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2026-01-01

Decision on Capital Adequacy of Credit Institutions

The Council of the Central Bank of Montenegro issued this Decision to establish the regulatory framework for the capital adequacy of credit institutions. It defines the composition of own funds and eligible liabilities, specifies calculation methods for capital ratios, and sets standards for credit, market, operational, and leverage risks. The document also provides detailed definitions of key financial terms and permits institutions to apply stricter internal capital requirements than those mandated.

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[unofficial translation] Pursuant to Article 44 paragraph 2 item 3 of the Central Bank of Montenegro Law (OGM 40/10, 06/13, 70/17, 125/23), and Article 115a paragraph (3) and Article 134 paragraph (9) of the Law on Credit Institutions (OGM 72/19, 82/20, 8/21, 24/25), the Council of the Central Bank of Montenegro, at its meeting held on 9 June 2025, passed the following DECISION ON CAPITAL ADEQUACY OF CREDIT INSTITUTIONS PART ONE BASIC PROVISIONS Subject matter Article 1 This Decision governs:

  1. types and features of financial instruments and other elements to be included in own funds and eligible liabilities of credit institution;
  2. the method of calculating own funds, total exposure to risk, and capital adequacy ratios of credit institutions;
  3. the methods and approaches for calculating capital requirements relating to entirely quantifiable, uniform and standardised elements of credit risk, market risk, operational risk, settlement risk; and
  4. leverage. Application of stricter requirements Article 2 (1) A credit institution may hold own funds and its components in excess of, or undertake measures that are stricter than those required by this Decision. (2) Where a credit institution decides to apply higher amount of own funds than required or stricter criteria for recognising instruments of capital, within the meaning of paragraph (1) of this Article, it shall define those higher levels and stricter criteria in its internal acts and apply them consistently, and those criteria shall not be contrary to the provisions of this Decision. (3) Where a credit institution decides to apply stricter measures referred to in paragraph (1) of this Article in determining risk weighted exposure amount using Standardised Approach, it may define stricter risk weights for certain risk categories in its internal acts, but it may not use other risk categories than those prescribed by this Decision.

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 2 Meaning of terms Article 3 (1) Terms used in this Decision shall have the following meaning:

  1. investment firm means any legal person whose regular occupation or business is the provision of one or more investment services to third parties and/or the performance of one or more investment activities on a professional basis;
  2. collective investment undertaking (hereinafter: CIU) means an undertaking for collective investment in transferable securities (UCITS) or an alternative investment fund (AIF) managed by the manager of an alternative investment fund (AIFM) established in Montenegro, the European Union or a third country, which is subject to regulations applicable in Montenegro, the European Union or a third country that applies prudential regulation equivalent to the regulation in Montenegro or the European Union;
  3. undertaking for collective investment in transferable securities (hereinafter: UCITS) means an open-ended investment fund with a public offering: ­ with the sole object of collective investment of assets raised from the public bid of capital in the fund in transferable securities or in other liquid financial assets referred to in the law governing the investment funds, and which operates on the principle of risk-spreading; ­ with investment units which are, at the request of holders, repurchased or redeemed, directly or indirectly, out of those fund’s assets, and actions taken by the UCITS management company to ensure that the market value of an investment unit does not vary significantly from their net asset value of its units shall be equivalent to such repurchase or redemption;
  4. alternative investment fund (hereinafter: AIF) means an investment fund established in accordance with the law governing the alternative investment funds, which raise capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors and which does not require authorisation within the meaning of the law governing the organisation and operations of open-ended investment funds with a public offering;
  5. public sector entity means a non-profit body responsible to central government, regional government or local self-government, or to authorities that exercise the same responsibilities as regional government or local self￾government, or a non-profit undertaking that is owned by or set up and sponsored by central government or regional government or local self￾government, and that has explicit guarantee arrangements, and may include self-administered bodies governed by law that are under public supervision;
  6. third-country insurance undertaking means a third-country insurance undertaking which would require a license issued by the competent authority if its head office were located in Montenegro or at the territory of the European Union;
  7. third-country reinsurance undertaking means a third-country reinsurance undertaking which would require a license issued by competent authority if its head office were located in Montenegro or at the territory of the European Union;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 3 8) parent investment firm means an investment firm with a head office in a specific state that has an investment firm as a subsidiary undertaking, where that subsidiary undertaking is not the sole subsidiary undertaking; 9) EU parent investment firm means a parent investment firm licensed in a Member State, which is not a subsidiary undertaking of another investment firm; 10)recognised third-country investment firm means an investment firm which: ­ would be covered by a definition of investment firm if it were established in Montenegro or the European Union; ­ has authorisation in third-country; and ­ is subject to and complies with prudential rules of or administered by that third country that are at least as stringent as those laid down by the Capital Market Authority in Montenegro and the European Union; 11)dilution risk means the risk that an amount of purchased receivables is reduced through cash or non-cash receivables of the debtor to the creditor who has sold receivable to a credit institution, and of which a credit institution, as a buyer of purchased receivables was not aware; 12)probability of default (PD) means the probability of default of a debtor or, where applicable, of a credit facility over a one-year period, and, in the context of dilution risk, the probability of dilution of purchased receivables over a one￾year period; 13)loss given default (LGD) means the ratio of the loss on an exposure related to a single facility due to the default of a debtor or, where applicable, of a credit facility to the amount outstanding at default or at a given reference date after the date of default, and, in the context of dilution risk, the loss given dilution meaning the ratio of the loss on an exposure related to a purchased receivable due to dilution, to the amount outstanding of the purchased receivable; 14)conversion factor or credit conversion factor means the ratio of the undrawn amount of a commitment from a single facility that could be drawn from that single facility from a certain point in time before default and therefore outstanding at default to the undrawn amount of the commitment from that facility, the extent of the commitment being determined by the advised limit, unless the unadvised limit is higher; 15)credit risk mitigation means a technique used by a credit institution to reduce the credit risk associated with an exposure or exposures which that credit institution continues to hold; 16)funded credit protection means a technique of credit risk mitigation where the reduction of the credit risk on the exposure of a credit institution is derived from the right of that credit institution, in the event of the default of the debtor or credit facility or on the occurrence of other specified credit events relating to the debtor, to liquidate, or to obtain transfer or appropriation of, or to retain certain assets or amounts, or to reduce the amount of the exposure to, or to replace it with, the amount of the difference between the amount of the exposure and the amount of a claim on the credit institution; 17)unfunded credit protection means a technique of credit risk mitigation where the reduction of the credit risk on the exposure of a credit institution is derived from the obligation of a third party to pay an amount in the event of the default of the debtor or the credit facility or the occurrence of other specified credit events; 18)cash assimilated instrument means a certificate of deposit, a bond, including a covered bond, or any other non-subordinated instrument, which has been

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 4 issued by a lending credit institution, for which the lending credit institution has already received full payment and which shall be unconditionally reimbursed by the credit institution at its nominal value; 19)gold bullion means gold in the form of a commodity, including gold bars, ingots and coins, commonly accepted by the bullion market, where liquid markets for bullion exist, and the value of which is determined by the value of the gold content, defined by purity and mass, rather than by its interest to numismatists; 20)securitisation means a transaction or a scheme that has the meaning as established in Article 11 paragraph (3) of the Law on Credit Institutions (OGM 72/19, 8/21, 24/25), (hereinafter: the Law); 21)securitisation position means an exposure to a securitisation; 22)resecuritisation means securitisation where at least one of the underlying exposures is a securitisation position; 23)resecuritisation position means an exposure to a resecuritisation; 24)originator means a credit institution which: ­ itself or through connected persons, directly or indirectly, was involved in the original agreement which created direct or contingent liabilities of the debtor or potential debtor giving rise to the exposures being securitised; or ­ purchases a third party's exposures on its own account and then securitises them; 25)sponsor means a credit institution other than an originator that establishes and manages an asset-backed commercial paper programme or other securitisation scheme that purchases exposures from third-parties other securitisation that purchases exposures from third-party entities and which transfers active management of the portfolio included in such securitisation to an entity authorised to perform such activities; 26)original lender means an entity which, itself or through related entities, directly or indirectly, concluded the original agreement which created the obligations or potential obligations of the debtor or potential debtor giving rise to the exposures being securitised; 27)credit enhancement means a contractual arrangement whereby the credit quality of a position in a securitisation is improved in relation to what it would have been if the credit enhancement had not been provided, including the credit enhancement provided by more junior tranches in the securitisation and other types of credit protection; 28)securitisation special purpose entity (hereinafter: SSPE) means a business undertaking, trust or other entity, other than an originator or sponsor, established for the purpose of carrying out one or more securitisations, the activities of which are limited to those appropriate to accomplishing that objective, the structure of which is intended to isolate the obligations of the SSPE from those of the originator; 29)tranche means a contractually established segment of the credit risk associated with an exposure or a pool of exposures, where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment, without taking account of credit protection provided by third parties directly to the holders of positions in the segment or in other segments; 30)marking to market means the valuation of positions at readily available close out prices that are sourced independently, including exchange prices, screen prices or quotes from several reputable brokers;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 5 31)marking to model means any valuation which has to be benchmarked, extrapolated or otherwise calculated from one or more market inputs; 32)independent price verification means a process by which market prices or marking to model inputs are regularly verified for accuracy and independence; 33)recognised exchange means a regulated market or a third-country market that is considered to be equivalent to a regulated market and it has a clearing mechanism whereby contracts listed in Article 148 paragraph (8) of this Decision are subject to daily margin requirements which, in the opinion of the Central Bank of Montenegro (hereinafter: the Central Bank) provide appropriate protection; 34)property value means the value of a residential property or commercial immovable property determined in accordance with Article 256 paragraph (1) of this Decision; 35)residential property means: ­ an immovable property which has the nature of a dwelling and meets the requirements of regulations enabling the property to be occupied for housing purposes; ­ an immovable property which has the nature of a dwelling and is still under construction, provided that there is the expectation that the property will meet the requirements of regulations enabling the property to be occupied for housing purposes; ­ the right to inhabit an apartment in housing cooperatives located in Sweden; ­ land accessory to a property referred to in indent 1, 2, or 3 of this item; 36)commercial immovable property means any immovable property that is not residential property; 37)income producing real estate exposure or IPRE exposure means an exposure secured by one or more residential properties or commercial immovable properties where the fulfilment of the credit obligations related to the exposure materially depends on the cash flows generated by those immovable properties securing that exposure, rather than on the capacity of the debtor to fulfil the credit obligations from other sources; the primary source of such cash flows being lease or rental payments, or proceeds from the sale of the residential property or commercial immovable property; 38)non-income-producing real estate exposure or non-IPRE exposure means any exposure secured by one or more residential properties or commercial immovable properties that is not an IPRE exposure; 39)exposure secured by residential property or exposure secured by a mortgage on residential property means an exposure secured by residential property or an exposure regarded as such in accordance with Article 142 paragraph (4) of this Decision; 40)exposure secured by commercial immovable property or exposure secured by a mortgage on commercial immovable property means an exposure secured by a commercial immovable property; 41)exposure secured by immovable property or exposure secured by a mortgage on immovable property, or exposure secured by immovable property collateral means an exposure secured by a residential property or commercial immovable property or an exposure regarded as such in accordance with Article 142 paragraph (4) of this Decision; 42)market value for the purposes of immovable property means the estimated amount for which the property should exchange on the date of valuation

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 6 between a willing buyer and a willing seller in an arm's-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion; 43)applicable accounting framework means the accounting standards to which the credit institution is subject under the regulations governing the accounting of credit institutions; 44)one-year default rate means the ratio between the number of debtors or, where the definition of default is applied at credit facility level pursuant to Article 218 paragraph (2) of this Decision, credit facilities in respect of which a default is considered to have occurred during a period that starts from one year prior to a date of observation T, and the number of debtors, or where the definition of default is applied at credit facility level pursuant to Article 218 paragraph (2) of this Decision, credit facilities assigned to this grade or pool one year prior to that date of observation T; 45)land acquisition, development and construction exposures or ADC exposures means exposures to corporates or special purpose entities financing any land acquisition for development and construction purposes, or financing the development and construction of any residential property or commercial immovable property; 46)non-ADC exposure means any exposure secured by one or more residential properties or commercial immovable properties that is not an ADC exposure; 47)trade finance means financing, including also issuing guarantees, connected to the exchange of goods and services through financial products of fixed short￾term maturity, generally of less than one year, without automatic rollover, whereby such finance is generally uncommitted and requires satisfactory supporting transactional documentation for each drawdown request enabling refusal of the finance in the event of any doubt about creditworthiness or the supporting transactional documentation; repayment of trade finance exposures is usually independent of the borrower, the funds instead are coming from cash received from importers or resulting from proceeds of the sales of the underlying goods; 48)officially supported export credits means loans or non-banking loans to finance the export of goods or services for which an official export credit agency provides guarantees, insurance or direct financing; 49)repurchase agreement and reverse repurchase agreement mean any agreement in which a credit institution or its counterparty transfers securities or commodities or guaranteed rights relating to the title to securities or commodities where that guarantee is issued by a recognised exchange which holds the rights to the securities or commodities and the agreement does not allow a credit institution to transfer or pledge a particular security or commodity to more than one counterparty at one time, subject to a commitment to repurchase them, or substituted securities or commodities of the same description at a specified price on a future date specified, or to be specified, by the transferor, being a repurchase agreement for the credit institution selling the securities or commodities and a reverse repurchase agreement for the credit institution buying them; 50)repurchase transaction means any transaction governed by a repurchase agreement or a reverse repurchase agreement; 51)simple repurchase agreement means a repurchase transaction of a single asset, or of similar, non-complex assets, as opposed to a basket of assets;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 7 52)positions held with trading intent means any of the following: ­ proprietary positions and positions arising from client servicing and market making; ­ positions intended to be resold short term; ­ positions intended to benefit from actual or expected short-term price differences between buying and selling prices or from other price or interest rate variations; 53)multilateral trading facility (MTF) means a multilateral system, organised or operated by an investment firm or a market operator, which brings together multiple third-party buying and selling interests in financial instruments in accordance with the rules of that system; 54)qualifying central counterparty (QCCP) means a central counterparty that has been either authorised by the competent authority in Montenegro or European Union or established in third country and recognised by ESMA; 55)default fund means a fund established by a central counterparty and collects margins from its clearing members to cover losses of the clearing members that exceed the losses to be covered by margin lending requirements arising from the default, including the opening of a bankruptcy proceedings, of one or more clearing members; the central counterparty shall use contributions to the default fund of the non-defaulting clearing members and any other financial resources only after having exhausted the contributions of the defaulting clearing member; 56)pre-funded contribution to the default fund means a contribution to the default fund of a central counterparty that is paid in by a credit institution; 57)trade exposure means a current exposure, including a variation margin due to the clearing member but not yet received, and any potential future exposure of a clearing member or a client, to a central counterparty arising from contracts and transactions listed in Article 388 paragraph (1) of this Decision, as well as initial margin; 58)credit risk adjustment means the amount of specific and general loan loss impairments that have been recognised in the financial statements of the credit institution in accordance with the applicable accounting framework; 59)internal hedge means a position that materially offsets the component risk elements between a trading book position and one or more non-trading book positions or between two trading desks; 60)reference obligation means an obligation used for the purposes of determining the cash settlement value of a credit derivative; 61)nominated external credit assessment institution (ECAI) means an ECAI nominated for credit risk assessment by a credit institution; 62)accumulated other comprehensive income has the same meaning as under IAS 1 applied by a credit institution in accordance with the Law; 63)basic own funds mean the excess of assets over liabilities (reduced by the amount of own shares held by the insurance or reinsurance undertaking), increased by subordinate liabilities of insurance or reinsurance undertaking; 64)Tier 1 own-fund insurance items mean basic own-fund items of undertakings that are available or can be called up on demand to fully absorb losses on a going concern basis, or in the case of winding-up the total amount of the item is available to absorb losses and the repayment of the item is refused to its holder until all other obligations including insurance and reinsurance obligations towards policy holders and beneficiaries of insurance and reinsurance

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 8 contracts have been met (subordination), the items are not dated, and if they are dated, the relative duration of the items as compared to the duration of the insurance and reinsurance obligations of the undertaking shall be considered, the item is clear of encumbrances, it is free from mandatory fixed charges, it is free from requirements to redeem; 65)Additional Tier 1 own-fund insurance items mean basic own-fund items subject to the requirements to be classified into Tier 1 own-funs insurance items and their exclusion is laid down in the regulation governing this area; 66)Tier 2 own-fund insurance items means basic own-fund items which in case of winding-up the total amount of the item is available to absorb losses and the repayment of the item is refused to its holder until all other obligations including insurance and reinsurance obligations towards policy holders and beneficiaries of insurance and reinsurance contracts have been met (subordination), the items are not dated, and if they are dated, the relative duration of the items as compared to the duration of the insurance and reinsurance obligations of the undertaking shall be considered, the item is clear of encumbrances, it is free from mandatory fixed charges, it is free from requirements to redeem; 67)Tier 3 own-fund insurance items mean any basic or ancillary own-fund items which are not classified as Tier 1 and Tier 2 own-fund insurance items; 68)deferred tax assets have the same meaning as under the applicable accounting framework; 69)deferred tax assets that rely on future profitability means deferred tax assets the future value of which may be realised only in the event the credit institution generates taxable profit in the future; 70)deferred tax liabilities have the same meaning as under the applicable accounting framework; 71)defined benefit pension fund assets mean the assets of a defined pension fund or plan, as applicable, calculated after they have been reduced by the amount of obligations under the same fund or plan; 72)financial undertaking means insurance undertaking, reinsurance undertaking, insurance holding company and mixed financial holding company; 73)insurance holding company means a parent undertaking which is not a mixed financial holding company and the main business of which is to acquire and hold participations in subsidiary undertakings, where those subsidiary undertakings are exclusively or mainly insurance or reinsurance undertakings, or non-EU third-country insurance or reinsurance undertakings, at least one of such subsidiary undertakings being an insurance or reinsurance undertaking; 74)reserves for general banking risks mean the amount which a credit institution decides to put aside to cover such risks where that is required by the particular risks associated with banking; 75)goodwill has the same meaning as under the applicable accounting framework; 76)indirect holding means any exposure to an intermediate entity that has an exposure to capital instruments issued by a financial sector entity or to liabilities issued by a credit institution where, in the event the capital instruments issued by the financial sector entity or the liabilities issued by the credit institution were permanently written off, the loss that the credit institution would incur as a result would not be materially different from the loss the credit institution would incur from a direct holding of those capital instruments issued by the financial sector entity or of those liabilities issued by the credit institution;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 9 77)intangible assets have the same meaning as under the applicable accounting framework and includes goodwill; 78)other capital instruments mean capital instruments issued by financial sector entities that do not qualify as Common Equity Tier 1, Additional Tier 1 or Tier 2 instruments or Tier 1 own-fund insurance items, additional Tier 1 own-fund insurance items, Tier 2 own-fund insurance items or Tier 3 own-fund insurance items; 79)other reserves mean reserves within the meaning of the applicable accounting framework that are required to be disclosed under the applicable accounting standard, excluding any amounts already included in accumulated other comprehensive income or retained earnings; 80)minority interest means the amount of Common Equity Tier 1 capital of a subsidiary undertaking of a credit institution that is attributable to natural or legal persons other than those included in the prudential scope of consolidation of the credit institution; 81)profit has the same meaning as under the applicable accounting framework; 82)reciprocal cross holding means a holding by a credit institution of the own funds instruments or other capital instruments issued by financial sector entities where those entities also hold own funds instruments issued by the credit institution; 83)retained earnings means profits and losses brought forward as a result of the final application of profit or loss under the applicable accounting framework; 84)share premium account has the same meaning as under the applicable accounting framework; 85)temporary differences have the same meaning as under the applicable accounting framework; 86)synthetic holding means an investment by a credit institution in a financial instrument the value of which is directly linked to the value of the capital instruments issued by a financial sector entity; 87)distributable items means the amount of the profits at the end of the last financial year plus any profits brought forward and reserves available for that purpose, before distributions to holders of own funds instruments, less any losses brought forward, any profits which are non-distributable pursuant to applicable regulations or the credit institution's internal acts and any sums placed in non-distributable reserves in accordance with applicable regulations or the articles of association of the credit institution, in each case with respect to the specific category of own funds instruments to which applicable regulations, credit institutions' internal act, or articles of association relate; such profits, losses and reserves being determined on the basis of the individual accounts of the credit institution and not on the basis of the consolidated accounts; 88)servicer means an entity that manages a pool of purchased receivables or the underlying credit exposures on a day-to-day basis; 89)relevant third-country authority means a government or another authority which is, in accordance with the third-country regulations, officially recognised and authorised for exercising the supervision of credit institutions within the supervisory framework enforced in that country; 90)resolution entity has the same meaning as defined in the law governing the resolution of credit institutions;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 10 91)resolution group means a credit institution that is subject to resolution and its subsidiary undertakings other than: ­ credit institutions themselves that are subject to resolution; ­ subsidiary undertakings of other credit institutions that are subject to resolution; ­ credit institutions which have their head offices in third country that are not included in the resolution group in accordance with resolution plan and their subsidiary undertakings; or ­ credit institutions permanently affiliated to a central body and the central body itself when at least one of those credit institutions or the central body is a resolution entity, and their respective subsidiary undertakings; 92)global systemically important credit institution (G-SICI) means a credit institution that has been identified in accordance with Articles 158 and 159 of the Law; 93)material subsidiary undertaking means a subsidiary that on an individual or consolidated basis meets any of the following conditions: ­ the subsidiary undertaking holds more than 5% of the consolidated risk￾weighted assets of its original parent undertaking; ­ the subsidiary undertaking generates more than 5% of the total operating income of its original parent undertaking; ­ the total exposure measure, referred to in Article 563 paragraphs (4) to (7) of this Decision, of the subsidiary undertaking is more than 5% of the consolidated total exposure measure of its original parent undertaking; 94)G-SII entity means an entity with legal personality that is a G-SICI or is a part of a G-SICI; 95)bail-in tool has a meaning as defined in the law governing the resolution of credit institutions; 96)group means a group of undertakings of which at least one is a credit institution and which consists of a parent undertaking and its subsidiary undertakings; 97)securities financing transaction (SFT) means a repurchase transaction, a securities or commodities lending or borrowing transaction, or a margin lending transaction; 98)initial margin means any collateral, other than variation margin, collected from or posted to an entity to cover the current and potential future exposure of a transaction or of a portfolio of transactions in the period needed to liquidate those transactions, or to re-hedge their market risk, following the default of the counterparty to the transaction or portfolio of transactions; 99)trading desk means a well-identified group of dealers set up by the credit institution in accordance with Article 124 paragraph (1) of this Decision to jointly manage a portfolio of trading book positions or the non-trading book positions referred to in paragraphs (7) and (8) of this Article in accordance with a well￾defined and consistent business strategy and operating under the same risk management structure; 100) non-listed credit institution means a credit institution that has not issued securities that are admitted to trading on a regulated market; 101) commodity and emission allowance dealer means an undertaking the main business of which consists exclusively of the provision of investment services or activities in relation to: ­ commodity derivatives or commodity derivative contracts which may be settled in cash or physically, provided that they are traded on a regulated

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 11 market, a multilateral trading facility or an organised trading facility, unless otherwise determined or unless they are sold for commercial purposes; ­ financial contracts for differences; ­ derivatives and any other derivative contracts relating to climatic variables, freight rates, emission allowances, inflation rates or other official economic statistics that must be settled in cash at the option of one of the parties other than by reason of default or other termination event, as well as any other derivative contracts relating to assets, rights, obligations, indices and measures, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market, a multilateral trading facility or an organised trading facility; ­ rules on emission allowances, 102) revolving exposure means any exposure whereby the borrower’s outstanding balance is permitted to fluctuate based on its decisions to borrow and repay, up to an agreed limit; 103) transactor exposure means any revolving exposure that has at least 12 months of repayment history and that is one of the following: ­ an exposure for which, on a regular basis of at least every 12 months, the balance to be repaid at the next scheduled repayment date is determined as the drawn amount at a predefined reference date, with a scheduled repayment date not later than after 12 months, provided that the balance has been repaid in full at each scheduled repayment date for the previous 12 months; ­ an overdraft facility where there have been no drawdowns over the previous 12 months; 104) fossil fuel sector entity means a company, enterprise or undertaking statistically classified as having its principal economic activity in the coal, oil or gas sector of economic activities; 105) exposures subject to the impact of environmental or social factors means exposures hindering the ambition of Montenegro, European Union or third country to achieve its regulatory objectives relating to ESG factors, in a way that could have a negative financial impact on institutions in Montenegro, European Union or third country; 106) interim profits means profits as laid down in the applicable accounting framework, computed for a reference period shorter than a full financial year, and before the credit institution has taken a formal decision confirming such a profit or loss of the credit institution; 107) year-end profits means profits as defined in the applicable accounting framework, computed for a reference period equal to a full financial year, and before the credit institution has taken a formal decision confirming such a profit or loss of the credit institution. 108) pay-out ratio at consolidated level means the ratio between the amount of dividends referred to in indent 1 and the amount of profit referred to in indent 2 of this item, whereat if for a given year the ratio is negative or above 100%, the pay-out ratio shall be deemed to be 100%, and if for a given year the amount referred to in indent 2 of this item is zero, the pay-out ratio shall be deemed to be 0 % if the amount referred to in indent 1 of this item is zero, and 100 % if the amount referred to in indent 1 of this item is above zero:

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 12 ­ dividends, other than those paid in a form that does not reduce CET1 capital (e.g. scrip-dividends), distributed to owners of the consolidating entity; and ­ profit after tax attributable to owners of the consolidating entity; 109) pay-out ratio at solo level means the ratio between the amount of dividends referred to in indent 1 and the amount of profit referred to in indent 2 of this item, whereat if for a given year the ratio is negative or above 100%, the pay￾out ratio shall be deemed to be 100%, and if for a given year the amount referred to in indent 2 of this item is zero, the pay-out ratio shall be deemed to be 0 % if the amount referred to in indent 1 of this item is zero, and 100 % if the amount referred to in indent 1 of this item is above zero: ­ dividends, other than those paid in a form that does not reduce CET1 capital (e.g. scrip-dividends), distributed to owners of the entity; and ­ profit after tax; 110) delivery option means the possibility to redeem the mortgage loan by buying back the covered bond at market or at nominal value; 111) retail exposure means the exposure which, for a credit institution that applies the standardised approach referred to in Part Three Title II Subtitle 3 of this Decision when calculating capital requirements for credit risk, meets the requirements referred to in Article 161 paragraph (1) of this Decision, or for a credit institution that applies the internal ratings based approach referred to in Part Two Title II Subtitle 3 of this Decision when calculating capital requirements for credit risk, meets the requirements referred to in Article 189 paragraph (6) of this Decision; 112) non-trading book means all positions of a credit institution other than those included in the trading book; 113) equivalent third country means a third country that applies prudential regulation equivalent to the regulation applied in Montenegro or the European Union if it is listed as the third country with equivalent regulations which are published by the Central Bank or the European Commission; 114) covered bonds mean bonds that meet the eligibility requirements for covered bonds and which are issued by the credit institution which has their head office in Montenegro or EU Member State and is subject to special public supervision designed to protect bond-holder; 115) intermediate entity means any of the following entities that hold capital instruments of financial sector entities: ­ a collective investment undertaking (CIU); ­ a pension fund other than a defined benefit pension fund; ­ a defined benefit pension fund, where the credit institution is supporting the investment risk and where the defined benefit pension fund is not independent from its sponsoring institution; ­ entities that are directly or indirectly under the control or under significant influence of one of the following: a) the credit institution or its subsidiary undertakings; b) the parent undertaking of the credit institution or the subsidiary undertaking of that parent undertaking; c) the parent financial holding company of the credit institution or the subsidiary undertaking of that parent financial holding company; d) the parent mixed activity holding company of the credit institution or the subsidiary undertaking of the parent mixed activity holding company; or

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 13 e) the parent mixed financial holding company of the credit institution or the subsidiary undertaking of the parent mixed financial holding company; ­ entities that are jointly, directly or indirectly, under the control or under significant influence of one credit institution, several credit institutions, or a network of credit institutions, which are members of the same institutional protection scheme, or of the institutional protection scheme or the network of credit institutions affiliated to a central body that are not organised as a group to which the credit institution belongs; ­ special purpose entities; ­ entities whose activity is to hold financial instruments of financial sector entities; ­ any entity that the Central Bank considers to be used with the intention of circumventing the rules relating to the deduction of indirect and synthetic holdings, other than the following entities that are not considered intermediate entity: a) mixed activity holding company, credit institution, insurance undertaking and reinsurance undertaking; b) entities subject to the provisions of the Law and the provisions of this Decision; c) financial sector entities not listed under a) of this indent, which are supervised by a relevant authority in the manner that requirements for own funds deductions are applied by the amount of direct and indirect holdings in own instruments of capital and holdings of capital instruments of financial sector entities; (2) Terms used in Part Two Subtitle 3 of this Decision shall have the following meaning:

  1. exposure means an asset or off-balance sheet item;
  2. loss means economic loss, including material discount effects, and material direct and indirect costs associated with collecting on the instrument;
  3. expected loss (EL) means the ratio, related to a single facility, of the amount expected to be lost on an exposure from any of the following: ­ a potential default of a debtor over a one-year period to the amount outstanding at default; ­ a potential dilution event of purchased receivable over a one-year period to the amount outstanding at the date of occurrence of the dilution event;
  4. credit obligation means any obligation arising from a credit contract, including principal, accrued interest and fees, owed by a debtor;
  5. credit exposure means any on- or off -balance-sheet item, that results, or may result, in a credit obligation;
  6. facility or credit facility means a credit exposure arising from a contract or a set of contracts between a debtor and a credit institution;
  7. margin of conservatism means an add-on incorporated in risk parameter estimates to account for the expected range of estimation errors stemming from identified deficiencies in data, methods, models, and changes to underwriting standards, risk appetite, collection and recovery policies and any other source of additional uncertainty, as well as from general estimation error;
  8. appropriate adjustment means the impact on risk parameter estimates resulting from the application of methodologies within the estimation of risk parameters to correct the identified deficiencies in data and in estimation methods, and to account for changes to underwriting standards, risk appetite,

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 14 collection and recovery policies and any other source of additional uncertainty, to the extent possible in order to avoid biases in risk parameter estimates; 9) micro, small and medium-sized enterprise (SME) has the same meaning as under the law governing the accounting; 10)commitment means any contractual arrangement that a credit institution offers to a client, and is accepted by that client, to extend credit, purchase assets or issue credit substitutes; and any such arrangement that can be unconditionally cancelled by a credit institution at any time without prior notice to a debtor or any arrangement that can be cancelled by a credit institution where a debtor fails to meet the conditions set out in the facility documentation, including conditions that are required to be met by the debtor prior to any initial or subsequent drawdown under the arrangement, unless contractual arrangements meet all of the following conditions: ­ contractual arrangements where the credit institution receives no fees or commissions to establish or maintain those contractual arrangements; ­ contractual arrangements where the client is required to apply to the credit institution for the initial and each subsequent drawdown under those contractual arrangements; ­ contractual arrangements where the credit institution has full authority, regardless of the fulfilment by the client of the conditions set out in the contractual arrangement documentation, over the execution of each drawdown; ­ the contractual arrangements allow the credit institution to assess the creditworthiness of the client immediately prior to deciding on the execution of each drawdown and the credit institution has implemented and applies internal procedures that ensure that such an assessment is being made before the execution of each drawdown; ­ contractual arrangements that are offered to a business undertaking, including an SME, that is closely monitored on an ongoing basis; 11)unconditionally cancellable commitment means any commitment the terms of which permit the credit institution to cancel that commitment to the full extent allowable under consumer protection and related legal acts, where applicable, at any time without prior notice to the debtor or that effectively provide for automatic cancellation due to a deterioration in a borrower’s creditworthiness.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 15 PART TWO OWN FUNDS AND ELIGIBLE LIABILITIES TITLE I - OWN FUNDS ITEMS SUBTITLE 1 – Tier 1 Capital Tier 1 Capital Article 4 Tier 1 capital of a credit institution shall be the sum of Common Equity Tier 1 capital (CET1) and Additional Tier 1 capital (AT1) of a credit institution. SUBTITLE 2 – Common Equity Tier 1 capital Section 1 - Common Equity Tier 1 items and instruments Common Equity Tier 1 items Article 5 (1) Common Equity Tier 1 capital of a credit institution shall consist of the following items:

  1. capital instruments, where the conditions referred to in Article 8 of this Decision are met;
  2. share premium accounts related to instruments referred to in item 1) of this paragraph;
  3. retained earnings;
  4. accumulated other comprehensive income;
  5. other reserves;
  6. reserves for general banking risks; (2) The items referred to in paragraph (1) items 3) to 6) of this Article shall be recognised as Common Equity Tier 1 capital only where they are available to the credit institution for unrestricted and immediate use to cover risks or losses as soon as these occur. (3) For the purpose of paragraph (1) item 3) of this Article, a credit institution may, only with the prior authorisation of the Central Bank, include interim or year-end profits in the Common Equity Tier 1 capital before taking a formal decision confirming the final profit or loss of the credit institution. (4) The Central Bank shall grant authorisation referred to in paragraph (3) of this Article where the following conditions are met:
  7. those profits have been verified by persons independent of the credit institution that are responsible for the auditing of financial accounts of that credit institution;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 16 2) credit institution has demonstrated to the satisfaction of the Central Bank that any foreseeable charge or dividend has been deducted from the amount of those profits. (5) The conditions set out in paragraph (4) of this Article shall be met before the submission date of the prescribed reports on own funds to be submitted to the Central Bank in accordance with the regulation governing the reporting of credit institutions. (6) A verification of the interim or year-end profits of the credit institution shall provide an adequate level of assurance that those profits have been evaluated in accordance with the principles set out in the applicable accounting framework. (7) The verification referred to in paragraph (6) of this Article shall include:

  1. for year-end profits, audit report or a comfort letter stating that the audit has not been completed and nothing has come to the attention of the auditors that causes them to believe that the final report will include a qualified opinion;
  2. for interim profits, an audit report or a review report as defined by the International Standard on Review Engagements 2410. (8) The fulfilment of the conditions referred to in paragraph (4) item 2) of this Article shall be demonstrated by:
  3. a declaration of the credit institution that those profits have been recorded in accordance with the applicable accounting framework and that the scope of prudential consolidation is not materially wider than the scope of verification referred to in the external auditor's document referred to in paragraph (7) of this Article;
  4. the report on the main components of those interim or year-end profits, including deductions for any foreseeable charges or dividends, which is signed by a responsible person who has been duly authorised by the management body to sign on its behalf on the format prescribed by the Central Bank in the regulation governing the documentation supporting the application for granting authorisations. (9) The foreseeable dividends shall be the amount formally proposed or decided by the management body of the credit institution, whereat if such formal proposal or decision has not yet been taken, the dividend to be deducted shall be the highest of the following:
  5. the maximum dividend calculated in accordance with credit institution’s internal dividend policy;
  6. the dividend calculated on the basis of the average pay-out ratio over the last three years;
  7. the dividend calculated on the basis of the previous year's pay-out ratio. (10) The amount of dividends established otherwise that deviates from the method referred to in paragraph (9) of this Article shall not be recognised. (11) A credit institution may classify capital instrument as Common Equity Tier 1 instruments only with the prior authorisation of the Central Bank.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 17 (12) The Central Bank shall grant authorisation referred to in paragraph (11) of this Article if it evaluates that the issuance of Common Equity Tier 1 capital instruments meets the criteria set out in Article 8 of this Decision. (13) By way of derogation from paragraph (11) of this Article, a credit institution may classify Common Equity Tier 1 instruments that have been subsequently issued as Common Equity Tier 1 instruments for which they have already received that authorisation from the Central Bank, where the following conditions are met:

  1. the provisions governing those subsequent issuances of capital instruments are substantially the same as the provisions governing those issuances of capital instruments for which the credit institutions have already received authorisation; and
  2. credit institution has notified the Central Bank of those subsequent issuances of capital instruments sufficiently in advance of their classification as Common Equity Tier 1 instruments. (14) Other reserves referred to in paragraph (1) item 5) of this Article shall be the reserves for acquired treasury shares, other reserves established in the previous period and provisions for estimated losses under regulatory requirement. Foreseeable dividends Article 6 (1) The amount of foreseeable dividends referred to in Article 5 paragraph (4) item 2) of this Decision to be deducted by ia credit institution from the interim or year-end profits shall be determined in accordance with paragraphs (2) to (4) of this Article. (2) Where a credit institution’s management body has formally taken a decision or proposed a decision to the credit institution’s relevant management body regarding the amount of dividends to be distributed, this amount shall be deducted from the corresponding interim or year-end profits. (3) Where interim dividends are paid, the residual amount of interim profit resulting from the calculation laid down in paragraph (2) of this Article which is to be added to Common Equity Tier 1 items shall be reduced, taking into account the rules laid down in paragraphs (2) and (4) of this Article, by the amount of any foreseeable dividend which can be expected to be paid out from that residual interim profit with the final dividends for the full business year. (4) Before the credit institution's management body has formally taken or proposed a decision to the relevant management body on the distribution of dividends, the amount of foreseeable dividends to be deducted by the credit institution from the interim or year-end profits shall equal the amount of interim or year-end profits multiplied by the dividend payout ratio. (5) The dividend pay-out ratio shall be determined on the basis of the dividend policy approved for the relevant period by the competent body of the credit institution. (6) Where the dividend policy contains a pay-out range instead of a fixed value, the upper end of the range is to be used for the purpose of paragraph (2) of this Article

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 18 (7) In the absence of an approved dividend policy, or when, in the opinion of the Central Bank, it is likely that the credit institution will not apply its dividend policy or this policy is not a prudent basis upon which to determine the amount of deduction, the dividend pay-out ratio shall be based on the highest of the following:

  1. the average dividend pay-out ratio over the three years prior to the year under consideration;
  2. the dividend pay-out ratio of the year preceding the year under consideration. (8) The Central Bank may permit the credit institution to adjust the calculation of the dividend pay-out ratio as described in paragraph (7) of this Article to exclude exceptional dividends paid during the period. (9) A credit institution shall determine the amount of foreseeable dividends to be deducted taking into account any regulatory restrictions on distributions referred to in Articles 166 to 169 of the Law, whereby, in the case of the application of those restrictions, the foreseeable dividends to be deducted shall be based on the capital conservation plan agreed by the Central Bank pursuant to Article 170 of the Law, by including the amount of profit after deduction of foreseeable charges subject to such restrictions fully in Common Equity Tier 1 items where the condition referred to in Article 5 paragraph (4) item 1) of this Decision is met. (10) The amount of foreseeable dividends to be paid in a form that does not reduce the amount of Common Equity Tier 1 items, such as dividends in the form of shares, known as scrip-dividends, shall not be deducted from interim or year-end profits to be included in Common Equity Tier 1 items. (11) The Central Bank has received reasonable assurances from the credit institution that all necessary deductions to the interim or year-end profits and all those related to foreseeable dividends have been made, either under applicable accounting framework or under any other adjustments laid down in regulations of the Central Bank, before permitting the credit institution to include interim or year-end profits in Common Equity Tier 1 items. Foreseeable charges Article 7 (1) The amount of foreseeable charges, within the meaning of Article 5 paragraph (4) item 2) of this Decision, shall comprise the following:
  3. the amount of taxes; and
  4. the amount of any obligations or circumstances arising during the related reporting period which are likely to reduce the profits of the credit institution and for which the Central Bank deems that all necessary value adjustments, such as additional value adjustments according to Article 16 of this Decision, or provisions have not been made. (2) Foreseeable charges that have not already been taken into account in the profit and loss account shall be assigned to the interim period during which they have incurred so that each interim period bears a reasonable amount of these charges. Material or non-recurrent events shall be considered in full and without delay in the interim period during which they arise.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 19 (3) The Central Bank deems that all necessary deductions to the interim or year-end profits and all those related to foreseeable charges have been made, either under applicable accounting framework or under any other adjustments, before permitting credit institution to include interim or year-end profits in Common Equity Tier 1 items. Common Equity Tier 1 instruments Article 8 (1) Capital instrument shall qualify as Common Equity Tier 1 instrument only if the following conditions are met:

  1. the instrument is issued directly by the credit institution with the prior approval of the shareholders' assembly or, where permitted under applicable regulations, pursuant to the decision of the management body of the credit institution;
  2. the instrument is fully paid up and the acquisition of ownership of that instrument is not funded directly or indirectly by the credit institution;
  3. the instrument meets the conditions for capital and it is classified as share capital in accordance with the accounting framework and pursuant to the law governing bankruptcy and winding-up of banks;
  4. the instrument is clearly and separately disclosed on the balance sheet of the credit institution;
  5. the instrument is perpetual;
  6. the principal amount of the instrument may not be reduced or repaid, except in the following cases: ­ the winding-up of the credit institution; or ­ discretionary repurchases of the instrument or other discretionary means of reducing capital, where the credit institution has received the prior authorisation of the Central Bank in accordance with Article 87 of this Decision;
  7. the provisions governing the instrument do not indicate expressly or implicitly that the principal amount of the instrument would be reduced or repaid other than in the winding-up of the credit institution, and the credit institution does not otherwise provide such an indication prior to or at issuance of the instrument;
  8. the instrument meets the following conditions as regards distributions: ­ there is no preferential distribution treatment regarding the order of distribution payments, including in relation to other Common Equity Tier 1 instruments, and the provisions governing the instrument do not provide preferential rights to payment of distributions; ­ distributions to holder of the instrument may be paid only out of distributable items; ­ the conditions governing the instruments do not include a cap or other restriction on the maximum level of distributions; ­ the level of distributions is not determined on the basis of the amount for which the instruments were purchased at issuance; ­ the conditions governing the instruments do not include any obligation for the credit institution to make distributions to their holders and the credit institution is not otherwise subject to such an obligation; ­ non-payment of distributions does not constitute an event of default of the credit institution;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 20 ­ the cancellation of distributions imposes no restrictions on the credit institution; 9) compared to all the capital instruments issued by the credit institution, the instruments absorb the first and proportionately greatest share of losses as they occur, and each instrument absorbs losses to the same degree as all other Common Equity Tier 1 instruments; 10)the instrument ranks below all other claims in the event of bankruptcy or winding-up of the credit institution; 11)the instrument entitles their owners to a claim on the residual assets of the credit institution, which, in the event of its winding-up and after the payment of all senior claims, is proportionate to the amount of such instruments issued and is not fixed or subject to a cap; 12)the instrument is neither secured nor subject to a guarantee that enhances the seniority of the claim by any of the following entities: ­ the credit institution or its subsidiary undertakings; ­ the parent undertaking of the credit institution or its subsidiary undertakings; ­ the parent financial holding company or its subsidiary undertakings; ­ the mixed activity holding company or its subsidiary undertakings; ­ the mixed financial holding company and its subsidiary undertakings; ­ any undertaking that has close links with the entities referred to in indents 1 to 5 of this item; 13)the instrument that is not subject to any arrangement, contractual or otherwise, that enhances the seniority of claims under the instruments in bankruptcy or winding-up of the credit institution. (2) For the purposes of paragraph (1) item 2) of this Article, only the part of a capital instrument that is fully paid up shall be eligible to qualify as a Common Equity Tier 1 instrument. (3) The conditions laid down in paragraph (1) item 9) of this Article shall be deemed to be met notwithstanding a write down on a permanent basis of the principal amount of Additional Tier 1 or Tier 2 instruments. (4) The condition laid down in paragraph (1) item 6) of this Article shall be deemed to be met notwithstanding the reduction of the principal amount of the capital instrument within a resolution proceedings or as a consequence of a write down of capital instruments required by the Central Bank as resolution authority. (5) The condition laid down in paragraph (1) item 7) of this Article shall be deemed to be met notwithstanding the provisions governing the capital instrument indicating expressly or implicitly that the principal amount of the instrument would or might be reduced within a resolution proceedings or as a consequence of a write down of capital instruments required by the Central Bank as the resolution authority. (6) The condition laid down in paragraph (1) item 8) indent 3 of this Article shall be deemed to be met notwithstanding the instrument paying a dividend multiple, provided that such a dividend multiple does not result in a distribution that causes a disproportionate drag on own funds.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 21 (7) The condition set out in paragraph (1) item 8) indent 5 of this Article shall be considered to be met notwithstanding a subsidiary undertaking being subject to a profit and loss transfer agreement with its parent undertaking, according to which the subsidiary undertaking is obliged to transfer, following the preparation of its annual financial statements, its annual result to the parent undertaking, where the following conditions are met:

  1. the parent undertaking owns 90% or more of the voting rights and capital of the subsidiary undertaking;
  2. the parent undertaking and the subsidiary undertaking are located in the same state;
  3. the agreement was concluded for legitimate taxation purposes;
  4. in preparing the annual financial statements, the subsidiary undertaking has discretion to decrease the amount of distributions by allocating a part or all of its profits to its own reserves or reserves for general banking risk before making any payment to its parent undertaking;
  5. the parent undertaking is obliged under the agreement to fully compensate the subsidiary undertaking for all losses of the subsidiary undertaking;
  6. the agreement is subject to a notice period according to which the agreement can be terminated only by the end of an accounting year, with such termination taking effect no earlier than the beginning of the following accounting year, leaving the parent undertaking's obligation to fully compensate the subsidiary undertaking for all losses incurred during the current accounting year unchanged. (8) Where a credit institution has entered into a profit and loss transfer agreement, it shall notify the Central Bank without delay and provide the Central Bank with a copy of the agreement. (9) The credit institution shall also notify the Central Bank without delay of any changes to the profit and loss transfer agreement and the termination thereof. (10) A credit institution may not enter into more than one profit and loss transfer agreement. (11) For the purposes of paragraph (1) item 8) indent 1 of this Article, the differentiated distribution shall only reflect differentiated voting rights and in this respect, higher distributions shall only apply to Common Equity Tier 1 instruments with fewer or no voting rights. Multiple distributions constituting a disproportionate drag on own funds Article 9 (1) Distributions on Common Equity Tier 1 instruments referred to in Article 8 of this Decision shall be deemed not to constitute a disproportionate drag on capital where the following conditions are met:
  7. the dividend multiple is a multiple of the distribution paid on the voting instruments and not a predetermined fixed amount;
  8. the dividend multiple is set contractually or under the articles of association of the credit institution;
  9. the dividend multiple is not revisable;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 22 4) the same dividend multiple applies to all instruments with a dividend multiple; 5) the amount of the distribution on one instrument with a dividend multiple does not represent more than 125% of the amount of the distribution on one voting Common Equity Tier 1 instrument, which is expressed using the following formula: 𝑙𝑙 ≤ 1,25 × 𝑘𝑘 where: 𝑘𝑘 – shall represent the amount of the distribution on one instrument without a dividend multiple; 𝑙𝑙 – shall represent the amount of the distribution on one instrument with a dividend multiple; 6) total amount of the distributions paid on all Common Equity Tier 1 instruments during a one-year period does not exceed 105% of the amount that would have been paid if instruments with fewer or no voting rights received the same distributions as voting instruments, which shall be expressed using the following formula that shall be applied on a one-year basis: 𝑘𝑘𝑘𝑘 + 𝑙𝑙𝑙𝑙 ≤ (1,05) × 𝑘𝑘 × ( + ) where: 𝑘𝑘 – shall represent the amount of the distribution on one instrument without a dividend multiple; 𝑙𝑙 – shall represent the amount of the distribution on one instrument with a dividend multiple; – shall represent the number of voting instruments; – shall represent the number of non-voting instruments; (2) Where the condition referred to in paragraph (1) item 6) of this Article is not met, only the amount of the instruments with a dividend multiple that exceeds the threshold defined therein shall be deemed to cause a disproportionate drag on capital. (3) Where any of the conditions referred to in paragraph (1) items 1) to 5) of this Article are not met, all outstanding instruments with a dividend multiple shall be deemed to cause a disproportionate drag on capital. Preferential distributions regarding preferential rights to payments of distributions Article 10 (1) For the purposes of Article 8 of this Decision, a distribution on a Common Equity Tier 1 instrument shall be deemed to be preferential relative to other Common Equity Tier 1 instruments and regarding the order of distribution payments where at least one of the following conditions is met:

  1. distributions are decided at different times;
  2. distributions are paid at different times;
  3. the issuer shall pay the distributions on one type of Common Equity Tier 1 instruments before paying the distributions on another type of Common Equity Tier 1 instruments;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 23 4) a distribution is paid on some Common Equity Tier 1 instruments but not on others. (2) A distribution on a Common Equity Tier 1 instrument shall also be deemed to be preferential relative to other Common Equity Tier 1 instruments where there are differentiated levels of distribution, unless the conditions referred to in Article 9 paragraphs (1) to (3) of this Article are met. Indirect funding Article 11 (1) Indirect funding of capital instruments for the purposes of Article 8 paragraph (1) item 2), Article 42 paragraph (1) item 3) and Article 55 item 3) of this Decision or indirect funding of liabilities for the purpose of Article 65 paragraph (2) item 3) of this Decision shall be deemed funding that is not direct. (2) Direct funding shall refer to situations where a credit institution has granted a loan or other funding in any form to an investor that is used for the acquisition of ownership of the credit institution’s capital instruments or liabilities. (3) Direct funding shall also include funding granted for other purposes than acquiring ownership of the capital instruments or liabilities of a credit institution, to any natural or legal person who has a qualifying holding in the credit institution, or who is deemed to be a connected person, if the credit institution is not able to demonstrate that the transaction is realised at similar conditions as other transactions with third parties and the natural or legal person or the connected person does not have to rely on the distributions or on the sale of the capital instruments or liabilities held to support the payment of interest and the repayment of the funding. Applicable forms and nature of indirect funding of capital instruments and liabilities Article 12 (1) The applicable forms and nature of indirect funding of the acquisition of ownership of the capital instruments and liabilities of a credit institution shall include the following:

  1. funding of an investor’s acquisition of ownership, at issuance or thereafter, of the capital instruments or liabilities of a credit institution by any entities on which the credit institution has a direct or indirect control or by entities included in the scope of: ­ accounting or prudential consolidation of the credit institution; or ­ the consolidated balance sheet; or ­ the supplementary supervision of the credit institution;
  2. funding of an investor’s acquisition of ownership, at issuance or thereafter, of the capital instruments or liabilities of a credit institution by external entities that are protected by a guarantee or by the use of a credit derivative or are secured in some other way so that the credit risk is transferred to the credit institution, or to any entities on which the credit institution has a direct or indirect control or any entities included in the scope of: ­ accounting or prudential consolidation of the credit institution; or ­ the consolidated balance sheet; or

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 24 ­ the supplementary supervision of the credit institution; 3) funding of a borrower that passes the funding on to the ultimate investor for the acquisition of ownership, at issuance or thereafter, of the capital instruments or liabilities of a credit institution. (2) The funding shall be deemed indirect funding, for the purposes of paragraph (1) of this Article, where the following conditions are also met, where applicable:

  1. the investor is not included in the scope of: ­ accounting or prudential consolidation of the credit institution; ­ the consolidated balance sheet; or ­ the supplementary supervision of the credit institution;
  2. the external entity is not included in the scope of: ­ accounting or prudential consolidation of the credit institution; ­ the consolidated balance sheet; or ­ the supplementary supervision of the credit institution; (3) For the purposes of paragraph (2) item 1) indent 2 of this Article, an investor shall be deemed to be included in the scope of the extended aggregated calculation where the relevant capital instrument or liability is subject to consolidation or extended aggregated calculation in a way that the multiple use of own funds or eligible liabilities items and any creation of own funds or eligible liabilities between members of the institutional protection scheme is eliminated. (4) The applicable forms and nature of indirect funding of the acquisition of ownership of the capital instruments and liabilities of a credit institution shall include intragroup circular funding, which means any of the following:
  3. situations where a credit institution has granted a loan or other funding in any form to one of the entities referred to in paragraph (1) item 1) of this Article through another entity referred to in paragraph (1) item 1) of this Article, that is used for the acquisition of ownership of the credit institution’s capital instrument or liabilities;
  4. funding granted to one of the entities referred to in paragraph (1) item 1) of this Article, for other purposes than acquiring ownership of the capital instrument or liabilities of a credit institution through another entity referred to in paragraph (1) item 1) of this Article, provided that, taking into account any additional guidance as provided by the Central Bank for capital instruments, or its supervisory function, or with regard to liabilities, resolution function in consultation with the supervisory function, the credit institution is not able to demonstrate the following: ­ the transaction is realised at similar conditions as other transactions with third parties; ­ the investor does not have to rely on the distributions or on the sale of the capital instruments or liabilities held to support the payment of interest and the repayment of the funding. (5) When establishing whether the acquisition of ownership of a capital instrument or liability involves direct or indirect funding, the amount to be considered shall be net of any individually assessed impairment allowance made.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 25 (6) In order to avoid a qualification of direct or indirect funding and where the loan or other form of funding or guarantees is granted to any natural or legal person who has a qualifying holding in the credit institution or who is deemed to be a connected person, the credit institution shall ensure on an on-going basis that it has not provided the loan or other form of funding or guarantees for the purposes of acquiring ownership directly or indirectly of capital instruments or liabilities of that credit institution, and where the loan or other form of funding or guarantees is granted to other types of party, the credit institution shall make this control on a best effort basis. Consequences of the conditions for Common Equity Tier 1 instruments ceasing to be met Article 13 In the case where a Common Equity Tier 1 instrument ceases to meet the conditions laid down in Article 8 of this Decision, the following shall apply:

  1. that instrument shall immediately cease to qualify as a Common Equity Tier 1 instrument;
  2. the share premium accounts that relate to that instrument shall immediately cease to qualify as Common Equity Tier 1 items. Capital instruments subscribed by government authorities in emergency situations Article 14 A credit institution may, in emergency situations, include in Common Equity Tier 1 capital instruments that at least comply with the conditions referred to in Article 8 paragraph (1) items 2) to 5) of this Decision where the following conditions are met:
  3. the capital instruments are considered State aid, and is assured that they are issued within the context of recapitalisation measures pursuant to State aid rules existing at that time;
  4. the capital instruments are fully subscribed and held by the State or a relevant state administration body or state-owned entity;
  5. the capital instruments are able to absorb losses;
  6. in the event of winding-up, the capital instruments entitle their owners to a claim on the residual assets of the credit institution after the payment of all senior claims;
  7. there are adequate exit mechanisms of the State or, where applicable, a relevant state administration body or state-owned entity; and
  8. the Central Bank has granted its prior authorisation to the credit institution to include these instruments in Common Equity Tier 1 capital.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 26 Section 2 - Prudential filters Securitised assets Article 15 (1) A credit institution shall exclude from any element of own funds any increase in its capital under the applicable accounting framework that results from securitised assets, including the following:

  1. such an increase associated with future margin income that results in a gain on sale for the credit institution; and
  2. where the credit institution is the originator of a securitisation, net gains that arise from the capitalisation of future income from the securitised assets that provide credit enhancement to positions in the securitisation. (2) The gain on sale referred to in paragraph (1) item 1) of this Article means any recognised gain on sale for the credit institution that is recorded as an increase in any element of own funds and is associated with future margin income arising from a sale of securitised assets when they are removed from the credit institution’s balance sheet in the context of a securitisation transaction. (3) The recognised gain on sale shall be determined as the difference between the following two items, as determined by applying the accounting framework:
  3. the net value of the assets that the credit institution has received including any new asset acquired less any other asset that the credit institution has given or any new liability assumed; and
  4. the carrying amount of the securitised assets or of the part derecognised. (4) The recognised gain on sale which is associated with the future margin income, for the purposes of this Article, shall refer to the expected future ‘excess spread’ defined as the finance charge collections and other fee income received in respect of the securitised exposures net of costs and expenses. Cash flow hedges and changes in the value of own liabilities Article 16 (1) A credit institution shall not include the following items in any element of own funds:
  5. the fair value reserves related to gains or losses on cash flow hedges of financial instruments that are not valued at fair value, including projected cash flows;
  6. gains or losses on liabilities of the credit institution that are valued at fair value that result from changes in the own credit standing of the credit institution;
  7. fair value gains and losses on derivative liabilities of the credit institution that result from changes in the own credit risk of the credit institution. (2) For the purposes of paragraph (1) item 3) of this Article, credit institution shall not offset the fair value gains and losses arising from the credit institution’s own credit risk with those arising from its counterparty credit risk.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 27 (3) Without prejudice to paragraph (1) item 2) of this Article, a credit institution may include the amount of gains and losses on their liabilities in own funds where all the following conditions are met:

  1. the liabilities are in the form of bonds issued by a credit institution established in Montenegro and meet the conditions to be eligible as covered bonds;
  2. the changes in the value of the credit institution's assets and liabilities are due to the same changes in the credit institution's own credit standing;
  3. there is a close correspondence between the value of the bonds referred to in item 1) of this paragraph and the value of the credit institution's assets; and
  4. it is possible to redeem the mortgage loans by buying back the bonds financing the mortgage loans at market or nominal value. (4) For the purposes of paragraph (3) item 3) of this Article, a close correspondence between the value of a covered bond and the value of a credit institution's assets shall be deemed to exist when the following conditions are met:
  5. any changes in the fair value of the covered bonds issued by the credit institution results at all times in equal changes in the fair value of the assets underlying the covered bonds and the fair value shall be determined according to the applicable accounting framework;
  6. the mortgage loans underlying the covered bonds issued by the credit institution to finance the loans may be at any time redeemed by buying back the covered bonds at market or nominal value through the exercise of the delivery option;
  7. the transparent mechanism applies for determining the fair value of the mortgage loans and of the covered bonds. (5) Determining the value of the mortgage loans shall include calculating the fair value of the delivery option. (6) A close correspondence shall not be deemed to exist where, in accordance with paragraph (4) of this Article, a net profit or loss arises from changes in the value of the covered bonds or of the underlying mortgage loans with the embedded delivery option. Additional value adjustments Article 17 (1) When calculating the amount of their own funds, a credit institution shall apply prudent valuation requirements referred to in Article 126 of this Decision to all fair￾valued assets, and shall deduct from Common Equity Tier 1 capital the amount of any additional value adjustments (AVA) necessary. (2) The requirements referred to in paragraph (1) of this Article shall refer to all fair￾valued positions of the credit institution regardless of whether they are held in the trading book or not, and the term “position” shall solely refer to financial instruments and commodities or fair-valued portfolio of financial instruments or commodities. (3) A credit institution shall use AVA) solely for the calculation of Common Equity Tier 1 capital and shall not be included in the calculation of capital requirements for the positions in trading book.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 28 (4) The total AVA necessary to adjust fair values to the prudent value shall be calculated using core approach as laid down in Article 128 of this Decision, unless they meet the conditions for applying simplified approach referred to in Article 127 of this Decision. (5) Where the application of prudent valuation leads to a lower absolute carrying value for assets or higher absolute carrying value for liabilities than recognised in accounting, an AVA shall be calculated as the absolute value of the difference between the two, as the prudent value shall always be equal to or lower than the fair value for assets and equal to or higher than the fair value for liabilities. (6) For valuation positions that include the positions subject to hedge accounting, available-for-sale positions to the extent their valuation changes are subject to a prudential filter and exactly matching, offsetting positions, for which a change in accounting valuation has only a partial or zero impact on Common Equity Tier 1 capital, AVAs shall only be applied based on the proportion of the accounting valuation change that impacts Common Equity Tier 1 capital. (7) Where a credit institution calculates AVA based on market data, it shall consider the same range of market data as the data used in the independent price verification process in the manner laid down in Article 126 paragraphs (10) to (12) of this Decision. (8) A credit institution shall consider a full range of available and reliable market data sources to determine a prudent value including each of the following, where relevant:

  1. exchange prices in a liquid market;
  2. trades in the exact same or very similar instrument, either from the credit institution's own records or, where available, trades from across the market;
  3. tradable quotes from brokers and other market participants;
  4. consensus service data;
  5. indicative broker quotes; and
  6. counterparty collateral valuations. (9) Where a credit institution applies an expert-based approach, it shall consider alternative methods and sources of information, including each of the following, where relevant:
  7. the use of proxy data based on similar instruments for which sufficient data is available;
  8. the application of prudent shifts to valuation inputs;
  9. the identification of natural bounds to the value of an instrument. Unrealised gains and losses measured at fair value Article 18 A credit institution shall not make adjustments to remove from their own funds unrealised gains or losses on their assets or liabilities measured at fair value, except in the case of items referred to in Article 16 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 29 Section 3 - Deductions from Common Equity Tier 1 items, exemptions and alternatives Subsection 1 - Deductions from Common Equity Tier 1 items Deductions from Common Equity Tier 1 items Article 19 A credit institution shall deduct from Common Equity Tier 1 the following items:

  1. losses for the current financial year;
  2. intangible assets with the exception of prudently valued software assets the value of which is not negatively affected by resolution, bankruptcy or winding￾up of the credit institution;
  3. deferred tax assets that rely on future profitability;
  4. for a credit institution calculating risk-weighted exposure amounts using the Internal Ratings Based Approach (the IRB Approach), the IRB shortfall calculated in accordance with Article 200 of this Decision;
  5. defined benefit pension fund assets on the balance sheet of the credit institution;
  6. direct, indirect and synthetic holdings by a credit institution of own Common Equity Tier 1 instruments, including own Common Equity Tier 1 instruments that a credit institution is under an actual or contingent obligation to purchase by virtue of an existing contractual obligation;
  7. direct, indirect and synthetic holdings of the Common Equity Tier 1 instruments of financial sector entities where those entities have a reciprocal cross holding with the credit institution that the Central Bank considers to have been designed to inflate artificially the own funds of the credit institution;
  8. the applicable amount of direct, indirect and synthetic holdings by the credit institution of Common Equity Tier 1 instruments of financial sector entities where the credit institution does not have a significant investment in those entities;
  9. the applicable amount of direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1 instruments of financial sector entities where the credit institution has a significant investment in those entities; 10)the amount of items required to be deducted from Additional Tier 1 items pursuant to Article 54 of this Decision that exceeds the Additional Tier 1 items of the credit institution; 11)the amount of qualifying holdings in persons engaged in non-financial business activity that exceeds the limits prescribed in Article 175 paragraphs (1) and (2) of the Law; 12)the exposure amount of the following items which qualify for a risk weight of 1.250%, where the credit institution deducts that exposure amount from the amount of Common Equity Tier 1 items as an alternative to applying a risk weight of 1.250%: ­ securitisation positions in accordance with Article 280 paragraph (1) item 2), Article 281 paragraph (1) item 2) and Article 289 of this Decision; ­ free deliveries, in accordance with Article 527 paragraph (6) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 30 ­ positions in a basket for which a credit institution cannot determine the risk weight under the IRB approach, in accordance with Article 195 paragraphs (11) and (12) of this Decision; ­ exposures in the form of units or shares in a CIU that are assigned a risk weight of 1.250% in accordance with Article 175 paragraph (2) of this Decision. 13)any tax charge relating to Common Equity Tier 1 items foreseeable at the moment of its calculation, except where the credit institution suitably adjusts the amount of Common Equity Tier 1 items insofar as such tax charges reduce the amount up to which those items may be used to cover risks or losses; 14)the applicable amount of insufficient coverage for non-performing exposures; 15)for a minimum value commitment referred to in Article 175 paragraph (2) of this Decision, any amount by which the current market value of the units or shares in CIUs underlying the minimum value commitment falls short of the present value of the minimum value commitment and for which the credit institution has not already recognised a reduction of Common Equity Tier 1 items; 16)required provisions for estimated and potential losses for balance sheet and off-balance sheet items that are not deemed to be non-performing assets, as established in accordance with the Central Bank’s regulation governing asset classification and calculation of provisions for potential loan losses of a credit institution; 17)required provisions for estimated and potential losses for balance sheet and off-balance sheet items that are deemed to be non-performing assets, as established in accordance with the Central Bank’s regulation governing asset classification and calculation of provisions for potential loan losses of a credit institution; 18)applicable amount of excess in investment in immovable property calculated in accordance with the regulation governing the treatment of investments in immovable property and fixed assets. Deduction of losses for the current financial year Article 20 (1) For the purpose of calculating its Common Equity Tier 1 capital during the year, and irrespective of whether the credit institution closes its financial accounts at the end of each interim period, the credit institution shall determine its profit and loss accounts and deduct any resulting losses from Common Equity Tier 1 items as they arise. (2) for the purpose of calculation referred to in paragraph (1) of this Article, profit and loss accounts shall be determined in the same manner as for the purposes of compiling year-end financial reports. (3) Income and expenses shall be prudently estimated and shall be assigned to the interim period in which they incurred so that each interim period bears a reasonable amount of the anticipated annual income and expenses, whereat material or non￾recurrent events shall be considered in full and without delay in the interim period during which they arise.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 31 (4) Where losses for the current financial year have already reduced Common Equity Tier 1 items as a result of an interim or a year-end financial report, a deduction is not needed. (5) For the purpose of this Article, the financial report means that the profit and losses have been determined after a closing of the interim or the annual accounts in accordance with the prevailing accounting framework. (6) The provisions of paragraphs (1) to (5) of this Article shall apply in the same manner to gains and losses included in accumulated other comprehensive income. Deduction of intangible assets Article 21 A credit institution shall determine the amount of intangible assets to be deducted in accordance with the following:

  1. the amount to be deducted shall be reduced by the amount of associated deferred tax liabilities that would be extinguished if the intangible assets became impaired or were derecognised under the applicable accounting framework;
  2. the amount to be deducted shall include goodwill included in the valuation of significant investments of the credit institution;
  3. the amount to be deducted shall be reduced by the amount of the accounting revaluation of the subsidiary undertakings' intangible assets derived from the consolidation of subsidiary undertakings attributable to persons other than the undertakings included in the consolidation. Deduction of software assets that are classified as intangible assets for accounting purposes Article 22 (1) A credit institution shall deduct software assets that are intangible assets as defined in Article 19 item 2) of this Decision from Common Equity Tier 1 items in accordance with paragraphs (5) to (10) of this Article, and it shall determine the amount to be deducted on the basis of the prudential accumulated amortisation calculated in accordance with paragraphs (2) to (4) of this Article. (2) A credit institution shall calculate the amount of the prudential accumulated amortisation of the software assets referred to in paragraph (1) of this Article by multiplying the amount obtained from the calculation referred in item 1) of this paragraph by the number of days referred to in item 2) of this paragraph:
  4. the amount at which the software asset has been initially recognised on the balance sheet of the credit institution under the applicable accounting framework, divided by the lower of: ­ the number of days of useful life of the software asset, as estimated for accounting purposes; ­ three years, expressed in days, starting from the date referred to in paragraph (3) of this Article;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 32 2) the number of days elapsed since the date referred to in paragraph (3) of this Article, provided that this does not exceed the period referred in item 1) of this paragraph. (3) The prudential accumulated amortisation referred to in paragraph (1) of this Article shall be calculated starting from the date on which the software asset is available for use and begins to be amortised for accounting purposes. (4) By way of derogation from paragraph (3) of this Article, where a software asset has been acquired from any business undertaking, including a non-financial sector entity, that is part of the same group as the credit institution, the prudential accumulated amortisation referred to in paragraph (1) of this Article shall be calculated from the date on which that software asset began to be amortised under the applicable accounting framework on that business undertaking’s balance sheet. (5) A credit institution shall deduct from Common Equity Tier 1 items the amount resulting from the difference, if positive, between the amount referred to in item 1) of this paragraph and the amount referred to in item 2) of this paragraph:

  1. the prudential accumulated amortisation of a software asset calculated in accordance with paragraphs (2) to (4) of this Article;
  2. the sum of the accumulated amortisation and any accumulated impairment losses of that software asset recognised on that credit institution’s balance sheet under the applicable accounting framework. (6) By way of derogation from paragraph (5) of this Article, until the date on which the software asset is available for use and begins to be amortised for accounting purposes, a credit institution shall deduct from Common Equity Tier 1 items the full amount at which the software asset is recognised on that credit institution’s balance sheet under the applicable accounting framework. (7) The prudential amortisations and deductions set out in this Article shall be made separately for each software asset. (8) A credit institution's investments in maintaining, enhancing or upgrading existing software assets shall be treated as assets other than the related software assets, provided that those investments are recognised as an intangible asset on that credit institution’s balance sheet under the applicable accounting framework. (9) Without prejudice to paragraph (6) of this Article, the prudential accumulated amortisation of those investments of credit institution in maintaining, enhancing or upgrading existing software assets shall be calculated from the date on which they begin to be amortised under the applicable accounting framework. (10) The prudential accumulated amortisation of related existing software assets shall continue to be calculated from the date of their own initial amortisation for accounting purposes and until the end of the period of the prudential amortisation determined in accordance with paragraph (2) item 1) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 33 Deduction of deferred tax assets that rely on future profitability Article 23 (1) A credit institution shall determine, for the purposes of Article 19 item 3) of this Decision, the amount of deferred tax assets that rely on future profitability that require deduction from Common Equity Tier 1 capital in accordance with this Article. (2) Except where the conditions laid down in paragraph (3) of this Article are met, a credit institution shall calculate the amount of deferred tax assets that rely on future profitability without reducing it by the amount of the associated deferred tax liabilities of the credit institution. (3) The amount of deferred tax assets that rely on future profitability may be reduced by the amount of the associated deferred tax liabilities of the credit institution, where the following conditions are met:

  1. the entity has a legally enforceable right under applicable regulations to set off those current tax assets against current tax liabilities;
  2. the deferred tax assets and the deferred tax liabilities relate to taxes levied by the same tax authority and on the same taxable entity. (4) The associated deferred tax liabilities of the credit institution, for the purposes of paragraph (3) of this Article. may not include deferred tax liabilities that reduce the amount of intangible assets or defined benefit pension fund assets required to be deducted. (5) The amount of associated deferred tax liabilities referred to in paragraph (4) of this Article shall be allocated between the following:
  3. deferred tax assets that rely on future profitability and arise from temporary differences that are not deducted in accordance with Article 43 paragraph (1) of this Decision; and
  4. all other deferred tax assets that rely on future profitability. (6) A credit institution shall allocate the associated deferred tax liabilities according to the proportion of deferred tax assets that rely on future profitability that the items referred to in paragraph (5) of this Article represent. (7) The offsetting between deferred tax assets and associated deferred tax liabilities shall be done separately for each taxable entity. (8) Associated deferred tax liabilities shall be limited to those that arise from the tax law of the same jurisdiction as the deferred tax assets. (9) For the calculation of deferred tax assets and liabilities at consolidated level, a taxable entity includes any number of entities which are members of the same tax group, fiscal consolidation, fiscal unity or consolidated tax return under applicable national law. (10) The amount of associated deferred tax liabilities which are eligible for offsetting deferred tax assets that rely on future profitability is equal to the difference between the amount of deferred tax liabilities as recognised under the applicable accounting

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 34 framework and the amount of associated deferred tax liabilities arising from intangible assets and from defined benefit pension fund assets. Tax overpayments, tax loss carry backs and deferred tax assets that do not rely on future profitability Article 24 A credit institution shall not deduct the following items from own funds, instead, they shall be subject to a risk weight in accordance with the provisions of this Decision that relate to credit risk by applying Standardised Approach or IRB approach:

  1. overpayments of tax by the credit institution for the current year; and
  2. current year tax losses of the credit institution carried back to previous years that give rise to a claim on, or a receivable from, Government of Montenegro, local self-governments or local tax authority, where applicable. Deductions of foreseeable tax charges Article 25 (1) A credit institution may, for the purposes of Article 19 item 13) and Article 54 paragraph (1) item 6) of this Decision, may consider that foreseeable tax charges have been already taken into account where it applies the accounting framework and accounting policies that provide for the full recognition of current and deferred tax liabilities related to transactions and other events recognised in the balance sheet or the profit and loss account. (2) For the purposes of paragraph (1) of this Article, the Central Bank shall be satisfied that all necessary deductions have been made, either under applicable accounting standards or under any other value adjustments. (3) When the credit institution is calculating its Common Equity Tier 1 capital on the basis of financial statements made in accordance with the International Accounting Standards and International Financial Reporting Standards, the condition of paragraph (1) of this Article shall be deemed to be fulfilled. (4) Where the condition referred to in paragraph (1) of this Article is not fulfilled, the credit institution shall decrease its Common Equity Tier 1 items by the estimated amount of current and deferred tax charges not yet recognised in the balance sheet and profit and loss account related to transactions and other events recognised in the balance sheet or the profit and loss account, which have been determined using the approach equivalent to International Accounting Standards and International Financial Reporting Standards. (5) The estimated amount of deferred tax charges may not be netted against deferred tax assets that are not recognised in the financial statements.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 35 Deduction of negative amounts resulting from the calculation of expected loss amounts Article 26 The amount to be deducted from Common Equity Tier 1 capital in accordance with Article 19 item 4) of this Decision shall not be reduced by a rise in the level of deferred tax assets that rely on future profitability, or other additional tax effects, that could occur if provisions were to rise to the level of expected losses referred to in Articles 199 and 200 of this Decision. Deduction of defined benefit pension fund assets Article 27 (1) For the purposes of Article 19 item 5) of this Decision, the amount of defined benefit pension fund assets to be deducted from Common Equity Tier 1 capital shall be reduced by the following:

  1. the amount of any associated deferred tax liability which could be extinguished if the assets became impaired or were derecognised under the applicable accounting framework;
  2. the amount of assets in the defined benefit pension fund which the credit institution has an unrestricted ability to use, provided that the credit institution has received the prior authorisation of the Central Bank. (2) Assets referred to in paragraph (1) item 2) of this Article which is used to reduce the amount to be deducted from Common Equity Tier 1 capital shall receive a risk weight in accordance with the provisions of this Decision that relate to credit risk by applying Standardised Approach or IRB Approach, whichever is applied by the credit institution. (3) The Central Bank shall only grant the authorisation referred to in paragraph (1) item 2) of this Article where the unrestricted ability to use the respective defined benefit pension fund assets entails immediate and unfettered access to the assets such as when the use of the assets is not barred by a restriction of any kind and there are no claims of any kind from third parties on these assets. (4) Unfettered access to the assets, within the meaning referred to in paragraph (3) of this Article, is likely to exist when the credit institution is not required to request and receive specific authorisation from the manager of the pension funds or the pension beneficiaries each time it would access excess funds in the plan. (5) A defined benefit pension fund shall be deemed to be independent from its sponsoring credit institution where the following conditions are met:
  3. the defined benefit pension fund is legally separate from the sponsoring credit institution and its governance is independent;
  4. the articles of association, the articles of incorporation and the internal rules of the specific pension fund, as applicable, have been approved by an independent regulatory authority or the rules governing the incorporation and functioning of the defined benefit pension fund, as applicable, are established in the applicable law of Montenegro, EU Member States or a third country;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 36 3) the trustees or administrators of the defined pension fund have an obligation under applicable law to act impartially in the best interests of the scheme beneficiaries instead of those of the sponsor, to manage assets of the defined pension fund prudently and to conform to the restrictions set out in the articles of association, the articles of incorporation and the internal rules of the specific pension fund, as applicable, or statutory or regulatory framework described in item 2) of this paragraph; and 4) the articles of association or the articles of incorporation or the rules governing the incorporation and functioning of the defined benefit pension fund referred to in item 2) of this paragraph include restrictions on investments that the defined pension scheme can make in own funds instruments issued by the sponsoring credit institution. (6) Where a defined benefit pension fund holds own funds instruments of the sponsoring credit institution, the sponsoring credit institution shall treat that holding as an indirect holding of own Common Equity Tier 1 instruments, own Additional Tier 1 instruments or own Tier 2 instruments, as applicable. (7) The amount to be deducted from the Common Equity Tier 1 items, Additional Tier 1 items or Tier 2 items of the sponsoring credit institution, shall be calculated in accordance with Article 33 of this Decision. Deduction of holdings of own Common Equity Tier 1 instruments Article 28 (1) For the purposes of Article 19 item 6) of this Decision, a credit institution shall calculate holdings of own Common Equity Tier 1 instruments on the basis of gross long positions. (2) By way of derogation from paragraph (1) of this Article:

  1. a credit institution may calculate the amount of holdings of own Common Equity Tier 1 instruments on the basis of the net long position provided that both the following conditions are met: ­ the long and short positions are in the same underlying exposure and the short positions involve no counterparty risk; and ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book;
  2. a credit institution shall determine the amount to be deducted for direct, indirect and synthetic holdings of index securities by calculating the underlying exposure to own Common Equity Tier 1 instruments included in those indices;
  3. a credit institution may net gross long positions in own Common Equity Tier 1 instruments resulting from holdings of index securities against short positions in own Common Equity Tier 1 instruments resulting from short positions in the underlying indices, including where those short positions involve counterparty risk, provided that both the following conditions are met: ­ the long and short positions are in the same underlying indices; ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 37 Significant investment in a financial sector entity Article 29 (1) For the purposes of determining deductions from Common Equity Tier 1 instruments, it shall be deemed that a credit institution has a significant investment in a financial sector entity where any of the following conditions is met:

  1. the credit institution owns more than 10% of the Common Equity Tier 1 instruments issued by that entity;
  2. the credit institution has close links with that entity and owns Common Equity Tier 1 instruments issued by that entity;
  3. the credit institution owns Common Equity Tier 1 instruments issued by that entity and the entity is not included in consolidation pursuant to the Law but is included in the same accounting consolidation as the credit institution for the purposes of financial reporting under the applicable accounting framework. (2) For the purposes of Article 19 item 9) of this Decision, in order to assess whether a credit institution owns more than 10% of the Common Equity Tier 1 instruments issued by a financial sector entity, in accordance with paragraph (1) item 1) of this Article, the credit institution shall add the amounts of their gross long positions in direct holdings, as well as indirect holdings of Common Equity Tier 1 instruments of this financial sector entity referred to in Article 3 paragraph (1) item 115) indents 4 to 8 of this Decision. (3) The Central Bank shall take into account indirect and synthetic holdings in order to assess whether the conditions referred to in paragraph (1) items 2) and 3) of this Article are met. Deduction of holdings of Common Equity Tier 1 instruments of financial sector entities and where a credit institution has a reciprocal cross holding designed artificially to inflate own funds Article 30 A credit institution shall make the deductions referred to in Article 19 items 7),
  4. and 9) of this Decision in accordance with the following: holdings of Common Equity Tier 1 instruments and other capital instruments of financial sector entities shall be calculated on the basis of the gross long positions; for the purposes of deduction, Tier 1 own-fund insurance items shall be treated as holdings of Common Equity Tier 1 instruments. Deduction of holdings of Common Equity Tier 1 instruments of financial sector entities Article 31 A credit institution shall apply the deductions referred to in Article 19 items 8) and 9) of this Decision in accordance with the following provisions:
  5. a credit institution may calculate direct, indirect and synthetic holdings of Common Equity Tier 1 instruments of the financial sector entities on the basis of the net long position in the same underlying exposure provided that both the following conditions are met:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 38 ­ the maturity date of the short position is either the same as, or later than the maturity date of the long position or the residual maturity of the short position is at least one year; and ­ either both the long position and the short position are held in the trading book or both are held in the non-trading book; 2) a credit institution shall determine the amount to be deducted for direct, indirect and synthetic holdings of index securities by calculating the underlying exposure to the capital instruments of the financial sector entities in those indices. Synthetic holdings of capital instruments Article 32 (1) For the purposes of Article 19 items 6), 8) and 9) of this Decision, the following financial products shall be considered synthetic holdings of capital instruments:

  1. derivative instruments that have capital instruments of a financial sector entity as their underlying or have the financial sector entity as their reference entity; and
  2. guarantees or credit protection provided to a third party in respect of the third party's investments in a capital instrument of a financial sector entity. (2) The financial products provided for in paragraph (1) of this Article shall include the following:
  3. investments in total return swaps (TRS) on a capital instrument of a financial sector entity;
  4. call options purchased by the credit institution on a capital instrument of a financial sector entity;
  5. put options sold by the credit institution on a capital instrument of a financial sector entity or any other actual or contingent contractual obligation of the credit institution to purchase its own funds instruments;
  6. investments in forward purchase agreements on a capital instrument of a financial sector entity. (3) The amount of synthetic holdings to be deducted from Common Equity Tier 1 items as required by Article 19 items 6), 8) and 9) of this Decision shall be as follows:
  7. for holdings in the trading book: ­ for options, the delta equivalent amount of the relevant instruments calculated in accordance with the provisions of this Decision governing the calculation of capital requirements for market risk; ­ for any other synthetic holdings, the nominal or notional amount, as applicable;
  8. for holdings in the non-trading book: ­ for call options, the current market value; ­ for any other synthetic holdings, the nominal or notional amount, as applicable. (4) A credit institution shall deduct the synthetic holdings referred to in paragraph (3) of this Article from the date of signature of the contract between the credit institution and the counterparty.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 39 Deductions of indirect holdings of capital instruments Article 33 (1) The amount of indirect holdings of Common Equity Tier 1 instruments to be deducted as required by Article 19 items 6), 8) and 9) of this Decision, shall be calculated in one of the following ways:

  1. according to the default approach set out in Article 34 of this Decision; or
  2. where the credit institution demonstrates to the satisfaction of the Central Bank that the approach described in item 1) of this paragraph is excessively burdensome, according to the structure-based approach described in Article 35 of this Decision. (2) By way of derogation from paragraph (1) item 2) of this Article, a credit institution shall not use the structure-based approach for calculating the amount of those deductions in relation to investments in intermediate entities referred to in Article 3 paragraph (1) item 115) indents 4 and 5 of this Decision. Default approach for the calculation of indirect holdings of capital instruments Article 34 (1) For the purposes of Article 33 paragraph (1) item 1) of this Decision, the amount of indirect holdings of Common Equity Tier 1 instruments to be deducted as required by Article 19 items 6), 8) and 9) of this Decision, using the default approach, shall be calculated as follows:
  3. where the exposures of all investors to the intermediate entity rank pari passu, the amount shall be equal to the percentage of funding multiplied by the amount of Common Equity Tier 1 instruments of the financial sector entity held by the intermediate entity;
  4. where the exposures of all investors to the intermediate entity do not rank pari passu, the amount shall be equal to the percentage of funding multiplied with the lower of the following amounts: ­ the amount of Common Equity Tier 1 instruments of the financial sector entity held by the intermediate entity; ­ the credit institution's exposure to the intermediate entity together with all other funding provided to the intermediate entity that rank pari passu with the credit institution's exposure. (2) The calculation method set out in paragraph (1) item 2) of this Article shall be made for each tranche of funding that ranks pari passu with the funding provided by the credit institution. (3) The percentage of funding for the purposes of paragraph (1) of this Article shall be the credit institution's exposure to the intermediate entity divided by the sum of the credit institution's exposure to the intermediate entity and of all other exposures to this intermediate entity that rank pari passu with the credit institution's exposure. (4) The calculation laid down in paragraph (1) of this Article shall be made separately for each holding in a financial sector entity held by each intermediate entity.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 40 (5) Where investments in Common Equity Tier 1 instruments of a financial sector entity are held indirectly through subsequent or several intermediate entities, the percentage of funding set out in paragraph (1) of this Article shall be determined by dividing the amount referred to in item 1) of this paragraph by the amount referred to in 2) of this paragraph:

  1. the result of the multiplication of amounts of funding provided by the credit institution to intermediate entities, by the amounts of funding provided by these intermediate entities to subsequent intermediate entities, and by amounts of funding provided by these subsequent intermediate entities to the financial sector entity;
  2. the result of the multiplication of amounts of capital instruments or other instruments as relevant, issued by each intermediate entity. (6) The percentage of funding referred to in paragraph (5) of this Article shall be calculated separately for each holding in a financial sector entity held by intermediate entities and for each tranche of funding that ranks pari passu with the funding provided by the credit institution and the subsequent intermediate entities. Structure-based approach for the calculation of indirect holdings of capital instruments Article 35 (1) For the purposes of Article 33 paragraph (1) item 2) of this Decision, using the structure-based approach, the amount to be deducted from Common Equity Tier 1 items referred to in Article 19 item 6) of this Decision shall be equal to the percentage of funding, as defined in Article 34 paragraph (3) of this Decision, multiplied by the amount of Common Equity Tier 1 instruments of the institution held by the intermediate entity. (2) The amount to be deducted from Common Equity Tier 1 items referred to in Article 19 items 8) and 9) of this Decision shall be equal to the percentage of funding, as defined in Article 34 paragraph (3) of this Decision, multiplied by the aggregate amount of Common Equity Tier 1 instruments of financial sector entities held by the intermediate entity. (3) For the purposes of paragraphs (1) and (2) of this Article, a credit institution shall calculate separately per intermediate entity the aggregate amount of Common Equity Tier 1 instruments of the credit institution that the intermediary entity holds and the aggregate amount of Common Equity Tier 1 instrument of other financial sector entities that the intermediate entity holds. (4) The credit institution shall consider the amount of holdings in Common Equity Tier 1 instruments of financial sector entities calculated in accordance with paragraph (2) of this Article as a significant investment referred to in Article 29 of this Decision and shall deduct the amount in accordance with Article 19 item 9) of this Decision. (5) Where the investments in Common Equity Tier 1 instruments are held indirectly through subsequent or several intermediate entities, Article 34 paragraphs (5) and (6) of this Decision shall apply.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 41 (6) Where a credit institution is not able to identify the aggregate amounts that the intermediate entity holds in Common Equity Tier 1 instruments of the credit institution or in Common Equity Tier 1 instruments of financial sector entities, the credit institution shall estimate the amounts it cannot identify by using the maximum amounts that the intermediate entity is able to hold on the basis of its investment mandates. (7) Where a credit institution is not able to determine, on the basis of the investment mandate, the maximum amount that the intermediate entity holds in Common Equity Tier 1 instruments of the credit institution or in Common Equity Tier 1 instruments of financial sector entities, the credit institution shall treat the amount of funding that it holds in the intermediate entity as an investment in its own Common Equity Tier 1 instruments and shall deduct them in accordance with Article 19 item 6) of this Decision. (8) By way of derogation from paragraph 7 of this Article, a credit institution shall treat the amount of funding that it holds in the intermediate entity as a non-significant investment and shall deduct them in accordance with Article 19 item 8) of this Decision, where the following conditions are met:

  1. the amounts of funding are less than 0,25% of the credit institution's Common Equity Tier 1 capital;
  2. the amounts of funding are less than EUR 10 million; and
  3. the credit institution cannot reasonably determine the amounts of its own Common Equity Tier 1 instruments that the intermediate entity holds. (9) Where funding to the intermediate entity is in the form of units or shares of a CIU, the credit institution may rely on the third parties referred to in Article 172 paragraph (12) of this Decision, and under the conditions set by that Article, calculate and report the aggregate amounts referred to in paragraph (6) of this Article. Order and maximum amount of deductions of indirect holdings of own funds instruments of financial sector entities Article 36 (1) Subject to the limits laid down in paragraphs (2) or (3) of this Article, as applicable, where the intermediate entity holds Common Equity Tier 1 instruments, Additional Tier 1 instruments and Tier 2 instruments of financial sector entities, the Common Equity Tier 1 instruments shall be deducted first, the Additional Tier 1 instruments shall be deducted second, and the Tier 2 instruments last. (2) Where the intermediate entity holds own funds instruments of credit institutions, when applying paragraph (1) of this Article to each type of holding, a credit institution shall deduct the holdings of their own funds instruments first. (3) Where a credit institution holds capital instruments of financial sector entities indirectly, the amount to be deducted from the credit institution's own funds shall not be higher than the lower of the following amounts:
  4. the total funding provided by the credit institution to the intermediate entity;
  5. the amount of own funds instruments held by the intermediate entity in the financial sector entity.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 42 Deduction of holdings of Common Equity Tier 1 instruments where a credit institution does not have a significant investment in a financial sector entity Article 37 (1) For the purposes of Article 19 item 8) of this Decision, a credit institution shall calculate the applicable amount to be deducted by multiplying the amount referred to in item 1) of this paragraph by the factor derived from the calculation referred to in item 2) of this paragraph:

  1. the aggregate amount by which the direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1 instruments, Additional Tier 1 instruments and Tier 2 instruments of financial sector entities in which the credit institution does not have a significant investment exceeds 10 % of the aggregate amount of Common Equity Tier 1 items of the credit institution calculated after applying the following to Common Equity Tier 1 items: ­ Articles 15 to 18 of this Decision; ­ the deductions referred to in Article 19 paragraph (1) items 1) to 7), items
  2. to 15) of this Decision, excluding the amount to be deducted for deferred tax assets that rely on future profitability and arise from temporary differences; and ­ Articles 30 and 31 of this Decision;
  3. the amount of direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1 instruments of those financial sector entities in which the credit institution does not have a significant investment divided by the aggregate amount of direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1 instruments, Additional Tier 1 instruments and Tier 2 instruments of those financial sector entities. (2) A credit institution shall exclude underwriting positions held for five working days or fewer from the amount referred to in paragraph (1) items 1) of this Article and from the calculation of the factor referred to in paragraph (1) item 2) of this Article. (3) The amount to be deducted pursuant to paragraph (1) of this Article shall be apportioned across all Common Equity Tier 1 instruments held and the credit institution shall determine the amount of each Common Equity Tier 1 instrument that is deducted pursuant to paragraph (1) of this Article by multiplying the amount specified in item 1) of this paragraph by the proportion specified in item 2) of this paragraph:
  4. the amount of holdings required to be deducted pursuant to paragraph (1) of this Article;
  5. the proportion of the aggregate amount of direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1 instruments of financial sector entities in which the credit institution does not have a significant investment represented by each Common Equity Tier 1 instrument held. (4) The amount of holdings referred to Article 19 item 8) of this Decision that is equal to or less than 10% of the Common Equity Tier 1 items of the credit institution after applying the provisions laid down in paragraph (1) item 1) indents 1 to 3 of this Article shall not be deducted and shall be subject to the applicable risk weights in accordance with the provisions of this Decision relating to the credit risk by applying Standardised

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 43 Approach or IRB Approach and the requirements laid down in the provisions related to market risk. (5) A credit institution shall determine the amount of each Common Equity Tier 1 instrument that is risk weighted pursuant to paragraph (4) of this Article by multiplying the amount specified in item 1) of this paragraph by the amount specified in item 2) of this paragraph:

  1. the amount of holdings required to be risk weighted pursuant to paragraph (4) of this Article;
  2. the proportion resulting from the calculation referred to in paragraph (3) item 2) of this Article. (6) For the purposes of calculation of the amount referred to in paragraph (1) of this Article, a credit institution may choose not to identify goodwill separately. Deduction of holdings of Common Equity Tier 1 instruments where a credit institution has a significant investment in a financial sector entity Article 38 For the purposes of Article 19 item 9) of this Decision, the applicable amount to be deducted from Common Equity Tier 1 items shall exclude underwriting positions held for five working days or fewer and shall be determined in accordance with Articles 30 and31 and Articles 43 and 44 of this Decision. Other deductions for capital instruments of financial institutions Article 39 (1) Holdings of capital instruments of financial institutions shall be deducted as follows:
  3. all instruments qualifying as capital in accordance with regulations applicable to the financial institution that issued them and, where the financial institution is subject to solvency requirements, which are included in the highest quality Tier of regulatory own funds without any limits shall be deducted from Common Equity Tier 1 items;
  4. all instruments which qualify as capital in accordance with regulations applicable to the issuer and, where the financial institution is not subject to solvency requirements, which are perpetual, absorb the first and proportionately greatest share of losses as they occur, rank below all other claims in the event of bankruptcy and winding-up and have no preferential or predetermined distributions shall be deducted from Common Equity Tier 1 items;
  5. any subordinated instruments absorbing losses on a going-concern basis, including the discretion to cancel coupon payments, shall be deducted from Additional Tier 1 items, and where the amount of these subordinated instruments exceeds the amount of Additional Tier 1 capital, and where the amount of subordinated instruments exceeds the amount of Additional Tier 1 capital, the difference shall be deducted from Common Equity Tier 1 capital;
  6. any other subordinated instruments shall be deducted from Tier 2 items, and where the amount of these subordinated instruments exceeds the amount of Tier 2 capital, the difference shall be deducted from Additional Tier 1 items, and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 44 where the amount of Additional Tier 1 capital is insufficient, the remaining difference shall be deducted from Common Equity Tier 1 items; 5) any other instruments included in the financial institution’s own funds pursuant to the relevant applicable prudential framework or any other instruments for which the credit institution is not able to demonstrate that the conditions referred to in items 1), 2), 3) or 4) of this paragraph apply shall be deducted from Common Equity Tier 1 items. (2) In the cases referred to in paragraph (3) of this Article, a credit institution shall apply the deductions for the same component of capital for which the capital would qualify if it was issued by the credit institution itself. (3) The deductions referred to in paragraph (1) of this Article shall not apply to financial institution which is:

  1. authorised and supervised by the Central Bank or relevant competent authority and subject to prudential requirements equivalent to the provisions of this Decision and EU regulation; this approach shall also be applied to third country financial institutions where it has been concluded that the prudential regime of the third country concerned is equivalent;
  2. an electronic money institution;
  3. a payment institution; or
  4. an alternative investment fund manager. Capital instruments of third country insurance and reinsurance undertakings Article 40 (1) Holdings of capital instruments of third country insurance and reinsurance undertakings that are subject to a solvency regime that either has been assessed as non-equivalent to the solvency regime in Montenegro and the European Union, or that has not been assessed, shall be deducted as follows:
  5. all instruments which qualify as capital pursuant to regulations applicable to the third country insurance and reinsurance undertakings that issued them, and which are included in the highest quality Tier of regulatory own funds without any limits under the third-country regime shall be deducted from Common Equity Tier 1 items;
  6. any subordinated instruments absorbing losses on a going-concern basis, including the discretion to cancel coupon payments, shall be deducted from Additional Tier 1 items and where the amount of these subordinated instruments exceeds the amount of Additional Tier 1 capital, the difference shall be deducted from Common Equity Tier 1 items;
  7. any other subordinated instruments shall be deducted from Tier 2 items, and where the amount of these subordinated instruments exceeds the amount of Tier 2 capital, the difference shall be deducted from Additional Tier 1 items, and where this excess amount exceeds the amount of Additional Tier 1 capital, the remaining difference shall be deducted from Common Equity Tier 1 items;
  8. for third country insurance and reinsurance undertakings that are subject to prudential solvency requirements, any other instruments included in the third country insurance and reinsurance undertakings’ own funds pursuant to the relevant applicable solvency regime or any other instruments for which the credit institution is not able to demonstrate that conditions referred to in items

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 45 1), 2) or 3) of this paragraph apply shall be deducted from Common Equity Tier 1 items. (2) Where the solvency regime of the third country including rules on own funds, has been assessed as equivalent to the solvency regime in Montenegro and the European Union, holdings of capital instrument of the third-country insurance or reinsurance undertakings shall be treated as holdings of capital instruments of insurance or reinsurance undertakings authorised by competent authority in Montenegro or the European Union. (3) In the cases referred to in paragraph (2) of this Article, a credit institution shall apply the deductions in accordance with Article 30 item 2), Article 56 item 2) and Article 66 item 2) of this Decision. Capital instruments of undertakings excluded from the scope of application of regulations for insurance and reinsurance activities Article 41 Holdings of capital instruments of undertakings excluded from the scope of application of regulations for insurance and reinsurance activities shall be deducted as follows:

  1. all instruments qualifying as capital on the basis of the regulations applicable to the undertaking that issued them and that are included in the highest quality Tier of regulatory own funds without any limits shall be deducted from Common Equity Tier 1 capital;
  2. any subordinated instruments absorbing losses on a going-concern basis, including the discretion to cancel coupon payments, shall be deducted from Additional Tier 1 items, and where the amount of these subordinated instruments exceeds the amount of Additional Tier 1 capital, the difference shall be deducted from Common Equity Tier 1 items;
  3. any other subordinated instruments shall be deducted from Tier 2 items. If the amount of these subordinated instruments exceeds the amount of Tier 2 capital, the difference shall be deducted from Additional Tier 1 items and where this amount exceeds the amount of Additional Tier 1 capital, the remaining difference shall be deducted from Common Equity Tier 1 items;
  4. any other instruments included in the undertaking’s own funds pursuant to the relevant applicable solvency regime or any other instruments for which the institution is not able to demonstrate that conditions referred to in items 1), 2) or 3) of this paragraph apply shall be deducted from Common Equity Tier 1 capital. Non-performing exposures Article 42 (1) For the purposes of Article 19 paragraph (1) item 14) of this Decision, an exposure shall include any of the following items, provided that they are not included in the trading book of the credit institution:
  5. a debt instrument, including a debt security, a loan, an advance and a demand deposit;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 46 2) a loan commitment given, a financial guarantee given or any other surety or commitment given, irrespective of whether it is revocable or irrevocable, with the exception of undrawn credit facilities that may be cancelled unconditionally at any time and without notice, or that provide for automatic cancellation due to deterioration in the borrower's creditworthiness. (2) For the purposes of Article 19 item 14) of this Decision, the exposure value of a debt instrument shall be equal to its accounting value measured without taking into account any specific credit risk adjustments, AVA determined in accordance with Articles 17 and 126 of this Decision, amounts deducted in accordance with Article 19 item 14) of this Decision, other own funds reductions related to the exposure or partial write-offs made by the credit institution since the last time the exposure was classified as non- performing. (3) For the purposes of Article 19 item 14) of this Decision, the exposure value of a debt instrument that was purchased at a price lower than the amount owed by the debtor shall include the difference between the purchase price and the amount owed by the debtor. (4) For the purposes of Article 19 item 14) of this Decision, the exposure value of a loan commitment given, a financial guarantee given or any other commitment given as referred to in paragraph (1) item 2) of this Article shall be its nominal value, which shall represent the credit institution's maximum exposure to credit risk without taking account of any funded or unfunded credit protection, whereat the nominal value of a loan commitment given shall be the undrawn amount that the credit institution has committed to lend and the nominal value of a financial guarantee given shall be the maximum amount the entity could have to pay if the guarantee is called on. (5) The nominal value referred to in the paragraph (4) of this Article shall not take into account any specific credit risk adjustment, AVA in accordance with Articles 16 and 126 of this Decision, amounts deducted in accordance with Article 19 item 14) of this Decision or other own funds reductions related to the exposure. (6) For the purposes of Article 19 item 14) of this Decision, a credit institution shall determine the applicable amount of insufficient coverage separately for each non￾performing exposure to be deducted from Common Equity Tier 1 items by subtracting the amount determined in item 2) of this paragraph from the amount determined in item 1) of this paragraph, where the amount referred to in item 1) exceeds the amount referred to in item 2) of this paragraph:

  1. the sum of: ­ the unsecured part of each non-performing exposure, if any, multiplied by the applicable factor as determined in the regulation of the Central Bank governing the classification of assets and calculation of provisions for potential losses of a credit institution; and ­ the secured part of each non-performing exposure, if any, multiplied by the applicable factor as determined in the regulation of the Central Bank governing the classification of assets and calculation of provisions for potential losses of a credit institution;
  2. the sum of the following items provided they relate to the same non-performing exposure:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 47 ­ specific credit risk adjustments; ­ AVA in accordance with Articles 16 and 126 of this Decision; ­ other own funds reductions; ­ for credit institutions calculating risk-weighted exposure amounts using the Internal Ratings Based Approach, the absolute value of the amounts deducted pursuant to Article 19 item 4) of this Decision which relate to non￾performing exposures, where the absolute value attributable to each non￾performing exposure is determined by multiplying the amounts deducted pursuant to Article 19 item 4) of this Decision by the contribution of the expected loss amount for the non-performing exposure to total expected loss amounts for defaulted or non-defaulted exposures, as applicable; ­ where a non-performing exposure is purchased at a price lower than the amount owed by the debtor, the difference between the purchase price and the amount owed by the debtor; and ­ amounts written-off by the credit institution since the exposure was classified as non-performing. Subsection 2 - Exemptions from and alternatives to deduction from Common Equity Tier 1 items Threshold exemptions from deduction from Common Equity Tier 1 items Article 43 (1) A credit institution, when making the deductions required pursuant to Article 19 paragraph (1) items 3) and 9) of this Decision, shall not be required to deduct the amounts of the items referred to in items 1) and 2) of this paragraph, which in aggregate are equal to or less than the threshold amount referred to in paragraph (2) of this Article:

  1. deferred tax assets that are dependent on future profitability and arise from temporary differences, and in aggregate are equal to or less than 10% of the Common Equity Tier 1 items of the credit institution calculated after applying the following: ­ Articles 15 to 18 of this Decision; ­ Article 19 paragraph (1) items 1) to 8), items 12) to 15) of this Decision, excluding deferred tax assets that rely on future profitability and arise from temporary differences.
  2. where a credit institution has a significant holding in a financial sector entity, the direct, indirect and synthetic holdings of that credit institution of the Common Equity Tier 1 instruments of those entities that in aggregate are equal to or less than 10% of the Common Equity Tier 1 items of the credit institution calculated after applying the following: ­ Articles 15 to 18 of this Decision; ­ Article 19 paragraph (1) items 1) to 8), items 12) to 15) of this Decision excluding deferred tax assets that rely on future profitability and arise from temporary differences. (2) For the purposes of paragraph (1) of this Article, the threshold amount shall be equal to the amount referred to in item 1) of this paragraph multiplied by the percentage referred to in item 2) of this paragraph:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 48

  1. the residual amount of Common Equity Tier 1 items after applying the adjustments and deductions in Articles 15 to 19 of this Decision in full and without applying the threshold exemptions specified in this Article;
  2. 17.65%. (3) For the purposes of paragraph (1) of this Article, a credit institution shall determine the portion of deferred tax assets in the total amount of items that is not required to be deducted by dividing the amount specified in item 1) of this paragraph by the amount specified in item 2) of this paragraph:
  3. the amount of deferred tax assets that are dependent on future profitability and arise from temporary differences, and in aggregate are equal to or less than 10% of the Common Equity Tier 1 items of the credit institution;
  4. the sum of the following: ­ the amount referred to in item 1) of this paragraph, and ­ the amount of direct, indirect and synthetic holdings by the credit institution of the own funds instruments of financial sector entities in which the credit institution has a significant holding, and in aggregate are equal to or less than 10% of the Common Equity Tier 1 items of the credit institution. (4) The proportion of significant holdings in the total amount of items that is not required to be deducted is equal to 1 minus the proportion referred to in the paragraph (3) of this Article. (5) The amounts of the items that are not deducted pursuant to paragraph (1) of this Article shall be risk weighted at 250%. Requirement for deduction where consolidation and supplementary supervision are applied Article 44 (1) For the purposes of calculating own funds on an individual basis, a sub￾consolidated and a consolidated basis, where the Central Bank requires or authorises a credit institution to apply accounting consolidation method, deduction and aggregation method or book value/requirement deduction method referred to in regulations governing the supplementary supervision of financial conglomerates, the Central Bank may authorise credit institution not to deduct the holdings of own funds instruments of a financial sector entity in which the parent credit institution, parent financial holding company or parent mixed financial holding company or credit institution has a significant investment, provided that the following conditions are met:
  5. the financial sector entity is an insurance undertaking, a re-insurance undertaking or an insurance holding company;
  6. the insurance undertaking, re-insurance undertaking or insurance holding company is included in the same supplementary supervision in accordance with regulations governing the supplementary supervision of financial conglomerates as the parent credit institution, parent financial holding company or parent mixed financial holding company or credit institution that has the holding;
  7. the credit institution has received the prior authorisation from the Central Bank;
  8. prior to granting authorisation referred to in item 3) of this paragraph, and on a continuing basis, the Central Bank is satisfied that the level of integrated

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 49 management, risk management and internal controls regarding the entities that would be included in the scope of determined consolidation methods is adequate; 5) the holdings in the entity belong to one of the following: ­ the parent credit institution; ­ the parent financial holding company; ­ the parent mixed financial holding company; ­ the credit institution; ­ a subsidiary undertaking of one of the entities referred to in indents 1 to 4 of this item that is included in the scope of consolidation pursuant to the Law. (2) The chosen method referred to in paragraph (1) of this Article shall be applied in a consistent manner over time. (3) For the purposes of calculating own funds on an individual basis and a sub￾consolidated basis, a credit institution subject to supervision on a consolidated basis in accordance with the Law shall not deduct holdings of own funds instruments issued by financial sector entities included in the scope of consolidated supervision, unless the Central Bank determines those deductions to be required for specific purposes, in particular structural separation of banking activities and resolution planning. (4) The provisions of paragraph (3) of this Article shall not apply with regard to the deductions in accordance with Article 75 paragraph (7) of this Decision. (5) The holdings in respect of which deduction is not made in accordance with paragraph (1) of this Article shall qualify as exposures and shall be risk weighted in accordance with the provisions of this Decision that relate to the application of the Standardised Approach for the calculation capital requirements for credit risk. (6) The holdings in respect of which deduction is not made in accordance with paragraphs (3) and ($) of this Article qualify as exposures and shall be risk weighted at 100%. (7) Where a credit institution applies accounting consolidation method or deduction and aggregation method, the credit institution shall disclose the supplementary capital requirements and capital adequacy ratio of the financial conglomerate as calculated in accordance with the provisions of the law governing financial conglomerates. Section 4 - Common Equity Tier 1 capital Common Equity Tier 1 capital Article 45 The Common Equity Tier 1 capital of a credit institution shall consist of Common Equity Tier 1 items after the application of the adjustments required by Articles 15 to 18 of this Decision, the deductions pursuant to Article 19 and the exemptions and alternatives laid down in Articles 43, 44 and 104 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 50 SUBTITLE 3 - Additional Tier 1 capital Section 1 - Additional Tier 1 items and instruments Additional Tier 1 items Article 46 (1) Additional Tier 1 items shall consist of the following:

  1. capital instruments, where the conditions laid down in Article 47 paragraph (1) of this Decision are met;
  2. the share premium accounts related to the instruments referred to in item 1) of this paragraph. (2) Instruments referred to in paragraph (1) item 1) of this Article shall not qualify as Common Equity Tier 1 or Tier 2 items of the credit institution. Additional Tier 1 instruments Article 47 (1) Capital instruments shall qualify as Additional Tier 1 instruments only if the following conditions are met:
  3. a credit institution has directly issued the instruments and they are fully paid up;
  4. the instruments are not owned by any of the following: ­ the credit institution or its subsidiary undertakings; ­ an undertaking in which the credit institution has a participation in the form of ownership, direct or by way of control, of 20% or more of the voting rights or capital of that undertaking;
  5. the acquisition of the instruments is not funded directly or indirectly by the credit institution;
  6. the instruments rank below Tier 2 instruments in the event of the bankruptcy of the credit institution;
  7. the instruments are neither secured nor subject to a guarantee that enhances the seniority of the claims by any of the following: ­ the credit institution or its subsidiary undertakings; ­ the parent undertaking of the credit institution or its subsidiary undertakings; ­ the parent financial holding company or its subsidiary undertakings; ­ the mixed activity holding company or its subsidiary undertakings; ­ the mixed financial holding company or its subsidiary undertakings; or ­ any undertaking that has close links with entities referred to in indents 1 to 5 of this item;
  8. the instruments are not subject to any arrangement, contractual or otherwise, that enhances the seniority of the claim under the instruments in the case of bankruptcy or winding-up;
  9. the instruments are perpetual and the provisions governing them include no incentive for the credit institution to redeem them;
  10. where the provisions governing the instruments include one or more call options, the option to call may be exercised at the sole discretion of the issuer;
  11. the instruments may be called, redeemed or repurchased only where the conditions laid down in Article 87 of this Decision are met, and not before five

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 51 years after the date of issuance except where the conditions laid down in Article 88 paragraph (9) of this Decision are met; 10)the provisions governing the instruments do not indicate explicitly or implicitly that the instruments would or might be called, redeemed or repurchased by the credit institution, and the credit institution does not otherwise provide such an indication, except in the case of bankruptcy or winding-up of the credit institution; 11)the credit institution does not indicate explicitly or implicitly that the Central Bank would consent to a request to call, redeem or repurchase the instruments; 12)distributions under the instruments meet the following conditions: ­ they are paid out of distributable items; ­ the level of distributions made on the instruments will not be amended on the basis of the credit standing of the credit institution or its parent undertaking; ­ the provisions governing the instruments give the credit institution full discretion at all times to cancel the distributions on the instruments for an unlimited period and on a non-cumulative basis, and the credit institution may use such cancelled payments without restriction to meet its obligations as they fall due; ­ cancellation of distributions does not constitute an event of default of the credit institution; ­ the cancellation of distributions imposes no restrictions on the credit institution; 13)the instruments do not contribute to a determination that the liabilities of a credit institution exceed its assets, where such a determination is performed in accordance with the regulations governing the bankruptcy proceedings; 14)the provisions governing the instruments require that, upon the occurrence of a trigger event, the principal amount of the instruments be written down on a permanent or temporary basis or the instruments be converted to Common Equity Tier 1 instruments; 15)the provisions governing the instruments include no feature that could hinder the recapitalisation of the credit institution; 16)where the issuer is established in a third country and has been a part of a resolution group the resolution entity of which is established in Montenegro or the European Union or where the issuer is established in Montenegro or the European Union, the law or contractual provisions governing the instruments require that, upon a decision by the Central Bank as the resolution authority to exercise the write-down and conversion powers, the principal amount of the instruments is to be written down on a permanent basis or the instruments are to be converted to Common Equity Tier 1 instruments in accordance with the law governing the resolution of credit institutions; 17)where the issuer is established in third country and has not been a part of a resolution group the resolution entity of which is established in Montenegro or European Union, the law or contractual provisions governing the instruments require that, upon a decision by the relevant third-country authority, the principal amount of the instruments is to be written down on a permanent basis or the instruments are to be converted into Common Equity Tier 1 instruments; 18)where the issuer is established in a third country and has been a part of a resolution group the resolution entity of which is established in Montenegro or the European Union or where the issuer is established in Montenegro or

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 52 European Union, the instruments may only be issued under, or be otherwise subject to the laws of a third country where, under those laws, the exercise of the write-down and conversion powers is effective and enforceable on the basis of statutory provisions or legally enforceable contractual provisions that recognise resolution or other write-down or conversion actions; 19)the instruments are not subject to set-off or netting arrangements that would undermine their capacity to absorb losses. (2) For the purposes of paragraph (1) item 1) of this Article only the part of a capital instrument that is fully paid up shall be eligible to qualify as an Additional Tier 1 instrument. (3) For the purposes of paragraph (1) item 7) of this Article incentives to redeem shall mean all features that provide, at the date of issuance, an expectation that the capital instrument is likely to be redeemed. (4) The incentives to redeem referred to in paragraph (3) of this Article shall include the following forms:

  1. a call option combined with an increase in the credit spread of the instrument or the liability if the call is not exercised;
  2. a call option combined with a requirement or an investor option to convert the instrument into a Common Equity Tier 1 instrument where the call is not exercised;
  3. a call option combined with a change in reference rate where the credit spread over the second reference rate is greater than the initial payment rate minus the swap rate;
  4. a call option combined with an increase of the redemption amount in the future;
  5. a remarketing option combined with an increase in the credit spread of the instrument or a change in reference rate where the credit spread over the second reference rate is greater than the initial payment rate minus the swap rate where the instrument is not remarketed;
  6. a marketing of the instrument in a way which suggests to investors that the instrument will be called. Restrictions on the cancellation of distributions on Additional Tier 1 instruments and features that could hinder the recapitalisation of the institution Article 48 (1) For the purposes of Article 47 paragraph (1) item 12) indent 5 and item 15) of this Decision, the provisions governing Additional Tier 1 instruments shall not include in particular the following:
  7. a requirement for distributions on the instruments to be made in the event of a distribution being made on an instrument issued by the credit institution that ranks to the same degree as, or more junior than, an Additional Tier 1 instrument, including a Common Equity Tier 1 instrument;
  8. a requirement for the payment of distributions on Common Equity Tier 1, Additional Tier 1 or Tier 2 instruments to be cancelled in the event that distributions are not made on those Additional Tier 1 instruments;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 53 3) an obligation to substitute the payment of interest or dividend by a payment in any other form. (2) The credit institution shall not otherwise be subject to an obligation referred to in paragraph (1) item 3) of this Article. (3) Features that could hinder the recapitalisation of a credit institution, within the meaning of Article 47 paragraph (1) item 15) of this Decision, shall include provisions that require the credit institution to compensate existing holders of capital instruments where a new capital instrument is issued. Write down or conversion of Additional Tier 1 instruments Article 49 (1) For the purposes of Article 47 paragraph (1) item 14) of this Decision, the following provisions shall apply to Additional Tier 1 instruments:

  1. a trigger event occurs when the Common Equity Tier 1 capital ratio of the credit institution referred to Article 134 paragraph (2) item 1) of this Decision falls below either of the following: ­ 5,125 %; ­ a level higher than 5,125%, where determined by the credit institution and specified in the provisions governing the instrument;
  2. credit institution may specify in the provisions governing the instrument one or more trigger events in addition to that referred to in item 1) of this paragraph;
  3. where the provisions governing the instruments require them to be converted into Common Equity Tier 1 instruments upon the occurrence of a trigger event, those provisions shall specify either of the following: ­ the rate of such conversion and a limit on the permitted amount of conversion; ­ a range within which the instruments will convert into Common Equity Tier 1 instruments;
  4. where the provisions governing the instruments require their principal amount to be written down upon the occurrence of a trigger event, the write down shall reduce all the following: ­ the claim of the holder of the instrument in the bankruptcy or winding-up of the credit institution; ­ the amount required to be paid in the event of the call or redemption of the instrument; and ­ the distributions made on the instrument.
  5. where the Additional Tier 1 instruments have been issued by a subsidiary undertaking established in a third country, the 5.125% or higher trigger referred to in item 1) of this paragraph shall be calculated in accordance with the applicable regulations of that third country or contractual provisions governing the instruments, provided that the Central Bank is satisfied that those provisions are at least equivalent to the requirements set out in this Article. (2) Write down or conversion of an Additional Tier 1 instrument shall, under the applicable accounting framework, generate items that qualify as Common Equity Tier 1 items.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 54 (3) The amount of Additional Tier 1 instruments recognised in Additional Tier 1 items is limited to the minimum amount of Common Equity Tier 1 items that would be generated if the principal amount of the Additional Tier 1 instruments were fully written down or converted into Common Equity Tier 1 instruments. (4) The aggregate amount of Additional Tier 1 instruments that is required to be written down or converted upon the occurrence of a trigger event may be no less than the lower of the following:

  1. the amount required to restore fully the Common Equity Tier 1 ratio of the credit institution to 5.125%;
  2. the full principal amount of the instrument. (5) When a trigger event occurs, credit institution shall do the following:
  3. immediately notify the Central Bank thereof;
  4. notify the holders of the Additional Tier 1 instruments; and
  5. write down the principal amount of the instruments, or convert the instruments into Common Equity Tier 1 instruments without delay, but no later than within one month, in accordance with the requirement laid down in this Article. (6) A credit institution issuing Additional Tier 1 instruments to be converted to Common Equity Tier 1 on the occurrence of a trigger event shall ensure that its authorised share capital is at all times sufficient for converting all such convertible Additional Tier 1 instruments into shares if a trigger event occurs. (7) A credit institution shall obtain all necessary authorisations at the date of issuance of convertible Additional Tier 1 instruments referred to in paragraph (6) of this Article and the credit institution shall maintain at all times the necessary prior authorisation to issue the Common Equity Tier 1 instruments into which such Additional Tier 1 instruments would convert upon occurrence of a trigger event. (8) A credit institution issuing Additional Tier 1 instruments to be converted to Common Equity Tier 1 on the occurrence of a trigger event shall ensure that there are no procedural impediments to that conversion by virtue of its articles of incorporation or articles of association or contractual arrangements. Procedures and timing for determining the event triggering the write-down or conversion of Additional Tier 1 instruments Article 50 (1) Where the credit institution has established that the Common Equity Tier 1 ratio has fallen below the level specified in Article 49 paragraph (1) item 1) of this Decision that activates conversion or write- down of the instrument, the management body or any other relevant body of the credit institution shall without delay determine that a trigger event has occurred and there shall be an irrevocable obligation to write-down or convert the instrument. (2) The amount to be written-down or converted shall be determined as soon as possible and within a maximum period of one month from the time it is determined that the trigger event has occurred pursuant to paragraph (2) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 55 (3) The Central Bank may require that the maximum period of one month referred to in paragraph (2) of this Article is reduced in cases where it assesses that sufficient certainty on the amount to be converted or written down is established or in cases where it assesses that an immediate conversion or write-down is needed. (4) Where an independent review of the amount to be written down or converted is required according to the provisions governing the Additional Tier 1 instrument, or where the Central Bank requires an independent review for the determination of the amount to be written down or converted, the management body or any other relevant body of the credit institution shall see that this is done immediately. (5) The independent review shall be completed as soon as possible and shall not create impediments for the credit institution to write-down or convert the Additional Tier 1 instrument and to meet the requirements laid down in paragraphs (2) and (3) of this Article. Write-up of the principal amount following a write-down Article 51 (1) The write-down of the principal amount shall apply on a pro rata basis to all holders of Additional Tier 1 instruments that include a similar write-down mechanism and an identical trigger level. (2) The write-down shall be considered to be temporary, within the meaning of Article 47 paragraph (1) item 14) of this Decision, where the following conditions are met:

  1. any distributions payable after a write-down shall be based on the reduced amount of the principal;
  2. write-ups shall be based on profits after the credit institution has taken a formal decision confirming the final profits;
  3. any write-up of the instrument or payment of coupons on the reduced amount of the principal shall be operated at the full discretion of the credit institution subject to the constraints arising from items 4) to 6) of this paragraph and there shall be no obligation for the credit institution to operate or accelerate a write￾up under specific circumstances;
  4. a write-up shall be operated on a pro rata basis among similar Additional Tier 1 instruments that have been subject to a write-down;
  5. the maximum amount to be attributed to the sum of the write-up of the instrument together with the payment of coupons on the reduced amount of the principal shall be equal to the profit of the credit institution multiplied by the amount obtained by dividing the amount determined in indent 1 of this item by the amount determined in indent 2 of this item: ­ the sum of the nominal amount of all Additional Tier 1 instruments of the credit institution before write-down that have been subject to a write-down; ­ the total Tier 1 capital of the credit institution;
  6. the sum of any write-up amounts and payments of coupons on the reduced amount of the principal shall be treated as a payment that results in a reduction of Common Equity Tier 1 and shall be subject, together with other distributions on Common Equity Tier 1 instruments, to the restrictions relating to the maximum distributable amount as referred to in Article 167 of the Law.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 56 (3) For the purposes of paragraph (2) item 5) of this Article, the calculation shall be made at the moment when the write-up is operated. Use of special purpose entities for indirect issuance of own funds instruments Article 52 (1) For the purposes of Article 47 paragraph (1) item 16) and Article 61 item 16) paragraph (1) item 14) of this Decision, where the credit institution or an entity within the consolidation issues a capital instrument that is subscribed by a special purpose entity, this capital instrument shall not, at the level of the credit institution or of that entity included in consolidation, receive recognition as capital of a higher quality than the lowest quality of the capital issued to the special purpose entity and the capital issued to third parties by the special purpose entity. (2) The requirement referred to in paragraph (1) of this Article shall apply at the consolidated, sub-consolidated and individual levels of application of prudential requirements. (3) The rights of the holders of the instruments issued by a special purpose entity shall be no more favourable than if the instrument was issued directly by the credit institution or an entity within the consolidation. Consequences of the conditions for Additional Tier 1 instruments ceasing to be met Article 53 In the case an Additional Tier 1 instrument ceases meet the conditions laid down in Article 47 paragraph (1) of this Decision, the following shall apply:

  1. that instrument shall immediately cease to qualify as an Additional Tier 1 instrument; and
  2. the part of the share premium accounts that relates to that instrument shall immediately cease to qualify as an Additional Tier 1 item. Section 2 - Deductions from Additional Tier 1 items Deductions from Additional Tier 1 items Article 48 (1) A credit institution shall deduct the following from Additional Tier 1 items:
  3. direct, indirect and synthetic holdings by a credit institution of own Additional Tier 1 instruments, including own Additional Tier 1 instruments that a credit institution could be obliged to purchase as a result of existing contractual obligations;
  4. direct, indirect and synthetic holdings of the Additional Tier 1 instruments of financial sector entities with which the credit institution has reciprocal cross holdings that the Central Bank considers to have been designed to inflate artificially the own funds of the credit institution;
  5. the applicable amount of direct, indirect and synthetic holdings of the Additional Tier 1 instruments of financial sector entities determined in accordance with

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 57 Article 58 of this Decision, where a credit institution does not have a significant investment in those entities; 4) direct, indirect and synthetic holdings by the credit institution of the Additional Tier 1 instruments of financial sector entities where the credit institution has a significant investment in those entities, excluding underwriting positions held for five working days or fewer; 5) the amount of items required to be deducted from Tier 2 items pursuant to Article 64 of this Decision that exceeds the Tier 2 items of the credit institution; and 6) any tax charge relating to Additional Tier 1 items foreseeable at the moment of its calculation, except where the credit institution suitably adjusts the amount of Additional Tier 1 items insofar as such tax charges reduce the amount up to which those items may be applied to cover risks or losses. (2) For the purposes of paragraph (1) items 1), 3) and 4) of this Article, the provisions of Article 27 paragraphs (5) to (7) and Articles 32 to 35 of this Decision shall apply mutatis mutandis or with necessary corresponding changes, whereat references to Common Equity Tier 1 capital shall be read as references to Additional Tier 1 capital. Deductions of holdings of own Additional Tier 1 instruments Article 55 (1) For the purposes of Article 54 paragraph (1) item 1) of this Decision, a credit institution shall calculate holdings of own Additional Tier 1 instruments on the basis of gross long positions. (2) By way of derogation from paragraph (1) of this Article:

  1. a credit institution may calculate the amount of holdings of own Additional Tier 1 instruments on the basis of the net long position provided that both the following conditions are met: ­ the long and short positions are in the same underlying exposure and the short positions involve no counterparty risk; ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book;
  2. a credit institution shall determine the amount to be deducted for direct, indirect or synthetic holdings of index securities by calculating the underlying exposure to own Additional Tier 1 instruments in those indices;
  3. a credit institution may net gross long positions in own Additional Tier 1 instruments resulting from holdings of index securities against short positions in own Additional Tier 1 instruments resulting from short positions in the underlying indices, including where those short positions involve counterparty risk, provided that both the following conditions are met: ­ the long and short positions are in the same underlying indices; ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 58 Deduction of holdings of Additional Tier 1 instruments of financial sector entities and where a credit institution has a reciprocal cross holding designed artificially to inflate own funds Article 56 A credit institution shall make the deductions referred to in Article 54 paragraph (1) items 2), 3) and 4) of this Decision as follows:

  1. holdings of Additional Tier 1 instruments shall be calculated on the basis of the gross long positions;
  2. Additional Tier 1 own-fund insurance items shall be treated as holdings of Additional Tier 1 instruments for the purposes of deduction. Deduction of holdings of Additional Tier 1 instruments of financial sector entities Article 57 A credit institution shall make the deductions referred to in Article 54 paragraph (1) items 3) and 4) of this Decision as follows:
  3. they may calculate direct, indirect and synthetic holdings of Additional Tier 1 instruments of the financial sector entities on the basis of the net long position in the same underlying exposure provided that the following conditions are met: ­ the maturity date of the short position is either the same as, or later than the maturity date of the long position or the residual maturity of the short position is at least one year; ­ either both the short position and the long position are held in the trading book or both are held in the non-trading book.
  4. they shall determine the amount to be deducted for direct, indirect and synthetic holdings of index securities by calculating the underlying exposure to the capital instruments of the financial sector entities in those indices. Deduction of holdings of Additional Tier 1 instruments where a credit institution does not have a significant investment in a financial sector entity Article 58 (1) For the purposes of Article 54 paragraph (1) item 3) of this Decision, a credit institution shall calculate the applicable amount to be deducted by multiplying the amount referred to in item 1) of this paragraph by the factor derived from the calculation referred to in item 2) of this paragraph:
  5. the aggregate amount by which the direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1, Additional Tier 1 and Tier 2 instruments of financial sector entities in which the credit institution does not have a significant investment exceeds 10% of the Common Equity Tier 1 items of the credit institution calculated after applying the following: ­ Articles 15 to 18 of this Decision; ­ Article 19 paragraph (1) items 1) to 7), items 12) to 15) of this Decision, excluding deferred tax assets that rely on future profitability and arise from temporary differences; and ­ Articles 30 and 31 of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 59 2) the amount of direct, indirect and synthetic holdings by the credit institution of the Additional Tier 1 instruments of those financial sector entities in which the credit institution does not have a significant investment divided by the aggregate amount of all direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1, Additional Tier 1 and Tier 2 instruments of those financial sector entities. (2) A credit institution shall exclude underwriting positions held for five working days or fewer from the amount referred to in paragraph (1) item 1) of this Article and from the calculation of the factor referred to in paragraph (1) item 2) of this Article. (3) The amount to be deducted pursuant to paragraph (1) of this Article shall be apportioned across all Additional Tier 1 instruments held and the credit institution shall determine the amount of each Additional Tier 1 instrument to be deducted pursuant to paragraph (1) of this Article by multiplying the amount specified in item 1) of this paragraph by the proportion specified in item 2) of this paragraph:

  1. the amount of holdings required to be deducted pursuant to paragraph (1) of this Article;
  2. the proportion of the aggregate amount of direct, indirect and synthetic holdings by the credit institution of the Additional Tier 1 instruments of financial sector entities in which the institution does not have a significant investment represented by each Additional Tier 1 instrument held. (4) The amount of holdings referred to in Article 54 paragraph (1) item 3) of this Decision that is equal to or less than 10% of the Common Equity Tier 1 items of the credit institution after applying the provisions laid down in paragraph (1) item 1) indents 1, 2 and 3 of this Article shall not be deducted and shall be subject to the applicable risk weights for credit risk by applying Standardised Approach or IRB Approach and the requirements laid down in the provisions relating to market risk, as applicable. (5) A credit institution shall determine the amount of each Additional Tier 1 instrument that is risk weighted pursuant to paragraph (4) of this Article by multiplying the amount specified in item 1) of this paragraph by the amount specified in item 2) of this paragraph:
  3. the amount of holdings required to be risk weighted pursuant to paragraph (4) of this Article;
  4. the proportion resulting from the calculation in paragraph (3) item 2) of this Article. Section 3 - Additional Tier 1 capital Additional Tier 1 capital Article 59 The Additional Tier 1 capital of a credit institution shall consist of Additional Tier 1 items after the deduction of the items referred to in Article 54 and the application of Article 104 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 60 SUBTITLE 4 - Tier 2 capital Section 1 - Tier 2 items and instruments Tier 2 items Article 60 (1) Tier 2 capital items shall consist of the following:

  1. capital instruments where the conditions set out in Article 61 of this Decision are met, and to the extent specified in Article 62 of this Decision;
  2. the share premium accounts related to instruments referred to in item 1) of this paragraph;
  3. for credit institutions calculating risk-weighted exposure amounts in accordance with the Standardised Approach, general credit risk adjustments, gross of tax effects, of up to 1.25% of risk-weighted exposure amounts calculated in accordance with the Standardised Approach; and
  4. for credit institutions calculating risk-weighted exposure amounts in accordance with the IRB Approach, the IRB excess, where applicable, gross of tax effects, resulting from the calculation laid down in Article 200 of this Decision up to 0.6% of risk-weighted exposure amounts calculated under IRB Approach. (2) Items included under paragraph (1) item 1) of this Article shall not qualify as Common Equity Tier 1 or Additional Tier 1 items. Tier 2 instruments Article 61 (1) Capital instruments shall qualify as Tier 2 instruments, provided that the following conditions are met:
  5. the instruments are directly issued by a credit institution and they are fully paid up;
  6. the instruments are not owned by any of the following: ­ the credit institution or its subsidiary undertakings; ­ an undertaking in which the credit institution has participation in the form of ownership, direct or by way of control, of 20% or more of the voting rights or capital of that undertaking;
  7. the acquisition of ownership of the instruments is not funded directly or indirectly by the credit institution;
  8. the claim on the principal amount of the instruments under the provisions governing the instruments ranks below any claim from eligible liabilities instruments;
  9. the instruments are not secured or are not subject to a guarantee or other surety that enhances the seniority of the claim by any of the following entities: ­ the credit institution or its subsidiary undertakings; ­ the parent undertaking of the credit institution or its subsidiary undertakings; ­ the parent financial holding company or its subsidiary undertakings; ­ the mixed activity holding company or its subsidiary undertakings; ­ the mixed financial holding company or its subsidiary undertakings;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 61 ­ any undertaking that has close links with entities referred to in indents 1 to 5 of this item; 6) the instruments are not subject to any arrangement that otherwise enhances the seniority of the claim under the instruments; 7) the instruments have an original maturity of at least five years; 8) the provisions governing the instruments do not include any incentive for their principal amount to be redeemed or repaid, as applicable by the credit institution prior to their maturity; 9) where the instruments include one or more early repayment options, including call options, the options are exercisable at the sole discretion of the issuer; 10)the instruments may be called, redeemed, repaid or repurchased early only where the conditions set out in Article 87 of this Decision are met, and not before five years after the date of issuance, except where the conditions set out in Article 88 paragraph 9) of this Decision are met; 11)the provisions governing the instruments do not indicate explicitly or implicitly that the instruments would be called, redeemed, repaid or repurchased early, as applicable, by the credit institution other than in the case of the bankruptcy or winding-up of the credit institution and the credit institution does not otherwise provide such an indication; 12)the provisions governing the instruments do not give the holder the right to accelerate the future scheduled payment of interest or principal, other than in the case of the bankruptcy or winding-up of the credit institution; 13)the level of interest or dividends payments, as applicable, due on the instruments will not be amended on the basis of the credit standing of the credit institution or its parent undertaking; 14)where the issuer is established in a third country and has been designated as part of a resolution group the resolution entity of which is established in Montenegro or the European Union or where the issuer has its head office in Montenegro or the European Union, the law or contractual provisions governing the instruments require that, upon a decision passed by the Central Bank as the resolution authority for credit institutions, to exercise the write-down and conversion powers that refer to the principal amount of the instruments is to be written down on a permanent basis or the instruments are to be converted to Common Equity Tier 1 instruments specified by the law governing the resolution of credit institutions; 15)where the issuer is established in a third country and has not been designated as a part of a resolution group the resolution entity of which has its head office in Montenegro or the European Union, the law or contractual provisions governing the instruments require that, upon a decision by the relevant third￾country authority, the principal amount of the instruments is to be written down on a permanent basis or the instruments are to be converted into Common Equity Tier 1 instruments; 16)where the issuer is established in a third country and has been designated as part of a resolution group the resolution entity of which is established in Montenegro or the European Union or where the issuer has its head office in Montenegro or the European Union, the instruments may only be issued under, or be otherwise subject to the laws of a third country where, under those laws, the exercise of the write-down and conversion powers is effective and enforceable on the basis of statutory provisions or legally enforceable

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 62 contractual provisions that recognise resolution or other write-down or conversion actions; 17)the instruments are not subject to set-off or netting arrangements that would undermine their capacity to absorb losses. (2) For the purposes of paragraph (1) item 1) of this Article, only the part of the capital instrument that is fully paid up shall be eligible to qualify as a Tier 2 instrument. Amortisation of Tier 2 instruments Article 62 (1) The full amount of Tier 2 instruments with a residual maturity of more than five years shall qualify as Tier 2 items. (2) The extent to which Tier 2 instruments qualify as Tier 2 items during the final five years of maturity of the instruments is calculated by multiplying the result derived from the calculation referred to in item 1) of this paragraph by the amount referred to in item 2) of this paragraph as follows:

  1. the carrying amount of the instruments on the first day of the final five-year period of their contractual maturity divided by the number of days in that period;
  2. the number of remaining days of contractual maturity of the instruments. Consequences of the conditions for Tier 2 instruments ceasing to be met Article 63 Where in the case of a Tier 2 instrument the conditions laid down in Article 61 of this Decision cease to be met, the following shall apply:
  3. that instrument shall immediately cease to qualify as a Tier 2 instrument;
  4. the part of the share premium accounts that relate to that instrument shall immediately cease to qualify as Tier 2 items. Section 2 - Deductions from Tier 2 items Deductions from Tier 2 items Article 64 (1) The following shall be deducted from Tier 2 items:
  5. direct, indirect and synthetic holdings by a credit institution of own Tier 2 instruments, including own Tier 2 instruments that a credit institution could be obliged to purchase as a result of existing contractual obligations;
  6. direct, indirect and synthetic holdings of the Tier 2 instruments of financial sector entities with which the credit institution has reciprocal cross holdings that the Central Bank considers to have been designed to inflate artificially the own funds of the credit institution;
  7. the applicable amount determined in accordance with Article 68 of this Decision of direct, indirect and synthetic holdings of the Tier 2 instruments of financial sector entities, where a credit institution does not have a significant investment in those entities;
  8. direct, indirect and synthetic holdings by the credit institution of the Tier 2 instruments of financial sector entities where the credit institution has a

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 63 significant investment in those entities, excluding underwriting positions held for fewer than five working days; 5) the amount of items required to be deducted from eligible liabilities items pursuant to Article 75 of this Decision that exceeds the eligible liabilities items of the credit institution. (2) For the purposes of paragraph (1) items 1), 3) and 4) of this Article, the provisions of Article 27 paragraphs (5) to (7) and Articles 32 to 35 of this Decision shall apply mutatis mutandis or with necessary corresponding changes, whereat references to Common Equity Tier 1 capital shall be read as references to Tier 2 capital. Deductions of holdings of own Tier 2 instruments Article 65 (1) For the purposes of Article 64 item 1) of this Decision, a credit institution shall calculate holdings on the basis of the gross long positions. (2) By way of derogation from paragraph (1) of this Article:

  1. a credit institution may calculate the amount of holdings on the basis of the net long position provided that both the following conditions are met: ­ the long and short positions are in the same underlying exposure and the short positions involve no counterparty risk; ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book;
  2. a credit institution shall determine the amount to be deducted for direct, indirect and synthetic holdings of index securities by calculating the underlying exposure to own Tier 2 instruments in those indices;
  3. a credit institution may net gross long positions in own Tier 2 instruments resulting from holdings of index securities against short positions in own Tier 2 instruments resulting from short positions in the underlying indices, including where those short positions involve counterparty risk, provided that both the following conditions are met: ­ the long and short positions are in the same underlying indices; ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book. Deduction of holdings of Tier 2 instruments of financial sector entities and where a credit institution has a reciprocal cross holding designed artificially to inflate own funds Article 66 A credit institution shall make the deductions referred to in Article 64 items 2),
  4. and 4) of this Decision in the following manner:
  5. holdings of Tier 2 instruments shall be calculated on the basis of the gross long positions;
  6. holdings of Tier 2 own-fund insurance items and Tier 3 own-fund insurance items shall be treated as holdings of Tier 2 instruments for the purposes of deduction.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 64 Deduction of holdings of Tier 2 instruments of financial sector entities Article 67 A credit institution shall make the deductions referred to in Article 64 items 3) and 4) of this Decision in accordance with the following:

  1. a credit institution may calculate direct, indirect and synthetic holdings of Tier 2 instruments of the financial sector entities on the basis of the net long position in the same underlying exposure where the following conditions are met: ­ the maturity date of the short position is either the same as, or later than the maturity date of the long position or the residual maturity of the short position is at least one year; ­ either both the long position and the short position are held in the trading book or both are held in the non-trading book;
  2. a credit institution shall determine the amount to be deducted for direct, indirect and synthetic holdings of index securities by looking through to the underlying exposure to the capital instruments of the financial sector entities in those indices. Deduction of Tier 2 instruments where a credit institution does not have a significant investment in a relevant entity Article 68 (1) For the purposes of Article 64 item 3) of this Decision, a credit institution shall calculate the applicable amount to be deducted by multiplying the amount referred to in item 1) of this paragraph by the factor derived from the calculation referred to in item
  3. of this paragraph:
  4. the aggregate amount by which the direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1, Additional Tier 1 and Tier 2 instruments of financial sector entities in which the credit institution does not have a significant investment exceeds 10% of the Common Equity Tier 1 items of the credit institution calculated after applying the following: ­ Articles 15 to 18 of this Decision; ­ Article 19 paragraph (1) items 1) to 7), items 12) to 15) of this Decision, excluding the amount to be deducted for deferred tax assets that rely on future profitability and arise from temporary differences; ­ Articles 30 and 31 of this Decision;
  5. the amount of direct, indirect and synthetic holdings by the credit institution of the Tier 2 instruments of financial sector entities in which the credit institution does not have a significant investment divided by the aggregate amount of all direct, indirect and synthetic holdings by the institution of the Common Equity Tier 1, Additional Tier 1 and Tier 2 instruments of those financial sector entities. (2) A credit Institution shall exclude underwriting positions held for five working days or fewer from the amount referred to in paragraph (1) item 1) of this Article and from the calculation of the factor referred to in paragraph (1) item 2) of this Article. (3) The amount to be deducted pursuant to paragraph (1) of this Article shall be apportioned across each Tier 2 instrument held, and a credit institution shall determine the amount to be deducted from each Tier 2 instrument that is deducted pursuant to

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 65 paragraph (1) of this Article by multiplying the amount specified in item 1) of this paragraph by the proportion specified in point item 2) of this paragraph:

  1. the total amount of holdings required to be deducted pursuant to paragraph (1) of this Article;
  2. the proportion of the aggregate amount of direct, indirect and synthetic holdings by the credit institution of the Tier 2 instruments of financial sector entities in which the credit institution does not have a significant investment represented by each Tier 2 instrument held. (4) The amount of holdings referred to in Article 64 paragraph (1) item 3) of this Decision that is equal to or less than 10% of the Common Equity Tier 1 items of the credit institution after applying the provisions laid down in paragraph (1) item 1) indents 1 to 3 of this Article shall not be deducted and shall be subject to the applicable risk weights by applying Standardised Approach or IRB Approach and the requirements laid down in the provisions relating to market risk, as applicable. (5) A credit institution shall determine the amount of each Tier 2 instrument that is risk weighted pursuant to paragraph (4) of this Decision by multiplying the amount specified in item 1) of this paragraph by the amount specified in item 2) of this paragraph:
  3. the amount of holdings required to be risk weighted pursuant to paragraph (4) of this Article;
  4. the proportion resulting from the calculation in paragraph (3) item 2) of this Article. Section 3 - Tier 2 capital Tier 2 capital Article 69 The Tier 2 capital of a credit institution shall consist of the Tier 2 items of the credit institution after the deductions referred to in Article 64 and the application of Article 88 of this Decision. SUBTITLE 5 - Own funds Own funds Article 70 The own funds of a credit institution shall consist of the sum of its Tier 1 capital and Tier 2 capital.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 66 SUBTITLE 6 - Eligible liabilities Section 1 - Eligible liabilities items and instruments Eligible liabilities items Article 71 (1) Eligible liabilities shall consist of the following items, unless they fall into any of the categories of excluded liabilities laid down in paragraph (2) of this Article, and to the extent specified in Article 73 of this Decision:

  1. eligible liabilities instruments where the conditions set out in Article 72 of this Decision are met, to the extent that they do not qualify as Common Equity Tier 1, Additional Tier 1 or Tier 2 items;
  2. Tier 2 instruments with a residual maturity of at least one year, to the extent that they do not qualify as Tier 2 items in accordance with Article 62 of this Decision. (2) The following liabilities shall be excluded from eligible liabilities items:
  3. covered deposits;
  4. sight deposits and short-term deposits with an original maturity of less than one year;
  5. the part of eligible deposits from natural persons and micro, small and medium￾sized enterprises which exceeds the coverage level specified by the law governing the deposit protection;
  6. deposits that would be eligible deposits from natural persons, micro, small and medium–sized enterprises if they were not made through branches located outside Montenegro of credit institutions with their head offices in Montenegro;
  7. secured liabilities, including covered bonds and liabilities in the form of financial instruments used for hedging purposes that form an integral part of the cover pool and that in accordance with applicable regulations are secured in a manner similar to covered bonds, provided that all secured assets relating to a covered bond cover pool remain unaffected, segregated and with enough funding and excluding any part of a secured liability or a liability for which collateral has been pledged that exceeds the value of the assets, pledge, lien or collateral against which it is secured;
  8. any liability that arises by virtue of the holding of client assets or client money including client assets or client money held on behalf of collective investment undertakings, provided that such a client is protected under the applicable regulations governing bankruptcy;
  9. any liability that arises by virtue of a fiduciary relationship between the resolution entity or any of its subsidiary undertakings (as fiduciary) and another person (as beneficiary), provided that such a beneficiary is protected under the applicable regulations governing bankruptcy or other applicable regulation;
  10. liabilities to credit institutions, excluding liabilities to entities that are part of the same group, with an original maturity of less than seven days;
  11. liabilities with a remaining maturity of less than seven days and which are owed to recognised central counterparty of a third-country; 10)a liability to any of the following persons: ­ an employee in relation to accrued salary, pension benefits or other fixed remuneration, except for the variable component of the remuneration that

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 67 is not regulated by a collective agreement, and except for the variable component of the remuneration of persons referred to in Article 124 paragraph (2) of the Law whose performance of assignments and activities within their powers may significantly impact the risk profile of a credit institution; ­ a commercial partner or trade creditor where the liability arises from the provision to the credit institution or the parent undertaking of goods or services that are critical to the daily functioning of the credit institution's or parent undertaking's operations, including IT services, utilities and the rental (leasing), servicing and upkeep of premises; ­ tax and social security authorities, provided that those liabilities are preferred under the applicable law; ­ deposit guarantee schemes where the liability arises from contributions due in accordance with the law governing the deposit protection; 11)liabilities arising from derivatives; 12)liabilities arising from debt instruments with embedded derivatives. (3) For the purposes of paragraph (2) item 12) of this Article, debt instruments containing early redemption options exercisable at the discretion of the issuer or of the holder, and debt instruments with variable interests derived from a broadly used reference rate such as Euribor or Libor, shall not be considered as debt instruments with embedded derivatives solely because of such features. Eligible liabilities instruments Article 72 (1) Liabilities of a credit institution shall qualify as eligible liabilities instruments, provided that they comply with the conditions set out in this Article and only to the extent specified in this Article. (2) Liabilities shall qualify as eligible liabilities instruments, where the following conditions are met:

  1. the liabilities are directly issued or raised, as applicable, by a credit institution and are fully paid up;
  2. the liabilities are not owned by any of the following entities: ­ the credit institution or an entity included in the same resolution group; ­ an undertaking in which the credit institution has a direct or indirect participation in the form of ownership, direct or by way of control, of 20% or more of the voting rights or capital of that undertaking;
  3. the acquisition of ownership of the liabilities is not funded directly or indirectly by the resolution entity;
  4. the claim on the principal amount of the liabilities under the provisions governing the instruments is fully subordinated to claims arising from the excluded liabilities referred to in Article 71 paragraph (2) of this Decision, and subordination requirement shall be considered to be met if: ­ the contractual provisions governing the liabilities specify that in the event of normal bankruptcy proceedings, the claim on the principal amount of the instruments ranks below claims arising from any of the excluded liabilities referred to in Article 71 paragraph (2) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 68 ­ the applicable law specifies that in the event of normal bankruptcy proceedings, the claim on the principal amount of the instruments ranks below claims arising from any of the excluded liabilities referred to in Article 71 paragraph (2) of this Decision; or ­ the instruments are issued by a resolution entity which does not have on its balance sheet any excluded liabilities as referred to in Article 71 paragraph (2) of this Decision that rank pari passu or junior to eligible liabilities instruments; 5) the liabilities are neither secured, nor subject to a guarantee or surety or any other arrangement that enhances the seniority of the claim by any of the following: ­ the credit institution or its subsidiary undertakings; ­ the parent undertaking of the credit institution or its subsidiary undertakings; or ­ any undertaking that has close links with entities referred to in indents 1 and 2 of this item; 6) the liabilities are not subject to set-off or netting arrangements that would undermine their capacity to absorb losses in resolution; 7) the provisions governing the liabilities do not include any incentive for their principal amount to be called, redeemed or repurchased prior to their maturity or repaid early by the credit institution, as applicable, except in the cases referred to in Article 73 paragraph (3) of this Decision; 8) the liabilities are not redeemable by the holders of the instruments prior to their maturity, except in the cases referred to in Article 71 paragraph (2) of this Decision; 9) subject to Article 73 paragraphs (3) and (4) of this Decision, where the liabilities include one or more early repayment options, including call options, the options are exercisable at the sole discretion of the issuer, except in the cases referred to in Article 73 paragraph (2) of this Decision; 10)the liabilities may only be called, redeemed, repaid or repurchased early where the conditions set out in Articles 87 and 95 of this Decision are met; 11)the provisions governing the liabilities do not indicate explicitly or implicitly that the liabilities would be called, redeemed, repaid or repurchased early, as applicable by the resolution entity other than in the case of the bankruptcy or winding-up of the credit institution and the credit institution does not otherwise provide such an indication; 12)the provisions governing the liabilities do not give the holder the right to accelerate the future scheduled payment of interest or principal, other than in the case of the bankruptcy or winding-up of the resolution entity; 13)the level of interest or dividend payments, as applicable, due on the liabilities is not amended on the basis of the credit standing of the resolution entity or its parent undertaking; 14)for instruments issued after 1 January 2022, the relevant contractual documentation and, where applicable, the prospectus related to the issuance explicitly refer to the possible exercise of the write-down and conversion powers in accordance with the law governing the resolution of credit institutions. (3) For the purposes of paragraph (2) item 1) of this Article, only the parts of liabilities that are fully paid up shall be eligible to qualify as eligible liabilities instruments.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 69 (4) For the purposes of paragraph (2) item 4) of this Article, where some of the excluded liabilities referred to in Article 71 paragraph (2) of this Decision are subordinated to ordinary unsecured claims under applicable regulations governing bankruptcy proceedings, inter alia, due to being held by a creditor who has close links with the debtor, by being or having been a shareholder, in a control or group relationship, a member of the management body or related to any of those persons, subordination shall not be assessed by reference to claims arising from such excluded liabilities. (5) In addition to the liabilities referred to in paragraph (2) of this Article, the Central Bank as the resolution authority may authorise liabilities to qualify as eligible liabilities instruments up to an aggregate amount that does not exceed 3.5% of the total risk exposure amount calculated in accordance with Article 114 paragraph (3) of this Decision, where:

  1. all the conditions set out in paragraphs (2) to (4) of this Article are met, except for the condition set out in paragraph (2) item 4) of this Article;
  2. the liabilities rank pari passu with the lowest ranking excluded liabilities referred to in Article 71 paragraph (2) of this Article with the exception of the excluded liabilities that are subordinated to ordinary unsecured claims under applicable regulations governing bankruptcy proceedings referred to in paragraph (4) of this Article; and
  3. the inclusion of those liabilities in eligible liabilities items would not give rise to a material risk of a successful legal challenge or of valid compensation claims as assessed by the Central Bank as the resolution authority. (6) The Central Bank may, as the resolution authority, authorise liabilities to qualify as eligible liabilities instruments in addition to the liabilities referred to in paragraph (2) of this Article, where:
  4. the credit institution is not authorised to include in eligible liabilities items the liabilities referred to in paragraph (5) of this Article;
  5. all the conditions set out in paragraphs (2) to (4) of this Article are met, except for the condition set out in paragraph (2) item 4) of this Article;
  6. the liabilities rank pari passu or are senior to the lowest ranking excluded liabilities referred to in Article 71 paragraph (2) of this Decision, with the exception of the excluded liabilities subordinated to ordinary unsecured claims under applicable regulations governing bankruptcy proceedings referred to in paragraph (4) of this Article;
  7. on the balance sheet of the credit institution, the amount of the excluded liabilities referred to in Article 71 paragraph (2) of this Decision which rank pari passu or below those liabilities in bankruptcy proceedings does not exceed 5% of the amount of the own funds and eligible liabilities of the credit institution;
  8. the inclusion of those liabilities in eligible liabilities items would not give rise to a material risk of a successful legal challenge or of valid compensation claims as assessed by the Central Bank as the resolution authority. (7) The Central Bank may, as a resolution authority, only authorise a credit institution to include liabilities referred to either in paragraph (5) or (6) of this Article as eligible liabilities items.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 70 (8) The resolution function of the Central Bank organised in accordance with the law governing the resolution of credit institutions shall consult the supervisory function of the Central Bank when examining whether the conditions set out in this Article are fulfilled. Amortisation of eligible liabilities instruments Article 73 (1) Eligible liabilities instruments with a residual maturity of at least one year shall fully qualify as eligible liabilities items. (2) Eligible liabilities instruments with a residual maturity of less than one year shall not qualify as eligible liabilities items. (3) For the purposes of paragraph (1) of this Article, where an eligible liabilities instrument includes a holder redemption option exercisable prior to the stated original maturity of the instrument, the maturity of the instrument shall be defined as the earliest possible date on which the holder can exercise the redemption option and request redemption or repayment of the instrument. (4) For the purposes of paragraph (1) of this Article, where an eligible liabilities instrument includes an incentive for the issuer to call, redeem, repay or repurchase the instrument prior to the stated original maturity of the instrument, the maturity of the instrument shall be defined as the earliest possible date on which the issuer can exercise that option and request redemption or repayment of the instrument. (5) For the purposes of paragraph (1) of this Article, where an eligible liabilities instrument includes early redemption options that are exercisable at the sole discretion of the issuer prior to the stated original maturity of the instrument, but where the provisions governing the instrument do not include any incentive for the instrument to be called, redeemed, repaid or repurchased prior to its maturity and do not include any option for redemption or repayment at the discretion of the holders, the maturity of the instrument shall be defined as the stated original maturity. Consequences of the eligibility conditions ceasing to be met Article 74 (1) Where an eligible liabilities instrument ceases to meet the applicable conditions set out in Article 72 of this Decision, the liabilities shall immediately cease to qualify as eligible liabilities instruments. (2) Liabilities referred to in Article 72 paragraph (2) of this Decision may continue to count as eligible liabilities instruments as long as they qualify as eligible liabilities instruments under Article 72 paragraph (5) or (6) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 71 Section 2 - Deductions from eligible liabilities items Deductions from eligible liabilities items Article 75 (1) A credit institution that is subject to Article 117 of this Decision shall deduct the following from eligible liabilities items:

  1. direct, indirect and synthetic holdings by the credit institution of own eligible liabilities instruments, including own liabilities that that credit institution could be obliged to purchase as a result of existing contractual obligations;
  2. direct, indirect and synthetic holdings by the credit institution of eligible liabilities instruments of G-SII entities with which the credit institution has reciprocal cross holdings that the Central Bank considers to have been designed to artificially inflate the loss absorption and recapitalisation capacity of the resolution entity;
  3. the applicable amount determined in accordance with Article 79 of this Decision of direct, indirect and synthetic holdings of eligible liabilities instruments of G￾SII entities, where the credit institution does not have a significant investment in those entities; and
  4. direct, indirect and synthetic holdings by the credit institution of eligible liabilities instruments of G-SII entities, where the credit institution has a significant investment in those entities, excluding underwriting positions held for five business days or fewer. (2) For the purposes of this Section, all instruments ranking pari passu with eligible liabilities instruments shall be treated as eligible liabilities instruments, with the exception of instruments ranking pari passu with instruments recognised as eligible liabilities pursuant to Article 72 paragraphs (5) and (6) of this Decision. (3) For the purposes of this Section, a credit institution may calculate the amount of holdings of the eligible liabilities instruments referred to in Article 72 paragraph (5) of this Decision as follows: ℎ = �(𝐻𝐻𝑖𝑖 ∙ 𝑙𝑙𝑖𝑖 𝐿𝐿𝑖𝑖 ) 𝑖𝑖 where: ℎ = the amount of holdings of the eligible liabilities instruments referred to in Article 72 paragraph (5) of this Decision; 𝑖𝑖 = the index denoting the issuing credit institution; 𝐻𝐻𝑖𝑖 = the total amount of holdings of eligible liabilities of the issuing credit institution i referred to in 72 paragraph (5) of this Decision; 𝑙𝑙𝑖𝑖 = the amount of liabilities included in eligible liabilities items by the issuing credit institution i within the limits specified in Article 72 paragraph (5) of this Decision according to the latest disclosures by the issuing credit institution; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 72 𝐿𝐿 = the total amount of the outstanding liabilities of the issuing credit institution i referred to in Article 72 paragraph (5) of this Decision according to the latest disclosures by the issuer. (4) Where a parent institution in Montenegro that is subject to Article 117 of this Decision has direct, indirect or synthetic holdings of own funds instruments or eligible liabilities instruments of one or more subsidiary undertakings which do not belong to the same resolution group as the credit institution which is a parent undertaking, the Central Bank, as the resolution authority of that parent credit institution, after duly considering the opinion of the resolution authorities or relevant third-country authorities of any subsidiary undertakings concerned, may permit the credit institution which is a parent undertaking to deduct such holdings by deducting a lower amount specified by the Central Bank as the resolution authority of that credit institution which is a parent undertaking. (5) The adjusted amount shall be at least equal to the amount (m) calculated as follows: mi = max�0; OPi + LPi − max{0; β ∙ [Oi + Li − max{ri ∙ aRWAi; wi ∙ aLREi}]}�, where: i = the index denoting the subsidiary; OPi = the amount of own funds instruments issued by subsidiary undertaking and held by the credit institution which is a parent undertaking; LPi = the amount of eligible liabilities instruments issued by subsidiary undertaking and held by the credit institution which is a parent undertaking; β = percentage of own funds instruments and eligible liabilities instruments issued by subsidiary undertaking and held by credit institution which is a parent undertaking, calculated as follows: β = OPi + LPi the amount of all own funds instruments and eligible liabilities instruments issued by subsidiary i Oi = the amount of own funds of subsidiary undertaking i, not taking into account the deduction calculated in accordance with this paragraph; Li = the amount of eligible liabilities of subsidiary undertaking i, not taking into account the deduction calculated in accordance with this paragraph; ri = the ratio applicable to subsidiary undertaking i at the level of its resolution group in accordance with Article 117 paragraph (1) item 1) of this Article and regulation governing the method for determining minimum requirement for own funds and eligible liabilities of credit institutions and the reporting method or for third-country subsidiary undertaking, an equivalent resolution requirement applicable to subsidiary undertaking i in the third country where it has its head office, insofar as that requirement is met with instruments that would be considered own funds or eligible liabilities under this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 73 aRWAi = the total risk exposure amount of the G-SII entity i calculated in accordance with Article 114 paragraph (3) of this Decision and Article 117 applied to each resolution entity and parent undertaking on a consolidated basis; wi = the ratio applicable to subsidiary undertaking i at the level of its resolution group in accordance with Article 117 paragraph (1) item 2) of this Decision and regulation governing the method for determining minimum requirement for own funds and eligible liabilities of credit institutions and the reporting method or for third-country subsidiary undertaking, an equivalent resolution requirement applicable to subsidiary undertaking i in the third country where it has its head office, insofar as that requirement is met with instruments that would be considered own funds or eligible liabilities under this Decision; aLREi = the total exposure measure of the G-SII entity i calculated in accordance with Article 563 paragraph (4) of this Decision or, for third-country subsidiaries, calculated in accordance with the applicable local regulations. (6) Where the credit institution which is a parent undertaking is allowed to deduct the adjusted amount in accordance with paragraphs (4) and (5) of this Article, the subsidiary undertaking shall deduct the difference between the amount of holdings of own funds instruments and eligible liabilities instruments referred to in paragraphs (4) and (5) of this Article and that adjusted amount. (7) A credit institution shall deduct from eligible liabilities items their holdings of own funds instruments and eligible liabilities instruments where the following conditions are met:

  1. the own funds instruments and eligible liabilities instruments are held by a credit institution or entity that is not itself a resolution entity but that is a subsidiary undertaking of a resolution entity or of a third-country entity that would be a resolution entity if it were established in Montenegro or the EU;
  2. the credit institution or entity referred to in item 1) of this paragraph is required to comply with the requirements laid down in Article 118 of this Decision and Article 32 of the Law on Resolution of Credit Institutions;
  3. the own funds instruments and eligible liabilities instruments held by the credit institution or entity referred to in item 1) of this paragraph were issued by a credit institution or entity referred to in Article 118 of this Decision and Article 32 of the Law on Resolution of Credit Institutions that is not itself a resolution entity and that belongs to the same resolution group as the credit institution or entity referred to in item 1) of this paragraph. (8) By way of derogation from paragraph (7) of this Article, holdings of own funds instruments and eligible liabilities instruments shall not be deducted where the credit institution or entity referred to in paragraph (7) item 1) of this Article is required to comply with the requirement referred to in paragraph (7) item 2) of this Article on a consolidated basis and the credit institution or entity referred to in paragraph (7) item
  4. of this Article is included in the consolidation of the credit institution or entity referred to in paragraph (7) item 1) of this Article. (9) For the purposes of paragraphs (7) and (8) of this Article, the reference to eligible liabilities items shall be understood as a reference to any of the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 74 eligible liabilities items taken into account for the purposes of complying with the requirement laid down in Article 118 of this Decision; liabilities that meet the conditions set out in Article 7 paragraph (2) of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method. (10) For the purposes of paragraphs (7) and (8) of this Article, the reference to own funds instruments and eligible liabilities instruments shall be understood as a reference to any of the following:

  1. own funds instruments and eligible liabilities instruments that meet the conditions set out in Article 118 paragraphs (2) and (3) of this Decision;
  2. own funds and liabilities that meet the conditions set out in Article 7 paragraphs (2) and (3) of Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method. Deduction of holdings of own eligible liabilities instruments Article 76 (1) For the purposes of Article 75 paragraph (1) item 1) of this Decision, a credit institution shall calculate holdings on the basis of the gross long positions. (2) By way of derogation from paragraph (1) of this Article:
  3. credit institution may calculate the amount of holdings on the basis of the net long position, provided that both the following conditions are met: ­ the long and short positions are in the same underlying exposure and the short positions involve no counterparty risk; ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book;
  4. credit institution shall determine the amount to be deducted for direct, indirect and synthetic holdings of index securities by calculating the underlying exposure to own eligible liabilities instruments in those indices; ­ credit institution may net gross long positions in own eligible liabilities instruments resulting from holdings of index securities against short positions in own eligible liabilities instruments resulting from short positions in underlying indices, including where those short positions involve counterparty risk, provided that both the following conditions are met: ­ the long and short positions are in the same underlying indices; and ­ either both the long and the short positions are held in the trading book or both are held in the non-trading book. Deduction base for eligible liabilities items Article 77 For the purposes of Article 75 paragraph (1) items 2), 3) and 4) of this Decision, a credit institution shall deduct the gross long positions subject to the exceptions laid down in Articles 78 and 79 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 75 Deduction of holdings of eligible liabilities of other G-SII entities Article 78 A credit institution that does not apply the exception set out in Article 80 of this Decision shall make the deductions referred to in Article 75 paragraph (1) items 3) and 4) of this Decision in accordance with the following:

  1. they may calculate direct, indirect and synthetic holdings of eligible liabilities instruments on the basis of the net long position in the same underlying exposure, provided that the following conditions are met: ­ the maturity date of the short position is either the same as, or later than the maturity date of the long position or the residual maturity of the short position is at least one year; and ­ either both the long position and the short position are held in the trading book or both are held in the non-trading book;
  2. they shall determine the amount to be deducted for direct, indirect and synthetic holdings of index securities by looking through to the underlying exposure to the eligible liabilities instruments in those indices. Deduction of eligible liabilities where the credit institution does not have a significant investment in G-SII entities Article 79 (1) For the purposes of Article 75 paragraph (1) item 3) of this Decision, a credit institution shall calculate the applicable amount to be deducted by multiplying the amount referred to in item 1) of this paragraph by the factor derived from the calculation referred to in item 2) of this paragraph:
  3. the aggregate amount by which the direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1, Additional Tier 1, Tier 2 instruments of financial sector entities and eligible liabilities instruments of G￾SII entities in none of which the credit institution has a significant investment exceeds 10% of the Common Equity Tier 1 items of the credit institution calculated after applying the following: ­ Articles 15 to 18 of this Decision; ­ Article 19 paragraph (1) items 1) to 7), items 12) to 15) of this Decision, excluding the amount to be deducted for deferred tax assets that rely on future profitability and arise from temporary differences; ­ Articles 30 and 31 of this Decision;
  4. the amount of direct, indirect and synthetic holdings by the credit institution of the eligible liabilities instruments of G-SII entities in which the credit institution does not have a significant investment divided by the aggregate amount of the direct, indirect and synthetic holdings by the credit institution of the Common Equity Tier 1, Additional Tier 1, Tier 2 instruments of financial sector entities and eligible liabilities instruments of G-SII entities in none of which the resolution entity has a significant investment. (2) A credit institution shall exclude underwriting positions held for five business days or fewer from the amounts referred to in paragraph (1) item 1) of this Article and from the calculation of the factor in accordance with paragraph (1) item 2) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 76 (3) The amount to be deducted pursuant to paragraph (1) of this Article shall be apportioned across each eligible liabilities instrument of a G-SII entity held by the credit institution, and the amount of each eligible liabilities instrument that is deducted pursuant to paragraph (1) of this Article shall be determined by multiplying the amount specified in item 1) of this paragraph by the proportion specified in item 2) of this paragraph:

  1. the amount of holdings required to be deducted pursuant to paragraph (1) of this Article;
  2. the proportion of the aggregate amount of direct, indirect and synthetic holdings by the credit institution of the eligible liabilities instruments of G-SII entities in which the credit institution does not have a significant investment represented by each eligible liabilities instrument held by the credit institution. (4) The amount of holdings referred to in Article 75 paragraph (1) item 3) of this Decision that is equal to or less than 10% of the Common Equity Tier 1 items of the credit institution after applying the provisions laid down paragraph (1) item 1) indents 1 to 3 of this Article shall not be deducted and shall be subject to the applicable risk weights for credit risk by applying the Standardised Approach or IRB Approach and the requirements laid down in the provisions that relate to market risk, as applicable. (5) A credit institution shall determine the amount of each eligible liabilities instrument that is risk weighted pursuant to paragraph (4) of this Article by multiplying the amount of holdings required to be risk weighted pursuant to paragraph (4) of this Article by the proportion resulting from the calculation specified in paragraph (3) item 2) of this Article. Trading book exception from deductions from eligible liabilities items Article 80 (1) A credit institution may decide not to deduct a designated part of their direct, indirect and synthetic holdings of eligible liabilities instruments, that in aggregate and measured on a gross long position basis is equal to or less than 5% of the Common Equity Tier 1 items of the credit institution after applying Articles 15 to 19 of this Decision, provided that all the following conditions are met:
  3. the holdings are in the trading book; and
  4. the eligible liabilities instruments are held for no longer than 30 business days. (2) The amounts of the items that are not deducted pursuant to paragraph (1) of this Article shall be subject to own funds requirements for items in the trading book. (3) Where, in the case of holdings not deducted in accordance with paragraph (1) of this Article, the conditions set out in that paragraph cease to be met, the holdings shall be deducted in accordance with Article 77 of this Decision without applying the exceptions laid down in Articles 78 and 79 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 77 Section 3 - Own funds and eligible liabilities Eligible liabilities Article 81 The eligible liabilities of a credit institution shall consist of the eligible liabilities items of the credit institution after the deductions referred to in Article 75 of this Decision. Own funds and eligible liabilities Article 82 The own funds and eligible liabilities of a credit institution shall consist of the sum of its own funds and its eligible liabilities. SUBTITLE 7 - General requirements for own funds and eligible liabilities Distributions on instruments Article 83 (1) Capital instruments and liabilities for which a credit institution has the sole discretion to decide to pay distributions in a form other than cash or own funds instruments shall not be eligible to qualify as Common Equity Tier 1, Additional Tier 1, Tier 2 or eligible liabilities instruments, unless the credit institution has received the prior authorisation of the Central Bank. (2) The Central Bank shall grant the prior authorisation referred to in paragraph (1) of this Article only where they consider all the following conditions to be met:

  1. the ability of the credit institution to cancel payments under the instrument would not be adversely affected by the discretion referred to in paragraph (1) of this Article, or by the form in which distributions could be made;
  2. the ability of the capital instrument or of the liability to absorb losses would not be adversely affected by the discretion referred to in paragraph (1) of this Article, or by the form in which distributions could be made;
  3. the quality of the capital instrument or liability would not otherwise be reduced by the discretion referred to in paragraph (1) of this Article, or by the form in which distributions could be made. (3) The supervisory function of the Central Bank shall consult the resolution function of the Central Bank regarding a credit institution's compliance with the conditions referred to in paragraph (2) of this Article before granting the prior authorisation referred to in paragraph (1) of this Article. (4) Capital instruments and liabilities for which a legal person other than the credit institution issuing them has the discretion to decide or require that the payment of distributions on those instruments or liabilities shall be made in a form other than cash or own funds instruments shall not be eligible to qualify as Common Equity Tier 1, Additional Tier 1, Tier 2 or eligible liabilities instruments.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 78 (5) A credit institution may use a broad market index as one of the bases for determining the level of distributions on Additional Tier 1, Tier 2 and eligible liabilities instruments. (6) Provision of paragraph (5) of this Article shall not apply where the credit institution is a reference entity in that broad market index unless the following conditions are met:

  1. the credit institution considers movements in that broad market index not to be significantly correlated to the credit standing of the credit institution, its parent credit institution or parent financial holding company or parent mixed financial holding company or parent mixed activity holding company; and
  2. the Central Bank has not reached a different determination from that referred to in item 1) of this paragraph. (7) Credit institution shall report and disclose the broad market indices on which their capital instruments and eligible liabilities instruments rely. (8) An interest rate index shall be deemed to be a broad market index if it fulfils all of the following conditions:
  3. it is used to set interbank lending rates in one or more currencies;
  4. it is used as a reference rate for floating rate debt issued by the credit institution in the same currency, where applicable;
  5. it is calculated as an average rate by a body independent of the credit institutions that are contributing to the index (‘panel’);
  6. each of the rates set under the index is based on quotes submitted by a panel of institutions active in that interbank market;
  7. the composition of the panel referred to in item 3) of this paragraph ensures a sufficient level of representativeness of institutions present in Montenegro or the EU. (9) For the purposes of paragraph (8) item 5) of this Article, a sufficient level of representativeness shall be deemed to be achieved in either of the following cases:
  8. where the panel referred to in paragraph (8) item 3) of this Article includes at least 6 different contributors before any discount of quotes is applied for the purposes of setting the rate; or
  9. where all of the following conditions are met: ­ the panel referred to in paragraph (8) item 3) of this Article includes at least 4 different contributors before any discount of quotes is applied for the purposes of setting the rate; ­ the contributors to the panel referred to in paragraph (8) item 3) of this Article represent at least 60% of the related market. (10) The related market referred to in paragraph (9) item 2) indent 2 of this Article shall be the sum of assets and liabilities of the effective contributors to the panel in the domestic currency divided by the sum of assets and liabilities in the domestic currency of credit institutions and money market funds. (11) A stock index shall be deemed to be a broad market index where it is appropriately diversified in accordance with Article 508 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 79 Holdings of capital instruments issued by regulated financial sector entities that do not qualify as own funds Article 84 A credit institution shall not deduct from any element of own funds direct, indirect or synthetic holdings of capital instruments issued by a regulated financial sector entity that do not qualify as own funds of that entity and it shall apply risk weights to such holdings for credit risk by applying Standardised Approach. Deduction and maturity requirements for short positions Article 85 The maturity requirements for short positions referred to in Article 31 paragraph (1) item 1), Article 57 paragraph (1) item 1), Article 671 item 1) and Article 78 item 1) of this Decision shall be considered to be met in respect of positions held where all the following conditions are met:

  1. the credit institution has the contractual right to sell on a specific future date to the counterparty providing the hedge the long position that is being hedged; and
  2. the counterparty providing the hedge to the credit institution is contractually obliged to purchase from the credit institution on that specific future date the long position referred to in item 1) of this paragraph. Index holdings of capital instruments Article 86 (1) For the purposes of Article 28 paragraph (1) item 1), Article 31 paragraph (1) item 1), Article 55 paragraph (1) item 1), Article 57 item 1), Article 65 paragraph (2) item 1), Article 76 paragraph (2) item 1) and Article 78 item 1) of this Decision, a credit institution may reduce the amount of a long position in a capital instrument by the portion of an index that is made up of the same underlying exposure that is being hedged, where the following conditions are met:
  3. either both the long position being hedged and the short position in an index used to hedge that long position are held in the trading book or both are held in the non-trading book;
  4. the positions referred to in item 1) of this paragraph are held at fair value on the balance sheet of the credit institution;
  5. the short position referred to in item 1) of this paragraph qualifies as an effective hedge under the internal control processes of the credit institution; and
  6. the Central Bank assess the adequacy of the internal control processes referred to in item 3) of this paragraph on at least an annual basis. (2) Where the Central Bank has granted its prior authorisation, a credit institution may use a conservative estimate of the underlying exposure of the credit institution to instruments included in indices as an alternative to a credit institution calculating its exposure to the items referred to in one or more of the following points:
  7. own Common Equity Tier 1, Additional Tier 1, Tier 2 and eligible liabilities instruments included in indices;
  8. Common Equity Tier 1, Additional Tier 1 and Tier 2 instruments of financial sector entities, included in indices;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 80 3) eligible liabilities instruments of credit institution, included in indices. (3) The Central Bank shall grant the prior authorisation referred to in paragraph (2) of this Article only where the credit institution has demonstrated to their satisfaction that it would be operationally burdensome for the credit institution to monitor its underlying exposure to the items referred to in one or more of the items of paragraph (2) of this Article, as applicable. (4) An estimate is sufficiently conservative when either of the following conditions is met:

  1. where the investment mandate (investment policy) of the index specifies that a capital instrument of a financial sector entity an eligible liabilities instrument of a credit institution which is part of the index cannot exceed a maximum percentage of the index, the credit institution uses that percentage as an estimate for the value of the holdings that is deducted from its Common Equity Tier 1, Additional Tier 1 or Tier 2 items, as applicable in accordance with Article 39 paragraph (2) of this Decision or from Common Equity Tier 1 capital in situations where the credit institution cannot determine the precise nature of the holding; or, for a credit institution subject to the requirements of Article 117 of this Decision, its eligible liabilities items; or
  2. where the credit institution is unable to determine the maximum percentage referred to in item 1) of this paragraph and where the index, as evidenced by its investment policy or other relevant information, includes capital instruments of financial sector entities or eligible liabilities instruments of credit institution, the credit institution deducts the full amount of the index holdings from its Common Equity Tier 1, Additional Tier 1 or Tier 2 items, as applicable in accordance with Article 39 paragraph (2) of this Decision or from Common Equity Tier 1 capital in situations where the credit institution cannot determine the precise nature of the holding or, for a credit institution subject to the requirements of Article 117 of this Decision, its eligible liabilities items. (5) For the purposes of paragraph (4) of this Article, the following rules shall apply:
  3. an indirect holding arising from an index holding comprises the proportion of the index invested in the Common Equity Tier 1, Additional Tier 1 and Tier 2 instruments of financial sector entities or eligible liabilities instruments of credit institution included in the index;
  4. an index includes index funds, equity or bond indices or any other scheme where the underlying instrument is an own funds instrument issued by a financial sector entity or an eligible liabilities instrument issued by a credit institution. (6) Operationally burdensome, within the meaning of paragraph (3) of this Article, shall be situations under which look-through approaches to capital holdings in financial sector entities on an ongoing basis are unjustified, as assessed by the Central Bank. (7) When assessing the nature of operationally burdensome situations, the Central Bank shall take into account the low materiality and short holding period of such positions.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 81 (8) A holding period of short duration shall require the strong liquidity of the index to be evidenced by the credit institution. (9) For the purpose of paragraph (7) of this Article, a position shall be deemed to be of low materiality where all of the following conditions are met:

