## _cr13124

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---

### Overview and background
- Impact of the crisis:
  - System assets: 384 percent of GDP in 2000 → 470 percent of GDP in 2007.
  - Banking sector size: reduced to 310 percent of GDP in mid-2012 after initial deleveraging.
  - Cross-border claims: fell from 300 percent of GDP in 2008 to 58 percent of GDP in mid-2012.
  - Largest remaining foreign exposures: the Czech Republic, France, Ireland, the United Kingdom, and the United States.
- Document date: April 25, 2013.
- Ongoing transformation involves significant downside risks; policy momentum should be sustained to preserve stability.

### Key vulnerabilities
- Low profitability and weak macroeconomic prospects:
  - Growth outlook weak, risks skewed to the downside.
  - Structurally high bank costs, diminishing earning capacity, regulatory reform impacts.
  - Housing price downturn would exacerbate capital pressures.
  - Prolonged low interest rates create vulnerabilities for banks and life insurers.
  - Legacy portfolios plus low rates may challenge viability of some firms’ business models.
- Intensified bank–insurer–sovereign links:
  - Market confidence fragile; domestic political risks pre-2014 elections.
  - Sovereign spread widening would raise funding costs and worsen capital and liquidity positions.
  - Large public debt limits government remedial capacity.
- Stress-testing insights:
  - Aggregate initial capital solid, but several banks would see significant profitability deterioration under stress.
  - Credit risk limited owing to historically low loss rates; real estate overvaluation vulnerabilities warrant closer examination.
  - Insurers sufficiently capitalized under current solvency regime; under market-consistent valuation supervisors should be vigilant.

### High-priority recommendations (verbatim actions and timing)
- Overall financial stability oversight
  - Formalize procedures and improve information exchange between the NBB and FSMA. Immediate
  - Make stress testing a routine tool within the macro-financial policy and surveillance framework. Short term
  - Enhance further stress testing of insurers using a market consistent valuation framework. Short term
  - Complete ongoing business model reviews for banks and insurance companies and develop sector strategies. Short term
  - Develop explicit conglomerates supervision framework and ensure consistent governance application. Medium term
  - Designate the NBB as the macroprudential authority, ensure regular dialogue with FSMA and MOF. Medium term
- Banking regulation and supervision
  - Review supervisory processes and calibrate intensity/resources based on risk profiles, particularly for smaller institutions. Short term
  - Embed engagement with bank and insurance boards in supervisory process. Medium term
  - Empower the NBB to pre-approve a major acquisition by a credit institution. Medium term
  - Maintain current liquidity regulatory regime until Basel III LCR fully adopted at European level. Ongoing
- Insurance regulation and supervision
  - Formulate baseline prudential supervisory program and risk-based conduct-of-business supervision. Short term
  - Align insurance stress testing findings with contingency planning under recovery and resolution framework. Short term
  - Implement elements of Solvency II, including ORSA. Medium term
  - Empower NBB to take immediate recovery measures notwithstanding an appeal by an insurer. Medium term
- Securities markets supervision
  - Establish an Emerging Risk Committee at the FSMA and formalize framework for detecting/monitoring emerging risks. Medium term
- Crisis management and resolution
  - Formalize domestic coordination via a crisis management MOU and cross-institutional coordination group. Short term
  - Request recovery and resolution plans (RRPs) for all domestic systemically important firms. Short term
  - Grant NBB explicit mandate as the resolution authority. Medium term
  - Improve bank resolution toolkit: reduce ex ante procedural requirements, extend framework to all banks, enhance special inspector powers. Medium term
  - Revamp deposit guarantee scheme, establish ex ante fund and depositor preference. Medium term

### Macroeconomic outlook and fiscal position
- Growth:
  - Growth slowed significantly since start of 2012 and expected to stagnate through 2013.
  - Main external factor: weak external demand in the European Union.
- Labor and public finances:
  - Unemployment rate has begun to edge upward.
  - General government deficit widened to 3.9 percent of GDP in 2012.
  - Debt-to-GDP dynamics tenuous given low growth prospects.
- Reforms:
  - Labor market and pension reforms aimed at boosting employment and potential growth; implementation is challenging and competitiveness continues to fall.

### Sovereign–bank linkages and contingent liabilities
- Banking sector exposure to Belgian government (including local authorities): 11 percent of banking sector assets in mid-2012.
- Contingent fiscal liabilities from state aid to Dexia, Fortis, and KBC: estimated to have reached 18 percent of GDP.
- Belgium’s recapitalization of Dexia: €5.5 billion injected in December 2012; recapitalization amounts to 2.3 percent of GDP; contingent liabilities from funding guarantees add up to 14 percent of GDP; funding guarantees ceiling reduced to €85 billion.

### Financial system structure: insurance and asset management
- Insurance industry size and concentration:
  - Insurance industry: 69 percent of GDP at end-2011 (€255 billion).
  - Top five life insurers: 71 percent of total assets in 2011.
  - Top five nonlife insurers: 58 percent of assets in 2011.
  - Nine insurance groups derived, on average, more than 90 percent of their premiums from domestic operations in 2011.
- Asset management:
  - UCIT assets under management: 80 percent of GDP (or €293 billion) at mid-2012; 4 percent of European market share.
  - Non-UCIT assets under management: €250 billion (68 percent of GDP).

### Household sector: real estate, debt, vulnerabilities
- House prices:
  - Prices more than doubled in past decade; up by 90 percent in real terms since 2000.
  - Various estimates: Belgian housing market overvalued by 5−20 percent.
- Household indebtedness and mortgage metrics:
  - Household indebtedness: 90 percent of disposable income.
  - About 20 percent of borrowers use 50 percent of disposable income or more to service mortgage.
  - Share of variable interest rate debt has risen, especially for low-income households.
  - NBB findings: some recent mortgages to low-income households have LTVs close to 100 percent (vs. average about 65 percent).
  - Aggregate: 40 percent of outstanding mortgages have LTVs above 80 percent.
- Policy implication: monitor risk build-up and weigh merits of activating macroprudential tools.

### Corporate sector: profitability, debt, competitiveness
- Corporate profits fell sharply in 2008; short-lived recovery in 2010–11; bankruptcy rates rose significantly in fall 2012.
- Business start-ups declined by 21 percent year-on-year.
- Nonfinancial corporate debt: 87 percent of GDP in Q3 2012 (consolidated, excluding intra-company lending).
- Banks’ exposure to the sector stable at about a third of total loans in 2007–12.
- Competitiveness: since 2011 Belgium has fallen behind Germany, France, and the Netherlands as unit labor costs grew faster.

### Banking-sector vulnerabilities and resilience
- Reorientation and deleveraging:
  - Aggregate bank assets fell by 25 percent since 2007; exposures outside Belgium dropped by over 40 percent.
- Capitalization and leverage:
  - Tier 1 capital for the Belgian banking system: 11.5 percent of risk-weighted assets in 2008 → 13.4 percent mid-2012.
  - Leverage ratios: regulatory capital at 6.2 percent of total assets for the system and 6.1 percent for the group of six largest banks.
- Liquidity and funding:
  - Liquidity pressures abated; reduced wholesale funding and central bank repos.
  - Average NBB liquidity ratio: 263 percent (against a norm of 100 percent).
  - Access to wholesale funding could worsen if sovereign risk perceptions deteriorate.
- Profitability: banks struggle for profitability; structural costs remain high and interest margins under pressure.

### Exposures, network risks, and cross-border spillovers
- Shift from peripheral sovereign exposures to Belgian sovereign exposures.
- Network analysis (see Box 2) key points:
  - Largest direct vulnerability to extreme credit and funding shocks: France, Germany, and the Netherlands.
  - Shocks to banks in the United States and the United Kingdom have a greater, albeit second-round, impact on Belgium.
  - An extreme credit and funding shock in Belgium would have important outward effects on Luxembourg, the Netherlands, and the Czech Republic.
- Outward exposures to Central and Eastern Europe fell by about 22 percent since end-2007; exposure to the Czech Republic remained high and relatively stable.

### Box 2 — Network analysis of spillover risk (selected findings and parameters)
- Methodology/data:
  - Bilateral interbank exposures across 18 countries; exposure and capital data at end-September 2012.
  - Credit shock: loss given default of 100 percent on interbank exposures.
  - Funding shock: withdrawal of 35 percent on interbank funding and a haircut of 50 percent on forced asset sales.
- Key findings — spillovers to Belgium:
  - The United States and the United Kingdom pose the biggest potential risk to Belgium, followed closely by France.
  - A credit-only or credit and funding shock from the United States, the United Kingdom, or France would be extreme, resulting in complete or near complete depletion of regulatory capital.
  - Belgium particularly vulnerable to credit and funding shocks from Germany and the Netherlands.
- Key findings — spillovers from Belgium:
  - Extreme credit and funding shock in Belgium would affect Luxembourg, the Netherlands, and the Czech Republic most.
  - Impact confined to less than 25 percent of regulatory capital in Luxembourg, the Netherlands, and the Czech Republic.

### Stress testing (banking and insurance) — selected quantitative outcomes
- Banking sector CET1 impacts under two adverse macro scenarios (mid-2012 data):
  - CET1 capital ratio declines by 4.2 percentage points under the severe short-term “double-dip recession” and by 3.5 percentage points under the protracted “slow-growth scenario.”
  - A few institutions fall below the capital hurdle rate; shortfall could reach up to 3.6 percent of aggregate CET1.
  - Market-implied valuation haircuts applied reduce CET1 by more than €4.6 billion or 10.4 percent under adverse scenarios.
- Liquidity metrics:
  - Revised LCR announced in January 2013 would improve system-wide ratio from 83 percent to 103 percent, with only one institution falling below threshold.
  - Average NSFR: 112 percent; most banks have NSFR ratios higher than 95 percent.
  - NBB liquidity ratio: average 263 percent; extending horizon to one month yields small overall liquidity shortfall concentrated in few institutions (0.5 percent of eligible assets).
- Insurance sector stress testing (six largest insurers, >70 percent of sector):
  - Valuation methods: Solvency I, QIS 5, and full market-consistent valuation (MCV).
  - Under Solvency I: all but one firm exceed Solvency I hurdle under mild and severe scenarios; hidden reserves buffer shocks.
  - Under MCV: most firms likely to experience significant decline in solvency ratios; sector severely undercapitalized under both stress scenarios.
  - Market-implied valuation haircuts decreased the QIS-5 solvency ratio with weighted SCRs by 45 and 54 percentage points under mild and severe scenarios, respectively.

### Insurance regulation and supervision — progress and remaining needs
- Progress:
  - Strengthened solvency requirements for life insurers with legacy exposures.
  - Enhanced risk management requirements and integrated vertical and horizontal supervisory analyses.
- Remaining needs:
  - Adopt a more principles-based delegation to NBB for enforceable rules.
  - Empower NBB to take immediate recovery measures notwithstanding appeals.
  - Formulate baseline supervisory program; inspect outsourced functions; review external auditors’ and actuaries’ roles.
  - FSMA to focus on market conduct and be resourced for risk-based supervision of >17,000 intermediaries.
  - Consider early implementation of elements of Solvency II, including ORSA and market-consistent valuation.

### Financial market infrastructures and covered bonds
- Euroclear:
  - Transaction volume: €580.6 trillion in 2011; daily average settlement value around €1.1 trillion; settlement services for securities from 44 markets in 53 currencies.
- Bank of New York Mellon SA/NV: €18 trillion in custody; European business centered in Brussels.
- Covered bonds framework (2012):
  - Enacted August 2012; Royal decrees published October 18, 2012 enabled issuance by end-2012.
  - Two Belgian banks issued covered bonds rated “Aaa/AAA”; placements trade just below Belgian government bonds.
  - Cap on covered bond issuance: eight percent of total assets of the issuing credit institution.
  - Initial KBC placement: banks accounted for 48 percent of the placement.
  - Supervisory role: NBB approves structures, monitors encumbrance, oversees integrity and disclosures.
- Systemic risk consideration: large bank participation in placements increases sector interconnectedness.

### Crisis management, resolution, and deposit insurance
- Progress since 2010 legislation: improvements in systemic situation tools, recovery planning by D-SIBs and systemically relevant FMIs.
- Remaining priorities:
  - Robust and flexible resolution framework.
  - Comprehensive reform of deposit insurance: create segregated ex ante fund financed by industry contributions; fold current fund resources into new scheme; set minimum target fund size; consider depositor preference; exclude cooperative corporation shares from coverage.
  - Strengthen NBB mandate as resolution authority; reduce ex ante procedural requirements; broaden powers to holding companies and nonsystemic situations; strengthen special inspector powers.
  - Liquidation framework: revise bankruptcy-based procedures to enable rapid transfer of critical operations to third parties under resolution oversight.

### Risk Assessment Matrix — selected high-concern risks
- 1. Protracted slow European growth and persistent low interest rates:
  - Overall concern: Medium; Relative likelihood: High; Potential impact: High.
  - Consequences: crippled bank and insurer profitability; asset price declines.
- 2. Political uncertainty and fiscal strain causing sovereign spread widening:
  - Overall concern: Medium; Relative likelihood: Medium; Potential impact: Medium.
  - Consequences: higher funding costs, downgrades to banks/insurers, collateral haircut strain.
- 3. Spillover from intensification of euro area crisis:
  - Overall concern: Medium; Relative likelihood: High; Potential impact: High.
  - Consequences: contagion, market stress, potential deposit runs.
- 4. Housing price correction:
  - Overall concern: Medium; Relative likelihood: Medium; Potential impact: Medium.
  - Drivers: house prices up 90 percent in real terms since 2000; pockets of mortgage LTV and variable-rate exposure.

### Stress-testing macroeconomic scenarios (selected entries — percentage changes / levels preserved)
- Real GDP (Baseline / DD / SG):
  - Baseline: 2013 0.3, 2014 1.0, 2015 1.3, 2016 1.4, 2017 1.4
  - DD: 2013 -1.6, 2014 -0.4, 2015 0.6, 2016 1.0, 2017 1.1
  - SG: 2013 -0.6, 2014 0.1, 2015 0.4, 2016 0.5, 2017 0.5
- Unemployment rate (% of labor force):
  - Baseline: 2013 7.8, 2014 7.6, 2015 7.5, 2016 7.3, 2017 7.4
  - DD: 2013 8.0, 2014 8.6, 2015 9.3, 2016 9.7, 2017 10.3
  - SG: 2013 7.9, 2014 8.1, 2015 8.5, 2016 8.9, 2017 9.6
- Short-term interest rate [EONIA] (In percent):
  - Baseline: 2013 0.4 through 2017 0.4
  - DD: 2013 1.0, 2014 1.0, 2015 0.9, 2016 0.9, 2017 0.8
  - SG: 2013 0.4, 2014 0.4, 2015 0.4, 2016 0.3, 2017 0.3
- 10-year sovereign bond yield (In percent):
  - Baseline: 2013 3.1, 2014 3.4, 2015 3.6, 2016 3.8, 2017 3.8
  - DD: 2013 3.3, 2014 3.6, 2015 3.8, 2016 3.9, 2017 3.9
  - SG: 2013 3.0, 2014 3.3, 2015 3.5, 2016 3.8, 2017 3.8

### Regulatory, supervisory and standards observations (BCP / ICP highlights)
- Banking supervision:
  - High level of compliance with Basel Core Principles overall; NBB has clear legal powers and mandate to detect threats to financial stability.
  - Tier 1 capital ratio: 11.6 percent in 2008 → 14.8 percent in mid-2012 (aggregate).
  - Four dominant banking groups represent almost ¾ of consolidated system assets.
  - NBB practices: risk-based supervision, ICAAP, SREP, liquidity stress testing, macro-financial dashboard.
  - Remaining needs: clearer legal relationship between supervisory and financial stability functions, formal MOU between NBB and FSMA, proportionate supervisory intensity for nonsystemic firms, improved documentation and baseline supervision.
- Insurance supervision (ICP assessment):
  - Twin Peaks structure (April 2011): NBB (micro-/macro-prudential) and FSMA (conduct).
  - Insurers held €104 billion (41 percent of assets) in government bonds at end-2011; €59.6 billion in Belgian government bonds.
  - Solvency I not risk-based; move toward market-consistent valuation and Solvency II elements recommended ahead of timeline for prudential clarity.
  - Key recommendations: revise Flashing Light, implement ORSA, strengthen ALM and valuation practices, enhance disclosure and conduct-of-business supervision.
- AML/CFT:
  - Last FATF Mutual Evaluation: June 2005; new FATF assessment tentatively scheduled in September 2014.
  - Mission could not conclude AML/CFT compliance is sufficiently embedded in supervisory framework; monitoring for smaller banks unclear.

