB imposed stringent approval conditions effectively discouraging reliance on the measure. - NBB introduced early warning indicators linked to the SCR ratio and prohibits insurers relying on transitional measures to meet the SCR ratio from paying policyholders’ bonus. - Some insurers executed buy-backs of legacy products with incentives of 10 to 25 percent; buy-back programs (e.g., Ethias) reduced legacy portfolio to less than 5 percent of original size; total buy-back amount reached EUR 7 billion. ### Horizontal reviews, risk identification and supervisory actions (Box 5) - NBB conducts horizontal reviews including ad-hoc reporting requirements, Financial Soundness Indicators (FSIs), and intensive supervisory reviews of outliers. - Reviews target investment risk, interest rate risk, spread risk, liquidity risk and identify outliers for supervisory action. - Interest rate review used four indicators: average guaranteed rate; share of insurance liabilities with guaranteed rates above 80 percent of the 10-year Belgium government bond yield; average remaining maturity of insurance liabilities; share of technical provisions with a guarantee of future premiums. - One large insurance group with high interest rate risk was identified and subject to recovery measures that improved its financial position. - Investment review identified increasing investments into mortgage loans by some insurers: mortgage loan investments increased from EUR 8 billion to EUR 13 billion from end-2014 to 2016. - One small insurer invested more than 50 percent of its total portfolio into mortgage loans. - NBB is considering additional reporting requirements to capture average Loan to Value (LTV) and Debt to Income (DTI) for mortgage portfolios. - Liquidity review covers surrender risk and comparison of illiquid assets/liabilities and off-balance sheet instruments like repos and securities lending. - Indicator of surrenders identified many Belgian insurers suffering negative cash flows; however, most insurers have liquid assets of more than three times their liquid liabilities and for all insurers liquid assets exceed liquid liabilities. - NBB identified only a small number of companies relying extensively on derivatives and repo transactions. - Horizontal reviews have been effective in identifying industry trends and outliers; methods are straightforward and easy for line supervisors to use. ### Liquidity risk and potential macroprudential responses - Life insurance shift to asset management type products improves resiliency to low interest rates but increases potential liquidity risk from higher redemptions, especially if interest rates spike. - NBB is considering measures to address liquidity risk, including imposing minimum requirements on the surrender value calculation (such as charges and market value adjustment) to be applied to new policies. - Recommendation: NBB is encouraged to seek to impose appropriate measures to address increasing liquidity risk while considering policyholder protection, obtaining advice from FSMA and consumer protection agencies, and communicating to policyholders. ### Volatility of Solvency II capital ratios and the Volatility Adjustment (VA) - Solvency II introduces the Volatility Adjustment (VA) to stabilize solvency figures by partially offsetting asset-side losses with additional capital resources. - VA is calculated by EIOPA based on a euro area wide reference portfolio, which differs from the average investment portfolio of Belgian insurers. - VA may not fully reflect Belgian insurers' economic features, leaving Solvency II figures volatile even with VA; insurers may need a higher safety margin above target solvency ratio. - The SCR ratio with VA of Belgian insurers may increase in case of credit spread increases in euro area periphery countries when it is supposed to decrease, potentially sending wrong signals to the market and undermining trust in Solvency II. ### Recommendations (numbered in source) - 123. The NBB should enhance the dialogue with insurers with higher reliance on lower quality capital instruments to improve the quality of capital. - Some insurers rely on lower quality capital instruments (such as subordinated loans from parent banks). - Industry reliance on future unrealized gains from existing policies with higher redemption risk increases reputational risk. - NBB should engage insurers relying on lower quality capital instruments to establish plans to improve capital quality gradually. - 124. The NBB is encouraged to enhance monitoring of intragroup transactions and seek the introduction of quantitative limits to intragroup exposures. - Solvency II’s principle-based PPP may not adequately limit intragroup exposures. - NBB should enhance monitoring and consider quantitative limits if the principle-based approach cannot prevent excessive concentration through large intragroup transactions. - 130. NBB is encouraged to seek to impose appropriate measures to address increasing liquidity risk of the insurance sector. - Measures may restrict redemptions and reduce convenience for policyholders; consider policyholder protection and coordination with FSMA and consumer protection agencies and communicate to policyholders. - 131. NBB should consider imposing more detailed reporting requirements on insurers with large exposures to mortgage loans. - NBB currently lacks granular data on mortgage portfolio quality. - Collect key risk indicators: LTV, DTI, PD, LGD and prepayment