  1. the individual net exposure arising from index holdings measured before any look-through is performed does not exceed 2% of Common Equity Tier 1 items as calculated in Article 37 paragraph (1) item 1) of this Decision;
  2. the aggregated net exposure arising from index holdings measured before any look-through is performed does not exceed 5% of Common Equity Tier 1 items as calculated in Article 37 paragraph (1) item 1) of this Decision;
  3. the sum of the aggregated net exposure arising from index holdings measured before any look-through is performed and of any other holdings that shall be deducted pursuant to Article 19 paragraph (1) item 1) of this Decision does not exceed 10% of Common Equity Tier 1 items as calculated in Article 37 paragraph (1) item 1) of this Decision. Conditions for reducing own funds and eligible liabilities Article 87 (1) A credit institution shall obtain the prior authorisation of the Central Bank to do any of the following:
  4. reduce, redeem or repurchase Common Equity Tier 1 instruments issued by the credit institution in accordance with applicable regulations;
  5. reduce, distribute or reclassify as another own funds item the share premium accounts related to own funds instruments;
  6. effect the call, redemption, repayment or repurchase of Additional Tier 1 or Tier 2 instruments prior to the date of their contractual maturity. (2) A credit institution shall obtain the prior authorisation of the Central Bank as the resolution authority for credit institutions to effect the call, redemption, repayment or repurchase of eligible liabilities instruments that are not covered by paragraph (1) of this Article, prior to the date of their contractual maturity. (3) A credit institution shall obtain the prior authorisation of the Central Bank for reducing own funds that it obtained by acquiring own shares pursuant to Article 178 of the Law. Authorisation to reduce own funds Article 88 (1) The Central Bank shall grant authorisation to a credit institution to reduce, call, redeem, repay or repurchase Common Equity Tier 1, Additional Tier 1 or Tier 2 instruments, or to reduce, distribute or reclassify related share premium accounts, where:
  7. before or at the same time as any of the actions referred to in Article 87 paragraph (1) this Decision, the credit institution replaces the instruments or the related share premium accounts referred to in Article 87 paragraph (1) of this Decision with own funds instruments of equal or higher quality at terms that are sustainable for the income capacity of the credit institution; or

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 82 2) the credit institution has demonstrated to the satisfaction of the Central Bank that the own funds and eligible liabilities of the credit institution would, following the action referred to in Article 87paragraph (1) of this Decision, exceed the requirements laid down in this Decision, the Law and the law governing the resolution of credit institutions by a margin that the Central Bank considers necessary. (2) Where a credit institution provides sufficient safeguards as to its capacity to operate with own funds above the amounts required in the Law and this Decision, the Central Bank may grant that credit institution a general prior authorisation to take any of the actions set out in Article 87 paragraph (1) of this Decision, subject to criteria that ensure that any such future action will be in accordance with the conditions set out in paragraph (1) items 1) and 2) of this Article. (3) That general prior authorisation referred to in paragraph (2) of this Article shall be granted only for a specified period, which shall not exceed one year, after which it may be renewed. (4) The general prior authorisation referred to in paragraph (2) of this Article shall be granted for a certain predetermined amount, which shall be set by the Central bank. (5) In the case of Common Equity Tier 1 instruments, that predetermined amount referred to in paragraph (4) of this Article shall not exceed 3% of the relevant issue and shall not exceed 10% of the amount by which Common Equity Tier 1 capital exceeds the sum of the Common Equity Tier 1 capital requirements laid down in the Law, the law governing the resolution of credit institutions and this Decision and a margin that the Central Bank considers necessary. (6) In the case of Additional Tier 1 or Tier 2 instruments, that predetermined amount referred to in paragraph (4) of this Article shall not exceed 10% of the relevant issue and shall not exceed 3% of the total amount of outstanding Additional Tier 1 or Tier 2 instruments, as applicable. (7) The Central Bank shall withdraw the general prior authorisation where a credit institution breaches any of the criteria provided for the purposes of that authorisation. (8) When assessing the sustainability of the replacement instruments for the income capacity of the credit institution referred to in paragraph (1) item 1) of this Article, the Central Bank shall consider the extent to which those replacement capital instruments would be more costly for the credit institution than those capital instruments or share premium accounts they would replace. (9) The Central Bank may allow the credit institution to call, redeem, repay or repurchase Additional Tier 1 or Tier 2 instruments or related share premium accounts during the five years following their date of issuance where the conditions set out in paragraph (1) of this Article and one of the following conditions is met:

  1. there is a change in the regulatory classification of those instruments that would be likely to result in their exclusion from own funds or reclassification as own funds of lower quality, and both the following conditions are met: ­ the Central Bank considers such a change to be sufficiently certain;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 83 ­ the credit institution demonstrates to the satisfaction of the Central Bank that the regulatory reclassification of those instruments was not reasonably foreseeable at the time of their issuance; 2) there is a change in the applicable tax treatment of those instruments which the credit institution demonstrates to the satisfaction of the Central Bank is material and was not reasonably foreseeable at the time of their issuance; 3) before or at the same time as the action referred to in Article 87 paragraph (1) of this Decision, the credit institution replaces the instruments or related share premium accounts referred to in Article 87 paragraph (1) of this Decision with own funds instruments of equal or higher quality at terms that are sustainable for the income capacity of the credit institution and the Central Bank has permitted that action on the basis of the determination that it would be beneficial from a prudential point of view and justified by exceptional circumstances; or 4) the Additional Tier 1 or Tier 2 instruments are repurchased for market making purposes. (10) Sustainable for the income capacity of the credit institution within the meaning of paragraph (1) item 1) and paragraph (9) item 3) of this Article shall mean that the profitability of the credit institution, as assessed by the Central Bank, continues to be sound or does not see any negative change after the replacement of the instruments or the related share premium accounts referred to in Article 87 paragraph (1) of this Decision with own funds instruments of equal or higher quality, at that date and for the foreseeable future. (11) When assessing the profitability referred to in paragraph (10) of this Article, the Central Bank shall take into account the credit institution’s profitability in stress situations. Process and data requirements for an application by a credit institution to carry out redemptions, reductions and repurchases of own funds instruments Article 89 (1) A credit institution may not announce redemptions, reductions and repurchases of own funds instruments to holders of the instruments before it has obtained the prior authorisation of the Central Bank. (2) Where the actions listed in Article 87 paragraph (1) of this Decision are expected to take place with sufficient certainty, and once the prior authorisation of the Central Bank has been obtained, the credit institution shall deduct the corresponding amounts of own funds instruments to be redeemed, reduced or repurchased or the amounts of the related share premium accounts to be reduced or distributed, as applicable, from corresponding elements of its own funds before the effective redemptions, reductions, repurchases or distributions occur. (3) Sufficient certainty referred to in paragraph (2) of this Article shall in particular be deemed to exist where the credit institution has publicly announced its intention to redeem, reduce or repurchase an own funds instrument.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 84 (4) A credit institution shall deduct, from the moment the Central Bank has granted authorisation referred to in Article 88 paragraph (2) of this Decision, the predetermined amount from corresponding elements of the credit institution’s own funds. (5) When applying for a prior authorisation of the Central Bank, including a general prior authorisation referred to in Article 88 paragraph (2) of this Decision, for actions listed in Article 87 paragraph (1) of this Decision, and where the related own funds instruments are purchased for passing them on to employees of the credit institution as part of their remuneration, the credit institution shall notify the Central Bank that those instruments are purchased for that specific purpose. (6) By way of derogation from paragraphs (2) to (4) of this Article, a credit institution shall deduct instruments from corresponding elements of the own funds, for the time they are held by the credit institution. (7) A credit institution shall not be required to make the deductions where the expenses related to any action in accordance with paragraphs (2) to (4) of this Article are already included in own funds as a result of an interim or a year-end financial report. (8) The Central Bank shall grant a prior authorisation, other than the general prior authorisation referred to in Article 88 paragraph (2) of this Decision, for a specified period of time, necessary to perform any of the actions listed in Article 87 paragraph (1) of this Decision, which shall not exceed one year. (9) The provisions of paragraphs (1) to (8) of this Article shall apply at the consolidated, sub-consolidated and individual levels of application of prudential requirements, as applicable. Submission of application by the credit institution to carry out redemptions, reductions and repurchases of own funds instruments Article 90 (1) A credit institution shall submit an application for prior authorisation, including the general prior authorisation referred to in Article 88 paragraph (2) of this Decision, to the Central Bank before taking any of the actions referred to in Article 87 paragraph (1) of this Decision. (2) The provisions of paragraph (1) of this Article shall apply at consolidated, sub￾consolidated and individual levels of application of prudential requirements, as applicable. Content of the application to be submitted by the credit institution to carry out redemptions, reductions and repurchases of own funds instruments Article 91 (1) A credit institution shall submit the following information accompanying the application referred to in Article 91 of this Decision:

  1. a well-founded explanation of the rationale for performing one of the actions referred to in Article 87 paragraph (1) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 85 2) information about whether the authorisation sought is based on Article 88 paragraph (1) items 1) and 2) or paragraph 2) of the same Article of this Decision; 3) where a credit institution seeks to call, redeem or repurchase Additional Tier 1 or Tier 2 instruments or related share premium accounts during the five years following their date of issuance pursuant to Article 88 paragraph (9) of this Decision, how the conditions of that Article are met; 4) present and forward-looking information that shall cover at least a three year period, on the amounts and percentages corresponding to the following requirements for own funds and eligible liabilities: ­ the Common Equity Tier 1 capital requirement, the Tier 1 capital requirement, and the own funds requirement laid down in Article 134 paragraph (2) items 1) to 3) of the Law; ­ to address risks other than the risk of excessive leverage, the additional Common Equity Tier 1 capital requirement, the Additional Tier 1 capital requirement, and the additional own funds requirement laid down in Article 281 of the Law, whichever is applicable; ­ the combined buffer requirement referred to in Article 165 of the Law; ­ the leverage ratio requirement laid down in Article 115a of the Law, and where applicable any adjustment in accordance with Article 550 paragraph (7) of this Decision; ­ to address the risk of excessive leverage, the additional Common Equity Tier 1 capital requirement, and the additional Tier 1 capital requirement referred to in Article 281 of the Law, whichever is applicable; ­ the Tier 1 G-SICI leverage ratio buffer requirement laid down in Article 134 paragraph (2) item 1) of the Law, whichever is applicable; ­ the risk-based requirement for own funds and eligible liabilities laid down in Article 117 paragraph (1) item 1) or Article 118 of this Decision, where applicable, and the non-risk based requirement for own funds and eligible liabilities laid down in Article 117 paragraph (1) item 2) or Article 118 of this Decision, where applicable; ­ the minimum requirement for own funds and eligible liabilities referred to in Article 29 of the Law on Resolution of Credit Institutions as required in accordance with Articles 30 and 31 of that Law, as applicable, and calculated as the amount of own funds and eligible liabilities, and expressed as percentages of the total risk exposure amount of the credit institution, calculated in accordance with Article 114 paragraph (3) of this Decision, and the amount of own funds and eligible liabilities expressed as percentages of the total exposure measure of the relevant entity, calculated in accordance with Article 563 paragraph (4) and Article 564 of this Decision; 5) present and forward-looking information on the level and composition of own funds and the level and composition of own funds and eligible liabilities held to ensure compliance with the requirements referred to in item 4) indents 1 to 8 of this paragraph before and after performing any of the actions listed in Article 87 paragraph (1) of this Decision; 6) the credit institution’s summary assessment on the impact of the action that the credit institution has planned to take in accordance with Article 87paragraph (1) of this Decision, and any such action that the credit institution additionally envisages to undertake within a three year period, on compliance with the requirements referred to in item 4) indents 1 to 8 of this paragraph;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 86 7) where the credit institution seeks to replace own funds instruments or the related share premium accounts pursuant to Article 88 paragraph (1) item 1) or Article 88 paragraph (9) item 3) of this Decision: ­ information on the residual maturity of the replaced own funds instruments, if any, and the maturity of the own funds instruments replacing them; ­ the ranking in bankruptcy hierarchy of the replaced own funds instruments and of the own funds instruments replacing them; ­ the cost of the own funds instruments replacing the instruments or the shared premium accounts referred to in Article 87 paragraph (1) of this Decision; ­ the planned timing of the issuance of the own funds instruments replacing the instruments or share premium accounts referred to in Article 87 paragraph (1) of this Decision; ­ the impact on the profitability of the credit institution pursuant to Article 88 paragraph (1) item 1) or Article 88 paragraph (9) item 3) of this Decision; 8) an evaluation of the risks to which the credit institution is or might be exposed and whether the level of own funds and eligible liabilities ensures an appropriate coverage of such risks, including outcomes of stress tests on main risks evidencing potential losses; 9) coverage in terms of own funds of the applicable guidance on the proposed level and composition of additional own funds communicated by the Central Bank pursuant to Article 281b of the Law before and after performing any of the actions listed in Article 87 paragraph (1) of this Decision, covering a three year period; 10)any other information considered necessary by the Central Bank for evaluating the appropriateness of granting an authorisation in accordance with Article 88 of this Decision. (2) For the purposes of paragraph (1) item 5) of this Article, the information shall cover at least a three year period and, with regard to liabilities, shall include specifications of the following amounts, as applicable:

  1. liabilities which qualify as eligible liabilities instruments pursuant to Article 72 paragraph (2) of this Decision;
  2. liabilities which the Central Bank as the resolution authority of credit institutions has permitted to qualify as eligible liabilities instruments pursuant to Article 72 paragraphs (5) or (6) of this Decision;
  3. liabilities which are included in the amount of own funds and eligible liabilities of resolution entities pursuant to Article 6 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method;
  4. liabilities that arise from debt instruments with embedded derivatives included in the amount of own funds and eligible liabilities pursuant to Article 6 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method;
  5. liabilities issued by a subsidiary undertakings which qualify for inclusion in the consolidated eligible liabilities instruments of a credit institution subject to Article 117 in accordance with Article 113 of this Decision or of a resolution entity pursuant to Article 6 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 87 6) eligible liabilities instruments taken into account for the purpose of complying with the requirement for own funds and eligible liabilities for credit institutions that are material subsidiary undertakings of non-EU G-SIIs pursuant to Article 118 paragraph (3) of this Decision and for the purpose of complying with the minimum requirement for own funds and eligible liabilities for entities that are not themselves resolution entities, pursuant to Article 7 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method. (3) The Central Bank shall waive the submission of some of the information listed in paragraph (1) of this Article where it is satisfied that this information is already available to it. (4) The provisions of paragraphs (1) to (3) of this Article shall apply at the individual, consolidated and sub-consolidated levels of application of prudential requirements, where applicable. Additional information to be submitted with an application for a general prior authorisation to carry out redemptions, reductions and repurchases of own funds instruments Article 92 (1) Where a credit institution applies for a general prior authorisation as referred to in Article 88 paragraph (2) of this Decision for an action referred to in Article 87 paragraph (1) item 1) of this Decision, it shall specify the amount of each relevant Common Equity Tier 1 issue that is subject to that application. (2) Where a credit institution applies for a general prior authorisation in accordance with Article 87 paragraph (1) item 3) of this Decision, it shall specify in the application all of the following:

  1. the amount of each relevant outstanding issue subject to the application;
  2. the total carrying amount of outstanding instruments in each relevant tier of capital. (3) A credit institution may include in an application for a general prior authorisation for an action under Article 87 paragraph (1) items 1) and 3) of this Decision own funds instruments still to be issued, subject to specification of the information referred to in paragraph (2) items 1) and 2) of this Article, as applicable, to be provided to the Central Bank following the relevant issuance. (4) The provisions of paragraphs (1) to (3) of this Article shall apply at the consolidated, sub-consolidated and individual levels of application of prudential requirements, as applicable.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 88 Information to be submitted with an application for a renewal of a general prior authorisation to carry out redemptions, reductions and repurchases of own funds instruments Article 93 (1) Before the expiry of a general prior authorisation as referred to in Article 88 paragraph (2) of this Decision, a credit institution may submit an application for its renewal for a period of up to one additional year each time, provided that the credit institution does not request an increase in the predetermined amount set when the general prior authorisation was granted and does not change the rationale as referred to in Article 91 paragraph (1), item 1) , when the original general prior authorisation was requested. (2) When applying for the renewal of the general prior authorisation referred to in paragraph (1) of this Article, the credit institution shall be exempted from the obligation to provide the information referred to in Article 91 paragraph (1) items 1) to 4) and items 6), 7) and 9) of this Decision. Timing of the application to be submitted by the credit institution and processing of the application to carry out redemptions, reductions and repurchases of own funds instruments Article 94 (1) A credit institution shall, other than a general prior authorisation as referred to in Article 88 paragraph (2) of this Decision, transmit to the Central Bank a complete application and the information referred to in Article 91 of this Decision at least four months in advance of the date where one of the actions listed in Article 87 paragraph (1) of this Decision will be announced to the holders of the instruments. (2) A credit institution shall, for obtaining a general prior authorisation as referred to in Article 88 paragraph (2) of this Decision, transmit a complete application and the information referred to in Articles 91 and 92 of this Decision to the Central Bank at least four months before the date on which any of the actions listed in Article 87 paragraph (1) of this Decision will be carried out. (3) By way of derogation from paragraph (2), where a credit institution submits to the Central Bank an application for a renewal of a general prior authorisation pursuant to Article 88 paragraph (2) of this Decision and Article 93 of this Decision, it shall transmit the application and the information required under Articles 90, 91 and 93 of this Decision to the Central Bank at least three months before the expiration of the period for which the original general prior authorisation was granted. (4) The Central Bank may allow credit institution on a case-by-case basis and under exceptional circumstances to transmit the application referred to in paragraphs (1) and (3) of this Article within a time frame shorter than the three months period. (5) The Central Bank shall process an application of the credit institution during either the period of time referred to in paragraphs (1), (2) and (3) of this Article or during the period of time referred to in paragraph (4) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 89 (6) The Central Bank shall take into account new information, where any is available and where they consider this information to be material, received during the period of processing referred to in paragraph (5) of this Article. (7) The Central Bank shall begin processing the application only when they are satisfied that the information required under Articles 92 and 93 of this Decision has been received from the credit institution. Authorisation to reduce eligible liabilities instruments Article 95 (1) The Central Bank, as the credit institutions’ resolution authority, shall grant authorisation to a credit institution to call, redeem, repay or repurchase eligible liabilities instruments where one of the following conditions is met:

  1. before or at the same time as any of the actions referred to in Article 87 paragraph (2) of this Decision, the credit institution replaces the eligible liabilities instruments with own funds or eligible liabilities instruments of equal or higher quality at terms that are sustainable for the income capacity of the credit institution;
  2. the credit institution has demonstrated to the satisfaction of the Central Bank, as the credit institutions’ resolution authority, that the own funds and eligible liabilities of the credit institution would, following the action referred to in Article 87 paragraph (2) of this Decision, exceed the requirements for own funds and eligible liabilities laid down in the Law, the law governing the resolution of credit institutions and this Decision by an account that the Central Bank, as the credit institutions’ resolution authority, in agreement with the supervisory function of the Central Bank, considers necessary;
  3. the credit institution has demonstrated to the satisfaction of the Central Bank, as the credit institutions’ resolution authority, that the partial or full replacement of the eligible liabilities with own funds instruments is necessary to ensure compliance with the own funds requirements laid down in the Law and this Decision for continuing authorisation. (2) Where a credit institution provides sufficient safeguards as to its capacity to operate with own funds and eligible liabilities above the amount of the requirements laid down in the Law, the law governing the resolution of credit institutions and this Decision, the Central Bank may, based on the proposal of the resolution function of the Central Bank determined after consulting the supervisory function of the Central Bank, grant that credit institution a general prior authorisation to effect calls, redemptions, repayments or repurchases of eligible liabilities instruments, subject to criteria that ensure that any such future action will be in accordance with the conditions set out in paragraph (1) items 1) and 2) of this Article. (3) General prior authorisation referred to in paragraph (2) of this Article shall be granted only for a specified period, which shall not exceed one year, after which it may be renewed.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 90 (4) The general prior authorisation referred to in paragraph (2) of this Article shall be granted for a certain predetermined amount, which shall be set by the Central Bank as the credit institutions’ resolution authority. (5) The resolution function of the Central Bank shall inform the supervisory function of the Central Bank on each granted general prior authorisation referred to in paragraph (2) of this Article. (6) The Central Bank, as the resolution authority, shall withdraw the general prior authorisation referred to in paragraph (2) of this Article where a credit institution breaches any of the criteria provided for the purposes of that authorisation. (7) When assessing the sustainability of the replacement instruments for the income capacity of the credit institution referred to in paragraph (1) item (1) of this Article, the Central Bank, as the resolution authority, shall consider the extent to which those replacement capital instruments or replacement eligible liabilities would be more costly for the credit institution than those they would replace. (8) Sustainable for the income capacity of the credit institution within the meaning of paragraph (1) item 1) of this Article shall mean that the profitability of the credit institution, as assessed by the Central Bank as the credit institutions' resolution authority, continues to be sound or does not see any negative change after the replacement of the eligible liabilities instruments with own funds or eligible liabilities instruments of equal or higher quality, at that date and for the foreseeable future. (9) When assessing the profitability referred to in paragraph (8) of this Article, the Central Bank, as the credit institutions' resolution authority, shall take into account the credit institution’s profitability in stress situations. Requirements, limits and procedures for submitting application by a credit institution to reduce eligible liabilities instruments Article 96 (1) A credit institution may not announce calls, redemptions, repayments and repurchases of eligible liabilities instruments to holders of those instruments before the credit institution has obtained the prior authorisation of the Central Bank as the credit institutions’ resolution authority. (2) Where the actions listed in Article 87 paragraph (2) of this Decision are expected to take place with sufficient certainty, and once the prior authorisation of the Central Bank as the credit institutions’ resolution authority has been obtained, the credit institution shall deduct the amounts to be called, redeemed, repaid or repurchased from the credit institution’s eligible liabilities instruments before the effective calls, redemptions, repayments or repurchases occur. (3) Sufficient certainty referred to in paragraph (2) of this Article shall in particular be deemed to exist where the credit institution has publicly announced its intention to call, redeem, repay or repurchase an eligible liabilities instrument.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 91 (4) A credit institution shall, from the moment Central Bank as a credit institutions’ resolution authority has granted the general prior authorisation as referred to in Article 95 paragraph (2) of this Decision, deduct the predetermined amount from its eligible liabilities instruments. (5) The Central Bank, as the credit institutions’ resolution authority, shall grant a prior authorisation, other than the general prior authorisation referred to in Article 95 paragraph (2) of this Decision, for a specified period of time, necessary to perform any of the actions listed in Article 87 paragraph (2) of this Decision, which shall not exceed one year. (6) Where a credit institution applies for a general prior authorisation as referred to in Article 95 paragraph (2) of this Decision, the predetermined amount for which the Central Bank as the credit institutions’ resolution authority has granted the general prior authorisation shall not exceed 10% of the total amount of outstanding eligible liabilities instruments. (7) The provisions of paragraphs (1) to (6) of this Article shall apply at consolidated, sub-consolidated and individual levels of application of requirements for own funds and eligible liabilities, as applicable. Submission by the credit institution of an application to reduce eligible liabilities instruments Article 97 (1) A credit institution shall submit to the Central Bank, as the credit institutions’ resolution authority, an application for prior authorisation, including the general prior authorisation as referred to in Article 95 paragraph (2) of this Decision, before taking an action as referred to in Article 87 paragraph (2) of this Decision. (2) The provisions of paragraph (1) of this Article shall apply at individual, consolidated and sub- consolidated levels of application of requirements for own funds and eligible liabilities, as applicable. Content of the application to be submitted by the credit institution to call, redeem, repay or repurchase eligible liabilities instruments Article 98 (1) A credit institution shall submit the following information accompanying the application referred to in Article 97 of this Decision shall be accompanied by all of the following:

  1. a well-founded explanation of the rationale for performing any of the actions referred to in Article 87 paragraph (2) of this Decision;
  2. information about whether the authorisation sought is based on Article 95 paragraph (1) items 1), 2) or 3) or paragraph (2) of the same Article of this Decision;
  3. present and forward-looking information that shall cover at least a three year period, on the following requirements for own funds and eligible liabilities: ­ the risk-based requirement for own funds and eligible liabilities laid down in Article 117 paragraph (1) item 1) or Article 118 of this Decision, where applicable, and the non-risk based requirement for own funds and eligible

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 92 liabilities laid down in Article 117 paragraph (1) item 2) or Article 118 of this Decision, where applicable; ­ the minimum requirement for own funds and eligible liabilities laid down in Article 29 of the Law on Resolution of Credit Institutions calculated in accordance with Articles 30 and 31 of that Law, as applicable, the amount of own funds and eligible liabilities expressed as percentages of the total risk exposure amount of the credit institution, calculated in accordance with Article 114 paragraph (3) of this Decision, and the amount of own funds and eligible liabilities expressed as percentages of the total exposure measure of the relevant entity, calculated in accordance with Article 563 paragraphs (4) to (7) of this Decision and Article 564 of this Decision; ­ the combined buffer requirement referred to in Article 165 of the Law; 4) present and forward-looking information on the level and composition of own funds and eligible liabilities held to ensure compliance, respectively, with the requirements referred to in paragraph item 3) indents 1 to 3 of this paragraph, before and after performing the action referred to in Article 87 paragraph (2) of this Decision, whereat the information shall cover at least a three year period and shall, with regard to eligible liabilities, include specifications of the following amounts, as applicable: ­ liabilities which qualify as eligible liabilities instruments pursuant to Article 72 paragraph (2) of this Decision; ­ liabilities which the Central Bank, as credit institutions’ resolution authority, has permitted to qualify as eligible liabilities instruments pursuant to Article 72 paragraphs (5) or (6) of this Decision; ­ liabilities which are included in the amount of own funds and eligible liabilities of resolution entities pursuant to Article 6 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method; ­ liabilities that arise from debt instruments with embedded derivatives included in the amount of own funds and eligible liabilities pursuant to Article 6 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method; ­ liabilities issued by a subsidiary undertaking which qualify for inclusion in the consolidated eligible liabilities instruments of a credit institution subject to Article 117 pursuant to Article 113 of this Decision or of a resolution entity pursuant to Article 6 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method; ­ eligible liabilities instruments taken into account for the purposes of complying with the requirement for own funds and eligible liabilities for credit institutions that are material subsidiary undertakings of non-EU G￾SIIs pursuant to Article 118 paragraph (3) of this Decision and for the purpose of complying with the minimum requirement for own funds and eligible liabilities for entities that are not themselves resolution entities, pursuant to Article 7 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method; 5) the credit institution’s summary assessment on the impact of the action that the credit institution has planned to take in accordance with Article 87 paragraph

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 93 (2) of this Decision, and any such action that the credit institution additionally envisages to undertake within a three year period, on compliance with the requirements referred to in item 3) indents 1 to 3 of this paragraph; 6) where the credit institution seeks to replace eligible liabilities instruments pursuant to Article 95 paragraph (1) item 1) of this Decision: ­ information on the residual maturity of the replaced eligible liabilities instruments and the maturity of the own funds or eligible liabilities instruments replacing them; ­ the ranking in bankruptcy of the replaced eligible liabilities instruments and of the own funds or eligible liabilities instruments replacing them; ­ the cost of the own funds or eligible liabilities instruments replacing the eligible liabilities instruments; ­ the planned timing of the issuance of the own funds or eligible liabilities instruments replacing the eligible liabilities instruments referred to in Article 87 paragraph (2) of this Decision; ­ the impact on the profitability of the credit institution pursuant to Article 95 paragraph (1) item 1); 7) an evaluation of the risks to which the credit institution is or might be exposed, in particular whether the level of own funds and eligible liabilities ensures an appropriate coverage of such risks, including outcomes of stress tests on main risks evidencing potential losses; 8) where a credit institution applies Article 95 paragraph (1) item 3) of this Decision, demonstration that the partial or full replacement of the eligible liabilities instruments with own funds instruments is necessary to ensure compliance with the own funds requirements; 9) any other information considered necessary by the Central Bank as the credit institutions’ resolution authority for evaluating the appropriateness of granting a authorisation in accordance with Article 95 of this Decision. (2) The Central Bank may waive the submission of some of the information listed in paragraph (1) of this Article where it is satisfied that it already has that information. (3) The provisions of paragraphs (1) and (2) of this Article shall apply at individual, consolidated and sub-consolidated levels of application of requirements for own funds and eligible liabilities, as applicable. Additional information to be submitted by a credit institution with the application for a general prior authorisation to call, redeem, repay or repurchase eligible liabilities instruments Article 99 (1) Where a credit institution submits an application for a general prior authorisation referred to in Article 95 paragraph (2) of this Decision for an action under Article 87 paragraph (2) of this Decision, the credit institution shall specify in the application the total amount of outstanding eligible liabilities instruments, including the total amount of outstanding eligible liabilities instruments that meet the conditions referred to in Article 95 of this Decision or Article 6 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 94 (2) Where a credit institution submits an application for a general prior authorisation for an action under Article 87 paragraph (2) of this Decision, it may include in its application own fund instruments still to be issued, subject to specification of the final amount referred to in paragraph (1) of this Article, to be provided to the Central Bank as the credit institutions’ resolution authority following the issuance concerned. Information to be submitted by a credit institution with an application for a renewal of a general prior authorisation to call, redeem, repay or repurchase eligible liabilities instruments Article 100 (1) Before the expiry of the general prior authorisation granted pursuant to Article 95 paragraph (2) of this Decision, a credit institution may submit an application for its renewal for a period of up to one additional year each time, provided that the credit institution does not request an increase in the predetermined amount set when the original general prior authorisation was granted and does not change the rationale referred to in Article 98 paragraph (1) item 1), when the original general prior authorisation was requested. (2) When applying for the renewal of a general prior authorisation referred to in paragraph (1) of this Article, the credit institution shall not be obliged to provide the information referred to in Article 98 paragraph (1) items 1) to 3) and items 5), 6), 7) and 9 ) of this Decision. Timing of the application to be submitted by the credit institution and processing of the application of the credit institution to call, redeem, repay or repurchase eligible liabilities instruments Article 101 (1) A credit institution shall submit, for a prior authorisation, other than the general prior authorisation referred to in Article 95 paragraph (2) of this Decision, a complete application and the information referred to in Article 95 of this Decision to the Central Bank as the credit institutions’ resolution authority at least four months before the date on which one of the actions listed in Article 87 paragraph (2) of this Decision. (2) A credit institution shall submit, for the general prior authorisation referred to in Article 95 paragraph (2) of this Decision, a complete application and the information referred to in Articles 98 and 99 of this Decision to the Central Bank as the credit institutions’ resolution authority at least four months before the date on which one of the actions listed in Article 87 of this Decision will be carried out. (3) By way of derogation from paragraph (2), where a credit institution submits to the Central Bank, as the credit institutions’ resolution authority, an application for the renewal of the general prior authorisation pursuant to Article 95 paragraph (2) of this Decision and Article 100, the institution shall submit application and the information required under Articles 98, 99 and 100 of this Decision to the Central Bank, as the credit institutions’ resolution authority, at least three months before the expiration of the period for which the original general prior authorisation was granted.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 95 (4) The Central Bank as the credit institutions’ resolution authority may allow credit institution, on a case-by-case basis and under exceptional circumstances, to submit the application referred to in paragraphs (1), and (3) of this Article within a time frame shorter than the periods set out in those paragraphs. (5) The Central Bank as the credit institutions’ resolution authority shall process an application during either the period of time referred to in paragraphs (1), (2) and (3) of this Article or during the period of time referred to in paragraph (4) of this Article. (6) The Central Bank as the credit institutions’ resolution authority shall take into account new information received during the processing of application referred to in paragraph (5) of this Article, where any such new information is available and where they consider that information to be material. (7) The Central Bank as the credit institutions’ resolution authority shall process the application only where they are satisfied that the credit institution has provided them with all the information required under Article 98 and, where applicable, Articles 99 and 100 of this Decision. Simplified requirements for credit institutions subject to the minimum requirement for own funds and eligible liabilities at a level that does not exceed an amount sufficient to absorb losses Article 102 (1) By way of derogation from Articles 98, 99 and 100, a credit institution for which the Central Bank as the credit institutions’ resolution authority has set the minimum requirement for own funds and eligible liabilities laid down in Article 29 of the Law on Resolution of Credit Institutions at a level that does not exceed an amount sufficient to absorb losses in accordance with Article 3 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method, shall submit with the application referred to in Article 97of this Decision the following:

  1. a well-founded explanation of the rationale for performing any of the actions referred to in Article 87 paragraph (2) of this Decision;
  2. information about whether the authorisation sought is based on Article 95 paragraph (1) items 1), 2) or 3) or paragraph (2) of the same Article of this Decision. (2) A general prior authorisation referred to in Article 95 paragraph (2) of this Decision, granted following an application made in accordance with paragraph (1) of this Article, shall not be subject to the restriction set out in Article 96 paragraph (6) of this Decision. (3) By way of derogation from Article 101 of this Decision, the credit institution referred to in paragraph (1) of this Article shall submit the application referred to in Article 97 of this Decision to the Central Bank as the credit institutions’ resolution authority at least three months before the date on which one of the actions listed in Article 87 of this Decision will be announced to the holders of the instruments or, in the case of an application for a general prior authorisation referred to in Article 95 of this Decision, at least three months before the date on which one of the actions listed in Article 87 paragraph (2) of this Decision will be carried out.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 96 (4) Where the Central Bank as the credit institutions’ resolution authority does not oppose in writing the application referred to in Article 97 of this Decision within the periods specified in paragraph (3) of this Article, the authorisation shall be deemed granted. (5) The provisions of this Article shall apply at individual, consolidated and sub￾consolidated levels of application of requirements for own funds and eligible liabilities, as applicable. Cooperation between the Central Bank supervisory function and resolution function when granting the authorisation to reduce eligible liabilities instruments Article 103 (1) Where credit institution submits a complete application for a prior authorisation, including the general prior authorisation referred to in Article 95 paragraph (2) of this Decision, the Central Bank’s resolution function shall submit without delay that application to the Central Bank’s supervisory function, including the information referred to in Article 98 of this Decision and, where applicable, Article 99, Article 100 or Article 102. (2) At the same time of the submission of the information referred to in paragraph (1) of this Article, the Central Bank’s resolution function shall make a request for consultation to the Central Bank’s supervisory function on the application received, which shall include the reciprocal exchange of any other relevant information for the assessment of the application by both functions of the Central Bank. (3) Both functions of the Central Bank – the supervisory function and the resolution function shall agree on an adequate time limit for providing a response to the consultation referred to in paragraph (2), which shall not exceed three months from the moment of receipt of the request for consultation and that shall be reduced to two months where the consultation concerns the renewal of a general prior authorisation pursuant to Article 100 of this Decision or a general prior authorisation pursuant to Article 102 of this Decision. (4) The Central Bank, as the credit institutions’ resolution authority, shall consider the views received from the supervisory function before taking a decision on the authorisation. (5) Where the Central Bank as the credit institutions’ resolution authority, for granting authorisation to a credit institution, in accordance with Article 95 paragraph (1) item 2) of this Decision, requires prior consent of the supervisory function, it shall ensure that the resolution function, within two months from the request for consultation referred to in paragraph (2), or within one month where the consultation concerns the renewal of a general prior authorisation pursuant to Article 100 of this Decision or a general prior authorisation pursuant to Article 102 of this Decision, communicate to the supervisory function the proposed margin by which, following the action referred to in Article 78 paragraph (2) of this Decision, it considers necessary that the own funds and eligible liabilities of the credit institution must exceed its requirements.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 97 (6) The Central Bank’s supervisory function shall, within three weeks or, where the consultation concerns the renewal of a general prior authorisation pursuant to Article 100 of this Decision or a general prior authorisation pursuant to Article 102 of this Decision, within two weeks, after receiving the communication referred to in paragraph (5) of this Article, submit in writing to the resolution function its written agreement, and in the event that it disagrees or partially disagrees with the resolution function, it shall inform the resolution function within that period, stating its reasons. (7) By way of derogation from paragraph (3) of this Article, where the agreement of the supervisory function of the Central Bank is required in accordance with Article 95 paragraph (1) item 2) of this Decision, the supervisory function of the Central Bank shall provide the resolution function of the Central Bank with a response to the consultation referred to in paragraph (2) of this Article at the same time as the its written agreement referred to in paragraph (6) of this Article. (8) By way of derogation from paragraphs (3) to (7) of this Article, where the maximum time period for processing the application referred to in paragraph (1) is shorter than four months in accordance with Article 102 paragraphs (3) or (4), the periods of time referred to in paragraphs (3), (5) and (6) of this Article shall be agreed between both functions of the Central Bank – the resolution function and supervisory function taking into account the relevant maximum time period. (9) Both functions of the Central Bank – the resolution function and supervisory function shall endeavour to reach the agreement referred to in paragraph (6) of this Article in order to ensure that the application referred to in paragraph (1) is processed in any event within the period of time referred to in Article 102 paragraphs (1), (2), (3) or (4) of this Decision. (10) The resolution function of the Central Bank shall communicate to the supervisory function the decision taken on the authorisation without undue delay. (11) The resolution authority shall also inform the supervisory function in case of withdrawal of the general prior authorisation where a credit institution breaches any of the criteria provided for the purposes of that authorisation. Temporary waiver from deduction from own funds and eligible liabilities Article 104 (1) Where a credit institution holds capital instruments or liabilities that qualify as own funds instruments in a financial sector entity or as eligible liabilities instruments in credit institution and where the Central Bank considers those holdings to be for the purposes of a financial assistance operation designed to reorganise and restore the viability of that entity or that credit institution, the Central Bank may waive on a temporary basis the provisions on deduction from own funds that would otherwise apply to those instruments. (2) A temporary waiver referred to in paragraph (1) of this Article shall be of a duration that does not exceed the timeframe envisaged under the financial assistance operation plan.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 98 (3) The waiver referred to in paragraph (1) of this Article shall not be granted for a period longer than 5 years. (4) The waiver shall apply only in relation to new holdings of own funds instruments in the financial sector entity or eligible liabilities instruments in the credit institution subject to the financial assistance operation. (5) For the purposes of providing a temporary waiver for deduction from own funds and eligible liabilities, the Central Bank may deem the temporary holdings referred to in paragraph (1) of this Article to be held for the purposes of a financial assistance operation designed to reorganise and save a financial sector entity where the operation is carried out under a plan and approved by the Central Bank, and where the plan clearly states phases, timing and objectives and specifies the interaction between the temporary holdings and the financial assistance operation Assessment of compliance with the conditions for own funds instruments and eligible liabilities instruments Article 105 (1) A credit institution shall have regard to the substantial features of instruments and not only their legal form when assessing compliance with the requirements for own funds and eligible liabilities. (2) The assessment of the substantial features of instruments referred to in paragraph (1) of this Article shall take into account all arrangements related to the instruments, even where those are not explicitly set out in the terms and conditions of the instruments themselves, for the purpose of determining that the combined economic effects of such arrangements are compliant with the objective of the relevant provisions. TITLE II - MINORITY INTEREST AND ADDITIONAL TIER 1 AND TIER 2 INSTRUMENTS ISSUED BY SUBSIDIARY UNDERTAKINGS OF CREDIT INSTITUTION Minority interests that qualify for inclusion in consolidated Common Equity Tier 1 capital Article 106 (1) Minority interests shall comprise the sum of Common Equity Tier 1 items of a subsidiary undertakings where the following conditions are met: 3) the subsidiary undertaking is one of the following: ­ a credit institution; ­ an undertaking that is subject to the requirements of the Law and this Decision; or ­ an intermediate financial holding company or intermediate mixed financial holding company that is subject to the requirements of this Decision on a sub-consolidated basis, or an intermediate investment holding company that is on a consolidated basis subject to the requirements of Capital Market

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 99 Authority governing the operations of investment firms and equivalent EU regulations; ­ an investment firm; ­ an intermediate financial holding company in a third country, provided that it is subject to prudential requirements as stringent as those applied to credit institutions of that third country, whereat, in the European Commission assessment, they are equivalent to those of this Decision and the EU regulation; 4) the subsidiary undertaking is included fully in the consolidation pursuant to the Law; 5) the Common Equity Tier 1 items, referred to in the introductory part of this paragraph, are owned by persons other than the undertakings included in the consolidation pursuant to the Law. (2) Minority interests that are funded directly or indirectly, through a special purpose entity or otherwise, by the parent undertaking of the credit institution, or its subsidiary undertakings shall not qualify as consolidated Common Equity Tier 1 capital. Qualifying Additional Tier 1, Tier 1, Tier 2 capital and qualifying own funds Article 107 Qualifying Additional Tier 1, Tier 1, Tier 2 capital and qualifying own funds shall comprise the minority interest, Additional Tier 1 or Tier 2 instruments, as applicable, plus the related share premium accounts, of a subsidiary undertaking where the following conditions are met:

  1. the subsidiary undertaking is: ­ a credit institution; ­ an undertaking that is subject to the requirements of the Law and this Decision; ­ an intermediate financial holding company or intermediate mixed financial holding company that is subject to the requirements of this Decision on a sub-consolidated basis, or an intermediate investment holding company that is on a consolidated basis subject to the requirements of Capital Market Authority governing the operations of investment firms and equivalent EU regulations; ­ an investment firm; ­ an intermediate financial holding company in a third country, provided that it is subject to prudential requirements as stringent as those applied to credit institutions of that third country, whereat, those prudential requirements are equivalent to those of this Decision and the EU regulation;
  2. the subsidiary undertaking is included fully in the scope of consolidation pursuant to the Law; and
  3. the Common Equity Tier 1 items, referred to in the introductory part of this paragraph, are owned by persons other than the undertakings included in the consolidation pursuant to the Law.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 100 Minority interests included in consolidated Common Equity Tier 1 capital Article 108 (1) A credit institution shall determine the amount of minority interests of a subsidiary undertaking that is included in consolidated Common Equity Tier 1 capital by subtracting from the minority interests of that undertaking the result of multiplying the amount referred to in item 1) of this paragraph by the percentage referred to in item 2) of this paragraph: 3) the Common Equity Tier 1 capital of the subsidiary undertaking minus the lower of the amounts referred to in indent 1 or 2 of this item: ­ the amount of Common Equity Tier 1 capital of that subsidiary undertaking required to meet the following: a) where the subsidiary undertaking is one of those listed in Article 106 paragraph (1) item 1) of this Decision, but not an investment firm or an intermediate investment holding company, the amount of Common Equity Tier 1 capital required to meet the sum of the requirement laid down in Article 134 paragraph (2) of the Law, the specific own funds requirements referred to in Article 279 paragraph (1) item 1) of the Law, the combined buffer requirement defined in Article 166 of the Law, more stringent prudential requirements when identifying increased macroprudential risks and any additional local supervisory regulations in third countries; b) where the subsidiary undertaking is an investment firm or an intermediate investment holding company, the amount of Common Equity Tier 1 capital required to meet the sum of the own funds requirements, additional capital requirements laid down in regulations governing the operations of investment firms, and any local supervisory regulations in third countries that relate to operations of investment firms;

  • the amount of consolidated Common Equity Tier 1 capital that relates to that subsidiary undertaking that is required on a consolidated basis to meet the sum of the requirement laid down in Article 134 paragraph (2) of the Law, the specific own funds requirements referred to in Article 279 paragraph (1) item 1) of the Law, the combined buffer requirement defined in Article 166 of the Law, more stringent prudential requirements when identifying increased macroprudential risks and any additional local supervisory regulations in third countries insofar as those requirements are to be met by Common Equity Tier 1 capital;
  1. the minority interests of the subsidiary undertaking expressed as a percentage of all Common Equity Tier 1 instruments of that undertaking. (2) By way of derogation from paragraph (1) item 1) of this Article, the Central Bank may allow a credit institution to subtract either of the amounts referred to in item 1) indent 1 or 2 of that paragraph, once the credit institution has demonstrated to the satisfaction of the Central Bank that the additional amount of minority interest is available to absorb losses at consolidated level. (3) The calculation referred to in paragraph (1) of this Article shall be undertaken on a sub-consolidated basis for each subsidiary undertaking referred to in Article 106 paragraph (1) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 101 (4) By way of derogation from paragraph (1) of this Article, a credit institution may choose not to undertake this calculation for a subsidiary undertaking referred to in Article 106 paragraph (1) of this Article and in that case the minority interest of that subsidiary undertaking may not be included in consolidated Common Equity Tier 1 capital. (5) Where the Central Bank derogates from the application of prudential requirements on an individual basis, as laid down in Article 309 paragraph (4) of the Law, the minority interest within the subsidiary undertaking to which the waiver is applied shall not be recognised in own funds at the sub-consolidated or at the consolidated level, as applicable. (6) The Central Bank may grant a waiver from the application of this Article to a parent financial holding company where:

  1. its principal activity is to acquire holdings;
  2. it is subject to prudential supervision on a consolidated basis;
  3. it consolidates a subsidiary credit institution in which it has only a minority holding by virtue of the control relationship;
  4. more than 90% of the consolidated required Common Equity Tier 1 capital of that holding arises from the subsidiary credit institution referred to in item 3) of this paragraph calculated on a sub-consolidated basis. (7) For the purpose of specifying the sub-consolidation calculation required in accordance with paragraph (3) of this Article, Article 109 paragraphs (3) and (4), and Article 11 paragraph (3) of this Decision, the qualifying minority interests of a subsidiary undertaking referred to in Article 106 of this Decision that is itself a parent undertaking of an entity referred to in Article 106 paragraph (1) of this Decision shall be calculated in accordance with paragraphs (8) to (10) of this Article. (8) Where the Central Bank has exercised the discretion that allows parent credit institutions on an individual basis to include subsidiary undertakings in the calculation of their requirements, the calculation to be undertaken in accordance with paragraphs (9) and (10) of this Article shall be made on the basis of the situation of the credit institution as if the discretion had not been exercised. (9) Where the subsidiary undertaking complies with the capital requirements of this Decision on consolidated basis, it shall apply the following:
  5. the Common Equity Tier 1 capital of that subsidiary undertaking on its consolidated basis referred to in paragraph (1) item 1) of this Article shall include the eligible minority interests that arise from its own subsidiary undertakings calculated in accordance with this Article and the provisions of this Decision;
  6. for the purpose of the sub-consolidation calculation, the amount of Common Equity Tier 1 capital required according to paragraph (1) item 1) indent 1 of this Article shall be the amount required to meet the Common Equity Tier 1 requirements of that subsidiary undertaking at its consolidated level calculated in accordance with paragraph (1) item 1) of this Article, and the Central Bank shall determine specific requirements referred to in Article 279 of the Law;
  7. the amount of consolidated Common Equity Tier 1 capital required, according to paragraph (1) item 1) indent 2 of this Article, shall be the contribution of the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 102 subsidiary undertaking on the basis of its consolidated situation to the Common Equity Tier 1 own funds requirements of the credit institution for which the eligible minority interests are calculated on a consolidated basis, whereat, for the purpose of calculating the contribution of subsidiary undertaking, all intra￾group transactions between undertakings included in the prudential scope of consolidation of the credit institution shall be eliminated. (10) When performing the consolidation referred to in paragraph (9) item 3) of this Article, the subsidiary undertaking shall not include capital requirements arising from its subsidiary undertakings which are not included in the prudential scope of consolidation of the credit institution for which the eligible minority interests are calculated. (11) Where the waiver referred to in paragraph (45) of this Article applies to a subsidiary undertaking, any parent undertaking of the subsidiary undertaking benefiting from the waiver may include in its Common Equity Tier 1 capital minority interests arising from subsidiary undertakings of the subsidiary undertaking itself benefiting from the waiver, provided that the calculations referred to in paragraph (1) of this Article have been made for each of those subsidiary undertakings. (12) The amount of Common Equity Tier 1 included in the own funds at the level of the parent undertaking shall not exceed the amount that would be included if no waiver had been granted to the subsidiary undertaking. (13) Where a parent credit institution has an intermediate subsidiary undertaking, which is not referred to in Article 106 paragraph (1) of this Decision and where this intermediate subsidiary undertaking itself has subsidiary undertakings which are referred to in Article 106 paragraph (1) of this Decision, the parent credit institution may include in its Common Equity Tier 1 capital the amount of minority interest arising from those subsidiary undertakings calculated according to paragraph (1) of this Decision. (14) The parent credit institution referred to in paragraph (12) of this Article may not include in its Common Equity Tier 1 capital any minority interests arising from an intermediate subsidiary undertaking which is not referred to in Article 106 paragraph (1) of this Decision. (15) The methodology set out in paragraphs (8) to (10) of this Article shall also apply mutatis mutandis to the calculation of the amount of qualifying Tier 1 instruments under Article 109 of this Decision and the amount of qualifying own funds under Article 111 of this Decision. Qualifying Tier 1 instruments included in consolidated Tier 1 capital Article 109 (1) A credit institution shall determine the amount of qualifying Tier 1 capital of a subsidiary undertaking that is included in consolidated own funds by subtracting from the qualifying Tier 1 capital of that undertaking the result of multiplying the amount referred to in item 1) by the percentage referred to in item 2) of this paragraph:

  1. the Tier 1 capital of the subsidiary undertaking minus the lower of the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 103

  • the amount of Tier 1 capital of the subsidiary undertaking that meets the following: a) where a subsidiary undertakings is one of the undertakings referred to in Article 106 paragraph (1) item 1) of this Decision, but not an investment firm or an intermediary investment company, the amount of Tier 1 capital required to meet the sum of the requirement laid down in Article 134 paragraph (2) of the Law, the specific own funds requirements referred to in Article 279 paragraph (1) item 1) of the Law, the combined buffer requirement defined in Article 166 of the Law, more stringent prudential requirements when identifying increased macroprudential risks and any additional local supervisory regulations in third countries; b) where a subsidiary undertaking is an investment firm or an intermediate investment holding company, the amount of Tier 1 capital required to meet the own funds requirements, additional capital requirements laid down in regulations governing the operations of investment firms, and any local supervisory regulations in third countries that relate to operations of investment firms;
  • the amount of consolidated Tier 1 capital that relates to the subsidiary undertaking that is required on a consolidated basis to meet the sum of the requirement laid down in Article 134 paragraph (2) of the Law, the specific own funds requirements referred to in Article 279 paragraph (1) item 1) of the Law, the combined buffer requirement defined in Article 166 of the Law, more stringent prudential requirements when identifying increased macroprudential risks and any additional local supervisory regulations in third countries insofar as those requirements are to be met by Tier 1 capital;
  1. the qualifying Tier 1 capital of the subsidiary undertaking expressed as a percentage of all Common Equity Tier 1 items and Additional Tier 1 items of that undertaking. (2) By way of derogation from paragraph (1) item 1) of this Article, the Central Bank may allow a credit institution to subtract either of the amounts referred to in item 1) indent 1 or 2 of that paragraph, once the credit institution has demonstrated to the satisfaction of the Central Bank that the additional amount of Tier 1 capital is available to absorb losses at consolidated level. (3) The calculation referred to in paragraph (1) of this Article shall be undertaken on a sub-consolidated basis for each subsidiary undertaking referred to in Article 106 paragraph (1) of this Decision. (4) By way of derogation from paragraph (1) of this Decision, a credit institution may choose not to undertake this calculation for a subsidiary undertaking referred to in Article 106 paragraph (1) of this Decision and in that case, the qualifying Tier 1 capital of that subsidiary undertaking may not be included in consolidated Tier 1 capital. (5) Where the Central Bank derogates from the application of prudential requirements on an individual basis, as laid down in Article 309 paragraph (4) of the Law, Tier 1 instruments within the subsidiary undertaking to which the waiver is applied shall not be recognised as own funds at the sub-consolidated or at the consolidated level, as applicable.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 104 Qualifying Tier 1 capital included in consolidated Additional Tier 1 capital Article 110 Without prejudice to Article 108 paragraph (6) of this Decision, a credit institution shall determine the amount of qualifying Tier 1 capital of a subsidiary undertaking that is included in consolidated Additional Tier 1 capital by subtracting from the qualifying Tier 1 capital of that undertaking included in consolidated Tier 1 capital the minority interests of that undertaking that are included in consolidated Common Equity Tier 1 capital. Qualifying own funds included in consolidated own funds Article 111 (1) A credit institution shall determine the amount of qualifying own funds of a subsidiary undertaking that is included in consolidated own funds by subtracting from the qualifying own funds of that undertaking the result of multiplying the amount referred to in item 1) by the percentage referred to in item 2) of this paragraph:

  1. the own funds of the subsidiary undertaking minus the lower of the following:
  • the amount of own funds of the subsidiary undertaking required to meet the following: a) where the subsidiary undertaking is one of the undertakings referred to in Article 106 paragraph (1) item 1) of this Decision, but not an investment firm or an intermediary investment holding company, the amount of own funds reguired to meet the sum of the requirement laid down in Article 134 paragraph (2) of the Law, the specific own funds requirements referred to in Article 279 paragraph (1) item 1) of the Law, the combined buffer requirement defined in Article 166 of the Law, more stringent prudential requirements when identifying increased macroprudential risks and any additional local supervisory regulations in third countries; b) where a subsidiary undertaking is an investment firm or an intermediate investment holding company, the amount of own funds required to meet the own funds requirements, additional capital requirements laid down in regulations governing the operations of investment firms, and any local supervisory regulations in third countries that relate to operations of investment firms;
  • the amount of consolidated own funds that relates to the subsidiary undertaking that is required on a consolidated basis to meet the sum of the requirement laid down in Article 134 paragraph (2) item 2) of the Law, the specific own funds requirements referred to in Article 279 paragraph (1) item
  1. of the Law, the combined buffer requirement defined in Article 166 of the Law, more stringent prudential requirements when identifying increased macroprudential risks and any additional local supervisory regulations in third countries insofar as those requirements are to be met by own funds;
  2. the qualifying own funds of the subsidiary undertaking, expressed as a percentage of the sum of all the Common Equity Tier 1 items, Additional Tier 1 items and Tier 2 items, excluding the amounts referred to in Article 60 paragraph (1) items 3) and 4) of that undertaking.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 105 (2) By way of derogation from paragraph (1) item 1) of this Article, the Central Bank may allow a credit institution to subtract either of the amounts referred to in indent 1 or 2 of that item, once the credit institution has demonstrated to the satisfaction of the Central Bank that the amount of own funds is available to absorb losses at consolidated level. (3) The calculation referred to in paragraph (1) of this Article shall be undertaken on a sub-consolidated basis for each subsidiary undertaking referred to in Article 106 paragraph (1) of this Decision. (4) By way of derogation from paragraph (1) of this Article, a credit institution may choose not to undertake this calculation for a subsidiary undertaking referred to in Article 106 paragraph (1) of this Decision and in that case, the qualifying own funds of that subsidiary undertaking may not be included in consolidated own funds. (5) Where the Central Bank derogates from the application of prudential requirements on an individual basis, as laid down in Article 309 paragraph (4) of the Law, own funds instruments within the subsidiary undertakings to which the waiver is applied shall not be recognised as own funds at the sub-consolidated or at the consolidated level, as applicable. Qualifying own funds instruments included in consolidated Tier 2 capital Article 112 Without prejudice to the provision of Article 108 paragraph (6) of this Decision, a credit institution shall determine the amount of qualifying own funds of a subsidiary undertaking that is included in consolidated Tier 2 capital by subtracting from the qualifying own funds of that undertaking that are included in consolidated own funds the qualifying Tier 1 capital of that undertaking that is included in consolidated Tier 1 capital. Qualifying eligible liabilities instruments Article 113 Liabilities issued by a subsidiary undertaking established in Montenegro that belongs to the same resolution group as the resolution entity shall qualify for inclusion in the consolidated eligible liabilities instruments of a credit institution subject to Article 117 of this Decision, where the following conditions are met:

  1. they are issued in accordance with Article 7 of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method;
  2. they are bought by an existing shareholder that is not part of the same resolution group as long as the exercise of the write-down or conversion powers in accordance with the law governing the resolution of credit institutions does not affect the control of the subsidiary undertaking by the resolution entity;
  3. they do not exceed the amount determined by subtracting the amount referred to in indent 1 from the amount referred to in indent 2 of this item:
  • the sum of the liabilities issued to and bought by the resolution entity either directly or indirectly through other entities in the same resolution group and the amount of own funds instruments that are issued in accordance with

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 106 Article 7 paragraph (2) of the Decision on more detailed method for determining minimum requirements for own funds and eligible liabilities of credit institutions and the reporting method;

  • the amount determined in accordance with Articles 31 and 32 of the Law on Resolution of Credit Institutions. PART THREE - CAPITAL REQUIREMENTS TITLE I - GENERAL REQUIREMENTS AND VALUATION SUBTITLE 1 - Required level of own funds Own funds requirements Article 114 (1) Own funds requirements of a credit institution shall include the maintenance of the following capital adequacy ratios in accordance with Article 134 and 134a of the Law:
  1. Common Equity Tier 1 capital adequacy ratio;
  2. Tier 1 capital adequacy ratio;
  3. total capital adequacy ratio; and
  4. leverage ratio. (2) A credit institution shall calculate their capital adequacy ratios referred to in paragraph (1) items 1) to 3) of this Article as follows:
  5. the Common Equity Tier 1 capital adequacy ratio shall be calculated as the ratio between the Common Equity Tier 1 capital of the credit institution and the total risk exposure amount, expressed as a percentage;
  6. the Tier 1 capital adequacy ratio shall be calculated as the ratio between the Tier 1 capital and the total risk exposure amount, expressed as a percentage;
  7. the total capital adequacy ratio shall be calculated as the ratio between the own funds and the total risk exposure amount, expressed as a percentage;
  8. leverage ratio shall be calculated in accordance with Articles 563 to 570 of this Decision. (3) The total risk exposure amount (TREA) shall be calculated as follows: TREA = max {U − TREA; x ∙ S − TREA} where: TREA = the total risk exposure amount of an entity; U − TREA = the un-floored total risk exposure amount of the entity calculated in accordance with paragraph (4) of this Article; S − TREA = the standardised total risk exposure amount of the entity calculated in accordance with paragraph (5) of this Article; X = 72,5%.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 107 (4) The un-floored total risk exposure amount shall be calculated as the sum of the amounts referred to in items 1) to 7) of this paragraph after having taken into account provisions of paragraph (6) of this Article:

  1. the risk-weighted exposure amounts for credit risk, including counterparty credit risk, and dilution risk, calculated in accordance with Title II of this Part of the Decision and Article 527 of this Decision, in respect of all business activities of a credit institution, excluding risk-weighted exposure amounts from the trading￾book business of the credit institution;
  2. the own funds requirements for the trading-book business of a credit institution for the following: ­ market risk, calculated in accordance with Title IV of this Part of the Decision; ­ large exposures exceeding the limits specified in Article 172 of the Law, to the extent that a credit institution is permitted to exceed those limits, as determined in accordance with the provisions of Article 561 of this Decision;
  3. the own funds requirements for market risk, calculated in accordance with Title IV of this Part of the Decision for all non-trading book business activities that are subject to foreign exchange risk or commodity risk;
  4. the own funds requirements for settlement risk, calculated in accordance with Articles 526 and 528 of this Decision;
  5. the own funds requirements for credit valuation adjustment risk (CVA risk), calculated in accordance with Title VI of this Part of the Decision;
  6. the own funds requirements for operational risk, calculated in accordance with Title III of this Part of the Decision;
  7. the risk-weighted exposure amounts for counterparty credit risk arising from the trading book business of the credit institution for the following types of transactions and agreements, calculated in accordance with Title II of this Part of the Decision:
  • contracts listed in Article 148 paragraph (8) of this Decision and credit derivatives;
  • repurchase transactions, securities or commodities lending or borrowing transactions based on securities or commodities;
  • margin lending transactions;
  • long settlement transactions. (5) The standardised total risk exposure amount shall be calculated as the sum of paragraph (4) items 1) to 7) of this Article, after having taken into account paragraph (6) of this Article and the following requirements:
  1. the risk-weighted exposure amounts for credit risk, including counterparty credit risk, and dilution risk, referred to in paragraph (4) item 1) of this Article, and for counterparty credit risk arising from the trading book business of the credit institution as referred to in item 7) of that paragraph shall be calculated without using any of the following approaches:
  • the internal model approach for master netting agreements set out in Article 258 of this Decision;
  • the IRB Approach set out in Title II, Chapter 3 of this Decision;
  • the Securitisation IRB Approach set out in Articles 302, 303 and 304 and the Internal Assessment Approach set out in Article 309 of this Decision;
  • the Internal Model Method set out in Title II, Chapter 6, Section 6 of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 108 2) the own funds requirements for market risk for the trading book business referred to in paragraph (4) item 2) indent 1 of this Article shall be calculated without using:

  • the alternative internal model approach set out in Title IV, Chapter 3 of this Decision; or
  • any approach listed under item 1) of this paragraph, where applicable;
  1. the own funds requirements for all non-trading book business activities of a credit institution that are subject to foreign exchange risk or commodity risk referred to in paragraph (4) item 3) of this Article shall be calculated without using the alternative internal model approach set out in Title IV, Chapter 3 of this Decision. (6) The following provisions shall apply to the calculations of the un-floored total risk exposure amount referred to in paragraph (4) of this Article and of the standardised total risk exposure amount referred to in paragraph (5) of this Article:
  2. the own funds requirements referred to in paragraph (4) items 4), 5) and 6) of this Article, shall include those arising from all business activities of a credit institution;
  3. the own funds requirements set out in paragraph (4) items 2) to 6) of this Article shall be multiplied by 12.5. Adjustment of risk-weighted exposures to non-defaulted SMEs Article 115 (1) A credit institution shall, for the purpose of calculating risk-weighted exposure amounts for credit risk referred to in Article 114 paragraph (4) item 1) and paragraph (5) item 1) of this Decision, adjust the risk-weighted exposure amounts to small and medium-sized enterprises – (hereinafter: the exposure to SME) that are not in default, calculated by applying Standardised Approach or IRB Approach, applying on the previously obtained amount the following factors:
  4. a risk-weight of 0,7619 to exposures or a part of the exposure to SME in total amount of EUR 1 million;
  5. a risk-weight of 0,85 to a part of the exposure exceeding EUR 1 million; (2) The calculation referred to in paragraph (1) of this Article shall be made by applying the following formula: 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅∗ = 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 ∙ 𝑚𝑚 𝑚𝑚{ ∗; 1.000.000 𝐸𝐸 } ∙ 0,7619 + 𝑚𝑚𝑚𝑚𝑚𝑚{ ∗ − 1.000.000 𝐸𝐸 } ∙ 0,85 ∗ where: 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅∗ = 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 adjusted by an SME supporting factor; ∗ = the total amount owed to the credit institution, its subsidiary undertakings, its parent undertakings and other subsidiary undertakings of those parent undertakings, including any exposure in default, but excluding claims or contingent claims secured on residential property collateral, by the SME or the group of connected clients of the SME.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 109 (3) For the purposes of paragraph (1) this Article, the following conditions should be met:

  1. an exposure to an SME shall have the meaning laid down in Article 4 paragraph (2) item 9) of this Decision;
  2. the exposure to an SME shall be included in one of the following exposure classes:
  • retail exposures,
  • corporate exposures, or
  • exposures secured by mortgages on immovable property excluding ADC exposures;
  1. a credit institution shall take reasonable steps to correctly determine E*. Adjustment of risk-weighted exposures to entities funding infrastructure projects of public interest Article 116 (1) Risk-weighted exposures for credit risk calculated in accordance with Title II of this Part of the Decision shall be multiplied by a factor of 0,75, provided that the exposure complies with all the following criteria:
  2. the exposure is included in the corporate exposure class referred to in Article 114 item 7) of this Decision or Article 189 paragraph (2) item 4) of this Decision, with the exclusion of exposures in default;
  3. the exposure is to an entity which was created specifically to finance or operate physical structures or facilities, systems and networks that provide or support essential public services;
  4. the source of repayment of the obligation of a debtor is represented for not less than two thirds of its amount by the income generated by the assets being financed, rather than the following:
  • independent capacity of a broader commercial enterprise;
  • subsidies;
  • grants; or
  • funding provided by one or more of the entities listed in paragraph (2) item
  1. indents 1 and 2 of this Article;
  2. the debtor can meet its financial obligations even under severely stressed conditions that are relevant for the risk of the project;
  3. the cash flows that the debtor generates are predictable and cover all future loan repayments during the duration of the loan;
  4. the re-financing risk of the exposure is low or adequately mitigated, taking into account any:
  • subsidies;
  • grants; or
  • funding provided by one or more of the entities listed in paragraph (2) item
  1. indents 1 or 2 of this Article;
  2. the contractual arrangements provide lenders with a high degree of protection including the following:
  • where the revenues of the debtor are not funded by payments from a large number of users, the contractual arrangements shall include provisions that effectively protect lenders against losses resulting from the termination of the project by the party which agrees to purchase the goods or services provided by the debtor;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 110

  • the debtor has sufficient reserve funds fully funded in cash or other financial arrangements with highly rated guarantors to cover the contingency funding and working capital requirements over the lifetime of the assets referred to in item 2) of this paragraph;
  • the lenders have a substantial degree of control over the assets and the income generated by the debtor;
  • the lenders have the benefit of security to the extent permitted by applicable law in assets and contracts critical to the infrastructure business or have alternative mechanisms in place to secure their position;
  • equity instruments are pledged to lenders such that they are able to take control of the entity upon default;
  • the use of net operating cash flows after mandatory payments from the project for purposes other than servicing debt obligations is restricted;
  • there are contractual restrictions on the ability of the debtor to perform activities that may be detrimental to lenders, including the restriction that new debt cannot be issued without the consent of existing creditors or investors;
  1. the obligation is senior to all other claims other than statutory claims and claims from derivatives counterparties;
  2. where the debtor is in the construction phase, the following criteria shall be fulfilled by the equity investor, or where there is more than one equity investor, the following criteria shall be fulfilled by a group of equity investors as a whole:
  • the equity investors have a history of successfully overseeing infrastructure projects, the financial strength and the relevant expertise;
  • the equity investors have a low risk of default, or there is a low risk of material losses for the debtor as a result of their default;
  • there are adequate mechanisms in place to align the interest of the equity investors with the interests of lenders; 10)the debtor has adequate safeguards to ensure completion of the project according to the agreed specification, budget or completion date; including strong completion guarantees or the involvement of an experienced constructor and adequate contract provisions for liquidated damages; 11)where operating risks are material, they are properly managed; 12)the debtor uses tested technology and design; 13)all necessary permits and authorisations have been obtained; 14)the debtor uses derivatives only for risk-mitigation purposes; and 15)the debtor has carried out an assessment whether the assets being financed contribute to the following environmental objectives:
  • climate change mitigation;
  • climate change adaptation;
  • sustainable use and protection of water and marine resources;
  • transition to a circular economy, waste prevention and recycling;
  • pollution prevention and control;
  • protection of healthy ecosystems. (2) For the purposes of paragraph (1) item 5) of this Article, the cash flows generated shall not be considered predictable unless a substantial part of the revenues satisfies the following conditions:
  1. one of the following criteria is met:
  • the revenues are availability-based;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 111

  • the revenues are subject to a rate-of-return regulation;
  • the revenues are subject to a take-or-pay contract;
  • the level of output or the usage and the price shall independently meet one of the following criteria: a) it is regulated, b) it is contractually fixed, c) it is sufficiently predictable as a result of low demand risk;
  1. where the revenues of the debtor are not funded by payments from a large number of users, the party which agrees to purchase the goods or services provided by the debtor shall be one of the following:
  • a central bank, a central government, a regional government or a local self￾government, provided that they are assigned a risk weight of 0% in accordance with Articles 151 and 152 of this Decision or are assigned an ECAI rating with a credit quality step of at least 3;
  • a public sector entity, provided that it is assigned a risk weight of 20% or below in accordance with Article 153 of this Decision or is assigned an ECAI rating with a credit quality step of at least 3;
  • a multilateral development bank referred to in Article 154 paragraph (4) of this Decision;
  • an international organisation referred to in Article 155 of this Decision;
  • a corporate entity which has been assigned an ECAI rating with a credit quality step of at least 3; or
  • an entity that is replaceable without a significant change in the level and timing of revenues. (3) A credit institution shall notify the Central Bank of exposures to infrastructure projects calculated in accordance with paragraph (1) of this Article. Requirements for own funds and eligible liabilities for G-SICIs Article 117 (1) A credit institution identified as resolution entity and that is a G-SICI or part of a G￾SICI shall, in accordance with Article 119 of this Decision and exceptions set out in paragraph (2) of this Article, meet the following requirements for own funds and eligible liabilities:
  1. a risk-based ratio of 18%, representing the own funds and eligible liabilities of the credit institution expressed as a percentage of the total risk exposure amount calculated in accordance with Article 114 paragraph (3) of this Decision;
  2. a non-risk-based ratio of 6,75%, representing the own funds and eligible liabilities of the credit institution expressed as a percentage of the total exposure measure referred to in Article 563 paragraphs (4) to (7) of this Decision. (2) The requirements laid down in paragraph (1) of this Article shall not apply in the following cases:
  3. within the three years following the date on which the credit institution or the group of which the credit institution is part has been identified as a G-SICI;
  4. within the two years following the date on which the Central Bank, in pursuing its mandate as the resolution authority, has applied the bail-in tool in accordance with the law governing the resolution of credit institutions;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 112 3) within the two years following the date on which the resolution entity has put in place an alternative private sector measure referred to in Article 35 paragraph (1) item 2) the Law on Resolution of Credit Institutions by which capital instruments and other liabilities have been written down or converted into Common Equity Tier 1 items in order to recapitalise the resolution entity without the application of resolution tools. Requirement for own funds and eligible liabilities for non-EU G-SICI Article 118 (1) Where a credit institution is a material subsidiary undertaking of non-EU G-SICI and which is not a resolution entity, it shall at all times meet the requirements for own funds and eligible liabilities equal to 90% of the requirements for own funds and eligible liabilities laid down in Article 117 of this Decision. (2) A credit institution shall, for the purpose of complying with paragraph (1) of this Article, take into account Additional Tier 1, Tier 2 and eligible liabilities instruments only where those instruments are owned by the ultimate parent undertaking of the non-EU G-SICI and have been issued directly or indirectly through other entities within the same group, provided that all such entities are established in the same third country as that ultimate parent undertaking or in Montenegro or in the EU. (3) A credit institution may, for the purpose of complying with paragraph (1) of this Article, take into amount eligible liabilities instrument only where it fulfils the following additional conditions:

  1. in the event of normal bankruptcy proceedings, the claim resulting from the liability ranks below claims resulting from liabilities that do not fulfil the conditions set out in paragraph (2) of this Article and that do not qualify as own funds;
  2. it is subject to the write-down or conversion powers in accordance with Articles 48, 49 and 52 of the Law on Resolution of Credit Institutions. Derogation for small trading book business Article 119 (1) By way of derogation from Article 114 paragraph (4) item 2) and paragraph (5) item
  3. of this Decision, a credit institution may calculate the own funds requirement for their trading-book business in accordance with paragraph (2) of this Article, provided that the size of the credit institution's on- and off-balance-sheet trading-book business is equal to or less than both of the following thresholds on the basis of an assessment carried out on a monthly basis using the data as of the last day of the month:
  4. 5% of the credit institution's total assets;
  5. EUR 50 million. (2) Where both conditions set out in paragraph (1) of this Article are met, the credit institution may calculate the own funds requirement for their trading-book business as follows:
  6. for the contracts listed in Article 148 paragraph (8) item 1) of this Decision, contracts relating to equities which are referred to in Article 148 paragraph (8) item 3) of this Decision and credit derivatives, credit institution may exempt

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 113 those positions from the own funds requirement referred to in Article 114 paragraph (4) item 2) and paragraph (5) item 2) of this Decision; 2) for trading book positions other than those referred to in item 1) of this paragraph, credit institution may replace the own funds requirement referred to in Article 114 paragraph (4) item 2) and paragraph (5) item 2) of this Decision with the requirement calculated in accordance with Article 114 paragraph (4) item 1) and paragraph (5) item 1) of this Decision. (3) A credit institution shall calculate, for the purposes of paragraph (1) of this Article, the size of their on- and off-balance-sheet trading book business on the basis of data as of the last day of each month in accordance with the following requirements:

  1. all the positions assigned to the trading book in accordance with Article 122 of this Decision shall be included in the calculation except for the following:
  • positions concerning foreign exchange and commodities;
  • positions in credit derivatives that are recognised as internal hedges against non-trading book credit risk exposures or counterparty risk exposures and the credit derivate transactions that perfectly offset the market risk of those internal hedges as referred to in Article 140 paragraphs (3) and (5) of this Decision;
  1. all positions included in the calculation in accordance with item1) of this paragraph shall be valued at their market value on that given date, whereby where the market value of a position is not available on a given date, credit institution shall take a fair value for the position on that date; where the market value and fair value of a position are not available on a given date, credit institution shall take the most recent of the market value or fair value for that position;
  2. the absolute value of total long positions shall be summed with the absolute value of short positions. (4) For the purposes of paragraph (3) of this Article, a long position shall be the one where the market value of the position increases when the value of its main risk driver increases, and a short position shall be the one where the market value of the position decreases when the value of its main risk driver increases. (5) For the purposes of paragraph (3) of this Article, the value of the aggregated long (short) position shall be equal to the sum of the values of the individual long (short) positions included in the calculation in accordance with item 1) of that paragraph. (6) Where both conditions set out in paragraph (1) of this Article are met, irrespective of the obligations set out in Article 104 paragraph (1) and Article 111 paragraphs (5) to (8) of the Law, the credit institution shall not apply Articles 112 paragraphs (3) and (4), Article 121 and Article 124 of this Decision. (7) A credit institution shall notify the Central Bank when it calculates, or ceases to calculate, the own funds requirements of their trading-book business in accordance with paragraph (2) of this Article. (8) A credit institution that no longer meets one or more of the conditions set out in paragraph (1) of this Article shall immediately notify the Central Bank thereof.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 114 (9) A credit institution shall cease to calculate the own funds requirements of its trading-book business in accordance with paragraph (2) of this Article within three months of one of the following occurring:

  • the credit institution does not meet the conditions set out in paragraph (1) items
  1. or 2) of this Article for three consecutive months;
  • the credit institution does not meet the conditions set out in paragraph (1) items
  1. or 2) of this Article during more than 6 out of the last 12 months. (10) Where a credit institution has ceased to calculate the own funds requirements of its trading-book business in accordance with this Article, Central Bank shall only permit the credit institution to calculate the own funds requirements of its trading- book business in accordance with this Article where it demonstrates to the Central Bank that all the conditions set out in paragraph (1) of this Article have been met for an uninterrupted full-year period. (11) A credit institution shall not enter into, buy or sell a trading-book position for the sole purpose of complying with any of the conditions set out in paragraph (1) of this Article during the monthly assessment. SUBTITLE 2 - Trading book Requirements for the trading book Article 120 (1) Positions in the trading book shall be either free of restrictions on their tradability or able to be hedged. (2) Trading intent shall be evidenced on the basis of the strategies, policies and procedures set up by the credit institution to manage the position or portfolio in accordance with Articles 121, 122 and 123 of this Decision. (3) A credit institution shall establish and maintain systems and controls to manage their trading book in accordance with Articles 121 of this Decision. (4) For the purpose of calculating the own funds requirements for market risk in accordance with the approach referred to in Article 413 paragraph (1) item 2) of this Decision, trading book positions shall be assigned to trading desks. (5) Positions in the trading book shall be subject to the requirements for prudent valuation specified in Article 126 of this Decision. (6) A credit institution may shall treat internal hedges in accordance with Article 140 of this Decision. Management of the trading book Article 121 (1) A credit institution shall have in place clearly defined policies and procedures for the overall management of the trading book, which address in particular the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 115

  1. the activities which the credit institution considers to be trading business and as constituting part of the trading book for own funds requirement purposes;
  2. the extent to which a position can be marked-to-market daily by reference to an active, liquid two-way market;
  3. for positions that are marked-to-model, the extent to which the credit institution can:
  • identify all material risks of the position;
  • hedge all material risks of the position with instruments for which an active, liquid two-way market exists;
  • derive reliable estimates for the key assumptions and parameters used in the model;
  1. the extent to which the credit institution can, and is required to, generate valuations for the position that can be validated externally in a consistent manner;
  2. the extent to which legal restrictions or other operational requirements would impede the credit institution's ability to effect a liquidation or hedge of the position in the short term;
  3. the extent to which the credit institution can, and is required to, actively manage the risks of positions within its trading operation;
  4. the extent to which the credit institution may reclassify risk or positions between the non-trading and trading books and the requirements for such reclassifications as referred to in Article 123 of this Decision. (2) In managing its positions or portfolios of positions in the trading book, the credit institution shall have in place the following:
  5. a clearly documented trading strategy for the position or portfolios in the trading book, which shall be approved by senior management and include the expected holding period;
  6. clearly defined policies and procedures for the active management of positions or portfolios in the trading book, which include the following:
  • which positions or portfolios of positions may be entered into by each trading desk or, as the case may be, by designated dealers;
  • the setting of position limits and monitoring them for appropriateness;
  • ensuring that dealers have the autonomy to enter into and manage the position within agreed limits and according to the approved strategy;
  • ensuring that positions are reported to senior management as an integral part of the credit institution's risk management process; and
  • ensuring that positions are actively monitored with reference to market information sources and an assessment is made of the marketability or hedgeability of the position or its component risks, including the assessment, the quality and availability of market inputs to the valuation process, level of market turnover, sizes of positions traded in the market;
  • active anti-fraud procedures and controls; and
  1. clearly defined policies and procedures to monitor the positions against the credit institution's trading strategy, including the monitoring of turnover and positions for which the originally intended holding period has been exceeded.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 116 Inclusion in the trading book Article 122 (1) A credit institution shall have in place clearly defined policies and procedures for determining which position to include in the trading book for the purposes of calculating their capital requirements, in accordance with Article 112 and this Article taking into account the credit institution's risk management capabilities and practices. (2) A credit institution shall fully document its compliance with those policies and procedures referred to in paragraph (1) of this Article, and shall subject them to an internal audit on at least a yearly basis and shall make the results of that audit available to the Central Bank. (3) A credit institution shall have in place an independent risk control function which shall evaluate, on an ongoing basis, whether its instruments are being properly assigned to the trading book or the non-trading book. (4) A credit institution shall assign positions in the following instruments to the trading book:

  1. instruments that meet the criteria set out in Article 413 paragraphs (10) to (13) of this Decision, for the inclusion in the alternative correlation trading portfolio (ACTP);
  2. instruments that would give rise to a net short credit or net short equity position in the non-trading book, with the exception of the own liabilities of the institution, unless such positions meet the criteria referred to in item 5) of this paragraph
  3. instruments resulting from securities underwriting commitments, where those underwriting commitments relate only to securities that are expected to be purchased by the credit institution on the settlement date;
  4. instruments classified unambiguously as having a trading purpose under the accounting framework applicable to the credit institution;
  5. instruments resulting from market-making activities;
  6. positions held with trading intent in CIUs, provided that those CIUs meet at least one of the conditions set out in paragraph (15) of this Article;
  7. listed equity instruments;
  8. trading-related securities financing transactions;
  9. options, or other derivatives, embedded in the own liabilities of the credit institution in the non-trading book that relate to credit risk or equity risk. (5) For the purposes of paragraph (4) of this Acrticle, a credit institution shall have a net short equity position where a decrease in the equity’s price results in a profit for the credit institution or it shall have a net short credit position where the credit spread increase, or the deterioration in the creditworthiness of the issuer or group of issuers, results in a profit for the credit institution. (6) A credit institution shall continuously monitor whether instruments give rise to a net short credit or net short equity position in the non-trading book. (7) For the purposes of paragraph (4) item 9) of this Article, a credit institution shall split the embedded option, or other derivative, from its own liability in the non-trading book that relates to credit risk or equity risk. It shall assign the embedded option, or

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 117 other derivative, to the trading book and shall leave the own liability in the non-trading book, whereat, due to its nature, it is not possible to split the instrument, a credit institution shall assign the whole instrument to the trading book and shall duly document the reason for applying that treatment. (8) A credit institution shall not assign positions in the following instruments to the trading book:

  1. instruments designated for securitisation warehousing;
  2. real estate holdings-related instruments;
  3. unlisted equities;
  4. instruments related to retail and SME credit;
  5. positions in other CIUs than those referred to in paragraph (4) item 6) of this Article;
  6. derivative contracts and CIUs with one or more of the underlying instruments referred to in items 1) to 4) of this paragraph;
  7. instruments held for hedging a particular risk of one or more positions in an instrument referred to in items 1) to 6) and items 8) and 9) of this paragraph;
  8. own liabilities of the credit institution, unless such instruments meet the criteria referred to in paragraph (4) item 5), or the criteria referred to in paragraph (7) of this Article;
  9. instruments in hedge funds. (9) By way of derogation from paragraph (4) of this Article, a credit institution may assign to the non-trading book a position in an instrument referred to in items 4) to 9) of that paragraph, subject to the authorisation of the Central Bank. (10) The Central Bank shall give authorisation referred to in paragraph (9) of this Article to a credit institution where it has demonstrated to the satisfaction of the Central Bank that the position is not held with trading intent or does not hedge positions held with trading intent. (11) By way of derogation from paragraph (8) of this Article, a credit institution may assign to the trading book a position in an instrument referred to in item 9) of that paragraph, subject to the authorisation of the Central Bank. (12) The Central Bank shall give authorisation referred to in paragraph (11) of this Article to a credit institution where it has demonstrated to the satisfaction of the Central Bank that the position is held with trading intent, or hedges positions held with trading intent, and that the credit institution meets at least one of the conditions set out in paragraph (8) of this Article for that position. (13) Where a credit institution has assigned to the trading book a position in an instrument other than the instruments referred to in paragraph (4) items 1), 2) or 3) of this Article, the Central Bank may ask the credit institution to provide evidence to justify such assignment, and where the credit institution fails to provide suitable evidence, the Central Bank may require the credit institution to reassign that position to the non￾trading book. (14) Where a credit institution has assigned to the non-trading book a position in an instrument other than the instruments referred to in paragraph (8) of this Article, the Central Bank may ask the credit institution to provide evidence to justify such

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 118 assignment and where the credit institution fails to provide suitable evidence, the Central Bank may require the credit institution to reassign that position to the trading book. (15) A credit institution shall assign to the trading book a position in a CIU, other than the positions referred to in paragraph (8) item 6) of this Article that is held with trading intent, where the credit institution meets any of the following conditions:

  1. the credit institution is able to obtain sufficient information about the individual underlying exposures of the CIU;
  2. the credit institution is not able to obtain sufficient information about the individual underlying exposures of the CIU, but the credit institution has knowledge of the content of the mandate of the CIU and is able to obtain daily price quotes for the CIU. Reclassification of a position Article 123 (1) A credit institution shall have in place clearly defined policies for identifying the exceptional circumstances which justify the reclassification of a trading book position as a non-trading book position or, conversely, the reclassification of a non-trading book position as a trading book position, for the purpose of determining their own funds requirements to the satisfaction of the Central Bank. (2) The credit institution shall review those policies referred to in paragraph (1) of this Article at least once a year. (3) The Central Bank shall grant authorisation to a credit institution to reclassify a trading book position as a non-trading book position or conversely a non-trading book position as a trading book position for the purpose of determining their own funds requirements only where the credit institution has provided the written evidence that its decision to reclassify that position is the result of an exceptional circumstance that is consistent with the policies the credit institution has in place in accordance with paragraph (1) of this Article. (4) For the purposes of paragraph (3) of this Article, the credit institution shall provide sufficient evidence to the Central Bank that the position no longer meets the condition to be classified as a trading book or non-trading book position pursuant to Article 122 of this Decision. (5) The management board of a credit institution shall approve the decision on reclassification referred to in paragraph (3) of this Article. (6) Where the Central Bank has granted authorisation for the reclassification referred to in paragraph (3) of this Article, the credit institution which received that authorisation shall:
  3. disclose, without delay, ­ information that its position has been reclassified, and ­ where the effect of that reclassification is a reduction in the credit institution's own funds requirements, the size of that reduction; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 119 2) where the effect of that reclassification is a reduction in the credit institution's own funds requirements, not recognise that effect until the position matures, unless the Central Bank authorises it to recognise that effect at an earlier date. (7) The credit institution shall calculate the net change in the amount of its own funds requirements arising from the reclassification of the position as the difference between the own funds requirements immediately after the reclassification and the own funds requirements immediately before the reclassification, each calculated in accordance with Article 114 of this Decision. (8) The calculation referred to in paragraph (7) of this Article shall not take into account the effects of any factors other than the reclassification. (9) The reclassification of a position in accordance with this Article shall be irrevocable, except in the exceptional circumstances referred to in paragraph (1) of this Article. (10) By way of derogation from paragraph (1) of this Article, a credit institution may reclassify a non-trading book position as a trading book position pursuant to Article 122 paragraph (4) item 4) of this Decision without seeking authorisation from the Central Bank, and the requirements laid down in paragraphs (6) to (8) of this Article shall continue to apply to the credit institution. (11) The credit institution shall immediately notify the Central Bank where the reclassification referred to in paragraph (10) of this Article has occurred. Requirements for trading desk Article 124 (1) For the purpose of calculating the own funds requirements for market risk in accordance with the approach referred to in Article 413 paragraph (1) item 2) of this Decision, a credit institution shall establish trading desks and shall assign each of their trading book positions and their non-trading book positions referred to in paragraphs (7), (8) and (9) of this Article to one of those trading desks. (2) Trading book positions shall be attributed to the same trading desk only where those positions are in compliance with the agreed business strategy for that trading desk and are consistently managed and monitored in accordance with paragraph (3) of this Article. (3) A credit institution's trading desks shall at all times meet the following requirements:

  1. each trading desk shall have a clear and distinctive business strategy and a risk management structure that is adequate for its business strategy;
  2. each trading desk shall have a clear organisational structure; positions in a given trading desk shall be managed by dealers that the credit institution has assigned to one trading desk only, where at each dealer shall have dedicated functions in the trading desk;
  3. position limits shall be set within each trading desk according to the business strategy of that trading desk;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 120 4) reports on the activities, profitability, risk management and regulatory requirements at the trading desk level shall be produced at least on a weekly basis and communicated to the management board on a regular basis; 5) each trading desk shall have a clear annual business plan including a well￾defined remuneration policy on the basis of sound criteria used for performance measurement; and 6) reports on maturing positions, intra-day trading limit breaches, daily trading limit breaches and actions taken by the credit institution to address those breaches, as well as assessments of market liquidity, shall be prepared for each trading desk on a monthly basis and made available to the Central Bank. (4) By way of derogation from paragraph (3) item 2) of this Article, a credit institution may assign a dealer to more than one trading desk, provided that the credit institution demonstrates to the satisfaction of the Central Bank that the assignment has been made due to business or resource considerations and the assignment preserves the other qualitative requirements set out in this Article applicable to dealers and trading desks. (5) A credit institution shall notify the Central Bank of the manner in which it complies with paragraph (3) of this Article. (6) The Central Bank may require a credit institution to change the structure or organisation of its trading desks to comply with this Article. (7) A credit institution shall, for the purpose of calculating their own funds requirements for market risk, assign each of their non-trading book positions that are subject to foreign exchange risk or commodity risk to trading desks established in accordance with paragraph (1) of this Article that manage risks that are similar to the risks of those positions. (8) By way of derogation from paragraph (7) of this Article, a credit institution may, when calculating their own funds requirements for market risk, establish one or more trading desks to which they assign exclusively non-trading book positions that are subject to foreign exchange risk or commodity risk. (9) The trading desks referred to in paragraph (8) of this Article shall not be subject to the requirements set out in paragraphs (1) to (4) of this Article. Treatment of foreign exchange risk hedges of capital ratios Article 125 (1) A credit institution which has deliberately taken a risk position in order to hedge, at least partially, against adverse movements in foreign exchange rates on any of its capital ratios as referred to in Article 134 paragraph (2) items 1), 2) and 3) of the Law, may, subject to the authorisation of the Central Bank, exclude that risk position from the own funds requirements for foreign exchange risk referred to in Article 413 paragraph (1) of this Decision, provided that the following conditions are met:

  1. the maximum amount of the risk position that is excluded from the own funds requirements for market risk is limited to the amount of the risk position that

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 121 neutralises the sensitivity of any of the capital ratios to the adverse movements in foreign exchange rates; 2) the risk position is excluded from the own funds requirements for market risk for at least six months; 3) the credit institution has established an appropriate risk management framework for hedging the adverse movements in foreign exchange rates on any of its capital ratios, including a clear hedging strategy and governance structure; 4) the credit institution has provided to the Central Bank a justification for excluding a risk position from the own funds requirements for market risk, the details of that risk position and the amount to be excluded. (2) Any exclusion of risk positions from the own funds requirements for market risk in accordance with paragraph (1) of this Article shall be applied consistently. (3) The Central Bank shall approve any changes by the credit institution to the risk management framework referred to in paragraph (1) item 3) of this Article and to the details of the risk positions referred to in paragraph (1) item 4) of this Article. Requirements for prudent valuation Article 126 (1) All trading book positions and non-trading book positions measured at fair value shall be subject to the standards for prudent valuation specified in this Article. (2) A credit institution shall in particular ensure that the prudent valuation of their trading book positions achieves an appropriate degree of certainty having regard to the dynamic nature of trading book positions and non-trading book positions measured at fair value, the demands of prudential soundness and the mode of operation and purpose of capital requirements in respect of trading book positions and non-trading book positions measured at fair value. (3) A credit institution shall establish and maintain systems and controls sufficient to provide prudent and reliable valuation estimates and those systems and controls shall include at least the following elements:

  1. documented policies and procedures for the process of valuation, including clearly defined responsibilities of the various areas involved in the determination of the valuation, sources of market information and review of their appropriateness, guidelines for the use of unobservable inputs reflecting the credit institution's assumptions of what market participants would use in pricing the position, frequency of independent valuation, timing of closing prices, procedures for adjusting valuations, month end and ad-hoc verification procedures;
  2. reporting lines for the department accountable for the valuation process that are clear and independent of the front office, which shall be submitted to the management board. (4) A credit institution shall revalue trading book positions at fair value at least on a daily basis, and report those changes in the value of those positions in the profit and loss account of the credit institution.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 122 (5) A credit institution shall mark their trading book positions and non-trading book positions measured at fair value to market whenever possible, including when applying the relevant capital treatment to those positions. (6) When marking to market, a credit institution shall use the more prudent side of bid and offer unless the credit institution can close out at mid-market, and where credit institution makes use of this derogation, it shall inform the Central Bank every six months of the positions concerned and furnish evidence that it can close out at mid￾market. (7) Where marking to market is not possible, the credit institution shall conservatively mark to model their positions and portfolios, including when calculating own funds requirements for positions in the trading book and positions measured at fair value in the non-trading book. (8) A credit institution shall comply with the following requirements when marking to model:

  1. senior management shall be aware of the elements of the trading book or of other fair-valued positions which are subject to mark to model and shall understand the materiality of the uncertainty thereby created in the reporting of the risk/performance of the business;
  2. credit institution shall source market inputs, where possible, in line with market prices, and shall assess the appropriateness of the market inputs of the particular position being valued and the parameters of the model on a frequent basis;
  3. where available, a credit institution shall use valuation methodologies which are accepted market practice for particular financial instruments or commodities;
  4. where the model is developed by the credit institution itself, it shall be based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process;
  5. a credit institution shall have in place formal change control procedures and shall hold a secure copy of the model and use it periodically to check valuations;
  6. persons responsible for risk management in a credit institution shall be aware of the weaknesses of the models used and how best to reflect those in the valuation output; and
  7. credit institution's models shall be subject to periodic review to determine the accuracy of their performance, which shall include assessing the continued appropriateness of assumptions, analysis of profit and loss versus risk factors, and comparison of actual close out values to model outputs. (9) For the purposes of paragraph (8) item 4) of this Article, the model shall be developed or approved independently of the trading desk and shall be independently tested, including validation of the mathematics, assumptions and software implementation. (10) A credit institution shall perform independent price verification in addition to daily marking to market or marking to model.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 123 (11) Verification of market prices and model inputs shall be performed by a person or unit independent from persons or units that benefit from the trading book, at least monthly, or more frequently depending on the nature of the market or trading activity. (12) Where independent pricing sources are not available to a credit institution or pricing sources are more subjective, prudent measures such as valuation adjustments may be appropriate. (13) A credit Institution shall establish and develop procedures for considering valuation adjustments. (14) A credit institution shall formally consider the following valuation adjustments:

  1. unearned credit spreads;
  2. close-out costs;
  3. operational risks;
  4. market price uncertainty:
  5. early termination;
  6. investing and funding costs;
  7. future administrative costs; and,
  8. where relevant, model risk. (15) A credit institution shall establish and maintain procedures for calculating an adjustment to the current valuation of any less liquid positions, which can in particular arise from market events or credit institution-related situations such as concentrated positions and/or positions for which the originally intended holding period has been exceeded. (16) A credit institution shall, where necessary, make such adjustments in addition to any changes to the value of the position required for financial reporting purposes and shall design such adjustments to reflect the illiquidity of the position. (17) A credit institution shall, within the procedure referred to in paragraph (16) of this Article, consider several factors when determining whether a valuation adjustment is necessary for less liquid positions and those factors shall include the following:
  9. the additional amount of time it would take to hedge out the position or the risks within the position beyond the liquidity horizons that have been assigned to the risk factors of the position in accordance with Article 469 of this Decision;
  10. the volatility and average of bid/offer spreads;
  11. the availability of market quotes (number and identity of market makers) and the volatility and average of trading volumes including trading volumes during periods of market stress;
  12. market concentrations;
  13. the ageing of positions;
  14. the extent to which valuation relies on marking-to-model; and
  15. the impact of other model risks. (18) When using third party valuations or marking to model, a credit institution shall consider whether to apply a valuation adjustment, and consider the need to establish adjustments for less liquid positions and on an ongoing basis review their continued

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 124 suitability, as well as it shall also explicitly assess the need for valuation adjustments relating to the uncertainty of parameter inputs used by models. (19) With regard to complex products, including securitisation exposures and n-th-to￾default credit derivatives, a credit institution shall explicitly assess the need for valuation adjustments to reflect the model risk associated with using a possibly incorrect valuation methodology and the model risk associated with using unobservable (and possibly incorrect) calibration parameters in the valuation model. Simplified approach for determining AVA Article 127 (1) A credit institution may apply the simplified approach for the determination of AVAs only if the sum of the absolute value of fair-valued assets and liabilities, as stated in the credit institution's financial statements under the applicable accounting framework, is less than EUR 15 billion. (2) Exactly matching, offsetting fair-valued assets and liabilities shall be excluded from the calculation of paragraph (1) of this Article. (3) For fair-valued assets and liabilities for which a change in accounting valuation has a partial or zero impact on Common Equity Tier 1 capital, their values shall only be included in the calculation referred to in paragraph (1) of this Article in proportion to the impact of the relevant valuation change on Common Equity Tier 1 capital. (4) A credit institution shall calculate AVA under the simplified approach as 0,1 % of the sum of the absolute value of fair-valued assets and liabilities laid down in paragraph (1) of this Article. (5) The threshold referred to in paragraph (1) of this Article shall apply on an individual and consolidated basis. (6) Where the threshold is breached on a consolidated basis, the core approach as defined in Article 128 of this Decision shall be applied to all entities included in the consolidation. (7) Where the credit institution applying the simplified approach fails to meet the condition of paragraph (1) of this Article for two consecutive quarters, it shall immediately notify the Central Bank and shall agree on a plan to implement the core approach referred to in Article 128 of this Decision within the following two quarters. Core approach for determining AVA Article 128 (1) A credit institution shall determine AVA under the core approach as the sum of all AVAs determined for each of the category level referred to in Article 126 paragraphs (14) to (17) of this Decision, in accordance with paragraph (2) of this Article. (2) For the purposes of paragraph (1) of this Article, AVA shall be determined at the category level in accordance with the provisions of Articles 129 to 137 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 125 (3) By way of derogation from paragraph (2) of this Article, where a credit institution cannot apply Articles 129 to 1137 of this Decision, a “fall-back approach” shall apply, whereby the related financial instruments shall be identified and an AVA shall be calculated as the sum of the following:

  1. 100% of the net unrealised profit on the related financial instruments;
  2. 10% of the notional value of the related financial instruments in the case of derivatives;
  3. 25% of the absolute value of the difference between the fair value and the unrealised profit, as determined in item 1) of this paragraph, of the related financial instruments in the case of non-derivatives. (4) For the purposes of paragraph (3) item 1) of this Article, unrealised profit shall mean the change, where positive, in fair value since trade inception, determined on a first-in-first-out basis. (5) Fair-valued assets and liabilities for which a change in accounting valuation has a partial or zero impact on CET1 capital, shall be included in the calculation referred to in paragraph (1) of this Article only based on the proportion of the accounting valuation change that impacts Common Equity Tier 1 capital. (6) Additional valuation adjustment shall be considered to be the excess of valuation adjustments required to achieve the identified prudent value, over any adjustment applied in the credit institution's fair value that can be identified as addressing the same source of valuation uncertainty as the AVA. (7) Where an adjustment applied in the credit institution's fair value cannot be identified as addressing a specific AVA category at the level at which the relevant AVA is calculated, that adjustment shall not be included in the calculation of AVA. (8) Additional value adjustment shall always be positive, including at valuation exposure level, category level, both pre and post aggregation. Calculation of unearned credit spreads AVA Article 129 (1) A credit institution shall calculate the unearned credit spreads AVA to reflect the valuation uncertainty in the adjustment necessary according to the applicable accounting framework to include the current value of expected losses due to counterparty default on derivative positions. (2) A credit institution shall include the element of the AVA relating to market price uncertainty within the market price uncertainty AVA category. (3) The element of the AVA relating to close-out cost uncertainty shall be included within the close-out costs AVA category. (4) The element of the AVA relating to model risk shall be included within the model risk AVA category.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 126 Calculation of close-out costs AVA Article 130 (1) A credit institution shall calculate close-out costs AVA at valuation exposure level (‘individual close-out costs AVAs’). (2) Where a credit institution has calculated a market price uncertainty AVA for a valuation exposure based on an exit price, the individual close-out costs AVAs may be assessed to have zero value. (3) Where a credit institution applies the derogation referred to in Article 126 paragraph (6) of this Decision, the individual close-out costs AVA may be assessed to have zero value, on the condition that the credit institution provides evidence that it is 90 % confident that sufficient liquidity exists to support the exit of the related valuation exposures at mid-price. (4) Where a valuation exposure cannot be shown to have a zero close-out costs AVA, a credit institution shall use the data sources defined in Article 17 paragraphs of this Decision and the close-out costs AVA shall be calculated as described in paragraphs (5) and (6) of this Article. (6) A credit institution shall calculate close-out costs AVA on valuation exposures related to each valuation input used in the relevant valuation model at one of the following levels of granularity:

  1. where decomposed, all valuation inputs required to calculate an exit price for the valuation position; or
  2. the price of the instrument. (6) Each of the valuation inputs referred to in paragraph (5) item 1) of this Article shall be treated separately. (7) Where a valuation input consists of a matrix of parameters, the close-out cost AVA shall be calculated based on the valuation exposures related to each parameter within that matrix. (8) Where a valuation input does not refer to tradable instruments, a credit institution shall explicitly map the valuation input and the related valuation exposure to a set of market tradable instruments. (9) A credit institution may reduce the number of parameters of the valuation input for the purpose of calculating AVA using any appropriate methodology provided the reduced parameters satisfy all the following requirements:
  3. the total value of the reduced valuation exposure is the same as the total value of the original valuation exposure;
  4. the reduced set of parameters can be mapped to a set of market tradable instruments; and
  5. the ratio of variance measure 2 over variance measure 1, based on historical data from the most recent 100 trading days, is less than 0,1.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 127 (10) For the purposes of paragraph (9) item 3) of this Article, variance measure 1 shall mean profit and loss variance of the valuation exposure based on the unreduced valuation input and variance measure 2 shall mean profit and loss variance of the valuation exposure based on the unreduced valuation input minus the valuation exposure based on the reduced valuation input. (11) Where a reduced number of parameters is used for the purpose of calculating AVA, the determination that the criteria set out in paragraph (9) of this Article are met shall be subject to competent control function review and internal validation on at least an annual basis. (12) A credit institution shall determine close-out costs AVA as follows:

  1. where sufficient data exists to construct a range of plausible bid-offer spreads for a valuation input, credit institution shall estimate a point within the range where they are 90% confident that the spread they could achieve in exiting the valuation exposure would be at that price or better;
  2. where insufficient data exists to construct a plausible range of bid-offer spreads, credit institution shall use an expert-based approach using qualitative and quantitative information available to achieve a level of certainty in the prudent value that is equivalent to that targeted where a range of plausible values is available and in that case, the credit institution shall notify the Central Bank of the valuation exposures for which this approach is applied, and the methodology used to determine the AVA;
  3. credit institution shall calculate the close-out costs AVA by applying 50% of the estimated bid-offer spread calculated in accordance with either item 1) or item
  4. to the valuation exposures related to the valuation inputs defined in paragraphs (5) to (11) of this Article. (13) A credit institution shall calculate the total category level AVA for close-out costs by applying to the individual close-out costs AVAs the formulae for either Method 1 or Method 2: Method 1 APVA = (FV – PV) – α · (FV – PV) = (1- α) · (FV – PV) AVA = Σ APVA Method 2 APVA = max {0, (FV – PV) – α · (EV – PV)} = max {0, FV – α · EV –(1- α) · PV} AVA = Σ APVA Where: FV = the valuation exposure-level fair value after any accounting adjustment applied in the credit institution's fair value that can

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 128 be identified as addressing the same source of valuation uncertainty as the relevant AVA; PV = the valuation exposure-level prudent value determined in accordance with this Decision; EV = the expected value at a valuation exposure level taken from a range of possible values; α = the aggregation factor of 50% APVA = the valuation exposure-level AVA after adjusting for aggregation; AVA = the total category-level AVA after adjusting for aggregation. Calculation of operational risk AVA Article 131 (1) A credit institution shall estimate an operational risk AVA by assessing the potential losses that may be incurred as a result of operational risk related to valuation processes, whereat the estimate shall include an assessment of valuation positions judged to be at-risk during the balance sheet substantiation process, including those due to legal disputes. (2) A credit institution shall calculate an operational risk AVA of 10% of the sum of the aggregated category level AVA for market price uncertainty and close-out costs. Calculation of market price uncertainty AVA Article 132 (1) A credit institution shall calculate market price uncertainty AVAs at valuation exposure level (‘individual market price uncertainty AVAs’). (2) The market price uncertainty AVA shall only be assessed to have zero value only where the following conditions are met:

  1. the credit institution has firm evidence of a tradable price for a valuation exposure or a price can be determined from reliable data based on a liquid two￾way market as described in Article 502 paragraph (2) of this Decision;
  2. the sources of market data set out in Article 17 paragraph (8) of this Decision do not indicate any material valuation uncertainty. (3) Where a valuation exposure cannot be shown to have a zero AVA, a credit institution shall, when assessing the market price uncertainty AVA, use the data sources defined in Article 17 7 of this Decision 7 and, in this case, it shall determine the market price uncertainty AVA in accordance with paragraphs (4) to (8) of this Article. (4) A credit institution shall calculate AVA on valuation exposures related to each valuation input used in the relevant valuation model at one of the following granularity levels:
  3. where decomposed, all the valuation inputs required to calculate an exit price for the valuation position; or

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 129 2) the price of the instrument. (5) Each of the valuation inputs referred to in paragraph (4) item 1) of this Article shall be treated separately. (6) Where a valuation input consists of a matrix of parameters, a credit institution shall calculate AVA based on the valuation exposures related to each parameter within that matrix. (7) Where a valuation input does not refer to tradable instruments, a credit institution shall map the valuation input and the related valuation exposure to a set of market tradable instruments. (8) A credit institution may reduce the number of parameters of the valuation input for the purpose of calculating AVA using any appropriate methodology provided the reduced parameters satisfy the following requirements:

  1. the total value of the reduced valuation exposure is the same as the total value of the original valuation exposure;
  2. the reduced set of parameters can be mapped to a set of market tradable instruments;
  3. the ratio of variance measure 2 over variance measure 1, based on historical data from the most recent 100 trading days, is less than 0,1. (9) Variance measure 1 referred to in paragraph (8) item 3) of this Article shall mean profit and loss variance of the valuation exposure based on the unreduced valuation input and ‘variance measure 2’ shall mean profit and loss variance of the valuation exposure based on the unreduced valuation input minus the valuation exposure based on the reduced valuation input. (10) Where a reduced number of parameters is used for the purpose of calculating AVA, the determination that the criteria set out in paragraph (9) of this Article are met shall be subject to competent control function review of the netting methodology and internal validation on at least an annual basis. (11) Market price uncertainty AVA shall be determined as follows:
  4. where sufficient data exists to construct a range of plausible values for a valuation input: ­ for a valuation input where the range of plausible values is based on exit prices, credit institution shall estimate a point within the range where they are 90% confident they could exit the valuation exposure at that price or better; ­ for a valuation input where the range of plausible values is created from mid prices, credit institution shall estimate a point within the range where they are 90% confident that the mid value they could achieve in exiting the valuation exposure would be at that price or better;
  5. where insufficient data exists to construct a plausible range of values for a valuation input, credit institution shall use an expert-based approach using qualitative and quantitative information available to achieve a level of certainty in the prudent value of the valuation input that is equivalent to that targeted under item 1) of this paragraph and in that case, the credit institution shall notify

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 130 the Central Bank of the valuation exposures for which this approach is applied, and the methodology used to determine the AVA; 3) a credit institution shall calculate the market price uncertainty AVA based on one of the following approaches: ­ it shall apply the difference between the valuation input values estimated according to item 1) or 2) of this paragraph, and the valuation input values used for calculating fair value to the valuation exposure of each valuation position; ­ it shall combine the valuation input values estimated according to item 1) or 2) of this paragraph and they shall revalue valuation positions based on those values and the credit institution shall then take the difference between the revalued positions and fair-valued positions. (12) A credit institution shall calculate the total category level AVA for market price uncertainty by applying to individual market price uncertainty AVA the formulae for either Method 1 or Method 2 laid down in Article 130 paragraph (13) of this Decision. Calculation of early termination AVA Article 133 (1) A credit institution shall estimate an early termination AVA considering the potential losses arising from non-contractual early terminations of client trades. (2) A credit institution shall calculate the early termination AVA taking into account the percentage of client trades that have historically terminated early and the losses that arise in those cases. Calculation of investing and funding costs AVA Article 134 (1) A credit institution shall calculate the investing and funding costs AVA to reflect the valuation uncertainty in the funding costs used when assessing the exit price according to the applicable accounting framework. (2) The element of the AVA relating to market price uncertainty shall be included within the market price uncertainty AVA category. (3) The element of the AVA relating to close-out cost uncertainty shall be included within the close-out costs AVA category. (4) The element of the AVA relating to model risk shall be included within the model risk AVA category. Calculation of future administrative costs AVA Article 135 (1) Where a credit institution calculates market price uncertainty and close-out cost AVAs for a valuation exposure, which imply fully exiting the exposure, a credit institution may assess a zero AVA for future administrative costs.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 131 (2) Where a valuation exposure cannot be shown to have a zero AVA according to paragraph (1) of this Article, a credit institution shall calculate the future administrative cost AVA (‘individual future administrative costs AVA’) considering the administrative costs and future hedging costs over the expected life of the valuation exposures for which a direct exit price is not applied for the close-out costs AVA, discounted using a rate which approximates the risk-free rate. (3) For the purposes of paragraph (2) of this Article, future administrative costs shall include all incremental staffing and fixed costs that are likely to be incurred in managing the portfolio but a reduction in these costs may be assumed as the size of the portfolio reduces. (4) A credit institution shall calculate the total category level AVA for future administrative costs AVA as the sum of individual future administrative costs AVAs. Calculation of model risk AVA Article 136 (1) A credit institution shall estimate a model risk AVA for each valuation model (‘individual model risk AVA’) by considering valuation model risk which arises due to the potential existence of a range of different models or model calibrations, which are used by market participants, and the lack of a firm exit price for the specific product being valued. (2) A credit institution shall not consider valuation model risk which arises due to calibrations from market derived parameters, which shall be captured according to Article 132 of this Decision. (3) A credit institution shall calculate model risk AVA using one of the approaches defined in paragraphs (4) and (5) of this Article. (4) Where possible, a credit institution shall calculate the model risk AVA by determining a range of plausible valuations produced from alternative appropriate modelling and calibration approaches, and in this case, a credit institution shall estimate a point within the resulting range of valuations where they are 90% confident they could exit the valuation exposure at that price or better. (5) Where a credit institution is unable to use the approach defined in paragraph (4) of this Article, it shall apply an expert-based approach to estimate the model risk AVA, which shall consider all of the following:

  1. complexity of products relevant to the model;
  2. diversity of possible mathematical approaches and model parameters, where those model parameters are not related to market variables;
  3. the degree to which the market for relevant products is ‘one way’;
  4. the existence of unhedgeable risks in relevant products; and
  5. the adequacy of the model in capturing the behaviour of the pay-off of the products in the portfolio. (6) A credit institution that uses models based on the approach referred to in paragraph (5) of this Article shall notify the Central Bank thereof, and the methodology used to determine the AVA.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 132 (7) Where a credit institution applies the approach described in paragraph (5) of this Article, the prudence of the approach shall be confirmed annually by comparing the following:

  1. the AVAs calculated using the expert-based approach referred to in paragraph (5) of this Article, if it were applied to a material sample of the valuation models for which the credit institution applies the approach referred to in paragraph (4) of this Article; and
  2. the AVAs produced by the approach referred to in paragraph (4) of this Article for the same sample of valuation models as referred to in item1) of this paragraph. (8) A credit institution shall calculate the total category level AVA for model risk by applying to individual model risk AVAs the formulae for either Method 1 or Method 2 laid down in the Article 130 paragraph (13) of this Decision. Calculation of concentrated positions AVA Article 137 (1) A credit institution shall estimate a concentrated position AVA for concentrated valuation positions (‘individual concentrated positions AVA’) by applying the following:
  3. they shall identify concentrated valuation positions;
  4. for each identified concentrated valuation position, where a market price applicable for the size of the valuation position is unavailable, they shall estimate a prudent exit period;
  5. where the prudent exit period exceeds 10 days, they shall estimate an AVA taking into account: ­ the volatility of the valuation input; ­ the volatility of the bid offer spread; and ­ the impact of the hypothetical exit strategy on market prices. (2) For the purposes of paragraph (1) item 1) of this Article, the identification of concentrated valuation positions shall consider all of the following:
  6. the size of all valuation positions relative to the liquidity of the related market;
  7. the credit institution's ability to trade in that market;
  8. the average daily market volume and typical daily trading volume of the credit institution. (3) A credit institution shall establish and document the methodology applied to determine concentrated valuation positions for which a concentrated positions AVA shall be calculated. (4) The total category level AVA for concentrated positions AVA shall be calculated as the sum of individual concentrated positions AVAs. Documentation requirements Article 138 (1) A credit institution shall document appropriately the prudent valuation methodology, which should include internal policies providing guidance on:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 133

  1. the range of methodologies for quantifying AVAs for each valuation position;
  2. the hierarchy of methodologies for each asset class, product, or valuation position;
  3. the hierarchy of market data sources used in the AVA methodology;
  4. the required characteristics of market data to justify a zero AVA for each asset class, product, or valuation position;
  5. the methodology applied where an expert-based approach is used to determine an AVA;
  6. the methodology for determining whether a valuation position requires a concentrated position AVA;
  7. the assumed exit horizon for the purpose of calculating AVAs for concentrated positions, where relevant; and
  8. the fair-valued assets and liabilities for which a change in accounting valuation has a partial or zero impact on Common Equity Tier 1 capital according to Article 127 paragraphs (2) and (3) and Article 128 paragraph (5) of this Decision. (2) A credit institution shall also maintain records to allow the calculation of AVA at valuation exposure level to be analysed, and information from the AVA calculation process shall be provided to senior management to allow an understanding of the level of valuation uncertainty on the credit institution's portfolio of fair-valued positions. (3) The documentation specified in paragraph (1) of this Article shall be reviewed at least annually and approved by senior management. Systems and controls requirements Article 139 (1) An independent control unit of the credit institution shall authorise initially AVA, and monitor subsequently. (2) A credit institution shall have effective controls related to the governance of all fair￾valued positions, and adequate resources to implement those controls and ensure robust valuation processes even during a stressed period, which shall include:
  9. review and assessment of valuation model performance at least once a year;
  10. management approval on all significant changes to valuation policies;
  11. a clear statement of the credit institution's risk appetite for exposure to positions subject to valuation uncertainty which is monitored at an aggregate credit institution-wide level;
  12. independence in the valuation process between risk taking and control units;
  13. a comprehensive internal audit process related to valuation processes and controls. (3) A credit institution shall ensure there are effective and consistently applied controls related to the valuation process for fair-valued positions, which shall be subject to regular internal audit review and they shall include:
  14. a precisely defined credit institution-wide product inventory, ensuring that every valuation position is uniquely mapped to a product definition;
  15. valuation methodologies, for each product in the inventory covering choice and calibration of model, fair value adjustments, AVA, independent price verification

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 134 methodologies applicable to the product, and the measurement of valuation uncertainty; 3) validation process ensuring that, for each product, both the risk-taking and relevant control departments approve the product-level methodologies described in item 2) of this paragraph and certify that they reflect the actual practice for every valuation position mapped to the product; 4) defined thresholds based on observed market data for determining when valuation models are no longer sufficiently robust; 5) a formal internal price valuation process based on prices independent from the relevant trading desk; 6) a new product approval processes referencing the product inventory and involving all internal stakeholders relevant to risk measurement, risk control, financial reporting and the assignment and verification of valuations of financial instruments; 7) a new deal review process to ensure that pricing data from new trades are used to assess whether valuations of similar valuation exposures remain appropriately prudent. Internal hedges Article 140 (1) An internal hedge shall in particular meet the following requirements:

  1. it shall not be primarily intended to avoid or reduce own funds requirements;
  2. it shall be properly documented and subject to particular internal approval and audit procedures;
  3. it shall be dealt with at market conditions;
  4. the market risk that is generated by the internal hedge shall be dynamically managed in the trading book within the authorised limits;
  5. it shall be carefully monitored in accordance with adequate procedures. (2) The requirements set out in paragraph (1) of this Article shall apply without prejudice to the requirements applicable to the hedged position in the non-trading book or in the trading book, where relevant. (3) Where a credit institution hedges a non-trading book credit risk exposure or counterparty risk exposure using a credit derivative booked in its trading book, that credit derivative position shall be recognised as an internal hedge of the non-trading book credit risk exposure or counterparty risk exposure for the purpose of calculating the risk-weighted exposure amounts referred to in Article 114 paragraph (4) item 1) of this Decision where the credit institution enters into another credit derivative transaction with an eligible third party protection provider that meets the requirements for unfunded credit protection in the non-trading book and perfectly offsets the market risk of the internal hedge. (4) Internal hedge recognised in accordance with the paragraph (1) of this Article and the credit derivative entered into with the third party shall be included in the trading book for the purpose of calculating the own funds requirements for market risk.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 135 (5) A credit institution shall, for calculating the own funds requirements for market risk using the approach referred to in Article 413 paragraph (1) item 2) of this Decision, assign both positions to the same trading desk that manages similar risks. (6) Where a credit institution hedges a non-trading book equity risk exposure using an equity derivative booked in its trading book, that equity derivative position shall be recognised as an internal hedge of the non-trading book equity risk exposure for the purpose of calculating the risk-weighted exposure amounts referred to in Article 114 paragraph (4) item 1) of this Decision where the credit institution enters into another equity derivative transaction with an eligible third party protection provider that meets the requirements for unfunded credit protection in the non-trading book and perfectly offsets the market risk of the internal hedge. (7) Internal hedge recognised in accordance with paragraph (6) of this Article and the equity derivative entered into with the eligible third-party protection provider shall be included in the trading book for the purpose of calculating the own funds requirements for market risk. (8) A credit institution shall, for calculating the own funds requirements for market risk using the approach referred to in Article 413 paragraph (1) item 1) of this Decision, assign both positions to the same trading desk that manages similar risks. (9) For the purposes of paragraphs (3) to (8) of this Article, the credit or equity derivative transaction entered into by a credit institution may be composed of multiple transactions with multiple eligible third party protection providers, provided that the resulting aggregated transaction meets the conditions set out in those paragraphs. (10) Where a credit institution hedges non-trading book interest rate risk exposures using an interest rate risk position booked in its trading book, that interest rate risk position shall be considered to be an internal hedge for the purpose of assessing the interest rate risk arising from non-trading positions in accordance with Articles 109 and 264 of the Law where the following conditions are met:

  1. for the purpose of calculating capital requirement for market risk using the approach referred to in Article 413 paragraph (1) items 1), 2) and 3) of this Decision, the position has been assigned to a separate portfolio from the other trading book position, the business strategy of which is solely dedicated to manage and mitigate the market risk of internal hedges of interest rate risk exposure;
  2. for the purpose of calculating capital requirement for market risk using the approach referred to in Article 413 paragraph (1) item 2) of this Decision, the position has been assigned to a trading desk, the business strategy of which is solely dedicated to manage and mitigate the market risk of internal hedges of interest rate risk exposure;
  3. the credit institution has fully documented how the position mitigates the interest rate risk arising from non-trading book positions for the purposes of the requirements laid down in Articles 109 and 246 of the Law. (11) For the purposes of paragraph (10) item 1) of this Article, the credit institution may assign to that portfolio other interest rate risk positions entered into with third parties, or with its own trading book, as long as the credit institution perfectly offsets the market

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 136 risk of those interest rate risk positions entered into with its own trading book by entering into opposite interest rate risk positions with third parties. (12) For the purposes of paragraph (10) item 2) of this Article, the following requirements shall apply to the trading desk:

  1. that trading desk may enter into other interest rate risk positions with third parties or with other trading desks of the credit institution, as long as those positions meet the requirements for inclusion in the trading book referred to in Article 122 of this Decision and those other trading desks perfectly offset the market risk of those other interest rate risk positions by entering into opposite interest rate risk positions with third parties;
  2. no trading book positions other than those referred to in item 1) of this paragraph are assigned to that trading desk;
  3. by way of derogation from Article 124 of this Decision, that trading desk shall not be subject to the requirements set out in paragraphs (1) to (4) of that Article. (13) The own funds requirements for the market risk of all the positions assigned to the separate portfolio as referred to in paragraph (10) item 1) of this Article or to the trading desk referred to in item 2) of that paragraph, shall be calculated on a stand￾alone basis, in addition to the own funds requirements for the other trading book positions. (14) Where a credit institution hedges a credit valuation adjustment (CVA) risk exposure using a derivative instrument entered into with its trading book, the position in that derivative instrument shall be recognised as an internal hedge for the CVA risk exposure for the purpose of calculating the own funds requirements for CVA risk in accordance with the approaches set out in Article 532 or 558 of this Decision, where the following conditions are met:
  4. the derivative position is recognised as an eligible hedge in accordance with Article 560 of this Decision;
  5. where the derivative position is subject to any of the requirements set out in Article 416 paragraph (2) items 2) or 3) or in Article 418 paragraph (1) item 3) of this Decision the credit institution perfectly offsets the market risk of that derivative position by entering into opposite positions with third parties. (15) The opposite trading book position of the internal hedge recognised in accordance with paragraph (14) of this Article shall be included in the institution’s trading book to calculate the own funds requirements for market risk. TITLE II OWN FUNDS REQUIREMENTS FOR CREDIT RISK SUBTITLE 1 - General principles Approaches to credit risk Article 141 (1) When calculating risk-weighted exposure amounts for the purposes of Article 114 paragraph (4) items 1) and 7) of this Decision, a credit institution shall apply the Standardised Approach provided for in Subtitle 2 or, the Internal Ratings Based

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 137 Approach (IRB Approach) provided for in Subtitle 3 of this Title, if the Central Bank authorised the application of IRB Approach, in accordance with Article 185 of this Decision. (2) When calculating risk-weighted exposure amounts for the purposes of Article 114 paragraph (4) items 1) and 7) of this Decision, a credit institution shall, for trade exposures and for default fund contributions to a central counterparty, apply the treatment set out in Subtitle 6 Section 9 of this Title, while, for all other types of exposures to a central counterparty, a credit institution shall treat those exposures as exposures to:

  1. an institution for other types of exposures to a qualifying CCP; or
  2. a corporate for other types of exposures to a non-qualifying CCP. (3) The exposures investment firms, credit institutions and exchanges with head offices outside Montenegro, or in the EU Member States and third countries, as well as the exposures to financial institutions from those countries authorised and supervised by competent authorities from those countries and subject to prudential requirements comparable to those applied to credit institutions in terms of robustness, shall be treated as exposures to a credit institution only if the third country applies prudential and supervisory requirements to that entity that are at least equivalent to those applied in this Decision and in the EU. Use of credit risk mitigation technique under the Standardised Approach and the IRB Approach Article 142 (1) For an exposure to which a credit institution applies the Standardised Approach under Subtitle 2 or the IRB Approach under Subtitle 3 of this Title, but without using its own estimates of LGD pursuant to Article 185 of this Decision, a credit institution may take into account the effects of funded credit protection in accordance with Subtitle 3 of this Title when calculating the risk-weighted exposure amounts for the purposes of Article 114 paragraph (4) items 1) to 7) of this Decision or, when calculating expected loss amounts for the purposes of Article 19 item 4) and Article 60 paragraph (1) item 4) of this Decision. (2) For an exposure to which a credit institution applies the IRB Approach by using their own estimates of LGD pursuant to Article 185 of this Decision, a credit institution may take into account the effects of funded credit protection in accordance with Subtitle 3 of this Title when calculating the risk-weighted exposure amounts for the purposes of Article 114 paragraph (4) items 1) to 7) of this Decision or, when calculating expected loss amounts for the purposes of Article 19 item 4) and Article 60 paragraph (1) item 4) of this Decision. (3) Where a credit institution applies the IRB Approach by using its own estimates of LGD pursuant to Article 185 of this Decision for both the original exposure and for comparable direct exposures to the protection provider, a credit institution may take into account the effect of unfunded credit protection in accordance with Subtitle 3 of this Title when calculating the risk-weighted exposure amounts for the purposes of Article 114 paragraph (4) items 1) to 7) of this Decision, and, where relevant, expected loss amounts for the purposes of the calculation referred to in Article 19 item 4) and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 138 Article 60 paragraph (1) item 4) of this Decision, and in all other cases, the credit institution may take into account the effect of unfunded credit protection when calculating risk-weighted exposure amounts and expected loss amounts in accordance with Subtitle 4 of this Title. (4) Where the conditions set out in paragraph (5) of this Article are met, a credit institution may regard loans to natural persons as exposures secured by a mortgage on residential property, instead of being treated as guaranteed exposures, for the purposes of Subtitles 2, 3 and 4 of this Title, as applicable, where the following conditions for those loans have been fulfilled:

  1. the majority of loans to natural persons for the purchase of residential properties in Montenegro are not provided as mortgages in legal form;
  2. the majority of loans to natural persons for the purchase of residential properties in Montenegro are guaranteed by a protection provider with a credit assessment by a nominated ECAI corresponding to credit quality step 1 or 2, that is required to repay the credit institution in full where the original borrower defaults;
  3. the credit institution has the legal right to take a mortgage on the residential property in the event that the protection provider referred to in item 2) of this paragraph does not meet or becomes unable to meet its obligations under the guarantee provided. (5) For the purposes of paragraph (4) of this Article, a credit institution may treat loans granted to natural persons as exposures secured by a mortgage on residential property, instead of being treated as guaranteed exposures, where the following conditions are met:
  4. for an exposure that is treated under the Standardised Approach, the exposure meets all of the requirements to be assigned to the exposure class ‘exposures secured by mortgages on immovable property’ pursuant to Articles 163 and 164 of this Decision, with the exception that the credit institution granting the loan does not hold a mortgage over the residential property;
  5. for an exposure that is treated under the IRB Approach, the exposure meets all of the requirements to be assigned to the IRB exposure class ‘retail exposures secured by residential property’ referred to in Article 189 paragraph (2) item 5) indent 2 of this Decision, with the exception that the credit institution granting the loan does not hold a mortgage over the residential property;
  6. there is no mortgage lien on the residential property when the loan is granted and the borrower is contractually committed not to grant any mortgage lien without the consent of the credit institution that originally granted the loan;
  7. the protection provider is an eligible protection provider as referred to in Article 239 of this Decision, and has a credit assessment by a nominated ECAI corresponding to credit quality step 1 or 2;
  8. the protection provider is a credit institution or a financial sector entity subject to own funds requirements comparable to those applicable to credit institutions or insurance undertakings;
  9. the protection provider has established a fully-funded mutual guarantee fund or equivalent protection for insurance undertakings to absorb credit risk losses, the calibration of which is periodically reviewed by the Central Bank or Insurance Supervision Agency, whichever is applicable, and is subject to periodic stress testing, at least every two years;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 139 7) the credit institution is contractually and legally empowered to take a mortgage on the residential property in the event that the protection provider does not meet or becomes unable to meet its obligations under the guarantee provided. (6) A credit institution that uses the option provided for in paragraph (4) of this Article for a given eligible protection provider under the mechanism referred to in that paragraph shall do so for all its exposures to natural persons guaranteed by that protection provider under that mechanism. Treatment of securitisation positions Article 143 A credit institution shall calculate the risk-weighted exposure amount for a position they hold in a securitisation in accordance with Subtitle 5 of this Title. Treatment of credit risk adjustment Article 144 (1) A credit institution applying the Standardised Approach shall treat general credit risk adjustments in accordance with Article 60 paragraph (1) item 3) of this Decision. (2) A credit institution applying the IRB Approach shall treat general credit risk adjustments in accordance with Article 200, Article 60 paragraph (1) item 4) and Article 19 item 4) of this Decision. (4) For the purposes of this Article and Subtitles 2 and 3 of this Title, general and specific credit risk adjustments shall exclude funds for general banking risk. (4) A credit institution using the IRB Approach that apply the Standardised Approach for a part of their exposures on consolidated or individual basis, in accordance with Articles 167 and 169 of this Decision shall determine the part of general credit risk adjustment that shall be assigned to the treatment of general credit risk adjustment under the Standardised Approach and to the treatment of general credit risk adjustment under the IRB Approach as follows:

  1. where applicable, when a credit institution included in the consolidation exclusively applies the IRB Approach, general credit risk adjustments of this credit institution shall be assigned to the treatment set out in paragraph (2) of this Article;
  2. where applicable, when a credit institution included in the consolidation exclusively applies the Standardised Approach, general credit risk adjustment of this credit institution shall be assigned to the treatment set out in paragraph (1) of this Article;
  3. the remainder of credit risk adjustment shall be assigned on a pro rata basis according to the proportion of risk weighted exposure amounts subject to the Standardised Approach and subject to the IRB Approach. (5) A credit institution shall include, in the calculation of general and specific credit risk adjustments, all amounts by which a credit institution’s Common Equity Tier 1 capital has been reduced in order to reflect losses exclusively related to credit risk according to the applicable accounting framework and recognised as such in the profit or loss

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 140 account, irrespective of whether they result from impairments, value adjustments or provisions for off-balance sheet items. (6) All amounts referred to in paragraph (5) of this Article which have been recognised during the financial year, may only be included in the calculation of general and specific credit risk adjustments if the respective amounts have been deducted from a credit institution’s Common Equity Tier 1 capital, either in accordance with Article 19 of this Decision, or, in the event of interim profits or year-end profits that have not been approved in accordance with Article 5 paragraphs (3) and (4) of this Decision. (7) The adjustments referred to in paragraph (5) of this Article relating to general credit risk adjustments shall be the amount for which the criteria referred to in items 1) and 2) of this paragraph are met, while the remaining amounts of adjustments referred to in paragraph (5) shall relate to specific credit risk adjustments: criteria:

  1. they are freely and fully available, as regards to timing and amount, to meet credit risk losses that have not yet materialised;
  2. they reflect credit risk losses for a group of exposures for which the credit institution has currently no evidence that a loss event has occurred. (8) The calculation of general credit risk adjustments, provided that they meet the criteria referred to in paragraph (7) of this Article, shall include the following losses:
  3. losses recognised to cover higher average portfolio loss experience over the last years although there is currently no evidence of loss events supporting these loss level observed in the past;
  4. losses for which the credit institution is not aware of a credit deterioration for a group of exposures but where some degree of non-payment is statistically probable based on past experience. (9) Impairments determined by the credit institution in accordance with the IFRS 9 requirements (Stage 1, Stage 2, and Stage 3) shall be considered specific credit risk adjustments. Calculation specific adjustments for the purpose of determining the exposure value Article 145 (1) For the purposes of determining the exposure value according to Articles 148, 207, 208, 282 and 310 of this Decision, a credit institution shall calculate specific adjustments related to an exposure as the amounts of specific adjustments for that single exposure, or as the amounts of specific adjustments that the credit institution has assigned to that exposure in accordance with paragraphs (2) to (5) of this Article. (2) Where a specific adjustment reflects losses related to the credit risk of a group of exposures, a credit institution shall assign that specific adjustment to all single exposures of that group proportionally to the risk-weighted exposure amounts, and the exposure values shall be determined without taking into account any specific credit risk adjustments.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 141 (3) For the treatment of expected loss amounts referred to in Article 200 of this Decision for a group of non- defaulted exposures a credit institution shall not be required to assign a specific credit risk adjustment to the single exposures of the group. (4) Where a specific credit risk adjustment relates to a group of exposures the credit risk own funds requirements of which are calculated partially under the Standardised Approach and partially under the IRB Approach, the credit institution shall assign that specific credit risk adjustment to the group of exposures covered by each of the Approaches proportionally to the risk weighted exposure amounts of the group before applying the actions referred to in paragraphs (2) and (3) of this Article, whereat, the exposure values shall be determined without taking into account any specific credit risk adjustments. (5) When assigning the specific credit risk adjustments to exposures, a credit institution shall ensure that the same portion is not assigned twice to different exposures. (6) A credit institution shall always include the following losses in the calculation of specific credit risk adjustments:

  1. losses recognised in the profit or loss account for instruments measured at fair value that represent credit risk impairment under the applicable accounting framework;
  2. losses as a result of current or past events affecting a significant individual exposure or exposures that are not individually significant which are individually or collectively assessed;
  3. losses for which historical experience, adjusted on the basis of current observable data, indicates that the loss has occurred but the credit institution is not yet aware which individual exposure has suffered these losses. Calculation of specific adjustments for own funds requirements for the purposes of the determination of default Article 146 (1) Without prejudice to the provisions of Article 144 paragraph (5) of this Decision, when calculating the specific credit risk adjustments for the purposes of assigning the risk weights referred to in Article 167 paragraph (1) items 1) and 2) of this Decision to the unsecured part of a defaulted exposure, a credit institution shall include any positive difference between the amount owed by the debtor on that exposure and the sum of the following:
  4. the additional own funds reduction if that exposure was written-off fully;
  5. any already existing own funds reductions related to that exposure. (2) For the purposes of determining default in accordance with Article 178 of this Decision, a credit institution shall calculate specific adjustments as the amounts of specific adjustments related to the credit risk of a single exposure or single debtor. Monitoring of contractual arrangements that are not commitments Article 147 A credit institution shall monitor contractual arrangements that meet all of the conditions set out in Article 4 paragraph (2) item 10) indents 1 to 5 of this Decision,

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 142 and shall document to the satisfaction of the Central Bank their compliance with all those conditions. SUBTITLE 2 - Standardised approach Section 1 - General principles Exposure value Article 148 (1) The exposure value of an asset item shall be its accounting value remaining after the following has been applied:

  1. specific credit risk adjustments in accordance with Article 144 of this Decision;
  2. additional value adjustments (AVA) in accordance with Articles 17 of this Decision related to non-trading book activities of the credit institution;
  3. insufficient coverage of non-performing exposures by impairments deducted from Common Equity Tier 1 capital in accordance with Article 19 item 14) of this Decision;
  4. reserve requirements for estimated and potential losses for on- and off- balance sheet items in accordance with Article 19 items 16) and 17) of this Decision; and
  5. other own funds reductions related to the asset item. (2) The exposure value of an off-balance sheet item referred to in paragraph (3) of this Article shall be the amount of its nominal value after reduction of specific credit risk adjustments and amounts of insufficient coverage of non-performing exposures by impairments deducted from Common Equity Tier 1 capital in accordance with Article 19 items 16) and 17) of this Decision multiplied by the following percentage or conversion factor:
  6. 100% for items in bucket 1;
  7. 50% for items in bucket 2;
  8. 40% for items in bucket 3;
  9. 20% for items in bucket 4;
  10. 0% for items in bucket 5. (3) The off-balance sheet items referred to in paragraph (2) of this Article shall be assigned to the following buckets:
  11. bucket 1:
  • credit derivatives and general guarantees of indebtedness, including standby letters of credit serving as financial guarantees for loans and securities, and acceptances, including endorsements with the character of acceptances, as well as any other direct credit substitutes;
  • sale and repurchase agreements and asset sales with recourse where the credit risk remains with the credit institution;
  • securities lent by the credit institution or securities posted by the credit institution as collateral, including instances where those arise out of repo￾style transactions;
  • forward asset purchases, forward deposits and partly paid shares and securities, which represent commitments with certain drawdown;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 143

  • off-balance-sheet items constituting a credit substitute where not explicitly included in any other category;
  • other off-balance-sheet items carrying similar risk.
  1. bucket 2:
  • note issuance facilities (NIFs) and revolving underwriting facilities (RUFs) regardless of the maturity of the underlying facility;
  • performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions and similar transaction-related contingent items, excluding trade finance off-balance-sheet items referred to in bucket 4; and
  • other off-balance-sheet items carrying similar risk.
  1. bucket 3:
  • the undrawn amount of commitments, regardless of the maturity of the underlying facility, unless they fall under another category; and
  • other off-balance-sheet items carrying similar risk.
  1. bucket 4:
  • trade finance off-balance-sheet items: a) warranties, including tender and performance bonds and associated advance payment and retention guarantees, and guarantees not having the character of credit substitutes; b) irrevocable standby letters of credit not having the character of credit substitutes; c) short-term, self-liquidating trade letters of credit arising from the movement of goods, in particular documentary credits collateralised by the underlying shipment, in case of an issuing institution or a confirming institution; and
  • other off-balance-sheet items carrying similar risk.
  1. bucket 5:
  • the undrawn amount of unconditionally cancellable commitments;
  • the undrawn amount of retail credit lines for which the terms permit the credit institution to cancel them to the full extent allowable under consumer protection and related legal acts;
  • undrawn credit facilities for tender and performance guarantees which may be cancelled unconditionally at any time without prior notice, or that do effectively provide for automatic cancellation due to deterioration in a borrower’s creditworthiness; and
  • other off-balance-sheet items carrying similar risk. (4) The exposure value of a commitment on an off-balance-sheet item as referred to in paragraph (2) of this Article shall be the lower of the following percentages of the commitment’s nominal value after the deduction of specific credit risk adjustments and amounts deducted in accordance with Article 19 item 14), 16) and 17) of this Decision:
  1. the percentage referred to in paragraph (2) of this Article that is applicable to the item on which the commitment is made;
  2. the percentage referred to in paragraph (2) of this Article that is applicable to the type of commitment.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 144 (5) Contractual arrangements offered by a credit institution, but not yet accepted by the client, that would become commitments if accepted by the client, shall be treated as commitments and the percentage applicable shall be the one provided for in accordance with paragraph (2) of this Article. (6) For contractual arrangements of the credit institution that meet the conditions set out in Article 4 paragraph (2) item 10) indents 1) to 5) of this Decision, the applicable percentage shall be 0%. (7) Where a credit institution is using the Financial Collateral Comprehensive Method under Article 260 of this Decision, the exposure value of securities or commodities sold, posted or lent under a securities financing transactions shall be increased by the volatility adjustment appropriate to such securities or commodities in accordance with Articles 260 and 261 of this Decision. (8) The exposure value of a derivative instrument referred to in items 1), 2) and 3) of this paragraph shall be determined in accordance with Subtitle 6 of this Title with the effects of contracts of novation and other netting agreements taken into account for the purposes of those methods in accordance with Subtitle 6 of this Title taking into account the effects of contracts of novation and other netting agreements as specified in that Subtitle:

  1. interest-rate contracts:
  • single-currency interest rate swaps;
  • basis-swaps;
  • forward rate agreements;
  • interest-rate futures;
  • interest-rate options; and
  • other contracts of similar nature.
  1. foreign-exchange contracts and contracts concerning gold:
  • cross-currency interest-rate swaps;
  • forward foreign-exchange contracts;
  • currency futures;
  • currency options;
  • other contracts of a similar nature; and
  • contracts of a nature similar to those referred to in indents 1 to 5 of this item concerning gold.
  1. contracts of a nature similar to those referred to in item 1) indents 1 to 5 and item
  2. indents 1 to 4 of this paragraph concerning other reference items or indices and which, as a minimum, include instruments not otherwise included in item 1) or 2) of this paragraph, such as:
  • options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, commodities, financial indices or financial measures which may be settled physically or in cash, and
  • financial contracts for differences. (9) A credit institution may determine the exposure value of securities financing transactions and long settlement transactions in accordance with Subtitles 4 or 6 of this Title.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 145 (10) Where an exposure is subject to funded credit protection, the exposure value applicable to that item may be amended in accordance with Subtitle 4 of this Title. Exposure classes Article 149 Each exposure shall be assigned to one of the following exposure classes:

  1. exposures to central governments or central banks;
  2. exposures to regional governments or local authorities;
  3. exposures to public sector entities;
  4. exposures to multilateral development banks;
  5. exposures to international organisations;
  6. exposures to credit institutions;
  7. exposures to corporates;
  8. retail exposures;
  9. exposures secured by mortgages on immovable property and ADC exposures; 10)exposures in default; 11)subordinated debt exposures; 12)exposures in the form of covered bonds; 13)items representing securitisation positions; 14)exposures to institutions and corporates with a short-term credit assessment; 15)exposures in the form of units or shares in collective investment undertakings (‘CIUs’); 16)equity exposures; 17)other items. Calculation of risk-weighted exposure amounts Article 150 (1) When calculating risk-weighted exposure amounts, a credit institution shall apply risk weights to all exposures, unless those exposures are deducted from own funds or are subject to the treatments referred to in Article 75 paragraph (1) of this Decision, in accordance with the provisions of Section 2 of this Subtitle. (2) The risk weight shall be applied on the basis of the exposure class to which the exposure is assigned and, to the extent specified in Section 2 of this Subtitle, its credit quality. (3) Credit quality may be determined by reference to the credit assessments of external credit assessment institutions (ECAI) or the credit assessments of export credit agencies (ECA) in accordance with Section 3 of this Subtitle. (4) With the exception of exposures assigned to the exposure classes set out in Article 149 items 1), 2) and 3) of this Decision where the assessment in accordance with Article 106 paragraph (6) of the Law reflects higher risk characteristics than those implied by the credit quality step to which the exposure would be assigned based on the applicable credit assessment of the nominated ECAI or export credit agency, the credit institution shall assign a risk weight at least one credit quality step higher than the risk weight implied by the credit assessment of the nominated ECAI or export credit agency.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 146 (5) For the purposes of applying a risk weight, as referred to in paragraphs (1) to (4) of this Article, the exposure value shall be multiplied by the risk weight specified or determined in accordance with Section 2 of this Subtitle. (6) Where an exposure is subject to credit protection, the exposure value or the risk weight applicable to that exposure, as appropriate, may be amended in accordance with this Subtitle and Subtitle 4 of this Title. (7) Risk-weighted exposure amounts for securitised exposures shall be calculated in accordance with Subtitle 5 of this Title. (8) The exposure value of any item for which no risk weight is provided in Section 2 of this Subtitle shall be assigned a risk-weight of 100%. (9) With the exception of exposures giving rise to Common Equity Tier 1, Additional Tier 1 or Tier 2 items, a credit institution may, subject to the authorisation of the Central Bank, decide not to apply the requirements of paragraphs (1) to (4) of this Article to the exposures to a counterparty which is its parent undertaking, its subsidiary undertaking, a subsidiary undertaking of its parent undertaking or an undertaking that is managed by that credit institution on a unified basis pursuant to a contract concluded with that undertaking or provisions in the memorandum or articles of association of that undertaking, or the administrative, management or supervisory bodies of that undertaking consist for the major part of the same persons in the credit institution. (10) The Central Bank shall grant the authorisation referred to in paragraph (9) of this Article if the following conditions are fulfilled:

  1. the counterparty is a credit institution, a financial institution subject to appropriate prudential requirements;
  2. the counterparty is included in the same consolidation as the credit institution on a full basis;
  3. the counterparty is subject to the same risk evaluation, measurement and control procedures as the credit institution;
  4. the counterparty is established in Montenegro; and
  5. there is no current or foreseen material practical or legal impediment to the prompt transfer of own funds or repayment of liabilities from the counterparty to the credit institution. (11) Where the credit institution, in accordance with paragraphs (9) and (10) of this Article, is authorised by the Central Bank not to apply the requirements referred to in paragraph (1) of this Article, it may assign a risk weight of 0 % to those exposures. Section 2 - Risk weights Exposures to central governments or central banks Article 151 (1) Exposures to central governments and central banks shall be assigned a 100% risk weight, except in the cases referred to in paragraphs (2) to (6) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 147 (2) Exposures to central governments and central banks for which a credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 referred to in this paragraph, which corresponds to the credit assessment of the ECAI in accordance with Article 178 paragraph (3) of this Decision. Table 1 Credit quality step 1 2 3 4 5 6 Risk weight 0% 20% 50% 100% 100% 150% (3) Exposures to the European Central Bank (ECB) shall be assigned a 0% risk weight. (4) Exposures to EU Member States' central governments, and central banks denominated and funded in the domestic currency of that central government and central bank shall be assigned a risk weight of 0%. (5) Exposures to the Government of Montenegro and the Central Bank denominated and funded in EUR shall be assigned a risk weight of 0%. (6) Exposures to third countries' central governments and central banks denominated and funded in the domestic currency of those countries may be assigned a risk weight which is lower than that indicated in paragraphs (1) and (2) of this Article, if the following conditions are met:

  1. those third countries are considered countries equivalent tin accordance with Article 3 item 113) of this Decision;
  2. competent authorities of those third countries assigned risk weights which are lower than those referred to in paragraphs (1) and (2) of this Article. (7) A credit institution shall assign risk weights to the exposures referred to in paragraph (6) of this Article which are equal to those assigned by competent authorities of third countries. (8) Exposure to the central government, within the meaning of this Decision, shall be exposures to government units funded from the State Budget, as follows:
  3. in Montenegro: exposures to the Parliament of Montenegro, the Government of Montenegro, the President of Montenegro, the ministries, the Constitutional Court, basic courts, higher courts, the Supreme Court, the Administrative Court, commercial courts, the Appellate Court, the State Prosecutor's Office, the Police Administration, other spending units and independent spending units;
  4. other spending units shall be: the Protector of Human Rights and Freedoms, the State Audit Institution of Montenegro (hereinafter: the State Audit Institution), state funds, public institutions and other independent legal persons funded from the State Budget;
  5. other independent spending units shall be: independent government bodies and other legal persons that are not part of the ministries but are funded from the State Budget;
  6. in other countries: exposures to government units funded from the budget and which are treated as central government in accordance with regulations of those countries governing the operations of credit institutions.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 148 Exposures to regional governments or local authorities Article 152 (1) Exposures to regional governments or local authorities for which a credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 of this paragraph, which corresponds to the credit assessment of the ECAI in accordance with Article 178 paragraph (3) of this Decision. Table 1 Credit quality step 1 2 3 4 5 6 Risk weight 20% 50% 50% 100% 100% 150% (2) Exposures to regional governments or local authorities for which a credit assessment by a nominated ECAI is not available shall be assigned a risk weight in accordance with Table 2 of this paragraph that corresponds to the credit quality step to which exposures to the central government of the jurisdiction in which regional governments or local authorities are incorporated are assigned. Table 2 Credit quality step 1 2 3 4 5 6 Risk weight 20% 50% 100% 100% 100% 150% (3) Exposures to regional governments or local authorities referred to in paragraph (2) of this Article shall be assigned a risk weight of 100% where the central government of the jurisdiction in which regional governments or local authorities are incorporated is unrated. (4) By way of derogation from paragraphs (1) to (3) of this Article, exposures to regional governments or local authorities shall be treated as exposures to the central government in whose jurisdiction they are established where there is no difference in risk between such exposures because of the specific revenue-raising powers of the regional governments or local authorities, and the existence of specific institutional arrangements the effect of which is to reduce their risk of default. (5) Exposures to churches or religious communities shall be treated as exposures to regional governments or local authorities where churches or religious communities are constituted in the form of a legal person and raise taxes in accordance with legal acts conferring on them the right to do so, whereat these exposures shall not be subject to the application of paragraph (4) of this Article. (6) By way of derogation from paragraphs (1) to (3) of this Article, where competent authorities of a third-country which applies supervisory and regulatory arrangements at least equivalent to those applied in the EU treat exposures to regional governments or local authorities as exposures to their central government and there is no difference in risk between such exposures because of the specific revenue-raising powers of regional government or local authorities and to specific institutional arrangements to reduce the risk of default, a credit institution may risk weight exposures to such regional governments and local authorities in the same manner.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 149 (7) By way of derogation from paragraphs (1) to (3) of this Article, exposures to regional government or local self-government units of the EU Member States that are not referred to in paragraphs (4), (5) and (6) of this Article and are denominated and funded in the domestic currency of that regional government or local self-government unit shall be assigned a risk weight of 20 %. (7) Exposures to local self-government units in Montenegro which are denominated and funded in EUR shall be assigned a risk weight 20%. Exposures to public sector entities Article 153 (1) Exposures to public sector entities for which there is no credit assessment by a nominated ECAI shall be assigned a risk weight in accordance with Table 1 of this paragraph, which corresponds to the credit quality step assigned to exposures to the central government in which the public sector entity is incorporated. Table 1 credit quality step assigned to the central government 1 2 3 4 5 6 risk weight 20% 50% 100% 100% 100% 150% (2) Exposures to public sector entities established in countries whose central government does not have an established credit assessment from an ECAI shall be assigned a risk weight of 100%. (3) Exposures to public sector entities for which a credit assessment by a nominated ECAI is available shall be treated in accordance with Article 152 paragraph (1) of this Decision. (4) Exposures to public sector entities with an original maturity of three months or less shall be assigned a risk weight of 20%. (5) In exceptional circumstances, a credit institution may treat exposures to public sector entities established in Montenegro as exposures to the Government of Montenegro, i.e. local self-government units, only if there are guarantees from the Government of Montenegro, i.e. local self-government units, so that, in the opinion of the Central Bank, there is no difference in risk between the mentioned exposures. (6) In exceptional circumstances, exposures to public sector entities from EU Member States may be treated as exposures to the central government, regional or local self￾government unit of that EU Member State under whose jurisdiction they are established, if, in the opinion of the competent authority of those EU Member States, there is no difference in risk between the said exposures due to the existence of a guarantee by the central government or regional or local self-government unit. (7) Exposures to public sector entities from third countries that are considered equivalent countries within the meaning of Article 3 paragraph (1) item 113 of this Decision, which are treated by the competent authorities of those third countries in

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 150 accordance with paragraphs (1) and (2) or paragraph (3) of this Article, may be treated by a credit institution in the same manner as those competent authorities, and if this is not the case, a risk weight of 100% shall be applied. Exposures to multilateral development banks Article 154 (1) Exposures to multilateral development banks not listed in paragraph (4) of this Article and for which a credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 of this paragraph. Table 1 credit quality step 1 2 3 4 5 6 risk weight 20% 30% 50% 100% 100% 150% (2) Exposures to multilateral development banks not listed in paragraph (4) of this Article, for which there is no credit assessment by a nominated ECAI, shall be assigned a risk weight of 50%. 3) Multilateral development banks are considered to be:

  1. Inter-American Investment Corporation;
  2. Black Sea Trade and Development Bank;
  3. Central American Bank for Economic Integration and
  4. CAF - Development Bank of Latin America. (4) Exposures to the following multilateral development banks are assigned a risk weight of 0%:
  5. International Bank for Reconstruction and Development;
  6. International Finance Corporation;
  7. Inter-American Development Bank;
  8. Asian Development Bank;
  9. African Development Bank;
  10. Council of Europe Development Bank;
  11. Nordic Investment Bank;
  12. Caribbean Development Bank;
  13. European Bank for Reconstruction and Development; 10)European Investment Bank; 11)European Investment Fund; 12)Multilateral Investment Guarantee Agency; 13)International Finance Facility for Immunisation; 14)Islamic Development Bank; 15)International Development Association; 16)The Asian Infrastructure Investment Bank. (5) The part of the unpaid subscribed capital of the European Investment Fund shall be assigned a risk weight of 20%.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 151 Exposures to international organisations Article 155 A risk weight of 0% is assigned to exposures to the following international organisations:

  1. the European Union and the European Atomic Energy Community;
  2. the International Monetary Fund;
  3. the Bank for International Settlement;
  4. the European Financial Stability Facility;
  5. the European Stability Mechanism;
  6. an international financial institution established by two or more EU Member States, whose aim is to provide financing and financial assistance to its members that are in serious financial difficulties or threatened with such difficulties. Exposures to credit institutions Article 156 (1) Exposures to credit institutions for which a credit assessment by a nominated ECAI is available shall be risk-weighted in accordance with Article 157 of this Decision. (2) Exposures to credit institutions for which a credit assessment by a nominated ECAI is not available shall be risk-weighted in accordance with Article 158 of this Decision. (3) Exposure to a credit institution in the form of reserve requirement that a credit institution holds with another credit institution shall be risk weighted as an exposure to the Central Bank, the ECB or an EU Member State, if the following conditions are met:
  7. the applicable regulations governing the reserve requirement of credit institutions regulate holding of the reserve requirement with another credit institution;
  8. in the event of the bankruptcy or winding-up of the credit institution where the reserve requirements are held, the reserve requirements are fully repaid to the credit institution in a timely manner and are not made available to meet other liabilities of the credit institution. (4) Exposures to financial institutions authorised and supervised by the Central Bank and subject to prudential requirements comparable to those applied to credit institutions in terms of robustness shall be treated as exposures to credit institutions (5) For the purposes of paragraph (4) of this Article, a financial institution shall be a legal person other than the credit institution whose activity is defined in Article 16 item
  9. of the Law and which performs financial services as laid down in Article 5 items 2) to 6), 9) to 12) and items 14) and 15) of the Law.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 152 Exposures to rated credit institutions Article 157 (1) Exposures to credit institutions for which a credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 of this paragraph, which corresponds to the credit assessment of the ECAI in accordance with Article 178 paragraph (3) of this Decision. Table 1 Credit quality step 1 2 3 4 5 6 Risk weight 20% 30% 50% 100% 100% 150% (2) Exposures to a credit institution with an original maturity of three months or less for which a credit assessment by a nominated ECAI is available and exposures which arise from the movement of goods across national borders with an original maturity of six months or less and for which a credit assessment by a nominated ECAI is available, shall be assigned a risk weight in accordance with Table 2 of this paragraph, which corresponds to the credit assessment of the ECAI in accordance with Article 178 paragraph (3) of this Decision. Table 2 Credit quality step 1 2 3 4 5 6 Risk weight 20% 20% 20% 50% 50% 150% (3) The interaction between the treatment of short-term credit assessment under Article 171 of this Decision and the general preferential treatment for short-term exposures set out in paragraph (2) of this Article shall be as follows:

  1. if there is no short-term exposure assessment, the general preferential treatment for short-term exposures as specified in paragraph (2) of this Article shall apply to all exposures to credit institutions of up to three months residual maturity;
  2. if there is a short-term assessment and such an assessment determines the application of a more favourable or identical risk weight than the use of the general preferential treatment for short-term exposures, as specified in paragraph (2) of this Article, then the short-term assessment shall be used for that specific exposure only, and other short-term exposures shall follow the general preferential treatment for short-term exposures, as specified in paragraph (2) of this Article;
  3. if there is a short-term assessment and such an assessment determines a less favourable risk weight than the use of the general preferential treatment for short-term exposures, as specified in paragraph (2) of this Article, then the general preferential treatment for short-term exposures shall not be used and all unrated short-term claims shall be assigned the same risk weight as that applied by the specific short-term assessment.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 153 Exposures to unrated credit institutions Article 158 (1) Exposures to credit institutions for which a credit assessment by a nominated ECAI is not available shall be assigned to one of the following grades:

  1. where all of the following conditions are met, exposures to credit institutions shall be assigned to Group A:
  • the credit institution has adequate capacity to meet its financial commitments, including repayments of principal and interest, in a timely manner, for the projected life of the assets or exposures and irrespective of economic cycles and business conditions;
  • the credit institution meets or exceeds the requirement laid down in Article 134 paragraph (1) of the Law, taking into account stricter macroprudential requirements when identifying increased macroprudential risks, where applicable, the specific own funds requirements referred to in Article 279 of the Law, the combined buffer requirement defined in Article 166 of the Law, or any equivalent and additional local supervisory or regulatory requirements in third countries insofar as those requirements are published and are to be met by Common Equity Tier 1 capital, Tier 1 capital or own funds, as applicable;
  • information about whether the requirements referred to in indent 2 of this item are met or exceeded by the credit institution is publicly disclosed or otherwise made available to the lending credit institution;
  • the assessment performed by the lending credit institution in accordance with Article 106 of the Law has not revealed that the credit institution does not meet the conditions set out in indents 1 and 2 of this item;
  1. where all of the following conditions are met and at least one of the conditions in item 1) of this paragraph is not met, exposures to credit institutions shall be assigned to Group B:
  • the credit institution is subject to substantial credit risk, including repayment capacities that are dependent on stable or favourable economic or business conditions;
  • the credit institution meets or exceeds the requirement laid down in Article 134 paragraph (2) of the Law, taking into account stricter macroprudential requirements when identifying increased macroprudential risks, where applicable, the specific own funds requirements referred to in Article 279 of the Law, or any equivalent and additional local supervisory or regulatory requirements in third countries insofar as those requirements are published and are to be met by Common Equity Tier 1 capital, Tier 1 capital or own funds, as applicable;
  • information about whether the requirements referred to in indent 2 of this item are met or exceeded by the credit institution is publicly disclosed or otherwise made available to the lending credit institution;
  • the assessment performed by the lending credit institution in accordance with Article 106 of the Law has not revealed that the institution does not meet the conditions set out in indents 1 and 2 of this item.
  1. where exposures to credit institutions are not assigned to Group A or B, or where any of the following conditions is met, exposures to credit institutions shall be assigned to Group C:
  • the credit institution has material default risks and limited margins of safety;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 154

  • adverse business, financial or economic conditions are very likely to lead, or have led, to the credit institution’s inability to meet its financial commitments;
  • where audited financial statements are required by law for the credit institution, the external auditor has issued an adverse audit opinion or has expressed substantial doubt about the credit institution’s ability to continue as a going concern in its audited financial statements or audited reports within the previous 12 months. (2) For the purposes of paragraph (1) item 2) indent 2 of this Article, equivalent and additional local supervisory or regulatory requirements shall not include capital buffers equivalent to those defined in Article 166 of the Law. (3) For exposures to financial institutions that are treated as exposures to credit institutions in accordance with Article 156 paragraph (4) of this Decision, for the purpose of assessing whether the conditions set out in paragraph (1) item 1) indent 2 and item 2) indent 2 of this Article, a credit institution shall assess whether those financial institutions meet or exceed any comparable prudential requirements. (4) Exposures assigned to Group A, B or C in accordance with paragraph (1) of this article shall be assigned a risk weight as follows:
  1. exposures assigned to Group A, B or C which meet any of the following conditions shall be assigned a risk weight for short-term exposures in accordance with paragraph (1) of this Article:
  • the exposure has an original maturity of three months or less;
  • the exposure has an original maturity of six months or less and arises from the movement of goods across national borders;
  1. exposures assigned to Group A which are not short term shall be assigned a risk weight of 30 % where all of the following conditions are met:
  • the exposure does not meet any of the conditions set out in item 1) of this paragraph;
  • the credit institution’s Common Equity Tier 1 capital ratio is equal to or higher than 14 %;
  • the credit institution’s leverage ratio is equal to or higher than 5 %;
  1. exposures assigned to Group A, B or C that do not meet the conditions set out in items 1) or 2) of this Article shall be assigned a risk weight in accordance with Table 1 referred to in this paragraph. Table 1 Credit risk assessment Group A Group B Group C Risk weight for short-term exposures 20% 50% 150% Risk weight 40% 75% 150% (5) Where an exposure to a credit institution is not denominated in the domestic currency of the jurisdiction of incorporation of that credit institution, or where that credit institution has booked the credit obligation in a branch in a different jurisdiction and the exposure is not in the domestic currency of the jurisdiction in which the branch operates, the risk weight assigned in accordance with item 1), 2) or 3) of this Article to exposures other than those with a maturity of one year or less stemming from self-

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 155 liquidating, trade-related contingent items that arise from the movement of goods across national borders shall not be lower than the risk weight of an exposure to the central government of the country where the institution is incorporated. Exposures to corporates Article 159 (1) Exposures for which a credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 of this paragraph which corresponds to the credit assessment of the ECAI in accordance with Article 178 paragraph (3) of this Decision. Table 1 Credit quality step 1 2 3 4 5 6 Risk weight 20% 50% 75% 100% 150% 150% (2) Exposures for which such a credit assessment is not available shall be assigned a 100% risk weight.