### Institutional culture and supervisory follow-up
- Need for more intensive and intrusive supervision; promote supervisory “will to act.”
- Strengthen conglomerates supervision: uniform approach to cross-sectoral risk identification and consistent application of group-wide governance.
- Institutionalize stress testing (top-down and bottom-up) within macroprudential and supervisory frameworks; obtain more granular prudential information on intragroup transactions.

_International Monetary Fund staff report — Belgium: Financial System Stability Assessment (Executive Summary), April 25, 2013._

### 2013. The views expressed in this document are those of the staff team and do not necessarily reflect

### BELGIUM FINANCIAL SYSTEM STABILITY ASSESSMENT — EXECUTIVE SUMMARY

### Overview and background
- The impact of the crisis on Belgium was substantial, resulting in a sharp output contraction, wide-spread instability in financial markets, and an abrupt deterioration in banks’ financial positions requiring substantial state support.
- Following authorities’ response, a radically changed and downsized financial system emerged. Ongoing transformation involves significant downside risks, and the policy momentum should be sustained to preserve stability.
- Structural features noted:
  - System assets grew from 384 percent of GDP in 2000 to 470 percent of GDP in 2007.
  - An initial deleveraging reduced the size of the banking sector to 310 percent of GDP in mid-2012.
  - Cross-border claims fell from 300 percent of GDP in 2008 to 58 percent of GDP in mid-2012.
  - Largest remaining foreign exposures: the Czech Republic, France, Ireland, the United Kingdom, and the United States.
- Document date: April 25, 2013.

### Key vulnerabilities
- Low profitability and weak macroeconomic prospects:
  - Growth outlook for Belgium is weak, with risks skewed to the downside.
  - Banks face structurally high costs, diminishing earning capacity, and regulatory reform impacts.
  - A downturn in housing prices would further exacerbate capital pressures.
  - Prolonged low interest rates create vulnerabilities for banks and life insurers.
  - Legacy portfolios plus low rates may call into question viability of some firms’ business models, necessitating close supervisory monitoring.
- Intensified links between banks, insurers, and the Belgian sovereign:
  - Market confidence remains fragile in the euro area; domestic political risks will persist as 2014 elections approach.
  - A widening of the sovereign spread would raise funding costs and worsen capital and liquidity positions of banks and insurers in an environment of constrained profitability.
  - Large public debt limits the government’s capacity for remedial measures.
- Stress-testing insights:
  - Banks’ initial capital levels are solid in aggregate, but several banks would experience significant deterioration of profitability under stress.
  - Given forthcoming additional capital requirements, capital pressures could emerge in the medium term.
  - Credit risk appears limited owing to historically low loss rates, but potential vulnerabilities from real estate overvaluation warrant closer examination.
  - Insurers remain sufficiently capitalized under the current solvency regime; under market-consistent valuation supervisors should remain vigilant and advance contingency planning under the new recovery and resolution framework.

### Regulatory and supervisory framework
- Compliance with international standards for regulation and supervision of banks and insurers is generally high.
- Good risk-based practices are employed, particularly for large groups; a proportionate supervisory approach should be espoused for smaller institutions.
- The decision to adopt elements of Solvency II ahead of schedule is welcome.
- Remaining priorities:
  - Strengthening the conduct of business regime for insurers and intermediaries.
  - Increasing supervisory resources.
  - Finalizing the operational cooperation framework between the NBB and FSMA.
- Effective regulation, supervision, and oversight of Euroclear Bank—a systemically important FMI—is in place. Authorities should work closely with Luxembourg counterparts responsible for Clearstream Bank Luxembourg to ensure a level playing field in risk management practices, and broaden cooperation with involvement of the ECB.

### Supervision culture and conglomerates
- Financial stability risks underscore the need for more intensive and intrusive supervision.
- Promote a supervisory culture in which the “will to act” is both expected and rewarded to manage complexities in the transforming system.
- Need for a more uniform approach to identification and assessment of cross-sectoral risks to improve conglomerates supervision and consistent application of group-wide governance requirements.

### Crisis management, resolution, and deposit insurance
- Bank failures have been handled decisively, but the resolution toolkit remains work in progress.
- 2010 legislation for systemic situations brought improvements; progress made on recovery planning by D-SIBs and systemically relevant infrastructures.
- Still needed:
  - Robust and flexible resolution framework.
  - Comprehensive reform of the deposit insurance.

### EU-wide context and implications
- Assessment performed against rapidly evolving EU-wide landscape.
- Bank supervision will shift to the ECB, but operational local responsibilities will likely remain important in transition and steady state.
- Oversight of conglomerates will become more challenging; close coordination with the ECB will be needed.
- Maintaining momentum in improving supervisory practices in Belgium remains important.

### High-priority recommendations (verbatim actions and timing as presented)
- Overall financial stability oversight
  - Formalize procedures and improve information exchange between the NBB and FSMA. Immediate
  - Make stress testing a routine tool within the macro-financial policy and surveillance framework. Short term
  - Enhance further stress testing of insurers using a market consistent valuation framework. Short term
  - Complete the ongoing business model reviews for both banks and insurance companies and develop a strategy for both sectors over the medium term. Short term
  - Develop an explicit conglomerates supervision framework and ensure consistent application of governance requirements across financial conglomerates. Medium term
  - Designate the NBB as the macroprudential authority, ensuring a regular dialogue with FSMA and MOF on macroprudential and financial stability matters. Medium term
- Banking regulation and supervision
  - Review supervisory processes and calibrate intensity and resource allocation based on institutions’ risk profiles, particularly for smaller institutions. Short term
  - Embed engagement with bank and insurance boards in the supervisory process in a systematic way. Medium term
  - Empower the NBB to pre-approve a major acquisition by a credit institution. Medium term
  - Maintain current liquidity regulatory regime until the Basel III Liquidity Coverage Ratio (LCR) is fully adopted and phased in at the European level. Ongoing
- Insurance regulation and supervision
  - Formulate a baseline prudential supervisory program for insurers and risk-based conduct-of-business supervision of insurers and intermediaries. Short term
  - Align findings of insurance tress testing with contingency planning in the context of the recovery and resolution framework. Short term
  - Implement elements of Solvency II, including an Own Risk and Solvency Assessment regime. Medium term
  - Empower the NBB to take immediate recovery measures notwithstanding an appeal by an insurer. Medium term
- Securities markets supervision
  - Establish an Emerging Risk Committee at the FSMA and formalize framework for detecting and monitoring emerging risks. Medium term
- Crisis management and resolution framework
  - Formalize domestic coordination arrangements for the financial safety net participants via a crisis management MOU and the establishment of a cross-institutional coordination group. Short term
  - Request recovery and resolution plans (RRPs) for all domestic systemically important firms. Short term
  - Grant NBB an explicit mandate as the resolution authority. Medium term
  - Improve the bank resolution toolkit by reducing ex ante procedural requirements, extending the framework to all banks and enhancing powers for special inspectors. Medium term
  - Revamp the deposit guarantee scheme, establish ex ante fund and depositor preference. Medium term

*International Monetary Fund staff report — Belgium: Financial System Stability Assessment (Executive Summary), April 25, 2013.*

### 3.      Following a short-lived recovery, growth has slowed significantly since the start of

### _cr13124 - 3.      Following a short-lived recovery, growth has slowed significantly since the start of

### Macroeconomic outlook and fiscal position
- Growth slowed significantly since the start of 2012 and is expected to stagnate through 2013.
- Main external factor: weak external demand in the European Union (the main trading partner).
- Domestic demand deteriorating due to higher uncertainty, depressed consumer and business sentiment, and fiscal consolidation.
- Unemployment rate has begun to edge upward.
- General government deficit widened to 3.9 percent of GDP in 2012.
- Dynamics of the debt-to-GDP ratio remain tenuous in light of low growth prospects.
- Government reforms: labor market and pension reforms aimed at boosting the employment rate and potential growth; implementation is challenging and competitiveness continues to fall.

### Sovereign-bank linkages and contingent liabilities
- Total exposure of the banking sector to the Belgian government (including exposure to local authorities) increased substantially since 2008 and stood at 11 percent of banking sector assets in mid-2012.
- Contingent fiscal liabilities from state aid to Dexia, Fortis, and KBC are estimated to have reached 18 percent of GDP.
- Fiscal consolidation is critical given substantial exposures to the Belgian government and limited fiscal headroom.

### Financial system structure: insurance and asset management
- Belgian insurance industry size and concentration:
  - Insurance industry accounted for 69 percent of GDP at end-2011 (i.e., €255 billion).
  - The top five life insurers accounted for 71 percent of the total assets in 2011.
  - The top five nonlife insurers held 58 percent of assets in 2011.
  - Composite insurers dominate; nine insurance groups derived, on average, more than 90 percent of their premiums from domestic operations in 2011.
  - The largest insurance group wrote more than a third of premiums abroad.
- Asset management industry:
  - UCIT assets under management stood at 80 percent of GDP (or €293 billion) at mid-2012 and represent 4 percent of European market share.
  - Non-UCIT assets under management amounted to €250 billion (68 percent of GDP).

### Financial market infrastructure and covered bonds framework
- Euroclear: largest clearing and settlement system in Europe located in Belgium; transaction volume of €580.6 trillion in 2011.
- Bank of New York Mellon SA/NV: with €18 trillion worth of securities held in custody, operates as a global custodian and asset manager with European business centered in Brussels.
- NBB coordinates oversight of SWIFT.
- New covered bonds framework (2012):
  - Enacted August 2012; publication of two Royal decrees on October 18, 2012 enabled issuance by end-2012.
  - Provides dedicated on-balance-sheet structures, dual recourse to the cover pool and the issuer, and issuance limits to mitigate funding-risk concentration.

### Household sector: real estate, debt, and vulnerabilities
- Real estate prices:
  - Prices have more than doubled in the past decade.
  - Up by 90 percent in real terms since 2000.
  - Various estimates suggest the Belgian housing market is overvalued by 5−20 percent.
- Household indebtedness and mortgage vulnerabilities:
  - Household indebtedness at 90 percent of disposable income.
  - About 20 percent of borrowers need to use 50 percent of their disposable income or more to service their mortgage.
  - Share of variable interest rate debt has risen, especially for low-income households.
  - NBB findings (2012 Financial Stability Report):
    - Loan-to-value (LTV) ratios for a portion of recently originated mortgages to low-income households have been close to 100 percent (vs. the average of about 65 percent).
    - On aggregate, 40 percent of the outstanding stock of mortgages have LTVs above 80 percent.
- Policy implication: Build-up of risk should be closely monitored; authorities should weigh merits of activating specific macroprudential tools if needed.

### Corporate sector: profitability, debt, and competitiveness
- Corporate cycle:
  - Profits fell sharply in 2008, particularly for sectors exposed to global trade.
  - Short-lived recovery in 2010 and 2011; corporate bankruptcy rates increased significantly in fall 2012.
  - Business start-ups declined by 21 percent year-on-year.
- Nonfinancial corporate debt:
  - On a consolidated basis (excluding intra-company lending) stood at 87 percent of GDP in Q3 2012.
  - Banks’ exposure to the sector stable at about a third of total loans in 2007–12.
- Competitiveness: Since 2011, Belgium has fallen behind Germany, France, and the Netherlands in export performance as unit labor costs have grown faster than those of its neighbors due to sticky inflation and wage indexation.

### Implementation of 2006 FSAP recommendations and supervisory developments
- Progress made, especially in banking supervision intensity and system-wide monitoring tools:
  - Introduction of an intensive Internal Capital Adequacy Assessment Process (ICAAP) for determining Pillar II capital requirements.
  - Liquidity stress testing for the banking sector.
  - Introduction of a macro-financial risk dashboard.
- Remaining gaps:
  - Recommendations on conglomerate supervision and governance remain relevant.
  - Need for better communication and coordination between supervisory institutions.
  - Supervisory tools for monitoring group-wide risks need upgrading.
  - Crisis management framework needs further upgrades owing in part to EU-wide developments.
- Insurance supervision:
  - Significantly strengthened but further work needed, particularly in strengthening the solvency framework.
  - FSMA to focus on market and business conduct; plan to adopt a risk-based approach to conduct supervision must be adequately resourced.
  - Debate ongoing whether pension funds supervision should move from FSMA to NBB.

### Financial crisis response, restructuring, and remaining execution risks
- Authorities’ response to the 2008 crisis was prompt and forceful: capital injections and government guarantees facilitated major restructuring of the financial sector and were stabilizing.
- Intervened institutions are in different stages of recovery; deleveraging well advanced.
- Some banks remain reliant on public support; difficult market conditions could impede deleveraging through asset disposals.
- Unwinding state support will take time and depends on restoring financial stability across the euro area.

### Dexia restructuring
- Dismantling the Dexia Group is long-term and complex; requires continued vigilance and coordination with French authorities.
- Belgian and French governments injected additional capital of €5.5 billion into Dexia in December 2012 and reduced the funding guarantees ceiling to €85 billion.
- European Commission approved sovereign funding guarantees for Dexia and its restructuring plan on December 28, 2012.
- Belgium’s recapitalization of Dexia amounts to 2.3 percent of GDP; contingent liabilities arising from funding guarantees add up to 14 percent of GDP.

### Banking-sector vulnerabilities and resilience
- Consolidation and profitability:
  - Banks have struggled for profitability since the crisis; structural costs remain high.
  - Further efficiency gains might be difficult due to natural wage drift and growth of operating expenses.
  - Interest margins likely to come under pressure due to greater reliance on more costly term deposits and longer maturity bonds and limited pricing power in saturated domestic lending market.
- Asset redeployment and focus on domestic market:
  - Aggregate bank assets fell by 25 percent since 2007 owing to a drop of exposures outside Belgium by over 40 percent.
  - This reorientation increased focus on home markets; overall level of impairments has remained relatively modest so far.
- Intragroup funding and intragroup exposures underscore the importance of robust intragroup exposure reporting and conglomerate supervision.
- Capitalization and leverage:
  - Tier 1 capital for the Belgian banking system rose from 11.5 percent of risk-weighted assets in 2008 to 13.4 percent mid-2012.
  - Leverage ratios: regulatory capital at 6.2 percent of total assets for the system and 6.1 percent for the group of six largest banks.
- Liquidity and funding:
  - Liquidity and funding pressures have abated; banks reduced dependence on wholesale funding and collateralized central bank repos.
  - Stricter liquidity regulation by the NBB in 2011 supported liquidity risk management.
  - Eurosystem measures eased investor concerns but increased asset encumbrance in several large banks.
  - Access to wholesale funding could become more difficult if market perception of sovereign risk deteriorates.

