## 1luxea2024005

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### Executive summary and scope
- Review focus: specific aspects of the Luxembourg banking supervisory regime relating to Less Significant Institutions (LSIs), and follow-up on recommendations from the 2017 FSAP.
- Areas examined: CSSF supervisory approach to liquidity (including division of liquidity responsibilities with the BCL), interest rate risk in the banking book (IRRBB), operational risk, related-party exposures, supervision of intragroup exposures, adequacy of CSSF supervisory resources, effectiveness of the on-site inspection regime, home/host arrangements, and the rationale for designation of Clearstream Banking Luxembourg (CBL) as an LSI.
- Mission timeline:
  - Scoping meetings: May 11–17, 2023 and June 16, 2023.
  - On-site mission: October 4–18, 2023.
- Reference framework: 2012 version of the “Basel Core Principles for Effective Banking Supervision” (BCP) used as reference (no formal BCP assessment).

### Key findings (overview)
- Progress since 2017 FSAP:
  - On-site inspection regime strengthened significantly; timeline for completion of reports reduced.
  - Additional staff recruited, expanding banking expertise.
  - Monitoring of intragroup exposures and waiver compliance tightened.
  - CSSF and BCL closely monitor LSIs’ sovereign debt and residential real estate exposures.
- No material weaknesses identified in supervisory processes for focal areas (LSI supervision of liquidity, IRRBB, operational risk, related-party transactions).
  - CSSF follows SSM established SREP policies and procedures for these supervision areas.
  - Comprehensive and sufficiently regular data is collected in each area; risk analysis is detailed and supported by satisfactory IT systems.
- Key gaps and vulnerabilities:
  - Governance: Government representation on the CSSF Board continues potentially to constrain the autonomy to set its own budget; no evidence of interference encountered, but structure retains potential for future interference.
  - Division of liquidity supervision: BCL performs liquidity supervision (including preparation of LSREPs) for 19 LSIs; selection criteria should be further refined. MoU between BCL and CSSF on liquidity supervision is drafted but not signed.
  - CBL classification: CBL’s global systemic interconnectedness and substitutability, structural and operational complexity may justify an ECB decision to take over direct supervision of CBL as an LSI pursuant to Article 6(5)(b) of the SSM Regulation and Article 67(2)(b)-(d) of the SSM Regulatory Framework. CSSF advised to request ECB direct supervision of CBL as an LSI.
  - Credit register: Working Group chaired by the BCL produced a first draft report; progress delayed due to COVID-19. BCL should ensure active pursuit with clear deadlines.
  - Third Country Branches (TCBs): No TCB currently holds a material amount of retail deposits; current policies may not adequately address potential future risks if TCBs accept retail deposits in Luxembourg.

### Institutional setting and sector statistics (selected)
- CSSF supervisory remit: prudential supervision of Luxembourg’s financial sector except Significant Institutions (SIs) — direct responsibility of the ECB — and insurance undertakings (Commissariat aux Assurances).
- Under ECB oversight:
  - CSSF supervisory responsibility for 62 LSIs, with liquidity supervision for 19 of those LSIs undertaken by the BCL, and 13 third country branches.
- Banking sector (as of June 30, 2023):
  - Total number of banks operating in Luxembourg: 120 banks.
    - 45 Significant Institutions
    - 62 Less Significant Institutions
    - 13 Third Country Branches
  - Ownership and legal form:
    - 67 Foreign owned – subsidiary
    - 45 Foreign owned – branch
    - 8 Domestically owned
  - By business model (Total assets for 2023Q1 in €bill):
    - Custodian banking: 250.779
    - Universal banking: 213.455
    - Corporate finance: 198.850
    - Private banking: 156.395
    - Clearing, treasury and-or payment services: 55.434
    - Retail and commercial banking: 22.774
    - Covered bonds banking: 14.440
  - By SSM supervisory status (Total assets for 2023Q1 in €bill):
    - Significant Institutions: 636.107
    - Less Significant Institutions: 173.604
    - Third Country Branches: 102.406
  - Sector features:
    - Foreign-owned banks account for 92 percent of total bank assets.
    - Bank assets steady at 13 times GDP since 2017.
    - Investment fund sector is the second largest in the world and 78 times GDP.
    - CET1 capital ratio increased to 23.1 percent in 2022.
    - Non-performing loans are 1 percent of gross loans.
    - Banks’ liquidity coverage ratio (LCR) around 150 percent.

### Governance and operational independence of the CSSF
- Board composition and appointment:
  - CSSF Board: seven members appointed by the Grand Duke on a proposal from the Government in Council.
    - A majority of four members are appointed representatives of the Ministry of Finance (MoF).
    - Three members are appointed as representatives of regulated sectors (ABBL, ALFI, IRE).
  - Executive Board: nominated by the Grand Duke on a proposal by the government for a renewable five-year term; currently five members.
- Findings:
  - No current evidence that the governance structure constrains operational independence.
  - Legal composition (government majority and industry representatives) could give rise to questions about independence and compliance with international standards and introduces potential for government or industry interference.
  - Board has no power to intervene on prudential or supervisory matters or day-to-day management; these remain the preserve of the Executive Board.
  - Sound international practices call for independent boards composed primarily of unaffiliated members.
- Recommendation:
  - Safeguard the independence of the CSSF board members through changing the law.
  - Contingency: If legal amendments are not feasible, consider issuing subsidiary legislation to establish procedural safeguards within legal constraints.
  - Implementation guidance: Secondary legislation should define clear roles for the board and executive board and develop criteria regarding budget proposals, board member nominations and dismissals.

### Division of supervisory liquidity responsibilities: BCL and CSSF
- Legal and operational context:
  - BCL legal role: responsible for “supervising the general liquidity situation on the markets as well as for assessing market operators in this regard” under its organic law and BCL Regulation 2009/No. 4 of April 29, 2009.
  - Article 2.9 of the SSM Framework Regulation allows BCL to carry out supervisory tasks within national law and the SSM Framework Regulation.
  - Principle-based working arrangements established at SSM inception; BCL has responsibility for ongoing liquidity supervision of 19 LSIs and 10 third country branches.
- MoU:
  - A draft MoU has been prepared and should be finalized and signed as a matter of priority.
  - Main provisions: BCL participation in JSTs and on-site inspections, cooperation and division of work for LSI liquidity supervision, cooperation in liquidity crises, coordination in European/international working groups, consultation on regulations and circulars, cooperation on liquidity stress tests.
- Operational cooperation and data:
  - BCL participates in JSTs of eight banking groups.
  - Liquidity data submitted by all banks is made available to both BCL and CSSF; exchanges on individual institutions occur ad-hoc and in crisis contexts.
- Recommendations:
  - Finalize and sign the MoU between BCL and CSSF as a matter of priority.
  - BCL and CSSF should further specify the criteria for LSIs to be supervised by the BCL and review the group periodically.
  - Keep under review the arrangement whereby BCL undertakes the LSREP assessment for a group of LSIs; incorporate regular review in the MoU.