Specialised lending exposures Article 160 (1) A credit institution shall, within the corporate exposure class referred to in Article 149 item 7) of this Decision, separately identify as specialised lending exposures, exposures with all of the following characteristics:

  1. the exposure is to an entity which was created specifically to finance or operate physical assets or is an exposure that is economically comparable to such an exposure;
  2. the exposure is not related to the financing of residential property or commercial immovable property and is within the definitions of object finance, project finance or commodity finance exposures laid down in paragraph (3) of this Article;
  3. the contractual arrangements governing the obligation related to the exposure give the credit institution a substantial degree of control over the assets and the income that they generate;
  4. the primary source of repayment of the obligation related to the exposure is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise. (2) Specialised lending exposures for which a directly applicable credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 referred to in this paragraph. Table 1 Credit quality step 1 2 3 4 5 6 Risk weight 20% 50% 75% 100% 150% 150% (3) Specialised lending exposures for which a directly applicable credit assessment by a nominated ECAI is not available shall be assigned a risk weight as follows:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 156

  1. 100%, where the purpose of a specialised lending exposure is to finance the acquisition of physical assets, including ships, aircraft, satellites, railcars, and fleets, and the income to be generated by those assets comes in the form of cash flows generated by the specific physical assets that have been financed and pledged or assigned to the lender (‘object finance exposures’);
  2. 100%, where the purpose of a specialised lending exposure is to provide for short-term financing of reserves, inventories or receivables of exchange-traded commodities, including crude oil, metals or crops, and the income to be generated by those reserves, inventories or receivables is to be the proceeds from the sale of the commodity (‘commodity finance exposures’);
  3. where the purpose of a specialised lending exposure is to finance an individual project, either in the form of construction of a new capital installation or refinancing of an existing installation, with or without improvements, for the development or acquisition of large, complex and expensive installations, including power plants, chemical processing plants, mines, transportation infrastructure, environment, and telecommunications infrastructure, in which the lending credit institution looks primarily to the revenues generated by the financed project, both as the source of repayment and as security for the loan (‘project finance exposures’), a credit institution shall apply the following risk weights:
  • 130% where the project to which the exposure is related is in the pre￾operational phase;
  • 80%, provided that the adjustment to own funds requirements for credit risk referred to in Article 116 of this Decision is not applied, where the project to which the exposure is related is in the operational phase and the exposure meets all of the following criteria referred to in paragraph (5) of this Article;
  • 100% where the project to which the exposure is related is in the operational phase and the exposure does not meet the conditions set out in paragraph (5) of this Article. (4) Operational phase, within the meaning of paragraph (3) item 3) of this Article, shall be the phase in which the entity that was specifically created to finance the project, or that is economically comparable, meets both of the following conditions:
  1. the entity has a positive net cash flow that is sufficient to cover any remaining contractual obligation;
  2. the entity has a declining long term debt. (5) Exposure for which weight referred to in paragraph (3) item 3) indent 2 is assigned shall meet the following conditions:
  3. there are contractual restrictions on the ability of the debtor to perform activities that might be detrimental to lending credit institution, including the restriction that new debt cannot be issued without the consent of existing debt providers;
  4. the debtor has sufficient reserve funds fully funded in cash, or other financial arrangements with an entity, to cover the contingency funding and working capital needs over the lifetime of the project being financed, provided that the entity is assigned an ECAI rating by a recognised ECAI with a credit quality step of at least 3 or, in the case of credit institution calculating risk-weighted exposure amounts and expected loss amounts by applying IRB Approach, where the entity does not have a credit assessment by a recognised ECAI, that entity is assigned with an internal credit rating equivalent to a credit quality step

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 157 of at least 3 by the credit institution, provided that that entity is internally rated by the credit institution in accordance with the provisions of Subtitle 3 Section 6 of this Title; 3) the project to which the exposure is related generates cash flows that are predictable and cover all future loan repayments; 4) where the revenues of the debtor are not funded by payments from a large number of users, the source of repayment of the obligation depends on one main counterparty and that main counterparty is one of the following:

  • a central bank, a central government, a regional or a local-self government units, provided that they are assigned a risk weight of 0 % in accordance with Articles 151 and 152 of this Decision, or are assigned an ECAI rating with a credit quality step of at least 3 by a recognised ECAI; or, in the case of credit institution calculating risk-weighted exposure amounts and expected loss amounts by applying IRB Approach, where the central bank, central government, regional or local self-government units do not have a credit assessment by a recognised ECAI, they are assigned with an internal credit rating equivalent to a credit quality step of at least 3 by the credit institution, provided that they are internally rated by the institution in accordance with the provisions of Subtitle 3 Section 6 of this Title;
  • a public sector entity, provided that that entity is assigned a risk weight of 20% or below in accordance with Article 153 of this Decision, or is assigned an ECAI rating with a credit quality step of at least 3 by a recognised ECAI or, in the case of credit institution calculating risk-weighted exposure amounts and expected loss amounts by applying IRB Approach, where the public sector entity does not have a credit assessment by a recognised ECAI, that public sector entity is assigned with an internal credit rating equivalent to a credit quality step of at least 3 by the institution, provided that that public sector entity is internally rated by the credit institution in accordance with Subtitle 3 Section 6 of this Title;
  • a business undertaking (corporate entity) which has been assigned an ECAI rating with a credit quality step of at least 3 by a recognised ECAI, or, in the case of credit institution calculating risk-weighted exposure amounts and expected loss amounts by applying IRB Approach, where the corporate entity does not have a credit assessment by a recognised ECAI, that corporate entity is assigned an internal credit rating equivalent to a credit quality step of at least 3 by the credit institution, provided that that corporate entity is internally rated by the institution in accordance with the provisions of Subtitle 3 Section 6 of this Title;
  1. the contractual provisions governing the exposure to the debtor provide for a high degree of protection for the lending credit institution in the case of a default of the debtor;
  2. the main counterparty, or other counterparties which similarly comply with the eligibility criteria for the main counterparty, effectively protect the lending credit institution against losses resulting from the termination of the project;
  3. all assets and contracts necessary to operate the project have been pledged to the lending credit institution to the extent permitted by applicable law;
  4. the lending credit institution is able to take control of the debtor entity in the case of a default event.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 158 (6) For the purposes of paragraph (5) item 3 of this Article, the cash flows generated shall not be considered predictable unless a substantial part of the revenues satisfies one or more of the following conditions:

  1. the revenues are availability-based, meaning that, once construction is completed, the debtor is entitled, as long as the contractual conditions are fulfilled, to payments from its contractual counterparties which cover operating and maintenance costs, debt service costs and equity returns as the debtor operates the project, and those payments are not subject to swings in demand, such as traffic levels, and are adjusted typically only for lack of performance or lack of availability of the asset to the public;
  2. the revenues are subject to a rate-of-return regulation;
  3. the revenues are subject to a take-or-pay contract. Retail exposures `Article 161 (1) Retail exposures mean exposures that meet the following criteria:
  4. the exposure to one or more natural persons or to an SME (hereinafter: retail);
  5. the total amount owed to the credit institution, its parent undertakings and its subsidiary undertakings, by the debtor or group of connected persons, including any exposure in default but excluding exposures secured by residential property, up to the property value shall not, to the knowledge of the credit institution, which shall take reasonable steps to confirm the situation, exceed EUR 500,000;
  6. the exposure represents one of a significant number of exposures with similar characteristics, such that the risks associated with such exposure are substantially reduced;
  7. the credit institution treats the exposure in its risk management framework and manages the exposure internally as a retail exposure consistently over time and in a manner that is similar to the treatment by the credit institution of other retail exposures. (2) When determining whether the exposure value meets the threshold laid down in paragraph (1) item 3) of this Article, a credit institution shall not reduce the amount of total debt referred to in paragraph (1) item 3) of this Article by the value adjustments determined based on those exposures, but it shall take gross amount. (3) The present value of retail minimum lease payments shall be eligible for the retail exposure class. (4) Exposures that do not comply with the criteria referred to in paragraph (1) items 1) to 3) of this Article shall not be eligible for the retail exposures class. (5) The following exposures shall not be considered to be retail exposures:
  8. non-debt exposures conveying a subordinated, residual claim on the assets or income of the issuer;
  9. debt exposures and other securities, partnerships, derivatives, or other vehicles, the economic substance of which is similar to the exposures specified in item 1) of this paragraph;
  10. all other exposures in the form of securities.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 159 (6) Retail exposures as referred to in paragraph (1) of this Article shall be assigned a risk weight of 75%, with the exception of transactor exposures, which shall be assigned a risk weight of 45%. (7) Where any of the criteria referred to in paragraph (1) of this Article are not met for an exposure to one or more natural persons, the exposure shall be considered a retail exposure and shall be assigned a risk weight of 100%. (8) By way of derogation from paragraph (1) of this Article, exposures due to loans granted by a credit institution to pensioners or employees with a permanent contract against the unconditional transfer of part of the borrower's pension or salary to that credit institution shall be assigned a risk weight of 35%, provided that the following conditions are met:

  1. to repay the loan, the borrower unconditionally authorises the pension fund or employer to make direct payments to the credit institution by deducting the monthly payments on the loan from the borrower's monthly pension or salary;
  2. the risks of death, inability to work, unemployment or reduction of the net monthly pension or salary of the borrower are properly covered through an insurance policy underwritten by the borrower to the benefit of the credit institution;
  3. the monthly payments to be made by the borrower on all loans that meet the conditions set out in items 1) and 2) of this paragraph do not in aggregate exceed 20% of the borrower's net monthly pension or salary;
  4. the maximum original maturity of the loan is equal to or less than ten years. Exposures to a currency mismatch Article 162 (1) A credit institution shall, for exposures to natural persons that are assigned to the exposure class referred to in Article 149 item 8) of this Decision, or for exposures to natural persons that qualify as exposures secured by mortgages on residential property that are assigned to the exposure class referred to in this Section shall be multiplied by a factor of 1,5, whereby the resulting risk weight shall not be higher than 150%, where the following conditions are met:
  5. the exposure is denominated in a currency which is different from the currency of the debtor’s source of income;
  6. the debtor does not have a hedge for its payment risk due to the currency mismatch, either by a financial instrument or foreign currency income that matches the currency of the exposure, or the total of such hedges available to the borrower covers less than 90% of each instalment for this exposure. (2) Where a credit institution is unable to single out those exposures with a currency mismatch, the risk weight multiplier of 1,5 shall apply to all unhedged exposures where the currency of the exposures is different from the domestic currency of the country of residence of the debtor. (3) For the purposes of this Article, source of income refers to any source that generates cash flows to the debtor, including from remittances, rental incomes or salaries, whilst

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 160 excluding proceeds from selling assets or similar recourse actions by the credit institution. (4) By way of derogation from paragraph (1), where the pair of currencies referred to in paragraph (1) item 1) of this Article is composed of the euro and the currency of a Member State participating in the second stage of economic and monetary union (ERM II), the risk weight multiplier of 1,5 shall not apply. Exposures secured by mortgages on immovable property Article 163 (1) A credit institution shall treat a non-ADC exposure that does not meet all of the conditions set out in paragraph (3) of this Article, or any part of a non-ADC exposure that exceeds the nominal amount of the lien on the property, as follows:

  1. a non-IPRE exposure shall be risk weighted as an exposure to the counterparty that is not secured by the immovable property concerned;
  2. an IPRE exposure shall be assigned a risk weight of 150%. (2) A credit institution shall treat a non-ADC exposure, up to the nominal amount of the lien on the property, where all of the conditions set out in paragraph (3) of this Article are met, as follows:
  3. where the exposure is secured by a residential property, a credit institution shall treat: ­ a non-IPRE exposure in accordance with Article 164 paragraphs 1) to 5) of this Decision; ­ an IPRE exposure in accordance with 164 paragraphs 1) to 5) of this Decision where it meets any of the following conditions: a) the immovable property securing the exposure is the debtor’s primary residence, either where the immovable property as a whole constitutes a single housing unit or where the immovable property securing the exposure is a housing unit that is a separated part within the immovable property; b) the exposure is to a natural person and is secured by an income￾producing residential housing unit, either where the immovable property as a whole constitutes a single housing unit or where the housing unit is a separated part within the immovable property, and total exposures of the credit institution to that natural person are not secured by more than four immovable properties, including those which are not residential properties or which do not meet any of the criteria set out in this item, or separate housing units within immovable properties; c) the exposure is to associations or cooperatives of natural persons that are regulated by national law and exist with the sole purpose of granting their members the use of a primary residence in the property securing the loan; d) the exposure is to public housing companies or not-for-profit associations that are regulated by law and exist to serve social purposes and to offer tenants long-term housing; ­ (iii) an IPRE exposure which does not meet any of the conditions set out in indent 2 of this item, shall be treated in accordance with Article 164 paragraphs 6) and 7) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 161 2) where the exposure is secured by commercial immovable property, it shall be treated as follows: ­ a non-IPRE exposure shall be treated in accordance with 164 paragraphs

  1. to 5) of this Decision; ­ an IPRE exposure shall be treated in accordance with Article 164 paragraphs 6) and 7) of this Decision. (3) In order to be eligible for the treatment referred to in paragraph (2) of this Article, an exposure secured by an immovable property shall fulfil all of the following conditions:
  2. the immovable property securing the exposure meets any of the following conditions: ­ the immovable property has been fully completed; ­ the immovable property is forest or agricultural land; ­ the lending is to a natural person and the immovable property is either a residential property under construction or it is land upon which a residential property is planned to be constructed where that plan has been legally approved by all relevant authorities, as applicable, and where any of the following conditions is met: a) the immovable property does not have more than four residential housing units and will be the primary residence of the debtor and the lending to the natural person is not indirectly financing ADC exposures; b) a central government, regional government or local self-government unit or a public sector entity is involved, exposures to which are treated in accordance with Article 152 paragraph (4) or Article 153 paragraphs
  3. and 6) of this Decision, and has the legal powers and ability to ensure that the property under construction will be finished within a reasonable time frame and is required, or has committed in a legally binding manner, to ensure completion where the construction would otherwise not be finished within such reasonable time frame; alternatively, there is an equivalent legal mechanism in place to ensure that the property under construction is completed within a reasonable timeframe;
  4. the exposure is secured by a first lien held by the institution on the immovable property, or the credit institution holds the first lien and any sequentially lower ranking lien on that property;
  5. the property value is not materially dependent upon the credit quality of the debtor;
  6. all information required at origination of the exposure and for monitoring purposes is properly documented, including information on the ability of the debtor to repay and on the valuation of the property;
  7. the requirements set out in Article 246 of this Decision are met and the valuation rules set out in Article 265 paragraph (1) of this Decision are complied with. (4) For the purposes of paragraph (3) item 3) of this Article, a credit institution may exclude situations where purely macro-economic factors affect both the property value and the performance of the debtor. (5) For the purposes of paragraph (3) item 4) of this Article, a credit institution shall put in place underwriting policies with respect to the origination of exposures secured by

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 162 immovable property that include the assessment of the ability of the borrower to repay and relevant metrics for that assessment and their respective maximum levels. (6) By way of derogation from paragraph (3) item 2) of this Article, in jurisdictions where junior liens provide the holder with a claim on collateral that is legally enforceable and constitutes an effective credit risk mitigant, junior liens held by an institution other than the one holding the senior lien may also be recognised, including where the credit institution does not hold the senior lien or does not hold a lien ranking between a more senior lien and a more junior lien both held by the credit institution. (7) For the purposes of paragraph (6) of this Article, the rules governing the liens shall ensure all of the following:

  1. each credit institution holding a lien on a property can initiate the sale of the property independently from other entities holding a lien on the property;
  2. where the sale of the property is not carried out by means of a public auction, entities holding a senior lien take reasonable steps to obtain a fair market value or the best price that may be obtained in the circumstances when exercising any power of sale on their own. (8) For the purpose of calculating risk-weighted exposure amounts for undrawn facilities, liens that satisfy all eligibility requirements set out in paragraph (3) of this Article and, where applicable, paragraphs (4) and (5) of this Article, may be recognised where drawing under the facility is conditional on the prior or simultaneous filing of a lien to the extent of the credit institution’s interest in the lien once the facility is drawn, such that the credit institution does not have any interest in the lien to the extent that the facility is not drawn. (9) For the purposes of Article 164 paragraphs (6) and (7) and Article 165 paragraphs
  3. and 7) of this Decision, the exposure-to-value (‘ETV’) ratio shall be calculated by dividing the gross exposure amount by the property value subject to the following conditions:
  4. the gross exposure amount shall be calculated as the accounting value of the asset item related to the exposure secured by immovable property and any undrawn but committed amount that, once drawn, would increase the exposure value of the exposure which is secured by immovable property; that gross exposure amount shall be calculated without taking into account: ­ specific credit risk adjustments in accordance with Article 144 of this Decision; ­ additional value adjustments in accordance with Article 17 of this Decision related to the non-trading book business of the credit institution; ­ amounts deducted in accordance with Article 19 items 14), 16) and 17) of this Decision; and ­ other own funds reductions related to the asset item;
  5. the gross exposure amount shall be calculated without taking into account any type of funded or unfunded credit protection, except for pledged deposits accounts with the lending credit institution that meet all requirements for on￾balance-sheet netting, either under master netting agreements in accordance with Articles 234 and 244 of this Decision or under other on-balance-sheet netting agreements in accordance with Articles 233 and 243 of this Decision and have been unconditionally and irrevocably pledged for the sole purpose

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 163 of fulfilling the credit obligation related to the exposure secured by immovable property; 3) for exposures that are required to be treated in accordance with Article 164 paragraphs 6) and 7) or Article 165 paragraphs 6) and 7) of this Decision where a party other than the credit institution holds a senior lien and a junior lien held by the credit institution is recognised under paragraphs 6) and 7) of this Article, the gross exposure amount shall be calculated as the sum of the gross exposure amount of the lien held by the credit institution and of the gross exposure amounts for all other liens of equal or higher ranking seniority than the lien held by the credit institution. (10) For the purposes of paragraph (9) item 1) of this Article, where a credit institution has more than one exposure secured by the same immovable property and those exposures are secured by liens on that immovable property that are sequential in ranking order without any lien held by a third party ranking in-between, the exposures shall be treated as a single combined exposure and the gross exposure amounts for the individual exposures shall be summed up to calculate the gross exposure amount for the single combined exposure. (11) For the purposes of paragraph (9) item 3) of this Article, where there is insufficient information to be able to ascertain the ranking of the other liens, the credit institution shall treat those liens as ranking pari passu with the junior lien held by the credit institution, whereby the credit institution shall first determine the risk weight in accordance with Article 164 paragraphs 6) and 7) or Article 165 paragraphs 6) and 7) of this Decision (the ‘base risk weight’), as applicable, and it shall then adjust this risk weight by a multiplier of 1,25, for the purposes of calculating the risk-weighted amounts of junior liens, and the risk weight resulting from multiplying the base risk weight by 1,25 shall be capped at the risk weight that would be applied to the exposure if the requirements in paragraph (3) of this Article were not met. (12) Where the base risk weight corresponds to the lowest exposure-to-default bucket, the multiplier shall not be applied. (13) Where a credit institution leases immovable property (leasing transaction), its exposure to a tenant under an immovable property leasing transaction under which the credit institution is the lessor and the tenant has an option to purchase shall qualify as exposures secured by immovable property and shall be treated in accordance with the treatment set out in Article 164 or 165 of this Decision, if the applicable conditions set out in this Article are met, provided that the exposure of the credit institution is secured by its ownership of the property. (14) Where the Central Bank, on the basis of the analysis of data collected from credit institutions, in accordance with paragraph (16) of this Article, and on any other relevant indicators, assesses that the risk weights laid down in Articles 164 and 165 of this Decision, for exposures secured by immovable property located in the territory of Montenegro are not appropriately based on the loss experience of exposures secured by immovable property and forward-looking immovable property market developments, or it concludes that the risk weights set out in Article 164 and 165 of this Decision do not adequately reflect the actual risks related to exposures to one or more property segments secured by mortgages on residential property or on

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 164 commercial immovable property located in one or more parts of the territory of Montenegro, and if it considers that the inadequacy of the risk weights could adversely affect current or future financial stability in Montenegro, it may increase the risk weights referred to in Article 164 paragraph (1), Article 164 paragraph (6), Article 165 paragraph (1) or Article 165 paragraph (6) of this Decision or impose stricter criteria than those set out in paragraph (3) of this Article for exposures to one or more property segments secured by mortgages on immovable property located in one or more parts of the territory of Montenegro, whilst those risk weights may not exceed 150%. (15) Where the Central Bank sets higher risk weights or stricter criteria pursuant to paragraph (14) of this Article, the credit institution shall have a six-month transitional period to apply them. (16) A credit institution shall report to the Central on an annual basis the following data:

  1. losses stemming from exposures for which a credit institution has recognised residential property as collateral, in each case up to the lower of the pledged amount or 55% of the property value of the residential property, unless otherwise decided under Article 14 of this Article, where applicable;
  2. overall losses stemming from exposures for which a credit institution has recognised residential property as collateral, in each case up to the lower of the pledged amount or 100% of the property value of the residential property;
  3. the exposure value of all outstanding exposures for which an institution has recognised residential property as collateral, in each case up to the lower of the pledged amount and 100 % of the property value of the residential property;
  4. losses stemming from exposures for which a credit institution has recognised commercial immovable property as collateral, in each case up to the lower of the pledged amount or 55% of the property value of the commercial immovable property, unless otherwise decided under Article 14 of this Article, where applicable;
  5. overall losses stemming from exposures for which a credit institution has recognised commercial immovable property as collateral in each case up to the lower of the pledged amount or 100% of the property value of the commercial immovable property;
  6. the exposure value of all outstanding exposures for which a credit institution has recognised commercial immovable property as collateral, in each case up to the lower of the pledged amount or 100% of the property value of the commercial immovable property. Exposures secured by mortgages on residential property Article 164 (1) A credit institution shall assign a risk weight of 20% to an exposure secured by residential property as referred to in Article 163 paragraph (2) item 1) indents 1 and 2 of this Decision, the part of the exposure up to 55 % of the property value. (2) Where a credit institution holds a junior lien and there are more senior liens not held by that credit institution, to determine the part of the credit institution’s exposure that is eligible for the 20% risk weight, it shall reduce the amount of 55% of the property value by the amount of the more senior liens not held by the credit institution.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 165 (3) Where liens not held by the credit institution rank pari passu with the lien held by the credit institution, to determine the part of the credit institution’s exposure that is eligible for the 20% risk weight, it shall reduce the amount of 55% of the property value by the amount of any more senior liens not held by the credit institution, and then reduce the obtained amount by the product of the amount referred to in items 1) and 2) of this paragraph:

  1. 55% of the property value, reduced by the amount of more senior liens, if any, both held by the credit institution and held by other credit institutions; and
  2. the amount of liens not held by the credit institution that rank pari passu with the lien held by the credit institution divided by the sum of all pari passu liens. (4) Where, in accordance with Article 163 paragraph (14) of this Decision, the Central Bank has set a higher risk weight or a lower percentage of the property value than those referred to in paragraph (1) of this Article, a credit institution shall use the risk weight or percentage set in accordance with 163 paragraph (14) of this Decision. (5) The remaining part of the exposure referred to in paragraph (1), if any, shall be risk weighted as an exposure to the counterparty that is not secured by residential property. (6) A credit institution shall assign to an exposure as referred to in Article 163 paragraph (2) item 1) indent 3 the risk weight set in accordance with the respective exposure-to-value risk weight bucket in Table 1. Table 1 ETV ETV ≤ 50% 50% < ETV ≤ 60% 60% < ETV ≤ 80% 80% < ETV ≤ 90% 90% < ETV ≤ 100% ETV > 100% Risk weight 30% 35% 45% 60% 75% 105% (7) For the purposes of paragraph (6) of this Article, where, in accordance with Article 163 paragraph (14) of this Decision, the Central Bank has set a higher risk weight or a lower exposure-to-value percentage than those referred to in this paragraph, a credit institution shall use the risk weight or percentage set in accordance with 163 paragraph (14) of this Decision. Exposures secured by mortgages on commercial immovable property Article 165 (1) A credit institution shall assign a risk weight of 60% to an an exposure secured by commercial immovable property as referred to in Article 163 paragraph (2) item 2) indent 1 of this Decision, the part of the exposure up to 55% of the property value. (2) Where a credit institution holds a junior lien and there are more senior liens not held by that credit institution, to determine the part of the credit institution’s exposure that is eligible for the 60% risk weight, it shall reduce the amount of 55% of the property value by the amount of the more senior liens not held by the credit institution. (3) Where liens not held by the credit institution rank pari passu with the lien held by the credit institution, to determine the part of the credit institution’s exposure that is eligible for the 60 % risk weight, it shall reduce the amount of 55% of the property value by the amount of any more senior liens not held by the credit institution, and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 166 then reduce the obtained amount by the product of the amount referred to in items 1) and 2) of this paragraph:

  1. 55% of the property value, reduced by the amount of more senior liens, if any, both held by the credit institution and held by other credit institutions; and
  2. the amount of liens not held by the credit institution that rank pari passu with the lien held by the credit institution divided by the sum of all pari passu liens. (4) Where, in accordance with Article163 paragraph (14) of this Decision, the Central Bank has set a higher risk weight or a lower percentage of the property value than those referred to in this paragraph, a credit institution shall use the risk weight or percentage set in accordance with Article 163 paragraph (14) of this Decision. (5) The remaining part of the exposure referred to in paragraph (1), if any, shall be risk weighted as an exposure to the counterparty that is not secured by commercial immovable property. (6) A credit institution shall assign to an exposure as referred to in Article 163 paragraph (2) item 1) indent 3 the risk weight set in accordance with the respective exposure-to-value risk weight bucket in Table 1. Table 1 ETV ≤ 60% 60% < ETV ≤ 80% ETV > 80% Risk weight 70% 90% 110% (7) For the purposes of paragraph (6) of this Article, where, in accordance with Article 163 paragraph (14) of this Decision, the Central Bank has set a higher risk weight or a lower exposure-to-value percentage than those referred to in this paragraph, a credit institution shall use the risk weight or percentage set in accordance with Article 163 paragraph (14) of this Decision. Land acquisition, development and construction exposures Article 166 (1) A credit institution shall assign a risk weight of 150% to an ADC exposure. (2) A credit institution may assigne to an ADC exposure to residential property a risk weight of 100%, provided that the credit institution applies sound origination and monitoring standards which meet the requirements laid down in Articles 104 and 106 of the Law and where at least one of the following conditions is met:
  3. legally binding pre-sale or pre-lease contracts for which the purchaser or tenant has made a substantial cash deposit which is subject to forfeiture if the contract is terminated or where the financing is ensured in an equivalent manner, or legally binding sale or lease contracts, including where the payment is made by instalments as the construction works progress, amount to a significant portion of total contracts;
  4. the debtor has substantial equity at risk, which is represented as an appropriate amount of debtor-contributed equity to the residential property value upon completion.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 167 Exposures in default Article 167 (1) The unsecured part of any item where the debtor has defaulted in accordance with Article 218 of this Decision, or in the case of retail exposures, the unsecured part of any credit facility which has defaulted in accordance with Article 218 of this Decision shall be assigned a risk weight of:

  1. 150%, where the sum of specific credit risk adjustments and of the amounts deducted in accordance with Article 19 item 14) of this Decision is less than 20% of the unsecured part of the exposure value if those specific credit risk adjustments and deductions were not applied;
  2. 100%, where the sum of the specific credit risk adjustments and of the amounts deducted in accordance with Article 19 item 14) of this Decision is no less than 20% of the unsecured part of the exposure value if those specific credit risk adjustments and deductions were not applied. (2) For the purpose of calculating the specific credit risk adjustments referred to in paragraph (1) of this Article for an exposure that is purchased when already in default, a credit institution shall include in the calculation any positive difference between the amount owed by the debtor on that exposure and the sum of the additional own funds reduction if that exposure were fully written off and any already existing own funds reductions related to that exposure. (3) For the purpose of determining the secured part of the past due item, eligible collateral and guarantees shall be those eligible for credit risk mitigation purposes under Subtitle 4 of this title. (4) The exposure value remaining after specific credit risk adjustments of non-IPRE exposures secured by residential property or commercial immovable property in accordance with Articles 164 and 164 of this Decision, shall be assigned a risk weight of 100% if a default has occurred in accordance with Article 218 of this Decision. Subordinated debt exposures Article 168 (1) A credit institution shall treat the following exposures as subordinated debt exposures:
  3. debt exposures which are subordinated to claims of ordinary unsecured creditors;
  4. own funds instruments to the extent that those instruments are not considered to be equity exposures in accordance with Article 178 paragraph (1) of this Decision; and
  5. exposures arising from the institution’s holding of eligible liabilities instruments that meet the conditions set out in Article 72 of this Decision. (2) A credit institution shall assign to subordinated debt exposures a risk weight of 150%, unless those subordinated debt exposures are deducted from own funds or subject to the treatment set out in Article 75 paragraph (7) of this Decision. Exposures in the form of covered bonds

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 168 Article 169 (1) To be eligible for the preferential treatment set out in paragraphs (14) and (15) of this Article, covered bonds, which are in accordance with the regulation governing covered bonds issued by credit institutions with registered office in Montenegro or an EU Member State and which are subject to a separate public oversight aimed at protecting bond holder, shall meet the requirements set out in paragraphs (8) to (13) of this Article and shall be collateralised by any of the following eligible assets:

  1. exposures to or guaranteed by central governments, the Government of Montenegro, the Central Bank of Montenegro, public sector entities or local self￾government units;
  2. exposures to or guaranteed by central governments, the ESCB central banks, public sector entities, regional governments or local authorities in the EU Member States;
  3. exposures to or guaranteed by third country central governments, third-country central banks, multilateral development banks, international organisations that qualify for the credit quality step 1 in accordance with this Subtitle, and exposures to or guaranteed by third-country public sector entities, third-country regional governments or third- country local authorities that are risk weighted as exposures to institutions or central governments and central banks in accordance with Article 152 paragraphs (2) and (3) or paragraph (4) or Article 153 paragraphs (1) to (3) or paragraphs (5) and (6) of this Decision respectively and that qualify for the credit quality step 1 as set out in this Subtitle, and exposures within the meaning of this item that qualify as a minimum for the credit quality step 1 as set out in this Subtitle, provided that they do not exceed 20% of the nominal amount of outstanding covered bonds of the issuing credit institutions;
  4. exposures to credit institutions that qualify for credit quality step 1 or credit quality step 2 or exposures to credit institutions that qualify for credit quality step 3 where those exposures are in the form of:
  • short-term deposits with an original maturity not exceeding 100 days, where those deposits are used to meet the cover pool liquidity buffer requirement for investor’s protection, and are governed by a regulation governing covered bonds;
  • derivative contracts that are included in the cover pool exclusively for risk hedging purposes, their volume is adjusted in the case of a reduction in the hedged risk and they are removed when the hedged risk ceases to exist; the derivative contracts are sufficiently documented; the derivative contracts are segregated in accordance with the regulation governing this issue; the derivative contracts cannot be terminated upon the bankruptcy or resolution of the credit institution that issued the covered bonds; the derivative contracts comply with the rules specifying the eligibility criteria for the hedging counterparties, and the necessary documentation to be provided in relation to derivative contracts;
  1. loans secured by residential property up to the lesser of the principal amount of the liens that are combined with any prior liens and 80% of the value of the pledged properties;
  2. residential loans fully guaranteed by an eligible protection provider referred to in Article 239 of this Decision qualifying for the credit quality step 2 or above as set out in this Subtitle, where the portion of each of the loans that is used to

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 169 meet the requirement set out in this paragraph for collateralisation of the covered bond does not represent more than 80% of the value of the corresponding residential property located in France, and where a loan-to￾income ratio respects at most 33% when the loan has been granted and there shall be no mortgage liens on the residential property when the loan is granted; the loan-to-income ratio represents the share of the gross income of the borrower that covers the reimbursement of the loan, including the interests; the protection provider shall be either a financial institution authorised and supervised by the competent authorities and subject to prudential requirements comparable to those applied to credit institutions in terms of robustness or a credit institution or an insurance undertaking which shall establish a mutual guarantee fund or equivalent protection for insurance undertakings to absorb credit risk losses, whose calibration shall be periodically reviewed by the competent authority; both the credit institution and the protection provider shall carry out a creditworthiness assessment of the borrower; 7) loans secured by commercial immovable property up to the lesser of the principal amount of the liens that are combined with any prior liens and 60% of the value of the pledged properties, whereat the loans secured by commercial immovable property are eligible where the loan-to-value ratio of 60% is exceeded up to a maximum level of 70% if the value of the total assets pledged as collateral for the covered bonds exceed the nominal amount outstanding on the covered bond by at least 10 %, and the bondholders’ claim meets the legal certainty requirements set out in Subtitle 4, and the bondholders’ claim shall take priority over all other claims on the collateral; 8) loans secured by maritime liens on ships up to the difference between 60% of the value of the pledged ship and the value of any prior maritime liens. (2) For the purposes of paragraph (3) of this Article, exposures caused by the transmission and management of the payments of the debtors of loans secured by pledged properties of debt securities or by the transmission and management of liquidation proceeds in respect of such loans shall not be comprised in calculating the limits referred to in that paragraph. (3) For the purposes of paragraph (1) item 3) of this Article, the following shall apply:

  1. for exposures to credit institutions that qualify for credit quality step 1, the exposure shall not exceed 15% of the nominal amount of outstanding covered bonds of the issuing credit institution;
  2. for exposures to credit institutions that qualify for credit quality step 2, the exposure shall not exceed 10% of the nominal amount of outstanding covered bonds of the issuing credit institution;
  3. for exposures to credit institutions that qualify for credit quality step 3 that take the form of short-term deposits, as referred to in paragraph 1 item 3) indent 1 of this Article, or the form of derivative contracts, as referred to in paragraph 1 item 3) indent 2 of this Article, the total exposure shall not exceed 8% of the nominal amount of outstanding covered bonds of the issuing credit institution; the competent authorities designated for the supervision of covered bonds in accordance with the regulation governing this area may allow exposures to credit institutions that qualify for credit quality step 3 in the form of derivative contracts, provided that significant potential concentration problems in the EU

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 170 Member States concerned due to the application of credit quality step 1 and 2 requirements referred to in this paragraph can be documented; 4) the total exposure to credit institutions that qualify for credit quality step 1, 2 or 3 shall not exceed 15% of the nominal amount of outstanding covered bonds of the issuing credit institution and the total exposure to credit institutions that qualify for credit quality step 2 or 3 shall not exceed 10% of the nominal amount of outstanding covered bonds of the issuing credit institution. (4) Paragraph (3) of this Article shall not apply to the use of covered bonds as eligible collateral as permitted for Intragroup pooled covered bond structures in accordance with the regulation governing this area. (5) For the purposes of paragraph (1) of this Article, the limit of 80% shall apply on a loan-by-loan basis, shall determine the portion of the loan contributing to the coverage of liabilities attached to the covered bond, and shall apply throughout the entire maturity of the loan. (6) For the purposes of paragraph (1) items 6) and 7) of this Article, the limits of 60% or 70% shall apply on a loan-by-loan basis, shall determine the portion of the loan contributing to the coverage of liabilities attached to the covered bond, and shall apply throughout the entire maturity of the loan. (7) The situations referred to in paragraph (1) items 1) to 6) of this Article shall also include collateral that is exclusively restricted by legislation to the protection of the bond-holder against losses. (8) For immovable property and ships collateralising covered bonds that comply with this Decision, the requirements set out in Article 246 shall be met, and the monitoring of property values in accordance with Article 246 paragraph (3) of this Decision shall be carried out frequently and at least annually for all immovable property and ships. (9) For the purpose of valuing immovable property, the designated competent authorities may allow that property to be valued at or at less than the market value, or in those Member States that have laid down rigorous criteria for the assessment of the mortgage lending value in statutory or regulatory provisions, at the mortgage lending value of that property, without applying the limits set out in Article 265 paragraph (1) item 5) of this Decision. (10) In addition to being collateralised by the eligible assets listed in paragraph (1) of this Article, covered bonds shall be subject to a minimum level of 5% of overcollateralisation. (11) For the purposes of paragraph (11) of this Article, the total nominal amount of all cover assets as defined in point (4) of Article 3 of that Directive shall be at least of the same value as the total nominal amount of outstanding covered bonds (‘nominal principle’), and shall consist of eligible assets as set out in paragraph (1) of this Article. (12) The assets contributing to a minimum level of overcollateralisation shall not be subject to the limits on exposure size set out in paragraph (3) of this Article and shall not count towards those limits.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 171 (13) Eligible assets listed in paragraph (1) of this Article may be included in the cover pool as substitution assets as defined by regulation governing covered bonds, subject to the limits on credit quality and exposure size set out in paragraphs (1) and (3) of this Article. (14) Covered bonds for which a directly applicable credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 which corresponds to the credit assessment of the ECAI in accordance with Article 178 paragraph (3) of this Decision. Table 1 Credit quality step 1 2 3 4 5 6 Risk weight 10% 20% 20% 50% 50% 100% (15) Covered bonds for which a directly applicable credit assessment by a nominated ECAI is not available shall be assigned a risk weight on the basis of the risk weight assigned to senior unsecured exposures to the credit institution which issues them, by applying the following correspondence between risk weights:

  1. if the exposures to the credit institution are assigned a risk weight of 20%, the covered bond shall be assigned a risk weight of 10%;
  2. if the exposures to the credit institution are assigned a risk weight of 30%, the covered bond shall be assigned a risk weight of 15%;
  3. if the exposures to the credit institution are assigned a risk weight of 40%, the covered bond shall be assigned a risk weight of 20%;
  4. if the exposures to the credit institution are assigned a risk weight of 50%, the covered bond shall be assigned a risk weight of 20%;
  5. if the exposures to the credit institution are assigned a risk weight of 75%, the covered bond shall be assigned a risk weight of 35%;
  6. if the exposures to the credit institution are assigned a risk weight of 100%, the covered bond shall be assigned a risk weight of 50%;
  7. if the exposures to the credit institution are assigned a risk weight of 150%, the covered bond shall be assigned a risk weight of 100%. Items representing securitisation positions Article 170 Risk-weighted exposure amounts for securitisation positions shall be determined in accordance with Subtitle 5 of this Title. Exposures to credit institutions and business undertakings with a short-term credit assessment Article 171 Exposures to credit institutions and exposures to business undertakings for which a short- term credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 1 which corresponds to the credit assessment of the ECAI in accordance with Article 178 paragraph (3) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 172 Table 1 Credit quality step 1 2 3 4 5 6 Risk weight 20% 50% 100% 150% 150% 150% Own funds requirements for exposures in the form of units or shares in CIUs Article 172 (1) A credit institution shall calculate the risk-weighted exposure amount for their exposures in the form of units or shares in a CIU by multiplying the risk-weighted exposure amount of the CIU's exposures, calculated in accordance with the approaches referred to in paragraph (2) of this Article, with the percentage of units or shares held by that credit institution. (2) Where the conditions set out in paragraphs (5) to (8) of this Article are met, a credit institution may apply the look-through approach in accordance with Article 173 paragraph (1) of this Decision or the mandate-based approach in accordance with Article 173 paragraphs (2) and (3) of this Decision. (3) Subject to Article 174 paragraph (2) of this Decision, a credit institution that do not apply the look-through approach or the mandate-based approach shall assign a risk weight of 1,250% (‘fall-back approach’) to their exposures in the form of units or shares in a CIU. (4) A credit institution may calculate the risk-weighted exposure amount for their exposures in the form of units or shares in a CIU by using a combination of the approaches referred to in paragraphs (2) and (3) of this Article, provided that the conditions for using those approaches are met. (5) A credit institution may determine the risk-weighted exposure amount of a CIU's exposures in accordance with the approaches set out in Article 173 of this Decision, where all the following conditions are met:

  1. the CIU is as defined in Article 3 item 2) of this Decision;
  2. the CIU's prospectus or equivalent document includes the following:
  • the categories of assets in which the CIU is authorised to invest;
  • where investment limits apply, the relative limits and the methodologies to calculate them;
  1. reporting by the CIU or the CIU management company to the credit institution complies with the following requirements:
  • the exposures of the CIU are reported at least as frequently as those of the credit institution;
  • the granularity of the financial information is sufficient to allow the credit institution to calculate the CIU's risk-weighted exposure amount in accordance with the approach chosen by the credit institution; and
  • where the credit institution applies the look-through approach, information about the underlying exposures is verified by an independent third party. (6) By way of derogation from paragraph (5) item 1) of this Article, multilateral and bilateral development banks and other credit institutions that co-invest in a CIU with multilateral or bilateral development banks may determine the risk-weighted exposure

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 173 amount of that CIU's exposures in accordance with the approaches set out in Article 173 of this Decision, provided that the conditions set out in paragraph (5) items 2) and 3) of this Article are met and that the CIU's investment mandate limits the types of assets that the CIU can invest in to assets that promote sustainable development in developing countries. (7) A credit institution shall notify the Central Bank of the CIUs to which they apply the treatment referred to in paragraph (6) of this Article. (8) By way of derogation from paragraph (5) item 3) indent 1 of this Article, where the credit institution determines the risk-weighted exposure amount of a CIU's exposures in accordance with the mandate-based approach, the reporting by the CIU or the CIU management company to the credit institution may be limited to the investment mandate of the CIU and any changes thereof and may be done only when the credit institution incurs the exposure to the CIU for the first time and when there is a change in the investment mandate of the CIU. (9) A credit institution that does not have adequate data or information to calculate the risk-weighted exposure amount of a CIU's exposures in accordance with the approaches set out in Article 173 of this Decision may rely on the calculations of a third party, provided that all the following conditions are met:

  1. the third party is one of the following:
  • the depository institution, which is a credit institution or a financial institution of the CIU, provided that the CIU exclusively invests depository financial institution;
  • for CIUs not covered by indent 1 of this item, the CIU management company, provided that the company meets the condition set out in paragraph (5) item 1) of this Article;
  1. the third party carries out the calculation in accordance with the approaches set out in Article 173 paragraph (1), (2) or (5) of this Decision, as applicable;
  2. an external auditor has confirmed the correctness of the third party's calculation. (10) A credit institution that relies on third-party calculations shall multiply the risk￾weighted exposure amount of a CIU's exposures resulting from those calculations by a factor of 1,2. (11) By way of derogation from paragraph (10) of this Article, where the credit institution has unrestricted access to the detailed calculations carried out by the third party, the factor of 1,2 shall not apply and the credit institution shall provide those calculations to the Central Bank upon request. (12) Where a credit institution applies the approaches referred to in Article 173 of this Decision for the purpose of calculating the risk-weighted exposure amount of a CIU's exposures (‘level 1 CIU’), and any of the underlying exposures of the level 1 CIU is an exposure in the form of units or shares in another CIU (‘level 2 CIU’), the risk-weighted exposure amount of the level 2 CIU's exposures may be calculated by using any of the three approaches described in paragraphs (2), (3) and (4) of this Article, and the credit institution may use the look-through approach to calculate the risk-weighted exposure amounts of CIUs' exposures in level 3 and any subsequent level only where

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 174 it used that approach for the calculation in the preceding level. In any other scenario it shall use the fall-back approach. (13) The risk-weighted exposure amount of a CIU's exposures calculated in accordance with the look-through approach and the mandate-based approach shall be capped at the risk-weighted amount of that CIU's exposures calculated in accordance with the fall-back approach. (14) By way of derogation from paragraph (1) of this Article, the credit institution that applies the look-through approach in accordance with Article 173 paragraph (1) of this Decision may calculate the risk-weighted exposure amount for their exposures in the form of units or shares in a CIU by multiplying the exposure values of those exposures, calculated in accordance with Article 148 of this Decision, with the risk weight (𝑅𝑅 𝑖𝑖 ∗ ) calculated in accordance with the formula set out in Article 175 of this Article, provided that the following conditions are met:

  1. the credit institution measures the value of their holdings of units or shares in a CIU at historical cost but measure the value of the underlying assets of the CIU at fair value if they apply the look-through approach;
  2. a change in the market value of the units or shares for which credit institution measures the value at historical cost changes neither the amount of own funds of those institutions nor the exposure value associated with those holdings. Approaches for calculating risk-weighted exposure amounts of CIUs Article 173 (1) Where the conditions set out in Article 172 paragraphs (5) to (8) of this Decision are met, credit institution that has sufficient information about the individual underlying exposures of a CIU shall look through to those exposures to calculate the risk￾weighted exposure amount of the CIU, risk weighting all underlying exposures of the CIU as if they were directly held by those credit institutions. (2) Where the conditions set out in Article 172 paragraph (5) and (8) of this Decision are met, credit institution that does not have sufficient information about the individual underlying exposures of a CIU to use the look-through approach may calculate the risk-weighted exposure amount of those exposures in accordance with the limits set in the CIU's mandate and relevant regulations. (3) A credit institution shall carry out the calculations referred to in paragraph (2) of this Article under the assumption that the CIU first incurs exposures to the maximum extent allowed under its mandate or relevant regulations in the exposures attracting the highest own funds requirement and then continues incurring exposures in descending order until the maximum total exposure limit is reached, and that the CIU applies leverage to the maximum extent allowed under its mandate or relevant regulations, where applicable. (4) A credit institution shall carry out the calculations referred to in paragraph (2) of this Article in accordance with the methods set out in this Subtitle, Subtitle 5, and Subtitle 6 Sections 3, 4 or 5 of this Title.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 175 (5) By way of derogation from Article 114 paragraph (4) item 5) of this Decision, a credit institution that calculates the risk-weighted exposure amount of a CIU's exposures in accordance with paragraphs (1) or paragraphs (2) to (4) of this Article may calculate the own funds requirement for the credit valuation adjustment risk of derivative exposures of that CIU as an amount equal to 50% of the own funds requirement for those derivative exposures calculated in accordance with Subtitle 6 Section 3, 4 or 5 of this Title, as applicable. (6) By way of derogation from paragraph (5) of this Article, a credit institution may exclude from the calculation of the own funds requirement for credit valuation adjustment risk derivative exposures which would not be subject to that requirement if they were incurred directly by the credit institution. (7) When applying the mandate-based approach in accordance with paragraph (2) of this Article, where the CIU’s mandate does not exclude that the underlying of a CIU’s derivative position constitutes an on- or off-balance sheet exposure, but the exposure value or, in the case of off-balance sheet exposures, the applicable percentage pursuant to Article 148 of this Decision, is unknown, a credit institution shall use the full notional amount of the derivative position as the exposure value for the calculation of the risk-weighted exposure amounts. (8) For the purposes of determining the exposure value as set out in paragraph (7) of this Article, where the notional amount of the derivative positions is unknown, a credit institution shall use a conservative estimation based on the maximum notional amount of the derivatives allowed under a CIU’s mandate as the exposure value. Exclusions from the approaches for calculating risk-weighted exposure amounts of CIUs Article 174 (1) A credit institution may exclude from the calculations referred to in Article 172 of this Decision Common Equity Tier 1, Additional Tier 1, Tier 2 instruments and eligible liabilities instruments held by a CIU which credit institution shall deduct in accordance with Articles 19, 54, 64 and 75 of this Decision. (2) A credit institution may exclude from the calculations referred to in Article 172 of this Decision equity exposures underlying exposures in the form of units or shares in CIUs to entities whose credit obligations are assigned a 0% risk weight under this Subtitle, including those publicly sponsored entities where a 0% risk weight can be applied, and equity exposures referred to in Article 176 paragraph (9) of this Decision, and instead apply the treatment set out in Article 176 of this Decision to those equity exposures. Treatment of off-balance-sheet exposures to CIUs Article 175 (1) A credit institution shall calculate the risk-weighted exposure amount for their off￾balance-sheet items with the potential to be converted into exposures in the form of units or shares in a CIU by multiplying the exposure values of those exposures

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 176 calculated in accordance with Article 148 of this Decision, with the following risk weight:

  1. for all exposures for which credit institutions use one of the approaches set out in Article 173 of this Decision: 𝑅𝑅 𝑖𝑖 ∗ = 𝑅𝑅𝑅𝑅𝑅𝑅 𝑖𝑖 𝑖𝑖 ∗ ∙ 𝑖𝑖 𝐸𝐸𝑖𝑖 where: 𝑅𝑅 𝑖𝑖 ∗ = Risk weight; 𝑖𝑖 = the index denoting the CIU; 𝑅𝑅𝑅𝑅𝑅𝑅 𝑖𝑖 = the amount calculated in accordance with Article 150 of this Decision for a CIUi; 𝑖𝑖 ∗ = the exposure value of the exposures of CIUi; 𝑖𝑖 = the accounting value of assets of CIUi; and; 𝐸𝐸𝑖𝑖 = the accounting value of the equity of CIUi;
  2. for all other exposures, 𝑅𝑅 𝑖𝑖 ∗ = 1.250%. (2) A credit institution shall calculate the exposure value of a minimum value commitment that meets the conditions set out in paragraph (5) of this Article as the discounted present value of the guaranteed amount using a default risk-free discount factor that is derived from a risk- free rate pursuant to Article 425 paragraphs (3) or (4) of this Decision, as applicable. (3) A credit institution may reduce the exposure value of the guaranteed minimum value commitment by any losses recognised with respect to the minimum value commitment under the applicable accounting standard. (4) A credit institution shall calculate the risk-weighted exposure amount for off￾balance-sheet exposures arising from minimum value commitments that meet all the conditions set out in paragraph (5) of this Article by multiplying the exposure value of those exposures by a conversion factor of 20% and the risk weight derived under Article 172 or 194 of this Decision. (5) A credit institution shall determine the risk-weighted exposure amount for off￾balance-sheet exposures arising from minimum value commitments in accordance with paragraphs (2) to (4) of this Article where all the following conditions are met:
  3. the off-balance-sheet exposure of the credit institution is a guaranteed minimum value commitment for an investment into units or shares of one or more CIUs under which the credit institution is only obliged to pay out under the minimum value commitment where the market value of the underlying exposures of the CIU or CIUs is below a predetermined threshold at one or more points in time, as specified in the contract;
  4. the CIU is any of the following:
  • a UCITS as defined in Article 3 item 3) of this Decision; or
  • an AIF as defined in Article 3 item 4) of this Decision which solely invests in transferable securities or in other liquid financial assets, where the mandate

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 177 of the AIF does not allow a leverage higher than its total net value of the portfolio; 3) the current market value of the underlying exposures of the CIU underlying the minimum value commitment without considering the effect of the off-balance￾sheet minimum value commitments covers or exceeds the present value of the threshold specified in the minimum value commitment; 4) when the excess of the market value of the underlying exposures of the CIU or CIUs over the present value of the minimum value commitment declines, the credit institution, or another undertaking in so far as it is covered by the supervision on a consolidated basis to which the credit institution itself is subject to the Law, can influence the composition of the underlying exposures of the CIU or CIUs or limit the potential for a further reduction of the excess in other ways; 5) the ultimate direct or indirect beneficiary of the minimum value commitment is typically a natural person or an SME (hereinafter: a retail client). (6) For the purposes of paragraph (5) item 5) of this Article, a retail client shall be a client other than the professional client. (7) A professional client shall be a client having an experience, knowledge and qualifications for passing its own investment decisions and adequately assesses risks to which it is exposed. (8) A professional client shall be considered to be the following:

  1. entities which are required to be authorised or regulated to operate in the financial markets, such as:
  • credit institutions;
  • investment firms;
  • other authorised or regulated financial institutions;
  • insurance companies;
  • collective investment schemes and management companies of such schemes;
  • pension funds and management companies of such funds;
  • commodity and commodity derivatives dealers;
  • local market participants;
  • other institutional investors;
  1. large undertakings meeting two of the following size requirements on a company basis:
  • balance sheet total: EUR 20 000 000
  • net turnover: EUR 40 000 000
  • own funds: EUR 2 000 000
  1. national and regional governments, including public bodies that manage public debt, central banks, international and supranational institutions such as
  • the World Bank,
  • the IMF,
  • the ECB,
  • the EIB, and
  • other similar international organisations.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 178 4) other institutional investors whose main activity is to invest in financial instruments, including entities dedicated to the securitisation of assets or other financing transactions. Equity exposures Article 176 (1) All of the following shall be considered equity exposures:

  1. any exposure that meets all of the following conditions:
  • it is irredeemable in the sense that the return of invested funds can be achieved only by the sale of the investment or sale of the rights to the investment or by the liquidation of the issuer;
  • it does not embody an obligation on the part of the issuer;
  • it conveys a residual claim on the assets or income of the issuer;
  1. instruments that would qualify as Tier 1 items if issued by a credit institution;
  2. instruments that embody an obligation on the part of the issuer and meet any of the following conditions: ­ the issuer is able to defer the settlement of the obligation indefinitely; ­ the obligation requires, or permits at the issuer’s discretion, settlement by issuance of a fixed number of the issuer’s equity shares; ­ the obligation requires, or permits at the issuer’s discretion, settlement by issuance of a variable number of the issuer’s equity shares and, ceteris paribus, any change in the value of the obligation is attributable to, comparable to, and in the same direction as, the change in the value of a fixed number of the issuer’s equity shares; ­ the holder of the instrument has the option of requiring that the obligation be settled in equity shares, unless one of the following conditions is met: a) in the case of a traded instrument, the credit institution has demonstrated to the satisfaction of the Central Bank that the instrument is traded on the market more like the debt of the issuer than like its equity; b) in the case of non-traded instruments, the credit institution has demonstrated to the satisfaction of the Central Bank that the instrument should be treated as a debt position;
  3. debt obligations and other securities, partnerships, derivatives or other vehicles structured in such a way that the economic substance is similar to the exposures referred to in items 1), 2) and 3) of this paragraph, including liabilities from which the return is linked to that of equities;
  4. equity exposures that are recorded as a loan but arise from a debt- equity swap made as part of the orderly realisation or restructuring of the debt. (2) For the purposes of paragraph (1) item 3) indent 3 of this Article, obligations include those that require or permit settlement by issuance of a variable number of the issuer’s equity shares, for which the change in the monetary value of the obligation is equal to the change in the fair value of a fixed number of equity shares multiplied by a specified factor, where both the factor and the referenced number of shares are fixed. (3) For the purposes of paragraph (1) item 3) indent 4 of this Article, where one of the conditions laid down in that indent is met, the credit institution may decompose the risks for regulatory purposes, subject to the prior permission of the Central Bank.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 179 (4) Equity investments shall not be treated as equity exposures in any of the following cases:

  1. the equity investments are structured in such a way that their economic substance is similar to the economic substance of debt holdings which do not meet the criteria set out in paragraph (1) of this Article;
  2. the equity investments constitute securitisation exposures. (5) Equity exposures, other than those referred to in paragraphs (6) to (11) of this Article, shall be assigned a risk weight of 250%, unless those exposures are required to be deducted or risk weighted in accordance with Part Two of this Decision. (6) The following equity exposures to unlisted companies shall be assigned a risk weight of 400%, unless those exposures are required to be deducted or risk weighted in accordance with Part Two of this Decision:
  3. investments for short-term resale purposes;
  4. investments in venture capital firms or similar investments which are acquired in anticipation of significant short-term capital gains. (7) By way of derogation from paragraph (6) of this Article, a credit institution shall assign to long-term equity investments, including investments in equities of corporate clients with which the credit institution has or intends to establish a long-term business relationship and debt-equity swaps for corporate restructuring purposes a risk weight in accordance with paragraph (5) or (9) of this Article, as applicable. (8) For the purposes of this Article, a long-term equity investment is an equity investment that is held for three years or longer or incurred with the intention to be held for three years or longer as approved by the credit institution’s senior management. (9) A credit institution that has received the prior authorisation of the Central Bank may assign a risk weight of 100% to equity exposures incurred under legislative programmes to stimulate specified sectors of the economy, up to the part of such equity exposures that in aggregate does not exceed 10% of the credit institution’s own funds, that comply with all of the following conditions:
  5. the legislative programmes provide significant subsidies or guarantees, including by multilateral development banks, public development credit institutions as defined in Article 564 paragraph (2) of this Decision or international organisations, for the investment to the credit institution;
  6. the legislative programmes involve some form of government oversight;
  7. the legislative programmes involve restrictions on the equity investment, such as limitations on the size and types of businesses in which the credit institution is investing, on allowable amounts of ownership interests, on the geographical location and on other relevant factors that limit the potential risk of the investment for the investing credit institution. (10) Equity exposures to central banks shall be assigned a risk weight of 0%. (11) An equity holding that is recorded as a loan but that has arisen from a debt-equity swap made as part of the orderly realisation or restructuring of the debt shall not be

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 180 assigned a risk weight lower than the risk weight that would apply if the equity holding were treated as a debt exposure. Other items Article 177 (1) Tangible assets within the meaning of land and buildings occupied by a credit institution for its own activities shall be assigned a risk weight of 100%. (2) Prepayments and accrued income for which a credit institution is unable to determine the counterparty shall be assigned a risk weight of 100%. (3) Cash items in the process of collection shall be assigned a 20% risk weight. (4) Cash owned and held by the credit institution, or in transit, and equivalent cash items shall be assigned a 0 % risk weight. (5) Gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities shall be assigned a 0% risk weight. (6) In the case of asset sale and repurchase agreements and outright forward purchases, the risk weight shall be that assigned to the assets in question and not to the counterparties to the transactions. (7) Where a credit institution provides credit protection for a number of exposures subject to the condition that the nth default among the exposures shall trigger payment and that this credit event shall terminate the contract, the risk weights of the exposures included in the basket will be aggregated, excluding n-1 exposures, up to a maximum of 1 250 % and multiplied by the nominal amount of the protection provided by the credit derivative to obtain the risk-weighted exposure amount, whereat the n-1 exposures to be excluded from the aggregation shall be determined on the basis that they shall include those exposures each of which produces a lower risk-weighted exposure amount than the risk-weighted exposure amount of any of the exposures included in the aggregation. (8) The exposure value for leases shall be the discounted minimum lease payments. Minimum lease payments are the payments over the lease term that the lessee is or can be required to make and any bargain option the exercise of which is reasonably certain, and a party other than the lessee may be required to make a payment related to the residual value of a leased property and that payment obligation fulfils the set of conditions in Article 239 of this Decision regarding the eligibility of protection providers as well as the requirements for recognising other types of guarantees provided in Articles 251, 252 and 253 of this Decision, that payment obligation may be taken into account as unfunded credit protection under Subtitle 4 of this Title. (9) The exposures referred to in paragraph (8) of this Article shall be assigned to the relevant exposure class in accordance with Article 129 of this Decision, and when the exposure is a residual value of leased assets, the risk-weighted exposure amounts shall be calculated as follows:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 181 𝑅𝑅 𝑅𝑅 𝑤𝑤𝑤𝑤 𝑤𝑤ℎ𝑡𝑡 𝑡𝑡 𝑒𝑒𝑒𝑒 𝑒𝑒𝑒𝑒 = 1 𝑡𝑡 ∙ 100% ∙ 𝑣𝑣 where t is the greater of 1 and the nearest number of whole years of the lease remaining. Section 3 - Recognition and mapping of credit risk assessment Subsection 1 - Recognition of ECAIs Use of credit assessments by ECAIs Article 178 (1) An external credit assessment may be used to determine the risk weight of an exposure under this Subtitle only if it has been issued by an ECAI or has been endorsed by an ECAI. (2) An ECAI shall be recognised provided that it is included in the list of recognised ECAIs published by the Central Bank on its website. (3) The Central Bank shall publish also the mapping of credit risk assessments of ECAIs on its website. Subsection 2 - Use of credit assessments by Export Credit Agencies Use of credit assessments by export credit agencies Article 179 (1) For the purpose of Article 151 of this Decision, a credit institution may use credit assessments of an Export Credit Agency that the credit institution has nominated, if either of the following conditions is met:

  1. it is a consensus risk score from export credit agencies participating in the OECD ‘Arrangement on Guidelines for Officially Supported Export Credits’;
  2. the Export Credit Agency publishes its credit assessments, and the Export Credit Agency subscribes to the OECD agreed methodology, and the credit assessment is associated with one of the eight minimum export insurance premiums that the OECD agreed methodology establishes. (2) A credit institution may revoke its nomination of an Export Credit Agency and it shall substantiate the revocation if there are concrete indications that the intention underlying the revocation is to reduce the capital adequacy requirements. (3) Exposures for which a credit assessment by an Export Credit Agency is recognised for risk weighting purposes shall be assigned a risk weight in accordance with the following table: Table 1 MPOIP 0 1 2 3 4 5 6 7 Risk weight 0% 0% 20% 50% 100% 100% 100% 150%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 182 Section 4 - Use of the ECAI credit assessments for the determination of risk weights General requirements Article 180 (1) A credit institution may nominate one or more ECAIs to be used for the determination of risk weights to be assigned to assets and off-balance sheet items. (2) A credit institution may revoke its nomination of an ECAI. (3) A credit institution shall substantiate the revocation if there are concrete indications that the intention underlying the revocation is to reduce the capital adequacy requirements. (4) A credit institution shall not use selectively credit assessments. (5) A credit institution shall use solicited credit assessments of the ECAI. (6) In using credit assessment, the credit institution shall comply with the following requirements:

  1. a credit institution which decides to use the credit assessments produced by an ECAI for a certain class of items shall use those credit assessments consistently for all exposures belonging to that class;
  2. a credit institution which decides to use the credit assessments produced by an ECAI shall use them in a continuous and consistent way over time;
  3. credit institution shall only use ECAIs credit assessments that take into account all amounts both in principal and in interest owed to it;
  4. where only one credit assessment is available from a nominated ECAI for a rated item, that credit assessment shall be used to determine the risk weight for that item;
  5. where two credit assessments are available from nominated ECAIs and the two correspond to different risk weights for a rated item, the higher risk weight shall be assigned;
  6. where more than two credit assessments are available from nominated ECAIs for a rated item, the two assessments generating the two lowest risk weights shall be referred to, whereby if the two lowest risk weights are different, the higher risk weight shall be assigned, and if the two lowest risk weights are the same, that risk weight shall be assigned;
  7. for exposures to credit institutions, a credit institution shall not use an ECAI credit assessment that incorporates assumptions of implicit government support, unless the respective ECAI credit assessment refers to a credit institution owned by or set up and sponsored by central governments, regional government units or local self-government units. (7) For the purposes of paragraph (6) item 7) of this Article, a credit institution, other than credit institutions owned by or set up and sponsored by central governments, regional government units or local self-government units, for which only ECAI credit

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 183 assessments exist which incorporate assumptions of implicit government support, exposures to such credit institutions shall be treated as exposures to unrated credit institutions in accordance with Article 158 of this Decision. (9) Implicit government support means that the central government, regional government units or local self-government units would act to prevent creditors of the credit institution from incurring losses in the event of the credit institution’s default or distress. Issuer and issue credit assessment Article 181 (1) Where a credit assessment exists for a specific issuing programme or facility to which the item constituting the exposure belongs, this credit assessment shall be used to determine the risk weight to be assigned to that item. (2) Where no directly applicable credit assessment exists for a certain item, but a credit assessment exists for a specific issuing programme or facility to which the item constituting the exposure does not belong or a general credit assessment exists for the issuer, then that credit assessment shall be used in either of the following cases:

  1. the credit assessment produces a higher risk weight than would be the case if the exposure were treated as unrated and the exposure concerned:
  • is not a specialised lending exposure;
  • ranks pari passu or junior in all respects to the specific issuing programme or facility or to senior unsecured exposures of that issuer, as relevant;
  1. the credit assessment produces a lower risk weight than would be the case if the exposure were treated as unrated and the exposure concerned:
  • is not a specialised lending exposure;
  • ranks pari passu or senior in all respects to the specific issuing programme or facility or to senior unsecured exposures of that issuer, as relevant. (3) In all other cases, the exposure shall be treated as unrated. (4) Paragraphs (1) and (2) if this Article shall not prevent the application of Article 169 of this Decision that refer to covered bonds. (5) Credit assessments for issuers within a corporate group may not be used as credit assessment of another issuer within the same corporate group.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 184 Long-term and short-term credit assessments Article 182 (1) Short-term credit assessments may only be used for short-term asset and off￾balance sheet items constituting exposures to credit institutions and business undertakings. (2) Any short-term credit assessment shall only apply to the item the short-term credit assessment refers to, and it shall not be used to derive risk weights for any other item, except in the following cases:

  1. if a short-term rated facility is assigned a 150% risk weight, then all unrated unsecured exposures on that debtor whether short-term or long-term shall also be assigned a 150% risk weight;
  2. if a short-term rated facility is assigned a 50% risk-weight, no unrated short￾term exposure shall be assigned a risk weight lower than 100%. Domestic and foreign currency items Article 183 (1) A credit assessment that refers to an item denominated in the debtor's domestic currency cannot be used to derive a risk weight for another exposure on that same debtor that is denominated in a foreign currency. (2) By way of derogation from paragraph (1) of this Article, where an exposure arises through a credit institution's participation in a loan that has been extended by, or has been guaranteed against convertibility and transfer risk by, a multilateral development bank referred to in Article 154 paragraph (4) of this Decision, whose preferred creditor status is recognised in the market, the credit assessment on the debtors' domestic currency item may be used to derive a risk weight for an exposure on that same debtor that is denominated in a foreign currency. (3) For the purposes of paragraph (2) of this Article, where the exposure denominated in a foreign currency is guaranteed against convertibility and transfer risk, the credit assessment on the debtor’s domestic currency item may only be used for risk weighting purposes on the guaranteed part of that exposure, and the part of that exposure that is not guaranteed shall be risk weighted based on a credit assessment on the debtor that refers to an item denominated in that foreign currency. SUBTITLE 3 - Internal Ratings Based Approach Section 1 – Authorisation of the Central Bank to use the IRB Approach Definitions Article 184 (1) For the purposes of this Subtitle, the following definitions shall apply:
  3. rating system means all of the methods, processes, controls, data collection and IT systems that support the assessment of credit risk, the assignment of

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 185 exposures to rating grades or pools, and the quantification of default and loss estimates that have been developed for a certain type of exposures; 2) exposure class means any of the exposure classes referred to in Article 189 paragraph (2) of this Decision; 3) corporate exposure means an exposure assigned to any of the exposure classes referred to in Article 189 paragraph (2) item 4) of this Decision; 4) retail exposure means an exposure assigned to any of the exposure classes referred to in Article 189 paragraph (2) item 5) of this Decision; 5) regional government units, local self-government units and public sector entities’ units exposure means an exposure assigned to any of the exposure classes referred to in Article189 paragraph (2) item 2) of this Decision; 6) type of exposures means a group of homogeneously managed exposures which are formed by a certain type of facilities and which may be limited to a single entity or a single sub-set of entities within a group provided that the same type of exposures is managed differently in other entities of the group; 7) business unit means any separate organisational or legal entities, business lines, geographical locations; 8) large regulated financial sector entity means a financial sector entity which meets the following conditions:

  • the entity’s total assets, or the total assets of its parent company where the entity has a parent company, calculated on an individual or consolidated basis, are greater than or equal to EUR 70,000,000,000, using the most recent audited financial statement or consolidated financial statement in order to determine asset size;
  • the entity is subject to prudential requirements, directly on an individual or consolidated basis, or indirectly from the prudential consolidation of its parent undertaking, in accordance with the regulations in Montenegro or laws of other country applying the prudential supervisory or legal at least equivalent to those Montenegro or European Union acts;
  1. unregulated financial sector entity means a financial sector entity that does not fulfil the condition referred to in item 8) indent 2 of this Article;
  2. large corporate shall have the meaning as laid down in the Law on Accounting; 11)debtor grade means a risk category within the debtor rating scale of a rating system, to which debtors are assigned on the basis of a specified and distinct set of rating criteria, from which estimates of probability of default (PD) are derived; 12)facility grade means a risk category within a rating system's facility scale, to which exposures are assigned on the basis of a specified and distinct set of rating criteria, from which own estimates of LGD are derived; 13)PD/LGD modelling adjustment approach means an adjustment of the LGD or modelling an adjustment of both the PD and the LGD of the underlying exposure; 14)protection-provider-RW-floor means the risk weight applicable to a comparable, direct exposure to the protection provider;
  3. recognised unfunded credit protection, for an exposure to which a credit institution applies the IRB Approach by using its own estimates of LGD under Article 185 of this Decision, means an unfunded credit protection whose effect on the calculation of risk-weighted exposure amounts or expected loss amounts

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 186 of the underlying exposure is taken into account with one of the following methods, in accordance with Article 143 paragraph (3) of this Decision:

  • PD/LGD modelling adjustment approach;
  • substitution of risk parameters approach under A-IRB as defined in Article 230 item 5) of this Decision; 16)SA-CCF means the percentage applicable in accordance with Subtitle 2 and Article 148 paragraph (2) of this Decision; 17)IRB-CCF means own estimates of credit conversion factor. (2) For the purposes of paragraph (1) item 10) of this Article, in making the assessment for the sales threshold, the amounts shall be reported, as they are, in the audited financial statements of the corporates or, for corporates that are part of consolidated groups, their consolidated groups according to the accounting standard applicable to the ultimate parent undertaking of the consolidated group, whereas the figures shall be based on the average amounts calculated over the prior three years, or on the latest amounts updated every three years by the credit institution. Authorisation to use the IRB Approach Article 185 (1) Where the conditions set out in this Subtitle are met, the Central Bank shall authorise a credit institution to calculate their risk-weighted exposure amounts using the IRB Approach. (2) A credit institution shall obtain prior authorisation to use the IRB Approach of the Central Bank, including own estimates of LGD and IRB-CCF for each exposure class and for each rating system and for each approach to estimating LGDs and CCFs used. (3) A credit institution shall obtain the prior authorisation of the Central Bank for the following:
  1. material changes to the range of application of a rating system that the credit institution has received authorisation to use; and
  2. material changes to a rating system that the credit institution has received authorisation to use. (4) The range of application of a rating system referred to in paragraph (3) item 1) of this Article shall comprise all exposures of the relevant type of exposure for which that rating system was developed. (5) A credit institution shall notify the Central Bank of all changes to rating systems. Central Bank's assessment of an application to use an IRB Approach Article 186 (1) The Central Bank shall grant authorisation pursuant to Article 185 of this Decision for a credit institution to use the IRB Approach, including, where applicable, to use own estimates of LGD and conversion factors, only if it is satisfied that requirements laid down in this Subtitle are met, in particular those laid down in Section 6 of this Subtitle, and that the systems of the credit institution for the management and rating of credit risk exposures are sound and implemented with integrity and, in particular,

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 187 that the credit institution has demonstrated to the satisfaction of the Central Bank that the following conditions are met:

  1. the credit institution's rating systems provide for a meaningful assessment of debtor and transaction characteristics, a meaningful differentiation of risk and accurate and consistent quantitative estimates of risk;
  2. internal ratings and default and loss estimates used in the calculation of own funds requirements and associated systems and processes play an essential role in the risk management and decision-making process, and in the credit approval, internal capital allocation and corporate governance functions of the credit institution;
  3. the credit institution has a credit risk control unit responsible for its rating systems that is appropriately independent and free from undue influence;
  4. the credit institution collects and stores all relevant data to provide effective support to its credit risk measurement and management process;
  5. the credit institution documents its rating systems and the rationale for their design and validates its rating systems;
  6. the credit institution has validated each rating system during an appropriate time period prior to the authorisation to use this rating system, has assessed during this time period whether the rating system is suited to the range of application of the rating system, and has made necessary changes to these rating system following from its assessment;
  7. the credit institution has calculated under the IRB Approach the own funds requirements resulting from its risk parameters estimates and is able to submit the reporting to the Central Bank;
  8. the credit institution has assigned and continues with assigning each exposure in the range of application of a rating system to a rating grade or pool of this rating system. (2) The requirements to use an IRB Approach, including own estimates of LGD and conversion factors, shall apply also where a credit institution has implemented a rating system, or model used within a rating system, that it has purchased from a third-party vendor. Prior experience of using IRB approaches Article 187 (1) A credit institution applying to use the IRB Approach shall have been using for the IRB exposure classes in question rating systems that were broadly in line with the requirements set out in Section 6 of this Subtitle for internal risk measurement and management purposes for at least three years prior to its qualification to use the IRB Approach. (2) A credit institution applying for the use of own estimates of LGDs and conversion factors shall demonstrate to the satisfaction of the Central Bank that it has been estimating and employing own estimates of LGDs and conversion factors in a manner that is broadly consistent with the requirements for use of own estimates of those parameters set out in Section 6 of this Subtitle for at least three years prior to qualification to use own estimates of LGDs and conversion factors.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 188 (3) Where the credit institution extends the use of the IRB Approach subsequent to its initial authorisation, the experience of the credit institution shall be sufficient to satisfy the requirements of paragraphs (1) and (2) of this Article in respect of the additional exposures covered, and if the use of rating systems is extended to exposures that are significantly different from the scope of the existing coverage, such that the existing experience cannot be reasonably assumed to be sufficient to meet the requirements of these provisions in respect of the additional exposures, then the requirements of paragraphs (1) and (2) of this Article shall apply separately for the additional exposures. Measures to be taken where the credit institutions cease to meet the requirements of this Subtitle Article 188 Where a credit institution ceases to comply with the requirements laid down in this Subtitle, it shall notify the Central Bank thereof and do one of the following:

  1. present to the satisfaction of the Central Bank a plan for a timely return to compliance and realise this plan within a period agreed with the Central bank; or
  2. demonstrate to the satisfaction of the Central Bank that the effect of non￾compliance is immaterial. Methodology to assign exposures to exposure classes Article 189 (1) The methodology used by a credit institution for assigning exposures to different exposure classes shall be appropriate and consistent over time. (2) Each exposure shall be assigned to one of the following exposure classes:
  3. exposures to central governments and central banks;
  4. exposures to regional government units, local self-government units and public sector entities, to be assigned to the following exposure classes:
  • exposures to regional government units and local self-government units;
  • exposures to public sector entities;
  1. exposures to credit institutions;
  2. exposures to corporates to be assigned to the following exposure classes:
  • exposures to business undertakings in general;
  • exposures based on specialised lending;
  • exposures based on purchased receivables from business undertakings;
  1. retail exposures to be assigned to the following exposure classes:
  • qualifying revolving retail exposures (QRREs);
  • retail exposures secured by residential property;
  • retail purchased receivables;
  • other retail exposures;
  1. equity exposures;
  2. exposures in the form of units or shares in a CIU;
  3. items representing securitisation positions;
  4. other non credit-obligation assets.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 189 (3) The following exposures shall be assigned to the class referred to in paragraph (2) item 1) of this Article:

  1. exposures to multilateral development banks referred to in Article 154 paragraph (4) of this Decision;
  2. exposures to international organisations assigned a risk weight of 0% under Article 155 of this Decision. (4) By way of derogation from paragraph (2) of this Article, exposures to regional government units, local self-government units and public sector entities shall be assigned to the exposure class referred to in paragraph (2) item 1) of this Article where those exposures are treated as exposures to central governments in accordance with Article 152 or Article 153 of this Decision. (5) The following exposures shall be assigned to the class referred to in paragraph (2) item 5) of this Article:
  3. exposures to multilateral development banks which are not assigned a 0% risk weight under Article 154 of this Decision; and
  4. exposures to financial institutions which are treated as exposures to credit institutions in accordance with Article 156 paragraph (4) of this Decision. (6) To be eligible for the retail exposure class referred to in paragraph (2) item 4) of this Article, exposures shall meet the following criteria:
  5. they shall be one of the following:
  • exposures to one or more natural persons;
  • exposures to an SME, provided that the total amount owed to the credit institution and parent undertakings and its subsidiary undertakings, including any exposure in default, by the debtor client or group of connected persons, but excluding exposures secured by residential property, up to the property value does not, to the knowledge of the credit institution, which shall take reasonable steps to verify the amount of that exposure, exceed EUR 500,000;
  • exposures secured by residential property, including first and subsequent liens, term loans, revolving home equity lines of credit, and exposures as referred to in Article 142 paragraphs (4) and (5) of this Decision, regardless of the exposure size, provided that the exposure is either of the following: a) an exposure to a natural person; b) an exposure to associations or cooperatives of natural persons that are regulated under national law and exist with the sole purpose of granting their members the use of a primary residence in the property securing the loan;
  1. they are treated by the credit institution in its risk management consistently over time and in a similar manner;
  2. they are not managed just as individually as exposures in the corporate exposure class referred to in paragraph (2) item 4) of this Article;
  3. they each represent one of a significant number of similarly managed exposures. (7) In addition to the exposures listed in paragraph (6) of this Article, the present value of retail minimum lease payments shall be included in the retail exposure class.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 190 (8) Exposures fulfilling the conditions set out in paragraph (6) item 1) indent 3 and items 2), 3) and 4) of this Article shall be assigned to the exposure class referred to in paragraph (2) item 5) indent 2 of this Article. (9) By way of derogation from paragraph (8) of this Article, the Central Bank may exclude from the exposure class referred to in paragraph (2) item 5) indent 2 of this Article, loans to natural persons who have mortgaged more than four immovable properties or housing units, including the loans to natural persons referred to in Article 142 paragraph (4) of this Decision, and assign those loans to one of the exposure classes referred to in paragraph (2) item 4) of this Article. (10) Retail exposures belonging to a type of exposures meeting all of the following conditions shall be assigned to the exposure class referred to in paragraph (2) item 5) indent 1 of this Article:

  1. the exposures of that type of exposures are to one or more natural persons;
  2. the exposures of that type of exposures are revolving, unsecured, and, to the extent they are not drawn immediately and unconditionally, cancellable by the credit institution;
  3. the maximum exposure in that type of exposure to a single natural person is EUR 100 000 or less;
  4. that type of exposures has exhibited low volatility of loss rates, relative to its average level of loss rates, especially within the low PD bands;
  5. the treatment of exposures assigned to that type of exposures as a qualifying revolving retail exposure is consistent with the underlying risk characteristics of that type of exposures. (11) By way of derogation from paragraph (10) item 2) of this Article, the requirement to be unsecured shall not apply in respect of collateralised credit facilities linked to a wage account, and in that case, amounts recovered from the collateral shall not be taken into account in the LGD estimates. (12) A credit institution shall identify within the exposure class referred to in paragraph (2) item 5) indent 1 of this Article transactor exposures (‘QRRE transactors’) and exposures that are not transactor exposures (‘QRRE revolvers’), whereas QRREs with less than 12 months of repayment history shall be identified as QRRE revolvers. (13) Unless they are assigned to the exposure class referred to in paragraph (2) item
  6. of this Article, the exposures referred to in Article 176 paragraph (1) of this Decision shall be assigned to the exposure class referred to in paragraph (2) item 6) of this Article. (14) Any credit obligation not assigned to the exposure classes referred to in paragraph (2) items 1), 2), 3), 5), 6), 7) or 8) of this Article, shall be assigned to one of the exposure classes referred to in paragraph (2) item 4) indent 1, 2 or 3 of this Article. (15) Within the corporate exposure class laid down in paragraph (2) item 4) of this Article, a credit institution shall separately identify as specialised lending exposures, exposures which possess the following characteristics:
  7. the exposure is to an entity which was created specifically to finance or operate physical assets or is an economically comparable exposure;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 191 2) the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate; and 3) the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise. (16) Exposures referred to in paragraph (15) of this Article shall be assigned to the exposure class referred to in paragraph (2) item 4) of this Article, and shall be categorised as follows: ‘project finance’ (PF), ‘object finance’ (OF), ‘commodity finance’ (CF) and ‘income-producing real estate’ (IPRE). (17) The residual value of leased properties shall be assigned to the exposure class laid down in Article 207 paragraphs (6) to (8) of this Decision, except to the extent that residual value is already included in the lease exposure laid down in paragraphj (2) item 9) of this Article. (18) The exposure from providing protection under an nth-to-default basket credit derivative shall be assigned to the same class laid down in paragraph (2) of this Article to which the exposures in the basket would be assigned, except if the individual exposures in the basket would be assigned to various exposure classes in which case the exposure shall be assigned to the corporates exposure class laid down in paragraph (2) item 4) of this Article. Conditions for implementing the IRB Approach across different classes of exposure and business units Article 190 (1) A credit institution that is permitted to apply the IRB Approach in accordance with Article 141 paragraph (1) of this Decision shall, together with any parent undertaking and its subsidiary undertakings, implement the IRB Approach for at least one of the exposure classes referred to in Article 189 paragraph (2) items 1), 2), 3), 4), 5) or 9) of this Decision. (2) Once a credit institution has implemented the IRB Approach for a certain type of exposures within an exposure class, it shall do so for all exposures within that exposure class, unless it has received the authorisation of the Central Bank to use the Standardised Approach permanently in accordance with Article 92 of this Decision. (3) A credit institution may, subject to the prior authorisation of the Central Bank, implement the IRB Approach sequentially across the different types of exposures within a certain exposure class within the same business unit and across different business units in the same group, or for the use of own estimates of LGD or for the use of IRB-CCF. (4) The Central Bank shall determine the period over which a credit institution and any parent undertaking and its subsidiary undertakings shall be required to implement the IRB Approach for all exposures within a certain exposure class across different types of exposures within the same business unit and across different business units in the same group, or for the use of own estimates of LGD or for the use of IRB-CCF, whereat that period shall be one that the Central Bank considers to be appropriate on the basis

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 192 of the nature and scale of the activities of the credit institution concerned, or of any parent undertaking and its subsidiary undertakings, and the number and nature of rating systems to be implemented. (5) A credit institution carry out implementation of the IRB Approach in accordance with conditions determined by the Central Bank. (6) The Central Bank shall define conditions in a way that they ensure that the flexibility under paragraph (1) of this Article is not used selectively for the purpose of achieving reduced own funds requirements in respect of those types of exposures or business units that are yet to be included in the IRB Approach or in the use of own estimates of LGD or in the use of IRB-CCF. Conditions to revert to the use of less sophisticated approaches Article 191 (1) A credit institution that uses the IRB Approach for a particular exposure class or type of exposure shall not stop using that approach and use instead the Standardised Approach for the calculation of risk-weighted exposure amounts unless the following conditions are met:

  1. the credit institution has demonstrated to the satisfaction of the Central Bank that the use of the Standardised Approach is not made with a view to engaging in regulatory arbitrage, including by unduly reducing the own funds requirements of the credit institution, is necessary on the basis of the nature and complexity of the credit institution’s total exposures of that type and would not have a material adverse impact on the solvency of the credit institution or its ability to manage risk effectively; and
  2. the credit institution has received the prior authorisation of the Central Bank. (2) A credit institution which has obtained the authorisation in accordance with Article 193 paragraphs (9) and (10) of this Decision to use own estimates of LGDs and conversion factors, shall not revert to the use of LGD values and conversion factors referred to in Article 193 paragraphs (9) and (10) of this Decision unless the following conditions are met:
  3. the credit institution has demonstrated to the satisfaction of the Central Bank that the use of LGDs and conversion factors laid down in Article 193 paragraphs (9) and (10) of this Decision for a certain exposure class or type of exposure is not proposed in order to reduce the own funds requirement of the credit institution,
  4. the use of LGDs and conversion factors referred to in Article 193 paragraphs (9) and (10) of this Decision is necessary on the basis of nature and complexity of the credit institution's total exposures of this type and would not have a material adverse impact on the solvency of the credit institution or its ability to manage risk effectively;
  5. the credit institution has received the prior permission of the Central Bank. (3) The application of paragraphs (1) and (2) of this Article is subject to the conditions for rolling out the IRB Approach determined by the Central Bank in accordance with Article 190 of this Decision and the authorisation for permanent partial use of the IRB Approach referred to in Article 192 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 193 Conditions for permanent partial use Article 192 (1) A credit institution shall apply the Standardised Approach for all of the following exposures:

  1. exposures assigned to the exposure class referred to in Article 189 paragraph (2) item 6) of this Decision;
  2. exposures assigned to exposure classes or belonging to types of exposures within an exposure class, for which the credit institution has not received the prior authorisation of the Central Bank to use the IRB Approach for the calculation of the risk-weighted exposure amounts and expected loss amounts. (2) A credit institution that is permitted to use the IRB Approach for the calculation of risk-weighted exposure amounts and expected loss amounts for a given exposure class may, subject to the Central Bank’s prior authorisation, apply the Standardised Approach for some types of exposures within that exposure class, including exposures of foreign branches and different product groups, where those types of exposures are immaterial in terms of size and perceived risk profile. (3) In addition to the exposures referred to in paragraph (2) of this Article a credit institution may, subject to the Central Bank’s prior authorisation, apply the Standardised Approach for the following exposures where the IRB Approach is applied for other types of exposures within the same exposure class:
  3. exposures to Government of Montenegro and the Central Bank of Montenegro;
  4. exposures to central governments and central banks of the Member States and their regional government units or local self-government units and public sector entities, provided that: ­ there is no difference in risk between the exposures to that central government and central bank and those other exposures because of specific public arrangements; and ­ exposures to central governments and central banks are assigned a 0% risk weight under Article 151 paragraph (2) or (4) of this Decision;
  5. exposures of a credit institution to a counterparty which is its parent undertaking, its subsidiary undertaking or a subsidiary undertaking of its parent undertaking, provided that the counterparty is a credit institution or a financial holding company, mixed financial holding company, financial institution, asset management company or ancillary services undertaking subject to appropriate prudential requirements or an undertaking is managed by a credit institution on a unified basis in accordance with a contract concluded with that undertaking, or the memorandum or articles of association of those other undertakings; or if the administrative, management or supervisory bodies of that undertaking consist in the majority of the same persons in those bodies and in credit institution. (4) A credit institution that is permitted to use the IRB Approach for the calculation of risk-weighted exposure amounts for only some types of exposures within an exposure class shall apply the Standardised Approach for the remaining types of exposures within that exposure class.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 194 (5) A credit institution may, in addition to the exposures referred to in paragraphs (2), (3) and (4) of this Article, apply the Standardised Approach for exposures to churches and religious communities which meet the requirements set out in Article 152 paragraph (5) of this Decision. Section 2 - Calculation of risk-weighted exposure amounts Subsection 1 - Treatment by type of exposure class Treatment by exposure class Article 193 (1) The risk-weighted exposure amounts for credit risk for exposures belonging to one of the exposure classes referred to in Article 189 paragraph (2) items 1), 2), 3), 4), 5) and 9) of this Decision shall be calculated in accordance with Subsection 2 of this Section unless those exposures are deducted from own funds or are subject to the treatment referred to in Article 75 paragraph (7) of this Decision. (2) The risk-weighted exposure amounts for dilution risk for purchased receivables shall be calculated in accordance with Article 198 of this Decision. (3) Where a credit institution has full recourse to the seller of purchased receivables for default risk and for dilution risk, the provisions of this Article and Article 194 and Article 199 paragraphs (1) to (4) of this Decision in relation to purchased receivables shall not apply and the exposure shall be treated as a collateralised exposure. (4) The calculation of risk-weighted exposure amounts for credit risk and dilution risk shall be based on the relevant parameters associated with the exposure in question and they shall include PD, LGD, maturity (hereinafter referred to as ‘M’) and exposure value of the exposure, whereat PD and LGD may be considered separately or jointly, in accordance with Section 4 of this Subtitle. (5) The calculation of risk weighted exposure amounts for credit risk for specialised lending exposures may be calculated in accordance with Article 195 paragraph (6) of this Decision. (6) For exposures belonging to the exposure classes referred to in Article 189 paragraph (2) items 1) to 5) of this Decision, credit institution shall provide their own estimates of PDs in accordance with Article 185 of this Decision and Section 6 of this Subtitle. (7) For retail exposures, a credit institution shall provide own estimates of LGD, and IRB-CCF where applicable pursuant to Article 207 paragraphs (14) to (17) and paragraphs (20) to (23) of this Decision, in accordance with Article 185 and Section 6 of this Subtitle. (8) A credit institution shall use SA-CCFs where Article 207 paragraphs (14) to (17) and paragraphs (20) to (23) of this Decision do not allow for the use of IRB-CCF.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 195 (9) A credit institution shall apply for the following exposures the LGD values set out in Article 202 paragraph (1) of this Decision and SA-CCFs in accordance with Article 207 paragraphs (14) to (23) of this Decision:

  1. exposures assigned to the exposure class referred to in Article 189 paragraph (2) item 3) of this Decision;
  2. exposures to financial sector entities other than those referred to in item 1) of this paragraph;
  3. exposures to large corporates not assigned to the exposure class referred to in Article 189 paragraph (2) item 4) indent 2 of this Decision. (10) For exposures belonging to the exposure classes referred to in Article 189 paragraph (2) items 1), 2) or 4) of this Decision, except for the exposures referred to in paragraph (9) of this Article, a credit institution shall apply the LGD values set out in Article 202 paragraph (1) of this Decision and the SA-CCFs in accordance with Article 207 paragraphs (14) to (23) of this Decision, unless they have been permitted to use their own estimates of LGD and IRB-CCF for those exposures in accordance with paragraph (11) of this Article. (11) For the exposures referred to in paragraph (9) of this Article, the Central Bank shall permit a credit institution to use own estimates of LGD, and IRB-CCF where applicable pursuant to Article 207 paragraphs (14) to (17) and paragraphs (20) to (23) of this Decision, in accordance with Article 185 and Section 6 of this Subtitle. (12) The risk-weighted exposure amounts for securitised exposures and for exposures belonging to the exposure class referred to in Article 89 paragraph (2) item 8) of this Decision shall be calculated in accordance with Subtitle 5 of this Title. (13) For exposures in the form of shares or units in a CIU belonging to the exposure class referred to in Article 189 paragraph (2) item 8) of this Decision, a credit institution shall apply the treatment set out in Article 194, unless those exposures are deducted from own funds or are subject to the treatment set out in Article 75 paragraph (7) of this Decision. Treatment of exposures in the form of units or shares in CIUs Article 194 (1) A credit institution shall calculate the risk-weighted exposure amounts for their exposures in the form of units or shares in a CIU by multiplying the risk-weighted exposure amount of the CIU, calculated in accordance with the approaches set out in paragraphs (2) and (5) of this Article, with the percentage of units or shares held by that credit institution. (2) Where the conditions set out in Article 172 paragraphs (5) to (8) of this Decision are met, a credit institution that has sufficient information about the individual underlying exposures of a CIU shall look through to those underlying exposures to calculate the risk-weighted exposure amount of the CIU, risk weighting all underlying exposures of the CIU as if they were directly held by that credit institution. (3) By way of derogation from Article 114 paragraph (4) item 5) of this Decision, a credit institution that calculates the risk-weighted exposure amount of the CIU in

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 196 accordance with paragraph (1) or 2 of this Article may calculate the own funds requirement for credit valuation adjustment risk of derivative exposures of that CIU as an amount equal to 50% of the own funds requirement for those derivative exposures calculated in accordance with Subtitle 6 Section 3, 4 or 5 of this Title, as applicable. (4) By way of derogation from paragraph (3) of this Article, a credit institution may exclude from the calculation of the own funds requirement for credit valuation adjustment risk derivative exposures which would not be subject to that requirement if they were incurred directly by the credit institution. (5) A credit institution that applies the look-through approach in accordance with paragraphs (2) to (4) of this Article and that do not use the methods set out in this Subtitle or in Subtitle 5 of this Title, as applicable, for all or parts of the underlying exposures of the CIU shall calculate risk-weighted exposure amounts and expected loss amounts for all or those parts of the underlying exposures in accordance with the following principles:

  1. for underlying exposures that would be assigned to the exposure class referred to in Article 189 paragraph (2) item 6) of this Decision, institutions shall apply the Standardised Approach laid down in Subtitle 2;
  2. for exposures assigned to the items representing securitisation positions referred to in Article 189 paragraph (2) item 8) of this Decision, a credit institution shall apply the treatment set out in Article 290 of this Decision as if those exposures were directly held by that credit institution;
  3. for all other underlying exposures, a credit institution shall apply the Standardised Approach laid down in Subtitle 2 of this Title. (6) Where the conditions set out in Article 173 paragraph (5) of this Decision are met, a credit institution that do not have sufficient information about the individual underlying exposures of a CIU may calculate the risk-weighted exposure amount for those exposures in accordance with the mandate-based approach set out in Article 173 paragraphs (2) to (4) of this Decision, except in the case of exposures referred to in paragraph (5) of this Article the credit institution shall apply the approaches set out therein. (7) Subject to Article 174 paragraph (2) of this Decision, a credit institution that do not apply the look-through approach in accordance with paragraphs (2), (3) and (4) of this Article or the mandate-based approach in accordance with paragraph (6) of this Article shall apply the fall-back approach referred to in Article 172 paragraph (2) of this Decision. (8) A credit institution may calculate the risk-weighted exposure amount for their exposures in the form of units or shares in a CIU by using a combination of the approaches referred to in this Article, provided that the conditions for using those approaches are met. (9) A credit institution that does not have adequate data or information to calculate the risk-weighted amount of a CIU in accordance with the approaches set out in paragraphs (2) to (6) of this Article may rely on the calculations of a third party, provided that all the following conditions are met:
  4. the third party is one of the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 197 ­ the depository institution or the depository financial institution of the CIU, provided that the CIU exclusively invests in securities and deposits all securities at that depository institution or depository financial institution; ­ for CIUs not covered by indent 1 of this item, the CIU management company, provided that the CIU management company meets the criteria set out Article 172 paragraph (5) item 1) of this Decision; 2) for exposures other than those listed in paragraph (5) items 1), 2) and 3) of this Article, the third party carries out the calculation in accordance with the look￾through approach set out in Article 173 paragraph (1) of this Decision; 3) for exposures listed in paragraph (5) items 1), 2) and 3) of this Article, the third party carries out the calculation in accordance with the approaches set out therein; 4) an external auditor has confirmed the correctness of the third party's calculation. (10) A credit institution that relies on third-party calculations shall multiply the risk weighted exposure amounts of a CIU's exposures resulting from those calculations by a factor of 1,2. (11) By way of derogation from paragraph (10) of this Article, where the credit institution has unrestricted access to the detailed calculations carried out by the third party, the 1,2 factor shall not apply. (12) A credit institution shall provide the calculations referred to in paragraph (11) of this Article to the Central Bank upon request. (13) For the purposes of this Article, Article 172 paragraphs (12) and (13) and Articles 173 and 174 of this Decision shall apply using the risk weights calculated in accordance with Subtitle 3 of this Title. Subsection 2 - Calculation of risk-weighted exposure amounts for credit risk Risk-weighted exposure amounts for exposures to central governments and central banks, exposures to regional government units, local self-government units and public sector entities, exposures to institutions and exposures to corporates (business undertakings) Article 195 (1) Subject to the application of the specific treatments laid down in paragraphs (2), (3) and (4) of this Article, the risk-weighted exposure amounts for exposures to central governments and central banks, exposures to regional government units, local self￾government units and public sector entities, exposures to credit institutions and exposures to corporates shall be calculated according to the following formulae: Risk weighted exposure amount = risk weight (RW) ∙ exposure value where the risk weight RW is defined as:

  1. if PD = 0, RW shall be 0;
  2. if PD = 1, i.e., for defaulted exposures:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 198

  • where a credit institution applies the LGD values set out in Article 202 paragraph (1) of this Decision, RW shall be 0;
  • where a credit institution uses own estimates of LGDs, RW shall be: RW = max{0;12,5 ∙ (LGD – ELBE}; where the expected loss best estimate (hereinafter: ‘ELBE) shall be the credit institution's best estimate of expected loss for the defaulted exposure in accordance with Article 221 paragraph (1) item 8) of this Decision;
  1. if 0 < PD < 1 𝑅𝑅𝑅𝑅 = �𝐿𝐿𝐿𝐿𝐿𝐿 ∙ 𝑁𝑁 � 1 √1−𝑅𝑅 ∙ (𝑃𝑃 ) + � 𝑅𝑅 1−𝑅𝑅 ∙ (0,999)� − 𝐿𝐿𝐿𝐿𝐿𝐿 ∙ 𝑃𝑃 � ∙ 1+(𝑀𝑀−2,5)∙𝑏𝑏 1−1,5∙𝑏𝑏 where: N = the cumulative distribution function for a standard normal random variable, i.e. N(x) equals the probability that a normal random variable with mean of 0 and variance of 1, is less than or equal to x. G = the inverse cumulative distribution function for a standard normal random variable, i.e. if x = G(z), x is the value such that N(x) = z; R = the coefficient of correlation, which is defined as: 𝑅𝑅 = 0,12 1 − −50∙𝑃𝑃𝑃𝑃 1 − −50 + 024 ∙ �1 − 1 − −50∙𝑃𝑃𝑃𝑃 1 − −50 � b = the maturity adjustment factor, which is defined as: b = [0,11852 – 0,05478 * ln(PD)] 2;

M = the maturity, expressed in years and determined in accordance with Article 203 of this Decision. (2) For exposures to large regulated financial sector entities and to unregulated financial sector entities, the coefficient of correlation R referred to in paragraph (1) item 3) of this Article or paragraph (3) of this Article, as applicable, shall be multiplied by 1,25 when calculating the risk weights of those exposures. (3) For exposures to business undertakings where the total annual sales for the consolidated group of which the business undertaking is a part is less than EUR 50,000,000, a credit institution may, for the calculation of risk weights for corporate exposures referred to in paragraph (1) item 3), use the following correlation formula: R = 0,12 1 − e−50∙PD 1 − e−50 + 0,24 ∙ �1 − 1 − e−50∙PD 1 − e−50 � − 0,04 ∙ �1 − min{max{5, 8}, 50} − 5 45 �,

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 199 where S is expressed as total annual sales in millions of euro with EUR 5,000,000 ≤ S ≤ EUR 50,000,000, whereat if the reported sales are less than EUR 5,000,000, they shall be treated as if they were equivalent to EUR 5,000,000. (4) For purchased receivables the total annual sales shall be the weighted average by individual exposures of the pool. (5) For the purposes of paragraph (3) of this Article, a credit institution shall substitute total assets of the consolidated group for total annual sales when total annual sales are not a meaningful indicator of firm size and total assets are a more meaningful indicator than total annual sales. (6) For specialised lending exposures in respect of which a credit institution is not able to estimate PDs or the credit institution's PD estimates do not meet the requirements set out in Section 6 of this Subtitle, the credit institution shall assign risk weights to these exposures in accordance with Table 1, as follows: Table 1 Remaining Maturity category 1 category 2 category 3 category 4 category 5 Less than 2,5 years 50% 70% 115% 250% 0% Equal or more than 2,5 years 70% 90% 115% 250% 0% (7) In assigning risk weights to specialised lending exposures, a credit institution shall take into account the following factors: financial strength, political and legal environment, transaction and/or asset characteristics, strength of the sponsor and developer, including any public private partnership income stream, and security package, in the manner prescribed in Annex 1 which forms an integral part of this Decision. (8) For their purchased corporate receivables a credit institution shall comply with the requirements set out in Article 225 of this Decision. (9) A credit institution may, for purchased corporate receivables that, in addition to the requirements referred to in paragraph (8) of this Article, meet the requirements referred to in Article 196 paragraph (6) of this Decision, use the risk quantification standards for corporate exposures as set out in Section 6 of this Subtitle, where it would be unduly burdensome for a credit institution to use the risk quantification standards for corporate exposures as set out in Section 6 for these receivables. (10) For purchased corporate receivables, refundable purchase price discounts, collaterals or partial guarantees that provide first loss protection for default losses and/or dilution losses may be treated as a first loss protection by the purchaser of the receivables or by the beneficiary of the collateral or of the partial guarantee in accordance with Subsections 2 and 3 of Section 3 of Subtitle 5 of this Title, whereat the seller providing the refundable purchase price discount and the provider of a collateral or a partial guarantee shall treat those as an exposure to a first loss position in accordance with Subsections 2 and 3 of Section 3 of Subtitle 5 of this Title.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 200 (11) Where a credit institution provides credit protection for a number of exposures subject to the condition that the nth default among the exposures shall trigger payment and that this credit event shall terminate the contract, it shall aggregate the risk weights of the exposures included in the basket, excluding n-1 exposures, where the sum of the expected loss amount multiplied by 12,5 and the risk-weighted exposure amount shall not exceed the nominal amount of the protection provided by the credit derivative multiplied by 12,5, whereat the n-1 exposures to be excluded from the aggregation shall be determined on the basis that they shall include those exposures each of which produces a lower risk-weighted exposure amount than the risk-weighted exposure amount of any of the exposures included in the aggregation. (12) A 1,250% risk weight shall apply to positions in a basket for which a credit institution cannot determine the risk-weight under the IRB Approach. Risk-weighted exposure amounts for retail exposures Article 196 (1) The risk-weighted exposure amounts for retail exposures shall be calculated in accordance with the following formulae: Risk-weighted exposure amount = risk weight (RW) ∙ exposure value where the risk weight RW is defined as follows:

  1. if PD = 1, i.e., for defaulted exposures, RW shall be RW = max {0; 12,5 · (LGD - ELBE)} where ELBE shall be the credit institution's best estimate of expected loss for the defaulted exposure in accordance with Article 221 paragraph (1) item 8) of this Decision;
  2. if 0 < PD < 1, then RW = �LGD ∙ N� 1 √1 − R ∙ G(PD) + � R 1 − R ∙ G(0,999)� − LGD ∙ PD� ∙ 12,5 where: N = the cumulative distribution function for a standard normal random variable, i.e. N(x) equals the probability that a normal random variable with mean of 0 and variance of 1, is less than or equal to x; G = the inverse cumulative distribution function for a standard normal random variable, i.e. if x = G(z), x is the value such that N(x) = z; R = the coefficient of correlation, which is defined as:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 201 𝑅𝑅 = 0,03 ∙ 1 − −35∙𝑃𝑃𝑃𝑃 1 − −35 + 0,16 ∙ �1 − 1 − −35∙𝑃𝑃𝑃𝑃 1 − −35 � (2) For retail exposures that are not in default and are secured or partially secured by residential property, a coefficient of correlation R of 0,15 shall replace the figure produced by the coefficient of correlation formula in paragraph (1) item 2) of this Article. (3) The risk weight calculated for an exposure partially secured by residential property pursuant to paragraph (1) item 2) of this Article, taking into account a coefficient of correlation R as set out in paragraph (2) of this Article, shall be applied both to the secured and the unsecured part of that exposure. (4) For QRREs that are not in default, a coefficient of correlation R of 0,04 shall replace the figure produced by the coefficient of correlation formula in paragraph (1) item 2) of this Article. (5) The Central Bank shall review the relative volatility of loss rates across QRREs belonging to the same type of exposures, as well as across the aggregate QRRE exposure class. (6) To be eligible for the retail treatment, purchased receivables shall comply with the requirements set out in Article 225 of this Decision and the following conditions:

  1. the credit institution has purchased the receivables from unrelated third party sellers, and its exposure to the debtor of the receivable does not include any exposures that are directly or indirectly originated by the credit institution itself;
  2. the purchased receivables shall be generated on market conditions between the seller and the debtor, and as such, inter-company accounts receivables and receivables subject to contra-accounts between firms that buy and sell to each other are ineligible;
  3. the purchasing credit institution has a claim on all proceeds from the purchased receivables or a pro-rata interest in the proceeds;
  4. the portfolio of purchased receivables is sufficiently diversified. (7) For purchased retail receivables, refundable purchase price discounts, collaterals or partial guarantees that provide first loss protection for default losses and/or dilution losses, may be treated as a first loss protection by the purchaser of the receivables or by the beneficiary of the collateral or of the partial guarantee in accordance with Subsections 2 and 3 of Section 3 of Subtitle 5 of this Title, and the seller providing the refundable purchase price discount and the provider of a collateral or a partial guarantee shall treat those as an exposure to a first loss position in accordance with Subsections 2 and 3 of Section 3 of Subtitle 5 of this Title. (8) For hybrid pools of purchased retail receivables where purchasing credit institution cannot separate exposures secured by immovable property collateral and qualifying revolving retail exposures from other retail exposures, the retail risk weight function producing the highest capital requirements for those exposures shall apply.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 202 Risk-weighted exposure amounts for other non credit-obligation assets Article 197 A credit institution shall calculate the risk-weighted exposure amounts for other assets by applying the following formulae: 𝑅𝑅 𝑅𝑅 − 𝑤𝑤𝑤𝑤 𝑤𝑤ℎ𝑡𝑡 𝑡𝑡 𝑒𝑒𝑒𝑒 𝑒𝑒𝑒𝑒 = 100% ∙ 𝑒𝑒𝑒𝑒 𝑒𝑒𝑒𝑒 𝑣𝑣 , except for:

  1. cash and cash equivalents as well as gold bullion held in the credit institution’s vault or on an allocated basis to the extent backed by bullion liabilities, in which case a 0% risk-weight shall be assigned;
  2. when the exposure is a residual value of leased assets in which case it shall be calculated as follows: 1 t ∙ 100% ∙ exposure value

where t is the greater of 1 and the nearest number of whole years of the lease remaining. Subsection 3 - Calculation of risk-weighted exposure amounts for dilution risk of purchased receivables Risk-weighted exposure amounts for dilution risk of purchased receivables Article 198 (1) A credit institution shall calculate the risk-weighted exposure amounts for dilution risk of purchased corporate and retail receivables in accordance with the formula set out in Article 195 paragraph (1) of this Decision. (2) A credit institution shall determine the input parameters PD and LGD in accordance with Section 4 of this Subtitle. (3) A credit institution shall determine the exposure value in accordance with Section 5 of this Subtitle. (4) For the purposes of this Article, the value of M is 1 year. (5) The Central Bank shall exempt a credit institution from calculating and recognising risk-weighted exposure amounts for dilution risk of a type of exposures caused by purchased corporate or retail receivables where the credit institution has demonstrated to the satisfaction of the Central Bank that dilution risk for that credit institution is immaterial for this type of exposures.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 203 Section 3 - Expected loss amounts Treatment by exposure type Article 199 (1) The calculation of expected loss amounts shall be based on the same input figures of PD, LGD and the exposure value for each exposure as are used for the calculation of risk-weighted exposure amounts in accordance with Article 193 of this Decision. (2) The expected loss amounts for securitised exposures shall be calculated in accordance with Subtitle 5 of this Title. (3) The expected loss amount for exposures belonging to the ‘other non credit obligations assets’ exposure class referred to in Article 189 paragraph (2) item 9) of this Decision shall be zero. (4) The expected loss amounts for exposures in the form of shares or units of a CIU referred to in Article 194 of this Decision shall be calculated in accordance with the methods set out in this Article. (5) The expected loss (EL) and expected loss amounts for exposures to corporates, credit institutions, central governments and central banks, regional government units and local self-government units and public sector entities and retail exposures shall be calculated by applying the following formulae: 𝐸𝐸 𝑙𝑙 ( ) = 𝑃𝑃 ∗ 𝐿𝐿𝐿𝐿𝐿𝐿 𝐸𝐸 𝑙𝑙 = [𝑚𝑚 𝑏𝑏𝑏𝑏] 𝑒𝑒𝑒𝑒 𝑒𝑒𝑒𝑒 𝑣𝑣 (6) For defaulted exposures (PD = 100%) where a credit institution uses its own estimates of LGDs, EL shall be ELBE, the credit institution's best estimate of expected loss for the defaulted exposure in accordance with Article 221 paragraph (1) item 8) of this Decision. (7) For specialised lending exposures, where a credit institution uses the methods set out in Article 195 paragraph (6) of this Decision for assigning risk weights, the expected loss values shall be calculated by applying percentages in accordance with Table 2. Table 2 Remaining Maturity category 1 category 2 category 3 category 4 category 5 Less than 2,5 years 0% 0,4% 2,8% 8% 50% Equal or more than 2,5 years 0,4% 0,8% 2,8% 8% 50% (8) The expected loss amount for a minimum value commitment that meets all the requirements set out in Article 175 paragraph (5) shall be zero/

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 204 (9) The expected loss amounts for dilution risk of purchased receivables shall be calculated in accordance with the following formula: 𝑒𝑒 𝑙𝑙 ( ) = 𝑃𝑃 ∙ 𝐿𝐿𝐿𝐿𝐿𝐿 𝑒𝑒 𝑙𝑙 = ∙ 𝑒𝑒𝑒𝑒 𝑒𝑒𝑒𝑒 𝑣𝑣 Treatment of expected loss amounts, IRB shortfall and IRB excess Article 200 (1) A credit institutions shall subtract the expected loss amounts of exposures referred to in Article 199 paragraphs (5), (6), (7) and (9) of this Decision from the sum of all of the following:

  1. the general and specific credit risk adjustments related to those exposures, calculated in accordance with Article 144 of this Decision;
  2. AVA due to counterparty default determined in accordance with Article 17 of this Decision and related to exposures for which the expected loss amounts are calculated in accordance with Article 199 paragraphs (5), (6), (7) and (9) of this Decision;
  3. other own funds reductions related to those exposures other than the deductions made in accordance with Article 39 item 14) of this Decision. (2) Where the calculation performed in accordance with paragraph (1) of this Article results in a positive amount, the amount obtained shall be called “IRB excess”. (3) Where the calculation performed in accordance with paragraph (1) of this Article results in a negative amount, the amount obtained shall be called “IRB shortfall”. (4) For the purposes of the calculation referred to in the paragraph (1) of this Article, a credit institution shall treat discounts determined in accordance with Article 207 paragraph (1) of this Decision on balance-sheet exposures purchased when in default in the same manner as specific credit risk adjustments. (5) Discounts on balance-sheet exposures purchased when not in default shall not be allowed to be included in the calculation of the IRB shortfall or IRB excess. (6) Specific credit risk adjustments on exposures in default shall not be used to cover expected loss amounts on other exposures. (7) Expected loss amounts for securitised exposures and general and specific credit risk adjustments related to those exposures shall not be included in the calculation of the IRB shortfall or IRB excess.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 205 Section 4 - PD, LGD and effective maturity Subsection 1 - Exposures to business undertakings, credit institutions, central governments and central banks, regional government units and local self-government units and public sector entities Probability of default (PD) Article 201 (1) For the exposures assigned to the exposure classes referred to tin Article 189 paragraph (2) item 3) or 4) of this Decision, for the sole purpose of calculating risk￾weighted exposure amounts and the expected loss amounts of those exposures, in particular for the purposes of Articles 195, 198 and 199 paragraphs (1), (5), (6) and (9) of this Decision, the PD value that is used for each exposure as an input of the risk￾weighted exposure amounts and expected loss formulae shall not be less than the following PD input floor value: 0,05%. (2) For exposures assigned to the exposure classes referred to in Article 189 paragraph (2) item 2) of this Decision, for the sole purpose of calculating risk-weighted exposure amounts and the expected loss amounts of those exposures, the PD value that is used for each exposure as an input of the risk-weighted exposure amounts and expected loss formulae shall not be less than the following PD input floor value: 0,03%. (3) For purchased corporate receivables in respect of which a credit institution is not able to estimate PDs or a credit institution's PD estimates do not meet the requirements set out in Section 6 of this Subtitle, the PDs shall be determined in accordance with the following methods:

  1. for senior claims on purchased corporate receivables, the PD shall be the credit institution’s estimate of EL divided by LGD for these receivables;
  2. for subordinated claims on purchased corporate receivables, the PD shall be the credit institution's estimate of EL;
  3. a credit institution that has received the authorisation of the Central Bank to use own LGD estimates for corporate exposures pursuant to Article 185 of this Decision and that can decompose its EL estimates for purchased corporate receivables into PDs and LGDs in a manner that the Central Bank considers to be reliable, may use the PD estimate that results from this decomposition. (4) The PD of debtors in default shall be 100%. (5) For an exposure covered by an unfunded credit protection, a credit institution using own estimates of LGD under Article 185 of this Decision for both the exposure that is covered by the unfunded credit protection and for comparable direct exposures to the protection provider may recognise the unfunded credit protection in the PD in accordance with Article 224 of this Decision. (6) For dilution risk of purchased corporate receivables, PD shall be set equal to the EL estimates of the credit institution for dilution risk. (7) A credit institution that has received authorisation from the Central Bank pursuant to Article 185 of this Decision to use own estimates of LGD for corporate exposures

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 206 that can decompose its EL estimates for dilution risk of purchased corporate receivables into PDs and LGDs in a manner that the Central Bank considers to be reliable, may use the PD estimates that result from that decomposition. (8) A credit institution may recognise unfunded credit protection in the PD in accordance with Subtitle 4 of this Title. (9) A credit institution that has received the authorisation of the Central Bank pursuant to Article 185 of this Decision to use own LGD estimates for dilution risk of purchased corporate receivables, may recognise unfunded credit protection by adjusting PDs subject to Article 201 paragraph (3) of this Decision. Loss given default (LGD) Article 202 (1) A credit institution shall use the following LGD values:

  1. for senior exposures without eligible funded credit protection to central governments and central banks, to financial sector entities and to regional government units, local self-government units and public sector entities: 45%;
  2. for senior exposures without eligible funded credit protection to corporates which are not financial sector entities: 40%;
  3. for subordinated exposures without eligible collateral: 75%;
  4. for covered bonds eligible for the treatment set out in Article 169 paragraph (14) or (15) of this Decision may be assigned an LGD value of 11,25%;
  5. for senior purchased corporate receivables exposures where an institution is not able to estimate PDs or where the institution’s PD estimates do not meet the requirements set out in Section 6: 40 %;
  6. for subordinated purchased corporate receivables exposures where a credit institution is not able to estimate PDs or the credit institution's PD estimates do not meet the requirements set out in Section 6 of this Subtitle: 100%;
  7. for dilution risk of purchased corporate receivables: 100%. (2) For dilution and default risk, if a credit institution has received authorisation from the Central Bank to use own LGD estimates for corporate exposures pursuant to Article 185 of this Decision and it can decompose its EL estimates for purchased corporate receivables into PDs and LGDs in a manner the Central Bank considers to be reliable, the LGD estimate for purchased corporate receivables may be used. (3) For an exposure covered by an unfunded credit protection, a credit institution using own estimates of LGD pursuant to Article 185 of this Decision for both the exposure that is covered by an unfunded credit protection and for comparable direct exposures to the protection provider may recognise the unfunded credit protection in the LGD in accordance with Article 224 of this Decision. (4) For exposures assigned to the exposure classes referred to in Article 189 paragraph (2) item 4) of this Decision, for the sole purpose of calculating risk-weighted exposure amounts and the expected loss amounts of those exposures, and in particular for the purposes of Article 195 paragraph (1) item 3), Article 198 and Article 199 paragraphs (1), (5), (6) and (9) of this Decision, where own estimates of LGD are

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 207 used, the LGD values for each exposure used as an input of the risk-weighted exposure amounts and expected loss formulae shall not be less than the following LGD input floor values, calculated in accordance with paragraph (6) of this Article. Table 1 LGD input floors �𝐿𝐿𝐿𝐿𝐿𝐿𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓� for exposures belonging to the exposure classes referred to in Article 189 paragraph (2) item 4) of this Decision �𝐿𝐿𝐿𝐿𝐿𝐿𝑈𝑈−𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓� – exposures without eligible funded credit protection (FCP) �𝐿𝐿𝐿𝐿𝐿𝐿𝑆𝑆−𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓� – exposures fully secured by eligible funded credit protection (FCP) 25% Financial collateral 0% Receivables 10% Residential property or commercial immovable propetry 10% Other physical collateral 15% (5) For exposures assigned to the exposure classes referred to in Article 189 paragraph (2) item 2) of this Decision, for the sole purpose of calculating risk-weighted exposure amounts and the expected loss amounts of those exposures, and in particular for the purposes of Article 195 paragraph (1) item 3), Article 198 and Article 199 paragraphs (1), (5), (6) and (9) of this Decision, where own estimates of LGD are used, the LGD value used as an input of the risk-weighted exposure amounts and expected loss formulae for exposures without eligible FCP shall not be less than the following LGD input floor value: 5%. (6) For the purposes of paragraph (4) of this Article, the LGD input floors in Table 1 in that paragraph for exposures fully secured by eligible funded credit protection shall apply when the value of the funded credit protection, after the application of the volatility adjustments Hc and Hfx concerned in accordance with Article 266 of this Decision, is equal to or exceeds the value of the underlying exposure. (7) For the purposes of paragraph (4) of this Article and for the purposes of the application of the relevant related adjustments, Hc and Hfx, in accordance with Article 266 of this Decision, funded credit protection shall be eligible pursuant to this Subtitle, and the type of funded credit protection ‘other physical collateral’ in Table 1 referred to in Article 266 of this Decision, shall be understood as ‘other physical and other eligible collateral’. (8) The applicable LGD input floor �𝑳𝑳𝑳𝑳𝑳𝑳𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇� for an exposure partially secured by FCP is calculated as the weighted average of 𝑳𝑳𝑳𝑳𝑳𝑳𝑼𝑼−𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇 for the part of the exposure without FCP and 𝑳𝑳𝑳𝑳𝑳𝑳𝑺𝑺−𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇 for the fully secured part, as follows: 𝑳𝑳𝑳𝑳𝑳𝑳𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇 = 𝑳𝑳𝑳𝑳𝑳𝑳𝑼𝑼−𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇 ∙ 𝑬𝑬𝑼𝑼 𝑬𝑬 ∙ (𝟏𝟏 + 𝑯𝑯𝑬𝑬) + 𝑳𝑳𝑳𝑳𝑳𝑳𝑺𝑺−𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇𝒇 ∙ 𝑬𝑬𝑺𝑺 𝑬𝑬 ∙ (𝟏𝟏 + 𝑯𝑯𝑬𝑬) where 𝐿𝐿𝐿𝐿𝐿𝐿𝑈𝑈−𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 i 𝐿𝐿𝐿𝐿𝐿𝐿𝑆𝑆−𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 are the relevant floor values in Table 1 of this Article, while E, ES, EU i HE are determined in accordance with Article 266 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 208 (9) Where a credit institution that uses own estimates of LGD for a given type of unsecured exposures to corporates and unsecured exposures to regional government units, local self-government units and public sector entities is not able to take into account the effect of the funded credit protection securing one of the exposures of that type of exposures in the own estimate of LGD due to lack of data on recoveries for that funded credit protection, the credit institution may use the formula set out in Article 266 of this Decision, with the exception that the LGDU in that formula shall be the credit institution’s own estimate of LGD for unsecured exposures, and in that case, the funded credit protection shall be eligible in accordance with Subtitle 4 of this Title and the credit institution’s own estimate of LGD used as LGDU shall be calculated based on underlying loss data excluding any recoveries arising from that funded credit protection. Maturity Article 203 (1) A credit institution that has not received authorisation from the Central Bank to use own estimates of LGD, the maturity value (M) shall be applied consistently and, be set at 2,5 years, except for exposures arising from securities financing transactions, for which M shall be 0,5 years, or, alternatively, be calculated in accordance with paragraph (2) of this Article. (2) For exposures for which a credit institution applies own estimates of LGD, the maturity value (M) shall be calculated using periods expressed in years, as set out in this paragraph and subject to paragraphs (4) to (7) of this Article, whereat the M shall be no greater than five years, except in the cases specified in Article 588 paragraph (3) of this Decision, where M as specified therein shall be used. (3) A credit institution shall calculate M as follows in each of the following cases:

  1. for an instrument subject to a cash flow schedule, M shall be calculated in accordance with the following formula: 𝑀𝑀 = 𝑚𝑚𝑚𝑚𝑚𝑚 �1, 𝑚𝑚 𝑚𝑚 � ∑𝑡𝑡 𝑡𝑡 ∙ 𝐶𝐶𝐶𝐶𝑡𝑡 ∑𝑡𝑡 𝐶𝐶𝐶𝐶𝑡𝑡 , 5�� where CFt denotes the cash flows (principal, interest payments and fees) contractually payable by the debtor in period t;
  2. for derivatives subject to a master netting agreement, M shall be the weighted average remaining maturity of the exposure, where M shall be at least 1 year, and the notional amount of each exposure shall be used for weighting the maturity;
  3. for exposures arising from fully or nearly-fully collateralised derivative instruments listed in Article 148 paragraph (8) of this Decision and fully or nearly-fully collateralised margin lending transactions which are subject to a master netting agreement, M shall be the weighted average remaining maturity of the transactions where M shall be at least 10 days;
  4. for repurchase transactions or securities or commodities purchase or sale transactions which are subject to a master netting agreement, M shall be the weighted average remaining maturity of the transactions where M shall be at least five days, and the notional amount of each transaction shall be used for weighting the maturity;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 209 5) for secured lending transactions which are subject to a master netting agreement, M shall be the weighted average remaining maturity of the transactions where M shall be at least 20 days, and the notional amount of each transaction shall be used for weighting the maturity; 6) for a master netting agreement including more than one of the transaction types corresponding to items 3), 4) and 5) of this paragraph, M shall be the weighted average remaining maturity of the transactions where M shall be at least the longest holding period, expressed in years, applicable to such transactions as provided for in Article 261 paragraph (2) of this Decision, either 10 days or 20 days, depending on the cases; the notional amount of each transaction shall be used for weighting the maturity; 7) a credit institution that has received the authorisation of the Central Bank pursuant to Article 185 of this Decision to use own PD estimates for purchased corporate receivables, for drawn amounts under a committed purchase facility, M shall equal the purchased receivables exposure weighted average maturity, where M shall be at least 90 days; this same value of M shall also be used for undrawn amounts under a committed purchase facility provided that the facility contains effective covenants, early amortisation triggers, or other features that protect the purchasing credit institution against a significant deterioration in the quality of the future receivables it is required to purchase over the facility's term; Absent such effective protections, M for undrawn amounts shall be calculated as the sum of the longest-dated potential receivable under the purchase agreement and the remaining maturity of the purchase facility, where M shall be at least 90 days; 8) for any instrument other than those referred to in this paragraph or when a credit institution is not in a position to calculate M in the manner set out in item 1) of this paragraph, the M shall be the maximum remaining time (in years) that the debtor is permitted to take to fully discharge its contractual obligations, including the principal, interest, and fees, where M shall be at least one year; 9) for a credit institution using the Internal Model Method (IMM) set out in Section 6 of Subtitle 6 of this Title to calculate the exposure values, M shall be calculated for exposures to which they apply this method and for which the maturity of the longest-dated contract contained in the netting set is greater than one year in accordance with the following formula: 𝑀𝑀 = 𝑚𝑚 𝑚𝑚 � ∑ 𝐸𝐸𝐸𝐸 𝐸𝐸 𝑡𝑡𝑘𝑘 𝑘𝑘 ∙ ∆𝑡𝑡𝑘𝑘 ∙ 𝑡𝑡𝑘𝑘 ∙ 𝑡𝑡𝑘𝑘 + ∑ 𝑡𝑡𝑘𝑘 ∙ ∆𝑡𝑡𝑘𝑘 ∙ 𝑡𝑡𝑘𝑘 ∙ (1 − 𝑡𝑡𝑘𝑘 𝑘𝑘 ) ∑𝑘𝑘 𝐸𝐸𝐸𝐸 𝐸𝐸 𝑡𝑡𝑘𝑘 ∙ ∆𝑡𝑡𝑘𝑘 ∙ 𝑡𝑡𝑘𝑘 ∙ 𝑡𝑡𝑘𝑘 , 5� where: 𝑆𝑆𝑡𝑡𝑘𝑘 = A dummy variable whose value at future period tk is equal to 0 if tk > 1 year and to 1 if tk ≤ 1; 𝑡𝑡𝑘𝑘 = the expected exposure at the future period tk; 𝐸𝐸𝐸𝐸 𝐸𝐸 𝑡𝑡𝑘𝑘 = the effective expected exposure at the future period tk; 𝑡𝑡𝑘𝑘 = the risk-free discount factor for future time period tk; Δtk = tk - tk-1;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 210 10) a credit institution that uses an internal model to calculate a one-sided CVA may use, subject to the authorisation of the Central Bank, the effective credit duration estimated by the internal model as M; 11)subject to paragraph (2) of this Article, for netting sets in which all contracts have an original maturity of less than one year the formula referred to in item

  1. of this paragraph shall apply; 12)for a credit institution using the approaches referred to in Article 531 of this Decision paragraphs (1) or (2) of this Decision to calculate the own funds requirements for the CVA risk of transactions with a given counterparty, M shall be no greater than 1 in the formula set out in Article 195 paragraph (1) item 3) of this Decision, for the purpose of calculating the risk-weighted exposure amounts for counterparty risk for the same transactions, as referred to in Article 114 paragraph (4) item 1) or 7) of this Decision, as applicable; 13)for revolving exposures, M shall be determined using the maximum contractual termination date of the facility; a credit institution shall not use the repayment date of the current drawing if that date is not the maximum contractual termination date of the facility. (4) Where the documentation requires daily re-margining and daily revaluation and includes provisions that allow for the prompt liquidation or set off of collateral in the event of default or failure to remargin, M shall be the weighted average remaining maturity of the transactions and M shall be at least one day for:
  2. fully or nearly-fully collateralised derivatives listed in Article 148 paragraph (8) of this Decision;
  3. fully or nearly-fully collateralised margin lending transactions;
  4. repurchase transactions, transactions of securities or commodities lending or borrowing to or from the counterparty. (5) In addition to cases referred to in paragraph (4) of this Article, for qualifying short￾term exposures which are not part of the credit institution's ongoing financing of the debtor, M shall be at least one-day, and these qualifying short term exposures shall include the following:
  5. exposures to institutions or investment firms arising from settlement of foreign exchange obligations;
  6. self-liquidating short-term trade finance transactions and corporate purchased receivables, provided that the respective exposures have a residual maturity of up to one year;
  7. exposures arising from settlement of securities purchases or sales within the usual delivery period or two business days;
  8. exposures arising from cash settlements by wire transfer and settlements of electronic payment transactions and prepaid cost, including overdrafts arising from failed transactions that do not exceed a short, fixed agreed number of business days;
  9. issued as well as confirmed letters of credit that are short term, that is, they have a maturity below one year, and are self-liquidating. (6) For exposures to business undertakings with head office in Montenegro or the European Union which are not large business undertakings, a credit institution may choose to set for all such exposures M as set out in paragraph (1) instead of applying paragraph (2) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 211 (7) Maturity mismatches shall be treated as specified in Subtitle 4 of this Title. (8) For the purpose of expressing in years the minimum numbers of days referred to in paragraph (3) items 3) to 6) and paragraph (4) of this Article, the minimum numbers of days shall be divided by 365,25. Non-application of PD, LGD and CCF input floors Article 204 For the purposes of Subtitle 3 of this Title, and in particular with regard to Article 201 paragraph (1), Article 202 paragraph (4), Article 206 paragraph (5) and Article 207 paragraph (24), where an exposure is covered by an eligible guarantee provided by the Government of Montenegro, the Central Bank of Montenegro, and EU Member State central government or central bank or by the ECB, a credit institution shall not apply the PD, LGD and CCF input floors to the part of the exposure covered by that guarantee, while the part of the exposure that is not covered by that guarantee shall be subject to the PD, LGD and CCF input floors concerned. Subsection 2 - Retail exposures Probability of default (PD) Article 205 (1) For the sole purpose of calculating risk-weighted exposure amounts and the expected loss amounts of those exposures, and in particular for the purposes of Articles 196, 198, and 199 paragraph (1), (5), (6) and (9) of this Decision, the PD for each exposure that is used as an input of the risk-weighted exposure amounts and expected loss formulae shall be the higher of the one-year PD associated with the internal borrower grade or pool to which the retail exposure is assigned and the following PD input floor values:

  1. 0,1 % for QRRE revolvers;
  2. 0,05 % for retail exposures which are not QRRE revolvers. (2) The PD of debtors or, where an obligation approach is used, the PD of exposures in default shall be 100%. (3) For dilution risk of purchased receivables, PD shall be set equal to EL estimates for dilution risk. (4) If a credit institution may decompose its EL estimates for dilution risk of purchased receivables into PDs and LGDs in a manner the Central Bank considers to be reliable, the credit institution may use the PD estimate. (5) For an exposure covered by an unfunded credit protection, a credit institution using own estimates of LGD under Article 185 of this Decision for comparable direct exposures to the protection provider may recognise the unfunded credit protection in the PD in accordance with Article 225 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 212 Loss given default (LGD) Article 206 (1) A credit institution shall provide own estimates of LGD subject to the requirements specified in Section 6 of this Subtitle and to authorisation of the Central Bank granted in accordance with Article 185 of this Decision. (2) For dilution risk of purchased receivables, an LGD value of 100 % shall be used. (3) Where a credit institution may decompose its expected loss estimates for dilution risk of purchased receivables into PDs and LGDs in a reliable manner, the credit institution may use its own estimates of LGD. (4) A credit institution using own estimates of LGD pursuant to Article 185 of this Decision for comparable direct exposures to the protection provider may recognise the unfunded credit protection in the LGD in accordance with Article 224 of this Decision. (5) For the sole purpose of calculating risk-weighted exposure amounts and expected loss amounts for retail exposures, and in particular pursuant to Article 196 paragraph (1) item 2), Article 198, and Article 199 paragraph (1), (5), (6) and (9) of this Decision, the LGD values for each exposure used as an input of the risk-weighted exposure amounts and expected loss formulae shall not be less than the LGD input floor values set out in Table 1 of this paragraph, calculated in accordance with paragraph (4) of this Article: Table 1 LGD input floors (LGDfloor) for retail exposures Exposure without funded credit protection (LGDU-floor) Exposure secured by funded credit protection (LGDS-floor) Retail exposure secured by residential property N/A Retail exposure secured by residential property 5% QRRE 50% QRRE N/A Other retail exposure 30% Other retail exposure secured by financial collateral 0% Other retail exposure secured by receivables 10% Other retail exposure secured by residential property or commercial immovable property 10% Other retail exposure secured by other physical collateral 15% (6) For the purposes of paragraph (5) of this Article, the following shall apply:

  1. LGD input floors referred to in paragraph (5) Table 1of this Article shall be applicable for exposures secured by funded credit protection when the funded credit protection is eligible pursuant to this Subtitle;
  2. except for retail exposures secured by residential property, the LGD input floors referred to in paragraph (5) Table 1 of this Article shall be applicable to exposures fully secured by funded credit protection where the value of the funded credit protection, after the application of the relevant volatility adjustments in accordance with Article 266 of this Decision, is equal to or

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 213 exceeds the exposure value of the underlying exposure; for the purpose of the application of the relevant related adjustments, Hc and Hfx, in accordance with Article 266 of this Decision, funded credit protection shall be eligible pursuant to this Subtitle; 3) except for retail exposures secured by residential property, the applicable LGD input floor for an exposure partially secured by funded credit protection is calculated in accordance with the formula set out in Article 202 paragraphs (6), (7) and (8) of this Decision; 4) for retail exposures secured by residential property, the applicable LGD input floor shall be fixed at 5% irrespective of the level of collateral provided by the residential property. (4) A credit institution shall not assign guaranteed exposures an adjusted PD or LGD such that the adjusted risk weight would be lower than that of a comparable, direct exposure to the guarantor. (5) For the purposes of Article 173 paragraph (2) of this Decision, the LGD of a comparable direct exposure to the protection provider referred to in Article 172 paragraphs (3) and (4) of this Decision shall either be the LGD associated with an unhedged facility to the guarantor or the unhedged facility of the debtor, depending upon whether, in the event that both the guarantor and debtor default during the life of the hedged transaction, available evidence and the structure of the guarantee indicate that the amount recovered would depend on the financial condition of the guarantor or debtor, respectively. (6) The exposure weighted average LGD for all retail exposures secured by residential property and not benefiting from guarantees from central governments shall not be lower than 10%. (7) Where the Central Bank, on the basis of the analysis of data obtained from the credit institutions for the exposures secured by immovable property located in the territory of Montenegro, in accordance with paragraph (9) of this Article and other relevant indicators, assesses that the LGD floors referred to in paragraph (3) of this Article are not adequate, and if it considers that the inadequacy of LGD input floor values could adversely affect current or future financial stability in the country, it may set higher LGD input floor values for those exposures located in one or more parts of the territory of Montenegro, which may be applied at the level of one or more property segments of such exposures. (8) Where the Central Bank, in accordance with paragraph (7) of this Article, sets higher LGD floors, a credit institution shall have a six-month transitional period to apply them. (9) A credit institution shall report to the Central Bank on an annual basis the following data:

  1. losses stemming from exposures for which a credit institution has recognised residential property as collateral, in each case up to the lower of the pledged amount and the property value of the residential property, where applicable;
  2. overall losses stemming from exposures for which a credit institution has recognised residential property as collateral, in each case up to the lower of the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 214 pledged amount and 100 % of the property value of the residential property, where applicable; 3) the exposure value of all outstanding exposures for which a credit institution has recognised residential property as collateral, in each case up to the lower of the pledged amount and 100 % of the property value of the residential property, where applicable; 4) losses stemming from exposures for which a credit institution has recognised commercial immovable property as collateral, in each case up to the lower of the pledged amount and the property value of the commercial immovable property, where applicable; 5) overall losses stemming from exposures for which a credit institution has recognised commercial immovable property as collateral in each case up to the lower of the pledged amount and 100 % of the property value of the commercial immovable property, where applicable; 6) the exposure value of all outstanding exposures for which a credit institution has recognised commercial immovable property as collateral, in each case up to the lower of the pledged amount and 100 % of the property value of the commercial immovable property, where applicable. Section 5 - Exposure value Exposures to business undertakings, credit institutions, central governments and central banks, regional government units and local self-government units and public sector entities and retail exposures Article 207 (1) Unless noted otherwise, the exposure value of on-balance sheet exposures shall be the accounting value measured without taking into account any credit risk adjustments made. (2) The rule referred to in paragraph (1) of this Article shall also apply to assets purchased at a price different than the amount owed. (3) For purchased assets, the difference between the amount owed and the accounting value remaining after specific credit risk adjustments have been applied that has been recorded on the balance-sheet of the credit institution when purchasing the asset is denoted discount if the amount owed is larger, and premium if it is smaller. (4) Where a credit institution uses a master netting agreement in relation to repurchase transactions or securities or commodities lending or borrowing transactions, the exposure value shall be calculated in accordance with Subtitle 4 or 6 of this Title. (5) A credit institution shall, for the purposes of calculating the exposure value for on￾balance sheet netting of loans and deposits, apply the methods set out in Subtitle 4 of this Title. (6) The exposure value for leases shall be the discounted minimum lease payments.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 215 (7) Minimum lease payments shall comprise the payments over the lease term that the lessee is or can be required to make and any bargain option (i.e. option the exercise of which is reasonably certain). (8) If a party other than the lessee may be required to make a payment related to the residual value of a leased asset and this payment obligation fulfils the set of conditions referred to in Article 239 of this Decision regarding the eligibility of protection providers as well as the requirements for recognising other types of guarantees and sureties provided in Article 251 of this Decision, the payment obligation may be taken into account as unfunded credit protection in accordance with Subtitle 4 of this Title. (9) In the case of any contract referred to in Article 148 paragraph (8) of this Decision, the exposure value shall be determined by the methods set out in Subtitle 6 of this Title and shall not take into account any credit risk adjustment made. (10) The exposure value for the calculation of risk-weighted exposure amounts of purchased receivables shall be the value determined in accordance with paragraph (1) of this Article minus the capital requirements for dilution risk prior to credit risk mitigation. (11) Where an exposure takes the form of securities or commodities sold, posted or lent under repurchase transactions or securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions, the exposure value shall be the value of the securities or commodities determined in accordance with Article 261 of this Decision. (12) Where the Financial Collateral Comprehensive Method as set out under Article 260 of this Decision is used, the exposure value shall be increased by the volatility adjustment appropriate to such securities or commodities, as set out therein. (13) The exposure value of repurchase transactions, securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions may be determined in accordance with Subtitle 6 or Article 240 paragraph (3) of this Decision. (14) The exposure value of off-balance-sheet items which are not contracts as referred to in Article 148 paragraph (8) of this Decision shall be calculated by using IRB-CCF or SA-CCFs, in accordance with paragraphs (18) to (23) of this Article and Article 193 paragraphs (9) and (10) of this Decision. (15) Where only the drawn balances of revolving facilities have been securitised, a credit institution shall ensure that they continue to hold the required amount of own funds against the undrawn balances associated with the securitisation. (16) A credit institution that has not received authorisation to use IRB-CCF shall calculate the exposure value as the committed but undrawn amount multiplied by the SA-CCF concerned. (17) A credit institution that uses IRB-CCF shall calculate the exposure value for undrawn commitments as the undrawn amount multiplied by IRB-CCF.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 216 (18) For an exposure for which a credit institution has not received authorisation to use IRB-CCF, the applicable CCF shall be the SA-CCF as provided for in Subtitle 2 for the same types of items as laid down in Article 148 of this Decision. (19) The amount to which the SA-CCF is to be applied shall be the lower of the value of the committed but undrawn amount and the value that reflects any possible constraining of the availability of the facility, including the existence of an upper limit on the potential lending amount which is related to a debtor’s reported cash flow, where a facility is constrained in that way, the credit institution shall have sufficient line monitoring and management procedures to support the existence of that constraining. (20) A credit institution which, subject to the authorisation of the Central Bank, meets the requirements for the use of IRB-CCF as specified in Section 6 of this Subtitle, it shall use IRB-CCF for exposures arising from undrawn revolving commitments treated under the IRB Approach provided that those exposures would not be subject to a SA￾CCF of 100% under the Standardised Approach. (21) A credit institution shall use SA-CCFs for:

  1. all other off-balance-sheet items, in particular undrawn non-revolving commitments;
  2. exposures where the minimum requirements for calculating IRB-CCF as specified in Section 6 of this Subtitle are not met by the credit institution or where the Central Bank has not authorised the use of IRB-CCF. (22) For the purposes of this Article, a commitment shall be deemed ‘revolving’ where it lets a debtor obtain a loan where the debtor has the flexibility to decide how often to withdraw from the loan and at what intervals, allowing the debtor to drawdown, repay and redraw loans advanced to it. (23) Contractual arrangements that allow prepayments and subsequent redraws of those prepayments shall be considered revolving. (24) Where IRB-CCF are used for the sole purpose of calculating risk-weighted exposure amounts and expected loss amounts of exposures arising from revolving commitments other than exposures assigned to the exposure class in accordance with Article 189 paragraph (2) item 1) of this Decision, in particular pursuant to Article 195 paragraph (1) item 3), Article 198 and Article 199 paragraphs (1), (5), (6) and (9) of this Decision, the exposure value for each exposure used as an input of the risk￾weighted exposure amount and expected loss formulae shall not be less than the sum of:
  3. the drawn amount of the revolving commitment;
  4. 50% of the off-balance exposure amount of the remaining undrawn part of the revolving commitment calculated using the applicable SA-CCF provided for in Article 148 of this Decision. (25) The sum of items (1) and (2) referred to in paragraph (24) of this Article shall be referred to as the ‘CCF input floor’.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 217 (26) Where a credit institution has committed by a contract on assuming the commitment to assume another commitment, it shall apply the lower of the two conversion factors associated with the individual commitment. Other assets Article 208 The exposure value of other non-credit-obligation assets shall be the accounting value remaining after specific credit risk adjustment have been applied. Section 6 - Requirements for the IRB approach Subsection 1- Rating systems General principles Article 209 (1) Where a credit institution uses multiple rating systems, the rationale for assigning a debtor or a transaction to a rating system shall be documented and applied in a manner that appropriately reflects the level of risk. (2) A credit institution shall periodically review the debtor and transaction assignment criteria and processes to determine whether they remain appropriate for the current portfolio and external conditions. (3) Where a credit institution uses direct estimates of risk parameters for individual debtors or transactions these may be seen as estimates assigned to grades on a continuous rating scale. Structure of rating systems Article 210 (1) The structure of rating systems for exposures to business undertakings, institutions and central governments and central banks and regional government units, local self￾government units and public sector entities shall comply with the following requirements:

  1. a rating system shall take into account debtor and transaction risk characteristics;
  2. a rating system shall have a debtor rating scale which reflects exclusively quantification of the risk of debtor’s default, and the debtor rating scale shall have a minimum of seven grades for non-defaulted debtors and minimum one grade for defaulted debtors;
  3. a credit institution shall document the relationship between debtor grades in terms of the level of default risk each grade implies and the criteria used to distinguish that level of default risk;
  4. a credit institution with a portfolio concentrated in a particular market segment and range of default risk shall have enough debtor grades within that range to avoid undue concentrations of debtors in a particular grade, and if there are significant concentrations within a single grade, the credit institution shall have

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 218 supported convincing empirical evidence that the debtor grade covers a reasonably narrow PD band and that the default risk posed by all debtors in the grade falls within that band; 5) the Central Bank shall allow the credit institution to use own estimates of LGDs for capital requirements calculation, where a rating system has a distinct facility rating scale which exclusively reflects LGD related transaction characteristics; the facility grade definition shall include both a description of how exposures are assigned to the grade and of the criteria used to distinguish the level of risk across grades; 6) if there are significant concentrations within a single facility grade, the credit institution shall have convincing empirical evidence that the facility grade covers a reasonably narrow LGD band, respectively, and that the risk posed by all exposures in the grade falls within that band. (2) A credit institution using the methods set out in Article 195 paragraph (6) of this Decision for assigning risk weights for specialised lending exposures need not have a debtor rating scale which reflects exclusively quantification of the risk of debtor default for these exposures, and the credit institution shall have for these exposures at least four grades for non-defaulted debtors and at least one grade for defaulted debtors. (3) The structure of rating systems for retail exposures shall comply with the following requirements:

  1. rating systems shall reflect both debtor and transaction risk, and shall capture all relevant debtor and transaction characteristics;
  2. the credit institution shall ensure that the level of risk differentiation is such that the number of exposures in a given grade or pool is sufficient to allow for meaningful quantification and validation of the loss characteristics at the grade or pool level, and the credit institution shall ensure that the distribution of exposures and debtors across grades or pools is such as to avoid excessive concentrations;
  3. the process of assigning exposures to grades or pools shall provide for a meaningful differentiation of risk, for a grouping of sufficiently homogenous exposures, and shall allow for accurate and consistent estimation of loss characteristics at grade or pool level; for purchased receivables the grouping shall reflect the seller's underwriting practices and the heterogeneity of its customers. (4) A credit institution shall consider the following risk factors when assigning exposures to grades or pools:
  4. debtor risk characteristics;
  5. transaction risk characteristics, including product and funded credit protection types, recognised unfunded credit protection, loan-to- value (LTV) measures, seasoning and seniority, and the credit institution shall explicitly address cases where several exposures benefit from the same funded or unfunded credit protection;
  6. delinquency, except where a credit institution demonstrates to the satisfaction of the Central Bank that delinquency is not a material factor of risk for the exposure.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 219 Assignment to grades or pools Article 211 (1) A credit institution shall have specific definitions, processes and criteria for assigning exposures to grades or pools that comply with the following requirements:

  1. the grade or pool definitions and criteria shall be sufficiently detailed to allow those charged with assigning ratings to consistently assign debtors or individual credit exposures posing similar risk to the same grade or pool, and this consistency shall exist across all business lines, departments and geographic locations;
  2. the documentation of the rating process shall clearly allow third parties to understand the assignments of exposures to grades or pools, to replicate grade and pool assignments and to evaluate the appropriateness of the assignments to a grade or a pool; and
  3. the criteria shall also be consistent with the credit institution's internal lending standards and its policies for handling debtors and individual credit exposures it deems troubled. (2) A credit institution shall take all relevant information into account in assigning debtors and individual credit exposures to grades or pools, such information shall be current and shall enable the credit institution to forecast the future performance of the exposure. (3) The level of conservatism of a credit institution in assigning exposures to debtor and exposure grades or pools should depend on the amount of information the credit institution possesses, thus the less information a credit institution has, the more conservative shall be its assignments of exposures to debtor and exposure grades or pools. (4) If a credit institution uses an external rating as a primary factor determining an internal rating assignment, it shall also consider other relevant information. (5) Institutions shall use a time horizon longer than one year in assigning ratings. (6) A debtor’s rating shall represent the credit institution’s assessment of the debtor’s ability and willingness to contractually perform despite adverse economic conditions or the occurrence of unexpected events. (7) Rating systems shall be designed in such a way that idiosyncratic changes and, where they are material drivers of risk for the type of exposure, industry-specific changes are a driver of migrations from one grade or pool to another, whereby business cycle effects may also be a driver of migrations. Assignment of exposures Article 212 (1) A credit institution shall carry out the assignment of exposures to central governments and central banks, exposures to regional government units, local self-

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 220 government units and public sector entities, exposures to credit institutions and exposures to corporates, in accordance with the following criteria:

  1. each debtor shall be assigned to a debtor grade as part of the credit approval process;
  2. for those exposures for which a credit institution has received the authorisation of the Central Bank to use own estimates of LGDs and conversion factors pursuant to Article 185 of this Decision, the credit institution shall also assign each exposure to a facility grade on a rating scale as part of the credit approval process;
  3. a credit institution using the methods set out in Article 195 paragraph (5) of this Decision for assigning risk weights for specialised lending exposures shall assign each of these exposures to a grade in accordance with Article 210 paragraph (2) of this Decision;
  4. a credit institution shall assign a separate rating to each separate legal person to which it is exposed;
  5. a credit institution shall assign all separate exposures to the same debtor to the same debtor grade, irrespective of any differences in the nature of each specific transaction, except that it may assign separate exposures to the same debtor to multiple grades in the following cases: − when, due to the country transfer risk, separate exposures to the same debtor may be assigned to multiple grades depending on whether the exposures are denominated in local or foreign currency; − when the treatment of associated guarantees to an exposure may be reflected in an adjusted assignment to a debtor grade; or − when consumer protection, bank secrecy or other regulations prohibit the exchange of client data. (2) For the purposes of the paragraph (1) item 4) of this Article, a credit institution shall have appropriate policies for the treatment of individual debtor clients and groups of connected persons, which should contain a process for the identification of Specific Wrong-Way Risk for each legal person to which the credit institution is exposed. (3) For the purposes of Subtitle 6 of this Title, transactions with counterparties where a Specific Wrong-Way Risk has been identified shall be treated differently when calculating their exposure value. (4) For retail exposures, each exposure shall be assigned to a grade or a pool as part of the credit approval process. (5) For the purposes of grade and pool assignments a credit institution shall:
  6. document the situations in which human judgement may override the inputs or outputs of the assignment process and the personnel responsible for approving these overrides.
  7. document these overrides and note down the personnel responsible;
  8. analyse the performance of the exposures whose assignments have been overridden whereby the analysis shall include an assessment of the performance of exposures whose rating has been overridden by a particular person, responsible for approving the overrides.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 221 Integrity of assignment process Article 213 (1) For exposures to central governments and central banks, exposures to regional government units, local self-government units and public sector entities, exposures to institutions and exposures to corporates, the assignment process shall meet the following requirements:

  1. assignments and periodic reviews of assignments shall be completed or approved by an independent party that does not directly benefit from decisions to extend the credit;
  2. a credit institution shall review assignments at least annually and adjust the assignment where the result of the review does not justify carrying forward the current assignment, whereby the assignments of debtors rated as high-risk debtors and exposures rated as problem exposures shall be subject to more frequent review; a credit institution shall undertake a new assignment if material information on the debtor or exposure becomes available;
  3. a credit institution shall have an effective process to obtain and update relevant information on debtor characteristics that affect PDs, and on transaction characteristics that affect LGDs or conversion factors. (2) For retail exposures, a credit institution shall at least annually review debtor and individual credit exposures’ assignments and adjust the assignment where the result of the review does not justify carrying forward the current assignment, or review the loss characteristics and delinquency status of each identified pool of exposures, whichever applicable. (3) For retail exposures, a credit institution shall also at least annually review in a representative sample the status of individual exposures within each pool of exposures as a means of ensuring that exposures continue to be assigned to the correct pool, and adjust the assignment where the result of the review does not justify carrying forward the current assignment. Use of models Article 214 (1) A credit institution shall use statistical or other mathematical methods (‘models’) to assign exposures to debtor or facility grades or pools, which shall meet the following criteria:
  4. the model shall have good predictive power and own funds requirements shall not be distorted as a result of its use;
  5. the credit institution shall have in place a process for vetting data inputs into the model, which includes an assessment of the accuracy, completeness and appropriateness of the data;
  6. the data used to build the model shall be representative in terms of the credit institution's actual portfolio of debtors or exposures;
  7. the credit institution shall have a regular cycle of model validation that includes monitoring of model performance and stability, review of model specification, and testing of model outputs against outcomes;
  8. the credit institution shall complement the statistical model by judgement and oversight of the experts employed in a credit institution to review model-based

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 222 assignments and to ensure that the models are used appropriately. Review procedures shall aim at finding and limiting errors associated with model weaknesses; the expert judgements shall take into account all relevant information not considered by the model and the credit institution shall document how expert judgement and model results are to be combined. (2) For the purposes of paragraph (1) item 1) of this Article, the input variables shall form a reasonable and effective basis for the resulting predictions. (3) The model shall not have material biases. (4) There shall be a functional link between the inputs and the outputs of the model, which may be determined through expert judgement, where appropriate. Documentation of rating systems Article 215 (1) A credit institution shall document the design and operational details of its rating systems, and the documentation shall provide evidence of compliance with the requirements set out in this Section, and include exposure differentiation, rating criteria, responsibilities of parties that rate debtors and exposures, frequency of assignment reviews, and management oversight of the rating process. (2) A credit institution shall document the rationale for and analysis supporting its choice of rating criteria, and all major changes in the risk rating process, and such documentation shall support identification of changes made to the risk rating process subsequent to the last review by the Central Bank, whereby the organisation of rating assignment including the rating assignment process and the internal control structure shall also be documented. (3) A credit institution shall document the specific definitions of default and loss used internally and prove their consistency with the definitions set out in this Decision. (4) Where a credit institution employs statistical models in the rating process, it shall document their methodologies and this documentation shall:

  1. provide a detailed outline of the theory, assumptions and mathematical and empirical basis of the assignment of risk parameters estimates to grades, individual debtors, exposures, or pools of exposures, and the data sources used to estimate the model;
  2. establish a rigorous statistical process including out-of-sample and out-of-time performance tests for validating the model;
  3. indicate any circumstances under which the model does not work effectively. (5) A credit institution shall demonstrate to the satisfaction of the Central Bank that the requirements of this Article are met, where a credit institution has obtained a rating system, or model used within a rating system, from a third-party vendor and that vendor refuses or restricts the access of the credit institution to information pertaining to the methodology of that rating system or model, or underlying data used to develop that rating system or model, on the basis that such information is proprietary.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 223 Data maintenance Article 216 (1) A credit institution shall collect and store data on aspects of their internal ratings. (2) For exposures to central governments and central banks, exposures to regional government units, local self-government units and public sector entities, exposures to credit institutions and exposures to corporates, a credit institution shall collect and store:

  1. complete rating histories on debtors and recognised guarantors;
  2. the dates the ratings were assigned;
  3. the key data and methodology used to derive the rating;
  4. the data on the persons responsible for the rating assignment;
  5. the identity of debtors and exposures that defaulted;
  6. the date and circumstances of such defaults;
  7. data on the PDs and realised default rates associated with rating grades and ratings migration. (3) For exposures for which this Subtitle allows the use of own estimates of LGD or the use of IRB-CCF but for which a credit institution does not use own estimates of LGD or IRB-CCF, the credit institution shall collect and store data on comparisons between realised LGDs and the values as set out in Article 202 paragraph (1) of this Decision, and between realised CCFs and SA-CCFs as set out in Article 207 paragraphs (18) and (19) of this Decision. (4) A credit institution using own estimates of LGDs and conversion factors shall collect and store:
  8. complete histories of data on the individual credit exposure ratings and LGD and conversion factor estimates associated with each rating scale;
  9. the dates on which the ratings were assigned and the estimates were made;
  10. the key data and methodology used to derive the individual credit exposure ratings and LGD and conversion factor estimates;
  11. the data on the persons who assigned the individual credit exposure rating and the persons who provided LGD and conversion factor estimates;
  12. data on the estimated and realised LGDs and conversion factors associated with each defaulted exposure,
  13. data on the LGD of the exposure before and after adjusting for the effects of a guarantee or credit derivative, for those credit institutions that reflect the credit risk mitigating effects of guarantees or credit derivatives through LGD;
  14. data on the components of loss for each defaulted exposure. (5) For retail exposures, a credit institution shall collect and store:
  15. data used in the process of allocating exposures to grades or pools;
  16. data on the estimated PDs, LGDs and conversion factors associated with grades or pools of exposures;
  17. the data on the identity of debtors and exposures that defaulted;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 224 4) for defaulted exposures, data on the grades or pools to which the exposure was assigned over the year prior to default and the realised outcomes on LGD and conversion factor; 5) data on loss rates for qualifying revolving retail exposures. Stress tests used in assessment of capital adequacy Article 217 (1) A credit institution shall have in place sound stress testing processes for use in the assessment of its capital adequacy. (2) Stress testing should involve identifying possible events or future changes in economic conditions that could have unfavourable effects on a credit institution's credit exposures and assessment of the institution's ability to withstand such changes. (3) A credit institution shall regularly perform credit risk stress tests to assess the effect of certain specific conditions on its capital requirements for credit risk. (4) A credit institution shall decide on the selection of tests to be applied, which shall be subject to supervisory review. (5) The tests to be employed shall be meaningful and consider the effects of severe, but plausible, recession scenarios. (6) A credit institution shall assess migration in its ratings under the stress test scenarios. (7) Stress testing shall be performed on the vast majority of a credit institution's total exposure. (8) The scenarios used under paragraph (2) of this Article shall also include ESG risk drivers, in particular physical risk and transition risk drivers stemming from climate change. Subsection 2 - Risk quantification Default of a debtor Article 218 (1) A default shall be considered to have occurred with regard to a particular debtor when either or both of the following conditions have been met:

  1. a credit institution considers that the debtor is unlikely to pay its credit obligations to the credit institution, the parent undertaking or any of its subsidiary undertakings in full, without recourse by the credit institution to actions such as realising security;
  2. the debtor is more than 90 days past due on any material credit obligation to the credit institution, the parent undertaking or any of its subsidiary undertakings.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 225 (2) In the case of retail exposures, a credit institution may apply the definition of default laid down in paragraph (1) items 1) and 2) of this Article at the level of an individual credit facility (exposure) rather than in relation to the total obligations of a debtor. (3) The following shall apply for the purposes of paragraph (1) item 2) of this Article:

  1. for overdrafts, days past due commence once a debtor has breached an advised limit, has been advised a limit smaller than current outstandings, or has drawn credit without authorisation and the underlying amount is material;
  2. for the purposes of item 1) of this paragraph, an advised limit comprises any credit limit determined by the credit institution and about which the debtor has been informed by the credit institution;
  3. days past due for credit card exposures commence on the minimum payment due date;
  4. for the purposes of paragraph (1) item 2) of this Article, the materiality of a credit obligation past due shall be assessed against a threshold referred to in paragraphs (8) and (10) of this Article;
  5. a credit institution shall have documented policies in respect of the counting of days past due, in particular in respect of the re-ageing of individual credit exposures and the granting of extensions, amendments or deferrals, renewals, and netting of existing accounts, which shall be applied consistently over time, and shall be in line with the internal risk management and decision procedures of the credit institution. (4) For the purposes of paragraph (1) item 1) of this Article, when assessing the debtor’s unlikeliness to meet their obligations regularly, a credit institution shall take into account the following circumstances:
  6. the credit institution puts the credit obligation on non-accrued status;
  7. the credit institution recognises specific credit adjustments resulting from a significant perceived decline in credit quality of the debtor subsequent to the credit institution taking on the exposure;
  8. the credit institution sells the credit obligation at a material credit-related economic loss;
  9. the credit institution consents to a forbearance measures as defined in the regulation governing the criteria and the manner of classification of assets and calculation of provisions for potential loan losses of a credit institution where that measure is likely to result in a diminished financial obligation due to the material forgiveness, or postponement, of principal, interest or, where relevant fees;
  10. the credit institution has filed for the debtor's bankruptcy or a similar proceedings in respect of a debtor's credit obligation to the credit institution, the parent undertaking or any of its subsidiary undertakings;
  11. the debtor has sought or has been placed in bankruptcy or similar protection where this would avoid or delay repayment of a credit obligation to the credit institution, the parent undertaking or any of its subsidiary undertakings. (5) A credit institution that uses external data that is not itself consistent with the definition of default laid down in paragraph (1) of this Article, shall make appropriate adjustments of that data to achieve broad equivalence with the definition of default.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 226 (6) For the purposes of paragraph (3) item 4) of this Article, the materiality threshold comprises two components, the absolute component and the relative component. (7) The absolute component shall be expressed as the sum of all amounts past due owed by a debtor to the credit institution, the parent undertaking of that credit institution or any of its subsidiary undertakings (credit obligation past due). (8) For retail exposures, the absolute component referred to in paragraph (7) of this Article shall amount to EUR 100, and for other, non-retail exposures it shall amount to EUR 500. (9) The relative component shall be expressed as a percentage reflecting the amount of the debtor’s credit obligation past due in relation to the total amount of all on-balance sheet exposures to that debtor of the credit institution, the parent undertaking of that institution or any of its subsidiary undertakings, excluding equity exposures. (10) The relative component referred to in paragraph (9) of this Article shall amount to 1% for all exposures of the credit institution. (11) The condition set out in paragraph (1) item 2) of this Article shall be considered to be met if the debtor has exceeded the absolute and the relative component for 90 consecutive days. (12) Where the credit arrangement explicitly allows the debtor to change the schedule, suspend or postpone the payments under certain conditions, and the debtor acts within the rights granted in the contract, the changed, suspended or postponed instalments should not be considered past due, but the counting of days past due should be based on the new schedule once it is specified. (13) If the debtor changes the schedule, suspends or postpones the payments, the credit institution should analyse the reasons for such a change and assess the possible indications of the debtor's unlikeliness to pay. (14) If the credit institution considers that a previously defaulted exposure is such that no trigger of default continues to apply, it shall rate the debtor or individual credit exposure as they would for a non-defaulted exposure, and where the definition of default is subsequently triggered, another default would be deemed to have occurred. (14) Detailed criteria for the occurrence of default are set out in Guidelines provided in Annex 2, which makes an integral part of this Decision. Overall requirements for estimation Article 219 (1) In quantifying the risk parameters to be associated with rating grades or pools, a credit institution shall apply the following requirements:

  1. a credit institution's own estimates of the risk parameters PD, LGD, conversion factor and EL shall incorporate all relevant data, information and methods, and these estimates shall be derived using both historical experience and empirical

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 227 evidence, and not based purely on judgemental considerations, and they shall be plausible and intuitive and shall be based on the material drivers of the respective risk parameters; the less data a credit institution has, the more conservative it shall be in its estimation; 2) a credit institution shall provide a breakdown of its loss experience in terms of default frequency, LGD, conversion factor, or loss where EL estimates are used, by the factors it sees as the drivers of the respective risk parameters, and these estimates shall be representative of long run experience; 3) a credit institution shall take into account any changes in lending practice or the process for pursuing recoveries over the observation periods referred to in Article 220 paragraph (1) item 8) and paragraph (4) item 5), Article 221 paragraph (1) item 10) and paragraphs (5) to (8), and Article 222 paragraphs (11), (12) and (13) of this Decision; a credit institution's estimates shall reflect the implications of technical advances and new data and other information, as it becomes available; a credit institution shall review their estimates when new information comes to light but at least on an annual basis; 4) the population of exposures represented in the data used for estimation of risk parameters, the lending standards used when the data was generated and other relevant characteristics shall be comparable with those of the credit institution's exposures and standards, the economic and market conditions that underlie the data shall be relevant to current and foreseeable conditions, and the number of exposures in the sample and the data period used for quantification shall be sufficient to provide the credit institution with confidence in the accuracy and robustness of its estimates; 5) for purchased receivables the estimates shall reflect all relevant information available to the purchasing credit institution regarding the quality of the underlying receivables, including data for similar pools provided by the seller, by the purchasing credit institution, or by external sources; the purchasing credit institution shall evaluate any data relied upon which is provided by the seller; 6) to overcome biases, a credit institution shall include appropriate adjustments in its estimates to the extent possible; after having included an appropriate adjustment, it shall add to its estimates a sufficient margin of conservatism that is related to the expected range of estimation errors; where methods and data are considered to be less satisfactory, the expected range of errors is larger, and the margin of conservatism shall be larger. (2) Where a credit institution uses different estimates for the calculation of risk weights and for internal purposes, they shall be documented and be reasonable. (3) Where a credit institution uses data that is pooled across credit institutions it shall meet the following requirements:

  1. the rating systems and criteria of other credit institutions in the pool shall be similar to its own rating systems and criteria;
  2. the pool shall be representative of the portfolio for which the pooled data is used;
  3. a credit institution shall use the pooled data consistently over time for its estimates;
  4. the credit institution shall remain responsible for the integrity of its rating systems; and
  5. the credit institution shall maintain sufficient in-house understanding of its rating systems, including the ability to effectively monitor and audit the rating process.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 228 Specific requirements for PD estimation Article 220 (1) In quantifying the risk parameters to be associated with rating grades or pools, a credit institution shall apply the following specific requirements for PD estimation to exposures to central governments and central banks, exposures to regional government units, local self-government units and public sector entities, exposures to credit institutions and exposures to corporates:

  1. a credit institution shall estimate PDs by debtor grade from long run averages of one-year default rates, whereat PD estimates for debtors that are highly leveraged or for debtors whose assets are predominantly traded assets shall reflect the performance of the underlying assets based on periods of stressed volatilities;
  2. for purchased corporate receivables a credit institution may estimate the EL by debtor grade from long run averages of one-year realised default rates;
  3. if a credit institution derives long run average estimates of PDs and LGDs for purchased corporate receivables from an estimate of EL, and an appropriate estimate of PD or LGD, it shall ensure that the process for estimating total losses meets the overall standards for estimation of PD and LGD set out in this part of the Decision, and the outcome shall be consistent with the concept of LGD as set out in Article 221 paragraph (1) item 1) of this Decision;
  4. a credit institution may use PD estimation techniques only with appropriate supporting analysis, and it shall also recognise the importance of judgmental considerations in combining results of different techniques and in making adjustments for limitations of techniques and information;
  5. where a credit institution uses data on internal default experience for the estimation of PDs, the estimates shall be reflective of current underwriting standards and of any differences in the rating system that generated the data and the current rating system, and where underwriting standards or rating systems have changed, after including an appropriate adjustment, the credit institution shall add a greater margin of conservatism in its estimate of PD related to the expected range of estimation errors that is not already covered by the appropriate adjustment;
  6. where a credit institution associates or maps its internal grades to the scale used by an ECAI or a similar organisation and then attributes the default rate observed for the external organisation's grades to the its own grades the following conditions should be fulfilled:
  • mappings shall be based on a comparison of internal rating criteria to the criteria used by the external organisation and on a comparison of the internal and external ratings of any common debtors;
  • a credit institution shall avoid any biases or inconsistencies in the mapping approach or underlying data;
  • the criteria of the external organisation underlying the data used for quantification shall be oriented to default risk only and not reflect transaction characteristics;
  • a credit institution shall include in the analysis a comparison of the default definitions used, subject to the requirements set out in Article 218 of this Decision;
  • a credit institution shall document the basis for the mapping;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 229 7) where a credit institution uses statistical default prediction models it may estimate PDs as the simple average of default-probability estimates for individual debtors in a given grade, and the use of default probability models for this purpose shall meet the standards specified in Article 214 of this Decision; 8) irrespective of whether a credit institution is using external, internal, or pooled data sources, or a combination of the three for its PD estimation, the length of the underlying historical observation period used shall be at least five years for at least one source; 9) irrespective of the method used to estimate PD, a credit institution shall estimate a PD for each rating grade based on the observed historical average one-year default rate that is an arithmetic average based on the number of debtors (count weighted); other approaches, including exposure-weighted averages, shall not be permitted (2) For the purposes of paragraph (1) item 8) of this Article, where the available observation period spans a longer period for any source, and where those data are relevant, that longer period shall be used, and the data shall include a representative mix of good and bad years of the economic cycle relevant for the type of exposures. (3) A credit institution which has not received authorisation of the Central Bank pursuant to Article 185 of this Decision to use own estimates of LGD or to use IRB￾CCF may, subject to the authorisation of the Central Bank, use, when it implements the IRB Approach, relevant data covering a period of two years, and the period to be covered shall be increased by one year each year until relevant data cover at least five years. (4) For retail exposures, a credit institution shall apply the following requirements:

  1. a credit institution shall estimate PDs by debtor grade or pool from long run averages of one-year default rates and default rates shall be calculated at individual credit exposure level only where the definition of default is applied at individual credit exposure level pursuant to Article 218 paragraph (2) of this Decision;
  2. PD estimates may also be derived from an estimate of total losses and appropriate estimates of LGDs;
  3. a credit institution shall regard internal data for assigning exposures to grades or pools as the primary source of information for estimating loss characteristics, and it may use external data (including pooled data) or statistical models for quantification provided that strong links both exist between the credit institution's process of assigning exposures to grades or pools and the process used by the external data source, and between the credit institution's internal risk profile and the composition of the external data;
  4. a credit institution that derives long run average estimates of PD and LGD for retail exposures from an estimate of total losses and an appropriate estimate of PD or LGD shall ensure that the process for estimating total losses meets the overall standards for estimation of PD and LGD set out in this part of the Decision, and the outcome shall be consistent with the concept of LGD as set out in Article 221 paragraph (1) item 1) of this Decision;
  5. irrespective of whether a credit institution is using external, internal or pooled data sources, or a combination of the three, for its PD estimation, the length of

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 230 the underlying historical observation period used shall be at least five years for at least one source; 6) a credit institution shall identify and analyse expected changes of risk parameters over the life of credit exposures (seasoning effects). (5) For purchased retail receivables, a credit institution may use external and internal reference data, and it shall use all relevant data sources as points of comparison. (6) For the purposes of paragraph (4) item 1) of this Article, the PD shall be based on the observed historical average one-year default rate. (7) For the purposes of paragraph (4) item 5) of this Article, where the available observation spans a longer period for any source, and where those data are relevant, a credit institution shall use that longer period, and the data shall include a representative mix of good and bad years of the economic cycle relevant for the type of exposures. (8) A credit institution may, subject to the authorisation of the Central Bank, institutions use, when it implements the IRB Approach, relevant data covering a period of two years, whereat the period to be covered shall be increased by one year each year until relevant data cover at least five years. Specific requirements for own-LGD estimates Article 221 (1) In quantifying the risk parameters to be associated with rating grades or pools, a credit institution shall apply the following specific requirements own-LGD estimates:

  1. a credit institution shall estimate LGDs by individual credit exposure grade or pool on the basis of the average realised LGDs by facility grade or pool using all observed defaults within the data sources (default weighted average);
  2. a credit institution shall use LGD estimates that are appropriate for an economic downturn if those are more conservative than the long- run average, which a credit institution shall, to the extent a rating system is expected to deliver realised LGDs at a constant level by grade or pool over time, adjust to its estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn;
  3. a credit institution shall consider the extent of any dependence between, on the one hand, the risk of the debtor and, on the other hand, that of funded credit protection, other than master netting agreements and on-balance-sheet netting of loans and deposits, or its provider;
  4. a credit institution shall treat in its assessment of LGD currency mismatches between the underlying obligation and the funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits, in an conservative manner;
  5. where LGD estimates take into account the existence of funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits, those estimates shall not solely be based on the estimated market value of the funded credit protection;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 231 6) where LGD estimates take into account the existence of funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits, a credit institution shall establish internal requirements for the management, legal certainty and risk management of that funded credit protection, and those requirements shall be generally consistent with those set out in Subsection 1 of Section 3 of Subtitle 4 of this Title; 7) where a credit institution recognises funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits for determining the exposure value for counterparty credit risk in accordance with Section 5 or 6 of Subtitle 6 of this Title, any amount expected to be recovered from that funded credit protection shall not be taken into account in the LGD estimates; 8) for the specific case of exposures already in default, a credit institution shall use the sum of its best estimate of expected loss for each exposure given current economic circumstances and exposure status and its estimate of the increase of loss rate caused by possible additional unexpected losses during the recovery period, i.e. between date of default and final liquidation of the exposure; 9) where a credit institution has recognised penalties for late payments, imposed on the debtor before the time of default, in its income statement, a credit institution shall include the amounts recognised in income statement in its measure of exposure and loss; 10)for exposures to business undertakings, credit institutions, central governments and central banks, and regional government units, local self￾government units and public sector entities, estimates of LGD shall be based on data over a minimum of five years, increasing by one year each year after implementation of IRB Approach until a minimum of seven years is reached, for at least one data source, if the available observation period spans a longer period for any source, and the data are relevant, that longer period shall be used. (2) For the purposes of paragraph (1) item 1) of this Article, a credit institution shall adequately take into account recoveries realised in the course of the relevant recovery processes from any type of funded credit protection as well as from unfunded credit protection not falling under the definition referred to in Article 184 paragraph (1) item 15) of this Decision. (3) For the purposes of paragraph (1) item 3) of this Article, a credit institution shall treat the cases where there is a significant degree of dependence in a conservative manner. (4) For the purposes of paragraph (1) item 5) of this Article, LGD estimates shall take into account the effect of the potential inability of the credit institution to expeditiously gain control of their collateral and liquidate it. (5) For retail exposures, a credit institution may:

  1. derive LGD estimates from realised losses and appropriate estimates of PDs;
  2. reflect future drawings either in their conversion factors or in their LGD estimates;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 232 3) for purchased retail receivables use external and internal reference data to estimate LGDs. (6) For the purposes of paragraph (5) item 2) of this Article, where a credit institution includes future additional drawings in their conversion factors, those should be taken into account in the LGD in both the numerator and the denominator, and where a credit institution does not include future additional drawings in its conversion factors, those should be taken into account in the LGD numerator only. (7) For retail exposures, estimates of LGD shall be based on data over a minimum of five years. (8) A credit institution may, subject to the authorisation of the Central Bank use, when it implements the IRB Approach, relevant data covering a period of two years, and the period to be covered shall be increased by one year each year until relevant data cover at least five years. Specific requirements for own-conversion factor estimates Article 222 (1) In quantifying the risk parameters to be associated with rating grades or pools, a credit institution shall apply the following requirements specific to own-conversion factor estimates:

  1. a credit institution shall estimate conversion factors by individual credit exposure (facility) grade or pool on the basis of the average realised conversion factors by facility grade or pool using the default weighted average resulting from all observed defaults within the data sources;
  2. a credit institution shall use conversion factor estimates that are appropriate for an economic downturn if those are more conservative than the long-run average, i.e. a credit institution shall, to the extent a rating system is expected to deliver realised conversion factors at a constant level by grade or pool over time, make adjustments to its estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn;
  3. a credit institution’s IRB-CCF shall reflect the possibility of additional drawings by the debtor up to and after the time a default event is triggered;
  4. in arriving at estimates of conversion factors a credit institution shall consider its specific policies and strategies adopted in respect of account monitoring and payment processing, as well as consider its ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events;
  5. a credit institution shall have adequate systems and procedures in place to monitor individual credit exposure amounts, current outstandings against committed lines and changes in outstandings per debtor and per grade, or it shall be able to monitor outstanding balances on a daily basis;
  6. if a credit institution uses different estimates of conversion factors for the calculation of risk-weighted exposure amounts and internal purposes it shall be documented and be reasonable;
  7. a credit institution’s IRB-CCF shall be estimated using a 12-month fixed-horizon approach;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 233 8) a credit institution’s IRB-CCF shall be based on reference data that reflect the debtor, individual credit exposure and bank management practice characteristics of the exposures to which the estimates are applied. (2) For the purposes of the paragraph (1) item 1) of this Article, where a credit institution observes a negative realised conversion factor on their default observations, the realised conversion factor on those observations shall be equal to zero for the purpose of quantification of their IRB-CCF. (3) A credit institution may use the information of the negative realised conversion factor in the process of model development for the purpose of risk differentiation. (4) For the purposes of paragraph (1) item 3) of this Article, IRB-CCF shall incorporate a greater margin of conservatism where a stronger positive correlation can reasonably be expected between the default frequency and the magnitude of the conversion factor. (5) For the purposes of paragraph (1) item 7) of this Article, each default shall be linked to relevant debtor and individual credit exposure characteristics at the fixed reference date defined as 12 months prior to the date of default. (6) For the purposes of paragraph (1) item 8) of this Article, IRB-CCF applied to particular exposures shall not be based on data that comingle the effects of disparate characteristics or data from exposures that exhibit materially different risk characteristics. (7) IRB-CCF shall be based on appropriately homogenous segments, and for that purpose, the following practices shall only be allowed on the basis of a detailed scrutiny and justification by a credit institution:

  1. SME or mid-market underlying data being applied to large corporate debtors;
  2. data from commitments with a small unused limit availability being applied to facilities with a large unused limit availability;
  3. data from delinquent debtors or blocked for further drawdowns at the reference date being applied to debtors with no known delinquency or relevant restrictions;
  4. data that have been affected by changes in the debtors’ mix of borrowing and other credit-related products over the observation period unless those data have been effectively adjusted by removing the effects of the changes in the product mix. (8) For the purposes of paragraph (7) item 4) of this Article, a credit institution shall demonstrate to the Central Bank that it has a detailed understanding of the impact of changes in customer product mix on the exposures reference data sets and associated IRB-CCF, and that the impact is immaterial or has been effectively mitigated within their estimation process and, in that regard, the following shall not be deemed appropriate:
  5. setting floors or caps to CCF or exposure value observations, with the exception of the realised conversion factor equal to zero, in accordance with paragraph (2) of this Article;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 234 8) using debtor-level estimates that do not fully cover the relevant product transformation options or that inappropriately combine products with very different characteristics; 9) adjusting only material observations affected by product transformation; 10)excluding observations affected by product profile transformation. (9) A credit institution shall ensure that their IRB-CCF are effectively quarantined from the potential effects of region of instability caused by a facility being close to being fully drawn at the reference date. (10) Reference data shall not be capped at the principal amount outstanding of a facility or the available facility limit, whereat accrued interest, other due payments and drawings in excess of facility limits shall be included in the reference data. (11) For exposures to business undertakings, credit institutions, central governments and central banks, and regional government units, local self-government units and public sector entities, estimates of conversion factors shall be based on data over a minimum of five years, increasing by one year each year after implementation of IRB Approach until a minimum of seven years is reached, for at least one data source. If the available observation period spans a longer period for any source, and the data are relevant, a credit institution shall use that longer period. (12) For retail exposures, a credit institution may reflect future drawings either in its conversion factors or in its LGD estimates. (13) For retail exposures, estimates of conversion factors shall be based on data over a minimum of five years. A credit institution may, subject to the authorisation of the Central Bank, use, when it implements the IRB Approach, relevant data covering a period of two years, and the period to be covered shall be increased by one year each year until relevant data cover at least five years. Criteria for identifying economic downturn Article 223 (1) A credit institution shall, for the purposes of Article 221 paragraph (1) item 2) and Article 222 paragraph (1) item 2) of this Decision, identify an economic downturn for a given type of exposures, by applying the following rules:

  1. the nature of an economic downturn is characterised by a set of economic indicators that are classified as relevant for exposures within that type of exposures in accordance with the rules laid down in paragraph (4) of this Article;
  2. in terms of severity, an economic downturn is indicated by the most severe value relating to a 12-month period (‘the most severe 12-month value’) that is observed, for each economic indicator in the relevant indicator set, over a historical time￾span determined for that economic indicator in accordance with paragraph (8) of this Article;
  3. an economic downturn is comprised of one or more distinct downturn periods covering the peaks and troughs related to the most-severe 12-month values for the economic indicators in the relevant indicator set, each such period being of a duration determined in accordance with paragraph (9) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 235 (2) For the purposes of paragraph (1) item 2) of this Article, the 12-month periods to which values for an economic indicator relate may start at any point in time within the applicable time-span. (3) For the purposes of paragraph (1) item 3) of this Article:

  1. a downturn period is a period in which an economic indicator reaches its most severe 12-month value;
  2. where, for different, significantly correlated economic indicators, the peaks or troughs related to the most severe 12-month values are reached simultaneously or shortly after each other, the downturn periods in which those indicators reach their most severe 12-month value are to be treated as one single downturn period covering the most severe 12-month values for all those indicators. (4) The following economic indicators shall be classified as relevant for exposures within a given type of exposures:
  3. gross domestic product (GDP);
  4. unemployment rate;
  5. externally provided aggregate default rates, where available;
  6. externally provided aggregate credit losses, where available; (5) In addition to the economic indicators referred to in paragraph (4) of this Article, the following indicators may be used:
  7. for exposures to large business undertakings or to retail small and medium-sized enterprises: sector- or industry-specific indices;
  8. for residential property exposures to large business undertakings or to retail debtors: residential immovable property prices or residential immovable property price indices;
  9. for commercial immovable property exposures to large business undertakings or to retail debtors secured by a mortgage on commercial immovable property:
  • commercial immovable property prices or commercial immovable property price indices;
  • commercial immovable property rental prices or commercial immovable property rental price indices;
  1. for retail exposures other than those falling within items 1), 2) and 3) of this paragraph: total household debt and disposable personal income, in each case where available;
  2. for specialised lending exposures:
  • in the case of immovable property: immovable property prices or immovable property price indices, immovable property rental prices, or immovable property rental price indices for residential, commercial or industrial property, as applicable,
  • in the case of project finance: prices for the underlying products supplied,
  • in the case of object finance: indices for the relevant type or types of collateral,
  • in the case of commodity finance: prices or price indices for the relevant type of commodity;
  1. for exposures to credit institutions: financial credit indices;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 236 (6) In addition to the economic indicators listed in paragraphs (4) and (5) of this Article, a credit institution may also use other economic indicators that are explanatory variables for, or indicators of, the economic cycle specific to exposures in the type of exposures under consideration. (7) The economic indicators identified for exposures within a type of exposures in accordance with paragraphs (4) to (6) of this Article should reflect the geographical distribution and, where applicable, the sectoral distribution of the exposures within that type of exposures. (8) For the purposes of paragraph (1) item 2) of this Article, the historical time-span applicable to an economic indicator shall be the period of 20 years ending at the point in time at which the credit institution identifies the economic downturn in accordance with this Article, whereat, if the variability of an economic indicator over that 20-year period is not representative of the likely range of variability of that indicator in the future, the historical time-span applicable to that indicator shall be of such longer length as is sufficient to provide values that are representative of that likely range of variability. (9) For the purposes of paragraph (1) item 3) of this Article, the duration of a downturn period shall be determined as follows:

  1. in a case falling within paragraph (3) item 2) of this Article, the single downturn period shall be such period that is long enough to cover all the peaks or troughs related to the most severe 12-month values observed for the different economic indicators associated with that single downturn period;
  2. in all cases, whether or not falling within paragraph (3) item 2) of this Article, where the various 12-month values observed for the economic indicator or indicators in question over the applicable time-span do not significantly deviate from their most severe 12-month value over a specific, continuous period of time within the applicable time-span, the downturn period shall be long enough to reflect the prolonged severity observed for the economic indicator or indicators in question;
  3. in all cases, whether or not falling within paragraph (3) item 2) of this Article, where the economic indicator or indicators show adjacent peaks or troughs to those peaks or troughs related to the most severe 12-month values observed for the economic indicator or indicators in question over the applicable time-span and those adjacent peaks and troughs do not significantly deviate from the most severe 12-month value observed for that indicator or those indicators over that time-span and those adjacent peaks and troughs are related to the same overall economic condition, the downturn period shall be long enough to reflect the whole prolonged period over which those adjacent peaks or troughs are observed;
  4. in a case falling within paragraph (3) item 1) of this Article, where neither item 2) nor item 3) of this paragraph applies, the downturn period shall be the 12-month period to which the most severe 12-month value relates.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 237 Requirements for assessing the effect of unfunded credit protection for exposures to central governments and central banks, exposures to regional government units, local self-government and public sector entities, and exposures to business undertakings, where own estimates of LGD are used and for retail exposures Article 224 (1) The following requirements shall apply in relation to eligible guarantors and guarantees:

  1. a credit institution shall have clearly specified criteria for the types of guarantors it recognises for the calculation of risk-weighted exposure amounts;
  2. for recognised guarantors the same rules as for debtors as set out in Articles 212, 213 and 214 of this Decision shall apply;
  3. the guarantee shall be evidenced in writing, non-cancellable and non￾changeable on the part of the guarantor, in force until the obligation is satisfied in full, to the extent of the amount and tenor of the guarantee, and legally enforceable against the guarantor in a jurisdiction where the guarantor has assets to attach and enforce a judgement;
  4. the guarantee shall be unconditional. (2) For the purposes paragraph (1) item 4) of this Article, an ‘unconditional guarantee’ means a guarantee where the credit protection contract does not contain any clause the fulfilment of which is outside the direct control of the lending credit institution and that could prevent the guarantor from being debtor to pay out in a timely manner pursuant to the qualifying default of the debtor or to the non-payment by the original debtor. (3) A guarantee shall also be considered unconditional if the credit protection contract contains a clause providing that a flawed due diligence or fraud by the lending institution cancels or diminishes the extent of the guarantee offered by the guarantor. (4) Guarantees where the payment by the guarantor is subject to the credit institution first having to pursue the debtor and that only cover losses remaining after the credit institution has completed the workout process shall be considered unconditional. (5) A credit institution may recognise unfunded credit protection by using either the PD/LGD modelling adjustment approach, in accordance with this Article and subject to the requirement set out in paragraph (14) of this Article, or the substitution of risk parameters approach under A-IRB in accordance with Article 274 of this Decision and subject to the eligibility requirements of Subtitle 4 of this Title. (6) A credit institution shall have clear policies for assessing the effects of unfunded credit protection on risk parameters, shall be consistent with their internal risk management practices and shall reflect the requirements of this Article. (7) A credit institution shall clearly specify in those policies which of the specific methods described in paragraph (5) of this Article are used for each rating system, and it shall apply those policies consistently over time.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 238 (8) A credit institution shall have clearly specified criteria for adjusting grades, pools or own LGD estimates, and, in the case of retail and eligible purchased receivables, the process of allocating exposures to grades or pools, to reflect the impact of guarantees for the calculation of risk-weighted exposure amounts , which shall comply with the requirements set out in Articles 211, 212 and 213 of this Decision. (9) The criteria referred to in paragraph (5) of this Article should be plausible and intuitive, and they shall address the guarantor's ability and willingness to perform under the guarantee, the likely timing of any payments from the guarantor, the degree to which the guarantor's ability to perform under the guarantee is correlated with the debtor's ability to repay, and the extent to which residual risk to the debtor remains. (10) The requirements for guarantees in this Article shall apply also for single-name credit derivatives, whereat, if there is a mismatch between the underlying obligation and the reference obligation of the credit derivative or the obligation used for determining whether a credit event has occurred, the requirements referred to in Article 254 paragraph (3) of this Decision shall apply. (11) A credit institution shall apply the provisions of paragraph (10) of this Article to the process of allocating exposures to grades or pools for retail exposures and eligible purchased receivables. (12) The criteria shall address the payout structure of the credit derivative and conservatively assess the impact this has on the level and timing of recoveries. The credit institution shall consider the extent to which other forms of residual risk remain. (13) First-to-default credit derivatives may be recognised as eligible unfunded credit protection. However, second-to-default and all other nth-to-default credit derivatives shall not be recognised as eligible unfunded credit protection. (14) Where a credit institution recognises unfunded credit protection by the PD/LGD modelling adjustment approach, the covered part of the underlying exposure shall not be assigned a risk weight which would be lower than the protection-provider-RW￾floor, and the protection-provider-RW-floor shall be calculated using the same PD, LGD and risk weight function as the ones applicable to comparable direct exposure to the protection provider as referred to in Article 274 of this Decision. (15) For retail guarantees, the requirements set out in paragraphs (1) to (9) shall also apply to the assignment of exposures to grades or pools, and the estimation of PD. Requirements for purchased receivables Article 225 (1) In quantifying the risk parameters to be associated with rating grades or pools for purchased receivables, a credit institution shall ensure the conditions laid down in paragraphs (2) to (11) of this Article are met.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 239 (2) The structure of individual credit exposure (based on the purchased receivable) shall ensure that under all foreseeable circumstances the credit institution has effective ownership and control of all cash remittances from purchased receivables. (3) When the debtor makes payments directly to a seller or servicer, the credit institution shall verify regularly that payments are forwarded completely and within the contractually agreed terms. (4) A credit institution shall have procedures to ensure that ownership over the receivables and cash receipts is protected against bankruptcy stays or legal challenges that could materially delay the lender's ability to liquidate or assign the receivables or retain control over cash receipts. (5) A credit institution shall monitor both the quality of the purchased receivables and the financial condition of the seller and servicer, and to that effect it shall:

  1. assess the correlation among the quality of the purchased receivables and the financial condition of both the seller and servicer, and have in place internal policies and procedures that provide adequate safeguards to protect against any contingencies, including the assignment of an internal rating for each seller and servicer;
  2. have clear and effective policies and procedures for determining seller and servicer eligibility; a credit institution or its agent shall conduct periodic reviews of sellers and servicers in order to verify the accuracy of reports from the seller or servicer, detect fraud or operational weaknesses, and verify the quality of the seller's credit policies and servicer's collection policies and procedures, and the findings of these reviews shall be documented;
  3. assess the characteristics of the purchased receivables pools, including over￾advances; history of the seller's arrears, bad debts, and bad debt allowances; payment terms, and potential contra accounts;
  4. have effective policies and procedures for monitoring on an aggregate basis the single-debtor concentrations both within and across purchased receivables pools;
  5. ensure that it receives from the servicer timely and sufficiently detailed reports of receivables ageings and dilutions to ensure compliance with the credit institution's eligibility criteria and advancing policies governing purchased receivables, and provide an effective means with which to monitor and confirm the seller's terms of sale and dilution. (6) The credit institution shall have systems and procedures for detecting deteriorations in the seller's financial condition and purchased receivables quality at an early stage, and for addressing emerging problems in a fast and efficient manner. (7) A credit institution shall, in particular, have clear and effective policies, procedures, and information systems to monitor covenant violations, and clear and effective policies and procedures for initiating legal actions and dealing with problem purchased receivables. (8) A credit institution shall have clear and effective policies and procedures governing the control of purchased receivables, loans, and cash.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 240 (9) A credit institution shall specify in its written internal policies all material elements of the receivables purchase programme, including the advancing rates, eligible collateral, necessary documentation, concentration limits, and the way cash receipts are to be handled, and these elements of the receivables purchase programme shall take appropriate account of all relevant and material factors, including the seller and servicer's financial condition, risk concentrations, and trends in the quality of the purchased receivables and the seller's customer base. (10) The internal systems shall ensure that funds are advanced only against specified supporting collateral and documentation. (11) A credit institution shall have an effective internal process for assessing compliance with all internal policies and procedures, and this process shall include:

  1. regular audits of all critical phases of the credit institution's receivables purchase programme;
  2. verification of the separation of duties: − between the assessment of the seller and servicer and the assessment of the debtor, and − between the assessment of the seller and servicer and the field audit of the seller and servicer;
  3. evaluations of back office operations, with particular focus on qualifications, experience, staffing levels;
  4. scope and quality of supporting automation systems. Subsection 3 - Validation of internal estimates Validation of internal estimates Article 226 A credit institution shall validate its internal estimates subject to the following requirements:
  5. the credit institution shall have robust systems in place to validate the accuracy and consistency of rating systems, processes, and the estimation of all relevant risk parameters, which must enable the credit institution to assess the performance of internal rating and risk estimation systems consistently and meaningfully;
  6. the credit institution shall regularly compare realised default rates with estimated PDs for each grade and, where realised default rates are outside the expected range for that grade, the credit institution shall specifically analyse the reasons for the deviation; the credit institution using own estimates of LGDs and conversion factors shall also perform analogous analysis for these estimates; such comparisons shall make use of historical data that cover as long a period as possible, and the credit institution shall document the methods and data used in such comparisons; this analysis and documentation shall be updated at least annually;
  7. the credit institution shall also use other quantitative validation tools and comparisons with relevant external data sources, whereat this analysis shall be based on data that are appropriate to the credit institution's portfolio, are updated regularly, and cover a relevant observation period so that the credit

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 241 institution’s internal assessments of the performance of its rating systems shall be based on as long a period as; 4) the methods and data used for quantitative validation shall be consistent through time, and the changes in estimation and validation methods and data (both data sources and periods covered) shall be documented; 5) the credit institution shall have appropriate internal standards for situations where deviations in realised PDs, LGDs, conversion factors and total losses, where EL is used, from expectations, become significant enough to call the validity of the estimates into question. These standards shall take account of business cycles and similar systematic variability in default experience. Where realised values continue to be higher than expected values, the credit institution shall revise estimates upward to reflect their default and loss experience. Subsection 5 - Internal governance and oversight Corporate governance Article 227 (1) A credit institution's management board and senior management shall approve all material aspects of the rating and estimation processes, and possess a general understanding of the rating systems of the credit institution and detailed comprehension of the associated reports that include information relating to ratings. (2) Senior management shall:

  1. report to the credit institution's management board of important changes or deviations from established policies that will materially impact the operations of the credit institution's rating systems;
  2. have a good understanding of the rating systems designs and operations;
  3. ensure, on an ongoing basis that the rating systems are operating properly. (3) Senior management shall be regularly informed by the credit risk control units about the performance of the rating process, areas needing improvement, and the status of efforts to improve previously identified deficiencies. (4) Internal ratings-based analysis of the credit institution's credit risk profile shall be an essential part of the management reporting to the senior management, and this reporting shall include in particular:
  4. risk profile by grade,
  5. migration across grades, estimation of the relevant parameters per grade,
  6. comparison of realised default rates, and to the extent that own estimates are used, of realised LGDs and realised conversion factors against expectations, and
  7. stress-test results. (5) Frequencies of the reporting referred to in paragraph (1) of this Article shall depend on the significance and type of information and the level of the recipient.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 242 Credit risk control Article 228 (1) The credit risk control function in a credit institution shall be independent from the persons and management functions responsible for originating or renewing exposures and that unit shall be responsible for the design or selection, implementation, oversight and performance of the rating systems, and it shall regularly produce and analyse reports on the output of the rating systems. (2) The areas of responsibility for the credit risk control function shall include:

  1. testing and monitoring grades and pools;
  2. production and analysis of summary reports of the credit institution's rating systems;
  3. implementing procedures to verify that grade and pool definitions are consistently applied across departments and geographic areas;
  4. reviewing and documenting any changes to the rating process, including the reasons for the changes;
  5. reviewing the rating criteria to evaluate if they remain predictive of risk. Changes to the rating process, criteria or individual rating parameters shall be documented and retained;
  6. active participation in the design or selection, implementation and validation of models used in the rating process;
  7. oversight of models used in the rating process;
  8. ongoing review and alterations to models used in the rating process. (3) The credit institution using pooled data in accordance with Article 219 paragraph (3) of this Decision may outsource the following tasks:
  9. production of information relevant to testing and monitoring grades and pools;
  10. production of summary reports of the credit institution's rating systems;
  11. production of information relevant to a review of the rating criteria to evaluate if they remain predictive of risk;
  12. documentation of changes to the rating process, criteria or individual rating parameters;
  13. production of information relevant to ongoing review and alterations to models used in the rating process. (4) The credit institution making use of paragraph (3) of this Article shall ensure that the Central Bank has access to all relevant information from the third party that is necessary for examining compliance with the requirements and that the Central Bank may perform on-site examinations to the same extent as within the credit institution. Internal Audit Article 229 Internal audit shall review at least annually the credit institution's rating systems and their operations, including the operations of the credit function and the estimation of PDs, LGDs, ELs and conversion factors, and the areas of review shall include adherence to all applicable requirements referred to in this Decision relating to the credit institution’s rating systems and their functioning.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 243 SUBTITLE 4 - Credit risk mitigation Section 1 – Meaning of terms and general requirements Meaning of terms Article 230 The terms used in this Subtitle, shall have the following meanings:

  1. lending credit institution means a credit institution which has the exposure in question;
  2. secured lending transaction means any transaction giving rise to an exposure secured by collateral which does not include a provision conferring upon the credit institution the right to receive margin (additional collateral) at least daily, if the value of the existing collateral decreases;
  3. capital market-driven transaction means any transaction giving rise to an exposure secured by collateral which includes a provision conferring upon the institution the right to receive additional collateral at least daily, if the value of the existing collateral decreases;
  4. underlying CIU means a CIU in the shares or interest of which another CIU has invested;
  5. substitution of risk parameters approach under A-IRB means the substitution, in accordance with Article 274 of this Decision, of both the probability of default and loss given default risk parameters of the underlying exposure with the corresponding PD and LGD that would be assigned under the IRB approach using own estimates of LGD to a comparable direct exposure to the protection provider. Principles for recognising the effect of credit risk mitigation techniques Article 231 (1) No exposure in respect of which a credit institution obtains credit risk mitigation shall produce a higher risk-weighted exposure amount or expected loss amount than an otherwise identical exposure in respect of which a credit institution has no credit risk mitigation. (2) Where the risk-weighted exposure amount already takes account of credit protection under Subtitle 2 or 3 of this Part of the Decision, as applicable, the credit institution shall not take into account that credit protection in the calculations under this Subtitle. (3) Where the provisions in Sections 2 and 3 of this Subtitle are met, a credit institution may adjust the calculation of risk-weighted exposure amounts under the Standardised Approach and the calculation of risk-weighted exposure amounts and expected loss amounts under the IRB Approach in accordance with the provisions of Sections 4, 5 and 6 of this Subtitle. (4) A credit institution shall treat cash, securities or commodities purchased, borrowed or received under a repurchase transaction or securities or commodities lending or borrowing transaction as collateral.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 244 (5) Where a credit institution calculating risk-weighted exposure amounts under the Standardised Approach has more than one form of credit risk mitigation covering a single exposure it shall do both of the following:

  1. subdivide the exposure into parts covered by each type of credit risk mitigation tool; and
  2. calculate the risk-weighted exposure amount for each part obtained in item (1) of this paragraph separately in accordance with the provisions of Subtitle 2 and this Subtitle of this Decision. (6) Where a credit institution calculating risk-weighted exposure amounts under the Standardised Approach covers a single exposure with credit protection provided by a single protection provider and that protection has differing maturities, it shall do both of the following:
  3. subdivide the exposure into parts covered by each credit risk mitigation tool; and
  4. calculate the risk-weighted exposure amount for each part obtained in item (1) of this paragraph separately in accordance with the provisions of Subtitle 2 and this Subtitle of this Decision. (7) Collateral that satisfies all eligibility requirements set out in this Subtitle may be recognised even for exposures associated with undrawn facilities, where drawing under the facility is conditional on the prior or simultaneous purchase or reception of collateral to the extent of the credit institution’s interest in the collateral once the facility is drawn, such that the credit institution does not have any interest in the collateral to the extent the facility is not drawn. Principles governing the eligibility of credit risk mitigation techniques Article 232 (1) The technique used to provide the credit protection together with the actions and steps taken and procedures and policies implemented by the lending credit institution shall be such as to result in credit protection arrangements which are legally effective and enforceable in all relevant jurisdictions. (2) The lending credit institution shall provide, upon request of the Central Bank, the most recent version of the independent, written and reasoned legal opinion or opinions that it used to establish whether its credit protection arrangement meets the conditions laid down in paragraph (1) of this Article. (3) The lending credit institution shall take all appropriate steps to ensure the effectiveness of the credit protection arrangement and to address the risks related to that arrangement. (4) A credit institution may recognise funded credit protection in the calculation of the effect of credit risk mitigation only where the assets relied upon for protection meet the following conditions:
  5. they are included in the list of eligible assets set out in Articles 235 to 238 of this Decision, as applicable; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 245 2) they are sufficiently liquid and their value over time sufficiently stable to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk-weighted exposure amounts and to the degree of recognition allowed. (5) A credit institution may recognise funded credit protection in the calculation of the effect of credit risk mitigation only where the lending credit institution has the right to liquidate or retain, in a timely manner, the assets from which the protection derives in the event of the default, bankruptcy or winding-up, or other credit event set out in the transaction documentation of the debtor and, where applicable, of the custodian holding the collateral, and the degree of correlation between the value of the assets relied upon for protection and the credit quality of the debtor shall not be too high. (6) In the case of unfunded credit protection, a protection provider shall qualify as an eligible protection provider only where it is recognised as such in Article 239 of this Decision. (7) In the case of unfunded credit protection, an instrument of the protection (protection agreement) shall qualify as an eligible protection agreement only where it meets the following conditions:

  1. the instrument is included in the list of eligible protection instruments set out in Articles 240 and 241 paragraphs (1) and (2) of this Decision;
  2. the instrument (protection agreement) is legally effective and enforceable in the relevant jurisdictions, to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk-weighted exposure amounts and to the degree of recognition allowed;
  3. the protection provider meets the criteria laid down in paragraph (6) of this Article. (8) Credit protection shall comply with the requirements set out in Section 3 of this Subtitle that relate to credit protection. (9) A credit institution shall be able to demonstrate to the Central Bank that it has adequate risk management processes to control those risks to which it may be exposed as a result of carrying out credit risk mitigation practices. (10) A credit institution shall, although credit risk mitigation has been taken into account for the purposes of calculating risk-weighted exposure amounts and, where applicable, expected loss amounts, continue to undertake a full credit risk assessment of the underlying exposure and be in a position to demonstrate the fulfilment of this requirement to the Central Bank. (11) For the purposes of paragraph (1) of this Article, for repurchase transactions and securities lending or commodities lending or borrowing transactions the underlying exposure shall be deemed to be the net amount of the exposure. Section 2 - Eligible forms of credit risk mitigation

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 246 Sub-section 1 - Funded credit protection On-balance sheet netting Article 233 (1) A credit institution may use on-balance sheet netting of mutual claims between itself and its counterparty as an eligible form of credit risk mitigation. (2) Without prejudice to Article 234 of this Decision, eligibility of on-balance sheet netting is limited to reciprocal cash balances between the credit institution and the counterparty. (3) A credit institution may adjust risk-weighted exposure amounts and, as relevant, expected loss amounts only for loans and deposits that they have received themselves and that are subject to an on-balance sheet netting agreement. Master netting agreements Article 234 (1) A credit institution applying the Financial Collateral Comprehensive Method set out in Article 259 of this Decision may take use as credit protection the bilateral netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions, or other capital market-driven transactions. (2) Without prejudice to Article 386 of this Decision, the collateral taken and securities or commodities borrowed within such agreements or transactions shall comply with the eligibility requirements for collateral set out in Articles 235 and 236 of this Decision. Eligibility of collateral under all approaches and methods Article 235 (1) A credit institution may use the following items as eligible collateral under all approaches and methods:

  1. cash on deposit with, or instruments that may be deemed as cash – so called cash assimilated instruments held by, the lending credit institution;
  2. debt securities issues by the Government of Montenegro or the Central Bank;
  3. debt securities, issued by central governments or central banks, which have a credit assessment by an ECAI or export credit agency where: ­ the ECAI or export credit agency has been nominated by the credit institution for the purposes of Subtitle 2 of this Title; ­ the credit assessment has been determined by EBA to be associated with credit quality step 1, 2, 3 or 4 under the rules for the risk weighting of exposures to central governments and central banks under Subtitle 2 of this Title;
  4. debt securities, issued by credit institutions, which have a credit assessment by an ECAI where: ­ the ECAI has been nominated by the institution for the purposes of Subtitle 2 of this Title;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 247 ­ the credit assessment has been determined by EBA to be associated with credit quality step 1, 2 or 3 under the rules for the risk weighting of exposures to institutions under Subtitle 2 of this Title; 5) debt securities, issued by other entities, which have a credit assessment by an ECAI where: ­ the ECAI has been nominated by the credit institution for the purposes of Subtitle 2 of this Title; ­ the credit assessment has been determined by EBA to be associated with credit quality step 1, 2 or 3 under the rules for the risk weighting of exposures to corporates under Subtitle 2 of this Title; 6) debt securities having a short-term credit assessment by an ECAI where: ­ the ECAI has been nominated by the credit institution for the purposes of Subtitle 2 of this Title; ­ the credit assessment has been determined by EBA to be associated with credit quality step 1, 2 or 3 under the rules for the risk weighting of short￾term exposures under Subtitle 2 of this Title; 7) equities or convertible bonds that are included in a main index; 8) gold; 9) securitisation positions that are not resecuritisation positions and which are subject to a 100% risk weight or lower in accordance with Article 305 to Article 308 of this Decision. (2) For the purposes of paragraph (1) item 1) of this Article, cash assimilated instrument means a certificate of deposit, bonds including covered bonds or any other non-subordinated instrument, which has been issued by the credit institution, for which it has already received full payment and which shall be unconditionally reimbursed by the institution at its nominal value. (3) Within the meaning of paragraph (1) item 3) of this Article, debt securities issued by central governments or central banks shall also include the following:

  1. debt securities issued by regional government units or local self-government units, exposures to which are treated as exposures to the central government in whose jurisdiction they are established under Article 152 paragraph (4) of this Decision;
  2. debt securities issued by public sector entities which are treated as exposures to central governments in accordance with Article 153 paragraphs (5) and (6) of this Decision;
  3. debt securities issued by multilateral development banks to which a 0% risk weight is assigned under Article 154 paragraph (4) of this Decision; and
  4. debt securities issued by international organisations which are assigned a 0% risk weight under Article 155 of this Decision. (4) Within the meaning of paragraph (1) item 4) of this Article, debt securities issued by credit institutions shall also include the following:
  5. debt securities issued by regional government units or local self-government units, other than those debt securities referred to in paragraph (3) item 1) of this Article;
  6. debt securities issued by public sector entities, exposures to which are treated in accordance with Article 153 paragraphs (1), (2), and (3) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 248 3) debt securities issued by multilateral development banks other than those to which a 0% risk weight is assigned under Article 154 paragraph (4) of this Decision. (5) A credit institution may use debt securities that are issued by other credit institutions and investment firms that do not have a credit assessment by an ECAI as eligible collateral where those debt securities fulfil the following criteria:

  1. they are listed on a recognised exchange;
  2. they qualify as senior debt;
  3. all other rated issues by the issuing credit institution of the same seniority have a credit assessment by an ECAI for which the EBA determined that corresponds at least to credit quality step 3 or above under the rules for the risk weighting of exposures to institutions or short term exposures under Subtitle 2 of this Title;
  4. the lending credit institution has no information to suggest that the issue would justify a credit assessment below that indicated in item 3) of this Article;
  5. the liquidity of the instrument is sufficient for these purposes. (6) A credit institution may use interest or shares in CIUs as eligible collateral where the following conditions are satisfied:
  6. the interest or shares have a daily public price quote;
  7. the CIUs are limited to investing in instruments that are eligible for recognition under paragraphs (1) and (5) of this Article; and
  8. the CIU meets the conditions laid down in Article 172 paragraph (5) of this Decision. (7) Where a CIU invests in shares or interest of another CIU, conditions laid down in paragraph (6) items 1), 2), and 3) of this Article shall apply equally to any such underlying CIU. (8) Where the CIU uses derivative instruments to hedge permitted investments, it shall not prevent interest or shares in that undertaking from being eligible as collateral. (9) For the purposes of paragraphs (6), (7) and (8) of this Article, where a CIU (the ‘original CIU’) or any of its underlying CIUs are not limited to investing in instruments that are eligible under paragraphs (1) and (5) of this Article, the following shall apply:
  9. where a credit institution applies the look-through approach referred to in Article 173 paragraph (1) or Article 194 paragraph (2) of this Article for direct exposures to a CIU, it may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU that are eligible under paragraphs (1) and (5) of this Article;
  10. where a credit institution applies the mandate-based approach referred to in Article 173 paragraph (2) or Article 194 paragraph (6) of this Article for direct exposures to a CIU, it may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU that are eligible under paragraphs (1) and (5) of this Article under the assumption that that CIU or any of its underlying CIUs have invested in non-eligible instruments to the maximum extent allowed under their respective mandates.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 249 (10) Where any underlying CIU has underlying CIUs of its own, the credit institution may use interest or shares in the original CIU as eligible collateral provided that they apply the methodology laid down in paragraph (9) of this Article. (11) Where non-eligible assets can have a negative value due to liabilities or contingent liabilities resulting from ownership, the credit institution shall:

  1. calculate the total value of the non-eligible assets; and
  2. where the amount obtained under item 1) of this paragraph is negative, subtract the absolute value of that amount from the total value of the eligible assets. (12) With regard to paragraph (1) items 3) to 6) of this Article, where a security has two credit assessments by ECAIs, the credit institution shall apply the less favourable assessment, and where a security has more than two credit assessments by ECAIs, the credit institution shall apply the two most favourable assessments, and where the two most favourable credit assessments are different, the credit institution shall apply the less favourable of the two. (13) The list of main indices, for the purposes of paragraph (1) item 7) of this Article, Article 236 paragraph (1) item 1), Article 261 paragraphs (1) and (6) and Article 386 paragraph (2) item 4) of this Decision, shall be given in Table 1 of Annex 3 which makes and integral part thereof. (14) The list of recognised exchanges, for the purposes of paragraph (5) item 1) of this Article, Article 236 paragraph (1) item 1), Article 261 paragraphs (1) and (6) and Article 386 paragraph (2) item 4) of this Decision, shall be given in Tables 2 and 3 of Annex 3 which makes and integral part thereof. Additional eligibility of collateral under the Financial Collateral Comprehensive Method Article 236 (1) A credit institution which, in addition to the collateral referred to in Article 235 of this Decision, uses the Financial Collateral Comprehensive Method set out in Article 260 of this Decision, the credit institution may use as eligible collateral:
  3. equities or convertible bonds not included in a main index but traded on a recognised exchange; and
  4. interest or shares in CIUs where the following conditions are met: − the interest or shares have a daily public price quote; and − the CIU is limited to investing in instruments that are eligible for recognition under Article 235 paragraphs (1) and (5) of this Decision and the items mentioned in item 1) of this paragraph. (2) In the case a CIU invests in interest or shares of another CIU, conditions referred to in paragraph (1) items 1) and 2) of this Article equally apply to any such underlying CIU. (3) Where a CIU uses derivative instruments to hedge permitted investments, it shall not prevent interest or shares in that undertaking from being eligible as collateral.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 250 (4) Where the CIU or any underlying CIU are not limited to investing in instruments that are eligible for recognition under Article 235 paragraphs (1) and (5) of this Decision and in the items referred to in paragraph (1) item 1) of this Article, the following shall apply:

  1. where a credit institution applies the look-through approach referred to in Article 173 paragraph (1) or 194 paragraph (2) of this Decision for direct exposures to a CIU, it may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU, that are eligible under Article 235 paragraphs (1) and (5) of this Decision, and the items referred to in paragraph (1) item 1) of this Article;
  2. where a credit institution applies the mandate-based approach referred to in Article 173 paragraph (2) or 194 paragraph (6) of this Decision for direct exposures to a CIUs, it may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU, that are eligible under Article 235 paragraphs (1) and (5) of this Decision, and the items referred to in paragraph (1) item 1) of this Article under the assumption that that CIU or any of its underlying CIUs have invested in non-eligible instruments to the maximum extent allowed under their respective mandates. (5) Where non-eligible instruments can have a negative value due to liabilities or contingent liabilities resulting from ownership, a credit institution shall:
  3. calculate the total value of the non-eligible instruments; and
  4. where the amount obtained under item 1) of this paragraph is negative, subtract the absolute value of that amount from the total value of the eligible instruments. Additional eligibility for collateral under the IRB Approach Article 237 (1) In addition to the collateral referred to in Articles 235 and 236 of this Decision, the credit institution that calculates risk-weighted exposure amounts and expected loss amounts under the IRB Approach may also use the following forms of collateral:
  5. immovable property collateral in accordance with paragraphs (2) to (6) of this Article;
  6. receivables in accordance with paragraph (8) of this Article;
  7. other physical collateral in accordance with paragraph (9) of this Article; and
  8. leasing in accordance with paragraph (11) of this Article. (2) Unless otherwise specified in the provisions of Article 163 paragraph (14) of this Decision, a credit institution may use as eligible collateral residential property which is or will be occupied or let by the owner, or the beneficial owner in the case of personal investment companies, and commercial immovable property, including offices and other commercial premises, where both the following conditions are met:
  9. the value of the property does not materially depend upon the credit quality of the debtor;
  10. the risk of the debtor does not materially depend upon the performance of the underlying property or project, but on the underlying capacity of the debtor to repay the debt from other sources, so that the repayment of individual credit exposure does not materially depend on any cash flow generated by the underlying property serving as collateral.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 251 (3) A credit institution may, for the purposes of paragraph (2) item 1) of this Article, exclude situations where purely macro-economic factors affect both the property value and the performance of the borrower. (4) A credit institution may derogate from paragraph (2) item (2) of this Article for exposures secured by residential property situated within the territory of Montenegro or an EU Member State or equivalent third country referred to in Article 3 paragraph (1) item 113), where the Central Bank or competent authority of that EU Member State, or third-country competent authority, has published evidence showing that a well￾developed residential property market is present in the territory of Montenegro or that EU Member State or equivalent third country, respectively, with loss rates referred to in Article 163 paragraph 16) of this Decision, that the credit institution shall report to the Central Bank, competent authority of that EU Member State or equivalent third country, that do not exceed any of the following limits:

  1. the aggregated amount referred to in Article 163 paragraph (16) item 1) of this Decision, divided by the aggregated amount referred to in Article 163 paragraph (16) item 3) of this Decision, does not exceed 0,3%; and
  2. the aggregated amount referred to in Article 163 paragraph (16) item 2) of this Decision, divided by the aggregated amount referred to in Article 163 paragraph (16) item 3) of this Decision, does not exceed 0,5%. (5) Where either of the conditions in paragraph (3) of this Article is not met in a given year, a credit institution shall not use the treatment set out in that paragraph until both conditions are satisfied in a subsequent year. (6) A credit institution may derogate from paragraph (2) item 2) of this Article for commercial immovable property situated within the territory of Montenegro or an EU Member State or equivalent third country referred to in Article 3 paragraph (1) item 113), where the Central Bank or competent authority of that EU Member State, or third-country competent authority, has published evidence showing that a well￾developed residential property market is present in the territory of Montenegro or that EU Member State or equivalent third country, respectively, with loss rates referred to in Article 163 paragraph 16) of this Decision, that the credit institution shall report to the Central Bank, competent authority of that EU Member State or equivalent third country, that do not exceed any of the following limits:
  3. the aggregated amount referred to in Article 163 paragraph (16) item 4) of this Decision, divided by the aggregated amount referred to in Article 163 paragraph (16) item 6) of this Decision, does not exceed 0,3%; and
  4. the aggregated amount referred to in Article 163 paragraph (16) item 5) of this Decision, divided by the aggregated amount referred to in Article 163 paragraph (16) item 6) of this Decision, does not exceed 0,5%. (6) Where either of the conditions in paragraph (6) of this Article is not met in a given year, a credit institution shall not use the treatment set out in that paragraph until both conditions are satisfied in a subsequent year. (7) A credit institution may use as eligible collateral amounts receivable linked to a commercial transactions with an original maturity of up to one year, except receivables

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 252 associated with securitisations, sub-participations or credit derivatives, as well as receivables from connected persons that may not be treated as eligible collateral. (9) The Central Bank shall allow a credit institution to use as eligible collateral physical collateral of a type other than those indicated in paragraphs (2) to (6) of this Article where all the following conditions are met:

  1. there are liquid markets, evidenced by frequent transactions taking into account the asset type, for the disposal of the collateral in an expeditious and economically efficient manner, and the credit institution shall carry out the assessment of the collateral marketability periodically, and where information indicates material changes in the market;
  2. there are well-established, publicly available market prices for the collateral, and the credit institution may consider market prices as:
  • well-established, where they come from reliable sources of information such as public indices and reflect the price of the transactions under normal conditions;
  • publicly available, where these prices are disclosed, easily accessible, and obtainable regularly and without any undue administrative or financial burden;
  1. the credit institution analyses the market prices, time and costs required to liquidate the collateral and the realised proceeds from the collateral;
  2. the credit institution demonstrates that in at least 90% of all liquidations for a given type of collateral the realised proceeds from the collateral are not below 70% of the collateral value, and where there is material volatility in the market prices, the credit institution demonstrates to the satisfaction of the Central Bank that its valuation of the collateral is sufficiently conservative. (10) A credit institution shall document the fulfilment of the conditions specified in paragraph (9) items 1) to 4) of this Article and those specified in Article 248 of this Decision. (11) Subject to the provisions of Article 266 paragraph (3) of this Decision, where the requirements set out in Article 249 of this Decision are met, exposures arising from transactions whereby the credit institution leases property to a third party may be treated in the same manner as loans collateralised by the type of property leased. Other funded credit protection Article 238 A credit institution may use the following other funded credit protection as eligible collateral:
  3. cash on deposit with, or cash assimilated instruments held by, another institution in a non-custodial arrangement and pledged to the lending credit institution;
  4. life insurance policies pledged to the lending credit institution;
  5. instruments issued by third party credit institutions or investment firms which will be repurchased by that credit institution or investment firm on request.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 253 Subsection 2 - Unfunded credit protection Eligibility of protection providers under all approaches Article 239 (1) A credit institution may use the following entities as eligible providers of unfunded credit protection:

  1. central governments and central banks;
  2. regional government units or local self-government units;
  3. multilateral development banks;
  4. international organisations to which a 0% risk weight is assigned in accordance with Article 155 of this Decision;
  5. public sector entities, claims on which are treated in accordance with Article 153 of this Decision;
  6. credit institutions, and financial institutions for which exposures to the financial institution are treated as exposures to credit institutions in accordance with Article 156 paragraph (4) of this Decision;
  7. regulated financial sector entities;
  8. where the credit protection is not provided to a securitisation exposure, other undertakings, that have a credit assessment by a nominated ECAI, including parent undertakings, subsidiary undertakings or affiliated entities of the debtor where a direct exposure to those parent undertakings, subsidiary undertakings or affiliated entities has a lower risk weight than the exposure to the debtor;
  9. qualifying central counterparties. (2) For the purposes of paragraph (1) item 7)of this Article, regulated financial sector entity means a financial sector entity meeting the condition set out in Article 184 paragraph (1), item 4) indent 2 of this Decision. (3) In addition to the protection providers referred to in paragraph (1) of this Article, business undertakings that are internally rated by the credit institution in accordance with Section 6 of Subtitle 3, shall be eligible providers of unfunded credit protection where the credit institution uses the IRB approach for exposures to those business undertakings. Eligibility of guarantees as unfunded credit protection Article 240 A credit institution may use guarantees and other sureties as eligible unfunded credit protection. Subsection 3 - Types of derivatives Eligible types of credit derivatives Article 241 (1) A credit institution may use, as eligible credit protection, the following types of credit derivatives and instruments composed of such credit derivatives or instruments that are economically effectively similar to credit derivatives:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 254

  1. credit default swaps (CDS);
  2. total return swaps; (TRS); and
  3. credit linked notes to the extent of their cash funding (CLN). (2) Credit protection arising from a total return swap purchased by a credit institution shall not qualify as eligible credit protection where the credit institution records the net payments received on the swap as net income, but does not record the offsetting deterioration in the value of the asset that is protected either through reductions in fair value or by an addition to reserves. (3) Where a credit institution conducts an internal hedge using a credit derivative, in order for the credit protection to qualify as eligible credit protection for the purposes of this Subtitle, the credit risk transferred to the trading book shall be transferred out to a third party or parties. (4) Where an internal hedge has been conducted in accordance with paragraph (3) of this Article and the requirements in this Subtitle have been met, the credit institution shall apply the rules set out in Sections 4 to 6 of this Subtitle for the calculation of risk￾weighted exposure amounts and expected loss amounts where it acquires unfunded credit protection. (5) First-to-default and all other nth-to-default credit derivatives shall not be eligible types of unfunded credit protection under this Subtitle. Eligible types of equity derivatives Article 242 (1) A credit institution may use equity derivatives which are total return swaps or other derivatives that have similar economic effects, as eligible credit protection only for the purpose of conducting internal hedges. (2) A credit institution may not be considered eligible where a credit institution buys credit protection through a total return swap and records the net payments received on the swap as net income, but does not record the offsetting deterioration in the value of the asset that is protected either through reductions in fair value or by an addition to reserves. (3) Where a credit institution conducts an internal hedge using an equity derivative, in order for the internal hedge to qualify as eligible credit protection for the purposes of this Subtitle, the credit risk transferred to the trading book shall be transferred out to a third party or parties. (4) Where an internal hedge has been conducted in accordance with paragraph (3) of this Article and the requirements in this Subtitle have been met, the credit institution shall apply the rules set out in Sections 4 to 6 of this Subtitle for the calculation of risk￾weighted exposure amounts and expected loss amounts where it acquires unfunded credit protection.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 255 Section 3 - Requirements Subsection 1 - Funded credit protection Requirements for on-balance sheet netting agreements other than master netting agreements referred to in Article 244 Article 243 On-balance sheet netting agreements other than master netting agreements referred to in Article 244 of this Decision shall qualify as an eligible form of credit risk mitigation where all the following conditions are met:

  1. those agreements are legally effective and enforceable in all relevant jurisdictions, including in the event of the bankruptcy or winding-up of a counterparty;
  2. the credit institution is able to determine at any time the assets and liabilities that are subject to those agreements;
  3. a credit institution monitors and controls the risks associated with the termination of the credit protection on an ongoing basis;
  4. a credit institution monitors and controls the relevant exposures on a net basis and does so on an ongoing basis. Requirements for specific master netting agreements Article 244 Master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions or other capital market driven transactions shall qualify as an eligible form of credit risk mitigation where the collateral provided under those agreements meets all the requirements laid down in Article 245 paragraphs (2) to (7) of this Decision and where the following conditions are met:
  5. they are legally effective and enforceable in all relevant jurisdictions, including in the event of the bankruptcy or winding-up of the counterparty;
  6. they give the non-defaulting party the right to terminate and close-out in a timely manner all transactions under the agreement upon the event of default, including in the event of the bankruptcy or winding-up of the counterparty;
  7. they provide for the netting of gains and losses on transactions closed out under an agreement so that a single net amount is owed by one party to the other. Requirements for financial collateral Article 245 (1) Financial collateral and gold shall qualify as eligible collateral under all approaches and methods, where all the requirements laid down in paragraphs (2) to (7) of this Article are met. (2) The credit quality of the debtor and the value of the collateral shall not have a material positive correlation, provided that where the value of the collateral is reduced significantly, this shall not alone imply a significant deterioration of the credit quality of the debtor, and where the credit quality of the debtor becomes critical, this shall not alone imply a significant reduction in the value of the collateral.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 256 (3) Securities issued by the debtor, or any person from the group connected with the debtor, shall not qualify as eligible collateral. (4) The debtor's own issues of covered bonds meeting the conditions referred to in Article 169 of this Decision shall qualify as eligible collateral when they are posted as collateral for a repurchase transaction, provided that they comply with the condition set out in paragraph (2) of this Article. (5) A credit institution shall fulfil any contractual and statutory requirements in respect of, and take all steps necessary to ensure, the enforceability of the collateral arrangements under the law applicable to its interest in the collateral. (6) A credit institution shall conduct sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions, and it shall re-conduct such review as necessary to ensure continuing enforceability. (7) A credit institution shall fulfil following operational requirements:

  1. it shall properly document the collateral arrangements and have in place clear and robust procedures for the timely liquidation of collateral;
  2. it shall use robust procedures and processes to control risks arising from the use of collateral, including risks of failed collateral liquidation or reduced credit protection, valuation risks, risks associated with the termination of the credit protection, concentration risk arising from the use of collateral and the interaction with the credit institution's overall risk profile;
  3. it shall have in place documented policies and practices concerning the types and amounts of collateral accepted;
  4. it shall calculate the market value of the collateral, and revalue it accordingly, at least once every six months and whenever they have reason to believe that a significant decrease in the market value of the collateral has occurred; ESG￾related considerations shall prompt an assessment of whether a significant decrease in the market value of the collateral has occurred;
  5. where the collateral is held by a third party, it shall take reasonable steps to ensure that the third party segregates the collateral from its own assets;
  6. it shall ensure that it devotes sufficient resources to the orderly operation of margin agreements with OTC derivatives and securities-financing counterparties, as measured by the timeliness and accuracy of their outgoing margin calls and response time to incoming margin calls;
  7. it shall have in place collateral management policies to control, monitor and report the following: − the risks to which margin agreements expose them; − the concentration risk to particular types of collateral assets; − the reuse of collateral including the potential liquidity shortfalls resulting from the reuse of collateral received from counterparties; − the surrender of rights on collateral posted to counterparties. (8) Financial collateral may qualify as eligible collateral under the Financial Collateral Simple Method if all requirements set out in paragraphs (2) to (7) of this Article have been met and if the residual maturity of the protection is at least as long as the residual maturity of the exposure.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 257 Requirements for immovable property collateral Article 246 (1) Immovable property shall qualify as eligible collateral only where all the requirements laid down in paragraphs (2) to (10) of this Article are met. (2) The following requirements on legal certainty shall be met

  1. all legal requirements for entering the pledge or another right into the cadastre of immovable property or another appropriate register have been fulfilled;
  2. a mortgage or charge is enforceable in all jurisdictions which are relevant at the time of the conclusion of the loan agreement and shall be properly filed on a timely basis; and
  3. the protection agreement and the legal process underpinning it enable the credit institution to realise the value of the protection within a reasonable timeframe. (3) A credit institution shall regularly monitor the value of the property and at a minimum once every year for commercial immovable property and once every three years for residential property, provided that the credit institution carries out more frequent monitoring where the market is subject to significant changes in conditions; (4) The property valuation shall be reviewed when information available to a credit institution indicates that the value of the property may have declined materially relative to general market prices, whereby for loans exceeding EUR 1,000,000 or 5% of the own funds of a credit institution, the property valuation shall be reviewed by such valuer at least every three years. (5) The property valuation referred to in paragraph (4) of this Article shall be carried out by a valuer who possesses the necessary qualifications, ability and experience to execute a valuation and who is independent from the credit decision process. (6) For the purposes of paragraph (4) of this Article, ESG-related considerations, including those related to limitations imposed by the relevant regulatory objectives and legal acts, as well as, where relevant for internationally active credit institutions, third￾country legal and regulatory objectives, shall be considered to be an indication that the property value might have declined materially, relative to general market prices. (7) A credit institutions may monitor the value of the immovable property and identify the immovable property in need of revaluation, in accordance with paragraphs (4) to (6) of this Article, by means of advanced statistical or other mathematical methods (‘models’), provided that those methods are developed independently from the credit decision process and all of the following conditions are met:
  4. the credit institution sets out, in its policies and procedures, the criteria for using models to monitor the values of collateral and to identify the properties that should be revaluated; those policies and procedures shall account for such models’ proven track record, property-specific variables considered, the use of minimum available and accurate information, and the models’ uncertainty;
  5. the credit institution ensures that the models used are: ­ property- and location-specific at a sufficient level of granularity;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 258 ­ valid and accurate, and subject to robust and regular back-testing against the actual observed transaction prices; ­ based on a sufficiently large and representative sample, based on observed transaction prices; ­ based on up-to-date data of high quality; 3) the credit institution is ultimately responsible for the appropriateness and performance of the models; 4) the credit institution ensures that the documentation of the models is up to date; 5) the credit institution has in place adequate IT processes, systems and capabilities and have sufficient and accurate data for any model-based monitoring of the value of immovable property collateral and identification of property in need of revaluation; 6) the estimates of models are independently validated and the validation process is generally consistent with the principles set out in Article 185, where applicable (8) A credit institution shall clearly define in its internal acts the types of residential property and commercial immovable property it accepts and its lending policies on loans secured by mortgage on immovable property. (9) The immovable property taken as credit protection shall be adequately insured against the risk of damage. (10) A credit institution shall have in place procedures to monitor that the immovable property taken as credit protection is adequately insured against the risk of damage. Requirements for receivables Article 247 (1) Receivables shall qualify as eligible collateral where all the requirements laid down in paragraphs (2) and (3) of this Article are met. (2) The following requirements on legal certainty shall be met:

  1. the legal mechanism by which the collateral is provided to a lending credit institution shall be robust and effective and ensure that that credit institution has clear rights over the receivables including the right to the proceeds from the sale of the receivables;
  2. a credit institution shall take all steps necessary in respect of the enforceability of security interest, whereby, the lending credit institution shall have a first priority claim over the receivables although such claims may still be subject to the claims of other creditors;
  3. a credit institution shall regularly conduct sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions;
  4. a credit institution shall properly document its collateral arrangements and shall have in place clear and robust procedures for the timely collection of collateral;
  5. a credit institution shall have in place procedures that ensure that any legal conditions required for declaring the default of a debtor and timely collection of collateral are observed;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 259 6) in the event of a debtor's financial distress or default, a credit institution shall have legal authority to sell or assign the receivables used as collateral to other parties without consent of the debtor. (3) The following requirements on risk management shall be met:

  1. a credit institution shall have in place a sound process for determining the credit risk associated with the receivables and such a process shall include analyses of a debtor's business and industry and the types of customers with whom that debtor does business, and where the credit institution relies on its debtors to ascertain the credit risk of the customers, the credit institution shall review the debtors' credit practices to ascertain their soundness and credibility;
  2. the difference between the amount of the exposure and the value of the receivables shall reflect all appropriate factors, including the cost of collection, concentration within the receivables pool pledged by an individual debtor, and potential concentration risk within the credit institution's total exposures beyond that controlled by the credit institution's general methodology;
  3. the credit institution shall maintain a continuous monitoring process appropriate to the receivables, and it shall also review, on a regular basis, compliance with loan covenants, environmental restrictions, and other legal requirements;
  4. receivables pledged by a debtor shall be diversified and not be unduly correlated with that debtor, and in the case of material positive correlation, a credit institution shall take into account the attendant risks in the setting of margins for the collateral pool as a whole;
  5. a credit institution shall not use receivables from affiliates of a debtor (including subsidiary undertakings and employees) as eligible credit protection;
  6. a credit institution shall have in place a documented process for collecting receivable payments in distressed situations;
  7. the credit institution shall have in place the requisite facilities for collection even when it normally relies on its debtors for collection. Requirements for other physical collateral Article 248 Physical collateral other than immovable property collateral shall qualify as eligible collateral under the IRB Approach where all the following conditions are met:
  8. the collateral arrangement under which the physical collateral is provided to a credit institution shall be legally effective and enforceable in all relevant jurisdictions and shall enable that credit institution to realise the value of the collateral within a reasonable timeframe;
  9. with the sole exception of permissible first priority claims referred to in Article 247 paragraph (2) item 2) of this Decision, only first liens on, or charges over, collateral shall qualify as eligible collateral and a credit institution shall have priority over all other lenders to the realised proceeds of the collateral;
  10. a credit institution shall monitor the value of the collateral on a frequent basis and at least once every year, and it shall carry out more frequent monitoring where the market is subject to significant changes in conditions;
  11. the loan agreement shall include detailed descriptions of the collateral as well as detailed specifications of the manner and frequency of revaluation;
  12. a credit institution shall clearly document in internal credit policies and procedures available for examination the types of physical collateral it accepts

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 260 and the policies and practices it has in place in respect of the appropriate amount of each type of collateral relative to the exposure amount; 6) a credit institution's credit policies with regard to the transaction structure shall address the following: − appropriate collateral requirements relative to the exposure amount; − the ability to liquidate the collateral readily; − the ability to establish objectively a price or market value; − the frequency with which the value can readily be obtained, including a professional appraisal or valuation; and − the volatility or a proxy of the volatility of the value of the collateral; 7) when conducting valuation and revaluation, a credit institution shall take fully into account any deterioration or obsolescence of the collateral, paying particular attention to the effects of the passage of time on fashion- or date￾sensitive collateral, where by for physical collateral, obsolescence of collateral shall also include ESG-related valuation considerations related to prohibitions or limitations imposed by the relevant European Union and Member States regulatory objectives and legal acts, as well as, where relevant for internationally active credit institutions, third-country legal and regulatory objectives; 8) a credit institution shall have the right to physically inspect the collateral, and it shall also have in place policies and procedures addressing its exercise of the right to physical inspection; 9) the collateral taken as protection shall be adequately insured against the risk of damage and a credit institution shall have in place procedures to monitor the adequacy of collateral insurance. (2) Where general security agreements, or other forms of floating charge, provide the lending credit institution with a registered claim over a business undertaking’s assets and where that claim contains both assets that are not eligible as collateral under the IRB Approach and assets that are eligible as collateral under the IRB Approach, the credit institution may recognise those latter assets as eligible funded credit protection, whereby that recognition shall be conditional on those assets meeting the requirements for eligibility of collateral under the IRB Approach as set out in this Chapter. Requirements for treating lease exposures as collateralised Article 249 A credit institution may treat exposures arising from leasing transactions as collateralised by the type of property leased, where all the following conditions are met:

  1. the conditions set out in Article 246 or 248 of this Decision, as applicable, for the type of property leased to qualify as eligible collateral are met;
  2. the lessor has in place robust risk management with respect to the use to which the leased asset is put, its location, its age and the planned duration of its use, including appropriate monitoring of the value of the security;
  3. the lessor has legal ownership of the asset and is able to exercise its rights as owner in a timely fashion;
  4. where this has not already been ascertained in calculating the LGD level, the difference between the value of the unamortised amount and the market value of the leased assets is not so large as to overstate the effects of credit protection attributed to the leased assets.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 261 Requirements for other funded credit protection Article 250 (1) Cash on deposit with, or cash assimilated instruments held by, a third party credit institution shall be eligible for the treatment set out in Article 268 paragraph (1) of this Decision, where the following conditions are met:

  1. the debtor's claim against the third party credit institution is openly pledged or assigned to the lending credit institution and such pledge or assignment is legally effective and enforceable in all relevant jurisdictions and is unconditional and irrevocable;
  2. the third party credit institution is notified of the pledge or assignment; and
  3. as a result of the notification, the third party credit institution is able to make payments solely to the lending credit institution or to other parties only with the lending credit institution's prior consent. (2) Life insurance policies pledged to the lending credit institution shall qualify as eligible collateral where the following conditions are met:
  4. the life insurance policy is openly pledged or assigned to the lending credit institution;
  5. the undertaking providing the life insurance is notified of the pledge or assignment and, as a result of the notification, may not pay amounts payable under the contract without the prior consent of the lending credit institution;
  6. the lending credit institution has the right to cancel the policy and receive the surrender value in the event of the default of the debtor;
  7. the lending credit institution is informed of any non-payments under the policy by the policy-holder;
  8. the life insurance policy is provided for the maturity of the loan, and where the life insurance policy ends before the loan maturity date, the credit institution shall ensure that the amount deriving from the insurance contract serves the credit institution as security until the loan maturity date;
  9. the pledge or assignment is legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the loan agreement;
  10. the surrender value is declared by the undertaking providing the life insurance and is non-reducible;
  11. the surrender value is to be paid by the undertaking providing the life insurance in a timely manner upon request;
  12. the surrender value shall not be requested without the prior consent of the credit institution; and 10)the undertaking providing the life insurance shall be registered in Montenegro or an EU Member State, and it shall be subject to supervision by the competent authorities of Montenegro or the EU Member State in which it was registered, and if it is registered in a third country, the life insurance policy shall be recognised only if that third country is considered an equivalent third country within the meaning of Article 3 item 113) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 262 Subsection 2 - Unfunded credit protection and credit linked notes Requirements common to guarantees and credit derivatives Article 251 (1) Subject to Article 252 paragraph (1) of this Decision, a credit protection deriving from a guarantee and other surety or credit derivative shall qualify as eligible unfunded credit protection where the following conditions are met:

  1. the credit protection is direct;
  2. the extent of the credit protection is clearly defined and incontrovertible;
  3. the credit protection contract does not contain any clause, the fulfilment of which is outside the direct control of the lender, that: − would allow the protection provider to cancel the protection unilaterally; − would increase the effective cost of protection as a result of a deterioration in the credit quality of the protected exposure; − could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original debtor fails to make any payments due, or when the leasing contract has expired for the purposes of recognising guaranteed residual value under Article 177 paragraphs (8) and (8) of this Decision and Article 207 paragraphs (6) to (8) of this Decision; − could allow the maturity of the credit protection to be reduced by the protection provider; and
  4. the credit protection contract is legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement. (2) For the purposes of paragraph (1) item 3) of this Article, although credit protection contract includes a clause which provides that flawed due diligence or fraud by the lending credit institution cancels or diminishes the extent of the credit protection offered by the guarantor, such credit protection shall not be disqualified from being eligible. (3) For the purposes of paragraph (1) item 3) of this Article, the protection provider may make one lump sum payment of all cash due under the claim, or may assume the future payment obligations of the debtor covered by the credit protection contract. (4) A credit institution shall demonstrate to the Central Bank that it has in place systems to manage potential risk concentration arising from its use of guarantees and other sureties and credit derivatives, as well as to demonstrate how its strategy in respect of its use of credit derivatives and guarantees and other sureties interacts with its management of its overall risk profile. (5) A credit institution shall fulfil any contractual and statutory requirements in respect of, and take all steps necessary to ensure, the enforceability of its unfunded credit protection under the regulations applicable to such contracts.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 263 (6) A credit institution shall have conducted sufficient legal review confirming the enforceability of the unfunded credit protection in all relevant jurisdictions, and it shall repeat such review as necessary to ensure continuing enforceability. Sovereign and other public sector counter-guarantees Article 252 (1) A credit institution may treat the exposures protected by a guarantee which is counter-guaranteed referred to in paragraph (2) of this Article as protected by a guarantee provided by the entities listed in that paragraph, provided that the following conditions are met:

  1. the counter-guarantee covers all credit risk elements of the claim;
  2. guarantee and the counter-guarantee meet the requirements for guarantees set out in Articles 251 and 253 paragraph (1) of this Decision, except that the counter-guarantee need not be direct; and
  3. the cover is robust and nothing in the historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct guarantee by the entity in question. (2) The treatment set out in paragraph (1) of this Article shall apply to exposures protected by a guarantee which is counter-guaranteed by any of the following entities:
  4. a central government or a central bank;
  5. a regional government unit or a local self-government unit;
  6. a public sector entity, claims on which are treated as claims on the central government in accordance with Article 153 paragraphs (5) and (6) of this Decision;
  7. a multilateral development bank or an international organisation, to which a 0% risk weight is assigned under or by virtue of Articles 154 paragraph (4) or 155 of this Decision;
  8. a public sector entity, claims on which are treated in accordance with Article 153 paragraphs (1), (2), and (3) of this Decision; (3) A credit institution shall apply the treatment set out in paragraph (1) of this Article also to an exposure which is not counter-guaranteed by any entity listed in paragraph (2) of this Article where that exposure's counter-guarantee is in turn directly guaranteed by one of those entities and the conditions listed in paragraph (1) of this Article are satisfied. Additional requirements for guarantees and other sureties Article 253 (1) Guarantees shall qualify as eligible unfunded credit protection where all the conditions in Article 251 of this Decision and the following conditions are met:
  9. on the qualifying default of or non-payment by the counterparty, the lending credit institution has the right to pursue, in a timely manner, the guarantor or provider of other surety for any cash due under the claim in respect of which the protection is provided and the payment by the guarantor shall not be subject to the lending credit institution first having to pursue the debtor;
  10. the guarantee or other surety is an explicitly documented obligation assumed by the guarantor;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 264 3) either of the following conditions is met: − the guarantee or other surety covers all types of payments the debtor is expected to make in respect of the exposure; or − where certain types of payment are excluded from the guarantee or other surety, the lending credit institution has adjusted the value of the guarantee or other surety to reflect the limited coverage. (2) The payment by the guarantor shall not be subject to the lending credit institution first having to pursue the debtor. (3) In the case of unfunded credit protection covering residential mortgage loans, the requirements in Article 251 paragraph (1) item 3) indent 3 of this Decision and in paragraph (1) item 1) of this Article have only to be satisfied within 24 months; (4) In the case of guarantees or other sureties provided in the context of mutual guarantee schemes or provided by or counter-guaranteed by entities listed in Article 252 paragraph (2) of this Decision, the requirements in paragraph (1) item 1) of this Article and Article 251 paragraph (1) item 3) indent 3 of this Decision shall be considered to be satisfied where either of the following conditions is met:

  1. the lending credit institution has the right to obtain in a timely manner a provisional payment by the guarantor that meets both the following conditions: − it represents an estimate of the amount of the loss, including losses resulting from the non-payment of interest and other types of payment which the debtor is obliged to make, that the lending credit institution is likely to incur; or − it is proportional to the coverage of the guarantee or other surety; and
  2. the lending credit institution can demonstrate to the satisfaction of the Central Bank that the effects of the guarantee or other surety, which shall also cover losses resulting from the non-payment of interest and other types of payments which the debtor is obliged to make, justify such treatment and that justification shall be properly documented and subject to dedicated internal approval and audit procedures. Additional requirements for credit derivatives Article 254 (1) Credit derivatives shall qualify as eligible unfunded credit protection where all the conditions in Article 251 of this Decision and the following conditions are met:
  3. the credit events specified in the credit derivative contract include: − the failure to pay the amounts due under the terms of the underlying obligation that are in effect at the time of such failure, with a grace period that is equal to or shorter than the grace period in the underlying obligation; − the bankruptcy, winding-up or inability of the debtor to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and analogous events; − the restructuring of the underlying obligation involving write-off or postponement of principal, interest or fees that results in a credit loss event;
  4. where credit derivatives allow for cash settlement: − a credit institution has in place a robust valuation process in order to estimate loss reliably;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 265 − there is a clearly specified period for obtaining post-credit-event valuations of the underlying obligation; 3) where the protection purchaser's right and ability to transfer the underlying obligation to the protection provider is required for settlement, the terms of the underlying obligation provide that any required consent to such transfer shall not be unreasonably withheld; 4) the identity of the parties responsible for determining whether a credit event has occurred is clearly defined; 5) the determination of the credit event is not the sole responsibility of the protection provider; and 6) the protection buyer has the right or ability to inform the protection provider of the occurrence of a credit event. (2) Where the credit events do not include restructuring of the underlying exposure as described in item 1) indent 3 of this Article, the credit protection may be eligible subject to a reduction in the value as specified in Article 269 paragraph (2) of this Decision. (3) A mismatch between the underlying obligation and the reference obligation under the credit derivative or between the underlying obligation and the obligation used for purposes of determining whether a credit event has occurred is permissible only where both the following conditions are met:

  1. the reference obligation or the obligation used for the purpose of determining whether a credit event has occurred, as the case may be, ranks pari passu with or is junior to the underlying obligation;
  2. the underlying obligation and the reference obligation or the obligation used for the purpose of determining whether a credit event has occurred, as the case may be, share the same debtor and legally enforceable cross-default or cross￾acceleration clauses are in place. (4) By way of derogation from paragraph (1) of this Article, for a corporate exposure covered by a credit derivative, the credit event referred to in item 1) indent 3 of that paragraph shall not be required to be specified in the derivative contract, provided that all of the following conditions are met:
  3. a 100% vote is needed to amend the maturity, principal, coupon, currency or seniority status of the underlying corporate exposure;
  4. the legal domicile in which the corporate exposure is governed has a well￾established bankruptcy code that allows for a company to reorganise and restructure, and provides for an orderly settlement of creditor claims. (5) Where the conditions set out in paragraph (4) items 1) and 2) of this Article are not met, the credit protection shall be considered to be eligible subject to a reduction in the value as specified in Article 269 paragraph (2) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 266 Section 4 - Calculating the effects of credit risk mitigation Subsection 1 - Funded credit protection Credit linked notes (CLN) Article 255 (1) Investments in credit linked notes (CLN) issued by the lending credit institution may be treated as cash collateral for the purpose of calculating the effect of funded credit protection in accordance with this Subsection, provided that the credit default swap (CDS) embedded in the CLN qualifies as eligible unfunded credit protection. (2) For the purpose of determining whether the CDS embedded in a CLN qualifies as eligible unfunded credit protection, the lending credit institution may consider the condition in Article 213 paragraph (7) item 3) to be met. On-balance sheet netting Article 256 A lending credit institution shall treat loans received and deposits that are subject to on-balance sheet netting as cash collateral for the purpose of calculating the effect of funded credit protection for those loans and deposits which are denominated in the same currency. Using the Supervisory Volatility Adjustment Approach for master netting agreements Article 257 (1) When a credit institution calculates the 'fully adjusted exposure value' (E*) for the exposures subject to an eligible master netting agreement covering repurchase transactions or securities or commodities lending or borrowing transactions or other capital market-driven transactions, it shall calculate the volatility adjustments that it needs to apply by using the Supervisory Volatility Adjustments Approach as set out in Articles 260 to 263 of this Decision for the Financial Collateral Comprehensive Method. (2) For the purpose of calculating E*, a credit institution shall:

  1. calculate the net position in each group of securities or in each type of commodity by subtracting: − the total value of a group of securities or of commodities of the same type lent, sold or provided under the master netting agreement; and − the total value of a group of securities or of commodities of the same type borrowed, purchased or received under the master netting agreement;
  2. calculate the net position in each currency, other than the settlement currency of the master netting agreement, by subtracting: − the sum of the total value of securities denominated in that currency lent, sold or provided under the master netting agreement and the amount of cash in that currency lent or transferred under that agreement; and − the sum of the total value of securities denominated in that currency borrowed, purchased or received under the master netting agreement and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 267 the amount of cash in that currency borrowed or received under that agreement; 3) apply the value of the volatility adjustment, or, where relevant, the absolute value of the volatility adjustment appropriate for a given group of securities or for a given type of commodities, to the absolute value of the positive or negative net position in the securities in that group of securities, or to the commodities from that type of commodities; 4) apply the foreign exchange risk (fx) volatility adjustment to the net positive or negative position in each currency other than the settlement currency of the master netting agreement. (3) A credit institution shall calculate E* in accordance with the following formula: E∗ = max �0,�Ei i −�Cj j

  • 0,4 ∙ Enet + 0,6 ∙ Egross √N +��Ek fx� k ∗ Hk fx� where: i = the index that denotes all separate securities, commodities or cash positions under the agreement that are either lent, sold with an agreement to repurchase, or posted by the credit institution to the counterparty; j = the index that denotes all separate securities, commodities or cash positions under the agreement that are either borrowed, purchased with an agreement to resell, or held by the credit institution; k = the index that denotes all separate currencies in which any securities, commodities or cash positions under the agreement are denominated; Ei = the exposure value of a given security, commodity or cash position i, that is either lent, sold with an agreement to repurchase, or posted to the counterparty under the agreement that would apply in the absence of credit protection, where a credit institution calculates the risk-weighted exposure amounts in accordance with Subtitle 2 or Subtitle 3 of this Title, as applicable; Cj = the value of a given security, commodity or cash position j that is either borrowed, purchased with an agreement to resell, or held by the institution under the agreement; Ek fx = the net position (positive or negative) in a given currency k other than the settlement currency of the agreement as calculated in accordance with paragraph (2) item 2) of this Article; Hk fx = the foreign exchange volatility adjustment for currency; Enet = the net exposure of the agreement, calculated as follows:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 268 𝑛𝑛𝑛𝑛 = ��| 𝑠𝑠 𝑠𝑠| ∙ 𝐻𝐻𝑠𝑠 𝑠𝑠 𝑁𝑁 =1 � where: l = the index that denotes all distinct groups of the same securities and all distinct types of the same commodities under the agreement; El sec = the net position (positive or negative) in a given group of securities l, or a given type of commodities l, under the agreement, calculated in accordance with paragraph (2) item 1) of this Article; Hl sec = the volatility adjustment appropriate to a given group of securities l, or a given type of commodities l, determined in accordance with paragraph (2) item 3) of this Article, and the sign of the volatility adjustment (Hl sec) shall be determined as follows:

  1. it shall have a positive sign where the group of securities l is lent, sold with an agreement to repurchase, or transacted in a manner similar to either a securities lending or a repurchase agreement;
  2. it shall have a negative sign where the group of securities l is borrowed, purchased with an agreement to resell, or transacted in a manner similar to either a securities borrowing or a reverse repurchase agreement; N = the total number of distinct groups of the same securities and distinct types of the same commodities under the agreement, whereat for the purposes of this calculation, those groups and types El sec for which |El sec| is less than 1 10 max l (|El sec|)shall not be counted; Egross = the gross exposure of the agreement, calculated as follows: Egross = ∑ |El sec| ∙ |Hl sec| N l=1 .”; (4) For the purpose of calculating risk-weighted exposure amounts and expected loss amounts for repurchase transactions or securities or commodities lending or borrowing transactions or other capital market-driven transactions covered by master netting agreements, a credit institution shall use E* as calculated under paragraph (3) of this Article as the exposure value of the exposure to the counterparty arising from the transactions subject to the master netting agreement for the purposes of Article 150 of this Decision under the Standardised Approach of this Decision or under the IRB Approach. (6) For the purposes of paragraphs (2) and (3) of this Article, ‘group of securities’ means securities which are issued by the same entity, have the same issue date, the same maturity, are subject to the same terms and conditions, and are subject to the same liquidation periods as indicated in Articles 261 of this Decision, as applicable.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 269 Using the internal models approach for master netting agreements Article 258 (1) A credit institution may, for the purpose of calculating risk-weighted exposure amounts and expected loss amounts for securities financing transactions or other capital market-driven transactions other than derivative transactions covered by an eligible master netting agreement that meets the requirements set out in Section 7 Subtitle 6 of this Title, calculate the fully adjusted exposure value (E*) of the agreement using the internal model approach, provided that the following conditions are met:

  1. the credit institution uses that approach only for exposures for which the risk￾weighted exposures amounts are calculated under the IRB Approach set out in Subtitle 3 of this Title;
  2. the credit institution is granted the authorisation to use that approach by the Central Bank. (2) A credit institution that uses an internal model approach shall do so for all counterparties and securities, with the exception of immaterial portfolios for which it may use the Supervisory Volatility Adjustments Approach laid down in Article 257 of this Decision. (3) The Central Bank shall authorise a credit institution to use an internal models approach referred to in paragraph (1) of this Article only where it is satisfied that the credit institution's system for managing the risks arising from the transactions covered by the master netting agreement is conceptually sound and implemented with integrity and where the following qualitative standards are met:
  3. the internal risk-measurement model used for calculating the potential price volatility for the transactions is closely integrated into the daily risk-management process of the credit institution and serves as the basis for reporting risk exposures to the senior management of the credit institution;
  4. the credit institution has a risk control unit that meets all the following requirements: − it is independent from business trading units and reports directly to senior management; − it is responsible for designing and implementing the credit institution's risk￾management system; and − it produces and analyses daily reports on the output of the risk￾measurement model and on the appropriate measures to be taken in terms of position limits;
  5. the daily reports produced by the risk-control unit are reviewed by a level of management with sufficient authority to enforce reductions of positions taken and of overall risk exposure;
  6. the risk control unit has sufficient employees skilled in the use of sophisticated models;
  7. the credit institution has established procedures for monitoring and ensuring compliance with a documented set of internal policies and controls concerning the overall operation of the risk-measurement system;
  8. the credit institution's models have a proven track record of reasonable accuracy in measuring risks demonstrated through the back-testing of its output using at least one year of data;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 270 7) the credit institution frequently conducts a rigorous programme of stress testing and the results of these tests are reviewed by senior management and reflected in the policies and limits it sets; 8) the credit institution conducts, as part of its regular internal auditing process, an independent review of its risk-measurement system, and this review shall include both the activities of the business trading units and of the independent risk-control unit; 9) at least once a year, the credit institution conducts a review of its risk￾management system; 10)the internal model meets the requirements set out in Article 379 paragraphs (11) and (12) and 381 of this Decision. (4) A credit institution's internal risk-measurement model shall capture a sufficient number of risk factors in order to capture all material price risks. (5) A credit institution may use empirical correlations within risk categories and across risk categories where its system for measuring correlations is sound and implemented with integrity. (6) A credit institution using the internal models approach shall calculate E* in accordance with the following formula: ∗ = 𝑚𝑚𝑚𝑚𝑚𝑚 �0, �� 𝑖𝑖 − 𝑖𝑖 �𝐶𝐶𝑖𝑖 𝑖𝑖 � + ℎ 𝑖𝑖 𝑣𝑣 � where: Ei = the exposure value for each separate exposure i under the agreement that would apply in the absence of the credit protection, where a credit institution calculates the risk-weighted exposure amounts under the Standardised Approach or where it calculates risk-weighted exposure amounts and expected loss amounts under the IRB Approach; Ci = the value of the securities borrowed, purchased or received or the cash borrowed or received in respect of each such exposure i; (7) When calculating risk-weighted exposure amounts using internal models, a credit institution shall use the previous business day's model output. (8) The calculation of the potential change in value referred to in paragraph (6) of this Article shall be subject to the following standards:

  1. it shall be carried out at least daily;
  2. it shall be based on a 99th percentile, one-tailed confidence interval;
  3. it shall be based on a 5-day liquidation period for repurchase transaction or securities lending or borrowing transactions, and for other transactions a 10- day liquidation period shall be used;
  4. it shall be based on an effective historical observation period of at least one year except where a shorter observation period is justified by a significant upsurge in price volatility;
  5. the data set used in the calculation shall be updated on quarterly basis.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 271 (9) In the case of repurchase transactions, securities or commodities lending or borrowing transactions and margin lending or similar transactions or netting set which meets the criteria set out in Article 372 paragraphs (3) to (7) of this Decision, the minimum holding period shall be brought in line with the margin period of risk that would apply under those paragraphs and Article 372 paragraph (8) of this Decision. Financial Collateral Simple Method Article 259 (1) A credit institution may use the Financial Collateral Simple Method only where it calculates risk-weighted exposure amounts in accordance with the Standardised Approach. (2) A credit institution shall not use both methods (Financial Collateral Simple Method and Financial Collateral Comprehensive Method), except for the purposes of Article 190 paragraph (1) and 192 paragraph (2) of this Decision, whereby it shall not use this exception selectively with the purpose of achieving reduced own funds requirements or with the purpose of circumventing other regulations. (3) Under the Financial Collateral Simple Method, a credit institution shall assign to eligible financial collateral a value equal to its market value as determined in accordance with Article 245 paragraph (7) item 4) of this Decision. (4) A credit institution shall assign to those portions of exposure values that are collateralised by the market value of eligible collateral the risk weight that it would assign under Subtitle 2 of this Title where the lending credit institution had a direct exposure to the collateral instrument, and for this purpose, the exposure value of an off-balance sheet item referred to in Article 148 paragraph (3) of this Decision shall be equal to 100% of the item's value rather than the exposure value indicated in paragraph (2) of that Article. (5) A credit institution shall assign a risk weight of 0% to the collateralised portion of the exposure arising from repurchase transaction and securities lending or borrowing transactions which fulfil the criteria in Article 263 of this Decision, and where the counterparty to the transaction is not a core market participant referred to in paragraph (3) of this Article, a credit institution shall assign a risk weight of 10%. (6) A credit institution shall assign a risk weight of 0%, to the extent of the collateralisation, to the exposure values determined under Subtitle 6 of this Title for the derivative instruments referred to in Article 148 paragraph (8) of this Decision and subject to daily marking-to-market, collateralised by cash or cash assimilated instruments where there is no currency mismatch. (7) A credit institution shall assign a risk weight of 10%, to the extent of the collateralisation, to the exposure values of transactions referred to in paragraph (6) of this Article collateralised by debt securities issued by central governments or central banks which are assigned a 0% risk weight under Subtitle 2 of this Title.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 272 (8) For transactions other than those referred to in paragraphs (5), (6), and (7) of this Article, a credit institution may assign a 0% risk weight where the exposure and the collateral are denominated in the same currency, and either of the following conditions is met:

  1. the collateral is cash on deposit or a cash assimilated instrument; or
  2. the collateral is in the form of debt securities issued by central governments or central banks eligible for a 0% risk weight under Article 151 of this Decision, and its market value has been discounted by 20%. (9) For the purpose of paragraphs (6), (7), and (8) of this Article debt securities issued by central governments or central banks shall include:
  3. debt securities issued by regional government units or local self-government units exposures to which are treated in accordance with Article 152 of this Decision as exposures to the central government in whose jurisdiction they are established;
  4. debt securities issued by multilateral development banks to which a 0% risk weight is assigned under Article 154 paragraph (4) of this Decision;
  5. debt securities issued by international organisations which are assigned a 0% risk weight under Article 155 of this Decision; and
  6. debt securities issued by public sector entities which are treated as exposures to central governments in accordance with Article 153 paragraphs (5) and (6) of this Decision. Financial Collateral Comprehensive Method Article 260 (1) In order to take account of price volatility, a credit institution shall apply volatility adjustments to the market value of collateral, as set out in Articles 261 to 263 of this Decision, when valuing financial collateral for the purposes of the Financial Collateral Comprehensive Method. (2) Where collateral is denominated in a currency that differs from the currency in which the underlying exposure is denominated, a credit institution shall add an adjustment reflecting currency volatility to the volatility adjustment appropriate to the collateral as set out in Articles 261 to 263 of this Decision. (3) In the case of OTC derivatives transactions covered by netting agreements recognised by the Central Bank under Subtitle 6 of this Title, a credit institution shall apply a volatility adjustment reflecting currency volatility when there is a mismatch between the collateral currency and the settlement currency, and where multiple currencies are involved in the transactions covered by the netting agreement, the credit institution shall apply a single volatility adjustment reflecting currency volatility. (4) In calculating the volatility-adjusted value of the collateral (CVA), a credit institution shall take into account the following: 𝐶𝐶𝑉𝑉𝑉𝑉 = 𝐶𝐶 ∙ �1 − 𝐻𝐻𝐶𝐶 − 𝐻𝐻𝑓𝑓𝑓𝑓� where: C = the value of the collateral;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 273 HC = the volatility adjustment appropriate to the collateral, as calculated under Articles 261 to 263 of this Decision; Hfx = the volatility adjustment appropriate to currency mismatch, as calculated under Articles 261 to 263 of this Decision. (5) A credit institution shall use the formula set out in paragraph (4) of this Article when calculating the volatility-adjusted value of the collateral for all transactions except for those transactions subject to recognised master netting agreements to which the provisions set out in Articles 257 and 258 of this Decision apply. (6) In calculating the volatility-adjusted value of the exposure (EVA), a credit institution shall take into account the following: 𝑉𝑉𝑉𝑉 = ∙ (1 + 𝐻𝐻𝐸𝐸) where: E = the exposure value as would be determined under Subtitle 2 or 3 of this Decision, as applicable, where the exposure was not collateralised; HE = the volatility adjustment appropriate to the exposure, as calculated under Articles 261 to 263 of this Decision; (7) In the case of OTC derivative transactions a credit institution applying the method referred to in Section 6 Subtitle 6 of this Title, shall calculate EVA as follows: EVA = E (8) For the purpose of calculating E in paragraphs (6) and (7) of this Article, the following shall apply:

  1. for a credit institution calculating risk-weighted exposure amounts under the Standardised Approach, the exposure value of an off-balance sheet item listed in Article 148 paragraph (3) of this Decision shall be a conversion factor of 100% of that item's value rather than the exposure value indicated in paragraph (2) of that Article;
  2. for off-balance-sheet items other than derivatives treated under the IRB Approach, a credit institution shall calculate their exposure values using a CCF of 100% instead of the SA-CCF or IRB-CCF provided for in Article 207 paragraphs (14) to (23) of this Decision. (9) A credit institution shall calculate the fully adjusted value of the exposure (E*), taking into account volatility of collateral and its risk-mitigating effects by using the following formulae: ∗ = max {0, 𝑉𝑉𝑉𝑉 − 𝐶𝐶𝑉𝑉𝑉𝑉 } where: EVA = the volatility adjusted value of the exposure as calculated in paragraphs (6) and (7) of this Article;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 274 CVAM = CVA (volatility-adjusted value of the collateral) further adjusted for any maturity mismatch in accordance with the provisions of Section 5 of this Subtitle; (10) In the case of OTC derivative transactions, a credit institution using the methods laid down in Sections 3, 4, and 5 of Subtitle 6 of this Title shall take into account the risk-mitigating effects of collateral in accordance with the provisions laid down in Sections 3, 4, and 5 of this Subtitle, as applicable. (11) A credit institution may calculate volatility adjustments by using the supervisory volatility adjustments referred to in Articles 261 to 263 of this Decision. (12) Where the collateral consists of a number of eligible items, a credit institution shall calculate the volatility adjustment (H) as follows: 𝐻𝐻 = � 𝑖𝑖𝐻𝐻𝑖𝑖 𝑖𝑖 where: ai = the proportion of the value of an eligible item i in the total value of collateral; Hi = the volatility adjustment applicable to eligible item i. Supervisory volatility adjustment under the Financial Collateral Comprehensive Method Article 261 (1) The volatility adjustments to be applied by a credit institution under the Supervisory Volatility Adjustments Approach, assuming daily revaluation, shall be those set out in the Tables 1 to 4 of this paragraph: VOLATILITY ADJUSTMENTS: Table 1 Credit quality step with which the credit assessme nt of the debt security is associate d Residual maturity(m), expressed in years Volatility adjustments for debt securities issued by entities described in Article 235 paragraph (1) item 3) Volatility adjustments for debt securities issued by entities described in Article 235 paragraph (1) items 4) and 5) Volatility adjustments for securitisation positions and meeting the criteria laid down in Article 235 paragraph (1) item 9) 20-day liquidatio n period (%) 10-day liquidat ion period (%) 5-day liquidatio n period (%) 20-day liquidatio n period (%) 10-day liquidatio n period (%) 5-day liquidatio n period (%) 20-day liquidatio n period (%) 10-day liquidation period (%) 5-day liquidation period (%) 1 m ≤ 1 0,707 0,5 0,354 1,414 1 0,707 2,828 2 1,414

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 275 Credit quality step with which the credit assessme nt of the debt security is associate d Residual maturity(m), expressed in years Volatility adjustments for debt securities issued by entities described in Article 235 paragraph (1) item 3) Volatility adjustments for debt securities issued by entities described in Article 235 paragraph (1) items 4) and 5) Volatility adjustments for securitisation positions and meeting the criteria laid down in Article 235 paragraph (1) item 9) 20-day liquidatio n period (%) 10-day liquidat ion period (%) 5-day liquidatio n period (%) 20-day liquidatio n period (%) 10-day liquidatio n period (%) 5-day liquidatio n period (%) 20-day liquidatio n period (%) 10-day liquidation period (%) 5-day liquidation period (%) 1 < m ≤ 3 2,828 2 1,414 4,243 3 2,121 11,314 8 5,657 3 < m ≤ 5 2,828 2 1,414 5,657 4 2,828 11,314 8 5,657 5 < m ≤ 10 5,657 4 2,828 8,485 6 4,243 22,627 16 11,314 m > 10 5,657 4 2,828 16,971 12 8,485 22,627 16 11,314 2 to 3 m ≤ 1 1,414 1 0,707 2,828 2 1,414 5,657 4 2,828 1 < m ≤ 3 4,243 3 2,121 5,657 4 2,828 16,971 12 8,485 3 < m ≤ 5 4,243 3 2,121 8,485 6 4,243 16,971 12 8,485 5 < m ≤ 10 8,485 6 4,243 16,971 12 8,485 33,941 24 16,971 m > 10 8,485 6 4,243 28,284 20 14,142 33,941 24 16,971 4 all 21,213 15 10,607 N/A

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 276 Table 2 Credit quality step with which the credit assessmen t of a short term debt security is associated Residual maturity (m), expressed in years Volatility adjustments for debt securities issued by entities as referred to in Article 235 paragraph (1) item 3), with short￾term credit assessments Volatility adjustments for debt securities issued by entities as referred to in Article 235 paragraph (1) items 4) and 5), with short-term credit assessments Volatility adjustments for securitisation positions and meeting the criteria laid down in Article Article 235 paragraph (1) item 9), with short-term credit assessments 20-day liquidatio n period (%) 10-day liquidati on period (%) 5-day liquidatio n period (%) 20-day liquidatio n period (%) 10-day liquidatio n period (%) 5-day liquidat ion period (%) 20-day liquidatio n period (%) 10-day liquidatio n period (%) 5-day liquidati on period (%) 1 0,707 0,5 0,354 1,414 1 0,707 2,828 2 1,414 2-3 1,414 1 0,707 2,828 2 1,414 5,657 4 2,828 Table 3: Other collateral or exposure types 20-day liquidation period (%) 10-day liquidation period (%) 5-day liquidation period (%) Main index equities, main index convertible bonds 28,284 20 14,142 Other equities or convertible bonds listed on a recognised exchange 42,426 30 21,213 Cash 0 Gold bullion 28,284 20 14,142 Table 4: Volatility adjustment for currency mismatch 𝐻𝐻𝑓𝑓𝑓𝑓 20-day liquidation period (%) 10-day liquidation period (%) 5-day liquidation period (%) 11,314 8 5,657 (2) The calculation of volatility adjustments in accordance with paragraph (1) of this Article shall be subject to the following conditions:

  1. for secured lending transactions the liquidation period shall be 20 business days;
  2. for repurchase transactions, except insofar as such transactions involve the transfer of commodities or guaranteed rights relating to title to commodities, and securities lending or borrowing transactions the liquidation period shall be 5 business days;
  3. for other capital market driven transactions, the liquidation period shall be 10 business days. (3) Where a credit institution has a transaction or netting set which meets the criteria set out in Article 372 paragraphs (3) to (7) of this Decision, the minimum holding period

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 277 shall be brought in line with the margin period of risk that would apply under those paragraphs. (4) In Tables 1 to 4 of paragraph (1) of this Article and in paragraphs (6) to (9) of this Article, the credit quality step with which a credit assessment of the debt security is associated shall be the credit quality step which is associated with the credit assessment in accordance with Subtitle 2 of this Title. (5) For the purpose of determining the credit quality step with which a credit assessment of the debt security is associated referred to in the paragraph (4) of this Article, Article 235 paragraph (12) of this Decision shall also apply. (6) For non-eligible securities or for commodities lent or sold under repurchase transactions or securities or commodities lending or borrowing transactions, the volatility adjustment shall be the same as for non-main index equities listed on a recognised exchange. (7) For eligible interest in CIUs the volatility adjustment shall be the weighted average volatility adjustments that would apply, having regard to the liquidation period of the transaction as specified in paragraph (2) of this Article, to the assets in which the fund has invested. (8) Where the assets in which the fund has invested are not known to the credit institution, the volatility adjustment shall be the highest volatility adjustment that would apply to any of the assets in which the fund has the right to invest. (9) For unrated debt securities issued by credit institutions and satisfying the eligibility criteria in Article 235 paragraph (5) of this Decision the volatility adjustments shall be the same as for securities issued by institutions or business undertakings with an external credit assessment associated with credit quality step 2 or 3. Scaling up of volatility adjustment under the Financial Collateral Comprehensive Method Article 262 (1) A credit institution shall apply the volatility adjustments set out in Article 261 of this Decision where there is daily revaluation. (2) Where the frequency of revaluation is less than daily, a credit institution shall apply larger volatility adjustments, and it shall calculate them by scaling up the daily revaluation volatility adjustments, using the following square-root-of- time formula: 𝐻𝐻 = 𝐻𝐻𝑀𝑀 ∙ �𝑁𝑁𝑅𝑅 + (𝑇𝑇𝑀𝑀 − 1) 𝑇𝑇𝑀𝑀 where: H = the volatility adjustment to be applied; HM = the volatility adjustment where there is daily revaluation; NR = the actual number of business days between revaluations;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 278 TM = the liquidation period for the type of transaction in question. Conditions for applying a 0% volatility adjustment under the Financial Collateral Comprehensive Method Article 263 (1) A credit institution that uses the Supervisory Volatility Adjustments Approach referred to in Article 261 of this Decision, may, for repurchase transactions and securities lending or borrowing transactions, apply a 0% volatility adjustment instead of the volatility adjustments calculated under Articles 261 and 262 of this Decision, provided that the conditions set out in paragraph (2) items 1) to 8) of this Article are satisfied, and where a credit institution uses the internal model approach set out in Article 258 of this Decision, it shall not use the treatment set out in this Article. (2) A credit institution may apply a 0% volatility adjustment where all the following conditions are met:

  1. the exposure and the collateral are cash or debt securities issued by central governments or central banks within the meaning of Article 235 paragraph (1) item 3) of this Decision and eligible for a 0% risk weight under Subtitle 2 of this Title;
  2. the exposure and the collateral are denominated in the same currency;
  3. the maturity of the transaction is no more than one day or the exposure and the collateral are subject to daily marking-to-market or daily re-margining;
  4. the time between the last marking-to-market before a failure to re-margin by the counterparty and the liquidation of the collateral is no more than four business days;
  5. the transaction is settled in a settlement system proven for that type of transaction;
  6. the documentation covering the agreement or transaction is standard market documentation for repurchase transactions or securities lending or borrowing transactions in the securities concerned;
  7. the transaction is governed by documentation specifying that where the counterparty fails to satisfy an obligation to deliver cash or securities or to deliver margin or otherwise defaults, then the transaction is immediately terminable; and
  8. the counterparty is considered a core market participant by the Central Bank. (3) The core market participants, within the meaning of paragraph (2) item 8) of this Article shall include the following entities:
  9. the entities mentioned in Article 235 paragraph (1) item 3) of this Decision exposures to which are assigned a 0% risk weight under Subtitle 2 of this Title;
  10. credit institutions;
  11. investment firms;
  12. other financial undertakings within the meaning of Article 3 paragraph (1) item
  13. of this Decision exposures to which are assigned a 20% risk weight under the Standardised Approach or which, in the case of a credit institution calculating risk-weighted exposure amounts and expected loss amounts under the IRB Approach, do not have a credit assessment by a recognised ECAI and are internally rated by the credit institution;
  14. regulated CIUs that are subject to capital or leverage requirements;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 279 6) regulated pension funds; and 7) recognised clearing organisations. Calculating risk-weighted exposure amounts the Financial Collateral Comprehensive method for exposures treated under the Standardised Approach Article 264 (1) Under the Standardised Approach, a credit institution shall use E* as calculated under Article 260 paragraph (9) of this Decision as the exposure value for the purposes of Article 150 of this Decision. (2) In the case of off-balance sheet items listed in Article 148 paragraph (3) of this Decision, the credit institution shall use E* as the value to which the conversion factors indicated in Article 148 paragraph (2) of this Decision shall be applied to arrive at the exposure value. Valuation principles for eligible collateral other than financial collateral Article 265 (1) The valuation of immovable property shall meet all of the following requirements:

  1. an independent valuer who possesses the necessary qualifications, ability and experience to execute a valuation appraises the value of immovable property independently from a credit institution’s mortgage acquisition, loan processing and loan decision process;
  2. the value of immovable property is appraised using prudently conservative valuation criteria which meet all of the following requirements: ­ the value of immovable property excludes expectations on price increases; ­ the value of immovable property is adjusted to take into account the potential for the current market value to be significantly above the value that would be sustainable over the life of the loan;
  3. the value of immovable property is documented in a transparent and clear manner;
  4. the value of immovable property is not higher than a market value for the immovable property where such market value can be determined;
  5. where the immovable property is revalued, the immovable property value does not exceed the average value measured for that property, or for a comparable property over the last six years for residential property or eight years for commercial immovable property or the value at origination, whichever is higher. (2) For the purpose of calculating the average value of immovable property, a credit institution shall take the average across property values observed at equal intervals and the reference period shall include at least three data points. (3) For the purpose of calculating the average value of immovable property, a credit institution may use the results of the monitoring of property values in accordance with Article 246 paragraph (3) of this Decision. (4) The property value may exceed that average value or the value at origination, as applicable, in the case of modifications made to the property that unequivocally

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 280 increase its value, such as improvements of the energy performance or improvements to the resilience, protection and adaptation to physical risks of the building or housing unit. (5) The property value shall not be revalued upward if a credit institution does not have sufficient data to calculate the average value except if the value increase is based on modifications that unequivocally increase its value. (6) The valuation of immovable property shall take account of any prior claims on the property, unless a prior claim is taken into account in the calculation of the gross exposure amount pursuant to Article 163 paragraph (9) item 3 of this Decision or as reducing the amount of 55% of the property value pursuant to Article 165 paragraphs (1) to (5) of this Decision, and reflect, where applicable, the results of the monitoring required under Article 246 paragraph (3) of this Decision. (7) In the case when the collateral is in the form of receivables, the value of receivables shall equal the amount receivable. (8) A credit institution shall value physical collateral other than immovable property at its market value. (9) For the purposes of this Article, the market value is the estimated amount for which the property would exchange on the date of valuation between a willing buyer and a willing seller in an arm's-length transaction. Calculating risk-weighted exposure amounts and expected loss amounts for an exposure with an eligible funded credit protection under the IRB Approach Article 266 (1) A credit institution shall, in accordance with the IRB Approach, except for those exposures referred to in Article 257 of this Decision, use the effective LGD (LGD*) as the LGD for the purposes of Subtitle 3 of this Title to recognise funded credit protection eligible pursuant to this Subtitle. (2) A credit institution shall calculate LGD* as follows: 𝐿𝐿𝐿𝐿𝐿𝐿∗ = 𝐿𝐿𝐿𝐿𝐿𝐿𝑈𝑈 ∙ 𝑈𝑈 ∙ (1 + 𝐻𝐻𝐸𝐸) + 𝐿𝐿𝐿𝐿𝐿𝐿𝑆𝑆 ∙ 𝑆𝑆 ∙ (1 + 𝐻𝐻𝐸𝐸) where :

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 281 = the exposure value before taking into account the effect of the funded credit protection; − for an exposure secured by financial collateral eligible in accordance with this Chapter, E shall be calculated in accordance with Article 260 paragraph (4) of this Decision; − in the case of securities lent or posted, E shall be equal to the cash lent or securities lent or posted; for securities that are lent or posted, the exposure value shall be increased by applying the volatility adjustment (𝐻𝐻𝐸𝐸) in accordance with Articles 260 to 263 of this Decision; 𝑆𝑆 = the current value of the funded credit protection received after the application of the volatility adjustment applicable to that type of funded credit protection (𝐻𝐻𝐶𝐶) and the application of the volatility adjustment for currency mismatches (𝐻𝐻𝑓𝑓𝑓𝑓) between the exposure and the funded credit protection, in accordance with paragraphs (3) and (4) of this Article, whereat 𝑠𝑠 shall be capped at the following value: ∙ (1 + 𝐻𝐻𝐸𝐸); 𝑢𝑢 = ∙ (1 + 𝐻𝐻𝐸𝐸) − 𝑆𝑆 𝐿𝐿𝐿𝐿𝐿𝐿𝑈𝑈 = the applicable LGD for an unsecured exposure as set out in Article 202paragraph (1) of this Decision; 𝐿𝐿𝐿𝐿𝐿𝐿𝑆𝑆 the applicable LGD to exposures secured by the type of eligible FCP used in the transaction, as specified in Table 1 referred to in paragraph (2) of this Article. (3) Table 1 of this paragraph specifies the values of LGDS and Hc applicable in the formula set out in paragraph (2) of this Decision: Table 1 Type of funded credit protection LGDs Volatility adjustment (Hc) Financial collateral 0% Volatility adjustment H as set out in Articles 261 to 263 of this Decision Receivables 20% 40% Residential property and commercial immovable property 20% 40% Other physical collateral 25% 40% Ineligible funded credit protection Not applicable 100% (4) Where an eligible funded credit protection is denominated in a different currency than that of the exposure, the volatility adjustment for currency mismatch (Hfx) shall be the same as the one that applies pursuant to Articles 261 to 263 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 282 (5) A credit institution may, as an alternative to the treatment set out in paragraphs (1), (2) and (3) of this Article and in accordance with Article 163 paragraph (14) of this Decision, may assign a 50% risk weight to the part of the exposure that is, within the limits set out in Article 164 paragraph (1), or Article 165 paragraph (1) of this Decision, fully collateralised by residential property or commercial immovable property situated within the territory of Montenegro or an EU Member State where all of the conditions set out in Article 237 paragraphs (4) and (5) or paragraphs (5) and (6) of this Decision are met. (6) To calculate risk-weighted exposure amounts and expected loss amounts for IRB exposures that fall within the scope of Article 257 of this Decision, a credit institution shall use E* in accordance with Article 257 paragraph (4) of this Decision and shall use LGD for unsecured exposures, as set out in Article 202 paragraph (1) items 1), 2) and 3) of this Decision. Calculating risk-weighted exposure amounts and expected loss amounts in the case of pools of eligible funded credit protection for an exposure treated under the IRB Approach Article 267 (1) A credit institution that has obtained multiple types of funded credit protection may, for exposures treated under the IRB Approach, apply the formula set out in Article 266 of this Decision, sequentially for each individual type of collateral. (2) A credit institution shall, for the purpose referred to in paragraph (1) of this Article, after each step of recognising one individual type of FCP, reduce the remaining value of the unsecured exposure (EU) by the adjusted value of the collateral (ES) recognised in that step. (3) In accordance with Article 266 paragraph (2) of this Decision, the total of ES across all funded credit protection types shall be capped at the value of ∙ (1 + 𝐻𝐻𝐸𝐸), resulting in the following formula: 𝑳𝑳𝑳𝑳𝑳𝑳∗ = 𝑳𝑳𝑳𝑳𝑳𝑳𝑼𝑼 ∙ 𝑬𝑬𝑼𝑼 𝑬𝑬 ∙ (𝟏𝟏 + 𝑯𝑯𝑬𝑬) + �𝑳𝑳𝑳𝑳𝑳𝑳𝑺𝑺,𝒊𝒊 𝒊𝒊 ∙ 𝑬𝑬𝑺𝑺,𝒊𝒊 𝑬𝑬 ∙ (𝟏𝟏 + 𝑯𝑯𝑬𝑬) where: 𝐿𝐿𝐿𝐿𝐿𝐿𝑆𝑆,𝑖𝑖 = the LGD applicable to funded credit protection i, as specified in Article 266 paragraph (3) of this Decision; 𝑆𝑆,𝑖𝑖 = the current value of funded credit protection i received after the application of the volatility adjustment applicable for the type of funded credit protection (Hc) pursuant to Article 266 paragraph (3) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 283 Other funded credit protection Article 268 (1) Where the conditions set out in Article 250 paragraph (1) of this Decision are met, cash on deposit with, or cash assimilated instruments held by, a third-party credit institution in a non-custodial arrangement and pledged to the lending credit institution, may be treated as a guarantee provided by the third-party credit institution. (2) Where the conditions set out in Article 250 paragraph (2) of this Decision are met, a credit institution shall subject the portion of the exposure collateralised by the current surrender value of life insurance policies pledged to the lending credit institution to the following treatment:

  1. where the exposure is subject to the Standardised Approach, it shall be risk￾weighted by using the risk weights specified in paragraph (4) of this Article;
  2. where the exposure is subject to the IRB Approach but not subject to the credit institution's own estimates of LGD, it shall be assigned an LGD of 40%. (3) In the event of a currency mismatch, a credit institution shall reduce the current surrender value in accordance with Article 269 paragraph (3) of this Decision, the value of the credit protection being the current surrender value of the life insurance policy. (4) For the purposes of paragraph (2) item 1) of this Article, a credit institution shall assign the following risk weights on the basis of the risk weight assigned to a senior unsecured exposure to the undertaking providing the life insurance:
  3. a risk weight of 20%, where the senior unsecured exposure to the undertaking providing the life insurance is assigned a risk weight of 20%;
  4. a risk weight of 35%, where the senior unsecured exposure to the undertaking providing the life insurance is assigned a risk weight of 50%;
  5. a risk weight of 52,5%, where the senior unsecured exposure to the undertaking providing the life insurance is assigned a risk weight of 75%
  6. a risk weight of 70%, where the senior unsecured exposure to the undertaking providing the life insurance is assigned a risk weight of 100%;
  7. a risk weight of 150%, where the senior unsecured exposure to the undertaking providing the life insurance is assigned a risk weight of 150%. (5) A credit institution may treat instruments repurchased on request that are eligible under Article 238 item 3) of this Decision as a guarantee by the issuing credit institution, and the value of the eligible credit protection shall be the following:
  8. where the instrument will be repurchased at its face value, the value of the protection shall be that amount;
  9. where the instrument will be repurchased at market price, the value of the protection shall be the value of the instrument valued in the same way as the debt securities that meet the conditions in Article 254 paragraph (5) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 284 Subsection 2 - Unfunded credit protection Valuation Article 269 (1) For the purpose of calculating the effects of unfunded credit protection in accordance with this Subsection, the value of unfunded credit protection (G) shall be the amount that the protection provider has undertaken to pay in the event of the default or non-payment of the debtor or on the occurrence of other specified credit events. (2) In the case of credit derivatives which do not include as a credit event restructuring of the underlying obligation involving write-off or postponement of principal, interest or fees that result in a credit loss event, the following shall apply:

  1. where the amount that the protection provider has undertaken to pay is not higher than the exposure value, a credit institution shall reduce the value of the credit protection calculated under paragraph (1) of this Article by 40%;
  2. where the amount that the protection provider has undertaken to pay is higher than the exposure value, the value of the credit protection shall be no higher than 60% of the exposure value. (3) Where unfunded credit protection is denominated in a currency different from that in which the exposure is denominated, a credit institution shall reduce the value of the credit protection by the application of a volatility adjustment as follows: ∗ = ∙ �1 − 𝐻𝐻𝑓𝑓𝑓𝑓� where: G* = the amount of credit protection adjusted for foreign exchange risk; G = the nominal amount of the credit protection; Hfx = the volatility adjustment for any currency mismatch between the credit protection and the underlying obligation determined in accordance with paragraph (5) of this Article. (4) Where there is no currency mismatch Hfx is equal to zero. (5) A credit institution shall base the volatility adjustments for any currency mismatch on a 10 business day liquidation period, assuming daily revaluation, and may calculate them based on the Supervisory Volatility Adjustments Approach as set out in Articles 261 of this Decision. (6) A credit institution shall scale up the volatility adjustments in accordance with Article 262 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 285 Calculating risk-weighted exposure amounts and expected loss amounts in the event of partial protection and tranching Article 270 Where a credit institution transfers a part of the risk of a loan to other persons in one or more tranches, the rules set out in Subtitle 5 of this Title shall apply, and the credit institution may consider materiality thresholds on payments below which no payment shall be made in the event of loss to be equivalent to retained first loss positions and to give rise to a tranched transfer of risk. Calculating risk-weighted exposure amounts under the substitution approach where the guaranteed exposure is treated under the Standardised Approach Article 271 (1) For the purposes of Article 150 paragraph (6) of this Decision, a credit institution shall calculate the risk-weighted exposure amounts for exposures with unfunded credit protection to which it applies the Standardised Approach, irrespective of the treatment of comparable direct exposure to the protection provider, in accordance with the following formula: max {0, − } ∙ + ∙ where: E = the exposure value in accordance with Article 148 of this Decision; for this purpose, the exposure value of an off-balance sheet item listed in paragraph (3) of that Article shall be 100% of its value rather than the exposure value indicated in paragraph (2) of that Article; GA = the amount of credit protection adjusted for foreign exchange risk (G*) as calculated under Article 269 paragraphs (3) and (4) of this Decision further adjusted for any maturity mismatch as laid down in Section 5 of this Subtitle; r = the risk weight of exposures to the debtor as specified under Subtitle 2 of this Title; g = the risk weight of exposures to the protection provider as specified under Subtitle 2 of this Title. (2) Where the protected amount (GA) is less than the exposure (E), a credit institution may apply the formula specified in paragraph (1) of this Article only where the protected and unprotected parts of the exposure are of equal seniority. (3) A credit institution may extend the preferential treatment set out in Article 151 paragraphs (4), (6), and (7) of this Decision to exposures or parts of exposures guaranteed by the central government or the central bank, as if those exposures were direct exposures to the central government or the central bank, provided that the conditions set out in Article 151 paragraphs (4), (6), and (7) of this Decision, as applicable, are met for such direct exposures.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 286 Calculating risk-weighted exposure amounts and expected loss amounts under the substitution approach where the guaranteed exposure is treated under the IRB Approach and a comparable direct exposure to the protection provider is treated under the Standardised Approach Article 272 (1) For exposures with unfunded credit protection to which an institution applies the IRB Approach set out in Chapter 3 and where comparable direct exposures to the protection provider are treated under the Standardised Approach, institutions shall calculate the risk-weighted exposure amounts in accordance with the following formula: max {0, − } ∙ + ∙ where: E = the exposure value determined in accordance with Section 5 of Subtitle 3 of this Title; for that purpose, a credit institution shall calculate the exposure value for off-balance-sheet items other than derivatives treated under the IRB Approach using a CCF of 100% instead of the SA-CCFs or IRB-CCF provided for in Article 207 paragraphs (14) to (23) of this Decision; GA = the amount of credit protection adjusted for foreign exchange risk (G*) as calculated in accordance with Article 269 paragraphs (3) and (4) of this Decision further adjusted for any maturity mismatch as laid down in Section 5 of this Subtitle; r = the risk weight of exposures to the debtor as specified in Subtitle 3; g = the risk weight applicable to a direct exposure to the protection provider as specified in Subtitle 2. (2) Where the amount of credit protection (GA) is less than the exposure value (E), a credit institution may apply the formula specified in paragraph (1) of this Article only where the protected and unprotected parts of the exposure are of equal seniority. (3) A credit institution may extend the preferential treatment set out in Article 151 paragraphs (4), (6) and (7) of this Decision, to exposures or parts of exposures guaranteed by the central government or the central bank as if those exposures were direct exposures to the central government or the central bank, provided that the conditions set out in Article 151 paragraphs (4), (6) and (7) of this Decision, as applicable, are met for such direct exposures. (4) The expected loss amount for the covered part of the exposure value shall be zero. (5) For any uncovered part of the exposure value (E), institutions shall use the risk weight and the expected loss corresponding to the underlying exposure. (6) A credit institution shall, for the calculation set out in Article 200 of this Decision, assign any general or specific credit risk adjustments or additional value adjustments in accordance with Article 17 of this Decision related to the non-trading book business

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 287 of the credit institution or other own funds reductions related to the exposure other than the deductions made in accordance with Article 19 items 14), 16) and 17) of this Decision, to the uncovered part of the exposure value. Calculating risk-weighted exposure amounts and expected loss amounts under the substitution approach where the guaranteed exposure is treated under the IRB Approach without the use of own estimates of LGD and a comparable direct exposure to the protection provider is treated under the IRB Approach Article 273 (1) A credit institution that applies the IRB Approach set out in Subtitle 3 of this Title for an exposure with unfunded credit protection, but without using its own estimates of LGD, and where comparable direct exposures to the protection provider treats under the IRB Approach set out in Subtitle 3 of this Title, the credit institution shall determine the covered part of the exposure as the lower of the exposure value (E) and the adjusted value of the unfunded credit protection (GA). (2) A credit institution that applies the IRB Approach to comparable direct exposures to the protection provider using own estimates of PD shall calculate the risk-weighted exposure amount and the expected loss amount for the covered part of the exposure value by using the PD of the protection provider and the LGD applicable for a comparable direct exposure to the protection provider as referred to in Article 202 paragraph (1) of this Decision, in accordance with paragraph (4) of this Article. (3) A credit institution shall, for subordinated exposures and non-subordinated unfunded credit protection, apply LGD to the covered part of the exposure value that is associated with senior claims and it shall account for any funded credit protection securing the unfunded credit protection in accordance with this Subtitle. (4) A credit institution shall calculate the risk weight and expected loss applicable to the covered part of the underlying exposure using the PD, the LGD specified in paragraphs (2) and (3) of this Article, and the same risk weight function as the ones used for a comparable direct exposure to the protection provider, and shall, where applicable, use the maturity (M) related to the underlying exposure, calculated in accordance with Article 203 of this Decision. (5) A credit institution that applies the IRB Approach to comparable direct exposures to the protection provider using the method provided for in Article 195 paragraphs (6) and (7) of this Decision shall use the risk weight and expected loss applicable to the covered part of the exposure that correspond to the ones provided for in Articles 195 paragraphs (6) and (7) and Article 199 paragraph (7) of this Decision. (6) Notwithstanding paragraph (5) of this Article, a credit institution that applies the IRB Approach to guaranteed exposures using the method provided for in Article 195 paragraphs (6) and (7) of this Decision shall calculate the risk weight and expected loss applicable to the covered part of the exposure using the PD, the LGD applicable for a comparable direct exposure to the protection provider as referred to in Article 202 paragraph (1) of this Decision, in accordance with paragraph (1) of this Article, and the same risk weight function as the ones used for a comparable direct exposure to the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 288 protection provider, and shall, where applicable, use the maturity (M) related to the underlying exposure, calculated in accordance with Article 203 of this Decision. (7) A credit institution shall, for subordinated exposures and non-subordinated unfunded credit protection, apply LGD to the covered part of the exposure value that is associated with senior claims and it shall account for any funded credit protection securing the unfunded credit protection in accordance with this Subtitle. (8) A credit institution shall, for any uncovered part of the exposure value (E), use the risk weight and the expected loss corresponding to the underlying exposure. (9) A credit institution shall, for the calculation set out in Article 200 of this Decision, assign any general or specific credit risk adjustments or additional value adjustments in accordance with Article 17 of this Decision related to the non-trading book business of the credit institution or other own funds reductions related to the exposure other than the deductions made in accordance with Article 19 items 14), 16) and 17) of this Decision, to the uncovered part of the exposure value. (10) For the purposes of this Article, (GA) is the amount of credit protection adjusted for foreign exchange risk (G*) as calculated under Article 269 paragraphs (3) and (4) of this Decision further adjusted for any maturity mismatch as laid down in Section 5 of this Subtitle. (11) The exposure value (E) shall be the exposure value determined in accordance with Section 5 of Subtitle 3 of this Title. (12) A credit institution shall calculate the exposure value for off-balance-sheet items other than derivatives treated under the IRB Approach using a CCF of 100% instead of the SA-CCFs or IRB-CCF provided for in Article 207 paragraphs (14) to (23) of this Decision. Calculating risk-weighted exposure amounts and expected loss amounts under the substitution approach where the guaranteed exposure is treated under the IRB Approach using own estimates of LGD and a comparable direct exposure to the protection provider is treated under the IRB Approach Article 274 (1) A credit institution that applies IRB Approach set out in Subtitle 3 of this Title for an exposure with unfunded credit protection using its own estimates of LGD and where comparable direct exposures to the protection provider are treated under the IRB Approach set out in Subtitle 3 of this Title, but without using its own estimates of LGD, shall determine the covered part of the exposure as the lower of the exposure value (E) and the adjusted value of the unfunded credit protection (GA), calculated in accordance with Article 272 paragraph (1) of this Decision. (2) A credit institution shall calculate the risk-weighted exposure amount and the expected loss amount for the covered part of the exposure value by using the PD, the LGD and the same risk weight function as the ones used for a comparable direct exposure to the protection provider, and shall, where applicable, use the maturity (M)

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 289 related to the underlying exposure, calculated in accordance with Article 203 of this Decision. (3) A credit institution that applies the IRB Approach set out in Subtitle 3 of this Title, but without using their own estimates of LGD to comparable direct exposures to the protection provider, shall determine the LGD in accordance with Article 202 paragraph (1) of this Decision. (4) A credit institution shall apply, for subordinated exposures and non-subordinated unfunded credit protection, the LGD to the covered part of the exposure value that is associated with senior claims and, in accordance with this Subtitle, it shall account for any funded credit protection securing the unfunded credit protection. (5) A credit institution that applies the IRB Approach set out in Subtitle 3 of this Title using their own estimates of LGD to comparable direct exposures to the protection provider shall calculate the risk weight and the expected loss applicable to the covered part of the underlying exposure using the PD, the LGD and the same risk weight function as the ones used for a comparable direct exposure to the protection provider, and shall, where applicable, use the maturity (M) related to the underlying exposure, calculated in accordance with Article 203 of this Decision. (6) A credit institution that applies the IRB Approach to comparable direct exposures to the protection provider using the method provided for in Article 195 paragraphs (6) and (7) of this Decision shall use the risk weight and expected loss applicable to the covered part of the exposure that correspond to the ones provided in Article 195 paragraphs (6) and (7) and Article 199 paragraph (7) of this Decision. (7) A credit institution shall, for any uncovered part of the exposure value (E), use the risk weight and the expected loss corresponding to the underlying exposure. (8) A credit institution shall, for the calculation set out in Article 200 of this Decision, assign any general or specific credit risk adjustments or additional value adjustments in accordance with Article 17 of this Decision related to the non-trading book business of the credit institution or other own funds reductions related to the exposure other than the deductions made in accordance with Article 19 items 14), 16) and 17) of this Decision, to the uncovered part of the exposure value. Section 5 - Maturity mismatches Maturity mismatch Article 275 (1) For the purpose of calculating risk-weighted exposure amounts, a maturity mismatch occurs when the residual maturity of the credit protection is less than that of the protected exposure. (2) Where protection has a residual maturity of less than three months and the maturity of the protection is less than the maturity of the underlying exposure that protection does not qualify as eligible credit protection..

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 290 (3) Where there is a maturity mismatch, the credit protection shall not qualify as eligible where either of the following conditions is met:

  1. the original maturity of the protection is less than one year;
  2. the exposure is a short term exposure specified by the Central Bank as being subject to a one-day floor rather than a one-year floor in respect of the maturity value (M) under Article 203 paragraphs (4) and (5) of this Decision. Maturity of credit protection Article 276 (1) The effective maturity of the underlying shall be the longest possible remaining time before the debtor is scheduled to fulfil its obligations and it may not be longer than five years. (2) The maturity of the credit protection, in accordance with paragraph (2) of this Article, shall be the time to the earliest date at which the protection may terminate or be terminated. (3) Where a protection seller has the right to terminate the protection unilaterally, a credit institution shall take the maturity of the protection to be the time to the earliest date at which the protection seller may exercise this right. (4) Where a protection buyer has the right to terminate the protection unilaterally, and the terms of the arrangement at origination of the protection contain a positive incentive for the credit institution to call the transaction before contractual maturity, a credit institution shall take the maturity of the protection to be the time to the earliest date at which the protection buyer may exercise this right, and otherwise the credit institution may consider that such an option does not affect the maturity of the protection. (5) Where a credit derivative is not prevented from terminating prior to expiration of any grace period required for a default on the underlying obligation to occur as a result of a failure to pay, a credit institution shall reduce the maturity of the protection by the length of the grace period. Valuation of credit protection Article 277 (1) For transactions subject to funded credit protection under the Financial Collateral Simple Method, where there is a mismatch between the maturity of the exposure and the maturity of the protection, the collateral shall not qualify as eligible funded credit protection. (2) For transactions subject to funded credit protection under the Financial Collateral Comprehensive Method, a credit institution shall reflect the maturity of the credit protection and of the exposure in the adjusted value of the collateral in accordance with the following formula: 𝐶𝐶𝑉𝑉𝑉𝑉 = 𝐶𝐶𝑉𝑉𝑉𝑉 ∙ 𝑡𝑡 − 𝑡𝑡∗ 𝑇𝑇 − 𝑡𝑡∗

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 291 where: CVA = the volatility adjusted value of the collateral as specified in Article 260 paragraphs (4) and (5) of this Decision or the amount of the exposure, whichever is lower; t = the number of years remaining to the maturity date of the credit protection calculated in accordance with Article 276 of this Decision, or the value of T, whichever is lower; T = the number of years remaining to the maturity date of the exposure calculated in accordance with Article 276, or five years, whichever is lower; t

  • = 0.25. (3) A credit institution shall use CVAM as CVA further adjusted for maturity mismatch in the formula for the calculation of the fully adjusted value of the exposure (E*) set out in Article 260 paragraph (9) of this Decision. (4) For transactions subject to unfunded credit protection, a credit institution shall reflect the maturity of the credit protection and of the exposure in the adjusted value of the credit protection in accordance with the following formula: = ∗ ∙ 𝑡𝑡 − 𝑡𝑡∗ 𝑇𝑇 − 𝑡𝑡∗ where: GA = G* adjusted for any maturity mismatch; G* = the amount of the protection adjusted for any currency mismatch; t = is the number of years remaining to the maturity date of the credit protection calculated in accordance with Article 276 of this Decision, or the value of T, whichever is lower; T = is the number of years remaining to the maturity date of the exposure calculated in accordance with Article 276 of this Decision, or five years, whichever is lower; t* = 0.25. (5) A credit institution shall use GA as the value of the protection for the purposes of Articles 269 to 273 of this Decision.

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 292 SUBTITLE 5 - Securitisation Section 1 - Criteria for simple, transparent, and standardised securitisations Definitions Article 278 (1) For the purposes of this Subtitle, the following definitions shall apply:

  1. clean-up call option means a contractual option that entitles the originator to call the securitisation positions before all of the securitised exposures have been repaid, either by repurchasing the underlying exposures remaining in the pool in the case of traditional securitisations or by terminating the credit protection in the case of synthetic securitisations, in both cases when the amount of outstanding underlying exposures falls to or below certain pre￾specified level;
  2. credit-enhancing interest-only strip means an on-balance sheet asset that represents a valuation of cash flows related to future margin income and is a subordinated tranche in the securitisation;
  3. liquidity facility means the securitisation position arising from a contractual agreement to provide funding to ensure timeliness of cash flows to investors;
  4. unrated position means a securitisation position which does not have an eligible credit assessment in accordance with Section 4 of this Subtitle of the Decision;
  5. rated position means a securitisation position which has an eligible credit assessment in accordance with Section 4 of this Subtitle of the Decision;
  6. senior securitisation position means a position backed or secured by a first claim on the whole of the underlying exposures, disregarding for these purposes amounts due under interest rate or currency derivative contracts, fees or other similar payments, and irrespective of any difference in maturity with one or more other senior tranches with which that position shares losses on a pro-rata basis;
  7. IRB pool means a pool of underlying exposures of a type in relation to which the credit institution has permission to use the IRB Approach and is able to calculate risk- weighted exposure amounts in accordance with Subtitle 3 of this Decision for all of these exposures;
  8. mixed pool means a pool of underlying exposures of a type in relation to which the credit institution has permission to use the IRB Approach and is able to calculate risk- weighted exposure amounts in accordance with Subtitle 3 of this Decision for some, but not all, of the exposures;
  9. overcollateralisation means any form of credit enhancement by virtue of which underlying exposures are posted in value which is higher than the value of the securitisation positions; 10)simple, transparent and standardised securitisation or STS securitisation means traditional securitisation, except ABCP programmes and transactions, that meets all the requirements set out in Articles 323 to 325 of this Decision; 11)asset-backed commercial paper programme or ABCP programme means a programme of securitisations the securities issued by which predominantly take the form of asset-backed commercial paper with an original maturity of one year or less;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 293 12)asset-backed commercial paper transaction or ABCP transaction means a securitisation within an ABCP programme; 13)traditional securitisation means a securitisation involving the transfer of the economic interest in the exposures being securitised through the transfer of ownership of those exposures from the originator to an SSPE or through sub￾participation by an SSPE, where the securities issued do not represent payment obligations of the originator; 14)synthetic securitisation means a securitisation where the transfer of risk is achieved by the use of credit derivatives or guarantees, and the exposures being securitised remain exposures of the originator; 15)revolving exposure means an exposure whereby debtors’ outstanding balances are permitted to fluctuate based on their decisions to borrow and repay, up to an agreed limit; 16)early amortisation provision means a contractual clause in a securitisation of revolving exposures or a revolving securitisation which requires, on the occurrence of defined events, investors’ securitisation positions to be redeemed before the originally stated maturity of those positions; 17)first loss tranche means the most subordinated tranche in a securitisation that is the first tranche to bear losses incurred on the securitised exposures and thereby provides protection to the second loss and, where relevant, higher ranking tranches; 18)mezzanine securitisation position means a position in the securitisation which is subordinated to the senior securitisation position and more senior than the first loss tranche, and which is subject to a risk weight lower than 1,250% and higher than 25% in accordance with Section 3 Subsections 2 and 3 of this Title of the Decision; 19)promotional entity means any undertaking or entity established by a Member State’s central government, and regional or local self-government, which grants promotional loans or grants promotional guarantees, whose primary goal is not to make profit or maximise market share but to promote that government’s or self-government's public policy objectives, provided that, subject to State aid rules, that government has an obligation to protect the economic basis of the undertaking or entity and maintain its viability throughout its lifetime, or that at least 90% of its original capital or funding or the promotional loan it grants is directly or indirectly guaranteed by the Member State’s central government, or regional or local self-government; 20) synthetic excess spread means the amount that, according to the documentation of a synthetic securitisation, is contractually designated by the originator to absorb losses of the securitised exposures that might occur before the maturity date of the transaction; 21)fully- supported ABCP programme means an ABCP programme that its sponsor directly and fully supports by providing to the SSPE one or more liquidity facilities covering at least all of the following: ­ all liquidity and credit risks of the ABCP programme; ­ any material dilution risks of the exposures being securitised; ­ any other transaction-level and programme-level costs if necessary to guarantee to the investor the full payment; 22)fully supported ABCP transaction means an ABCP transaction supported by a liquidity facility (at transaction level or at programme level) that covers items referred to in the previous definition;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 294 23)securitisation repository means a legal person that centrally collects and maintains the records of securitisations; 24)securitisation of non-performing exposures or NPE securitisation means a securitisation backed by a pool of non-performing exposures the nominal value of which makes up not less than 90% of the entire pool’s nominal value at the time of origination and at any later time where assets are added to or removed from the underlying pool due to replenishment, restructuring or any other relevant reason; 25)credit protection agreement means an agreement concluded between the originator and the investor to transfer the credit risk from the originator to the investor by means of credit derivatives or guarantees, whereby the originator commits to pay credit protection premium to the investor and the investor commits to make a payment to the originator in the event of the defined credit event; 26)credit protection premium means the amount the originator pays for the credit protection provided; 27)credit protection payment means the amount the investor has committed to pay to the originator in the event that a credit event defined in the agreement occurs. (2) Terms used in Articles 292 to 299 of this Decision shall have the following meaning:

  1. model development means the part of the process of the estimation of risk parameters that leads to an appropriate risk differentiation by specifying relevant risk drivers, building statistical or mechanical methods to assign exposures to debtor or facility grades or pools, and estimating intermediate parameters of the model, where relevant;
  2. calibration segment means a uniquely identified subset of the scope of application of the probability of default (‘PD’) or loss given default (‘LGD’) model that is jointly calibrated;
  3. qualifying securitised exposures means any of the following types of securitised exposures:
  • securitised exposures for which the credit institution calculating KIRB is not the servicer;
  • securitised exposures for which the credit institution calculating KIRB is the servicer and fulfils both of the following conditions: a) the credit institution was not involved in, or did not conclude, the original agreement that created the obligations or potential obligations of the debtor or potential debtor; b) the credit institution has limited access to data and information on those securitised exposures;
  1. internal model for calculating KIRB means a rating system for the calculation of KIRB referred to in Article 291 paragraph (4) of this Decision. (4) For the purposes of paragraph (2) item 2) of this Article, the PD and LGD models shall comprise all data and methods used as part of a rating system that deal with, respectively:
  2. the differentiation and quantification of own estimates of PD, where such data and methods are used to assess the default risk for each debtor or exposure covered by the PD model;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 295 2) the differentiation and quantification of own estimates of LGD, and the expected loss best estimate (‘ELBE’), where such data and methods are used to assess the level of loss in the case of default for each facility covered by the LGD model. (4) For the purposes of this Subtitle, the terms used in this Decision shall be construed as follows:

  1. seller of purchased receivables and seller shall, in provisions of this Decision that relate to purchased receivables and provided there is a SSPE, be read as ‘originator’;
  2. purchasing credit institution referred to in Article 196 paragraph (8), Article 203 paragraph (3), item 7), and Article 219 paragraph (1) item 5) of this Decision shall be read as ‘credit institution calculating KIRB in accordance with Article 291 paragraph (4) of this Decision’;
  3. credit institution’s exposures and standards referred to in Article 219 paragraph
  4. item 4) shall be read as ‘securitised exposures and standards applied to those exposures’;
  5. type of exposures referred to in Article 184 paragraph (1) item 6) of this Decision shall be read as groups of securitised exposures that would have been homogeneously managed by the credit institution calculating KIRB if they had not been securitised. (5) For pools of non-homogeneous securitised exposures, a credit institution calculating KIRB in accordance with this Decision may need to split such pools into sub￾pools of homogeneous securitised exposures to determine the risk- weighted exposure amount separately for each sub-pool for the calculation of KIRB in accordance with Article 291 paragraph (4) of this Decision, whereby references to ‘pools’ in this Decision shall be construed to include sub-pools, where appropriate. Criteria for STS securitisations qualifying for differentiated capital treatment Article 279 (1) Positions in an ABCP programme or ABCP transaction that qualify as positions in an STS securitisation shall be eligible for the treatment set out in Articles 304, 306 and 308 of this Decision where the following requirements are met:
  6. the underlying exposures meet, at the time of their inclusion in the ABCP programme, to the best knowledge of the originator or the original lender, the conditions for being assigned, under the Standardised Approach and taking into account any eligible credit risk mitigation, a risk weight equal to or smaller than 75% on an individual exposure basis where the exposure is a retail exposure or 100% for any other exposures; and
  7. the aggregate exposure value of all exposures to a single debtor at ABCP programme level does not exceed 2% of the aggregate exposure value of all exposures within the ABCP programme at the time the exposures were added to the ABCP programme, whereby for the purposes of this calculation, loans or leases to a group of connected clients, to the best knowledge of the sponsor, shall be considered as exposures to a single debtor. (2) In the case of trade receivables, paragraph (1) item 2) of this Article shall not apply where the credit risk of those trade receivables is fully covered by eligible credit

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 296 protection in accordance with Subtitle 4 of this Part of the Decision, provided that in that case the protection provider is a credit institution, an insurance undertaking or a reinsurance undertaking. (3) For the purposes of paragraph (2) of this Article, only the portion of the trade receivables remaining after taking into account the effect of any purchase price discount and overcollateralisation shall be used to determine whether they are fully covered and whether the concentration limit is met. (4) In the case of securitised residual leasing values, paragraph (1) item 2) of this Article shall not apply where those values are not exposed to refinancing or resell risk due to a legally enforceable commitment to repurchase or refinance the exposure at a pre-determined amount by a third party eligible under Article 239 paragraph (1) of this Decision. (5) By way of derogation from paragraph (1) item 1) of this Article, where a credit institution applies Article 284 paragraph (4) of this Decision, or has been granted authorisation to apply the Internal Assessment Approach in accordance with Article 309 of this Decision, the risk weight that a credit institution would assign to a liquidity facility that completely covers the ABCP issued under the programme is equal to or smaller than 100%. (6) Positions in a securitisation, other than an ABCP programme or ABCP transaction that qualify as positions in an STS securitisation, shall be eligible for the treatment set out in Articles 304, 306 and 308 of this Decision where the following requirements are met:

  1. at the time of inclusion in the securitisation, the aggregate exposure value of all exposures to a single debtor in the pool does not exceed 2% of the exposure values of the aggregate outstanding exposure values of the pool of underlying exposures, whereby for the purposes of this calculation, loans or leases to a group of connected persons shall be considered as exposures to a single debtor, and in the case of securitised residual leasing values, this item shall not apply where those values are not exposed to refinancing or resell risk due to a legally enforceable commitment to repurchase or refinance the exposure at a pre-determined amount by a third party eligible under Article 239 paragraph (1) of this Decision.
  2. at the time of their inclusion in the securitisation, the underlying exposures meet the conditions for being assigned, under the Standardised Approach and taking into account any eligible credit risk mitigation, a risk weight equal to or smaller than:
  • 40% on an exposure value-weighted average basis for the portfolio where the exposures are loans secured by residential mortgages or fully guaranteed residential loans, as referred to in Article 169 paragraph (1) item
  1. of this Decision;
  • 50% on an individual exposure basis where the exposure is a loan secured by a commercial mortgage;
  • 75% on an individual exposure basis where the exposure is a retail exposure;
  • for any other exposures, 100% on an individual exposure basis;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 297 3) where item 2) indents 1 and 2 of this paragraph apply, the loans secured by lower ranking security rights on a given asset shall only be included in the securitisation where all loans secured by prior ranking security rights on that asset are also included in the securitisation; 4) where item 2) indents 1 and 2 of this paragraph applies, no loan in the pool of underlying exposures shall have a loan-to-value ratio higher than 100%, at the time of inclusion in the securitisation, measured in accordance with Article 169 paragraph (1) item 5) and Article 265 paragraph (1) of this Decision. Section 2 - Recognition of significant risk transfer Traditional securitisation Article 280 (1) The originator credit institution of a traditional securitisation may exclude underlying exposures from its calculation of risk-weighted exposure amounts and, where relevant, expected loss amounts if either of the following conditions is fulfilled:

  1. significant credit risk associated with the underlying exposures has been transferred to third parties;
  2. the originator credit institution applies a 1,250% risk weight to all securitisation positions it holds in the securitisation or deducts these securitisation positions from Common Equity Tier 1 items in accordance with Article 19 item 11) of this Decision. (2) Significant credit risk shall be considered as transferred where:
  3. the risk-weighted exposure amounts of the mezzanine securitisation positions held by the originator credit institution in the securitisation do not exceed 50% of the risk-weighted exposure amounts of all mezzanine securitisation positions existing in this securitisation; or
  4. the originator credit institution does not hold more than 20% of the exposure value of the first loss tranche in the securitisation, provided that both of the following conditions are met:
  • the originator can demonstrate that the exposure value of the first loss tranche exceeds a reasoned estimate of the expected loss on the underlying exposures by a substantial margin; and
  • there are no mezzanine securitisation positions. (3) Where the possible reduction in risk-weighted exposure amounts, which the originator credit institution would achieve by the securitisation under paragraph (2) items 1) and 2) of this Article, is not justified by a commensurate transfer of credit risk to third parties, the Central Bank may decide on a case-by-case basis that significant credit risk shall not be considered as transferred to third parties. (4) By way of derogation from paragraphs (2) and (3) of this Article, the Central Bank may allow the originator credit institution to recognise significant credit risk transfer in relation to a securitisation where the originator credit institution demonstrates in each case that the reduction in capital requirements which the originator achieves by the securitisation is justified by a commensurate transfer of credit risk to third parties.

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 298 (5) The Central Bank shall grant authorisation referred to in paragraph (4) of this Article where the credit institution meets the following conditions:

  1. the credit institution has adequate internal risk management policies and methodologies to assess the transfer of credit risk; and
  2. the credit institution has also recognised the transfer of credit risk to third parties in each case for the purposes of the its internal risk management and its internal capital allocation. (6) In addition to the requirements set out in paragraphs (1) to (4) of this Article, the following conditions shall also be met:
  3. the transaction documentation reflects the economic substance of the securitisation;
  4. the securitisation positions do not constitute payment obligations of the originator credit institution;
  5. the underlying exposures are placed beyond the reach of the originator credit institution and its creditors, taking into account that the title to the underlying exposures shall be acquired by the SSPE by means of a true sale or assignment or transfer with the same legal effect in a manner that is enforceable against the seller or any other third party, whereby the transfer of the title to the SSPE shall not be subject to severe clawback provisions in the event of the seller’s insolvency;
  6. the originator credit institution does not retain control over the underlying exposures; it shall be considered that control is retained over the underlying exposures where the originator has the right to repurchase from the transferee the previously transferred exposures in order to realise their benefits or if it is otherwise required to re-assume transferred risk, if the originator credit institution has retained the servicing rights or obligations in respect of the underlying exposures, that fact shall not of itself constitute control of the exposures;
  7. the securitisation documentation does not contain terms or conditions that:
  • require the originator credit institution to alter the underlying exposures to improve the average quality of the pool; or
  • increase the yield payable to holders of positions or otherwise enhance the positions in the securitisation in response to a deterioration in the credit quality of the underlying exposures;
  1. where applicable, the transaction documentation makes it clear that the originator or the sponsor may only purchase or repurchase securitisation positions or repurchase, restructure or substitute the underlying exposures beyond their contractual obligations where such arrangements are executed in accordance with prevailing market conditions and the parties to them act in their own interest as free and independent parties (arm’s length);
  2. where there is a clean-up call option, that option shall also meet all of the following conditions:
  • it can be exercised at the discretion of the originator credit institution;
  • it may only be exercised when 10% or less of the original value of the underlying exposures remains unamortised; and
  • it is not structured to avoid allocating losses to credit enhancement positions or other positions held by investors in the securitisation and is not otherwise structured to provide credit enhancement;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 299 8) the originator credit institution has received an opinion from a qualified legal counsel confirming that the securitisation complies with the conditions set out in item 3) of this paragraph. Synthetic securitisation Article 281 (1) The originator credit institution of a synthetic securitisation may calculate risk￾weighted exposure amounts, and, where relevant, expected loss amounts with respect to the underlying exposures in accordance with Articles 287 and 288 of this Decision, where either of the following conditions is met:

  1. significant credit risk has been transferred to third parties either through funded or unfunded credit protection;
  2. the originator credit institution applies a 1,250% risk weight to all securitisation positions that it retains in the securitisation or deducts these securitisation positions from Common Equity Tier 1 items in accordance with Article 19 item
  3. of this Decision. (2) Significant credit risk shall be considered as transferred if:
  4. the risk-weighted exposure amounts of the mezzanine securitisation positions held by the originator credit institution in the securitisation do not exceed 50% of the risk-weighted exposure amounts of all mezzanine securitisation positions existing in this securitisation; or
  5. the originator credit institution does not hold more than 20% of the exposure value of the first loss tranche in the securitisation, provided that both of the following conditions are met:
  • the originator can demonstrate that the exposure value of the first loss tranche exceeds a reasoned estimate of the expected loss on the underlying exposures by a substantial margin; and
  • there are no mezzanine securitisation positions. (3) Where the possible reduction in risk-weighted exposure amounts, which the originator credit institution would achieve by the securitisation, is not justified by a commensurate transfer of credit risk to third parties, the Central Bank may decide on a case-by-case basis that significant credit risk shall not be considered as transferred to third parties. (4) By way of derogation from paragraphs (2) and (3) of this Article, the Central Bank may allow the originator credit institution to recognise significant credit risk transfer in relation to a securitisation where the originator credit institution demonstrates in each case that the reduction in own funds requirements which the originator achieves by the securitisation is justified by a commensurate transfer of credit risk to third parties. (5) The Central Bank shall grant the authorisation referred to in paragraph (4) of this Article where the credit institution meets both of the following conditions:
  1. the credit institution has adequate internal risk-management policies and methodologies to assess the transfer of credit risk; and
  2. the credit institution has also recognised the transfer of credit risk to third parties in each case for the purposes of the credit institution’s internal risk management and its internal capital allocation.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 300 (6) In addition to the requirements set out in paragraphs (1) to (5) of this Article, the following conditions shall also be met:

  1. the transaction documentation reflects the economic substance of the securitisation;
  2. the credit protection by virtue of which credit risk is transferred complies with Article 285 of this Decision;
  3. the securitisation documentation does not contain terms or conditions that:
  • impose significant materiality thresholds below which credit protection is deemed not to be triggered if a credit event occurs;
  • allow for the termination of the protection due to deterioration of the credit quality of the underlying exposures;
  • require the originator credit institution to alter the composition of the underlying exposures to improve the average quality of the pool; or
  • increase the credit institution’s cost of credit protection or the yield payable to holders of positions in the securitisation in response to a deterioration in the credit quality of the underlying pool;
  1. the credit protection is enforceable in all relevant jurisdictions;
  2. where applicable, the transaction documentation makes it clear that the originator or the sponsor may only purchase or repurchase securitisation positions or repurchase, restructure or substitute the underlying exposures beyond their contractual obligations where such arrangements are executed in accordance with prevailing market conditions and the parties to them act in their own interest as free and independent parties (arm’s length);
  3. where there is a clean-up call option, that option meets all the following conditions:
  • it may be exercised at the discretion of the originator credit institution;
  • it may only be exercised when 10% or less of the original value of the underlying exposures remains unamortised;
  • it is not structured to avoid allocating losses to credit enhancement positions or other positions held by investors in the securitisation and is not otherwise structured to provide credit enhancement;
  1. the originator credit institution has received an opinion from a qualified legal counsel confirming that the securitisation complies with the conditions set out in item 4) of this paragraph; Operational requirements for early amortisation provisions Article 282 Where the securitisation includes revolving exposures and early amortisation provisions or similar provisions, significant credit risk shall only be considered transferred by the originator credit institution where the requirements laid down in Articles 280 and 281 are met and the early amortisation provision, once triggered, does not:
  2. subordinate the credit institution’s senior or pari passu claim on the underlying exposures to the other investors’ claims;
  3. subordinate further the credit institution’s claim on the underlying exposures relative to other parties’ claims; or
  4. otherwise increase the credit institution’s exposure to losses associated with the underlying revolving exposures.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 301 Section 3 - Calculation of risk-weighted exposure amounts Subsection 1 - General Provisions Calculation of risk-weighted exposure amounts Article 283 (1) Where an originator credit institution has transferred significant credit risk associated with the underlying exposures of the securitisation in accordance with Section 2 of this Subtitle that credit institution may:

  1. in the case of a traditional securitisation, exclude the underlying exposures from its calculation of risk-weighted exposure amounts, and, as relevant, expected loss amounts;
  2. in the case of a synthetic securitisation, calculate risk-weighted exposure amounts, and, where relevant, expected loss amounts, with respect to the underlying exposures in accordance with Articles 287 and 288 of this Decision. (2) Where the originator credit institution has decided to apply paragraph (1) of this Article, it shall calculate the risk-weighted exposure amounts as set out in this Subtitle for the positions that it may hold in the securitisation. (3) Where the originator credit institution has not transferred significant credit risk or has decided not to apply paragraph (1) of this Article, it shall not be required to calculate risk-weighted exposure amounts for any position it may have in the securitisation but shall continue including the underlying exposures in its calculation of risk-weighted exposure amounts and, where relevant, expected loss amounts as if they had not been securitised. (4) Where there is an exposure to positions in different tranches in a securitisation, the exposure to each tranche shall be considered a separate securitisation position. (5) The providers of credit protection to securitisation positions shall be considered as holding positions in the securitisation. (6) Securitisation positions shall include exposures to a securitisation arising from interest rate or currency derivative contracts that the credit institution has entered into with the transaction. (7) Unless a securitisation position is deducted from Common Equity Tier 1 items pursuant to Article 19 item 11) of this Decision, the risk-weighted exposure amount shall be included in the credit institution’s total of risk-weighted exposure amounts for the purposes of Article 114 paragraph (3) of this Decision. (8) The risk-weighted exposure amount of a securitisation position shall be calculated by multiplying the exposure value of the position, calculated as set out in Article 284 of this Decision, by the relevant total risk weight.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 302 (7) The total risk weight referred to in paragraph (8) of this Article shall be determined as the sum of the risk weight set out in this Subtitle and any additional risk weight in accordance with Article 316 of this Decision. Exposure value Article 284 (1) The exposure value of a securitisation position shall be calculated as follows:

  1. the exposure value of an on-balance sheet securitisation position shall be its accounting value remaining after any relevant specific credit risk adjustments on the securitisation position have been applied in accordance with Article 144 of this Decision;
  2. the exposure value of an off-balance sheet securitisation position shall be its nominal value less any relevant specific credit risk adjustments on the securitisation position in accordance with Article 144 of this Decision, multiplied by the relevant conversion factor set out as follows: − the conversion factor shall be 100%, except in the case of cash advance facilities, − to determine the exposure value of the undrawn portion of the cash advance facilities, a conversion factor of 0% may be applied to the nominal amount of a liquidity facility that is unconditionally cancellable provided that repayment of draws on the facility are senior to any other claims on the cash flows arising from the underlying exposures and the credit institution has demonstrated to the satisfaction of the Central Bank that it is applying an appropriately conservative method for measuring the amount of the undrawn portion;
  3. the exposure value for the counterparty credit risk of a securitisation position that results from a derivative instrument listed in Article 148 paragraph (8) of this Decision, shall be determined in accordance with Subtitle 6 of this Decision;
  4. an originator credit institution may deduct from the exposure value of a securitisation position which is assigned 1,250% risk weight in accordance with Subsection 3 of this Section or deducted from Common Equity Tier 1 in accordance with Article 19 item 11) of this Decision, the amount of the specific credit risk adjustments on the underlying exposures in accordance with Article 144 of this Decision, and any non-refundable purchase price discounts connected with such underlying exposures to the extent that such discounts have caused the reduction of own funds;
  5. the exposure value of a synthetic excess spread shall include, as applicable, the following:
  • any income from the securitised exposures already recognised by the originator institution in its income statement under the applicable accounting framework that the originator institution has contractually designated to the transaction as synthetic excess spread and that is still available to absorb losses;
  • any synthetic excess spread that is contractually designated by the originator institution in any previous periods and that is still available to absorb losses;
  • any synthetic excess spread that is contractually designated by the originator institution for the current period and that is still available to absorb losses;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 303

  • any synthetic excess spread contractually designated by the originator institution for future periods. (2) For the purposes of paragraph (1) item 5) of this Article, any amount that is provided as collateral or credit enhancement in relation to the synthetic securitisation and that is already subject to an own funds requirement in accordance with this Subtitle shall be excluded from the exposure value. (3) Where a credit institution has two or more overlapping positions in a securitisation, it shall include only one of the positions in its calculation of risk-weighted exposure amounts. (4) Where the positions partially overlap, the credit institution may split the position into two parts and recognise the overlap in relation to one part only in accordance with the paragraph (3) of this Article, and alternatively, the credit institution may treat the positions as if they were fully overlapping by expanding for capital calculation purposes the position that produces the higher risk-weighted exposure amounts. (5) A credit institution may also recognise an overlap between the specific risk capital requirements for positions in the trading book and the capital requirements for securitisation positions in the non-trading book, provided that the credit institution is able to calculate and compare the capital requirements for the relevant positions. (6) For the purposes of paragraph (5) of this Article, two positions shall be deemed to be overlapping where they are mutually offsetting in such a manner that the credit institution is able to preclude the losses arising from one position by performing the obligations required under the other position. (7) Where Article 318 paragraph (1) item 4) applies to positions in an ABCP programme, the credit institution may use the risk weight assigned to a liquidity facility in order to calculate the risk-weighted exposure amount for the ABCP programme, provided that the liquidity facility covers 100% of the ABCP issued by the ABCP programme and the liquidity facility ranks pari passu with the ABCP in a manner that they form an overlapping position. (8) The credit institution shall notify the Central Bank where it has applied the provisions laid down in paragraph (7) of this Article. (9) For the purposes of determining the 100% coverage set out in paragraph (7) of this Article, the credit institution may take into account other liquidity facilities in the ABCP programme, provided that they form an overlapping position with the ABCP. Recognition of credit risk mitigation for securitisation positions Article 285 (1) A credit institution may recognise funded or unfunded credit protection with respect to a securitisation position where the requirements for credit risk mitigation laid down in this Subtitle and in Subtitle 4 of this Decision are met.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 304 (2) Eligible funded credit protection shall be limited to financial collateral which is eligible for the calculation of risk-weighted exposure amounts under Subtitle 2 of this Title as laid down under Subtitle 4 of this Title and recognition of credit risk mitigation shall be subject to compliance with the relevant requirements as laid down under Subtitle 4 of this Title. (3) Eligible unfunded credit protection and eligible unfunded credit protection providers shall be limited to those which are eligible in accordance with Subtitle 4 of this Title, and the recognition of credit risk mitigation shall be subject to compliance with the relevant requirements as laid down under Subtitle 4 of this Title. (4) By way of derogation from paragraph (3) of this Article, the eligible providers of unfunded credit protection listed in Article 239 paragraph (1) items 1) to 8) of this Decision shall have been assigned a credit assessment by a recognised ECAI which is credit quality step 2 or above at the time the credit protection was first recognised and is currently credit quality step 3 or above. (5) A credit institution which is allowed to apply the IRB Approach to a direct exposure to the protection provider may assess eligibility in accordance with paragraph (4) of this Article based on the equivalence of the PD for the protection provider to the PD associated with the credit quality steps referred to in Article 178 paragraph (3) of this Decision. (6) By way of derogation from paragraphs (2) and (3) of this Article, the securitisation special purpose entities (SSPEs) shall be eligible protection providers where the following conditions are met:

  1. the SSPE owns assets that qualify as eligible financial collateral in accordance with Subtitle 4 of this Title;
  2. the assets referred to in item 1) of this paragraph are not subject to claims or contingent claims ranking ahead or pari passu with the claim or contingent claim of the credit institution receiving unfunded credit protection; and
  3. all the requirements for the recognition of financial collateral set out in Subtitle 4 of this Title are met. (7) For the purposes of paragraph (6) of this Article, the amount of the protection adjusted for any currency and maturity mismatches (Ga) in accordance with Subtitle 4 of this Title shall be limited to the volatility adjusted market value of those assets and the risk weight of exposures to the protection provider as specified under the Standardised Approach (g) shall be determined as the weighted-average risk weight that would apply to those assets as financial collateral under the Standardised Approach. (8) Where a securitisation position benefits from full credit protection or a partial credit protection on a pro-rata basis, the following requirements shall apply:
  4. the credit institution providing credit protection shall calculate risk-weighted exposure amounts for the portion of the securitisation position benefiting from credit protection in accordance with Subsection 3 of this Section as if it held that portion of the position directly;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 305 2) the credit institution buying credit protection shall calculate risk-weighted exposure amounts in accordance with Subtitle 4 of this Title for the protected portion. (9) In all cases not covered by paragraph (8) of this Article, the following requirements shall apply:

  1. the credit institution providing credit protection shall treat the portion of the position benefiting from credit protection as a securitisation position and shall calculate risk-weighted exposure amounts as if it held that position directly in accordance with Subsection 3 of this Section, subject to paragraphs (10), (11), and (12) of this Article;
  2. the credit institution buying credit protection shall calculate risk-weighted exposure amounts for the protected portion of the position referred to in item 1) of this paragraph in accordance with Subtitle 4 of this Title, whereby it shall treat the portion of the securitisation position not benefiting from credit protection as a separate securitisation position and shall calculate risk-weighted exposure amounts in accordance with Subsection 3 of this Section, subject to paragraphs (10), (11), and (12) of this Article. (10) A credit institution using the Securitisation Internal Ratings Based Approach (SEC-IRBA) or the Securitisation Standardised Approach (SEC-SA) under Subsection 3 of this Section shall determine the attachment point (A) and detachment point (D) separately for each of the positions derived in accordance with paragraph (9) of this Article as if these had been issued as separate securitisation positions at the time of origination of the transaction, and the value of KIRB or KSA, respectively, shall be calculated taking into account the original pool of exposures underlying the securitisation. (11) A credit institution using the Securitisation External Ratings Based Approach (SEC-ERBA) under Subsection 3 of this Section, for the original securitisation position shall calculate risk-weighted exposure amounts for the positions derived in accordance with paragraph (9) of this Article as follows:
  3. where the derived position has the higher seniority, it shall be assigned the risk weight of the original securitisation position;
  4. where the derived position has the lower seniority, it may be assigned an inferred rating in accordance with Article 307 paragraph (7) of this Decision, and in that case, thickness input T shall only be computed on the basis of the derived position, and where a rating may not be inferred, the credit institution shall apply the higher of the risk weight resulting from either:
  • applying the Securitisation Standardised Approach in accordance with paragraph (10) of this Article and Subsection 3 of this Section; or
  • the risk weight of the original securitisation position under the SEC-ERBA. (12) The derived position with the lower seniority shall be treated as a non-senior securitisation position even if the original securitisation position prior to protection qualifies as senior.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 306 Implicit support Article 286 (1) A sponsor credit institution, or an originator credit institution which in respect of a securitisation has made use of Article 283 paragraphs (1), (2) and (3) in the calculation of risk-weighted exposure amounts or has sold instruments from its trading book to the effect that it is no longer required to hold own funds for the risks of those instruments shall not provide support, directly or indirectly, to the securitisation beyond its contractual obligations with a view to reducing potential or actual losses to investors. (2) A transaction shall not be considered as support for the purposes of paragraph (1) of this Article where the transaction has been duly taken into account in the assessment of significant credit risk transfer and both parties have executed the transaction acting in their own interest as free and independent parties (arm’s length), and for these purposes, the credit institution shall undertake a full credit review of the transaction and, in particular, take into account all of the following items:

  1. the repurchase price;
  2. the credit institution’s capital and liquidity position before and after repurchase;
  3. the performance of the underlying exposures;
  4. the performance of the securitisation positions; and
  5. the impact of support on the losses expected to be incurred by the originator relative to investors. (3) The originator credit institution and the sponsor credit institution shall notify the Central Bank of any transaction entered into in relation to the securitisation in accordance with paragraph (2) of this Article. (4) If an originator credit institution or a sponsor credit institution fails to comply with conditions set out in paragraph (1) in respect of a securitisation, the credit institution shall include all of the underlying exposures of that securitisation in its calculation of risk-weighted exposure amounts as if they had not been securitised and disclose:
  6. that it has provided support to the securitisation in breach of paragraph (1) of this Article; and
  7. the impact of the support provided in terms of capital requirements. Originator credit institution’s calculation of risk-weighted exposure amounts securitised in a synthetic securitisation Article 287 (1) For the purpose of calculating risk-weighted exposure amounts for the underlying exposures, the originator credit institution of a synthetic securitisation shall use the calculation methodologies set out in this Section where applicable instead of those set out in Subtitle 2 of this Section. (2) For a credit institution calculating risk-weighted exposure amounts and, where relevant, expected loss amounts with respect to the underlying exposures under Subtitle 3 of this Title, the expected loss amount in respect of such exposures shall be zero (0).

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 307 (3) The requirements set out in paragraphs (1) and (2) of this Article shall apply to the entire pool of exposures backing the securitisation. (4) Subject to Article 288 of this Decision, the originator credit institution shall calculate risk-weighted exposure amounts with respect to all tranches in the securitisation in accordance with this Section, including the positions in relation to which the credit institution is able to recognise credit risk mitigation in accordance with Article 285 of this Decision, and the risk weight to be applied to positions which benefit from credit risk mitigation may be amended in accordance with Subtitle 4 of this Title. Treatment of maturity mismatches in synthetic securitisations Article 288 (1) For the purposes of calculating risk-weighted exposure amounts in accordance with Article 287 of this Decision, any maturity mismatch between the credit protection by which the transfer of risk is achieved and the underlying exposures shall be calculated as follows:

  1. the maturity of the underlying exposures shall be taken to be the longest maturity of any of those exposures subject to a maximum of 5 years, and the maturity of the credit protection shall be determined in accordance with Subtitle 4 of this Title;
  2. an originator credit institution shall ignore any maturity mismatch in calculating risk-weighted exposure amounts for securitisation positions subject to a risk weight of 1,250% in accordance with this Section, and for all other positions, the maturity mismatch treatment set out in Subtitle 4 of this Title shall be applied in accordance with the following formula: 𝑅𝑅𝑅𝑅∗ = 𝑅𝑅𝑅𝑅𝑆𝑆 ⋅ [(𝑡𝑡 − 𝑡𝑡∗) ∕ (𝑇𝑇 − 𝑡𝑡∗)] + 𝑅𝑅𝑅𝑅 ⋅ [(𝑇𝑇 − 𝑡𝑡) ∕ (𝑇𝑇 − 𝑡𝑡∗)] where: RW* = risk-weighted exposure amounts for the purposes of Article 114 paragraph (4) item 1) of this Decision; RWAss = risk-weighted exposure amounts for the underlying exposures as if they had not been securitised, calculated on a pro-rata basis; RWSP = risk-weighted exposure amounts calculated under Article 287 of this Decision as if there was no maturity mismatch; T = maturity of the underlying exposures, expressed in years; t = maturity of credit protection, expressed in years; t* = 0.25.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 308 Reduction in risk-weighted exposure amounts Article 289 (1) Where a securitisation position is assigned a 1,250% risk weight under this Section, a credit institution may deduct the exposure value of such position from Common Equity Tier 1 capital in accordance with Article 19 item 11) of this Decision as an alternative to including the position in its calculation of risk-weighted exposure amounts, whereby the calculation of the exposure value may reflect eligible funded credit protection in accordance with Article 285 of this Decision. (2) Where a credit institution makes use of the alternative set out in paragraph (1) of this Article, it may subtract the amount deducted in accordance with Article 1 item 11) of this Decision from the amount specified in Article 312 of this Decision as maximum capital requirement that would be calculated in respect of the underlying exposures as if they had not been securitised. Subsection 2 - Hierarchy of methods and common parameters Hierarchy of methods Article 290 (1) A credit institution shall use one of the methods set out in Subsection 3 to calculate risk-weighted exposure amounts in accordance with the following hierarchy:

  1. where the conditions set out in Article 302 of this Decision are met, a credit institution shall use the SEC-IRBA in accordance with Articles 303 and 304 of this Decision;
  2. where the SEC-IRBA may not be used, a credit institution shall use the SEC￾SA in accordance with Articles 305 and 306 of this Decision;
  3. where the SEC-SA may not be used, a credit institution shall use the SEC￾ERBA in accordance with Articles 307 and 308 of this Decision for rated positions or positions in respect of which an inferred rating may be used. (2) For rated positions or positions in respect of which an inferred rating may be used, a credit institution shall use the SEC-ERBA instead of the SEC-SA in each of the following cases:
  4. where the application of the SEC-SA would result in a risk weight higher than 25% for positions qualifying as positions in an STS securitisation;
  5. where the application of the SEC-SA would result in a risk weight higher than 25% or the application of the SEC-ERBA would result in a risk weight higher than 75% for positions not qualifying as positions in an STS securitisation; or
  6. for securitisation transactions backed by pools of car purchase loans, car leases and equipment leases. (3) In cases not covered by paragraph (2) of this Article, and by way of derogation from paragraph (1) item 2) of this Article, a credit institution may decide to apply the SEC-ERBA instead of the SEC-SA to all of its rated securitisation positions or positions in respect of which an inferred rating may be used.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 309 (4) A credit institution shall notify the Central Bank on its decision on the application and any subsequent decision to further change the approach applied to all of its rated securitisation positions shall be notified by the credit institution to Central Bank immediately following that decision, and no later than 15 November of the current year, and in the absence of any objection by the Central Bank by 15 December of that year, the decision notified by the credit institution shall take effect from 1 January of the following year and shall be valid until a subsequently notified decision comes into effect, provided that a credit institution shall not use different approaches in the course of the same year. (5) By way of derogation from paragraph (1) of this Article, the Central Bank may prohibit a credit institution, on a case by case basis, from applying the SEC-SA when the risk-weighted exposure amount resulting from the application of the SEC-SA is not commensurate to the risks posed to the credit institution or to financial stability, including but not limited to the credit risk embedded in the exposures underlying the securitisation. (6) In the case of exposures not qualifying as positions in an STS securitisation, particular regard shall be had to securitisations with highly complex and risky features. (7) By way of derogation from paragraph (1) of this Article, a credit institution may apply the Internal Assessment Approach to calculate risk-weighted exposure amounts in relation to an unrated position in an ABCP programme or ABCP transaction in accordance with Article 310 of this Decision, provided that the conditions set out in Article 310 of this Decision are met. (8) Where a credit institution has received authorisation to apply the Internal Assessment Approach in accordance with Article 309 paragraph (3) of this Decision, and a specific position in an ABCP programme or ABCP transaction falls within the scope of application covered by such authorisation, the credit institution shall apply that approach to calculate the risk-weighted exposure amount of that position. (9) For a position in a re-securitisation, a credit institution shall apply the SEC-SA in accordance with Article 305 of this Decision, with the modifications set out in Article 313 of this Decision, and in all other cases, a risk weight of 1,250% shall be assigned to securitisation positions. Determination of KIRB and KSA Article 291 (1) A credit institution that applies the SEC-IRBA in accordance with Subsection 3 of this Section shall calculate KIRB in accordance with paragraphs (2) to (8) of this Article. (2) A credit institution shall determine KIRB by multiplying the risk-weighted exposure amounts that would be calculated under Subtitle 3 of this Decision in respect of the underlying exposures as if they had not been securitised by 8% divided by the exposure value of the underlying exposures, where KIRB shall be expressed in decimal form between zero and one.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 310 (3) For KIRB calculation purposes, the risk-weighted exposure amounts that would be calculated under Subtitle 3 of this Title in respect of the underlying exposures shall include:

  1. the amount of expected losses associated with all the underlying exposures of the securitisation including defaulted underlying exposures that are still part of the pool in accordance with Subtitle 3 of this Title; and
  2. the amount of unexpected losses associated with all the underlying exposures including defaulted underlying exposures in the pool in accordance with Subtitle 3 of this Title. (4) A credit institution may calculate KIRB in relation to the underlying exposures of the securitisation in accordance with the provisions set out in Subtitle 3 of this Title for the calculation of capital requirements for purchased receivables, and for these purposes, retail exposures shall be treated as purchased retail receivables and non-retail exposures as purchased corporate receivables. (5) A credit institution shall calculate KIRB separately for dilution risk in relation to the underlying exposures of a securitisation where dilution risk is material to such exposures. (6) Where losses from dilution and credit risks are treated in an aggregate manner in the securitisation, a credit institution shall combine the respective KIRB for dilution and credit risk into a single KIRB for the purposes of Subsection 3 of this Section. (7) The presence of a single reserve fund or overcollateralisation available to cover losses from either credit or dilution risk may be regarded as an indication that these risks are treated in an aggregate manner. (8) Where dilution and credit risk are not treated in an aggregate manner in the securitisation, a credit institution shall modify the treatment set out in paragraphs (6) and (7) of this Article to combine the respective KIRB for dilution and credit risk in a prudent manner. (9) A credit institution that applies the SEC-SA under Subsection 3 of this Section shall calculate KSA by multiplying the risk-weighted exposure amounts that would be calculated under Subtitle 2 of this Title in respect of the underlying exposures as if they had not been securitised by 8% divided by the value of the underlying exposures, where KSA shall be expressed in decimal form between zero and one. (10) When applying paragraph (9) of this Article, a credit institution shall calculate the exposure value of the underlying exposures without netting any specific credit risk adjustments and additional value adjustments in accordance with Articles 17 and 144 of this Decision and other own funds reductions. (11) When applying paragraphs (1) to (10) of this Article, where a securitisation structure involves the use of an SSPE, all the SSPE’s exposures related to the securitisation shall be treated as underlying exposures. (12) Without prejudice to paragraph (11) of this Article, the credit institution may exclude the SSPE’s exposures from the pool of underlying exposures for KIRB or KSA

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 311 calculation purposes if the risk from the SSPE’s exposures is immaterial or if it does not affect the credit institution’s securitisation position. (13) In the case of funded synthetic securitisations, any material proceeds from the issuance of credit-linked notes or other funded obligations of the SSPE that serve as collateral for the repayment of the securitisation positions shall be included in the calculation of KIRB or KSA if the credit risk of the collateral is subject to the tranched loss allocation. Conditions for calculating KIRB using KIRB-specific rating systems Article 292 For the purposes of Article 185 and Article 291 paragraph (4) of this Decision, The Central Bank shall grant an authorisation to the credit institution to calculate KIRB for securitised exposures using KIRB-specific rating systems as part of the credit institution’s IRB approach only if all of the following conditions are met:

  1. the range of application of the KIRB -specific rating system includes only qualifying securitised exposures;
  2. the credit institution has received authorisation to use the IRB approach in relation to at least one rating system within the exposure class to which the qualifying securitised exposures are assigned;
  3. all requirements of Subtitle 3 of this Title relating to rating systems are met, subject to item 4) of this paragraph;
  4. the credit institution complies with the conditions set out in Articles 293 to 299 this Decision, as set out in each of those Articles. Conditions to calculate KIRB using a rating system that has been approved for the use for own-originated exposures Article 293 (1) A credit institution may calculate KIRB in accordance with Article 291 paragraph (4) of this Decision using a rating system that has been approved for use for its own￾originated exposures where all of the following conditions are met:
  5. the rating system is used only for calculating the PD of non-retail qualifying securitised exposures;
  6. if not being securitised, the non-retail qualifying securitised exposures would fall within the range of application of the rating system that will be used;
  7. the credit institution calculating KIRB uses the LGD values set out in Article 295 paragraph (3) of this Decision;
  8. all requirements of Subtitle 3 of this Title relating to rating systems are met, subject to item 5) of this paragraph;
  9. the requirements laid down in Articles 294 and 297 paragraph (4) of this Decision are met with regard to the application of the purchased receivable requirements in the particular context of securitisation, as set out in each of those Articles;
  10. the requirements laid down in Article 298 paragraphs (3) to (8) and Article 299 of this Decision are met with regard to the use of data. (2) A credit institution that has received authorisation to apply the IRB approach for at least one rating system for own-originated exposures within the exposure class to

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 312 which the qualifying securitised exposures are assigned shall be considered to have gained the experience required by Article 187 of this Decision. Requirements for qualifying securitised exposures Article 294 (1) When quantifying the risk parameters to be associated with rating grades or pools for qualifying securitised exposures, a credit institution calculating KIRB shall be considered to comply with the requirements laid down in Article 225 of this Decision where it complies with the requirements laid down in paragraphs (3) to (9) of this Article. (2) A credit institution calculating KIRB may ensure compliance with paragraphs (3) to (9) through a party to the securitisation acting for and in the interest of the investors in the securitisation in accordance with the terms of the related securitisation documents. (3) When quantifying the risk parameters to be associated with rating grades or pools for qualifying securitised exposures, a credit institution calculating KIRB shall ensure that the structure of the securitisation meets all of the following requirements:

  1. the SSPE or the credit institution calculating KIRB has effective ownership and control of all cash remittances from the securitised exposures;
  2. the ownership of the securitised exposures and cash receipts is protected against bankruptcy stays or legal challenges that could materially impair the ability of the SSPE or the credit institution calculating KIRB to liquidate or assign the securitised exposures or retain control over cash receipts. (4) Where a debtor makes payments directly to an originator or servicer, the credit institution calculating KIRB shall have in place procedures to verify regularly that those payments are forwarded completely and within the contractually agreed terms. (5) The credit institution calculating KIRB shall monitor both the quality of the qualifying securitised exposures and the financial condition of the originator, seller, and servicer, and it shall:
  3. assess the correlation between the quality of the qualifying securitised exposures, including the potential of recovery in the case of default, and the financial condition of the originator, seller, and servicer;
  4. have in place internal policies and procedures that provide adequate safeguards to protect against any contingencies, including the assignment of an internal risk rating to the originator, seller, and servicer;
  5. have clear and effective policies and procedures for determining the eligibility of an originator, a seller and a servicer;
  6. conduct periodic reviews of originators, sellers and servicers to verify whether the reports of those originators, sellers or servicers are accurate, to detect fraud or operational weaknesses and to verify the quality of the originator’s or seller’s credit policies and servicer’s collection policies and procedures, and shall document the findings of those periodic reviews;
  7. assess:
  • the characteristics of the pools of qualifying securitised exposures, including over-advances;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 313

  • the history of the originator’s or seller’s arrears, bad debts and bad debt allowances;
  • the payment terms and potential contra accounts of the pools of qualifying securitised exposures;
  1. have in place effective policies and procedures for monitoring, on an aggregate basis, single-debtor concentrations both within and across pools of qualifying securitised exposures;
  2. ensure that it receives from the originator, seller, or servicer timely and sufficiently detailed reports of securitised exposures’ ageings and dilutions;
  3. have in place systems and procedures for detecting at an early stage deteriorations in the originator’s or seller’s financial condition and the qualifying securitised exposures’ quality and for addressing emerging problems proactively. (6) For the purposes of paragraph (5) item 7) of this Article, the reports shall provide all the necessary information on the qualifying securitised exposures:
  4. to assess the exposures’ compliance with the securitisation’s eligibility criteria and with the advancing policies governing such qualifying securitised exposures;
  5. to monitor and confirm the originator’s or seller’s terms of sale and dilution. (7) A credit institution calculating KIRB shall have in place clear and effective policies, procedures, and information systems to monitor covenant violations, to initiate legal actions and to deal with problematic qualifying securitised exposures. (8) A credit institution calculating KIRB shall have clear and effective policies and procedures for the monitoring or, where applicable, the control of the qualifying securitised exposures, credit, and cash, including all of the following:
  6. written internal policies specifying all material elements of the securitisation, including the advancing rates, eligible collateral, the required documentation, concentration limits, and the way cash receipts are to be handled;
  7. effective policies and procedures to ensure that the material elements referred to in item 1) of this paragraph take account of all relevant and material factors, including the originator’s, seller’s and servicer’s financial condition, risk concentrations and trends in the quality of the qualifying securitised exposures and the originator’s customer base;
  8. internal systems to ensure that funds are advanced only against specified supporting collateral and documentation. (9) A credit institution calculating KIRB shall have in place an internal process to assess compliance with the internal policies and procedures referred to in paragraphs (4) to (8) of this Article, including all of the following:
  9. regular audits of all critical phases of the securitisation;
  10. verification of the separation of duties for the assessments of the originator, seller, and servicer referred to in paragraph (5) and of the debtor;
  11. verification of the separation of the respective duties for the assessments of the originator, seller and servicer, referred to in paragraph (5) from the field audit of the originator, seller and servicer;
  12. evaluations of the credit institution’s back-office operations, including their qualifications, experience, staffing levels and supporting IT systems.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 314 General conditions for risk differentiation Article 295 (1) When assigning exposures to grades or pools, a credit institution calculating KIRB shall consider the originator’s or, where the originator acquired the securitised exposures from the original lender, the original lender’s underwriting standards and the servicer’s recovery practices and servicing standards, as potential risk drivers, unless those institutions use, for the quantification of the risk parameters associated with those grades or pools, different calibration segments for different originators, original lenders, and servicers. (2) A credit institution calculating KIRB may set LGD at 50 % for retail qualifying securitised exposures. (3) A credit institution calculating KIRB may set the following values for LGD, instead of the values laid down in Article 202 paragraph (1) items 5) and 6) of this Decision:

  1. 50 % for non-retail senior qualifying securitised exposures;
  2. 100 % for non-retail subordinated qualifying securitised exposures. Eligibility for the retail treatment of non-retail qualifying securitised exposures Article 296 (1) A credit institution calculating KIRB may, for non-retail qualifying securitised exposures, use the risk quantification standards for retail exposures laid down in Section 6 of Subtitle 3 of this Title where all of the following conditions are met:
  3. it would be unduly burdensome for the credit institution to use the risk quantification standards for corporate exposures laid down in Section 6 of Subtitle 3 of this Title;
  4. the following requirements are met, instead of the requirements laid down in Article 196 paragraph (6) items 1) to 4) of this Decision:
  • the SSPE or the credit institution calculating KIRB has purchased the non￾retail qualifying securitised exposures from third-party originators or sellers unrelated to the credit institution calculating KIRB, and the exposure of the SSPE or the credit institution calculating KIRB to the debtors in the pool of qualifying securitised exposures does not include any exposures that are directly or indirectly originated by the credit institution calculating KIRB;
  • the non-retail qualifying securitised exposures have been generated on an arm’s-length basis between the originator or seller and the debtor and, accordingly, do not contain inter-company accounts receivables and receivables subject to contra-accounts between undertakings that buy and sell to each other;
  • the SSPE or the credit institution calculating KIRB has a claim on all or part of the proceeds from the non-retail qualifying securitised exposures or a pro-rata interest in the proceeds;
  • the pool of qualifying securitised exposures is sufficiently diversified.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 315 (2) For the purposes of paragraph (1) item 1) of this Article, when assessing whether the use of the risk quantification standards for corporate exposures laid down in Section 6 of Subtitle 3 of this Title is unduly burdensome, a credit institution shall take into account all of the following factors:

  1. whether the cost of using the risk quantification standards for corporate exposures on non-retail qualifying securitised exposures is disproportionate;
  2. whether the credit institution’s access to and control of the relevant data on the securitised exposures is subject to significant impediments when compared to the ease of access to and control of data on retail exposures;
  3. whether the credit institution has limited capability to integrate any external or proxy data into existing risk and reporting systems;
  4. whether the pool of securitised exposures to which the risk quantification standards for retail exposures are to be applied is sufficiently granular to justify the assessment of undue burden in relation to the factors referred to in items 1), 2) and 3) of this paragraph;
  5. whether the size and frequency of the credit institution’s exposures to securitisations do not pose a material risk to that credit institution. (3) For the purposes of paragraph (2) item 1) of this Article, a credit institution may take into account the costs of developing a non-retail internal model for calculating KIRB, integrating a new calibration segment into an existing one, or integrating the data into the credit institution’s existing risk and reporting systems. (4) For the purposes of paragraph (2) item 4) of this Article, a pool of qualifying securitised exposures shall be deemed to be sufficiently granular where the number of underlying exposures of the securitisation to which the retail treatment is to be applied exceeds 100 and the aggregate exposure value of all such exposures to a single debtor in the pool does not exceed 2% of the aggregate outstanding exposure values of the pool of qualifying securitised exposures, whereby for the purposes of that calculation, loans or leases to a group of connected persons that have been funded by the SSPE or the credit institution calculating KIRB shall be considered as exposures to a single debtor. (5) For the purposes of paragraph (1) item 2) indents 1 and 2, paragraph (2) item 4) of this Article and Article 297 paragraph (1) item 1) of this Decision, a credit institution calculating KIRB shall, as applicable, assess the relationship between parties, the arm’s-length requirement, or the connectedness of persons, as referred to in those items, to the best of their knowledge, on the basis of either of the following types of information:
  6. information on the debtors, obtained at the time of the origination of the exposures from the originator, the seller or the original lender;
  7. information obtained from the servicer in the course of its servicing the exposures or in the course of its risk-management procedure. Eligibility for the retail treatment of retail qualifying securitised exposures Article 297 (1) For retail qualifying securitised exposures to be eligible for the risk quantification standards for retail exposures as set out in Section 6 of Subtitle 3 of this Title, all of

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 316 the following requirements shall be met instead of the requirements laid down in Article 196 paragraph (6) of this Decision:

  1. the qualifying securitised exposures have been generated on an arm’s-length basis between the originator and the debtor and, accordingly, those exposures do not contain inter-company accounts receivables and receivables subject to contra-accounts between firms that buy and sell to each other;
  2. the SSPE, or the credit institution calculating KIRB, have a claim on all proceeds from the qualifying securitised exposures or a pro-rata interest in those proceeds;
  3. the pool of qualifying securitised exposures is sufficiently diversified. (2) For retail qualifying securitised exposures that meet the requirements set out in paragraph (1) of this Article, a credit institution calculating KIRB shall calculate risk￾weighted exposure amounts for credit risk in accordance with Article 196 of this Decision, and, where applicable, Article 197 item 2) of this Decision. (3) For retail qualifying securitised exposures that do not meet the requirements set out in paragraph (1) of this Article, a credit institution calculating KIRB shall calculate risk-weighted exposure amounts for credit risk in accordance with Article 195 of this Decision, and, where applicable, Article 197 item 2) of this Decision. (4) To calculate KIRB for non-retail qualifying securitised exposures, irrespective of whether the conditions of Article 296 paragraphs (1) to (4) of this Decision for applying retail risk quantification standards are met in respect of such exposures, a credit institution shall calculate risk-weighted exposure amounts for credit risk in accordance with Article 195 of this Decision, and, where applicable, Article 197 item 2) of this Decision. Requirements on data and primary data Article 298 (1) Where the qualifying securitised exposures and the debtors of those exposures were not exposures or debtors of the credit institution calculating KIRB before the transfer of such exposures to the SSPE or to the credit institution calculating KIRB, instead of the requirement of representativeness of the data used for model development laid down in Article 214 paragraph (1) item 3) of this Decision, the representativeness of the data shall be assessed in relation to the qualifying securitised exposures. (2) Instead of the requirement laid down in Article 220 paragraph (4) item 3) of this Decision, a credit institution shall regard the data relating to the qualifying securitised exposures, the data of the portfolio of the originator or original lender based on similar underwriting standards from which they have been extracted, and the data relating to the collection and recovery policies adopted by the servicer as the primary source of information for estimating risk parameters for the model development, for the quantification of risk parameters, and for the application of the internal model for calculating KIRB. (3) For the purposes of paragraph (2) of this Article, for model development, for the quantification of risk parameters, for the application of the internal model for calculating

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 317 KIRB, and for the completion of the data, a credit institution calculating KIRB may use any relevant data other than the data referred to in that paragraph as proxy data. (4) The proxy data referred to in paragraph (3) of this Article can be internal, external, or pooled data in the sense used in Section 6 of Subtitle 3 of this Title. (5) When a credit institution calculating KIRB make use of proxy data in the course of the estimation of risk parameters, the requirements of Article 219 paragraph (1) item 6) of this Decision on conservatism shall also apply when a credit institution uses proxy data for the model development, the quantification of risk parameters, and the application of the internal model for calculating KIRB. (6) A credit institution calculating KIRB that uses proxy data shall assess the representativeness of those proxy data with regard to the data referred to in paragraph (2) of this Article and makes the necessary adjustments to the proxy data to align the quality of those data to the quality of the data referred to in that paragraph. (7) Where it is not possible to overcome the difference in quality by adjustments in the proxy data, a credit institution calculating KIRB shall adopt an appropriate margin of conservatism in the estimation of risk parameters in accordance with Article 219 paragraph (1) item 6) of this Decision. (8) A credit institution calculating KIRB may, for the model development, the quantification of risk parameters, and the application of the internal model for calculating KIRB, use the data on static and dynamic historical default and loss performance made available by originators and sponsors. Use of data that are not consistent with the definition of default as referred to in Article 197 of this Decision Article 299 (1) The calibration of risk parameters shall be based on the credit institution’s definition of default that is applicable to the respective internal model for calculating KIRB in accordance with Article 291 of this Decision. (2) A credit institution calculating KIRB that uses external data or proxy data for the calibration of risk parameters shall meet all of the following requirements:

  1. they shall ensure that the definition of default used in the data is consistent with Article 218 paragraphs (1) and (2) of this Decision;
  2. they shall ensure that the definition of default used in the data is consistent with the definition of default as implemented by the credit institution calculating KIRB in accordance with Article 291 paragraph (4) of this Decision for the relevant portfolio of qualifying securitised exposures, including all of the following:
  • the counting and number of days past due that triggers default;
  • the structure and level of the materiality threshold for past due credit obligations;
  • the definition of distressed restructuring that triggers default;
  • the type and level of specific credit risk adjustments that triggers default;
  • the criteria to return to non-defaulted status;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 318 3) they shall document sources of the data, the default definition used in those data, the analysis performed, and all identified differences. (3) For each of the differences identified in the definition of default resulting from the assessment on the consistency of the definition of default referred to in paragraph (1) of this Article, a credit institution calculating KIRB shall:

  1. assess whether the adjustment to the internal definition of default would lead to an increased or a decreased default rate, or whether that is impossible to determine;
  2. depending on the outcome of the assessment referred to in item 1) of this paragraph, either adjust the data accordingly, or be able to demonstrate that the difference is negligible in terms of the impact on all risk parameters and own funds requirements, as appropriate. (4) With regard to the totality of the differences identified in the definition of default resulting from the assessment referred to in paragraph (1) of this Article, a credit institution calculating KIRB shall, and taking into account the adjustments performed in accordance with paragraph (2) item 2) of this Article, achieve a broad equivalence with the internal definition of default used within the internal model for calculating KIRB, including, where possible, by comparing the default rate in internal data on a relevant type of exposures with external or proxy data. (5) Where the assessment referred to in paragraph (1) of this Article identifies differences in the definition of default that are non-negligible but not possible to overcome by adjustments in the data, a credit institution calculating KIRB shall adopt an appropriate margin of conservatism in the estimation of risk parameters in accordance with Article 219 paragraph (1) item 6) of this Decision, whereby a credit institution calculating KIRB shall ensure that such additional margin of conservatism reflects the materiality of the remaining differences in the definition of default and their possible impact on all risk parameters. Determination of attachment point (A) and detachment point (D) Article 300 (1) For the purposes of Subsection 3 of this Section, the attachment point (A) shall be equal to the threshold at which losses within the pool of underlying exposures would start to be allocated to the relevant securitisation position. (2) The attachment point (A) referred to in paragraph (1) of this Article shall be expressed as a decimal value between zero and one and shall be equal to the greater of zero and the ratio of the outstanding balance of the pool of underlying exposures in the securitisation minus the outstanding balance of all tranches that rank senior or pari passu to the tranche containing the relevant securitisation position including the exposure itself to the outstanding balance of all the underlying exposures in the securitisation. (3) For the purposes of Subsection 3 of this Section, the detachment point (D) shall be equal to the threshold at which losses within the pool of underlying exposures would result in a complete loss of principal for the tranche containing the relevant securitisation position.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 319 (4) The detachment point (D) shall be expressed as a decimal value between zero and one and shall be equal to the greater of zero and the ratio of the outstanding balance of the pool of underlying exposures in the securitisation minus the outstanding balance of all tranches that rank senior to the tranche containing the relevant securitisation position to the outstanding balance of all the underlying exposures in the securitisation. (5) When applying paragraphs (1) to (4) of this Article, a credit institution shall:

  1. treat overcollateralisation and funded reserve accounts as tranches and the assets comprising such reserve accounts as underlying exposures;
  2. disregard unfunded reserve accounts and assets that do not provide credit enhancement, such as those that only provide liquidity support, currency or interest rate swaps and cash collateral accounts related to those positions in the securitisation.
  3. for funded reserve accounts and assets providing credit enhancement, only treat as securitisation positions the parts of those accounts or assets that are loss-absorbing. (6) Where two or more positions of the same transaction have different maturities but share pro rata loss allocation, the calculation of the attachment points (A) and the detachment points (D) shall be based on the aggregated outstanding balance of those positions and the resulting attachment points (A) and detachment points (D) shall be the same. (7) For the purposes of calculating the attachment points (A) and detachment points (D) of a synthetic securitisation, the originator credit institution of the securitisation shall treat the exposure value of the securitisation position corresponding to synthetic excess spread referred to in Article 284 paragraph (1) item 5) as a tranche, and adjust the attachment points (A) and detachment points (D) of the other tranches it retains by adding that exposure value to the outstanding balance of the pool of underlying exposures in the securitisation, whereby a credit institution other than the originator shall not make this adjustment. Determination of tranche maturity (MT) Article 301 (1) A credit institution may, for the purposes of Subsection 3 of this Section and subject to paragraph (2) of this Article, measure the maturity of a tranche (MT) as:
  4. the weighted average maturity of the contractual payments due under the tranche in accordance with the following formula: �𝑡𝑡 ⋅ 𝐶𝐶𝐶𝐶𝑡𝑡 𝑡𝑡 ∕ �𝐶𝐶𝐶𝐶𝑡𝑡 𝑡𝑡 where CFt denotes all contractual payments (principal, interests and fees) payable by the debtor during period t; or
  5. the final legal maturity of the tranche in accordance with the following formula: 𝑀𝑀𝑇𝑇 = 1 + (𝑀𝑀𝐿𝐿 − 1) ∗ 80%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 320 where ML is the final legal maturity of the tranche. (2) The determination of a tranche maturity (MT), within the meaning of paragraph (1) of this Article, shall be subject in all cases to a floor of one year and a cap of five years. (3) A credit institution shall, in the cases where it may become exposed to potential losses from the underlying exposures by virtue of contract, determine the maturity of the securitisation position by taking into account the maturity of the contract plus the longest maturity of such underlying exposures, provided that for revolving exposures, the longest contractually possible remaining maturity of the exposure that might be added during the revolving period shall apply. Subsection 3 - Methods to calculate risk-weighted exposure amounts Conditions for the use of the Internal Ratings Based Approach (SEC-IRBA) Article 302 (1) A credit institution shall use the SEC-IRBA to calculate risk-weighted exposure amounts in relation to a securitisation position where the following conditions are met:

  1. the position is backed by an IRB pool or a mixed pool, provided that, in the latter case, the credit institution is able to calculate KIRB in accordance with Section 3 of this Subtitle on a minimum of 95% of the underlying exposure amount;
  2. the credit institution has sufficient information available in relation to the underlying exposures of the securitisation for the credit institution to be able to calculate KIRB; and
  3. the credit institution has not been precluded from using the SEC-IRBA in relation to a specified securitisation position in accordance with paragraphs (2) and (3) of this Article. (2) The Central Bank may on a case-by-case basis preclude the use of the SEC-IRBA where securitisations have highly complex or risky features. (3) Within the meaning of paragraph (2) of this Article, the following may be regarded as highly complex or risky features:
  4. credit enhancement that can be eroded for reasons other than portfolio losses;
  5. pools of underlying exposures with a high degree of internal correlation as a result of concentrated exposures to single sectors or geographical areas;
  6. transactions where the repayment of the securitisation positions is highly dependent on risk drivers not reflected in KIRB; or
  7. highly complex loss allocations between tranches. Calculation of risk-weighted exposure amounts under the SEC- IRBA Article 303 (1) Under the SEC-IRBA, the risk-weighted exposure amount for a securitisation position shall be calculated by multiplying the exposure value of the position calculated in accordance with Article 284 of this Decision by the applicable risk weight determined as follows, in all cases subject to a floor of 15%:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 321 RW = 1,250% when D ≤ KIRB RW=12.5⋅KSSFA(KIRB) when A ≥ KIRB RW= ��KIRB-A D-A � ⋅12.5� + ��D-KIRB D-A � ⋅12.5⋅KSSFA(KIRB)� when A < KIRB < D

where: KIRB is the capital requirement of the pool of underlying exposures as defined in Article 291 of this Decision; D is the detachment point as determined in accordance with Article 300 of this Decision; A is the attachment point as determined in accordance with Article 300 of this Decision; KSSFA(KIRB)= ea⋅u-ea⋅1 a(u-l) where: a = – (1/(p * KIRB)) u = D – KIRB l = max (A – KIRB; 0) where: p= max�0,3;�A+B* (1⁄N)+C* KIRB+D* LGD+E* MT�� where: N is the effective number of exposures in the pool of underlying exposures, calculated in accordance with paragraph (4) of this Article; LGD is the exposure-weighted average loss-given-default of the pool of underlying exposures, calculated in accordance with paragraph (5) of this Article; MT is the maturity of the tranche as determined in accordance with Article 301 of this Decision. The parameters A, B, C, D, and E shall be determined according to the following look-up table:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 322 A B C D E Non-retail Senior, granular (N ≥ 25) 0 3.56 –1.85 0.55 0.07 Senior, non-granular (N < 25) 0.11 2.61 –2.91 0.68 0.07 Non-senior, granular (N ≥ 25) 0.16 2.87 –1.03 0.21 0.07 Non-senior, non-granular (N < 25) 0.22 2.35 –2.46 0.48 0.07 Retail Senior 0 0 –7.48 0.71 0.24 Non-senior 0 0 –5.78 0.55 0.27 (2) If the underlying IRB pool comprises both retail and non-retail exposures, the pool shall be divided into one retail and one non-retail sub-pool and, for each sub-pool, a separate p-parameter (and the corresponding input parameters N, KIRB and LGD) shall be estimated, and subsequently, a weighted average p-parameter for the transaction shall be calculated on the basis of the p-parameters of each sub-pool and the nominal size of the exposures in each sub-pool. (3) Where a credit institution applies the SEC-IRBA to a mixed pool, the calculation of the p-parameter shall be based on the underlying exposures subject to the IRB Approach only, and the underlying exposures subject to the Standardised Approach shall be ignored for these purposes. (4) The effective number of exposures (N) shall be calculated as follows:

𝑁𝑁 = (∑ 𝑖𝑖1 )2 ∑ 𝑖𝑖 2 𝑖𝑖 where EADi represents the exposure value associated with the ith exposure in the pool, and multiple exposures to the same debtor shall be consolidated and treated as a single exposure. (5) The exposure-weighted average LGD shall be calculated as follows:

𝐿𝐿𝐿𝐿𝐿𝐿 = ∑ 𝐿𝐿𝐿𝐿𝐿𝐿𝑖𝑖 𝑖𝑖 ⋅ 𝑖𝑖 ∑ 𝑖𝑖𝑖𝑖 where LGDi represents the average LGD associated with all exposures to the ith debtor. (6) Where credit and dilution risks for purchased receivables are managed in an aggregate manner in a securitisation, the LGD input shall be construed as a weighted average of the LGD for credit risk and 100% LGD for dilution risk, while the weights shall be the stand-alone IRB Approach capital requirements for credit risk and dilution risk, respectively. (7) Within the meaning of paragraph (6) of this Article, the presence of a single reserve fund or overcollateralisation available to cover losses from either credit or dilution risk

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 323 may be regarded as an indication that these risks are managed in an aggregate manner. (8) Where the share of the largest underlying exposure in the pool (C1) is no more than 3%, a credit institution may use the following simplified method to calculate N and the exposure-weighted average LGDs:

𝑁𝑁 = �𝐶𝐶1 ⋅ 𝐶𝐶𝑚𝑚 + � 𝐶𝐶𝑚𝑚 − 𝐶𝐶1 𝑚𝑚 − 1 � ⋅ 𝑚𝑚𝑚𝑚𝑚𝑚{1 − 𝑚𝑚 ⋅ 𝐶𝐶1, 0}� −1 LGD = 0,50 where: Cm denotes the share of the pool corresponding to the sum of the largest m exposures; and m is set by the credit institution. (9) For the purposes of paragraph (8) of this Article, if only C1 is available and this amount is no more than 0.03, t the credit institution may set LGD as 0.50 and N as 1/C1. (10) Where the position is backed by a mixed pool and the credit institution is able to calculate KIRB on at least 95% of the underlying exposure amounts in accordance with Article 301 paragraph (1) item 1) of this Decision, the credit institution shall calculate the capital requirement for the pool of underlying exposures as: ⋅ 𝐾𝐾𝐼𝐼 𝐼𝐼 + (1 − ) ⋅ 𝐾𝐾𝑆𝑆 where d is the share of the exposure amount of underlying exposures for which the credit institution can calculate KIRB over the exposure amount of all underlying exposures. (11) Where a credit institution has a securitisation position in the form of a derivative to hedge market risks, including interest rate or currency risks, it may attribute to that derivative an inferred risk weight equivalent to the risk weight of the reference position calculated in accordance with this Article. (12) The reference position, within the meaning of paragraph (11) of this Article, shall be the position that is pari passu in all respects to the derivative or, in the absence of such pari passu position, the position that is immediately subordinate to the derivative. Treatment of STS securitisations under the SEC-IRBA Article 304 Under the SEC-IRBA, the risk weight for a position in an STS securitisation shall be calculated in accordance with Article 303 of this Decision, subject to the following modifications:

  1. risk-weight floor for senior securitisation positions = 10%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 324 2) p=[0.3;0.5⋅(A+B⋅(1 ⁄ N)+C⋅KIRB+D⋅LGD+E⋅MT)] Calculation of risk-weighted exposure amounts under the Standardised Approach (SEC-SA) Article 305 (1) Under the SEC-SA, the risk-weighted exposure amount for a position in a securitisation shall be calculated by multiplying the exposure value of the position as calculated in accordance with Article 284 of this Decision by the applicable risk weight determined as follows, in all cases subject to a floor of 15%: RW = 1,250 % when D ≤ KA RW=12.5⋅KSSFA(K𝐴𝐴) when A ≥ KA RW= ��K𝐴𝐴-A D-A � ⋅12.5� + ��D-KA D-A � ⋅12.5⋅KSSFA(K𝐴𝐴)� when A < KA < D

where: D is the detachment point as determined in accordance with Article 300 of this Decision; A is the attachment point as determined in accordance with Article 300 of this Decision; KA is a parameter calculated in accordance with paragraph (2) of this Article; KSSFA(K𝐴𝐴)= ea⋅u-ea⋅1 a(u-l) where: a = – (1/(p · KA)) u = D – KA l = max (A – KA; 0) p = l for a securitisation exposure that is not a re-securitisation exposure (2) For the purposes of paragraph (1) of this Article, KA shall be calculated as follow: 𝐾𝐾 = (1 − ) ⋅ 𝐾𝐾𝑆𝑆 + ⋅ 0.5 where: KSA is the capital requirement of the underlying pool as defined in Article 291 of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 325 W is the ratio obtained by dividing the amount referred to in item 1) by the amount referred to in item 2):

  1. the sum of the nominal amount of underlying exposures in default, and
  2. the sum of the nominal amount of all underlying exposures. (3) For the purposes of paragraph (2) of this Article, an exposure in default shall mean an underlying exposure which is either:
  3. 90 days or more past due;
  4. subject to bankruptcy or insolvency proceedings;
  5. subject to foreclosure or similar proceeding; or
  6. in default in accordance with the securitisation documentation. (4) Where a credit institution does not know the delinquency status for 5% or less of underlying exposures in the pool, the credit institution may use the SEC-SA subject to the following adjustment in the calculation KA: 𝐾𝐾 = � 𝑆𝑆 𝑆𝑆 1 𝑤𝑤ℎ 𝑊𝑊 𝑘𝑘 𝑇𝑇 × 𝐾𝐾𝑆𝑆 𝑆𝑆 1 𝑤𝑤ℎ 𝑊𝑊 𝑘𝑘 𝑛𝑛�
  • 𝑆𝑆 𝑆𝑆 2 𝑤𝑤ℎ 𝑊𝑊 𝑢𝑢 𝑇𝑇
  1. Where the credit institution does not know the delinquency status for more than 5% of underlying exposures in the pool, the position in the securitisation must be risk￾weighted at 1,250%. (6) Where a credit institution has a securitisation position in the form of a derivative to hedge market risks, including interest rate or currency risks, the credit institution may attribute to that derivative an inferred risk weight equivalent to the risk weight of the reference position calculated in accordance with this Article. (7) The reference position, for the purposes of paragraph (6) of this Article, shall be the position that is pari passu in all respects to the derivative or, in the absence of such pari passu position, the position that is immediately subordinate to the derivative. Treatment of STS securitisations under the SEC-SA Article 306 Under the SEC-SA the risk weight for a position in an STS securitisation shall be calculated in accordance with Article 305 of this Decision, subject to the following modifications:
  2. risk-weight floor for senior securitisation positions = 10%
  3. p = 0.5

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 326 Calculation of risk-weighted exposure amounts under the External Ratings Based Approach (SEC-ERBA) Article 307 (1) Under the SEC-ERBA, the risk-weighted exposure amount for a securitisation position shall be calculated by multiplying the exposure value of the position as calculated in accordance with Article 284 of this Decision by the applicable risk weight in accordance with this Article. (2) For exposures with short-term credit assessments or when a rating based on a short-term credit assessment may be inferred in accordance with paragraph (7) of this Article, the following risk weights shall apply: Table 1 Credit Quality Step 1 2 3 All other ratings Risk weight 15% 50% 100% 1.250% (3) For exposures with long-term credit assessments or when a rating based on a long￾term credit assessment may be inferred in accordance with paragraph (7) of this Article, the following risk weights shall apply, adjusted as applicable for tranche maturity (MT) in accordance with Article 301 of this Decision and paragraph (4) of this Article and for tranche thickness for non-senior tranches in accordance with paragraph (5) of this Article: Table 2 Credit Quality Step Senior tranche Non-senior (thin) tranche Tranche maturity (MT) Tranche maturity (MT) 1 year 5 years 1 year 5 years 1 15% 20% 15% 70% 2 15% 30% 15% 90% 3 25% 40% 30% 120% 4 30% 45% 40% 140% 5 40% 50% 60% 160% 6 50% 65% 80% 180% 7 60% 70% 120% 210% 8 75% 90% 170% 260% 9 90% 105% 220% 310% 10 120% 140% 330% 420% 11 140% 160% 470% 580% 12 160% 180% 620% 760% 13 200% 225% 750% 860% 14 250% 280% 900% 950% 15 310% 340% 1.050% 1.050% 16 380% 420% 1.130% 1.130%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 327 17 460% 505% 1.250% 1.250% All other 1.250% 1.250% 1.250% 1.250% (4) In order to determine the risk weight for tranches with a maturity between one and five years, a credit institution shall use linear interpolation between the risk weights applicable for one and five years’ maturity respectively in accordance with the Table under paragraph (3) of this Article. (5) In order to account for tranche thickness, a credit institution shall calculate the risk weight for non-senior tranches as follows: RW=[RW after adjusting for maturity according to paragraph (4) of this Article ]⋅[1-min(T;50%)] where: T = tranche thickness measured as D – A where: D is the detachment point as determined in accordance with Article 300 of this Decision. A is the attachment point as determined in accordance with Article 300 of this Decision. (6) The risk weights for non-senior tranches resulting from paragraphs (3), (4), and (5) of this Article shall be subject to a floor of 15%, and, in addition, the resulting risk weights shall be no lower than the risk weight corresponding to a hypothetical senior tranche of the same securitisation with the same credit assessment and maturity. (7) For the purposes of using inferred ratings, a credit institution shall attribute to an unrated position an inferred rating equivalent to the credit assessment of a rated reference position which meets all of the following conditions:

  1. the reference position ranks pari passu in all respects to the unrated securitisation position or, in the absence of a pari passu ranking position, the reference position is immediately subordinate to the unrated position;
  2. the reference position does not benefit from any third-party guarantees or other credit enhancements that are not available to the unrated position;
  3. the maturity of the reference position shall be equal to or longer than that of the unrated position in question; and
  4. on an ongoing basis, any inferred rating shall be updated to reflect any changes in the credit assessment of the reference position. (8) Where a credit institution has a securitisation position in the form of a derivative to hedge market risks, including interest rate or currency risks, the credit institution may attribute to that derivative an inferred risk weight equivalent to the risk weight of the reference position calculated in accordance with this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 328 (9) The reference position, within the meaning of paragraph (8) of this Article, shall be the position that is pari passu in all respects to the derivative or, in the absence of such pari passu position, the position that is immediately subordinate to the derivative. Treatment of STS securitisations under the SEC-ERBA Article 308 (1) Under the SEC-ERBA, the risk weight for a position in an STS securitisation shall be calculated in accordance with Article 307 of this Decision, subject to the modifications laid down in this Article. (2) For exposures with short-term credit assessments or when a rating based on a short-term credit assessment may be inferred in accordance with Article 307 paragraph (7) of this Decision, the following risk weights shall apply: Table 3 Credit Quality Step 1 2 3 All other ratings Risk weight 10% 30% 60% 1,250%

(3) For exposures with long-term credit assessments or when a rating based on a long￾term credit assessment may be inferred in accordance with Article 307 paragraph (7) of this Decision, the following risk weights shall be applied, adjusted for tranche maturity (MT) in accordance with Articles 301 and 307 paragraph (4) of this Decision and for tranche thickness for non-senior tranches in accordance with Article 307 paragraph (5) of this Decision: Table 4 Credit Quality Step Senior tranche Non-senior (thin) tranche Tranche maturity (MT) Tranche maturity (MT) 1 year 5 years 1 year 5 years 1 10% 10% 15% 40% 2 10% 15% 15% 55% 3 15% 20% 15% 70% 4 15% 25% 25% 80% 5 20% 30% 35% 95% 6 30% 40% 60% 135% 7 35% 40% 95% 170% 8 45% 55% 150% 225% 9 55% 65% 180% 255% 10 70% 85% 270% 345% 11 120% 135% 405% 500% 12 135% 155% 535% 655%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 329 13 170% 195% 645% 740% 14 225% 250% 810% 855% 15 280% 305% 945% 945% 16 340% 380% 1.015% 1.015% 17 415% 455% 1.250% 1.250% All other 1.250% 1.250% 1.250% 1.250% Scope and operational requirements for the Internal Assessment Approach Article 309 (1) A credit institution may calculate the risk-weighted exposure amounts for unrated positions in ABCP programmes or ABCP transactions under the Internal Assessment Approach in accordance with Article 310 of this Decision where the conditions set out in paragraph (3) of this Article have been met. (2) Where a credit institution has received authorisation to apply the Internal Assessment Approach in accordance with paragraph (3) of this Article, and a specific position in an ABCP programme or ABCP transaction falls within the scope of application covered by such authorisation, the credit institution shall apply that approach to calculate the risk-weighted exposure amount of that position. (3) The Central Bank shall grant a credit institution authorisation to apply the Internal Assessment Approach referred to in paragraph (2) of this Article within a clearly defined scope of application where all of the following conditions are met:

  1. all positions in the commercial paper issued from the ABCP programme are rated positions;
  2. the internal assessment of the credit quality of the position reflects the publicly available assessment methodology of one or more ECAIs for the rating of securitisation positions backed by underlying exposures of the type securitised;
  3. the commercial paper issued from the ABCP programme is predominantly issued to third-party investors;
  4. the credit institution’s internal assessment process is at least as conservative as the publicly available assessments of those ECAIs which have provided an external rating for the commercial paper issued from the ABCP programme, in particular with regard to stress factors and other relevant quantitative elements;
  5. the credit institution’s internal assessment methodology takes into account all relevant publicly available rating methodologies of the ECAIs that rate the commercial paper of the ABCP programme and includes rating grades corresponding to the credit assessments of ECAIs, whereby the credit institution shall document in its internal records an explanatory statement describing how the requirements set out in this item have been met and shall update such statement on a regular basis;
  6. the credit institution uses the internal assessment methodology for internal risk management purposes, including in its decision-making, management information and internal capital allocation processes;
  7. internal or external auditors, an ECAI, or the credit institution’s internal credit review or risk management function perform regular reviews of the internal assessment process and the quality of the internal assessments of the credit

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 330 quality of the credit institution’s exposures to an ABCP programme or ABCP transaction; 8) the credit institution tracks the performance of its internal ratings over time to evaluate the performance of its internal assessment methodology and makes adjustments, as necessary, to that methodology when the performance of the exposures routinely diverges from that indicated by the internal ratings; 9) the ABCP programme includes underwriting and liability management standards in the form of guidelines to the programme administrator on, at least:

  • the asset eligibility criteria, subject to item 10) of this paragraph;
  • the types and monetary value of the exposures arising from the provision of liquidity facilities and credit enhancements;
  • the loss distribution between the securitisation positions in the ABCP programme or ABCP transaction;
  • the legal and economic isolation of the transferred assets from the entity selling the assets; 10)the asset eligibility criteria in the ABCP programme provide for, at least:
  • exclusion of the purchase of assets that are significantly past due or defaulted;
  • limitation of excessive concentration to individual debtor or geographic area; and
  • limitation of the tenor of the assets to be purchased; 11)an analysis of the asset seller’s credit risk and business profile is performed including, at least, an assessment of the seller’s:
  • past and expected future financial performance;
  • current market position and expected future competitiveness;
  • leverage, cash flow, interest coverage and debt rating; and
  • underwriting standards, servicing capabilities, and collection processes; 12)the ABCP programme has collection policies and processes that take into account the operational capability and credit quality of the servicer and comprises features that mitigate performance-related risks of the seller and the servicer; 13)the aggregated estimate of loss on an asset pool that may be purchased under the ABCP programme takes into account all sources of potential risk, such as credit and dilution risk; 14)where the seller-provided credit enhancement is sized based only on credit￾related losses and dilution risk is material for the particular asset pool, the ABCP programme comprises a separate reserve for dilution risk; 15)the size of the required enhancement level in the ABCP programme is calculated taking into account several years of historical information, including losses, delinquencies, dilutions, and the turnover rate of the receivables; 16)the ABCP programme comprises structural features in the purchase of exposures in order to mitigate potential credit deterioration of the underlying portfolio, whereby such features may include liquidation triggers specific to a pool of exposures; 17)the credit institution evaluates the characteristics of the underlying asset pool, such as its weighted-average credit score, and identifies any concentrations to an individual debtor or geographic area and the granularity of the asset pool.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 331 (4) Within the meaning of paragraph (3) item 12) of this Article, performance-related risks may be mitigated through triggers based on the seller or servicer’s current credit quality to prevent commingling of funds in the event of the seller’s or servicer’s default; (5) Where the credit institution’s internal audit, credit review, or risk management functions perform the review provided for in paragraph (3) item 7) of this Article, those functions shall be independent from the credit institution’s internal functions dealing with ABCP programme business and customer relations. (6) A credit institution which has been granted authorisation to apply the Internal Assessment Approach by the Central Bank, shall not revert to the use of other methods for positions that fall within scope of application of the Internal Assessment Approach unless both of the following conditions are met:

  1. the credit institution has demonstrated to the satisfaction of the Central Bank that the credit institution has good cause to do so; and
  2. the credit institution has received the prior authorisation of the Central Bank. Calculation of risk-weighted exposure amounts under the Internal Assessment Approach Article 310 (1) Under the Internal Assessment Approach, the credit institution shall assign the unrated position in the ABCP programme or ABCP transaction to one of the rating grades laid down in Article 309 paragraph (3) item 5) of this Decision on the basis of its internal assessment, provided that the position shall be attributed an inferred rating which shall be the same as the credit assessments corresponding to that rating grade as laid down in Article 309 paragraph (3) item 5) of this Decision. (2) The rating inferred in accordance with paragraph (1) of this Article shall be at least at the level of investment grade or better at the time it was first assigned and shall be regarded as an eligible credit assessment by an ECAI for the purposes of calculating risk-weighted exposure amounts in accordance with Article 307 or 308 of this Decision, as applicable. Subsection 4 - Caps for securitisation positions Maximum risk weight for senior securitisation positions: look- through approach Article 311 (1) A credit institution which has knowledge at all times of the composition of the underlying exposures may assign the senior securitisation position a maximum risk weight equal to the exposure-weighted-average risk weight that would be applicable to the underlying exposures as if the underlying exposures had not been securitised. (2) In the case of pools of underlying exposures where the credit institution uses exclusively the Standardised Approach or the IRB Approach, the maximum risk weight of the senior securitisation position shall be equal to the exposure-weighted-average risk weight that would apply to the underlying exposures in accordance with Subtitle 2 or 3 of this Title, respectively, as if they had not been securitised.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 332 (3) In the case of mixed pools the maximum risk weight shall be calculated as follows:

  1. where the credit institution applies the SEC-IRBA, the Standardised Approach portion and the IRB Approach portion of the underlying pool shall each be assigned the corresponding Standardised Approach risk weight and IRB Approach risk weight respectively;
  2. where the credit institution applies the SEC-SA or the SEC-ERBA, the maximum risk weight for senior securitisation positions shall be equal to the Standardised Approach weighted-average risk weight of the underlying exposures. (4) Within the meaning of this Article, the risk weight that would be applicable under the IRB Approach in accordance with Subtitle 3 of this Title shall include the ratio of:
  3. expected losses multiplied by 12.5 to
  4. the exposure value of the underlying exposures. (5) Where the maximum risk weight calculated in accordance with paragraph (1) of this Article results in a lower risk weight than the risk-weight floors set out in Articles 303 to 308 of this Decision, as applicable, that maximum risk weight shall be used instead. Maximum capital requirements Article 312 (1) An originator credit institution, a sponsor credit institution or other credit institution using the SEC-IRBA or an originator credit institution or sponsor credit institution using the SEC-SA or the SEC-ERBA may apply a maximum capital requirement for the securitisation position it holds equal to the capital requirements that would be calculated under Subtitle 2 or 3 of this Title in respect of the underlying exposures had they not been securitised. (2) Within the meaning of this Article, the IRB Approach capital requirement shall include the amount of the expected losses associated with underlying exposures calculated under Subtitle 3 of this Title and that of unexpected losses. (3) In the case of mixed pools, the maximum capital requirement shall be determined by calculating the exposure-weighted average of the capital requirements of the IRB Approach and Standardised Approach portions of the underlying exposures in accordance with paragraph (1) of this Article. (4) The maximum capital requirement shall be the result of multiplying the amount calculated in accordance with paragraphs (1), (2), and (3) of this Article by the largest proportion of interest that the credit institution holds in the relevant tranches (V), expressed as a percentage and calculated as follows:
  5. for a credit institution that has one or more securitisation positions in a single tranche, V shall be equal to the ratio of the nominal amount of the securitisation positions that the credit institution holds in that given tranche to the nominal amount of the tranche;
  6. for a credit institution that has securitisation positions in different tranches, V shall be equal to the maximum proportion of interest across tranches, and for

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 333 these purposes, the proportion of interest for each of the different tranches shall be calculated as set out in item 1) of this paragraph. (5) When calculating the maximum capital requirement for a securitisation position in accordance with this Article, the entire amount of any gain on sale and credit￾enhancing interest-only strips arising from the securitisation transaction shall be deducted from Common Equity Tier 1 items in accordance with Article 19 item 11) of this Decision. Subsection 5 - Miscellaneous provisions Re-securitisations Article 313 (1) For a position in a re-securitisation, a credit institution shall apply the SEC-SA in accordance with Article 281 of this Decision, with the following changes:

  1. W = 0 for any exposure to a securitisation tranche within the pool of underlying exposures;
  2. p = 1.5;
  3. the resulting risk weight shall be subject to a risk-weight floor of 100%. (2) KSA for the underlying securitisation exposures shall be calculated in accordance with Subsection 2 of this Section. (3) The maximum capital requirements set out in Subsection 4 shall not be applied to re-securitisation positions. (4) Where the pool of underlying exposures consists of a mix of securitisation tranches and other types of assets, the KA parameter shall be determined as the nominal exposure weighted-average of the KA calculated individually for each subset of exposures. Treatment of non-performing exposures (NPE)securitisations Article 314 (1) For the purposes of this Article qualifying traditional NPE securitisation means a traditional NPE securitisation where the non-refundable purchase price discount is at least 50% of the outstanding amount of the underlying exposures at the time they were transferred to the SSPE. (2) The risk weight for a position in an NPE securitisation shall be calculated in accordance with Article 290 or 311 of this Decision, whereby the risk weight shall be subject to a floor of 100%, except when Article 307 of this Decision is applied. (3) By way of derogation from paragraph (2) of this Article, a credit institution shall assign a risk weight of 100% to the senior securitisation position in a qualifying traditional NPE securitisation, except when Article 307 of this Decision is applied. (4) A credit institution that applies the IRB Approach to any exposures in the pool of underlying exposures in accordance with Subtitle 3 of this Title and that are not

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 334 permitted to use own estimates of LGD and conversion factors for such exposures shall not use the SEC-IRBA for the calculation of risk-weighted exposure amounts for a position in an NPE securitisation and shall not apply paragraph (5) or (6) of this Article. (5) For the purposes of Article 312 paragraph (1) of this Decision, expected losses associated with exposures underlying a qualifying traditional NPE securitisation shall be included after deduction of the non-refundable purchase price discount and, where applicable, any additional specific credit risk adjustments. (6) A credit institution shall perform the calculation in accordance with the following formula: 𝐶𝐶 𝑚𝑚𝑚𝑚 = 𝑅𝑅 𝐼𝐼 𝐼𝐼 ∙ 8% + 𝑚𝑚𝑚𝑚𝑚𝑚 � 𝐼𝐼 𝐼𝐼 − 𝑁𝑁 ∙ 𝐸𝐸𝐼𝐼 𝐼𝐼 𝐸𝐸 − 𝑆𝑆 𝐼𝐼 𝐼𝐼; 0� +𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑆𝑆 ∙ 8% where: CRmax = the maximum capital requirement in the case of a qualifying traditional NPE securitisation; RWEAIRB = the sum of risk-weighted exposure amounts of the underlying exposures subject to the IRB Approach; ELIRB = the sum of expected loss amounts of the underlying exposures subject to the IRB Approach; NRPPD = the non-refundable purchase price discount; EVIRB = the sum of exposure values of the underlying exposures that are subject to the IRB Approach; EVPool = the sum of exposure values of all underlying exposures in the pool; SCRAIRB = for originator credit institution, the specific credit risk adjustments made by the credit institution with respect to those underlying exposures subject to the IRB Approach only if and to the extent these adjustments exceed the NRPPD; for investor credit institutions the amount is zero; RWEASA = the sum of risk-weighted exposure amounts of the underlying exposures subject to the Standardised Approach. (7) By way of derogation from paragraph (3) of this Article, where the exposure￾weighted average risk weight calculated in accordance with the look-through approach set out in Article 311 is lower than 100%, a credit institution may apply the lower risk weight, subject to a 50% risk-weight floor. (8) For the purposes of paragraph (6), originator credit institution that applies the SEC￾IRBA to a position and that is permitted to use own estimates of LGD and conversion factors for all underlying exposures subject to the IRB Approach in accordance with Subtitle 3, shall deduct the non-refundable purchase price discount and, where applicable, any additional specific credit risk adjustments from the expected losses

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 335 and exposure values of the underlying exposures associated with a senior position in a qualifying traditional NPE securitisation, in accordance with the following formula: 𝑅𝑅𝑅𝑅𝑚𝑚𝑚𝑚 = 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝐼𝐼 𝐼𝐼 + 𝑚𝑚𝑚𝑚𝑚𝑚 �12,5 ∙ � 𝐼𝐼 𝐼𝐼 − 𝑁𝑁 ∙ 𝐸𝐸𝐼𝐼 𝐼𝐼 𝐸𝐸 − 𝑆𝑆 𝐼𝐼 𝐼𝐼� ; 0� +𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑆𝑆 𝑚𝑚𝑚𝑚𝑚𝑚 � 𝐼𝐼 𝐼𝐼 − 𝑁𝑁 ∙ 𝐸𝐸𝐼𝐼 𝐼𝐼 𝐸𝐸 − 𝑆𝑆 𝐼𝐼𝑅𝑅 ; 0� + 𝐸𝐸𝑆𝑆 where: RWMAX = the risk weight, before applying the floor, applicable to a senior position in a qualifying traditional NPE securitisation when the look￾through approach is used; RWEAIRB = the sum of risk-weighted exposure amounts of the underlying exposures subject to the IRB Approach; RWEASA = the sum of risk-weighted exposure amounts of the underlying exposures subject to the Standardised Approach; ELIRB = the sum of expected loss amounts of the underlying exposures subject to the IRB Approach; NRPPD = the non-refundable purchase price discount; EVIRB = the sum of exposure values of the underlying exposures that are subject to the IRB Approach; EVPool the sum of exposure values of all underlying exposures in the pool; EVSA = the sum of exposure values of the underlying exposures that are subject to the Standardised Approach; SCRAIRB = for originator credit institution, the specific credit risk adjustments made by the credit institution with respect to those underlying exposures subject to the IRB Approach only if and to the extent these adjustments exceed the NRPPD; for investor credit institutions the amount is zero; (9) For the purposes of this Article of the Decision, the non-refundable purchase price discount shall be calculated by subtracting the amount referred to in item 2) from the amount referred to in item 1):

  1. the outstanding amount of the underlying exposures of the NPE securitisation at the time those exposures were transferred to the SSPE;
  2. the sum of the following:
  • the initial sale price of the tranches or, where applicable, parts of the tranches of the NPE securitisation sold to third party investors; and
  • the outstanding amount, at the time the underlying exposures were transferred to the SSPE, of the tranches or, where applicable, parts of tranches of that securitisation held by the originator. (10) For the purposes of paragraphs (5) to (8) of this Article, throughout the life of the transaction, the calculation of the non-refundable purchase price discount shall be adjusted downwards taking into account the realised losses, whereby any reduction in

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 336 the outstanding amount of the underlying exposures resulting from realised losses shall reduce the non-refundable purchase price discount, subject to a floor of zero. (11) Where a discount is structured in such a way that it can be refunded in whole or in part to the originator, such discount shall not count as a non-refundable purchase price discount for the purposes of this Article of the Decision. Senior positions in SME securitisations Article 315 An originator credit institution may calculate the risk-weighted exposure amounts of a securitisation position in an STS on-balance sheet securitisation as referred to in Articles 304, 306 or 308 of this Decision, as applicable, where the following conditions are met:

  1. the securitisation meets the requirements for STS securitisation set out in Article 279 paragraph (6) of this Decision;
  2. the position qualifies as the senior securitisation position. Additional risk weight Article 316 (1) Where a credit institution does not meet the requirements referred to in Articles 321, 322 and 329 of this Decision in any material respect by reason of negligence or omission by the credit institution, the Central Bank shall impose a proportionate additional risk weight of no less than 250% of the risk weight, capped at 1,250%, which shall apply to the relevant securitisation positions in the manner specified in Article 283 paragraph (9) of this Decision or Article 501 paragraph (3) of this Decision. (2) The Central Bank shall gradually increase the additional risk weight with each subsequent infringement of the due diligence and risk management provisions, and in doing so, it shall take into account the exemptions for certain securitisations provided for in Article 329 paragraph (15) of this Decision by reducing the risk weight they would otherwise impose under this Article in respect of a securitisation to which Article 329 paragraph (15) of this Decision applies. Section 4 - External credit assessments Use of credit assessments by External Credit Assessment Institutions Article 317 A credit institution may use only credit assessments to determine the risk weight of a securitisation position in accordance with this Subtitle where the credit assessment has been issued or has been endorsed by an ECAI.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 337 Requirements to be met by the credit assessments of External Credit Assessment Institutions Article 318 (1) For the purposes of calculating risk-weighted exposure amounts in accordance with Section 3 of this Subtitle, a credit institution shall only use a credit assessment of an ECAI where the following conditions are met:

  1. there is no mismatch between the types of payments reflected in the credit assessment and the types of payments to which the credit institution is entitled under the contract giving rise to the securitisation position in question;
  2. the ECAI publishes the credit assessments and information on loss and cash￾flow analysis, sensitivity of ratings to changes in the underlying ratings assumptions, including the performance of underlying exposures, and on the procedures, methodologies, assumptions, and key elements underpinning the credit assessments;
  3. the credit assessments are included in the ECAI’s transition matrix;
  4. the credit assessments are not based or partly based on unfunded support provided by the credit institution itself, and where a position is based or partly based on unfunded support, the credit institution shall consider that position as if it were unrated for the purposes of calculating risk-weighted exposure amounts for this position in accordance with Section 3 of this Subtitle; and
  5. the ECAI has committed to publishing explanations on how the performance of underlying exposures affects the credit assessment. (2) Information published in accessible format and that which is not made available only to a limited number of entities shall be considered as publicly available information referred to in paragraph (1) item 2) of this Article. (3) Notwithstanding paragraph (1) item 4) of this Article, where a position is based or partly based on unfunded support, the credit institution shall consider that position as if it were unrated for the purposes of calculating risk-weighted exposure amounts for this position in accordance with Section 3 of this Subtitle; Use of credit assessments Article 319 (1) A credit institution may decide to nominate one or more ECAIs the credit assessments of which shall be used in the calculation of its risk-weighted exposure amounts under this Subtitle (nominated ECAI). (2) A credit institution shall use the credit assessments of its securitisation positions in a consistent and non-selective manner and, for these purposes, it shall comply with the following requirements:
  6. a credit institution shall not use an ECAI’s credit assessments for its positions in some tranches and another ECAI’s credit assessments for its positions in other tranches within the same securitisation that may or may not be rated by the first ECAI;
  7. where a position has two credit assessments by nominated ECAIs, the credit institution shall use the less favourable credit assessment;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 338 3) where a position has three or more credit assessments by nominated ECAIs, the two most favourable credit assessments shall be used, and where the two most favourable assessments are different, the less favourable of the two shall be used; and 4) a credit institution shall not actively solicit the withdrawal of less favourable ratings. (3) Where the exposures underlying a securitisation benefit from full or partial eligible credit protection in accordance with Subtitle 4 of this Title, and the effect of such protection has been reflected in the credit assessment of a securitisation position by a nominated ECAI, the credit institution shall use the risk weight associated with that credit assessment. (4) Notwithstanding paragraph (3) of this Article, where the credit protection is not eligible under Subtitle 4 of this Title, the credit protection shall not be recognised and the securitisation position shall be treated as unrated. (5) Where a securitisation position benefits from eligible credit protection in accordance with Subtitle 4 of this Title, and the effect of such protection has been reflected in its credit assessment by a nominated ECAI, the credit institution shall treat the securitisation position as if it were unrated and calculate the risk-weighted exposure amounts in accordance with Subtitle 4 of this Title. Section 5 - General requirements for securitisation Selling of securitisations to retail clients Article 320 (1) The seller of a securitisation position shall not sell such a position to a retail client, unless all of the following conditions are fulfilled:

  1. the seller of the securitisation position has performed a suitability test;
  2. the seller of the securitisation position is satisfied, on the basis of the test referred to in item 1) of this paragraph, that the securitisation position is suitable for that retail client;
  3. the seller of the securitisation position immediately communicates in a report to the retail client the outcome of the suitability test. (2) Where the conditions set out in paragraph (1) pf this Article are fulfilled and the financial instrument portfolio of that retail client does not exceed EUR 500,000, the seller shall ensure, on the basis of the information provided by the retail client in accordance with paragraph (3), that the retail client does not invest an aggregate amount exceeding 10% of that client’s financial instrument portfolio in securitisation positions, and that the initial minimum amount invested in one or more securitisation positions is EUR 10,000. (3) The retail client shall provide the seller with accurate information on the retail client’s financial instrument portfolio, including any investments in securitisation positions.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 339 (4) For the purposes of paragraphs (2) and (3) of this Article, the retail client’s financial instrument portfolio shall include cash deposits and financial instruments, but shall exclude any financial instruments that have been given as collateral. Due-diligence requirements for institutional investors Article 321 (1) Prior to holding a securitisation position, an institutional investor, other than the originator, sponsor or original lender, shall verify that:

  1. where the originator or original lender established in Montenegro or the EU is not a credit institution or an investment firm, the originator or original lender grants all the loans giving rise to the underlying exposures on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing those loans and has effective systems in place to apply those criteria and processes;
  2. where the originator or original lender is established in a third country, the originator or original lender grants all the loans giving rise to the underlying exposures on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing those loans and has effective systems in place to apply those criteria and processes to ensure that credit-granting is based on a thorough assessment of the obligor’s creditworthiness;
  3. if established in Montenegro or the EU, the originator, sponsor or original lender retains on an ongoing basis a material net economic interest in accordance with Article 329 of this Decision and the risk retention is disclosed to the institutional investor in accordance with Article 322 of this Decision;
  4. if established in a third country, the originator, sponsor or original lender retains on an ongoing basis a material net economic interest which, in any event, shall not be less than 5%, determined in accordance with Article 329 of this Decision, and discloses the risk retention to institutional investors;
  5. the originator, sponsor or SSPE has, where applicable, made available the information required by Article 322 of this Decision in accordance with the frequency and modalities provided for in that Article;
  6. in the case of non-performing exposures, when selecting and pricing those exposures, reasonable and well-established standards are applied. (2) By derogation from paragraph (1) of this Article, as regards fully supported ABCP transactions, the requirement specified in paragraph (1) item 1) of this Article shall apply to the sponsor, which shall verify that the originator or original lender which is not a credit institution or an investment firm grants all the loans giving rise to the underlying exposures on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing those loans and has effective systems in place to apply those criteria and processes. (3) Prior to holding a securitisation position, an institutional investor, other than the originator, sponsor or original lender, shall carry out a due-diligence assessment which enables it to assess the risks involved. (4) That assessment shall consider at least:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 340

  1. the risk characteristics of the individual securitisation position and of the underlying exposures;
  2. all the structural features of the securitisation that can materially impact the performance of the securitisation position, including the contractual priorities of payment and priority of payment-related triggers, credit enhancements, liquidity enhancements, market value triggers, and transaction-specific definitions of default;
  3. with regard to a securitisation notified as, the compliance of that securitisation with the requirements provided for in Articles 323 to 325 or in Articles 326 to 328 of this Decision. (5) Notwithstanding paragraph (4) items 1) and 2) of this Article, in the case of a fully supported ABCP programme, institutional investors in the securities issued by that ABCP programme shall consider the features of the ABCP programme and the full liquidity support. (6) An institutional investor, other than the originator, sponsor or original lender, holding a securitisation position, shall at least:
  4. establish appropriate written procedures that are proportionate to the risk profile of the securitisation position and, where relevant, to the institutional investor’s trading and non-trading book, in order to monitor, on an ongoing basis, compliance with paragraphs (1), (3) and (4) of this Article and the performance of the securitisation position and of the underlying exposures, whereby where relevant, those written procedures shall include monitoring of the exposure type, the percentage of loans more than 30, 60 and 90 days past due, default rates, prepayment rates, loans in foreclosure, recovery rates, repurchases, loan modifications, payment holidays, collateral type and occupancy, and frequency distribution of credit scores or other measures of credit worthiness across underlying exposures, industry and geographical diversification, frequency distribution of loan to value ratios with band widths that facilitate adequate sensitivity analysis, and where the underlying exposures are themselves securitisation positions, institutional investors shall also monitor the exposures underlying those positions;
  5. in the case of a securitisation other than a fully supported ABCP programme, regularly perform stress tests on the cash flows and collateral values supporting the underlying exposures or, in the absence of sufficient data on cash flows and collateral values, stress tests on loss assumptions, having regard to the nature, scale and complexity of the risk of the securitisation position;
  6. in the case of fully supported ABCP programme, regularly perform stress tests on the solvency and liquidity of the sponsor;
  7. ensure internal reporting to its management body so that the management body is aware of the material risks arising from the securitisation position and so that those risks are adequately managed;
  8. be able to demonstrate to the Central Bank, upon request, that it has a comprehensive and thorough understanding of the securitisation position and its underlying exposures and that it has implemented written policies and procedures for the risk management of the securitisation position and for maintaining records of the verifications and due diligence in accordance with paragraphs (1), (2) and (3) of this Article and of any other relevant information;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 341 6) in the case of exposures to a fully supported ABCP programme, be able to demonstrate to the Central Bank, upon request, that it has a comprehensive and thorough understanding of the credit quality of the sponsor and of the terms of the liquidity facility provided. (7) Without prejudice to paragraphs (1) to (4), where an institutional investor has given another institutional investor authority to make investment management decisions that might expose it to a securitisation, the institutional investor may instruct that managing party to fulfil its obligations under this Article in respect of any exposure to a securitisation arising from those decisions. Transparency Article 322 (1) The originator, sponsor and SSPE of a securitisation shall, in accordance with paragraph (2) of this Article, make at least the following information available to holders of a securitisation position, to the Central Bank and, upon request, to potential investors:

  1. information on the underlying exposures on a quarterly basis, or, in the case of ABCP, information on the underlying receivables or credit claims on a monthly basis;
  2. all underlying documentation that is essential for the understanding of the transaction, including but not limited to, where applicable, the following documents: ­ the final offering document or the prospectus together with the closing transaction documents, excluding legal opinions; ­ for traditional securitisation the asset sale agreement, assignment, novation or transfer agreement and any relevant declaration of trust; ­ the derivatives and guarantee agreements, as well as any relevant documents on collateralisation arrangements where the exposures being securitised remain exposures of the originator; ­ the servicing, back-up servicing, administration and cash management agreements; ­ the trust deed, security deed, agency agreement, account bank agreement, guaranteed investment contract, incorporated terms or master trust framework or master definitions agreement or such legal documentation with equivalent legal value; ­ any relevant inter-creditor agreements, derivatives documentation, subordinated loan agreements, start-up loan agreements and liquidity facility agreements;
  3. where a prospectus has not been drawn up, a transaction summary or overview of the main features of the securitisation, including, where applicable: ­ details regarding the structure of the deal, including the structure diagrams containing an overview of the transaction, the cash flows and the ownership structure; ­ details regarding the exposure characteristics, cash flows, loss waterfall, credit enhancement and liquidity support features; ­ details regarding the voting rights of the holders of a securitisation position and their relationship to other secured creditors;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 342 ­ a list of all triggers and events referred to in the documents provided in accordance with item 2) of this paragraph that could have a material impact on the performance of the securitisation position; 4) in the case of STS securitisations, the STS notification; 5) quarterly investor reports, or, in the case of ABCP, monthly investor reports, containing the following: ­ all materially relevant data on the credit quality and performance of underlying exposures; ­ information on events which trigger changes in the priority of payments or the replacement of any counterparties, and, in the case of a securitisation which is not an ABCP transaction, data on the cash flows generated by the underlying exposures and by the liabilities of the securitisation; ­ information about the risk retained, including information on which of the modalities provided for in Article 329 paragraph (9) of this Decision has been applied, in accordance with that Article. 6) any inside information relating to the securitisation on insider dealing and market manipulation; 7) where item 6) of this paragraph does not apply, any significant event such as: ­ a material breach of the obligations provided for in the documents made available in accordance with item 2) of this paragraph, including any remedy, waiver or consent subsequently provided in relation to such a breach; ­ a change in the structural features that can materially impact the performance of the securitisation; ­ a change in the risk characteristics of the securitisation or of the underlying exposures that can materially impact the performance of the securitisation; ­ in the case of STS securitisations, where the securitisation ceases to meet the STS requirements or where the Central Bank has taken remedial or administrative actions; ­ any material amendment to transaction documents. (2) The information described in paragraph (1) items 2), 3) and 4) of this Article shall be made available before pricing. (3) The information described in paragraph (1) items 1) and 5) of this Article shall be made available simultaneously each quarter at the latest one month after the due date for the payment of interest or, in the case of ABCP transactions, at the latest one month after the end of the period the report covers. (4) In the case of ABCP, the information described in paragraph (1) item 1), item 3) indent 2 and item 5) indent 1 of this Article shall be made available in aggregate form to holders of securitisation positions and, upon request, to potential investors, and loan-level data shall be made available to the sponsor and, upon request, to the Central Bank. (5) The information described in paragraph (1) items 6) and 7) of this Article shall be made available without delay. (6) When complying with the requirements referred to in paragraphs (1) to (5) of this Article, the originator, sponsor and SSPE of a securitisation shall comply with national

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 343 law governing the protection of confidentiality of information and the processing of personal data in order to avoid potential breaches of such law as well as any confidentiality obligation relating to customer, original lender or debtor information, unless such confidential information is anonymised or aggregated. (7) The originator, sponsor and SSPE of a securitisation shall designate amongst themselves one entity to fulfil the information requirements pursuant to paragraph (1) items 1), 2), 4), 5), 6) and 7) of this Article. (8) The entity designated in accordance with paragraph (7) of this Article shall make the information for a securitisation transaction available by means of a securitisation repository. (9) Where no securitisation repository is officially registered in accordance with the regulation governing the land registration of the head office, the entity designated to fulfil the requirements set out in paragraphs (1) to (5) of this Article shall make the information available by means of a website that:

  1. includes a well-functioning data quality control system;
  2. is subject to appropriate governance standards and to maintenance and operation of an adequate organisational structure that ensures the continuity and orderly functioning of the website;
  3. is subject to appropriate systems, controls and procedures that identify all relevant sources of operational risk;
  4. includes systems that ensure the protection and integrity of the information received and the prompt recording of the information;
  5. makes it possible to keep record of the information for at least five years after the maturity date of the securitisation. (10) The entity responsible for reporting the information, and the securitisation repository where the information is made available shall be indicated in the documentation regarding the securitisation. Requirements relating to simplicity Article 323 (1) The title to the underlying exposures shall be acquired by the SSPE by means of a true sale or assignment or transfer with the same legal effect in a manner that is enforceable against the seller or any other third party. (2) The transfer of the title to the SSPE shall not be subject to severe clawback provisions in the event of the seller’s bankruptcy. (3) For the purpose of paragraph (2), any of the following shall constitute severe clawback provisions:
  6. provisions which allow the bankruptcy administrator of the seller to invalidate the sale of the underlying exposures solely on the basis that it was concluded within a certain period before the declaration of the seller’s bankruptcy;
  7. the SSPE can only prevent such invalidation if it can prove that it was not aware of the bankruptcy of the seller at the time of sale.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 344 (4) The provisions in national bankruptcy laws that allow the invalidation of the sale in the case of fraudulent transfers, unfair prejudice to creditors or transfers of particular creditors shall not constitute severe clawback provisions. (5) Where the seller is not the original lender, the true sale or assignment or transfer with the same legal effect of that seller (whether directly or through intermediate steps) shall meet the requirements set out in paragraphs (1) to (4) of this Article. (6) Where the transfer of the underlying exposures is performed by means of an assignment and perfected at a later stage than at the closing of the transaction, the triggers to effect such perfection shall include at least the following events:

  1. severe deterioration in the seller credit quality standing;
  2. bankruptcy of the seller; and
  3. unremedied breaches of contractual obligations by the seller, including the seller’s default. (7) The seller shall provide representations and warranties that, to the best of its knowledge, the underlying exposures included in the securitisation are not encumbered or otherwise in a condition that can be foreseen to adversely affect the enforceability of the true sale or assignment or transfer with the same legal effect. (8) The underlying exposures transferred from, or assigned by, the seller to the SSPE shall meet predetermined, clear and documented eligibility criteria which do not allow for active portfolio management of those exposures on a discretionary basis. (9) The substitution of exposures that are in breach of representations and warranties shall not be considered active portfolio management. (10) Exposures transferred to the SSPE after the closing of the transaction shall meet the eligibility criteria applied to the initial underlying exposures. (11) The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. (12) A pool of underlying exposures shall comprise only one asset type, and those exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors and, where applicable, guarantors. (13) The underlying exposures shall have defined periodic payment streams, the instalments of which may differ in their amounts, relating to rental, principal, or interest payments, or to any other right to receive income from assets supporting such payments, and they may also generate proceeds from the sale of any financed or leased assets. (14) The underlying exposures shall not include transferable securities, other than corporate bonds that are not listed on a trading venue. (15) The underlying exposures shall not include any securitisation position.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 345 (16) The underlying exposures shall be originated in the ordinary course of the originator’s or original lender’s business pursuant to underwriting standards that are no less stringent than those that the originator or original lender applied at the time of origination to similar exposures that are not securitised, whereby those standards and any material changes from prior underwriting standards shall be fully disclosed to potential investors without undue delay. (17) In the case of securitisations where the underlying exposures are residential loans, the pool of loans shall not include any loan that was marketed and underwritten on the premise that the loan applicant or, where applicable, intermediaries were made aware that the information provided might not be verified by the lender. (18) The originator or original lender shall have expertise in originating exposures of a similar nature to those securitised. (19) The underlying exposures shall be transferred to the SSPE after selection without undue delay and shall not include, at the time of selection, exposures in default within the meaning of Article 218 of this Decision or exposures to a credit-impaired debtor or guarantor, who, to the best of the originator’s or original lender’s knowledge:

  1. has been declared insolvent or had a court grant his creditors a final non￾appealable right of enforcement or material damages as a result of a missed payment or has undergone a debt-restructuring process with regard to his non￾performing exposures, except if:
  • a restructured underlying exposure has not presented new arrears since the date of the restructuring, which must have taken place at least one year prior to the date of transfer;
  • the information provided by the originator, sponsor and SSPE in accordance with Article 322 paragraph (1) item 1) and item 5) indent 1 of this Decision explicitly sets out the proportion of restructured underlying exposures, the time and details of the restructuring as well as their performance since the date of the restructuring;
  1. was, at the time of origination, on a public credit registry of persons with adverse credit history or another credit registry;
  2. has a credit assessment or a credit score indicating that the risk of contractually agreed payments not being made is significantly higher than for comparable exposures held by the originator which are not securitised. (20) The debtors shall, at the time of transfer of the exposures, have made at least one payment, except in the case of revolving securitisations backed by exposures payable in a single instalment or having a maturity of less than one year, including without limitation monthly payments on revolving credits. (21) The repayment of the holders of the securitisation positions shall not have been structured to depend predominantly on the sale of assets securing the underlying exposures, which shall not prevent such assets from being subsequently rolled-over or refinanced. (22) The repayment of the holders of the securitisation positions whose underlying exposures are secured by assets the value of which is guaranteed or fully mitigated

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 346 by a repurchase obligation by the seller of the assets securing the underlying exposures or by another third party shall not be considered to depend on the sale of assets securing those underlying exposures. Requirements relating to standardisation Article 324 (1) The originator, sponsor or original lender shall satisfy the risk-retention requirement in accordance with Article 329 of this Decision. (2) The interest-rate and currency risks arising from the securitisation shall be appropriately mitigated and any measures taken to that effect shall be disclosed. (3) Except for the purpose of hedging interest-rate or currency risk, the SSPE shall not enter into derivative contracts and shall ensure that the pool of underlying exposures does not include derivatives, whereby those derivatives shall be underwritten and documented according to common standards in international finance. (4) Any referenced interest payments under the securitisation assets and liabilities shall be based on generally used market interest rates, or generally used sectoral rates reflective of the cost of funds, and shall not reference complex formulae or derivatives. (5) Where an enforcement or an acceleration notice has been delivered:

  1. no amount of cash shall be trapped in the SSPE beyond what is necessary to ensure the operational functioning of the SSPE or the orderly repayment of investors in accordance with the contractual terms of the securitisation, unless exceptional circumstances require that an amount be trapped to be used, in the best interests of investors, for expenses in order to avoid the deterioration in the credit quality of the underlying exposures;
  2. principal receipts from the underlying exposures shall be passed to investors via sequential amortisation of the securitisation positions, as determined by the seniority of the securitisation position;
  3. repayment of the securitisation positions shall not be reversed with regard to their seniority;
  4. no provisions shall require automatic liquidation of the underlying exposures at market value. (6) Transactions which feature non-sequential priority of payments shall include triggers relating to the performance of the underlying exposures resulting in the priority of payments reverting to sequential payments in order of seniority. Such performance￾related triggers shall include at least the deterioration in the credit quality of the underlying exposures below a predetermined threshold. (7) The transaction documentation shall include appropriate early amortisation provisions or triggers for termination of the revolving period where the securitisation is a revolving securitisation, including at least the following:
  5. a deterioration in the credit quality of the underlying exposures to or below a predetermined threshold;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 347 2) the occurrence of an insolvency-related event with regard to the originator or the servicer; 3) the value of the underlying exposures held by the SSPE falls below a predetermined threshold (early amortisation event); 4) a failure to generate sufficient new underlying exposures that meet the predetermined credit quality (trigger for termination of the revolving period). (8) The transaction documentation shall clearly specify:

  1. the contractual obligations, duties and responsibilities of the servicer and the trustee, if any, and other ancillary service providers;
  2. the processes and responsibilities necessary to ensure that a default by or an insolvency of the servicer does not result in a termination of servicing, such as a contractual provision which enables the replacement of the servicer in such cases;
  3. provisions that ensure the replacement of derivative counterparties, liquidity providers and the account bank in the case of their default, insolvency, and other specified events, where applicable. (9) The servicer shall have expertise in servicing exposures of a similar nature to those securitised and shall have well-documented and adequate policies, procedures and risk-management controls relating to the servicing of exposures. (10) The transaction documentation shall set out in clear and consistent terms definitions, remedies and actions relating to delinquency and default of debtors, debt restructuring, debt forgiveness, forbearance, payment holidays, losses, charge offs, recoveries and other asset performance remedies, and it shall clearly specify the priorities of payment, events which trigger changes in such priorities of payment as well as the obligation to report such events, whereby any change in the priorities of payments which will materially adversely affect the repayment of the securitisation position shall be reported to investors without undue delay. (11) The transaction documentation shall include clear provisions that facilitate the timely resolution of conflicts between different classes of investors, voting rights shall be clearly defined and allocated to bondholders and the responsibilities of the trustee and other entities with fiduciary duties to investors shall be clearly identified. Requirements relating to transparency Article 325 (1) The originator and the sponsor shall make available data on static and dynamic historical default and loss performance, such as delinquency and default data, for substantially similar exposures to those being securitised, and the sources of those data and the basis for claiming similarity, to potential investors before pricing, whereby those data shall cover a period of at least five years. (2) A sample of the underlying exposures shall be subject to external verification prior to issuance of the securities resulting from the securitisation by an appropriate and independent party, including verification that the data disclosed in respect of the underlying exposures is accurate.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 348 (3) The originator or the sponsor shall, before the pricing of the securitisation, make available to potential investors a liability cash flow model which precisely represents the contractual relationship between the underlying exposures and the payments flowing between the originator, sponsor, investors, other third parties and the SSPE, and shall, after pricing, make that model available to investors on an ongoing basis and to potential investors upon request. (4) In the case of a securitisation where the underlying exposures are residential loans or auto loans or leases, the originator and sponsor shall publish the available information related to the environmental performance of the assets financed by such residential loans or auto loans or leases, as part of the information disclosed pursuant to point (a) of the first subparagraph of Article 322 paragraph (1) item 1) of this Decision. (5) The originator and the sponsor shall be responsible for compliance with Article 322 of this Decision. (6) The information required in accordance with Article 322 paragraph (1) item 1) of this Decision shall be made available to potential investors before pricing upon request, while the information required in accordance with items 2), 3) and 4) of the same paragraph shall be made available before pricing at least in draft or initial form. (7) The final documentation shall be made available to investors at the latest 15 days after closing of the transaction. Transaction-level requirements Article 326 (1) The title to the underlying exposures shall be acquired by the SSPE by means of a true sale or assignment or transfer with the same legal effect in a manner that is enforceable against the seller or any other third party. (2) The transfer of the title to the SSPE shall not be subject to severe clawback provisions in the event of the seller’s insolvency. (3) For the purpose of paragraph (2) of this Article, severe clawback provisions shall be:

  1. provisions which allow the bankruptcy administrator of the seller to invalidate the sale of the underlying exposures solely on the basis that it was concluded within a certain period before the declaration of the seller’s bankruptcy;
  2. provisions where the SSPE can only prevent the invalidation if it can prove that it was not aware of the bankruptcy of the seller at the time of sale. (4) Clawback provisions in national bankruptcy laws that allow the invalidation of the sale of underlying exposures in the case of fraudulent transfers, unfair prejudice to creditors or transfers intended to improperly favour particular creditors over others shall not constitute severe clawback provisions. (5) Where the seller is not the original lender, the true sale or assignment or transfer with the same legal effect of the underlying exposures to the seller, whether directly

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 349 or through intermediate steps, shall meet the requirements set out in paragraphs (1) to (4) of this Article. (6) Where the transfer of the underlying exposures is performed by means of an assignment and perfected at a later stage than at the closing of the transaction, the triggers to effect such perfection shall include at least the following events:

  1. severe deterioration in the seller credit quality standing;
  2. bankruptcy of the seller;
  3. unremedied breaches of contractual obligations by the seller, including the seller’s default. (7) The seller shall provide representations and warranties that, to the best of its knowledge, the underlying exposures are not encumbered or otherwise in a condition that can be foreseen to adversely affect the enforceability of the transfer. (8) The underlying exposures transferred to the SSPE shall meet predetermined, clear and documented eligibility criteria which do not allow for active portfolio management of those exposures on a discretionary basis. (9) The substitution of exposures that are in breach of representations and warranties shall not be considered active portfolio management. (10) Exposures transferred to the SSPE after the closing of the transaction shall meet the eligibility criteria applied to the initial underlying exposures. (11) The underlying exposures shall not include any securitisation position. (12) The underlying exposures shall be transferred to the SSPE after selection without undue delay and shall not include, at the time of selection, exposures in default within the meaning of Article 218 of this Decision or exposures to a credit-impaired debtor or guarantor, who, to the best of the originator’s or original lender’s knowledge:
  4. has been declared insolvent or had a court grant his creditors a final non￾appealable right of enforcement or material damages as a result of a missed payment within three years prior to the date of origination or has undergone a debt restructuring process with regard to his non-performing exposures within three years prior to the date of transfer or assignment of the underlying exposures to the SSPE, except if:
  • a restructured underlying exposure has not presented new arrears since the date of the restructuring, which must have taken place at least one year prior to the date of transfer or assignment of the underlying exposures to the SSPE; and
  • the information provided by the originator, sponsor and SSPE in accordance with Article 322 paragraph (1) item 1) and item 5) indent 1 of this Decision explicitly sets out the proportion of restructured underlying exposures, the time and details of the restructuring as well as their performance since the date of the restructuring;
  1. was, at the time of origination, where applicable, on a public credit registry of persons with adverse credit history or, where there is no such public credit registry, another credit registry that is available to the originator or original lender; or

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 350 3) has a credit assessment or a credit score indicating that the risk of contractually agreed payments not being made is significantly higher than for comparable exposures held by the originator which are not securitised. (13) The debtors shall, at the time of transfer of the exposures, have made at least one payment, except in the case of revolving securitisations backed by exposures payable in a single instalment or having a maturity of less than one year, including without limitation monthly payments on revolving credits. (14) The repayment of the holders of the securitisation positions shall not have been structured to depend predominantly on the sale of assets securing the underlying exposures, and it shall not prevent such assets from being subsequently rolled over or refinanced. (15) The repayment of the holders of the securitisation positions whose underlying exposures are secured by assets the value of which is guaranteed or fully mitigated by a repurchase obligation by the seller of the assets securing the underlying exposures or by another third party shall not be considered to depend on the sale of assets securing those underlying exposures. (16) The interest-rate and currency risks arising from the securitisation shall be appropriately mitigated and any measures taken to that effect shall be disclosed. (17) Except for the purpose of hedging interest-rate or currency risk, the SSPE shall not enter into derivative contracts and shall ensure that the pool of underlying exposures does not include derivatives, which shall be underwritten and documented according to common standards in international finance. (18) The transaction documentation shall set out, in clear and consistent terms, definitions, remedies and actions relating to delinquency and default of debtors, debt restructuring, debt forgiveness, forbearance, payment holidays, losses, charge-offs, recoveries and other asset-performance remedies. (19) The transaction documentation shall clearly specify the priorities of payment, events which trigger changes in such priorities of payment as well as the obligation to report such events, whereby any change in the priorities of payments which will materially adversely affect the repayment of the securitisation position shall be reported to investors without undue delay. (20) The originator and the sponsor shall make available data on static and dynamic historical default and loss performance, which are substantially similar exposures to those being securitised, and the sources of those data and the basis for claiming similarity, to potential investors before pricing, whereby if the sponsor does not have access to such data, it shall obtain from the seller access to data, on a static or dynamic basis, on the historical performance, such as delinquency and default data, for exposures substantially similar to those being securitised, and all such data shall cover a period no shorter than five years, except for data relating to trade receivables and other short-term receivables, for which the historical period shall be no shorter than three years.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 351 (21) ABCP transactions shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the characteristics relating to the cash flows of different asset types including their contractual, credit-risk and prepayment characteristics, whereby a pool of underlying exposures shall only comprise one asset type. (22) The pool of underlying exposures shall have a remaining weighted average life of not more than one year, and none of the underlying exposures shall have a residual maturity of more than three years. (23) By way of derogation from paragraph (22) of this Article, pools of auto loans, auto leases and equipment lease transactions shall have a remaining weighted average life of not more than three and a half years, and none of the underlying exposures shall have a residual maturity of more than six years. (24) The underlying exposures shall not include loans secured by residential or commercial mortgages or fully guaranteed residential loans, as referred to in Article 169 paragraph (1) item %) of this Decision, whereby the exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors with defined payment streams (rental, principal, interest, or related to any other right to receive income from assets). (25) The underlying exposures may also generate proceeds from the sale of any financed or leased assets, and they shall not include transferable securities other than corporate bonds, that are not listed on a trading venue. (26) Any referenced interest payments under the ABCP transaction’s assets and liabilities shall be based on generally used market interest rates, or generally used sectoral rates reflective of the cost of funds, but shall not reference complex formulae or derivatives. Referenced interest payments under the ABCP transaction’s liabilities may be based on interest rates reflective of an ABCP programme’s cost of funds. (27) Following the seller’s default or an acceleration event:

  1. no amount of cash shall be trapped in the SSPE beyond what is necessary to ensure the operational functioning of the SSPE or the orderly repayment of investors in accordance with the contractual terms of the securitisation unless exceptional circumstances require that an amount be trapped to be used, in the best interests of investors, for expenses in order to avoid the deterioration in the credit quality of the underlying exposures;
  2. principal receipts from the underlying exposures shall be passed to investors holding a securitisation position via sequential payment of the securitisation positions, as determined by the seniority of the securitisation position;
  3. no provisions shall require automatic liquidation of the underlying exposures at market value. (28) The underlying exposures shall be originated in the ordinary course of the seller’s business pursuant to underwriting standards that are no less stringent than those that the seller applies at the time of origination to similar exposures that are not securitised, and those standards pursuant to which the underlying exposures are originated and any material changes from prior underwriting standards shall be fully disclosed to the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 352 sponsor and other parties directly exposed to the ABCP transaction without undue delay, whereby the seller shall have expertise in originating exposures of a similar nature to those securitised. (29) Where an ABCP transaction is a revolving securitisation, the transaction documentation shall include triggers for termination of the revolving period, including at least the following:

  1. a deterioration in the credit quality of the underlying exposures to or below a predetermined threshold; and
  2. the occurrence of an insolvency-related event with regard to the seller or the servicer. (30) The transaction documentation shall clearly specify:
  3. the contractual obligations, duties and responsibilities of the sponsor, the servicer and the trustee, if any, and other ancillary service providers;
  4. the processes and responsibilities necessary to ensure that a default or insolvency of the servicer does not result in a termination of servicing;
  5. provisions that ensure the replacement of derivative counterparties and the account bank upon their default, insolvency and other specified events, where applicable;
  6. how the sponsor meets the requirements of Article 327 paragraph (4) of this Decision. Sponsor of an ABCP programme Article 327 (1) The sponsor of the ABCP programme shall be a credit institution. (2) The sponsor of an ABCP programme shall be a liquidity facility provider and shall support all securitisation positions on an ABCP programme level by covering all liquidity and credit risks and any material dilution risks of the securitised exposures as well as any other transaction- and programme-level costs if necessary to guarantee to the investor the full payment of any amount under the ABCP with such support. (3) The sponsor shall disclose a description of the support provided at transaction level to the investors including a description of the liquidity facilities provided. (4) Before being able to sponsor an STS ABCP programme, the credit institution shall demonstrate to the Central Bank that its role under paragraph (2) does not endanger its solvency and liquidity, even in an extreme stress situation in the market. (5) The requirement referred to in paragraph (4) of this Article shall be considered to be fulfilled where the Central Bank has determined on the basis of the supervisory review and evaluation that the arrangements, strategies, processes and mechanisms implemented by that credit institution and the own funds and liquidity held by it ensure the sound management and coverage of its risks. (6) The sponsor of the ABCP programme shall perform its own due diligence and shall verify compliance with the requirements set out in Article 321 paragraphs (1), (3) and (4) of this Decision, as applicable and verify that the seller has in place servicing

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 353 capabilities and collection processes that meet the requirements specified in Article 309 paragraph (2) items 8) to 16) of this Decision. (7) The seller, at the level of a transaction, or the sponsor, at the level of the ABCP programme, shall satisfy the risk-retention requirement referred to in Article 329 of this Decision. (8) In the event that the sponsor does not renew the funding commitment of the liquidity facility before its expiry, the liquidity facility shall be drawn down and the maturing securities shall be repaid. Programme-level requirements Article 328 (1) All ABCP transactions within an ABCP programme shall fulfil the requirements of Article 326 paragraphs (1) to (10) and paragraphs (16) to (30) of this Decision. (2) A maximum of 5% of the aggregate amount of the exposures underlying the ABCP transactions and which are funded by the ABCP programme may temporarily be non￾compliant with the requirements of Article 326 paragraphs (12) to (14), without affecting the STS status of the ABCP programme. (3) For the purpose of paragraph (2) of this Article, a sample of the underlying exposures shall regularly be subject to external verification of compliance by an appropriate and independent party. (4) The remaining weighted average life of the underlying exposures of an ABCP programme shall not be more than two years. (5) The ABCP programme shall be fully supported by a sponsor in accordance with Article 327 paragraphs (2) and (3) of this Decision. (6) The ABCP programme shall not contain any resecuritisation and the credit enhancement shall not establish a second layer of tranching at the programme level. (7) The securities issued by an ABCP programme shall not include call options, extension clauses or other clauses that have an effect on their final maturity, where such options or clauses may be exercised at the discretion of the seller, sponsor or SSPE. (8) The interest-rate and currency risks arising at ABCP programme level shall be appropriately mitigated and any measures taken to that effect shall be disclosed. (9) Except for the purpose of hedging referred to in paragraph (8) of this Article, the SSPE shall not enter into derivative contracts and shall ensure that the pool of underlying exposures does not include derivatives, which shall be underwritten and documented according to common standards in international finance. (10) The documentation relating to the ABCP programme shall clearly specify:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 354

  1. the responsibilities of the trustee and other entities with fiduciary duties, if any, to investors;
  2. the contractual obligations, duties and responsibilities of the sponsor, who shall have expertise in credit underwriting, the trustee, if any, and other ancillary service providers;
  3. the processes and responsibilities necessary to ensure that a default or insolvency of the servicer does not result in a termination of servicing;
  4. the provisions for replacement of derivative counterparties, and the account bank at ABCP programme level upon their default, insolvency and other specified events, where the liquidity facility does not cover such events;
  5. that, upon specified events, default or insolvency of the sponsor, remedial steps shall be provided for to achieve, as appropriate, collateralisation of the funding commitment or replacement of the liquidity facility provider;
  6. that the liquidity facility shall be drawn down and the maturing securities shall be repaid in the event that the sponsor does not renew the funding commitment of the liquidity facility before its expiry. (11) The servicer shall have expertise in servicing exposures of a similar nature to those securitised and shall have well-documented policies, procedures and risk￾management controls relating to the servicing of exposures. Risk retention Article 329 (1) The originator, sponsor or original lender of a securitisation shall retain on an ongoing basis a material net economic interest in the securitisation of not less than 5% and the interest shall be measured at the origination and shall be determined by the notional value for off-balance-sheet items. (2) Where the originator, sponsor or original lender have not agreed between them who will retain the material net economic interest, the originator shall retain the material net economic interest. (3) There shall be no multiple applications of the retention requirements for any given securitisation. (4) The material net economic interest shall not be split amongst different types of retainers and not be subject to any credit-risk mitigation or hedging. (5) For the purposes of this Article, an entity shall not be considered to be an originator where the entity has been established or operates for the sole purpose of securitising exposures. (6) When measuring the material net economic interest, the retainer shall take into account any fees that may in practice be used to reduce the effective material net economic interest. (7) In the case of traditional NPE securitisations, the requirement of this paragraph may also be fulfilled by the servicer provided that the servicer can demonstrate that it has expertise in servicing exposures of a similar nature to those securitised and that

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 355 it has well-documented and adequate policies, procedures and risk-management controls in place relating to the servicing of exposures. (8) Originators shall not select assets to be transferred to the SSPE with the aim of rendering losses on the assets transferred to the SSPE, measured over the life of the transaction, or over a maximum of 4 years where the life of the transaction is longer than four years, higher than the losses over the same period on comparable assets held on the balance sheet of the originator. (9) Only the following shall qualify as a retention of a material net economic interest of not less than 5% within the meaning of paragraph (1) of this Article:

  1. the retention of not less than 5 % of the nominal value of each of the tranches sold or transferred to investors;
  2. in the case of revolving securitisations or securitisations of revolving exposures, the retention of the originator’s interest of not less than 5 % of the nominal value of each of the securitised exposures;
  3. the retention of randomly selected exposures, equivalent to not less than 5 % of the nominal value of the securitised exposures, where such non-securitised exposures would otherwise have been securitised in the securitisation, provided that the number of potentially securitised exposures is not less than 100 at origination;
  4. the retention of the first loss tranche and, where such retention does not amount to 5 % of the nominal value of the securitised exposures, if necessary, other tranches having the same or a more severe risk profile than those transferred or sold to investors and not maturing any earlier than those transferred or sold to investors, so that the retention equals in total not less than 5 % of the nominal value of the securitised exposures;
  5. the retention of a first loss exposure of not less than 5 % of every securitised exposure in the securitisation.
  1. By way of derogation from paragraph (9) of this Article, in the case of NPE securitisations, where a non-refundable purchase price discount has been agreed, the retention of a material net economic interest for the purposes of that paragraph shall not be less than 5 % of the sum of the net value of the securitised exposures that qualify as non-performing exposures and, if applicable, the nominal value of any performing securitised exposures. (11) The net value of a non-performing exposure shall be calculated by deducting the non-refundable purchase price discount agreed at the level of the individual securitised exposure at the time of origination or, where applicable, a corresponding share of the non-refundable purchase price discount agreed at the level of the pool of underlying exposures at the time of origination from the exposure’s nominal value or, where applicable, its outstanding value at the time of origination. (12) For the purpose of determining the net value of the securitised non-performing exposures, the non-refundable purchase price discount may include the difference between the nominal amount of the tranches of the NPE securitisation underwritten by the originator for subsequent sale and the price at which these tranches are first sold to unrelated third parties.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 356 (13) Where a mixed financial holding company, a parent institution or a financial holding company or one of its subsidiary undertakings, as an originator or sponsor, securitises exposures from one or more credit institutions, investment firms or other financial institutions which are included in the scope of supervision on a consolidated basis, the requirements referred to in paragraph (1) of this Article may be satisfied on the basis of the consolidated situation of the related parent institution, financial holding company, or mixed financial holding company established in the Union. (14) The provision of paragraph (13) of this Article shall apply only where credit institutions, investment firms or financial institutions which created the securitised exposures comply with the requirements for risk management and requirements referred to in Article 321 of this Decision in a timely manner, to the originator or sponsor and to the Union parent credit institution, financial holding company or mixed financial holding company. (15) The provision of paragraph (1) of this Article shall not apply where the securitised exposures are exposures to entities referred to in items 1) to 4) of this paragraph or are exposures fully, unconditionally and irrevocably guaranteed by:

  1. central governments or central banks;
  2. regional governments, local authorities and public sector entities;
  3. credit institutions to which a 50 % risk weight or less is assigned;
  4. the multilateral development banks listed in Article 154 of this Decision. (16) The provision of paragraph (1) of this Article shall not apply to transactions based on a clear, transparent and accessible index, where the underlying reference entities are identical to those that make up an index of entities that is widely traded, or are other tradable securities other than securitisation positions. (17) The retention requirement referred to in paragraph (16) of this Article shall not apply to the transactions that include securitisation position in correlation trading portfolio, which are either reference instruments referred to in Article 338 paragraph (1) item 2) of this Decision or eligible for the inclusion in that portfolio. Retainers of a material net economic interest Article 330 (1) The requirement laid down in Article 329 paragraph (4) of this Decision, which states that the retained material net economic interest shall not be split amongst different types of retainers, shall be fulfilled by any of the following:
  5. the originator or originators;
  6. the sponsor or sponsors;
  7. the original lender or original lenders;
  8. the servicer or servicers in a traditional NPE securitisation. (2) Where more than one originator is eligible to fulfil the retention requirement, each originator shall fulfil that requirement on a pro rata basis by reference to the securitised exposures for which it is the originator.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 357 (3) Where more than one original lender is eligible to fulfil the retention requirement, each original lender shall fulfil that requirement on a pro rata basis by reference to the securitised exposures for which it is the original lender. (4) By way of derogation from paragraphs (2) and (3) of this Article, the retention requirement may be fulfilled in full by a single originator or original lender provided that:

  1. the originator or original lender has established and is managing the asset￾backed commercial paper (ABCP) programme or other securitisation; or
  2. the originator or original lender has established the ABCP programme or other securitisation and has contributed more than 50% of the total securitised exposures measured by nominal value at origination. (5) Where more than one sponsor is eligible to fulfil the retention requirement, the retention requirement shall be fulfilled by either:
  3. the sponsor whose economic interest is most closely aligned with the investor’s interest as agreed by all involved sponsors on the basis of objective criteria, including all of the following:
  • the transaction’s fee structure;
  • the sponsor’s involvement in the establishment and management of the ABCP programme or other securitisation;
  • the exposure to the credit risk of the securitisations; or
  1. each sponsor in proportion to the total number of sponsors. (6) Where more than one servicer is eligible to fulfil the retention requirement, the retention requirement shall be fulfilled:
  2. the servicer with the predominant economic interest in the successful workout of the exposures of the traditional NPE securitisation, as agreed by all servicers involved on the basis of objective criteria, including the transaction’s fee structure and the servicer’s available resources and expertise to manage the exposures’ workout process; or
  3. each servicer on a pro rata basis by reference to the securitised exposures that it manages, which shall be calculated as the sum of the net value of the securitised exposures that qualify as non-performing exposures and of the nominal value of the performing securitised exposures. (7) An entity shall not be considered to have been established or to operate for the sole purpose of securitising exposures as referred to in Article 329 paragraph (5) of this Decision, where the following applies:
  4. the entity has a strategy and the capacity to meet payment obligations consistent with a broader business model that involves material support from capital, assets, fees or other sources of income, so that the exposures to be securitised, retained interests or on any corresponding income from such exposures and interests are not the only or predominant source of revenue; and
  5. the members of the management body have the necessary experience to enable the entity to pursue the established business strategy, as well as adequate corporate governance arrangements. Fulfilment of the retention requirement through

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 358 a synthetic or contingent form of retention Article 331 (1) The fulfilment of the retention requirement in a manner equivalent to one of the options set out in Article 329 paragraph (9) of this Decision through a synthetic or contingent form of retention shall be considered valid where the following conditions are met:

  1. the amount retained is at least equal to the amount required under the option which the synthetic or contingent form of retention corresponds to; and
  2. the retainer has explicitly disclosed in the final offering document, prospectus, transaction summary or overview of the main features of the securitisation that it will retain a material net economic interest in the securitisation through a synthetic or contingent form on an ongoing basis. (2) For the purposes of paragraph (1) item 2) of this Decision, the retainer shall disclose in the final offering document, prospectus, transaction summary or overview of the main features of the securitisation all the details on the applicable synthetic or contingent form of retention, including the methodology used in the determination of the material net interest retained and an explanation to which of the options set out in Article 329 paragraph (9) of this Decision the retention is equivalent. (3) Where a retainer is not a credit institution, an insurance or reinsurance undertaking, such retention shall be fully collateralised in cash. Retention equivalent to not less than 5% of the nominal value of each of the tranches sold or transferred to investors Article 332 The retention referred to in Article 329 paragraph (9) item 1) of this Decision (vertical slice) shall be fulfilled by any of the following methods:
  3. direct retention of not less than 5% of the nominal value of each of the tranches sold or transferred to investors;
  4. the retention of an exposure which exposes its holder to the credit risk of each issued tranche of a securitisation transaction on a pro-rata basis of not less than 5% of the total nominal value of each of the issued tranches;
  5. the retention of not less than 5% of the nominal value of each of the securitised exposures, provided that the retained credit risk ranks pari passu with or is subordinated to the credit risk securitised in relation to the same exposures;
  6. the provision, in the context of an ABCP programme, of a liquidity facility, provided that all of the following conditions are met:
  • the liquidity facility covers 100% of the share of the credit risk of the securitised exposures of the securitisation transaction that is funded by the ABCP programme;
  • the liquidity facility covers the credit risk for as long as the retainer has to retain the material net economic interest;
  • the liquidity facility is provided by the originator, sponsor or original lender in the securitisation transaction;
  • the investors have been given access to information within the initial disclosure that enables them to verify that indents 1, 2, and 3 of this point are complied with.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 359 Retention of the originator’s interest in a revolving securitisation or securitisation of revolving exposures Article 333 The retention of the originator’s interest of not less than 5% of the nominal value of each of the securitised exposures as referred to in Article 329 paragraph (9) item 2) of this Decision shall only be considered fulfilled where the retained credit risk of such exposures ranks pari passu with, or is subordinated to, the credit risk securitised in relation to the same exposures. Retention of randomly selected exposures equivalent to no less than 5% of the nominal value of the securitised exposures Article 334 (1) The pool of at least 100 potentially securitised exposures from which retained non￾securitised and securitised exposures are to be randomly selected, as referred to in Article 329 paragraph (9) item 3) of this Decision, shall be sufficiently diverse to avoid an excessive concentration of the retained interest. (2) When selecting the exposures referred to in paragraph (1) of this Article, retainers shall take into account quantitative and qualitative factors that are appropriate for the type of securitised exposures to ensure that the distinction between retained non￾securitised and securitised exposures is random. (3) For the purposes of paragraph (2) of this Article, retainers shall take into consideration the following factors:

  1. the time of origination of the loan (vintage);
  2. the type of securitised exposures;
  3. the geographical location;
  4. the origination date;
  5. the maturity date;
  6. the loan to value ratio;
  7. the collateral type;
  8. the industry sector;
  9. the outstanding loan balance;
  10. any other factor deemed relevant by the retainer. (4) Retainers shall not select different individual exposures at different points in time, except where that may be necessary to fulfil the retention requirement in relation to a securitisation in which the securitised exposures fluctuate over time, either due to new exposures being added to the securitisation or to changes in the level of the individual securitised exposures. (5) Where the retainer is the securitisation’s servicer, the selection conducted in accordance with this Article shall not lead to a deterioration in the servicing standards applied by the retainer on the transferred exposures relative to the retained exposures.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 360 Retention of the first loss tranche Article 335 (1) The retention of the first loss tranche referred to in Article 329 paragraph (9) item 4) of this Decision shall be fulfilled by any of the following methods:

  1. holding either on-balance sheet or off-balance sheet positions;
  2. holding an exposure by means of a provision of a contingent form of retention or of a liquidity facility in the context of an ABCP programme, which fulfils all of the following criteria:
  • the exposure covers at least 5% of the nominal value of the securitised exposures;
  • the exposure constitutes a first loss position in relation to the securitisation;
  • the exposure covers the credit risk for the entire duration of the retention commitment;
  • the exposure is provided by the retainer;
  • the investors have been given access within the initial disclosure to all information necessary to verify that indents 1 to 4 of this item are complied with;
  1. overcollateralisation, if that overcollateralisation operates as a ‘first loss’ position of not less than 5% of the nominal value of the securitised exposures. (2) Where the first loss tranche exceeds 5% of the nominal value of the securitised exposures, the retainer may choose to retain a pro-rata portion of such first loss tranche only, provided that that portion is equivalent to at least 5% of the nominal value of the securitised exposures. Retention of a first loss exposure of not less than 5% of every securitised exposure Article 336 (1) The retention of a first loss exposure at the level of every securitised exposure as referred to in Article 329 paragraph (9) item 4) of this Decision shall only be considered to be fulfilled where the retained credit risk is subordinated to the credit risk securitised in relation to the same exposures. (2) By way of derogation from paragraph (1) of this Article, the retention of a first loss exposure at the level of every securitised exposure may also be fulfilled through the sale by the originator or original lender of the underlying exposures at a discounted value where each of the following conditions is met:
  2. the amount of the discount is not less than 5% of the nominal value of each exposure;
  3. the discounted sale amount is refundable to the originator or original lender only if that discounted sale amount is not absorbed by losses related to the credit risk associated to the securitised exposures. Application of the retention options on traditional NPE securitisations Article 337 (1) In the case of NPE securitisations as referred to in Article 329 paragraph (10) of this Decision, for the purpose of applying Article 332 item 1) and Articles 333 to 336

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 361 of this Decision to the share of non-performing exposures in the pool of underlying exposures of a securitisation, any reference to the nominal value of the securitised exposures shall be construed as a reference to the net value of the non-performing exposures. (2) For the purposes of Article 334 of this Decision, the net value of the retained non￾performing exposures shall be calculated using the same amount of the non￾refundable purchase price discount that would have been applied had the retained non-performing exposures been securitised. (3) For the purposes of Article 332 item 1) and Articles 333 to 336 of this Decision, the net value of the retained part of the non-performing exposures shall be calculated using the same percentage of the non-refundable discount that applies to the part that is not retained. (4) Where the non-refundable discount has been agreed at the level of the pool of underlying non-performing exposures or at sub-pool level, the net value of individual securitised non-performing exposures included in the pool shall be calculated by applying a proportionate share of the discount to their nominal value (or, where applicable, their outstanding value) at the time of origination. (5) Where the non-refundable purchase discount includes the difference between the nominal amount of one tranche or several tranches of an NPE securitisation underwritten by the originator for subsequent sale and the price at which that tranche or those tranches are first sold to unrelated third parties, that difference shall be taken into account in the calculation of the net value of individual securitised non-performing exposures by applying a corresponding share of the difference to each of the exposures in proportion to their nominal value. Measurement of the level of retention Article 338 (1) When measuring the level of retention of the net economic interest, the following criteria shall be applied:

  1. the origination shall be the time at which the exposures were first securitised, which shall be one of the following: − the date of the issuance of securities; − the date of the signature of the credit protection agreement; − the date of the agreement on a non-refundable purchase price discount;
  2. where the calculation of the level of retention is based on nominal values, the acquisition price of assets shall not be taken into account for the purpose of that calculation;
  3. the fee and interest income received in respect of the securitised exposures in a traditional securitisation net of costs and expenses (traditional excess spread) shall not be taken into account when measuring the retainer’s net economic interest;
  4. where the originator acts as the securitisation’s retainer and applies the retention option referred to in Article 329 paragraph (9) item 4) of this Decision, and where the exposure value of the synthetic excess spread that provides

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 362 credit enhancement to all the tranches of the synthetic securitisation and serves as a first loss protection is subject to regulatory capital requirements, the originator may take that exposure value into account when calculating the net economic interest by treating it as retention of the first loss tranche; 5) the retention option and methodology used to calculate the net economic interest shall not be changed during the life of a securitisation, unless exceptional circumstances require a change and that change is not used as a means to reduce the amount of the retained interest. (2) The retainer shall not be required to constantly replenish or readjust its retained interest to at least 5 % when losses are realised on its retained exposures or allocated to its retained positions. (3) The calculation of the net economic interest to be retained for credit facilities, including credit cards, shall be based on amounts already drawn, realised or received only and shall be adjusted in accordance with changes to those amounts. Prohibition of hedging or selling the retained interest Article 339 (1) The obligation laid down in Article 329 paragraph (1) of this Decision to retain on an ongoing basis a material net economic interest in the securitisation shall be deemed to have been met only where the following conditions are met:

  1. the retained material net economic interest is not subject to any credit risk mitigation or hedging of either the retained securitisation positions or the retained exposures; and
  2. the retainer does not sell, transfer or otherwise surrender all or part of the rights, benefits or obligations arising from the retained net economic interest. (2) By way of derogation from paragraph (1) item 1) of this Article, the retainer may hedge the net economic interest where the hedge is not against the credit risk of either the retained securitisation positions or the retained exposures. (3) The retainer may use retained exposures or securitisation positions as collateral for secured funding purposes including funding arrangements that involve a sale, transfer or other surrender of all or part of the rights, benefits or obligations arising from the retained net economic interest, provided that such use as collateral does not transfer the exposure to the credit risk of those retained exposures or securitisation positions to a third party. (4) Paragraph (1) item 2) of this Article, shall not apply in any of the following events:
  3. in the event of opening of the bankruptcy proceeding of the retainer;
  4. where the retainer, for legal reasons beyond its control and beyond the control of its shareholders, is unable to continue acting as a retainer; and
  5. in the case of retention on a consolidated basis.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 363 Fulfilment of the retention requirement in securitisations of own-issued debt instruments Article 340 Where an entity securitises its own-issued debt instruments, including covered bonds, and the underlying exposures of the securitisation comprise exclusively those own-issued debt instruments, the retention requirement referred to in Article 329 paragraph (1) of this Decision shall be considered complied with. Retention requirement in resecuritisations Article 341 (1) For resecuritisations, a retainer shall retain the material net economic interest in relation to each of the respective transaction levels. (2) By way of derogation from paragraph (1) of this Article, the originator of a resecuritisation shall not be obliged to retain a material net economic interest at the resecuritisation level where all of the following conditions are met:

  1. the originator of the resecuritisation is also the originator and the retainer of the underlying securitisation;
  2. the resecuritisation is backed solely by exposures which were retained by the originator in the underlying securitisation in excess of the required minimum requirement;
  3. there is no maturity mismatch between the underlying securitisation positions and the resecuritisation positions. (3) For the purposes of paragraphs (1) and (2) of this Article, retranching by the securitisation’s originator of an issued tranche into contiguous tranches shall not constitute a resecuritisation. Assets transferred to the SSPE Article 342 (1) Within the meaning of Article 329 paragraph (8) of this Decision, assets held on the balance sheet of the originator that according to the documentation of the securitisation meet the eligibility criteria, shall be deemed to be comparable to the assets to be transferred to the SSPE where both of the following conditions are met:
  4. the expected performance of both types of assets is determined by similar factors;
  5. on the basis of indicators (including past performance and models), it can be reasonably expected that the performance of the assets to be further held on the balance sheet will not be significantly better during the time period referred to in Article 329 paragraph (8) of this Decision than the performance of the assets to be transferred. (2) The assessment whether the originator has complied with the criteria referred to in 329 paragraph (8) of this Decision shall take into account any actions taken by the originator to comply with this requirement, and in particular any internal policies,

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 364 procedures and controls to prevent the systematic transfer of worse exposures into securitisation. (3) An originator shall be deemed to have complied with Article 329 paragraph (8) of this Decision where, after the securitisation, there are no comparable exposures left on the originator’s balance sheet, other than the exposures which the originator is already contractually committed to securitise, and provided that that fact has been clearly communicated to investors. Expertise requirement on the servicer of traditional NPE securitisations Article 343 (1) In the case of traditional NPE securitisations, servicers shall be deemed to have expertise in servicing exposures of a similar nature to those securitised where one of the following conditions is fulfilled:

  1. the members of the management body and the senior staff responsible for servicing exposures have adequate knowledge and skills;
  2. the business of the servicer (or of its consolidated group) has included the servicing of similar exposures for at least five years prior to the date of the securitisation; or
  3. all of the following points are complied with: − at least two of the members of the management body have the experience in the servicing of similar exposures, on a personal level, of at least five years; − senior staff responsible for managing the servicing of non-performing exposures have relevant professional experience of at least five years; and − the servicing function of the servicer is backed up by a back-up servicer that complies with item 2) of this paragraph. (2) Servicers shall substantiate and disclose their professional experience in sufficient detail to enable institutional investors to comply with their due diligence obligations laid down in Article 321 of this Decision, while respecting the applicable confidentiality requirements. SUBTITLE 6 – Counterparty credit risk Section 1 – Definitions Determination of the exposure value Article 344 (1) A credit institution shall determine the exposure value of derivative instruments listed in Article 148 paragraph (8) of this Decision in accordance with this Subtitle. (2) A credit institution may determine the exposure value of repurchase transactions, securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions in accordance with this Subtitle instead of making use of Subtitle 4 of this Title.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 365 Definitions Article 345 The terms used in this Subtitle shall have the following meanings:

  1. counterparty credit risk or CCR means the risk that the counterparty to a transaction could default before the final settlement of the transaction's cash flows;
  2. long settlement transaction means a transaction where a counterparty undertakes to deliver a security, a commodity, or a foreign exchange amount against cash, other financial instruments, or commodities, or vice versa, at a settlement or delivery date specified by contract that is later than the market standard for this particular type of transaction or five business days after the date on which the credit institution enters into the transaction, whichever is earlier;
  3. margin lending transactions means transactions in which a credit institution grants a loan in connection with the purchase, sale, carrying or trading of securities, wherein these transactions do not include other loans that are secured by collateral in the form of securities;
  4. netting set means a group of transactions between a credit institution and a single counterparty that is subject to a legally enforceable bilateral netting arrangement that is recognised under Section 7 of this Subtitle and Subtitle 4 of this Title. Each transaction that is not subject to a legally enforceable bilateral netting arrangement which is recognised under Section 7 of this Subtitle shall be treated as its own netting set for the purposes of this Subtitle. Under the Internal Model Method set out in Section 6 of this Subtitle, all netting sets with a single counterparty may be treated as a single netting set if negative simulated market values of the individual netting sets are set to 0 in the estimation of expected exposure (hereinafter: EE);
  5. risk position means a risk number that is assigned to a transaction under the Standardised Method set out in Section 5 of this Subtitle following a predetermined algorithm;
  6. hedging set means a group of transactions within a single netting set for which full or partial netting is allowed for determining the potential future exposure under the methods set out in Section 3 or 4 of this Subtitle;
  7. margin agreement means an agreement or provisions of an agreement under which one counterparty must supply collateral (pay the agreed amount) to a second counterparty when an exposure of that second counterparty to the first counterparty exceeds a specified level;
  8. one way margin agreement means a margin agreement under which a credit institution must post variable margin to a counterparty but is not entitled to receive variable margin from that counterparty or vice-versa;
  9. margin threshold means the largest amount of an exposure that remains outstanding before one party has the right to call for collateral; 10)margin period of risk means the time period from the most recent exchange of collateral covering a netting set of transactions with a defaulting counterparty until the transactions are closed out and the resulting market risk is re-hedged;
  10. effective maturity for a netting set with maturity greater than one year means the ratio of the sum of expected exposure over the life of the transactions

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 366 in the netting set discounted at the risk-free rate of return, divided by the sum of expected exposure over one year in the netting set discounted at the risk￾free rate, wherein this effective maturity may be adjusted to reflect rollover risk by replacing expected exposure with effective expected exposure for forecasting horizons under one year; 12) cross-product netting means the inclusion of transactions of different product categories within the same netting set pursuant to the cross-product netting rules set out in this Subtitle; 13) current market value or CMV means the net market value of all the transactions within a netting set gross of any collateral held or posted where positive and negative market values are netted in computing the CMV; 14) net independent collateral amount or NICA means the sum of the volatility￾adjusted value of net collateral received or posted, as applicable, to the netting set other than variable margin; 15) distribution of market values means the forecast of the probability distribution of net market values of transactions within a netting set for a future date (the forecasting horizon), given the realised market value of those transactions at the date of the forecast; 16) distribution of exposures means the forecast of the probability distribution of market values that is generated by setting forecast instances of negative net market values equal to zero; 17) risk-neutral distribution means a distribution of market values or exposures over a future time period where the distribution is calculated using market implied values such as implied volatilities; 18) actual distribution means a distribution of market values or exposures at a future time period where the distribution is calculated using historic or realised values such as volatilities calculated using past price or rate changes; 19) current exposure means the larger of zero and the market value of a transaction or portfolio of transactions within a netting set with a counterparty that would be lost upon the default of the counterparty, assuming no recovery on the value of those transactions in insolvency or winding-up; 20) peak exposure means a high percentile of the distribution of exposures, or the highest exposure value expected at particular future date before the maturity date of the longest transaction in the netting set; 21) expected exposure (hereinafter: EE) means the average of the distribution of exposures at a particular future date before the longest maturity transaction in the netting set matures; 22) effective expected exposure at a specific date (hereinafter: the effective EE) means the maximum expected exposure that occurs at that date or any prior date wherein, alternatively, it may be defined for a specific date as the greater of the expected exposure at that date or the effective expected exposure at any prior date; 23) expected positive exposure (hereinafter: EPE) means the weighted average over time of expected exposures, where the weights are the proportion of the entire time period that an individual expected exposure represents. For the purposes of calculating the own funds requirement, credit institutions shall take the average over the first year or, if all the contracts within the netting set mature within less than one year, over the time period until the contract with the longest maturity in the netting set has matured;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 367 24) effective expected positive exposure (hereinafter: the effective EPE) means the weighted average of effective expected exposure over the first year of a netting set or, if all the contracts within the netting set mature within less than one year, over the time period of the longest maturity contract in the netting set, where the weights are the proportion of the entire time period that an individual expected exposure represents; 25) rollover risk means the amount by which the EPE is understated when future transactions with a counterparty are expected to be conducted on an ongoing basis, in which case the additional exposure generated by those future transactions is not included in calculation of the EPE; 26) counterparty for the purposes of Section 7 of this Subtitle means any legal or natural person that enters into a netting agreement, and has the contractual capacity to do so; 27) contractual cross product netting agreement means a bilateral contractual agreement between a credit institution and a counterparty which creates a single legal obligation (based on netting of covered transactions) covering all bilateral master agreements and transactions belonging to different product categories that are included within the agreement, in which case the following shall be deemed different product categories: − repurchase transactions, securities and commodities lending and borrowing transactions; − margin lending transactions; and − the contracts listed in Article 148 paragraph (8) of this Decision; 28) payment leg means the payment agreed in an OTC derivative transaction with a linear risk profile which stipulates the exchange of a financial instrument for a payment, and in the case of transactions that stipulate the exchange of payment against payment, those two payment legs shall consist of the contractually agreed gross payments, including the notional amount of the transaction. Section 2 – Methods for calculating the exposure Methods for calculating the exposure value Article 346 (1) A credit institution shall calculate the exposure value for the contracts listed in Article 148 paragraph (8) of this Decision and for credit derivatives, with the exception of the credit derivatives referred to in paragraphs (7) and (9) of this Article, on the basis of one of the methods set out in Sections 3 to 6 in accordance with this Article. (2) A credit institution which does not meet the conditions set out in Article 347 paragraph (1) of this Decision shall not use the method set out in Section 4 of this Subtitle. (3) A credit institution which does not meet the conditions set out in Article 347 paragraph (2) of this Decision shall not use the method set out in Section 5 of this Subtitle. (4) A credit institution may use in combination the methods set out in Sections 3 to 6 of this Subtitle on a permanent basis within a group.

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 368 (5) A single credit institution may not use in combination the methods set out in Sections 3 to 6 of this Subtitle on a permanent basis. (6) Subject to authorisation of the Central Bank, in accordance with Article 370 paragraphs (1) to (4), a credit institution may determine the exposure value for the following items using the Internal Model Method set out in Section 6 of this Subtitle:

  1. the contracts listed in Article 148 paragraph (8) of this Decision;
  2. repurchase transactions;
  3. securities or commodities lending or borrowing transactions;
  4. margin lending transactions; and
  5. long settlement transactions. (7) When a credit institution purchases protection through a credit derivative against a non-trading book exposure or against a counterparty risk exposure, it may calculate its capital requirement for the hedged exposure in accordance with either of the following:
  6. Articles 269 to 273 of this Decision, or
  7. in accordance with Article 224 of this Decision, where authorisation has been granted in accordance with Article 185 of this Decision. (8) The exposure value for counterparty credit risk for those credit derivatives shall be zero, unless a credit institution applies the approach referred to in Article 386 paragraph (2) item 7) indent 2 of this Decision. (9) Notwithstanding paragraph (7) of this Article, a credit institution may choose consistently to include for the purposes of calculating capital requirements for counterparty credit risk all credit derivatives not included in the trading book and purchased as protection against a non-trading book exposure or against a counterparty credit risk exposure where the credit protection is recognised in accordance with this Decision. (10) Where a credit default swap (CDS) sold by a credit institution is treated by a credit institution as credit protection provided by that credit institution and where that contract is subject to capital requirement for credit risk of the underlying instrument for the full notional amount, their exposure value for the purposes of counterparty credit risk in the non-trading book shall be zero. (11) Under the methods set out in Sections 3 to 6 of this Subtitle, the exposure value for a given counterparty shall be equal to the sum of the exposure values calculated for each netting set with that counterparty. (12) By way of derogation from paragraph (11) of this Article, where one margin agreement applies to multiple netting sets with that counterparty and the credit institution is using one of the methods set out in Sections 3 to 6 of this Subtitle to calculate the exposure value of those netting sets, the exposure value shall be calculated in accordance with the relevant Section of this Subtitle. (13) For a given counterparty, the exposure value for a given netting set of OTC derivative instruments listed in Article 148 paragraph (8) of this Decision calculated in

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 369 accordance with this Subtitle shall be the greater of zero and the difference between the sum of exposure values across all netting sets with the counterparty and the sum of credit valuation adjustments for that counterparty being recognised by the credit institution as an incurred write-down, wherein the credit valuation adjustments shall be calculated without taking into account any netting debit value adjustment attributed to the own credit risk of the undertaking that has been already excluded from own funds in accordance with Article 16 paragraph (1) item 3) of this Decision. (14) In calculating the exposure value in accordance with the methods set out in Sections 3, 4 and 5 of this Subtitle, a credit institution may treat two OTC derivative contracts included in the same netting agreement that are perfectly matching as if they were a single contract with a notional principal equal to zero. (15) For the purposes of paragraph (14) of this Article, two OTC derivative contracts are perfectly matching when they meet the following conditions:

  1. their risk positions are opposite;
  2. their features, with the exception of the trade date, are identical; and
  3. their cash flows fully offset each other. (16) A credit institution shall determine the exposure value for exposures arising from long settlement transactions by any of the methods set out in Sections 3 to 6 of this Subtitle, regardless of which method the credit institution has chosen for treating OTC derivatives and repurchase transactions, securities or commodities lending or borrowing transactions, and margin lending transactions. (17) In calculating the capital requirements for long settlement transactions, a credit institution that uses the approach set out in Subtitle 3 of this Decision may assign the risk weights under the approach set out in Subtitle 2 on a permanent basis and irrespective of the materiality of those positions. (18) For the methods set out in Sections 3 to 6 of this Subtitle, a credit institution shall treat transactions where Specific Wrong-Way risk has been identified in accordance with Article 378 paragraph (3), paragraph (5) item 2), and paragraphs (6) and (7) of this Decision, as appropriate. Conditions for using simplified methods for calculating the exposure value Article 347 (1) A credit institution may calculate the exposure value of its derivative positions in accordance with the method set out in Section 4 of this Subtitle, provided that the size of its on- and off-balance-sheet derivative business is equal to or less than both of the following thresholds on the basis of an assessment carried out on a monthly basis using the data as of the last day of the month:
  4. 10 % of the credit institution's total assets;
  5. EUR 300,000,000. (2) A credit institution may calculate the exposure value of its derivative positions in accordance with the method set out in Section 5, provided that the size of its on- and off-balance-sheet derivative business is equal to or less than both of the following

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 370 thresholds on the basis of an assessment carried out on a monthly basis using the data as of the last day of the month:

  1. 5 % of the credit institution's total assets;
  2. EUR 100,000,000. (3) For the purposes of paragraphs (1) and (2) of this Article, a credit institution shall calculate the size of its on- and off-balance-sheet derivative business on the basis of data as of the last day of each month in accordance with the following requirements:
  3. derivative positions shall be valued at their market values on that given date; where the market value of a position is not available on a given date, a credit institution shall take a fair value for the position on that date, and where the market value and fair value of a position are not available on a given date, a credit institution shall take the most recent of the market value or fair value for that position;
  4. the absolute value of the aggregated long position shall be summed with the absolute value of the aggregated short position;
  5. all derivative positions shall be included, except credit derivatives that are recognised as internal hedges against non-trading book credit risk exposures. (4) For the purposes of the paragraph (3) of this Article, the meaning of long and short positions is the same as that set out in Article 119 paragraph (3) of this Decision. (5) For the purposes of paragraph (3) of this Article, the value of the aggregated long (short) position shall be equal to the sum of the values of the individual long (short) positions included in the calculation in accordance with paragraph (3) item 3) of this Article. (6) By way of derogation from paragraph (1) or (2) of this Article, as applicable, where the derivative business on a consolidated basis do not exceed the thresholds set out in paragraph (1) or (2) of this Article, as applicable, a credit institution which is included in the consolidation and which would have to apply the method set out in Section 3 or 4 of this Subtitle because it exceeds those thresholds on an individual basis, may, subject to the authorisation of the Central Bank, instead choose to apply the method that would apply on a consolidated basis. (7) A credit institution shall notify the Central Bank of the methods set out in Section 4 or 5 of this Subtitle that it uses, or ceases to use, as applicable, to calculate the exposure value of its derivative positions. (8) A credit institution shall not enter into a derivative transaction or buy or sell a derivative instrument for the sole purpose of complying with any of the conditions set out in paragraphs (1) and (2) of this Article during the monthly assessment of the volume of on- and off-balance sheet businesses.

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 371 Non-compliance with the conditions for using simplified methods for calculating the exposure value of derivatives and the simplified approach for calculating the capital requirements for CVA risk Article 348 (1) A credit institution that no longer meets one or more of the conditions set out in Article 347 paragraph (1) or (2) of this Decision shall immediately notify the Central Bank thereof. (2) A credit institution shall cease to calculate the exposure values of its derivative positions in accordance with Section 4 or 5 of this Subtitle and to calculate the capital requirements for CVA risk in accordance with Article 559 of this Decision, as applicable, within three months of the occurrence of one of the following:

  1. the credit institution does not meet the conditions set out in Article 347 paragraph (1) item 1) or paragraph (2) item 1) of this Decision, as applicable, or the conditions set out in Article 347 paragraph (1) item 2) or paragraph (2) item 2) of this Decision, as applicable, for three consecutive months;
  2. the credit institution does not meet the conditions set out in Article 347 paragraph (1) item 1) or paragraph (2) item 1) of this Decision, as applicable, or the conditions set out in Article 347 paragraph (1) item 2) or paragraph (2) item 2) of this Decision, as applicable, for more than six of the preceding 12 months. (3) A credit institution that has ceased to calculate the exposure values of its derivative positions in accordance with Section 4 or 5 of this Subtitle and to calculate the capital requirement for CVA risk in accordance with Article 559 of this Decision, as applicable, shall only be permitted to resume calculating the exposure value of its derivative positions as set out in Section 4 or 5 of this Subtitle and the capital requirement for CVA risk in accordance with Article 559 of this Decision where it demonstrates to the Central Bank that all of the conditions set out in Article 347 paragraph (1) or (2) of this Decision, have been met for an uninterrupted period of one year. Section 3 – Standardised approach for counterparty credit risk Exposure value Article 349 (1) A credit institution may calculate a single exposure value at netting set level for all the transactions covered by a contractual netting agreement where the following conditions are met:
  3. the netting agreement belongs to one of the types of contractual netting agreements referred to in Article 382 of this Decision;
  4. the netting agreement has been recognised by the Central Bank in accordance with Article 383 of this Decision; and
  5. the credit institution has fulfilled the obligations laid down in Article 384 of this Decision in respect of the netting agreement. (2) Where any of the conditions set out in the paragraph (1) of this Article are not met, the credit institution shall treat each transaction as if it was its own netting set.

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 372 (3) A credit institution shall calculate the exposure value of a netting set under the standardised approach for counterparty credit risk as follows: Exposure value = α · (RC + PFE) where: RC = the replacement cost calculated in accordance with Article 350 of this Decision; and PFE = the potential future exposure calculated in accordance with Article 354 of this Decision; α = 1,4. (4) The exposure value of a netting set that is subject to a contractual margin agreement shall be capped at the exposure value of the same netting set not subject to any form of margin agreement. (5) Where multiple margin agreements apply to the same netting set, or the same netting set includes both transactions subject to a margin agreement and transactions not subject to a margin agreement, a credit institution shall calculate its exposure value as follows:

  1. the credit institution shall establish the hypothetical sub-netting sets concerned, composed of transactions included in the netting set, as follows: − all transactions subject to a margin agreement and to the same margin period of risk as determined in accordance with Article 372 paragraphs (3) to (8) of this Decision, shall be allocated to the same sub-netting set; − all transactions not subject to a margin agreement shall be allocated to the same sub-netting set, distinct from the sub-netting sets referred to in indent 1 of this item;
  2. the credit institution shall calculate the replacement cost of the netting set in accordance with Article 350 paragraph (2) of this Decision, taking into account all transactions within the netting set, whether or not subject to a margin agreement, and apply the following: − CMV shall be calculated for all transactions within a netting set gross of any collateral held or posted where positive and negative market values are netted in computing the CMV; − NICA, VM, TH, and MTA, where applicable, shall be calculated separately as the sum across the same inputs applicable to each individual margin agreement of the netting set;
  3. the credit institution shall calculate the potential future exposure of the netting set referred to in Article 355 of this Decision by applying all of the following: − the multiplier referred to in Article 355 paragraphs (1) and (2) of this Decision shall be based on the inputs CMV, NICA and VM, as applicable, in accordance with item 2) of this paragraph; − ∑ 𝐴𝐴 ( ) shall be calculated in accordance with Article 355 of this Decision, separately for each hypothetical sub-netting set referred to in item
  4. of this paragraph. (6) A credit institution may set to zero the exposure value of a netting set that satisfies all the following conditions:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 373

  1. the netting set is solely composed of sold options;
  2. the current market value of the netting set is at all times negative;
  3. the premium of all the options included in the netting set has been received upfront by the credit institution to guarantee the performance of the contracts;
  4. the netting set is not subject to any margin agreement. (7) In a netting set, a credit institution shall replace a transaction which is a finite linear combination of bought or sold call or put options with all the single options that form that linear combination, taken as an individual transaction, for the purpose of calculating the exposure value of the netting set in accordance with this Section. Each such combination of options shall be treated as an individual transaction in the netting set in which the combination is included for the purpose of calculating the exposure value. (8) By way of derogation from paragraph (7) of this Article, a credit institution shall replace a vanilla digital option the strike of which equals K with the relevant collar combination of two sold and bought vanilla call or put options that meet the following requirements:
  5. the two options of the collar combination have: − the same expiry date and the same spot or forward price of the underlying instrument as the vanilla digital option; − strikes equal to 0,95∙K and 1,05∙K respectively;
  6. the collar combination replicates exactly the vanilla digital option payoff outside the range between the two strikes referred to in item 1) of this paragraph. (9) The risk position of the two options of the collar combination referred to in paragraph (8) shall be calculated separately in accordance with Article 356 of this Decision. (10) The exposure value of a credit derivative transaction representing a long position in the underlying instrument may be capped to the amount of outstanding unpaid premium provided it is treated as its own netting set that is not subject to a margin agreement. Replacement cost Article 350 (1) A credit institution shall calculate the replacement cost RC for netting sets that are not subject to a margin agreement, in accordance with the following formula: 𝑅𝑅 = 𝑚𝑚𝑚𝑚𝑚𝑚{𝐶𝐶 − 𝑁𝑁𝑁𝑁 , 0} (2) A credit institution shall calculate the replacement cost for a single netting set that is subject to a margin agreement in accordance with the following formula: RC = max{CMV – VM – NICA, TH + MTA – NICA, 0} where:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 374 RC = the replacement cost; VM = the volatility-adjusted value of the net variable margin received or posted, as applicable, to the netting set on a regular basis to reduce changes in the netting set's CMV; TH = the margin threshold applicable to the netting set under the margin agreement below which the credit institution cannot call for collateral; and MTA = the minimum transfer amount applicable to the netting set under the margin agreement. (3) A credit institution shall calculate the replacement cost for multiple netting sets that are subject to the same margin agreement in accordance with the following formula: RC = max ��max{CMVi , 0} − max{VMMA + NICAMA, 0}, 0 i �

  • max ��min{CMVi, 0} − min{VMMA + NICAMA, 0}, 0 i � where: RC = the replacement cost; i = the index that denotes the netting sets that are subject to the single margin agreement; CMVi = the CMV of netting set; VMMA = the sum of the volatility-adjusted value of collateral received or posted, as applicable, to multiple netting sets on a regular basis to reduce changes in their CMV; and NICAMA = the sum of the volatility-adjusted value of collateral received or posted, as applicable, to multiple netting sets other than VMMA. (4) For the purposes of paragraph (3) of this Article, NICAMA may be calculated at transaction (trade) level, at netting set level or at the level of all the netting sets to which the margin agreement applies depending on the level at which the margin agreement applies. Recognition and treatment of collateral Article 351 (1) For the purposes of this Section, a credit institution shall calculate the collateral amounts of VM, VMMA, NICA and NICAMA, by applying all the following requirements:
  1. where all the transactions included in a netting set belong to the trading book, only collateral that is eligible under Articles 235 and 386 of this Decision shall be recognised;

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 375 2) where a netting set contains at least one transaction that belongs to the non￾trading book, only collateral that is eligible under Article 235 of this Decision shall be recognised; 3) collateral received from a counterparty shall be recognised with a positive sign and collateral posted to a counterparty shall be recognised with a negative sign; 4) the volatility-adjusted value of any type of collateral received or posted shall be calculated in accordance with Article 260 of this Decision; 5) the same collateral item shall not be included in both VM and NICA at the same time; 6) the same collateral item shall not be included in both VMMA and NICAMA at the same time; 7) any collateral posted to the counterparty that is segregated from the assets of that counterparty and, as a result of that segregation, is bankruptcy remote in the event of the default or insolvency of that counterparty shall not be recognised in the calculation of NICA and NICAMA. (2) For the calculation of the volatility-adjusted value of collateral posted referred to in paragraph (1) item 4) of this Article, a credit institution shall replace the formula set out in Article 260 paragraph (4) of this Decision with the following formula: CVA = C · (1 + HC + Hfx) where: CVA = the volatility-adjusted value of collateral posted; and C = the collateral; HC and Hfx are defined in accordance with Article 260 paragraph (4) of this Decision. (3) For the purposes of paragraph (1) item 4) of this Article, a credit institution shall set the liquidation period relevant for the calculation of the volatility-adjusted value of any collateral received or posted in accordance with one of the following time horizons:

  1. one year for the netting sets referred to in Article 350 paragraph (1) of this Decision;
  2. the margin period of risk determined in accordance with Article 360 paragraph (1) item 2) of this Decision for the netting sets referred to in Article 350 paragraphs (2), (3), and (4) of this Decision. Mapping of transactions to risk categories Article 352 (1) A credit institution shall map each transaction of a netting set to one of the following risk categories to determine the potential future exposure of the netting set referred to in Article 355 of this Decision:
  3. interest rate risk;
  4. foreign exchange risk;
  5. credit risk;
  6. equity risk;
  7. commodity risk;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 376 6) other risks. (2) A credit institution shall conduct the mapping referred to in paragraph (1) of this Article on the basis of the primary risk driver of a derivative transaction. (3) The primary risk driver shall be the only material risk driver of a derivative transaction. (4) By way of derogation from paragraph (2) of this Article, a credit institution shall map derivative transactions that have more than one material risk driver to more than one risk category. (5) Where all the material risk drivers of one of the transactions referred to in paragraph (4) of this Article belong to the same risk category, a credit institution shall only be required to map that transaction once to that risk category on the basis of the most material of those risk driver, and where the material risk drivers of one of those transactions belong to different risk categories, a credit institution shall map that transaction once to each risk category for which the transaction has at least one material risk driver, on the basis of the most material of the risk drivers in that risk category. (6) Notwithstanding paragraphs (1) to (5) of this Article, when mapping transactions to the risk categories listed in paragraph (1) of this Article, a credit institution shall apply the following requirements:

  1. where the primary risk factor of a transaction, or the most material risk driver in a given risk category for transactions referred to in paragraph (3) of this Article, is an inflation variable, a credit institution shall map the transaction to the interest rate risk category;
  2. where the primary risk driver of a transaction, or the most material risk driver in a given risk category for transactions referred to in paragraph (3) of this Article, is a climatic conditions-variable, a credit institution shall map the transaction to the commodity risk category. Methods for identifying transactions with only one material risk driver, transactions with more than one material risk driver and for identifying the most material of those risk drivers Article 353 (1) For the purpose of identifying transactions with only one material risk driver and transactions with more than one material risk driver, a credit institution shall, at inception of each transaction, identify all the risk drivers of the transaction by determining the risk factors on which the cash flows of that transaction depend, having regard to at least the risk factors referred to in Articles 425 to 430 of this Decision. (2) The risk factors identified by the credit institution shall be the risk drivers of the transaction. (3) A credit institution shall not consider as risk drivers of a transaction the interest rate risk factors used to discount the cash flows of the transaction.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 377 (4) After the identification of all the risk drivers of a transaction, a credit institution shall, at inception of each transaction, identify transactions with only one material risk driver by applying the following:

  1. where the cash flows of the transaction depend exclusively on one risk driver that belongs to one of the risk categories referred to in Article 352 paragraph (1) of this Decision, a credit institution shall identify that risk driver as the only material risk driver of that transaction;
  2. where the cash flows of the transaction depend on more than one risk driver and where a credit institution has identified only one risk driver of that transaction as material in accordance with the method laid down in paragraph (6) or the method laid down in paragraphs (7) to (10) of this Article, a credit institution shall identify that risk driver as the only material risk driver of that transaction. (5) By way of derogation from paragraph (4) of this Article, for cross-currency interest￾rate swaps as referred to in Article 148 paragraph (8) item 2) indent 1 of this Decsision, a credit institution may identify the foreign exchange risk driver as the only material risk driver of the transaction. (6) For the purposes of Article 352 paragraphs (3) and (4) of this Decision, a credit institution shall identify all transactions other than those referred to in Article 2 of this Decision as transactions with more than one material risk driver. (7) After identification of all the risk drivers of a transaction in accordance with paragraphs (1), (2), and (3) of this Article and where the cash flows of the transaction depend on more than one risk driver, a credit institution shall identify the material risk drivers and the most material of those risk drivers by applying one of the methods laid down in paragraphs (8), (9), and (10) of this Article, as appropriate. (8) A credit institution shall apply the following steps at inception of the transaction:
  3. it shall consider all the risk drivers of the transaction identified in accordance with paragraphs (1) to (3) of this Article to be material risk drivers;
  4. for each risk category corresponding to those material risk drivers, it shall identify as the most material risk driver the risk driver corresponding to the highest risk category add-on from those referred to in Articles 362 to 367 of this Decision. (9) A credit institution shall apply the following steps at inception of the transaction, and then at least on a quarterly basis:
  5. it shall calculate the delta risk sensitivities in accordance with Article 431 of this Decision for each risk driver identified in accordance with paragraphs (1) to (3) of this Article;
  6. it shall calculate the weighted sensitivities in accordance with the formula laid down in Article 419 paragraph (6) of this Decision based on the sensitivities calculated in accordance with item 1) of this paragraph;
  7. for each of the risk categories referred to in Article 325 paragraph (1) of this Decision, it shall calculate the risk class specific capital requirement for market risk in accordance with the formula laid down in Article 419 paragraph (8) of this

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 378 Decision, based on all the weighted sensitivities referred to in item 2) of this paragraph of risk drivers that have been assigned to that risk category; 4) it shall rank all the risk class specific own funds requirements for market risk referred to in item 3) of this paragraph from the greatest to the smallest in absolute terms, in order to obtain a monotonically decreasing sequence of entries, where the entry 1 is the greatest absolute term, 2 is the second greatest term and so on; 5) it shall, for each entry 1 calculated and ranked in accordance with item 4) of this paragraph and in the order resulting from their ranking, verify whether the following condition is met: ∑ aj i j=1 ∑ ak 6 k=1 < Y% where: i = the index that denotes the risk categories referred to in Article 325 paragraph (1) of this Decision, ranked in accordance with item 4) of this paragraph and in the order resulting from that ranking; Y% = 60%. 6) it shall consider as material: − the risk drivers that correspond to the risk categories for which the condition laid down in item 5) of this paragraph of this paragraph is met; − the risk drivers that correspond to the first risk category for which that condition is not met; 7) they shall, for each of the risk categories that correspond to risk drivers that are not material in accordance with item 6) of this paragraph, verify whether the following condition is met by the corresponding entry a1: ai ∑ ak 6 k=1 ≥ Z% where: i = the index that denotes the risk categories referred to in Article 325 paragraph (1) of this Decision, ranked in accordance with item 4) of this paragraph and in the order resulting from that ranking, and that correspond to risk drivers that are not material in accordance with item 6) of this paragraph; Z% = 30% 8) in addition to the material risk drivers identified in accordance with item 6) of this paragraph, it shall also consider as material risk drivers those risk drivers that correspond to the risk categories for which the condition laid down in item 7) of this paragraph is met; 9) for each of the risk categories referred to in items 6) and 8) of this paragraph, it shall consider as the most material risk driver for that risk category the risk driver corresponding to the highest absolute value of the weighted sensitivities referred to in item 2) of this paragraph. (10) A credit institution that either meets the conditions set out in Article 119 paragraph (1) of this Decision, or are exempted from the reporting requirement in accordance

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 379 with Article 414 paragraph (1) of this Decision, may identify the most material risk driver by applying the following steps at inception of the transaction, and then at least on a quarterly basis:

  1. it shall calculate the risk category add-ons as referred to in Articles 362 to 367 of this Decision, as applicable, for each risk driver identified in accordance with paragraphs (1) to (3) of this Article, and where more than one risk driver identified in accordance with paragraphs (1) to (3) of this Article have been assigned to the same risk category, it shall keep for the application of item 2) of this paragraph the risk driver in that risk category corresponding to the highest risk category add-on in that risk category;
  2. it shall apply the steps laid down in paragraph (9), items 4) to 8) of this Article, where the entries used in those steps shall be based on the risk category add￾ons calculated in accordance with item 1) of this paragraph;
  3. it shall identify as the most material risk drivers in the relevant risk categories the material risk drivers identified as a result of the method referred to in item
  4. of this paragraph. Hedging sets Article 354 (1) A credit institution shall establish the relevant hedging sets for each risk category of a netting set and assign each transaction to those hedging sets as follows:
  5. transactions mapped to the interest rate risk category shall be assigned to the same hedging set only where their primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, is denominated in the same currency;
  6. transactions mapped to the foreign exchange risk category shall be assigned to the same hedging set only where their primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, is based on the same currency pair;
  7. all the transactions mapped to the credit risk category shall be assigned to the same hedging set;
  8. all the transactions mapped to the equity risk category shall be assigned to the same hedging set;
  9. transactions mapped to the commodity risk category shall be assigned to one of the following hedging sets on the basis of the nature of their primary risk driver or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision: − energy; − metals; − agricultural goods; − other commodities; − climatic conditions;
  10. transactions mapped to the other risks category shall be assigned to the same hedging set only where their primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, is identical.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 380 (2) For the purposes of paragraph (1) item 1) of this Article, transactions mapped to the interest rate risk category that have an inflation variable as the primary risk driver shall be assigned to separate hedging sets, other than the hedging sets established for transactions mapped to the interest rate risk category that do not have an inflation variable as the primary risk driver, wherein those transactions shall be assigned to the same hedging set only where their primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, is denominated in the same currency. (3) By way of derogation from paragraph (1) of this Article, a credit institution shall establish separate individual hedging sets in each risk category for the following transactions:

  1. transactions for which the primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, is either the market implied volatility or the realised volatility of a risk driver or the correlation between two risk drivers;
  2. transactions for which the primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, is the difference between two risk drivers mapped to the same risk category or transactions that consist of two payment legs denominated in the same currency and for which a risk driver from the same risk category of the primary risk driver is contained in the other payment leg than the one containing the primary risk driver. (4) For the purposes of paragraph (3) item 1) of this Article, a credit institution shall assign transactions to the same hedging set of the relevant risk category only where their primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, is identical. (5) For the purposes of paragraph (3) item 2) of this Article, a credit institution shall assign transactions to the same hedging set of the relevant risk category only where the pair of risk drivers in those transactions as referred to therein is identical and the two risk drivers contained in this pair are positively correlated, otherwise, a credit institution shall assign transactions referred to in paragraph (3) item 2) of this Article to one of the hedging sets established in accordance with paragraph (1) of this Article, on the basis of only one of the two risk drivers referred to in paragraph (3) item 2) of this Article. (6) For the purposes of paragraph (3) item 1) of this Article, a credit institution shall assign transactions to a separate hedging set of the relevant risk category following the same hedging set construction set out in paragraph (1) of this Article. (7) A credit institution shall make available upon request by the Central Bank the number of hedging sets established in accordance with paragraph (3) of this Article for each risk category, with the primary risk driver, or the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision, or the pair of risk drivers of each of those hedging sets and with the number of transactions in each of those hedging sets.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 381 Potential future exposure Article 355 (1) A credit institution shall calculate the potential future exposure of a netting set as follows: PFE = multiplier ∙ �AddOn(a) a where: PFE = the potential future exposure; a = the index that denotes the risk categories included in the calculation of the potential future exposure of the netting set; AddOn(a) = the add-on for risk category a calculated in accordance with Articles 362 to 367 of this Decision, as applicable; and multiplier = the multiplication factor calculated in accordance with the formula referred to in paragraph (4) of this Article. (2) For the purpose of the calculation referred to in paragraph (1) of this Article, a credit institution shall include the add-on of a given risk category in the calculation of the potential future exposure of a netting set where at least one transaction of the netting set has been mapped to that risk category. (3) The potential future exposure of multiple netting sets that are subject to one margin agreement, as referred in Article 350 paragraphs (3) and (4) of this Decision, shall be calculated as the sum of the potential future exposures of all the individual netting sets as if they were not subject to any form of a margin agreement. (4) For the purposes of paragraph (1) of this Article, the multiplier shall be calculated as follows: multiplier = � 1 if z ≥ 0 min �1, Floorm + (1 − Floorm) ∙ exp � z y �� if z < 0 where: Floorm = 5%; y = 2 ∙ (1 − Floorm) ∙ � AddOn(a) a z = ⎩ ⎪⎪ ⎨ ⎪⎪ ⎧ CMV − NICA for the netting sets referred to in Article 350 paragraph (1) of this Decision CMV − VM − NICA for the netting sets referred to in Article 350 paragraph (1) of this Decision CMVi − NICAi or the netting sets referred to in Article 350 paragraphs (3)and (4) of this Decision

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 382 NICAi = the net independent collateral amount calculated only for transactions that are included in netting set i. NICAi shall be calculated at trade level or at netting set level depending on the margin agreement. Calculation of the risk position Article 356 For the purpose of calculating the risk category add-ons referred to in Articles 362 to 367 of this Decision, a credit institution shall calculate the risk position of each transaction of a netting set as follows: RiskPosition = δ · AdjNot · MF where: δ = the supervisory delta of the transaction calculated in accordance with the formula laid down in Article 357 of this Decision; AdjNot = the adjusted notional amount of the transaction calculated in accordance with Article 359 of this Decision; and MF = the maturity factor of the transaction calculated in accordance with the formula laid down in Article 360 of this Decision. Supervisory delta Article 357 (1) A credit institution shall calculate the supervisory delta as follows:

  1. for call and put options that entitle the option buyer to purchase or sell an underlying instrument at a positive price on a single or multiple dates in the future, except where those options are mapped to the interest rate risk or commodity risk category, a credit institution shall use the following formula: δ = sign ∙ N�type ∙ ln � P K� + 0,5 ∙ σ2 ∙ T σ ∙ √T � where: (δ) = the supervisory delta; sign = –1, where the transaction is a sold call option or a bought put option; sign = +1, where the transaction is a bought call option or sold put option; type = –1, where the transaction is a put option; type = +1, where the transaction is a call option;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 383 N(x) = the cumulative distribution function for a standard normal random variable meaning the probability that a normal random variable with mean zero and variance of one is less than or equal to x; P = the spot or forward price of the underlying instrument of the option; for options the cash flows of which depend on an average value of the price of the underlying instrument, P shall be equal to the average value at the calculation date; K = the strike price of the option; T = the period between the expiry date of the option (Texp) and the reporting date; for options which can be exercised at one future date only, Texp is equal to that date; for options which can be exercised at multiple future dates, Texp is equal to the latest of those dates; Texp shall be expressed in years using the relevant business day convention; and 𝜎𝜎 = the supervisory volatility of the option determined in accordance with Table 1 on the basis of the risk category of the transaction and the nature of the underlying instrument of the option: Table 1 2) for tranches of a synthetic securitisation and a nth-to-default credit derivative, a credit institution shall use the following formula: δ = sign ∙ 15 (1 + 14 ∙ A) ∙ (1 + 14 ∙ D) where: sign = � +1 where credit protection has been obtained through the transaction −1 where credit protection has been provided through the transaction Risk category Underlying instrument Supervisory volatility Foreign exchange All 15% Credit Single-name instrument 100% Multiple-names instrument 80% Equity Single-name instrument 120% Multiple-names instrument 75% Commodity Electricity 150% Other commodities (excluding electricity) 70% Other All 150%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 384 A = the attachment point of the tranche; for a nth-to-default credit derivative transaction based on reference entities k, A = (n – 1)/k; and D = the detachment point of the tranche; for a nth-to-default credit derivative transaction based on reference entities k, D = n/k; 3) for transactions not referred to in items 1) or 2) of this paragraph, a credit institution shall use the following supervisory delta: δ = � +1 if the transaction is a long position in the primary risk driver or in the most material risk driver in the given risk category −1 if the transaction is a short position in the primary risk driver or in the most material risk driver in the given risk category (2) A credit institution using the forward price of the underlying instrument of an option shall ensure that:

  1. the forward price is consistent with the characteristics of the option;
  2. the forward price is calculated using a relevant interest rate prevailing at the reporting date;
  3. the forward price integrates the expected cash flows of the underlying instrument before the expiry of the option. (3) For the purposes of this Section, a long position in the primary risk driver or in the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision means that the market value of the transaction increases when the value of that risk driver increases and a short position in the primary risk driver or in the most material risk driver in the given risk category for transactions referred to in Article 352 paragraphs (4) and (5) of this Decision means that the market value of the transaction decreases when the value of that risk driver increases. Calculation of the supervisory delta Article 358 (1) A credit institution shall calculate the supervisory delta (δ) of call and put options, when mapped to the interest rate risk category, that is compatible with market conditions in which interest rates may be negative as follows: δ = sign ∙ N �option type ∙ ln � (P + λ) (K + λ) � � + 0,5 ∙ σ2 ∙ T σ ∙ √T � where: option type = � −1 where the transactionis a put option +1 where the transactionis a call option sign = � −1 where the transaction is a sold call option or a bought put option +1 where the transaction is a sold put option or a bought call option

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 385 N(x) = the cumulative distribution function for a standard normal random variable which reflects the probability that a normal random variable with mean zero and variance of one is less than or equal to ‘x’; P = the spot or forward price of the underlying instrument of the option; K = the strike price of the option; T = the expiry date of the option, expressed in years using the relevant business day convention; λ = the shift adequate to move both P and K into positive territory, determined in accordance with paragraph (2) of this Article; σ = the supervisory volatility of the option determined in accordance with paragraph (3) of this Article; (2) For the purposes of paragraph (1) of this Article, a credit institution shall calculate the shift (λ) for any call and put options as follows: λj=max(threshold - min(Pj,Kj), 0) where: Pj = the spot or forward price of the underlying instrument of the option j; Kj = the strike price of the option j; Threshold = 0.10% (3) For the purposes of paragraph (1) of this Article, a credit institution shall determine the supervisory volatility of the option on the basis of the risk category of the transaction and the nature of the underlying instrument of the option in accordance with the following table: Table 1 Risk category Underlying instrument Supervisory volatility Interest rate All 50% (4) A credit institution shall determine whether a transaction is a long or short position in the primary risk driver or in the most material risk driver in a given risk category by applying either of the following methods:

  1. it shall calculate the delta risk sensitivities of those risk drivers in accordance with Article 431 of this Decision and identify the transaction as a long position in a risk driver where the corresponding delta risk sensitivity is positive or as a short position where the corresponding delta risk sensitivity is negative;
  2. it shall assess the dependence of the structure of cash flows of the transactions on that risk driver or the hedging purpose of the transaction with respect to that risk driver and identify the transaction as either long or short position on the basis of that assessment.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 386 Adjusted notional amount Article 359 (1) A credit institution shall calculate the adjusted notional amount as follows:

  1. for transactions mapped to the interest rate risk category or the credit risk category, a credit institution shall calculate the adjusted notional amount as the product of the notional amount of the derivative contract and the supervisory duration factor, which shall be calculated as follows: supervisory duration factor = max{ exp(−R ∙ S) − exp (−R ∙ E) R ; 10 One Busines Year } where:
  2. for transactions mapped to the foreign exchange risk category, a credit institution shall calculate the adjusted notional amount as follows: − where the transaction consists of one payment leg, the adjusted notional amount shall be the notional amount of the derivative contract; − where the transaction consists of two payment legs and the notional amount of one payment leg is denominated in the credit institution's reporting currency, the adjusted notional amount shall be the notional amount of the other payment leg; − where the transaction consists of two payment legs and the notional amount of each payment leg is denominated in a currency other than the credit institution's reporting currency, the adjusted notional amount shall be the largest of the notional amounts of the two payment legs after those amounts have been converted into the credit institution's reporting currency at the prevailing spot exchange rate;
  3. for transactions mapped to the equity risk category or commodity risk category, a credit institution shall calculate the adjusted notional amount as the product of the market price of one unit of the underlying instrument of the transaction and the number of units in the underlying instrument referenced by the transaction;
  4. for transactions mapped to the other risks category, a credit institution shall calculate the adjusted notional amount on the basis of the most appropriate R = the supervisory discount rate; R = 5%; S = the period between the start date of a transaction and the reporting date, which shall be expressed in years using the relevant business day convention; E = the period between the end date of a transaction and the reporting date, which shall be expressed in years using the relevant business day convention; and One Business Year = one year expressed in business days using the relevant business day convention;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 387 method among the methods set out in items 1), 2), and 3) of this paragraph, depending on the nature and characteristics of the underlying instrument of the transaction. (2) For the purposes of paragraph 1) item 1) of this Article:

  1. the start date of a transaction is the earliest date at which at least a contractual payment under the transaction, to or from the credit institution, is either fixed or exchanged, other than payments related to the exchange of collateral in a margin agreement, and where the transaction has already been fixing or making payments at the reporting date, the start date of a transaction shall be equal to 0;
  2. where a transaction involves one or more contractual future dates on which the credit institution or the counterparty may decide to terminate the transaction prior to its contractual maturity, the start date of a transaction shall be equal to the earliest of the following: − the date or the earliest of the multiple future dates at which the credit institution or the counterparty may decide to terminate the transaction earlier than its contractual maturity; − the date at which a transaction starts fixing or making payments, other than payments related to the exchange of collateral in a margin agreement.
  3. where a transaction has a financial instrument as the underlying instrument that may give rise to contractual obligations additional to those of the transaction, the start date of a transaction shall be determined on the basis of the earliest date at which the underlying instrument starts fixing or making payments;
  4. the end date of a transaction is the latest date at which a contractual payment under the transaction, to or from the credit institution, is or may be exchanged;
  5. where a transaction has a financial instrument as an underlying instrument that may give rise to contractual obligations additional to those of the transaction, the end date of a transaction shall be determined on the basis of the last contractual payment of the underlying instrument of the transaction;
  6. where a transaction is structured to settle an outstanding exposure following specified payment dates and where the terms are reset so that the market value of the transaction is zero on those specified dates, the settlement of the outstanding exposure at those specified dates is considered a contractual payment under the same transaction; (3) For the purposes of paragraph (1) item 3) of this Article, where a transaction mapped to the equity risk category or commodity risk category is contractually expressed as a notional amount, a credit institution shall use the notional amount of the transaction rather than the number of units in the underlying instrument as the adjusted notional amount. (4) A credit institution shall determine the notional amount or number of units of the underlying instrument for the purpose of calculating the adjusted notional amount of a transaction referred to in paragraph (1) of this Article as follows:
  7. where the notional amount or the number of units of the underlying instrument of a transaction is not fixed until its contractual maturity: − for deterministic notional amounts and numbers of units of the underlying instrument, the notional amount shall be the weighted average of all the deterministic values of notional amounts or number of units of the underlying

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 388 instrument, as applicable, until the contractual maturity of the transaction, where the weights are the proportion of the time period during which each value of notional amount applies; − for stochastic notional amounts and numbers of units of the underlying instrument, the notional amount shall be the amount determined by fixing current market values within the formula for calculating the future market values; 2) for contracts with multiple exchanges of the notional amount, the notional amount shall be multiplied by the number of remaining payments still to be made in accordance with the provisions of contracts; 3) for contracts that provide for a multiplication of the cash-flow payments or a multiplication of the underlying of the derivative contract, the notional amount shall be adjusted by a credit institution to take into account the effects of the multiplication on the risk structure of those contracts. (5) A credit institution shall convert the adjusted notional amount of a transaction into their reporting currency at the prevailing spot exchange rate where the adjusted notional amount is calculated under this Article from a contractual notional amount or a market price of the number of units of the underlying instrument denominated in another currency. Maturity factor Article 360 (1) A credit institution shall calculate the maturity factor as follows:

  1. for transactions included in the netting sets referred to in Article 350 paragraph (1) of this Decision, a credit institution shall use the following formula: MF = �min{max{M, 10/OneBusinessYear}, 1} where: MF = the maturity factor; M = the remaining maturity of the transaction which is equal to the period of time needed for the termination of all contractual obligations of the transaction, for that purpose, any optionality of a derivative contract shall be considered to be a contractual obligation, and the remaining maturity shall be expressed in years using the relevant business day convention; Where a transaction has another derivative contract as underlying instrument that may give rise to additional contractual obligations beyond the contractual obligations of the transaction, the remaining maturity of the transaction shall be equal to the period of time needed for the termination of all contractual obligations of the underlying instrument;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 389 Where a transaction is structured to settle outstanding exposure following specified payment dates and where the terms are reset so that the market value of the transaction is zero on those specified dates, the remaining maturity of the transaction shall be equal to the time until the next reset date; and One Business Year = one year expressed in business days using the relevant business day convention; 2) for transactions included in the netting sets referred to in Article 350 paragraphs (2), (3), and (4) of this Decision the maturity factor is defined as: MF = 3 2 � MPOR OneBusinessYear where: MF = the maturity factor; MPOR = the margin period of risk of the netting set determined in accordance with Article 372 paragraph (3) to (8) of this Decision; and One Business Year = one year expressed in business days using the relevant business day convention. (2) When determining the margin period of risk for transactions between a client and a clearing member, a credit institution acting either as the client or as the clearing member shall replace the minimum period set out in Article 372 (3) item 2) of this Decision with five business days. (3) For the purposes of paragraph (1) of this Article, the remaining maturity shall be equal to the period of time until the next reset date for transactions that are structured to settle outstanding exposure following specified payment dates and where the terms are reset in such a way that the market value of the contract shall be zero on those specified payment dates. Hedging set supervisory factor coefficient Article 361 For the purpose of calculating the add-on of a hedging set as referred to in Articles 362 to 367 of this Decision, the hedging set supervisory factor coefficient ‘є’ shall be the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 390 є = ⎩ ⎪ ⎨ ⎪ ⎧ 1 for the hedging sets established in accordance with Article 354 paragraph (1)of this Decision 5 for the hedging sets established in accordance with Article 354 paragraph (3) item 1) of this Decision 0,5 for the hedging sets established in accordance with Article 354 paragraph (3) item 2) of this Decision Interest rate risk category add-on Article 362 (1) For the purposes of Article 355 of this Decision, a credit institution shall calculate the interest rate risk category add-on for a given netting set as follows: AddOnIR = �AddOnj IR j where: AddOnIR = the interest rate risk category add-on; j = the index that denotes all the interest rate risk hedging sets established in accordance with Article 354 paragraph (1) item 1) and with Article 354 paragraphs (3) to (6) of this Decision for the netting set; and AddOnj IR = the interest rate risk category add-on for hedging set j calculated in accordance with paragraph (2) of this Article. (2) A credit institution shall calculate the interest rate risk category add-on for hedging set j as follows: 𝐴𝐴 𝑗𝑗 𝐼𝐼 = 𝜖𝜖𝑗𝑗 ∙ 𝑆𝑆 𝐼𝐼 ∙ 𝐸𝐸𝐸𝐸 𝑗𝑗 𝐼𝐼 where: Єj = the hedging set supervisory factor coefficient of hedging set j determined in accordance with the applicable value specified in Article 361 of this Decision; SFIR = the supervisory factor for the interest rate risk category with a value equal to 0,5 %; and EffNotj IR = the effective notional amount of hedging set j calculated in accordance with paragraph 3 of this Article. (3) For the purpose of calculating the effective notional amount of hedging set j, a credit institution shall first map each transaction of the hedging set to the appropriate bucket in Table 2 of this paragraph, and it shall do so on the basis of the end date of each transaction as determined in Article 359 paragraph (1) item 1) of this Decision:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 391 Table 2 Bucket End date (in years) 1 > 0 and ≤1 2 > 1 and ≤5 3 > 5

(4) After the mapping referred to in paragraph (3) of this Article, a credit institution shall calculate the effective notional amount of hedging set j in accordance with the following formula: EffNotj IR = ��(Dj,1)2 + (Dj,2)2 + (Dj,3)2 + 1,4 ∙ Dj,1 ∙ Dj,2 + 1,4 ∙ Dj,2 ∙ Dj,3 + 0,6 ∙ Dj,1 ∙ Dj,3�

where: EffNotj IR = the effective notional amount of hedging set j; and Dj,k = the effective notional amount of bucket k of hedging set j calculated as follows: Dj,k = � RiskPositionI 1 ϵ Bucket k where: l = the index that denotes the risk position. Foreign exchange risk category add-on Article 363 (1) For the purposes of Article 355 of this Decision, a credit institution shall calculate the foreign exchange risk category add-on for a given netting set as follows: AddOnFX = �AddOnj FX j where: AddOnFX = the foreign exchange risk category add-on; j = the index that denotes the foreign exchange risk hedging sets established in accordance with Article 354 paragraph (1) item 1) and with Article 354 paragraphs (3), (4), and (5) of this Decision for the netting set; and AddOnj FX = the foreign exchange risk category add-on for hedging set j calculated in accordance with paragraph (2).

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 392 (2) A credit institution shall calculate the foreign exchange risk category add-on for hedging set j as follows: AddOnj FX = ϵj ∙ SFFX ∙ �EffNotj FX� where: єj = the hedging set supervisory factor coefficient of hedging set j determined in accordance with Article 361 of this Decision; SFFX = the supervisory factor for the foreign exchange risk category with a value equal to 4 %; EffNotj FX = the effective notional amount of hedging set j calculated as follows: EffNotj FX = � RiskPositionI 1 ϵ Hedging set j where: l = the index that denotes the risk position. Credit risk category add-on Article 364 (1) For the purposes of paragraph (2) of this Article, a credit institution shall establish the relevant credit reference entities of the netting set in accordance with the following:

  1. there shall be one credit reference entity for each issuer of a reference debt instrument that underlies a single-name transaction allocated to the credit risk category; single-name transactions shall be assigned to the same credit reference entity only where the underlying reference debt instrument of those transactions is issued by the same issuer;
  2. there shall be one credit reference entity for each group of reference debt instruments or single-name credit derivatives that underlie a multi-name transaction allocated to the credit risk category; multi-names transactions shall be assigned to the same credit reference entity only where the group of underlying reference debt instruments or single-name credit derivatives of those transactions have the same constituents. (2) For the purposes of Article 355 of this Decision, a credit institution shall calculate the credit risk category add-on for a given netting set as follows: AddOnCredit = �AddOnj Credit j where: AddOnCredit = credit risk category add-on;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 393 j = the index that denotes all the credit risk hedging sets established in accordance with Article 354 paragraph (1) item 3) and with Article 354 paragraphs (3), (4), and (5) of this Decision for the netting set; and AddOnj Credit = the credit risk category add-on for hedging set j calculated in accordance with paragraph 3 of this Article. (3) A credit institution shall calculate the credit risk category add-on for hedging set j as follows: AddOnj Credit = ϵj ��� ρk Credit k AddOn(Entityk)� 2

  • �(1 − (ρk Credit)2 k ) ∙ (AddOn(Entityk))2 where: AddOnj Credit = the credit risk category add-on for hedging set j; Єj = the hedging set supervisory factor coefficient of hedging set j determined in accordance with Article 361 of this Decision; K = the index that denotes the credit reference entities of the netting set established in accordance with paragraph (1) of this Article; ρk Credit = the correlation factor of the credit reference entity k, where the credit reference entity k has been established in accordance with paragraph (1) item 1) of this Article, ρk Credit = 50%, and where the credit reference entity k has been established in accordance with paragraph (1) item 2) of this Article, ρk Credit = 80%; and AddOn(Entityk) = the add-on for the credit reference entity k determined in accordance with paragraph (4) of this Article. (4) A credit institution shall calculate the add-on for the credit reference entity k as follows: AddOn(Entityk) = EffNotk Credit where: EffNotk Credit = the effective notional amount of the credit reference entity k calculated as follows:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 394 EffNotk Credit = � SFk,I Credit ∙ RiskPositionI 1 ϵ Credit reference entity k where: l = the index that denotes the risk position; and SFk,I Credit = the supervisory factor applicable to the credit reference entity k calculated in accordance with paragraph (5) of this Article. (5) A credit institution shall calculate the supervisory factor applicable to the credit reference entity k as follows:

  1. for the credit reference entity k established in accordance with paragraph (1) item 1) of this Article, SFk,I Credit shall be mapped to one of the six supervisory factors set out in Table 3 of this paragraph on the basis of an external credit assessment by a nominated ECAI of the corresponding individual issuer, and for an individual issuer for which a credit assessment by a nominated ECAI is not available: − a credit institution using the approach referred to in Subtitle 3 shall map the internal rating of the individual issuer to one of the external credit assessments; − a credit institution using the approach referred to in Subtitle 2 shall assign SFk,I Credit = 0,54% to that credit reference entity, however, where a credit institution applies Article 148 to risk weight counterparty credit risk exposures to that individual issuer, SFk,I Credit = 1,6% shall be assigned to that credit reference entity;
  2. for the credit reference entity k established in accordance with paragraph (1) item 2) of this Article: − where a risk position l assigned to the credit reference entity k is a credit index listed on a recognised exchange, SFk,I Credit shall be mapped to one of the two supervisory factors set out in Table 4 of this paragraph on the basis of the credit quality of the majority of its individual constituents; − where a risk position l assigned to the credit reference entity k is not referred to in point (i) of this point, SFk,I Creditshall be the weighted average of the supervisory factors mapped to each constituent in accordance with the method set out in item 1) of this paragraph, where the weights are defined by the proportion of notional of the constituents in that position. Table 3 Credit quality step Supervisory factor for single-name transactions 1 0.38% 2 0.42% 3 0.54% 4 1.06% 5 1.6% 6 6.0%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 395 Table 4 Dominant credit quality Supervisory factor for quoted indices Investment grade 0.38% Non-investment grade 1.06% Equity risk category add-on Article 365 (1) For the purposes of paragraph (2) of this Article, a credit institution shall establish the relevant equity reference entities of the netting set in accordance with the following:

  1. there shall be one equity reference entity for each issuer of a reference equity instrument that underlies a single-name transaction allocated to the equity risk category, and single-name transactions shall be assigned to the same equity reference entity only where the underlying reference equity instrument of those transactions is issued by the same issuer;
  2. there shall be one equity reference entity for each group of reference equity instruments or single-name equity derivatives that underlie a multi-name transaction allocated to the equity risk category, and multi-names transactions shall be assigned to the same equity reference entity only where the group of underlying reference equity instruments or single-name equity derivatives of those transactions, as applicable, has the same constituents. (2) For the purposes of Article 355 of this Decision, a credit institution shall calculate the equity risk category add-on for a given netting set as follows: AddOnEquity = �AddOnj Equity j where: AddOnEquity = the equity risk category add-on; j = the index that denotes all the equity risk hedging sets established in accordance with Article 354 paragraph (1) item
  3. and Article 354 paragraphs (3), (4), and (5) of this Decision for the netting set; and AddOnj Equity = the equity risk category add-on for hedging set j calculated in accordance with paragraph (3) of this Article. (3) A credit institution shall calculate the equity risk category add-on for hedging set j as follows: AddOnj Equity = ϵj ��� ρk Equity k ∙ AddOn(Entityk)� 2
  • �(1 − �ρk Equity� 2 ) k ∙ (AddOn(Entityk))2

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 396 where: AddOnj Equity = the equity risk category add-on for hedging set j; Єj = the hedging set supervisory factor coefficient of hedging set j determined in accordance with Article 361 of this Decision; K = the index that denotes the equity reference entities of the netting set established in accordance with paragraph (1); ρk Equity = the correlation factor of the equity reference entity k; where the equity reference entity k has been established in accordance with paragraph (1) item 1) of this Article, ρk Equity = 50%; where the equity reference entity k has been established in accordance with paragraph (1) item 1) of this Article, ρk Equity = 80%; and AddOn(Entityk) = the add-on for the equity reference entity k determined in accordance with paragraph (4) of this Article. (4) A credit institution shall calculate the add-on for the equity reference entity k as follows: AddOn(Entityk) = SKk Equity ∙ EffNotk Equity where: AddOn(Entityk) = the add-on for the equity reference entity k; SFk Equity = the supervisory factor applicable to the equity reference entity k; where the equity reference entity k has been established in accordance with point (a) of paragraph 1, SFk Equity = 32%; where the equity reference entity k has been established in accordance with point (b) of paragraph 1, SFk Equity = 20%; and EffNotk Equity = the effective notional amount of the equity reference entity k calculated as follows: EffNotk Equity = � RiskPositionI 1 ϵ Equity reference entity k where: l = the index that denotes the risk position.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 397 Commodity risk category add-on Article 366 (1) For the purposes of Article 355 of this Decision, a credit institution shall calculate the commodity risk category add-on for a given netting set as follows: AddOnCom = �AddOnj Com i where: AddOnCom = the commodity risk category add-on; j = the index that denotes the commodity hedging sets established in accordance with Article 354 paragraph (1) item 5) and Article 354 paragraphs (3), (4), and (5) of this Decision for the netting set; and AddOnj Com = the commodity risk category add-on for hedging set j calculated in accordance with paragraph (4) of this Article. (2) For the purpose of calculating the add-on for a commodity hedging set of a given netting set in accordance with paragraph (5) of this Article, a credit institution shall establish the relevant commodity reference types of each hedging set. (3) For the purposes of paragraph (2) of this Article, commodity derivative transactions shall be assigned to the same commodity reference type only where the underlying commodity instrument of those transactions has the same nature, irrespective of the delivery location and quality of the commodity instrument. (4) By way of derogation from paragraph (3) of this Article, the Central Bank may require a credit institution which is significantly exposed to the basis risk of different positions sharing the same nature as referred to in paragraph (2) of this Article to establish the commodity reference types for those positions using more characteristics than just the nature of the underlying commodity instrument, wherein in such a situation, commodity derivative transactions shall be assigned the same commodity reference type only where they share those characteristics. (5) A credit institution shall calculate the commodity risk category add-on for hedging set j as follows: AddOnj Com = ϵj ��ρCom ∙ �AddOn(Typek j k )� 2

  • (1 − (ρCom)2) ∙ �AddOn(Typek j )2 k where: AddOnj Com = the commodity risk category add-on for hedging set j;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 398 єj = the hedging set supervisory factor coefficient of hedging set j determined in accordance with Article 361 of this Decision; k = the correlation factor of the commodity risk category with a value equal to 40 %; ρCom = the index that denotes the commodity reference types of the netting set established in accordance with paragraphs (2) and (3) of this Article; and AddOn(Typek j ) = the add-on for the commodity reference type k calculated in accordance with paragraph (6) of this Article. (6) A credit institution shall calculate the add-on for the commodity reference type k as follows: AddOn(Typek j ) = SFk Com ∙ EffNotk Com where: AddOn�Typek j � = the add-on for the commodity reference type k; SFk Com = the supervisory factor applicable to the commodity reference type k, where the commodity reference type k corresponds to transactions allocated to the hedging set referred to in Article 354 paragraph (1) item 5) of this Decision, excluding transactions concerning electricity, SFk Com = 18%, and for transactions concerning electricity, SFk Com = 40%; and EffNotk Com = the effective notional amount of the commodity reference type k calculated as follows: EffNotk Com = � RiskPositionI 1 ϵ Commodity reference type k where: l = the index that denotes the risk position. Other risks category add-on Article 367 (1) For the purposes of Article 355 of this Decision, a credit institution shall calculate the other risks category add-on for a given netting set as follows: AddOnOther = �AddOnj Other j where:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 399 AddOnOther = the other risks category add-on; j = the index that denotes the other risk hedging sets established in accordance with Article 354 paragraph (1) item 6) and Article 354 paragraphs (3), (4), and (5) of this Decision for the netting set; and 𝐴𝐴 𝑗𝑗 𝑂𝑂 ℎ = the other risks category add-on for hedging set j calculated in accordance with paragraph (2) of this Article. (2) A credit institution shall calculate the other risks category add-on for hedging set j as follows: AddOnj Other = ϵj ∙ SFOther ∙ �EffNotj Other� where: AddOnj Other = the other risks category add-on for hedging set j; єj = the hedging set supervisory factor coefficient of hedging set j determined in accordance with Article 361 of this Decision; and SFOther = the supervisory factor for the other risk category with a value equal to 8%; EffNotj Other = the effective notional amount of hedging set j calculated as follows: EffNotj Other = � RiskPositionI 1 ϵ Hedging set j where: l = the index that denotes the risk position. Section 4 - Simplified standardised approach for counterparty credit risk Calculation of the exposure value Article 368 (1) A credit institution shall calculate a single exposure value at netting set level in accordance with Section 3of this Subtitle, subject to paragraph (2) of this Article. (2) The exposure value of a netting set shall be calculated in accordance with the following requirements:

  1. a credit institution shall not apply the treatment referred to in Article 349 paragraph (7) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 400 2) by way of derogation from Article 350 paragraph (1) of this Decision, for netting sets that are not referred to in Article 350 paragraph (2) of this Decision, a credit institution shall calculate the replacement cost in accordance with the following formula: 𝑅𝑅 = 𝑚𝑚𝑚𝑚𝑚𝑚{𝐶𝐶 , 0} where: RC = the replacement cost; and CMV = the current market value. 3) by way of derogation from Article 350 paragraph (2) of this Decision, for netting sets of transactions that are traded on a recognised exchange, transactions that are centrally cleared by a qualifying central counterparty referred to in Article 3 item 54 of this Decision, or transactions for which collateral is exchanged bilaterally with the counterparty, a credit institution shall calculate the replacement cost in accordance with the following formula: 𝑅𝑅 = 𝑇𝑇 + 𝑀𝑀 where: RC = the replacement cost; TH = the margin threshold applicable to the netting set under the margin agreement below which the credit institution cannot call for collateral; and MTA = the minimum transfer amount applicable to the netting set under the margin agreement; 4) by way of derogation from Article 350 paragraphs (3) and (4) of this Decision, for multiple netting sets that are subject to a margin agreement, a credit institution shall calculate the replacement cost as the sum of the replacement cost of each individual netting set, calculated in accordance with paragraph (1) of this Article as if they were not margined; 5) all hedging sets shall be established in accordance with Article 354 paragraph (1) of this Decision; 6) a credit institution shall set to 1 the multiplier in the formula that is used to calculate the potential future exposure in Article 355 paragraph (1) of this Decision, as follows: PFE = �AddOn(a) a where: PFE = the potential future exposure; and AddOn(a) = the add-on for risk category a;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 401 7) by way of derogation from Article 357 paragraph (1) of this Decision, for all transactions, a credit institution shall calculate the supervisory delta as follows:: 𝛿𝛿 = � +1 where the transaction is a long position in the primary risk driver −1 where the transaction is a short position in the primary risk driver where: δ = the supervisory delta; 8) the formula referred to in Article 359 paragraph (1) item 1) of this Decision that is used to compute the supervisory duration factor shall read as follows: supervisory duration factor = E – S where: 9) the maturity factor referred to in Article 360 paragraph (1) shall be calculated as follows: − for transactions included in netting sets referred to in Article 350 paragraph (1) of this Decision, MF = 1; − for transactions included in netting sets referred to in Article 350 paragraphs (2), (3), and (4) of this Decision, MF = 0,42; 10)the formula referred to in Article 362 paragraph (3) of this Decision that is used to calculate the effective notional amount of hedging set j shall read as follows: EffNotj IR = �Dj,1� + �Dj,2� + �Dj,3� where: EffNotj IR = the effective notional amount of hedging set j; and Dj,k = the effective notional amount of bucket k of hedging set j; 11)the formula referred to in Article 364 paragraph (3) of this Decision that is used to calculate the credit risk category add-on for hedging set j shall read as follows: AddOnj Credit = �|AddOn(Entityk)| k where: AddOnj Credit = the credit risk category add-on for hedging set j; and E = the period between the end date of a transaction and the reporting date; and S = the period between the start date of a transaction and the reporting date;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 402 AddOn(Entityk) = the add-on for the credit reference entity k; 12) the formula referred to in Article 365 paragraph (3) of this Decision that is used to calculate the equity risk category add-on for hedging set j shall read as follows: AddOnj Equity = �|AddOn(Entityk)| k where: AddOnj Equity = the equity risk category add-on for hedging set j; and AddOn(Entityk) = the add-on for the credit reference entity k; 13)the formula referred to in Article 366 paragraph (5) of this Decision that is used to calculate the commodity risk category add-on for hedging set j shall read as follows: AddOnj Com = ��AddOn(TypeK j )� k where: AddOnj Com = the commodity risk category add-on for hedging set j; and AddOn(Typek j ) = the add-on for the commodity reference type k. Section 5 – Original exposure method Calculation of the exposure value Article 369 (1) A credit institution may calculate a single exposure value for all the transactions within a contractual netting agreement where all the conditions set out in Article 349 paragraph (1) of this Decision are met, otherwise, a credit institution shall calculate an exposure value separately for each transaction, which shall be treated as its own netting set. (2) The exposure value of a netting set or a transaction shall be the product of 1.4 times the sum of the current replacement cost and the potential future exposure. (3) The current replacement cost referred to in paragraph (2) of this Article shall be calculated as follows:

  1. for netting sets of transactions that are traded on a recognised exchange and transactions that are centrally cleared by a qualifying central counterparty referred to in Article 3 item 54 of this Decision or transactions for which collateral

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 403 is exchanged bilaterally with the counterparty, a credit institution shall use the following formula: 𝑅𝑅 = 𝑇𝑇 + 𝑀𝑀 where: RC = the replacement cost; TH = the margin threshold applicable to the netting set under the margin agreement below which the credit institution cannot call for collateral; and MTA = the minimum transfer amount applicable to the netting set under the margin agreement; 2) for all other netting sets or individual transactions, a credit institution shall use the following formula: 𝑅𝑅 = 𝑚𝑚𝑚𝑚𝑚𝑚{𝐶𝐶 , 0} where: RC = the replacement cost; CMV = the current market value. (4) In order to calculate the current replacement cost, a credit institution shall update current market values at least monthly. (5) A credit institution shall calculate the potential future exposure referred to in paragraph (2) of this Article as follows:

  1. the potential future exposure of a netting set is the sum of the potential future exposure of all the transactions included in the netting set, calculated in accordance with item 2) of this paragraph;
  2. the potential future exposure of a single transaction is its notional amount multiplied by: − the product of 0,5 % and the residual maturity of the transaction expressed in years for interest-rate derivative contracts; − the product of 6 % and the residual maturity of the transaction expressed in years for credit derivative contracts; − 4 % for foreign-exchange derivatives; − 18 % for gold and commodity derivatives other than electricity derivatives; − 40 % for electricity derivatives; − 32 % for equity derivatives;
  3. the notional amount referred to in paragraph (3) item 2) of this Article shall be determined in accordance with Article 359 paragraphs (2) and (3) of this Decision for all derivatives listed in that item, in addition, the notional amount of the derivatives referred to in paragraph (5) item 2) indents 3 to 6 of this Article shall be determined in accordance with Article 359 paragraph (1) items 2) and
  4. of this Decision;
  5. the potential future exposure of netting sets referred to in of paragraph (3) item
  6. of this Decision shall be multiplied by 0,42.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 404 (6) For calculating the potential exposure of interest-rate derivatives and credit derivatives in accordance with paragraph (5) item 2 indents 1 and 2 of this Article, a credit institution may choose to use the original maturity instead of the residual maturity of the contracts. Section 6 – Internal Model Method (IMM) Authorisation to use the Internal Model Method (IMM) Article 370 (1) Where it assesses that a credit institution meets the requirement set out in paragraph (2) of this Article, the Central Bank shall grant the credit institution the authorisation to use the Internal Model Method (IMM) to calculate the exposure value for any of the following transactions:

  1. transactions in Article 346 paragraph (6) item 1) of this Decision;
  2. transactions in Article 346 paragraph (6) items 2), 3), and 4) of this Decision;
  3. transactions in Article 346 paragraph (6) items 1) to 4) of this Decision. (2) Where a credit institution has been granted the authorisation to use the IMM to calculate exposure value for any of the transactions mentioned in items 1) to 3) of this Article, it may also use the IMM for the transactions referred to in Article 346 paragraph (6) item 5) of this Decision. (3) Notwithstanding the Article 346 paragraphs (1) to (5) of this Decision, a credit institution may choose not to apply this method to exposures that are immaterial in size and risk and in such case, it shall apply one of the methods set out in Sections 3 to 5 of this Subtitle to these exposures where the relevant requirements for each approach are met. (4) The Central Bank shall grant the credit institution the authorisation to use the IMM for the calculations referred to in paragraph (1) of this Article only if the credit institution has demonstrated that it complies with the requirements set out in this Section, and the Central Bank verified that the systems for the management of counterparty credit risk maintained by the credit institution are sound and properly implemented. (5) The Central Bank may grant the credit institution the authorisation to implement the IMM sequentially across different transaction types for a limited period, and in such case, during this period of sequential implementation, the credit institution may use the methods set out in Section 3 or Section 5 of this Subtitle for transaction type for which they do not use the IMM. (6) For all OTC derivative transactions, and for long settlement transactions for which a credit institution has not received authorisation under paragraph (1) of this Article to use the IMM, the credit institution shall use the methods set out in Section 3 of this Subtitle, wherein those methods may be used in combination on a permanent basis within a group.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 405 (7) A credit institution which has been granted the authorisation in accordance with paragraph (1) of this Decision to use the IMM shall not revert to the use of the methods set out in Section 3 or Section 5 of this Subtitle unless it has been granted the authorisation to do so by the Central Bank. (8) The Central Bank shall grant the authorisation referred to in paragraph (7) of this Article if the credit institution demonstrates good cause for using the methods set out in Section 3 or Section 5 of this Subtitle. (9) If a credit institution ceases to comply with the requirements laid down in this Section, it shall notify the Central Bank and do one of the following:

  1. present to the Central Bank a plan for a timely return to compliance; or
  2. demonstrate to the satisfaction of the Central Bank that the effect of non￾compliance is immaterial. Exposure value Article 371 (1) Where a credit institution has been granted the authorisation, in accordance with Article 370 paragraph (1) of this Decision, to use the IMM to calculate the exposure value of some or all transactions referred to in that paragraph, it shall measure the exposure value of those transactions at the level of the netting set, wherein the model used by the credit institution for that purpose shall:
  3. specify the forecasting distribution for changes in the market value of the netting set attributable to joint changes in relevant market variables, such as interest rates, foreign exchange rates; and
  4. calculate the exposure value for the netting set at each of the future dates on the basis of the joint changes in the market variables. (2) In order for the model to capture the effects of margining, the model of the collateral value must meet the quantitative, qualitative and data requirements for the IMM in accordance with this Section and the credit institution may include in its forecasting distributions for changes in the market value of the netting set only eligible financial collateral as referred to in Articles 235, 236, and 386 paragraph (2) items 2) and 3) of this Decision. (3) The own funds requirement for counterparty credit risk with respect to the counterparty credit risk exposures to which a credit institution applies the IMM, shall be the higher of the following:
  5. the capital requirement for those exposures calculated on the basis of Effective EPE using current market data;
  6. the capital requirement for those exposures calculated on the basis of Effective EPE using a single consistent stress calibration for all counterparty credit risk exposures to which the IMM is applied. (4) Except for counterparties identified as having Specific Wrong-Way risk that fall within the scope of Article 378 paragraphs (5) and (6) of this Decision, a credit institution shall calculate the exposure value as the product of alpha (α) times Effective EPE, by using the following formula:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 406 Exposure value = α ⋅ EffectiveEPE

where: α = 1.4, unless the Central Bank requires a higher α or permits a credit institution to use its own estimates in accordance with paragraph (9) of this Article; Effective EPE - shall be calculated by estimating expected exposure (EEt) as the average exposure at future date t, where the average is taken across possible future values of relevant market risk factors, and the model shall estimate the EE at a series of future dates t1, t2, t3, etc.

(5) Effective EE shall be calculated recursively by using the following formula: EffectiveEEtk = max{EffectiveEEtk−1, EEtk} where: the current date is denoted as t0; Effective EEt0 equals current exposure. (6) Effective EPE is the average Effective EE during the first year of future exposure, and it shall be calculated using the formula to in this paragraph, wherein, if all contracts in the netting set mature within less than one year, EPE shall be the average of EE until all contracts in the netting set mature. Effective EPE = 1 min{1 year; maturity} ∙ � Effective EEtk ⋅△ tk min{1 year; maturity} k−1 where the weights△ 𝑡𝑡𝑘𝑘 = 𝑡𝑡𝑘𝑘 − 𝑡𝑡𝑘𝑘−1 allow for the case when future exposure is calculated at dates that are not equally spaced over time. (7) A credit institution shall calculate EE or peak exposure measures on the basis of a distribution of exposures that accounts for the possible non-normality of the distribution of exposures. (8) A credit institution may use a measure of the distribution calculated by the IMM that is more conservative than α multiplied by Effective EPE as calculated in accordance with the equation in paragraph (4) of this Article for every counterparty. (9) Notwithstanding paragraph (4) of this Article, the Central Bank may grant the credit institution the authorisation to use its own estimates of alpha (α), where:

  1. alpha shall equal the ratio of internal capital from a full simulation of counterparty credit risk exposure across counterparties (numerator) and internal capital based on EPE (denominator), wherein when estimated in accordance with this paragraph, alpha shall be no lower than 1,2; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 407 2) in the denominator, the EPE shall be used as if it were a fixed outstanding amount. (10) For the purposes of an estimate of alpha under paragraph 9:

  1. a credit institution shall ensure that the numerator and denominator are calculated in a manner consistent with the modelling methodology, parameter specifications and portfolio composition.
  2. the approach used to estimate α must be based on the credit institution's internal capital approach, be well documented and be subject to independent validation;
  3. a credit institution shall review its estimates of alpha on at least a quarterly basis, and more frequently when the composition of the portfolio varies over time;
  4. a credit institution shall also assess the model risk. (11) A credit institution shall demonstrate to the satisfaction of the Central Bank that its internal estimates of alpha capture in the numerator material sources of dependency of distribution of market values of transactions or of portfolios of transactions across counterparties, and the internal estimates of alpha shall take account of the granularity of portfolios. (12) In supervising the use of estimates under paragraph (9) of this Article, the Central Bank shall have regard to the significant variation in estimates of alpha that arises from the potential for mis-specification in the models used for the numerator, especially where convexity is present. (13) Where appropriate, volatilities and correlations of market risk factors used in the joint modelling of market and credit risk shall be conditioned on the credit risk factor to reflect potential increases in volatility or correlation in an economic downturn (recession). Exposure value for netting sets subject to a margin agreement Article 372 (1) If the netting set is subject to a margin agreement and daily mark-to-market valuation, a credit institution may use one of the following EPE measures:
  5. Effective EPE, calculated without taking into account any collateral held or posted by way of margin plus any collateral that has been posted to the counterparty independent of the daily valuation and margining process or current exposure;
  6. the increase factor reflecting the potential increase in exposure over the margin period of risk, plus the larger of: − the current exposure including all collateral currently held or posted, other than collateral called or in dispute; − the largest net exposure, including collateral under the margin agreement, that would not trigger a collateral call, wherein this amount shall reflect all applicable thresholds, minimum transfer amounts, independent amounts and initial margins under the margin agreement;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 408 3) if the model captures the effects of margining when estimating EE, the credit institution may, subject to the authorisation of the Central Bank, use the model's EE measure directly in the equation referred to in Article 371 paragraph (5) of this Decision, wherein the Central Bank shall grant such authorisation only if it verifies that the model properly captures the effects of margining when estimating EE, and where a credit institution has not received such authorisation, it shall use the Effective EPE measures referred to in items 1) and 2) of this paragraph. (2) For the purposes of paragraph (1) item 2) of this Article:

  1. a credit institution shall calculate the add-on as the expected positive change of the mark-to-market value of the transactions during the margin period of risk;
  2. changes in the value of collateral must be reflected using the Supervisory Volatility Adjustments Approach in accordance with Subtitle 4 Section 4 of this Title or the own estimates of volatility adjustments of the Financial Collateral Comprehensive Method, but no collateral payments shall be assumed during the margin period of risk;
  3. The margin period of risk is subject to the minimum periods set out in paragraphs (3) to (8) of this Article. (3) For transactions subject to daily re-margining and mark-to-market valuation, the margin period of risk used for the purpose of modelling the exposure value with margin agreements shall not be less than:
  4. 5 business days for netting sets consisting only of repurchase transactions, securities or commodities lending or borrowing transactions and margin lending transactions;
  5. 10 business days for all other netting sets. (4) Notwithstanding paragraph (3) items1) and 2) of this Article:
  6. for all netting sets where the number of trades exceeds 5 000 at any point during a quarter, the margin period of risk for the following quarter shall not be less than 20 business days wherein this exception shall not apply to credit institutions' trade exposures;
  7. for netting sets containing one or more trades involving either illiquid collateral, or an OTC derivative that cannot be easily replaced, the margin period of risk shall not be less than 20 business days. (5) A credit institution shall determine whether collateral is illiquid or whether OTC derivatives cannot be easily replaced in the context of stressed market conditions, characterised by the absence of continuously active markets where a counterparty would, within two days or fewer, obtain multiple price quotations that would not move the market or represent a price reflecting a market discount (in the case of collateral) or premium (in the case of an OTC derivative). (6) A credit institution shall consider whether trades or securities it holds as collateral are concentrated in a particular counterparty and if that counterparty exited the market precipitously whether the credit institution would be able to replace those trades or securities.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 409 (7) If a credit institution has been involved in more than two margin call disputes on a particular netting set over the immediately preceding two quarters that have lasted longer than the applicable margin period of risk under paragraphs (3) and (4) of this Article, the credit institution shall use a margin period of risk that is at least double the period specified in paragraphs (3) and (4) of this Article for that netting set for the subsequent two quarters.