### Exposures, network risks, and cross-border spillovers
- Banks’ exposures to vulnerable euro area sovereigns have declined significantly since the crisis; exposures to Greece, Portugal, Spain, and Italy declined and were replaced with exposures to the Belgian sovereign.
- Network analysis indicates largest direct vulnerability to extreme credit and funding shocks to banks in France, Germany, and the Netherlands.
- Shocks to banks in the United States and the United Kingdom would have a greater, albeit second-round, impact on Belgium.
- An extreme credit and funding shock in Belgium would have important outward effects on the banking systems in Luxembourg, the Netherlands, and the Czech Republic.
- Outward exposures to Central and Eastern Europe:
  - Exposures of Belgian banks to Central and Eastern Europe decreased by about 22 percent since end 2007 primarily through disposal of foreign subsidiaries.
  - Exposure to the Czech Republic remained high and relatively stable, with an almost equal split between loans and government securities.
  - Exposures to Turkey and Russia dropped most significantly.
- Systemically important infrastructure risks:
  - Euroclear Bank: daily average settlement value around €1.1 trillion; provides settlement services for securities from 44 markets in 53 currencies.
  - Bank of New York Mellon SA/NV: European subsidiary designated a global systemically important institution; Belgian subsidiary acts as a processing center for global custody activities outside the U.S.
  - SWIFT: NBB coordinates oversight; SWIFT plays a vital role in daily messaging for large number of systemically important firms.

*Source: _cr13124 - 3.      Following a short-lived recovery, growth has slowed significantly since the start of (IMF document content provided).*

### Box 2. Network Analysis of Spillover Risk for the Belgian Banking System

### Box 2. Network Analysis of Spillover Risk for the Belgian Banking System

### Methodology
- Network analysis of bilateral interbank exposures across 18 countries to identify financial systems of systemic importance to Belgium and systems vulnerable to Belgian spillovers.
- Two spillover mechanisms modeled:
  - Credit shock: “domino effects” from default of a banking system’s interbank obligations.
  - Credit-plus-funding shock: credit shock compounded by a funding shock and associated fire sale losses.
- Analysis focuses only on interbank exposures and uses a consistent definition of total regulatory capital for all countries.
- The simulation framework and algorithm are based on a global banking network approach.

### Data and Key Assumptions
- Exposure and capital data at end-September 2012 across 18 countries.
- Credit shock assumption: loss given default of 100 percent on interbank exposures.
- Funding shock assumptions: withdrawal of 35 percent on interbank funding and a haircut of 50 percent on forced asset sales.
- Results are sensitive to these shock assumptions; relative ranking of systemic countries remains unchanged.

### Key Findings — Spillovers to Belgium
- The United States and the United Kingdom represent, by far, the biggest potential risk to the Belgian banking system, albeit indirectly, followed closely by France.
- A credit-only or credit and funding shock through the interbank markets of the United States, the United Kingdom, or France would be extreme, resulting in a complete or near complete depletion of regulatory capital.
- Belgium is particularly vulnerable to credit and funding shocks from Germany and the Netherlands.
- Extreme tail shocks from other major economies would generate impairments of less than 50 percent of total capital.

### Key Findings — Spillovers from Belgium
- An extreme credit and funding shock in Belgium would affect Luxembourg, the Netherlands, and the Czech Republic most.
- The impact of a credit-only or credit and funding shock from Belgium would be important but confined to less than 25 percent of regulatory capital in Luxembourg, the Netherlands, and the Czech Republic.
- The impact on other financial systems considered would be relatively minor.

### Related Financial-Sector Context (from surrounding analysis)
- Insurers:
  - Insurers hold €104 billion, or 40 percent of total assets, of which €60 billion were in Belgian government bonds.
  - The average guaranteed rate of return still stood at 3.25 percent at end–2010.
  - Technical provisions associated with guaranteed rates for traditional individual policies totaled €32 billion (or 32 percent of the total technical provisions for this class of business) at end–2010.
- Stress testing and capital impacts:
  - Solvency stress tests (bottom-up and top-down) used mid-2012 data covering more than 90 percent of total assets of the domestic banking sector.
  - Two adverse macro scenarios: a severe short-term “double-dip recession” and a protracted “slow-growth scenario.”
  - Under the bottom-up approach, the Common Equity Tier 1 (CET1) capital ratio declines by 4.2 percentage points and 3.5 percentage points under the double-dip and slow-growth scenarios, respectively.
  - Given solid capital buffers, only a few institutions fall below the capital hurdle rate, by an amount that could reach up to 3.6 percent of the aggregate CET1 for the sector.
  - Market-implied valuation haircuts of more than five percent on Belgium, and more than 10 percent on higher yield euro area sovereigns, were applied to all on- and off-balance sheet exposures at mid-2012 prices; this factor reduces CET1 capital in the system by more than €4.6 billion or 10.4 percent under the adverse scenarios.
- Liquidity metrics and stress:
  - Revised calibration of the LCR announced in January 2013 would improve the system-wide ratio from 83 percent to 103 percent, with only one institution falling below the threshold.
  - Average Net Stable Funding Ratio (NSFR) at 112 percent.
  - Most banks have NSFR ratios higher than 95 percent.
  - Average NBB liquidity ratio of 263 percent (against a norm of 100 percent) indicating banks can withstand a week-long net cash outflows.
  - Extending the risk horizon to one month yields an overall liquidity shortfall concentrated in a very few institutions; the liquidity shortfall remains small at 0.5 percent of eligible assets.
  - Only four of the six largest banks pass the (unspecified) liquidity test referenced, though all exhibit NSFR ratios higher than 95 percent.

### Policy Recommendations and Supervisory Follow-up
- Conduct a thematic review of identified vulnerabilities and follow up with supervision.
- Authorities should:
  - Carefully assess the impact of further spread compression, interest rate shocks, and gradual deterioration of credit quality at some banks.
  - Expedite the consolidation process to restore confidence in the domestic banking sector.
  - Further strengthen banks’ capital buffers with a view to forthcoming Basel III requirements.
- Liquidity policy:
  - Given close alignment of the Basel III LCR and the Belgian liquidity ratio, preserve the current liquidity regime and maintain liquidity buffers before the LCR is fully adopted and phased in at the European level in 2018.
- Institutionalize and enhance stress testing:
  - Systematically integrate both top-down and bottom-up stress testing into the supervisory and macroprudential framework to inform assessment of individual firms and strengthen supervisors’ role in financial stability analysis.
  - Obtain more granular prudential information and supervisory review on intragroup transactions within conglomerates under severe stress and on vulnerabilities from real estate overvaluation.

*Prepared by Serkan Arslanalp and Oana Nedelescu; Marco Espinosa-Vega and Juan Solé, 2010, “Cross-border Financial Surveillance: A Network Perspective,” IMF Working Paper 10/105 referenced in source.*

### 37.      Stress testing of insurer solvency was undertaken as a bottom-up exercise using a

### _cr13124 - 37.      Stress testing of insurer solvency was undertaken as a bottom-up exercise using a

### Stress-testing scope and methodology
- Covered the six largest insurers: Ageas, AXA Belgium, Belfius Insurance, Ethias, KBC, P&V - Vivium Group, comprising more than 70 percent of the insurance sector.
- Conducted as a bottom-up exercise by insurers in collaboration with the FSAP team and NBB staff.
- Shocks and scenarios:
  - Two adverse market scenarios defined by the NBB: "mild" and "severe".
  - A mass lapse event in the life business.
  - Realization of the largest probable maximum losses (PML) on a single (man-made or natural) catastrophic tail event.
- Capital impact aggregation:
  - Firms calculated the overall capital impact by aggregating individual shock impacts using a correlation approach.
  - Own funds after scenarios were compared with the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR), subject to eligibility conditions.

### Valuation methods and rationale
- Impact calculated under three valuation standards:
  - Solvency I (current regulatory regime).
  - Solvency standard in QIS 5.
  - Full “market-consistent valuation” (MCV).
- Key observations:
  - Solvency I lacks risk-based elements and is unsuitable for quantifying capital impacts of economic shocks.
  - QIS 5 contains elements (e.g., illiquidity premium) that dampen the economic impacts of spread and interest rate movements.
  - MCV overcomes these valuation concerns and allows for a more realistic capital assessment by replicating liability cash flows with sovereign bonds only.

### Main findings on solvency outcomes
- Under Solvency I:
  - With the exception of one firm, all insurers exceeded the Solvency I hurdle under both the mild and severe adverse scenarios.
  - Hidden reserves (net unrealized capital gains or losses in excess of unrealized capital gains included in the statutory solvency margin) were sufficient to buffer shocks to market and underwriting risks.
- Under MCV (market-consistent valuation):
  - Most firms are likely to experience a significant decline in solvency ratios due to asset-liability mismatches, higher credit spreads, and a general increase of sovereign risk.
  - Assuming full market consistent valuation, the sector was severely undercapitalized under both stress scenarios, raising questions about some business models if the low interest rate environment persists over the medium term.
- Note on test severity:
  - The stress test was stricter than the valuation being discussed for future Solvency II regime because it did not include mitigating factors (e.g., illiquidity premiums, swap rates, matching adjustments) and used a pure risk-free discount rate.

### Impact of sovereign risk and quantified effects
- Sovereign risk materially affected insurers’ solvency:
  - Market-implied valuation haircuts (used for the banking sector stress test) applied to all direct and indirect insurer exposures at mid-2012 prices.
  - These haircuts decrease the QIS-5 solvency ratio with weighted solvency components (SCRs) by 45 and 54 percentage points under the mild and severe adverse scenarios, respectively.
  - Without using a correlation approach for aggregating risk factors, the decreases range between 30 and 46 percentage points.

### Liquidity risk and conglomerate considerations
- Liquidity risk can amplify solvency pressures under a more risk-sensitive valuation standard.
- In conglomerates, insurers might transfer liquid assets to banking operations in exchange for illiquid assets to increase expected yield, increasing liquidity risk and reducing tolerance for such transfers.
- The stress test shows limited tolerance for liquidity risk, especially for insurers with significant capital shortfalls in baseline and adverse scenarios.

### Policy recommendations and supervisory implications
- Apply an economic balance sheet approach (MCV) regularly to assess insurers’ solvency under stress:
  - Use stress tests to inform thematic reviews of individual and system-wide vulnerabilities.
  - Integrate stress testing with prudential supervision.
  - MCV-based analysis would allow the NBB to determine how dampeners in Solvency II could distort actual solvency positions.
- Develop a medium-term strategy for consolidation in the insurance sector:
  - Prepare contingency plans for insurers exposed to adverse but plausible shocks.
  - For groups and conglomerates, focus on potential secondary effects: rating downgrades, spillovers, contagion between legal entities via intragroup transactions.
- Strengthen supervision and macroprudential framework (contextual policy pointers in the chapter):
  - Financial stability framework reforms (Twin Peaks Law effective April 2011) and recent institutional changes require ongoing formalization of cooperation (e.g., an MOU on cooperation between NBB and FSMA came into effect in March 2013).
  - Authorities encouraged to promote a supervisory culture with a “will to act” and to consider the NBB as the designated macroprudential authority given its mandate and powers.

*Source: NBB and IMF staff calculations (from the IMF FSAP chapter content provided).*

### 56.      The authorities have made significant progress since the last FSAP, but scope remains

### _cr13124 - 56.      The authorities have made significant progress since the last FSAP, but scope remains

### Insurance sector regulation and supervision
- Progress and reforms:
  - Implemented strengthened solvency requirements for life insurers with exposures to legacy portfolios.
  - Enhanced risk management requirements for insurers.
  - The NBB has improved its supervisory framework by integrating vertical analyses of individual insurers with horizontal reviews of the insurance sector, leveraging its macroeconomic competencies.
- Remaining needs and recommendations:
  - Regular review of the practical implementation of the new institutional structure to ensure supervisory objectives are effectively achieved.
  - Adopt a more principles-based approach in delegating legal authority to the NBB to issue enforceable rules to facilitate supervisory discretion within the parameters set by the law.
  - Empower the NBB to take immediate recovery measures notwithstanding an appeal by an insurer.
  - The NBB should articulate clear policies to deal with potential conflicts in supervisory objectives, e.g., between financial stability and prudential safeguards for policyholders.
  - Further improvements in NBB’s risk-based supervision through:
    - Formulation of an appropriate baseline supervisory program.
    - Internal policies for inspecting functions outsourced by insurers.
    - Review of the effectiveness of contributions of external auditors and the role of actuaries.
  - Ensure the NBB is adequately resourced to achieve the appropriate supervisory intensity and effectiveness.
- Conduct-of-business and intermediaries:
  - Scope to raise professionalism of intermediaries to deter unhealthy competition arising from more than 17,000 of them.
  - FSMA proposal to adapt the EU Markets in Financial Instruments Directive 2 to insurers and insurance intermediaries is welcomed.
  - FSMA should be empowered to establish enforceable rules on:
    - Handling of claims and proper policy servicing by insurers.
    - Group market conduct requirements.
    - Combating and reporting insurance fraud by intermediaries.
  - FSMA needs a risk-based approach to manage a large population of regulated entities and ensure adequate resources for its supervisory strategy.

