Circular No. 88-1 on Minimum Capital Requirements

Bank of the Republic of Haiti CIRCULAR No. 88-1

In application of Articles 43 to 46 and 141 of the Law of May 14, 2012, concerning banks and other financial institutions, banks, credit card companies, development finance companies, and leasing companies, hereinafter referred to as "financial institutions," are required to comply with the provisions of this circular regarding minimum capital requirements in relation to risk coverage.

b) Risk-weighted assets: denominator of the capital adequacy ratio. Calculated by multiplying the nominal amount of asset items by risk weighting factors to make the counterparty risk associated with each unit of asset comparable. The risk inherent in off-balance sheet items is also taken into account. On-balance sheet and off-balance sheet items are weighted according to risk in accordance with Section 4 of this circular.

c) Claims: all sums of money that a financial institution (the creditor) is entitled to recover and which represent the consideration for a service rendered, a loan granted, or an investment made with a natural or legal person (the debtor).

d) Off-balance sheet items: commitments given and received by signature, without cash receipt or payment, the eventual execution of which could modify the amount or composition of the institution's equity: financing commitments, guarantees, securities, derivatives, and foreign exchange. Commitments designate agreements that oblige a financial institution, at the request of a client, to grant credit (in the form of loans or others, including acceptances, letters of credit, guarantees) or to purchase loans, securities, or other asset items. Normally, commitments involve a written contract or agreement.

These commitments include interest rate-related items (e.g., interest rate swaps, interest rate forward contracts, and purchased interest rate options) and foreign exchange-related items (e.g., gold contracts, currency swaps, simultaneous exchange contracts for rates and currencies, foreign exchange forward contracts, and purchased foreign exchange options) as well as credit commitments and credit substitutes. Direct credit substitutes include guarantees and equivalent instruments that secure financial claims.

1. Definitions

a) Asset: the entirety of an entity's equity. It includes all debit balances of the balance sheet accounts, including available and realizable values, operating values, prepaid expenses, fixed assets, as well as certain off-balance sheet items.

e) Credit or counterparty risk: risk incurred in the event of default by a counterparty or group of counterparties (affiliates).

g) Operational risk: risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events. This definition includes legal risk but excludes strategic and reputational risks. Major sources of operational risks may notably include:

1. Internal and external fraud;

2. Inappropriate employment practices and workplace safety practices;

3. Inappropriate practices concerning clients, products, and business activities;

4. Damage to physical assets;

5. Business interruptions and system failures;

6. Execution of operations, deliveries, and processes.

7. Minimum Capital Requirements

Every financial institution must hold capital allowing it to adequately cover, without limitation, credit or counterparty risks, operational risks, and market risks.

Regulatory capital consists of Core Tier 1 capital, Additional Tier 1 capital, and Tier 2 capital. They constitute the numerator of the risk-weighted asset coverage ratio including credit, operational, and market risks, and the denominator of the leverage ratio.

To this end, the financial institution must at all times respect the following capital adequacy standards:

Leverage ratio: Assets / Regulatory Capital A maximum multiple of 20 times between the assets of an institution on the one hand, and its regulatory capital on the other hand.

The leverage ratio (Assets/Regulatory Capital) allows measuring the adequacy of the overall level of a financial institution's capital relative to the size and growth of its assets. The numerator of the ratio includes the total of asset items at their net book value and the outstanding amounts of off-balance sheet items referred to in Section 4.2 of this circular. The denominator represents regulatory capital determined in accordance with Section 3 of this circular.

Risk-weighted asset coverage ratio: Regulatory Capital / Risk-Weighted Assets A minimum ratio of 12% between the regulatory capital of an institution on the one hand, and the total of on-balance sheet and off-balance sheet items weighted according to credit, operational, and market risk on the other hand.

i) Market risk: risk of loss in the value of positions due to price (rates) fluctuations in the market. Products concerned by this type of risk notably include: bonds and interest rate derivatives, equities, foreign exchange, and commodities.

The risk-weighted asset coverage ratio by capital allows measuring the sufficiency of a financial institution's capital relative to the credit risk on each asset and off-balance sheet item, operational risk, and specific risk associated with market operations. The numerator of the ratio represents regulatory capital. The denominator takes into account the total of on-balance sheet and off-balance sheet items weighted according to credit, operational, and market risks.