### Liquidity supervision of LSIs (metrics and supervisory activity)
- Regulatory basis:
  - LSIs subject to LCR in accordance with CRR and the LCR Delegated Act (LCRDA) and to NSFR in the CRR.
  - CSSF aligned approach formalized through Circular CSSF 22/816 and CSSF Regulation 18–03, as amended.
  - Qualitative requirements set out in the Law on the Financial Sector (LFS) (Article 53–22), and in CSSF Circulars 12/552 and 09/403.
  - SREP assessment performed according to Chapter 10 of the SSM LSI SREP Methodology, in line with EBA SREP guidelines (EBA/GL/2022/03).
- Current metrics (end-June 2023):
  - Average LCR for all LSIs: 230 percent, with total Level 1 assets representing 97 percent of high-quality liquid assets.
  - Average NSFR ratio for LSIs: 210 percent.
- Supervisory activity:
  - Neither CSSF nor BCL conducted an on-site liquidity inspection of LSIs over the past five years; one on-site inspection scheduled by early 2024, triggered by a weak SREP score for risk control.
  - Monthly Additional Liquidity Monitoring Metrics (ALMM) reports and quarterly asset encumbrance data received.
  - Annual ICLAAP submissions assessed during SREP.
  - Recent qualitative recommendations focused on stress testing frameworks, intraday liquidity risk management, risk appetite, and contingency funding plans.
  - Quantitative actions in 2022: CSSF imposed higher outflow factors on short term Private Banking deposits at two different banks — once under Article 25(3) of the LCRDA in ongoing supervision and once as a Pillar 2 measure under Article 53–5 of the LFS.

### Operational risk and resilience
- Legal and supervisory framework:
  - CRR sets quantitative framework; CRD sets operational risk management requirements transposed into law by the LFS.
  - LFS Article 53–21 requires policies and processes to evaluate and manage exposure to operational risk, including model risk, contingency and business continuity plans.
- Supervisory practice:
  - Operational risk integrated in SREP; quarterly monitoring of defined financial and non-financial key indicators in line with EBA guidelines (EBA/GL/2014/13).
  - Long Form Report (LFR) provides qualitative information annually.
  - Depth and intensity of analysis proportionate to risk profile; horizontal operational risk review conducted for sector-level benchmarks.
  - CSSF lacks dedicated operational risk experts but has sufficient expertise across relevant components to conduct on-site inspections.
- European developments and recommendation:
  - Guidance on operational resilience for LSIs is work in progress at European level.
  - Recommendation: CSSF should remain fully engaged at European level and incorporate finalized operational resilience requirements into its regulatory framework.
- CBL supervision:
  - CBL is a systemically important ICSD with inherently high operational risk.
  - CSSF has a dedicated team of four supervisors; BCL has two FTEs for oversight of CBL.
  - Supervision of CBL is intensive; coordination between BCL and CSSF appears effective.

### Related party lending
- Definitions and transparency:
  - “Related party” defined in Circular CSSF 12/552 (Part I Chapter 1).
  - “Related party transaction” defined in the self-assessment questionnaire sent annually to all banks; definitions consistent with BCBS.
  - Recommendation: Give related party transaction definition public prominence and set it out transparently in a Circular.
- Monitoring and supervisory practices:
  - Monitoring via off-site data analysis and on-site inspections.
  - Quantitative data received via semi-annual FINREP reports and quarterly large exposure reports.
  - Intragroup data available from monthly LCR and ALMM reports.
  - LFR provides primary qualitative information on policies, transfer pricing, governance and quantitative exposures.
  - Since 2017: eleven on-site inspections reviewing exposures to group entities and one on-site inspection reviewing conflicts of interest for transactions with the bank’s shareholder.
  - Finding: CSSF’s supervisory approach to related-party exposures is appropriate.

### Interest Rate Risk in the Banking Book (IRRBB) and bond portfolio analysis
- IRRBB framework and reporting:
  - CSSF follows SSM SREP methodology for LSIs; legal basis in EU legislation and Article 53 of the LFS; additional guidance in Chapter 8 of Circular 12/552.
  - Supervisory outlier tests:
    - EVE metric: eight standard interest rate shock scenarios.
    - NII metric: two parallel shift scenarios.
  - Banks report EVE and NII Supervisory Outlier tests once a year under eight scenarios for EVE and two scenarios for NII; banks calculate impacts quarterly and report immediately whenever the worst EVE exceeds 15 percent of a bank’s T1 capital.
- Bond portfolio sensitivity (March 2023 interest rate sensitivity analysis, 200-bps shock):
  - At end June 2023:
    - Bonds in the mark-to-market portfolio of all banks: EUR32 billion (3 percent of banking sector assets).
    - Bonds in the amortized portfolio: EUR 88 billion (9 percent of total banking assets).
  - Gross valuation losses (without hedges) under 200-bps shock (banks with solvency requirements only):
    - EUR 1.4 billion in the mark-to-market portfolio.
    - EUR 3.3 billion in the amortized cost bond portfolio.
  - Conclusion: CSSF judged potential losses limited and manageable given hedging arrangements; follow-up work conducted by line supervisors.
  - Supervisory capital action: No specific Pillar 2 capital add-ons applied in respect of IRRBB to date.
- IRRBB inspections and corrective actions:
  - Six staff with IRRBB knowledge; five on-site IRRBB inspections on LSIs in past five years.
  - Corrective actions included review of internal NMD models and documentation, review of internal risk limits and stress tests, aggregation across currencies, and review of risk appetite, KRIs, and early warning indicators.

### Designation of CBL and ECB direct supervision
- Legal/supervisory rationale:
  - CBL as a globally important FMI has systemic relevance locally and internationally; interconnectedness, substitutability, and structural and operational complexity can justify ECB takeover of direct supervision of CBL as an LSI (Article 6(5)(b) SSM Regulation; Article 67(2)(b)-(d) SSM Framework Regulation).
- Procedure:
  - Takeover of direct supervision is a derogation decision, subject to an enhanced duty to state reasons; may be decided by the ECB on its own initiative or requested by the CSSF under Article 6(5)(b) SSMR and Article 68 of the Framework Regulation.
- Recommendation:
  - CSSF should make further representation to justify ECB’s direct CBL supervision as an LSI.

### Intragroup exposures, home-host relationships, and TCBs
- Intragroup exposures (scale and trends):
  - Total intragroup exposures: €225 billion at end-year 2017; increased to €279 billion at end-March 2023.
  - At end-March 2023, around 70 percent of all intragroup exposures were branch intragroup exposures.
  - Intragroup exposures ~30 percent of total banking sector assets.
- Regulatory discretion and supervision:
  - Luxembourg opted for Member State Discretion exempting intragroup exposures from large exposure limits under Article 493(3)(c) CRR; transposed in Article 56-1 of the LFS with specified criteria.
  - CSSF internal guidance adds analysis of home country’s resolution regime and bail-in treatment.
  - Internal procedure for approving and monitoring intragroup waivers updated in 2023; waivers undergo thorough periodic review.
  - Enhanced reporting since 2018 provides granular intragroup maturity mismatch data.
  - CSSF monitors weekly CDS and ratings of parent entities and counterparties since 2017; reviews intensify in crisis.
  - Enforcement: six intragroup exemptions withdrawn since 2017 for various reasons.
- Home-host and TCBs:
  - As of June 30, 2023: CSSF competent authority for 62 LSIs and 13 branches of non-EU-credit institutions; host supervisor for 40 LSIs whose parent is outside Luxembourg; home supervisor for one banking group at consolidated European level; ten LSIs not part of any banking group.
  - TCB regime:
    - TCBs required to hold nominal capital on authorization of €8.7million; most report much higher capital.
    - Most TCBs apply for waivers from solvency requirements; no TCB refused a waiver to date.
    - Present policy (not formally documented) is not to allow a TCB to accept retail deposits on or after authorization.
    - At present, no TCB in Luxembourg currently holds a material amount of retail deposits.
  - EU developments:
    - EU proposals would categorize TCBs into Class 1 and Class 2; Class 1 to hold a minimum ‘capital endowment’ with a minimum of €10million; authorities may require subsidiarization for banks with aggregated EU assets above €40 billion.
  - Recommendation: CSSF should look to future-proof its TCB regime in case TCBs seek to accept retail deposits; consider whether proposed EU thresholds set an acceptable risk appetite or whether additional, lower thresholds are appropriate.