(8) For re-margining with a periodicity of N days, the margin period of risk shall be at least equal to the period specified in paragraphs (3) and (4) of this Article, F, plus N days minus one day, that is: Margin Period of Risk= F + N – 1. (9) If the internal model includes the effect of margining on changes in the market value of the netting set, a credit institution shall model collateral, other than cash of the same currency as the exposure itself, jointly with the exposure in its exposure value calculations for OTC derivatives and securities-financing transactions. (10) If a credit institution is not able to model collateral jointly with the exposure, it shall not recognise in its exposure value calculations for OTC derivatives the effect of collateral other than cash of the same currency as the exposure itself, unless the credit institution uses the volatility adjustments under the standard Supervisory Volatility Adjustments Approach in accordance with Subtitle 4 of this Title. 11) If a credit institution is not able to model collateral jointly with the exposure, it shall not recognise in its exposure value calculations for securities financing transactions the effect of collateral other than cash of the same currency as the exposure itself. (12) A credit institution using the IMM shall ignore in its models the effect of a reduction of the exposure value due to any clause in a collateral agreement that requires receipt of collateral when counterparty credit quality deteriorates. Management of counterparty credit risk — policies, processes and systems Article 373 (1) A credit institution shall establish and maintain a counterparty credit risk management framework, consisting of:

  1. policies, processes and systems to ensure the identification, measurement, management, authorisation and internal reporting of counterparty credit risk;
  2. procedures for ensuring that those policies, processes and systems are complied with. (2) The policies, processes and systems referred to in paragraph (1) of this Article shall be clear and reliable, implemented with integrity and documented, and the documentation shall include an explanation of the empirical techniques used to measure counterparty credit risk. (3) The counterparty credit risk management framework set out in paragraph (1) of this Article shall take account of market, liquidity, and legal and operational risks that

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 410 may be associated with counterparty credit risk, and such framework shall in particular ensure that the credit institution complies with the following principles:

  1. it assesses counterparty’s creditworthiness before contracting transactions;
  2. it takes due account of settlement and pre-settlement credit risk;
  3. it manages such risks as comprehensively as practicable at the counterparty level by aggregating counterparty credit risk exposures with other credit exposures and at the firm-wide level. (4) A credit institution shall ensure that its counterparty credit risk management framework includes the association with the liquidity risk, and in particular the following:
  4. potential incoming margin calls in the context of changes of variable margin or other margin types, such as initial or independent margin, under adverse market shocks;
  5. potential incoming calls for the return of excess collateral posted by counterparties;
  6. calls resulting from a potential downgrade of credit institution’s own external credit quality assessment. (5) A credit institution shall ensure that the nature and horizon of collateral re-use is consistent with its liquidity needs and does not jeopardise its ability to post or return collateral in a timely manner. (6) A credit institution's management board and senior management shall be actively involved in, and ensure that adequate resources are allocated to, the management of counterparty credit risk, and the senior management must be aware of the limitations and assumptions of the model used and the impact those limitations and assumptions can have on the reliability of the output through a formal process, and the senior management must also be aware of the uncertainties of the market environment and operational issues and of how these are reflected in the model. (7) The daily reports prepared on a credit institution's exposures to counterparty credit risk in accordance with Article 355 paragraph (2) item 2) of this Decision shall be submitted to the members of the management bodies of a credit institution with sufficient powers for both, limiting and reducing the potential exposure of a credit institution based on transactions agreed upon by credit managers or traders, as well as powers to limit and reduce the credit institution's overall counterparty credit risk exposure. (8) A credit institution's counterparty credit risk management framework established in accordance with paragraph (1) of this Article shall be used in conjunction with internal credit and trading limits. Credit and trading limits shall be related to the credit institution's risk measurement model in a manner that is consistent over time and that is well understood by credit managers, traders and senior management, and the credit institution shall have formal procedures to report breaches of risk limits to the appropriate level of management. (9) A credit institution's measurement of counterparty credit risk shall include measuring daily and intra-day use of credit lines.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 411 (10) The credit institution shall:

  1. measure current exposure gross and net of collateral;
  2. at portfolio and counterparty level, calculate and monitor peak exposure or potential future exposure at the confidence interval chosen by the credit institution;
  3. take account of large or concentrated positions, including by groups of related counterparties, by industry and by market. (11) A credit institution shall establish and maintain a routine and rigorous program of stress testing the results of which shall be reviewed regularly and at least quarterly by senior management and shall be reflected in the counterparty credit risk policies and limits set by the management body or senior management, and where stress tests reveal particular vulnerability to a given set of circumstances, the credit institution shall take prompt steps to manage those risks. Organisation structures for counterparty credit risk management Article 374 (1) A credit institution using the IMM shall establish and maintain:
  4. a risk control unit that complies with the conditions under paragraph (2) of this Article;
  5. a collateral management unit that complies with the conditions under paragraph (3) of this Article. (2) The risk control unit shall be responsible for the design and implementation of the counterparty credit risk management, including the initial and on-going validation of the model, and it shall carry out the following functions and meet the following requirements:
  6. it shall be responsible for the design and implementation of the counterparty credit risk management system of the credit institution;
  7. it shall produce daily reports on and analyse the output of the credit institution's risk measurement model, and that analysis shall include an evaluation of the relationship between measures of counterparty credit risk exposure values and trading limits;
  8. it shall control input data integrity and produce and analyse reports on the output of the credit institution's risk measurement model, including an evaluation of the relationship between measures of risk exposure and credit and trading limits;
  9. it shall be independent from units responsible for originating, renewing or trading exposures and free from undue influence;
  10. it shall have employees with adequate professional knowledge and experience;
  11. it shall report directly to the senior management of the credit institution;
  12. its work shall be closely integrated into the day-to-day credit risk management process of the credit institution; and
  13. its output shall be an integral part of the process of planning, monitoring and controlling the credit institution's credit and overall risk profile. (3) The collateral management unit shall carry out the following tasks and functions:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 412

  1. calculating and making margin calls, managing margin call disputes and reporting levels of independent amounts, initial margins and variable margins accurately on a daily basis;
  2. controlling the integrity of the data used to make margin calls, and ensuring that it is consistent and reconciled regularly with all relevant sources of data within the credit institution;
  3. tracking the extent of re-use of collateral and any amendment of the rights of the credit institution to or in connection with the collateral that it posts;
  4. reporting to the appropriate level of management the types of collateral assets that are reused, and the terms of such reuse including instrument, credit quality and maturity;
  5. tracking concentration to individual types of collateral accepted by the credit institution;
  6. reporting collateral management information on a regular basis, but at least quarterly, to senior management, including information on the type of collateral received and posted, the size, aging and cause for margin call disputes, wherein that internal reporting shall also reflect trends in these indicators. (4) Senior management shall allocate sufficient resources to the collateral management unit to ensure that its systems achieve an appropriate level of operational performance, as measured by the timeliness and accuracy of margin calls by the credit institution and the timeliness of the response of the credit institution to margin calls by its counterparties. (5) Senior management shall ensure that the organisational unit referred to in paragraph (1) item 2) of this Article has employees with adequate professional knowledge and experience to process calls and disputes in a timely manner even under severe market crisis, and to enable the credit institution to limit its number of large disputes caused by trade volumes. Review of counterparty credit risk management system Article 375 (1) A credit institution shall regularly conduct independent reviews of its counterparty credit risk management system through its internal auditing process. (2) The review referred to in paragraph (1) of this Article shall include both the activities of the control and collateral management units in accordance with Article 374 of this Decision and shall include, as a minimum:
  7. the adequacy of the documentation of the counterparty credit risk management system and process in accordance with Article 373 of this Decision;
  8. the organisation of the counterparty credit risk control unit required in accordance with Article 374 paragraph (1) item 2) of this Decision;
  9. the organisation of the collateral management unit required in accordance with Article 374 paragraph (1) item 2) of this Decision;
  10. the integration of counterparty credit risk measures into daily risk management;
  11. the authorisation process for risk pricing models and valuation systems used by front and back-office personnel;
  12. the validation of any significant change in the counterparty credit risk measurement process;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 413 7) the scope of counterparty credit risk captured by the risk measurement model; 8) the integrity of the management information system; 9) the accuracy and completeness of data on counterparty credit risk exposure; 10) the accurate reflection of legal terms in collateral and netting agreements into exposure value measurements; 11) the verification of the consistency, timeliness and reliability of data sources used to run models, including the independence of such data sources; 12) the accuracy and appropriateness of volatility and correlation assumptions; 13) the accuracy of valuation and risk transformation calculations; 14) the verification of the model's accuracy through frequent back-testing as set out in Article 380 paragraph (1) items 2) to 5) of this Decision; 15) the compliance of the counterparty credit risk control unit and collateral management unit with the relevant regulatory requirements. Use test Article 376 (1) A credit institution shall ensure that the distribution of exposures generated by the model used to calculate Effective EPE is closely integrated into the day-to-day counterparty credit risk management process of the credit institution, and that the output of the model is taken into account in the process of credit approval, counterparty credit risk management, internal capital allocation and corporate governance. (2) The credit institution shall demonstrate to the satisfaction of the Central Bank that it has been using a model to calculate the distribution of exposures upon which the EPE calculation is based that meets, broadly, the requirements set out in this Section for at least one year prior to receiving the authorisation to use the IMM in accordance with Article 370 of this Decision. (3) The model used to generate a distribution of exposures to counterparty credit risk shall be part of the counterparty credit risk management framework required by Article 376 of this Decision, and this framework shall include the measurement of usage of credit lines, aggregating counterparty credit risk exposures with other credit exposures and internal capital allocation. (4) In addition to EPE, a credit institution shall measure and manage current exposures and, where appropriate, the credit institution shall measure current exposure gross and net of collateral. (5) The use test is satisfied if a credit institution uses other counterparty credit risk measures, such as peak exposure, based on the distribution of exposures generated by the same model to compute EPE. (6) A credit institution shall have the systems capability to estimate EE daily, if necessary, unless it demonstrates to the satisfaction of the Central Bank that its exposures to counterparty credit risk warrant less frequent EE calculation. (7) The credit institution shall estimate EE for a period that adequately reflects the time structure of future cash flows and maturity of the contracts and in a manner that is consistent with the materiality and composition of the exposures.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 414 (8) Exposure shall be measured, monitored and controlled over the life of all contracts in the netting set and not only to the one-year horizon. (9) The credit institution shall have procedures in place to identify and control the counterparty credit risk where the exposure rises beyond the one-year horizon. (10) The credit institution shall use the model output indicating an increase in exposure as an input into the credit institution’s internal capital model. Stress testing Article 377 (1) A credit institution shall have a comprehensive stress testing programme for counterparty credit risk, including for use in assessment of capital requirements for counterparty credit risk, which complies with the requirements laid down in paragraphs (2) to (13) of this Article. (2) Stress testing shall identify possible events or future changes in economic conditions that could have unfavourable effects on credit institution's credit exposures and assess the credit institution's ability to withstand such changes. (3) The stress measures under the stress testing programme referred to in paragraph (1) of this Article shall be compared against risk limits and considered by the credit institution as part of the process set out in Article 108 of the Law. (4) The stress testing programme referred to in paragraph (1) of this Article shall comprehensively capture trades and aggregate exposures across all forms of counterparty credit risk at the level of specific counterparties in a sufficient time frame to conduct regular stress testing. (5) The stress testing programme referred to in paragraph (1) of this Article shall provide for at least monthly exposure stress testing of principal market risk factors such as interest rates, foreign currencies, equity instruments, credit margins, and commodity prices for all counterparties of the credit institution, in order to identify, and enable the credit institution when necessary to reduce outsized concentrations in specific directional risks, and exposure stress testing (including single factor, multifactor and material non-directional risks) and joint stressing of exposure and creditworthiness shall be performed at the counterparty-specific, counterparty group and aggregate credit institution-wide counterparty credit risk levels. (6) A credit institution shall apply at least quarterly multifactor stress testing scenarios and assess material non-directional risks including yield curve exposure and basis risks, wherein such multifactor stress tests shall, at a minimum, address the following scenarios in which the following occurs:

  1. severe economic or market events;
  2. broad market liquidity has decreased significantly;
  3. a large financial intermediary is liquidating positions.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 415 (7) The severity of the shocks of the underlying risk factors shall be consistent with the purpose of the stress test, and when evaluating solvency under stress, the shocks of the underlying risk factors shall be sufficiently severe to capture historical extreme market environments and extreme but plausible stressed market conditions. (8) The stress tests shall evaluate the impact of such shocks referred to in paragraph (7) of this Article on own funds, capital requirements and earnings. (9) For the purpose of day-to-day portfolio monitoring, hedging, and management of concentrations the testing programme shall also consider scenarios of lesser severity and higher probability. (10) The stress testing shall include provision, where appropriate, for reverse stress tests to identify extreme, but plausible, scenarios that could result in significant adverse outcomes, and reverse stress testing shall account for the impact of material non-linearity in the portfolio. (11) The results of the stress testing under the testing programme shall be reported regularly, at least on a quarterly basis, to senior management, and the reports and analysis of the results shall cover the largest counterparty-level impacts across the portfolio, material concentrations within segments of the portfolio (within the same industry or region), and relevant portfolio and counterparty specific trends. (12) Senior management shall take a lead role in the integration of stress testing into the risk management framework and risk culture of the credit institution and ensure that the results are meaningful and used to manage counterparty credit risk. (13) The results of stress testing for significant exposures shall be assessed against guidelines that indicate the credit institution's risk appetite, and referred to senior management for discussion and action when excessive or concentrated risks are identified. Wrong-Way Risk Article 378 (1) General Wrong-Way risk arises when the likelihood of default by counterparties is positively correlated with general market risk factors. (2) Specific Wrong-Way risk arises when future exposure to a specific counterparty is positively correlated with the counterparty's PD due to the nature of the transactions with the counterparty, and a credit institution shall be considered to be exposed to Specific Wrong-Way risk if the future exposure to a specific counterparty is expected to be high when the counterparty's probability of a default is also high. (3) A credit institution shall give due consideration to exposures that give rise to a significant degree of Specific and General Wrong-Way risk. (4) In order to identify General Wrong-Way risk, a credit institution shall design stress testing and scenario analyses to stress risk factors that are adversely related to

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 416 counterparty creditworthiness, and such testing shall address the possibility of severe shocks occurring when relationships between risk factors have changed. (5) A credit institution shall:

  1. monitor General Wrong-Way risk by product, by region, by industry, or by other categories that are relevant to the business;
  2. maintain procedures to identify, monitor and control cases of Specific Wrong￾Way risk for each legal entity, beginning at the inception of a transaction and continuing through the life of the transaction. (6) A credit institution shall calculate the capital requirements for CCR in relation to transactions where Specific Wrong-Way risk has been identified and where there exists a legal connection between the counterparty and the issuer of the underlying instrument of the OTC derivative or the underlying instrument of the transactions referred to in points Article 346 paragraph (6) items 2), 3), and 4) of this Decision, in accordance with the following principles:
  3. the instruments where Specific Wrong-Way risk exists shall not be included in the same netting set as other transactions with the counterparty, and shall each be treated as a separate netting set;
  4. within any such separate netting set, for single-name credit default swaps the exposure value equals the full expected loss in the value of the remaining fair value of the underlying instruments based on the assumption that the underlying issuer is in winding-up;
  5. LGD for a credit institution using the approach set out in Subtitle 3 shall be 100% for such swap transactions;
  6. for a credit institution using the approach set out in Subtitle 2, the applicable risk weight shall be that of an unsecured transaction;
  7. for all other transactions referencing a single name in any such separate netting set, the calculation of the exposure value shall be consistent with the assumption of a jump-to-default of those underlying obligations where the issuer is legally connected with the counterparty, and for transactions referencing a basket of names or index, the jump-to-default of the respective underlying obligations where the issuer is legally connected with the counterparty, shall be applied, if material;
  8. to the extent that the calculation uses existing market risk calculations for capital requirements for default risk as set out in Section 4 or 5 Subtitle 2, Title IV of this Part of the Decision, or for default risk using an internal default risk model as set out in Section 3 Subtitle 3 Title IV, that already contain an LGD assumption, the LGD in the formula used shall be 100 %.

(7) A credit institution shall provide senior management and the appropriate committee of the management board with regular reports on both Specific and General Wrong￾Way risks and the steps being taken to manage those risks. Integrity of the modelling process Article 379 (1) A credit institution shall ensure the integrity of modelling process as set out in Article 371 of this Decision where in particular the following conditions are met:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 417

  1. the model shall reflect transaction terms and specifications in a timely, complete, and conservative fashion;
  2. transaction terms shall include at least contract notional amounts, maturity, reference assets, margining arrangements and netting arrangements;
  3. those terms and specifications shall be maintained in a database that is subject to formal and periodic audit;
  4. a process for recognising netting arrangements that requires legal staff to verify that netting under those arrangements is legally enforceable;
  5. the verification required under item 4) of this paragraph shall be entered into the database mentioned in item 3) of this paragraph by an independent unit;
  6. the transmission of transaction terms and specification data to the EPE model shall be subject to internal audit;
  7. there shall be processes for formal reconciliation between the model and source data systems to verify on an ongoing basis that transaction terms and specifications are being reflected in EPE correctly or at least conservatively. (2) Current market data shall be used to determine current exposures, and a credit institution may calibrate its EPE model using either historic market data or market implied data to establish parameters of the underlying stochastic processes, such as drift, volatility and correlation. (3) If a credit institution uses historical data, it shall use at least three years of such data, and the data shall be updated at least quarterly or more frequently if necessary to reflect market conditions. (4) To calculate the Effective EPE using a stress calibration, a credit institution shall calibrate Effective EPE using either three years of data that includes a period of stress to the credit default spreads of its counterparties or market implied data from such a period of stress, wherein the requirements set out in paragraphs (5), (6), and (7) of this Article shall be applied by the credit institution for that purpose. (5) A credit institution shall demonstrate to the satisfaction of the Central Bank, at least quarterly, that the stress period used for the calculation under this paragraph coincides with a period of increased credit default swap or other credit (such as loan or corporate bond) spreads for a representative selection of its counterparties with traded credit spreads, and in situations where the credit institution does not have adequate credit spread data for a counterparty, it shall map that counterparty to specific credit spread data based on region, internal rating and business types. (6) The EPE model for all counterparties shall use data, either historic or implied, that include the data from the stressed credit period and shall use such data in a manner consistent with the method used for the calibration of the EPE model to current data. (7) To evaluate the effectiveness of its stress calibration for Effective EPE, a credit institution shall create several benchmark portfolios that are vulnerable to the main risk factors to which the credit institution is exposed, and the exposure to these benchmark portfolios shall be calculated using the following:
  8. a stress methodology, based on current market values and model parameters calibrated to stressed market conditions; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 418 2) the exposure generated during the stress period, but applying the method set out in this Section (end of stress period market value, volatilities, and correlations from the 3-year stress period). (8) The Central Bank shall require a credit institution to adjust the stress calibration if the exposures of those benchmark portfolios deviate substantially from each other. (9) A credit institution shall subject the model to a validation process that is clearly articulated in the credit institutions' policies and procedures, and such validation process must:

  1. specify the kind of testing needed to ensure model integrity and identify conditions under which the assumptions underlying the model are inappropriate and may therefore result in an understatement of EPE; and
  2. include a review of the comprehensiveness of the model. (10) A credit institution shall monitor the relevant risks and have processes in place to adjust its estimation of Effective EPE when those risks become significant, and, in complying with this paragraph, it shall:
  3. identify and manage its exposures to Specific Wrong-Way risk arising as specified in Article 378 paragraph (2) of this Decision and exposures to General Wrong-Way risk arising as specified in Article 378 paragraph (1) of this Decision;
  4. for exposures with a rising risk profile after one year, compare on a regular basis the estimate of a relevant measure of exposure over one year with the same exposure measure over the life of the exposure;
  5. for exposures with a residual maturity below one year, compare on a regular basis the replacement cost (current exposure) and the realised exposure profile, and store data that would allow such a comparison. (11) A credit institution shall have internal procedures to verify that, prior to including a transaction in a netting set, the transaction is covered by a legally enforceable netting contract that meets the requirements set out in Section 7 of this Subtitle. (12) A credit institution that uses collateral to mitigate its counterparty credit risk shall have internal procedures to verify that, prior to recognising the effect of collateral in its calculations, the collateral meets the legal certainty standards set out in Subtitle 4 of this Title. Requirements for the risk management system Article 380 (1) In connection with the counterparty credit risk management system, a credit institution shall ensure that:
  6. it shall conduct a regular programme of back-testing, comparing the risk measures generated by the model with realised risk measures, and hypothetical changes based on static positions with realised measures;
  7. it shall carry out an initial validation and an on-going periodic review of its counterparty credit risk exposure model and the risk measures generated by it, wherein the validation and review shall be independent of the model development;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 419 3) the management body and senior management shall be involved in the risk control process and shall ensure that adequate resources are devoted to credit and counterparty credit risk control, and that in this regard, the daily reports prepared by the independent risk control unit established in accordance Article 374 paragraph (1) item 1) of this Decision shall be reviewed by a level of management with sufficient seniority and authority to enforce both reductions of positions taken by individual traders and reductions in the overall risk exposure of the credit institution; 4) the internal risk measurement exposure model shall be integrated into the day￾to-day risk management process of the credit institution; 5) the risk measurement system shall be used in conjunction with internal trading and exposure limits, and, in this regard, exposure limits shall be related to the credit institution's risk measurement model in a manner that is consistent over time and that is well understood by traders, the credit function and senior management; 6) its risk management system is well documented, and, in particular, it shall maintain a documented set of internal policies, controls and procedures concerning the operation of the risk measurement system, and arrangements to ensure that those policies are complied with; 7) an independent review of the risk measurement system shall be carried out regularly in the credit institution's own internal auditing process, that this review shall include both the activities of the business trading units and of the independent risk control unit, that a review of the overall risk management process shall take place at regular intervals (and no less than once a year) and shall include, as a minimum, all items referred to in Article 375 of this Decision; 8) the on-going validation of counterparty credit risk models, including back￾testing, shall be reviewed periodically by a level of management with sufficient authority to decide the action that will be taken to address weaknesses in the models. (2) The Central Bank shall take into account the extent to which a credit institution meets the requirements of paragraph (1) of this Article when setting the level of alpha, as set out in Article 371 paragraph (4) of this Decision, and only a credit institution that complies fully with those requirements shall be eligible for application of the minimum multiplication factor. (3) A credit institution shall document the process for initial and on-going validation of its counterparty credit risk exposure model and the calculation of the risk measures generated by the models to a level of detail that would enable a third party to recreate, respectively, the analysis and the risk measures. That documentation shall set out the frequency with which back testing analysis and any other on-going validation will be conducted, how the validation is conducted with respect to data flows and portfolios and the analyses that are used. (4) A credit institution shall define criteria with which to assess its counterparty credit risk exposure models and the models that input into the calculation of exposure and maintain a written policy that describes the process by which unacceptable performance will be identified and remedied.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 420 (5) A credit institution shall define how representative counterparty portfolios are constructed for the purposes of validating the counterparty credit risk exposure model and its risk measures. (6) The validation of counterparty credit risk exposure models and their risk measures that produce forecast distributions shall consider more than a single statistic of the forecast distribution. Validation requirements Article 381 (1) As part of the initial and on-going validation of its counterparty credit risk exposure model and its risk measures, a credit institution shall ensure that the following requirements are met:

  1. the credit institution shall carry out back-testing using historical data on movements in market risk factors prior to the authorisation by the Central Bank in accordance with Article 370 paragraphs (1), (2), and (3) of this Decision, and that back-testing shall consider a number of distinct prediction time horizons out to at least one year, over a range of various initialisation dates and covering a wide range of market conditions;
  2. the credit institution using the approach set out in Article 372 paragraph (1) item
  3. of this Decision shall regularly validate its model to test whether realised current exposures are consistent with prediction over all margin periods within one year, and if some of the trades in the netting set have a maturity of less than one year, and the netting set has higher risk factor sensitivities without these trades, the validation shall take this into account;
  4. the credit institution shall back-test the performance of its counterparty credit risk exposure model and the model's relevant risk measures as well as the market risk factor predictions, wherein for collateralised trades, the prediction time horizons considered shall include those reflecting typical margin periods of risk applied in collateralised or margined trading;
  5. if the model validation indicates that Effective EPE is underestimated, the credit institution shall take the action necessary to address the inaccuracy of the model;
  6. the credit institution shall test the pricing models used to calculate counterparty credit risk exposure for a given scenario of future shocks to market risk factors as part of the initial and on-going model validation process, wherein the pricing models for options shall account for the nonlinearity of option value with respect to market risk factors;
  7. the counterparty credit risk exposure model shall capture the transaction￾specific information necessary to be able to aggregate exposures at the level of the netting set, and the credit institution shall verify that transactions are assigned to the appropriate netting set within the model;
  8. the counterparty credit risk exposure model shall include transaction-specific information to capture the effects of margining, wherein that model shall take into account: − both the current amount of margin and margin that would be passed between counterparties in the future, − the nature of margin agreements (unilateral or bilateral), the frequency of margin calls, the margin period of risk, the minimum threshold of un-

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 421 margined exposure the credit institution is willing to accept, and the minimum transfer amount, and − the mark-to-market change in the value of collateral posted or apply the rules set out in Subtitle 4; 8) the model validation process shall include static, historical back-testing programme on representative counterparty portfolios, and a credit institution shall conduct such back-testing programme on a number of representative counterparty portfolios (that are actual or hypothetical) at regular intervals, wherein those representative portfolios shall be chosen on the basis of their sensitivity to the significant risk factors and combinations of risk factors to which the credit institution is exposed; 9) a credit institution shall conduct back-testing that is designed to test the key assumptions of the counterparty credit risk exposure model and the relevant risk measures, including the modelled relationship between tenors of the same risk factor, and the modelled relationships between risk factors; 10)the performance of counterparty credit risk exposure models and its risk measures shall be subject to appropriate back-testing practice, and the back￾testing programme shall be capable of identifying poor performance in an EPE model's risk measures; 11)a credit institution shall validate its counterparty credit risk exposure models and all risk measures out to time horizons commensurate with the maturity of trades for which exposure is calculated using the IMM in accordance with Article 370 of this Decision; 12)a credit institution shall regularly test the pricing models used to calculate counterparty exposure against appropriate independent benchmarks as part of the on-going model validation process; 13)the on-going validation of a credit institution's counterparty credit risk exposure model and the relevant risk measures shall include an assessment of the adequacy of the recent performance; 14)the frequency with which the parameters of a counterparty credit risk exposure model are updated shall be assessed by a credit institution as part of the initial and on-going validation process; 15)the initial and on-going validation of counterparty credit risk exposure models shall assess whether or not the counterparty level and netting set exposure calculations of exposure are appropriate. (2) A credit institution may use a measure that is more conservative than the metric used to calculate regulatory exposure value for every counterparty in place of alpha multiplied by Effective EPE with the prior authorisation of the Central Bank, wherein the Central Bank shall assess the degree of relative conservatism upon initial approval and at the regular supervisory reviews of the EPE models while the credit institution shall validate the conservatism regularly. (3) The on-going assessment of model performance shall cover all counterparties for which the models are used. (4) If back-testing indicates that a model is not sufficiently accurate, the Central Bank shall revoke its authorisation for the model, or impose appropriate measures to ensure that the model is improved promptly.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 422 Section 7 – Contractual netting Recognition of contractual netting as risk-reducing Article 382 (1) A credit institution may treat as risk reducing in accordance with Article 383 of this Decision only the following types of contractual netting agreements where the netting agreement has been recognised by Central Bank in accordance with Article 384 of this Decision and where the credit institution meets the requirements set out in Article 385 of this Decision:

  1. bilateral contracts for novation between a credit institution and its counterparty, under which mutual claims and obligations are automatically off-set in such a way that the novation fixes one single net amount each time it applies so as to create a single new contract that replaces all former contracts and all obligations between parties pursuant to those contracts and is binding on the parties;
  2. other bilateral agreements between a credit institution and its counterparty; and
  3. contractual cross-product netting agreements for credit institutions that have received the authorisation to use the method set out in Section 6 for transactions falling under the scope of that method. (2) Netting across transactions entered into by different legal persons within a group shall not be recognised for the purposes of calculating the capital requirements. Recognition of contractual netting agreements Article 383 (1) The Central Bank shall recognise a contractual netting agreement only where the conditions set out in paragraph (2) of this Article and, where relevant, conditions set out in paragraph (6) of this Article are fulfilled. (2) The following conditions shall be fulfilled by contractual netting agreements used by a credit institution for the purposes of determining exposure value:
  4. the credit institution has concluded a contractual netting agreement with its counterparty which creates a single legal obligation, covering all included transactions, such that, in the event of default by the counterparty the credit institution would be entitled to receive or obliged to pay only the net sum of the positive and negative mark-to-market values of included individual transactions;
  5. the credit institution has made available to the Central Bank written and reasoned legal opinions to the effect that, in the event of a legal challenge of the netting agreement, the credit institution's claims and obligations would not exceed those referred to in item 1) of this paragraph, and such legal opinion shall refer to the applicable regulation pertaining to: − the jurisdiction in which the counterparty is established; − if a branch of an undertaking is involved, which is located in a country other than that where the undertaking is established, the jurisdiction in which the branch is located; − the jurisdiction whose law governs the individual transactions included in the netting agreement;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 423 − the jurisdiction whose law governs any contract or agreement necessary to effect the contractual netting; 3) credit risk to each counterparty is aggregated to arrive at a single legal exposure across transactions with each counterparty, and this aggregation shall be factored into credit limit purposes and internal capital calculation purposes; 4) the contract shall not contain any clause which, in the event of default of a counterparty, permits a non-defaulting counterparty to make limited payments only, or no payments at all, to the estate of the defaulting party, even if the defaulting party is a net creditor (i.e., walk-away clause). (3) If the Central Bank or another competent authority is not satisfied that the contractual netting is legally valid and enforceable under the law of each of the jurisdictions referred to in paragraph (2) item 2) of this Article, the contractual netting agreement shall not be recognised as risk-reducing for either of the counterparties, and competent authorities shall inform each other accordingly. (4) The legal opinions referred to in paragraph (2) item 2) of this Article may pertain to all types of contractual netting agreements. (5) The following additional conditions shall be fulfilled by contractual cross-product netting agreements:

  1. the net sum referred to in paragraph (2) item 1) of this Article is the net sum of the positive and negative close out values of any included individual bilateral master agreement and of the positive and negative mark-to- market value of the individual transactions (the ‘cross-product net amount’);
  2. the legal opinions referred to in paragraph (2) item 2) shall include opinions on the validity and enforceability of the entire contractual cross-product netting agreement under its terms and the impact of the netting arrangement on the material provisions of any included individual bilateral master agreement. Obligations of a credit institution Article 384 (1) A credit institution shall establish and maintain procedures to ensure that the legal validity and enforceability of its contractual netting is reviewed in the light of changes in the law of relevant jurisdictions referred to in Article 382 paragraph (2) item 2) of this Decision. (2) The credit institution shall maintain all required documentation relating to its contractual netting in its files. (3) The credit institution shall factor the effects of netting into its measurement of each counterparty's aggregate credit risk exposure and it shall manage its counterparty credit risk on the basis of those effects of that measurement. (4) In the case of contractual cross-product netting agreements referred to in Article 382 of this Decision, the credit institution shall maintain procedures under Article 382 paragraph (2) item 3) of this Decision to verify that any transaction which is to be

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 424 included in a netting set is covered by a legal opinion referred to in Article 382 paragraph (2) item 2) of this Decision. (5) Within the meaning of the contractual cross-product netting agreement, the credit institution shall continue to comply with the requirements for the recognition of bilateral netting and the requirements of Subtitle 4 for the recognition of credit risk mitigation, as applicable, with respect to each included individual bilateral master agreement and transaction. Effects of recognition of netting as risk-reducing Article 385 Netting for the purposes of Sections 3 to 6 of this Subtitle shall be recognised as set out in those Sections. Section 8 – Items in the trading book Items in the trading book Article 386 (1) Provisions of this Article shall include a reference to derivative instruments for the referred to in Article 148 paragraph (8) of this Decision, and to derivative instruments for the transfer of credit risk. (2) When calculating risk-weighted exposure amounts for counterparty risk of items in the trading book, a credit institution shall comply with the following principle:

  1. a credit institution shall not use the Financial Collateral Simple Method set out in Article 259 of this Decision for the recognition of the effects of financial collateral;
  2. in the case of repurchase transactions and securities or commodities lending or borrowing transactions booked in the trading book, a credit institution may recognise as eligible collateral all financial instruments and commodities that are eligible to be included in the trading book;
  3. for exposures arising from OTC derivative instruments booked in the trading book, a credit institution may recognise commodities that are eligible to be included in the trading book as eligible collateral;
  4. for the purposes of calculating volatility adjustments where such financial instruments or commodities which are not eligible under Subtitle 4 of this Title are lent, sold or provided, or borrowed, purchased or received by way of collateral or otherwise under such a transaction, and a credit institution is using the Supervisory Volatility Adjustments Approach under Section 3 of Subtitle 4 of this Title, a credit institution shall treat such instruments and commodities in the same way as non-main index equities listed on a recognised exchange;
  5. where a credit institution is using the Own Estimates of Volatility adjustments Approach under Section 3 Subtitle 4 of this Title in respect of financial instruments or commodities which are not eligible under Subtitle 4 of this Title, it shall calculate volatility adjustments for each individual item, and, where a credit institution has obtained the approval to use the internal models approach defined in Subtitle 4 of this Title, it may also apply that approach in the trading book;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 425 6) in relation to the recognition of master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions, or other capital market-driven transactions, a credit institution shall only recognise netting across positions in the trading book and the non-trading book when the netted transactions fulfil the following conditions: − all transactions are marked to market daily; − any items borrowed, purchased or received under the transactions may be recognised as eligible financial collateral under Subtitle 4 of this Title, without the application of items 3) to 5) of this paragraph; 7) where a credit derivative included in the trading book forms part of an internal hedge and the credit protection is recognised under this Regulation in accordance with Article 241 of this Decision, a credit institution shall apply one of the following approaches: − treat it as if there were no counterparty risk arising from the position in that credit derivative; or − consistently include for the purpose of calculating the capital requirements for counterparty credit risk all credit derivatives in the trading book forming part of internal hedges or purchased as protection against a counterparty credit risk exposure where the credit protection is recognised as eligible under Subtitle 4 of this Decision. Section 9 – Capital requirements for exposures to a central counterparty (CCP) Definitions Article 387 For the purposes of this Section, the following definitions apply:

  1. bankruptcy remote, in relation to client assets, means that effective arrangements exist which ensure that those assets will not be available to the creditors of a CCP or of a clearing member in the event of the insolvency of that CCP or clearing member respectively, or that the assets will not be available to the clearing member to cover losses it incurred following the default of a client or clients other than those that provided those assets;
  2. CCP-related transaction means a contract or a transaction listed in Article 388 paragraph (1) of this Decision between a client and a clearing member that is directly related to a contract or a transaction listed in that paragraph between that clearing member and a CCP;
  3. clearing member (member of CCP settlement system) means an undertaking which participates in a CCP and which is responsible for discharging the financial obligations arising from that participation;
  4. client means an undertaking with a contractual relationship with a clearing member of a CCP which enables that undertaking to clear its transactions with that CCP;
  5. cash transaction means a transaction in cash, debt instruments or equities, a spot foreign exchange transaction or a spot commodities transaction; however, within the meaning of this definition, repurchase transactions, securities or commodities lending transactions, and securities or commodities borrowing transactions, are not cash transactions;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 426 6) indirect clearing arrangement means an arrangement that does not increase counterparty risk and ensure that assets and positions of the counterparty benefit from protection; 7) higher-level client means an entity providing clearing services to a lower-level client; 8) lower-level client means an entity accessing the services of a CCP through a higher-level client; 9) multi-level client structure means an indirect clearing arrangement under which clearing services are provided to a credit institution by an entity which is not a clearing member, but is itself a client of a clearing member or of a higher￾level client; 10)unfunded contribution to a default fund means a contribution that a credit institution that acts as a clearing member has contractually committed to provide to a CCP after the CCP has depleted its default fund to cover the losses it incurred following the default of one or more of its clearing members; 11)fully guaranteed deposit lending or borrowing transaction means a fully collateralised money market transaction in which two counterparties exchange deposits and a CCP interposes itself between them to ensure the performance of those counterparties' payment obligations. Material scope Article 388 (1) This Section applies to the following contracts and transactions, for as long as they are outstanding with a CCP:

  1. the derivative contracts listed in Article 148 paragraph (8) of this Decision and credit derivatives;
  2. securities financing transactions and fully guaranteed deposit lending or borrowing transactions; and
  3. long settlement transactions. (2) This Section does not apply to exposures arising from the settlement of cash transactions. (3) A credit institution shall apply the treatment laid down in Title V to trade exposures arising from those transactions and a 0% risk weight to default fund contributions covering only those transactions. (4) A credit institution shall apply the treatment set out in Article 394 of this Decision to default fund contributions that cover any of the contracts listed in paragraph (1) of this Article in addition to cash transactions. (5) For the purposes of this Section, the following requirements shall apply:
  4. the initial margin shall not include contributions to a CCP for mutualised loss sharing arrangements;
  5. the initial margin shall include collateral deposited by a credit institution acting as a clearing member or by a client in excess of the minimum amount required respectively by the CCP or by the credit institution acting as a clearing member, provided the CCP or the credit institution acting as a clearing member may, in

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 427 appropriate cases, prevent the credit institution acting as a clearing member or the client from withdrawing such excess collateral; 3) where a CCP uses the initial margin to mutualise losses among its clearing members, a credit institution that acts as clearing member shall treat that initial margin as a default fund contribution. Monitoring of exposures to CCPs Article 389 (1) A credit institution shall monitor all its exposures to CCPs and shall lay down procedures for the regular reporting of information on those exposures to senior management and appropriate committees. (2) A credit institution shall assess, through appropriate scenario analysis and stress testing, whether the level of own funds held against exposures to a CCP, including potential future or contingent credit exposures, exposures from default fund contributions and, where the credit institution is acting as a clearing member, exposures resulting from contractual arrangements as laid down in Article 391 of this Decision, adequately relates to the inherent risks of those exposures. (3) For the purposes of monitoring exposures in paragraph (2) of this Article to a CCP based on payments to default fund, or for calculating capital requirements referred to in Articles 395 and 396 of this Decision, the credit institution acting as a clearing member, shall receive the following information from the CCP at least on a monthly basis, or more often if requested by the Central Bank:

  1. the hypothetical capital (KCCP) determined by the CCP;
  2. the sum of pre-funded contributions (DFCM);
  3. the amount of its pre-funded financial resources that it is required to use — by law or due to a contractual agreement with its clearing members — to cover its losses following the default of one or more of its clearing members before using the default fund contributions of the remaining clearing members (DFCCP). (4) Where the CCP has more than one default fund, it shall report the information referred to in paragraph (3) of this Article for each default fund separately. Treatment of clearing members' exposures to CCPs Article 390 (1) A credit institution that acts as a clearing member, either for its own purposes or as a financial intermediary between a client and a central counterparty (CCP), shall calculate the capital requirements for its exposures to a CCP as follows:
  4. it shall apply the treatment set out in Article 393 of this Decision to its trade exposures with the CCP;
  5. it shall apply the treatment set out in Article 394 of this Decision to its default fund contributions to the CCP. (2) For the purposes of paragraph (1) of this Article, the sum of a credit institution's capital requirements for its exposures to a qualified central counterparty due to trade exposures and default fund contributions shall be subject to a cap equal to the sum of

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 428 capital requirements that would be applied to those same exposures if the CCP were a non-qualifying CCP. Treatment of clearing members' exposures to clients Article 391 (1) A credit institution that acts as a clearing member and, in that capacity, acts as a financial intermediary between a client and a CCP shall calculate the capital requirements for its CCP-related transactions with that client in accordance with Sections 1 to 8 of this Subtitle, with Section 4 of Subtitle 4 of this Title and with Title VI of this Decision, as applicable. (2) Where a credit institution acting as a clearing member enters into a contractual arrangement with a client of another clearing member that facilitates, in case that a credit institution fails to meet its contractual obligations towards that client, the transfer of positions and collateral referred to in Article 392 paragraph (2) item 2) of this Decision for that client, and that contractual agreement gives rise to a contingent obligation for that credit institution, that credit institution may attribute an exposure value of zero to that contingent obligation. (3) Where a credit institution that acts as a clearing member uses the methods set out in Section 3 or 6 of this Subtitle to calculate the capital requirement for its exposures, the following provisions shall apply:

    1. by way of derogation from Article 372 paragraph (3) of this Decision, the credit institution may use a margin period of risk of at least five business days for its exposures to a client;
  2. the credit institution shall apply a margin period of risk of at least 10 business days for its exposures to a CCP;
  3. by way of derogation from Article 372 paragraph (4) of this Decision, where a netting set included in the calculation meets the condition set out in item 1) of that paragraph, the credit institution may disregard the limit set out in that item, provided that the netting set does not meet the condition set out in item 2) of that paragraph and does not contain disputed trades or exotic options;
  4. where a CCP retains variable margin against a transaction, and the credit institution's collateral is not protected against the insolvency of the CCP, the credit institution shall apply a margin period of risk that is the equal to one year or the remaining maturity of the transaction, whichever is shorter, with a floor of 10 business days. (4) By way of derogation from Article 368 paragraph (2) item 9) of this Decision, where a credit institution that acts as a clearing member uses the method set out in Section 4 of this Subtitle to calculate the capital requirement for its exposures to a client, the credit institution may use an effective maturity factor of 0,21 for its calculation. (5) By way of derogation from Article 369 paragraph (4) item 4) of this Decision, where a credit institution that acts as a clearing member uses the method set out in Section 5 of this Subtitle to calculate the capital requirements for its exposures to a client, that credit institution may use a maturity factor of 0,21 in that calculation.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 429 (6) A credit institution that acts as a clearing member may use the reduced exposure at default resulting from the calculations set out in paragraphs (3), (4), and (5) of this Article for the purposes of calculating its capital requirements for CVA risk in accordance with Title VI of this Part. (7) A credit institution that acts as a clearing member that collects collateral from a client for a CCP-related transaction and passes the collateral on to the CCP may recognise that collateral to reduce its exposure to the client for that CCP-related transaction. (8) In the case of a multi-level client structure, the treatment set out in the paragraph (7) of this Article may be applied at each level of that structure. Treatment of clients' exposures Article 392 (1) A credit institution that is a client shall calculate the capital requirements for its CCP-related transactions with its clearing member in accordance with Sections 1 to 8 of this Subtitle, with Section 4 of Subtitle 4 of this Title and with Title VI of this Decision, as applicable. (2) Without prejudice to the approach specified in paragraph (1) of this Article, where a credit institution is a client, it may calculate the capital requirements for its trade exposures for CCP-related transactions with its clearing member in accordance with Article 393 provided that all the following conditions are met:

  1. the positions and assets of that credit institution related to those transactions are distinguished and segregated, at the level of both the clearing member and the CCP, from the positions and assets of both the clearing member and the other clients of that clearing member and as a result of that distinction and segregation those positions and assets are bankruptcy remote in the event of the default or insolvency of the clearing member or one or more of its other clients;
  2. laws, regulations, rules and contractual arrangements applicable to or binding that credit institution or the CCP facilitate the transfer of the client's positions relating to those contracts and transactions and of the corresponding collateral to another clearing member within the applicable margin period of risk in the event of default or insolvency of the original clearing member. In such circumstance, the client's positions and the collateral shall be transferred at market value unless the client requests to close out the position at market value;
  3. the client has conducted a sufficiently thorough legal review, which it has kept up to date, that substantiates that the arrangements that ensure that the condition set out in item 2) of this paragraph is met are legal, valid, binding and enforceable under the relevant laws of the relevant jurisdiction or jurisdictions; and
  4. the CCP is qualified central counterparty (QCCP). (3) When assessing its compliance with the condition set out in paragraph (2) item 2) of this Article, a credit institution may take into account any clear precedents of transfers of client positions and of corresponding collateral at a CCP, and any industry intent to continue with that practice.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 430 (4) By way of derogation from paragraph (2) of this Article, where a credit institution that is a client fails to meet the condition set out in item 1) of that paragraph because that credit institution is not protected from losses in case the clearing member and another client of the clearing member jointly default, provided that all the other conditions set out in items 1) to 4) of that paragraph are met, the credit institution may calculate the capital requirements for its trade exposures for CCP-related transactions with its clearing member in accordance with Article 393 of this Decision, subject to replacing the 2% risk weight set out in Article 393 paragraph (1) item 1) of this Decision with a 4 % risk weight. (5) In the case of a multi-level client structure, a credit institution that is a lower-level client accessing the services of a CCP through a higher-level client may apply the treatment set out in paragraph (2) or (3) of this Article only where the conditions set out therein are met at every level of that structure. Capital requirements for trade exposures Article 393 (1) A credit institution shall apply the following treatment to its trade exposures with CCP:

  1. it shall apply a risk weight of 2% to the exposure values of all its trade exposures with QCCPs;
  2. it shall apply the risk weight used for the Standardised Approach to credit risk as set out in Article 141 paragraph (2) item 2) of this Decision to all its trade exposures with non-qualifying CCPs;
  3. where a credit institution is acting as a financial intermediary between a client and a CCP and the terms of the CCP-related transaction stipulate that the credit institution is not obligated to reimburse the client for any losses suffered due to changes in the value of that transaction in the event that the CCP defaults, that credit institution may set the exposure value of the trade exposure with the CCP that corresponds to that CCP-related transaction to zero;
  4. where a credit institution acts as a financial intermediary between a client and a CCP, and the terms of the CCP-related transaction stipulate that the credit institution is required to reimburse the client for any losses suffered due to changes in the value of that transaction in the event that the CCP defaults, that credit institution shall apply the treatment in item 1) or 2) of this paragraph, as applicable, to the trade exposure with the CCP that corresponds to that CCP-related transaction. (2) By way of derogation from paragraph (1) of this Article, where assets posted as collateral to a CCP or a clearing member are bankruptcy remote in the event that the CCP, the clearing member or one or more of the other clients of the clearing member become insolvent, a credit institution may attribute an exposure value of zero to the counterparty credit risk exposures for those assets. (3) A credit institution shall calculate exposure values of its trade exposures with a CCP in accordance with Sections 1 to 8 of this Subtitle and with Section 4 of Subtitle 4 of this Title, as applicable.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 431 (4) A credit institution shall calculate the risk weighted exposure amounts for its trade exposures with CCPs for the purposes of Article 114 paragraph (3) of this Decision as the sum of the exposure values of its trade exposures with CCPs, calculated in accordance with paragraphs (2) and (3) of this Article, multiplied by the risk weight determined in accordance with paragraph (1) of this Article. Capital requirements for contributions to the default fund of a CCP Article 394 A credit institution that acts as a clearing member shall apply the following treatment to its exposures arising from its contributions to the default fund of a CCP:

  1. it shall calculate the capital requirement for its pre-funded contributions to the default fund of a QCCP in accordance with the approach set out in Article 395 of this Decision;
  2. it shall calculate the capital requirement for its pre-funded and unfunded contributions to the default fund of a non-qualifying CCP in accordance with the approach set out in Article 396 of this Decision;
  3. it shall calculate the capital requirement for its unfunded contributions to the default fund of a QCCP in accordance with the treatment set out in Article 397 of this Decision. Capital requirements for pre-funded contributions to the default fund of a QCCP Article 395 (1) The exposure value for a credit institution's pre-funded contribution to the default fund of a QCCP (DFi) shall be the amount paid in or the market value of the assets delivered by that credit institution reduced by any amount of that contribution that the QCCP has already used to absorb its losses following the default of one or more of its clearing members. (2) A credit institution shall calculate the capital requirement to cover the exposure arising from its prefunded contribution as follows: Ki = max �KCCP ∙ DFi DFCCP + DFCM , 8% ∙ 2% ∙ DFi� where: Ki = capital requirement; i = the index denoting the clearing member; KCCP the hypothetical capital of the QCCP communicated to the credit institution by the QCCP in accordance with Article 389 paragraphs (3) and (4) of this Decision; DFi = the pre-funded contribution;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 432 DFCCP = the pre-funded financial resources of the CCP communicated to the credit institution by the CCP in accordance with Article 389 paragraphs (3) and (4) of this Decision; DFCM = the sum of pre-funded contributions of all clearing members of the QCCP communicated to the credit institution by the QCCP in accordance with Article 389 paragraphs (3) and (4) of this Decision. (3) A credit institution shall calculate the risk-weighted exposure amounts for exposures arising from that credit institution's pre-funded contribution to the default fund of a QCCP for the purposes of Article 114 paragraph (3) of this Decision as the capital requirement, calculated in accordance with paragraph (2) of this Article, multiplied by 12.5. Capital requirements for pre-funded contributions to the default fund of a non￾qualifying CCP and for unfunded contributions to a non-qualifying CCP Article 396 (1) A credit institution shall apply the following formula to calculate the capital requirements for the exposures arising from its pre-funded contributions to the default fund of a non-qualifying CCP and from unfunded contributions to such CCP: K = DF + UC where: K = capital requirement; DF = the pre-funded contributions to the default fund of a non-qualifying CCP; and UC = the unfunded contributions to the default fund of a non-qualifying CCP. (2) A credit institution shall calculate the risk-weighted exposure amounts for exposures arising from that credit institution's contribution to the default fund of a non￾qualifying CCP for the purposes of Article 114 paragraph (3) of this Decision as the capital requirement, calculated in accordance with paragraph (1) of this Article, multiplied by 12.5. Capital requirements for unfunded contributions to the default fund of a QCCP Article 397 A credit institution shall apply a 0 % risk weight to its unfunded contributions to the default fund of a QCCP.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 433 Capital requirements for exposures to CCPs that cease to meet certain conditions Article 398 (1) A credit institution shall apply the treatment set out in paragraph (1) of this Article where it has become known to it, following a public announcement or notification from the competent authority of a CCP used by that credit institution or from that CCP itself, that the CCP will no longer comply with the conditions for authorisation or recognition, as applicable. (2) Where the condition set out in paragraph (1) of this Article is met, a credit institution shall, within three months of becoming aware of the circumstance referred to therein, or at an earlier time if the Central Bank so requires, do the following with respect to their exposures to that CCP:

  1. apply the treatment set out in Article 393 paragraph (1) item 2) of this Decision to its trade exposures to that CCP;
  2. apply the treatment set out in Article 396 of this Decision to its pre-funded contributions to the default fund of that CCP and to its unfunded contributions to that CCP;
  3. treat its exposures to that CCP, other than the exposures listed in items 1) and
  4. of this paragraph, as exposures to a corporate in accordance with the Standardised Approach for credit risk set out in Subtitle 2 of this Title. TITLE III – CAPITAL REQUIREMENTS FOR OPERATIONAL RISK SUBTITLE 1 – Calculation of the own funds requirement for operational risk Definitions Article 399 For the purposes of this Title, the following definitions apply:
  5. operational risk event means any event linked to an operational risk which generates a loss or multiple losses, within one or multiple financial years;
  6. aggregated gross loss means the sum of all gross losses linked to the same operational risk event over one or multiple financial years;
  7. aggregated net loss means the sum of all net losses linked to the same operational risk event over one or multiple financial years;
  8. grouped losses means all operational losses caused by a common underlying trigger or root cause that could be grouped into one operational risk event. Own funds requirement for operational risk Article 400 The own funds requirement for operational risk shall be the business indicator component calculated in accordance with Article 401 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 434 Business indicator component Article 401 A credit institution shall calculate its business indicator component in accordance with the following formula: 𝐵𝐵 = � 0,12 ∙ 𝐵𝐵 , 𝑤𝑤ℎ 𝑒𝑒 𝐵𝐵 ≤ 0,15 0,12 + 0,15 ∙ (𝐵𝐵 − 1), 𝑤𝑤ℎ 𝑒𝑒 0,15 < 𝐵𝐵 ≤ 30 4,47 + 0,18 ∙ (𝐵𝐵 − 30), 𝑤𝑤ℎ 𝑒𝑒 𝐵𝐵 > 30 � where: 𝐵𝐵 = the business indicator component; 𝐵𝐵 = the business indicator, expressed in billion euro, calculated in accordance with Article 402 of this Decision. Business indicator Article 402 (1) A credit institution shall calculate its business indicator in accordance with the following formula: 𝐵𝐵 = + 𝑆𝑆 + where: 𝐵𝐵 = the business indicator, expressed in billion euro; = the interest, leases and dividend component, expressed in billion euro and calculated in accordance with paragraph (2) of this Article; 𝑆𝑆 = the services component, expressed in billion euro and calculated in accordance with paragraph (3) of this Article; = the financial component, expressed in billion euro and calculated in accordance with paragraph (4) of this Article. (2) For the purposes of paragraph (1) of this Article, a credit institution shall calculate the interest, leases and dividend component in accordance with the following formula: = 𝑚𝑚 𝑚𝑚( , 0,0225 ∙ ) + where: = the interest, leases and dividend component; = the interest component calculated as the annual average of the absolute values of the differences of the total amount referred to in items 1) to 4) and the total amount referred to in items 5) to 7 over the last three financial years:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 435

  1. interest income from all financial assets and other interest income;
  2. finance income from financial leases;
  3. income from operating leases;
  4. profits from leased assets,
  5. interest expenses from all financial liabilities and other interest expenses;
  6. interest expense from financial and operating leases;
  7. depreciation and impairment of, and losses from operating leased assets; = the asset component calculated as the annual average of the sum of the gross amounts of items referred to in items 1) to 4), over the last three financial years on the basis of the amounts at the end of each of the respective financial years:
  8. loans (the outstanding amount);
  9. advances;
  10. interest bearing securities, including government bonds;
  11. lease assets; = the dividend component, which is the annual average over the last three financial years of the credit institution’s dividend income from investments in equity instruments and funds reported on an individual basis in the financial statements of the credit institution, including dividend income from non-consolidated subsidiary undertakings, associates and joint ventures. (3) For the purposes of paragraph (1) of this Article, the services component shall be calculated in accordance with the following formula: 𝑆𝑆 = 𝑚𝑚𝑚𝑚𝑚𝑚( , ) + 𝑚𝑚𝑚𝑚𝑚𝑚( , ) where: SC = the services component; OI = the other operating income, which is the annual average over the last three financial years of the credit institution’s income from ordinary banking operations not included in other items of the business indicator but of similar nature; OE = the other operating expenses, which is the annual average over the last three financial years of the credit institution’s expenses and losses from ordinary banking operations not included in other items of the business indicator but of similar nature, and from operational risk events;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 436 FI = the fee and commission income component, which is the annual average over the last three financial years of the credit institution’s income received from providing advice and services, including income received by the credit institution as an outsourcer of financial services; FE = the fee and commission expenses component, which is the annual average over the last three financial years of the credit institution’s expenses paid for receiving advice and services, including outsourcing fees paid by the credit institution for the supply of financial services, but excluding outsourcing fees paid for the supply of non-financial services. (4) For the purposes of paragraph (1) of this Article, the financial component shall be calculated in accordance with the following formula: = 𝑇𝑇 + 𝐵𝐵 where: = the financial component; 𝑇𝑇 = the trading book component, which is the annual average of the absolute values over the last three financial years of the net profit or loss, as applicable, on the credit institution’s trading book, determined as appropriate either in accordance with accounting standards or in accordance with Subtitle 3 Title I of this Part, including from trading assets and trading liabilities, from hedge accounting and from exchange differences; 𝐵𝐵 = the banking book component, which is the annual average of the absolute values over the last three financial years of the net profit or loss, as applicable, on the credit institution’s non-trading book, including from financial assets and liabilities measured at fair value through profit and loss, from hedge accounting, from exchange differences and from realised gains and losses on financial assets and liabilities not measured at fair value through profit and loss. (5) A credit institution shall not use any of the following elements in the calculation of their business indicator:

  1. income and expenses from insurance or reinsurance business;
  2. premiums paid and payments received from insurance or reinsurance policies purchased;
  3. administrative expenses, including staff expenses, outsourcing fees paid for the supply of non-financial services, and other administrative expenses;
  4. recovery of administrative expenses including recovery of payments on behalf of customers;
  5. expenses of premises and fixed assets, except where those expenses result from operational risk events;
  6. depreciation of tangible assets and amortisation of intangible assets, except the depreciation related to operating lease assets, which shall be included in financial and operating lease expenses;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 437 7) provisions and reversal of provisions, except where those provisions relate to operational risk events; 8) expenses due to share capital repayable on demand; 9) impairment and reversal of impairment; 10)changes in goodwill recognised in profit or loss; 11)corporate income tax. (6) Where a credit institution has been in operation for less than three years, it shall use forward-looking business estimates in calculating the relevant components of its business indicator, subject to the satisfaction of the Central Bank, provided that the credit institution shall start using historical data as soon as that data are available. Adjustments to the business indicator Article 403 (1) A credit institution shall include business indicator items of amalgamated, merged or acquired entities or activities in their business indicator calculation from the time of the amalgamation or merger or acquisition, as applicable, and shall cover the last three financial years. (2) A credit institution may request authorisation from the Central Bank to exclude from the business indicator amounts related to disposed entities or activities. SUBTITLE 2 – Data collection and governance Calculation of the annual operational risk loss Article 404 (1) A credit institution with a business indicator equal to or exceeding EUR 75,000,000 shall calculate its annual operational risk loss as the sum of all net losses over a given financial year, calculated in accordance with Article 406 paragraph (1) of this Decision, that are equal to or exceed the loss data thresholds set out in Article 407 paragraph (1) of this Decision. (2) By way of derogation from paragraph (1) of this Article, the Central Bank may grant a waiver from the requirement to calculate an annual operational risk loss to a credit institution with a business indicator that does not exceed EUR 100,000,000, provided that the credit institution has demonstrated to the satisfaction of the Central Bank that it would be unduly burdensome for the credit institution to apply paragraph (1) of this Article. (3) For the purposes of paragraph (1) of this Article, the relevant business indicator shall be the highest value of the business indicator that the credit institution has reported at the last eight reporting reference dates. (4) A credit institution that has not yet reported its business indicator shall use its most recent business indicator.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 438 Loss data set Article 405 (1) A credit institution that calculates annual operational risk loss in accordance with Article 404 paragraph (1) of this Decision shall have in place arrangements, processes and mechanisms to establish and maintain updated on an ongoing basis a loss data set compiling for each of the following recorded operational risk event:

  1. the gross loss amounts;
  2. non-insurance recoveries;
  3. insurance recoveries;
  4. reference dates and grouped losses;
  5. losses from misconduct events. (2) The credit institution’s loss data set shall capture all operational risk events stemming from all entities that are part of the scope of consolidation. (3) For the purpose of paragraph (1) of this Article, a credit institution shall:
  6. include in the loss data set each operational risk event recorded during one or multiple financial years;
  7. use the date of accounting for including losses related to operational risk events in the loss data set;
  8. allocate losses and recoveries related to a common operational risk event or related operational risk events over time and posted to the accounts over several years, to the corresponding financial years of the loss data set, in line with their accounting treatment. (4) A credit institution shall also collect:
  9. information about the reference dates of operational risk events, including: − the date when the operational risk event happened or first began (“date of occurrence”); − the date on which the credit institution became aware of the operational risk event (“date of discovery”); − the date or dates on which an operational risk event results in a loss, or the reserve or provision against a loss, recognised in the credit institution’s profit and loss accounts (“date of accounting”);
  10. information on any recoveries of gross loss amounts as well as descriptive information about the drivers or causes of the loss events. (5) The level of detail of any descriptive information referred to in paragraph (4) of this Article shall be commensurate with the size of the gross loss amount. (6) A credit institution shall not include in the loss data set operational risk events related to credit risk that are accounted for in the risk-weighted exposure amount for credit risk. (7) A credit institution shall include in the loss data set the operational risk events that relate to credit risk but are not accounted for in the risk-weighted exposure amount for credit risk.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 439 (8) A credit institution shall treat operational risk events related to market risk as operational risk, and it shall include them in the loss data set. (9) A credit institution shall, upon request from the Central Bank, be able to map its historical internal loss data to the event type. (10) For the purposes of this Article, a credit institution shall ensure the soundness, robustness and performance of their IT systems and infrastructure necessary to maintain and update the loss data set, in particular by ensuring all of the following:

  1. its IT systems and infrastructure are sound and resilient and that that soundness and resilience can be maintained on a continuous basis;
  2. its IT systems and infrastructure are subject to configuration management, change management and release management processes;
  3. where a credit institution outsources parts of the maintenance of its IT systems and infrastructure, the soundness, robustness and performance of the IT systems and infrastructure is ensured by confirming at least the following: − its IT systems and infrastructure are sound and resilient and that soundness and resilience can be maintained on a continuous basis; − the process for planning, creating, testing and deploying the IT systems and infrastructure is sound and proper with reference to project management, risk management, governance, engineering, quality assurance and test planning, systems’ modelling and development, quality assurance in all activities, including code reviews and, where appropriate, code verification, and testing, including user acceptance; − its IT systems and infrastructure are subject to configuration management, change management and release management processes; − the process for planning, creating, testing and deploying the IT systems and infrastructure and contingency plans is approved by the management body or senior management, and the management body and senior management are periodically informed about the IT systems and infrastructure performance. Calculation of net loss and gross loss Article 406 (1) For the purposes of Article 404 paragraph (1) of this Decision, a credit institution shall calculate for each operational risk event a net loss as follows: 𝑙𝑙 = 𝑙𝑙 − where: 𝑙𝑙 = a loss linked to an operational risk event before recoveries of any type; = one or multiple independent occurrences, related to the original operational risk event, separated in time, in which funds or inflows of economic benefits are received from a third party.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 440 (2) A credit institution shall maintain on an ongoing basis an updated calculation of the net loss for each specific operational risk event. (3) For the purposes of paragraph (2) of this Article, a credit institution shall update the net loss calculation based on the observed or estimated variations of the gross loss and the recovery for each of the last 10 financial years, and where losses, linked to the same operational risk event, are observed during multiple financial years within that 10-year time window, the credit institution shall calculate and maintain updated:

  1. the net loss, gross loss and recovery for each of the financial years of the 10- year time window where that net loss, gross loss and recovery were recorded;
  2. the aggregated net loss, aggregated gross loss and aggregated recovery of all relevant financial years of the 10-year time window. (4) For the purposes of paragraph (1) of this Article, the following items shall be included in the gross loss computation:
  3. direct charges, such as impairments, settlements, amounts paid to make good the damage, penalties and interest in arrears and legal fees, to the credit institution’s profit and loss accounts and write-offs due to the operational risk event, including: − where the operational risk event relates to market risk, the costs to unwind market positions in the recorded loss amount of the operational risk items; − where payments relate to failures or inadequate processes of the credit institution, penalties, interest charges, late-payment charges, legal fees and, with the exclusion of the tax amount originally due, tax, unless that amount is already included under item 5) of this paragraph;
  4. costs incurred as a consequence of the operational risk event, including external expenses with a direct link to the operational risk event and costs of repair or replacement, incurred to restore the position that was prevailing before the operational risk event occurred;
  5. provisions or reserves accounted for in the profit and loss accounts against the potential operational loss impact, including those from misconduct events;
  6. losses stemming from operational risk events with a definitive financial impact which are temporarily booked in transitory or suspense accounts and are not yet reflected in the profit and loss accounts (“pending losses”);
  7. negative economic impacts booked in a financial year and which are due to operational risk events impacting the cash flows or financial statements of previous financial years (“timing losses”). (5) For the purposes of paragraph (4) item 4) of this Article, a credit institution shall include material pending losses in the loss data set within a time period commensurate with the size and age of the pending item. (6) For the purposes of paragraph (4) item 5) of this Article, the credit institution shall:
  8. include in the loss data set material timing losses where those losses are due to operational risk events that span more than one financial year;
  9. include in the recorded loss amount of the operational risk item of financial year losses that are due to the correction of booking errors that occurred in any previous financial year, even where those losses do not directly affect third parties;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 441 3) where there are material timing losses and the operational risk event affects directly third parties, including customers, service providers and employees of the credit institution, the credit institution shall also include the official restatement of previously issued financial reports. (7) For the purposes of paragraph (1) of this Article, a credit institution shall exclude the following items from the gross loss computation:

  1. costs of general maintenance of contracts on property, plant or equipment;
  2. internal or external expenditure to enhance the business after the operational risk losses, including upgrades, improvements, risk assessment initiatives and enhancements;
  3. insurance premiums. (8) For the purposes of paragraph (1) of this Article, recoveries shall be used to reduce gross losses only where the credit institution has received payment, wherein receivables shall not be considered as recoveries. (9) Upon request from the Central Bank, the credit institution shall provide all documentation needed to verify the payments received and factored in the calculation of the net loss of an operational risk event. Loss data thresholds Article 407 (1) To calculate the annual operational risk loss referred to in Article 404 paragraph (1) of this Decision, a credit institution shall take into account from the loss data set operational risk events with a net loss, calculated in accordance with Article 406 of this Decision, that are equal to or exceed EUR 20,000. (2) In the case of an operational risk event that leads to losses during more than one financial year, as referred to in Article 406 paragraphs (2) and (3) of this Decision, the net loss to be taken into account for the thresholds referred to in paragraphs (1) of this Article shall be the aggregated net loss. Exclusion of losses Article 408 (1) A credit institution may request authorisation from the Central Bank to exclude from the calculation of its annual operational risk loss exceptional operational risk events that are no longer relevant to the credit institution’s risk profile, where all of the following conditions are met:
  4. the credit institution can demonstrate to the satisfaction of the Central Bank that the cause of the operational risk event at the origin of those operational risk losses will not occur again;
  5. the aggregated net loss of the corresponding operational risk event is either of the following: − equal to or exceed 10 % of the credit institution’s average annual operational risk loss, calculated over the last 10 financial years and based on the threshold referred to in Article 407 paragraph (1) of this Decision, where the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 442 operational risk loss event refers to activities that are still part of the business indicator; − related to an operational risk event that refers to activities divested from the business indicator in accordance with Article 403 paragraph (2) of this Decision; 3) the operational risk loss was in the loss database for a minimum period of one year, unless the operational risk loss is related to activities divested from the business indicator in accordance with Article 403 paragraph (2) of this Decision. (2) For the purposes of paragraph (1) item 3) of this Article, the minimum period of one year shall start from the date on which the operational risk event, included in the loss data set, first became greater than the materiality threshold provided for in Article 407 paragraph (1) of this Decision. (3) A credit institution requesting the authorisation (permission) referred to in paragraph 1 of this Article shall provide the Central Bank with documented justifications for the exclusion of an exceptional operational risk event, including:

  1. description of the operational risk event;
  2. proof that the loss from the operational risk event is above the materiality threshold for loss exclusion referred to in paragraph (1), item 2) indent 1 of this Article, including the date on which that operational risk event became greater than the materiality threshold;
  3. the date on which the operational risk event concerned would be excluded, considering the minimum retention period set out in paragraph (1), item 3) of this Article;
  4. the reason why the operational risk event is no longer deemed relevant to the credit institution’s risk profile;
  5. a demonstration that there are no similar or residual legal exposures and that the operational risk event to be excluded has no relevance to other activities or products;
  6. reports of the credit institution’s independent review or validation, confirming that the operational risk event is no longer relevant and that there are no similar or residual legal exposures;
  7. proof that the Central Bank, through the credit institution’s approval processes, has approved the request for exclusion of the operational risk event and the date of such approval;
  8. the impact of the exclusion of the operational risk event on the annual operational risk loss. Inclusion of losses from amalgamated or merged or acquired entities or activities Article 409 (1) Losses stemming from amalgamated or merged or acquired entities or activities shall be included in the loss data set as soon as the business indicator items related to those entities or activities are included in the credit institution’s business indicator calculation in accordance with Article 403 paragraph (1) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 443 (2) For the purposes of paragraph (1) of this Article, a credit institution shall include losses observed during a 10-year period prior to the acquisition or amalgamation or merger. Comprehensiveness, accuracy and quality of the loss data Article 410 (1) A credit institution shall have in place the organisation and processes to ensure the comprehensiveness, accuracy and quality of the loss data and to subject that data to independent review. (2) The Central Bank shall periodically, and at least every five years, review the quality of the loss data of a credit institution that calculates an annual operational risk loss in accordance with Article 404 paragraph (1) of this Decision, or every three years for a credit institution with a business indicator that exceeds EUR 100,000,000. Operational risk management framework Article 411 A credit institution shall have in place:

  1. a well-documented assessment and management system for operational risk which is closely integrated into day-to-day risk management processes, forms an integral part of the process of monitoring and controlling the credit institution’s operational risk profile, and for which clear responsibilities have been assigned; the assessment and management system for operational risk shall identify the credit institution’s exposures to operational risk and track relevant operational risk data, including material loss data;
  2. an operational risk management function that is independent from the credit institution’s business and operational units;
  3. a system of reporting to senior management that provides operational risk reports to relevant functions within the credit institution;
  4. a system of regular monitoring and reporting of operational risk exposures and loss experience, and procedures for taking appropriate corrective actions;
  5. procedures for ensuring compliance, and policies for the treatment of non￾compliance;
  6. regular reviews of the credit institution’s operational risk assessment and management processes and systems, carried out by internal or external auditors that possess the necessary knowledge;
  7. internal validation processes that operate in a sound and effective manner;
  8. transparent and accessible data flows and processes associated with the credit institution’s operational risk assessment system. Loss event type classification Article 412 The loss events types are the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 444 Table 1 Event-Type Category Definition Internal fraud  Losses due to acts of a type intended to defraud, misappropriate property or circumvent regulations, the law or company policy, excluding diversity/discrimination events, which involves at least one internal party; External fraud  Losses due to acts of a type intended to defraud, misappropriate property or circumvent the law, by a third party; Employment Practices and Workplace Safety  Losses arising from acts inconsistent with employment, health or safety laws or agreements;  Losses from payment of personal injury claims, or from diversity/discrimination events; Clients, Products & Business Practices  Losses arising from an unintentional or negligent failure to meet a professional obligation to specific clients (including fiduciary and suitability requirements), or from the nature or design of a product; Damage to Physical Assets  Losses arising from loss or damage to physical assets from natural disaster or other events Business disruption and system failures  Losses arising from disruption of business or system failures Execution, Delivery & Process Management  Losses from failed transaction processing or process management,  Losses from relations with trade counterparties and service provider TITLE IV – OWN FUNDS REQUIREMENTS FOR MARKET RISK SECTION 1 – General provisions Approaches for calculating the own funds requirements for market risk Article 413 (1) A credit institution shall calculate the own funds requirements for market risk for all its trading book positions and all its non-trading book positions that are subject to foreign exchange risk or commodity risk in accordance with the following approaches:

  1. the alternative standardised approach set out in Subtitle 2 of this Title;
  2. the alternative internal model approach set out in Subtitle 3 of this Title for those positions assigned to trading desks for which the credit institution has been

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 445 granted authorisation by the Central Bank to use that alternative approach as set out in Article 465 paragraph (1) of this Decision; 3) the simplified standardised approach referred to in paragraph (4) of this Article, provided that the credit institution meets the conditions set out in Article 414 paragraph (1) of this Decision. (2) By way of derogation from paragraph (1) of this Article, a credit institution shall not calculate own funds requirements for foreign exchange risk for trading book positions and non-trading book positions that are subject to foreign exchange risk where those positions are deducted from the credit institution’s own funds. (3) The credit institution shall document its use of the derogation set out in paragraph (2) of this Article, including its impact and materiality, and make the information available, upon request, to the Central Bank. (4) The own funds requirements for market risk calculated in accordance with the simplified standardised approach shall be the sum of the following own funds requirements, as applicable:

  1. the own funds requirements for position risk referred to in Subtitle 4 of this Title, multiplied by: − 1,3, for the general and specific risks of positions in debt instruments, excluding securitisation instruments as referred to in Article 501 of this Decision; − 3,5, for the general and specific risks of positions in equity instruments;
  2. the own funds requirements for foreign exchange risk referred to in Subtitle 3 of this Title, multiplied by 1,2;
  3. the own funds requirements for commodity risk referred to in Subtitle 6 of this Title, multiplied by 1,9;
  4. the own funds requirements for securitisation instruments as referred to in Article 501 of this Decision. (5) A credit institution using the alternative internal model approach referred to in paragraph (1) item 2) of this Article to calculate the own funds requirements for market risk of trading book positions and non-trading book positions that are subject to foreign exchange risk or commodity risk shall report to the Central Bank the monthly calculation of the own funds requirements for market risk using the alternative standardised approach referred to in paragraph (1) item 1) of this Article for each trading desk to which those positions have been assigned in accordance with Article 124 of this Decision. (6) A credit institution may use a combination of the alternative standardised approach referred to in paragraph (1) item 1) of this Article and the alternative internal model approach referred to in paragraph (1) item 2) of this Article on a permanent basis, provided that the total own funds requirements for market risk calculated using the alternative internal model approach represent at least 10% of the total own funds requirements for market risk. (7) On an individual basis, a credit institution shall not use either of the approaches referred to in paragraph (1) items 1) and 2) of this Article in combination with the simplified standardised approach referred to in paragraph (1) item 3) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 446 (8) At consolidated level, a credit institution may use a combination of all three approaches referred to in paragraph (1) items 1), 2), and 3) of this Article to calculate the own funds requirements for market risk in accordance with Article 415 paragraph (4) item 2) of this Decision, as long as the simplified standardised approach is not used in combination with the other two approaches within a single legal entity. (9) A credit institution shall not use the alternative internal model approach referred to in paragraph (1) item 2) of this Article, for instruments in its trading book that are securitisation positions or positions included in the alternative correlation trading portfolio (ACTP) set out in paragraphs (10) to (13) of this Article. (10) Securitisation positions and nth-to-default credit derivatives that meet all the following criteria shall be included in the ACTP:

  1. the positions are neither re-securitisation positions, nor options on a securitisation tranche, nor any other derivatives of securitisation exposures that do not provide a pro-rata share in the proceeds of a securitisation tranche;
  2. all their underlying instruments are: − single-name instruments, including single-name credit derivatives, for which a liquid two-way market exists; − commonly-traded indices based on the instruments referred to in indent 1 of this item. (11) For the purposes of paragraph (10) of this Article, a two-way market is considered to exist where there are independent bona fide offers to buy and sell, so that a price that is reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one day and settled at that price within a relatively short time conforming to trade custom. (12) Positions with any of the following underlying instruments shall not be included in the ACTP:
  3. underlying instruments that are assigned to the exposure classes referred to in Article 149 items 8) or 9) of this Decision;
  4. a claim on a special purpose entity, collateralised, directly or indirectly, by a position that, in accordance with paragraph (10) of this Article, would itself not be eligible for inclusion in the ACTP. (13) A credit institution may include in the ACTP positions that are neither securitisation positions nor nth-to-default credit derivatives but that hedge other positions in that portfolio, provided that a liquid two-way market within the meaning of paragraph (10) item 2) of this Article exists for the instrument or its underlying instruments. Conditions for using the simplified standardised approach Article 414 (1) A credit institution may calculate the own funds requirements for market risk by using the simplified standardised approach referred to in Article 431 paragraph (1) item 3) of this Decision, provided that the size of the credit institution’s on- and off￾balance-sheet business that is subject to market risk is equal to or less than each of

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 447 the following thresholds, on the basis of an assessment carried out on a monthly basis using data as of the last day of the month:

  1. 10 % of the credit institution's total assets;
  2. EUR 500,000,000. (2) A credit institution shall calculate the size of their on- and off-balance- sheet business that is subject to market risk using data as of the last day of each month in accordance with the following requirements:
  3. all the positions assigned to the trading book shall be included, except credit derivatives that are recognised as internal hedges against non-trading book credit risk exposures and the credit derivative transactions that perfectly offset the market risk of the internal hedges as referred to in Article 140 paragraph (3) of this Decision;
  4. all non-trading book positions that are subject to foreign exchange risk or commodity risk shall be included, except those positions that are excluded from the calculation of the own funds requirements for foreign exchange risk in accordance with Article 125 of this Decision or that are deducted from the credit institutions’ own funds;
  5. all positions shall be valued at their market values on that date, except for positions referred to in item 2) of this paragraph, and where the market value of a trading book position is not available on a given date, a credit institution shall take a fair value for the trading book position on that date, and where the fair value and market value of a trading book position are not available on a given date, a credit institution shall take the most recent market value or fair value for that position;
  6. all non-trading book positions that are subject to foreign exchange risk shall be considered as an overall net foreign exchange position and valued in accordance with Article 516 of this Decision;
  7. all the non-trading book positions that are subject to commodity risk shall be valued in accordance with Articles 521 and 522 of this Decision;
  8. the absolute value of the aggregated long position shall be summed with the absolute value of the aggregated short position. (3) For the purposes of paragraph (2) of this Article, the meaning of long and short positions is the same as the meaning set out in Article 119 paragraph (3) of this Decision. (4) For the purposes of paragraph (2) of this Article, the value of the aggregated long (short) position shall be equal to the sum of the values of the individual long (short) positions included in the calculation in accordance with items 1) and 2) of that paragraph. (5) A credit institution shall notify the Central Bank when they calculate, or cease to calculate, their own funds requirements for market risk in accordance with this Article. (6) A credit institution that no longer meets one or more of the conditions set out in paragraph (1) of this Article shall immediately notify the Central Bank thereof.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 448 (7) A credit institution shall cease to calculate the own funds requirements for market risk in accordance with the approach referred to in Article 413 paragraph (1) item 3) of this Decision, within three months of either of the following cases:

  1. the credit institution does not meet the condition set out in paragraph (1) item
  2. or (2) of this Article for three consecutive months; or
  3. the credit institution does not meet the condition set out in paragraph (1) item
  4. or (2) of this Article during more than 6 out of the last 12 months. (8) The Central Bank shall permit a credit institution that has ceased to calculate the own funds requirements for market risk using the approach referred to in Article 413 paragraph (1), item 3) of this Decision to start calculating the own funds requirements for market risk using that approach only where it demonstrates to the Central Bank that all of the conditions set out in paragraph (1) of this Article have been met for an uninterrupted period of one year. (9) A credit institution shall not enter into, buy or sell a position only for the purpose of complying with any of the conditions set out in paragraph (1) of this Article during the monthly assessment. Authorisation for consolidated requirements Article 415 (1) Subject to paragraph (2) of this Article, and for the purpose of calculating net positions and own funds requirements in accordance with this Title on a consolidated basis, a credit institution may use positions in one credit institution or undertaking to offset positions in another credit institution or undertaking. (2) A credit institution shall apply calculating net positions and own funds requirements in accordance with paragraph (1) of this Article with the authorisation of the Central Bank, where the following conditions are met:
  5. there is a satisfactory allocation of own funds within the group; and
  6. the regulatory, legal or contractual framework in which the credit institutions operates guarantees mutual financial support within the group. (3) An undertaking located in a third country, shall meet the following conditions in addition to those set out in paragraph (2) of this Article:
  7. such undertaking has been authorised in a third country and either satisfies the definition of a credit institution or is a recognised third-country investment firm;
  8. on an individual basis, such undertaking complies with own funds requirements equivalent to those laid down in this Decision; and
  9. no regulations exist in the third country in question which might significantly affect the transfer of funds within the group. (4) Where the Central Bank has not granted a credit institution the authorisation referred to in paragraph (2) of this Article for at least one credit institution or undertaking of the group, the following requirements shall apply for the calculation of the own funds requirements for market risk on a consolidated basis in accordance with this Title:
  10. the credit institution shall calculate net positions and own funds requirements in accordance with this Title for all positions in credit institutions or undertakings

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 449 of the group for which the credit institution has been granted the authorisation referred to in paragraph (2) of this Article, using the treatment set out in paragraph (1) of this Article; 2) the credit institution shall calculate net positions and own funds requirements in accordance with this Title individually for all positions in each credit institution or undertaking of the group for which the credit institution has not been granted the authorisation referred to in paragraph (2) of this Article; 3) the credit institution shall calculate the total own funds requirements in accordance with this Title on a consolidated basis by adding the amounts calculated in items 1) and 2) of this paragraph. (5) For the purposes of the calculation referred to in paragraph (4), items 1) and 2), a credit institution and an undertaking referred to therein shall use the same reporting currency as the reporting currency used to calculate the own funds requirements for market risk in accordance with this Title on a consolidated basis for the group. SUBTITLE 2 – Alternative standardised approach Section 1 – General provisions Scope, structure and qualitative requirements of the alternative standardised approach Article 416 (1) A credit institution shall have in place, and make available to the Central Bank, a documented set of internal policies, procedures and controls for monitoring and ensuring compliance with the requirements of this Subtitle, and any changes to those policies, procedures and controls shall be notified to the competent authorities in due course. (2) A credit institution shall calculate the own funds requirements for market risk in accordance with the alternative standardised approach for a portfolio of trading book positions or non-trading book positions that are subject to foreign exchange or commodity risk as the sum of the following three components:

  1. the own funds requirement under the sensitivities-based method set out in Section 2 of this Subtitle;
  2. the own funds requirement for the default risk set out in Section 5 of this Subtitle which is only applicable to the trading book positions referred to in that Section;
  3. the own funds requirement for residual risks set out in Section 4 of this Subtitle which is only applicable to the trading book positions referred to in that Section. (3) By way of derogation from paragraph (3) of this Article, a credit institution shall calculate the own funds requirements for market risk in accordance with the alternative standardised approach for the credit institution’s holdings of its own debt instruments as the sum of the two components referred to in paragraph (2) items 1) and 3) of this Article. (4) When calculating the own funds requirements for market risk for own debt instruments under the sensitivities-based method referred to in paragraph (2) item 1)

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 450 of this Article, the credit institution shall exclude from that calculation the risks from the credit institution’s own credit spread. (5) A credit institution shall have a risk control unit that shall:

  1. be independent from business trading units and that reports directly to senior management;
  2. be responsible for designing and implementing the alternative standardised approach;
  3. produce and analyse monthly reports on the output of the alternative standardised approach, as well as the appropriateness of the credit institution’s trading limits. (6) A credit institution shall independently review the alternative standardised approach they use for the purposes of this Subtitle to the satisfaction of the Central Bank, either as part of its regular internal auditing process, or by mandating a third￾party undertaking to conduct that review, and the outcome of such a review shall be reported to the appropriate management bodies. (7) For the purposes of the first subparagraph, ‘third-party undertaking’ means an undertaking that provides auditing or consulting services to a credit institution and that has staff with sufficient skills in the area of market risk. (8) The review of the alternative standardised approach referred to in paragraph (6) of this Article shall cover the activities of both the business trading units and of the independent risk control unit, and shall assess at least the following:
  4. the internal policies, procedures and controls for monitoring and ensuring compliance with the requirements referred to in paragraph (1) of this Article;
  5. the adequacy of the documentation of the risk management system and processes and the organisation of the risk control unit referred to in paragraph (5) of this Article;
  6. the accuracy of sensitivity computations and of the process used to derive those computations from the credit institution’s pricing models that serve as a basis for reporting profit and loss to senior management, as referred to in Article 433 of this Decision;
  7. the verification process that the credit institution employs to evaluate the consistency, timeliness and reliability of the data sources used in the calculation of the own funds requirements for market risk using the alternative standardised approach, including the independence of those data sources; (9) A credit institution shall conduct the review referred to in paragraph (8) of this Article at least once a year, or on a less frequent basis of up to every two years where the credit institution can demonstrate to the satisfaction of the Central Bank that the size, systemic importance, nature, scale and complexity of its trading book business justifies a less frequent review. (10) The Central Bank shall verify that the calculation referred to in paragraph (2) of this Article, including the implementation by a credit institution of the requirements set out in this Subtitle and in Article 414 of this Decision, is performed with integrity.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 451 Section 2 – Sensitivities – based method for calculating the own funds requirement Definitions Article 417 For the purposes of this Subtitle, the following definitions apply:

  1. risk class means one of the following categories: − general interest rate risk; − credit spread risk (CSR) for non-securitisation; − credit spread risk for securitisation not included in the alternative correlation trading portfolio (non-ACTP CSR); − credit spread risk for securitisation included in the alternative correlation trading portfolio (ACTP CSR); − equity risk; − commodity risk; − foreign exchange risk;
  2. sensitivity means the relative change in the value of a position, as a result of a change in the value of one of the relevant risk factors of the position, calculated with the credit institution's pricing model in accordance with Subsection 2 of Section 3 of this Subtitle;
  3. bucket means a sub-category of positions within one risk class with a similar risk profile to which a risk weight as defined in Subsection 1 of Section 3 of this Subtitle is assigned. Components of the sensitivities-based method Article 418 (1) A credit institution shall calculate the own funds requirement for market risk under the sensitivities-based method by aggregating the following three own funds requirements in accordance with Article 421 of this Decision:
  4. own funds requirements for delta risk which capture the risk of changes in the value of an instrument due to movements in its non-volatility related risk factors;
  5. own funds requirements for vega risk which capture the risk of changes in the value of an instrument due to movements in its volatility-related risk factors; and
  6. own funds requirements for curvature risk which capture the risk of changes in the value of an instrument due to movements in the main non-volatility related risk factors not captured by the own funds requirements for delta risk. (2) (2) For the purpose of the calculation referred to in paragraph (1) of this Article:
  7. all the positions of instruments with optionality shall be subject to the own funds requirements referred to in paragraph (1) of this Article for the risks other than exotic underlyings of the instruments as referred to in Article 434 of this Decision;
  8. all the positions of instruments without optionality shall be subject to the own funds requirements referred to in paragraph (1) item 1) of this Article for the risks other than exotic underlyings of the instruments as referred to in Article 434 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 452 (3) For the purposes of this Subtitle, instruments with optionality include, among others: calls, puts, caps, floors, swap options, barrier options and exotic options. (4) Embedded options, such as prepayment or behavioural options, shall be considered to be stand-alone positions in options for the purpose of calculating the own funds requirements for market risk. (5) For the purposes of this Subtitle, instruments whose cash flows can be written as a linear function of the underlying's notional amount shall be considered to be instruments without optionality. (6) By way of derogation from paragraph (2) item 2) of this Article, a credit institution may choose to subject all the positions of instruments without optionality to the own funds requirements referred to in paragraph (1) items 1) and 3) of this Article. (7) A credit institution that chooses to use the approach set out in paragraph (6) of this Article shall notify the Central Bank thereof at least three months before the first use, and after those three months have elapsed and provided that the Central Bank has not objected, the credit institution may use that approach until the Central Bank informs the credit institution that it is no longer permitted to do so. (8) A credit institution that wishes to stop using the approach set out in paragraph (6) of this Article shall notify the Central Bank thereof at least three months before stopping that use, and it may stop applying that approach, unless the Central Bank has objected within that three-month period. (9) When calculating the own funds requirements for non-trading book positions subject to foreign exchange risk under the sensitivities-based method, a credit institution shall use as a basis the last available accounting value of those positions. (10) By way of derogation from paragraph (9) of this Article, a credit institution may use the last available fair value of a non-trading book position that is subject to foreign exchange risk, provided that it measures all its non-trading book positions at fair value at least on a quarterly basis, and when using this derogation, a credit institution shall apply it consistently to all non-trading book positions subject to foreign exchange risk. (11) A credit institution shall update the last available value that is used as a basis for calculating the own funds requirements for foreign exchange risk in accordance with paragraphs (9) and (10) of this Article at least on a monthly basis, by reflecting the changes in the value of the foreign exchange risk factors. (12) A credit institution shall identify the currency of denomination of the item as the foreign currency whose depreciation against its reporting currency would lead to the highest impairment of the item, where all of the following conditions are met:

  1. the item is not measured at fair value;
  2. the item is subject to the risk of impairment due to foreign exchange risk;
  3. the accounting value of the item is not updated at each reporting date to reflect the changes in the exchange rate between the foreign currency and the reporting currency.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 453 (13) Where a credit institution calculates the own funds requirements for market risk on a consolidated basis, it shall identify the currency of denomination of an item as the reporting currency of the credit institution which recognises that item in its individual financial statement, where all of the following conditions are met:

  1. the item is not measured at fair value;
  2. the item is subject to the risk of impairment due to foreign exchange risk;
  3. the credit institution’s reporting currency differs from the reporting currency of the credit institution that recognises the item in its individual financial statement;
  4. the accounting value of the item is not updated at each reporting date to reflect the changes in the exchange rate between the foreign currency and the reporting currency of the credit institution recognising the item in its individual financial statement. (14) When calculating the own funds requirements for non-trading book positions subject to commodity risk under the sensitivities-based method, a credit institution shall use as a basis the latest available fair value of those positions, and it shall measure those positions at fair value at least on a monthly basis. Own funds requirements for delta and vega risks Article 419 (1) A credit institution shall apply the delta and vega risk factors described in Subsection 1 Section 3 of this Subtitle to calculate the own funds requirements for delta and vega risks. (2) A credit institution shall apply the process set out in paragraphs (3) to (8) of this Article to calculate own funds requirements for delta and vega risks. (3) For each risk class, the sensitivity of all instruments in scope of the own funds requirements for delta or vega risks to each of the applicable delta or vega risk factors included in that risk class shall be calculated by using the corresponding formulas in Subsection 2 Section 3 of this Subtitle, and if the value of an instrument depends on several risk factors, the sensitivity shall be determined separately for each risk factor. (4) Sensitivities shall be assigned to one of the buckets ‘b’ within each risk class. (5) Within each bucket ‘b’, the positive and negative sensitivities to the same risk factor shall be netted, giving rise to net sensitivities (sk) to each risk factor k within a bucket. (6) The net sensitivities to each risk factor within each bucket shall be multiplied by the corresponding risk weights set out in Section 6 of this Subtitle, giving rise to weighted sensitivities to each risk factor within that bucket in accordance with the following formula: WSk = RWk ∙ sk where: WSk = the weighted sensitivities; RWk = the risk weights; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 454 sk = the risk factor. (7) The weighted sensitivities to the different risk factors within each bucket shall be aggregated in accordance with the formula below, where the quantity within the square root function is floored at zero, giving rise to the bucket-specific sensitivity, wherein the corresponding correlations for weighted sensitivities within the same bucket (ρkl), set out in Section 6 of this Subtitle, shall be used: Kb = ��WSk 2 +�� ρkl k≠lk WSkWSI k where: Kb = the bucket-specific sensitivity; and WS = the weighted sensitivities. (8) The bucket-specific sensitivity shall be calculated for each bucket within a risk class in accordance with paragraphs (5), (6) and (7) of this Article, and once the bucket￾specific sensitivity has been calculated for all buckets, weighted sensitivities to all risk factors across buckets shall be aggregated in accordance with the formula below, using the corresponding correlations γbc for weighted sensitivities in different buckets set out in Section 6 of this Subtitle, giving rise to the risk-class specific own funds requirement for delta or vega risk: Risk-class specific own funds requirement for delta or vega risk = = ��Kb 2 b +�� γbc c≠bb SbSc where: Sb = ΣkWSk for all risk factors in bucket b, and Sc = Σk WSk in bucket c; where those values for Sb and Sc produce a negative number for the overall sum of � 𝐾𝐾𝑏𝑏 2 𝑏𝑏

  • �� ≠ 𝑏𝑏𝑏𝑏𝑏𝑏 𝑏𝑏 𝑆𝑆𝑏𝑏𝑆𝑆 a credit institution shall calculate the risk-class specific own funds requirements for delta or vega risk using an alternative specification wherein Sb = max [min (Σk WSk, Kb), – Kb] for all risk factors in bucket b and Sc = max [min (Σk WSk, Kc), – Kc] for all risk factors in bucket c. (9) The risk-class specific own funds requirements for delta or vega risk shall be calculated for each risk class in accordance with paragraphs (1) to (8) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 455 Own funds requirements for curvature risk Article 420 (1) A credit institution shall perform the calculations laid down in paragraph (3) of this Article for each risk factor of the instruments subject to the own funds requirement for curvature risk, except for the risk factors referred to in paragraph (4) of this Article. (2) For a given risk factor, a credit institution shall perform those calculations on a net basis across all the positions of the instruments subject to the own funds requirement for curvature risk that contain that risk factor. (3) For a given risk factor k included in one or more instruments referred to in paragraph (1) of this Article, a credit institution shall calculate the upward net curvature risk position of that risk factor (𝐶𝐶 𝑘𝑘

  • ) and the downward net curvature risk position of that risk factor (𝐶𝐶 𝑘𝑘 −) as follows: (𝐶𝐶 𝑘𝑘 +) = −�𝐶𝐶 𝑖𝑖

𝑖𝑖 (𝐶𝐶 𝑘𝑘 −) = −�𝐶𝐶 𝑖𝑖 − 𝑖𝑖 𝐶𝐶 𝑖𝑖

  • = 𝑖𝑖 � 𝑘𝑘 𝑅𝑅 ( 𝑐𝑐 )+ � − 𝑖𝑖( 𝑘𝑘) − 𝑅𝑅𝑅𝑅𝑘𝑘 𝑐𝑐 × 𝑖𝑖 𝐶𝐶 𝑖𝑖 − = 𝑖𝑖� 𝑘𝑘 𝑅𝑅 ( 𝑐𝑐 )− � − 𝑖𝑖( 𝑘𝑘) + 𝑅𝑅𝑅𝑅𝑘𝑘 𝑐𝑐 × 𝑖𝑖 where: 𝑖𝑖 = the index that denotes all the positions of instruments referred to in paragraph (1) of this Article and including risk factor k; 𝑘𝑘 = the current value of risk factor k; 𝑖𝑖( 𝑘𝑘) = the value of instrument i as estimated by the pricing model of the credit institution based on the current value of risk factor k; 𝑖𝑖 � 𝑘𝑘 𝑅𝑅 ( 𝑐𝑐 )+ � = the value of instrument i as estimated by the pricing model of the credit institution based on an upward shift of the value of risk factor k; 𝑖𝑖� 𝑘𝑘 𝑅𝑅 ( 𝑐𝑐 )− � = the value of instrument i as estimated by the pricing model of the credit institution based on a downward shift of the value of risk factor k; 𝑅𝑅𝑅𝑅𝑘𝑘 𝑐𝑐 = the risk weight applicable to risk factor k determined in accordance with Section 6 of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 456 𝑖𝑖 = the delta sensitivity of instrument i with respect to risk factor k, calculated in accordance with Article 431 of this Decision. (4) By way of derogation from paragraph (3) of this Article, for curves of risk factors that belong to the general interest rate risk (GIRR), credit spread risk (CSR) and commodity risk classes, a credit institution shall perform the calculations laid down in paragraph (8) of this Article at the level of the entire curve instead of at the level of each risk factor that belongs to the curve. (5) For the purposes of the calculation referred to in paragraph (3) of this Article, where 𝑘𝑘 is a curve of risk factors allocated to the general interest rate risk, credit spread risk and commodity risk classes, 𝑖𝑖 shall be the sum of the delta sensitivities to the risk factor of the curve across all tenors of the curve. (6) In order to determine a bucket-level own funds requirement for curvature risk, a credit institution shall aggregate, in accordance with the following formula the upward and downward net curvature risk positions, calculated in accordance with paragraph (3) of this Article, of all the risk factors assigned to that bucket in accordance with Section 3 Subtitle 1 of this Title:

Kb = ⎩ ⎪ ⎨ ⎪ ⎧ max(Kb +, Kb −) , where Kb

  • ≠ Kb − Kb +, where Kb
  • = Kb − i �CVRk

k

�CVRk − k

Kb −, otherwise where: 𝑏𝑏 = the index that denotes a bucket of a given risk class; 𝐾𝐾𝑏𝑏 = own funds requirements for curvature risk for bucket b; Kb + = �max (0,� max �max�CVRk +, 0� 2

  • � � pklCVRk +CVRl +ψ(CVRk +, CVRl +) kl≠k � k Kb − = �max (0,� max �max(CVRk −, 0)2 + � � pklCVRk −CVRl −ψ(CVRk −, CVRl −) kl≠k � k 𝜓𝜓( , ) = � 0, 𝑤𝑤ℎ 𝑒𝑒 < 0 𝑖𝑖 < 0 1, ℎ 𝑒𝑒 𝑘𝑘 = the intra-bucket correlations between risk factors k and l as prescribed in Subtitle 6;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 457 𝑘𝑘, 𝑙𝑙 = the indices that denote all the risk factors of instruments referred to in paragraph (1) of this Article that are assigned to bucket b; CVRk

  • = the upward net curvature risk position; CVRk − = the downward net curvature risk position; (7) By way of derogation from paragraph (6) of this Article, for the bucket-level own funds requirements for curvature risk of bucket 18 of Article 447 of this Decision, of bucket 18 of Article 450 of this Decision, of bucket 25 of Article 452 of this Decision and of bucket 11 of Article 455 of this Decision the following formula shall be used: Kb = max ��max(CVRk +, 0) 𝑘𝑘 ,�max(CVRk −, 0) 𝑘𝑘 � (8) A credit institution shall calculate the risk-class own funds requirements for curvature risk (RCCR) by aggregating all the bucket-level own funds requirements for curvature risk within a given risk class as follows: RCCR = �max �o,�Kb 2 b
  • �� γbcSbScψ(Sb, Sc) bc≠b � where: 𝑏𝑏, = the indices that denote all the buckets of a given risk class that corresponds to instruments referred to in paragraph (1) of this Article; 𝐾𝐾𝑏𝑏 = own funds requirements for curvature risk for bucket b; Sb = � � CVRk +, where Kb = Kb +, in accordance with paragraph (6) of this Article k � CVRk − k , otherwise ψ(x, y) = � 0, where x < 0 i y < 0 1, otherwise γbc = the inter-bucket correlations between buckets b and c as set out in Section 6 of this Subtitle. (9) The own funds requirement for curvature risk shall be the sum of the risk class own funds requirements for curvature risk calculated in accordance with paragraph (8) of this Article across all risk classes to which at least one risk factor of the instruments referred to in paragraph (1) of this Article belongs.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 458 Aggregation of risk-class specific own funds requirements for delta, vega and curvature risks Article 421 (1) A credit institution shall aggregate risk-class specific own funds requirements for delta, vega and curvature risks in accordance with the process set out in paragraphs (2), (3) and (4) of this Article. (2) The process to calculate the risk-class specific own funds requirements for delta, vega and curvature risks prescribed in Articles 419 and 420 of this Decision shall be performed three times per risk class, each time using a different set of correlation parameters ρkl (correlation between risk factors within a bucket) and γbc (correlation between buckets within a risk class), wherein each of those three sets shall correspond to a different scenario, as follows:

  1. the medium correlations scenario, wherein the correlation parameters ρkl and γbc remain unchanged from those specified in Section 6 of this Subtitle;
  2. the high correlations scenario, wherein the correlation parameters ρkl and γbc that are specified in Section 6 of this Subtitle shall be uniformly multiplied by 1,25, with ρkl and γbc subject to a cap at 100%;
  3. the ‘low correlations’ scenario, wherein the correlation parameters ρkl and γbc that are specified in Section 6 of this Subtitle shall be replaced by: 𝜌𝜌𝑘𝑘 = max (2 ∙ 𝜌𝜌𝑘𝑘 − 100%; 75% ∙ 𝜌𝜌𝑘𝑘 ), i 𝑏𝑏 = max (2 ∙ 𝑏𝑏 − 100%; 75% ∙ 𝑏𝑏 ), respectively. (3) A credit institution shall calculate the sum of the delta, vega and curvature risk￾class specific own funds requirements for each scenario to determine three scenario￾specific, own funds requirements. (4) The own funds requirement under the sensitivities-based method shall be the highest of the three scenario-specific own funds requirements referred to in paragraph (3) of this Article. Treatment of index instruments and other multi-underlying instruments Article 422 (1) A credit institution shall use a look-through approach for index and other multi￾underlying instruments in accordance with the following:
  4. for the purposes of calculating the own funds requirements for delta and curvature risk, a credit institution shall consider that they hold individual positions directly in the underlying constituents of the index or other multi￾underlying instruments, except for a position in an index included in the ACTP for which they shall calculate a single sensitivity to the index;
  5. a credit institution is allowed to net the sensitivities to a risk factor of a given constituent of an index instrument or other multi-underlying instrument with the sensitivities to the same risk factor of the same constituent of single name instruments, except for positions included in the ACTP;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 459 3) for the purposes of calculating the own funds requirements for vega risk, a credit institution may either directly hold individual positions in the underlying constituents of the index or other multi-underlying instrument, or calculate a single sensitivity to the underlying of that instrument, and in the latter case, a credit institution shall assign the single sensitivity to the relevant bucket as set out in Subsection 1 Section 6 of this Subtitle, as follows: − where, taking into account the weightings of that index, more than 75% of constituents in that index would be mapped to the same bucket, a credit institution shall assign the sensitivity to that bucket and treat it as a single￾name sensitivity in that bucket; − in all other cases, a credit institution shall assign the sensitivity to the relevant index bucket. (2) By way of derogation from paragraph (1) item 1) of this Article, a credit institution may calculate a single sensitivity to a position in a listed equity or credit index for the purposes of calculating the own funds requirements for delta and curvature risks provided the listed equity or credit index meets the conditions set out in paragraph (3) of this Article, and in that case, a credit institution shall assign the single sensitivity to the relevant bucket as set out in Subsection 1 Section 6 of this Subtitle as follows:

  1. where, taking into account the weightings of that listed index, more than 75% of constituents in that listed index would be mapped to the same bucket, a credit institution shall assign that sensitivity to that bucket and treated as a single￾name sensitivity in that bucket;
  2. in all other cases, a credit institution shall assign the sensitivity to the relevant listed index bucket. (3) A credit institution may use the approach set out in paragraph (2) of this Article for instruments referencing a listed equity or credit index where all of the following conditions are met:
  3. the constituents of the listed index and their respective weightings in that index are known;
  4. the listed index contains at least 20 constituents;
  5. no single constituent contained within the listed index represents more than 25% of the total market capitalisation of that index;
  6. no set comprising one tenth of the total number of constituents of the listed index, rounded up to the next integer, represents more than 60% of the total market capitalisation of that index;
  7. the total market capitalisation of all the constituents of the listed index is no less than EUR 40,000,000,000. (4) A credit institution shall use, consistently over time, only the approach set out in paragraph (1) of this Article or the approach set out in paragraph (2) of this Article for all the instruments that reference a listed equity or credit index that meets the conditions set out in paragraph (3) of this Article, and in the case of switching from one approach to another, a credit institution shall obtain prior authorisation of the Central Bank. (5) For an index or other multi-underlying instrument, the sensitivity inputs for the calculation of delta and curvature risks shall be consistent, irrespective of the approaches used for that instrument.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 460 (6) Index or multi-underlying instruments which bear other residual risks as referred to in Article 434 of this Decision shall be subject to the residual risk add-on referred to in Section 4 of this Subtitle. Treatment of collective investment undertakings Article 423 (1) A credit institution shall calculate the own funds requirements for market risk of a position in a CIU using one of the following approaches:

  1. a credit institution that meets the condition set out in Article 122 paragraph (15) item 1) of this Decision, shall calculate the own funds requirements for market risk of that position by looking through the underlying positions of the CIU, on a monthly basis, as if those positions were directly held by the credit institution;
  2. a credit institution that meets the condition set out in Article 122 paragraph (15) item 2) of this Decision, shall calculate the own funds requirements for market risk of that position by using either of the following approaches: − it shall consider the position in the CIU as a single equity position allocated to the bucket ‘other sector’ in Article 455 paragraph (1) Table 8 of this Decision; − it shall consider the limits set in the CIU’s mandate and in the relevant law. (2) For the purposes of the calculation referred to in the paragraph (1) item 2) indent 2 of this Article, the credit institution may calculate the own funds requirements for counterparty credit risk and own funds requirements for credit valuation adjustment (CVA) risk of derivative positions of the CIU using the simplified approach set out in Article 173 paragraph (5) of this Decision. (3) For the purposes of the approaches referred to in paragraph (1) item 2) of this Article the credit institution shall:
  3. apply the own funds requirements for default risk set out in Section 5 of this Subtitle and the residual risk add-on set out in Section 4 of this Subtitle to a position in a CIU, where the mandate of that CIU allows it to invest in exposures that shall be subject to those own funds requirements; when using the approach referred to in paragraph (1) item 2) indent 1 of this Article, the credit institution shall consider the position in the CIU as a single unrated equity position allocated to the bucket ‘unrated’ in in Article 438 paragraph (1) Table 2 of this Decision; and
  4. for all positions in the same CIU, use the same approach among the approaches set out in paragraph (1) item 2) of this Article to calculate the own funds requirements on a stand-alone basis as a separate portfolio. (4) By way of derogation from paragraph (1) of this Article, where a credit institution has a position in a CIU that tracks an index benchmark so that the annualised return difference between the CIU and the tracked index benchmark over the last 12 months is below 1% in absolute terms, ignoring fees and commissions, the credit institution may treat that position as a position in the tracked index benchmark, wherein a credit institution shall verify compliance with that condition when the credit institution enters into the position and, after that, at least annually.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 461 (5) Where, for the purposes of Article 4 of this Decision, data for the last 12 months are not fully available, a credit institution may, subject to authorisation from the Central Bank, use an annualised return difference from a period shorter than 12 months. (6) A credit institution may use a combination of the approaches referred to in paragraph (1) items 1) and 2), for its positions in CIUs, wherein it may use only one of those approaches for all positions in the same CIU. (7) For the purposes of paragraph (1) item 2) indent 2 of this Article, a credit institution shall calculate the own funds requirements for market risk by determining the hypothetical portfolio of the CIU that would attract the highest own funds requirements in accordance with Article 416 paragraph (2) item 1) of this Decision based on the CIU’s mandate or relevant law, taking into account the leverage to the maximum extent, where applicable. (8) The credit institution shall use the same hypothetical portfolio as the one referred to in paragraph (7) of this Article to calculate, where applicable, the own funds requirements for default risk set out in Section 5 of this Subtitle and the residual risk add-on set out in Section 4 of this Subtitle to a position in a CIU. (9) The use of the methodology developed by the credit institution to determine the hypothetical portfolios of all positions in CIUs for which the calculations referred to in paragraph (7) of this Article are used shall be approved by the Central Bank. (10) A credit institution may use the approaches referred to in paragraph (1) of this Article only where the CIU meets all of the conditions set out in Article 172 paragraph (5) of this Decision, and where the CIU does not meet all of the conditions set out in Article 172 paragraph (5) of this Decision, the credit institution shall assign its positions in that CIU to the non-trading book. (11) To calculate the own funds requirements for market risk of a CIU position in accordance with the approach set out in paragraph (1) item 1) of this Article, a credit institution may rely on a third party to perform such calculation, provided that all of the following conditions are met:

  1. the third party is one of the following: − the depository institution or the depository financial institution of the CIU, provided that the CIU exclusively invests in securities and deposits all securities at that depository institution or depository financial institution; − for CIUs not covered by indent 1 of this item, the CIU management company, provided that the CIU management company meets the criteria set out in Article 172 paragraph (5) of this Decision; − a third-party vendor on condition that the data, information or risk metrics are provided or calculated by the third parties referred to in indents 1 or 2of this item, or by another such third-party vendor;
  2. the third party provides the credit institution with the data, information or risk metrics to calculate the own funds requirement for market risk of the CIU position in accordance with the approach referred to in paragraph (1) item 1) of this Article;
  3. an external auditor of the credit institution has confirmed the adequacy of the third-party’s data, information or risk metrics referred to in item 2) of this

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 462 paragraph and the Central Bank has unrestricted access to those data, information or risk metrics upon request. Underwriting positions Article 424 (1) A credit institution may use the process set out in paragraph (2) of this Article for calculating the own funds requirements for market risk of underwriting positions of debt or equity instruments. (2) A credit institution shall apply one of the appropriate multiplying factors listed in paragraph (3) Table 1 of this Article to the net sensitivities of all the underwriting positions in each individual issuer, excluding the underwriting positions which are subscribed or sub-underwritten by third parties on the basis of formal agreements, and calculate the own funds requirements for market risk in accordance with the approach set out in this Subtitle on the basis of the adjusted net sensitivities. (3) Multiplying factors mentioned in paragraph (2) of this Article are given in the following table: Table 1 (4) For the purposes of paragraph (3) of this Article, ‘business day 0’ referred to in Table 1 means the business day on which the credit institution becomes unconditionally committed to accepting a known quantity of securities at an agreed price. (5) A credit institution shall notify the Central Bank of the application of the process set out in this Article. Section 3 – Risk factor and sensitivity definitions Subsection 1 - Risk factor definitions General interest rate risk factors Article 425 (1) For all general interest rate risk factors, including inflation risk and cross-currency basis risk, there shall be one bucket per currency, each containing different types of risk factor. Business day 0 0% Business day 1 10% Business days 2 and 3 25% Business day 4 50% Business day 5 75% After business day 5 100%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 463 (2) The delta general interest rate risk factors applicable to interest rate-sensitive instruments shall be the relevant risk-free rates per currency and per each of the following maturities: 0,25 years, 0,5 years, 1 year, 2 years, 3 years, 5 years, 10 years, 15 years, 20 years, 30 years, and a credit institution shall assign risk factors to the specified vertices by linear interpolation or by using a method that is most consistent with the pricing functions used by the independent risk control function of the credit institution to report market risk or profits and losses to senior management. (3) A credit institution shall obtain the risk-free rates per currency from money market instruments held in the trading book of the credit institution that have the lowest credit risk, such as overnight index swaps. (4) Where a credit institution cannot apply the approach referred to in paragraph (3) of this Article, the risk-free rates shall be based on one or more market-implied swap curves used by the credit institution to mark positions to market, such as the interbank offered rate swap curves. (5) Where the data on market-implied swap curves described in paragraphs (3) and (4) of this Article are insufficient, the risk-free rates may be derived from the most appropriate sovereign bond curve for a given currency. (6) Where a credit institution uses the general interest rate risk factors derived in accordance with the procedure set out in the paragraph (5) of this Article for sovereign debt instruments, the sovereign debt instrument shall not be exempted from the capital requirements for credit spread risk, and in those cases, where it is not possible to disentangle the risk-free rate from the credit spread component, the sensitivity to the risk factor shall be allocated both to the general interest rate risk and to credit spread risk classes. (7) In the case of general interest rate risk factors, each currency shall constitute a separate bucket, and a credit institution shall assign risk factors within the same bucket, but with different maturities, a different risk weight, in accordance with Section 6 of this Subtitle. (8) A credit institution shall apply additional risk factors for inflation risk to debt instruments whose cash flows are functionally dependent on inflation rates, and those additional risk factors shall consist of one vector of market-implied inflation rates of different maturities per currency, wherein for each instrument, the vector shall contain as many components as there are inflation rates used as variables by the credit institution's pricing model for that instrument. (9) A credit institution shall calculate the sensitivity of the instrument to the additional risk factor for inflation risk referred to in paragraph (8) of this Article as the change in the value of the instrument, according to its pricing model, as a result of a 1 basis item shift in each of the components of the vector, wherein each currency shall constitute a separate bucket, and within each bucket, a credit institution shall treat inflation as a single risk factor, regardless of the number of components of each vector.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 464 (10) A credit institution shall offset all sensitivities to inflation within a bucket, calculated as described in paragraph (9) of this Article, in order to give rise to a single net sensitivity per bucket. (11) Debt instruments that involve payments in different currencies shall also be subject to cross-currency basis risk between those currencies. (12) For the purposes of the sensitivities-based method, the risk factors to be applied by a credit institution shall be the cross-currency basis risk of each currency over either US dollar or euro. (13) The credit institution shall compute cross currency bases that do not relate to either basis over US dollar or basis over euro either on “basis over US dollar” or “basis over euro”. (14) Each cross-currency basis risk factor shall consist of one vector of cross-currency basis of different maturities per currency, wherein, for each debt instrument, the vector shall contain as many components as there are cross-currency bases used as variables by the credit institution's pricing model for that instrument, and each currency shall constitute a different bucket. (15) A credit institution shall calculate the sensitivity of the instrument to the cross￾currency basis risk factor as the change in the value of the instrument, according to its pricing model, as a result of a 1 basis item shift in each of the components of the vector, wherein each currency shall constitute a separate bucket, and within each bucket there shall be two possible distinct risk factors: basis over euro and basis over US dollar, regardless of the number of components there are in each cross-currency basis vector, wherein the maximum number of net sensitivities per bucket shall be two. (16) The vega general interest rate risk factors applicable to options with underlyings that are sensitive to general interest rate shall be the implied volatilities of the relevant risk-free rates as described in paragraphs (3) and (4) of this Article, which shall be assigned to buckets depending on the currency and mapped to the following maturities within each bucket: 0,5 years, 1 year, 3 years, 5 years, 10 years, wherein there shall be one bucket per currency. (17) For netting purposes, a credit institution shall consider implied volatilities linked to the same risk-free rates and mapped to the same maturities to constitute the same risk factor. (18) Where a credit institution maps implied volatilities to the maturities as referred to in this paragraph, the following requirements shall apply:

  1. where the maturity of the option is aligned with the maturity of the underlying, a single risk factor shall be considered, which shall be mapped to that maturity;
  2. where the maturity of the option is shorter than the maturity of the underlying, the following risk factors shall be considered as follows: − the first risk factor shall be mapped to the maturity of the option; − the second risk factor shall be mapped to the residual maturity of the underlying of the option at the expiry date of the option.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 465 (19) The curvature general interest rate risk factors to be applied by credit institutions shall consist of one vector of risk-free rates, representing a specific risk-free yield curve, per currency, and each currency shall constitute a different bucket, wherein, for each instrument, the vector shall contain as many components as there are different maturities of risk-free rates used as variables by the credit institution's pricing model for that instrument. (20) A credit institution shall calculate the sensitivity of the instrument to each risk factor used in the curvature risk formula in accordance with Article 420 of this Decision. (21) For the purposes of the curvature risk, a credit institution shall consider vectors corresponding to different yield curves and with a different number of components as the same risk factor, provided that those vectors correspond to the same currency. (22) A credit institution shall offset sensitivities to the same risk factor, but there shall be only one net sensitivity per bucket. (23) There shall be no curvature risk own funds requirements for inflation and cross currency basis risks. Credit spread risk factors for non-securitisation Article 426 (1) The delta credit spread risk factors to be applied by a credit institution to non￾securitisation instruments that are sensitive to credit spread shall be the issuer credit spread rates of those instruments, inferred from the relevant debt instruments and credit default swaps, and mapped to each of the following maturities: 0,5 years, 1 year, 3 years, 5 years, 10 years. (2) A credit institution shall apply one risk factor per issuer and maturity, regardless of whether those issuer credit spread rates are inferred from debt instruments or credit default swaps, wherein the buckets shall be sector buckets, as referred to in Section 6 of this Subtitle, and each bucket shall include all the risk factors allocated to the relevant sector. (3) The vega credit spread risk factors to be applied by a credit institution to options with non-securitisation underlyings that are sensitive to credit spread shall be the implied volatilities of the underlying's issuer credit spread rates inferred as laid down in paragraph (1) of this Article, which shall be mapped to the following maturities in accordance with the maturity of the option subject to own funds requirements: 0,5 years, 1 year, 3 years, 5 years, 10 years, wherein the same buckets shall be used as the buckets that were used for the delta credit spread risk for non-securitisation. (4) The curvature credit spread risk factors to be applied by a credit institution to non￾securitisation instruments shall consist of one vector of credit spread rates, representing a credit spread curve specific to the issuer, wherein for each instrument, the vector shall contain as many components as there are different maturities of credit spread rates used as variables in the credit institution’s pricing model for that instrument, wherein the same buckets shall be used as the buckets that were used for the delta credit spread risk for non-securitisation.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 466 (5) A credit institution shall calculate the sensitivity of the instrument to each risk factor used in the curvature risk formula in accordance with Article 420 of this Decision. (6) For the purposes of the curvature risk, a credit institution shall consider vectors inferred from either relevant debt instruments or credit default swaps and with a different number of components as the same risk factor, provided that those vectors correspond to the same issuer. Credit spread risk factors for securitisation Article 427 (1) A credit institution shall apply the credit spread risk factors referred to in paragraph (3) of this Article to securitisation positions that are included in the ACTP, as referred to in Article 413, paragraphs (10) to (13) of this Decision. (2) A credit institution shall apply the credit spread risk factors referred to in paragraph (7) of this Article to securitisation positions that are not included in the ACTP, as referred to in Article 413, paragraphs (10) to (13) of this Decision. (3) The buckets applicable to the credit spread risk for securitisations that are included in the ACTP shall be the same as the buckets applicable to the credit spread risk for non-securitisations, as referred to in Section 6 of this Subtitle. (4) The buckets applicable to the credit spread risk for securitisations that are not included in the ACTP shall be specific to that risk-class category, as referred to in Section 6 of this Subtitle. (5) The credit spread risk factors to be applied by a credit institution to securitisation positions that are included in the ACTP are the following:

  1. the delta risk factors shall be all the relevant credit spread rates of the issuers of the underlying exposures of the securitisation position, inferred from the relevant debt instruments and credit default swaps, and for each of the following maturities: 0,5 years, 1 year, 3 years, 5 years, 10 years.
  2. the vega risk factors applicable to options with securitisation positions that are included in the ACTP as underlyings shall be the implied volatilities of the credit spreads of the issuers of the underlying exposures of the securitisation position, inferred as described in item 1) of this paragraph, which shall be mapped to the following maturities in accordance with the maturity of the corresponding option subject to own funds requirements: 0,5 years, 1 year, 3 years, 5 years, 10 years.
  3. the curvature risk factors shall be the relevant credit spread yield curves of the issuers of the underlying exposures of the securitisation position expressed as a vector of credit spread rates for different maturities, inferred as indicated in item 1) of this paragraph; for each instrument, the vector shall contain as many components as there are different maturities of credit spread rates that are used as variables by the credit institution’s pricing model for that instrument. (6) A credit institution shall calculate the sensitivity of the securitisation position to each risk factor used in the curvature risk formula as specified in Article 420 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 467 (7) For the purposes of the curvature risk, a credit institution shall consider vectors inferred either from relevant debt instruments or credit default swaps and with a different number of components as the same risk factor, provided that those vectors correspond to the same issuer. (8) The credit spread risk factors to be applied by a credit institution to securitisation positions that are not included in the ACTP shall refer to the spread of the tranche rather than the spread of the underlying instruments and shall be the following:

  1. the delta risk factors shall be the relevant tranche credit spread rates, mapped to the following maturities, in accordance with the maturity of the tranche: 0,5 years, 1 year, 3 years, 5 years, 10 years;
  2. the vega risk factors applicable to options with securitisation positions that are not included in the ACTP as underlyings shall be the implied volatilities of the credit spreads of the tranches, each of them mapped to the following maturities in accordance with the maturity of the option subject to own funds requirements: 0,5 years, 1 year, 3 years, 5 years, 10 years;
  3. the curvature risk factors shall be the same as those described in item 1) of this paragraph; to all those risk factors, a common risk weight shall be applied, as referred to in Section 6 of this Subtitle. Equity risk factors Article 428 (1) The buckets for all equity risk factors shall be the sector buckets referred to in Section 6 of this Subtitle. (2) The equity delta risk factors to be applied by a credit institution shall be all the equity spot prices and all equity repo rates. (3) For the purposes of equity risk, a specific equity repo curve shall constitute a single risk factor, which is expressed as a vector of repo rates for different maturities, wherein for each instrument, the vector shall contain as many components as there are different maturities of repo rates that are used as variables by the credit institution’s pricing model for that instrument. (4) A credit institution shall calculate the sensitivity of an instrument to an equity risk factor as the change in the value of the instrument, according to its pricing model, as a result of a 1 basis item shift in each of the components of the vector. (5) A credit institution shall offset sensitivities to the repo rate risk factor of the same equity security, regardless of the number of components of each vector. (6) The equity vega risk factors to be applied by a credit institution to options with underlyings that are sensitive to equity shall be the implied volatilities of equity spot prices which shall be mapped to the following maturities in accordance with the maturities of the corresponding options subject to capital requirements: 0,5 years, 1 year, 3 years, 5 years, 10 years, wherein there shall be no own funds requirements for vega risk for equity repo rates. (7) The equity curvature risk factors to be applied by a credit institution to options with underlyings that are sensitive to equity are all the equity spot prices, regardless of the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 468 maturity of the corresponding options, wherein there shall be no curvature risk own funds requirements for equity repo rates. Commodity risk factors Article 429 (1) The buckets for all commodity risk factors shall be the sector buckets referred to in Section 6 of this Subtitle. (2) The commodity delta risk factors to be applied by a credit institution to commodity sensitive instruments shall be all the commodity spot prices per commodity type and per each of the following maturities: 0,25 years, 0,5 years, 1 year, 2 years, 3 years, 5 years, 10 years, 15 years, 20 years, 30 years. (3) A credit institution shall only consider two commodity prices of the same type of commodity, and with the same maturity to constitute the same risk factor where the set of legal terms regarding the delivery location are identical. (4) The commodity vega risk factors to be applied by a credit institution to options with underlyings that are sensitive to commodity shall be the implied volatilities of commodity prices per commodity type, which shall be mapped to the following maturities in accordance with the maturities of the corresponding options subject to own funds requirements: 0,5 years, 1 year, 3 years, 5 years, 10 years. (5) A credit institution shall consider sensitivities to the same commodity type and allocated to the same maturity to be a single risk factor which the credit institution shall then offset. (6) The commodity curvature risk factors to be applied by a credit institution to options with underlyings that are sensitive to commodity shall be one set of commodity prices with different maturities per commodity type, expressed as a vector, wherein for each instrument, the vector shall contain as many components as there are prices of that commodity that are used as variables by the credit institution’s pricing model for that instrument, wherein a credit institution shall not differentiate between commodity prices by delivery location. (7) The sensitivity of the instrument to each risk factor used in the curvature risk formula shall be calculated as specified in Article 420 of this Decision, wherein for the purposes of curvature risk, a credit institution shall consider vectors having a different number of components to constitute the same risk factor, provided that those vectors correspond to the same commodity type. Foreign exchange risk factors Article 430 (1) The foreign exchange delta risk factors to be applied by a credit institution to foreign exchange sensitive instruments shall be all the spot exchange rates between the currency in which an instrument is denominated and the credit institution’s reporting currency or the credit institution’s base currency where the credit institution is using a base currency in accordance with paragraph (8) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 469 (2) There shall be one bucket per currency pair, containing a single risk factor and a single net sensitivity. (3) The foreign exchange vega risk factors to be applied by a credit institution to options with underlying instruments that are sensitive to foreign exchange shall be the implied volatilities of exchange rates between currency pairs, and those implied volatilities shall be mapped to the following maturities in accordance with the maturities of the corresponding options subject to own funds requirements: 0,5 years, 1 year, 3 years, 5 years and 10 years. (4) The foreign exchange curvature risk factors to be applied by a credit institution to instruments with underlying instruments that are sensitive to foreign exchange shall be the foreign exchange delta risk factors referred to in paragraph (1) of this Article. (5) A credit institution shall not be required to distinguish between onshore and offshore variants of a currency for all foreign exchange delta, vega and curvature risk factors. (6) Where a foreign exchange rate that is the underlying of an instrument i that is subject to own funds requirements for curvature risks neither refers to the credit institution’s reporting currency nor the credit institution’s base currency, the credit institution may divide by 1,5 the corresponding components 𝐶𝐶 𝑖𝑖

  • and 𝐶𝐶 𝑖𝑖 − set out in Article 420 paragraph (3) of this Decision for which 𝑘𝑘 is the foreign exchange risk factor between one of the two currencies of the underlying instrument and the credit institution’s reporting currency or the credit institution’s base currency, as applicable. (7) Subject to authorisation from the Central Bank, a credit institution may divide by 1,5 the components 𝐶𝐶 𝑖𝑖
  • and 𝐶𝐶 𝑖𝑖 − set out in Article 420 paragraph (3) of this Decision consistently for all the foreign exchange risk factors of instruments concerning foreign exchange and subject to own funds requirement for curvature risk, provided that any foreign exchange risk factors based on the credit institution’s reporting currency or the credit institution’s base currency, as applicable, that are included in the calculation of those components are shifted simultaneously. (8) By way of derogation from paragraphs (1) and (4) of this Article, a credit institution may replace, subject to authorisation from the Central Bank, its reporting currency by another currency (‘the base currency’) in all the spot exchange rates to express the delta and curvature foreign exchange risk factors where all of the following conditions are met:
  1. the credit institution uses only one base currency;
  2. the credit institution applies the base currency consistently to all its trading book and non-trading book positions;
  3. the credit institution has demonstrated to the satisfaction of the Central Bank that: − using the chosen base currency provides an appropriate risk representation for the credit institution’s positions subject to foreign exchange risks; − the choice of base currency is compatible with the manner in which the credit institution manages those foreign exchange risks internally;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 470 − the choice of base currency is not driven primarily by the desire to reduce the credit institution’s own funds requirements; 4) the credit institution takes into account the translation risk between the reporting currency and the base currency. (9) A credit institution that has been granted the authorisation to use a base currency as set out in paragraph (8) of this Article shall convert the resulting own funds requirements for foreign exchange risk into the reporting currency using the prevailing spot exchange rate between the base currency and the reporting currency. Subsection 2 - Sensitivity definitions Delta risk sensitivities Article 431 (1) A credit institution shall calculate delta general interest rate risk (GIRR) sensitivities as follows:

  1. the sensitivities to risk factors consisting of risk-free rates shall be calculated as follows: 𝑆𝑆 𝑘𝑘𝑘𝑘 = 𝑖𝑖( 𝑘𝑘 + 0,0001, , … ) − 𝑖𝑖( 𝑘𝑘 , , … ) 0,0001 where: 𝑆𝑆 𝑘𝑘𝑘𝑘 = the sensitivities to risk factors consisting of risk-free rates; rkt = the rate of a risk-free curve k with maturity t; Vi (.) = the pricing function of instrument i; and x,y = risk factors other than rkt in the pricing function Vi;
  2. the sensitivities to risk factors consisting of inflation risk and cross-currency basis shall be calculated as follows: 𝑆𝑆 𝑗𝑗 = 𝑖𝑖� 𝑗𝑗 + 0,0001 𝑚𝑚, , 𝑧𝑧 … � − 𝑖𝑖( 𝑗𝑗 , , 𝑧𝑧 … ) 0,0001 where: 𝑆𝑆 𝑗𝑗 = the sensitivities to risk factors consisting of inflation risk and cross￾currency basis; 𝑗𝑗 = a vector of m components representing the implied inflation curve or the cross-currency basis curve for a given currency j with m being equal to the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 471 number of inflation or cross-currency related variables used in the pricing model of instrument “i”; 𝑚𝑚 = the unity matrix of dimension (1 x m); 𝑖𝑖 (.)= the pricing function of the instrument “i”; and y, z = other variables in the pricing model. (2) A credit institution shall calculate the delta credit spread risk sensitivities for all securitisation and non-securitisation positions as follows: 𝑆𝑆𝐶𝐶 𝑘𝑘𝑘𝑘 = 𝑖𝑖 (𝐶𝐶 𝑘𝑘 + 0,001, , … ) − 𝑖𝑖 (𝐶𝐶 𝑘𝑘 , , … ) 0,0001 where: 𝑆𝑆𝐶𝐶 𝑘𝑘𝑘𝑘 = the delta credit spread risk sensitivities for all securitisation and non￾securitisation positions; 𝑘𝑘 = the value of the credit spread rate of an issuer j at maturity t; 𝑖𝑖 (.) = the pricing function of instrument “i”; x,y = risk factors other than cskt in the pricing function Vi. (3) A credit institution shall calculate delta equity risk sensitivities as follows:

  1. the sensitivities to risk factors consisting of equity spot prices shall be calculated as follows: 𝑆𝑆𝑘𝑘 = 𝑖𝑖 (1,01 𝐸𝐸𝑘𝑘, , , … ) − 𝑖𝑖 ( 𝐸𝐸𝑘𝑘, , , … ) 0,01 where: Sk = the sensitivities to risk factors consisting of equity spot prices; k = a specific equity security; EQk = the value of the spot price of that equity security; Vi (.) = the pricing function of instrument “I”; and x,y = risk factors other than EQk in the pricing function Vi;
  2. the sensitivities to risk factors consisting of equity repo rates shall be calculated as follows: 𝑆𝑆 𝑘𝑘 = 𝑖𝑖� 𝑘𝑘 + 0,0001 𝑚𝑚, , 𝑧𝑧 … � − 𝑖𝑖( 𝑘𝑘 , , 𝑧𝑧 … ) 0,0001

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 472 where: 𝑆𝑆 𝑘𝑘 = the sensitivities to risk factors consisting of equity repo rates; k = the index that denotes the equity; 𝑘𝑘 = a vector of m components representing the repo term structure for a specific equity k with m being equal to the number of repo rates corresponding to different maturities used in the pricing model of instrument i; 𝑚𝑚 = the unity matrix of dimension (1 · m); Vi (.) = the pricing function of the instrument i; and y,z = risk factors other than ��𝑘𝑘𝑘𝑘 �� in the pricing function Vi; (4) A credit institution shall calculate the delta commodity risk sensitivities to each risk factor k as follows: 𝑆𝑆𝑘𝑘 = 𝑖𝑖(1,01𝐶𝐶 𝑘𝑘, , 𝑧𝑧 … ) − 𝑖𝑖(𝐶𝐶 𝑘𝑘, , 𝑧𝑧 … ) 0,01 where: Sk = the delta commodity risk sensitivities; k = a given commodity risk factor; CTYk = the value of risk factor k; 𝑖𝑖 (.) = the pricing function of instrument i as a function of risk factor i; and y,z = risk factors other than CTYk in the pricing model of instrument i. (5) A credit institution shall calculate the delta foreign exchange risk sensitivities to each foreign exchange risk factor k as follows: 𝑆𝑆𝑘𝑘 = 𝑖𝑖(1,01 𝑘𝑘, , 𝑧𝑧 … ) − 𝑖𝑖( 𝑘𝑘, , 𝑧𝑧 … ) 0,01 where: Sk = the delta foreign exchange risk sensitivities; k = a given foreign exchange risk factor; FXk = the value of the risk factor k;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 473 𝑖𝑖 (.) = the pricing function of instrument i as a function of the risk factor i; and y,z = risk factors other than FXk in the pricing model of instrument i. (6) The value of the delta foreign exchange risk sensitivity calculated in accordance with paragraph (5) of this Article corresponding to the items referred to in 418 paragraphs (12) and (13) of this Decision shall be equal to the value which those items have in the currency of denomination identified in accordance with paragraph (5) of this Article, multiplied by the spot exchange rate between the currency of denomination and the credit institution’s reporting currency. Vega risk sensitivities Article 432 (1) A credit institution shall calculate the vega risk sensitivity of an option to a given risk factor 𝑘𝑘 as follows: 𝑆𝑆𝑘𝑘 = 𝑖𝑖(1,01 ∙ 𝑣𝑣 𝑘𝑘, , ) − 𝑖𝑖(𝑣𝑣 𝑘𝑘, , ) 0,01 where: Sk = the vega risk sensitivity; k = a specific vega risk factor, consisting of an implied volatility; volk = the value of that risk factor, which should be expressed as a percentage; and x,y = risk factors other than volk in the pricing function Vi. (2) In the case of risk classes where vega risk factors have a maturity dimension, but where the rules to map the risk factors are not applicable because the options do not have a maturity, a credit institution shall map those risk factors to the longest prescribed maturity, and those options shall be subject to the residual risks add-on (3) In the case of options that do not have a strike (strike price) or barrier and options that have multiple strikes or barriers, a credit institution shall apply the mapping to strikes and maturity used internally by the credit institution to price the option, and those options shall also be subject to the residual risks add-on. (4) A credit institution shall not calculate the vega risk for securitisation tranches included in the ACTP, as referred to in Article 413 paragraphs (10) to (13) of this Decision, that do not have an implied volatility, and own funds requirements for delta and curvature risk shall be computed for those securitisation tranches.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 474 Requirements on sensitivity computations Article 433 (1) A credit institution shall derive sensitivities from the credit institution's pricing models that serve as a basis for reporting profit and loss to senior management, using the formulas set out in this Subsection. (2) By way of derogation from paragraph (1) of this Article, the Central Bank may require a credit institution that has been granted authorisation to use the alternative internal model approach set out in Subtitle 3 of this Title to use the pricing functions of the risk-measurement system of their internal model approach in the calculation of sensitivities under this Subtitle for the purposes of the calculation and the reporting requirements set out in Article 413 paragraph (3) of this Decision. (3) When calculating delta risk sensitivities of instruments with optionality as referred to in Article 418 paragraph (2) item 1) of this Decision, a credit institution may assume that the implied volatility risk factors remain constant. (4) When calculating vega risk sensitivities of instruments with optionality as referred to in Article 418 paragraph (2) item 2) of this Decision, the following requirements shall apply:

  1. for general interest rate risk and credit spread risk, a credit institution shall assume, for each currency, that the underlying instruments of the volatility risk factors for which vega risk is calculated follows either a lognormal or normal distribution in the pricing models used for those instruments;
  2. for equity risk, commodity risk and foreign exchange risk, a credit institution shall assume that the underlying instruments of the volatility risk factors for which vega risk is calculated follows a lognormal distribution in the pricing models used for those instruments. (5) A credit institution shall calculate all sensitivities except for the sensitivities to credit valuation adjustments. (6) By way of derogation from paragraph (1) of this Article, subject to the authorisation of the Central Bank, a credit institution may use alternative definitions of delta risk sensitivities in the calculation of the own funds requirements of a trading book position under this Subtitle, provided that the credit institution meets all the following conditions:
  3. those alternative definitions are used for internal risk management purposes or for the reporting of profits and losses to senior management by an independent risk control unit within the credit institution; and
  4. the credit institution demonstrates that those alternative definitions are more appropriate for capturing the sensitivities for the position than are the formulas set out in this Subsection, and that the resulting sensitivities do not materially differ from those obtained by applying formulas. (7) By way of derogation from paragraph (1) of this Article, subject to the authorisation of the Central Bank, a credit institution may calculate vega sensitivities on the basis of a linear transformation of alternative definitions of sensitivities in the calculation of the own funds requirements of a trading book position under this Subtitle, provided that the credit institution meets the following conditions:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 475

  1. those alternative definitions are used for internal risk management purposes or for the reporting of profits and losses to senior management by an independent risk control unit within the credit institution; and
  2. the credit institution demonstrates that those alternative definitions are more appropriate for capturing the sensitivities for the position than are the formulae set out in this Subsection, that the linear transformation referred to in this paragraph reflects a vega risk sensitivity, and that the resulting sensitivities do not materially differ from the ones applying those formulae. Section 4 – The residual risk add-on Own funds requirements for residual risks Article 434 (1) In addition to the own funds requirements for market risk set out in Section 2 of this Subtitle, a credit institution shall apply additional own funds requirements to instruments exposed to residual risks in accordance with this Article. (2) Instruments are considered to be exposed to residual risks where they meet any of the following conditions:
  3. the instrument references an exotic underlyings, which, for the purposes of this Subtitle, means a trading book instrument referencing an underlying exposure that is not in the scope of the delta, vega or curvature risk treatments under the sensitivities-based method laid down in Section 2 of this Subtitle or the own funds requirements for the default risk set out in Section 5 of this Subtitle;
  4. the instrument is an instrument bearing other residual risks, which, for the purposes of this Subtitle, means any of the following instruments: − an instrument that is subject to the own funds requirements for vega and curvature risk under the sensitivities-based method set out in Section 2 of this Subtitle and that generates pay-offs that cannot be replicated as a finite linear combination of plain-vanilla options with a single underlying equity price, commodity price, exchange rate, bond price, credit default swap price or interest rate swap; − an instrument that is a position that is included in the ACTP referred to in Article 413 paragraph (10) of this Decision, wherein hedges that are included in that ACTP, as referred to in Article 413 paragraph (13) of this Decision, shall not be considered. (3) A credit institution shall calculate the additional own funds requirements referred to in paragraph (1) of this Article as the sum of gross notional amounts of the instruments referred to in paragraph (2) of this Article, multiplied by the following risk weights:
  5. 1,0 % in the case of instruments referred to in paragraph (2) item 1) of this Article;
  6. 0,1 % in the case of instruments referred to in paragraph (2) item 2) of this Article. (4) By way of derogation from paragraph (1) of this Article, a credit institution shall not apply the own funds requirement for residual risks to an instrument that meets any of the following conditions:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 476

  1. the instrument is listed on a recognised exchange;
  2. the instrument is eligible for central clearing in accordance with regulations governing clearing;
  3. the instrument perfectly offsets the market risk of another position in the trading book, in which case the two perfectly matching trading book positions shall be exempted from the own funds requirement for residual risks. (5) Longevity risk, weather, natural disasters and future realised volatility shall be considered as exotic underlyings for the purposes of paragraph (2) item 1) of this Article. (6) An instrument shall not be considered as meeting the conditions set out in paragraph (2) item 2) of this Article solely on the grounds that it bears one or more of the following risks:
  4. risk arising from transactions where the delivery obligation can be fulfilled within a range of deliverable instruments and where the counterparty has the possibility to deliver the least valuable of those instruments;
  5. risk of a change in the implied volatility of an instrument with optionality, relative to the implied volatility of other instruments with optionality with the same underlying and maturity, but different moneyness;
  6. correlation risk arising from an index option, where the index meets the conditions set out in Article 422 paragraph (3) of this Decision;
  7. correlation risk arising from an option in a collective investment undertaking tracking an index benchmark, where the tracking meets the conditions set out in Article 423 paragraph (4) of this Decision and the index meets the conditions set out in Article 422 paragraph (3) of this Decision;
  8. dividend risk arising from a derivative instrument whose underlying does not consist solely of dividend payments. (7) It shall be deemed that the following instruments meet the conditions set out in paragraph (2) of this Article and that they represent residual risk-bearing instruments:
  9. options where the pay-offs depend on the path followed by the price of the underlying asset and not just its final price on the exercise date;
  10. options that start at a predefined date in the future and whose strike price is not yet determined at the time at which the option is in the trading book of the credit institution;
  11. options whose underlying is another option;
  12. options with discontinuous pay-offs;
  13. options allowing the holder to modify the strike price or other terms of the contract before the maturity of the options;
  14. options that can be exercised on a finite set of predetermined dates;
  15. options whose underlying asset is denominated in one currency but whose pay￾offs are settled in a different currency, with a predetermined exchange rate between the two currencies;
  16. multi-underlying options, excluding those referred to in paragraph (6) items 3) and 4) of this Article;
  17. options subject to behavioural risk, only where all of the following conditions are met: − the option lies with a retail client; − a significant amount of these options is held in the trading book;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 477 − the behavioural risk of these options is assessed by the credit institution to be material. Section 5 – Own funds requirements for the default risk Definitions and general provisions Article 435 (1) For the purposes of this Section, the following definitions apply:

  1. short exposure means that the default of an issuer or group of issuers leads to a gain for the credit institution, regardless of the type of instrument or transaction creating the exposure;
  2. long exposure means that the default of an issuer or group of issuers leads to a loss for the credit institution, regardless of the type of instrument or transaction creating the exposure;
  3. gross jump-to-default (gross JTD) amount means the estimated size of the loss or gain that the default of the debtor would produce for a specific exposure;
  4. net jump-to-default (net JTD) amount means the estimated size of the loss or gain that a credit institution would incur due to the default of a debtor, after offsetting between gross JTD amounts has taken place;
  5. loss given default or LGD means the loss given default of the debtor on an instrument issued by that debtor expressed as a share of the notional amount of the instrument;
  6. default risk weight means the percentage representing the estimated probability of the default of each debtor, according to the creditworthiness of that debtor. (2) Own funds requirements for the default risk shall apply to debt and equity instruments, to derivative instruments having those instruments as underlyings and to derivatives, the pay-offs or fair values of which are affected by the default of a debtor other than the counterparty to the derivative instrument itself. (3) A credit institution shall calculate default risk requirements separately for each of the following types of instruments: − non-securitisations, − securitisations that are not included in the ACTP, and − securitisations that are included in the ACTP. (4) The final own funds requirements for the default risk to be applied by a credit institution shall be the sum of all three components referred to in paragraph (3) of this Article. (5) For traded non-securitisation credit and equity derivatives, JTD amounts by individual constituents shall be determined by applying a look-through approach.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 478 Subsection 1 - Own funds requirements for the default risk for non￾securitisations Gross jump-to-default amounts Article 436 (1) A credit institution shall calculate the gross JTD amounts for each long exposure to debt instruments as follows: JTDlong = max{LGD Vnotional + P&Llong + Adjustmentlong; 0} where: JTDlong = the gross JTD amount for the long exposure; Vnotional = the notional amount of the instrument from which the exposure arises; P&Llong = a term which adjusts for gains or losses already accounted for by the credit institution due to changes in the fair value of the instrument creating the long exposure, wherein gains shall enter into the formula with a positive sign and losses shall enter into the formula with a negative sign; and P&Llong=VA- Vnotional, where the VA is the market value of the instrument from which the exposure arises for the credit institution at the time of the calculation of the gross JTD amount for that exposure. Adjustmentlong = where the instrument from which the exposure arises is a derivative instrument, the amount by which, due to the structure of the derivative instrument, the credit institution's loss in the event of default would be increased or reduced relative to the full loss on the underlying instrument; increases shall enter into the formula with a positive sign and decreases shall enter into the formula with a negative sign; Adjustmentlong=-VF where the VF is the market value of the instrument from which the exposure arises for the credit institution, calculated under the assumption that at the time of the calculation of the gross JTD amount for that exposure, the debt instrument defaulted and experienced a zero recovery rate. (2) A credit institution shall calculate the gross JTD amounts for each short exposure to debt instruments as follows: JTDshort = min{LGD Vnotional + P&Lshort + Adjustmentshort; 0}

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 479 where: JTDshort = the gross JTD amount for the short exposure; Vnotional = the notional amount of the instrument from which the exposure arises that shall enter into the formula with a negative sign; P&Lshort = a term which adjusts for gains or losses already accounted for by the credit institution due to changes in the fair value of the instrument creating the short exposure; gains shall enter into the formula with a positive sign and losses shall enter into the formula with a negative sign; P&Lshort=VA- Vnotional, where the VA is the market value of the instrument from which the exposure arises for the credit institution at the time of the calculation of the gross JTD amount for that exposure. Adjustmentshort = where the instrument from which the exposure arises is a derivative instrument, the amount by which, due to the structure of the derivative instrument, the credit institution's gain in the event of default would be increased or reduced relative to the full loss on the underlying instrument; decreases shall enter into the formula with a positive sign and increases shall enter into the formula with a negative sign. Adjustmentshort=-VF where the VF is the market value of the instrument from which the exposure arises for the credit institution, calculated under the assumption that at the time of the calculation of the gross JTD amount for that exposure, the debt instrument defaulted and experienced a zero recovery rate. (3) For the purposes of the calculation set out in paragraphs (1) and (2) of this Article, the LGD for debt instruments to be applied by a credit institution shall be the following:

  1. exposures to non-senior debt instruments shall be assigned an LGD of 100%;
  2. exposures to senior debt instruments shall be assigned an LGD of 75%;
  3. exposures to covered bonds, as referred to in Article 169 of this Decision, shall be assigned an LGD of 25%. (4) For the purposes of the calculations set out in paragraphs (1) and (2) of this Article, notional amounts shall be determined as follows:
  4. in the case of a bond, the notional amount is the face value of the bond;
  5. in the case of a sold put option on a bond, the notional amount is the notional amount of the option; in the case of a bought call option on a bond, the notional amount is 0.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 480 (5) For exposures to equity instruments, a credit institution shall calculate the gross JTD amounts as follows: JTDlong = max {LGD · Vnotional + P&Llong + Adjustmentlong; 0} JTDshort = min {LGD · Vnotional + P&Lshort + Adjustmentshort; 0} where: JTDlong = the gross JTD amount for the long exposure; Vnotional = the notional amount of the instrument from which the exposure arises; the notional amount is the fair value of the equity for cash equity instruments; for the JTDshort formula, the notional amount of the instrument shall enter into the formula with a negative sign; P&Llong = a term which adjusts for gains or losses already accounted for by the credit institution due to changes in the fair value of the instrument creating the long exposure, wherein gains shall enter into the formula with a positive sign and losses shall enter into the formula with a negative sign; P&Llong=VA- Vnotional, where the VA is the market value of the instrument from which the exposure arises for the credit institution at the time of the calculation of the gross JTD amount for that exposure; Adjustmentlong = the amount by which, due to the structure of the derivative instrument, the credit institution's loss in the event of default would be increased or reduced relative to the full loss on the underlying instrument; increases shall enter into the formula with a positive sign and decreases shall enter into the formula with a negative sign; Adjustmentlong=-VF Where VF is the market value of the instrument from which the exposure arises for the credit institution, calculated under the assumption that at the time of the calculation of the gross JTD amount for that exposure, the equity instrument experienced a full loss in value. JTDshort = the gross JTD amount for the short exposure; P&Lshort = a term which adjusts for gains or losses already accounted for by the credit institution due to changes in the fair value of the instrument creating the short exposure; gains shall enter into the formula with a positive sign and losses shall enter into the formula with a negative sign; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 481 Adjustmentshort = the amount by which, due to the structure of the derivative instrument, the credit institution's gain in the event of default would be increased or reduced relative to the full loss on the underlying instrument; decreases shall enter into the formula with a positive sign and increases shall enter into the formula with a negative sign. Adjustmentshort=-VF Where VF is the market value of the instrument from which the exposure arises for the credit institution, calculated under the assumption that at the time of the calculation of the gross JTD amount for that exposure, the equity instrument experienced a full loss in value. (6) A credit institution shall assign an LGD of 100% to equity instruments for the purposes of the calculation set out in paragraph (5) of this Article. (7) In the case of exposures to default risk arising from derivative instruments whose pay-offs in the event of default of the debtor are not related to the notional amount of a specific instrument issued by that debtor or to the LGD of the debtor or an instrument issued by that debtor, a credit institution shall use alternative methodologies to estimate the gross JTD amounts. (8) The alternative methodology to estimate the gross JTD amounts of the exposures referred to in paragraph (7) of this Article shall consist in calculating the difference between the market value of a derivative instrument as referred to in that paragraph, from which the exposure arises for the credit institution at the time of the estimation of the gross JTD amount, and the market value of that derivative instrument, calculated under the assumption that the debtor is in default at that time. (9) Where the debtor is in default at the time of the estimation, and the market value of the instrument from which the exposure arises for the credit institution at that time reflects the gain or loss resulting from the default of the debtor, the alternative methodology referred to in paragraph (7) of this Article shall consist in regarding the gross JTD amount of the exposure to be zero. (10) For the purposes of paragraphs (1) and (2) of this Article, a credit institution shall determine the notional amounts of instruments other than those referred to in paragraph (4) of this Article by use of the following formulae:

  1. for exposures to debt instruments classified as senior debt instruments or covered bonds, the notional amount of the instrument from which the exposure arises shall be: − in case of a long exposure: Notional amount = VD − VF 1 + LGD − in case of a short exposure:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 482 Notional amount = VF − VD 1 + LGD where: LGD = the LGD assigned to the debt instrument in accordance with paragraph (3) of this Article; VD = the market value of the instrument from which the exposure arises for the credit institution, calculated under the assumption that, at the time of the calculation of the gross JTD amount for that exposure, the debt instrument defaulted and experienced a recovery rate equal to (1–LGD); VF = the market value of the instrument from which the exposure arises for the credit institution, calculated under the assumption that at the time of the calculation of the gross JTD amount for that exposure, the debt instrument defaulted and experienced a zero recovery rate. 2) for exposures to debt instruments classified as non-senior debt instruments, the notional amount of the instrument from which the exposure arises shall be zero. (11) For the purposes of paragraph (5) of this Article, the notional amount of the instrument from which the exposure arises, and that is not a cash equity instrument, shall be zero. Net jump-to-default amounts Article 437 (1) A credit institution shall calculate net JTD amounts by offsetting the gross JTD amounts of short exposures and long exposures, wherein the offsetting (netting) shall only be possible between exposures to the same debtor where the short exposures have the same seniority as, or lower seniority than, the long exposures. (2) Offsetting shall be either full or partial, depending on the maturities of the offsetting exposures, and it shall be carried out as follows:

  1. offsetting shall be full where all offsetting exposures have maturities of one year or more;
  2. offsetting shall be partial where at least one of the offsetting exposures has a maturity of less than one year, in which case the size of the JTD amount of each exposure with a maturity of less than one year shall be multiplied by the ratio of the exposure's maturity relative to one year. (3) Where no offsetting is possible, gross JTD amounts shall equal net JTD amounts in the case of exposures with maturities of one year or more, and in the case of gross JTD amounts with maturities of less than one year, the gross JTD amounts with maturities of less than one year shall be multiplied by the ratio of the exposure's maturity relative to one year, with a floor of three months, to calculate net JTD amounts.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 483 (4) For the purposes of paragraphs (2) and (3) of this Article, the maturities of the derivative contracts shall be considered, rather than those of their underlying instruments, wherein cash equity exposures shall be assigned a maturity of either one year or three months, at the credit institution's discretion. (5) Where the contractual or legal terms of a derivative position having a debt or equity cash instrument as an underlying, and hedged with that debt or equity cash instrument, allow a credit institution to close out both legs of that position at the time of the expiry of the first-to-mature of the two legs with no exposure to default risk of the underlying, the net jump-to-default amount of the combined position shall be set equal to zero. Calculation of the own funds requirements for the default risk Article 438 (1) Net JTD amounts, irrespective of the type of counterparty, shall be multiplied by the default risk weights that correspond to their credit quality, as specified in the following Table: Table 2 (2) Exposures which would receive a 0% risk-weight under the Standardised Approach for credit risk in accordance with Title II, Subtitle 2 of this Part of the Decision shall receive a 0% default risk weight for the own funds requirements for the default risk. (3) The weighted net JTD shall be allocated to the following buckets: business undertakings, central governments, and local self-government units/municipalities. (4) Weighted net JTD amounts shall be aggregated within each bucket, in accordance with the following formula: DRCb = max ��� RWi ∙ net JTDi i ϵ long � − WtS ∙ �� RWi ∙ |net JTDi| i ϵ short � ; 0� where: DRCb = the own funds requirement for the default risk for bucket b; Credit quality category Default risk weight Credit quality step 1 0.5% Credit quality step 2 3% Credit quality step 3 6% Credit quality step 4 15% Credit quality step 5 30% Credit quality step 6 50% Unrated 15% Defaulted 100%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 484 i = the index that denotes an instrument belonging to bucket b; RWi = the risk weight; and WtS = a ratio recognising a benefit for hedging relationships within a bucket, which shall be calculated as follows: WtS = ∑ netJTDlong ∑ netJTDlong + ∑|netJTDshort| (5) For the purposes of calculating the DRCb and the WtS, the long positions and short positions shall be aggregated for all positions within a bucket, regardless of the credit quality step to which those positions are allocated, to produce the bucket-specific own funds requirements for the default risk. (6) The final own funds requirement for the default risk for non-securitisations shall be calculated as the simple sum of the bucket-level own funds requirements. (7) For the purposes of this Article, an exposure shall be assigned the credit quality category corresponding to the credit quality category that it would be assigned under the standardised approach for credit risk set out in Title II, Subtitle 2 of this Part of the Decision. Subsection 2 – Own funds requirements for the default risk for securitisations not included in the ACTP Jump-to-default amounts Article 439 (1) Gross jump-to-default amounts for securitisation exposures shall be their market value or, if their market value is not available, their fair value determined in accordance with the applicable accounting framework. (2) Net jump-to-default amounts shall be determined by offsetting long gross jump-to￾default amounts and short gross jump-to-default amounts, wherein the offsetting shall only be possible between securitisation exposures with the same underlying asset pool and belonging to the same tranche, and no offsetting shall be permitted between securitisation exposures with different underlying asset pools, even where the attachment and detachment points are the same. (3) Where, by decomposing or combining existing securitisation exposures, other existing securitisation exposures can be perfectly replicated, except for the maturity dimension, the exposures resulting from that decomposition or combination may be used instead of the existing securitisation exposures for the purposes of offsetting. (4) Where, by decomposing or combining existing exposures in underlying names, the entire tranche structure of an existing securitisation exposure can be perfectly replicated, the exposures resulting from that decomposition or combination may be used instead of the existing securitisation exposures for the purposes of offsetting, and, where underlying names are used in that manner, they shall be removed from the non-securitisation default risk treatment.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 485 (5) Article 437 of this Decision shall apply to both existing securitisation exposures and to securitisation exposures used in accordance with paragraph (3) or (4) of this Article, and the relevant maturities shall be those of the securitisation tranches. Calculation of the own funds requirement for the default risk for securitisations Article 440 (1) Net JTD amounts of securitisation exposures shall be multiplied by 8% of the risk weight that applies to the relevant securitisation exposure, including STS securitisations, in the non-trading book in accordance with the hierarchy of approaches set out in Section 3, Subtitle 5, Title II of this Part of the Decision and irrespective of the type of counterparty. (2) A maturity of one year shall be applied to all tranches, where risk weights are calculated in accordance with the SEC-IRBA and SEC-ERBA. (3) The risk-weighted JTD amounts for individual cash securitisation exposures shall be capped at the fair value of the position. (4) Risk-weighted net JTD amounts shall be assigned to the following buckets:

  1. one common bucket for all business undertakings, regardless of the region;
  2. 44 different buckets corresponding to one bucket per region for each of the 11 asset classes defined in paragraph (5) of this Article. (5) For the purposes of paragraph (4) of this Article, the 11 asset classes are the following:
  3. ABCP;
  4. auto loans/leases;
  5. residential mortgage-backed securities (RMBS);
  6. credit cards;
  7. commercial mortgage-backed securities (CMBS);
  8. collateralised loan obligations;
  9. collateralised debt obligations squared (CDO-squared);
  10. small and medium-sized enterprises (SMEs);
  11. student loans; 10)other retail; 11)other wholesale. (6) For the purposes of the paragraph (4) of this Article, the four regions are:
  12. Asia;
  13. Europe;
  14. North America; and
  15. The rest of the world. (7) In order to assign a securitisation exposure to a bucket, a credit institution shall rely on a classification commonly used in the market.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 486 (8) A credit institution shall assign each securitisation exposure to only one of the buckets referred to in paragraphs (5) and (6) of this Article, wherein any securitisation exposure that a credit institution cannot assign to a bucket for an asset class or region shall be assigned to the asset class ‘other retail’ or ‘other wholesale’ or to the region ‘rest of the world’, respectively. (9) Weighted net JTD amounts shall be aggregated within each bucket in the same manner as for default risk of non-securitisation exposures, using the formula referred to in Article 438 paragraph (4) of this Decision, resulting in the own funds requirement for the default risk for each bucket. (10) The final own funds requirement for the default risk for securitisations not included in the ACTP shall be calculated as the simple sum of the bucket-level own funds requirements. Subsection 3 – Own funds requirements for the default risk for securitisations included in the ACTP P Scope Article 441 (1) For the ACTP, the own funds requirements shall include the default risk for securitisation exposures and for non-securitisation hedges, wherein those hedges shall be removed from the default risk calculations for non-securitisation. (2) A credit institution shall not realise diversification benefit between the own funds requirements for the default risk for non-securitisations, the own funds requirements for the default risk for securitisations not included in the ACTP and own funds requirements for the default risk for securitisations included in the ACTP. Jump-to-default amounts for the ACTP Article 442 (1) For the purposes of this Article, the following definitions apply:

  1. decomposition with a valuation model means that a single name constituent of a securitisation is valued as the difference between the unconditional value of the securitisation and the conditional value of the securitisation assuming that single name defaults with an LGD of 100%;
  2. replication means that the individual securitisation index tranches are combined to replicate another tranche of the same index series, or to replicate an untranched position in the index series;
  3. decomposition means replicating an index by a securitisation of which the underlying exposures in the pool are identical to the single name exposures that compose the index. (2) The gross JTD amounts for securitisation exposures and non-securitisation exposures in the ACTP shall be their market value or, if their market value is not available, their fair value determined in accordance with the applicable accounting framework.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 487 (3) Nth-to-default products shall be treated as tranched products with the following attachment and detachment points:

  1. attachment point = (N – 1) / Total Names;
  2. detachment point = N / Total Names; where ‘Total Names’ shall be the total number of names (entities) in the underlying basket or pool. (4) Net JTD amounts shall be determined by offsetting long gross JTD amounts and short gross JTD amounts, wherein such offsetting shall only be possible between exposures that are otherwise identical except for maturity, and the offsetting shall only be possible as follows:
  3. for indices, index tranches and bespoke tranches, offsetting shall be possible across maturities within the same index family, series and tranche, subject to the provisions on exposures of less than one year laid down in Article 437 of this Decision; long gross JTD amounts and short gross JTD amounts that perfectly replicate each other may be offset through decomposition into single name equivalent exposures using a valuation model, and in such cases, the sum of the gross JTD amounts of the single name equivalent exposures obtained through decomposition shall be equal to the gross JTD amount of the undecomposed exposure;
  4. offsetting through decomposition as set out in item 1) of this paragraph shall not be allowed for re-securitisations or derivatives on securitisation;
  5. for indices and index tranches, offsetting shall be possible across maturities within the same index family, series and tranche by replication or by decomposition; where the long exposures and short exposures are otherwise equivalent, apart from one residual component, offsetting shall be allowed and the net JTD amount shall reflect the residual exposure;
  6. different tranches of the same index series, different series of the same index and different index families may not be used to offset each other. Calculation of the own funds requirements for the default risk for the ACTP Article 443 (1) Net JTD amounts shall be multiplied by:
  7. for non-tranched products, the default risk weights corresponding to their credit quality as specified in Article 438 paragraphs (1) and (2) of this Decision; and
  8. for tranched products, the default risk weights referred to in Article 440 paragraph (1) of this Decision. (2) Risk-weighted net JTD amounts shall be assigned to buckets that correspond to an index. (3) Weighted net JTD amounts shall be aggregated within each bucket in accordance with the following formula: DRCb = � RWi ∙ netJTDi − WtSACTP ∙ � � RWi ∙ |netJTDi| i∈short � i∈long

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 488 where: DRCb = the own funds requirement for the default risk for bucket b; i = an instrument belonging to bucket b; RWi = the risk weight; and WtSACTP = the ratio recognising a benefit for hedging relationships within a bucket, which shall be calculated in accordance with the WtS formula set out in Article 438 paragraph (4) of this Decision, but using long positions and short positions across the entire ACTP and not just the positions in the particular bucket. (4) A credit institution shall calculate the own funds requirements for the default risk for the ACTP by using the following formula: DRCACTP = max ��max{DRCb, 0} + 0,5 ∙ (min{DRCb, 0}; 0) b � where: DRCACTP = the own funds requirement for the default risk for the ACTP; and DRCb = the own funds requirement for the default risk for bucket b￾Section 6 – Risk weights and correlations Subsection 1 – Delta risk weights and correlations Risk weights for general interest rate risk Article 444 (1) For currencies not included in the most liquid currency sub-category as referred to in in Article 469 of this Decision, the risk weights of the sensitivities to the risk-free rate risk factors shall be as provided in the Table 3 of this paragraph. Table 3 Bucket Maturity Risk Weight 1 0.25 years 1.7% 2 0.5 years 1.7% 3 1 year 1.6% 4 2 years 1.3% 5 3 years 1.2% 6 5 years 1.1%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 489 (2) A credit institution shall apply a risk weight of 1.6 % to all sensitivities of inflation and to cross currency basis risk factors. (3) The risk weights of risk factors based on the currencies included in the most liquid currency sub-category as referred to in in Article 469 of this Decision, and the domestic currency of the credit institution shall be the following:

  1. for risk-free rate risk factors, the risk weights referred to in paragraph (1) Table 3 of this Article divided by √2;
  2. for inflation risk factor and cross currency basis risk factors, the risk weights referred to in paragraph 2 of this Article divided by √2. Intra bucket correlations for general interest rate risk Article 445 (1) Between two weighted sensitivities of general interest rate risk factors WSk and WSl within the same bucket, and with the same assigned maturity but corresponding to different curves, correlation ρkl shall be set at 99,90%. (2) Between two weighted sensitivities of general interest rate risk factors WSk and WSl within the same bucket, corresponding to the same curve, but having different maturities, correlation shall be set in accordance with the following formula: max �e �−ϑ |Tk−TI| min{Tk−TI} � ; 40%� where: (3) Between two weighted sensitivities of general interest rate risk factors WSk and WSl within the same bucket, corresponding to different curves and having different maturities, the correlation pkl shall be equal to the correlation parameter specified in paragraph (2) of this Article, multiplied by 99,90%. (4) Between any given weighted sensitivity of general interest rate risk factors WSk and any given weighted sensitivity of inflation risk factors WSl, the correlation shall be set at 40%. (5) Between any given weighted sensitivity of cross-currency basis risk factors WSk and any given weighted sensitivity of general interest rate risk factors WSl, including another cross-currency basis risk factor, the correlation shall be set at 0%. 7 10 years 1.1% 8 15 years 1.1% 9 20 years 1.1% 10 30 years 1.1% Tk (respectively Tl) = the maturity that relates to the risk-free rate; Θ = 3%.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 490 Correlations across buckets for general interest rate risk Article 446 (1) The parameter γbc = 50% shall be used to aggregate risk factors belonging to different buckets.

(2) The parameter γbc= 80 % shall be used to aggregate an interest rate risk factor based on a currency as referred to in Article 461 paragraph (3) of this Decision and an interest rate risk factor based on the euro. Risk weights for credit spread risk for non-securitisations Article 447 (1) Risk weights for the sensitivities to credit spread risk factors for non-securitisations shall be the same for all maturities (0,5 years, 1 year, 3 years, 5 years, 10 years) within each bucket in Table 4 of this paragraph. Table 4 Bucket number Credit quality Sector Risk weight (%) 1 All The Government of Montenegro, the Central Bank of Montenegro, central governments and central banks of Member States 0.50% 2 Credit quality step 1 to 3 Central governments, including central banks, of a third country, multilateral development banks and international organisations referred to in Article 154 paragraph (4) or Article 155 of this Decision 0.5% 3 Regional or local self-government units and public sector entities 1.0% 4 Financial sector entities including credit institutions incorporated or established by a central government, regional or local self-government and promotional lenders 5.0% 5 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 3.0% 6 Consumer goods and services, transportation and storage, administrative and support service activities 3.0% 7 Technology, telecommunications 2.0% 8 Health care, utilities, professional and technical activities 1.5% 9 Covered bonds issued by credit institutions established in Member States 1.0% 10 Credit quality step 1 Covered bonds issued by credit institutions in third countries 1,5% Credit quality 2.5%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 491 Bucket number Credit quality Sector Risk weight (%) steps 2 to 3 11 Credit quality step 4 to 6 and unrated Central government, including central banks, third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) or Article 155 of this Decision 3.0% 12 Regional or local self-government units and public sector entities 4.0% 13 Financial sector entities, including credit institutions incorporated or established by a central government, regional or local self-government units, promotional lenders and covered bonds 12.0% 14 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 7.0% 15 Consumer goods and services, transportation and storage, administrative and support service activities 8.5% 16 Technology, telecommunications 5.5% 17 Health care, utilities, professional and technical activities 5.0% 18 Other sector 12.0% 19 Listed credit indices with a majority of its individual constituents being investment grade 1.5% 20 Listed credit indices with a majority of its individual constituents being non￾investment grade or unrated 5% (2) For the purposes of this Article, an exposure shall be assigned the credit quality category corresponding to the credit quality category that it would be assigned under the standardised approach for credit risk set out in Subtitle 2, Title II of this Part of the Decision. (3) To assign a risk exposure to a sector, a credit institution shall rely on a classification that is commonly used in the market for grouping issuers by sector.

(4) A credit institution shall assign each issuer to only one of the sector buckets in Table 4 paragraph (1) of this Article, wherein risk exposures from any issuer that a credit institution cannot assign to a sector in such a manner shall be assigned to bucket 18 (Other sector) in Table 4. (5) By way of derogation from paragraphs (3) and (4) of this Article, a credit institution may assign a risk exposure of an unrated covered bond to bucket 4 where the credit institution that issued the covered bond has credit quality step 1 to 3.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 492 Intra-bucket correlations for credit spread risk for non-securitisations Article 448 (1) The correlation parameter ρkl between two sensitivities WSk and WSl within the same bucket shall be set as follows: 𝜌𝜌𝑘𝑘 = 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) ∙ 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) ∙ 𝜌𝜌𝑘𝑘 (𝑏𝑏 ) where: 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) shall be equal to 1 where the two names of sensitivities k and l are identical; it shall be equal to 35% where the two names of sensitivities k and l are in buckets 1 to 18 in Table 4 paragraph (1) Article 447 of this Decision, otherwise it shall be equal to 80%; 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) shall be equal to 1 where the two vertices of the sensitivities k and l are identical, otherwise it shall be equal to 65%; and 𝜌𝜌𝑘𝑘 (𝑏𝑏 ) shall be equal to 1 where the two sensitivities are related to the same curves, otherwise it shall be equal to 99,90%. (2) The correlation parameters referred to in paragraph (1) of this Article shall not apply to bucket 18 in Table 4 paragraph (1) Article 447 of this Decision. (3) The capital requirement for the delta risk aggregation formula within bucket 18 shall be equal to the sum of the absolute values of the net weighted sensitivities allocated to that bucket: 𝐾𝐾𝑏𝑏(𝑏𝑏 18) = �| 𝑘𝑘| 𝑘𝑘 Correlations across buckets for credit spread risk for non-securitisations Article 449 The correlation parameter γbc that applies to the aggregation of sensitivities between different buckets shall be set as follows: γbc = γbc (rating) ∙ γbc (sector) where: 𝑏𝑏 ( 𝑟𝑟) shall be equal to:

  1. 1, where buckets b and c are buckets 1 to 17 and both buckets have the same credit quality step (either credit quality step 1 to 3 or credit quality step 4 to 6); otherwise, it shall be equal to 50%; for the purposes of that calculation, bucket 1 shall be considered as belonging to the same credit quality step as buckets that have credit quality step 1 to 3;
  2. 1, where either bucket b or c is bucket 18;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 493 3) 1, where bucket b or c is bucket 19 and the other bucket has credit quality step 1 to 3; otherwise, it shall be equal to 50%; 4) 1, where bucket b or c is bucket 20 and the other bucket has credit quality step 4 to 6; otherwise, it shall be equal to 50%; 𝑏𝑏 (𝑠𝑠 𝑠𝑠 ) shall be equal to 1 where the two buckets belong to the same sector, and otherwise shall be equal to the corresponding percentage set out in Table 5 of this Article. Table 5 Risk weights for credit spread risk for securitisations included in the ACTP Article 450 (1) Risk weights for the sensitivities to credit spread risk factors for securitisations included in the ACTP risk factors shall be the same for all maturities (0,5 years, 1 year, 3 years, 5 years, 10 years) within each bucket and shall be specified for each bucket in Table 6 of this paragraph. Table 6 Bucket number Credit quality Sector Risk weight 1 All Central government, including central banks, of Member States 4.0% 2 Credit quality step 1 to 10 Central government, including central banks, third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) or Article 155 of this Decision 4.0% Bucket 1, 2, and 11 3 and 12 4 and 13 5 and 14 6 and 15 7 and 16 8 and 17 9 and 10 18 19 20 1, 2, and 11 75% 10% 20% 25% 20% 15% 10% 0% 45% 45% 3 and 12 5% 15% 20% 15% 10% 10% 0% 45% 45% 4 and 13 5% 15% 20% 5% 20% 0% 45% 45% 5 and 14 20% 25% 5% 5% 0% 45% 45% 6 and 15 25% 5% 15% 0% 45% 45% 7 and 16 5% 20% 0% 45% 45% 8 and 17 5% 0% 45% 45% 9 and 10 0% 45% 45% 18 0% 0% 19 75% 20

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 494 Bucket number Credit quality Sector Risk weight 3 Regional or local self-government units and public sector entities 4.0% 4 Financial sector entities including credit institutions incorporated or established by a central government, regional or local self-government and promotional lenders 8.0% 5 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 5.0% 6 Consumer goods and services, transportation and storage, administrative and support service activities 4.0% 7 Technology, telecommunications 3.0% 8 Health care, utilities, professional and technical activities 2.0% 9 Covered bonds issued by credit institutions established in Member States 3.0% 10 Covered bonds issued by credit institutions in third countries 6.0% 11 Credit quality step 11 to 17 Central government, including central banks, third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) or Article 155 of this Decision 13.0% 12 Regional or local self-government units and public sector entities 13.0% 13 Financial sector entities including credit institutions incorporated or established by a central government, regional or local self-government and promotional lenders 16.0% 14 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 10.0% 15 Consumer goods and services, transportation and storage, administrative and support service activities 12.0% 16 Technology, telecommunications 12.0% 17 Health care, utilities, professional and technical activities 12.0% 18 Other sector 13.0% (2) For the purposes of this Article, an exposure shall be assigned the credit quality step corresponding to the credit quality step that it would be assigned under the standardised approach for credit risk set out in Subtitle 2, Title II of this Part of the Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 495 (3) By way of derogation from paragraph (2) of this Article, a credit institution may assign a risk exposure of an unrated covered bond to bucket 4 where the credit institution that issues the covered bond has a credit quality step 1 to 3. Correlations for credit spread risk for securitisations included in the ACTP Article 451 (1) The delta risk correlation ρkl shall be derived in accordance with Article 448 of this Decision, except that, for the purposes of this paragraph, 𝜌𝜌𝑘𝑘 (𝑏𝑏 𝑠𝑠) shall be equal to 1 where the two sensitivities are related to the same curves, otherwise it shall be equal to 99,00%. (2) The correlation γbc shall be derived in accordance with Article 449 of this Decision. Risk weights for credit spread risk for securitisations not included in the ACTP Article 452 (1) Risk weights for the sensitivities to credit spread risk factors for securitisation not included in the ACTP shall be the same for all maturities (0,5 years, 1 year, 3 years, 5 years, 10 years) within each bucket and shall be specified for each bucket in in Table 7 of this paragraph. Table 7 Bucket number Credit quality Sector Risk weight 1 Senior and credit quality step 1 to 10 RMBS – Prime 0.9% 2 RMBS – Mid-Prime 1.5% 3 RMBS – Sub-Prime 2.0% 4 CMBS 2.0% 5 Asset backed securities (ABS) — Student loans 0.8% 6 ABS — Credit cards 1.2% 7 ABS — Auto 1.2% 8 Collateralised loan obligations (CLO) non-ACTP 1.4% 9 Non-senior and credit quality step 1 to 10 RMBS – Prime 1.125% 10 RMBS – Mid-Prime 1.875% 11 RMBS – Sub-Prime 2.5% 12 Credit quality step 11 to 17 and unrated CMBS 2.5% 13 ABS — Student loans 1% 14 ABS — Credit cards 1.5% 15 ABS — Auto 1.5% 16 CLO non-ACTP 1.75%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 496 (2) To assign a risk exposure to a sector, a credit institution shall rely on a classification that is commonly used in the market for grouping issuers by sector. (3) A credit institution shall assign each tranche to one of the sector buckets in Table 7 paragraph (2) of this Article, wherein risk exposures from any tranche that a credit institution cannot assign to any of the buckets 1 to 24, shall be assigned to bucket 25 (Other sector). (4) For the purposes of this Article, an exposure shall be assigned the credit quality step corresponding to the credit quality step that it would be assigned under the External Rating Based Approach set out in Subtitle 5, Title II of this Part of the Decision. Intra-bucket correlations for credit spread risk for securitisations not included in the ACTP Article 453 (1) Between two sensitivities WSk and WSl within the same bucket, the correlation parameter ρkl shall be set as follows: 𝜌𝜌𝑘𝑘 = 𝜌𝜌𝑘𝑘 (𝑡𝑡 ℎ ) ∙ 𝜌𝜌𝑘𝑘 𝑡𝑡 ∙ 𝜌𝜌𝑘𝑘 𝑏𝑏 where: 𝜌𝜌𝑘𝑘 (𝑡𝑡 ℎ ) shall be equal to 1 where the two names of sensitivities k and l are within the same bucket and are related to the same securitisation tranche (more than 80% overlap in notional terms), otherwise it shall be equal to 40%; 𝜌𝜌𝑘𝑘 𝑡𝑡 shall be equal to 1 where the two vertices of the sensitivities k and l are identical, otherwise it shall be equal to 80%; and 𝜌𝜌𝑘𝑘 𝑏𝑏 shall be equal to 1 where the two sensitivities are related to the same curves, otherwise it shall be equal to 99,90%. (2) The correlation parameters referred to in paragraph 1 shall not apply to bucket 25 in Table 7 paragraph (1) Article 452 of this Decision. 17 RMBS – Prime 1.575% 18 RMBS – Mid-Prime 2.625% 19 RMBS – Sub-Prime 3.5% 20 CMBS 3.5% 21 ABS — Student loans 1.4% 22 ABS — Credit cards 2.1% 23 ABS — Auto 2.1% 24 CLO non-ACTP 2.45% 25 Other sector 3.5%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 497 (3) The own funds requirement for the delta risk aggregation formula within bucket 25 shall be equal to the sum of the absolute values of the net weighted sensitivities allocated to that bucket: Kb(bucket 25) = �|WSk| k Correlations across buckets for credit spread risk for securitisations not included in the ACTP Article 454 (1) The correlation parameter γbc shall apply to the aggregation of sensitivities between different buckets and shall be set at 0%. (2) The own funds requirement for bucket 25 shall be added to the overall risk class level capital, with no diversification or hedging effects recognised with any other bucket. Risk weights for equity risk Article 455 (1) Risk weights for the sensitivities to equity and equity repo rate risk factors shall be specified for each bucket in Table 8 of this Article. Table 8 Bucket number Market capitalisation Economy Sector Risk weight for equity spot price Risk weight for equity repo rate 1 Large Emerging market economy Consumer goods and services, transportation and storage, administrative and support service activities, healthcare, utilities 55% 0.55% 2 Telecommunications, industrials 60% 0.60% 3 Basic materials, energy, agriculture, manufacturing, mining and quarrying 45% 0.45% 4 Financials including government-backed financials, real estate activities, technology 55% 0.55% 5 Advanced economy Consumer goods and services, transportation and storage, administrative and support service activities, healthcare, utilities 30% 0.30% 6 Telecommunications, industrials 35% 0.35%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 498 (2) When assigning a risk exposure to a sector, a credit institution shall rely on a classification that is commonly used in the market for grouping issuers by sector. (3) A credit institution shall assign each issuer to one of the sector buckets in Table 8 paragraph (1) of this Article and shall assign all issuers from the same industry to the same sector. (4) Risk exposures from any issuer that a credit institution cannot assign to a sector in such a manner shall be assigned to bucket 11 in Table 8 paragraph (1) of this Article. (5) Multinational or multi-sector equity issuers shall be assigned to a particular bucket on the basis of the most material region and sector in which the equity issuer operates. (6) For the purposes of specifying risk weights for the sensitivities to equity and equity repo rate risk factors, the following countries shall constitute advanced economies:

  1. Member States of the European Union and countries which are Parties to the Agreement on the European Economic Area;
  2. the overseas countries and territories which have special relations with Denmark, France or the Netherlands, including the Faeroe Islands and those listed in Annex II to the Treaty on the Functioning of the European Union.
  3. the following third countries: − Australia; − Canada; − Hong Kong; − Japan; − Mexico; − New Zealand; − Singapore; − Switzerland; − the United Kingdom; − the United States. 7 Basic materials, energy, agriculture, manufacturing, mining and quarrying 40% 0.40% 8 Financials including government-backed financials, real estate activities, technology 50% 0.50% 9 Small Emerging market economy All sectors described under bucket numbers 1, 2, 3 and 4 70% 0.70% 10 Advanced economy All sectors described under bucket numbers 5, 6, 7 and 8 50% 0.50% 11 Other sector 70% 0,70% 12 Large market capitalisation, advanced economy indices 15% 0,15% 13 Other indices 25% 0,25%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 499 (7) For the purposes of specifying risk weights for the sensitivities to equity and equity repo rate risk factors, countries not listed in paragraph (6) of this Article shall constitute emerging markets. Intra-bucket correlations for equity risk Article 456 (1) The delta risk correlation parameter ρkl between two sensitivities WSk and WSl within the same bucket shall be set at 99,90% where one is a sensitivity to an equity spot price and the other is a sensitivity to an equity repo rate and where both sensitivities are related to the same equity issuer name. (2) In cases other than the cases referred to in paragraph (1) of this Article, the correlation parameter ρkl between two sensitivities WSk and WSl to equity spot price within the same bucket shall be set as follows:

  1. 15% between two sensitivities within the same bucket that fall under the category large market capitalisation, emerging market economy (bucket number 1, 2, 3 or 4);
  2. 25% between two sensitivities within the same bucket that fall under the category large market capitalisation, advanced economy (bucket number 5, 6, 7 or 8);
  3. 7,5% between two sensitivities within the same bucket that fall under the category small market capitalisation, emerging market economy (bucket number 9);
  4. 12,5% between two sensitivities within the same bucket that fall under the category small market capitalisation, advanced economy (bucket number 10);
  5. 80% between two sensitivities within the same bucket that fall under either index bucket (bucket number 12 or 13). (3) The correlation parameter ρkl between two sensitivities WSk and WSl to equity repo rates within the same bucket shall be set in accordance with paragraph (2) items 1) to
  6. of this Article. (4) Between two sensitivities WSk and WSl within the same bucket where one is a sensitivity to an equity spot price and the other a sensitivity to an equity repo rate and both sensitivities relate to a different equity issuer name, the correlation parameter ρkl shall be set to the correlation parameters specified in paragraph (2) of this Article, multiplied by 99,90 %. (5) The correlation parameters specified in paragraphs (1) to (4) of this Article shall not apply to bucket 11. (6) The capital requirement for the delta risk aggregation formula within bucket 11 shall be equal to the sum of the absolute values of the net weighted sensitivities allocated to that bucket: 𝐾𝐾𝑏𝑏(𝑏𝑏𝑏𝑏𝑏𝑏 𝑏𝑏 11) = �| 𝑘𝑘| 𝑘𝑘

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 500 Correlations across buckets for equity risk Article 457 (1) The correlation parameter γbc shall apply to the aggregation of sensitivities between different buckets. (2) It shall be set in relation to the buckets of Table 8 paragraph (1) Article 455 of this Decision as follows:

  1. 15% where the two buckets fall within bucket numbers 1 to 10;
  2. 0% where either of the two buckets fall within bucket number 11;
  3. 75% where the two buckets fall within bucket number 12 and 13;
  4. 45% otherwise. Risk weights for commodity risk Article 458 Risk weights for sensitivities to commodity risk factors are provided in Table 9 of this Article. Table 9 Intra-bucket correlations for commodity risk Article 459 (1) For the purposes of this Article, any two commodities shall be considered distinct commodities where there exist in the market two contracts that are differentiated only by the underlying commodity to be delivered against each contract. (2) The correlation parameter ρkl between two sensitivities WSk and WSl within the same bucket shall be set as follows: 𝜌𝜌𝑘𝑘 = 𝜌𝜌𝑘𝑘 ( 𝑐𝑐 𝑐𝑐) ∙ 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) ∙ 𝜌𝜌𝑘𝑘 (𝑏𝑏 ) where: Bucket number Bucket name Risk weight 1 Energy — solid combustibles 30% 2 Energy — liquid combustibles 35% 3 Energy — electricity 60% 3.a Energy — EU ETS carbon trading 40% 3.b Energy — non-EU ETS carbon trading 60% 4 Freight 80% 5 Metals — non-precious 40% 6 Gaseous combustibles 45% 7 Precious metals (including gold) 20% 8 Grains and oilseed 35% 9 Livestock and dairy 25% 10 Softs and other agricultural commodities 35% 11 Other commodities 50%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 501 𝜌𝜌𝑘𝑘 ( 𝑐𝑐 𝑐𝑐) shall be equal to 1 where the two commodities of sensitivities k and l are identical, otherwise it shall be equal to the intra-bucket correlations in Table 10 of this Article; 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) shall be equal to 1 where the two vertices of the sensitivities k and l are identical, otherwise it shall be equal to 99%; and 𝜌𝜌𝑘𝑘 (𝑏𝑏 ) shall be equal to 1, where the two sensitivities are identical in the delivery location of a commodity, otherwise it shall be equal to 99,90%. (3) The intra-bucket correlations 𝜌𝜌𝑘𝑘 ( 𝑐𝑐 𝑐𝑐) are: Table 10 (4) Notwithstanding paragraph (1) of this Article, the following rules apply:

  1. two risk factors that are allocated to bucket 3 in Table 10 paragraph (3) of this Article and that concern electricity which is generated in different regions or is delivered at different periods under the contractual agreement shall be considered distinct commodity risk factors;
  2. two risk factors that are allocated to bucket 4 in Table 10 paragraph (3) of this Article and that concern freight where the freight route or week of delivery differ shall be considered distinct commodity risk factors. Correlations across buckets for commodity risk Article 460 The correlation parameter γbc applying to the aggregation of sensitivities between different buckets shall be set at:
  3. 20% - where the two buckets fall within bucket numbers 1 to 10 in Table 10 paragraph (3) Article 459 of this Decision;
  4. 0% - where either of the two buckets is bucket number 11 in Table 10 paragraph (3) Article 459 of this Decision. Bucket number Bucket name Correlation 𝜌𝜌𝑘𝑘 (commodity) 1 Energy — solid combustibles 55% 2 Energy — liquid combustibles 95% 3 Energy — electricity and carbon trading 40% 4 Freight 80% 5 Metals — non-precious 60% 6 Gaseous combustibles 65% 7 Precious metals (including gold) 55% 8 Grains and oilseed 45% 9 Livestock and dairy 15% 10 Softs and other agricultural commodities 40% 11 Other commodity 15%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 502 Risk weights for foreign exchange risk Article 461 (1) A risk weight of 15% shall be applied to all sensitivities of foreign exchange risk factors. (2) The risk weight of the foreign exchange risk factors concerning currency pairs which are composed of the euro and the currency of a Member State participating in the second stage of the economic and monetary union (ERM II) shall be one of the following:

  1. the risk weight referred to in paragraph (1) of this Article, divided by 3;
  2. the maximum fluctuation within the fluctuation band formally agreed by the Member State and the European Central Bank, if that fluctuation band is narrower than the fluctuation band defined under ERM II. (3) Notwithstanding paragraph (2) of this Article, the risk weight of the foreign exchange risk factors concerning currencies referred to in paragraph (2) of this Article which participate in the ERM II with a formally agreed fluctuation band narrower than the standard band of plus or minus 15% shall equal the maximum percentage fluctuation within that narrower band. (4) The risk weight of the foreign exchange risk factors included in the most liquid currency pairs sub-category as referred to in Article 469 paragraph (8) item 3) of this Decision shall be the risk weight referred to in paragraph (1) of this Article divided by √2. (5) Where the daily exchange-rate data for the preceding three years show that a currency pair composed of euro and a non-euro currency of a Member State is constant and that the credit institution is always able to face a zero bid/ask spread on the respective trades related to that currency pair, the credit institution may apply the risk weight referred to in paragraph (1) of this Article divided by 2, provided that it has the explicit authorisation of the Central Bank to do so. Correlations for foreign exchange risk Article 462 A uniform correlation parameter γbc equal to 60% shall apply to the aggregation of sensitivities to foreign exchange risk factors. Subsection 2 – Vega and curvature risk weights and correlations Vega and curvature risk weights Article 463 (1) Buckets for vega risk factors shall be similar to the buckets established for delta risk factors in accordance with Subsection 1 Section 3 of this Subtitle. (2) Risk weights for sensitivities to vega risk factors shall be assigned in accordance with the risk class of the risk factors, in accordance with Table 1 of this paragraph.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 503 Table 1 (3) Buckets used in the context of delta risk in Subsection 1 of this Section shall be used in the curvature risk context unless specified otherwise in this Subtitle. (4) For foreign exchange and equity curvature risk factors, the curvature risk weights shall be relative shifts equal to the delta risk weights referred to in Subsection 1 of this Section. (5) For general interest rate, credit spread and commodity curvature risk factors, the curvature risk weight shall be the parallel shift of all vertices for each curve on the basis of the highest prescribed delta risk weight referred to in Subsection 1 of this Section for the relevant risk bucket. Vega and curvature risk correlations Article 464 (1) Between vega risk sensitivities within the same bucket of the general interest rate risk (GIRR) class, the correlation parameter 𝜌𝜌𝑘𝑘 shall be set as follows: ρkl = min �ρkl (option maturity) ∙ ρkl (underlying maturity) ; 1� where: ρkl (option maturity) shall be equal to −𝛼𝛼 �𝑇𝑇𝑘𝑘−𝑇𝑇𝑙𝑙� 𝑚𝑚𝑚𝑚𝑚𝑚�𝑇𝑇𝑘𝑘;𝑇𝑇𝑙𝑙� where α shall be set at 1%, Tk and Tl shall be equal to the maturities of the options for which the vega sensitivities are derived, expressed as a number of years; and ρkl (underlying maturity) is equal to −𝛼𝛼 �𝑇𝑇𝑘𝑘 𝑈𝑈−𝑇𝑇𝐼𝐼 𝑈𝑈� 𝑚𝑚𝑚𝑚𝑚𝑚�𝑇𝑇𝑘𝑘 𝑈𝑈;𝑇𝑇𝑙𝑙 𝑈𝑈� where α is set at 1%, 𝑇𝑇𝑘𝑘 𝑈𝑈 and 𝑇𝑇𝑈𝑈 shall be equal to the maturities of the underlyings of the options for which the vega sensitivities are derived, minus the maturities of the corresponding options, expressed in both cases as a number of years. Risk class Risk weights general interest rate risk (GIRR) 100% CSR non-securitisations 100% CSR securitisations (ACTP) 100% CSR securitisations (non-ACTP) 100% Equity (large capitalisation and indices) 77.78% Equity (small capitalisation and other sector) 100% Commodity 100% Foreign exchange 100%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 504 (2) Between vega risk sensitivities within a bucket of the other risk classes, the correlation parameter ρkl shall be set as follows: ρkl = min �ρkl (DELTA) ∙ ρkl (opion maturity) ; 1� where: ρkl (DELTA) shall be equal to the delta intra-bucket correlation corresponding to the bucket to which vega risk factors k and l would be allocated; and ρkl (opion maturity) shall be set in accordance with paragraph (1) of this Article. (3) With regard to vega risk sensitivities between buckets within a risk class (GIRR and non-GIRR), the same correlation parameters for γbc, as specified for delta correlations for each risk class in Section 4 of this Subtitle, shall be used in the vega risk context. (4) There shall be no diversification or hedging benefit recognised in the standardised approach between vega risk factors and delta risk factors, thus vega risk charges and delta risk charges shall be aggregated by simple summation. (5) The curvature risk correlations shall be the square of corresponding delta risk correlations ρkl and γbc referred to in Subsection 1 of this Subtitle. SUBTITLE 3 - Alternative internal model approach Section 1 - Authorisation and own funds requirements Alternative internal model approach and authorisation to use alternative internal models Article 465 (1) The alternative internal model approach may be used by a credit institution to calculate its own funds requirements for market risk, provided that the credit institution meets all of the requirements laid down in this Subtitle. (2) After having verified a credit institution' compliance with the requirements set out in Articles 473, 474 and 475 of this Decision, the Central Bank shall grant authorisation to that credit institution to calculate its own funds requirements for the portfolio of all positions assigned to trading desks by using its alternative internal models in accordance with Article 466 of this Decision, provided that all the following requirements are met:

  1. the trading desks were established in accordance with Article 124 of this Decision;
  2. the credit institution has provided to the Central Bank a rationale for the inclusion of the trading desks in the scope of the alternative internal model approach;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 505 3) the trading desks have met the back-testing requirements referred to in Article 471 paragraph (3) of this Decision; 4) the trading desks have met the profit and loss attribution (‘P&L attribution’) requirements referred to in Article 472 of this Decision; 5) for trading desks that have been assigned at least one of those trading book positions referred to in Article 477 of this Decision, the trading desks fulfil the requirements set out in Article 478 of this Decision for the internal default risk model; 6) no securitisation or re-securitisation positions have been assigned to the trading desks. 7) no positions in CIUs that meet the condition set out in Article 122 paragraph (15) item 2) of this Decision, have been assigned to the trading desks. (3) For the purposes of paragraph (2) item 2) of this Article, not including a trading desk in the scope of the alternative internal model approach shall not be motivated by the fact that the own funds requirement calculated under the alternative standardised approach set out Article 413 paragraph (5) of this Decision would be lower than the own funds requirement calculated under the alternative internal model approach. (4) A credit institution that has been granted authorisation to use the alternative internal model approach shall also meet the reporting requirement set out in Article 413 paragraph (5) of this Decision. (5) A credit institution that has been granted the authorisation referred to in paragraph (2) of this Article shall immediately notify the Central Bank that one of its trading desks no longer meets at least one of the requirements set out in that paragraph, and that credit institution shall no longer be permitted to apply provisions of this Subtitle to any of the positions assigned to that trading desk and shall calculate the own funds requirements for market risk in accordance with the approach set out in Subtitle 2 of this Title for all the positions assigned to that trading desk from the earliest reporting date and until the credit institution demonstrates to the Central Bank that the trading desk again fulfils all the requirements set out in paragraph (2) of this Article. (6) By way of derogation from paragraph (5) of this Article, in extraordinary circumstances, the Central Bank may authorise a credit institution to continue using its alternative internal models for the purpose of calculating the own funds requirements for the market risk of a trading desk that no longer meets the conditions referred to in paragraph (2) item 3) of this Article and in Article 472 paragraph (1) of this Decision. (7) For positions assigned to the trading desks for which a credit institution has not been granted authorisation as referred to in paragraph (2) of this Article, the own funds requirements for market risk shall be calculated by that credit institution in accordance with Subtitle 2 of this Title, wherein for the purposes of that calculation, all those positions shall be considered on a stand-alone basis as a separate portfolio. (8) Material changes to the use of alternative internal models that a credit institution has received authorisation to use, the extension of the use of alternative internal models that the credit institution has received authorisation to use, and material changes to the credit institution's choice of the subset of the modellable risk factors

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 506 referred to in Article 468 paragraph (2) of this Decision, shall require separate authorisation from the Central Bank. (9) A credit institution shall notify the competent authorities of all other extensions and changes to the use of the alternative internal models for which the credit institution has received authorisation.