rate. - Insurance supervisors should coordinate with banking regulators to identify best risk indicators and collect such information from insurers with large mortgage exposures. ### Crisis management and resolution - Insurance Supervisory Law provides recovery measures: suspension of redemptions, prohibition of dividends, requiring additional reserves, requiring insurers to reduce risks, imposing additional liquidity rules. - NBB can suspend parts of or all businesses, order replacement of management, and order insurers to transfer their assets and liabilities (including related reinsurance contracts). - Insurance law places policyholders as the highest class of creditors in insolvency. - There are three guarantee funds (small in size) to benefit policyholders in case of idiosyncratic failure of a small insurer. *Source: IMF country report excerpt.* ### 133. The establishment of effective recovery and resolution plans for large insurance ### The establishment of effective recovery and resolution plans for large insurance groups ### Recovery and resolution plans for insurance groups: current status and findings - The establishment of formal recovery and resolution plans is not required for insurance groups; many groups are part of D-SIFI bank-led FCs where banking groups are required to have recovery and resolution plans. - The NBB has: - conducted a pilot exercise of solo level pre-emptive recovery plans, - involved the crisis management group of a G-SII as a key host supervisor, - developed actual recovery plans for a large insurer facing financial distress. - Currently, insurance operations are not yet fully incorporated into recovery and resolution plans at the FC level. - ICP requires contingency plans and procedures on their specific risks for both going and gone-concern situations. ### Recommendations on recovery and contingency planning (paragraph 134) - The NBB should ensure that systemically important insurance groups have robust recovery or contingency plans. - For systemically important insurance groups belonging to systemically important banking groups, competent authorities should ensure that the groups’ recovery plans are developed with due consideration of the insurance subsidiaries. - Other insurance groups, which do not belong to systemically important banking groups, should develop contingency plans based on ORSA and reverse stress testing. ### Financial conglomerate (FC) supervision: structure and current realities - There are currently three banking-led FCs operating in Belgium: - One headed by a credit institution (Belfius), - Two headed by a mixed financial holding company (KBC group and Argenta group). - All three are SIs as defined by the SSM Regulation. - There are no insurance-led FCs or mixed-activity groups. - Supervisory practices: - The Belgian legal framework for FC supervision has been substantially enhanced via the new BL and the new Insurance Law, providing symmetric regimes for bank and insurance led FCs. - BL transposed provisions of FICOD and CRD and aims to anticipate future changes to FICOD to better reflect the JFP and recommendations of the 2013 IMF FSAP. - BL goes beyond FICOD by including mixed activity financial holding companies within the scope of FC supervision and determining parent companies are responsible for compliance with obligations from supplementary conglomerate supervision. - Supervisory procedures consider the FC dimension in the SREP and assess capital adequacy, risk concentration, intra-group transactions, and risk management and internal control mechanisms at the FC level. - Supervisory expectations and best practices for FCs need further development to increase effectiveness. ### Powers and authority: legal framework, gaps, and supervisory tools - FICOD (initially adopted in 2002) establishes the regulatory framework for FCs and supplementary supervision in the EU; it incorporates some JFP elements from 2012. - FICOD introduces supplementary supervision to review group risks (double-gearing, transparency of structure, contagion, concentrations, conflicts of interest) and provides for a coordinator among supervisors. - Shortcomings of FICOD (EC staff working document, July 2017) include: - FICOD defines a MFHC as the parent company of an FC, which is not a regulated entity; limited powers over these companies. - FICOD does not designate a single point of entry for supervisory intervention with clear assignment of responsibility for supplementary supervision. - Definition of FC is prescriptive, static and not risk-based. - There is no recovery and resolution framework directly applicable to FCs. - There are no harmonized templates for reporting significant intra-group transactions, risk concentrations or capital calculation. - Amendments to CRD IV (applicable since June 2013) enhance applicability of consolidated supervision to bank-led FCs and align FC supplementary supervision with SREP review as provided in CRD IV, but: - The amendments do not place FHCs or MFHCs under full direct supervision on an individual level. - BL provisions and scope: - Under BL, consolidated supervision as well as supplementary supervision can be exercised at the top level of the group. - Article 170 BL specifies intra-group transactions and risk concentration as supplementary risk categories for supervisory measures. - Article 188 BL defines the scope of supplementary FC supervision to include all undertakings, regulated or unregulated, that form part of the group