### Residential Real Estate (RRE) and sovereign debt monitoring
- Sovereign debt:
  - 2017: Luxembourg banks had over €60 billion in sovereign debt at end-December 2015.
  - At end-June 2023: total sovereign bond holdings €37 billion.
  - LSIs’ sovereign bond exposures: €8 billion (5 percent of balance sheet size) with weighted average duration circa one year.
  - Monitoring: Macroprudential Division monitors sovereign holdings via annual solvency stress tests, weekly rating analysis and semi-annual market risk monitoring.
- RRE monitoring:
  - Macroprudential Division and BCL follow RRE developments via quarterly monitoring of housing supply, credit supply, house prices, housing demand, interest rates and indicators (price-to-income, debt-to-income).
  - Use of house price-at-risk and house price overvaluation models to stress future RRE developments.
  - Further BCL and CSSF RRE work covered in second part of FSAP mission in January 2024.

### Credit register development
- Background:
  - Luxembourg had no credit bureau at 2017 FSAP.
  - ECB Anacredit initiative scheduled to go live in 2027, limited to corporate exposures and not publicly available to banks.
- 2019 Working Group (chaired by BCL):
  - Participants: ABBL, ACA, CNPD, MoF, CSSF, CAA.
  - Objectives: prevent over-indebtedness and provide authorities/lenders with central overview of borrower debt.
  - Progress: Covid delayed work; first draft report produced covering nominative information on natural persons, loan materiality thresholds, entities covered, and legal setup considerations.
  - Recommendation: Developmental work on setting up a credit register should be actively pursued by all parties with clear deadlines.

### Resources, staffing, supervisory timeliness, and progress on 2017 FSAP
- Staffing growth:
  - Total FTEs: 173 FTE at end-2017 to 221 FTE at end-year 2022.
  - On-site inspection (OSI) department: 57.85 FTE at 31/12/2017 to 72.35 FTE at 31/12/2022; current OSI complement ~80 FTE.
- Risk expertise (selected):
  - AML: 2 managers, 18 agents, 5,65 on-site FTE.
  - Banking risks: 1 manager, 13 agents, 6,10 on-site FTE.
  - Corporate governance & Business model: 1 manager, 14 agents, 4,65 on-site FTE.
  - IT risks: 3 managers, 7 agents, 2,50 on-site & off-site FTE.
  - Interest rate risk, own funds: 1 manager, 0,39 on-site + off-site FTE.
  - Liquidity: 1 manager, 0,39 on-site + off-site FTE.
- Staff turnover (2018–2022 percentages):
  - Banking department: 3,49 (2018), 6,48 (2019), 2,07 (2020), 7,21 (2021), 3,13 (2022).
  - On-site inspection department: 4,65 (2018), 6,81 (2019), 6,72 (2020), 4,15 (2021), 2,78 (2022).
- Supervisory timeliness:
  - Average time between closing meeting of an on-site inspection and communication of findings reduced from six months (2017) to less than three months on average.
- Progress since 2017 FSAP:
  - No changes to CSSF governance structure in relation to BCP 2.
  - Internal procedure on intragroup exposures goes further than relevant ECB Regulation and Guideline 2017/697 by considering home country resolution regime and bail-in risk.
  - OSI Team headcount increased to approx. 80 FTE; timeline for OSI reports reduced to < 3 months on average.
  - Circular CSSF 18/703 introduced semi-annual reporting of borrower-related residential real estate indicators and harmonized LTV, DTI and DSTI definitions.
  - Draft MoU between BCL and CSSF on liquidity supervision drafted but not signed.
  - Pecuniary sanctions framework fully applied in line with EU Directives.
  - Macroprudential Division monitors sovereign holdings via annual stress tests, weekly rating analysis and semi-annual market risk monitoring.
  - Directive (EU) 2019/878 strengthened oversight at European level of financial holding companies and mixed financial holding companies.

### Main recommendations (selected, including priority and urgency)
- Safeguard the independence of the CSSF board members through changing the law; if legal amendments not feasible, consider subsidiary legislation to establish procedural safeguards.
  - Priority: Medium
  - Urgency: Near Term
- The BCL and CSSF should finalize the MoU on responsibilities for bank liquidity supervision.
  - Priority: High
  - Urgency: Near Term
- The BCL and CSSF should clarify the criteria used to determine the set of LSIs to be supervised for liquidity purposes by the BCL; arrangement should be regularly reviewed.
  - Priority: Medium
  - Urgency: Near Term
- The BCL should ensure that all parties on the Working Group actively pursue work on setting up a credit register with clear deadlines set.
  - Priority: High
  - Urgency: Medium Term
- The CSSF should make further representation to justify ECB’s direct CBL supervision as an LSI based on the SSM Regulatory Framework.
  - Priority: High
  - Urgency: Near Term
- Timing definitions: Near term: < 12 months; Medium term: 12 to 24 months.

*Source: EXECUTIVE SUMMARY (1luxea2024005).*

### EXECUTIVE SUMMARY_  ______________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Introduction and scope
- Review focus: specific aspects of the Luxembourg banking supervisory regime relating to Less Significant Institutions (LSIs), and follow-up on recommendations from the 2017 FSAP.
- Areas examined: CSSF supervisory approach to liquidity (including division of liquidity responsibilities with the BCL), interest rate risk in the banking book (IRRBB), operational risk, related-party exposures, supervision of intragroup exposures, adequacy of CSSF supervisory resources, effectiveness of the on-site inspection regime, home/host arrangements, and the rationale for designation of Clearstream Banking Luxembourg (CBL) as an LSI.
- Mission timeline and contacts:
  - Scoping meetings: May 11–17, 2023 and June 16, 2023.
  - On-site mission: October 4–18, 2023.
  - Review used the 2012 version of the “Basel Core Principles for Effective Banking Supervision” (BCP) as the reference (no formal BCP assessment).