Own funds requirements when using alternative internal models Article 466 (1) A credit institution using an alternative internal model shall calculate the own funds requirements for the portfolio of all positions assigned to the trading desks for which the credit institution has been granted authorisation as referred to in Article 465 paragraph (2) of this Decision as the higher of the following:

  1. the sum of the following values: − the credit institution's previous day's expected shortfall risk measure, calculated in accordance with Article 467 of this Decision (ESt-1), and − the credit institution's previous day's stress scenario risk measure, calculated in accordance with Section 5 of this Subtitle (SSt-1); or
  2. the sum of the following values: − the average of the credit institution's daily expected shortfall risk measure, calculated in accordance with Article 467 of this Decision for each of the preceding sixty business days (ESavg), multiplied by the multiplication factor (mc); and − the average of the credit institution's daily stress scenario risk measure, calculated in accordance with Section 5 of this Subtitle for each of the preceding sixty business days (SSavg). (2) Where calculating the own funds requirements for market risk using an internal model in accordance with the first paragraph (1) of this Article, a credit institution shall not include its own credit spreads in the calculation of the measures referred to in items 1) and 2) of that paragraph for positions in the credit institution’s own debt instruments. (3) A credit institution holding positions in traded debt and equity instruments that are included in the scope of the internal default risk model and assigned to the trading desks referred to in paragraph (1) of this Article shall fulfil an additional own funds requirement, expressed as the higher of the following values:
  3. the most recent own funds requirement for default risk, calculated in accordance with Section 3 of this Subtitle; or
  4. the average of the amount referred to in item 1) of this Article over the preceding 12 weeks. (4) By way of derogation from the paragraph (3) of this Article, a credit institution shall not be subject to the additional own funds requirement for the holdings of its own debt instruments. (5) A credit institution using an alternative internal model shall calculate the total own funds requirements for market risk for all trading book positions and all non-trading

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 507 book positions generating foreign exchange risk or commodity risk in accordance with the following formula: AIMAtotal = min (AIMA + PLAaddon + ASAnon−aima; ASAall portfolio) + max (AIMA − ; 0) where: (6) When calculating the own funds requirements for non-trading book positions subject to foreign exchange risk in accordance with the alternative internal model approach, a credit institution should use as a basis the last available accounting value of those positions. (7) By way of derogation from paragraph (6) of this Article, a credit institution may use the last available fair value of a non-trading book position that is subject to foreign exchange risk, provided that they measure all their non-trading book positions at fair value at least on a quarterly basis, wherein, when using this derogation, the credit institutions shall apply it consistently to all non-trading book positions subject to foreign exchange risk. AIMA = the sum of the own funds requirements referred to in paragraphs (1) and (4) of this Article; PLAaddon = the additional own funds requirement referred to in Article 472 paragraph (2) of this Decision; ASAnon−aima = the own funds requirements for market risk as calculated under the alternative standardised approach referred to in Article 413 paragraph (1) item 1) of this Decision, for the portfolio of trading book positions and non-trading book positions generating foreign exchange risk or commodity risk for which the credit institution uses the alternative standardised approach to calculate the own funds requirements for market risk; ASAall portfolio = the own funds requirements for market risk as calculated under the alternative standardised approach referred to in Article 413 paragraph (1) item 1) of this Decision, for the portfolio of all trading book positions and all non-trading book positions generating foreign exchange risk or commodity risk; = the own funds requirements for market risk as calculated under the alternative standardised approach referred to in Article 413 paragraph (1) item 1) of this Decision, for the portfolio of trading book positions and non-trading book positions generating foreign exchange risk or commodity risk for which the credit institution uses the approach referred to in Article 413 paragraph (1) item 2) of this Decision, to calculate the own funds requirements for market risk.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 508 (8) A credit institution should update the last available value that is used as a basis for calculating the own funds requirements for foreign exchange risk in accordance with paragraphs (6) and (7) of this Article on a daily basis, by reflecting changes in the value of the foreign exchange risk factors. (9) When updating the last available value of a non-trading book position on a daily basis, a credit institution should update the value of all risk factors for positions for which it used the derogation laid down in Article 472 paragraph (5) of this Decsion. Section 2 – General Requirements

Expected shortfall risk measure Article 467 (1) A credit institution shall calculate the expected shortfall risk measure referred to in Article 466 paragraph (1) item 1) of this Decision for any given date ‘t’ and for any given portfolio of trading book positions and non-trading book positions that are subject to foreign exchange or commodity risk as follows: ESt = ρ ∙ (UESt) + (1 − ρ) ∙ �UESt i i where: ESt = the expected shortfall risk measure; i = the index that denotes the five broad categories of risk factors listed in the first column of Table 2 of Article 469 of this Decision; UESt = the unconstrained expected shortfall measure calculated as follows: UESt = PESt RS ∙ max � PESt FC PESt RC , 1� UESt i = the unconstrained expected shortfall measure for broad risk factor category i and calculated as follows: UESt i = PESt RS,i ∙ max � PESt FC,i PESt RC,i , 1� ρ = the supervisory correlation factor across broad categories of risk; ρ = 50%; 𝑃𝑃 𝑡𝑡 𝑅𝑅 = the partial expected shortfall measure that shall be calculated for all the positions in the portfolio in accordance with Article 468 paragraph (2) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 509 (2) A credit institution shall only apply scenarios of future shocks to the specific set of modellable risk factors applicable to each partial expected shortfall measure, as set out in Article 468 of this Decision, when determining each partial expected shortfall measure for the calculation of the expected shortfall risk measure in accordance with paragraph (1) of this Article. (3) Where at least one transaction of the portfolio has at least one modellable risk factor which has been mapped to the broad risk factor category i in accordance with Article 469 of this Decision, a credit institution shall calculate the unconstrained expected shortfall measure for the broad risk factor category i and include it in the formula for the expected shortfall risk measure referred to in paragraph (1) of this Article. (4) By way of derogation from paragraph 1, a credit institution may reduce the frequency of the calculation of the unconstrained expected shortfall measures UESi t and of the partial expected shortfall measures 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 , 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 and 𝑃𝑃 𝑡𝑡 𝐹𝐹 ,𝑖𝑖 for all broad risk factor categories i from daily to weekly, provided that both of the following conditions are met:

  1. the credit institution is able to demonstrate to the Central Bank that calculating the unconstrained expected shortfall measure 𝑡𝑡 𝑖𝑖 does not underestimate the market risk of the relevant trading book positions; and
  2. the credit institution is able to increase the frequency of calculation of 𝑡𝑡 𝑖𝑖 , 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 , 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 and 𝑃𝑃 𝑆𝑆𝑡𝑡 𝐹𝐹 ,𝑖𝑖 from weekly to daily where required by the Central Bank. PESt RC = the partial expected shortfall measure that shall be calculated for all the positions in the portfolio in accordance with Article 468 paragraph (4) of this Decision; PESt FC = the partial expected shortfall measure that shall be calculated for all the positions in the portfolio in accordance with Article 468 paragraph (5) of this Decision; PESt RS,i = the partial expected shortfall measure for broad risk factor category i that shall be calculated for all the positions in the portfolio in accordance with Article 468 paragraph (2) of this Decision; PESt RC,i = the partial expected shortfall measure for broad risk factor category i that shall be calculated for all the positions in the portfolio in accordance with Article 468 paragraph (4) of this Decision; and PESt FC,i = the partial expected shortfall measure for broad risk factor category i that shall be calculated for all the positions in the portfolio in accordance with of Article 468 paragraph (5) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 510 (5) When calculating the expected shortfall risk measure referred to in this Article and the stress scenario risk measure referred to in Article 476 of this Decision, in relation to non-trading book positions subject to foreign exchange risk, a credit institution shall apply scenarios of future shocks or extreme scenarios of future shock, respectively, only to risk factors that belong to the foreign exchange broad risk factor category referred to in Article 469 paragraph (1) of this Decision. (6) A credit institution should capture in its risk-measurement model the risk of impairment due to changes in the relevant exchange rates posed by items that are subject to that risk, where those items are not measured at fair value and their accounting values are not updated at each reporting date to reflect the changes in the exchange rate between the foreign currency and the reporting currency of the credit institution recognising the item in its individual financial statement. (7) For the purposes of both, commodity and foreign exchange risks in accordance with the alternative internal model, a credit institution should use as a basis the last available fair value of those positions and measure those positions at fair value on a daily basis. (8) In relation to non-trading book positions subject to commodity risk only, when calculating the expected shortfall risk measure or the stress scenario risk measure referred to in Article 476 of this Decision, a credit institution should apply scenarios of future shocks or extreme scenarios of future shock, respectively, only to risk factors that belong to the commodity broad risk factor category referred to in Article 469 paragraph (1) of this Decision. (9) In relation to non-trading book positions subject to commodity risk and foreign exchange risk, when calculating the expected shortfall risk measure referred to in this Article 3 or the stress scenario risk measure referred to in Article 476 of this Decision, a credit institution should apply scenarios of future shocks or extreme scenarios of future shock, respectively, to the risk factors that belong to the commodity or foreign exchange broad risk factor categories referred to in Article 469 paragraph (1) of this Decision. Partial expected shortfall calculations Article 468 (1) A credit institution shall calculate all the partial expected shortfall measures referred to in Article 467 paragraph (1) of this Decision as follows:

  1. daily calculations of the partial expected shortfall measures;
  2. at 97,5th percentile, one tailed confidence interval;
  3. for a given portfolio of trading book positions and non-trading book positions that are subject to foreign exchange or commodity risk, a credit institution shall calculate the partial expected shortfall measure at time ‘t’ in accordance with the following formula:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 511 PESt = ��PESt(T)� 2

  • ��PESt(T, j) ∙ ��LHj − LHj−1� 10 � j≥2 where: Table 1 (2) For the purpose of calculating the partial expected shortfall measures 𝑃𝑃 𝑡𝑡 𝑅𝑅 and 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 referred to in Article 467 paragraph (1) of this Decision, in addition to the requirements set out in paragraph (1) of this Article, a credit institution shall meet the following requirements:
  1. in calculating 𝑃𝑃 𝑡𝑡 𝑅𝑅 , a credit institution shall only apply scenarios of future shocks to a subset of the modellable risk factors of the positions in the portfolio PESt = the partial expected shortfall measure at time t; j = the index that denotes the five liquidity horizons listed in the first column of Table 1 of this paragraph; LHj = the length of liquidity horizons j as expressed in days in Table 1 of this paragraph; T = the base time horizon, where T = 10 days; PESt(T) = the partial expected shortfall measure that is determined by applying scenarios of future shocks with a 10-day time horizon only to the specific set of modellable risk factors of the positions in the portfolio set out in paragraphs (2) to (5) of this Article for each partial expected shortfall measure referred to in Article 467 paragraph (1) of this Decision; and PESt(T,j) = the partial expected shortfall measure that is determined by applying scenarios of future shocks with a 10-day time horizon only to the specific set of modellable risk factors of the positions in the portfolio set out in paragraphs (2) to (5) of this Article for each partial expected shortfall measure referred to in Article 467 paragraph (1) of this Decision and of which the effective liquidity horizon, as determined in accordance with Article 46p paragraph (2) of this Decision), is equal or longer than LHj. Liquidity horizon j Length of liquidity horizon j (in days) 1 10 2 20 3 40 4 60 5 120

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 512 which has been chosen by the credit institution, in accordance with the Central Bank requirements, so that the following condition is met with the sum taken over from the preceding 60 business days: 1 60 ∙ �PESt−k RC PESt−k FC 59 k=0 ≥ 75% 2) in calculating 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 , a credit institution shall only apply scenarios of future shocks to the subset of the modellable risk factors of the positions in the portfolio chosen by the credit institution for the purposes of item 1) of this paragraph and which have been mapped to the broad risk factor category ‘i’ in accordance with Article 469 of this Decision; 3) the data inputs used to determine the scenarios of future shocks applied to the modellable risk factors referred to in items 1) and 2) of this paragraph shall be calibrated to historical data from a continuous 12-month period of financial stress that shall be identified by the credit institution in order to maximise the value of 𝑃𝑃 𝑡𝑡 𝑅𝑅 , and for the purpose of identifying that stress period, a credit institution shall use an observation period starting at least from 1 January 2007, in accordance with the Central Bank requirements; and 4) the data inputs of 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 shall be calibrated to the 12-month stress period that has been identified by the credit institution for the purposes of item 3) of this paragraph. (3) A credit institution that no longer meets the requirement referred to in paragraph (2) item 1) of this Article shall immediately notify the Central Bank thereof and shall update the subset of the modellable risk factors within two weeks in order to meet that requirement, and where, after two weeks, that credit institution has failed to meet that requirement, the credit institution shall revert to the approach set out in Subtitle 2 of this Title to calculate the own funds requirements for market risk for some trading desks, until that credit institution is able to demonstrate to the Central Bank that it is meeting the requirement set out in paragraph (2) item 1) of this Article; (4) For the purpose of calculating the partial expected shortfall measures 𝑃𝑃 𝑡𝑡 𝑅𝑅 and 𝑃𝑃 𝑡𝑡 𝑅𝑅 ,𝑖𝑖 referred to in Article 467 paragraph (1) of this Decision, a credit institution shall, in addition to the requirements set out in paragraph (1) of this Article, meet the following requirements:

  1. in calculating 𝑃𝑃 𝑡𝑡 𝑅𝑅 , a credit institution shall only apply scenarios of future shocks to the subset of the modellable risk factors of the positions in the portfolio referred to in paragraph (2) item 1) of this Article;
  2. in calculating 𝑃𝑃 𝑡𝑡 𝑅𝑅 , a credit institution shall only apply scenarios of future shocks to the subset of the modellable risk factors of the positions in the portfolio referred to in paragraph (2) item 2) of this Article;
  3. the data inputs used to determine the scenarios of future shocks applied to the modellable risk factors referred to in items 1) and 2) of this paragraph shall be calibrated to historical data referred to in paragraph (5) item 3) of this Article, and those data shall be updated on at least a monthly basis.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 513 (5) For the purpose of calculating the partial expected shortfall measures 𝑃𝑃 𝑡𝑡 𝐹𝐹 and 𝑃𝑃 𝑡𝑡 𝐹𝐹 ,𝑖𝑖 referred to in Article 467 paragraph (1) of this Decision, a credit institution shall, in addition to the requirements set out in paragraph (1) of this Article, meet the following requirements:

  1. in calculating 𝑃𝑃 𝑡𝑡 𝐹𝐹 , a credit institution shall apply scenarios of future shocks to all the modellable risk factors of the positions in the portfolio;
  2. in calculating 𝑃𝑃 𝑡𝑡 𝐹𝐹 ,𝑖𝑖 , a credit institution shall apply scenarios of future shocks to all the modellable risk factors of the positions in the portfolio which have been mapped to the broad risk factor category i in accordance with Article 469 of this Decision;
  3. the data inputs used to determine the scenarios of future shocks applied to the modellable risk factors referred to in items 1) and 2) of this paragraph shall be calibrated to historical data from the preceding 12- month period, and where there is a significant upsurge in the price volatility of a material number of modellable risks factors of a credit institution's portfolio which are not in the subset of the risk factors referred to in paragraph (2) item 1) of this Article, the Central Bank may require a credit institution to use historical data for a period shorter than the preceding 12-months, but such a shorter period shall not be shorter than the preceding six-months. (6) In calculating a given partial expected shortfall measure as referred to in Article 467 paragraph (1) of this Decision, a credit institution shall maintain the values of the modellable risks factors for which it has not been required to apply scenarios of future shocks for that partial expected shortfall measure under paragraphs (2) to (5) of this Article. Liquidity horizons Article 469 (1) A credit institution shall map each risk factor of positions assigned to the trading desks for which they have been granted authorisation as referred to in Article 465 paragraph (2) of this Decision, or for which they are in the process of being granted such authorisation, to one of the broad categories of risk factors listed in Table 2 of this Article and to one of the broad sub-categories of risk factors listed in that Table. (2) The liquidity horizon of a risk factor of the positions referred to in paragraph (1) of this Article shall be the liquidity horizon of the corresponding broad sub-category of risk factors to which it has been mapped. (3) By way of derogation from paragraph (1) of this Article, for a given trading desk, a credit institution may decide to replace the liquidity horizon of a broad sub-category of risk factors listed in Table 2 of this Article with one of the longer liquidity horizons listed in Table 1 of Article 468 of this Decision, and where a credit institution takes such a decision, the longer liquidity horizon shall apply to all the modellable risk factors of the positions assigned to that trading desk that have been mapped to that broad sub￾category of risk factors for the purpose of calculating the partial expected shortfall measures in accordance with Article 468 paragraph (1) item 3) of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 514 (4) A credit institution shall notify the Central Bank of the trading desks and the broad sub-categories of risk factors to which it decides to apply the treatment referred to in paragraph (3) of this Article. (5) For the purpose of calculating the partial expected shortfall measures in accordance with Article 468 paragraph (1) item 3) of this Decision, the effective liquidity horizon of a given modellable risk factor of a given trading book position or a non-trading book position that is subject to foreign exchange or commodity risk shall be calculated as follows: EffectiveLH = � SubCatLH if Mat > LH5 min�SubCatLH, minj�LHj/LHj ≥ Mat�� ako je LH1 ≤ Mat ≤ LH5 LH1 if Mat < LH1 where: (6) Currency pairs that are composed of the euro and the currency of a Member State participating in ERM II shall be included in the most liquid currency pairs sub-category within the broad category of foreign exchange risk factor of Table 2 of this Article. (7) Currencies of Member States participating in ERM II shall be included in the most liquid currencies and domestic currency sub-category within the broad category of interest rate risk factor of Table 2 of this Article. (8) A credit institution shall verify the appropriateness of the mapping referred to in paragraph (1) of this Article on at least a monthly basis. Table 2 Broad categories of risk factors Broad sub-categories of risk factors Liquidity horizons Length of the liquidity horizon (in days) Interest rate Most liquid currencies and domestic currency 1 10 Other currencies (excluding most liquid currencies) 2 20 Volatility 4 60 Other types 4 60 Credit spread Central government, including central banks, of Member States 2 20 EffectiveLH = the effective liquidity horizon; Mat = the maturity of the trading book position; SubCatLH = the length of liquidity horizon of the modellable risk factor determined in accordance with paragraph (1) of this Article; and minj{LHj/LHj ≥ Mat} = the length of one of the liquidity horizons listed in Table 1 of Article 468 of this Decision which is the nearest liquidity horizon above the maturity of the trading book position.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 515 Broad categories of risk factors Broad sub-categories of risk factors Liquidity horizons Length of the liquidity horizon (in days) Covered bonds issued by credit institutions in Member States (Investment Grade) 2 20 Sovereign bonds (Investment grade) 2 20 Sovereign bonds (High yield) 3 40 Corporate bonds (Investment grade) 3 40 Corporate bonds (High yield) 4 60 Volatility 5 120 Other types 5 120 Equity Equity price (Large market capitalisation) 1 10 Equity price (Small market capitalisation) 2 20 Volatility (Large market capitalisation) 2 20 Volatility (Small market capitalisation) 4 60 Other types 4 60 Foreign exchange Most liquid currency pairs 1 10 Other currency pairs (excluding most liquid currency pairs) 2 20 Volatility 3 40 Other types 3 40 Commodity Energy price and carbon emissions price 2 20 Precious metal price and non-ferrous metal price 2 20 Other commodity prices (excluding energy price, carbon emissions price, precious metal price and non￾ferrous metal price) 4 60 Energy volatility and carbon emissions volatility 4 60 Precious metal volatility and non-ferrous metal volatility 4 60 Other commodity volatilities (excluding energy volatility, carbon emissions volatility, precious metal volatility and non-ferrous metal volatility) 5 120 Other types 5 120 (9) When mapping risk factors to the broad risk factor categories of Table 2 of this Article, a credit institution shall assign each risk factor to the most appropriate broad risk factor category, having regard to the nature of the risk captured by the risk factor and the data used as inputs for the risk factor in the risk measurement model. (10) When mapping risk factors to the broad risk factor sub-categories under the broad risk factor category of Table 2 of this Article, a credit institution shall assign the risk factor to the most appropriate broad risk factor sub-category of that broad risk factor category, having regard to the nature of the risk captured by the risk factor and the data used as inputs for the risk factor in the risk measurement model. (11) For the purposes of paragraph (9) of this Article, where the nature of the risk factor does not correspond to any broad risk factor categories of Table 2 of this Article, a credit institution shall map that risk factor to the broad risk factor category ‘Commodity’ of that Table and to the broad risk factor sub-category ‘Other types’ of that category. (12) For the purposes of paragraph (9) of this Article, for a risk factor that could be mapped to more than one broad risk factor category or broad risk factor sub-category, a credit institution shall identify all of those corresponding categories and corresponding sub-categories, and among those broad risk factor categories or those corresponding broad risk factor sub-categories, the risk factor shall be mapped to the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 516 broad risk factor category and the corresponding broad risk factor sub-category having the longest liquidity horizon, and where more than one broad risk factor category or corresponding broad risk factor sub-category have the same longest liquidity horizon, the risk factor may be mapped to any of those broad risk factor categories and their corresponding broad risk factor sub-categories. (13) By way of derogation from paragraphs (9) to (12) of this Article, where a credit institution represents a position in a homogeneous index instrument as a single risk factor in its risk measurement model, the credit institution may choose to map the risk factor in accordance with the methodology set out in paragraph (15) of this Article. (14) For the purposes of paragraph (13) of this Article, a ‘homogeneous index’ shall mean an index that has one of the following compositions:

  1. equities or other indices composed by equities only;
  2. bonds or other indices composed by bonds only;
  3. credit default swaps or other indices composed of credit default swaps only;
  4. commodities or other indices composed of commodities only. (15) The liquidity horizon of a single risk factor modelling a homogeneous index instrument as referred to in paragraph (13) of this Article may be determined by a credit institution as follows:
  5. the credit institution shall map the risk factor to the broad risk factor category of Table 2 of this Article corresponding to the appropriate category for the homogenous index composition;
  6. the credit institution shall apply the general methodology laid down in paragraphs (9) to (12) of this Article separately to each of the homogeneous index’s constituents to determine their appropriate liquidity horizons;
  7. the credit institution shall compute the weighted average of the liquidity horizons determined in accordance with item 2) of this paragraph on the basis of each constituent’s respective weight in the index;
  8. the liquidity horizon of the risk factor modelling the homogeneous index instrument shall be the shortest liquidity horizon of the index’s constituents sub￾categories which is greater or equal to the weighted average referred to in item
  9. of this paragraph. (16) For the purposes of paragraph (15) of this Article, a risk factor of a homogenous index instrument having the composition referred to in paragraph (14) items 2) and 3) of this Article, shall be mapped to the broad risk factor category ‘Credit spread’. (17) By way of derogation from paragraphs (9) to (12) of this Article, a credit institution shall map the following inflation risk factors as follows:
  10. it shall map inflation risk factors for a given currency to the broad risk factor category ‘Interest rate’, and to the broad risk factor sub-category of that currency;
  11. it shall map mono-currency basis risk factors and cross-currency basis risk factors to the broad risk factor category ‘Interest Rate’, and to the broad risk factor sub-category of the currency denominating the basis.;
  12. it shall map equity repo rates and dividend risk factors to the broad risk factor category ‘Equity’.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 517 (18) By way of derogation from paragraphs (9) to (12) of this Article, for the purpose of determining the broad risk factor sub-category, equity repo rates and dividend risk factors for a given equity shall be treated as risk factors corresponding to the volatility of that equity. (19) The currencies that constitute the most liquid currencies sub-category of the broad category of the interest rate risk factor of Table 2 of this Article shall be the following:

  1. Euro (EUR),
  2. US Dollar (USD),
  3. Pound Sterling (GBP),
  4. Japanese Yen (JPY),
  5. Australian Dollar (AUD),
  6. Swedish Krona (SEK),
  7. Canadian Dollar (CAD). (20) The currency pairs that constitute the most liquid currency pairs sub-category of the broad category of the foreign exchange risk factor of Table 2 of this Article shall be those listed in Annex 4 which forms an integral part of this Decision. (21) For the purposes of the equity price and volatility sub-category of the broad category of equity risk factor of Table 2 of this Article, an equity with large market capitalisation shall meet at least one of the following conditions:
  8. the market capitalisation of the equity is greater than EUR 1,750,000,000;
  9. the equity is included in one of the main indices set out in Annex 3 which forms an integral part of this Decision. (22) All other equities than those referred to in paragraph (21) of this Article shall be considered as equities with small market capitalisation. Assessment of the modellability of risk factors Article 470 (1) A credit institution shall assess the modellability of all the risk factors of the positions assigned to the trading desks for which it has been granted authorisation as referred to in Article 465 paragraph (2) of this Decision or is in the process of being granted such authorisation. (2) For the purposes of the assessment referred to in paragraph (1) of this Article, the Central Bank may allow a credit institution to use market data provided by third-party vendors. (3) The Central Bank may require a credit institution to consider not modellable a risk factor that has been assessed as modellable by the credit institution in accordance with paragraph (1) of this Article, where the Central Bank finds that the data inputs used to determine the scenarios of future shocks applied to the risk factor do not meet the Central Bank criteria on data accuracy and criteria on the calibration of the data inputs where market data are unavailable.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 518 (4) As part of the assessment referred to in paragraph (1) of this Article, a credit institution shall calculate the own funds requirements for market risk in accordance with Article 476 of this Decision for those risk factors that are not modellable. (5) In extraordinary circumstances, occurring during periods of significant reduction in certain trading activities across financial markets, the Central Bank may allow a credit institution using the approach set out in this Subtitle to consider as modellable risk factors that have been assessed as not modellable by a credit institution in accordance with paragraph (1) of this Article, provided that the following conditions are met:

  1. the risk factors subject to the treatment correspond to the trading activities which are significantly reduced across financial markets;
  2. the treatment is applied temporarily, and for not more than six months within one financial year;
  3. the treatment does not significantly reduce the total own funds requirements for market risk of the credit institution applying it. Supervisory back-testing requirements and multiplication factors Article 471 (1) For the purposes of this Article, an ‘overshooting’ means a one- day change in the value of a portfolio composed of all the positions assigned to the trading desk that exceeds the related value-at-risk number calculated on the basis of the credit institution's alternative internal model in accordance with the following requirements:
  4. the calculation of the VaR shall be subject to a one-day holding period;
  5. scenarios of future shocks shall apply to the risk factors of the trading desk's positions referred to in Article 472 paragraph (3) of this Decision and which are considered modellable in accordance with Article 470 of this Decision;
  6. data inputs used to determine the scenarios of future shocks applied to the modellable risk factors shall be calibrated to historical data referred to in Article 468 paragraph (5) item 3) of this Decision;
  7. unless stated otherwise in this Article, the credit institution's alternative internal model shall be based on the same modelling assumptions as those used for the calculation of the expected shortfall risk measure referred to in Article 466 paragraph (1) item 1) of this Decision. (2) A credit institution shall count daily overshootings on the basis of back-testing of the hypothetical and actual changes in the value of the portfolio composed of all the positions assigned to the trading desk. (3) A credit institution's trading desk shall be deemed to meet the back-testing requirements where the number of overshootings for that trading desk that occurred over the most recent 250 business days does not exceed any of the following:
  8. 12 overshootings for the VaR number, calculated at a 99th percentile one tailed￾confidence interval on the basis of back-testing of the hypothetical changes in the value of the portfolio;
  9. 12 overshootings for the value-at-risk number, calculated at a 99th percentile one tailed-confidence interval on the basis of back-testing of the actual changes in the value of the portfolio;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 519 3) 30 overshootings for the VaR number, calculated at a 97,5th percentile one tailed-confidence interval on the basis of back-testing of the hypothetical changes in the value of the portfolio; 4) 30 overshootings for the value-at-risk number, calculated at a 97,5th percentile one tailed-confidence interval on the basis of back-testing of the actual changes in the value of the portfolio. (4) A credit institution shall count daily overshootings in accordance with the following:

  1. the back-testing of hypothetical changes in the value of the portfolio shall be based on a comparison between the end-of-day value of the portfolio and, assuming unchanged positions, the value of the portfolio at the end of the subsequent day;
  2. the back-testing of actual changes in the value of the portfolio shall be based on a comparison between the end-of-day value of the portfolio and its actual value at the end of the subsequent day, excluding fees and commissions; and; and
  3. an overshooting shall be counted for each business day for which the credit institution is not able to assess the value of the portfolio or is not able to calculate the VaR number referred to in paragraph (3) of this Article. (5) A credit institution shall calculate, in accordance with paragraphs (6) to (8) of this Article, the multiplication factor (mc) referred to in Article 466 of this Decision for the portfolio of all the positions assigned to the trading desks for which it has been granted authorisation to use alternative internal models as referred to in Article 465 paragraph (2) of this Decision. (6) The multiplication factor (mc) shall be equal to at least the sum of 1.5 and an add￾on determined in accordance with Table 3 of this Article, wherein for the portfolio referred to in paragraph (5) of this Article, that add-on shall be calculated on the basis of the number of overshootings that occurred over the most recent 250 business days as evidenced by the credit institution’s back-testing of the VaR number calculated in accordance with item 1) of this paragraph, wherein the calculation of the add-on shall be subject to the following requirements:
  4. an overshooting shall be a one-day change in the portfolio's value that exceeds the related VaR number calculated by the credit institution's internal model in accordance with the following: − a one-day holding period; − a 99th percentile, one tailed confidence interval; − scenarios of future shocks shall apply to the risk factors of the trading desks' positions referred to in Article 472 paragraph (3) of this Decision and which are considered modellable in accordance with Article 470 of this Decision; − the data inputs used to determine the scenarios of future shocks applied to the modellable risk factors shall be calibrated to historical data referred to in Article 468 paragraph (5) item 3) of this Decision; − unless stated otherwise in this Article, the credit institution's internal model shall be based on the same modelling assumptions as those used for the calculation of the expected shortfall risk measure referred to in Article 466 paragraph (1) item 1) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 520 2) the number of overshootings shall be equal to the greater of the number of overshootings under hypothetical and the actual changes in the value of the portfolio. Table 3 (7) In extraordinary circumstances, the Central Bank may authorise a credit institution to do one or both of the following:

  1. limit the calculation of the add-on to that resulting from overshootings under the back-testing of hypothetical changes where the number of overshootings under the back-testing of actual changes does not result from deficiencies in the credit institution’s alternative internal model;
  2. exclude the overshootings evidenced by the back-testing of hypothetical or actual changes from the calculation of the add-on where those overshootings do not result from deficiencies in the credit institution’s alternative internal model. (8) For the purposes of the paragraph (6) of this Article, the Central Bank may increase the value of multiplication factor (mc) above the sum referred to in that paragraph, where a credit institution’s alternative internal model shows deficiencies preventing the appropriate measurement of the own funds requirements for market risk. (9) The Central Bank shall monitor the appropriateness of the multiplication factor referred to in paragraph (5) of this Article and the compliance of trading desks with the back-testing requirements referred to in paragraph (3) of this Article. (10) A credit institution shall promptly notify, the Central Bank of over shootings that result from their back-testing programme and provide an explanation for those overshootings, and in any case shall notify the competent authorities thereof no later than within five business days after the occurrence of an overshooting. (11) By way of derogation from paragraph (2) and paragraphs (6) to (8) of this Article, the Central Bank may authorise a credit institution not to count an overshooting where a one-day change in the value of its portfolio that exceeds the related VaR number calculated by that credit institution’s internal model is attributable to a non-modellable risk factor. Number of overshootings Add-on Fewer than 5 0.00 5 0.20 6 0.26 7 0.33 8 0.38 9 0.42 More than 9 0.50

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 521 Profit and loss attribution requirement Article 472 (1) A credit institution’s trading desk meets the P&L attribution requirements where the theoretical changes in the value of that trading desk’s portfolio, based on the credit institution’s risk-measurement model, are either close or sufficiently close to the hypothetical changes in the value of that trading desk’s portfolio, based on the credit institution’s pricing model. (2) Notwithstanding paragraph 1 of this Article, where the theoretical changes in the value of a trading desk’s portfolio, based on the credit institution’s risk-measurement model, are sufficiently close to the hypothetical changes in the value of that trading desk’s portfolio, based on the credit institution’s pricing model, the credit institution shall calculate, for all positions assigned to that trading desk, an additional own funds requirement to the own funds requirements referred to in Article 466 paragraphs (1) and (2) of this Decision. (3) On the basis of the results of the P&L attribution requirement referred to in paragraph (1) of this Article, a credit institution shall determine and document a precise list of risk factors included in the credit institution’s risk-measurement model that are deemed appropriate for verifying the credit institution’s compliance with the back￾testing requirement set out in Article 471 of this Decision, wherein the credit institution shall track any change to the list of those risk factors. (4) A credit institution calculating the hypothetical and the actual changes in the value of the portfolio referred to in Articles 471 and this Article in relation to a non-trading book position which is subject to foreign exchange risk, should calculate the value of that non-trading book position at the end of the day following the computation of the VaR number referred to in Article 471 of this Decision by using the value of that non￾trading book position at the end of the previous day and updating the component reflecting the foreign exchange risk of that position. (5) Where the value of a non-trading book position does not change linearly with movements in an exchange rate to which it is subject, a credit institution may calculate the value of that non-trading book position at the end of the day following the computation of the VaR number referred to in Article 471 of this Decision by using the value of that non-trading book position at the end of the previous day and updating all the components the credit institution uses to value that non-trading book position. (6) When applying the paragraph (5) of this Article, a credit institution should apply it consistently to all positions in the trading desk that do not change linearly with movements in an exchange rate of the currency to which those positions are subject. (7) A credit institution calculating the hypothetical and the actual changes in the value of the portfolio referred to in Article 471 of this Decision in relation to a non-trading book position which is subject to commodity risk or both to commodity and foreign exchange risk, should calculate the value of that non-trading book position at the end of the day following the computation of the VaR number referred to in Article 471 of this Decision in accordance with one of the following methods:

  1. a credit institution should use the value of that non-trading book position at the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 522 end of the previous day and update only the components reflecting the foreign exchange and commodity risks; 2) a credit institution should use the value of that non-trading book position at the end of the previous day and update all the components the credit institution uses to value that non-trading book position. (8) When applying paragraph (7) of this Article, a credit institution shall apply it consistently for all positions subject to commodity risk in the trading desk. (9) A credit institution shall apply paragraphs (4) to (8) of this Article to non-trading book positions that are included both in the portfolio on the day of the computation of the VaR number referred to in Article 471 of this Decision, and in the portfolio on the day following the computation of that value-at-risk number. Requirements on risk measurement Article 473 (1) A credit institution using an internal risk-measurement model to calculate the own funds requirements for market risk as referred to in Article 466 of this Decision shall ensure that that model meets the following requirements:

  1. the internal risk-measurement model shall capture a sufficient number of risk factors, which shall include at least the risk factors referred to in Subsection 1, Section 3, Subtitle 2 of this Part of the Decision unless the credit institution demonstrates to the Central Bank that the omission of those risk factors does not have a material impact on the results of the P&L attribution requirement referred to in Article 472 of this Decision, and a credit institution shall be able to explain to the Central Bank why it has incorporated a risk factor in its pricing model but not in its internal risk-measurement model;
  2. the internal risk-measurement model shall capture nonlinearities for options and other products as well as correlation risk and basis risk;
  3. the internal risk-measurement model shall incorporate a set of risk factors that correspond to the interest rates in each currency in which the credit institution has interest rate sensitive on- or off-balance- sheet positions; the credit institution shall model the yield curves using one of the generally accepted approaches, wherein the yield curve shall be divided into various maturity segments to capture the variations of volatility of rates along the yield curve; for material exposures to interest-rate risk in the major currencies and markets, the yield curve shall be modelled using a minimum of six maturity segments, and the number of risk factors used to model the yield curve shall be proportionate to the nature and complexity of the credit institution's trading strategies, the model shall also capture the risk spread of less than perfectly correlated movements between different yield curves or different financial instruments on the same underlying issuer;
  4. the internal risk-measurement model shall incorporate risk factors corresponding to gold and to the individual foreign currencies in which the credit institution’s positions are denominated; for CIUs, the actual foreign exchange positions of the CIU shall be taken into account; a credit institution may rely on third-party reporting of the foreign exchange position of the CIU, provided that the correctness of that report is adequately ensured;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 523 5) the sophistication of the modelling technique shall be proportionate to the materiality of the credit institution' activities in the equity markets; the internal risk-measurement model shall use a separate risk factor at least for each of the equity markets in which the credit institution holds significant positions and at least one risk factor that captures systemic movements in equity prices and the dependency of that risk factor on the individual risk factors for each equity market; 6) the internal risk-measurement model shall use a separate risk factor at least for each commodity in which the credit institution holds significant positions, unless the credit institution has a small aggregate commodity position compared to all its trading activities, in which case it may use a separate risk factor for each broad commodity type; for material exposures to commodity markets, the model shall capture the risk of less than perfectly correlated movements between commodities that are similar, but not identical, the exposure to changes in forward prices arising from maturity mismatches, and the convenience yield between derivative and cash positions; 7) the proxies used shall show a good track record for the actual position held, shall be appropriately conservative, and shall be used only where the available data are insufficient, such as during the period of stress referred to in Article 468 paragraph (2) item 3) of this Decision; 8) for material exposures to volatility risks in instruments with optionality, the internal risk-measurement model shall capture the dependency of implied volatilities across strike prices and options' maturities; 9) for positions in CIUs, a credit institution shall look through the underlying positions of the CIUs at least on a weekly basis to calculate its own funds requirements in accordance with this Subtitle; where the look-through approach is carried out weekly, a credit institution shall be able to monitor the risks resulting from significant changes in the composition of the CIU; a credit institution that does not have adequate data inputs or information to calculate the own funds requirements for market risk of a CIU position in accordance with the look-through approach may rely on a third party to obtain those data inputs or information, provided that all of the following conditions are met: − the third party is one of the following: a) the depository institution or the depository financial institution of the CIU, provided that the CIU exclusively invests in securities and deposits all securities at that depository institution or depository financial institution; b) the CIU management company, provided that it meets the criteria set out in Article 172 paragraph (5) item 1) of this Decision; c) a third-party vendor, on the condition that the data, information or risk metrics are provided or calculated by the third parties referred to under (a) or (b) of this indent or another such third-party vendor; − the third party provides the credit institution with the data, information or risk metrics to calculate the own funds requirements for market risk of the CIU position in accordance with the look-through approach referred to in this item; − an external auditor of the credit institution has confirmed the adequacy of the third-party data, information or risk metrics referred to in indent 2, and the Central Bank has unrestricted access to those data, information or risk metrics upon request.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 524 (2) A credit institution may use empirical correlations within broad categories of risk factors and, for the purpose of calculating the unconstrained expected shortfall measure UESt as referred to in Article 467 paragraph (1) of this Decision across broad categories of risk factors only where the credit institution’s approach for measuring those correlations is sound, consistent with either the applicable liquidity horizons or, to the satisfaction of the Central Bank, with the base time horizon of 10 days set out in Article 468 paragraph (1) of this Decision, and implemented with integrity. Qualitative requirements Article 474 (1) Any internal risk-measurement model used for the purposes of this Subtitle should be conceptually sound, calculated and implemented with integrity, and comply with all the following qualitative requirements:

  1. any internal risk-measurement model used to calculate capital requirements for market risk shall be closely integrated into the daily risk management process of the credit institution and shall serve as the basis for reporting risk exposures to senior management;
  2. a credit institution shall have a risk control unit that is independent from business trading units and that reports directly to senior management; that unit shall: − be responsible for designing and implementing any internal risk￾measurement model used in the alternative internal model approach for the purposes of this Subtitle; − be responsible for the overall risk management system; − produce and analyse daily reports on the output of any internal model used to calculate own funds requirements for market risk, and on the appropriateness of measures to be taken in terms of trading limits;
  3. the management board and senior management shall be actively involved in the risk-control process, and the daily reports produced by the risk control unit shall be reviewed at a level of management with sufficient authority to require the reduction of positions taken by individual traders and to require the reduction of the credit institution's overall risk exposure;
  4. the credit institution shall have a sufficient number of staff with a level of skills that is appropriate to the sophistication of the internal risk-measurement models, and a sufficient number of staff with skills in the trading, risk control, audit and back-office areas;
  5. the credit institution shall have in place a documented set of internal policies, procedures and controls for monitoring and ensuring compliance with the overall operation of its internal risk-measurement models;
  6. any internal risk-measurement model, including any pricing model, shall have a proven track record of being reasonably accurate in measuring risks, and shall not differ significantly from the models that the credit institution uses for its internal risk management;
  7. the credit institution shall frequently conduct rigorous programmes of stress testing, including reverse stress tests, which shall encompass any internal risk￾measurement model; the results of those stress tests shall be reviewed by senior management at least on a monthly basis and shall comply with the policies and limits approved by the management board; the credit institution shall take appropriate actions where the results of those stress tests show

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 525 excessive losses arising from the trading's business of the credit institution under certain circumstances; 8) the credit institution shall conduct an independent review of its internal risk￾measurement models, either as part of its regular internal auditing process, or by mandating a third-party undertaking to conduct that review, which shall be conducted to the satisfaction of the Central Bank. (2) A validation unit, which is separate from the risk control unit referred to in the paragraph (1) item 2) of this Article, shall conduct the initial and ongoing validation of any internal risk-measurement model used in the alternative internal model approach for the purposes of this Subtitle. (3) For the purposes of paragraph (1) item 8) of this Article, a third-party undertaking means an undertaking that provides auditing or consulting services to a credit institution and that has staff who have sufficient skills in the area of market risk in trading activities. (4) The review referred to in paragraph (1) item 8) of this Article shall include both the activities of the business trading units and the independent risk control unit, wherein the credit institution shall conduct a review of its overall risk management process at least once a year, and that review shall assess the following:

  1. the adequacy of the documentation of the risk management system and process and the organisation of the risk control unit;
  2. the integration of risk measures into daily risk management and the integrity of the management information system;
  3. the processes the credit institution employs for approving the risk-pricing models and valuation systems that are used by front and back-office personnel;
  4. the scope of risks captured by the model, the accuracy and appropriateness of the risk-measurement system, and the validation of any significant changes to the internal risk-measurement model;
  5. the accuracy and completeness of position data, the accuracy and appropriateness of volatility and correlation assumptions, the accuracy of valuation and risk sensitivity calculations, and the accuracy and appropriateness for generating data proxies where the available data are insufficient to meet the requirement set out in this Subtitle;
  6. the verification process that the credit institution employs to evaluate the consistency, timeliness and reliability of the data sources used to run any of its internal risk-measurement models, including the independence of those data sources;
  7. the verification process that the credit institution employs to evaluate back￾testing requirements and P&L attribution requirements that are conducted in order to assess the accuracy of its internal risk-measurement models, including the independence of those data sources;
  8. where the review is performed by a third-party undertaking in accordance with paragraph (1) item 8) of this Article, the verification that the internal validation process set out in Article 475 of this Decision fulfils its objectives. (5) A credit institution shall update the techniques and practices they use for any of the internal risk-measurement models used for the purposes of this Subtitle to take

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 526 into account the evolution of new techniques and best practices that develop in respect of those internal risk-measurement models. Internal validation Article 475 (1) A credit institution shall have processes in place to ensure that any internal risk￾measurement models used for the purposes of this Subtitle have been adequately validated by suitably qualified parties that are independent of the development process, in order to ensure that any such models are conceptually sound and adequately capture all material risks. (2) A credit institution shall conduct the validation referred to in paragraph (1) of this Article in the following circumstances:

  1. when any internal risk-measurement model is initially developed and when any significant changes are made to that model; and
  2. on a periodic basis, and where there have been significant structural changes in the market or changes to the composition of the portfolio which might lead to the internal risk-measurement model no longer being adequate. (3) The validation of the internal risk-measurement models of a credit institution shall not be limited to back-testing and P&L attribution requirements, but shall, at a minimum, include the following:
  3. tests to verify whether the assumptions made in the internal model are appropriate and do not underestimate or overestimate the risk;
  4. own internal model validation tests, including back-testing in addition to the regulatory back-testing programmes, in relation to the risks and structures of their portfolios;
  5. the use of hypothetical portfolios to ensure that the internal risk-measurement model is able to account for particular structural features that may arise, for example, material basis risks and concentration risk, or the risks associated with the use of proxies. Calculation of stress scenario risk measure Article 476 (1) The ‘stress scenario risk measure’ of a given non-modellable risk factor means the loss that is incurred in all trading book positions or non-trading book positions that are subject to foreign exchange or commodity risk of the portfolio which includes that non￾modellable risk factor when an extreme scenario of future shock is applied to that risk factor. (2) A credit institution shall develop appropriate extreme scenarios of future shock for all non-modellable risk factors, in accordance with the guidelines provided in Annex 5 which forms an integral part of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 527 Section 3 – Internal default risk model Scope of the internal default risk model Article 477 (1) All the positions of a credit institution that have been assigned to the trading desks for which a credit institution has been granted authorisation as referred to in Article 465 paragraph (2) of this Decision shall be subject to an own funds requirement for default risk where those positions contain at least one risk factor that has been mapped to the broad categories of ‘equity’ or ‘credit spread’ risk factors in accordance with Article 469 paragraph (1) of this Decision. (2) The requirement referred to in paragraph (1) of this Article, which is incremental to the risks captured by the own funds requirements referred to in Article 466 paragraph (1) of this Decision, shall be calculated using the credit institution's internal default risk model, which shall comply with the requirements laid down in this Section. (3) For each of the positions referred to in paragraph (1) of this Article, a credit institution shall identify one issuer of traded debt or equity instruments related to at least one risk factor. Authorisation to use an internal default risk model Article 478 (1) The Central Bank shall grant a credit institution an authorisation to use an internal default risk model to calculate the own funds requirements referred to in Article 466 paragraph (2) of this Decision for all the trading book positions referred to in Article 477 of this Decision that are assigned to a trading desk for which the internal default risk model complies with the requirements set out in Articles 474, 475, 479, 480 and 481 of this Decision. (2) Where the trading desk of a credit institution, to which at least one of the trading book positions referred to in Article 477 of this Decision has been assigned, does not meet the requirements set out in paragraph (1) of this Article, the own funds requirements for market risk of all positions in that trading desk shall be calculated in accordance with the approach set out in Subtitle 2 of this Part of the Decision. Own funds requirements for default risk using an internal default risk model Article 479 (1) A credit institution shall calculate the own funds requirements for default risk using an internal default risk model for the portfolio of all trading book positions as referred to in Article 477 of this Decision as follows:

  1. the own funds requirements shall be equal to a VaR number measuring potential losses in the market value of the portfolio caused by the default of an issuer related to those positions at the 99,9% confidence interval over a one￾year time horizon;
  2. the potential loss referred to in item 1) of this paragraph means a direct or indirect loss in the market value of a position which was caused by the default

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 528 of the issuers and which is incremental to any losses already taken into account in the current valuation of the position, wherein the default of the issuers of equity positions shall be represented by the value for the issuers' equity prices being set to zero; 3) a credit institution shall determine default correlations between different issuers on the basis of a conceptually sound methodology, using objective historical data on market credit spreads or equity prices that cover at least a 10 year period that includes the stress period identified by the credit institution in accordance with Article 468 paragraph (2) of this Decision, wherein the calculation of default correlations between different issuers shall be calibrated to a one-year time horizon; 4) the internal default risk model shall be based on a one-year constant position assumption. (2) A credit institution shall calculate the own funds requirement for default risk using an internal default risk model as referred to in paragraph (1) of this Article on at least a weekly basis. (3) By way of derogation from paragraph (1) items 1) and 2) of this Article, a credit institution may replace the one-year time horizon with a time horizon of sixty days for the purpose of calculating the default risk of some or all of the equity positions, where appropriate, and in such case, the calculation of default correlations between equity prices and default probabilities shall be consistent with a time horizon of sixty days and the calculation of default correlations between equity prices and bond prices shall be consistent with a one-year time horizon. Recognition of hedges in an internal default risk model Article 480 (1) A credit institution may incorporate hedges in their internal default risk model and may net positions where the long positions and short positions relate to the same financial instrument. (2) In its internal default risk models, a credit institution may only recognise hedging or diversification effects associated with long and short positions involving different instruments or different securities of the same debtor, as well as long and short positions in different issuers by explicitly modelling the gross long and short positions in the different instruments, including modelling of basis risks between different issuers. (3) In its internal default risk models, a credit institution shall capture material basis risks in hedging strategies that arise from differences in the type of product, seniority in the capital structure, internal or external ratings, vintage and other differences. (4) A credit institution shall ensure that maturity mismatches between a hedging instrument and the hedged instrument that could occur during the one-year time horizon, where those mismatches are not captured in its internal default risk model, do not lead to a material underestimation of risk.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 529 (5) A credit institution shall recognise a hedging instrument only to the extent that it can be maintained even as the debtor approaches a credit event or other event. Particular requirements for an internal default risk model Article 481 (1) The internal default risk model referred to in Article 478 paragraph (1) of this Decision shall be capable of modelling the default of individual issuers as well as the simultaneous default of multiple issuers, and shall take into account the impact of those defaults in the market values of the positions that are included in the scope of that model, and for that purpose, the default of each individual issuer shall be modelled using two types of systematic risk factors. (2) The internal default risk model shall reflect the economic cycle, including the dependency between recovery rates and the systematic risk factors referred to in paragraph (1) of this Article. (3) The internal default risk model shall reflect the nonlinear impact of options and other positions with material nonlinear behaviour with respect to price changes, and the credit institution shall also have due regard to the amount of model risk inherent in the valuation and estimation of price risks associated with those products. (4) The internal default risk model shall be based on data that are objective and up-to￾date. (5) To simulate the default of issuers in the internal default risk model, the credit institution's estimates of default probabilities shall meet the following requirements:

  1. the default probabilities shall be floored at: − 0,01% for exposures to which a 0% risk weight is applied in accordance with Articles 151 to 155 of this Decision, − 0,01% for covered bonds to which a 10% risk weight is applied in accordance with Article 169 of this Decision; − otherwise, the default probabilities shall be floored at 0,03%;
  2. the default probabilities shall be based on a one-year time horizon, unless stated otherwise in this Section;
  3. the default probabilities shall be measured using, solely or in combination with current market prices, data observed during a historical period of at least five years of actual past defaults and extreme declines in market prices equivalent to default events, wherein default probabilities shall not be inferred solely from current market prices;
  4. a credit institution that has been granted authorisation of the Central Bank to estimate default probabilities in accordance with Section 1, Subtitle 3, Title II of this Part of the Decision for the exposure class and the rating system corresponding to a given issuer shall use the methodology set out therein to calculate the default probabilities of that issuer, provided that the data to make such an estimate are available;
  5. a credit institution that has not been granted authorisation of the Central Bank to estimate default probabilities referred to in item 4) of this paragraph shall develop an internal methodology or use external sources to estimate these

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 530 default probabilities consistently with the requirements applicable to estimates of default probability under this Article (6) For the purposes of paragraph (5) item 4) of this Article, the data to estimate the default probabilities of a given issuer of a trading book position are available where, at the calculation date, the credit institution has a non-trading book position on the same debtor for which it estimates default probabilities in accordance with Section 1, Subtitle 3, Title II of this Part of the Decision to calculate its own funds requirements set out in that Subtitle. (7) To simulate the default of issuers in the internal default risk model, the credit institution's estimates of loss given default should meet the following requirement:

  1. the loss given default estimates are floored at 0%;
  2. the loss given default estimates shall reflect the seniority of each position;
  3. a credit institution that has been granted authorisation of the Central Bank to estimate LGD in accordance with Section 1, Subtitle 3, Title II of this Part of the Decision, for the exposure class and the rating system corresponding to a given exposure shall use the methodology set out therein to calculate LGD estimates of that issuer, provided that the data to make such an estimate are available;
  4. a credit institution that has not been granted authorisation to estimate LGD referred to in item 3) of this paragraph shall develop an internal methodology or use external sources to estimate LGD consistently with the requirements applying to estimates of LGD under this Article. (8) For the purposes of paragraph (7) item 3) of this Article, the data to estimate the LGD of a given issuer of a trading book position are available where, at the calculation date, the credit institution has a non-trading book position on the same exposure for which it estimates LGD in accordance with Section 1, Subtitle 3, Title II of this Part of the Decision to calculate its own funds requirements set out in that Subtitle. (9) As part of the independent review and validation of the internal models that they use for the purposes of this Subtitle, including for the risk-measurement system, a credit institution shall:
  5. verify that its approach for the modelling of correlations and price changes is appropriate for its portfolio, including the choice and weights of the systematic risk factors in the model;
  6. perform a variety of stress tests, including sensitivity analyses and scenario analyses, to assess the qualitative and quantitative reasonableness of the internal default risk model, in particular with regard to the treatment of concentrations, wherein the tests shall not be limited to the range of past events experienced; and
  7. apply appropriate quantitative validation including relevant internal modelling benchmarks. (10) The internal default risk model shall appropriately reflect issuer concentrations and concentrations that can arise within and across product classes under stressed conditions.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 531 (11) The internal default risk model should be consistent with the credit institution's internal risk management methodologies for identifying, measuring, and managing trading risks. (12) A credit institution should have clearly defined policies and procedures for determining the default assumptions for correlations between different issuers in accordance with Article 479 paragraph (1) item 3) of this Decision and the preferred choice of method for estimating the default probabilities in paragraph (5) item 5) of this Article and the loss given default in paragraph (7) item 4) of this Article. (13) A credit institution shall document its internal models so that its correlation assumptions and other modelling assumptions are transparent to the Central Bank. Requirements for the internal methodology for estimating default probabilities Article 482 (1) A credit institution’s internal methodology, or a part of it, used for estimating default probabilities in accordance with Article 481 paragraph (5) item 5) of this Decision, must fulfil the same requirements as those that apply to the methodologies used by a credit institution that has been permitted to estimate default probabilities in accordance with Subtitle 3, Title II of this Part of the Decision. (2) By way of derogation from paragraph 1, a credit institution’s internal methodology, or a part of it, for estimating default probabilities shall fulfil the requirements set out in paragraph (3) or (4) of this Article, as applicable, where, for a given issuer, all of the following conditions are met on a quarterly basis:

  1. no external sources fulfilling the requirements set out in Article 483 of this Decision are already available for estimating default probabilities for that issuer;
  2. the use of an internal methodology, or a part of it, fulfilling the requirements set out in paragraph (1) of this Article is either: − not feasible due to a lack of input data for that issuer; or − disproportionate in relation to the materiality or the holding period of the relevant positions for that issuer, based on the trading strategy adopted for such positions;
  3. the value of ‘m’, calculated in accordance the formula laid down in paragraph (7) of this Article, is any of the following: − lower than or equal to 10 %; or − higher than 10%, and the credit institution carries out the following: a) investigates whether additional external sources fulfilling the requirements set out in Article 483 of this Decision are available and uses those sources to reduce the value of ‘m’ to a value which is lower than or equal to 10%; b) conducts a sensitivity and scenario analysis to assess the qualitative and quantitative soundness of the internal methodology or part of it. (3) For the sensitivity analysis referred to in paragraph (2) item 3) indent 2 under c of this Article, a credit institution shall assess the sensitivity of the own funds requirements calculated in accordance with Article 479 paragraph (1) of this Decision in relation to all trading book positions referred to in Article 477 of this Decision by assigning to the issuers covered at the time of the calculation by the internal

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 532 methodology or part of it, which fulfil the requirements set out in paragraph (4) or (6) of this Article, as applicable, one rating grade higher than and one rating grade lower than the one used to fulfil those requirements. (4) Where the conditions set out in paragraph (2) of this Article are met, a credit institution’s internal methodology, or a part of it, shall assign to an issuer an estimate of default probability which is equal to or higher than the maximum of the following values:

  1. the highest default probability assigned to investment grade issuers of positions under the scope of the credit institution’s internal default risk model and for which the conditions set out in paragraph (2) of this Article are not met;
  2. the equally weighted average of default probabilities assigned to issuers of positions under the scope of the credit institution’s internal default risk model and for which the conditions set out in paragraph (2) of this Article are not met. (5) For the purposes of paragraph (4) item 2) of this Article, a credit institution may exclude defaulted issuers when calculating the equally weighted average of default probabilities, where it can ensure that the conditions set out in paragraph (2) are not met for such defaulted issuers. (6) By way of derogation from paragraphs (4) and (5) of this Article, where the conditions set out in paragraph (2) are met and the own funds requirements for default risk decrease as the value of default probability assigned to a given issuer increases, a credit institution’s internal methodology or a part of it shall assign to that issuer an estimate of default probability which is equal to or lower than the value assigned in accordance with paragraph (4) item 2) of this Article. (7) For the purposes of paragraph (2) item 3) of this Article, a credit institution shall calculate the value of ‘m’ in accordance with the following formula: m = DRC (full scope) − DRC (other methodologies and external sources) DRC (full scope) where: DRC (full scope) = the own funds requirements calculated in accordance with Article 479 paragraph (1) of this Decision on the full scope of the trading book positions referred to in Article 477 of this Decision; DRC (other methodologies and external sources) = the own funds requirements calculated in accordance with Article 479 paragraph (1) of this Decision relating exclusively to the trading book positions referred to in Article 477 of this Decision for the issuers of which the conditions set out in paragraph (2) of this Article are not met.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 533 Requirements for external sources for estimating default probabilities Article 483 (1) When using external sources for estimating default probabilities in accordance with Article 481 paragraph (5) item 5) of this Decision, a credit institution shall, in accordance with Articles 475 paragraph (2) and Article _ paragraph (9) of this Decision, validate the estimates of default probabilities on a periodic basis for their use in the internal default risk model. (2) A credit institution should obtain the estimates of default probabilities from external sources by employing a methodology that is conceptually sound and that fulfils the requirements set out in paragraph (4) of this Article. (3) A credit institution that uses more than one external source shall establish a hierarchy of those external sources. (4) Before applying the floor referred to in Article 481 paragraph (5) item 1) of this Decision, a credit institution shall ensure that the methodology referred to in paragraph (2) of this Article fulfils all of the following requirements:

  1. the methodology, based on the debtor grade scale (rating) used, where that scale could also be continuous, shall provide estimates of default probabilities corresponding to the applicable time horizon referred to in Article 481 paragraph (5) item 2) of this Decision that meet all of the following conditions: − the estimates of default probabilities are considered accurate for all debtor grades having analysed their expected range of estimation errors; − the estimates of default probabilities are consistent across debtor grades; − the estimates of default probabilities provide a meaningful differentiation of risk and strictly increase as the creditworthiness of the debtor decreases; − the values of the estimates of default probabilities are not set to zero for a debtor grade solely on the basis that no defaults have been observed in the past for that debtor grade;
  2. where the methodology’s estimates of default probabilities are not derived in combination with current market prices, a credit institution shall analyse any differences it observes between those estimates and estimates that are derived in combination with current market prices, as referred to in Article 481 paragraph (5) item 3) of this Decision. Requirements for the internal methodology for estimating losses given default Article 484 (1) A credit institution’s internal methodology, or a part of it, used for estimating LGD in accordance with Article 481 paragraph (7) item 4) of this Decision, must fulfil the same requirements as those that apply to the methodology used by a credit institution that has been granted authorisation to estimate LGD in accordance with Title II, Subtitle 3 of this Part of this Decision. (2) By way of derogation from paragraph (1) of this Article, a credit institution’s internal methodology, or a part of it, for estimating LGD must fulfil the requirements set out in

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 534 paragraphs (3) or (4) of this Article, as applicable, where, in relation to a given position, all of the following conditions are met on a quarterly basis:

  1. no external sources fulfilling the requirements set out in Article 485 of this Decision are already available for estimating LGD for that position;
  2. the use of an internal methodology, or a part of it, fulfilling the requirements set out in paragraph (1) of this Article is either: − not feasible due to a lack of input data for that position; or − disproportionate in relation to the materiality or the holding period of that position, based on the trading strategy adopted for that position;
  3. the value of ‘m’, calculated in accordance with the formula laid down in paragraph (5) of this Article, is any of the following: − lower than or equal to 10%; or − higher than 10%, and the credit institution investigates whether additional external sources fulfilling the requirements set out in Article 485 of this Decision are available and uses those sources to reduce the value of ‘m’ to a value which is lower than or equal to 10%. (3) Where the conditions set out in paragraph (2) of this Article are met, a credit institution’s internal methodology, or a part of it, must assign to a position an estimate of LGD which is equal to or higher than the following:
  4. 75% for positions in subordinated debt instruments;
  5. 45% for positions subordinated unsecured debt;
  6. 11.25% for covered bond positions;
  7. 25% for any other positions. (4) By way of derogation from paragraph (3) of this Article, where the conditions set out in paragraph (2) of this Article are met and the own funds requirements for default risk decrease as the value of LGD assigned to a given position increases, a credit institution’s internal methodology, or a part of it, must assign to that position an estimate of LGD which is equal to or lower than the values set out in paragraph (3) of this Article. (5) For the purposes of paragraph (2) item 3) of this Article, a credit institution shall calculate the value of ‘m’ in accordance with the formula set out in Article 482 paragraph (7) of this Decision, where the term DRC (other methodologies and external sources) represents the own funds requirements calculated in accordance with Article _ paragraph (1) of this Decision relating exclusively to the trading book positions referred to in Article 477 of this Decision for which the conditions set out in paragraph (2) of this Article are not met. Requirements for external sources for estimating LGD Article 485 (1) When using external sources for estimating LGD in accordance with Article 481 paragraph (7) item 4) of this Decision, a credit institution shall, in accordance with Articles 475 paragraph (2) and _ paragraph (9) of this Decision, validate the estimates of LGD on a periodic basis for their use in the internal default risk model. (2) A credit institution that uses more than one external source shall establish a hierarchy of those external sources.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 535 Documentation Article 486 (1) A credit institution whose internal methodology, or a part of it, meets the conditions set out in Article 482 paragraph (2) or Article 484 paragraph (2) of this Decision, shall, in relation to all the issuers and positions covered under those Articles, document all of the following:

  1. that no external sources fulfilling the requirements set out in Article 483 or in Article 485 of this Decision, as applicable, are available for estimating default probabilities for those issuers and LGD for those positions, respectively;
  2. that the use of an internal methodology fulfilling the requirements set out in Article 482 paragraph (1) of this Decision for estimating default probabilities for those issuers, or in Article 484 paragraph (1) of this Decision for estimating LGD, respectively, would not be feasible due to a lack of input data, or that it would be disproportionate in relation to the materiality or the holding period in line with the trading strategy;
  3. the values of ‘m’, calculated in accordance with the formulae laid down in Article 482 paragraph (7) and Article 484 paragraph (5) of this Decision. (2) A credit institution shall keep an up-to-date inventory of the external data sources used for the purposes of Articles 483 and 485 of this Decision which must contain all of the following:
  4. a description of the methodologies used to obtain estimates of default probabilities from external sources in accordance with Article 483 paragraphs (1) and (2) of this Decision;
  5. documentation and underlying rationale where a credit institution has identified different terms, information or assumptions in accounting for expected credit losses and the estimates of default probabilities from external sources for exposures under the internal default risk model for the purpose of ensuring sound credit risk management, as approved by senior management;
  6. a description of the methodologies used to obtain estimates of LGD from external sources in accordance with Article 485 paragraph (1) of this Decision;
  7. the results of the validation performed in accordance with Article 483 paragraph (1) and Article 485 paragraph (1) of this Decision;
  8. the hierarchy of the external sources used, in accordance with Article 483 paragraph (3) and Article 485 paragraph (2) of this Decision. (3) For the purposes of paragraph (2) item 1) of this Article, where the estimates of default probabilities differ from those used in the internal risk management methodologies and those differences are not due to the requirements set out in Article 481 paragraph (5) of this Decision, those differences must be part of the description of the methodologies. (4) For the purposes of paragraph (2) item 3) of this Article, where the estimates of LGD differ from those used in the internal risk management methodologies and those differences are not due to the requirements set out in Article 481 paragraph (6) of this Decision, those differences must be part of the description of the methodologies.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 536 SUBTITLE 4 – Own funds requirements for position risk Section 1 – General provisions and specific instruments Own funds requirements for position risk Article 487 (1) The credit institution's own funds requirement for position risk shall be the sum of the own funds requirements for the general and specific risk of its positions in debt and equity instruments. (2) Securitisation positions in the trading book shall be treated as debt instruments. Netting Article 488 (1) The absolute value of the excess of a credit institution's long (short) positions over its short (long) positions in the same instruments (equity instruments, debt instruments and convertible securities, identical financial futures, options, warrants and covered warrants) shall be its net position in each of those different instruments. (2) In calculating the net position of a credit institution, positions in derivative instruments shall be treated as laid down in Articles 489 to 494 of this Decision, and credit institution' holdings of their own debt instruments shall be disregarded in calculating specific risk capital requirements under Article 500 of this Decision. (3) No netting shall be possible between a convertible instrument and an offsetting position in the instrument underlying it. (4) All net positions, irrespective of their signs, shall be converted on a daily basis into EUR at the prevailing spot exchange rate before their aggregation. Interest rate futures and forwards Article 489 (1) Interest-rate futures, forward-rate agreements (FRAs) and forward commitments to buy or sell debt instruments shall be treated as combinations of long and short positions, specifically:

  1. a long interest-rate futures position shall be treated as a combination of: − a liability position (a borrowing) maturing on the delivery date of the futures contract, and − a holding of an asset with maturity date equal to that of the instrument or notional position underlying the futures contract in question;
  2. a sold FRA will be treated as: − a long position with a maturity date equal to the settlement date plus the contract period, and − a short position with maturity equal to the settlement date.
  3. a forward commitment to buy a debt instrument shall be treated as a combination of: − a liability position (a borrowing) maturing on the delivery date, and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 537 − a long (spot) position in the debt instrument itself. (2) For the purposes of paragraph (1) items 1) and 2) of this Article, both the borrowing and the asset holding shall be included in the first category set out in Table 1 in Article 500 of this Decision in order to calculate the own funds requirement for specific risk for interest-rate futures and FRAs. (3) For the purposes of calculating own funds for specific risk, the borrowing referred to in paragraph (1) item 3) of this Article shall be included in the first category set out in Table 1 in Article 500 of this Decision, and the debt instrument under whichever column is appropriate for it in the same table. (4) For interest-rate futures and forward-rate agreements, ‘long position’ shall mean a position in which a credit institution has fixed the interest rate it will receive at some time in the future, and ‘short position’ shall mean a position in which it has fixed the interest rate it will pay at some time in the future. Options and warrants Article 490 (1) For the purposes of this Subtitle, when calculating own funds requirements for position risk, options and warrants on interest rates, debt instruments, equities, equity indices, financial futures, swaps and foreign currencies shall be treated as if they were positions equal in value to the amount of the underlying instrument to which the option refers, multiplied by its delta for the purposes, and the latter positions may be netted off against any offsetting positions in the identical underlying securities or derivatives. (2) The amount of delta used for options shall be that of the exchange in which those options are traded. (3) For OTC-options, or where delta is not available for the option concerned, the credit institution may calculate delta itself using an appropriate model, subject to authorisation by the Central Bank. (4) The Central Bank shall grant the authorisation referred to in paragraph (3) to the credit institution, if the model appropriately estimates the rate of change of the option's or warrant's value with respect to small changes in the market price of the instrument underlying the option or warrant. (5) For the purpose of determining the own funds requirements, a credit institution shall adequately reflect other risks, apart from the delta risk (risk of change in the option value), associated with options. (6) Risks related to options and warrants, apart from the delta risk, can include, but are not limited to the following:

  1. risks arising from changes in the instrument's gamma referred to as ‘gamma risk’ or ‘convexity risk’;
  2. risks arising from changes in its vega referred to as ‘vega risk’ or ‘volatility risk’;
  3. risks arising from changes in interest rates referred to as ‘interest rate risk’ or ‘rho risk’;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 538 4) nonlinearities which cannot be captured by gamma risk and the risk of implied correlation on basket options or warrants. (7) Of the risks referred to in paragraph (6) of this Article, only the gamma and vega risks are of such materiality that they should be covered when determining total own funds requirements for position risks arising from options. (8) A credit institution may, depending on the complexity of options and warrants operations, and subject to authorisation from the Central Bank, use internal models to calculate own funds requirements for gamma and vega risks of options and warrants. (9) A credit institution shall calculate its own funds requirements for market risk in relation to the non-delta risk of options or warrants according to one of the following approaches:

  1. the simplified approach;
  2. the delta plus approach; or
  3. the scenario approach. (10) When calculating own funds requirements on a consolidated basis a credit institution may combine the use of different approaches, but on an individual basis, a credit institution may only combine the scenario approach and the delta plus approach subject to the conditions established in Articles 492 and 493 of this Decision. (11) For the purposes of calculating own funds requirements for market risk in relation to the risk of options or warrants (gamma and vega but not delta risks), a credit institution shall take the following steps:
  4. break down baskets of options or warrants into their fundamental components;
  5. break down caps and floors or other options which relate to interest rates at various dates, into a chain of independent options referring to different time periods (‘caplet’ and ‘floorlets’);
  6. treat options or warrants on fixed-to-floating interest rates swaps into options or warrants on the fixed interest leg of the swap;
  7. treat options or warrants that relate to more than one underlying instrument as a basket of options or warrants where each option has a single distinct underlying. Calculation of own funds requirements for non-delta position risks on options or warrants applying the simplified approach Article 491 (1) Where a credit institution exclusively purchases options and warrants, it may use the simplified approach to calculate the own funds requirements relative to non-delta risks only for options or warrants which are calculated as the higher amount between zero and the difference between the following values:
  8. the gross amount, as described in paragraphs (2) to (5) of this Article;
  9. the risk weighted delta equivalent amount, which shall be calculated as the market value of the underlying instrument, multiplied by the delta and then multiplied by one of the following relevant weightings: − for specific and general equity risk or interest rate risk, according to Subtitle 4 of this Title;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 539 − for commodity risk, according to Subtitle 6 of this; and − for foreign exchange risk, according to Subtitle 5 of this Title. (2) For options or warrants which fall under one of the following two categories, the gross amount referred to in paragraph (1) of this Article shall be determined according to paragraphs (3) and (4) of this Article:

  1. where the buyer has the unconditional right to buy the underlying asset at a predetermined price at the expiration date or at any time before the expiration date, and where the seller has the obligation to fulfil the buyer's demand (‘simple call options or warrants’);
  2. where the buyer has the unconditional right to sell the underlying asset in the same manner as described in 1) of this Article (‘simple put options or warrants’). (3) The gross amount referred to in paragraph (1) of this Article shall be calculated as the maximum between zero and the market value of the underlying security multiplied by the sum of specific and general market risk own funds requirements for the underlying instrument minus the amount of the profit, if any, resulting from the instant execution of the option (‘in the money’), where one of the following conditions is met:
  3. the option or warrant incorporates a right to sell the underlying asset (‘long put’) and is combined with holdings in the underlying asset (‘long position in the underlying instrument’);
  4. the option or warrant incorporates a right to buy the underlying asset (‘long call’) and is combined with the promise to sell holdings in the underlying instrument (‘short position in the underlying asset’). (4) Where the option or warrant incorporates a right to buy the underlying asset (‘long call’) or a right to sell the underlying asset (‘long put’), the gross amount referred to in paragraph (1) of this Article shall be the lesser of the following two amounts:
  5. the market value of the underlying security multiplied by the sum of specific and general market risk requirements for the underlying asset;
  6. the value of the position determined by the mark-to-market method or the mark￾to-model method (‘market value of the option or warrant’). (5) For all types of options or warrants which do not have the characteristics referred to in paragraph (2) of this Article, the gross amount referred to in paragraph (1) of this Article shall be the market value of the option or warrant. Calculation of own funds requirements for non-delta position risks on options or warrants applying the Delta-plus approach Article 492 (1) Where a credit institution opts to apply the Delta-plus approach, for options and warrants whose gamma is a continuous function in the price of the underlying and whose vega is a continuous function in the implied volatility (‘continuous options and warrants’), the own funds requirements for non-delta risks on options or warrants shall be calculated as the sum of the following requirements:
  7. the own funds requirements for gamma risk, representing the first (partial) derivative of delta with reference to the price of the underlying instrument which, for bond options or warrants is the first (partial) derivative of delta with reference

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 540 to the yield-to-maturity (interest rate) of the underlying bond, and for swaptions is the first (partial) derivative of the delta with reference to the swap rate; 2) the requirement for vega risk, representing to the first (partial) derivative of the value of an option or warrant, with reference to the implied volatility. (2) Implied volatility referred to in paragraph (1) of this Article shall be taken to be the value of the volatility in the option or warrant pricing formula for which, given a certain pricing model and given the level of all other observable pricing parameters, the theoretical price of the option or warrant is equal to its market value, where ‘market value’ is understood in the manner described in Article 491 paragraph (4) of this Decision. (3) The own funds requirements for non-delta risks related to non-continuous options or warrants shall be determined as follows:

  1. where the options or warrants have been bought, as the maximum amount between zero and the difference between the following values: − the market value of the option or warrant, understood in the manner described in Article 491 paragraph (4) of this Decision; − the risk weighted delta equivalent amount, understood in the manner described in Article 491 paragraph (1) item 2) of this Decision;
  2. where the options or warrants have been sold, as the maximum between zero and the difference between the following amounts: − the relevant market value of the underlying asset, which shall be taken to be either the maximum possible payment at expiry date, if it is contractually fixed, or the market value of the underlying asset or the effective notional value if no maximum possible payment is contractually fixed; − the risk weighted delta equivalent amount, understood in the manner described in Article 491 paragraph (1) item 2) of this Decision. (4) The value for gamma and vega used in the calculation of own funds requirements shall be calculated using an appropriate pricing model as referred to in Article 490 paragraph (1), Article 516 paragraph (1) and Article 522 paragraphs (4) to (6) of this Decision. (5) Where either gamma or vega cannot be calculated in accordance with paragraph (4) of this Article, the own funds requirement on non-delta risks shall be calculated according to paragraph (3) of this Article. (6) For the purposes of paragraph (1) item 1) of this Article, the own funds requirements for gamma risk shall be calculated by a process consisting of the following sequence of steps:
  3. for each individual option or warrant a gamma impact shall be calculated using the following formula: 𝑖𝑖 = 1 2 ∙ ∙ 2, where: − for options or warrants on interest rates or bonds VU is equal to the assumed change in yield (interest rates) indicated in column 5 of Table 2 of Article 503 of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 541 − for equity options or warrants and equity indices VU is equal to the market value of the underlying multiplied by the weight of 8% indicated in Article 507 of this Decision; − for currency and gold options or warrants VU is equal to the market value of the underlying instrument, calculated in the EUR and multiplied by the weight of 8% indicated in Article 515 of this Decision or — if appropriate — the weight of 4% or 1.6% indicated in Article 518 of this Decision; − for commodity options or warrants VU is equal to the market value of the underlying instrument, multiplied by the weight of 15% indicated in point (Article 524 paragraph (1) item 1) of this Decision; 2) the gamma impacts of individual options or warrants which refer to the same distinct underlying instrument type shall be summed up: − for interest rates in the same currency: each maturity time band as set out in Table 2 of Article 503 of this Decision; − for equities and stock indices: each individual market; − for foreign currencies and gold: each currency pair and gold; − for commodities: commodities considered identical as in accordance with Article 521 paragraph (5) of this Decision; 3) the negative values resulting from item 2) of this paragraph shall be summed up, and the absolute value of the sum of all of those negative values shall provide the own funds requirements for gamma risk, where the positive values shall be disregarded. (7) For the purposes of paragraph (1) item 2) of this Article, the own funds requirement for vega risk shall be calculated by a process consisting of the following sequence of steps:

  1. for each individual option the value of vega shall be determined;
  2. for each individual option an assumed plus/minus 25% shift in the implied volatility shall be calculated, where implied volatility shall be understood in the manner described in paragraph (2) of this Article;
  3. for each individual option the vega value resulting from the step in item 1) of this paragraph shall be multiplied by the assumed shift in implied volatility resulting from the step in item 2 of this paragraph;
  4. for each distinct underlying type, understood in the manner described in paragraph (6) item 2) indents 1 to 4 of this Article, the values resulting from the step in item 3) of this paragraph shall be summed up;
  5. the sum of absolute values resulting from the step in item 4) of this paragraph shall provide the total own funds requirement for vega risk. Calculation of own funds requirements for non-delta position risks on options or warrants applying the scenario approach Article 493 (1) A credit institution may use the scenario approach where it fulfils all of the following requirements:
  6. it has established a risk control unit that monitors the risk of the options portfolio and reports the results to the management;
  7. it has notified the Central Bank of a predefined scope of exposures to be covered by this approach consistently over time, wherein it shall, when notifying the Central Bank thereof, define the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 542 − the precise positions that are subject to the scenario approach, including the type of product or identified desk and portfolio; − the distinctive risk management approach that applies to such positions; − the dedicated IT application that applies to such positions; and − a justification for the allocation of those positions to the scenario approach, with regard to those positions allocated to other approaches; 3) it integrates the results of the scenario approach in the internal reporting to the management of the credit institution. (2) For each distinct underlying instrument type, as referred to in Article 492 paragraph (6) item 2) indents 1 to 4 of this Decision, a credit institution shall define a scenario matrix which contains a set of scenarios. (3) The first dimension of the scenario matrix shall be the price changes in the underlying instrument above and below its current value, wherein that range of changes shall consist of the following:

  1. for interest rate options or warrants, plus/minus the assumed change in interest rates set out in Table 2 column 5 Article 503 of this Decision;
  2. for options or warrants on equity or equity indices, plus/minus the weight of 8% provided in Article 507 of this Decision;
  3. for foreign exchange and gold options or warrants, plus/minus the weight of 8% indicated in Article 515 of this Decision or, where appropriate, plus/minus the weight of 4% or 1.6% indicated in Article 518 of this Decision;
  4. for commodity options (warrants), plus/minus the weight of 15% indicated in Article 524 paragraph (1) item 1) of this Decision. (4) The price change scenarios in the underlying instrument shall be defined by a grid of at least seven points which includes the current observation and divides the range indicated in in paragraph (3) of this Article in equally spaced intervals. (5) The second dimension of the scenario matrix shall be defined by volatility changes, the range of which shall be between plus/minus 25 % of the implied volatility, where implied volatility shall be defined in accordance with Article 492 paragraph (2) of this Decision, and that range shall be divided into a grid of at least three points which include a 0 % change and where the range is divided into equally spaced intervals (6) The scenario matrix is determined by all possible combinations of points, as referred to in paragraphs (4) and (5) of this Article, where each combination shall constitute a single scenario. (7) According to the scenario approach, the own funds requirement on non-delta risk of options or warrants shall be calculated through a process consisting of the following sequence of steps:
  5. for each individual option or warrant, all the scenarios referred to in paragraphs (2) to (6) of this Article shall be applied to calculate simulated net loss or gain corresponding to each scenario, and that simulation shall be done using full revaluation methods, by simulating the price changes by the use of pricing models and without relying to local approximations of those models;
  6. for each distinct underlying instrument type, as referred to in Article 492 paragraph (6) item 2) indents 1 to 4 of this Decision, the values obtained as a

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 543 result of the calculation in item 1) of this paragraph and referring to the individual scenarios, shall be aggregated; 3) for each distinct underlying instrument type as referred to in Article 492 paragraph (6) item 2) indents 1 to 4 of this Decision, the ‘relevant scenario’ shall be calculated as the scenario for which the values determined in accordance with item 2) of this paragraph result in the largest loss, or the lowest gain if there are no losses; 4) for each distinct underlying instrument type, as referred to in Article 492 paragraph (6) item 2) indents 1 to 4 of this Decision, the own funds requirements shall be calculated in accordance with the following formula: Own funds requirement = min(0, PC − DE) where: PC – PC (‘Price Change’) is the sum of price changes of the options with the same distinct underlying instrument type understood in the manner described in Article 492 paragraph (6) item 2) indents 1 to 4 (negative sign for losses and positive sign for gains) and corresponding to the relevant scenario determined in item 3) of this paragraph; DE – is the ‘delta effect’ calculated as follows: = ∙ 𝑃𝑃𝑃𝑃 , where: ADEV – (‘aggregated delta equivalent value’) is the sum of negative or positive deltas, multiplied by the market value of the underlying instrument of the contract, of options that have the same distinct underlying instrument type referred to in Article 492 paragraph (6) item 2) indents 1 to 4 of this Decision; PPCU – (‘percentage price change of the underlying’) is the percentage price change of the underlying instrument referred to in Article 492 paragraph (6) item 2) indents 1 to 4 of this Decision, corresponding to the relevant scenario determined in in item 3) of this paragraph; 5) the total own funds requirement in the case of non-delta risk of options or warrants shall be the sum of the own fund requirements obtained from the calculation referred to in item 4) of this paragraph for all distinct underlying instrument types as referred to in Article 492 paragraph (6) item 2) indents 1 to 4 of this Decision. Swaps Article 494 (1) Swaps shall be treated for interest-rate risk purposes on the same basis as on￾balance-sheet instruments.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 544 (2) An interest-rate swap under which a credit institution receives the amount of interest equivalent to floating-rate interest and pays the amount of interest equivalent to fixed-rate interest shall be treated as a combination of:

  1. a long position in a floating-rate instrument of maturity equivalent to the period until the next interest fixing, and
  2. a short position in a fixed-rate instrument with the same maturity as the swap itself. Interest rate risk on derivative instruments Article 495 (1) A credit institution which marks to market and manages the interest-rate risk on the derivative instruments in accordance with the provisions of Articles 489, 490, and 494 of this Decision on a discounted-cash-flow basis may, subject to authorisation by the Central Bank, use sensitivity models to calculate the value of those positions. (2) The Central Bank shall grant the authorisation referred to in paragraph (1) of this Article if the models generate positions which have the same sensitivity to interest￾rate changes as the underlying cash flows. (3) Sensitivity models referred to in paragraph (1) of this Article may be used for any bond which is amortised over its residual life rather than via one final repayment of principal. (4) Sensitivity to interest-rate shall be assessed with reference to independent movements in sample rates across the yield curve, with at least one sensitivity point in each of the maturity bands set out in Table 2 in Article 503 of this Decision. (5) The positions shall be included in the calculation of own funds requirements for general risk of debt instruments. (6) A credit institution which does not use models under paragraph (1) of this Article may, treat as fully offsetting any positions in derivative instruments covered in Articles 489, 490, and 494 of this Decision which meet the following conditions at least:
  3. the positions are of the same value and denominated in the same currency;
  4. the reference rate (for floating-rate positions) or coupon (for fixed-rate positions) is closely matched;
  5. the next interest-fixing date (for floating-rate positions) or residual maturity (for fixed-rate positions) corresponds with the following limits: ­ for positions with residual maturity date or next interest fixing date of less than one month: the dates must be the same; for positions with residual maturity date or next interest fixing date between one month and one year: the dates shall not differ by more than seven days; ­ for positions with residual maturity date or next interest fixing date over one year: the dates shall not differ by more than 30 days.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 545 Credit derivatives Article 496 (1) When calculating the own funds requirement for general and specific risk of the party who assumes the credit risk (the ‘protection seller’), unless specified differently, the notional amount of the credit derivative contract shall be used, wherein the credit institution may elect to replace the notional value by the notional value plus the net market value change of the credit derivative since trade inception, a net downward change from the protection seller's perspective carrying a negative sign. (2) When calculating the specific risk charge, other than for total return swaps, the maturity of the credit derivative contract, rather than the maturity of the obligation, shall apply. (3) Positions in credit derivatives shall be determined as follows:

  1. a total return swap (TRS) represents a combination of the following: ­ a long position in the underlying obligation (when calculating own funds requirements for general position risk); ­ a short position in the risk-free government bonds (0% risk weight under Title II, Subtitle 2 of this Part of the Decision) with a maturity equivalent to the period until the next interest fixing (when calculating own funds requirements for general position risk), and ­ a long position in the underlying obligation (when calculating own funds requirements for specific position risk);
  2. credit default swap (CDS) does not create a position for general risk but only for specific risk, thus the credit institution shall record a synthetic long position in a reference obligation, wherein, in the case that the derivative is rated externally and meets the conditions for a qualifying debt item, a long position in the derivative shall be recorded, and if premium or interest payments are due under the CDS, these cash flows shall be represented as notional positions in government bonds;
  3. when calculating own funds requirements for general position risk, a single name credit linked note creates a long position in the general risk of the note itself, as an interest rate product; when calculating own funds requirements for specific position risk, a synthetic long position is created in a reference obligation and an additional long position is created in the issuer of this instrument, and where the credit linked note has an external rating and meets the conditions for a qualifying debt item, when calculating own funds requirements for specific position risk a single long position of that note need only be recorded;
  4. in addition to a long position in the issuer of the note, a multiple name credit linked note providing proportional protection (when calculating own funds requirement for specific position risk) has a position in each reference entity, wherein the total notional amount of the contract is proportionally assigned across the positions according to their share in the total notional value of the contract, and where more than one exposure to the same person exists, when calculating own funds requirement for specific position risk, the exposure with the highest risk weighting shall be used;
  5. a first-asset-to-default credit derivative has a position for the notional amount in an obligation of each reference entity, and if the size of the maximum credit

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 546 event payment is lower than the own funds requirement determined in this manner, the credit institution may take the maximum payment when calculating the own funds requirement for specific risk. (3) A -n-th-asset-to-default credit derivative has a position for the notional amount in an obligation of each reference entity less the n-1 reference entities with the lowest specific position risk own funds requirement, and if the size of the maximum credit event payment is lower than the own funds requirement determined in this manner, the credit institution may take the maximum payment when calculating the own funds requirement for specific risk. (4) Where an n-th-to-default credit derivative is externally rated, the protection seller (provider) shall calculate the specific position risk own funds requirement using the external rating of the derivative and apply the respective securitisation risk weights. (5) When calculating the specific position risk own funds requirement, the protection buyer, or the party that carrying out the credit risk transfer, shall apply the notional amount of the credit derivative contract, wherein the positions shall carry opposite signs in relation to the sign of the protection seller's position, wherein the credit institution may elect to replace the notional value of the contract by the value equal to the notional value plus the net market value change of the credit derivative since trade inception date, a net downward change from the protection seller's perspective carrying a negative sign, and if at a given moment there is a call option (instrument providing the purchase right) in combination with a step-up, such moment shall be treated as the maturity of the protection. (6) Credit derivatives in accordance with the provisions of Article 413 paragraphs (10) and (11) or paragraph (13) of this Decision shall be included only in the determination of the specific position risk own funds requirement in accordance with the provisions of Article 502 paragraph (2) of this Decision. Securities sold under a repurchase agreement or lent Article 497 The transferor of securities or guaranteed rights relating to title to securities in a repurchase agreement and the lender of securities in a securities lending shall include these securities in the calculation of its own funds requirement for position risk under this Subtitle, provided that such securities are trading book positions. Section 2 – Debt instruments Net positions in debt instruments Article 498 A credit institution shall classify net positions in each instrument according to the currency in which they are denominated and shall calculate the own funds requirement for general and specific risk in each individual currency separately.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 547 Sub-Section 1 – Specific position risk Cap on the own funds requirement for a net position in debt instruments Article 499 (1) A credit institution may define the maximum amount of the own funds requirement for specific risk of a net position in a debt instrument at the maximum possible default￾risk related loss. (2) For a short position, the limit (maximum amount) referred to in paragraph (1) of this Article may be calculated as a change in value due to the instrument or, where relevant, the underlying exposure immediately becoming risk-free. Own funds requirement for non-securitisation debt instruments Article 500 (1) A credit institution shall assign its net positions in the trading book in instruments that are not securitisation positions as calculated in accordance with Article 488 of this Decision to the appropriate categories depending on their issuer or debtor, external or internal credit assessment, and residual maturity, and then multiply them by the weightings shown in the aforementioned table. (2) When determining the own funds requirement for specific risk, a credit institution shall sum all weighted positions referred in paragraph (1) of this Article, regardless of whether they are long or short positions. (3) The following table shall be used for assigning the net positions in the trading book referred to in paragraph (1) of this Article: Table 1 Categories Specific risk own funds requirement debt securities which would receive a 0% risk weight under the Standardised Approach for credit risk 0% debt securities which would receive a 20% or 50% risk weight under the Standardised Approach for credit risk and other qualifying items as defined in paragraph (6) of this Article 0.25% (residual term to final maturity six months or less)1.00% (residual term to final maturity greater than six months and up to and including 24 months) 1.60% (residual term to maturity exceeding 24 months) debt securities which would receive a 100% risk weight under the Standardised Approach for credit risk 8% debt which would receive a 150 % risk weight under the Standardised Approach for credit risk 12%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 548 (4) A credit institution which applies the IRB Approach to the exposure class of which the issuer of the debt instrument forms part, to qualify for a risk weight under the Standardised Approach for calculating own funds requirement for credit risk as referred to in paragraph (1) of this Article, the issuer of the exposure shall have an internal rating with a PD equivalent to or lower than that associated with the appropriate credit quality step under the Standardised Approach. (5) A credit institution may calculate the specific risk own funds requirements for any bonds that qualify for a 10% risk weight in accordance with the provisions of Article 169 paragraphs (14) and (15) of this Decision as half (1/2, or 50%) of the applicable specific risk own funds requirement for the second category in Table 1 of paragraph (3) of this Article (debt securities which would receive a 20% or 50% risk weight under the Standardised Approach for credit risk and other qualifying items as defined in paragraph (6) of this Article). (6) Other qualifying items are:

  1. long and short positions in assets for which a credit assessment by a nominated ECAI is not available and which meet the following conditions: ­ they are considered by the credit institution to be sufficiently liquid; ­ their investment quality is, according to the credit institution's own assessment, at least equivalent to that of the assets belonging to the category 2 referred to under Table 1 of paragraph (3) of this Article; and ­ they are listed on at least one regulated;
  2. long and short positions in assets issued by a credit institution which calculates the own funds requirements in accordance with the provisions of this Decision and which are, according to the credit institution's assessment, considered to be sufficiently liquid and whose investment quality is, according to the credit institution's assessment, at least equivalent to that of the assets belonging to the category 2 referred to under Table 1 of paragraph (3) of this Article;
  3. securities issued by a credit institution that are deemed to be of equivalent, or higher, credit quality than those corresponding to category 2, under the Standardised Approach for credit risk of exposures to credit institutions prescribed by tis Decision, equivalent EU regulations or third country regulations comparable with this Decision (7) A credit institution that makes use of paragraph (6) items 1) or 2) of this Article shall have a documented methodology in place to assess whether assets meet the requirements in those items and shall notify this methodology to the Central Bank. Own funds requirement for securitisation instruments Article 501 (1) For instruments in the trading book that are securitisation positions, a credit institution shall weight the net positions as calculated in accordance with Article 488 paragraph (1) of this Decision with 8% of the risk weight the credit institution would apply to the position in its non-trading book according to Section 3, Subtitle 5, Title II of this Part of the Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 549 (2) When determining risk weights for the purposes of paragraph (1) of this Article, a credit institution shall use exclusively the approach set out in Section 3, Subtitle 5, Title II of this Part of the Decision. (3) For securitisation positions that are subject to an additional risk weight in accordance with Article 283 paragraph (9) of this Decision, 8% of the total risk weight shall be applied. (4) A credit institution shall sum all weighted positions resulting from the application of paragraphs (1), (2), and (3) of this Article regardless of whether they are long or short, in order to calculate its own funds requirement against specific risk, except for securitisation positions subject to Article 502 paragraph (2) of this Decision. (5) Where an originator credit institution of a traditional securitisation does not meet the conditions for significant risk transfer set out in Article 280 of this Decision, it shall include the exposures underlying the securitisation in its calculation of own funds requirement as if those exposures had not been securitised. (6) Where an originator credit institution of a synthetic securitisation does not meet the conditions for significant risk transfer set out in Article 281 of this Decision, it shall include the exposures underlying the securitisation in its calculation of own funds requirements as if those exposures had not been securitised and shall ignore the effect of the synthetic securitisation for credit protection purposes. Own funds requirement for the correlation trading portfolio Article 502 (1) For the purposes of this Article, a credit institution shall determine its correlation trading portfolio in accordance with Article 413 paragraphs (10) to (13) of this Decision. (2) A credit institution shall determine the larger of the following amounts as the specific risk own funds requirement for the correlation trading portfolio:

  1. the total specific risk own funds requirement that would apply just to the net long positions of the correlation trading portfolio;
  2. the total specific risk own funds requirement that would apply just to the net short positions of the correlation trading portfolio. Subsection 2 – General position risk Maturity-based calculation of general position risk Article 503 (1) When calculating the own funds requirements against general position risk a credit institution shall weight all positions according to maturity in accordance with the provisions of paragraph (2) of this Article, wherein the own funds requirements shall be reduced when a weighted position is held alongside an opposite weighted position within the specific maturity column, given that the long and short weighted positions are mutually netted.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 550 (2) A reduction in the own funds requirement may also be made when the opposite weighted positions (long and short) fall into different maturity columns, with the size of this reduction depending both on whether the two mutually netted positions fall into the same zone, or not, and on the particular zone in which he netting is carried out. (3) A credit institution shall assign all net positions into appropriate maturity columns (columns 2 or 3 of the Table below) in the Table 2 of this paragraph: Table 2 zone maturity column weights (in %) assumed interest rate change (in %) coupon (interest) rate of 3% or more coupon (interest) rate of less than 3% one 0 ≤ 1 month 0 ≤ 1 month 0.00 —

1 ≤ 3 months > 1 ≤ 3 months 0.20 1.00 3 ≤ 6 months > 3 ≤ 6 months 0.40 1.00 6 ≤ 12 months > 6 ≤ 12 months 0.70 1.00 two 1 ≤ 2 years > 1.0 ≤ 1,9 years 1.25 0.90 2 ≤ 3 years > 1.9 ≤ 2,8 years 1.75 0.80 3 ≤ 4 years > 2.8 ≤ 3,6 years 2.25 0.75 three 4 ≤ 5 years > 3.6 ≤ 4,3 years 2.75 0.75 5 ≤ 7 years > 4.3 ≤ 5,7 years 3.25 0.70 7 ≤ 10 years > 5.7 ≤ 7,3 years 3.75 0.65 10 ≤ 15 years > 7.3 ≤ 9.3 years 4.50 0.60 15 ≤ 20 years > 9.3 ≤ 10.6 years 5.25 0.60 20 years > 10.6 ≤ 12.0 years 6.00 0.60 12.0 ≤ 20.0 years 8.00 0.60 20 years 12.50 0.60 (4) Assignment into columns shall be carried out on the basis of residual maturity in the case of fixed-rate instruments and on the basis of the period until the interest rate is next set in the case of instruments on which the interest rate is variable (before final maturity). (5) A credit institution shall distinguish between debt instruments with a coupon of 3% or more and those with a coupon of less than 3% and thus allocate them to column 2 or column 3 in Table 2 of paragraph (2) of this Article, and it shall then weigh each of thus assigned net positions by the appropriate weights referred to in column 4 in Table 2 in paragraph (2) of this Article. (6) The credit institution shall work out the sum of the weighted long positions and the sum of the weighted short positions in each maturity column, wherein the sum of the weighted long positions which are matched by the sum of the weighted short positions in each maturity column shall be the matched weighted position in that maturity column, while the residual long or short position shall be the unmatched weighted position for the same maturity column.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 551 (7) The credit institution shall calculate the sum of matched weighted positions obtained in accordance with paragraph (5) of this Article of this Article for each column. (8) The credit institution shall compute the totals of the unmatched weighted long positions for the maturity column included in each of the zones in Table 2 of paragraph (2) of this Article to be able to calculate the amount of the unmatched weighted long position for each zone, and to calculate, in the same manner, the sum of the unmatched weighted short positions for each maturity column included in each of the zones to compute the unmatched weighted short position for each zone. (9) The part of the unmatched weighted long position for a given zone that is matched by the unmatched weighted short position for the same zone shall be the matched weighted position for that zone, and the part of the unmatched weighted long or unmatched weighted short position for a zone that cannot be thus matched shall be the unmatched weighted position for that zone. (10) The amount of the unmatched weighted long or short position in zone one which is matched by the unmatched weighted short or long position in zone two shall then be the matched weighted position between zones one and two; the same matching shall be undertaken between the amount of the unmatched weighted long or short position in zone two which is left over and the unmatched weighted position in zone three in order to calculate the matched weighted position between zones two and three. (11) The credit institution may reverse the order of matching between zones as defined in paragraph (9) of this Article, so as to calculate the matched weighted position between zones two and three before calculating that position between zones one and two. (12) The remainder of the unmatched weighted position in zone one shall then be matched with the remaining amount of the unmatched position in zone three (which remained unmatched after the previous matching between that zone and zone two), in order to derive the amount of matched weighted position between zones one and three. (13) Residual positions, following the matching as set out in the provisions of paragraphs (10), (11), and (12) shall be summed. (14) The own funds requirement shall be calculated as the sum of the following items:

  1. 10% of the sum of the matched weighted positions in all maturity columns;
  2. 40% of the matched weighted position in zone one;
  3. 30% of the matched weighted position in zone two;
  4. 30% of the matched weighted position in zone three;
  5. 40% of the matched weighted position between zones one and two and between zones two and three;
  6. 150% of the matched weighted position between zones one and three;
  7. 100% of the residual unmatched weighted positions. (15) When carrying out maturity-based calculation the own funds requirements against general position risk, in addition to debt instruments, the following FX derivatives,

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 552 which are in addition to FX risk also exposed to interest rate risk, shall also be considered:

  1. FX Forwards;
  2. FX Swaps; and
  3. cross-Currency Interest Rate Swap (CIRS). Duration-based calculation of general risk Article 504 (1) When calculating the own funds requirement for the general risk on debt instruments, a credit institution may use a duration-based approach, instead of the approach set out in the provisions of Article 503 of this Decision, provided that the it does so on a consistent basis. (2) A credit institution applying the duration-based approach referred to in paragraph (1) of this Article shall take the market value of each fixed-rate debt instrument and hence calculate its yield to maturity, which is implied discount rate for that instrument, and in the case of floating-rate instruments, the credit institution shall take the market value of each instrument and hence calculate its yield on the assumption that the principal is due when the interest rate can next be changed. (3) Applying the modified duration would provide a conservative estimation of the real loss that a credit institution would experience in case of an increase in interest rates; therefore, modified duration (MD) overestimates potential losses in case of an increase in interest rates and underestimating potential gains in case of a decrease in interest rates. (4) A credit institution shall calculate the modified duration of each debt instrument on the basis of the following formula: 𝑚𝑚 = 1 + 𝑅𝑅 where D represents duration calculated according to the following formula: = ∑ 𝑡𝑡 ∙ 𝐶𝐶𝑡𝑡 (1 + 𝑅𝑅)𝑡𝑡 𝑀𝑀 𝑡𝑡=1 ∑ 𝐶𝐶𝑡𝑡 (1 + 𝑅𝑅)𝑡𝑡 𝑀𝑀 𝑡𝑡=1 where: R = yield to maturity; Ct = cash payment in time t; M = total maturity. (5) The concept of modified duration is valid only for instruments not subject to prepayment risk, and when the counterparty has the possibility of paying an obligation based on issued debt instrument (callable bond) before it reaches its date of maturity (for long positions) or when the counterparty has the possibility to ask for an early repayment (puttable bond) based on the issued instrument from the credit institution

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 553 (for short positions), it is necessary to perform corrected modified duration (CMD), to reflect this risk. (6) Corrected modified duration (CMD) aimed at including early repayment risk of the instrument results in lower own funds requirements compared to those determined in line with the standardised approach if early repayment option were not to be taken into consideration because the duration of the debt instrument with embedded optionality is reduced compared to a standard instrument (e.g., vanilla instrument). (7) Lower own funds requirements referred to in paragraph (6) of this Article reflect the fact that the real maturity of the bond would almost certainly be the first date on which the bond can be called; all instruments subject to early repayment risk, typically debt instruments, differ from standard instruments as their maturity is no longer fixed, but becomes variable, and this uncertainty in the maturity of the product is introduced by the embedded optionality, which gives the right to extinguish in advance the reference obligation. (8) Aimed at determining own funds requirement for instruments with early repayment embedded optionality, thus treating them as hybrid instruments, it is necessary to perform segregation of those instruments into two components:

  1. standard (vanilla) bond; and
  2. interest rate option. (9) Since the value of the instrument is equal to the value of the standard (vanilla) bond instrument, plus or minus (depending on whether the credit institution has bought or sold the option) the value of the embedded option, the corrected modified duration – CMD is approximated as the difference of the modified duration (MD) of the vanilla instrument (bond) and the first order approximation of the change in value of the option due to the change in the underlying value (i.e. equivalent to the delta) of the option embedded, adjusted by the current price of the bond. (10) As the embedded optionality introduces negative or positive gamma, it must be taken into consideration and treated as factor, then adjusted by the price of the bond and the change in the value of interest rate, divided by two, wherein the calculation of gamma impact shall be performed in line with the provisions of Articles 491, 492 and 493 of this Decision. (11) Apart from the aforementioned adjustments, it is necessary to consider additional correction factor in order to reflect any significant transaction costs that the early payment of the callable bond might produce, as well as behavioural factors, which would reflect the fact that some of the options’ buyers might decide not to execute the option despite being in the money, wherein this additional correction shall be either considered in the delta / gamma calculations or, alternatively, treated as a separate factor. (12) The assessment of the additional factor is based on historical data, obtained from the credit institution’s own experience or from external sources, wherein the data on the behavioural factors may be obtained from the assessment of other balance sheet elements subject to early repayment risk, such as those observed for retail clients in the nontrading book, and the additional factor, consisting of transaction costs and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 554 behavioural factors, is introduced to ensure that the corrected modified duration reflects conservatively the maturity of the callable bond, so it should never lead to a shorter CMD than if it was not considered in the calculation. (13) Calculation of the corrected modified duration shall be performed using the following formula: 𝐶𝐶 = 𝑀𝑀 × 𝜑𝜑 × 𝜔𝜔; where: MD = modified duration; 𝜑𝜑 = 𝐵𝐵 𝑃𝑃 𝜔𝜔 = 1 + ∆ + 1 2 𝛾𝛾 + 𝜓𝜓 P = price of bond with the embedded optionality; B = theoretical price of the vanilla bond; ∆ = delta of the embedded option; = gamma of the embedded option; = change in the value of the reference instrument; 𝜓𝜓 = additional factor (consistent with a general IRR movement 100b.p.), that will be zero if already included in the calculation of gamma and delta. (14) A credit institution may calculate the corrected modified duration – CMD by revaluing the instrument after assessing the effects of shifting the IRR by 100 b.p. in which case, no gamma correction is necessary, since the instrument is fully revalued and no delta approximation is applied, in addition, the credit institution may also directly include the additional correction, or treat it otherwise as a separate additional factor (𝜓𝜓). (15) In the case referred to in paragraph (14) of this Article, the following formula shall apply: 𝐶𝐶 = 𝑃𝑃−∆ −𝑃𝑃+∆𝑟𝑟 2×𝑃𝑃0×∆ + 𝜓𝜓; where: 𝑃𝑃0 = the current market price of the product; 𝑃𝑃∓∆ = theoretical price of the product after a negative and a positive IRR shock equals ∆ ; Δ = hypothetical interest rate change of 50 b.p; 𝜓𝜓 = transaction costs and behavioural variables consistent with an IRR shift of 100 b.p. Value of this additional factor shall be equal to zero if already included in the calculation of theoretical product price following the calculation of negative and positive interest shocks.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 555 (16) A credit institution shall allocate each debt instrument to the appropriate zone in the Table 3 of this paragraph on the basis of the determined modified duration of each instrument. Table 3 (17) A credit institution shall calculate the duration-weighted position for each instrument by multiplying its market price by its modified duration and by the assumed interest-rate change for an instrument with that particular modified duration in line with Table 3 from paragraph (16) of this Article. (18) A credit institution shall calculate its duration-weighted long and its duration￾weighted short positions within each zone, wherein the amount of the former which are matched by the latter within each zone shall be the matched duration-weighted position for that zone. (19) A credit institution shall calculate the unmatched duration-weighted positions for each zone, and it shall then follow the provisions of Article 503 paragraphs (10) to (13) of this Decision pertaining to the treatment of unmatched weighted positions between zones. (20) Own funds requirement shall in that case be calculated as the sum of the following items:

  1. 2% of the matched duration-weighted position for each zone;
  2. 40% of the matched duration-weighted positions between zones one and two and between zones two and three;
  3. 150% of the matched duration-weighted position between zones one and three;
  4. 100% of the residual unmatched duration-weighted positions. Section 3 – Equities Net positions in equity instruments Article 505 (1) A credit institution shall separately sum and all its net short positions in accordance with the provisions of Article 488 of this Decision, wherein the sum of the absolute values of all its net long and net short positions shall be its overall gross position. (2) A credit institution shall calculate, separately for each market, the difference between the sum of the net long and the net short positions, wherein the sum of the absolute values of those differences (net long and net short positions) shall be its overall net position. zone Modified duration (in years) Assumed interest (change in%) one > 0 ≤ 1.0 1.00 two > 1.0 ≤ 3.6 0.85 three > 3.6 0.70

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 556 (3) For the purpose of calculating a net position in equity instruments, in accordance with paragraph (2) of this Article, the term market shall entail:

  1. for Montenegro, all equity instruments listed in the stock-exchange;
  2. for EU Member States that are members of euro area, all equity instruments listed in the stock-exchanges of EU Member States that use EUR as national currency;
  3. for all EU Member States that are not part of the euro area and third countries, all equity instruments listed in the stock-exchanges registered in those countries. Specific risk of equity instruments A credit institution shall multiply its overall gross position by 8% weight in order to calculate its own funds requirement against specific risk of equity instruments. General risk of equity instruments Article 507 The capital requirement against general risk of equity instruments shall be the credit institution’s overall net position multiplied by 8% weight. Stock indices Article 508 (1) Stock-index futures, the delta-weighted equivalents of options in stock-index futures and stock indices collectively referred to as “stock-index futures’, may be broken down into positions in each of their constituent equities, and these positions may be treated as underlying positions in the equities in question, and may be netted against opposite positions in the underlying equities themselves, wherein the credit institution shall notify the Central Bank of the use it makes of that treatment. (2) Where a stock-index future is not broken down into its underlying positions, it shall be treated as if it were an individual equity instrument. (3) The specific risk on this individual equity instrument referred to in paragraph (2) of this Article can be ignored if the stock-index future in question is exchange traded and represents a relevant appropriately diversified index. (4) Appropriately diversified index, for the purpose of paragraph (3) of this Article is the index that fulfils all of the following criteria:
  4. index contains at least 20 equity instruments;
  5. no single entity contained within them represents more than 25% of the total index;
  6. 10% of the largest equity instruments (rounding up the number of equities to the superior natural number) represent less than 60 % of the total index;
  7. the index must encompass equities from at least four industries of production and services from the market: − oil and gas; − basic materials; − industrials;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 557 − consumer goods; − health care; − consumer services; − telecommunications; − utilities; − financials; and − technology. (5) The list of appropriately diversified indices is provided in Annex 6 which forms an integral part of this Decision. Section 4 – Underwriting Reduction of net positions Article 509 (1) A credit institution performing the underwriting of debt and equity instruments, may use the procedure referred to in paragraph (2) of this Article in calculating its own funds requirements. (2) The credit institution shall first calculate its net positions by deducting (excluding) the underwriting positions which are subscribed or sub-underwritten by third parties on the basis of formal agreements, and then reducing the net positions by the appropriate reduction factor referred to in Table 4 of this paragraph and calculating its own funds requirements using the reduced underwriting positions. Table 4 working day 0: 100% working day 1: 90% working days 2 i 3: 75% working day 4: 50% working day 5: 25% after working day 5: 0% (3) Working day “zero” shall be the working day on which the credit institution becomes unconditionally committed to accepting an agreed known quantity of securities at a predefined price. (4) A credit institution shall notify the Central Bank of the manner in which it applies the reduction method referred to in paragraph (2) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 558 Section 5 – Specific risk own funds requirements for positions hedged by credit derivatives Allowance for hedges by credit derivatives Article 510 (1) An allowance shall be given for hedges provided by credit derivatives, in accordance with the provisions of paragraphs (2) to (6) of this Article. (2) A credit institution shall treat the position in the credit derivative as one “leg” (positions with specific sign), and the hedged position that has the same nominal, or, where applicable, notional amount, as the other “leg”, or their opposite positions. (3) Full allowance shall be given when the values of the two legs move in the opposite direction and broadly to the same extent as is the case in the following situations:

  1. the two legs consist of identical instruments;
  2. a long cash position is hedged by a total rate of return swap (or vice versa) and there is an exact match between the reference obligation and the underlying exposure (i.e., the cash position), wherein the maturity of the swap itself may be different from that of the underlying exposure. (4) In case referred to in paragraph (3) of this Article, a specific risk own funds requirement shall not be determined for either side of the position. (5) An 80% offset will be applied when the values of the two legs always move in the opposite direction and where there is an exact match in terms of the reference obligation, the maturity date of both the reference obligation and the credit derivative, and the currency of the underlying exposure, and the key features of the credit derivative contract shall not cause the price movement of the credit derivative to materially deviate from the price movements of the cash position, wherein to the extent that the transaction transfers risk, an 80% specific risk offset will be applied to the side of the transaction with the higher own funds requirement, while the specific risk own funds requirements on the other side shall be zero. (6) Partial allowance shall be given, absent the situations in paragraphs (3), (4), and (5) of this Article, in the following situations:
  3. the position meets the criteria under paragraph (3) item 2) of this Article but there is a mismatch between the reference obligation and the underlying exposure; however, the position meets the following conditions: ­ the reference obligation ranks pari passu with or is junior to the underlying obligation; ­ the underlying obligation and reference obligation share the same debtor and have legally enforceable cross-default or cross-acceleration clauses;
  4. the position meets the criteria under paragraph (3) item 1) or paragraph (5) of this Article, but there is a currency and maturity mismatch between the credit protection and the underlying asset, wherein such currency mismatch shall be included in the own funds requirement for foreign exchange risk; and
  5. the position meets the criteria under paragraph (5) of this Article, but there is a mismatch between the cash position and the credit derivative; however, the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 559 underlying instrument (asset) is included in the (deliverable) obligations in the credit derivative documentation. (7) A credit institution that has opted for giving partial allowance shall, rather than adding the specific risk own funds requirements for each side of the transaction, only apply the higher of the two own funds requirements. (8) In all situations not meeting the criteria under paragraphs (3) to (6) of this Article, an own funds requirement for specific risk shall be calculated for both sides of the positions separately. Allowance for hedges by first and nth-to default credit derivatives Article 511 The allowance set out in the provisions of Article 510 of this Decision shall apply to the first-to-default credit derivatives and nth-to-default credit derivatives, as follows:

  1. a credit institution that makes use of the credit protection for a number of reference entities underlying a credit derivative under the terms that the first default shall trigger payment and that this credit event shall immediately terminate the contract, may offset specific risk for the reference entity to the level equal to the lowest amount of specific risk own funds requirement among those underlying reference entities, in accordance with Table 1 in Article 500 of this Decision;
  2. where the nth default among the exposures triggers payment under the credit protection, the protection buyer may only offset specific risk if protection has also been obtained for defaults 1 to n-1 or when n-1 defaults have already occurred, and in such cases, the methodology set out in item 1) of this Article pertaining to the first-to-default credit derivatives shall be applied appropriately amended for nth-to-default products. Section 6 – Own funds requirements for CIUs Own funds requirements for CIUs Article 512 (1) Own funds requirement for position risk, comprising specific and general risk for positions in CIUs, shall be calculated by applying 32% weight to the exposure amount. (2) Own funds requirement for position risk, comprising specific and general risk, and foreign-exchange risk for positions in CIUs shall amount to 40%, except in the cases referred to in Article 517 of this Decision, and in the case of amended gold treatment referred to in Article 516 paragraph (7) of this Decision. (3) No netting shall be permitted between the reference investments in a CIU and other positions held by the credit institution, except in the cases referred to in Article 514 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 560 General criteria for CIUs Article 513 Positions in CIUs shall be eligible for the approach set out in Article 514 of this Decision, where the following conditions are met:

  1. the CIU's prospectus or equivalent document shall include all of the following: where investment limits apply, the relative limits and the methodologies to calculate them; ­ the categories of assets in which the CIU is authorised to invest; ­ where the CIU applies investment limits, the relative limits and the methodologies to calculate them; ­ where leverage is allowed, the maximum level of leverage; ­ where concluding OTC financial derivatives transactions or repurchase transactions or securities borrowing or lending is allowed, a policy to limit counterparty risk arising from these transactions;
  2. the business of the CIU shall be reported in half-yearly and annual reports to enable an assessment to be made of the assets and liabilities, income and operations over the reporting period;
  3. the shares or units of the CIU shall be redeemable in cash, out of the CIU’s assets, on a daily basis at the request of the unit holder;
  4. investments in the CIU shall be segregated from the assets of the CIU manager;
  5. the credit institution shall carry out adequate risk assessment of the CIU;
  6. CIUs shall be managed by persons supervised in accordance with regulations of Montenegro, the EU Member states with CIU registered office or third countries using regulatory or supervisory principles equivalent to the EU legislation. Specific methods for CIUs Article 514 (1) Where a credit institution is aware of the underlying investments of the CIU on a daily basis, the credit institution may observe those investments as its own positions in those underlying instruments in order to calculate the own funds requirements for position risk, comprising specific and general risk. (2) Under the approach referred to in paragraph (1) of this Article, positions in CIUs shall be treated as positions in the underlying investments of the CIU, and netting shall be permitted between positions in the underlying investments of the CIU and other positions held by the credit institution, provided that the credit institution holds a sufficient quantity of shares or investment units to allow for redemption in exchange for the underlying investments. (3) A credit institution may calculate the own funds requirement for position risk (comprising specific and general risk) for positions in CIUs by assuming positions representing those necessary to replicate the composition and performance of the externally generated index or fixed basket of equities or debt securities referred to in item 1) of this paragraph, subject to the following conditions:
  7. the purpose of the CIU's mandate (investment prospectus) is to replicate the composition and performance of an externally generated index or fixed basket of equities or debt securities; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 561 2) a minimum correlation coefficient between daily returns on the CIU and the index or basket of equities or debt securities it tracks of 0,9 can be clearly established over a minimum period of six months. (4) Where a credit institution does not dispose of information regarding the underlying investments of the CIU on a daily basis, it may calculate the own funds requirements for position risk (comprising specific and general risk), subject to the following conditions:

  1. it will be assumed that the CIU first invests to the maximum extent allowed under its mandate in the asset classes requiring the highest own funds requirements for general and specific risk separately, and then continues making investments in the asset classes requiring own funds requirements in descending order, until the maximum total investment limit is reached, wherein the position in the CIU shall be treated as a direct holding in the assumed position;
  2. the credit institution shall take account of the maximum indirect exposure that it could achieve by taking leveraged positions through the CIU when calculating its own funds requirement for general and specific risk separately, by proportionally increasing the position in the CIU up to the maximum exposure to the underlying investment items resulting from the mandate; and
  3. if the own funds requirement for general and specific risk, calculated in accordance with the provisions of this paragraph, exceed the permitted amount of own funds requirement set out in Article 512 paragraph (1) of this Decision, the ceredit institution shall cap the own funds requirement at that permitted level. (5) A credit institution may rely on the following third parties to calculate and report own funds requirements for position risk for positions in CIUs meeting the criteria under paragraphs (1) to (4) of this Article, in accordance with the methods set out in this Subtitle:
  4. the depository of the CIU provided that the CIU exclusively invests in securities and deposits all securities at this depository;
  5. for other CIUs, the CIU management company, provided that the CIU management company meets the criteria set out in Article 172 paragraph (5) item 1) of this Decision. (6) An external auditor shall confirm the correctness of the calculation determined by third parties referred to in paragraph (5) of this Article. SUBTITLE 5 – Own funds requirements for foreign-exchange risk De minimis and weighting for foreign exchange risk Article 515 (1) The credit institution shall calculate an own funds requirement for foreign exchange risk if the sum of its overall net foreign-exchange position and its net gold position, calculated in accordance with the provisions of Article 516 of this Decision, for own funds, exceeds 2% of its own funds.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 562 (2) The own funds requirement for foreign exchange risk shall be the sum of its overall net foreign-exchange position and its net gold position, converted to reporting currency at valid spot exchange rate, multiplied by 8%. Calculation of the overall net foreign exchange position Article 516 (1) A credit institution’s net open position in each currency (including reporting, EUR, currency) and in gold shall be calculated as the sum of the following elements (positive or negative):

  1. the net spot position (e.g., all asset items less all liability items, including accrued interest, in the currency in question or, for gold, the net spot position in gold);
  2. the net forward position, which represents all amounts to be received less all amounts to be paid under forward exchange and gold transactions, including currency and gold futures and the principal on currency swaps not included in the spot position;
  3. irrevocable guarantees and similar instruments that are certain to be called and likely to be irrecoverable;
  4. the net delta, or delta-based, equivalent of the total book of foreign-currency and gold options;
  5. the market value of other options. (2) The delta used for purposes of paragraph (1) item 4) of this Article shall be that of the exchange concerned, wherein for OTC options, or where delta is not available from the exchange concerned, the credit institution may calculate delta itself using an appropriate model, subject to authorisation by the Central Bank. (3) The Central Bank shall grant the authorisation referred to in paragraph (2) of this Article, if the model appropriately estimates the rate of change of the option's or warrant's value with respect to small changes in the market price of the underlying instrument. (4) The credit institution may include net future income/expenses not yet accrued but already fully hedged if it does so consistently. (5) A credit institution may break down net positions in composite currencies into the component currencies in accordance with the quotas in force. (6) A credit institution may use the net present value when calculating the net open position in each currency and in gold provided that the credit institution applies this approach consistently. (7) Net short and long positions in each currency other than the reporting (EUR) currency and the net long or short position in gold shall be converted at spot rates into the reporting (EUR) currency, and they shall then be summed separately to form the total of the net short positions and the total of the net long positions respectively, wherein the higher of these two totals shall be the credit institution’s overall net foreign￾exchange position. (8) A credit institution shall adequately reflect other risks associated with options, apart from the delta risk, in the own funds requirements.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 563 Foreign exchange position risk in CIUs Article 517 (1) For the purposes of Article 516 of this Decision, in respect of positions in CIUs, a credit institution shall take into account the actual foreign exchange positions of the CIU. (2) A credit institution may rely on the following third parties' reporting of the foreign exchange positions in the CIU:

  1. the depository institution of the CIU, provided that the CIU exclusively invests in securities and deposits all securities at this depository institution;
  2. for other CIUs, the CIU management company, provided that the CIU management company meets the criteria set out in Article 172 paragraph (5) item 1) of this Decision. (3) An external auditor shall confirm the correctness of the calculation of third parties referred to in paragraph (2) of this Article. (4) Where a credit institution does not dispose of the information regarding the foreign exchange positions in a CIU, it shall assume that the CIU is invested up to the maximum extent allowed under the CIU's mandate in other foreign exchange and the credit institution shall, for trading book positions, take account of the maximum indirect exposure that it could achieve by taking leveraged positions through the CIU when calculating its own funds requirement for foreign exchange risk. (5) Fulfilling obligations referred to in paragraph (4) of this Article shall be done by proportionally increasing the position in the CIU up to the maximum exposure to the underlying investment items resulting from the investment mandate, and the assumed position of the CIU in foreign exchange shall be treated as a separate currency according to the treatment of investments in gold, subject to the addition of the total long position to the total long open foreign exchange position and the total short position to the total short open foreign exchange position where the direction of the CIU's investment is available, wherein there shall be no netting allowed between such positions prior to the calculation of the open foreign exchange position. Closely correlated currencies Article 518 (1) A credit institution may provide lower own funds requirements for foreign exchange risk for relevant closely correlated currencies. (2) A pair of currencies is deemed to be closely correlated only if the likelihood of a loss — calculated on the basis of daily exchange-rate data for the preceding three or five years — occurring on equal and opposite positions in such currencies over the following 10 working days, which is 4% or less of the value of the matched position in question (valued in terms of the reporting currency) has a probability of at least 99%, when an observation period of three years is used, and 95%, when an observation period of five years is used.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 564 (3) For the purpose of paragraph (2) of this Article, closely correlated currencies against the EUR currency shall be the following currencies:

  1. Albanian lek (ALL);
  2. The Bosnia and Herzegovina convertible mark (BAM);
  3. Canadian Dollar (CAD),
  4. Swiss franc (CHF);
  5. Czech koruna (CZK);
  6. Moroccan dirham (MAD);
  7. North Macedonian denar (MKD);
  8. Romanian leu (RON);
  9. Serbian dinar (RSD); i 10)Singapore Dollar (SGD). (4) The own funds requirement on the matched position in two closely correlated currencies shall be 4% multiplied by the value of the matched position. (5) In calculating the own funds requirements for foreign exchange risk, a credit institution may disregard positions in currencies, which are subject to a legally binding intergovernmental agreement to limit its variation relative to other currencies covered by the same agreement, and the credit institution shall calculate its matched positions in such currencies and subject them to a own funds requirement no lower than half (50%) of the maximum permissible variation laid down in the intergovernmental agreement in question in respect of the currencies concerned. (6) A credit institution may calculate the own funds requirement for foreign exchange risk on the matched positions in currencies of the EU Member States participating in the second stage of the economic and monetary union as 1.6% of the value of such matched positions. (7) For the purposes of paragraph (6) the currencies belonging to the ERM II shall be the Bulgarian Lev (BGN) and the Danish Krone (DKK). (8) Only the unmatched positions in currencies referred to in this Article shall be incorporated into the overall net open position in accordance with Article 516 paragraph (7) of this Decision. SUBTITLE 6 – Own funds requirements for commodities risk Choice of method for determining own funds requirement for commodities risk Article 519 In accordance with Articles 520, 521, and 522 of this Decision, a credit institution shall calculate the own funds requirement for commodities risk using one of the methods set out in Article 523, 524, or 525 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 565 Ancillary commodities business Article 520 (1) A credit institution with ancillary agricultural commodities business may determine the own funds requirements for commodities risk using the value of physical commodity stock at the end of each year for the following year where all of the following conditions are met:

  1. at any time of the year, it holds the credit institution maintains the amount of own funds for the coverage of this risk which is not lower than the average own funds requirement for that risk estimated on a conservative basis for the coming year;
  2. the credit institution estimates on a conservative basis the expected volatility for the figure calculated under item 1) of this paragraph;
  3. its average capital requirement for this risk does not exceed 5% of its own funds or EUR 1 million and, taking into account the volatility estimated in accordance with item 2) of this paragraph, the expected peak own funds requirements do not exceed 6.5% of its own funds;
  4. the credit institution monitors on an ongoing basis whether the estimates carried out in accordance with items 1) and 2) of this paragraph still reflect the reality. (2) A credit institution shall notify to the Central Bank the use it makes of the option provided in paragraph (1) of this Article. Positions in commodities Article 521 (1) Each position in commodities or commodity derivatives shall be expressed in terms of the standard unit of measurement, and the spot price (current market price) in each commodity shall be expressed in EUR currency. (2) Positions in gold or gold derivatives shall be considered as being subject to foreign￾exchange risk thus the own funds requirements for commodities risk shall be calculated in accordance with Subtitle 3 or 5 of this Decision, as appropriate. (3) For the purpose of Article 524 paragraph (1) of this Decision, the excess of a credit institution’s long positions over its short positions, or vice versa, in the same commodity and identical commodity futures, options and warrants shall be its net position in each commodity. (4) Derivative instruments shall be treated, as laid down in Article 522 of this Decision, as positions in the underlying commodity. (5) For the purposes of calculating a position in a commodity, the following positions shall be treated as positions in the same commodity:
  5. positions in different sub-categories of commodities in cases where the sub￾categories are deliverable against each other;
  6. positions in similar commodities if they are close substitutes and where a minimum correlation of 0.9 between price movements can be clearly established over a minimum period of one year.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 566 Particular instruments Article 522 (1) Commodity futures and forward commitments to buy or sell individual commodities shall be incorporated in the measurement system as notional (hypothetical) amounts in terms of the standard unit of measurement and assigned a maturity with reference to expiry date. (2) Commodity swaps where one side of the transaction is a fixed price and the other the current market price shall be treated, as a series of positions equal to the notional (hypothetical) amount of the contract, with, where relevant, one position corresponding with each payment on the swap and slotted into the maturity bands in Article 523 paragraph (1) of this Decision, wherein the positions shall be long positions if the credit institution is paying a fixed price and receiving a floating price and short positions if the credit institution is receiving a fixed price and paying a floating price. (3) Commodity swaps where the sides of the transaction are in different commodities are to be reported in the relevant reporting column for the maturity ladder approach. (4) Options and warrants on commodities or on commodity derivatives shall be treated as if they were positions equal in value to the amount of the underlying commodity to which the option refers, multiplied by its delta, wherein the thus calculated positions may be netted off against any offsetting positions in the identical underlying commodity or commodity derivative. (5) For the purpose of paragraph (3) of this Article, the credit institution shall use the delta of the exchange in which the option in question is traded, and for OTC options, or where delta is not available from the exchange concerned, the credit institution may calculate delta itself using an appropriate model, subject to authorisation by the Central Bank. (6) The CBCG shall grant the authorisation referred to in paragraph (5) of this Article if the model appropriately estimates the rate of change of the option's or warrant's value with respect to small changes in the market price of the underlying instrument. (7) A credit institution shall adequately reflect other risks associated with options, apart from the delta risk, when calculating own funds requirements. (8) Where a credit institution carries out either of the following functions, it shall include the commodities concerned in the calculation of its own funds requirement for commodities risk:

  1. the transferor of commodities or guaranteed rights relating to title to commodities in a repurchase agreement;
  2. the lender of commodities in a commodities lending agreement.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 567 Maturity ladder approach Article 523 (1) Where a credit institution uses a maturity ladder to calculate own funds requirement for commodities risk, it shall assign all positions in that commodity to the appropriate maturity columns in line with Table 1 of this Article. Table 1: (2) All physical stocks shall be assigned to the first maturity band (column) between 0 and up to and including 1 month. (3) Positions in the same commodity may be offset and assigned to the appropriate maturity bands on a net basis for the following:

  1. positions in contracts maturing on the same date;
  2. positions in contracts maturing within 10 days of each other if the contracts frum which those positions arise are traded on markets which have daily delivery dates. (4) A credit institution shall calculate the sum of the long positions and the sum of the short positions in each maturity band, wherein the amount of the former which are matched by the latter in a given maturity band shall be the matched positions in that band, while the residual long or short position shall be the unmatched position for the same band. (5) That part of the unmatched long (short) position for a given maturity band that is matched by the unmatched short (long) position, or vice versa, for a maturity band further out shall be the matched position between two maturity bands, and the residual part of the unmatched long or unmatched short position that cannot be thus matched shall be the unmatched position. (6) A credit institution’s own funds requirement for each commodity type shall be calculated as the sum of the following:
  3. the sum of the matched long and short positions, multiplied by the appropriate spread rate as indicated in the second column of Table 1 from paragraph (1) of this Article for each maturity band and by the spot price for the commodity; Maturity band (1) Spread rate (in %) (2) 0 ≤ 1 month 1.50

1 ≤ 3 months 1.50 3 ≤ 6 months 1.50 6 ≤ 12 months 1.50 1 ≤ 2 years 1.50 2 ≤ 3 years 1.50 3 years 1.50

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 568 2) the matched position between two maturity bands for each maturity band into which an unmatched position is carried forward, multiplied by 0.6%, which is the carry rate and by the spot price for the commodity; 3) the residual unmatched positions, multiplied by 15% which is the outright rate and by the spot price for the commodity. (7) A credit institution’s overall own funds requirement for commodities risk shall be calculated as the sum of the own funds requirements for commodities risk calculated for each type of commodity in accordance with paragraph (6) of this Article. Simplified approach Article 524 (1) A credit institution shall calculate own funds requirement for commodities risk for each type of commodity as the sum of the following:

  1. 15% of the net position, long or short, multiplied by the spot price for the commodity;
  2. 3% of the gross position, long plus short, multiplied by the spot price for the commodity. (2) A credit institution’s overall own funds requirement for commodities risk shall be calculated; in accordance with the simplified approach, as the sum of the own funds requirements for commodities risk calculated for each type of commodity in accordance with paragraph (1) of this Article. Extended maturity ladder approach Article 525 (1) When calculating own funds requirements for commodity risk, a credit institution that fulfils conditions from paragraph (2) of this Article, may use the minimum spread, carry and outright rates set out in Table 2 of this paragraph instead of those indicated in Article 523 of this Decision. Table 2 Precious metals (except gold) Base metals Base metals Other, including energy products Spread rate (%) 1.0 1.2 1.5 1.5 Carry rate (%) 0.3 0.5 0.6 0.6 Outright rate (%) 8 10 12 15 (2) A credit institution fulfils the conditions to apply extended maturity ladder from paragraph (1) of this Article, if it:
  3. undertakes significant commodities business;
  4. has an appropriately diversified commodities portfolio; (3) A credit institution shall notify the use it makes of the extended maturity ladder approach to the Central Bank.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 569 TITLE V – OWN FUNDS REQUIREMENTS FOR SETTLEMENT RISK Settlement/delivery risk Article 526 (1) In the case of transactions in which debt instruments, equities, foreign currencies and commodities excluding repurchase transactions and securities or commodities lending and securities or commodities borrowing are unsettled after their due delivery dates, a credit institution shall calculate the price difference to which it is exposed. (2) The price difference shall be calculated as the difference between the agreed settlement price for the debt instrument, equity, foreign currency or commodity in question and its current market value, where the difference could involve a loss for the credit institution. (3) The credit institution shall multiply that price difference referred to in paragraph (2) of this Article by the appropriate factor referred to in Table 1 of this paragraph in order to calculate the credit institution’s own funds requirement for settlement risk. Table 1 (4) When calculating own funds requirements for settlement risk, the credit institution should include derivatives, as derivatives may also have settlement risk. Free deliveries Article 527 (1) When calculating own fund requirements for free deliveries, a credit institution shall apply the treatment referred to in Table 2 of this paragraph where:

  1. it has paid for securities, foreign currencies or commodities before receiving them or it has delivered securities, foreign currencies or commodities before receiving payment for them;
  2. in the case of cross-border transactions, one day or more has elapsed since it made that payment or delivery. number of working days after due settlement date (%) 5 – 15 8 16 – 30 50 31– 45 75 46 or more 100

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 570 Table 2: Capital treatment for free deliveries (2) In applying a risk weight to free delivery exposures treated according to Column 3 of Table 2 of paragraph (1) of this Article, a credit institution using the IRB approach set out in Title II, Subtitle 3 of this Part of the Decision may assign PDs to counterparties, for which it has no other non-trading book exposure, on the basis of the counterparty's external rating. (3) A credit institution using own estimates of “LGDs” may apply the LGD set out in Article 202 paragraph (1) of this Decision to free delivery exposures treated according to Column 3 of Table 2 paragraph (1) of this Decision, provided that they apply it to all such exposures. (4) A credit institution using the Internal Ratings Based approach set out in Title II, Subtitle 3 of this Part of the Decision may apply the risk weights of the Standardised Approach, as set out in Title II, Subtitle 2 of this Part of the Decision, provided that it applies them to all such exposures, or may apply a 100% risk weight to all such exposures. (5) If the amount of positive exposure resulting from free delivery transactions is not material, a credit institution may apply a risk weight of 100% to these exposures, except where a risk weight of 1.250% in accordance with Column 4 of Table 2 of paragraph (1) of this Article is required. (6) As an alternative to applying a risk weight of 1.250% to free delivery exposures according to Column 4 of Table 2 of paragraph (1) of this Article, a credit institution may deduct the value transferred plus the current positive exposure of those exposures from Common Equity Tier 1 items in accordance with Article 19 item 11) of this Decision. Waiver Article 528 Where a system wide failure of a settlement system, a clearing system or a central counterparty occurs, the Central Bank may waive the own funds requirements calculated as set out in Articles 526 and 527 of this Decision until the situation is rectified, and in this case, the failure of a counterparty to settle a trade shall not be deemed a default for purposes of credit risk. Column 1 Column 1 Column 1 Column 1 Transaction Type Up to first contractual payment or delivery leg From first contractual payment or delivery leg up to four days after second contractual payment or delivery leg From 5 business days post second contractual payment or delivery leg until extinction of the transaction Free delivery No own funds requirement Treat as an exposure Treat as an exposure risk weighted at 1.250%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 571 TITLE VI – OWN FUNDS REQUIREMENTS FOR CREDIT VALUATION ADJUSTMENT RISK (CVA RISK) Meaning of credit valuation adjustment Article 529 (1) For the purposes of this Title and Subtitle 6, Title II of this Part of the Decision, “credit valuation adjustment” or “CVA” means an adjustment to the mid-market valuation of the portfolio of transactions with a counterparty, and that adjustment reflects the current market value of the credit risk of the counterparty to the credit institution, but does not reflect the current market value of the credit risk of the credit institution to the counterparty. (2) For the purposes of this Title, ‘CVA risk’ means the risk of losses arising from changes in the value of CVA, calculated for the portfolio of transactions with a counterparty as set out in paragraph (1) of this Article, due to movements in counterparty credit spread risk factors and in other risk factors embedded in the portfolio of transactions. Scope Article 530 (1) A credit institution shall calculate the own funds requirements for CVA risk in accordance with this Title for all OTC derivative instruments in respect of all of its business activities, other than credit derivatives recognised to reduce risk-weighted exposure amounts for credit risk. (2) A credit institution shall include in the calculation of own funds required by paragraph (1) of this Article securities financing transactions that are fair-valued under the accounting framework applicable to the credit institution, where the credit institution’s CVA risk exposures arising from those transactions are material. (3) Transactions with a qualifying central counterparty and a client's transactions with a clearing member, when the clearing member is acting as an intermediary between the client and a qualifying central counterparty, and the transactions give rise to a trade exposure of the clearing member to the qualifying central counterparty, are excluded from the capital requirements for CVA risk. (4) The following transactions shall be excluded from the own funds requirements for CVA risk:

  1. transactions with non-financial counterparties established in Montenegro, EU Member States or with non-financial counterparties established in a third country, where those transactions do not exceed the clearing threshold: − for credit derivatives – EUR 1,000,000,000 in gross notional value, − for equity derivatives – EUR 1,000,000,000 in gross notional value, − for interest rate derivatives – EUR 3 billion in gross notional value, − for foreign exchange derivatives – EUR 3,000,000,000 in gross notional value, − for commodity derivatives – EUR 4,000,000,000 in gross notional value,

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 572 − for all other previously unmentioned OTCs – EUR 4,000,000,000 in gross notional value, 2) an intragroup transaction entered into with non-financial counterparties which are part of the same group provided that all the following conditions are met: − credit institution and non-financial counterparties are included in the same consolidation on a full basis in accordance with the Law; − are subject to appropriate centralised risk evaluation, measurement and control procedures; − non-financial counterparties have their head offices in Montenegro, EU Member States or, if established in a third country, that third country equivalent country referred to in Article 3 paragraph (1) item 113 of this Decision; 3) an intragroup transaction entered into with financial counterparties, financial institutions or ancillary services undertakings referred to in Article 5 paragraph (2) of the Law, with head offices in Montenegro, EU Member States or a third country which applies prudential and supervisory requirements to such financial counterparties, financial institutions or ancillary services undertakings referred to in Article 5 paragraph (2) of the Law, which are at least equivalent to those applied in Montenegro and the EU; 4) transactions with counterparties representing pension scheme arrangements for which there is no obligation to settle; 5) transactions with counterparties referred to in indents 1 to 7 of this paragraph and transactions with counterparties for which Article 151 paragraphs (4) and (5) and Article 152 paragraph (4) of this Decision establish a 0% risk weight for exposures to those counterparties: − the members of the ESCB and other Member States’ bodies performing similar functions and other Union public bodies charged with or intervening in the management of the public debt; − the Bank for International Settlements; − the central banks and public bodies charged with or intervening in the management of the public debt in the Japan, United States of America, Australia, Canada, Hong Kong, Mexico, Singapore, Switzerland, the United Kingdom of Great Britain and Northern Ireland; − the following multilateral development banks: the International Bank for Reconstruction and Development, the International Finance Corporation, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the Council of Europe Development Bank, the Nordic Investment Bank, the Caribbean Development Bank, the European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund; and the Multilateral Investment Guarantee Agency; − public sector entities; − the European Financial Stability Facility; and − the European Stability Mechanism. (5) Where a non-financial counterparty exceeds the clearing threshold referred to in paragraph (4) item 1) of this Article, or where the clearing threshold changes in a way that the non-financial counterparty ceases to meet the criterium for exemption credit institution ceases to be exempt from the calculation of the own funds requirement for

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 573 CVA risk, the outstanding contracts with that counterparty shall remain exempt until the date of their maturity. (6) By way of derogation from paragraph (4) of this Article, a credit institution may choose to calculate the own funds requirements for CVA risk, using any of the approaches referred to in Article 531 paragraph (1) of this Decision, for the transactions that are excluded pursuant to paragraph (4) of this Article, where the credit institution uses eligible hedges determined in accordance with Article 560 of this Decision to reduce the CVA risk of those transactions, wherein the credit institution shall establish policies to specify the application and calculation of the own funds requirements for CVA risk for such transactions. (7) A credit institution shall report to the Central Bank the results of the calculations of the own funds requirements for CVA risk for all transactions referred to in paragraph (4) of this Article, and for that purpose, it shall calculate those requirements using the relevant approaches set out in Article 531 paragraph (1) of this Decision that it would have used to satisfy an own funds requirement for CVA risk if those transactions were not excluded from the scope pursuant to paragraph (4) of this Article. (8) For the purposes of paragraph (4) item 1) of this Article, non-financial counterparty (NFC) shall be a counterparty other than a financial counterparty (FC), or a central counterparty (CCP). (9) The following shall be deemed financial counterparty:

  1. investment firms;
  2. credit institutions;
  3. insurance undertakings or a reinsurance undertaking;
  4. UCITS and, where relevant, their management company, unless that UCITS is set up exclusively for the purpose of serving one or more employee share purchase plans;
  5. institutions for occupational retirement provision;
  6. alternative investment funds (AIF); and
  7. central securities depositories. (10) For the purpose of paragraph (4) item 1) of this Article, a credit institution may consider a counterparty to be non-financial counterparties established in a third country if they meet the following requirements:
  8. they are established in a third country;
  9. they are established in Montenegro or an EU Member State, in line with this Decision or EU regulations they would be considered non-financial counterparties. (11) A credit institution shall verify if the counterparty represents a non-financial counterparty established in a third country:
  10. at the inception of trading with a new counterparty;
  11. once a year for the existing counterparties;
  12. in the case there are information indicating that the counterparty ceased to be non-financial counterparty established in a third country. (12) A credit institution shall substantiate its opinion that an undertaking is a non￾financial counterparty established in a third country.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 574 (13) In order to exclude transactions with non-financial counterparty established in a third country from own funds requirements for CVA risk in accordance with paragraph (4) item 1) of this Article, a credit institution shall verify for each class of OTC derivatives contract whether the gross notional value of the OTC derivatives contract of the non-financial counterparty in that type of derivative is larger than corresponding clearing threshold defined in paragraph (4) item 1) indents 1 to 5 of this Article:

  1. at the start of each new trading with that counterparty;
  2. on an annual basis, except where for any of the classes of OTC derivatives the gross notional value of OTC derivatives transactions of the non-financial counterparty established in a third country is greater than 75% of the clearing threshold value for that derivative class, in which case verification shall be performed on a quarterly basis. (14) A credit institution shall identify all non-financial counterparties that meet the criteria set out in paragraph (4) item 1) of this Article for exclusions from calculation of capital requirements for CVA risk regardless of where they are established – in Montenegro, EU Member State or a third country, and because of that, a credit institution shall define suitable arrangements with non-financial counterparties in order to ensure continuous provision of information on their status in terms of compliance with the clearing threshold. (15) Compliance of non-financial counterparty with the defined clearing threshold from paragraph (4) item 1) indents 1 to 5 of this Article shall be determined by the non￾financial counterparty trading with OTC derivatives, who should submit that information to the credit institution, wherein the credit institution shall not be required to verify the information submitted by the non-financial counterparty, unless it is in possession of information which clearly demonstrates that the reports of the non￾financial counterparty are inaccurate. (16) If the credit institution is not able to obtain information on the status of the non￾financial counterparty's compliance with the clearing threshold, it shall calculate capital requirements for CVA risk for all transactions performed with that counterparty. (16) In respect of the non-financial counterparties, intragroup transaction shall be the OTC derivatives contract concluded with the counterparty that is part of the same group provided that both counterparties are entirely covered by the same consolidation and are the subject of the appropriate centralised risk assessment, measurement procedures and risk control, and that the counterparty is established in Montenegro, the EU Member State or a third country. Approaches for calculating the own funds requirements for CVA risk Article 531 (1) A credit institution shall calculate the own funds requirements for CVA risk for all transactions referred to in Article 530 of this Decision in accordance with the following approaches:

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Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 575

  1. the standardised approach set out in Article 532 of this Decision, where the credit institution has been granted authorisation by the Central Bank to use that approach;
  2. the basic approach set out in Article 558 of this Decision;
  3. the simplified approach set out in Article 559 of this Decision, provided that the credit institution meets the conditions set out in paragraph (1) of that Article. (2) A credit institution shall not use the approach referred to in paragraph (1) item 3), of this Article in combination with the approach referred to in item 1) or 2) of that paragraph. (3) A credit institution may use a combination of the approaches referred to in paragraph (1), items 1) and 2), to calculate the own funds requirements for CVA risk on a permanent basis for:
  4. different counterparties;
  5. different eligible netting sets with the same counterparty;
  6. different transactions of the same eligible netting set, provided that any of the conditions referred to in paragraph (5) of this Article are satisfied. (4) For the purposes of paragraph (3) item 3) of this Article, a credit institution shall split the eligible netting set into a hypothetical netting set containing the transactions subject to the approach referred to in paragraph (1), item 1) of this Article, and a hypothetical netting set containing the transactions subject to the approach referred to in paragraph (1), item 2) of this Article. (5) For the purposes of paragraph (3) item 3) of this Article, the credit institution shall meet the following conditions:
  7. the credit institution shall split the netting set consistently with the treatment of the legal netting set when calculating the CVA for accounting purposes;
  8. the authorisation granted by the Central Bank to use the approach referred to in paragraph (1), item 1) of this Article, is limited to the corresponding hypothetical netting set and does not cover all transactions within the eligible netting set. (6) A credit institution shall document how it uses a combination of the approaches referred to in paragraph (1), items 1) and 2) of this Article, and as set out in this paragraph, to calculate the own funds requirements for CVA risk on a permanent basis. Standardised approach

Article 532 (1) The Central Bank shall grant a credit institution an authorisation to calculate its own funds requirements for CVA risk for a portfolio of transactions with one or more counterparties by using the standardised approach in accordance with paragraph (5) of this Article, after having assessed whether the credit institution complies with the following requirements:

  1. the credit institution has established a distinct unit which is responsible for the credit institution’s overall risk management and hedging of CVA risk;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 576 2) for each counterparty concerned, the credit institution has developed a regulatory CVA model to calculate the CVA of that counterparty in accordance with Article 533 of this Decision; 3) for each counterparty concerned, the credit institution is able to calculate, at least on a monthly basis, the sensitivities of its CVA to the risk factors concerned as determined in accordance with Article 534 of this Decision; 4) for all positions in eligible hedges recognised in accordance with Article 560 of this Decision for the purpose of calculating the own funds requirements for CVA risk using the standardised approach, the credit institution is able to calculate, and at least on a monthly basis, the sensitivities of those positions to the relevant risk factors determined in accordance with Article 534 of this Decision; 5) the credit institution has established a risk control unit that shall: − be independent from business trading units and the unit referred to in item

  1. of this paragraph; − report directly to the management body; − be responsible for designing and implementing the standardised approach and shall produce and analyse monthly reports on the output of that approach; − assess the appropriateness of the credit institution’s trading limits and include the results of that assessment in its monthly reports; − have a sufficient number of staff with a level of skills that is appropriate to fulfil its purpose. (2) For the purposes of paragraph (1) item 3) of this Article, the sensitivity of a counterparty’s CVA to risk factors shall mean the relative change in the value of that CVA, as a result of a change in the value of one of the relevant risk factors of that CVA, calculated using the credit institution’s regulatory CVA model in accordance with Articles 541 and 542 of this Decision. (3) For the purposes of paragraph (1) item 4) of this Article, the sensitivity of a position in an eligible hedge to a risk factor means the relative change in the value of that position, as a result of a change in the value of one of the relevant risk factors of that position, calculated using the credit institution’s pricing model in accordance with Articles 541 and 542 of this Decision. (4) For the purpose of calculating the own funds requirements for CVA risk, the following definitions shall apply:
  2. “risk class” means any of the following categories: − interest rate risk; − counterparty credit spread risk; − reference credit spread risk; − equity risk; − commodity risk; − foreign exchange risk;
  3. “CVA portfolio” means the portfolio composed of the aggregate CVA and the eligible hedges referred to in paragraph (1) item 4) of this Article;
  4. “aggregate CVA” means the sum of the CVAs calculated using the regulatory CVA model for the counterparties referred to in paragraph (1) of this Article.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 577 (5) A credit institution shall determine the own funds requirements for CVA risk using the standardised approach as the sum of the following own funds requirements calculated in accordance with Article 534 of this Decision:

  1. the own funds requirements for delta risk which capture the risk of changes in the credit institution’s CVA portfolio due to movements in the relevant non￾volatility related risk factors;
  2. the own funds requirements for vega risk which capture the risk of changes in the credit institution’s CVA portfolio due to movements in the relevant volatility related risk factors. Regulatory CVA model Article 533 (1) A regulatory CVA model used for calculating the own funds requirements for CVA risk in accordance with Article 532 of this Decision shall be conceptually sound, implemented with integrity, and comply with of the following requirements:
  3. the regulatory CVA model is capable of modelling the CVA of a given counterparty, recognising netting and margin agreements at netting set level, where relevant, in accordance with this Article;
  4. the credit institution estimates the counterparty’s probabilities of default from the counterparty credit spreads and market-consensus expected loss given default for that counterparty;
  5. the expected loss given default referred to in item 1) of this paragraph shall be the same as the market-consensus expected loss given default referred to in item 2) of this paragraph, unless the credit institution can demonstrate that the seniority of the portfolio of transactions with that counterparty differs from the seniority of senior unsecured bonds issued by that counterparty;
  6. at each future time point, the simulated discounted future exposure of the portfolio of transactions with a counterparty is calculated with an exposure model by repricing all transactions in that portfolio, based on the simulated joint changes of the market risk factors that are material to those transactions using an appropriate number of scenarios, and discounting the prices to the date of calculation using risk-free interest rates;
  7. the regulatory CVA model is capable of modelling significant dependency between the simulated discounted future exposure of the portfolio of transactions and the counterparty credit spreads;
  8. where the transactions of the portfolio are included in a netting set subject to a margin agreement and daily mark-to-market valuation, the collateral posted and received as part of that agreement is recognised as a risk mitigant in the simulated discounted future exposure, where all of the following conditions are met: ­ the credit institution determines the margin period of risk relevant for that netting set in accordance with the requirements set out in Article 372 paragraphs (3) and (8) of this Decision, and reflects that margin period in the calculation of the simulated discounted future exposure; ­ all applicable features of the margin agreement, including the frequency of margin calls, the type of contractually eligible collateral, the threshold amounts, the minimum transfer amounts, the independent amounts and the initial margins for both the credit institution and the counterparty are

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 578 appropriately reflected in the calculation of the simulated discounted future exposure; ­ the credit institution has established a collateral management unit that complies with Article 374 of this Decision for all collateral recognised for calculating the own funds requirements for CVA risk using the standardised approach. (2) For the purposes of paragraph (1) item 1) of this Article, CVA shall have a positive sign and shall be calculated as a function of the counterparty’s expected loss given default, an appropriate set of the counterparty’s probabilities of default at future time points and an appropriate set of simulated discounted future exposures of the portfolio of transactions with that counterparty at future time points until the maturity of the longest transaction in that portfolio. (3) For the purposes of the demonstration referred to in paragraph (1) item 3) of this Article, collateral received from the counterparty shall not change the seniority of the exposure. (4) For the purposes of paragraph (1) item 6) indent 3 of this paragraph, where the credit institution has already established a collateral management unit for using the internal model method referred to in Article 370 of this Decision, the credit institution shall not be required to establish an additional collateral management unit where that credit institution demonstrates to the Central Bank that such a unit complies with the requirements set out in Article 374 of this Decision for the collateral recognised for calculating the own funds requirements for CVA risk using the standardised approach. (5) For the purposes of paragraph (1) item 2) of this Article, where the credit default swap spreads of the counterparty are observable in the market, a credit institution shall use those spreads, and where such credit default swap spreads are not available, a credit institution shall use one of the following:

  1. credit spreads from other instruments issued by the counterparty reflecting current market conditions;
  2. proxy spreads that are appropriate considering the rating, industry and region of the counterparty. (6) A credit institution using a regulatory CVA model shall comply with of the following qualitative requirements:
  3. the exposure model referred to in paragraph (1) of this Article is part of the credit institution’s internal CVA risk management system that includes the identification, measurement, management, approval and internal reporting of CVA and CVA risk for accounting purposes;
  4. the credit institution has in place a process for ensuring compliance with a documented set of internal policies, controls, assessment of model performance and procedures concerning the exposure model referred to in paragraph (1) of this Article;
  5. the credit institution shall have an independent validation unit that shall: − be responsible for the effective initial and ongoing validation of the exposure model referred to in paragraph (1) of this Article; − be independent from business credit and trading units, including the unit referred to in Article 532 paragraph (1) item 1) of this Decision;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 579 − report directly to senior management; − have a sufficient number of staff with a level of skills that is appropriate to fulfil that purpose; 4) the senior management shall be actively involved in the risk control process and shall regard CVA risk control as an essential aspect of the business, to which appropriate resources need to be devoted; 5) the credit institution shall document the process for initial and ongoing validation of the exposure model referred to in paragraph (1) of this Article to a level of detail that would enable a third party to understand how the models operate, their limitations, and their key assumptions, and recreate the analysis; that documentation shall set out the minimum frequency with which ongoing validation will be conducted, as well as other circumstances, such as a sudden change in market behaviour, under which additional validation shall be conducted; it shall describe how the validation is conducted with respect to data flows and portfolios, what analyses are used and how representative counterparty portfolios are constructed; 6) the pricing models used in the exposure model referred to in paragraph (1) of this Article for a given scenario of simulated market risk factors shall be tested against appropriate independent benchmarks for a wide range of market states as part of the initial and ongoing model validation process, wherein pricing models for options shall account for the non-linearity of option value with respect to market risk factors; 7) an independent review of the credit institution’s internal CVA risk management system referred to in item 1) of this paragraph shall be carried out by the credit institution’s internal auditing process on a regular basis, wherein that review shall include the activities both of the unit referred to in Article 532 paragraph (1) item 1) and of the independent validation unit referred to in item 3) of this paragraph; 8) the regulatory CVA model used by the credit institution for calculating the simulated discounted future exposure referred to in paragraph (1) of this Article, shall reflect transaction terms and specifications and margin agreements in a timely, complete, and conservative manner, and the terms and specifications shall reside in a secure database subject to formal and periodic audit, wherein the transmission of transaction terms and specifications data and margin agreements to the exposure model shall also be subject to internal audit, and formal reconciliation processes shall be in place between the internal model and source data systems to verify on an ongoing basis that transaction terms, specifications and margin agreements are being reflected in the exposure system correctly or, at least, conservatively; 9) the current and historical market data inputs used in the model by the credit institution for calculating the simulated discounted future exposure referred to in paragraph (1) of this Article shall be acquired independently of the business lines and fed into that model in a timely and complete manner and maintained in a secure database subject to formal and periodic audit, wherein a credit institution shall have a well-developed data integrity process to handle inappropriate data observations, and where the model relies on proxy market data, a credit institution shall design internal policies to identify suitable proxies and shall demonstrate empirically on an ongoing basis that the proxies provide a conservative representation of the underlying risk;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 580 10)the exposure model referred to in paragraph c of this Article shall capture the transaction specific and contractual information necessary in order to aggregate exposures at the level of the netting set, wherein a credit institution shall verify that transactions are assigned to the appropriate netting set within the model. (7) For the purpose of calculating the own funds requirements for CVA risk, the exposure model referred to in paragraph (1) of this Article may have different specifications and assumptions in order to meet all requirements laid down in Article 532 of this Decision, except that its market data inputs and netting recognition shall remain the same as the ones used for accounting purposes. Own funds requirements for delta and vega risks Article 534 (1) A credit institution shall apply the delta and vega risk factors described in Articles 535 to 540, and the process set out in paragraphs 2 to 14 of this Article, to calculate the own funds requirements for delta and vega risks. (2) For each risk class referred to in Article 532 paragraph (4) of this Decision, the sensitivity of the aggregate CVAs and the sensitivity of all positions in eligible hedges falling within the scope of the own funds requirements for delta or vega risk to each of the applicable delta or vega risk factors included in that risk class shall be calculated by using the corresponding formulae set out in Articles 541 and 542 of this Decision, and where the value of an instrument depends on several risk factors, the sensitivity shall be determined separately for each risk factor. (3) For the calculation of the vega risk sensitivities of the aggregate CVAs, sensitivities both to volatilities used in the exposure model to simulate risk factors and to volatilities used to reprice option transactions in the portfolio with the counterparty shall be included. (4) By way of derogation from paragraph (1) of this Article, subject to the authorisation of the Central Bank, a credit institution may use alternative definitions of delta and vega risk sensitivities in the calculation of the own funds requirements of a trading book position under this Chapter, provided that the credit institution meets all of the following conditions:

  1. those alternative definitions are used for internal risk management purposes or for the reporting of profits and losses to senior management by an independent risk control unit within the credit institution;
  2. the credit institution demonstrates that those alternative definitions are more appropriate for capturing the sensitivities of the position than the formulae set out in Articles 541 and 542 of this Decision, and that the resulting delta and vega risk sensitivities do not materially differ from the ones obtained applying the formulae set out in Articles 541 and 542 of this Decision, respectively. (5) Where an eligible hedge is an index instrument, a cred institution shall calculate the sensitivities of that eligible hedge to all relevant risk factors by applying the shift of one of the relevant risk factors to each of the index constituents.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 581 (6) A credit institution may introduce additional risk factors that correspond to qualified index instruments for the following risk classes:

  1. counterparty credit spread risk;
  2. reference credit spread risk; and
  3. equity risk. (7) For the purposes of delta risks, an index instrument shall be considered qualified where it meets the conditions set out in Article 422 of this Decision, and for vega risks, all index instruments shall be considered qualified. (8) A credit institution shall calculate sensitivities of CVA and eligible hedges to qualified index risk factors in addition to sensitivities to the non-index risk factors. (9) A credit institution shall calculate delta and vega risk sensitivities to a qualified index risk factor as a single sensitivity to the underlying qualified index. (10) Where 75 % of the constituents of a qualified index are mapped to the same sector as set out in Articles 548, 551 and 554, the credit institution shall map the qualified index to that same sector, otherwise, the credit institution shall map the sensitivity to the applicable qualified index bucket. (11) The weighted sensitivities of the aggregate CVA and of the market value of all eligible hedges to each risk factor shall be calculated by multiplying the respective net sensitivities by the corresponding risk weight, in accordance with the following formulae: WSk CVA = RWk ∙ Sk CVA WSk hedges = RWk ∙ Sk hedges where: k = the index that denotes the risk factor k; WSk CVA = the weighted sensitivity of the aggregate CVA to risk factor k; RWk = the risk weight applicable to the risk factor k; Sk CVA = the net sensitivity of the aggregate CVA to risk factor k; WSk hedges = the weighted sensitivity of the market value of all eligible hedges in the CVA portfolio to risk factor k; Sk hedges = the net sensitivity of the market value of all eligible hedges in the CVA portfolio to risk factor k. (12) A credit institution shall calculate the net-weighted sensitivity WSk of the CVA portfolio to risk factor k in accordance with the following formula: 𝑘𝑘 = WSk CVA − WSk hedges

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 582 (13) The net-weighted sensitivities within the same bucket shall be aggregated in accordance with the following formula, using the corresponding correlations ρkl to weighted sensitivities within the same bucket set out in Articles 544, 549 and 552 of this Decision, giving rise to the bucket-specific sensitivity Kb: Kb = ��WSk 2 + � � ρkl kϵb lϵb,k≠l WSkWSI kϵb

  • R ∙ ���WSk hedges� 2 � kϵb where: Kb = the bucket-specific sensitivity of bucket b; WSk = the net-weighted sensitivities; ρkl = the corresponding intra-bucket correlation parameters; R = the hedging disallowance parameter equal to 0.01. (14) The bucket-specific sensitivity shall be calculated in accordance with paragraphs (11), (12) and (13) of this Article for each bucket within a risk class, and once the bucket-specific sensitivity has been calculated for all buckets, weighted sensitivities to all risk factors across buckets shall be aggregated in accordance with the following formula, using the corresponding correlations γbc for weighted sensitivities in different buckets set out in Articles 544, 547, 550, 553, 555, 557 of this Decision, giving rise to the risk-class specific own funds requirements for delta or vega risk: The risk-class specific own funds requirements for delta or vega risk = = mCVA��Kb 2 b
  • �� γbc c≠bb SbSc where:

mCVA = a multiplier factor which is equal to 1, wherein the Central Bank may increase the value of mcva where the credit institution’s regulatory CVA model shows deficiencies preventing the appropriate measurement of the own funds requirements for CVA risk; Kb = the bucket-specific sensitivity of bucket b; γbc = the correlation parameter between buckets b and c; Sb = max �−Kb; min ��WSk; kϵb Kb�� for all risk factors in bucket b Sc = max �−Kc; min ��WSk; kϵc Kc�� for all risk factors in bucket c