as defined in Article 164 BL. - Article 185 BL transposes the principle of supplementary supervision for credit institutions that head an FC or have a MFHC parent. - Article 183 BL addresses MAHCs and the ability to request information from MAHCs that own credit institutions. - Article 213 BL provides the supervisory authority with access to credit institutions, FCs, MFHCs, subsidiaries and all undertakings included in the consolidated whole or in the FC to obtain information useful for consolidated or supplementary supervision. - Standards and transparency: - Article 9(4) FICOD amended: regulated entities at FC level must regularly provide supervisory authority details on legal structure, governance and organizational structure, including regulated entities, non-regulated entities and significant branches. - Article 21, §3 BL requires every credit institution to draw up a governance memorandum including internal organizational structure for the institution and, where applicable, the group or subgroup. - Article 194, §4 BL requires credit institutions ensure a transparent group structure; designated entities must regularly communicate distinctive features of the group’s legal structure, policy for business organization and management structure. - Supervisory tools and corrective measures (Article 234 BL and related): - Supervisory authority may fix a deadline to remedy situations where a credit institution, FHC or MFHC is not operating in accordance with regulatory provisions. - Until remedied, the supervisory authority may: - Impose more stringent or additional own funds requirements; - Impose the application of specific rules governing valuation or adjustment of value for own funds requirements; - Require that all or part of the distributable profits be placed in a reserve; - Limit or prohibit any distribution of dividends or any payment, particularly of interest, to shareholders or to the holders of additional Tier 1 capital instruments, insofar as the suspension of the resulting payments does not result in the commencement of winding-up proceedings; - Limit the amount of variable remuneration to a percentage of the profits; - Impose specific liquidity rules, stricter than those stipulated by applicable standards, including limitations on mismatches between the institution’s assets and liabilities; - Require the institution to reduce the risks of certain activities or products or of its organization, where applicable, by requiring the sale of all or part of its business or network; - Impose rules on the concentration of risks or the limitation of exposure, stricter than those defined in CRR; - Impose additional reporting obligations or higher reporting frequencies regarding risks, own funds or liquidity positions; - Impose the publication of more detailed, frequent information. - In extreme cases, the supervisory authority may appoint a special commissioner, order the replacement of all or part of the members of the governing body by a deadline it determines, appoint one or more provisional managers, order to call a general meeting of shareholders with a well determined agenda, suspend the exercise of all or part of the business or prohibit such business or order the company to sell any shares it holds (Article 236 BL). - Recovery and resolution framework gap: - There is no EU-wide recovery and resolution framework applicable directly to deteriorating situations in FCs; the framework relies on existing frameworks for banks and insurers. - Article 9(2)(d) FICOD recognizes recovery plans as governance tools and part of risk management processes. - FHCs and MFHCs are required to draw up recovery plans under the BRRD as transposed into national legislation; FCs designated as G-SIBs and G-SIIs are requested to draw up and maintain recovery and resolution plans under the FSB Key Attributes. ### Recommendations on FC supervision and FICOD amendments (paragraph 152) - Authorities should seek amendments to FICOD to: - Ensure ability to address risks arising from FC-level activities. - Enhance supervisory authority over holding companies (FHCs and MFHCs are unregulated entities and do not require authorization for establishment). - Provide harmonized reporting and flexibility in defining the supervisory perimeter and/or require authorization of holding companies. - The BL strengthens supervisory authority over holding companies and makes them de-facto regulated, but the lack of direct supervisory authority in FICOD limits flexibility to identify and include affiliates not specifically identified in Union laws or regulations. ### Supplementary supervision: coordination, information exchange, and SREP practice - The ECB is the supervisory authority and designated coordinator for the three Belgian FCs. - For an FC, the SREP includes assessment of: - potential impact of non-banking activities on the banking activities of the group, - the group’s risk profile, profitability, and capital and liquidity position, - the financial situation at the FC level. - JSTs identify and monitor risks from non-banking activities and transmission mechanisms to the banking element; assessment and any recommendations occur at the end of the process. - To perform coordination, the ECB may receive FC data from the supervised banking entity and may also receive information from competent insurance supervisors. - FICOD provides that competent authorities responsible for supervised entities in an FC and the appointed coordinator should provide one another with any information essential or relevant for each authority’s supervisory tasks under sectoral rules and FICOD. *Source: cr1870 - 133. The establishment of effective recovery and resolution plans for large insurance (PDF chapter).