### Conglomerates supervision
- Current approach and limitations:
  - Belgian authorities have been prudent within constraints of the EU-wide framework, choosing stricter regimes where possible (i.e., consolidated banking supervision).
  - Belgian framework incorporates shortcomings of the EU framework, including limited supervisory powers and tools for FCs headed by mixed financial holding companies (MFHCs) and weaknesses in conglomerate-wide capital and liquidity measurement and requirements.
  - A planned revision of relevant EU directives would address some gaps, while other changes depend on further EU-wide changes.
- Recommended NBB actions:
  - Put in place a more comprehensive approach to conglomerate supervision to detect conglomerate-wide risks such as contagion and conflicts of interest.
  - Develop a uniform set of expectations regarding all financial conglomerates, elaborated internally within the NBB as a baseline for supervision of this type of group.
  - Improve risk scorecards for the insurance and securities sectors to enhance assessment of cross-sectoral risks.
  - Increase active supervisory involvement to complement self-reporting and auditors’ checks:
    - Ensure governance guidelines are consistently applied to address conflicts of interest within groups.
    - Conduct more validation and back testing to strengthen integrity of self-reporting and audit mechanisms.
    - Better articulate supervisory processes, including internal capital adequacy assessment reporting by groups, more frequent on-site reviews, and discussions with boards, management, internal and external auditors.
    - Promote greater use of available supervisory data for ongoing supervision, benchmarking across conglomerates, and forward-looking cross-sectoral risk assessments, including early identification of risk build-up.
  - Formalize cooperation between the NBB and FSMA to enhance effectiveness of conglomerate supervision.
- Note: Technical Note on Financial Conglomerates Supervision provides additional detail. (Footnote 27)

### Securities markets and regulation
- Assessment focus:
  - A full IOSCO Principles assessment was not undertaken; mission focused on evaluation of product regulation, adequacy of new regulatory structure, and compliance with new IOSCO principles, including systemic risk monitoring.
- Recommendations for FSMA:
  - Build on existing investor education and protection initiatives.
  - Give priority to resourcing execution of newly designed programs.
  - Develop formal structures to identify and manage emerging and systemic risks.
  - Establish an Emerging Risk Committee with formal collaboration protocols with the NBB.
- Note: Technical Note on Securities Regulation provides additional detail. (Footnote 28)

### Soundness and oversight of market infrastructures (Euroclear Bank and related FMIs)
- Euroclear Bank assessment highlights:
  - Subject of a full CPSS/IOSCO Principles for Financial Market Infrastructures assessment in the context of the EU FSAP.
  - Important risk measures taken to reduce systemic risk, but some need further improvement to fully observe recently adopted international standards.
  - Substantial improvements in collateral and liquidity management frameworks.
  - Developed recovery plans and plans for orderly winding down of operations; should take measures to be operationally ready for implementation.
  - Operational risk is well-controlled; contingency plans and back-up facilities allow for timely recovery of operations and completion of settlement process.
  - Going forward, upgrade risk management policies and practices to reduce potential unsecured credit exposures to participants and other linked securities settlement systems.
- Supervision and cross-border cooperation:
  - Euroclear Bank is subject to regulation, supervision, and oversight by the NBB and FSMA, but cooperation with Luxembourg authorities should be improved.
  - Legal framework provides Belgian authorities powers to obtain timely information and induce change.
  - Because Euroclear Bank offers similar services to Clearstream Bank Luxembourg, closer cooperation is needed to ensure a level playing field for implementation of CPSS/IOSCO-aligned risk management measures.
  - Cooperation exists for the interoperability link (the “bridge”); reinforcing and broadening cooperation, with involvement of the ECB, would allow coordinated recommendations and parallel implementation.
  - Upon implementation of the SSM, both Clearstream Bank and Euroclear Bank will come under the ECB umbrella, potentially leveling the playing field.
- National securities depositories:
  - Belgian, French, and Dutch authorities cooperate effectively; national securities depositories share a common settlement platform provided by the Euroclear Group and are subject to regulation, supervision and oversight by their respective national authorities.
  - Crisis management frameworks are in place and regularly tested and updated.
- Notes:
  - This section draws on assessments conducted during the EU FSAP in November and December 2012. (Footnote 29)
  - CPSS/IOSCO Principles for Financial Market Infrastructures. (Footnote 30)

### Crisis management and safety nets
- Institutional setup and coordination:
  - Belgian institutional setup for crisis management is largely appropriate, but adoption of explicit coordination arrangements would be beneficial.
  - Authorities encouraged to strengthen the mandate of the NBB as the resolution authority, building on the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions (Footnote 32).
  - Consider reviving pre-institutional-change crisis preparation and management MOUs.
  - Establish a cross-institutional Coordination Group for joint risk assessments, scenario analyses, crisis management simulations related to operational process, and enhanced policy coordination in case of financial distress.
- Recovery and resolution planning:
  - Progress made in recovery planning: authorities are requesting recovery plans from domestic systemically important banks and systemically relevant financial market infrastructures.
  - Going forward, develop resolution plans where relevant in cooperation with international peers.
  - Create a legal requirement for formulation of RRPs for all firms that are of systemic importance, including for insurers.
- Framework for orderly resolution and liquidation:
  - Framework enhanced, but weaknesses remain.
  - NBB can utilize a range of measures to intervene proportionally where a bank breaches law or prudential regulations.
  - Emergency liquidity assistance framework functioned adequately; government able to support banking system via guarantees and public recapitalization.
  - Consider introduction of better options for loss allocation (e.g., ‘bail-in’ tools foreseen by draft EU Bank Recovery and Resolution Directive).
  - Procedure to transfer assets and liabilities of, or shares in, systemically important firms (introduced in 2010) should be revised to reduce uncertainty and mitigate potential stability risks entailed in ex ante judicial review.
  - Broaden scope of such powers to holding companies and nonsystemic situations to allow more cost effective resolution strategies.
  - Strengthen powers of special inspectors to restore institutions or prepare them for orderly liquidation.
  - Liquidation framework improvements:
    - Bankruptcy proceedings based on corporate bankruptcy procedures appear ill suited to credit institutions.
    - Enhance liquidation processes to provide for rapid transfer of critical operations (e.g., payments, custody, clearing and settlement systems) to a third party under oversight of the resolution authority, while remainder of the estate is dealt with under the general regime.
- Deposit guarantee scheme recommendations:
  - Current protection provided by a two-tier system: the Protection Fund for Deposits and Financial Instruments (autonomous public institution with legal personality) and the Special Protection Fund for Deposits and Life Insurance (operating under the Belgian Treasury).
  - Recommend creation of a segregated fund, financed via ex ante industry contributions and with robust arrangements for back-up funding, to increase transparency and allow for prompt and cost-effective payouts.
  - Current resources of both existing funds should be folded into the new scheme.
  - Set a sufficiently ambitious minimum target fund size to absorb a simultaneous default of multiple midsized institutions.
  - Authorities encouraged to exclude shares issued by cooperative corporations from future coverage under the deposit guarantee scheme and to consider introduction of depositor preference.
  - Recalibrated deposit insurance scheme should be allowed to contribute funding to resolution actions, up to the amount of its distributions in case of a deposit payout.

### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- Assessment timetable and background:
  - In line with relevant IMF Board decisions, a full reassessment of Belgium’s AML/CFT framework is required.
  - Belgium was last assessed in 2005 by the Financial Action Task Force (FATF); a new assessment by the FATF is tentatively scheduled in September 2014.
  - Although outside the 18-month timeframe, the planned FATF assessment is acceptable for the purposes of the current FSAP. (Footnote 33)
- 2005 FATF assessment findings and subsequent measures:
  - 2005 assessment found Belgium’s AML/CFT framework largely complied with the standard, particularly in criminalization of money-laundering and terrorist financing.
  - Shortcomings identified included supervision of nonbank financial institutions, transparency of beneficial ownership and control of legal entities, regulation of designated nonfinancial businesses and professions, and freezing of terrorist assets.
  - Since 2005, authorities reportedly took steps to address shortcomings, including measures to reinforce freezing of terrorist assets (2006) and adoption of a new AML/CFT law (2010).

*Source: IMF staff report content provided in the content unit.*

### 73.      The NBB’s current practice in integrating AML/CFT processes into overall supervisory

### The NBB’s current practice in integrating AML/CFT processes into overall supervisory

### Summary of assessment findings
- The mission examined the National Bank of Belgium’s (NBB) practice in integrating AML/CFT processes into the overall supervisory process as part of the BCP assessment.
- The mission was unable to conclude that AML/CFT compliance is sufficiently embedded in the supervisory framework.
- It is unclear how monitoring of compliance is undertaken for smaller banks that are subject to on-site inspections only infrequently.
- The FATF does not have sufficient capacity to advance the assessment given that there are other countries that face the same issue as Belgium.

### Implications
- Lack of clear embedding of AML/CFT in supervision raises risks that compliance weaknesses may go undetected, particularly in smaller institutions visited only infrequently on-site.
- Limited FATF capacity constrains external progress on advancing assessments where national practices are uncertain or incomplete.

*Source: _cr13124 - 73.      The NBB’s current practice in integrating AML/CFT processes into overall supervisory*

### Appendix I. Belgian Covered Bonds and Financial Stability

### Appendix I. Belgian Covered Bonds and Financial Stability Considerations

### Considerations on covered bonds and financial stability
- Covered bonds provided a funding backstop during the global financial crisis, mainly for investment-grade banks (rated “BBB-/Baa3” and better), when many markets were effectively closed.
- Covered bonds can:
  - Reduce banks’ reliance on deposits.
  - Lower rollover risk.
  - Facilitate a gradual scaling back of refinancing operations with the ECB.
  - Reduce default probabilities and deliver cost-efficient funding with longer maturities to reverse asset-liability mismatch.
- Recent regulatory developments supporting covered bonds:
  - Covered bonds rated “AA-/Aa3” or higher will count toward the LCR under the Basel III framework while securitizations are excluded.
  - Solvency II assigns a lower capital charge for covered bonds compared to other nongovernment and/or unsecured assets.
  - Resolution tools such as ‘bail in’ do not apply to covered bonds.
- Supervisory role of the NBB:
  - The NBB will approve each structure, monitor total encumbrance build-up, and maintain oversight of the integrity of covered bond structures and investor disclosures.

### The Belgian covered bond framework
- The completed legal framework opens a new source of secured funding.
- The legislation gives investors direct recourse to:
  - The segregated assets in the covered pool and
  - The other assets of the issuing bank (general estate).
- Market response and issuance:
  - Two Belgian banks have issued covered bonds under the new legal framework.
  - Both placements have been rated “Aaa/AAA” by Moody’s and Fitch.
  - These placements trade at prices just below Belgian government bonds but significantly higher than comparable secured debt issued by other European financials.
  - Banks were significant investors, accounting for 48 percent of the initial KBC placement.
- Systemic risk consideration:
  - Large participation by banks in covered bond placements increases interconnectedness across the sector, potentially increasing risks to financial stability.

### Cover pool and structural features
- Covered bonds are on-balance sheet debt obligations secured by a dedicated reference (or “cover”) portfolio of assets, with the issuer fully liable for all interest and principal payments.
- In the case of Belgian covered bonds, all obligations related to the bonds are backed by an exclusive claim on the cover pool that is recorded in the cover register.
- Roles and oversight (as described in source diagram):
  - Cover Pool Administrator (approved by NBB in case of issuer insolvency)
  - Cover Pool Monitor
  - Issuing Bank (any bank with a license from the NBB)
  - National Bank of Belgium (NBB)
  - Investors
  - Cover Pool (collateral assets)
  - Other Assets, Cash and Securities, Covered Bonds, Senior Unsecured Liabilities, Subordinated Liabilities, Shareholder’s Funds
  - Legal Framework (Pandbrieven Act)
  - Issuance and Regular Monitoring

### Secondary market pricing and encumbrance limits
- To mitigate structural subordination, legislation caps covered bond issuance to eight percent of the total assets of the issuing credit institution.
- Rationale and effects of the cap:
  - Mitigates the risk that issuer inability to satisfy claims from unsecured creditors (including depositors) increases loss for unsecured creditors.
  - If covered bond funding replaces unsecured funding, the effectiveness of bail-in as a resolution tool will be adversely impacted.
  - Capping issuance benefits both covered bond holders and unsecured creditors by preserving the economic value of full recourse and reducing cover pool dilution risk if covered bond issuance grows faster than total liabilities or unencumbered asset quality declines.
  - Requires banks to regularly disclose asset encumbrance details such as amounts and overcollateralization, including that relating to dedicated subsidiaries; policymakers should rank such disclosure high on their agenda.
- Additional suggested information:
  - Contingency plans in the event encumbrance levels are substantially larger than estimated would be useful.
- International practices:
  - Covered bond legislation in other countries imposes similar caps in some cases; while the majority of EU countries have eschewed this option, some countries have adopted or are considering encumbrance limits.

### Table summary (as provided)
- Table title: Covered Bond Legislation in Selected Countries.
- Entries (Country — Year of Introduction/Amendment — Encumbrance Limit):
  - Australia — 2011 — Yes
  - Belgium — 2011 — Yes
  - Canada — 2007 (amendments introduced in 2011) — Yes
  - Denmark — 1795 (amended 2007) — No
  - France — 1999 — No
  - Germany — 1769 (amended 2005, revised 2010) — No
  - Italy — 2005 — Yes
  - Netherlands — 2008 — Case-by-case
  - South Korea — 2009 — No
  - Spain — 2003 — No
  - United Kingdom — 2008 (amendments introduced in 2011) — Case-by-case
  - United States — Draft legislation introduced in 2011 — No
- Notes from table:
  - OSFI applies a limit on issuance in Canada but it is unclear whether it remains in place after establishment of a statutory framework.
  - The FDIC applies an asset encumbrance limit in the United States, which will cease once draft legislation has passed the U.S. Congress.

*Source: _cr13124 - Appendix I. Belgian Covered Bonds and Financial Stability*

### Appendix IV. Risk Assessment Matrix

### Appendix IV. Risk Assessment Matrix

### Risk Matrix Summary
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path discussed in this report (which is the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline. The RAM reflects staff's views on the source of risks and overall level of concerns as of the time of discussions with the authorities.

### 1. Protracted period of slow European growth and persistent low interest rates
- Overall level of concern: Medium
- Relative likelihood: High
- Potential impact on financial stability if threat is realized: High
- Key risk drivers and channels:
  - The WEO forecast remains flat; with no sharp or deep decline but consensus forecasts are less optimistic
  - There is a risk that recovery does not take hold or that euro area or global slowdown becomes worse than anticipated
  - Drag of confidence in euro area sovereigns on growth could be amplified
  - The likelihood of this risk materializing is heightened by continuing policy uncertainty in euro area, and an increasing impact of austerity measures on the region
  - Further erosion of the economic position of insurers and banks reduces their risk bearing capacity
- Potential financial stability consequences:
  - Bank and insurer profitability and ability to rebuild capital levels would be crippled; ability to complete restructurings compromised
  - Asset price decline would be a further hit to balance sheets

### 2. Political uncertainty and fiscal strain cause sharp widening of sovereign spreads
- Overall level of concern: Medium
- Relative likelihood: Medium
- Potential impact on financial stability if threat is realized: Medium
- Key risk drivers and channels:
  - Debt levels are high and have risen significantly owing mainly to crisis measures
  - Sovereign-financial sector link further intensified
  - Political stability is fragile as uncertainty continues in the run up to elections, could result in a relaxation of fiscal discipline
  - Yields have remained low into 2013 and some pre-financing has taken place; however, there are large refinancing needs in 2013 and 2014
  - Large direct exposure to Belgian sovereign leaves banks and insurers vulnerable to sharp spread widening, which would pass through to solvency and liquidity positions
  - Collateral haircuts could place a further strain on liquidity management and restructuring in an environment where tolerance for liquidity risk is already limited
- Potential financial stability consequences:
  - A sovereign downgrade would be likely followed by a downgrade to banks and insurers, driving up funding costs.

### 3. Spillover from strong intensification of euro area crisis
- Overall level of concern: Medium
- Relative likelihood: High
- Potential impact on financial stability if threat is realized: High
- Key risk drivers and channels:
  - Stalled or incomplete delivery or incomplete commitments at the national or euro area level could reignite financial stress
  - Any euro area country debt restructuring could see spreads widen further and significant haircuts applied to Belgium debt as spillover concerns about debt sustainability rise
  - Contagion from the fallout could see financial market stress exceeding levels following the collapse of Lehman and significant deposit runs.
  - Banks’ direct exposure to peripheral countries is limited and falling, with the exception of Italy. There is no direct exposure via subsidiaries, except for Ireland. Insurers’ exposure is limited.