Risk-Based Capital Ratio = Regulatory Capital / (RWA_credit + EFPRO / 8.33 + EFPRM / 8.33) > 12%

RWA_credit = Risk-Weighted Assets for Credit Risk EFPRO = Capital Requirement for Operational Risk EFPRM = Capital Requirement for Market Risk

Risk coverage standards by capital must be applied by financial institutions on a consolidated basis, where applicable. The consolidating entity includes all subsidiaries that must be consolidated.

When a financial institution is itself a subsidiary of another regulated institution, the capital sufficiency standards for the subsidiary must be applied on a non-consolidated basis.

3. Elements of Regulatory Capital

Core Tier 1 capital (Category 1) aims to ensure the continuity of the financial institution's operations. They consist of the highest quality elements due to their permanence and the absence of mandatory fixed costs charged to results.

Tier 2 capital (Category 2) contributes to the overall strengthening of the financial capacity of a financial institution. They consist of the elements defined in Section 3.2.

The BRH may refuse or limit the inclusion by an institution in its capital of certain of the elements listed below when it considers that the characteristics of these elements do not ensure their permanence, although they contribute significantly to meeting the standards set in Section 2.

3.1. Core Tier 1 Capital (Category 1)

Core Tier 1 capital consists of Core Tier 1a capital and Additional Tier 1b capital.

3.1.1. Core Tier 1a Capital

Elements to include in Core Tier 1 Capital (Category 1a):

Core Tier 1a capital includes:

• Capital or endowment in the case of branches of foreign banks;
• Share premium (issue or merger premiums actually received corresponding to the difference between the selling price of shares and their nominal value);
• Legal reserve;
• Profits from the last closed fiscal year may be taken into account, before their approval by the general assembly of shareholders, under the following conditions:
  • They are determined after deduction of all foreseeable charges and dividends;
  • They are subject to an unqualified opinion from an approved independent audit firm;
  • They are subject to prior authorization from the BRH.

Note that the positive result of the current fiscal year cannot be taken into account in capital.

Furthermore, the following elements resulting from the consolidation process are included in Core Tier 1 Capital (Category 1a):

• The counterpart, in consolidated reserves, of goodwill paid upon the acquisition of a stake (i.e., the difference between the price paid and the share of net assets in the acquired company);
• Differences on equity method investments (share of reserves and results of entities consolidated by equity method);
• The translation difference appearing in the liabilities of consolidated accounts (difference resulting from the conversion at different exchange rates of the balance sheet and results of consolidated entities whose accounts are kept in foreign currencies);
• Minority interests in the form of Core Tier 1 Capital (Category 1a).

Elements to deduct from Core Tier 1 Capital (Category 1a):

• Unpaid capital;
• Treasury shares (self-held shares) evaluated at their book value;
• Retained losses from previous years;
• Pending losses;
• Negative result of the current fiscal year;
• Participations in other regulated establishments outside the consolidation perimeter;
• Intangible fixed assets including goodwill or trade name, and, where applicable, the excess of the right of use of leased assets over the related lease liability recognized respectively in assets and liabilities of the balance sheet, in accordance with generally recognized accounting principles, notably IFRS 16 on lease contracts.

For the calculation of capital on a consolidated basis, the following are also deductible from Core Tier 1 Capital:

• Goodwill and deferred taxes appearing in the assets of consolidated accounts;
• The amount of participations in the form of Core Tier 1 Capital (Category 1a) in other regulated establishments appearing in consolidated accounts for equity method participations and non-consolidated participations.

3.1.2. Additional Tier 1b Capital

Elements to include in Additional Tier 1 Capital (Category 1b):

Financial instruments meeting the following criteria:

• Fully paid;
• Of unlimited duration or with a minimum notice period of 5 years and repayment subject to prior BRH approval;
• Not held, not financed, and not guaranteed by the reporting institution or by a unit of the same group;
• Subordinated to all liabilities except for elements included in Core Tier 1 Capital (Category 1a);
• Absence of right to early repayment or exclusively at the initiative of the issuers and absence of contractual clause creating a strong incentive for early repayment.

Minority interests appearing in consolidated accounts in the form of other Core Tier 1 Capital (Category 1b) are also to be included in this category.