### Key findings
- Progress since 2017 FSAP:
  - On-site inspection regime strengthened significantly.
  - Timeline for completion of reports reduced.
  - Additional staff recruited, expanding banking expertise.
  - Monitoring of intragroup exposures and waiver compliance tightened.
  - CSSF and BCL closely monitor LSIs’ sovereign debt and residential real estate exposures.
- No material weaknesses identified in the CSSF’s supervisory processes for the review’s focal areas (LSI supervision of liquidity, IRRBB, operational risk, related-party transactions).
  - CSSF follows SSM established SREP policies and procedures for these supervision areas.
  - Comprehensive and sufficiently regular data is collected in each area.
  - Risk analysis is detailed and supported by satisfactory IT systems.
  - Horizontal supervision appears embedded effectively in supervisory processes.
- Key gaps and vulnerabilities identified:
  - Government representation on the CSSF Board continues potentially to constrain the autonomy of the CSSF to set its own budget; no evidence of interference was encountered, but the Board’s structure retains potential for future interference.
  - Division of liquidity supervision: BCL performs liquidity supervision (including preparation of LSREPs) for 19 LSIs; arrangement is uncommon as a key element of supervision is not conducted by the National Competent Authority (NCA). The selection criteria for those 19 LSIs should be further refined. The MoU between BCL and CSSF on liquidity supervision is drafted but not signed.
  - CBL classification: Clearstream Banking Luxembourg (CBL) is defined by the SSM as an LSI and supervised by the CSSF, but CBL’s global systemic interconnectedness and substitutability, structural and operational complexity may justify an ECB decision to take over direct supervision of CBL as an LSI pursuant to Article 6(5)(b) of the SSM Regulation and Article 67(2)(b)-(d) of the SSM Regulatory Framework. CSSF advised to request ECB direct supervision of CBL as an LSI.
  - Credit register: A Working Group chaired by the BCL with public and private participants has been set up to analyze potential setting up of a credit register; progress delayed due to COVID-19 but a first draft report produced. BCL should ensure active pursuit of work with clear deadlines.
  - Third Country Branches (TCBs): Currently no TCB in Luxembourg holds a material amount of retail deposits, consistent with CSSF’s current position; however, current policies may not adequately address potential future risks if TCBs accept retail deposits in Luxembourg.

### Institutional setting and sector statistics
- CSSF responsibilities: prudential supervision of Luxembourg’s financial sector except:
  - Significant credit institutions (SIs) — direct responsibility of the ECB.
  - Insurance undertakings — responsibility of the Commissariat aux Assurances (CAA).
- Under ECB oversight:
  - CSSF supervisory responsibility for 62 LSIs, with liquidity supervision for 19 of those LSIs undertaken by the BCL, and 13 third country branches.
- CSSF executive bodies:
  - Executive Board, Resolution Board, Depositor and Investor Protection Board.
  - Executive Board: Director General and four other directors (currently five members).
  - Board (composition discussed under governance).
- Banking sector (as of June 30, 2023):
  - Total number of banks operating in Luxembourg: 120 banks.
    - 45 Significant Institutions
    - 62 Less Significant Institutions
    - 13 Third Country Branches
  - Ownership and legal form:
    - 67 Foreign owned – subsidiary
    - 45 Foreign owned – branch
    - 8 Domestically owned
  - By business model (Total assets for 2023Q1 in €bill):
    - Custodian banking: 250.779
    - Universal banking: 213.455
    - Corporate finance: 198.850
    - Private banking: 156.395
    - Clearing, treasury and-or payment services: 55.434
    - Retail and commercial banking: 22.774
    - Covered bonds banking: 14.440
  - By SSM supervisory status (Total assets for 2023Q1 in €bill):
    - Significant Institutions: 636.107
    - Less Significant Institutions: 173.604
    - Third Country Branches: 102.406
  - Sector features:
    - Foreign-owned banks account for 92 percent of total bank assets.
    - Bank assets steady at 13 times GDP since 2017.
    - Investment fund sector is the second largest in the world and 78 times GDP.
    - CET1 capital ratio increased to 23.1 percent in 2022.
    - Non-performing loans are 1 percent of gross loans.
    - Banks’ liquidity coverage ratio (LCR) around 150 percent.

### Governance and operational independence of the CSSF
- Governance structure:
  - CSSF Board: seven members appointed by the Grand Duke on a proposal from the Government in Council.
    - A majority of four members are appointed representatives of the Ministry of Finance (MoF).
    - Three members are appointed as representatives of regulated sectors: currently Chairman of the Bankers’ Association of Luxembourg (ABBL), Director General of Luxembourg Association for the Funds’ Industry (ALFI), and a representative from the Institut des réviseurs d'entreprises (IRE).
  - Executive Board: nominated by the Grand Duke on a proposal by the government for a renewable five-year term; currently five members.
- Recommendations from 2017 FSAP reiterated (structure giving potential for future Ministerial or outside interference):
  - Consider supervisor answerable to Parliament rather than minister.
  - Board comprising independent directors.
  - Board able to determine its own budget.

### Main recommendations (from Table 1)
- Safeguard the independence of the CSSF board members through changing the law. In cases where legal amendments are not feasible, consider issuing subsidiary legislation to establish procedural safeguards to the extent feasible within the constraints provided under the law.
  - Priority: Medium
  - Urgency: Near Term
- The BCL and CSSF should finalize the MoU on responsibilities for bank liquidity supervision.
  - Priority: High
  - Urgency: Near Term
- The BCL and CSSF should clarify the criteria used to determine the set of LSIs to be supervised for liquidity purposes by the BCL. The arrangement whereby the BCL undertakes the LSREP assessment for a group of LSIs should be kept regularly under review.
  - Priority: Medium
  - Urgency: Near Term
- The BCL should ensure that all parties on the Working Group actively pursue the developmental work on setting up a credit register with clear deadlines set.
  - Priority: High
  - Urgency: Medium Term
- The CSSF should make further representation to justify ECB’s direct CBL supervision as an LSI based on the SSM Regulatory Framework.
  - Priority: High
  - Urgency: Near Term
- Note on timing: Near term: < 12 months; Medium term: 12 to 24 months.

*Source: EXECUTIVE SUMMARY (1luxea2024005).*

### 12.      Despite there being no current evidence of the governance structure constraining

### 1luxea2024005 - 12.      Despite there being no current evidence of the governance structure constraining

### Governance and independence of the CSSF board
- Finding: There is no current evidence that the governance structure constrains operational independence.
- Finding: The legal composition of the CSSF board (government majority and presence of industry representatives) could give rise to questions about independence and compliance with international standards and introduces potential for government or industry interference.
- Finding: The Board has no power to intervene, directly or indirectly, on prudential or supervisory matters or on the day-to-day management of the CSSF; these remain the preserve of the Executive Board.
- Finding: Sound international practices call for independent boards composed primarily of unaffiliated members.
- Finding: The 2017 FSAP recommended changes in the law; the situation demands legal changes.
- Policy recommendation: Safeguard the independence of CSSF board members through changing the law.
- Contingency recommendation: If legal amendments are not feasible, consider issuing subsidiary legislation to establish procedural safeguards to the extent feasible within the constraints provided under the law.
- Implementation guidance: Secondary legislation should, to the extent feasible within legal constraints, define clear roles for the board and executive board in the two-tier structure and develop criteria particularly regarding government actions related to budget proposals, board member nominations and dismissals, to future-proof against undue pressures.