### 4. Housing price correction
- Overall level of concern: Medium
- Relative likelihood: Medium
- Potential impact on financial stability if threat is realized: Medium
- Key risk drivers and channels:
  - House prices have more than doubled in ten years and increased steadily through the financial crisis, outpacing increases in other advanced countries
  - The share of variable interest rate in total household debt has risen for low income households, increasing vulnerability to unemployment and disposable income shock.
  - While unemployment remains moderate, there is a downside risk if weak outlook in Europe persists
  - Most properties are owner occupied, Belgian households have high net worth
  - LTV ratios remain moderate on average, however there are pockets of vulnerability in new vintages of mortgage loans
- Potential financial stability consequences:
  - Sharp housing downturn would compound bank capital pressures in the medium term.
  - Structural features suggest that a gradual correction is likely, leaving banks time to adjust
  - Staff estimates suggest only a moderate overvaluation of housing stock

*Source: Appendix IV. Risk Assessment Matrix (extracted from the report).*

### 5. Regulatory and Market-Based Standards and Parameters

### _cr13124 - 5. Regulatory and Market-Based Standards and Parameters

### Calibration of risk parameters
- Banks’ models for point in time PDs and down-cycle LGDs.
- RWAs were estimated using through-the-cycle PDs, plus adjustments for loan portfolio concentration and changes in default risk.
- PDs and LGDs:
  - PD estimated as change in the stock of nonperforming loans (via satellite model) while provisioning levels at the start of the forecast horizon is maintained; thus, LGD is assumed to be 100 percent.
- RWAs are estimated in accordance with AIRB under Basel III, plus adjustments for loan portfolio concentration and changes in default risk.

### Regulatory/Accounting and Market-Based Standards
- Full Basel III transition schedule.
- Capital definition according to the Basel III framework. During the forecast horizon it has to comply with the envisaged phase-in of capital deductions and the phase-out of noneligible forms of capital, without consideration of grandfathering.
- Phase-in of total regulatory adjustments to common CET1 capital:
  - 20 percent (per annum) of CET1 capital (such as goodwill, deferred tax assets and minority interests that exceed the permissible limit) deducted between 2014 and 2017; firms must document deductions if amount is less than 29.0/20.4 percent [4 largest banks/other banks]* 80/100 = 23.2/16.3 percent (29.0/20.4 percent is the average value for large banks (Group 1)/small banks (Group 2) according to the results from results from the Basel III monitoring exercise as of 31 December 2011QIS-7).
- Phase-out of non-CET1 and Tier 2 capital elements:
  - the higher of either 10 percent (per annum) of the amount of capital to be phased-out based on the QIS-6 results for Group 1 (large banks) at 26.8 percent or the amount of capital maturing each year subject to phase-out between 2013 and 2017.
- Risk-weighted assets (RWAs):
  - RWAs for market and operational risk remain constant throughout the forecast period.
  - RWAs for credit risk are subject to the Basel I floor and sensitive to the regulatory impact due to Basel III based on firm’s own data; there is no regulatory impact on RWAs for market risk as Belgium has adopted Basel 2.5 on 31 December 2011; in addition, credit RWAs are sensitive both changes in PDs and portfolio correlations: (a) nonlinear effect of changes in PDs and (b) concentration risk impact on RWAs.
  - RWAs for credit risk are subject to the Basel I floor and sensitive to the regulatory impact due to Basel III (according to QIS-6 results), which increase by at least 17.25 percent [4 largest banks] and 3.1 percent [other banks] (independent of asset growth) between 2013 and 2015, respectively.
- RWA impact of defaulted loans:
  - The risk-weights for credit risk are subsequently reduced by the RWAs of defaulted exposures, which are approximated by taking 2.5 times the average RWAs for nondefaulted exposures (accounting for the fact that risk-weights for defaulted exposures were higher prior to default).

### Reporting Format for Results (Capital Adequacy)
- Basel III (Common Equity Tier 1, Tier 1, Total Capital, conservation buffer) for each year of the risk horizon.
- Firms reported capital adequacy for each year over the forecast horizon based on an output template provided by IMF staff. In case of a capital shortfall, firms calculated the recapitalization needs.
- Firms reported the major risk drivers (profitability, credit/trading losses, RWAs) and showed the marginal impact of including:
  - (i) haircuts on sovereign debt holdings;
  - (ii) capital phase-in/phase-out according to Basel III; and
  - (iii) FX shocks.
- Firms reported alternative stress test results without considering the restrictions on the behavioral adjustment of banks as separate output.
- Staff-determined variant:
  - Staff determined capital adequacy for each year over the forecast horizon. In case of a capital shortfall, recapitalization needs are calculated. The major risk drivers (profitability, credit/trading losses, RWAs) were identified together with the marginal impact of including (i) haircuts on sovereign debt holdings, and (ii) capital phase-in/phase-out according to Basel III.

### Banking Sector: Liquidity Risk — Institutional Perimeter
- Institutions included:
  - 6 largest banks (KBC, Belfius, BNP Paribas Fortis, ING Belgium, AXA Bank Europe, and Argenta) [for Basel III measures (old LCR and NSFR)].
  - 6 largest banks (KBC, Belfius, BNP Paribas Fortis, ING Belgium, AXA Bank Europe, and Argenta) [for Basel III measure (revised LCR)].
  - entire banking system, excluding foreign branches, Euroclear and Bank of NY Mellon (which is a custodian bank) [for NBB Liquidity Ratios].
- Data and baseline date:
  - Source: institutions’ own granular data.
  - Date: end-June 2012.
  - Scope: solo basis (BNP Paribas Fortis, ING Belgium) and consolidated basis (KBC, Belfius, AXA Bank Europe, and Argenta); only unencumbered liquid assets (generating cash inflows), i.e., that can be sold or used as collateral to receive funding (with the exception of cash/cash-equivalents) are included in the test (“liquidity scope”).
  - Source (NBB Liquidity Ratios): supervisory data (NBB Liquidity Ratios) and calculations based on institutions’ own granular data (revised LCR).
  - Date (NBB): end-June 2012.
  - Scope (NBB): solo and consolidated basis; only unencumbered liquid assets (generating cash inflows), i.e., that can be sold or used as collateral to receive funding (with the exception of cash/cash-equivalents) are included in the test (“liquidity scope”).

### Channels of Risk Propagation — Methodology
- Definition of Basel III measures as per guidance published on Dec. 2010 (including assessment of haircuts on liquid assets, assumption on expected and contingent cash in- and outflows).
- Definition of revised LCR as per guidance published on Jan. 2013 (including assessment of haircuts on liquid assets, assumption on expected and contingent cash in- and outflows).
- Calculation of NBB Liquidity Ratio (at one week and one month).

### Risks and Buffers
- Risks:
  - Funding liquidity.
  - Market liquidity.
- Buffers:
  - Constant funding structure; no counterbalancing capacity.
  - Ability to respond to withdrawals without having access to ECB facilities.
  - Constant funding structure; no counterbalancing capacity.
  - Ability to respond to withdrawals without having access to extraordinary ECB facilities.

### Tail shocks
- Size of the shock:
  - Bank run and dry up of wholesale funding markets, taking into account haircuts to liquid assets.
- NBB liquidity ratio: three alternative scenarios which assume:
  - (i) the absence of a deposit run;
  - (ii) the escalation of sovereign risk (requiring higher valuation haircuts for collateralized funding with central banks); and
  - (iii) the absence of contingent cash inflows from related parties.

### Regulatory and Market-Based Standards and Parameters (Liquidity)
- Regulatory standards:
  - Basel III ratios: LCR (old version), NSFR.
  - Basel III ratios: LCR (new version).
  - National requirement: NBB liquidity ratio (one week and one month).

### Reporting Format for Results (Liquidity)
- Output presentation:
  - Hurdle metrics: distribution of ratios.
  - Hurdle metrics: distribution of ratios, number of failed banks, liquidity shortfall relative to unencumbered assets.

### Macroeconomic Scenarios for Stress Testing Exercise (Banking Sector) — Key variables (percentage change from previous period, unless otherwise indicated)
- Scenarios: Baseline Scenario / Severe Double-Dip (DD) Scenario / Slow Growth (SG) Scenario
- Real GDP:
  - Baseline: 2013 0.3, 2014 1.0, 2015 1.3, 2016 1.4, 2017 1.4
  - DD: 2013 -1.6, 2014 -0.4, 2015 0.6, 2016 1.0, 2017 1.1
  - SG: 2013 -0.6, 2014 0.1, 2015 0.4, 2016 0.5, 2017 0.5
- Private consumption:
  - Baseline: 2013 0.2, 2014 0.8, 2015 1.0, 2016 1.1, 2017 0.9
  - DD: 2013 -0.1, 2014 0.2, 2015 0.7, 2016 1.0, 2017 0.9
  - SG: 2013 0.1, 2014 0.5, 2015 0.7, 2016 0.9, 2017 0.7
- Gross fixed capital formation:
  - Baseline: 2013 -0.1, 2014 1.8, 2015 3.2, 2016 3.5, 2017 3.5
  - DD: 2013 -1.8, 2014 -0.7, 2015 1.7, 2016 2.6, 2017 3.1
  - SG: 2013 -0.9, 2014 0.4, 2015 1.8, 2016 2.0, 2017 2.2
- Exports (goods and services):
  - Baseline: 2013 0.5, 2014 1.5, 2015 3.1, 2016 3.8, 2017 4.5
  - DD: 2013 -3.6, 2014 -1.0, 2015 1.9, 2016 2.9, 2017 3.9
  - SG: 2013 -2.4, 2014 0.0, 2015 2.4, 2016 2.4, 2017 2.8
- Imports (goods and services):
  - Baseline: 2013 0.4, 2014 1.5, 2015 3.4, 2016 4.1, 2017 4.7
  - DD: 2013 -1.9, 2014 -0.3, 2015 2.4, 2016 3.3, 2017 4.2
  - SG: 2013 -1.3, 2014 0.3, 2015 2.8, 2016 3.1, 2017 3.4
- Inventories:
  - Baseline: 0.0 0.0 0.0 0.0 0.0
  - DD: 0.0 0.0 0.0 0.0 0.0
  - SG: 0.1 0.1 0.0 0.0 0.0
- Household saving ratio (% of disp. inc.):
  - Baseline: 2013 16.2, 2014 16.5, 2015 16.7, 2016 17.1, 2017 17.6
  - DD: 2013 15.2, 2014 15.9, 2015 16.3, 2016 16.7, 2017 17.1
  - SG: 2013 15.8, 2014 16.0, 2015 16.2, 2016 16.5, 2017 17.0
- Unemployment rate (% of labor force):
  - Baseline: 2013 7.8, 2014 7.6, 2015 7.5, 2016 7.3, 2017 7.4
  - DD: 2013 8.0, 2014 8.6, 2015 9.3, 2016 9.7, 2017 10.3
  - SG: 2013 7.9, 2014 8.1, 2015 8.5, 2016 8.9, 2017 9.6
- Total employment:
  - Baseline: 2013 0.3, 2014 0.8, 2015 0.8, 2016 0.9, 2017 0.9
  - DD: 2013 0.1, 2014 -0.1, 2015 -0.1, 2016 0.2, 2017 0.3
  - SG: 2013 0.2, 2014 0.3, 2015 0.2, 2016 0.2, 2017 0.2
- Consumption prices:
  - Baseline: 2013 1.9, 2014 1.4, 2015 1.2, 2016 1.2, 2017 1.2
  - DD: 2013 3.8, 2014 2.6, 2015 2.0, 2016 1.7, 2017 1.4
  - SG: 2013 2.6, 2014 2.4, 2015 2.3, 2016 2.2, 2017 2.0
- House prices:
  - Baseline: 2013 0.0, 2014 0.5, 2015 1.6, 2016 2.2, 2017 2.5
  - DD: 2013 -2.0, 2014 -0.7, 2015 0.8, 2016 1.2, 2017 1.5
  - SG: 2013 -0.7, 2014 -0.3, 2015 0.9, 2016 1.5, 2017 1.7
- Commercial real estate prices:
  - Baseline: 2013 0.0, 2014 0.5, 2015 1.6, 2016 2.2, 2017 2.5
  - DD: 2013 -2.0, 2014 -0.7, 2015 0.8, 2016 1.2, 2017 1.5
  - SG: 2013 -0.7, 2014 -0.3, 2015 0.9, 2016 1.5, 2017 1.7
- Equity market index:
  - Baseline: 2013 2.0, 2014 2.5, 2015 2.6, 2016 2.7, 2017 2.7
  - DD: 2013 -20.9, 2014 1.2, 2015 0.1, 2016 1.0, 2017 1.4
  - SG: 2013 -7.7, 2014 -1.8, 2015 -1.5, 2016 -1.8, 2017 -0.5
- GDP deflator:
  - Baseline: 2013 1.7, 2014 1.5, 2015 1.3, 2016 1.3, 2017 1.3
  - DD: 2013 2.3, 2014 2.7, 2015 2.0, 2016 1.8, 2017 1.5
  - SG: 2013 1.9, 2014 2.1, 2015 2.2, 2016 2.1, 2017 2.0
- ULC, whole economy:
  - Baseline: 2013 2.0, 2014 2.1, 2015 1.9, 2016 1.7, 2017 1.8
  - DD: 2013 4.3, 2014 4.1, 2015 2.8, 2016 1.8, 2017 1.9
  - SG: 2013 3.0, 2014 3.4, 2015 3.3, 2016 2.1, 2017 2.1
- Terms of trade:
  - Baseline: 2013 0.0, 2014 0.2, 2015 0.2, 2016 0.2, 2017 0.2
  - DD: 2013 -1.3, 2014 0.3, 2015 0.0, 2016 0.1, 2017 0.2
  - SG: 2013 -0.5, 2014 -0.1, 2015 0.0, 2016 -0.1, 2017 0.0
- Short-term interest rate [EONIA] (In percent):
  - Baseline: 2013 0.4, 2014 0.4, 2015 0.4, 2016 0.4, 2017 0.4
  - DD: 2013 1.0, 2014 1.0, 2015 0.9, 2016 0.9, 2017 0.8
  - SG: 2013 0.4, 2014 0.4, 2015 0.4, 2016 0.3, 2017 0.3
- Short-term interest rate [3-month T-bill] (In percent):
  - Baseline: 2013 0.9, 2014 0.9, 2015 0.9, 2016 0.9, 2017 0.9
  - DD: 2013 1.3, 2014 1.5, 2015 1.7, 2016 1.9, 2017 1.9
  - SG: 2013 0.9, 2014 0.9, 2015 0.9, 2016 0.6, 2017 0.6
- 10-year sovereign bond yield (In percent):
  - Baseline: 2013 3.1, 2014 3.4, 2015 3.6, 2016 3.8, 2017 3.8
  - DD: 2013 3.3, 2014 3.6, 2015 3.8, 2016 3.9, 2017 3.9
  - SG: 2013 3.0, 2014 3.3, 2015 3.5, 2016 3.8, 2017 3.8