Elements to deduct from Additional Tier 1 Capital (Category 1b):

Financial institutions deduct from Additional Tier 1 Capital (Category 1b):

• Financial instruments of Additional Tier 1 Capital (Category 1b) nature issued by the institution and self-held;
• The amount of participations in the form of other Core Tier 1 Capital (Category 1b) in other regulated establishments appearing in consolidated accounts for equity method participations and non-consolidated participations.

Furthermore, the following amounts must be deducted from Additional Tier 1 Capital:

• The excess of limits provided in the circular on credit risk concentration;
• The undervaluation of the provision for doubtful loans in accordance with the provisions provided in the circular on loan classification, provisions for doubtful loans, and recognition of accrued interest on loans;
• Any other undervaluation of provisions;
• The fraction of minority interests in all forms exceeding 120% of the risk-weighted assets of the concerned consolidated entities.

3.2. Tier 2 Capital (Category 2)

Considered as Tier 2 Capital:

1. Financial instruments meeting all the following criteria:

   • Issued and paid;
   • Not held, not financed, and not guaranteed by the institution or its group;
   • Subordinate to all other liability elements except for elements included in Core Tier 1 Capital;
   • Initial duration of at least 5 years, with progressive reduction of the percentage of inclusion over the last 5 years;
   • No possibility of early repayment or only after 5 years, in which case at the sole initiative of the issuer and with prior BRH approval;
   • Absence of contractual clause creating a strong incentive for early repayment;
   • Absence of clause increasing the amount of interest or dividends on these instruments in case of unfavorable evolution of the institution's or its group's situation.

2. Issue premiums of the instruments referred to in point 1 above;

3. Minority interests in the form of instruments referred to in point 1 above;

4. General reserve for loan losses (provisions on current and reportable loans provided for by the circular on loan classification, constitution of provisions for doubtful loans, and recognition of accrued interest on loans);

5. Provisions for expected credit losses on loans and other assets, in accordance with IFRS 9 standard on financial instruments.

Amortization and Deduction of Tier 2 Capital

Financial instruments admitted as Tier 2 Capital are subject to an annual linear discount (amortization) in the five years preceding the repayment or redemption maturity. Consequently, the balances of financial instruments admitted as Tier 2 Capital must be amortized according to the following criteria:

Residual Maturity | Percentage 5 years and more | 100% 4 years to less than 5 years | 80% 3 years to less than 4 years | 60% 2 years to less than 3 years | 40% 1 year to less than 2 years | 20% Less than one year | 0%

Self-held Tier 2 Capital or held in other non-consolidated financial institutions is deducted, at their book value, from Tier 2 Capital.

3.3. Limits Relative to Capital

a) Core Tier 1 Capital (Category 1a): They must, at all times, be at least equal to 6.75% of risk-weighted assets.

b) Total Core Tier 1 Capital (Categories 1a and 1b): They must, at all times, be at least equal to 9% of risk-weighted assets.

c) Total Capital (Categories 1 and 2): They must, at all times, be at least equal to 12% of risk-weighted assets.

3.4. Conservation Buffer

In addition to the minimum requirement of 12% set above, financial institutions must permanently constitute, on an individual and consolidated basis, an additional capital cushion fixed at 2.5% of risk-weighted assets and which must be composed entirely of elements of Core Tier 1 Capital (Category 1a).

Non-compliance with this requirement does not constitute an infraction subject to disciplinary measures but requires constituting or reconstituting this cushion when the fixed level is not respected, by limiting the distribution of profits according to a variable percentage depending on the importance of the shortfall.

In total, financial institutions are required to respect the following global capital requirements:

• Core Tier 1a Capital: minimum ratio of 9.25% of risk-weighted assets
• Core Tier 1 Capital: minimum ratio of 11.50% of risk-weighted assets
• Total Capital: minimum ratio of 14.5% of risk-weighted assets.

4. Risk Weighting Factors

Taux d'inclusion dans les fonds propres (Inclusion Rate in Capital) 100% 80% 60% 40% 20% 0%

An example of the calculation of requirements set in Sections 3.3 and 3.4 is presented in Annex I.

Risk weighting factors aim to measure the risk-equivalent of on-balance sheet and off-balance sheet items. Weighting rates are fixed according to risk: 0%, 20%, 50%, 75%, 100%, and 150%.