*Source: IMF mission text.*

### Division of supervisory liquidity responsibilities: BCL and CSSF
- Context: Following Regulation (EU) No 1024/2013 (SSM Regulation) and SSM entry into force, the ECB assumed central supervisory authority roles: direct supervision of SIs and indirect supervision of LSIs. The CSSF was designated as the Luxembourg NCA as per CRR/CRD.
- Legal role of BCL: Under its organic law BCL is responsible for “supervising the general liquidity situation on the markets as well as for assessing market operators in this regard.” BCL Regulation 2009/No. 4 of April 29, 2009 provided guidance on liquidity supervision. Article 2 specified scope focused mainly on credit institutions that are monetary policy counterparties and, on a case-by-case basis, other operators likely to have significant impact on liquidity or monetary policy operations. Article 2.9 of the SSM Framework Regulation allows BCL to carry out supervisory tasks within national law and the SSM Framework Regulation.
- Operational arrangements: BCL and CSSF established principle-based working arrangements at operational level regarding shared liquidity supervision responsibilities for banks; arrangements were established at SSM inception to strengthen liquidity supervision of Luxembourg LSIs.
- MoU status and recommended actions:
  - A draft MoU has been prepared and should be finalized and signed as a matter of priority.
  - Main provisions of the MoU include:
    - Clarification of BCL participation in Joint Supervisory Teams (JSTs) and in on-site inspections of SIs organized by the ECB.
    - Specific topics regarding cooperation and division of work between BCL and CSSF for liquidity supervision of LSIs.
    - Co-operation between BCL and CSSF in cases of liquidity crisis.
    - Representation and co-ordination in European and international working groups.
    - Consultation on new regulations and circulars.
    - Cooperation regarding liquidity stress tests.
- Operational cooperation:
  - BCL and CSSF participate together in JSTs on supervision of SIs to ensure effective ongoing supervision of liquidity risk.
  - BCL participates in the JSTs of eight banking groups (all banking groups headquartered in Luxembourg under direct ECB supervision, and selected banking groups headquartered elsewhere in the Euro area with important subsidiaries in Luxembourg).
  - Liquidity data submitted by all banks is made available to both BCL and CSSF; further exchanges of information regarding individual institutions occur on an ad-hoc basis and in potential crisis contexts.
- Division of supervisory remit for LSIs:
  - In line with 2015 principle-based working arrangements, BCL has responsibility for ongoing liquidity supervision of 19 LSIs and 10 third country branches (TCBs).
  - The arrangement is uncommon (supervision element outside the NCA) but has not proved ineffective as of time of writing.
  - When set up in 2015, main criterion for inclusion under BCL remit was size. ECB classification for SIs and LSIs does not reflect composition of Luxembourg banking sector; allocation under BCL remit does not include all SIs and contains some LSIs under ECB classification for liquidity purposes.
  - Minor changes to composition of LSIs supervised by BCL since 2015 were driven by structural changes (e.g., conversion of a subsidiary to a branch) and not specified criteria.
  - Recommendation: BCL and CSSF should further specify the criteria for LSIs to be supervised by the BCL and review the group periodically.
- LSREP and coordination:
  - BCL undertakes annual Liquidity SREP (LSREP) assessments for the specified group of LSIs; completed LSREP is shared with CSSF and integrated into overall SREP.
  - For LSIs, BCL issues qualitative recommendations and follows-up on remediation; regulatory exemptions and quantitative add-ons on regulatory liquidity requirements are issued by CSSF following consultation with BCL, since CSSF remains the responsible authority.
  - Recommendation: BCL and CSSF should keep under review the arrangement whereby BCL undertakes the LSREP assessment for a group of LSIs; regular review should be incorporated in the MoU.
  - Recommendation: The BCL and CSSF should finalize the MoU as a matter of priority.

*Source: IMF mission text.*

### Liquidity supervision of LSIs
- Regulatory framework:
  - Legislative and regulatory framework for liquidity supervision of LSIs is set by the EU.
  - LSIs are subject to the Liquidity Coverage Ratio (LCR) in accordance with the Capital Requirements Regulation (CRR) and the LCR Delegated Act (LCRDA) and to the Net Stable funding Ratio (NSFR) in the CRR.
  - CSSF has aligned supervisory approach with ECB, formalized through Circular CSSF 22/816 and CSSF Regulation 18–03, as amended.
  - Qualitative requirements for LSIs to maintain sound liquidity risk management are set out in the Law on the Financial Sector (LFS) (Article 53–22), and further specified in CSSF Circulars 12/552 and 09/403.
  - Assessment of liquidity risk management framework is performed during SREP according to Chapter 10 of the Single Supervisory Mechanism (SSM) LSI SREP Methodology, in line with EBA SREP guidelines (EBA/GL/2022/03).
- Current liquidity metrics and supervisory activity:
  - At end-June 2023, the CSSF reports an average LCR for all LSIs at 230 percent, with total Level 1 assets representing 97 percent of high-quality liquid assets.
  - At end-June 2023, the average NSFR ratio for LSIs stood at 210 percent.
  - Neither CSSF nor BCL have conducted an on-site liquidity inspection of LSIs over the past five years; one on-site inspection is scheduled to take place by early 2024, triggered by a weak SREP score for risk control within the LSI.
- Ongoing monitoring and past supervisory focus:
  - Bank liquidity and funding profiles are assessed by line-supervision on an on-going basis through analysis of prudential data and other information.
  - In addition to regular LCR and NSFR data, CSSF and BCL receive a monthly Additional Liquidity Monitoring Metrics (ALMM) report and quarterly data on asset encumbrance.
  - The Internal Capital and Liquidity Adequacy Assessment Process (ICLAAP) submission is received annually from LSIs and assessed during the annual SREP process.
  - Over the past three years, qualitative recommendations on liquidity by BCL/CSSF focused mainly on weaknesses in stress testing frameworks, intraday liquidity risk management, banks’ risk appetite, and weaknesses in contingency funding plans.
  - Quantitative measures: CSSF imposed higher outflow factors on short term Private Banking deposits at two different banks in 2022. The first measure was taken in accordance with Article 25(3) of the LCRDA in ongoing supervision; the second measure was imposed as a Pillar 2 measure in accordance with Article 53–5 of the LFS.

*Source: IMF mission text.*

### Operational risk and resilience
- Legal and supervisory framework:
  - The CRR sets quantitative framework for LSIs to maintain capital against operational risks; the CRD sets operational risk management requirements and was transposed into law by the LFS.
  - LFS establishes general principles for governance, internal controls, and risk management and includes dedicated provisions on operational risk in line with CRD.
  - LFS Article 53–21 requires CRR institutions to implement policies and processes to evaluate and manage exposure to operational risk, including model risk, covering low-frequency high-severity events, and to have contingency and business continuity plans.
- Supervisory practice:
  - Ongoing supervision of operational risk forms an integral part of SREP for each LSI; operational risks are assessed on an ongoing basis by line supervisors for all LSIs and third country branches.
  - Assessment includes quarterly monitoring of defined financial and non-financial key indicators in line with EBA guidelines (EBA/GL/2014/13, Title 3 Monitoring of key indicators).
  - Qualitative information on operational risk is provided in the Long Form Report (LFR) submitted annually by each LSI.
  - Depth and intensity of analysis is proportionate to the risk profile and/or complexity of the bank; quarterly analysis involves quantitative assessment of main risk factors based on prudential reporting and predefined Key Risk Indicators (KRIs).
  - Horizontal operational risk review is conducted to determine sector-level operational risk and provide benchmarks and indicators across credit institutions.
  - CSSF does not have dedicated experts specifically in operational risk but has sufficient expertise across components (governance, IT, depository banks, AML, outsourcing, etc.) to conduct on-site inspections when required.
- European policy developments and action:
  - Guidance on operational resilience requirements for LSIs remains work in progress as European-wide policy evolves.
  - Recommendation: CSSF should remain fully engaged at a European level to monitor developments on operational resilience requirements and fully incorporate them into their regulatory framework when finalized.
- CBL supervision:
  - CBL, a systemically important ICSD, has a business model with inherently high operational risk.
  - CSSF has a dedicated team of four experienced supervisors supervising CBL; BCL has two full time equivalents (FTEs) for its oversight responsibilities for CBL.
  - Supervision of CBL by CSSF and BCL is intensive; staff are in contact most days. CBL provides additional reports required under the Central Securities Depositories Regulation (CSDR) including performance of the Securities Settlement System, business continuity testing, manual interventions, and operational incidents.
  - Coordination and collaboration between BCL and CSSF on CBL appear effective.