* ### 155. Supplementary supervision does not substitute sectorial supervision but builds on it ### Supplementary supervision does not substitute sectorial supervision but builds on it ### Scope and objectives of supplementary supervision - Supplementary supervision addresses risks that stem from the activities of a group in the other financial sectors, and does not substitute sectorial supervision. - Key risk areas addressed: - (i) capital adequacy at group level (i.e., avoidance of “double gearing” across the sectors); - (ii) contagion (i.e., supervising intra-group transactions); - (iii) concentration (i.e., supervising risk concentration across business lines); - (iv) conflicts of interest (i.e., issues with respect to corporate governance); and - (v) complexity. - SSM Supervisory Manual guidance for supplementary supervision of FCs establishes a twofold approach: - Determine possible spill-over risks, whether risks are incorporated into ICAAP at FC level and banking group level and, if parent undertaking is a FHC, whether ICAAP is performed at FHC level. - Identify possible channels of contagion that may impact the capital of the banking group. Possible channels listed include: intragroup liquidity arrangements, intragroup guarantees, whether the bank will be able to operate standalone if the insurance company fails, and reputational risk from asset management business. - Current status: - The Manual is under review for update and inclusion of additional guidance. - Existing guidance is high level; given the compendium of EU directives/regulations and national laws and the unregulated status of FHCs, more detailed guidance may be needed. - For some FCs, application of supplementary supervision has been waived by agreement of competent authorities when thresholds in Article 3 of FICOD for significance are not reached; nevertheless, possible transmission of risks and reputational risks (e.g., money laundering and asset management) remain and should be addressed when relevant. ### Corporate governance (FC-level governance) - Expectations and legal framework: - Holding companies are expected to implement appropriate governance arrangements throughout the whole group, without prejudice to individual entities. - For FCs where banking is the dominant sector, the legal framework enables the supervisor to assign responsibility for capital adequacy, risk management and governance to the parent undertaking, making FHCs and MFHCs de facto regulated entities. - Parent companies should issue guidelines to undertakings in the FC to ensure FC-wide policies and procedures comply with prudential requirements (must respect the Companies Code). - Governance arrangements for credit institutions need to be applied at the FC level when banking is the most important sector of the FC. - Parents’ compliance obligations include: ensuring appropriate structure for the organization of the group; appropriate internal control and risk management systems; and independent audit function. - Governance arrangements should include: appropriate integrity policy; remuneration policy that penalizes risk taking beyond the level tolerated by the FC; measures for business continuity. - Fit and proper criteria for board members, senior management and control persons that apply to credit institutions also apply to FHCs and MAHCs that head FCs. - Responsibilities of board members of the parent company are aligned with banking sector requirements. - Internal control and procedures: - BL requires the head of the FC to ensure appropriate internal control and administrative and accounting procedures to manage specific FC risks. - Procedures should be available at the consolidated and sub-consolidated level and include: - appropriate procedures for monitoring solvency at a group level so that all major risks are correctly identified and monitored and the own funds are sufficient in light of the risks incurred; and - adequacy of procedures and systems for the identification, measurement, monitoring and control of intragroup transactions and risk concentrations. - Transparency and reporting: - FCs are required to ensure a transparent group structure. - Parents should communicate to supervisors their policy for business organization and management structure applicable to all regulated and unregulated subsidiaries and significant branches. - Every credit institution must draw up a governance memorandum including the entire internal organizational structure of the group or sub-group for which it is the final parent undertaking. - A description of the legal structure of the FC should be published annually and material changes must be communicated and approved by supervisors. - Supervisory assessment: - Adequacy of FC governance is assessed in the SREP, which contains an additional FC dimension assessing how the FC perspective reflects on business model, governance, risks to capital, liquidity and funding of the banking group. - Group-wide governance is expected to cascade down to sub-structures in banking and insurance without requiring sector differentiation. - JSTs are expected to highlight shortcomings from insurance or other non-banking sectors that could impact the banking group and focus on