### Liquidity Stress Test Parameters (Basel III Measures) — Selected highlights
- Liquidity Coverage Ratio (LCR) [old version, Dec. 2010]:
  - Stock of high-quality liquid assets would need to cover 30-day net cash outflows.
  - Assets that remain liquid under stress: (i) government debt holdings and other exposure with zero percent risk-weighting [haircut: 0 percent], (ii) high-quality bonds and covered bonds (rated 'AA-' and higher) [15], and (iii) sovereign, central bank and PSE assets qualifying for 20 percent risk-weighting [15]; non-cumulative cash inflows: contractual obligations based on given maturities from financials/other counterparties [discount factor: 100/50 percent].
  - Liabilities (cash outflows) assumptions include term deposits with residual maturity > 1 month [discount factor: 0 percent], stable/less stable retail deposits and unsecured wholesale funding from SMEs [5/10], unsecured wholesale funding with/without operational relationship/funding from other financial institutions [25/75/100] or from non-financials, sovereigns and PSEs [75], interbank market funding secured with illiquid assets [100], secured funding backed by 'Level 1' assets/'Level 2' assets and by other valuable assets [0/15/25], portion of high-quality liquid asset needed to satisfy margin calls [5], market value change of net derivative assets [20], draw-down rates for committed credit/liquidity facilities to non-financial corporates, sovereigns and PSEs [100] and for committed credit/liquidity facilities to financial institutions [100].
  - Bank assumptions: collateralized assets maturing within 30 days, portion of assets reinvested, and renewal rate for amortizing loans and other assets; no inflows from new or the renewal of interbank lending in times of stress, and no consideration of access to ECB liquidity on the basis of non-LCR buffer eligible assets; cash inflows limited to 75 percent of cash outflows.
- Liquidity Coverage Ratio (LCR) [revised version, Jan. 2013] - adapted to liquidity reporting by banks to NBB:
  - Assets that remain liquid under stress: (i) government debt holdings and other exposure with zero percent risk-weighting [0], (ii) high-quality bonds and covered bonds (rated 'AA-' and higher) [15], (iii) corporate bonds (rated within the range of 'A+' to 'BBB-') [50], (iv) sovereign, central bank and PSE assets qualifying for 20 percent risk-weighting [15], (v) RMBS (rated 'AA' and higher) [25], and (vi) common equity [50]; non-cumulative cash inflows: contractual obligations based on given maturities from financials/other counterparties [100/50].
  - Liabilities assumptions: unsecured wholesale funding from non-financials, sovereigns and PSEs [40]; operations with central banks for all types of assets [0]; draw-down rates for committed credit/liquidity facilities to non-financial corporates and financial institutions adjusted to [30]/[40].
  - Level 2 assets limited to 40 percent of Level 1 assets; corporate bonds, RMBS and equity (Level 2B assets) capped at 15 percent of the liquidity buffer.
  - NBB LCR specific assumptions: (i) third-party RMBS (rated 'AAA') that banks hold qualify for inclusion in liquidity buffer (max. average LTV of 80 percent at issuance), (ii) self-issued RMBS are not swapped with other counterparties, (iii) banks do not hold corporate bonds (rated within the range of 'A+' to 'BBB-') and RMBS (rated 'AA' and higher) [no data available], (iv) the Belgian deposit guarantee scheme (DGS) does not comply with requirements for lower run-off rate retail deposits (i.e., no application of decreased 3 percent run-off rate).
- Net Stable Funding Ratio (NSFR):
  - Required stable funding definitions by asset class with percentages: cash/short-term unsecured instruments [0]; debt issued by 0 percent risk-weighted counterparties [5]; unencumbered, senior non-financial bonds, rated at least 'AA-' and maturity > 1 year [20]; unencumbered, listed equities and securities, rated 'A+' to 'A-' and maturity > 1 year [50]; loans to non-financial sector, maturity < 1 year [50]; gold [50]; unencumbered residential mortgages and other loans, maturity > 1 year [65]; other loans to retail clients and SMEs, maturity < 1 year [85]; net derivatives receivables and all other assets [100]; undrawn off-balance sheet assets [10].
  - Available stable funding: capital and long-term debt (> 1 year) [100]; 'stable deposits' of retail and SMEs (< 1 year) [90]; 'less stable' deposits of retail and SMEs (< 1 year) [80]; wholesale funding provided by non-financials (< 1 year) [50]; all other liabilities [0].
  - Assumptions: No inflows of interbank lending in times of stress; no consideration of access to ECB liquidity on the basis of non-eligible assets.

### NBB Liquidity Ratio (one-week and one-month) — Selected parameters
- One-week horizon (one-off aggregate outflow of liabilities for 1 week):
  - Liquid financial assets: cash and cash balances with central banks [haircut: 0 percent]; securities and bank loans eligible at the ECB/Eurosystem, BoE or SNB [5-30]; securities and bank loans which can be mobilized in repo transactions [15-50]; marketable securities [20-55]; potentially re-usable securities received as collateral [60].
  - Non-cumulative cash inflows: expected cash inflows related to credit extension without liquid financial assets as collateral [discount factor: 100 percent]; expected inflows related to maturing transactions with liquid securities and bank loans [100]; net contractual cash flows related to derivatives [100] and maximum additional cash flows [5]; maturing inflows from related parties [100]; potential inflows from related and third parties [100] except uncommitted lines to related parties [50].
  - Cash outflows: cash outflows related to maturing and non-maturity funding without liquid financial assets as collateral [discount factor: 100 percent] with exceptions for sight deposit and regulated savings deposits from private households or SME clients [5]; expected outflows related to transactions with liquid securities and bank loans [100]; maturing outflows to related parties [100]; contingent claims to related and third parties [5] except uncommitted credit lines [2.5].
- One month horizon (one-off aggregate outflow of liabilities for 1 month):
  - Liquid financial assets: cash and cash balances with central banks [0]; securities and bank loans eligible at the ECB/Eurosystem, BoE or SNB [5-30]; securities and bank loans which can be mobilised in repo transactions [15-50]; marketable securities [20-55]; potentially re-usable securities received as collateral [60].
  - Non-cumulative cash inflows: expected cash inflows related to credit extension without liquid financial assets as collateral [100]; expected inflows related to maturing transactions with liquid securities and bank loans [100]; net contractual cash flows related to derivatives [100] and maximum additional cash flows [15]; inflows from related parties [100]; potential inflows from related and third parties [100] except uncommitted lines to related parties [50].
  - Cash outflows: cash outflows related to maturing funding without liquid financial assets as collateral, with the exception of sight deposit and regulated savings deposits [100] and exception for sight deposit and regulated savings deposits from private households or SME clients [20]; expected outflows related to transactions with liquid securities and bank loans [100]; maturing outflows to related parties [100]; contingent claims to related and third parties [15] except uncommitted credit lines [7.5].
- NBB Liquidity Ratio interpretation:
  - A NBB stress test ratio higher than 100 percent implies a liquidity shortage if the stress scenario would materialize at the reporting date (i.e., potentially required liquidity > potentially available liquidity); only unencumbered liquid assets are included in the test; new unsecured financing and securitization impossible within the time horizon; no offsetting cash inflows from new or renewed wholesale lending; central bank eligible collateral can be monetized at appropriate haircuts; repo markets are open at appropriate haircuts; fire-sale of assets possible at appropriate haircuts; re-use of collateral received possible at appropriate haircuts; potential unsecured support in convertible currencies only from related parties; no renewal of term retail and wholesale deposits; and full convertibility between currencies (within time frame of one week).
- NBB one-month alternative scenarios:
  - (i) “no deposit run scenario”: non-cumulative cash outflows from private sector deposits [from 20 to 0];
  - (ii) “no intergroup funding scenario”: potential non-cumulative cash inflows from committed lines with related parties [from 100 to 0];
  - (iii) “rising sovereign risk scenario”: increase of haircuts on liquid assets: bonds issued by central governments or central banks eligible at ECB/Eurosystem, BoE or SNB [from 5 to 7.5].

*Italic: Source — _cr13124 - 5. Regulatory and Market-Based Standards and Parameters (PDF chapter)._

### Annex I. Report on the Observance of Standards and Codes

### Annex I. Report on the Observance of Standards and Codes (ROSCs)—Summary Assessments: BELGIUM — BASEL CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION

### Background
- Belgian financial system described as relatively large, concentrated, and interconnected, with solid capital buffers on aggregate.
- Post 2008 deleveraging: an initial significant reduction in system size followed by a second, slower wave of deleveraging currently underway.
- Four dominant banking groups represent almost ¾ of consolidated system assets.
- Assets of foreign-owned banks account for over half of the sector.
- Links between banks and the Belgian sovereign intensified due to the crisis; total exposure of the banking sector to the federal government at 10 percent of banking sector assets in mid-2012.
- Tier 1 capital ratio rose from 11.6 percent of risk-weighted assets in 2008 to 14.8 percent in mid 2012 on aggregate.
- Domestic economic challenges and sovereign risk perceptions remain sources of uncertainty; outlook for economic growth remains weak.
- Regulatory and supervisory regime reorganized in 2011: integrated regulator (CBFA) replaced; prudential supervision allocated to the NBB and market conduct/consumer protection to the FSMA; all bank and insurance supervision staff moved to the NBB.

### NBB Approach to Supervision
- Belgium has a well developed public infrastructure supporting effective banking supervision; legal system based on civil law and influenced by EU regulations, directives and decisions.
- High level of compliance with the Basel Core Principles (BCPs) achieved despite elevated stress and forthcoming higher regulatory standards (capital and liquidity).
- NBB deploying high-quality supervisory practices and implementing enhancement projects to integrate processes, improve data handling flexibility, and strengthen firm-specific and horizontal analysis.
- NBB instituted enhancements such as an annual risk review and is executing a focused multi-faceted plan of improvements.

### Assessment Challenges
- Assessment updates significant regulatory and supervisory developments since 2004 under the BCP methodology of 2006.
- Assessment reflects framework in place at time of review and does not evaluate pending international/EU decisions (e.g., finalization of Basel III implementation in Europe or potential Single Supervisory Mechanism).
- Focused on major banks and banking groups as required by the BCP methodology.

### Preconditions for Effective Supervision
- Preconditions (stable macroeconomic environment, sound legal and accounting framework, effective procedures for securities market problem resolution) appear to be in place in Belgium.

### Main Findings

- Objectives, independence, powers, transparency, and cooperation (CP 1)
  - NBB has clear legal power to conduct prudential supervision and a legal mandate to detect threats to financial stability.
  - Legal mandate does not clarify relationship between NBB’s supervisory function and financial stability function or how to balance priorities in the event of conflict.
  - Recommendation: provide greater legal clarity if NBB Organic Law is revised and publish a mission statement of NBB objectives irrespective of legal changes.
  - NBB has clear lines of accountability, transparency and separate funding when acting in supervisory capacity; no evidence of interference with operational independence.
  - Supervisory resources are stretched; NBB encouraged to scrutinize plans to ensure robustly adequate resources to deliver supervisory projects and day-to-day practice; contingency planning recommended for potential EU developments (e.g., Banking Union) or crisis re-emergence.
  - NBB operates within a clear and balanced legal framework; Banking Law (Article 57) allows swift action in urgent situations; extensive remedial powers balanced by need for Royal Decree ratification where applicable.
  - General framework for information exchange well articulated; domestic coordination needs formal MOU between NBB and FSMA; planned amendments to Twin Peaks Law (to rectify drafting oversights on gateway for information exchange) desirable and should be concluded.

- Licensing and structure (CPs 2–5)
  - Legal framework for authorization, ongoing supervision standards and permissible activities is clearly stated.
  - Both NBB and FSMA legally responsible to prevent public being misled into placing deposits with nonauthorized institutions.
  - NBB reviewed fit and proper policies; assessment scope widened to include key personnel such as heads of compliance, internal audit and risk management even if not part of senior management.
  - Change of control and major acquisitions broadly well governed; NBB has comprehensive powers for governance scrutiny for systemically relevant institutions.
  - Recommendation for nonsystemic firms: establish pre-notification or pre-approval thresholds for acquisitions in nonfinancial entities.

- Prudential regulation and requirements (CPs 6–18)
  - Belgian banks increased level and quality of capital in CET1 following stress; Tier 1 capital ratios range between 11.5 percent and 20.6 percent for systemically important banks as at March 2012.
  - Capital ratios have a high share of CET1, increasing despite crisis-related state intervention and Tier 2 instrument run-off ahead of Basel III.
  - Basel III increased minimum capital adequacy requirements remain challenging for some banks due to stricter capital definitions and deductions.
  - NBB’s Pillar 2 approach well developed using a scorecard for risk analysis (qualitative and quantitative); at least annually NBB determines minimum capital adequacy requirements on a forward looking basis using SREP and ICAAP analyses and, if available, banks’ economic capital models; stress testing probes resilience of capital buffers.
  - Senior management must submit an annual self assessment of the control environment to the NBB; external auditor provides a factual evaluation of management’s self assessment but not positive assurance on design/effectiveness of controls—NBB should place limited reliance on this report without on-site review.
  - Annual meetings with the full Board of Directors should be mandatory for all banks to assess Board oversight role; current practice has frequent meetings with Board members but formal minimum supervisory standard is recommended.
  - Large exposure limits strengthened but warrant overhaul for small institutions. EU legislation: exposures net of eligible credit risk mitigation; hard limit of 25 percent of own funds for exposure to an individual or connected group. Directive 2009/111/EC affects smaller firms with own funds below €600 million permitting a limit of 25 percent of own funds or €150 million, whichever is the higher, for exposures to institutions; sum of exposures to all connected clients that are not institutions must not exceed 25 percent of own funds; where €150 million is the higher limit, value of the exposure shall not exceed a reasonable limit determined by credit institutions though must not be higher than 100 percent of the credit institution's own funds.
  - Liquidity regime well embedded: systemic banks report liquidity daily plus weekly meetings and monthly liquidity stress test. Definition of eligible liquid assets broader than Basel LCR but run-off assumptions for liabilities are more stringent. Stress test introduced in 2009 as observation ratio with full implementation from 2011 to aid transition to Basel LCR in 2015. Authorities advised to keep current regime until full LCR implementation in EU to preserve liquidity buffers.
  - Interest rate risk in banking book well established; interest rate risk stress test ratios require banks to hold capital to cover economic value losses from adverse structural interest rate changes prescribed by NBB. Ratios provide consistent measure but may not fully capture bank-specific risks; interest rate risk considered as a Pillar 2 risk when evaluating minimum capital ratios.

- Methods of ongoing banking supervision (CPs 19–20)
  - Supervisory staff conducting high-quality risk-based supervision both on- and off-site.
  - NBB has sound analytical processes being refreshed to emphasize forward-looking perspectives; new tools expected to support dialogue between institutions and supervisors.
  - Continued incorporation of insurance risk within global group risk assessments is important and planned enhancements should be implemented.
  - NBB restructured on-site supervision and ensured effective coordination with off-site teams.
  - NBB applies comprehensive supervisory program to systemic firms but must ensure “globally balanced supervisory planning” covers all supervised firms; need for a risk-based supervisory process to allocate intensity of supervisory attention proportionate to institution profile and to guide prioritization when resources are scarce.

- Reporting, accounting and disclosure (CPs 21–22)
  - External auditor of a bank accredited by NBB based on independence, experience, competence and organization.
  - External auditor provides audit opinion on financial accounts (six monthly and annually) and on management’s annual self assessment of internal control environment and reliability of prudential returns.
  - Banks required to report on a solo and, if part of a group, consolidated basis. Belgium accounting rules (Belgium GAAP) apply on a solo basis and IFRS on a consolidated basis if consolidated accounts required by EU directives.
  - Banks submit quarterly prudential returns for key data (capital adequacy, balance sheet, earnings etc.); liquidity reported more frequently on a monthly basis.

- Corrective and remedial powers of supervisors (CP 23)
  - NBB has a broad range of corrective and remedial powers and evidence shows readiness to use them; threat of using powers sometimes sufficient to obtain desired outcomes.
  - NBB examining possibility of making disciplinary powers more graduated, particularly through use of fines.