*Source: IMF mission text.*

### Related party lending
- Definitions and transparency:
  - Definition of “related party” is set out in Circular CSSF 12/552 (Part I Chapter 1).
  - Definition of “related party transaction” is set out in the self-assessment questionnaire sent annually to all banks.
  - Both definitions are consistent with BCBS definitions.
  - Recommendation: The related party transaction definition should be given public prominence and set out transparently in a Circular.
- Monitoring and supervisory practices:
  - Monitoring of related party transactions within LSIs is undertaken through off-site data analysis and on-site inspections.
  - CSSF receives quantitative data on related party lending via semi-annual EBA Financial Reporting (FINREP reports) and quarterly large exposure reports.
  - Intragroup data are available from monthly LCR and ALMM reports.
  - Primary qualitative source is the Long Form Report (LFR) which includes descriptions of policies and processes, related party transactions risk assessment, confirmations on arm's length basis, transfer pricing methodology, governance arrangements, and quantitative information on related party exposures (on- and off-balance sheet), guarantees, and profit and loss data.
  - On-site inspections examine policies, procedures, outsourcing arrangements, conflict of interest management, and transfer pricing where relevant; on-site credit review inspections assess group of connected clients via credit file samples.
  - Since 2017, CSSF has conducted eleven on-site inspections reviewing exposures to group entities and one on-site inspection reviewing conflicts of interests for transactions with the bank’s shareholder.
  - Finding: Review of LFR data and on-site review demonstrated CSSF’s supervisory approach to identifying and managing risks from related-party exposures is appropriate.

*Source: IMF mission text.*

### Interest Rate Risk in the Banking Book (IRRBB)
- Framework and methodology:
  - CSSF approach to supervising IRRBB of LSIs is effective.
  - Legal/regulatory basis: relevant EU legislation and Article 53 of the LFS; additional guidance in Chapter 8 of Circular 12/552.
  - CSSF follows SSM SREP methodology for LSIs for assessment and rating of IRRBB and IRRBB stress testing, in line with EBA and SSM practices.
- Quantitative and reporting arrangements:
  - Quantitative assessment of supervisory outlier tests is based on:
    - eight standard interest rate shock scenarios for the EVE metric, and
    - two parallel shift scenarios for the NII metric.
  - Data fields and questions cover main risk drivers (currencies, optionality, non-maturity deposit (NMD)).
  - Outlier banks must respond to an additional set of qualitative and quantitative questions.
  - Relevant data are collected in line with standard SSM reporting requirements; additional FINREP information is collected on valuation of assets/liabilities, hedges, and profit and loss accounts (interest rate margin, other comprehensive income, etc.).
  - Banks report EVE and NII metrics of Supervisory Outlier tests defined in Circular CSSF 08/338 to the CSSF once a year under eight different interest rate scenarios for EVE, and two interest rate scenarios for NII.
  - Banks are requested to calculate impact of interest rate shocks on NII and EVE quarterly and immediately report to the CSSF whenever the worst EVE exceeds 15 percent of a bank’s T1 capital.

*Source: IMF mission text.*

*Source: IMF mission text contained in content unit 1luxea2024005 - 12.*

### 35.      Regular analyses of bond and equity portfolios are undertaken.  In March 2023, the

### Regular analyses of bond and equity portfolios are undertaken.

### Interest rate sensitivity analysis and bond portfolios
- In March 2023, the CSSF undertook an interest rate sensitivity analysis on the amortized cost and mark-to-market bond portfolios of all banks using a 200-bps shock scenario to assess valuation losses on both portfolios.
- At end June 2023:
  - Bonds in the mark-to-market portfolio of all banks stood at EUR32 billion, which represented 3 percent of banking sector assets.
  - Bonds in the amortized portfolio stood at EUR 88 billion, representing 9 percent of total banking assets.
- Gross valuation losses and solvency implications (without hedges) of the 200-bps interest rate shock scenario (banks with solvency requirements only):
  - EUR 1.4 billion in the mark-to-market portfolio.
  - EUR 3.3 billion in the amortized cost bond portfolio.
- Conclusion: The CSSF judged these potential losses to be limited and manageable given hedging arrangements in the banks concerned. Follow-up work on the most impacted banks was conducted by line supervisors as part of on-going supervision.
- Supervisory capital action: In line with the general add-on policy based on the overall SREP score, the CSSF has not applied specific Pillar 2 capital add-ons in respect of IRRBB on any bank to date.

### IRRBB inspections, findings, and corrective actions
- CSSF resourcing for IRRBB on-site inspections:
  - Six members of staff with knowledge of IRRBB, ranging from entry to advanced skills.
  - Five on-site IRRBB inspections have been conducted on LSIs in the past five years.
- File review outcome: Confirmed the thoroughness of the on-site process and its output.
- Corrective actions required of banks in relation to IRRBB included:
  - Review of internal NMD models used and the documentation supporting the models.
  - Review of internal risk limits and forward-looking stress tests/ICAAP stress tests to ensure they are commensurate and proportionate to the business model and risks.
  - Review of stress test calculation and aggregation of different currencies.
  - Review of risk appetite, KRIs, early warning indicators and risk limits used by banks.

### Designation of CBL Direct Supervision by the ECB
- Legal and supervisory rationale:
  - Under the EU legal framework, the particular supervisory challenges posed by the CBL could justify, by way of exception to the default distribution of competences between the ECB and the NCAs, the ECB's takeover of the direct supervision of CBL as an LSI.
  - As a globally important FMI, CBL has systemic relevance both at a local and at an international level; its interconnectedness, substitutability characteristics, and structural and operational complexity support consistent application of high supervisory standards.
  - Justification references: Article 6(5)(b) of the SSM Regulation, and Article 67(2)(b)-(d) of the SSM Framework Regulation.
- Procedure and duty to state reasons:
  - A takeover of direct supervision of an LSI by the ECB is a decision of derogation and is subject to an enhanced duty to state reasons.
  - The takeover may be decided by the ECB on its own initiative (after consulting with the CSSF) or requested to the ECB by the CSSF under Article 6(5)(b) SSMR, as implemented by Article 68 of the Framework Regulation.
- Assessment: Provided the CSSF can present the necessary and sufficient justification for deviating from the default rule, the ECB's takeover of direct supervision is justified, despite CBL being an LSI.
- Recommendation:
  - The CSSF should make further representation to justify ECB’s direct CBL supervision as an LSI.