Applicable weighting rates depend on four different factors: the degree of exposure to counterparty risk, the nature of the asset items, the nature of the counterparty concerned, and the rating assigned to that counterparty.

4.1. On-Balance Sheet Items

Risk Weighting Factor of 20%:

• Claims on financial institutions covered by this circular and those of banks whose countries are classified in categories 0 and 1 or high-income countries not rated in the country risk classification published by the OECD, with the exception of claims that the rules applicable to these counterparties rank in their capital (e.g., subordinated bonds), which must be weighted at 100%;
• Claims on States and Central Banks appearing in category 2 of the country risk classification published by the OECD within the framework of the Export Credits Arrangement;
• Checks in collection and other effects in transit.

Risk Weighting Factor of 50%:

• Claims on customers (housing loans) guaranteed by a first-ranking mortgage on a residential property that is or will be occupied or rented by the borrower. The residential property must be intended entirely for habitation by persons;
• Mortgage credits other than first-ranking granted for the acquisition or renovation of a residential property (which is or will be occupied or rented by the borrower and intended entirely for habitation by persons), provided that the banking institution already holds a first-ranking mortgage on said property;
• Claims on States and Central Banks whose countries are classified in category 3 of the country risk classification published by the OECD;
• Claims on banks whose countries are classified in category 2 of the country risk classification published by the OECD;
• Mortgage securities fully and specifically guaranteed by mortgage loans, provided that these latter are themselves guaranteed by a first-ranking mortgage on a residential property.

Risk Weighting Factor of 0%:

• Cash or assimilated items (banknotes, coins, and gold holdings);
• Claims on the Haitian State and the BRH;
• Claims on States and Central Banks of countries appearing in categories 0 and 1 of the country risk classification published by the Organisation for Economic Co-operation and Development (OECD) on its website within the framework of the Export Credits Arrangement, as well as non-rated high-income countries appearing in this classification;
• Claims on other borrowers assimilable to sovereigns (International Monetary Fund (IMF), Bank for International Settlements (BIS), European Union (EU), European Central Bank (ECB));
• Claims on multilateral development banks (MDBs) listed in Annex III;
• Claims on customers guaranteed 100% by one or more pledges without dispossession having as underlying elements debt securities issued by the BRH, only if the repayment of capital and interest is guaranteed in the hands of the lender;
• All asset items deducted from capital in application of the provisions of Sections 3.1.1. and 3.1.2.

For the application of this weighting ratio (50%), claims guaranteed by mortgages referred to in the first two points are taken into account up to the limit of the fair value of the property(ies), determined on the basis of an independent expert report duly argued. If applicable, the amount of the claim exceeding the fair value of the property is to be weighted at 100%.

Risk Weighting Factor of 75%:

• Claims on customers guaranteed by a first-ranking mortgage on a commercial property up to 10% of the fair value of the property(ies), determined on the basis of two independent expert reports. If applicable, the amount of the claim exceeding the fixed limit is to be weighted at 100%;
• Real estate and movable leasing credits up to the market value of the financed property.

Risk Weighting Factor of 100%:

• All claims and asset items not appearing in other weighting factors and not deducted from capital.

Risk Weighting Factor of 150%:

• Non-performing loans (excluding credit cards) net of provisions for doubtful loans for which the provisions for doubtful loans constituted are less than 50% of the net unsecured outstanding amount;
• Non-performing credit card portfolio net of provisions;
• Claims on States, Central Banks, and banks whose countries are classified in category 7 of the country risk classification published by the OECD.

4.2. Off-Balance Sheet Items

The nominal value of an off-balance sheet item does not always reflect the value of counterparty risk. To estimate potential commitments, the nominal value of the item is multiplied by a conversion factor into credit equivalent to obtain an amount in credit equivalent. The amount obtained is then treated as an on-balance sheet item subject to the weighting factor corresponding to its counterparty risk. Conversion factors into credit equivalent vary depending on whether it concerns interest rate and foreign exchange items or other off-balance sheet items.

4.2.1. Conversion Factors for Items Related to Interest Rates and Foreign Exchange

There are two different methods for evaluating off-balance sheet items related to interest rates and foreign exchange: the marked-to-market method and the current risk (initial risk) method. For the application of this circular, financial institutions may...