- Consolidated and cross border banking supervision (CPs 24–25)
  - NBB has necessary legal powers and regulatory structures to facilitate consolidated supervision; focus on EU supervisory colleges given significance of cross-border activities.
  - NBB actively uses college environment to test group risk-focused management and ensure adequate capital distribution within groups.
  - NBB values home-host relationships and has cooperation arrangements and MOUs in place with relevant jurisdictions; quality of execution of EU-imposed joint assessment/decision processes depends on supervisory authorities.

### Key Statistics and Numeric Highlights
- Four dominant banking groups represent almost ¾ of consolidated system assets.
- Total exposure of the banking sector to the federal government: 10 percent of banking sector assets in mid-2012.
- Tier 1 capital ratio: 11.6 percent in 2008 and 14.8 percent in mid 2012 (aggregate).
- Tier 1 capital ratios for systemically important banks ranged between 11.5 percent and 20.6 percent as at March 2012.
- Directive threshold: own funds below €600 million; alternative exposure threshold €150 million; exposure cap not higher than 100 percent of the credit institution's own funds.

*Source: Annex I. Report on the Observance of Standards and Codes (ROSCs)—Summary Assessments, BELGIUM, Basel Core Principles for Effective Banking Supervision.*

### 2. Permissible activities

### _cr13124 - 2. Permissible activities

### Overview of supervisory framework and definitions
- The laws provide clear definitions.

### Licensing and ownership controls
- Licensing criteria: The NBB has sound practices and has been reviewing its regime for assessing “fit and proper.”
- Transfer of significant ownership: The NBB’s policies and procedures are comprehensive and there is an increasing focus on looking “upwards” through the shareholding and ownership structure above the institution.
- Major acquisitions: The NBB has powers to object to strategic decisions by systemic firms and meets this principle for such firms. However, nonsystemic firms could make a major acquisition in a nonfinancial sector without either pre-notification or pre-approval.
- Recommendation (Table 2, CP4): Introduce a legal obligation for a credit institution to notify the NBB of a material adverse development that may negatively affect the suitability of a major shareholder.
- Recommendation (Table 2, CP5): Amend laws or regulations to ensure that the NBB has the right of pre-approval of a major acquisition by a credit institution in the nonfinancial sector.

### Capital adequacy and related transactions
- Investment in insurance subsidiaries is deducted 100 percent from total capital, consistent with EU law but not Basel II which requires deduction 50:50 from Tier 1 and Tier 2. This treatment is relevant for Belgium’s largest domestic consolidated banks but will be modified to align with Basel II from 2013. The NBB plans to apply the Basel III treatment of participations in insurance companies in the future.
- Belgian banks may lend to shareholders to subscribe to the capital of the bank where repayment of the loan depends on the dividends received from the capital instrument. This practice:
  - Means that capital is not able to absorb losses and cannot be classified as ‘paid up’.
  - Means published capital adequacy ratios of banks are artificially inflated, weakening the transparency of the true loss absorbency of capital.
  - The regulation has been amended to address this issue with a transition period from January 1, 2014, but at the time of the mission, capital figures included instruments funded in this manner.
- Authorities’ response:
  - The regulation will be adapted as from 1 January 2013 for insurance participations (paragraph 35).
  - NBB states current regulation is fully in line with the Basel 3 framework eligibility criterion 11 regarding instruments being directly issued and paid-in and not funded by the bank; transitional measures were introduced for existing credits at end December 2010 (paragraphs 36–37).
  - NBB will follow new European regulation requiring disclosure of the impact of any transitional measures (paragraph 38).
  - Belgian regulation also deducts credits to shareholders when not granted at market conditions or when no evidence shareholders have sufficient revenues other than distributions on capital instruments (paragraph 39).
  - NBB considers compliance with principle 6 from 1 January 2013 on (paragraph 40).

### Risk management, governance, and internal controls
- Risk management process (CP7): Focuses on Board oversight; regulations require Boards to approve risk management strategies and the ICAAP, but supervisory assessment may not involve annual direct engagement with the full Board (independent nonexecutive directors), even for systemic banks. Without direct engagement and challenge, the supervisor cannot form a comprehensive view of Board oversight of risk management.
- Recommendation (Table 2, CP7):
  - Continue to update the Circular on Internal Governance with emphasis on role of the Board.
  - Develop a comprehensive risk management standard articulating NBB’s minimum expectations for banks and groups.
  - Require Internal Audit to formally report to the Audit Committee; formalize submission of major policies to the NBB when approved by the Board.
  - Baseline supervisory program to include meetings with nonexecutive directors (at least annually), review of Board minutes, onsite testing of controls and risk management, and a meeting with the external auditor; link supervision program to the risk scorecard.
  - Establish a formal cycle for all accredited internal models (Pillar 1) to be assessed regularly.
- Internal control and audit (CP17): Supervisory model places reliance on the credit institution and the external auditor to assess control environment. The frequency, depth and comprehensiveness of supervisors’ testing should be enhanced.
- Recommendation (Table 2, CP17): Consider obtaining positive assurance from external auditor on design and effectiveness of controls extending beyond current external auditor engagement scope.
- Authorities’ response:
  - NBB plans to review internal governance, including risk management, starting in the autumn of 2013 and will consider IMF recommendations (paragraph 41).
  - On internal control assurance, NBB discusses options: require internal audit adherence to IIA/BCBS guidance, require external auditors to give positive assurance (references to PCAOB AS 5 and ISAE 3000), or obtain positive assurance via on-site inspections within the NOVA project, noting limitations on yearly comprehensive assurance for all institutions (paragraphs 46–47).

### Credit risk, large exposures, and related-party exposures
- Credit risk (CP8): No requirement for major credit risk exposures over a pre-defined level to be decided by senior management or Board. Critical credit decisions can be made by bank officers who may not be fully informed of all risks.
- Recommendation (Table 2, CP8): An effective delegation structure will strengthen risk management and help avoid conflicts of interest when granting credit.
- Large exposure limits (CP10): LE regime permits concentration risk for smaller banks who may exceed the 25 percent limit up to 100 percent of own funds if the exposure is less than 150 million euro. Gross exposure, not taking into account credit risk mitigation, can be higher. Smaller banks may be less able to raise additional equity and may lack timely reporting and risk management.
- Authorities’ response: NBB will examine whether to use national discretion to set stricter limit on large exposures within smaller institutions when transposing CRD IV (paragraph 43).
- Exposure to related parties (CP11): No single regulation or integrated process to identify, monitor and report exposures to related parties approved by the board; requirements are applied through several regulations.

### Problem assets, provisions, accounting, and disclosure
- Problem assets, provisions, and reserves (CP9): Accounting standards govern preparation and presentation of general purpose, publicly disclosed financial statements by banks.
- Accounting and disclosure (CP22): Belgian GAAP applies at a solo level and IFRS for consolidated accounts. There is no concrete plan to harmonize accounting methodologies; differing valuation treatments may reduce consistency when comparing risk profiles.

### Market, liquidity, operational, and interest rate risks
- Market risks (CP13): Regulatory framework updated to include Basel II.5 enhancements. Value-at-risk is the main risk management tool used to limit positions; post-crisis, Belgian banks’ trading activities (text truncated in source).
- Liquidity risk (CP14): Regulatory requirements are relatively well advanced with a quantitative test similar to the Basel LCR in place since 2011. Daily reporting for larger systemic banks is robust. Follow-up of the self assessment process has not been conducted across all banks.
- Operational risk (CP15): On-site assessments frequency is risk-based and annual for systemic firms; for medium and small banks frequency varies between one and four years. Quantitative and qualitative information is included in offsite analysis and used in scorecarding.
- Interest rate risk in the banking book (CP16): Prudential requirements are well established. NBB has made strong efforts to implement new standards and embedded interest rate risk in core work.
- Recommendation (Table 2, CP16):
  - Write a single regulation to replace multiple rules texts; include stress testing and a limit framework reflecting risk appetite.
  - Require functional and operational separation of markets and treasury function.
  - Consider requiring an Asset Liability Committee for all credit institutions.
  - Extend cross-sectoral analysis to a greater number of banks.
- Authorities’ response: Interest rate risk is a priority in NBB's Risk Review 2013; since 2012 NBB has an extensive program to develop supervision on interest rate risk and will consider translating recommendations into practice (paragraph 45).

### Supervisory approach, techniques, and reporting
- Supervisory approach (CP19): NBB has a sound analytical process being refreshed and deepened in analytical insight and IT capabilities. New tools should support more forward-looking analysis and integrate insurance risk into global group risk assessments.
- Supervisory techniques (CP20): NBB applies a comprehensive supervisory program to systemic firms but lacks a formal process to identify proportionate supervisory intensity for nonsystemic firms. NBB needs to identify minimum levels of supervisory activity and ensure capability to monitor and update plans. NBB has embarked on multiple projects to support this.
- Recommendation (Table 2, CP20): Put in place a formal supervisory process to ensure each institution systematically receives appropriate intensity of supervisory attention proportionate to its profile.
- Supervisory reporting (CP21): Well developed system for assessing prudential returns. Financial analysis in integrated supervisory teams mainly on a quarterly basis, feeding into peer group comparison and suggested supervisory action.
- Recommendation (Table 2, CP21): Align reporting dates so returns are submitted at the same reporting date to enable integrated and timely financial analysis.

### Corrective powers, consolidated supervision, and home-host relations
- Corrective and remedial powers (CP23): NBB has wide remedial and corrective powers and evidence of willingness to use them. Planned legal changes to permit the NBB Board to apply periodic penalty payments will be a useful additional power.
- Consolidated supervision (CP24): NBB has legal powers and implemented regulatory structure to facilitate consolidated supervision and has developed working relationships with key supervisory authorities for group oversight of systemic firms.
- Home-host relationships (CP25): Cooperation agreements and MOUs exist with all relevant authorities; increasingly mature dialogue, information exchange and joint activities are being undertaken.

### AML/CFT integration in supervision
- Abuse of financial services (CP18): Last FATF Mutual Evaluation Report was in June 2005, and the next is due in 2014. The 2005 report indicates AML/CFT regulation and guidance compliance appears very satisfactory.
- BCP assessment could not conclude that AML/CFT compliance is sufficiently embedded in supervisory framework. It is unclear how monitoring of compliance is undertaken for smaller banks subject only infrequently to on-site inspections.

### Authorities’ overall response and planned actions
- The NBB can subscribe to the general conclusions and main findings and is satisfied with overall high level of compliance with the 2006 Banking Core Principles, acknowledging challenges from crisis conditions and recent integration of prudential supervision (paragraph 30).
- NBB will reconsider adequacy of supervisory resources to achieve appropriate supervisory intensity and effectiveness in the course of 2013 (paragraph 32).
- NBB will provide obligations for notification of material adverse developments and right of pre-approval of major acquisitions in the nonfinancial sector on occasion of next Banking Law modification (paragraphs 33–34).
- NBB plans to review internal governance and risk management starting autumn 2013 (paragraph 41).

*Source: _cr13124 - 2. Permissible activities (extracted content).*

### 48.      We consider that obtaining, in a systematic and sufficiently documented way, comfort as to

### 48. We consider that obtaining, in a systematic and sufficiently documented way, comfort as to the design and effectiveness of internal controls is indeed necessary

### Internal controls and sources of supervisory comfort
- Comfort should be obtained through a pre-defined combination of:
  - senior management's self-assessment (as approved by the Board);
  - ICAAP reporting;
  - input from the internal auditors (cf. recent BCBS document about the internal audit function in banks);
  - input from the external auditor;
  - NBB on-site inspections to test these different inputs.
- The report by the external auditor is one building block and its importance should not be overestimated.
- The process for integrating these building blocks and for steering interaction between them could be made somewhat stricter.
- The NBB will enhance its own quality assurance on the input of the external auditor and include this work when designing baseline supervision (see also BCP 20).

### Supervisory action, planning, and documentation (BCP 20)
- Supervisory action and planning:
  - generally based on priorities and oriented to high risk institutions;
  - needs better documentation of choices and presentation of supervisory planning and realized actions on the basis of a formally agreed and sector wide methodology.
- Internal documentation and team practices:
  - pressure on team members to strengthen internal documentation processes;
  - systematic introduction of standard presentation, including comparison to peers, to make risk assessment more comprehensive and ensure level playing field.
- Enhanced scorecard system:
  - will strengthen structured dialogue with institutions and approved commissioners and competent supervisory authorities (notably via colleges of supervisors);
  - will drive the decision making process, and will be systematically used and included in periodic reporting to the Board;
  - will facilitate clustering on a more refined and risk-focused basis and lead to more balanced and risk based supervisory planning and appropriate assignment of staff.

### Baseline supervision and supervisory reporting (BCP 21)
- At the time of closing the FSAP mission, the NBB has started work to implement a baseline supervision approach.
- The NBB is in the process of identifying different clusters and must define a baseline supervision even for low risk institutions.
- The European Implementing Technical Standards (ITSs) on reporting, being prepared by the EBA in the context of the future CRD IV, will shorten remittance dates for prudential returns and will become directly applicable in Belgium.
- Since January 2012, the NBB has been conducting on-site inspection based on audit techniques, with clear scoping and formalized work program; it issues formal reports on findings and remedial measures and monitors implementation. NBB may inspect service providers of outsourced functions but has not conducted such inspections.

### Insurance sector background and structure (IAIS ICPs)
- Assessment updates regulatory and supervisory developments in Belgian insurance sector since 2006; benchmarked against ICPs issued October 2011.
- Supervisory architecture overhauled with Twin Peaks structure in April 2011:
  - NBB: micro- and macro-prudential supervision of insurers;
  - FSMA: registration of intermediaries and supervision of conduct of business by insurers and intermediaries.
- Industry scale and concentration:
  - assets held by banks are five times of those held by insurers as at September 2011;
  - there are 92 direct insurers;
  - 23 composite insurers conduct both life and nonlife operations, accounting for more than 90 percent of total industry assets;
  - in 2011, the top five life insurers accounted for 71 percent of the assets while the top five nonlife insurers held 58 percent of the assets;
  - the top three insurance groups held more than 60 percent of the total assets as at end-2011.

### Insurance sector risks and exposures
- Post-crisis developments:
  - Belgian insurers were adversely affected by the global financial crisis and continue to confront challenges related to legacy portfolios and economic uncertainties in Europe.
  - Government support was extended to a few insurers in 2008.
  - Insurance industry’s solvency position has continued to weaken since 2009.
  - Life insurers have significant exposures to guaranteed high returns in part of their legacy portfolios.
- Asset composition:
  - insurers held high levels of government bonds: €104 billion, accounting for 41 percent of assets as at end-2011, of which €59.6 billion were in Belgian government bonds;
  - investments in corporate bonds represent 23 percent of total assets.
- Product and market dynamics:
  - insurers gradually shifting toward contracts that offer lower guarantees, though some new contracts offer more policy options increasing surrender risk;
  - demand for life policies eroded by households' stronger preference for liquidity;
  - nonlife insurers have taken measures to improve underwriting performance but remain susceptible to investment risks.