### Progress on 2017 FSAP recommendations (overview)
- The CSSF has made considerable progress in responding to the recommendations in the 2017 FSAP. Actions taken address governance, intragroup exposure supervision, on-site inspection resourcing and timeliness, real estate monitoring, harmonization of borrower metrics, and cooperation on credit registries and liquidity supervision.
- Selected actions taken (as presented):
  - No changes to the governance structure of the CSSF in relation to BCP 2.
  - CSSF internal procedure on intragroup exposures goes further than the relevant ECB Regulation and Guideline 2017/697 on options and discretions by considering the home country’s resolution regime and assessing the bail-in risk of intragroup exposures.
  - On-site inspections (OSI) Team headcount increased to approx. 80 FTE.
  - CSSF increased number of risk experts available for on-site inspections.
  - Timeline of completion of on-site inspection reports reduced to less than 3 months on average.
  - Quarterly assessments of RRE developments and Circular CSSF 18/703 introduced semi-annual reporting of borrower-related residential real estate indicators; harmonized LTV, DTI and DSTI definitions included in Circular 18/703.
  - Draft MoU between the BCL and CSSF on liquidity supervision drafted but not yet signed.
  - Pecuniary sanctions framework fully applied by the CSSF in line with EU Directives.
  - Active engagement with foreign supervisors through MoUs, joint supervisory teams, and supervisory colleges.
  - Macroprudential Division monitors banks’ holdings of sovereign debt closely via annual stress tests, weekly rating analysis and semi-annual market risk monitoring.
  - Directive (EU) 2019/878 strengthened oversight at European level of financial holding companies and mixed financial holding companies.

### Resources and staffing in banking supervision
- CSSF staffing growth and composition:
  - Total FTEs grew from 173 Full Time Equivalents (FTE) at end-2017 to 221 FTE at end-year 2022.
  - On-site inspection (OSI) department FTEs: 57.85 at 31/12/2017 to 72.35 at 31/12/2022, with a notable increase of +13.25 FTE between 2017 and 2018.
  - Current complement in OSI stands at 80 FTE (most staff in OSI).
- Risk expertise staff complement (selected specialties and FTEs):
  - AML: 2 managers, 18 agents, 5,65 on-site FTE.
  - Banking risks: 1 manager, 13 agents, 6,10 on-site FTE.
  - Corporate governance & Business model: 1 manager, 14 agents, 4,65 on-site FTE.
  - IT risks: 3 managers, 7 agents, 2,50 on-site & off-site FTE.
  - Interest rate risk, own funds: 1 manager, 0,39 on-site + off-site FTE.
  - Liquidity: 1 manager, 0,39 on-site + off-site FTE.
- Staff turnover:
  - Turnover figures by department (2018–2022, expressed as percentages): Banking department: 3,49 (2018), 6,48 (2019), 2,07 (2020), 7,21 (2021), 3,13 (2022). On-site inspection department: 4,65 (2018), 6,81 (2019), 6,72 (2020), 4,15 (2021), 2,78 (2022).
  - Turnover remains very low overall; salaries are very competitive and job security is an attraction.
- Assessment: The CSSF has made significant progress since 2017 to increase staffing resources in absolute numbers and breadth of knowledge and appears adequately resourced to perform its current supervisory functions.

### Supervisory approach and timeliness
- Improvement since 2017:
  - Average time between the closing meeting of an on-site inspection and communication of findings reduced from six months (2017) to less than three months on average.
  - Table 7 (timing of on-site inspection reports) provides a breakdown by type of on-site report.

### Interconnectedness with foreign-based banking parent groups and intragroup exposures
- Intragroup exposure trends and scale:
  - Total intragroup exposures: €225 billion at end-year 2017; increased to €279 billion at end-March 2023.
  - At end-March 2023, around 70 percent of all intragroup exposures were branch intragroup exposures.
  - Intragroup exposures have remained broadly stable as a share of total assets of all Luxembourg banks at around 30 percent of total banking sector assets.
- Regulatory discretion and internal guidance:
  - Luxembourg opted for the Member State Discretion exempting intragroup exposures from large exposure limits under Article 493(3)(c) of the CRR; enshrined in Article 56-1 of the LFS.
  - Article 56-1 criteria (as listed):
    - the counterparty is a CRR institution, a third-country credit institution or a third-country investment firm.
    - the financial situation in terms of risks and solvency and the liquidity situation of the counterparties concerned does not entail disproportionate credit risks for the CRR institution.
    - the financing of the exposures concerned does not incur material liquidity risks for the CRR institution in respect of maturity mismatches and currencies.
    - the exposures concerned would not trigger a disproportionate negative impact on the CRR institution where a resolution procedure had been applied to all or part of the group to which the CRR institution belongs.
  - CSSF internal guidance interprets these criteria and goes further by analyzing the home country’s resolution regime to establish treatment of intra-group liabilities in a bail-in situation.
- Supervisory enhancements since 2017:
  - Internal procedure for approving and monitoring intragroup waivers updated in 2023.
  - All banks required to provide a detailed assessment of compliance with Article 56-1(1) when applying for a waiver.
  - CSSF considers latest data on deposits guaranteed by the Luxembourg Deposit Guarantee Fund (FGDL) when assessing waiver risk.
  - Waivers undergo thorough periodic reviews by off-site supervision with a dedicated questionnaire submitted by LSIs and SIs to evaluate compliance.
  - Enhanced reporting of intragroup exposures commenced in 2018 to provide more granular data on intragroup maturity mismatches, including intragroup inflows and outflows per maturity bucket.
  - Since 2017, the CSSF monitors weekly (and more frequently in times of crisis) CDS and ratings of parent entities and main counterparties, and sovereign debt ratings and bond yields of the country of origin of the parent entity and main counterparty.
- Enforcement actions:
  - The CSSF has withdrawn six intragroup exemptions since 2017 for reasons including a parent company money laundering scandal, subordination of intragroup liabilities in the home country’s insolvency law, significant deterioration in credit quality of the group, and changes in legal status of the parent company.

### Treatment of intragroup liabilities in resolution: BRRD2 implications
- BRRD2 effect and Article 44(2)(h) (January 2021 stocktake conclusion):
  - Article 44(2)(h) excludes intragroup liabilities from bail-in subject to three conditions:
    - The Luxembourg subsidiary is part of the same resolution group as the intragroup counterparty.
    - The Luxembourg subsidiary is not designated as a resolution entity within the aforementioned resolution group.
    - The liabilities in question do not rank below ordinary unsecured liabilities under the relevant national law governing normal insolvency proceedings.
- MREL assessment and Article 46-6 of the BRRD law:
  - Where a subsidiary holds liabilities referred to in letter (h) of Article 44(2) that rank below ordinary unsecured liabilities under the law of the Member State governing normal insolvency proceedings applicable to the entity that issued these liabilities, the Resolution Board shall assess whether own funds and MREL instruments are sufficient to support the preferred resolution strategy.
  - If insufficient, the Resolution Board shall adjust the MREL requirement to cover the insufficiency.