sector interactions. - Supervisory authorities have access to credit institutions, FHCs and MFHCs and their subsidiaries and all other undertakings included in the FC. - Recommendation summary on governance: - Supervisory procedures to ensure adequacy of the FC-wide structure and governance could be further developed. - The SSM Supervisory Manual identifies risks to consider but provides limited insight beyond regulatory requirements; defining best practices for governance models at FC level is challenging but important to enhance FC supervision effectiveness. ### Capital adequacy and liquidity (bank-led FCs and the Danish Compromise) - Dual capital frameworks: - Bank-led FCs are subject to two calculations of capital adequacy based on FICOD and CRD/CRR. - All Belgian FCs are bank-led and therefore subject to: - group-based capital requirement based on CRD/CRR; and - FC level capital requirement based on FICOD supplementary supervision. - Interaction with the Danish Compromise: - Due to a deviation of CRD/CRR from the Basel Framework (the Danish Compromise), the CRD/CRR requirement tends to be less conservative than that based on FICOD. - FCs that use the Danish Compromise are not waived from supplementary supervision under FICOD; to benefit from the Danish Compromise in CRR, the group needs to be a recognized FC. - Therefore, all three Belgian FCs are subject to supplementary supervision. - FICOD capital calculation (Article 6): - Capital adequacy calculation is based on aggregation of each sector’s requirements. - Where a banking group has an insurance undertaking within the group or vice versa, the group can choose one of three methods: - (i) accounting consolidation method (based on consolidated balance sheet); - (ii) deduction and aggregation method (based on aggregation of solo accounts with bank participation in insurance undertakings deducted from its capital); - (iii) combination method (combination of methods i and ii). - In both methods, solvency requirements are derived from the sum of those calculated for each sector. Eligibility of capital instruments depends on sectorial rules. - Practical emphasis and disclosure: - Supervisory analysis is mainly carried out by referring to the group-level capital ratio under CRD/CRR, calculated according to the Danish Compromise. - Regulators and market participants pay attention to the group level ratio; it is also subject to disclosure requirements (Pillar 3). - While FC-level capital adequacy is also subject to disclosure for groups benefiting from the Danish Compromise, emphasis is on the CRD/CRR capital ratio, creating a strong incentive for FCs to improve the CRD/CRR ratio. - CRR deviation specifics: - CRR (Articles 49 and 471) grants the option to allow, under certain conditions, bank-led FCs to apply low risk weights to participations in insurance companies. - In practice, IRB banking groups can apply a risk weight of 370 percent instead of deducting the investment from regulatory capital. - This approach tends to result in a significantly lower capital requirement than deduction; other approaches (PD/LGD or internal model approaches) could lead to even lower risk weights. - In principle, investments in insurance subsidiaries should be deducted from the parent’s capital; impact of deduction is similar to imposing a 1,250 percent risk weight on the investment. - Several Belgian FCs with material insurance operations have been authorized to use the Danish Compromise, which might result in a sizable increase of capital ratios at the parent banking group and holding company levels. - Depending on methods applied, by switching equity investment to sub-ordinated debt, banks may reduce required capital invested in insurance subsidiaries and improve their capital ratio under CRD/CRR. - Currently, three banking-led FCs apply the 370 percent risk weight to all capital instruments of the subsidiaries regardless of their quality. - Regulatory arbitrage and gaps: - Different regulatory requirements for banks and insurers enable regulatory arbitrage: - Definition and requirements for capital instruments differ between banks and insurers; e.g., Solvency II Tier 2 allows some unpaid instruments. - Treatment of banks’ investments in insurers differs from insurers’ investments in banks. - Solvency II implementation reduced arbitrage opportunities but material differences remain. - There is no FC level regulatory requirement on liquidity or leverage: - Banking groups are subject to liquidity requirements (LCR and NSFR) and leverage ratio, while Solvency II does not have such requirements in Pillar 1. - As a result, no Pillar 1 requirement on liquidity or leverage at the FC level exists. - Industry practice for liquidity risk management has developed differently between banking and insurance groups; comprehensive liquidity risk assessment has not in practice been achieved at the FC level. - Intragroup transactions may underestimate true liquidity risk, which is not incorporated in either Pillar 1 or Pillar 2 capital requirements: - Insurance subsidiaries provide a sizable amount of liquidity to banking entities, partly due to lack of regulatory limits on intragroup transactions (e.g., insurance subsidiary can provide deposits and margins for derivative transactions to parent or group bank). - Asymmetric regulatory regime for liquidity risk, where insurance entities are excluded from LCR and NSFR even if they belong to the banking group, might be behind such