### Preconditions, governance, and supervisory capacity
- Preconditions:
  - macroeconomic, fiscal and legal frameworks partly shaped by EU membership;
  - accounting, auditing and actuarial standards adopted are in line with international best practices;
  - Deposit Guarantee Scheme covers policyholders of traditional life policies (except group insurance related to employee benefits) up to €100,000 per policyholder since 2008.
- Corporate governance and fit-and-proper:
  - legally binding minimum governance requirements supplemented by comply-or-explain approach;
  - NBB assessing governance practices as input to Scorecard System and risk-based supervision;
  - NBB revising fit and proper regulation to extend suitability requirements to Key Persons in Control Functions and to require notifications of circumstances that may materially adversely affect suitability.
- Legal and supervisory capacity gaps:
  - scope for strengthening NBB’s legal capacity to issue enforceable rules in a more principles-based manner;
  - NBB should be empowered to take immediate recovery measures notwithstanding an appeal by an insurer;
  - need to articulate policies to manage potential conflicts in supervisory objectives (e.g., financial stability vs. policyholder protection).
- Resourcing:
  - NBB and FSMA should be adequately resourced; NBB advised to regularly review resource planning for appropriate supervisory intensity and baseline program;
  - resource implications from implementation of Solvency II and supervision of complex cross-border groups/conglomerates;
  - FSMA needs a risk-based supervisory approach to manage more than 17,000 intermediaries and ensure adequate implementation resources.

### Main findings and recommended improvements
- Progress achieved:
  - implementation of Flashing Light Provisions to strengthen life insurer solvency for legacy exposures;
  - enhanced risk management requirements;
  - integrated supervisory framework combining vertical and horizontal analyses and leveraging macroeconomic competencies;
  - enhanced checks-and-balances through separation of vertical and horizontal supervision and offsite/onsite reviews.
- Areas for improvement:
  - formulate an appropriate baseline supervisory program;
  - establish internal policies for inspecting functions outsourced by insurers;
  - review effectiveness of contributions of external auditors and the role of actuaries;
  - review conduct-of-business (COB) regulation and supervision to enhance professionalism of intermediaries (training/qualification), deter unhealthy competition among more than 17,000 intermediaries, and enable FSMA to establish enforceable rules on claims handling, group-level market conduct, and combating/reporting insurance fraud by intermediaries.
- Observance with ICPs:
  - updated regulatory framework has a high level of observance with the ICPs;
  - majority of downgrades reflect gaps in regulatory framework: scope of fit and proper requirements; duties of directors with respect to policyholders; public disclosures; updating prudential standards for asset-liability management; realistic contingency plans.
- Supervisory reporting and Scorecard system:
  - Scorecard facilitates documentation, consistency of supervisory assessments, and structured discussion of supervisory issues;
  - intensity of supervisory engagement prioritized on a risk basis;
  - NBB empowered to collect extensive regulatory and statistical information at solo and group levels.

*Source: IMF staff assessment contained in the provided content unit.*

### 11. Enforcement The NBB and the FSMA have a wide range of powers to take enforcement

### _cr13124 - 11. Enforcement The NBB and the FSMA have a wide range of powers to take enforcement

### Enforcement
- The NBB and the FSMA have a wide range of powers to take enforcement action and impose sanctions.
- A transparent process and engagement of Sanctions Committees (to be established) in the NBB and of the Sanctions Committee of the FSMA helps ensure proportionate and consistent sanction decisions.

### Winding-up and Exit from the Market
- Winding-up of insurers is based on the procedure set out in the Insolvency Law (insolvency) and the Company Code (dissolution and liquidation), subject to certain modifications set out in the Insurance Law.
- Policyholders have priority of claim above other unsecured creditors in the event of a winding-up.
- The Insurance Law determines the point at which it is no longer permissible for an insurer to continue its business.

### Reinsurance and Other Forms of Risk Transfer
- The NBB requires insurers to submit comprehensive information on their reinsurance programs and its IT Tool calculates standard early warning indicators automatically.
- Reinsurance is taken into account in the PCR (solvency margin) using rough proxies and the risk mitigating effect might be under- or overstated for some forms of reinsurance (e.g., for nonproportional covers).
- Reinsurance credit risks are not considered adequately.
- Concentration risk arising from reinsurance ceded to only one or few reinsurers is not considered.

### Valuation
- Valuation of assets and liabilities for solvency purposes must conform to applicable accounting standards at both solo (BGAAP) and group level (IFRS).
- Valuation approach for assets covering TP is generally market-based, except for sovereign bonds, which are valued at amortized cost less depreciation/impairment.
- TP are valued at historical cost.
- NBB has reviewed insurers’ valuation of certain assets in more depth since the financial crisis and has taken action against insurers for insufficient rigor (notably on impairments).
- NBB focuses mainly on the level of TP and less on the methods used to calculate TP.
- The current valuation standard for TP is based on implicit prudence without an explicit current estimate and Margin over Current Estimate (MOCE), making analysis of sufficiency of TP more difficult for the NBB.

### Investment and Asset-Liability Management (ALM)
- Regulatory requirements apply only to the assets covering insurers’ TP; there are no requirements on free assets.
- ALM requirements for some insurers have been implemented since 2006 in relation to the Flashing Light provision.
- Insurers must formulate crisis scenarios and quantify the impact as part of their ALM framework.
- Effective supervision of ALM hinges on adequate technical supervisory capacity.

### Enterprise Risk Management for Solvency Purposes (ICP 16)
- Current prudential standards have established some elements of regulatory requirements for enterprise risk management by insurers.
- To meet ICP 16, clearer requirements and more comprehensive scope are needed on insurers’ risk management policy, particularly for investment and underwriting risks.
- Enterprise risk management should be supported by an ORSA. Currently, some elements of ORSA are applicable only to those insurers exempted from the Flashing Light provision.

### Capital Adequacy (ICP 17)
- Solvency I framework is not risk-based—the capital requirement does not take all material risk into account, e.g., credit risk, and where risks are taken into account it is not done explicitly.
- Capital requirement is not consistent with the valuation standard.
- Capital adequacy does not explicitly consider on a realistic basis: asset liability matching; reinsurance and other risk mitigating measures; diversification between risks.
- Group capital requirements based on Solvency I do not take into account group-specific risks (e.g., contagion risks).
- While there are two solvency control levels, the MCR is not a minimum bound that triggers automatic strongest supervisory actions in absence of corrective action by an insurer.

### Intermediaries (ICP 18)
- Registration conditions for intermediaries are clear and transparent; training and qualification requirements imposed by the FSMA comply with the EU IMD directive.
- Scope to raise continuous professional development requirements.
- FSMA supervision focuses mainly on checking compliance with registration requirements.
- Pre-contract information disclosure is adequate on an intermediary’s status and relationship with insurers but disclosure on potential conflict of interest could be enhanced, particularly relating to remuneration arrangements.
- FSMA conducts on-site inspections and has withdrawn or suspended registrations of intermediaries who failed to meet requirements.
- Legal framework provides protection for clients’ monies handled through intermediaries.

### Conduct of Business (COB) (ICP 19)
- Current COB regime focuses on prohibition against unfair and misleading practices.
- Implementation of the voluntary moratorium of structured products considered “particularly complex” in August 2011 is a commendable supervisory initiative.
- FSMA has proposed amendments to the Supervision Law to impose a general obligation on insurers and insurance intermediaries to act fairly, honestly and professionally in the best interests of their clients and provide correct, clear and not misleading information.
- Proposed adaptation of MiFID 2 to insurance intermediation will enhance COB requirements.

### Public Disclosure (ICP 20)
- Current disclosure regime focuses on financial position and performance of insurers and has significant gaps in disclosures on: technical provisions, risk management and exposures, details of performance and capital adequacy.
- Application of IFRS as from financial year 2012 has improved disclosures in consolidated accounts.
- Impending implementation of Solvency II will bring the disclosure regime in line with international best practices.

### Countering Fraud in Insurance
- No specific legislation on insurance fraud, but general criminal law adequately addresses fraudulent conduct relating to insurance, subject to criminal proceedings.
- Supervisory attention for fraud is part of assessments relating to governance/risk management, compliance and internal audit functions.
- Industry measures include training programs, sharing information via databases and a new code of conduct concerning insurance fraud prevention.
- NBB and FSMA may cooperate, coordinate and exchange information relating to insurance frauds with other competent authorities, including foreign authorities.

### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- NBB and FSMA are aware of AML/CFT risks of the insurance industry and have effective mechanisms to cooperate, coordinate and exchange information with domestic and foreign supervisors/FIUs.
- Authorities are reviewing the current AML-CFT regime to take account of the new FATF Recommendations of February 2012.

### Group-wide Supervision (ICP 23)
- Supplementary supervision of insurance groups is shaped by EU Directive and facilitated by EIOPA coordination framework.
- NBB has adequate powers and flexibility to determine scope of insurance groups and to supervise both regulated and nonregulated entities within a group.
- NBB is actively involved in supervisory colleges as both home and host supervisor.
- No group-wide market conduct requirements.
- Scope to establish consistent supervisory processes for group supervision (e.g., reporting intragroup transactions).
- NBB has concluded supervisory cooperation agreements with other supervisors but scope for improvement remains.

### Macroprudential Surveillance and Insurance Supervision (ICP 24)
- As central bank and prudential supervisor, NBB is well placed for effective macroprudential surveillance.
- NBB collects extensive quantitative and qualitative information quarterly, complemented by ad-hoc questionnaires if necessary.
- Macrofinancial Committee serves as forum for exchange of information on macro-financial developments in Belgium and in countries where Belgian institutions have exposure.
- Risk Committee oversees cross-sectoral risk analyses to facilitate early detection of potential systemic threats/risks.
- NBB participates in EIOPA stress testing exercises and conducts its own stress tests of the Belgian insurance sector.

### Supervisory Cooperation and Coordination (ICP 25)
- NBB has established comprehensive coordination arrangements with other involved supervisors for legal-entity and group-wide supervision.
- NBB chairs three supervisory colleges as group-wide supervisor.
- NBB coordinates with relevant agencies from other sectors, including central banks and government ministries.
- Pending implementation of Solvency II, coordination arrangements have not been concluded for all insurance groups although colleges operate in line with EIOPA templates.
- NBB became a signatory to the IAIS Multilateral MOU in December 2011.

### Cross-border Cooperation and Coordination on Crisis Management (ICP 24 / cross-border)
- Belgian regime is based on the EU framework, which has been partially operationalized.
- Coordination arrangements and emergency plans have not yet been implemented for all supervisory colleges that NBB participates in.
- Some insurance groups are still developing contingency plans.

### Key Recommendations (extracted from Table 4)
- ICP 1: Conduct regular reviews of practical implementation of the Twin Peaks structure; consider more principle-based approach delegating legal authority to NBB to issue enforceable rules.
- ICP 2: Empower NBB to declare recovery decisions immediately executable notwithstanding appeal; ensure NBB and FSMA have adequate supervisory resources; clarify Minister’s supervision scope; establish escalation policies; review Internal Audit Service resources.
- ICP 3: Expedite conclusion of MOU between NBB and FSMA to guide cooperation and exchange of information.
- ICP 4: Expedite finalisation of draft Royal Decree establishing proportionate regulatory requirements for local mutual insurance associations and cooperative societies.
- ICP 5: Expedite revision of fit and proper regulation.
- ICP 6: Consider empowering NBB and FSMA to approve conversion of mutual companies to stock companies.
- ICP 7: Establish clearer supervisory expectations on directors’ duties and adequate board powers/resources.
- ICP 9: Strengthen ongoing supervision by: developing baseline supervisory program; strategizing risk-based COB supervision by FSMA; reviewing leveraging external auditors and actuaries; establishing internal policies for inspecting outsourced functions; ensuring adequate supervisory resources and technical capacity.
- ICP 13: Strengthen prudential standards relating to reinsurance; require insurers to embed reinsurance risk management; formulate standards for risk transfer to capital markets.
- ICP 14: Enhance NBB supervisory assessment to include explicit consideration of assumptions and methods used to estimate TP; build technical capacity; monitor cost of insurance liabilities for life insurers’ legacy portfolios with high guarantees; strengthen Flashing Light approach and put in place market consistent valuation standard for TP; consider introducing market consistent valuation ahead of official Solvency II timeline.
- ICP 15: Update prudential standards for ALM to reflect evolving international best practices; strengthen supervisory capacity; establish formal regulatory requirements on investments of insurance groups.
- ICP 16: Implement ORSA earlier than official Solvency II timeline; support ORSA with sound valuation and risk assessment framework; ensure transparency given prolonged low-interest rate risk.
- ICP 17: In planning early implementation of certain elements of Solvency II: a) explore strengthening quantitative and qualitative elements of solvency framework (e.g., ORSA) and conduct quantitative impact studies; b) work with industry to improve Solvency II market consistent balance sheet and capital calculations; c) enhance prudential standards for intragroup transactions; d) formulate stress testing and scenario analysis framework; e) review adequacy of supervisory resources for implementation.
- ICP 18: Adapt MiFID 2 for insurance intermediation; review continuous professional development requirements; amend Intermediation Law to impose time limit for migration of sub-agents.
- ICP 19: Strengthen COB regime by implementing proposed amendments to Supervision Law and MiFID 2, empowering FSMA to issue enforceable rules on claims handling, fact-finding of client needs, and ensuring FSMA resourcing.
- ICP 20: Address significant gaps in disclosure requirements.
- ICP 21: Empower NBB and FSMA to issue enforceable rules requiring insurers and intermediaries to report insurance fraud.
- ICP 22: Periodically reconsider whether nonlife insurance should be covered by AML/CTF regime in Belgium.
- ICP 23: Plan for adequate supervisory resources to supervise insurance groups, especially complex cross-border groups that are domestic SIFIs.
- ICP 24 / Cross-border Crisis: Conclude coordination arrangements and emergency plans; regularly test arrangements and plans; consider empowering NBB to require insurers and groups to establish crisis management/contingency plans.

### Authorities’ Response (selected)
- ICP 1: NBB finds it early to conduct a thorough review of Twin Peaks but will deal with gaps, duplication or coordination issues when they appear.
- ICP 2: NBB agrees to rectify inconsistency between immediate execution possibility for banking and insurance recovery measures in case of an appeal via amendment of the NBB Organic Law.
- ICP 2: NBB will reconsider adequacy of supervisory resources in the course of 2013.
- ICP 5: NBB is revising fit and proper regulation, holding a public consultation; adoption planned in the course of 2013.
- ICP 7: NBB agrees with corporate governance recommendations and plans to incorporate them when revising governance requirements in the second half of 2013.
- ICP 9: NBB continues development of scorecarding approach to establish baseline supervisory program; plans to recruit additional staff (e.g., actuaries); will consider internal policies for inspecting outsourced functions; will reflect on assessing contributions of external auditors and actuaries.
- ICP 14: NBB is revising the Flashing Light approach, including exemption file method, to better monitor adequacy of technical provisions for life insurers’ legacy portfolios with high guarantees. Revised Flashing Light approach will be implemented in the second half of 2013.
- ICP 14 / 16: NBB will seriously consider EIOPA decisions to advance implementation of some parts of Solvency II, including ORSA.
- ICP 17: NBB is reflecting on measures to strengthen solvency framework including adaptation of Flashing Light approach, revision of profit sharing mechanism and alternative ways to decrease the maximum guaranteed interest rate.
- ICP 17: NBB participates in EIOPA working groups and has launched an impact assessment to test proposed measures for products with long term guarantees.
- ICP 17: NBB plans to conduct an EIOPA-led stress test in the second half of 2013 and will continue periodic vulnerabilities analyses to monitor life insurers’ legacy portfolios with high guarantees.
- ICP 20: NBB is planning to introduce higher disclosure requirements under Solvency II.

*Source: INTERNATIONAL MONETARY FUND*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13124.pdf_