*Source: Excerpts from the CSSF/IMF chapter covering paragraphs 35–52.*

### 53.      The CSSF has strengthened its monitoring and supervision of intragroup exposures,

### The CSSF has strengthened its monitoring and supervision of intragroup exposures

### Intragroup exposures and supervisory monitoring
- The CSSF has strengthened its monitoring and supervision of intragroup exposures, and specifically of the waiver process, since 2017.
- Intragroup exposures continue to present a material feature of the Luxembourg banking sector.
- The CSSF has assessed the financial stability impact of such exposures in the event of failure and bail-in of the wider group.
- This risk is mitigated by the provisions of the BRRD2.
- The CSSF has effective ongoing supervisory procedures at both the bank and sector level to monitor intragroup exposures to assess the risk to both individual LSIs and SIs and to the sector more generally.

### Home‑host relationships and supervisory arrangements
- 2017 FSAP recommendation: the CSSF should ensure close interaction with the supervisors of the parents or groups of LSIs outside the Euro area.
- As of June 30, 2023:
  - The CSSF was the competent authority for 62 LSIs and 13 branches of non-EU-credit institutions.
  - The CSSF is host supervisor for 40 LSIs whose parent entity is located outside of Luxembourg.
  - The CSSF is home supervisor for one banking group for which it exercises the ultimate consolidated supervision at European level.
  - Ten LSIs are not part of any banking group.
- Cooperative arrangements: The CSSF either has Memoranda of Understanding with home authorities or participates in joint supervisory teams, supervisory colleges, coordinates in case of need at SSM level, or has annual meetings with home authorities.
- Small host jurisdiction challenges:
  - Subsidiaries can be systemically relevant domestically but non-significant for the home supervisor and the international banking group.
  - Past crises show subsidiaries can generate under-capitalization and liquidity problems within the host country if the parent group encounters financial difficulties, with associated fiscal costs.
  - In crises, liquid and near-liquid assets within subsidiaries are transferred quickly to the ailing parent group.
  - These dynamics can affect financial stability, market confidence, and the perception of the host jurisdiction’s financial system.

### Third Country Branches (TCBs)
- The CSSF applies the same regulatory and supervisory framework for TCBs as for all other banks authorized in Luxembourg.
- Authorization and capital:
  - TCBs are required to hold nominal capital upon authorization based on the minimum requirement under Luxembourg law (€8.7million).
  - Most TCBs report much higher levels of capital than the minimum requirement.
- Waivers and reporting:
  - Most TCBs apply, upon authorization, for a waiver from the solvency requirements and no TCB has been refused a waiver to date.
  - All TCBs are required to submit the normal suite of regulatory reports which are monitored in line with routine supervisory practice.
  - Reported data on capital and liquidity within the branch provide some reassurance, but it is untested in law whether the reported capital allocated to the TCB and placed locally would be available in the event of a failure at the parent bank.
- Retail deposits and business models:
  - At present, no TCB in Luxembourg currently holds a material amount of retail deposits.
  - The business models of all TCBs in Luxembourg are predominantly trade-oriented and failure at parent bank level would have limited implications for the FGDL.
  - CSSF’s current policy (not formally documented internally or publicly) is not to allow a TCB to accept retail deposits on or after authorization.
- EU policy developments and implications:
  - The EU is planning to harmonize the EU framework for TCBs and the CSSF is fully engaged in the ongoing policy development.
  - The proposals aim to categorize TCBs into two classes (Class 1 and Class 2) based on specific criteria around size of assets and retail deposits.
  - Class 1 TCBs will be required, inter alia, to hold a minimum ‘capital endowment’ based on a percentage of total liabilities with a minimum of €10million.
  - Member States shall also provide authorities with the necessary powers to ensure that, among others, systemically important TCBs defined as banks with aggregated assets in the EU above €40 billion assets may be required to subsidiarize.
  - The CSSF should consider whether the proposed thresholds set out in the EU set an acceptable risk appetite for the authority or whether additional, lower thresholds would be more appropriate to future-proof its regulatory regime if Luxembourg TCBs seek to accept retail deposits.

### Recommendation (TCB regime)
- The CSSF should look to future-proof its third country branch regime in the event that TCBs seek to accept retail deposits.

### Credit risk — Sovereign debt
- 2017 FSAP note: Luxembourg banks had over €60 billion in sovereign debt at end-December 2015.
- Sovereign bond holdings have fallen since 2017, with total holdings standing at €37 billion at end-June 2023.
- LSIs’ sovereign bond exposures at €8 billion remain very low in terms of balance sheet size (5 percent) and their weighted average duration is circa one year.
- Ongoing monitoring:
  - The CSSF’s Macroprudential Division monitors sovereign debt holdings through its annual banking sector (solvency) stress test, analysis of weekly rating developments and semi-annual market risk monitoring.
  - Concentration risk analysis is part of ongoing off-site supervision and SREP procedure by micro-prudential supervision.

### Residential Real Estate (RRE) market monitoring
- 2017 FSAP recommended continued close monitoring of residential mortgage lending due to concentration in a small number of banks.
- The CSSF’s Macroprudential Division and the BCL follow RRE developments through:
  - Quarterly monitoring of housing supply, credit supply, house prices, housing demand, interest rates and indicators such as price-to-income and debt-to-income data.
  - Use of a house price-at-risk model and a house price overvaluation model to stress future developments in the RRE market.
- Further consideration of BCL and CSSF work on RRE was part of the second part of the FSAP mission in January 2024.

### Credit register development
- 2017 FSAP: Luxembourg had no credit bureau; BCL participated in an ECB initiative to introduce a harmonized credit database across the euro area.
- The ECB (Anacredit) initiative is scheduled to go live in 2027 but will be limited to corporate exposures (not households) and not made publicly available to banks.
- 2019 working group on a Luxembourg credit registry:
  - Chaired by the BCL and includes the ABBL, the Insurance Companies Association (ACA), the National Commission for Data Protection (CNPD), the MoF, the CSSF and the CAA.
  - Objectives: (i) contribute to financial stability by preventing over-indebtedness and (ii) allow authorities and lenders to have a complete and central overview of a borrower's debt.
  - Covid delayed progress; the working group has produced a first draft report covering information to be included (e.g., nominative information on natural persons, loan materiality thresholds, entities covered by the scope (e.g., non-bank entities)) and legal setup considerations (private law, professional secrecy constraints, other legislative issues).
- Recommendation:
  - The developmental work on setting up a credit register should be actively pursued by all parties on the Working Group with clear deadlines set.

### Regulation of nonbank holding companies
- 2017 FSAP recommended advocating for stronger oversight at the European level of nonbank holding companies that include banks.
- Directive (EU) 2019/878 (published June 7, 2019) amended Directive 2013/36/EU (CRD) and introduced new approval and oversight powers relating to financial holding companies and mixed financial holding companies (CRDV).
- Transposition:
  - The transposition of the CRD V was carried out through the law of May 20, 2021 (the Law), which amends the LFS.
  - The Law implements new requirements of the CRD V applicable to financial holding companies and mixed financial holding companies (MFHCs).
  - Articles 34-1 to 34-3 of the LFS (transposing Art. 21a of the CRD V) introduce a new approval process for and direct supervisory powers over certain MFHCs.
  - The aim is to ensure such holding companies can be held directly responsible for ensuring compliance with consolidated prudential requirements stemming from CRD V and Regulation (EU) No 575/2013 (CRR).

*Source: IMF country report content (excerpts provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1luxea2024005.pdf_