transactions. ### Box 6 — Sources of Regulatory Arbitrage (summary) - Solvency II improvements vs remaining differences: - Solvency II covers risk of both assets and liabilities with market-consistent valuation; Solvency I did not fully cover asset-side credit and market risk. - Banking regime allows cost basis accounting widely; Solvency II requires market-consistent valuation for the entire balance sheet. - Capital instruments under Solvency II are categorized as Tier 1 and 2 with similar conditions as banking, but differences remain (e.g., recognition of Value in Force as core Tier I without limit; more generous treatment of deferred tax assets). - CRD/CRR allows a parent bank to not deduct its investment in insurance subsidiaries and to use normal risk weights on those investments, even though quality of capital in insurance subsidiaries tends to be lower. - Solvency II allows more comprehensive use of internal models; banking internal model use is more restricted and likely to be further limited. - Differences may incentivize transfer of low risk weighted assets (e.g., mortgage loans) from banks to insurers or transfer of illiquid/high-risk assets to insurers due to different liquidity and leverage regimes. - Liquidity and spread risk differences: - Banking groups are subject to LCR and NSFR and leverage ratio requirements; Solvency II does not have such Pillar 1 requirements. - Solvency II’s Pillar 1 liquidity charge focuses on potential losses from asset fire sales, narrower than LCR/NSFR scope; industry practice for liquidity risk management in insurance sector not fully established. - Solvency II requires much higher capital for spread risk, especially for long term corporate bonds; banks’ capital requirements for banking book bonds cover primarily default/migration risk, not full mark-to-market spread risk. - Supervisory suggestions from Box 6: - NBB and SSM are encouraged to review intragroup transactions more carefully to analyze motivations behind the transactions. - NBB and SSM should review transactions and address material side effects from regulatory arbitrage transactions and take appropriate actions (such as imposition of Pillar 2 and/or Pillar 3 requirements). ### Recommendations (capital, liquidity, and supervisory integration) - The SSM and NBB should impose more robust requirements for the integration of risk management by groups that rely on the Danish Compromise: - Article 49 of the CRR requires competent authorities to be satisfied with level of integrated management, risk management and internal controls as a condition for approving the Danish Compromise and on a continuous basis. - Integration of risk management and internal controls does not yet seem sufficient even in groups that rely on the approach. - SSM and NBB should impose more robust requirements for integration of risk management in bank-led conglomerates that use the Danish Compromise. - The SSM and NBB should incorporate sector-level analysis into FC-level supervision more actively: - Solvency II implementation for insurance subsidiaries provides good information about more economic-based measurement of risks. - FC supervisors should coordinate more closely with insurance supervisors regarding quality of insurance subsidiaries’ capital instruments. - Supervisors should use information from supplementary supervision more actively. - Consideration of public disclosure is recommended to ensure bank-led conglomerates explain to the public their capital position more actively with due consideration of risks in the insurance sector. *Excerpt from IMF staff report: "cr1870 - 155. Supplementary supervision does not substitute sectorial supervision but builds on it."* ### 174. The SSM and NBB should monitor liquidity risk and establish a supervisory approach ### cr1870 - 174. The SSM and NBB should monitor liquidity risk and establish a supervisory approach ### Liquidity risk at FC level - Belgian insurers are exposed to liquidity risk more than before. - Banks may not be able to rely on the excessive liquidity which used to be available in the previous crises. - Recommendation: The SSM and NBB should develop a robust supervisory approach for FC level liquidity risk (such as more thorough analysis of liquidity risk from intragroup transactions, with potential inclusion of limits). ### Intragroup transactions: analysis and motivations - The SSM and NBB should analyze the nature of intragroup transactions to understand motivations and address side effects from regulatory arbitrage transactions promptly. ### Risk management framework requirements (FICOD, Article 9) - Regulated entities must have adequate risk management processes and internal control mechanisms at the FC level. - Risk management processes should include: - sound governance and management with the approval and periodical review of the strategies and policies by the appropriate governing body; - adequate capital adequacy policies; - procedures to ensure that the risk monitoring systems are well integrated into the FCs’ organization; - arrangements to contribute to and develop, if required, adequate recovery and resolution plans. - Internal control mechanisms should include: - adequate mechanisms as regards capital adequacy to identify and measure all material risks incurred; - sound reporting and accounting procedures to identify, measure, monitor and control the intra-group transactions and risk concentration. ### Application to FCs led by banks (BL provisions) - The BL provides the option to consider the whole group identified as a FC as the relevant scope for risk management requirements (BL, Article 188). - FCs led by banks are required to comply with the risk management requirements applicable to banking groups, including the maintenance of an independent, comprehensive and effective risk management framework, accompanied by a robust system of internal controls, effective internal audit and compliance functions (BL, Articles 167 to 170). ### Risk concentration and intra-group transactions and exposures - Article 7 of FICOD requires supervised entities to report significant risk concentrations at the FC level arising from exposures towards counterparties. - The coordinating supervisor, after consultation with the other relevant competent authorities, is responsible for identifying the type of risks that must be reported as well as the form and content of the report. - Competent authority must establish thresholds for identifying and reporting each significant risk concentration within the FC. If no thresholds are laid down, risk concentrations are regarded as significant if they are greater than 10 percent of the solvency requirements. - Quarterly information on concentrations is provided in regulatory reports (ad hoc adapted version of the FINREP-COREP reporting covering FC specific risks). - Article 8 of FICOD requires FCs to have adequate risk management and internal control procedures to identify and report significant intra-group transactions. If no thresholds are laid down by the competent authority, intra-group transactions are defined as significant if they are greater than 5 percent of the solvency requirements of the FC concerned. - Supervisors must consider the risk of contagion in the group, the existence of conflicts of interest, circumvention of sectoral legislation, as well as the level of the transactions. - The SSM Supervisory Manual addresses risk concentration and intra-group transaction reports to build a comprehensive view of the FC risks and complement the analysis of the FC’s business model. - Supervisors can impose restrictions to control risk concentration and intra-group transactions at the FC level. The BL allows supervisors to impose the sectoral provisions on risk concentration and intra-group exposures at the FC level (BL, Article 170). ### Reg 2015/2303 and supervisory practice - Regulation 2015/2303 supplements FICOD and expands Article 7 and 8 requirements by establishing more detailed definitions of intragroup transactions and risk concentration, and establishing reporting requirements to monitor both risks. - The regulation has not been fully implemented into supervisory practice. - Currently information collected and analyzed on FCs may not provide sufficient detail to monitor risk concentrations and intragroup transactions. ### Off-balance sheet activities - Legal framework limits supervisors’ ability to include off-balance sheet activities within group-wide supervision where entities do not meet the legal definition of the group (based on holdings of participations and common management). - As a result, off-balance sheet activities, including special purpose entities (SPE), tend to remain outside the scope of group-wide supervision. ### Recommendations - Expectations for the integrated risk management framework in FCs should be more clearly defined. Areas needing clarity include: - risk appetite; - governance arrangements; - appropriate FC-wide stress test procedures; - risk data aggregation; - recognition of risk diversification. - Thematic reviews and other inspections could be used to define best practices and provide more detailed guidance on supervision manuals. - Supervisory guidance should include evaluation of FC intragroup transactions to determine the economic purpose and provide “red flags” for transactions that may transfer sub-quality assets at book value between affiliates to avoid loss recognition. - Guidance should establish scope of coverage such as: investments and inter-company balances, real estate transfers, debt instruments and deposits as well as define supervisory measures and requirements. - Transactions should be made at arm’s length or the supervisory authority should be notified when they are not. - Off-balance sheet activities, including SPEs, should be brought within the scope of group-wide supervision of the FC. - Regulation should be amended to allow supervisors to develop a process for determining whether the nature of the relationship between the FC and a SPE requires the SPE to be fully or proportionally consolidated for regulatory purposes. - The overall nature of the relationship between SPEs and the FC should be fully considered, going beyond traditional control and influence criteria. - FC stress tests and scenario analyses should take into account all relevant off-balance sheet activities. - Guidance in Regulation 2015/2303 concerning intragroup transactions and concentration risk should be incorporated into FC supervision. The regulation provides guidance on defining significant intragroup transactions within an FC, risks that such transactions may pose, concentration risk arising from risk exposures to counterparties that are not part of the FC including off balance sheet items, and supervisory measures that may be imposed on FCs to address concentration and intragroup transaction risks. *Source: cr1870 - 174.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1870.pdf_