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 583 Interest rate risk factors Article 535 (1) For the interest rate delta risk factors, including inflation rate risk, there shall be one bucket per currency, with each bucket containing different types of risk factors. (2) The interest rate delta risk factors that are applicable to interest-rate sensitive instruments in the CVA portfolio shall be the risk-free rates per currency concerned and per each of the following maturities: 1 year, 2 years, 5 years, 10 years and 30 years. (3) The interest rate delta risk factors applicable to inflation-rate sensitive instruments in the CVA portfolio shall be the inflation rates per currency concerned and per each of the following maturities: 1 year, 2 years, 5 years, 10 years and 30 years. (4) The currencies for which a credit institution shall apply the interest rate delta risk factors in accordance with paragraph (1) of this Article shall be euro, Swedish krona, Australian dollar, Canadian dollar, British pound sterling, Japanese yen and US dollar, the credit institution’s reporting currency and the currency of a Member State participating in ERM II. (5) For currencies not specified in paragraph (4) of this Article, the interest rate delta risk factors shall be the absolute change of the inflation rate and the parallel shift of the entire risk-free curve for a given currency. (6) A credit institution shall obtain the risk-free rates per currency from money market instruments held in its trading book that have the lowest credit risk, including overnight index swaps. (7) Where a credit institution cannot apply the approach referred to in paragraph (6) of this Article, the risk-free rates shall be based on one or more market-implied swap curves used by the credit institution to mark positions to market, such as the interbank offered rate swap curves. (8) Where the data on market-implied swap curves described in paragraph (7) of this Article are insufficient, the risk-free rates may be derived from the most appropriate sovereign bond curve for a given currency. (9) The interest rate vega risk factor applicable to instruments in the CVA portfolio sensitive to interest rate volatility shall be all the volatilities of the interest rate of all tenors for a given currency. (10) The inflation rate vega risk factor applicable to instruments in the CVA portfolio sensitive to inflation rate volatility shall be all the volatilities of the inflation rate of all tenors for a given currency, and there shall be one net interest rate sensitivity and one net inflation rate sensitivity computed for each currency.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 584 Foreign exchange risk factors Article 536 (1) The foreign exchange delta risk factors to be applied by a credit institution to instruments in the CVA portfolio sensitive to foreign exchange spot rates shall be the spot foreign exchange rates between the currency in which an instrument is denominated and the credit institution’s reporting currency or the credit institution’s base currency where the credit institution is using a base currency in accordance with Article 430 paragraph (8) of this Decision, and there shall be one bucket per currency pair, containing a single risk factor and a single net sensitivity. (2) The foreign exchange vega risk factors to be applied by a credit institution to instruments in the CVA portfolio sensitive to foreign exchange volatility shall be the implied volatilities of foreign exchange rates between the currency pairs referred to in paragraph (1) of this Article, and there shall be one bucket for all currencies and maturities, containing all foreign exchange vega risk factors and a single net sensitivity. (3) A credit institution shall not be required to distinguish between onshore and offshore variants of a currency for foreign exchange delta and vega risk factors. Counterparty credit spread risk factors Article 537 (1) The counterparty credit spread delta risk factors applicable to counterparty credit spread sensitive instruments in the CVA portfolio shall be the credit spreads of individual counterparties and reference names and qualified indices for the following maturities: 0,5 years, 1 year, 3 years, 5 years and 10 years. (2) The counterparty credit spread risk class shall not be subject to vega risk own funds requirements. Reference credit spread risk factors Article 538 (1) The reference credit spread delta risk factors applicable to reference credit spread sensitive instruments in the CVA portfolio shall be the credit spreads of all maturities for all reference names within a bucket, and there shall be one net sensitivity computed for each bucket. (2) The reference credit spread vega risk factors applicable to instruments in the CVA portfolio sensitive to reference credit spread volatility shall be the volatilities of the credit spreads of all tenors for all reference names within a bucket, and there shall be one net sensitivity computed for each bucket. Equity risk factors Article 539 (1) The buckets for all equity risk factors shall be the buckets referred to in Article 522 of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 585 (2) The equity delta risk factors to be applied by institutions to instruments in the CVA portfolio sensitive to equity spot prices shall be the spot prices of all equities mapped to the same bucket referred to in paragraph (1) of this Article, and there shall be one net sensitivity computed for each bucket. (3) The equity vega risk factors to be applied by a credit institution to instruments in the CVA portfolio sensitive to equity volatility shall be the implied volatilities of all equities mapped to the same bucket referred to in paragraph (1) of this Article, and there shall be one net sensitivity computed for each bucket. Commodity risk factors Article 540 (1) The buckets for all commodity risk factors shall be the sector buckets referred to in Article 556 of this Decision. (2) The commodity delta risk factors to be applied by a credit institution to instruments in the CVA portfolio sensitive to commodity spot prices shall be the spot prices of all commodities mapped to the same sector bucket referred to in paragraph (1) of this Article, and there shall be one net sensitivity computed for each sector bucket. (3) The commodity vega risk factors to be applied by a credit institution to instruments in the CVA portfolio sensitive to commodity price volatility shall be the implied volatilities of all commodities mapped to the same sector bucket referred to in paragraph (1) of this Article, and there shall be one net sensitivity computed for each sector bucket. Delta risk sensitivities Article 541 (1) A credit institution shall calculate delta sensitivities consisting of interest rate risk factors as follows:

  1. the delta sensitivities of the aggregate CVA to risk factors consisting of risk-free rates, as well as of an eligible hedge to those risk factors, shall be calculated as follows: 𝑆𝑆 𝑘𝑘𝑘𝑘 𝐶𝐶 = 𝐶𝐶 ( 𝑘𝑘 + 0,0001, , … ) − 𝐶𝐶 ( 𝑘𝑘 , , … ) 0,0001 𝑆𝑆 𝑘𝑘𝑘𝑘 ℎ = 𝑖𝑖( 𝑘𝑘 + 0,0001, w, z … ) − 𝑖𝑖( 𝑘𝑘 , w, z … ) 0,0001 where: 𝑆𝑆 𝑘𝑘𝑘𝑘 𝐶𝐶 = the sensitivities of the aggregate CVA to a risk-free rate risk factor 𝑘𝑘 = the value of the risk-free rate risk factor k with maturity t; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model; x,y = risk factors other than rkt in 𝐶𝐶 ;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 586 𝑆𝑆 𝑘𝑘𝑘𝑘 ℎ = the sensitivities of the eligible hedge i to a risk-free rate risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than rkt in the pricing function Vi. 2) the delta sensitivities to risk factors consisting of inflation rates as well as of an eligible hedge to those risk factors, shall be calculated as follows: 𝑆𝑆𝑖𝑖 𝑘𝑘𝑘𝑘 𝐶𝐶 = 𝐶𝐶 (𝑖𝑖 𝑘𝑘 + 0,0001, , … ) − 𝐶𝐶 (𝑖𝑖 𝑘𝑘 , , … ) 0,0001 𝑆𝑆𝑖𝑖 𝑘𝑘𝑘𝑘 ℎ = 𝑖𝑖(𝑖𝑖 𝑘𝑘 + 0,0001, w, z … ) − 𝑖𝑖(𝑖𝑖 𝑘𝑘 , w, z … ) 0,0001 where: 𝑆𝑆𝑖𝑖 𝑘𝑘𝑘𝑘 𝐶𝐶 = the sensitivities of the aggregate CVA to an inflation rate risk factor; 𝑖𝑖 𝑘𝑘 = the value of an inflation rate risk factor k with maturity t; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model; x,y = risk factors other than 𝑖𝑖 𝑘𝑘 in 𝐶𝐶 ; 𝑆𝑆𝑖𝑖 𝑘𝑘𝑘𝑘 𝑧𝑧 š𝑡𝑡 𝑡𝑡 = the sensitivities of the eligible hedge i to an inflation rate risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than 𝑖𝑖 𝑘𝑘 in the pricing function Vi. (2) A credit institution shall calculate the delta sensitivities of the aggregate CVA to risk factors consisting of foreign exchange spot rates, as well as of an eligible hedge instrument to those risk factors, as follows: 𝑆𝑆𝐹𝐹𝐹𝐹𝑘𝑘 𝐶𝐶 = 𝐶𝐶 ( 𝑘𝑘 ∙ 1,01, , … ) − 𝐶𝐶 ( 𝑘𝑘, , … ) 0,01 𝑆𝑆𝐹𝐹𝐹𝐹𝑘𝑘 ℎ = 𝑖𝑖( 𝑘𝑘 ∙ 1,01, w, z … ) − 𝑖𝑖( 𝑘𝑘, w, z … ) 0,01 where: 𝑆𝑆𝐹𝐹𝐹𝐹𝑘𝑘 𝐶𝐶 = the sensitivities of the aggregate CVA to a foreign exchange spot rate risk factor; 𝑘𝑘 = the value of the foreign exchange spot rate risk factor k; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 587 x,y = risk factors other than 𝑘𝑘 in 𝐶𝐶 ; 𝑆𝑆𝐹𝐹𝐹𝐹𝑘𝑘 𝑧𝑧 š𝑡𝑡 𝑡𝑡 = the sensitivities of the eligible hedge i to a foreign exchange spot rate risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than 𝑘𝑘in the pricing function Vi; (3) A credit institution shall calculate the delta sensitivities of the aggregate CVA to risk factors consisting of counterparty credit spread rates, as well as of an eligible hedge instrument to those risk factors, as follows: 𝑆𝑆𝐶𝐶𝐶𝐶 𝑘𝑘𝑘𝑘 𝐶𝐶 = 𝐶𝐶 (𝐶𝐶𝐶𝐶 𝑘𝑘 + 0,0001, , … ) − 𝐶𝐶 (𝐶𝐶𝐶𝐶 𝑘𝑘 , , … ) 0,0001 𝑆𝑆𝐶𝐶𝐶𝐶 𝑘𝑘𝑘𝑘 ℎ = 𝑖𝑖(𝐶𝐶𝐶𝐶 𝑘𝑘 + 0,0001, w, z … ) − 𝑖𝑖(𝐶𝐶𝐶𝐶 𝑘𝑘 , w, z … ) 0,0001 where: 𝑆𝑆𝐶𝐶𝐶𝐶 𝑘𝑘𝑘𝑘 𝐶𝐶 = the sensitivities of the aggregate CVA to a counterparty credit spread rate risk factor; 𝐶𝐶𝐶𝐶 𝑘𝑘 = the value of the counterparty credit spread rate risk factor k at maturity t; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model; x,y = risk factors other than 𝐶𝐶𝐶𝐶 𝑘𝑘 in 𝐶𝐶 ; 𝑆𝑆𝐶𝐶𝐶𝐶 𝑘𝑘𝑘𝑘 ℎ = the sensitivities of the eligible hedge i to a counterparty credit spread rate risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than 𝐶𝐶𝐶𝐶 𝑘𝑘 in the pricing function Vi. (4) A credit institution shall calculate the delta sensitivities of the aggregate CVA to risk factors consisting of reference credit spread rates, as well as of an eligible hedge instrument to those risk factors, as follows: 𝑆𝑆 𝑘𝑘𝑘𝑘 𝐶𝐶 = 𝐶𝐶 ( 𝑘𝑘 + 0,0001, , … ) − 𝐶𝐶 ( 𝑘𝑘 , , … ) 0,0001 𝑆𝑆 𝑘𝑘𝑘𝑘 ℎ = 𝑖𝑖( 𝑘𝑘 + 0,0001, w, z … ) − 𝑖𝑖( 𝑘𝑘 , w, z … ) 0,0001 where: 𝑆𝑆 𝑘𝑘𝑘𝑘 𝐶𝐶 = the sensitivities of the aggregate CVA to a reference credit spread rate risk factor;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 588 𝑘𝑘 = the value of the reference credit spread rate risk factor k at maturity t; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model; x,y = risk factors other than 𝑘𝑘 in 𝐶𝐶 ; 𝑆𝑆 𝑘𝑘𝑘𝑘 ℎ = the sensitivities of the eligible hedge i to a reference credit spread rate risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than 𝑘𝑘 in the pricing function Vi. (5) A credit institution shall calculate the delta sensitivities of the aggregate CVA to risk factors consisting of equity spot prices, as well as of an eligible hedge instrument to those risk factors, as follows: 𝑆𝑆𝐸𝐸𝐸𝐸 𝐶𝐶 = 𝐶𝐶 ( 𝐸𝐸 ∙ 1,01, , … ) − 𝐶𝐶 (EQ, , … ) 0,01 𝑆𝑆𝐸𝐸𝐸𝐸 ℎ = 𝑖𝑖( 𝐸𝐸 ∙ 1,01, w, z … ) − 𝑖𝑖(EQ, w, z … ) 0,01 where: 𝑆𝑆𝐸𝐸𝐸𝐸 𝐶𝐶 = the sensitivities of the aggregate CVA to an equity spot price risk factor; EQ = the value of the equity spot price; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model; x,y = risk factors other than EQ in V CVA EQ in 𝐶𝐶 ; 𝑆𝑆𝐸𝐸𝐸𝐸 ℎ = the sensitivities of the eligible hedge i to an equity spot price risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than EQ in the pricing function Vi. (6) A credit institution shall calculate the delta sensitivities of the aggregate CVA to risk factors consisting of commodity spot prices, as well as of an eligible hedge instrument to those risk factors, as follows: 𝑆𝑆𝐶𝐶 = 𝐶𝐶 (1,01 ∙ 𝐶𝐶 , , … ) − 𝐶𝐶 (𝐶𝐶 , , … ) 0,01 𝑆𝑆𝐶𝐶 𝐶𝐶 ℎ = 𝑖𝑖(1,01 ∙ 𝐶𝐶 , w, z … ) − 𝑖𝑖(𝐶𝐶 , w, z … ) 0,01 where:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 589 𝑆𝑆𝐶𝐶 = the sensitivities of the aggregate CVA to a commodity spot price risk factor; 𝐶𝐶 = the value of the commodity spot price; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model;; x,y = risk factors other than 𝐶𝐶 in 𝐶𝐶 ; 𝑆𝑆𝐶𝐶 𝐶𝐶 ℎ = the sensitivities of the eligible hedge i to a commodity spot price risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than 𝐶𝐶 in the pricing function Vi. Vega risk sensitivities Article 542 A credit institution shall calculate the vega risk sensitivities of the aggregate CVA to risk factors consisting of implied volatility, as well as of an eligible hedge instrument to those risk factors, as follows: 𝑆𝑆 𝑘𝑘 𝐶𝐶 = 𝐶𝐶 (𝑣𝑣 𝑘𝑘 ∙ 1,01, , … ) − 𝐶𝐶 (𝑣𝑣 𝑘𝑘, , … ) 0,01 𝑆𝑆 𝑘𝑘 ℎ = 𝑖𝑖(𝑣𝑣 𝑘𝑘 ∙ 1,01, w, z … ) − 𝑖𝑖(𝑣𝑣 𝑘𝑘, w, z … ) 0,01 where: 𝑆𝑆𝑖𝑖 𝑘𝑘𝑘𝑘 𝐶𝐶 = the sensitivities of the aggregate CVA to an implied volatility risk factor; 𝑣𝑣 𝑘𝑘 = the value of the implied volatility risk factor; 𝐶𝐶 = the aggregate CVA calculated by the regulatory CVA model; x,y = risk factors other than𝑣𝑣 𝑘𝑘 in the pricing function 𝐶𝐶 ; 𝑆𝑆𝑖𝑖 𝑘𝑘𝑘𝑘 ℎ = the sensitivities of the eligible hedge instrument i to an implied volatility risk factor; 𝑖𝑖 = the pricing function of the eligible hedge i; w,z = risk factors other than 𝑣𝑣 𝑘𝑘u in the pricing function Vi. Risk weights for interest rate risk Article 543 (1) For the currencies referred to in Article 535 paragraph (4) of this Decision, the risk weights of risk-free rate delta sensitivities for each bucket shall be those provided in in Table 1 of this paragraph.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 590 Table 1 (2) For currencies other than the currencies referred to in Article 535 paragraph (4) of this Decision, the risk weight of risk-free rate delta sensitivities shall be 1.58 %. (3) For inflation rate risk denominated in one of the currencies referred to in Article 535 paragraph (4) of this Decision the risk weight of the delta sensitivity to the inflation rate risk shall be 1.11 %. (4) For inflation rate risk denominated in a currency other than the currencies referred to in Article 535 paragraph (4) of this Decision, the risk weight of the delta sensitivity to the inflation rate risk shall be 1.58 %. (5) The risk weights to be applied to sensitivities to interest rate vega risk factors and to inflation rate vega risk factors for all currencies shall be 100%. Intra-bucket correlations for interest rate risk Article 544 (1) For the currencies referred to in Article 535 paragraph (4) of this Decision, the credit institution shall apply the correlation parameters provided in Table 1 of this paragraph to the aggregation of the risk-free rate delta sensitivities between the different buckets set out in Article 543 of this Decision. Table 1 (2) A credit institution shall apply a correlation parameter of 40% for the aggregation of inflation rate delta risk sensitivity and risk-free rate delta sensitivity denominated in the same currency. (3) A credit institution shall apply a correlation parameter of 40% for the aggregation of inflation rate vega risk factor sensitivity and interest rate vega risk factor sensitivity denominated in the same currency. Bucket Maturity Risk weight 1 1 year 1.11% 2 2 years 0.93% 3 5 years 0.74% 4 10 years 0.74% 5 30 years 0.74% Bucket 1 2 3 4 5 1 100% 91% 72% 55% 31% 2 100% 87% 72% 45% 3 100% 91% 68% 4 100% 83% 5 100%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 591 Correlation across buckets for interest rate risk Article 545 The cross-bucket correlation parameter for interest rate delta and vega risks shall be set at 0.5 for all currency pairs. Risk weights for foreign exchange risk Article 546 (1) The risk weights for all delta sensitivities to foreign exchange risk factor between a credit institution’s reporting currency and another currency shall be 11%. (2) The risk weight of the foreign exchange risk factors concerning currency pairs which are composed of the euro and the currency of a Member State participating in ERM II shall be one of the following:

  1. the risk weight referred to in paragraph (1) of this Article, divided by 3;
  2. the maximum fluctuation within the fluctuation band formally agreed by the Member State and the ECB, if that fluctuation band is narrower than the fluctuation band defined under ERM II. (3) Notwithstanding paragraph (2) of this Article, the risk weight of the foreign exchange risk factors concerning currencies referred to in that paragraph which participate in ERM II with a formally agreed fluctuation band narrower than the standard band of plus or minus 15% shall equal the maximum percentage fluctuation within that narrower band. (4) The risk weights for all vega sensitivities to foreign exchange risk factor shall be 100%. Correlations for foreign exchange risk Article 547 (1) A uniform correlation parameter equal to 60% shall apply to the aggregation of sensitivities to delta foreign exchange risk factor across buckets. (2) A uniform correlation parameter equal to 60% shall apply to the aggregation of sensitivities to vega foreign exchange risk factor across buckets. Risk weights for counterparty credit spread risk Article 548 (1) The risk weights for the delta sensitivities to counterparty credit spread risk factors shall be the same for all maturities (0,5 years, 1 year, 3 years, 5 years, 10 years) within each bucket in Table 1 and shall be the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 592 Table 1 Bucket number Credit quality Sector Risk weight 1 All Government of Montenegro, Central Bank of Montenegro, central governments and central banks of Member States 0.5% 2 Credit quality step 1 to 3 Central government, including central banks, of third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) and Article 155 of this Decision 0.5% 3 Regional government or local self-government units and public sector entities 1.0% 4 Financial sector entities, including credit institutions established by a central government, a regional government or a local self-government unit, and promotional lenders 5.0% 5 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 3.0% 6 Consumer goods and services, transportation and storage, administrative and support service activities 3.0% 7 Technology, telecommunications 2.0% 8 Health care, utilities, professional and technical activities 1.5% 9 Covered bonds issued by credit institutions established in Member States 1.0% 10 Credit quality step 1 Covered bonds issued by credit institutions in third countries 1.5% Credit quality steps 2 to 3 2.5% 11 Credit quality steps 1 to 3 Other sector 5.0% 12 Qualified indices 1.5% 13 Credit quality step 4 to 6 and unrated Central government, including central banks, of third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) and Article 155 of this Decision 2.0% 14 Regional government or local self-government units and public sector entities 4.0%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 593 (2) Where there are no external ratings for a specific counterparty, a credit institution may, subject to authorisation by the Central Bank, map the internal rating to a corresponding external rating and assign a risk weight corresponding to either credit quality step 1 to 3 or credit quality step 4 to 6, otherwise, the risk weights for unrated exposures shall be applied. (3) To assign a risk exposure to a sector, a credit institution shall rely on a classification that is commonly used in the market for grouping issuers by sector, wherein the credit institution shall assign each issuer to only one of the sector buckets set out in Table 1 of paragraph (1) of this Article, and the risk exposures from any issuer that a credit institution cannot assign to a sector in such a manner shall be assigned to either bucket 11 or bucket 20 in Table 1 of paragraph (1) of this Article, depending on the credit quality of the issuer. (4) A credit institution shall assign to buckets 12 and 21 in Table 1 of paragraph (1) of this Article only exposures that reference qualified indices as referred to in Article 534 paragraph (6) of this Decision. (5) A credit institution shall use a look-through approach to determine the sensitivities of an exposure referencing a non-qualified index. Intra-bucket correlations for counterparty credit spread risk Article 549 (1) Between two sensitivities WSk and WSl, resulting from risk exposures assigned to sector buckets 1 to 11 and 13 to 20, as set out in of Article 548 paragraph (1) Table 1 of this Decision, the correlation parameter ρkl shall be set as follows: 𝜌𝜌𝑘𝑘 = 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) ∙ 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) ∙ 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) 15 Financial sector entities, including credit institutions established by a central government, a regional government or a local authority, and promotional lenders 12.0% 16 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 7.0% 17 Consumer goods and services, transportation and storage, administrative and support service activities 8.5% 18 Technology, telecommunications 5.5% 19 Health care, utilities, professional and technical activities 5.0% 20 Other sector 12.0% 21 Qualified indices 5.0%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 594 where: 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) shall be equal to 1 where the two vertices of the sensitivities k and l are identical, otherwise it shall be equal to 90%; 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) shall be equal to 1 where the two names of sensitivities k and l are identical, 90% if the two names are distinct but legally related, otherwise it shall be equal to 50; 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) shall be equal to 1 where the two names are both in buckets 1 to 11 or are both in buckets 13 to 20, otherwise it shall be equal to 80%. (2) Between two sensitivities WSk and WSl resulting from risk exposures assigned to sector buckets 12 and 21, the correlation parameter ρkl shall be set as follows: 𝜌𝜌𝑘𝑘 = 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) ∙ 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) ∙ 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) where: 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) shall be equal to 1 where the two vertices of the sensitivities k and l are identical, otherwise it shall be equal to 90%; 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) shall be equal to 1 where the two names of sensitivities k and l are identical and the two indices are of the same series, 90% if the two indices are the same but of distinct series, otherwise it shall be equal to 80%; 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) shall be equal to 1 where the two names are both in bucket 12 or both in bucket 21, otherwise it shall be equal to 80%. Correlations across buckets for counterparty credit spread risk Article 550 (1) The cross-bucket correlations for counterparty credit spread delta risk shall be as provided in Table 1 of this paragraph. Table 1 Bucket 1, 2, 3, 13 and 14 4 and 15 5 and 16 6 and 17 7 and 18 8 and 19 9 and 10 11 and 20 12 and i 21 1, 2, 3, 13 and 14 100% 10% 20% 25% 20% 15% 10% 0% 45% 4 and 15 100% 5% 15% 20% 5% 20% 0% 45% 5 and 16 100% 20% 25% 5% 5% 0% 45% 6 and 17 100% 25% 5% 15% 0% 45% 7 and 18 100% 5% 20% 0% 45%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 595 Risk weights for reference credit spread risk Article 551 (1) The risk weights for the delta sensitivities to reference credit spread risk factors shall be the same for all maturities (0,5 years, 1 year, 3 years, 5 years, 10 years) and all reference credit spread exposures within each bucket in Table 1 and shall be as provided in Table 1 of this paragraph. Table 1 8 and i 19 100% 5% 0% 45% 9 and 10 100% 0% 45% 11 and 20 100% 0% 12 and 21 100% Bucket number Credit quality Sector Risk weight 1 All Government of Montenegro, Central Bank of Montenegro, central governments and central banks of Member States 0.5% 2 Credit quality step 1 to 3 Central government, including central banks, of third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) and Article 155 of this Decision 0.5% 3 Regional government or local self￾government units and public sector entities 1.0% 4 Financial sector entities, including credit institutions established by a central government, a regional government or a local self-government unit, and promotional lenders 5.0% 5 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 3.0% 6 Consumer goods and services, transportation and storage, administrative and support service activities 3.0% 7 Technology, telecommunications 2.0% 8 Health care, utilities, professional and technical activities 1.5% 9 Covered bonds issued by credit institutions established in Member States 1.0%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 596 (2) Where there are no external ratings for a specific counterparty, a credit institution may, subject to authorisation by the Central Bank, map the internal rating to a corresponding external rating and assign a risk weight corresponding to either credit quality step 1 to 3 or credit quality step 4 to 6, otherwise, the risk weights for unrated exposures shall be applied. (3) Risk weights for reference credit spread volatilities shall be set at 100%. (4) To assign a risk exposure to a sector, a credit institution shall rely on a classification that is commonly used in the market for grouping issuers by sector, wherein a credit institution shall assign each issuer to only one of the sector buckets in Table 1 of paragraph (1) of this Article, and risk exposures from any issuer that a credit institution 10 Credit quality step 1 Covered bonds issued by credit institutions in third countries 1.5% Credit quality steps 2 to 3 2.5% 11 Credit quality steps 1 to 3 Qualified indices 1.5% 12 Credit quality step 4 to 6 and unrated Central government, including central banks, of third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) and Article 155 of this Decision 2.0% 13 Regional government or local self￾government units and public sector entities 4.0% 14 Financial sector entities, including credit institutions established by a central government, a regional government or a local authority, and promotional lenders 12.0% 15 Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 7.0% 16 Consumer goods and services, transportation and storage, administrative and support service activities 8.5% 17 Technology, telecommunications 5.5% 18 Health care, utilities, professional and technical activities 5.0% 19 Qualified indices 5.0% 20 Other sector 12,0%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 597 cannot assign to a sector in such a manner shall be assigned to bucket 20 in Table 1 of paragraph (1) of this Article. (5) A credit institution shall assign to buckets 11 and 19 in Table 1 of paragraph (1) of this Article only exposures that reference qualified indices as referred to in Article 534 paragraph (6) of this Decision. (6) A credit institution shall use a look-through approach to determine the sensitivities of an exposure referencing a non-qualified index. Intra-bucket correlations for reference credit spread risk Article 552 (1) Between two sensitivities WSk i WSl, resulting from risk exposures assigned to sector buckets 1 to 10, 12 to 18 and 20 in Table 1 of paragraph (1) of Article 551 of this Decision, the correlation parameter ρkl shall be set as follows: 𝜌𝜌𝑘𝑘 = 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) ∙ 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) ∙ 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) where: 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) shall be equal to 1 where the two vertices of the sensitivities k and l are identical, otherwise it shall be equal to 90%; 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) shall be equal to 1 where the two names of sensitivities k and l are identical, 90% if the two names are distinct but legally related, otherwise it shall be equal to 50%; 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) shall be equal to 1 where the two names are both in buckets 1 to 10, are both in buckets 12 to 18, or are both in bucket 20, otherwise it shall be equal to 80%. (2) Between two sensitivities WSk and WSl, resulting from risk exposures assigned to sector buckets 11 and 19, the correlation parameter ρkl shall be set as follows: 𝜌𝜌𝑘𝑘 = 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) ∙ 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) ∙ 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) where: 𝜌𝜌𝑘𝑘 (𝑡𝑡 ) shall be equal to 1 where the two vertices of the sensitivities k and l are identical, otherwise it shall be equal to 90%; 𝜌𝜌𝑘𝑘 (𝑛𝑛 𝑛𝑛) shall be equal to 1 where the two names of sensitivities k and l are identical and the two indices are of the same series, 90% if the two indices are the same but of distinct series, otherwise it shall be equal to 80%; 𝜌𝜌𝑘𝑘 (𝑞𝑞 ) shall be equal to 1 where the two names are both in bucket 11 or both in bucket 19, otherwise it shall be equal to 80%.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 598 Correlations across buckets for reference credit spread risk Article 553 (1) The cross-bucket correlations for reference credit spread delta risk and reference credit spread vega risk shall be as provided in Table 1 of this paragraph. Table 1 Bucket 1, 2 and 12 3 and 14 4 and 15 5 and 16 6 and 17 7 and 18 8 and 19 9 and 10 20 11 19 1, 2, and 12 100% 75% 10% 20% 25% 20% 15% 10% 0% 45% 45% 3 and 14 100% 5% 15% 20% 15% 10% 10% 0% 45% 45% 4 and 15 100% 5% 15% 20% 5% 20% 0% 45% 45% 5 and 16 100% 20% 25% 5% 5% 0% 45% 45% 6 and 17 100% 25% 5% 15% 0% 45% 45% 7 and 18 100% 5% 20% 0% 45% 45% 8 and 19 100% 5% 0% 45% 45% 9 and 10 100% 0% 45% 45% 20 100% 0% 0% 11 100% 75% 19 100% (2) By way of derogation from paragraph (1) of this Article, the cross-bucket correlation values calculated in that paragraph shall be divided by 2 for correlations between a bucket from the group of buckets 1 to 10 and a bucket from the group of buckets 12 to 18. Risk weight buckets for equity risk Article 554 (1) The risk weights for the delta sensitivities to equity spot price risk factors shall be the same for all equity risk exposures within each bucket in Table 1 and shall be the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 599 Table 1 Bucket number Market capitalisation Economy Sector Risk weight for equity spot price 1 Large Emerging market economy Consumer goods and services, transportation and storage, administrative and support service activities, healthcare, utilities 55% 2 Telecommunications, industrials 60% 3 Basic materials, energy, agriculture, manufacturing, mining and quarrying 45% 4 Financials, including government￾backed financials, immovable property activities, technology 55% 5 Advanced economy Consumer goods and services, transportation and storage, administrative and support service activities, healthcare, utilities 30% 6 Telecommunications, industrials 35% 7 Basic materials, energy, agriculture, manufacturing, mining and quarrying 40% 8 Financials, including government￾backed financials, immovable property activities, technology 50% 9 Small Emerging market economy All sectors described under bucket numbers 1, 2, 3 and 4 70% 10 Advanced economy All sectors described under bucket numbers 5, 6, 7 and 8 50% 11 Other sector 70%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 600 (2) For the purposes of paragraph (1) of this Article, a small and a large capitalisation shall have the meanings specified in Article 469 paragraphs (21) and (22), respectively. (3) For the purposes of paragraph (1) of this Article, an emerging market and an advanced economy shall have the meanings specified in Article 455 paragraphs (6) and (7), respectively. (4) When assigning a risk exposure to a sector, a credit institution shall rely on a classification that is commonly used in the market for grouping issuers by industry sector, wherein a credit institution shall assign each issuer to one of the sector buckets in Table 1 of paragraph (1) of this Article, and shall assign all issuers from the same industry to the same sector. (5) A credit institution shall assign risk exposures from any issuer that cannot be assigned to a sector in accordance with paragraph (4) of this Article to bucket 11. (6) Multinational or multi-sector equity issuers shall be allocated to a particular bucket on the basis of the most material region and sector in which the equity issuer operates. (7) The risk weights for equity vega risk shall be set at 78% for buckets 1 to 8 and bucket 12, and at 100% for all other buckets. Correlations across buckets for equity risk Article 555 The cross-bucket correlation parameter for equity delta and vega risk shall be set at:

  1. 15%, where the two buckets fall within buckets 1 to 10 in Table 1 of paragraph (1) of Article 554 of this Decision;
  2. 75%, where the two buckets are buckets 12 and 13 in Table 1 of paragraph (1) of Article 554 of this Decision;
  3. 45%, where one of the buckets is bucket 12 or 13 in Table 1 of paragraph (1) of Article 554 of this Decision, and the other bucket falls within buckets 1 to 10 in Table 1 of paragraph (1) of Article 554 of this Decision;
  4. 0%, where one of the two buckets is bucket 11 in Table 1 of paragraph (1) of Article 554 of this Decision. Risk weight buckets for commodity risk Article 556 (1) The risk weights for the delta sensitivities to commodity spot price risk factors shall be the same for all commodity risk exposures within each bucket in Table 1 and shall be the following: 12 Large Advanced economy Qualified indices 15% 13 Other Qualified indices 25%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 601 Table 1 (2) The risk weights for commodity vega risk shall be set at 100%. Correlations across buckets for commodity risk Article 557 (1) The cross-bucket correlation parameter for commodity delta risk shall be set at:

  1. 20%, where the two buckets fall within buckets 1 to 12 in Table 1 of paragraph (1) of Article 556 of this Decision;
  2. 0%, where one of the two buckets is bucket 13 in Table 1 of paragraph (1) of Article 556 of this Decision. (2) The cross-bucket correlation parameter for commodity vega risk shall be set at:
  3. 20%, where the two buckets fall within buckets 1 to 12 in Table 1 of paragraph (1) of Article 556 of this Decision;
  4. 0%, where one of the two buckets is bucket 13 in Table 1 of paragraph (1) of Article 556 of this Decision. Basic approach Article 558 (1) A credit institution shall calculate the own funds requirements for CVA risk in accordance with paragraph (3) or (4) of this Article, as applicable, for a portfolio of Bucket number Bucket name Risk weight for commodity spot price 1 Energy — solid combustibles 30% 2 Energy — liquid combustibles 35% 3 Energy — electricity 60% 4 Energy — EU ETS carbon trading 40% 5 Energy — non-EU ETS carbon trading 60% 6 Freight 80% 7 Metals — non-precious 40% 8 Gaseous combustibles 45% 9 Precious metals, including gold 20% 10 Grains and oilseed 35% 11 Livestock and dairy 25% 12 Softs and other agricultural commodities 35% 13 Other commodity 50%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 602 transactions with one or more counterparties by using one of the following formulae, as appropriate:

  1. the formula set out in paragraph (3) of this Article, where the credit institution includes in the calculation one or more eligible hedges recognised in accordance with Article 560 of this Decision;
  2. the formula set out in paragraph (4) of this Article, where the credit institution does not include in the calculation any eligible hedges recognised in accordance with Article 560 of this Decision. (2) A credit institution shall not use in combination the approaches set out in paragraph (1) items 1) and 2) of this Article. (3) A credit institution that meets the condition referred to in paragraph (1) item 1) of tis Article, shall calculate the own funds requirements for CVA risk as follows: BACVAtotal = β ∙ BACVAcsr-unhedged + DSCVA ∙ (1 – β) ∙ BACVAcsr-hedged where: BACVAtotal = the own funds requirements for CVA risk under the basic approach; BACVAcsr￾unhedged = the own funds requirements for CVA risk under the basic approach as calculated in accordance with paragraph (4) of this Article, for a credit institution that meets the condition set out in paragraph (1) item 2) of this Article; DSCVA = 0.65; β = 0.25; BACVAcsr−hedged = ��ρ ∙ �(SCVAc − SNHc) − IH c � 2
  • (1 − ρ2) ∙ �(SCVAc − SNHc)2 + �HMAc where: SCVAc = 1 𝛼𝛼 ∙ RWc ∙ � MNS c ∙ 𝑁𝑁 NSϵc ∙ 𝑁𝑁 SNHc = � ℎ ∙ 𝑅𝑅𝑅𝑅ℎ 𝑆𝑆 hϵc ∙ 𝑀𝑀ℎ 𝑆𝑆 ∙ 𝐵𝐵ℎ 𝑆𝑆 ∙ ℎ 𝑆𝑆 IH = �RWi ind ∙ Mi ind i ∙ Bi ind ∙ DFi ind HMAc = �(1 − rℎ 2 ) ∙ (𝑅𝑅𝑅𝑅ℎ 𝑆𝑆 ∙ 𝑀𝑀ℎ 𝑆𝑆 ∙ 𝐵𝐵ℎ 𝑆𝑆 ∙ ℎ 𝑆𝑆 )2 h

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 603 α = 1.4; ρ = 0.5; c = the index that denotes all counterparties for which the credit institution calculates the own funds requirements for CVA risk using the approach laid down in this Article; NS = the index that denotes all netting sets with a given counterparty for which the credit institution calculates the own funds requirements for CVA risk using the approach laid down in this Article; h = the index that denotes all single-name instruments recognised as eligible hedges in accordance with Article 560 of this Decision for a given counterparty for which the credit institution calculates the own funds requirements for CVA risk using the approach laid down in this Article; I = the index that denotes all index instruments recognised as eligible hedges in accordance with Article 560 of this Decision for all counterparties for which the credit institution calculates the own funds requirements for CVA risk using the approach laid down in this Article; RWc = the risk weight applicable to counterparty c, which shall be mapped to one of the risk weights based on a combination of sector and credit quality and determined in accordance with Table 1 of this Article, and where there are no external ratings for a specific counterparty, the credit institution may, subject to authorisation by the Central Bank, map the internal rating to a corresponding external rating and assign a risk weight corresponding to either credit quality step 1 to 3 or credit quality step 4 to 6 to the counterparty, otherwise, the risk weights for unrated exposures shall be applied; MNS c = the effective maturity for the netting set NS with counterparty c, which shall be calculated in accordance with Article 203 of this Decision; however, for that calculation, shall not be capped at five years, but at the longest contractual remaining maturity in the netting set;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 604 𝑁𝑁 = the counterparty credit risk exposure value of the netting set NS with counterparty c, including the effect of collateral in accordance with the methods set out in, Sections 3 to 6, Subtitle 6, Title II of this Part of the Decision, as applicable to the calculation of the own funds requirements for counterparty credit risk referred to in Article 114 paragraph (4) items 1) and 7) of this Decision; 𝑁𝑁 = the supervisory discount factor for the netting set NS with counterparty c, which shall be set at 1 for a credit institution, using the methods set out in Section 6, Subtitle 6, Title II of this Part of the Decision, and in all other cases, the supervisory discount factor shall be calculated as follows: 1 − −0,05 ∙ MNS c 0,05 ∙ MNS c ℎ = the supervisory correlation factor between the credit spread risk of counterparty c and the credit spread risk of a single-name instrument recognised as an eligible hedge h for counterparty c, determined in accordance with Table 2 of this Article; 𝑀𝑀ℎ 𝑆𝑆 = the residual maturity of a single-name instrument recognised as an eligible hedge; 𝐵𝐵ℎ 𝑆𝑆 = the notional value of a single-name instrument recognised as an eligible hedge; ℎ 𝑆𝑆 = the supervisory discount factor for a single-name instrument recognised as an eligible hedge, calculated as follows: 1 − −0,05 ∙ Mh SN 0,05 ∙ Mh SN 𝑅𝑅𝑅𝑅ℎ 𝑆𝑆 = the supervisory risk weight of a single-name instrument recognised as an eligible hedge, which shall be based on a combination of sector and credit quality of the reference credit spread of the hedging instrument and determined in accordance with Table 1 of this Article;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 605 Mi ind = the residual maturity of one or more positions in the same index instrument recognised as an eligible hedge, wherein in the case of more than one position in the same index instrument, Mi ind shall be the notional￾weighted maturity of all those positions; Bi ind = the full notional value of one or more positions in the same index instrument recognised as an eligible hedge; DFi ind = the supervisory discount factor for one or more positions in the same index instrument recognised as an eligible hedge, calculated as follows: 1 − −0,05 ∙ Mi ind 0,05 ∙ Mi ind RWi ind = the supervisory risk weight of an index instrument recognised as an eligible hedge, which shall be based on a combination of sector and credit quality of all index constituents, and calculated as follows:

  1. where all index constituents belong to the same sector and have the same credit quality, as determined in accordance with Table 1 of this Article, RWi ind shall be calculated as the relevant risk weight of Table 1 of this Article for that sector and credit quality multiplied by 0.7;
  2. where all index constituents do not belong to the same sector or do not have the same credit quality, RWi ind shall be calculated as a weighted average of the risk weights of all index constituents, as determined in accordance with Table 1 of this Article, multiplied by 0.7; Table 1 Sector of counterparty Credit quality Credit quality step 1 to 3 Credit quality step 4 to 6 and not rated Central government, including central banks, of third countries, multilateral development banks and international organisations referred to in Article 154 paragraph (4) and Article 155 of this Decision 0.5% 2.0% Regional government or local self-government units and public sector entities 1.0% 4.0%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 606 Table 2 Correlations between credit spread of counterparty and single-name hedge Single-name hedge h of counterparty i Value of rhc Counterparties referred to in Article 560 paragraph (4) item 1 indent 1 of this Decision 100% Counterparties referred to in Article 560 paragraph (4) item 1 indent 2 of this Decision 80% Counterparties referred to in Article 560 paragraph (4) item 1 indent 3 of this Decision 50% (4) A credit institution that meets the condition referred to in paragraph (1) item 2) shall calculate the own funds requirements for CVA risk as follows: BACVAcsr−unhedged = 𝐶𝐶 ��ρ ∙�SCVAc c � 2

  • (1 − ρ2) ∙ �𝑆𝑆 2 where all of the terms are the ones set out in paragraph (3) of this Article. Simplified approach Article 559 (1) A credit institution that meets all of the conditions set out in Article 347 paragraph (2) of this Decision or has been authorised by the Central Bank in accordance with Article 347 paragraph (6) of this Decision to apply the approach set out in Article 369 Financial sector entities, including credit institutions established by a central government, a regional government or a local self-government unit, and promotional lenders 5.0% 12.0% Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying 3.0% 7.0% Consumer goods and services, transportation and storage, administrative and support service activities 3.0% 8.5% Technology, telecommunications 2.0% 5.5% Health care, utilities, professional and technical activities 1.5% 5.0% Other sector 5.0% 12.0%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 607 of this Decision, may calculate the own funds requirements for CVA risk as the risk￾weighted exposure amounts for counterparty risk for non-trading book and trading book positions, respectively, referred to in Article 114 paragraph (4) items 1) and 7) of this Decision, divided by 12.5. (2) For the purposes of the calculation referred to in paragraph (1) of this Article, the following requirements shall apply:

  1. only transactions subject to the own funds requirements for CVA risk laid down in Article 530 of this Decision are subject to that calculation;
  2. credit derivatives that are recognised as internal hedges against counterparty risk exposures are not included in that calculation. (3) A credit institution that no longer meets one or more of the conditions set out in Article 347 paragraph (2) or (6) of this Decision, as applicable, shall comply with the requirements set out in Article 348 of this Decision. Eligible hedges Article 560 (1) Positions in hedging instruments shall be recognised as eligible hedges for the calculation of the own funds requirements for CVA risk in accordance with Articles 532 and 558 of this Decision where those positions meet all of the following requirements:
  3. they are used for the purpose of mitigating CVA risk and are managed as such;
  4. they can be entered into with third parties or with the credit institution’s trading book as an internal hedge, in which case they are to comply with Article 140 paragraph (14) of this Decision;
  5. only positions in hedging instruments as referred to in paragraphs (3) and (4) of this Article may be recognised as eligible hedges for the calculation of the own funds requirements for CVA risk in accordance with Articles 532 and 558 of this Decision, respectively; (2) For the purpose of calculating the own funds requirements for CVA risk in accordance with Article 532 of this Decision, positions in hedging instruments shall be recognised as eligible hedges where, in addition to the conditions set out in paragraph (1) of this Article, such hedging instruments form a single position in an eligible hedge and are not split into more than one position in more than one eligible hedge. (3) For the calculation of the own funds requirements for CVA risk in accordance with Article 532 of this Decision, only positions in the following hedging instruments shall be recognised as eligible hedges:
  6. instruments that hedge variability of the counterparty credit spread, with the exception of instruments referred to in Article 413 paragraph (9) of this Decision;
  7. instruments that hedge variability of the exposure component of CVA risk, with the exception of the instruments referred to in Article 413 paragraph (9) of this Decision. (4) For the calculation of the own funds requirements for CVA risk in accordance with Article 558 of this Decision, only positions in the following hedging instruments shall be recognised as eligible hedges:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 608

  1. single-name credit default swaps and single-name contingent-credit default swaps, referencing: ­ the counterparty directly; ­ an entity legally related to the counterparty, where legally related refers to cases where the reference name and the counterparty are either a parent undertaking and its subsidiary or two subsidiaries of a common parent; ­ an entity that belongs to the same sector and region as the counterparty;
  2. index credit default swaps. (5) Positions in hedging instruments entered into with third parties that are recognised as eligible hedges in accordance with paragraphs (1), (3) and (4) of this Article and included in the calculation of the own funds requirements for CVA risk shall not be subject to the own funds requirements for market risk set out in Title IV of this Part of the Decision. (6) Positions in hedging instruments that are not recognised as eligible hedges in accordance with this Article shall be subject to the own funds requirements for market risk set out in Title IV of this Part of the Decision. PART FOUR – OWN FUNDS REQUIREMENTS FOR EXCEEDING LARGE EXPOSURES Calculating own funds requirements for large exposures Article 561 (1) If a credit institution, based on trading book exposures, exceeds exposure limits to one person or a group of connected persons, prescribed in Article 172 of the Law, the amount of which is determined in line with the regulation of the Central Bank governing large exposures of credit institutions, it shall calculate own funds requirements based on allowed exposure excess limits in accordance with paragraphs (3), (4) and (5) of this Article. (2) The excess referred to in paragraph (1) of this Article shall be calculated by selecting those components of the total trading exposure to one person or a group of connected persons which attract the highest specific-risk requirements referred to in Subtitle 2, Title IV, Part Three and/or requirements referred to in Article 386 of this Decision and regulations of the Central Bank governing large exposures of credit institutions, the sum of which equals the amount of the excess. (3) Where the excess of exposure limit has not persisted for more than 10 days, the additional capital requirement shall be 200% of the own funds requirements referred to in paragraph 1, on these components. (4) If the exposure limit excess occurred within a period of 10 days, the components of the excess, selected in accordance with paragraph (2) of this Article, shall be allocated to the appropriate rows in Column 1 of Table 1 of paragraph (5) of this Article in ascending order of specific-risk own funds requirements referred to in Subtitle 2, Title IV, Part Three and/or requirements referred to in Article 386 and Title V, Part Three of this Decision.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 609 (5) The additional own funds requirement determined for exceeding large exposures from the trading book shall be equal to the sum of the specific-risk capital requirements referred to in Subtitle 2 Title IV, Part Three of this Decision and/or requirements referred to in Article 386 and Title V Part Three, for components where there is an excess, multiplied by the corresponding factor referred to in Column 2 of Table 2 of this paragraph. Table 1 Procedures to prevent a credit institution from avoiding the additional own funds requirement Article 562 (1) A credit institution shall not deliberately avoid the additional capital requirements set out in Article 561 of this Decision that it would be subject to on the basis of exposures exceeding the limits laid down in Article 172 of the Law, once those exposures have been maintained for more than 10 days, by means of temporarily transferring them to another undertaking, whether within the same group or not, or by undertaking artificial transactions to close out the exposure during the 10-day period and create a new exposure. (2) A credit institution shall have in place a system which shall ensure that any transfer which has the effect referred to in the paragraph (1) of this Article is immediately reported to the Central Bank. PART FIVE – LEVERAGE Leverage ratio Article 563 (1) Pursuant to Article 115 paragraph (2) of the Law, leverage shall be with respect to the own funds of the credit institution, the relative size of assets, off-balance sheet obligations and contingent obligations of the credit institution to pay or to deliver or to provide collateral, including obligations which can only be enforced during the bankruptcy or liquidation of the credit institution. Column 1: Excess over the limits (on the basis of a percentage of eligible capital) Column 2: Factors Up to 40% 200% From 40% do 60% 300% From 60% do 80% 400% From 80% do 100% 500% From 100% do 250% 600% Over 250% 900%

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 610 (2) Pursuant to Article 115a paragraph (1) of the Law, a credit institution shall maintain leverage ratio of 3%, calculated in accordance with the methodology as specified in paragraphs (3) to (7) of this Article. (3) The leverage ratio shall be calculated as a credit institution’s Tier 1 capital measure divided by that credit institution’s total exposure measure and shall be expressed as a percentage. (4) The total exposure of a credit institution, for the purpose of paragraph (3) of this Article, shall be the sum of the following items:

  1. asset items calculated in line with Article 565 paragraph (1) of this Decision, excluding: − derivative contracts referred to in Article 148 paragraph (8) of this Decision; − credit derivatives; and − positions referred to in Article 568 of this Decision;
  2. derivative contracts referred to in Article 148 paragraph (5) of this Decision and credit derivatives, including contracts and credit derivatives recorded off￾balance, calculated in line with Articles 566 and 567 of this Decision;
  3. add-ons for counterparty credit risk based in securities financing transactions (SFT) including those that are off-balance sheet referred to in Article 568 of this Decision;
  4. off-balance sheet items, calculated in line with Article 569 of this Decision, excluding: − derivative contracts referred to in Article 148 paragraph (8) of this Decision; − credit derivatives; − securities financing transactions (SFT); and − positions referred to in Articles 567 and 570 of this Decision, and
  5. regular-way purchases and sales awaiting settlement, calculated in line with Article 570 of this Decision. (5) A credit institution shall treat long settlement transactions in accordance with paragraph (4) items 1) to 4) of this Article, as applicable. (6) A credit institution may reduce the exposure values referred to in paragraph (4) items 1) to 4) of this Article by the corresponding amount of general credit risk adjustments to on- and off-balance-sheet items. (7) Where general credit risk adjustments have reduced the Tier 1 capital, an exposure floor shall be defined, so that the exposure of the credit institution minus the amount of those adjustments, cannot be lower than zero. (8) By way of derogation from paragraph (4) item 4) of this Article, the following provisions shall apply:
  6. a derivative instrument that is considered an off-balance-sheet item in accordance with paragraph (4) item 4) of this Article but is treated as a derivative in accordance with the applicable accounting framework, shall be subject to the treatment set out in paragraph (4) item 2) of this Article;
  7. where a client of a credit institution acting as a clearing member enters directly into a derivative transaction with a central counterparty (CCP) and the credit institution guarantees the performance of its client's trade exposures to the

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 611 central counterparty arising from that transaction, the credit institution shall calculate its exposure resulting from the guarantee in accordance with paragraph (4) item 2) of this Article, as if it had entered directly into the transaction with the client, including with regard to the receipt or provision of cash variable margin. (9) The treatment set out in paragraph (8) item 2) of this Article shall also apply to a credit institution acting as a higher-level client that guarantees the performance of its client's trade exposures. (10) For the purposes of paragraph (8) item 2) and paragraph (9) of this Article, a credit institution may consider an affiliated entity as a client only where that entity is outside the regulatory scope of consolidation at which the requirement set out in Article 114 paragraph (4) item 5) of this Decision is applied. (11) For the purposes of paragraph (4) item 5) of this Article and Article 570 of this Decision, “regular-way purchase or sale” means a purchase or a sale of a financial assets under contracts for which the terms require delivery of the financial assets within the period established generally by law or convention in the marketplace concerned. (12) Unless otherwise expressly provided for in this Part of the Decision, a credit institution shall calculate the total exposure measure in accordance with the following principles:

  1. physical or financial collateral, guarantees or credit risk mitigation purchased shall not be used to reduce the total exposure measure;
  2. assets shall not be netted with liabilities. (13) By way of derogation from paragraph (12) item 2) of this Article, a credit institution may reduce the exposure value of a pre-financing loan or an intermediate loan by the positive balance on the savings account of the debtor to which the loan was granted and only include the resulting amount in the total exposure measure, provided that all the following conditions are met:
  3. the granting of the loan is conditional upon the opening of the savings account at the credit institution granting the loan and both the loan and the savings account are regulated by the same sectoral law;
  4. the balance on the savings account cannot be withdrawn, in part or in full, by the debtor for the entire duration of the loan;
  5. the credit institution can unconditionally and irrevocably use the balance on the savings account to settle any claim originating under the loan agreement in cases regulated by the sectoral law referred to in item 1) of this paragraph, including the case of non-payment by or the insolvency of the debtor. (14) For the purpose of paragraph (13) of this Article, “pre-financing loan” or “intermediate loan” means a loan that is granted to the borrower for a limited period of time in order to bridge the borrower's financing gaps until the final loan is granted in accordance with the criteria laid down in the sectoral law regulating such transactions.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 612 Exposures excluded from the total exposure measure Article 564 (1) By way of derogation from Article 563 paragraphs (4) to (7) of this Decision, a credit institution may exclude any of the following exposures from its total exposure measure:

  1. the amounts deducted from Common Equity Tier 1 items in accordance with Article 19 item 4) of this Decision;
  2. the amount of assets deducted from Tier 1 capital;
  3. exposures that are assigned a risk weight of 0% in accordance with Article 150 paragraphs (9) and (10) of this Decision;
  4. where the credit institution is a public development credit institution, the exposures arising from assets that constitute claims on the Government of Montenegro, local self-government units or public sector entities in relation to public sector investments and promotional loans;
  5. the credit institution’s exposures to its shareholders, provided that such exposures are collateralised to the level of at least 125% by assets referred to in Article 169 paragraph (1) items 5) and 6) of this Decision, and those assets are accounted for in the shareholders’ leverage ratio requirement, where the credit institution is not a public development credit institution but it meets the following conditions: ­ credit institution's shareholders are credit institutions and do not exercise control over the credit institution; ­ credit institution complies with requirements of paragraph (3) items 1), 2), 3), and 5), of this Article; ­ credit institution's exposures are located in Montenegro; ­ credit institution is subject to some form of oversight by the Government of Montenegro on an ongoing basis; ­ credit institution's business model is limited to the pass-through of the amount corresponding to the proceeds raised through the issuance of covered bonds to its shareholders, in the form of debt instruments;
  6. where the credit institution is not a public development credit institution, the parts of exposures arising from passing-through promotional loans to other credit institutions;
  7. the guaranteed parts of exposures arising from export credits that meet the following conditions: − the guarantee is provided by an eligible provider of unfunded credit protection in accordance with Article 239 of this Decision, including by export credit agencies or by central governments; and − a 0% risk weight applies to the guaranteed part of the exposure in accordance with Article 151 paragraph (2) or (4) or Article 153 paragraphs (5) and (6) of this Decision;
  8. where the credit institution is a clearing member of a qualifying central counterparty (QCCP), the trade exposures of that credit institution, provided that they are cleared with that qualifying central counterparty and meet the conditions set out in Article 393 paragraph (1) item 3) of this Decision;
  9. where the credit institution is a higher-level client within a multi-level client structure, the trade exposures to the clearing member or to an entity that serves as a higher-level client to that credit institution, provided that the conditions set out in Article 392 paragraph (2) of this Decision are met and provided that the credit institution is not obligated to reimburse its client for any losses suffered

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 613 in the event of default of either the clearing member or the qualifying central counterparty; 10)fiduciary assets which meet all the following conditions: − they are recognised on the credit institution's balance sheet in accordance with applicable accounting regulations; − they meet the criteria for non-recognition set out in IFRS 9, as applied in accordance with the regulations; − they meet the criteria for non-consolidation set out in IFRS 10, where applicable; 11) exposures that meet the following conditions: − they are exposures to public sector entities; − they are treated in accordance with Article 153 paragraphs (5) and (6) of this Decision; and − they arise from deposits that the credit institution is legally obliged to transfer to the public sector entity referred to in item 1) of this paragraph for the purpose of funding general interest investments; 12)the excess collateral deposited at a third-party agent that has not been lent out; 13)where under the applicable accounting framework a credit institution recognises the variable margin paid in cash to its counterparty as a receivable asset, the receivable asset, provided that the conditions set out in 566 paragraph (6) items 1) to 5) of this Decision are met; 14) the securitised exposures from traditional securitisations that meet the conditions for significant risk transfer set out in Article 280 paragraph (2) of this Decision; 15)the exposures to the Central Bank in the form of coins and banknotes in EUR currency and assets representing claims on the Central Bank, including reserves held at the Central Bank, after the exclusion has met the conditions set out in paragraphs (9) and (10) of this Article; 16)where the credit institution is licensed as central securities depository and to provide banking-type ancillary services referred to in Article 5 paragraph (1) items 1), 2), 4), 5), 6) indents 2 and 3 of the Law, its exposures due to the provision of banking-type ancillary services listed in Article 5 paragraph (1) item

  1. of the Law which are directly related to the core services performed by central securities depository or non-banking-type ancillary services that generate credit and liquidity risks, defined by the regulation governing the operations of central securities depositories; 17)where the credit institution in question is designated by the central securities depository to provide banking-type ancillary services referred to in Article 5 paragraph (1) items 1), 2), 4), 5), 6) intents 2 and 3 of the Law, its exposures due to the provision of banking-type ancillary services listed in Article 5 paragraph (1) item 1) of the Law which are directly related to the core or ancillary services performed by central securities depository authorised to perform core or ancillary services of a central securities depository.
  2. the exposures that are subject to the treatment set out in Article 75 paragraph (7) of this Decision. (2) For the purposes of paragraph (1) item 14) of this Article, a credit institution shall include any retained exposure in the total exposure measure.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 614 (3) For the purposes of paragraph (1) items 4) and 6) of this Article, a public development credit institution shall mean a credit institution that meets all the following conditions:

  1. it has been established by the Government of Montenegro, or local self￾government;
  2. its activity is limited to advancing specified objectives of financial, social or economic public policy in accordance with the laws and other regulations provisions, including articles of association, by which that credit institution is regulated as non-competitive;
  3. its goal is not to maximise profit or market share;
  4. subject to state aid regulations, the Government of Montenegro, or local self￾government has an obligation to protect the credit institution's viability or directly or indirectly guarantee at least 90% of the credit institution's own funds requirements, funding requirements or promotional loans granted;
  5. it does not take covered deposits as defined in the Deposit Insurance Law or deposits that may be classified as fixed term or savings deposits from consumers. (4) For the purposes of paragraph (3) item 2) of this Article, public policy objectives may include the provision of financing for promotional or development purposes to specified economic sectors or geographical areas. (5) For the purposes of paragraph (3) items 4) and 6) of this Article, and without prejudice to the state aid rules and the obligations of the state thereunder, the Central Bank may, upon request of a credit institution, treat an organisationally, structurally and financially independent and autonomous unit of that credit institution as a public development credit institution, provided that the unit fulfils all the conditions listed in paragraph (3) of this Article and that such treatment does not affect the effectiveness of the supervision of that credit institution. (6) The Central Bank shall annually review decision from paragraph (5) of this Article. (7) For the purposes of paragraph (1) items 4) and 6) and paragraph (3) item 4) of this Article, “promotional loan” means a loan granted by a public development credit institution or an entity set up by the Government of Montenegro or a local self￾government, directly or through an intermediate credit institution on a non-competitive, not-for-profit basis, in order to promote the public policy objectives of the Government of Montenegro or a local self-government. (8) A credit institution shall not exclude the trade exposures referred to in paragraph (1) items 8) and 89 of this Article, where the condition set out in Article 563 paragraph (10) of this Decision is not met. (9) A credit institution may exclude the exposures listed in paragraph (1) item 15) of this Article where the following conditions are met:
  6. the Central Bank has determined and publicly declared that exceptional circumstances exist that warrant the exclusion in order to facilitate the implementation of monetary policies;
  7. the exclusion is granted for a limited period of time not exceeding one year.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 615 3) the Central Bank has determined and publicly announced the date when the exceptional circumstances are deemed to have occurred, and that date shall be set at the end of a quarter. (10) The exposures to be excluded under paragraph (1) item 15) of this Article shall meet both of the following conditions:

  1. they are denominated in the same currency as the deposits deposited with the credit institution; and
  2. their average maturity does not significantly exceed the average maturity of the deposits deposited with the credit institution. (11) By way of derogation from Article 134 paragraph (2) of the Law, where a credit institution excludes the exposures referred to in paragraph (1) item 15) of this Article, it shall at all times satisfy the following adjusted leverage ratio requirement for the duration of the exclusion: = 3% ∙ 𝐿𝐿 𝐿𝐿 − 𝐶𝐶 where: = the adjusted leverage ratio; 𝐿𝐿 = the credit institution’s total exposure measure as calculated in accordance with Article 563 paragraphs (4) to (7) of this Decision, including the exposures excluded in accordance with paragraph (1) item 15) of this Article, on the date referred to in paragraph (9) item 3) of this Article; and 𝐶𝐶 = the daily average total value of the exposures to the Central Bank, calculated over the full reserve maintenance period immediately preceding the date referred to in paragraph (9) item
  3. of this Article, that is eligible to be excluded in accordance with paragraph (1) item 15) of this Article. Calculation of the exposure value of assets Article 565 (1) A credit institution shall calculate the exposure value of assets, excluding derivative contracts referred to in Article 148 paragraph (8) of this Decision, credit derivatives and the positions referred to in Article 568 of this Decision in accordance with the following principles:
  4. the exposure value of assets means an exposure value as defined in Article 148 paragraph (1) of this Decision;
  5. securities financing transactions shall not be netted. (2) A cash pooling arrangement offered by a credit institution does not violate the condition set out in Article 563 paragraph (12) item 2) of this Decision only where the arrangement meets both of the following conditions:
  6. the credit institution offering the cash pooling arrangement transfers the credit and debit balances of several individual accounts of entities of a group included

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 616 in the arrangement (“original accounts”) into a separate, single account and thereby sets the balances of the original accounts to zero; 2) the credit institution carries out the actions referred to in item 1) of this paragraph on a daily basis. (3) For the purposes of paragraphs (2) and (4) of this Article, cash pooling arrangement means an arrangement wherein the credit or debit balances of several individual accounts are combined for the purposes of cash or liquidity management. (4) By way of derogation from paragraph (2) of this Article, a cash pooling arrangement that does not meet the condition set out in item 2) of that paragraph, but meets the condition set out in item 1) of that paragraph, does not violate the condition set out in paragraph (12) item 2) of Article 563 of this Decision, provided that the arrangement meets all the following conditions:

  1. the credit institution has a legally enforceable right to set off the balances of the original accounts through the transfer into a single account at any point in time;
  2. there are no maturity mismatches between the balances of the original accounts;
  3. the credit institution charges or pays interest based on the combined balance of the original accounts; and
  4. the Central Bank considers that the frequency by which the balances of all original accounts are transferred is adequate for the purpose of including only the combined balance of the cash pooling arrangement in the total exposure measure. (5) By way of derogation from paragraph (1) item 2) of this Article, a credit institution may calculate the exposure value of cash receivable and cash payable under securities financing transactions with the same counterparty on a net basis only where all the following conditions are met:
  5. the transactions have the same explicit final settlement date;
  6. the right to set off the amount owed to the counterparty with the amount owed by the counterparty is legally enforceable in the normal course of business and in the event of default, insolvency and bankruptcy;
  7. the counterparties intend to settle on a net basis or to settle simultaneously, or the transactions are subject to a settlement mechanism that results in the functional equivalent of net settlement. (6) For the purposes of paragraph (5) item 3) of this Article, a credit institution may consider that a settlement mechanism results in the functional equivalent of net settlement only where, on the settlement date, the net result of the cash flows of the transactions under that mechanism is equal to the single net amount under net settlement and all the following conditions are met:
  8. the transactions are settled through the same settlement system or settlement systems using a common settlement infrastructure; and
  9. the settlement arrangements are supported by cash or intraday credit facilities intended to ensure that the settlement of the transactions will occur by the end of the business day;
  10. any issues arising from the securities legs of the securities financing transactions do not interfere with the completion of the net settlement of the cash receivables and payables.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 617 (7) The condition set out in paragraph (6) item 3) of this Article is met only where the failure of any securities financing transaction in the settlement mechanism may delay settlement of only the matching cash leg or may create an obligation to the settlement mechanism, supported by an associated credit facility. (8) Where there is a failure of the securities leg of a securities financing transaction in the settlement mechanism at the end of the window for settlement in the settlement mechanism, a credit institution shall split out this transaction and its matching cash leg from the netting set and treat them on a gross basis. Calculation of the exposure value of derivatives Article 566 (1) A credit institution shall calculate the exposure value of derivative contracts listed in Article 148 paragraph (8) of this Decision and of credit derivatives, on-balance and off-balance-sheet, in accordance with the method set out in Section 3, Subtitle 6, Title II, Part Three of this Decision. (2) When calculating the exposure value, a credit institution may take into account the effects of contracts for novation and other netting agreements in accordance with Article 382 of this Decision. (3) A credit institution shall not take into account cross-product netting, but may net within the product category as referred to in Article 345 item 27) indent 3 of this Decision and credit derivatives where they are subject to a contractual cross-product netting agreement as referred to in Article 382 paragraph (1) item 3) of this Decision. (4) A credit institution shall include in the total exposure measure sold options even where their exposure value can be set to zero in accordance with the treatment laid down in Article 349 paragraph (6) of this Decision. (5) Where the provision of collateral related to derivative contracts reduces the amount of assets under the applicable accounting framework, a credit institution shall reverse that reduction. (6) For the purposes of paragraphs (1) to (4) of this Article, a credit institution calculating the replacement cost of derivative contracts in accordance with Article 350 of this Decision may recognise only collateral received in cash from their counterparties as the variable margin referred to in Article 350 of this Decision, where the applicable accounting framework has not already recognised the variable margin as a reduction of the exposure value and where the following conditions are met:

  1. for trades not cleared through a qualifying central counterparty, the credit institution does not segregate from its assets the cash received from the counterparty;
  2. the variable margin is calculated and exchanged at least daily based on a mark￾to-market valuation of derivatives positions;
  3. the variable margin received is in a currency specified in the derivative contract, governing master netting agreement, credit support annex to the qualifying

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 618 master netting agreement or as defined by any netting agreement with a qualifying central counterparty; 4) the variable margin received is the full amount that would be necessary to extinguish the mark-to-market exposure of the derivative contract subject to the threshold and minimum transfer amounts that are applicable to the counterparty; and 5) the derivative contract and the variable margin between the credit institution and the counterparty to that contract are covered by a single netting agreement that the credit institution may treat as risk-mitigating factor in accordance with Article 382 of this Decision. (7) Where a credit institution provides cash collateral to a counterparty and that collateral meets the conditions set out in paragraph (6) items 1) to 5) of this Article, the credit institution shall consider that collateral as the variable margin posted with the counterparty and shall include it in the calculation of the replacement cost. (8) For the purposes of paragraph (6) item 2) of this Article, a credit institution shall be considered to have met the condition set out therein where the variable margin is exchanged on the morning of the trading day following the trading day on which the derivative contract was stipulated, provided that the exchange is based on the value of the contract at the end of the trading day on which the contract was stipulated. (9) For the purposes of paragraph (6) item 4) of this Article, where a margin dispute arises, a credit institution may recognise the amount of non-disputed collateral that has been exchanged. (10) For the purposes of paragraph (1) of this Article, a credit institution shall not include collateral received in the calculation of net independent collateral amount (NICA) as defined in Article 345 item 14) of this Decision. (11) By way of derogation from paragraphs (6) and (10) of this Article, a credit institution may recognise any collateral received in accordance with Section 3, Chapter 6, Title II, Part Three of this Decision, where all of the following conditions are met:

  1. the collateral is received from a client for a derivative contract cleared by the credit institution on behalf of that client;
  2. the contract referred to in item 1) of this paragraph is cleared through a qualifying central counterparty;
  3. where the collateral has been received in the form of initial margin, that collateral shall not be segregated from the assets of the credit institution. (12) For the purposes of paragraph (1) of this Article, a credit institution shall set the value of the multiplier used in the calculation of the potential future exposure in accordance with Article 355 paragraph (1) of this Decision to one, except in the case of derivative contracts with clients where those contracts are cleared by a qualifying central counterparty. (13) By way of derogation from paragraph (1) of this Article, a credit institution may use the method set out in Section 4 or 5, Subtitle 6, Title II, Part Three of this Decision to determine the exposure value of the following:

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 619

  1. derivative contracts listed in Article 148 paragraph (8) of this Decision and credit derivatives, where they also use that method for determining the exposure value of those contracts for the purposes of meeting the own funds requirements set out in Article 134 paragraph (2), items 1), 2), and 3) of the Law;
  2. credit derivatives to which they apply the treatment set out in Article 346 paragraphs (7) and (8) or paragraph (10), where the conditions to use that method are met. (14) Where a credit institution applies one of the methods referred to in paragraph (13) of this Article, it shall not reduce the total exposure measure by the amount of margin it has received. Additional provisions on the calculation of the exposure value of written credit derivatives Article 567 (1) For the purposes of this Article, a written credit derivative shall mean any financial instrument through which a credit institution effectively provides credit protection including credit default swaps (CDS), total return swaps (TRS) and options where the credit institution has the obligation to provide credit protection under conditions specified in the options contract. (2) In addition to the calculation laid down in Article 566 of this Decision, a credit institution shall include in the calculation of the exposure value of written credit derivatives the effective notional amounts referenced in the written credit derivatives reduced by any negative fair value changes that have been incorporated in Tier 1 capital with respect to those written credit derivatives. (3) A credit institution shall calculate the effective notional amount of written credit derivatives by adjusting the notional amount of those derivatives to reflect the true exposure of the contracts that are leveraged or otherwise enhanced by the structure of the transaction. (4) A credit institution may fully or partly reduce the exposure value calculated in accordance with paragraphs (2) and (3) of this Article by the effective notional amount of purchased credit derivatives, provided that the following conditions are met:
  3. the remaining maturity of the purchased credit derivative is equal to or greater than the remaining maturity of the written credit derivative;
  4. the purchased credit derivative is otherwise subject to the same or more conservative material terms as those in the corresponding written credit derivative;
  5. the purchased credit derivative is not purchased from a counterparty that would expose the credit institution to Specific Wrong-Way risk, as defined in Article 378 paragraph (2) of this Decision;
  6. where the effective notional amount of the written credit derivative is reduced by any negative change in fair value incorporated in the credit institution's Tier 1 capital, the effective notional amount of the purchased credit derivative is reduced by any positive fair value change that has been incorporated in Tier 1 capital; and

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 620 5) the purchased credit derivative is not included in a transaction that has been cleared by the credit institution on behalf of a client or that has been cleared by the credit institution in its role as a higher-level client in a multi-level client structure and for which the effective notional amount referenced by the corresponding written credit derivative is excluded from the total exposure measure in accordance with Article 546 paragraph (1) items 8) or 9) of this Decision, as applicable. (5) For the purpose of calculating the potential future exposure in accordance with Article 566 paragraph (1) of this Decision, a credit institution may exclude from the netting set the portion of a written credit derivative which is not offset in accordance with paragraph (4) of this Article and for which the effective notional amount is included in the total exposure measure. (6) For the purposes of paragraph (4) item (2) of this Article, “material term” means any characteristic of the credit derivative that is relevant to the valuation thereof, including the level of subordination, the optionality, the credit events, the underlying reference entity or pool of entities, and the underlying reference obligation or pool of obligations, with the exception of the notional amount and the residual maturity of the credit derivative, and wherein two reference names shall be the same only where they refer to the same legal entity. (7) By way of derogation from paragraph 4 item 2) of this Article, a credit institution may use purchased credit derivatives on a pool of reference names to offset written credit derivatives on individual reference names within that pool where the pool of reference entities and the level of subordination in both transactions are the same. (8) A credit institution shall not reduce the effective notional amount of written credit derivatives where it buys credit protection through a total return swap (TRS) and records the net payments received as net income, but does not record any offsetting deterioration in the value of the written credit derivative in Tier 1 capital. (9) In the case of purchased credit derivatives in a pool of reference obligations, a credit institution may reduce the effective notional amount of written credit derivatives on individual reference obligations by the effective notional amount of purchased credit derivatives in accordance with paragraph (4) of this Article only where the protection purchased is economically equivalent to buying protection separately on each of the individual obligations in the pool. Counterparty credit risk add-on for securities financing transactions Article 568 (1) In addition to the calculation of the exposure value of securities financing transactions (SFT), including those that are off-balance-sheet in accordance with Article 565 paragraph (1) of this Decision, a credit institution shall include in the total exposure measure an add-on for counterparty credit risk calculated in accordance with paragraphs (2) or (3) of this Article, as applicable. (2) A credit institution shall calculate the add-on for transactions with a counterparty that are not subject to a master netting agreement that meets the conditions set out in

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 621 Article 244 of this Decision on a transaction-by-transaction basis in accordance with the following formula: 𝑖𝑖 ∗ = 𝑚𝑚𝑚𝑚𝑚𝑚{0, 𝑖𝑖 − 𝐶𝐶𝑖𝑖} where: 𝑖𝑖 ∗ = the add-on that a credit institution may set at zero, where 𝑖𝑖 is the cash lent to a counterparty and the associated cash receivable is not eligible for the netting treatment set out in Article 565 paragraph (5) of this Decision; 𝑖𝑖 = the index that denotes the transaction; 𝑖𝑖 = the fair value of securities or cash lent to the counterparty under transaction 𝑖𝑖; 𝐶𝐶𝑖𝑖 = the fair value of securities or cash received from the counterparty under transaction 𝑖𝑖. (3) A credit institution shall calculate the add-on for transactions with a counterparty that are subject to a master netting agreement that meets the conditions set out in Article 244 of this Decision on an agreement-by-agreement basis in accordance with the following formula: 𝑖𝑖 ∗ = 𝑚𝑚𝑚𝑚𝑚𝑚 �0,� 𝑖𝑖 𝑖𝑖 − �𝐶𝐶𝑖𝑖 𝑖𝑖 � where: 𝑖𝑖 ∗ = the add-on; 𝑖𝑖 = the index that denotes the netting agreement; 𝑖𝑖 = the fair value of securities or cash lent to the counterparty for the transactions that are subject to master netting agreement 𝑖𝑖, and; 𝐶𝐶𝑖𝑖 = the fair value of securities or cash received from the counterparty that is subject to master netting agreement 𝑖𝑖. (4) For the purposes of paragraphs (2) and (3) of this Article, the term counterparty includes also third-party agents that receive collateral in deposit and manage the collateral in the case of transactions with a third party. (5) By way of derogation from paragraph (1) of this Article, a credit institution may use the method set out in Article 259 of this Decision, subject to a 20% floor for the applicable risk weight, to determine the add-on for securities financing transactions including those that are off-balance-sheet. (6) A credit institution may use the method referred to in paragraph (5) of this Decision only where it also uses it for calculating the exposure value of those transactions for

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 622 the purpose of meeting the capital requirements as set out in Article 134 paragraph (2) items 1), 2) and 3) of the Law. (7) Where sale accounting is achieved for a repurchase transaction under the applicable accounting framework, the credit institution shall reverse all sales-related accounting entries. (8) Where a credit institution acts as an agent between two parties in a securities financing transaction, including an off-balance-sheet transaction, the following provisions shall apply to the calculation of the credit institution's total exposure measure:

  1. where the credit institution provides a collateral or guarantee to one of the parties in the securities financing transaction (SFT) and the collateral or guarantee is limited to any difference between the value of the security or cash the party has lent and the value of collateral the borrower has provided, the credit institution shall only include the add-on calculated in accordance with paragraph (2) or (3) of this Article, as applicable, in the total exposure measure;
  2. where the credit institution does not provide a collateral or guarantee to any of the involved parties, the transaction shall not be included in the total exposure measure;
  3. where the credit institution is economically exposed to the underlying security or the cash in the transaction to an amount greater than the exposure covered by the add-on, it shall include in the total exposure measure also the full amount of the security or the cash to which it is exposed;
  4. where the credit institution acting as agent provides a collateral or guarantee to both parties involved in a securities financing transaction, the credit institution shall calculate its total exposure measure in accordance with items 1), 2) and
  5. of this paragraph separately for each party involved in the transaction. Calculation of the exposure value of off-balance-sheet Article 569 (1) A credit institution shall calculate, in accordance with Article 148 paragraph (2) of this Decision, the exposure value of off-balance-sheet items, excluding derivative contracts referred to in paragraph (8) of that Article, credit derivatives, securities financing transactions and positions referred to in Article 567 of this Decision. (2) Where a commitment refers to the extension of another commitment, Article 148 paragraph of this Decision shall apply. (3) By way of derogation from paragraph (1) of this Article, a credit institution may reduce the credit exposure equivalent amount of an off-balance-sheet item by the corresponding amount of specific credit risk adjustments, and the calculation shall be subject to a floor of zero. (4) By way of derogation from Article 573 of this Decision, a credit institution shall apply a conversion factor of 10% to off-balance-sheet items in the form of unconditionally cancellable commitments.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 623 Calculation of the exposure value of regular-way purchases and sales awaiting settlement Article 570 (1) A credit institution shall treat cash related to regular-way sales and financial assets related to regular-way purchases which remain on the balance sheet until the settlement date as assets, in accordance with Article 563 paragraph (4) item 1) of this Decision. (2) A credit institution that, in accordance with the accounting framework, applies trade date accounting to regular-way purchases and sales which are awaiting settlement shall reverse out any offsetting between cash receivables for regular-way sales awaiting settlement and cash payables for regular-way purchase awaiting settlement allowed under that framework, wherein after a credit institution has reversed out the accounting offsetting, it may offset between those cash receivables and cash payables where both the related regular-way sales and purchases are settled on a delivery￾versus-payment basis. (3) A credit institution that, in accordance with the accounting framework, applies settlement date accounting to regular-way purchases and sales which are awaiting settlement, shall include in the total exposure measure the full nominal value of commitments to pay related to regular-way purchases. (4) A credit institution may offset the full nominal value of the commitments to pay related to regular-way purchases by the full nominal value of cash receivables related to regular-way sales awaiting settlement only where both of the following conditions are met:

  1. both the regular-way purchases and sales are settled on a delivery-versus￾payment basis; and
  2. the financial assets bought and sold that are associated with cash payables and receivables are fair valued through profit and loss and included in the credit institution's trading book. TRANSITIONAL PROVISION AND FINAL PROVISIONS Transitional provision for deductions from Common Equity Tier 1 items Article 571 (1) By way of derogation from Article 19 item (14) of this Decision, a credit institution shall not calculate the applicable amount of insufficient coverage for non-performing exposures created before 1 January 2022. (2) By way of derogation from Article 19 item (17) of this Decision, a credit institution shall not calculate the amount of required provisions for estimated and potential losses for balance sheet and off-balance sheet items that are deemed to be non-performing assets, as established in accordance with the Central Bank’s regulation governing asset classification and calculation of provisions for potential loan losses of a credit institution where those exposures were created before 1 January 2022;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 624 (3) For the purposes of paragraphs (1) and (2) of this Article, the exposures created before 1 January 2022, the conditions of which were changed by the credit institution by increasing the exposure towards the debtor, shall be deemed to have been created as at the day such change in conditions started to apply. Transitional provision for the output floor Article 572 (1) By way of derogation from Article 114 paragraph (3) of this Decision, a credit institution may apply the following percentages x, where calculating TREA:

  1. 55% by the end of 2026;
  2. 60% in 2027;
  3. 65% in 2028;
  4. 70% in 2029. (2) By way of derogation from Article 114 paragraph (3) of this Decision, a credit institution may, until 31 December 2029, apply the following formula where calculating TREA: TREA = min{max {U − TREA; x ∙ S − TREA}; 125% ∙ U − TREA} (3) For the purposes of paragraph (2) of this Article, a credit institution shall take into account the applicable percentage x referred to in paragraph (1) of this Article. Transitional provision for unconditional cancellable commitments Article 573 By way of derogation from Article 148 paragraph (2) of this Decision, a credit institution shall calculate the exposure value of an off-balance-sheet item in the form of unconditionally cancellable commitment by multiplying the percentage provided for in that Article by the following factors:
  5. 0% by the end of 2029;
  6. 25% in 2030;
  7. 50% in 2031;
  8. 75% in 2032. Transitional provision for specialised lending exposures Article 574 By way of derogation from Article 160 paragraph (3) item 1) of this Decision, a credit institution may, until 31 December 2032, assign a risk weight of 80% to specialised lending exposures as referred to in that item for which a directly applicable credit assessment by a nominated ECAI is not available, where the additional weight referred to in Article 116 of this Decision is not applied, and where the credit institution deems the exposure to be of high quality taking into account the following criteria:
  9. the debtor can meet its financial obligations even under severely stressed conditions due to the presence of all of the following features: − adequate exposure-to-value of the exposure (ETV ratio); − conservative repayment profile of the exposure;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 625 − commensurate remaining lifetime of the assets upon full pay-out of the exposure or alternatively recourse to a protection provider with high creditworthiness; − low refinancing risk of the exposure by the debtor or that risk is adequately reduced by a commensurate residual asset value or recourse to a protection provider with high creditworthiness; − the debtor has contractual restrictions over its activity and funding structure; − the debtor uses derivatives only for risk-mitigation purposes; − material operating risks are properly managed; 2) the contractual provisions on the assets provide the lender with a high degree of protection, including the following features: − the lender has a legally enforceable first-ranking right over the assets financed and, where applicable, over the income that they generate; − there are contractual restrictions on the ability of the debtor to make changes to the asset which would have a negative impact on its value; − where the asset is under construction, the lender has a legally enforceable first-ranking right over the assets and the underlying construction contracts; 3) the assets being financed meet all of the following standards to operate in a sound and effective manner: − the technology and design of the asset are tested; − all necessary permits and authorisations for the operation of the assets have been obtained; − where the asset is under construction, the debtor has adequate safeguards on the agreed specifications, budget and completion date of the asset, including strong completion guarantees or the involvement of an experienced constructor and adequate contract provisions for liquidated damages. Transitional provision for equity exposures Article 575 (1) By way of derogation from the treatment laid down in Article 176 paragraph (5) of this Decision, equity exposures shall be assigned the higher of the risk weight that the credit institution has applied to these exposures up to the commencement of application of this Decision, capped at 250%, and the risk-weights referred to in items

  1. to 5) of this paragraph:
  2. 100% by the end of 2026;
  3. 130% in 2027;
  4. 160% in 2028;
  5. 190% in 2029;
  6. 220% in 2030. (2) By way of derogation from Article 176 paragraph (6) of this Decision, equity exposures shall be assigned the higher of the risk weight that the credit institution has applied to these exposures up to the commencement of application of this Decision, and the risk-weights referred to in items 1) to 5) of this paragraph:
  7. 100% by the end of 2026;
  8. 160% in 2027;
  9. 220% in 2028;
  10. 280% in 2029;

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 626 5) 340% in 2030. Transitional provision for property revaluation requirements Article 576 By way of derogation from Article 265 paragraph (1) items 1) to 4) of this Decision, for exposures secured by residential property or commercial immovable property granted before the commencement of application of this Decision, a credit institution may continue to value residential property or commercial immovable property at or less than the market value, until a review of the property value is required in accordance with Article 246 paragraphs (3) to (6) of this Decision, or 31 December 2028, whichever is earlier. Transitional provision for leasing exposures as a credit risk mitigation technique Article 577 By way of derogation from Article 266 of this Decision, for exposures referred to in Article 237 paragraph (11) of this Decision where the asset leased corresponds to the ‘other physical collateral’ type of funded credit protection, a credit institution may apply the value of Hc corresponding to that type of funded credit protection refrerred to in Table 1 of paragraph (3) of Article 266 multiplied by the following percentages:

  1. 50% by the end of 2027;
  2. 80% in 2028;
  3. 100% in 2029. Transitional provision for own funds requirement for residual risks Article 578 (1) By way of derogation from Article 434 paragraph (1) of this Decision, until 31 December 2032, a credit institution shall not apply the own funds requirement for residual risks to instruments that aim solely to hedge the market risk of positions in the trading book that generate an own funds requirement for residual risks and are subject to the same type of residual risks as the positions they hedge, where it is able to demonstrate at all times that the instruments meet the conditions to be treated as hedging positions. (2) A credit institution shall report to the Central Bank on the results of calculation of own funds requirement for residual risks for all instruments subject to the exemption referred to in paragraph (1) of this Article. Repealed regulation Article 579 As from the commencement date of the application of this Decision, the Decision on Capital Adequacy of Credit Institutions (OGM 128/20, 140/21, 144/22 and 52/24) shall be repealed.

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 627 Entry into force Article 580 This Decision shall enter into force on the eighth day following that of its publication in the Official Gazette of Montenegro, and it shall apply from 1 January 2026. THE COUNCIL OF THE CENTRAL BANK OF MONTENEGRO

CHAIRPERSON Decision number 0101-4491-3/2025 GOVERNOR Podgorica, 9 June 2025 Irena Radović, m.p.

[[unofficial translation] ANNEX 1 Assigning risk weights to specialised lending exposures

  1. Where the purpose of a specialised lending exposure is to finance the development or acquisition of large, complex and expensive installations, including in particular power plants, chemical processing plants, mines, transportation infrastructure, environment, and telecommunications infrastructure, and the income to be generated by the assets is the money generated by the contracts for the output of the installation obtained from one or several parties which are not under management control of the sponsor(‘project finance exposures’), a credit institution may apply the assessment criteria set out in Table 1 of this Annex.
  2. Where the purpose of a specialised lending exposure is to finance the development or acquisition of real estate, including in particular office buildings to let, retail space, multifamily residential buildings, industrial or warehouse space, hotels and land, and the income to be generated by the real estate is lease or rental payments or the proceeds from the sale of such real estate obtained from one or several third parties (‘real estate exposures’), a credit institution may apply the assessment criteria set out in Table 2 of this Annex to this class of exposures when assigning risk weights.
  3. Where the purpose of a specialised lending exposure is to finance the acquisition of physical assets, including in particular ships, aircraft, satellites, railcars, and fleets, and the income to be generated by those assets is lease or rental payments obtained from one or several third parties (‘object financing exposures’), a credit institution may apply the assessment criteria set out in Table 3 of this Annex to this class of exposures when assigning risk weights.
  4. Where the purpose of a specialised lending exposure is to finance reserves, inventories or receivables of exchange-traded commodities, including in particular crude oil, metals, or crops, and the income to be generated by those reserves, inventories or receivables is to be the proceeds from the sale of the commodity (‘commodities financing exposures’), a credit institution may apply the assessment criteria set out in Table 4 of this Annex to this class of exposures when assigning risk weights.
  5. A credit institution shall, on the basis of an overall assessment, attribute a category 1 to 4 to each factor set out in the Tables 1 to 4 of this Annex, which is applicable to the class of specialised lending exposures, taking into consideration the categories attributed to each applicable sub-factor, as well as the relative importance of each sub-factor for the type of specialised lending exposures.
  6. A credit institution shall assign a weight (in percentage) that is not lower than 5% and not higher than 60% to each factor having regard to its relative importance for the type of specialised lending exposures.

[[unofficial translation] 7. Where the weighted average is a decimal number, a credit institution shall round that number to the nearest cardinal number. 8. A credit institution shall further specify each sub-factor into sub-factor components, and it shall attribute a category to each sub-factor component on the basis of the assessment criteria set out for that sub-factor, as well as the relative importance of each sub-factor component for the type of specialised lending exposure. 9. Where the credit institution takes into account additional relevant information (an ‘additional risk driver’) in accordance with Article 211 paragraph (2) of this Decision for a type of specialised lending exposures, it shall consider it jointly with the sub￾factor, which most closely corresponds to that additional risk driver. 10.Where, exceptionally, a sub-factor or sub-factor component is not relevant for all exposures belonging to a certain type of specialised lending exposures, the credit institution may decide not to apply that sub-factor or sub-factor component for any of the specialised lending exposures belonging to that category. 11.Where a sub-factor or a sub-factor component has identical assessment criteria in two or more categories (‘overlapping criteria’), and the specialised lending exposure conforms to those overlapping criteria, the credit institution shall attribute a category to the sub-factor or sub-factor component as follows: − Where overlapping criteria occur in two categories, the credit institution shall attribute the higher of the two categories. − Where overlapping criteria occur in three categories, the credit institution shall attribute the category between the lowest and the highest of the three categories. 12.Where the debtor is in default in the meaning of Article 218 of this Decision, the credit institution shall assign a risk weight of category 5 as set out in Table 1 of Article 195 paragraph (7) of this Decision to the specialised lending exposure. 13.A credit institution shall document the following information for each type of specialised lending exposures for which they assign risk weights in accordance with this Annex: − the assignment of weights to each factor, and the justification for that assignment; − a description of additional risk drivers and a justification for taking them into account in accordance with item 9 of this Annex, where applicable; − the justification for deciding not to apply a certain sub-factor or sub-factor component in accordance with item 10 of this Annex, where applicable. 14.A credit institution shall document the following information for each specialised lending exposure for which they assign risk weights in accordance with this Annex: − the class of the specialised lending exposure assigned;

[[unofficial translation] − the category of Table 1 of paragraph (7) of Article 195 of this Decision to which the specialised lending exposure has been assigned; − the remaining maturity as referred to in Table 1 of paragraph (7) of Article 195 of this Decision; − the assessment of exposure that led to the assignment of the risk weight to the exposure.

[[unofficial translation] Table 1: Assessment criteria for project finance exposures Factors / sub-factors Category 1 Category 2 Category 3 Category 4 Factor: financial strength (a) Sub-factor: market conditions Few competing suppliers or substantial and durable advantage in location, cost, or technology. Demand is strong and growing. Few competing suppliers or better than average location, cost, or technology but this situation may not last. Demand is strong and stable. Project has no advantage in location, cost, or technology. Demand is adequate and stable. Project has worse than average location, cost, or technology. Demand is weak and declining. (b) Sub-factor: financial ratios (e.g., debt service coverage ratio (DSCR1), Interest Coverage Ratio (ICR2), loan life coverage ratio (LLCR3), and debt-to-equity ratio). Strong financial ratios considering the level of project risk; very robust economic assumptions. Strong to acceptable financial ratios considering the level of project risk; robust project economic assumptions. Standard financial ratios considering the level of project risk Aggressive financial ratios considering the level of project risk. 1 The Debt Service Coverage ratio (‘DSCR’) refers to the ratio of the cashflow available for debt service which can be generated from the asset to the required repayment of the principal and the interest payments during the life of the loan, where the cashflow available for debt service is calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project. 2 The Interest Coverage Ratio (‘ICR’) refers to the ratio of the cashflow available for debt service which can be generated from the asset to the required repayment of the interest payments during the life of the loan, where the cashflow available for debt service is calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project. 3 The Loan Life Coverage Ratio (‘LLCR’) refers to the ratio of the net present value of the cashflow available for debt service to the outstanding debt balance, and refers to the number of times the cashflow available for debt service which can be generated from the asset can repay the outstanding debt balance over the scheduled life of the loan, where the cashflow available for debt service calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project..

[[unofficial translation] (c) Sub-factor: stress analysis on the basis of the income being generated during the tenor of the loan4 The project can meet its financial obligations under sustained, severely stressed economic or sectoral conditions. The project can meet its financial obligations under normal stressed economic or sectoral conditions. The project is only likely to default under severe economic conditions. The project is vulnerable to stresses that are not uncommon through an economic cycle, and may default in an economic downturn. The project is likely to default unless conditions improve soon. (d) Sub-factor: financial structure • Amortisation schedule (sub- factor component) Amortising debt without bullet repayment Amortising debt with no or insignificant bullet repayment Amortising debt repayments with limited bullet payment Bullet repayment or amortising debt repayments with high bullet repayment • Market/cycle and refinancing risk (sub-factor component) There is no or very limited exposure to market or cycle risk since the expected cashflows cover all future loan repayments during the tenor of the loan and there are no significant delays between the cashflows and the loan repayments. There is no or very low refinancing risk. The exposure to market or cycle risk is limited since the expected cashflows cover the majority of future loan repayments during the tenor of the loan and there are no significant delays between the cashflows and the loan repayments. There is low refinancing risk. There is moderate exposure to market or cycle risk since the expected cashflows cover only a part of future loan repayments during the tenor of the loan or there are some significant delays between the cashflows and the loan repayments There is significant exposure to market or cycle risk since the expected cashflows cover only a small part of future loan repayments during the tenor of the loan or there are some significant delays between the cashflows and the loan repayments. High refinancing risk. Average refinancing risk. High refinancing risk. (e) Sub-factor: foreign exchange risk 4 The tenor of a loan refers to the amount of time left for the repayment of a loan.

[[unofficial translation]

There is no foreign exchange risk because there is no difference in the currency of the loan and the income of the project or because the foreign exchange risk is fully hedged. There is no foreign exchange risk because there is no difference in the currency of the loan and the income of the project or because the foreign exchange risk is fully hedged. There is a difference in the currency of the loan and the income of the project, but the foreign exchange risk is considered low because the exchange rate is stable or because the foreign exchange risk is hedged to a large extent. There is a difference in the currency of the loan and the income of the project, and the foreign exchange risk is considered high because the exchange rate is volatile and the foreign exchange risk is not hedged to a large extent. Factor: political and legislative environment (a) Sub-factor: political risk, including transfer risk, considering project type and risk reduction mechanisms Very low exposure; strong reduction instruments, if needed Low exposure; satisfactory reduction instruments, if needed Moderate exposure; fair mitigants High exposure; no or weak reduction instruments (b) Sub-factor: force majeure risk (war, civil unrest, etc.) No or very low exposure to force majeure risk’ Limited exposure to force majeure risk Significant exposure to force majeure risk which is not sufficiently reduced Significant exposure to force majeure risk which is not reduced (c) Sub-factor: government support and project’s importance for the country over the long term Project of strategic importance for the country (preferably export￾oriented). Strong support from Government. Project considered important for the country. Good level of support from Government. Project may not be strategic but brings unquestionable benefits for the country. Support from Government may not be explicit. Project not key to the country. No or weak support from Government (d) Sub-factor: stability of legal and regulatory environment (risk of change in the regulations) Favourable and stable regulatory environment over the long term Favourable and stable regulatory environment over the medium term Regulatory changes can be predicted with a fair level of certainty Current or future regulatory issues may affect the project (e) Sub-factor: acquisition of all necessary supports and approvals for such relief from local content laws Strong Satisfactory Fair Weak

[[unofficial translation] (f) Sub-factor: enforceability of contracts, collateral and security Contracts, collateral and security are enforceable. Contracts, collateral and security are enforceable. Contracts, collateral and security are considered enforceable even if certain non-key issues may exist. There are unresolved key issues in respect if actual enforcement of contracts, collateral and security. Factor: transaction characteristics (a) Sub-factor: design and technology risk Fully proven technology and design Fully proven technology and design Proven technology and design – start-up issues are compensated for by a strong completion package Unproven technology and design; technology issues exist and/or complex design. (b) Sub-factor: construction risk • Permitting and siting (sub-factor component) All permits have been obtained Some permits are still outstanding but their receipt is considered very likely Some permits are still outstanding but the permitting process is well defined and they are considered routine. Key permits still need to be obtained and are not considered routine. Significant conditions may be attached. • Type of construction contract (sub-factor component) Fixed-price date-certain turnkey construction EPC5 (engineering and procurement contract) Fixed-price date-certain turnkey construction EPC Fixed-price date-certain turnkey construction contract with one or several contractors No or partial fixed￾price turnkey contract and/or interfacing issues with multiple contractors • Likelihood to finish the project at the agreed time and cost (sub-factor component) It is almost certain that the project will be finished within the agreed time horizon and at the agreed cost. It is very likely that the project will be finished within the agreed time horizon and at the agreed cost. It is uncertain whether the project will be finished within the agreed time horizon and at the agreed cost. There are indications that the project will not be finished within the agreed time horizon 5 An Engineering and Procurement Contract (‘EPC’) or ‘turnkey contract’ refers to an agreement between the engineering and procurement contractor (‘EPC contractor) and the developer, wherein the EPC contractor agrees to develop the detailed engineering design of the project, procure all the equipment and materials necessary, construct and deliver a functioning facility or asset to the developer, usually within an agreed time and budget.

[[unofficial translation] and at the agreed cost. • Completion guarantees6 or liquidated damages7 (sub- factor component) Substantial liquidated damages supported by financial substance and/or strong completion guarantee from sponsors with excellent financial standing Significant liquidated damages supported by financial substance and/or completion guarantee from sponsors with good financial standing Adequate liquidated damages supported by financial substance and/or completion guarantee from sponsors with good financial standing Inadequate liquidated damages or not supported by financial substance or weak completion guarantees • Track record and financial strength of contractor in constructing similar projects (sub- factor component) Strong Good Satisfactory Weak (c) Sub-factor: operating risk • Scope, nature and complexity of operations and maintenance contracts (sub-factor component) Strong long-term operations and maintenance contract8, preferably with contractual performance incentives9, and/or operations and maintenance reserve The operations and maintenance activities are relatively straightforward and transparent, and there is a long-term operations and maintenance contract, and/or operations and maintenance reserve account. The operations and maintenance activities are complex and an operations and maintenance contract is necessary. There is a limited long-term operations and maintenance contract and/or reserve account. The operations and maintenance activities are complex and an operations and maintenance contract is strictly necessary. There is no operations and maintenance contract. There is therefore the risk of 6 A completion guarantee refers to a guarantee provided by the contractor to the project’s lenders to undertake to deliver the project within the specified timeframe, and to pay for the cost overruns, if any. 7 A liquidated damage refers to a monetary compensation for a loss, detriment or injury to a person’s rights or property, awarded by a court judgment or by a contract stipulation regarding breach of contract. 8 An Operation and Maintenance contract refers to a contract between the developer and the operator. The developer delegates the operation, maintenance and often performance management of the project to an operator with expertise in the industry under the terms of the O&M contract (i.e. scope, term, operator responsibility, fees, and liquidated damages). 9 Performance incentives or performance based contracting refer to strategic performance metrics which directly relate contracting payment to these performance metrics. Performance metrics may measure availability, reliability, maintainability, supportability.

[[unofficial translation] accounts10, although an operations and maintenance contract is not strictly necessary to perform the required maintenance because the operations and maintenance activities are straightforward and transparent. high operational cost overruns beyond risk reduction mechanisms. • Operator’s expertise, track record, and financial strength (sub-factor component) Very strong, or committed technical assistance of the sponsors Strong Acceptable Limited/weak, or local operator dependent on local authorities (d) Sub-factor: revenue assessment, including off-take risk11 • What is the robustness of the revenue contracts (e.g., off-take contracts12,concession agreements, public private partnership income stream, and other revenue contracts)? What is the quality of the termination clauses13? (sub-factor component) Excellent robustness of the revenues Good robustness of the revenues Acceptable robustness of the revenues The revenues of the project are not certain and there are indications that some of the revenues may not be obtained. 10 An operation and maintenance reserve account refers to a fund into which money is deposited to be used for the purpose of meeting the costs of operation and maintenance of the project. 11 Off-take risk refers to the risk that the demand for the output or service does not exist at the price at which it is provided or the off-taker is unable or refuses to honour his commitment to purchase the output or service.. 12 An off-take contract refers to a contract between a producer of a resource/product/service and a buyer (‘off-taker’) of a resource to purchase/sell portions of the producer’s future production. An off-take contract is normally negotiated prior to the construction of a facility in order to secure a market for the future output of the facility. The purpose is to provide the producer with stable and sufficient revenue to pay its debt obligation, cover the operating costs and provide certain required return. 13 A termination clause refers to a provision in a contract which allows for its termination under specified circumstances.

[[unofficial translation] • If there is a take-or-pay14 or fixed￾price off-take contract (sub-factor component) Excellent creditworthiness of off- taker; strong termination clauses; tenor of contract comfortably exceeds the maturity of the debt. Good creditworthiness of off￾taker; strong termination clauses; tenor of contract exceeds the maturity of the debt. Acceptable financial standing of off- taker; normal termination clauses; tenor of contract generally matches the maturity of the debt. Weak off-taker; weak termination clauses; tenor of contract does not exceed the maturity of the debt. • If there is no take-or-pay or fixed￾price off-take contract (sub-factor component) Project produces essential services or a commodity sold widely on a world market; output can readily be absorbed at projected prices even at lower than historic market. growth rates. Project produces essential services or a commodity sold widely on a regional market that will absorb it at projected prices at historical growth rates. Commodity is sold on a limited market that may absorb it only at lower than projected prices. Project output is demanded by only one or a few buyers or is not generally sold on an organised market. (e) Sub-factor: supply risk • Price, volume and transportation risk of feed-stocks; supplier’s track record and financial strength (sub￾factor component) Long-term supply contract with supplier of excellent financial standing. Long-term supply contract with supplier of good financial standing. Long-term supply contract with supplier of good financial standing – a degree of price risk may remain. Short-term supply contract or long￾term supply contract with financially weak supplier – a degree of price risk definitely remains. • Reserve risks15 (e.g., natural resource development) (sub- factor component) Independently audited, proven and developed reserves well in excess of requirements over lifetime of the project. Independently audited, proven and developed reserves in excess of requirements over lifetime of the project. Proven reserves can supply the project adequately through the maturity of the debt. Project relies to some extent on potential and undeveloped reserves. Factor: strength of sponsor (including any public private partnership) (a) Sub-factor: financial strength of the sponsor Strong sponsor with high financial standing Good sponsor with good financial standing Sponsor with adequate financial standing Weak sponsor with clear financial weaknesses 14 A take-or-pay contract refers to a contract in which it is agreed that a client buys the output or service from the supplier or the client pays the supplier a penalty. Both the price and the penalty are fixed in the contract. 15 Reserve risk refers to the risk that the accessible reserves are smaller than estimated.

[[unofficial translation] (b) Sub-factor: track record of the sponsor and its country/sector experience Sponsor with excellent track record and country/sector experience Sponsor with satisfactory track record and country/sector experience Sponsor with adequate track record and country/sector experience Sponsor with no or questionable track record or country/sector experience (c) Sub-factor: sponsor support, as evidenced by equity, ownership clause16 and incentive to inject additional cash if necessary Strong. Project is highly strategic for the sponsor (core business – long- term strategy). Good. Project is strategic for the sponsor (core business – long-term strategy). Acceptable. Project is considered important for the sponsor (core business). Limited. Project is not key to sponsor’s long-term strategy or core business. Factor: security package (a) Sub-factor: assignment of contracts and accounts Fully comprehensive Comprehensive Acceptable Weak (b) Sub-factor: pledge of assets, taking into account quality, value and liquidity of assets First perfected security interest17 in all project assets, contracts, permits and accounts necessary to run the project Perfected security interest in all project assets, contracts, permits and accounts necessary to run the project Acceptable security interest in all project assets, contracts, permits and accounts necessary to run the project Little security or collateral for lenders; weak negative pledge clause18 (c) Sub-factor: lender’s control over cash flow (e.g., cash sweeps 19, independent escrow accounts20) Strong Satisfactory Fair Weak (d) Sub-factor: strength of the covenant package (mandatory Covenant package is strong for this type of project. Covenant package is satisfactory for this type of project. Covenant package is fair for this type of project. Covenant package is Insufficient for this type of project. 16 An ownership clause refers to a provision that states that a project cannot be owned by a different entity than the actual owner (sponsor). 17 First perfected security interest refers to a security interest in an asset (mortgaged as a collateral) protected from claims by other parties. A lien is perfected by registering it with appropriate statutory authority so that it is made legally enforceable and any subsequent claim on that asset is given a junior status. 18 A negative pledge clause refers to a provision that indicates that the institution will not pledge any of its assets if doing so gives the lenders less security. 19 A cash sweep refers to the mandatory use of excess free cash flows to pay down outstanding debt rather than distribute it to shareholders. 20 An independent escrow account refers to an account held in the sponsor’s name by a bank under the support of an escrow account agreement between the lender and borrower providing for irrevocable instructions from the borrower to the effect that all operational revenue or proceeds from sale of assets of the project will be paid into this account, and where the bank is authorised to make payments from available funds only as agreed in the project financing documents.

[[unofficial translation] prepayments21, payment deferrals22, payment cascade23, dividend restrictions24 …) (e) Sub-factor: reserve funds (debt service, operations and management, renewal and replacement, unforeseen events, etc.) Project may issue no additional debt. Project may issue extremely limited additional debt. Project may issue limited additional debt. Project may issue unlimited additional debt. Longer than average coverage period, all reserve funds fully funded in cash or letters of credit from highly rated bank Average coverage period, all reserve funds fully funded Average coverage period, all reserve funds fully funded Shorter than average coverage period, reserve funds funded from operating cash flows 21 A mandatory prepayment refers to a provision that requires the borrower to prepay a portion of the debt with certain proceeds if and when received before the maturity date. 22 A payment deferral refers to a provision that indicates that the borrower is allowed to start making payments at some specified time in the future. 23 A payment cascade refers to a provision wherein the project’s cash flows are summarised using a cash flow waterfall, which shows the priority of each cash inflow and outflow. 24 A dividend restriction refers to a provision that defines the circumstances in which the lender is able to prevent equity distributions.

[[unofficial translation]

[[unofficial translation] Table 2. Assessment criteria for real estate exposures Factors / sub-factors Category 1 Category 2 Category 3 Category 4 Factor: financial strength (a) Sub-factor: market conditions The supply and demand for the project’s type and location are currently in equilibrium. The number of competitive properties coming to market is equal or lower than forecasted demand. The supply and demand for the project’s type and location are currently in equilibrium. The number of competitive properties coming to market is roughly equal to forecasted demand. Market conditions are roughly in equilibrium. Competitive properties are coming on the market and others are in the planning stages. The design and capabilities of existing comparable properties are not state of the art as compared to new projects. Market conditions are weak. It is uncertain when conditions will improve and return to equilibrium. Comparable properties in the market are losing tenants at lease expiration. New lease terms of comparable properties are less favourable compared to those existing.

[[unofficial translation] (b) Sub-factor: financial ratios, i.e., Indicators of the borrower’s ability to repay The property’s financial ratios, measured by the property’s debt service coverage ratio (DSCR25) or interest coverage ratio (ICR26), are considered strong and are expected to remain strong taking into account the past evolution in financial ratios. DSCR or ICR is not relevant and should not be calculated for properties that are in the construction phase. The property’s financial ratios, measured by the property’s DSCR or ICR, are considered good and are expected to remain good taking into account the past evolution in financial ratios. The DSCR or ICR is not relevant and should not be calculated for properties that are in the construction phase. The property’s financial ratios measured by the property’s DSCR or ICR are satisfactory and are expected to remain satisfactory taking into account the past evolution in financial ratios. The DSCR or ICR is not relevant and should not be calculated for properties that are in the construction phase. The property’s financial ratios, measured by the property’s DSCR or ICR are weak and are expected to remain weak taking into account the past evolution in financial ratios. The DSCR or ICR is not relevant and should not be calculated for properties that are in the construction phase. (c) Sub-factor: advance ratio, i.e., the loan-to-value (LTV27) ratio as an indicators of the borrower’s willingness to repay The property’s loan to value ratio (LTV) is considered low given its property type. Where a secondary market exists, the transaction is underwritten to market standards. The property’s LTV is considered satisfactory given its property type. Where a secondary market exists, the transaction is underwritten to market standards. The property’s LTV is considered relatively high given its property type. The property’s LTV ratio is well above underwriting standards for new loans. 25 The Debt Service Coverage ratio (‘DSCR’) refers to the ratio of the cashflow available for debt service which can be generated from the asset to the required repayment of the principal and the interest payments during the life of the loan, where the cashflow available for debt service is calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project. 26 The Interest Coverage Ratio (‘ICR’) refers to the ratio of the cashflow available for debt service which can be generated from the asset to the required repayment of the interest payments during the life of the loan, where the cashflow available for debt service is calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project. 27 The Loan-to-Value ratio (‘LTV’) refers to the ratio of the loan amount to the value of the pledged assets.

[[unofficial translation] (d) Sub-factor: stress analysis on the basis of the income being generated during the tenor of the loan28 The property’s resources, contingencies and liability structure allow it to meet its financial obligations during a period of severe financial stress (e.g. interest rates, economic growth). The property can meet its financial obligations under a sustained period of financial stress (e.g. interest rates, economic growth). The property is likely to default only under severe economic conditions. During an economic downturn, the property would suffer a decline in revenue that significantly increase the risk of default. The property’s financial condition is strained and is likely to default unless conditions improve in the near term. (e) Sub-factor: cash-flow predictability 28 The tenor of a loan refers to the amount of time left for the repayment of a loan.

[[unofficial translation] • For complete and stabilised property (sub-factor component) The property’s leases are long-term with creditworthy tenants and their maturity dates are scattered, or a public private partnership guarantees a considerable part of the tenancy contracts. The majority of the property has several tenant lease contracts that are long-term, and with tenants that have on average a high creditworthiness, and with scattered maturity dates. A public private partnership may guarantee part of the tenancy contracts. Where the property has only one lease contract or one tenant has a very significant share in the income generated by the property, this tenant is of excellent creditworthiness and the contract includes covenants that ensure lease payments until the end of the project life or beyond. The property experiences a normal level of tenant turnover upon lease expiration. Its vacancy rate is low. Expenses are predictable. Most of the property’s leases are medium rather than long-term with tenants that range in creditworthiness. A public private partnership may guarantee only a minor part of the tenancy contracts. Where the property has only one lease contract or one tenant has a very significant share in the income generated by the property, this one tenant, the contract includes covenants that ensure lease payments until the end of the project life or beyond but the tenant has moderate creditworthiness. The proportion of short-term leases is significant with tenants that range in creditworthiness, or the property has only one lease contract, or one tenant has a very significant share in the income generated by the property, where that tenant has a low creditworthiness and/or the contract does not include the necessary covenants that ensure lease payments until the end of the project life or beyond.

[[unofficial translation] The property has a track record of tenant retention upon lease expiration. Its vacancy rate is low. Expenses (maintenance, insurance, security, and property taxes) are predictable. The property experiences a moderate level of tenant turnover upon lease expiration. Its vacancy rate is moderate. Expenses are relatively predictable but vary in relation to revenue. The property experiences a very high level of tenant turnover upon lease expiration. Its vacancy rate is high. Significant expenses are incurred preparing space for new tenants. • For complete but not stabilised property (sub-factor component) The cashflows obtained from the leasing activity, for instance obtained from a public private partnership, meet or exceed the expected cashflows used in the valuation of the property. The project should achieve stabilisation in the near future. The cashflows obtained from the leasing activity, for instance obtained from a public private partnership, meet or exceed the expected cashflows used in the valuation of the property. The project should achieve stabilisation in the near future. The cashflows obtained from the leasing activity, for instance obtained from a public private partnership, meet or exceed the expected cashflows used in the valuation of the property. The project should achieve stabilisation in the near future. The cashflows obtained from the leasing activity, for instance obtained from a public private partnership, meet or exceed the expected cashflows used in the valuation of the property. The project should achieve stabilisation in the near future.

[[unofficial translation] • For construction phase (sub- factor component) The property is entirely preleased through the tenor of the loan29 or pre-sold to a tenant or buyer of high creditworthiness, or the bank has a binding commitment for take￾out financing from a tenant or buyer of high creditworthiness, for instance through a public private partnership. The property is entirely pre-leased or pre-sold to a creditworthy tenant or buyer, or the bank has a binding commitment for permanent financing from a creditworthy lender, for instance through a public private partnership. Leasing activity is within projections but the building may not be pre- leased and there may not exist a take- out financing. The bank may be the permanent lender. The property is deteriorating due to cost overruns, market deterioration, tenant cancellations or other factors. There may be a dispute with the party providing the permanent financing Factor: political and legal environment (a) Sub-factor: legal and regulatory risks Jurisdiction is very favourable to repossession and enforcement of contracts. Jurisdiction is generally favourable to repossession and enforcement of contracts. Jurisdiction is generally favourable to repossession and enforcement of contracts, but repossession might be long and/or difficult. Poor or unstable legal and regulatory environment. Jurisdiction may make repossession and enforcement of contracts lengthy or impossible. (b) Sub-factor: political risk, including transfer risk, considering property type and mitigants Very low exposure; strong risk reduction instruments, if needed Low exposure; satisfactory risk reduction instruments, if needed Moderate exposure; fair risk reduction mechanisms High exposure; no or weak risk reduction instruments Factor: asset/transaction characteristics (a) Sub-factor: location Property is located in highly desirable location that is convenient to services that tenants desire. Property is located in desirable location that is convenient to services that tenants desire. The property location lacks a competitive advantage. The property is located in an undesirable location. 29Lenders in some markets exclusively use loan structures that include junior liens. Junior liens may be indicative of this level of risk if the total LTV inclusive of all senior positions does not exceed a typical first loan LTV.

[[unofficial translation] (b) Sub-factor: design and condition Property is favoured due to its design, configuration, and maintenance, and is highly competitive with new properties. Property is appropriate in terms of its design, configuration and maintenance. The property’s design and capabilities are competitive with new properties. Property is adequate in terms of its configuration, design and maintenance. The property’s configuration, design and maintenance have contributed to the property’s difficulties. Weaknesses exist in the property’s configuration, design or maintenance. (c) Sub-factor: property is under construction Construction budget is conservative and technical hazards are limited. Contractors are highly qualified and have high credit standing. Construction budget is conservative and technical hazards are limited. Contractors are highly qualified and have good credit standing. Construction budget is adequate and contractors are ordinarily qualified and have average credit standing. Project is over budget or unrealistic given its technical hazards. Contractors may be under qualified and have low credit standing. (d) Sub-factor: financial structure: • Amortisation schedule (sub- factor component) Amortising debt without bullet repayment Amortising debt with no or insignificant bullet repayment Amortising debt repayments with limited bullet payment Bullet repayment or amortising debt repayments with high bullet repayment • Market/cycle and refinancing risk (sub￾factor component) There is no or very limited exposure to market or cycle risk since the expected cashflows cover all future loan repayments during the tenor of the loan and there are no significant delays between the cashflows and the loan repayments. There is no or very low refinancing risk. The exposure to market or cycle risk is limited since the expected cashflows cover the majority of future loan repayments during the tenor of the loan and there are no significant delays between the cashflows and the loan repayments. There is low refinancing risk. There is moderate exposure to market or cycle risk since the expected cashflows cover only a part of future loan repayments during the tenor of the loan or there are some significant delays between the cashflows and the loan repayments. There is significant exposure to market or cycle risk since the expected cashflows cover only a small part of future loan repayments during the tenor of the loan or there are some significant delays between the cashflows and the loan repayments.

[[unofficial translation] Average refinancing risk. High refinancing risk. Factor: strength of sponsor/ developer (including any public private partnership) (a) Sub-factor: financial capacity and willingness to support the property. The sponsor/developer made a substantial cash contribution to the construction or purchase of the property. The sponsor/developer has substantial resources and limited direct and contingent liabilities. The sponsor/developer’s properties are diversified geographically and by property type. The sponsor/developer made a material cash contribution to the construction or purchase of the property. The sponsor/developer’s financial condition allows it to support the property in the event of a cash flow shortfall. The sponsor/ developer’s properties are located in several geographic regions. The sponsor/developer’s contribution may be immaterial or non￾cash. The sponsor/developer is average to below average in financial resources. The sponsor/developer lacks capacity or willingness to support the property. (b) Sub-factor: reputation and track record with similar properties. Experienced management and high sponsors’ quality; strong reputation and lengthy and successful record with similar properties Appropriate management and sponsors’ quality. The sponsor or management has a successful record with similar properties. Moderate management and sponsors’ quality. Management or sponsor track record does not raise serious concerns. Ineffective management and substandard sponsors’ quality. Management and sponsor difficulties have contributed to difficulties in managing properties in the past. (c) Sub-factor: relationships with relevant real estate actors Strong relationships with leading actors such as leasing agents Proven relationships with leading actors such as leasing agents Adequate relationships with leasing agents and other parties providing important real estate services Poor relationships with leasing agents and/or other parties providing important real estate services Factor: security package

[[unofficial translation] (a) Sub-factor: nature of lien Perfected first lien30 Perfected first lien Perfected first lien Ability of lender to foreclose is constrained. (b) Sub-factor: assignment of rents The lender has obtained an assignment for the majority of the rents. They maintain current tenant information that would facilitate providing notice to remit rents directly to the lender, such as a current rent roll and copies of the project’s leases. The lender has obtained an assignment for a significant part of the rents. They maintain current tenant information that would facilitate providing notice to the tenants to remit rents directly to the lender, such as current rent roll and copies of the project’s leases. The lender has obtained an assignment for a relatively small part of the rent. The lender has not maintained current tenant information that would facilitate providing notice to the tenants to remit rents directly to the lender, such as current rent roll and copies of the project’s leases. The lender has not obtained an assignment of the leases. (c) Sub-factor: quality of the insurance coverage Very good quality Good quality Appropriate quality Substandard quality 30 The Interest Coverage Ratio (‘ICR’) refers to the ratio of the cashflow available for debt service which can be generated from the asset to the required repayment of the interest payments during the life of the loan, where the cashflow available for debt service is calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project.

[[unofficial translation] Table 3. Assessment criteria for object finance exposures Factors / sub-factors Category 1 Category 2 Category 3 Category 4 Factor: financial strength (a) Sub-factor: market conditions Demand is strong and growing, strong entry barriers, low sensitivity to changes in technology and economic outlook. Demand is strong and stable. Some entry barriers, some sensitivity to changes in technology and economic outlook. Demand is adequate and stable, limited entry barriers, significant sensitivity to changes in technology and economic outlook. Demand is weak and declining, vulnerable to changes in technology and economic outlook, highly uncertain environment. (b) Sub-factor: financial ratios, i.e., DSCR31 or ICR32 Strong financial ratios considering the type of asset. Very robust economic assumptions. Strong/acceptable financial ratios considering the type of asset. Robust project economic assumptions. Standard financial ratios for the asset type Aggressive financial ratios considering the type of asset (c) Sub-factor: advance ratio, i.e., loan-to-value (LTV33) ratio Strong LTV ratio considering the type of asset Strong/good LTV ratio considering the type of asset Standard LTV ratio for the asset type Aggressive LTV ratio considering the type of asset (d) Sub-factor: stress analysis on the basis of the income being generated during the tenor of the loan34 Stable long-term revenues, capable of withstanding severely stressed conditions through an economic cycle Satisfactory short-term revenues. Loan can withstand some financial adversity. Default is only likely under severe economic conditions Uncertain short-term revenues. Cash flows are vulnerable to stresses that are not uncommon through an economic cycle. The loan may default in an economic downturn Revenues subject to strong uncertainties; even in normal economic conditions the asset may default, unless conditions improve 31 The Debt Service Coverage ratio (‘DSCR’) refers to the ratio of the cashflow available for debt service which can be generated from the asset to the required repayment of the principal and the interest payments during the life of the loan, where the cashflow available for debt service shall be calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project. 32 The Interest Coverage Ratio (‘ICR’) refers to the ratio of the cashflow available for debt service which can be generated from the asset to the required repayment of the interest payments during the life of the loan, where the cashflow available for debt service shall be calculated by subtracting operating expenditure, capital expenditure, debt and equity funding, taxes and working capital adjustments from the revenues generated by the project. 33 The Loan-to-Value ratio (‘LTV’) refers to the ratio of the loan amount to the value of the pledged assets. 34 The tenor of a loan refers to the amount of time left for the repayment of a loan.

[[unofficial translation] (e) Sub-factor: market liquidity Market is structured on a worldwide basis; assets are highly liquid. Market is worldwide or regional; assets are relatively liquid. Market is regional with limited prospects in the short term, implying lower liquidity. Local market and/or poor visibility. Low or no liquidity, particularly on niche markets. Factor: political and legislative environment (a) Sub-factor: legal and regulatory risks Jurisdiction is favourable to repossession and enforcement of contracts. Jurisdiction is favourable to repossession and enforcement of contracts. Jurisdiction is generally favourable to repossession and enforcement of contracts, even if repossession might be long and/or difficult. Poor or unstable legal and regulatory environment. Jurisdiction may make repossession and enforcement of contracts lengthy or impossible. (b) Sub-factor: political risk, including transfer risk, considering object type and risk reduction mechanisms Very low exposure; strong risk reduction instruments, if needed Low exposure; satisfactory risk reduction instruments, if needed Moderate exposure; fair risk reduction mechanisms High exposure; no or weak risk reduction instrument Factor: transaction characteristics (a) Sub-factor: amortisation schedule Amortising debt without bullet repayment Amortising debt with no or insignificant bullet repayment Amortising debt repayments with limited bullet payment Bullet repayment or amortising debt repayments with high bullet repayment (b) Sub-factor: market/cycle and refinancing risk There is no or very limited exposure to market or cycle risk since the expected cashflows cover all future loan repayments during the tenor of the loan35 and there are no significant delays between the cashflows and the loan repayments. The exposure to market or cycle risk is limited since the expected cashflows cover the majority of future loan repayments during the tenor of the loan and there are no significant delays between the cashflows and the loan repayments. There is low refinancing risk. There is moderate exposure to market or cycle risk since the expected cashflows cover only a part of future loan repayments during the tenor of the loan or there are some significant delays between the cashflows and the loan repayments. There is significant exposure to market or cycle risk since the expected cashflows cover only a small part of future loan repayments during the tenor of the loan or there are some significant delays between the cashflows and the loan repayments. 35 The tenor of a loan refers to the amount of time left for the repayment of a loan.

[[unofficial translation] There is no or very low refinancing risk. Average refinancing risk. High refinancing risk. (c) Sub-factor: operating risk • Permits/licensing (sub-factor component) All permits have been obtained; asset meets current and foreseeable safety regulations. All permits obtained or in the process of being obtained; asset meets current and foreseeable safety regulations. Most permits obtained or in process of being obtained, outstanding ones considered routine, asset meets current safety regulations. Problems in obtaining all required permits, part of the planned configuration and/or planned operations might need to be revised. • Scope and nature of operations and management contracts (sub￾factor component) Strong long-term operations and management contract36 , preferably with contractual performance incentives, and/or operations and management reserve accounts (if needed) Long-term operations and management contract, and/or operations and management reserve accounts37 (if needed) Limited operations and management contract or operations and management reserve account (if needed) No operations and management contract: risk of high operational cost overruns beyond risk reduction mechanisms 36 An Operation and Maintenance contract refers to a contract between the developer and the operator. The developer delegates the operation, maintenance and often performance management of the project to an operator with expertise in the industry under the terms of the operation and maintenance contract (i.e. scope, term, operator responsibility, fees, and liquidated damages). 37 An operation and maintenance reserve account refers to a fund into which money is deposited to be used for the purpose of meeting the costs of operation and maintenance of the project.

[[unofficial translation] • Operator’s financial strength, track record in managing the asset type and capability to re-market asset when it comes off-lease (sub-factor component) Excellent track record and strong re￾marketing capability Satisfactory track record and re-marketing capability Weak or short track record and uncertain re￾marketing capability No or unknown track record and inability to re￾market the asset Factor: asset characteristics (a) Sub-factor: configuration, size, design and maintenance (i.e., age, size for a plane) compared to other assets on the same market Strong advantage in design and maintenance. Configuration is standard such that the object meets a liquid market. Above average design and maintenance. Standard configuration, maybe with very limited exceptions – such that the object meets a liquid market Average design and maintenance. Configuration is somewhat specific, and thus might cause a narrower market for the object. Below average design and maintenance. Asset is near the end of its economic life. Configuration is very specific; the market for the object is very narrow. (b) Sub-factor: resale value Current resale value is well above debt value. Resale value is moderately above debt value. Resale value is slightly above debt value. Resale value is below debt value. (c) Sub-factor: sensitivity of the asset value and liquidity to economic cycles Asset value and liquidity are relatively insensitive to economic cycles. Asset value and liquidity are sensitive to economic cycles. Asset value and liquidity are quite sensitive to economic cycles. Asset value and liquidity are highly sensitive to economic cycles. Factor: strength of sponsor (including public private partnership) (a) Sub-factor: sponsors’ track record and financial strength Sponsors with excellent track record and high financial standing Sponsors with good track record and good financial standing Sponsors with adequate track record and good financial standing Sponsors with no or questionable track record and/or financial weaknesses Factor: security package (a) Sub-factor: asset control Legal documentation provides the lender effective control (e.g., a first perfected security interest38, or a leasing structure including such security) on the asset, Legal documentation provides the lender effective control (e.g., a perfected security interest, or a leasing structure including such security) on the asset, or on the company owning it. Legal documentation provides the lender effective control (e.g., a perfected security interest, or a leasing structure including such security) on the asset, or on the company owning it. The contract provides little security to the lender and leaves room to some risk of losing control on the asset. 38 First perfected security interest refers to a security interest in an asset (mortgaged as a collateral) protected from claims by other parties. A lien is perfected by registering it with appropriate statutory authority so that it is made legally enforceable and any subsequent claim on that asset is given a junior status.

[[unofficial translation] or on the company owning it. (b) Sub-factor: rights and means at the lender’s disposal to monitor the location and condition of the asset The lender is able to monitor the location and condition of the asset, at any time and place (regular reports, possibility to lead inspections). The lender is able to monitor the location and condition of the asset, almost at any time and place. The lender is able to monitor the location and condition of the asset, almost at any time and place. The lender’s ability to monitor the location and condition of the asset are limited. (c) Sub-factor: insurance against damages Strong insurance coverage including collateral damages with top quality insurance companies Satisfactory insurance coverage (not including collateral damages) with good quality insurance companies Fair insurance coverage (not including collateral damages) with acceptable quality insurance Weak insurance coverage (not including collateral damages) or with weak quality insurance

[[unofficial translation] Table 4. Assessment criteria for commodities finance exposures Factors / sub-factors Category 1 Category 2 Category 3 Category 4 Factor: financial strength (a) Sub-factor: degree of over￾collateralisation of trade Strong Good Satisfactory Weak Factor: political and legislative environment (a) Sub-factor: country risk No country risk Limited exposure to country risk (in particular, offshore location of reserves in an emerging country) Exposure to country risk (in particular, offshore location of reserves in an emerging country) Strong exposure to country risk (in particular, inland reserves in an emerging country) (b) Sub-factor: reduction of country risks Very strong risk reduction: Strong offshore mechanisms Strategic commodity 1st class buyer Strong risk reduction: Offshore mechanisms Strategic commodity Strong buyer Acceptable risk reduction: Offshore mechanisms Only partial risk reduction: No offshore mechanisms Non-strategic commodity Weak buyer

Less strategic commodity Acceptable buyer

Factor: asset characteristics (a) Sub-factor: liquidity and susceptibility to damage Commodity is quoted and can be hedged through futures or OTC instruments. Commodity is not susceptible to damage. Commodity is quoted and can be hedged through OTC instruments. Commodity is not susceptible to damage. Commodity is not quoted but is liquid. There is uncertainty about the possibility of hedging. Commodity is not susceptible to damage. Commodity is not quoted. Liquidity is limited given the size and depth of the market. No appropriate hedging instruments. Commodity is susceptible to damage. Factor: strength of sponsor (including public private partnership)

[[unofficial translation] 39 First perfected security interest refers to a security interest in an asset (mortgaged as a collateral) protected from claims by other parties. A lien is perfected by registering it with appropriate statutory authority so that it is made legally enforceable and any subsequent claim on that asset is given a junior status. (a) Sub-factor: financial strength of trader Very strong, relative to trading philosophy and risks Strong Adequate Weak (b) Sub-factor: track record, including ability to manage the logistic process Extensive experience with the type of transaction in question. Strong record of operating success and cost efficiency. Sufficient experience with the type of transaction in question. Above average record of operating success and cost efficiency. Limited experience with the type of transaction in question. Average record of operating success and cost efficiency. Limited or uncertain track record in general. Volatile costs and profits. (c) Sub-factor: trading controls and hedging policies Strong standards for counterparty selection, hedging, and monitoring Adequate standards for counterparty selection, hedging, and monitoring Past deals have experienced no or minor problems Trader has experienced significant losses on past deals (d) Sub-factor: quality of publication of financial information Excellent Good Satisfactory Publication of financial information contains some uncertainties or is insufficient Factor: security package (a) Sub-factor: asset control First perfected security interest39 provides the lender legal control of the assets at any time if needed. First perfected security interest provides the lender legal control of the assets at any time if needed. At some point in the process, there is a rupture in the control of the assets by the lender. The rupture is mitigated by knowledge of the trade process or a third party undertaking as the case may be. Contract leaves room for some risk of losing control over the assets. Recovery could be jeopardised.

[[unofficial translation] (b) Sub-factor: insurance against damages Strong insurance coverage including collateral damages with top quality insurance companies Satisfactory insurance coverage (not including collateral damages) with good quality insurance companies Fair insurance coverage (not including collateral damages) with acceptable quality insurance companies Weak insurance coverage (not including collateral damages) or with weak quality insurance companies

[[unofficial translation] ANNEX 2 GUIDELINES on the application of the definition of default Subject matter and scope

  1. These guidelines closely regulate the requirements on the application of the definition of default referred to in Article 218 of the Decision on Capital Adequacy of Credit Institutions (hereinafter: the Decision).
  2. These guidelines shall apply with respect to: − the approach based on internal rating systems in accordance with Subtitle 3, Title II, Part Three of the Decision; − the standardised approach for credit risk in accordance with the provision of Article 167 of the Decision with reference to Article 218 of the Decision.
  3. A credit institution that has received authorisation to use the IRB approach shall apply the requirements set out in these guidelines for the IRB approach to all exposures. Where the credit institution has received prior authorisation to a permanent exemption from the use of the IRB approach in accordance with Article 192 of the Decision, or authorisation to implement the IRB approach sequentially in accordance with Article 171 of the Decision, such credit institution may apply the requirements set out in these guidelines for the standardised approach for the relevant exposures under permanent exemption from the use of the IRB approach, or exposures included in the sequential implementation plan. Past due criterion in the identification of default 2.1. Counting days past due
  4. For the purposes of the application of Article 218 paragraph (1) item 2) of the Decision, where any amount of principal, interest or fee has not been paid at the date it was due, a credit institution should recognise this as the credit obligation past due. Where there are modifications of the schedule of credit obligations, as referred to in Article 218 paragraph (3) item 5) of the Decision, the credit institution’s policies should clarify that the counting of days past due should be based on the modified schedule of payments.
  5. Where the credit arrangement explicitly allows the debtor to change the schedule, suspend or postpone the payments under certain conditions and the debtor acts within the rights granted in the contract, the changed, suspended or postponed instalments should not be considered past due, but the counting of days past due should be based on the new schedule once it is specified. Nevertheless, if the debtor

[[unofficial translation] changes the schedule, suspends or postpones the payments, the credit institution should analyse the reasons for such a change and assess the possible indications of unlikeliness to pay, in accordance with Article 218 paragraphs (1) and (4) of the Decision and Subtitle III of these guidelines. 6. Where the repayment of the obligation is suspended because of a law allowing this option or other legal restrictions, the counting of days past due should also be suspended during that period. Nevertheless, in such situations, credit institutions should analyse, where possible, the reasons for exercising the option for such a suspension and should assess the possible indications of unlikeliness to pay, in accordance with Article 218 paragraphs (1) and (4) of the Decision and Subtitle III of these guidelines. 7. Where the repayment of the obligation is the subject of a dispute between the debtor and the credit institution, the counting of days past due may be suspended until the dispute is resolved, where at least one of the following conditions is met: − the dispute between the debtor and the credit institution over the existence or amount of the credit obligation has been introduced to a court or another formal procedure performed by a dedicated external body that results in a binding ruling in accordance with the applicable legal framework in the relevant jurisdiction; or − in the specific case of leasing, a formal complaint has been directed to the institution about the object of the contract and the merit of the complaint has been confirmed by independent internal audit, internal validation or another comparable independent auditing unit. 8. Where the debtor changes due to an event such as a merger or acquisition of the debtor or any other similar transaction, the counting of days past due should start from the moment a different person or entity becomes obliged to pay the obligation. The counting of days past due is, instead, unaffected by a change in the debtor’s name. 9. The calculation of the sum of all amounts past due that are related to any credit obligation of the debtor to the credit institution, parent undertaking or any of its subsidiaries to this debtor and which credit institutions are required to calculate for the purpose of comparison with the materiality threshold from Article 218 paragraphs (7) and (9) of the Decision should be performed with a frequency allowing timely identification of default. A credit institution should ensure that the information about the days past due and default is up-to-date whenever it’s being used for decision making, internal risk management, internal or external reporting and the capital requirements calculation processes. Where a credit institution calculates days past due less often than daily, it should ensure that the date of default is identified as the date when the past due criterion has actually been fulfilled. 10. The classification of the debtor to a defaulted status should not be subject to additional expert judgement; once the debtor meets the past due criterion all

[[unofficial translation] exposures to that debtor are considered defaulted, unless either of the following conditions is met: − the exposures are eligible as retail exposures and the credit institution applies the default definition at individual credit facility level; − a so called ‘technical past due situation’ is considered to have occurred, in accordance with item 8 of these guidelines. 2.2. Technical past due situation 11. A technical past due situation should only be considered to have occurred in any of the following cases: − where a credit institution identifies that the defaulted status was a result of data or system error of the credit institution, including manual errors of standardised processes but excluding wrong credit decisions, − where a credit institution identifies that the defaulted status was a result of the nonexecution, defective or late execution of the payment transaction ordered by the debtor or where there is evidence that the payment was unsuccessful due to the failure of the payment system, − where due to the nature of the transaction there is a time lag between the receipt of the payment by a credit institution and the allocation of that payment to the relevant account, so that the payment was made before the 90 days and the crediting in the client’s account took place after the 90 days past due, − u in the specific case of the purchase of receivables arrangements where the purchased receivables are recorded on the balance sheet of the credit institution and the materiality threshold set in Article 218 paragraphs (7) or (9) of the Decision is breached but none of the receivables to the debtor is past due more than 30 days. 12. Technical past due situations should not be considered as defaults in accordance with Article 218 of the Decision. All detected errors that led to technical past due situation should be rectified by a credit institution in the shortest timeframe possible. In the case of a credit institution that uses the IRB Approach, technical past due situations should be removed from the reference data set of defaulted exposures for the purpose of estimation of risk parameters. 2.3. Specific treatment for exposures to central government, local self￾government authorities and public sector entities 13. A credit institution may apply specific treatment for exposures to central government, local self-government authorities and public sector entities where all of the following conditions are met: − the contract is related to the supply of goods or services, where the administrative procedures require certain controls related to the execution of the contract before the payment can be made. This applies in particular to exposures arising from

[[unofficial translation] contracts on the purchase of receivables or similar types of arrangements but does not apply to instruments such as bonds, − the contract is related to the supply of goods or services, where the administrative procedures require certain controls related to the execution of the contract before the payment can be made. This applies in particular to exposures arising from contracts on the purchase of receivables or similar types of arrangements but does not apply to instruments such as bonds, − apart from the delay in payment no other indications of unlikeliness to pay as specified in accordance with Article 218 paragraph (1) item 1) and paragraph (4) of the Decision and these guidelines apply, the financial situation of the debtor is sound and there are no reasonable concerns that the obligation might not be paid in full, including any overdue interest, and − the obligation is past due not longer than 180 days. 14. A credit institution that decides to apply the specific treatment referred to in item 13 of these guidelines should apply the following: − these exposures should not be included in the calculation of the materiality threshold for other exposures to this debtor, − they should not be considered as defaults in the sense of Article 218 of this Decision, and − they should be clearly documented as exposures subject to the specific treatment. 2.4. Treatment of arrangements on the purchase of receivables 15. Where there are arrangements on the purchase of receivables wherein the ceded receivables are not recognised on the balance sheet of the factor and the factor is liable directly to the client up to a certain agreed percentage, the counting of days past due should commence from when the factoring account is in debit, i.e., from when the advances paid for the receivables exceed the percentage agreed between the factor and the client. For the purpose of determining items of the client of a factor that are past due, a credit institution should apply of the following: − compare the sum of the amount of the factoring account that is in debit and all other past due obligations of the client recorded in the balance sheet of the factor, against the absolute component of the materiality threshold set by the Central Bank in accordance with Article 218 paragraph (3) item 4) of the Decision, − compare the relation between the sum described in indent 1 of this item and the total amount of current value of the factoring account, i.e., the value of advances paid for the receivables and all other on-balance sheet exposures related with the credit obligations of the client, against the relative component of the materiality threshold set by the Central Bank in accordance with Article 218 paragraph (3) item 4) of the Decision. 16. Where there are arrangements on the purchase of receivables where the purchased receivables are recognised on the balance sheet of the factor and the factor has exposures to the debtors of the client, the counting of days past due should

[[unofficial translation] commence when the payment for a single receivable becomes due. In this situation, for a credit institution that uses the IRB Approach, by virtue of the fact that the ceded receivables are purchased receivables, where they meet the requirements of Article 196 of the Decision or in the case of purchased corporate receivables the requirements of Article 195 of the Decision, the default definition may be applied as for retail exposures in accordance with Subtitle VII of these guidelines. 17. Where the credit institution recognises events related to dilution risk of purchased receivables, these events should not be considered as leading to the default of the debtor. Where the amount of receivable has been reduced as a result of events related to dilution risk such as discounts, deductions, netting or credit notes issued (CLN) by the seller, the reduced amount of receivable should be included in the calculation of days past due. Where there is a dispute between the debtor and the seller and such event is recognised as related to dilution risk the counting of days past due should be suspended until the dispute is resolved. 18. Events recognised as related to dilution risk and hence excluded from the identification of default should be included in the calculation of capital requirements or internal capital for dilution risk. Where a credit institution recognises significant number of events related to dilution risk, it should analyse and document the reasons for such events and assess the possible indications of unlikeliness to pay, in accordance with Article 218 paragraphs (1) and (4) of the Decision and Subtitle V of these guidelines. 19. Where the debtor has not been adequately informed about the cession of the receivable by the factor’s client and the credit institution has evidence that the payment for the receivable has been made to the client, the credit institution should not consider the receivable to be past due. Where the debtor has been adequately informed about the cession of the receivable but has nevertheless made the payment to the client, the credit institution should continue counting the days past due according to the conditions of the receivable. 20. In the specific case of undisclosed arrangements on the purchase of receivables, where the debtors are not informed about the cession of the receivables but the purchased receivables are recognised on the balance sheet of the factor, the counting of days past due should commence from the moment agreed with the client when the payments made by the debtors should be transferred from the client to the factor. 2.5. Setting the materiality threshold 21. A credit institution should apply the materiality threshold for past due credit obligations set in Article 218 paragraphs (7) and (9) of the Decision. A credit institution may identify defaults on the basis of a lower threshold if it can demonstrate that this lower threshold is a relevant indication of unlikeliness to pay and does not lead to an

[[unofficial translation] excessive number of defaults that return to non-defaulted status shortly after being recognised as defaulted or decrease of capital requirements. In this case a credit institution should record in its database the information on the trigger of default as an additional specified indication of unlikeliness to pay. Indications of unlikeliness to pay 3.1. Non-accrued status 22. For the purposes of unlikeliness to pay as referred to in Article 218 paragraph (4) item

  1. of the Decision, a credit institution should consider that a creditor is unlikely to pay where interest related to credit obligations is no longer recognised in the income statement of the credit institution due to the decrease of the credit quality of the obligation. 3.2. Specific credit risk adjustments
  1. For the purposes of unlikeliness to pay as referred to in Article 218 paragraph (4) item
  1. of the Decision, all of the following specific credit risk adjustments (SCRA) should be considered to be a result of a significant perceived decline in the credit quality of a credit obligation and hence should be treated as an indication of unlikeliness to pay: − losses recognised in the profit or loss account for instruments measured at fair value that represent credit risk impairment under the applicable accounting framework, − losses as a result of current or past events affecting a significant individual exposure or exposures that are not individually significant which are individually or collectively assessed.
  1. The specific credit risk adjustments that cover the losses for which historical experience, adjusted on the basis of current observable data, indicate that the loss has occurred but the credit institution is not yet aware which individual exposure has suffered these losses (“incurred but not reported losses”), should not be considered an indication of unlikeliness to pay of a specific debtor.
  2. Where the credit institution treats an exposure as impaired such a situation should be considered an additional indication of unlikeliness to pay and hence the debtor should be considered defaulted regardless of whether there are any specific credit risk adjustments assigned to this exposure. Where in accordance with the accounting framework in the case of incurred but not reported losses exposures are recognised as impaired, these situations should not be treated as an indication of unlikeliness to pay
  3. Where the credit institution treats an exposure as credit-impaired under International Financial Reporting Standards (IFRS 9) - Financial Instruments, or assigns it to Stage 3 (as defined in IFRS 9, such exposure should be considered defaulted, except where

[[unofficial translation] the exposure has been considered credit-impaired due to the delay in payment and one or more of the following conditions are met: − The credit institution has replaced the 90 days past due with 180 days past due (in accordance with Article 218 paragraph (1) item 2) of the Decision) and this longer period is not used for the purpose of recognition of credit-impairment, − the materiality threshold referred to in Article 218 paragraphs (7) and (9) has not been breached; − the exposure has been recognised as a technical past due situation in accordance with item 11 of these Guidelines, − t the exposure meets the conditions of item 13 of these Guidelines. 27. Where the credit institution uses both IFRS 9 and another accounting framework it should choose whether to classify exposures as defaulted in accordance with items 23 to 25 or in accordance with item 26 of these Guidelines. Once this choice is made the credit institution should be applied consistently over time. 3.3. Sale of the credit obligation 28. U For the purposes of unlikeliness to pay as referred to in Article 218 paragraph (4) item 3) of the Decision, a credit institution should take into account both the character and materiality of the loss related to the sale of credit obligations, in accordance with the items 29 to 34 of these Guidelines. Transactions of traditional securitisation with significant risk transfer and any intragroup sales of credit obligations should be considered sale of credit obligations. 29. A credit institution should analyse the reasons for the sale of credit obligations and the reasons for any losses recognised thereby. Where the reasons for the sale of credit obligations were not related to credit risk, such as where there is the need to increase the liquidity of the credit institution or there is a change in business strategy, and the credit institution does not perceive the credit quality of those obligations as declined, the economic loss related with the sale of those obligations should be considered not credit-related. In that case the sale should not be considered an indication of default even where the loss is material, on condition of the appropriate, documented justification of the treatment of the sale loss as not credit-related. Credit institution may, in particular, consider the loss on the sale of credit obligations as non￾credit related where the assets subject to the sale are publicly traded assets and measured at fair value. Where, however, the loss on the sale of credit obligations is related to the credit quality of the obligations themselves, in particular where the credit institution sells the credit obligations due to the decrease in their quality, the credit institution should analyse the materiality of the economic loss and, where the economic loss is material, this should be considered an indication of default. 30. A credit institution should set a threshold for the credit-related economic loss related with the sale of credit obligations to be considered material, which should be calculated according to the following formula, and should not be higher than 5%:

[[unofficial translation] 𝐿𝐿 = − 𝑃𝑃 where: L - is the economic loss related with the sale of credit obligations; E - is the total outstanding amount of the obligations subject to the sale, including interest and fees; P - is the price agreed for the sold obligations. 31. In order to assess the materiality of the overall economic loss related with the sale of credit obligations, a credit institution should calculate the economic loss and compare it to the threshold referred to in item 30 of these Guidelines. Where the economic loss is higher than this threshold it should consider the credit obligations defaulted. 32. The sale of credit obligations may be performed either before or after the default. In the case of a credit institution that uses the IRB Approach, regardless of the moment of the sale, if the sale was related with a material credit-related economic loss, the information about the loss should be adequately recorded and stored for the purpose of the estimation of risk parameters. 33. If the sale of a credit obligation at a material credit-related economic loss occurred before the identification of default on that exposure, the moment of sale should be considered the moment of default. In the case of a partial sale of the total obligations of a debtor where the sale is associated to a material credit-related economic loss, all the remaining exposures to this debtor should be treated as defaulted, unless the exposures are eligible as retail exposures and the credit institution applies the default definition at facility level. 34. In the case of a sale of a portfolio of exposures the treatment of individual credit obligations within this portfolio should be determined in accordance with the manner the price for the portfolio was set. Where the price for the total portfolio was determined by specifying the discount on particular credit obligations, the materiality of credit-related economic loss should be assessed individually for each exposure within the portfolio. Where however the price was set only at the portfolio level, the materiality of credit-related economic loss may be assessed at the portfolio level and in that case, if the threshold specified in item 27 of these Guidelines is breached, all credit obligations within this portfolio should be treated as defaulted at the moment of the sale. 3.4. Restructuring of exposures 35. For the purposes of unlikeliness to pay as referred to in Article 218 paragraph (4) item 4) of the Decision, a restructuring should be considered to have occurred when concessions have been extended towards a debtor facing or about to face difficulties

[[unofficial translation] in meeting its financial commitments as specified by the decision governing asset classification in credit institutions. 36. Given that, as referred to in Article 218 paragraph (4) item 4) of the Decision, the debtor should be considered defaulted where the restructuring is likely to result in a diminished financial obligation, where considering forborne exposures, the debtor should be classified as defaulted only where the relevant forbearance measures are likely to result in a diminished financial obligation. 37. A credit institution should set a threshold for the diminished financial obligation that is considered to be caused by material forgiveness or postponement of principal, interest, or fees, and which should be calculated according to the following formula, and should not be higher than 1%: = 𝑁𝑁 ˳ − 𝑁𝑁 ₁ 𝑁𝑁 ˳ where: DO - diminished financial obligation, NPV0 - is net present value of cash flows (including unpaid interest and fees) expected under contractual obligations before the changes in terms and conditions of the contract discounted using the customer’s original effective interest rate, NPV1 - is net present value of the cash flows expected based on the new arrangement discounted using the customer’s original effective interest rate. 38. For the purposes of unlikeliness to pay as referred to in Article 218 paragraph (4) item 4) of the Decision, for each restructuring, a credit institution should calculate the diminished financial obligation and compare it with the threshold referred to in item 37 of these Guidelines. Where the diminished financial obligation is higher than this threshold, the exposures should be considered defaulted. If, however the diminished financial obligation is below the specified threshold, and in particular when the net present value of expected cash flows based on the restructuring arrangement is higher than the net present value of expected cash flows before the changes in terms and conditions, the credit institution should assess such exposures for other possible indications of unlikeliness to pay. Where the credit institution has reasonable doubts with regard to the likeliness of repayment in full of the obligation according to the new arrangement in a timely manner, the debtor should be considered defaulted. The indicators that may suggest unlikeliness to pay include the following: − a large lumpsum payment envisaged at the end of the repayment schedule; − irregular repayment schedule where significantly lower payments are envisaged at the beginning of repayment schedule; − significant grace period at the beginning of the repayment schedule;

[[unofficial translation] − the exposures to the debtor have been subject to restructuring more than once. 39. Any concession extended to a debtor already in default, should lead to classify the debtor as a restructuring. All exposures classified as forborne non-performing in accordance with decision governing classification of assets of credit institutions should be classified as default and subject to distressed restructuring. 40. Where any of the modifications of the schedule of credit obligations (in line with Article 218 paragraph (2) item 5) of the Decision) is the result of financial difficulties of a debtor, a credit institution should also assess whether a restructuring has taken place and whether an indication of unlikeliness to pay has occurred. 3.5. Bankruptcy of the debtor 41. For the purposes of unlikeliness to pay (in line with Article 218 paragraph (4) items 5) and 6) of the Decision), a credit institution should clearly specify in its internal policies what type of arrangement is treated as an order or as a protection similar to bankruptcy, taking into account all relevant legal frameworks as well as the following typical characteristics of such protection: ­ the protection scheme encompasses all creditors or all creditors with unsecured claims; ­ the terms and conditions of the protection scheme are approved by the court or other relevant public authority; ­ the terms and conditions of the protection scheme include a temporary suspension of payments or partial redemption of debt; ­ the measures involve some sort of control over the management of the company and its assets; ­ if the protection scheme fails, the company is likely to be liquidated. 42. A credit institution should treat arrangements of Member States that represent measures similar to bankruptcy in line with the EU regulations, as well as arrangements of third countries which in their essence represent protection measures similar to bankruptcy as a protection measure similar to bankruptcy. 3.5. Other indications of debtor’s unlikeliness to pay 43. A credit institution should specify in its internal policies and procedures other additional indications of unlikeliness to pay of a debtor, besides those specified in Article 218 paragraph (4) of the Decision. Those additional indications should be specified per type of exposures, as defined in Article 161 paragraph (1) item 2) of the Decision, reflecting their specificities, and they should be specified for all business lines, legal entities or geographical locations. The occurrence of an additional indication of unlikeliness to pay should either result in an automatic reclassification to defaulted exposures or trigger a case-by-case assessment and may include indications based on internal or external information.

[[unofficial translation] 44. The possible indications of debtor’s unlikeliness to pay that could be considered by a credit institution on the basis of internal information include the following: ­ a debtor’s sources of recurring income are no longer available to meet the payments of instalments; ­ there are justified concerns about a debtor’s future ability to generate stable and sufficient cash flows; ­ the debtor’s overall leverage level has significantly increased or there are justified expectations of such changes to leverage; ­ the debtor has breached the covenants of a credit contract; ­ the credit institution has called any collateral including a guarantee; ­ for the exposures to an individual: default of a company fully owned by a single individual where this individual provided the credit institution with a personal guarantee for all obligations of a company; ­ for retail exposures where the default definition is applied at the level of an individual credit facility, the fact that a significant part of the total obligation of the debtor is in default; − the reporting of an exposure as non-performing in accordance with the regulation of the Central Bank governing reporting on nonperforming exposures of credit institutions, except where credit institutions have replaced the 90 days past due with 180 days past due in accordance with Article 218 paragraph (1) item 2) of the Decision. 45. A credit institution should also take into account the information available in external databases, including credit registers, macroeconomic indicators and public information sources, including press articles and financial analyst’s reports. The indications of unlikeliness to pay that could be considered by a credit institution on the basis of external information include the following: ­ significant delays in payments to other creditors have been recorded in the relevant credit register; ­ a crisis of the sector in which the counterparty operates combined with a weak position of the counterparty in this sector; ­ disappearance of an active market for a financial asset because of the financial difficulties of the debtor; ­ a credit institution has information that a third party, in particular another credit institution, has filed for bankruptcy or similar protection of the debtor. 46. When specifying the criteria for debtor’s unlikeliness to pay, a credit institution should take into consideration the relations within the groups of connected clients. In particular, the credit institution should specify in its internal policies when the default of one debtor within the group of connected clients has a contagious effect on other entities within this group. Such specifications should be in line with the appropriate policies for the assignment of exposures to individual debtor to a debtor grade and to groups of connected clients (in accordance with Article 191 paragraph (1) item 4) of the Decision). Where such criteria have not been specified for a non-standard situation, in the case of default of a debtor that is part of a group of connected clients,

[[unofficial translation] credit institutions should assess the potential unlikeliness to pay of all other entities within this group on a case-by-case basis. 47. Where a financial asset was purchased or originated by a credit institution at a material discount credit institutions should assess whether that discount reflects the deteriorated credit quality of the debtor and whether there are any indications of default in accordance with these guidelines. The assessment of unlikeliness to pay should refer to the total amount owed by the debtor regardless of the price that the credit institution has paid for the asset. This assessment may be based on the due diligence performed before the purchase of the asset or on the analysis performed for the accounting purposes in order to determine whether the asset is credit￾impaired. 48. Credit institutions should have adequate policies and procedures to identify credit frauds. Typically, when credit fraud is identified, the exposure is already defaulted on the basis of material delays in payment. However, if the credit fraud is identified before default has been recognised this should be treated as an additional indication of unlikeliness to pay. 3.6. Governance procedures regarding unlikeliness to pay 49. A credit institution should establish policies regarding the definition of default in order to ensure its consistent and effective application and in particular they should have clear policies and procedures on the application of the criteria for unlikeliness to pay (as laid down in Article 218 paragraph (4) of the Decision) and all other indications of unlikeliness to pay as specified by the credit institution, covering all types of exposures (as defined in Article 161 paragraph (1) item 2) of the Decision), for all business lines, legal entities and geographical locations. 50. With regard to each indication of unlikeliness to pay by a debtor, a credit institution should define the adequate methods of their identification, including the sources of information and frequency of monitoring. The sources of information should include both internal and external sources, including in particular relevant external databases and registers. Application of the definition of default in external data 51. A credit institution that uses the IRB Approach and uses external data for the purpose of estimation of risk parameters (in accordance with Article 218 paragraph (5) of the Decision) should apply the requirements specified in items 52 to 55 of these Guidelines. 52. For the purposes of Article 218 paragraph (5) of the Decision, a credit institution should do all of the following:

[[unofficial translation] ­ verify whether the definition of default used in the external data is in line with the provisions of Article 218 of the Decision, ­ verify whether the definition of default used in the external data is consistent with the definition of default as implemented by the credit institution for the relevant portfolio of exposures, including in particular: a) the counting and number of days past due that triggers default, b) the structure and level of materiality threshold for past due credit obligations, c) the definition of distressed restructuring that triggers default, d) the type and level of specific credit risk adjustments that triggers default, and e) the criteria to return to non-defaulted status; and ­ document sources of external data, the default definition used in external data, the performed analysis and all identified differences. 53. For each difference identified in the definition of default resulting from the assessment of item 52 of these Guidelines, a credit institution should do the following: ­ assess whether the adjustment to the internal definition of default would lead to an increased or a decreased default rate or whether it is impossible to determine; ­ either perform appropriate adjustments in the external data or be able to demonstrate that the difference is negligible in terms of the impact on all risk parameters and capital requirements. 54. Regarding the totality of the differences identified in the definition of default resulting from the assessment of item 52 of these Guidelines and taking into account the adjustments performed in accordance with item 53 point (b) of these Guidelines, a credit institution should be able to demonstrate to the Central Bank that broad equivalence with the internal definition of default has been achieved, including, where possible by comparing the default rate in internal data on a relevant type of exposures with external data. 55. Where the assessment under item 52 of these Guidelines identifies differences in the definition of default which the process of item 53 of these Guidelines reveals to be non-negligible but not possible to overcome by adjustments in the external data, a credit institution must apply an appropriate margin of conservatism in the estimation of risk parameters as referred to in Article 198 paragraph (1) item (6) of the Decision. In that case the credit institution should ensure that this additional margin of conservatism reflects the materiality of the remaining differences in the definition of default and their possible impact on all risk parameters. Criteria for the return to a non-defaulted status 5.1. Minimum conditions for reclassification to a non-defaulted status 56. For the purposes of the application of Article 218 paragraph (13) of the Decision, except

[[unofficial translation] for situations referred to in item 54 of these Guidelines, a credit institution should apply the following: − consider that no trigger of default continues to apply to a previously defaulted exposure, where at least 3 months have passed since the moment that the conditions referred to in Article 218 paragraph (1) item 5) and paragraph (4) of the Decision cease to be met; − take into account the behaviour of the debtor during the period referred to in point (a) of this item; − take into account the financial situation of the debtor during the period referred to in point (a) of this item; − after the period referred to in point (a) of this item, perform an assessment, and, where the credit institution still finds that the debtor is unlikely to pay its obligations in full without recourse to realising security, the exposures should continue to be classified as defaulted until the credit institution is satisfied that the improvement of the credit quality is factual and permanent; − the conditions referred to in indents 1 to 4 of this item should be met also with regard to new exposures to the debtor, in particular where the previous defaulted exposures to this debtor were sold or written off. A credit institution may apply the period referred to in paragraph (1) indent 1 of this item to all exposures or apply different periods for different types of exposures. 57. For the purposes of the application of Article 218 paragraph (13) of the Decision, and where the restructuring according to item 35 of these Guidelines applies to a defaulted exposure, regardless of whether such restructuring was carried out before or after the identification of default, a credit institution should consider that no trigger of default continues to apply to a previously defaulted exposure, where at least one year has passed from the latest between one of the following events: − the moment of introducing the restructuring measures; − the moment when the exposure has been classified as defaulted; − the end of the grace period included in the restructuring arrangements 58. A credit institution should reclassify the exposure to a non-defaulted status after at least the one-year period referred to in item 60 of these Guidelines, where all of the following conditions are met: ­ during that period a material payment has been made by the debtor; material payment may be considered to be made where the debtor has paid, via its regular payments in accordance with the restructuring arrangements, a total equal to the amount that was previously past-due (if there were past-due amounts) or that has been written-off (if there were no past-due amounts) under the restructuring measures; ­ during that period the payments have been made regularly according to the schedule applicable after the restructuring arrangements; ­ there are no past due credit obligations according to the schedule applicable after the restructuring arrangements; ­ no indications of unlikeliness to pay as specified in Article 218 paragraph (4) of

[[unofficial translation] the Decision, or any additional indications of unlikeliness to pay specified by the credit institution apply; ­ the credit institution does not consider it otherwise unlikely that the debtor will pay its credit obligations in full according to the schedule after the restructuring arrangements without recourse to realising security. In this assessment a credit institution should examine in particular situations where a large lumpsum payment or significantly larger payments are envisaged at the end of the repayment schedule; ­ the conditions referred to in points (a) to (e) of this item should be met also with regard to new exposures to the debtor, in particular where the previous defaulted exposures to this debtor that were subject to distressed restructuring were sold or written off. 59. Where the debtor changes due to an event such as a merger or acquisition of the debtor or any other similar transaction, the credit institution should not apply item 58 under (a) of these Guidelines, and where the debtor’s name changes, instead, credit institutions should apply that point. 5.2 Monitoring of the effectiveness of the policy 60. For the purposes of the application of Article 218 paragraph (13) of the Decision, a credit institution should define clear criteria and policies regarding when the debtor can be classified back to non-defaulted status and more, in particular the following: − when it can be considered that the improvement of the financial situation of a debtor is sufficient to allow the full and timely repayment of the credit obligation; and − when the repayment is actually likely to be made even where there is an improvement in the financial situation of a debtor in accordance with point (a) of this item. 61. A credit institution should monitor on a regular basis the effectiveness of its policies mentioned in item 60 of these Guidelines, and in particular monitor and analyse: − the changes of status of the debtors or facilities; − the impact of the adopted policies on cure rates; − the impact of adopted policies on multiple defaults. 62. It is expected that the credit institution would have a limited number of debtors who default soon after returning to a non-defaulted status. In the case of extensive number of multiple defaults, the credit institution should revise its policies with regard to the reclassification of exposures. 63. The analysis of the changes in statuses of the debtors or facilities should in particular be taken into account for the purpose of specifying the periods referred to in items 57 and 58 of these Guidelines. A credit institution may specify longer periods for the exposures that have been classified as defaulted in the preceding 24 months.

[[unofficial translation] Consistency in the application of the definition of default 6.1. Overview 64. A credit institution should adopt adequate mechanisms and procedures in order to ensure that the definition of default is implemented and used in a correct manner, and should, in particular, ensure: − that default of a single debtor is identified consistently across the credit institution with regard to all exposures to this debtor in all relevant IT systems, including in all the legal entities within the group and in all geographical locations in accordance with items 65 to 67 of these Guidelines or for retail exposures in accordance with items 77 to 79 of these Guidelines; − that one of the following applies: a) the same definition of default is used consistently by a credit institution, parent undertaking or any of its subsidiaries and across the types of exposures, or b) where different definitions of default apply either within a group or across the types of exposures, the scope of application of each of the default definitions is clearly specified, in accordance with items 68 to 70 of these Guidelines; 6.2. Consistent identification of default of a single debtor 65. For the purposes of item 64 point (a) of these Guidelines, a credit institution should implement adequate procedures and mechanisms to ensure that the default of a single debtor is identified consistently across the credit institution with regard to all exposures to this debtor in all relevant IT systems, including in all the legal entities within the group and in all geographical locations where it is active in ways other than via a legal entity. 66. Where the exchange of client data among different legal entities within a credit institution, the parent undertaking or any of its subsidiaries is prohibited by consumer protection regulations, bank secrecy or other legislation resulting in inconsistencies in the identification of default of a debtor, the credit institution should inform the Central Bank of these legal impediments and, if it uses the IRB Approach it should also estimate the materiality of the inconsistencies in the identification of default of a debtor and their possible impact on the estimates of risk parameters. 67. Where the identification of default of a debtor in a manner fully consistent across the credit institution, the parent undertaking or any of its subsidiaries is very burdensome, requiring development of a centralised database of all clients or implementation of other mechanisms or procedures to verify the status of each client at all entities within the group, the credit institution need not apply such mechanisms or procedures if it can demonstrate that the effect of non-compliance is immaterial because there are no or very limited number of common clients among the relevant entities within a group and the exposure to these clients is immaterial.

[[unofficial translation] 6.3. Consistent use of the definition of default across types of exposures 68. For the purposes of item 64 provision under b) of these Guidelines, a credit institution, parent undertaking or any of its subsidiaries should use the same definition of default for a single type of exposures as defined in Article 161 paragraph (1) item 2) of the Decision. They may use different definitions of default for different types of exposures, including for certain legal entities or for presence in geographical locations in ways other than via a legal entity, where this is justified by the application of significantly different internal risk management practices or by different legal requirements applying in different jurisdictions, in particular by reasons such as: − different materiality thresholds set by competent authorities in their jurisdictions; − the use of 180 days instead of 90 days past due for certain types of exposures to which the IRB Approach is applied in some jurisdictions in accordance with Article 218 paragraph (1) item 2) of the Decision; − the specification of additional indications of unlikeliness to pay specific for certain legal entities, geographical locations or types of exposures. 69. For the purposes of item 64 under b) indent 2 of these Guidelines, and where different definitions of default are applied either across types of exposures in accordance with item 67 of these Guidelines, the credit institution’s internal procedures relating to the definition of default should ensure the following: − that the scope of application of each definition is clearly specified; − that the definition of default specified for a certain type of exposures, legal entity or geographical location is applied consistently to all exposures within the scope of application of each relevant definition of default. 70. Further, for a credit institution that uses the IRB Approach, the use of different default definitions has to be adequately reflected in the estimation of risk parameters in the case of ratings systems which scope of application encompasses different default definitions. Application of the definition of default for retail exposures 7.1. Level of application of the default definition for retail exposures 71. According to Article 218 paragraph (2) of the Decision, in the case of retail exposures, a credit institution may apply the definition of default at the level of an individual credit facility rather than in relation to the total obligations of a debtor. Therefore, a credit institution that uses the IRB Approach, in particular, may apply the definition of default at the level of the individual facility for retail exposures as defined in Article 165 paragraph (5) of the Decision. A credit institution that uses the Standardised Approach, instead may apply the definition of default at the level of an individual credit facility for all exposures that meet the criteria specified in Article 140 of the Decision, even where some of those exposures have been assigned to a different exposure class for the purpose of assigning a risk weight,

[[unofficial translation] such as exposures secured by mortgages on immovable property. 72. A credit institution should choose the level of application of the definition of default between debtor and facility for all retail exposures in a way that reflects its internal risk management practices. 73. A credit institution may apply the definition of default at the level of a debtor for some types of retail exposures and at the level of a credit facility for others, where this is well justified by internal risk management practices, for instance due to a different business model of a subsidiary, and where there is evidence that the number of situations where the same clients are subject to different definitions of default at different levels of application is kept to a strict minimum. 74. Where a credit institution decides to use different levels of application of the definition of default for different types of retail exposures, according to item 73 of these Guidelines, it should ensure that the scope of application of each definition of default is clearly specified and that it is used consistently over time for different types of retail exposures. In the case of a credit institution that uses the IRB Approach, the risk estimates should correctly reflect the definition of default applied to each type of exposures. 75. Where a credit institution uses different levels of application of the default definition with regard to certain retail portfolios, the treatment of common clients across such portfolios should be specified in its internal policies and procedures. In particular, where the exposure to which the definition of default at the debtor level applies fulfils either or both of the conditions of Article 218 paragraph (1) items 1) or 2) of the Decision, then all exposures to that debtor should be considered defaulted, including those that are subject to the application of the definition of default at individual credit facility level. Where the exposure subject to the application of the definition of default at individual credit facility level meets those conditions, the other exposures to the debtor should not be automatically reclassified to default status. Credit institution, however, may classify those other exposures as defaulted on the basis of other unlikeliness to pay considerations, as provided further in items 77 to 76 of these Guidelines. 76. The rules referred to in item 75 of these Guidelines should apply to the debtors treated under the Standardised Approach, where some exposures to a debtor fulfil the requirements of Article 140 of the Decision, while other exposures to the same debtor are in the form of securities and therefore do not qualify as retail. Where an exposure in the form of a security fulfils either or both of the conditions of Article 218 paragraph (1) items 1) and 2) of the Decision, all exposures to that debtor should be considered defaulted. Where the exposure that fulfils the requirements of Article 140 of the Decision meets those conditions and the credit institution applies the definition of default at the individual credit facility level, the other exposures to the debtor should not be automatically reclassified to default status. Credit institution however, may classify those other exposures as defaulted on the

[[unofficial translation] basis of other unlikeliness to pay considerations, as provided further in paragraphs 77 to 79 of these Guidelines. 7.2. Application of the definition of default for retail exposures at the facility level 77. Where, in accordance with Article 218 paragraph (2) of the Decision, the definition of default has been applied at the level of an individual credit facility with regard to retail exposures, a credit institution should not consider automatically the different exposures to the same debtor defaulted at the same time. Nevertheless, the credit institution should take into account that some indications of default are related with the condition of the debtor rather than the status of a particular exposure. This refers in particular to the indications of unlikeliness to pay related with the bankruptcy of the debtor as specified in Article 218 paragraph (4) items 5) and 6). Where such indication of default occurs, the credit institution should treat all exposures to the same debtor as defaulted regardless of the level of application of the definition of default. 78. A credit institution should consider also other indications of unlikeliness to pay and specify, in line with its internal policies and procedures, which indications of unlikeliness to pay reflect the overall situation of a debtor rather than that of the exposure. Where such other indications of unlikeliness to pay occur, all exposures to the debtor should be considered defaulted regardless of the level of application of the definition of default. 79. Additionally, where a significant part of the exposures to the debtor is in default, a credit institution may consider it unlikely that the other obligations of that debtor will be paid in full without recourse to actions such as realising security and treat them as defaulted as well. 7.3. Application of the definition of default for retail exposures at the debtor level 80. The application of the definition of default for retail exposures at the debtor level implies that, where any credit obligation of the debtor meets the conditions of Article 218 paragraph (1) items 1) or 2) of the Decision, then all exposures to that debtor should be considered defaulted. A credit institution that decides to apply the definition of default for retail exposures at the debtor level should specify detailed rules for the treatment of joint credit obligations and default contagion between exposures in its internal policies and procedures. 81. A credit institution should consider a joint credit obligation as an exposure to two or more debtors that are equally responsible for the repayment of the credit obligation. This notion does not extend to a credit obligation of an individual debtor secured

[[unofficial translation] by another individual or entity in the form of a guarantee or other credit protection. 82. Where one or both conditions from Article 218 paragraph (1) items 1) or 2) of the Decision are met with regard to a joint credit obligation of two or more debtors, a credit institution should consider all other joint credit obligations of the same set of debtors and all individual exposures to those debtors as defaulted, unless they can justify that the recognition of default on individual exposures is not appropriate because at least one of the following conditions apply: − the delay in payment of a joint credit obligation results from a dispute between the individual debtors participating in the joint credit obligation that has been introduced to a court or another formal procedure performed by a dedicated external body that results in a binding ruling in accordance with the applicable legal framework in the relevant jurisdiction, and there is no concern about the financial situation of the individual debtor; − a joint credit obligation is an immaterial part of the total obligations of an individual debtor. 83. The default of a joint credit obligation should not cause the default of other joint credit obligations of individual debtors with other individuals or entities, which are not involved in the credit obligation that has initially been defaulted; however, a credit institution should assess whether the default of the joint credit obligation at hand constitutes an indication of unlikeliness to pay with regard to the other joint credit obligations. 84. Where one or both of the conditions from Article 218 paragraph (1) items 1) or 2) of the Decision are met with regard to the credit obligation of an individual debtor, the contagious effect of this default should not automatically spread to any joint credit obligations of that debtor; nevertheless, a credit institution should assess such joint credit obligations for possible indications of unlikeliness to pay related with the default of one of the debtors. In any case, where all individual debtors have a defaulted status, their joint credit obligation should automatically also be considered defaulted. 85. A credit institution should identify, on the basis of the analysis of relevant legal provisions in a jurisdiction, and provide in its internal policies and procedures for the identification of the debtors that are legally fully liable for certain obligations jointly and severally with other debtors, therefore being fully liable for the entire amount of those obligations, but excluding credit obligations of an individual debtor secured by another individual or entity in the form of a guarantee or other credit protection. A typical example would be a married couple where, based on specific legal provisions applicable in the relevant jurisdiction, division of marital property (system of separate estates) does not apply. In the case of full mutual liability for all obligations, default of one of such debtors should be considered an indication of potential unlikeliness to pay of the other debtor and therefore a credit institution should assess whether the individual and

[[unofficial translation] joint credit obligations of these debtors should be considered defaulted. Where one of the joint and several debtors that are legally fully liable for all obligations, has a joint credit obligation with another client, the credit institution should assess whether indications of unlikeliness to pay occur also on the other joint credit obligations with third parties. 86. A credit institution should also analyse the forms of legal entities in relevant jurisdictions and the extent of liability of the owners, partners, shareholders or managers for the obligations of a company depending on the legal form of the entity. Where an individual is fully liable for the obligations of a company, default of that company should result in that individual being considered defaulted as well. Where such full liability for the obligations of a company does not exist, owners, partners or significant shareholders of a defaulted company should be assessed by the credit institution for possible indications of unlikeliness to pay with regard to their individual obligations. 87. Additionally, in the specific case of an individual entrepreneur where an individual is fully liable for both private and commercial obligations with both private and commercial assets the default of any of the private or commercial obligations should cause all private and commercial obligations of such individual to be considered as defaulted as well. 88. Where the definition of default is applied at the level of a debtor for retail exposures, the materiality threshold should also be applied at the level of a debtor. A credit institution should clearly specify in its internal policies and procedures the treatment of joint credit obligations in the application of the materiality threshold. 89. A joint debtor, or a specific set of individual debtors that have a joint obligation towards a credit institution, should be treated as a different debtor from each of the individual debtors. In the case the delay in payment occurs on a joint credit obligation, the materiality of such delay should be assessed by applying the materiality threshold referred to in Article 218 paragraph (3) item 4) of the Decision to all joint credit obligations granted to this specific set of debtors. For this purpose the individual exposures to debtors participating in a joint credit obligation or to any other subsets of such debtors should not be taken into account. However, where the materiality threshold for a joint debtor calculated in this way is breached, all joint credit obligations of this set of debtors and all individual exposures to the debtors participating in a joint credit obligation should be considered defaulted unless any of the conditions specified in item 82 of these Guidelines is met. 90. When delay in payment occurs on an individual credit obligation, the materiality of such delay should be assessed by applying the materiality threshold referred to in Article 218 paragraph (7) or (9) of the Decision to all individual credit obligations of this debtor, without taking into account any joint credit obligations of that debtor with other individuals or entities. Where the materiality threshold calculated in this

[[unofficial translation] way is breached, all individual exposures to this debtor should be considered defaulted. Documentation, internal policies and risk management processes 8.1. Timeliness of the identification of default 91. A credit institution should have effective processes that allow it to obtain the relevant information in order to identify defaults in a timely manner, and to channel the relevant information in the shortest possible time and, where possible, in an automated manner, to the personnel that is responsible for taking credit decisions, and more in particular: − where it applies automatic processes, such as counting of days past due, the identification of indications of default should be performed on a daily basis; − where it implements manual processes, such as checking external sources and databases, analysis of watch lists, analysis of the lists of forborne exposures, identification of SCRA, the information should be updated with a frequency that guarantees the timely identification of default. 92. A credit institution should verify on a regular basis that all forborne non-performing exposures are classified as default and subject to restructuring. A credit institution should also analyse on a regular basis the forborne performing exposures in order to determine whether any of them fulfils the indication of unlikeliness to pay as specified in Article 218 paragraph (4) item 4) of the Decision and in line with items 34 to 40 of these Guidelines. 93. Control mechanisms should ensure that the relevant information is used in the default identification process immediately after being obtained. All exposures to a defaulted debtor or all relevant exposures in case of the application of the definition of default at the facility level for retail exposures should be marked as defaulted in all relevant IT systems without undue delay. If delays occur in the recording of the default, such delays should not lead to errors or inconsistencies in risk management, risk reporting, the own funds requirements calculation or the use of data in risk quantification. In particular it should be ensured that the internal and external reporting figures reflect a situation where all exposures are correctly classified. 8.2. Documentation 94. A credit institution should document its policies regarding the definition of default including all triggers for identification of default and the exit criteria as well as clear identification of the scope of application of the definition of default and, more in particular it should: − document the operationalisation of all indications of default; − document the operationalisation of the criteria for reclassification of a defaulted

[[unofficial translation] debtor to a non-defaulted status; − keep an updated register of all definitions of default. 95. For the purposes of item 94 paragraph (1) provision under a) of these Guidelines, a credit institution should document the application of the definition of default in a detailed manner by including the operationalization of all indications of default, including the process, sources of information and responsibilities for the identification of particular indications of default. 96. For the purposes of item 94 paragraph (1) provision under b) of these Guidelines, a credit institution should document the operationalization of the criteria for reclassification of a defaulted debtor to a non-defaulted status, including the processes, sources of information and responsibilities assigned to relevant personnel in the credit institution. 97. For the purposes of items 95 and 96 of these Guidelines, the documentation should include description of all automatic mechanisms and manual processes, and where qualitative indications of default or criteria for the return to non-defaulted status are applied manually the description should be sufficiently detailed to facilitate common understanding and consistent application by all responsible personnel. 98. For the purposes of item 94 paragraph (1) provision under (c) of these Guidelines, a credit institution should keep an updated register of all current and past versions of the default definition at least starting from the date of application of these Guidelines. This register should include at least the following information: − the scope of application of the default definition, if there is more than one default definition used within the credit institution, the parent undertaking or any of its subsidiaries; − the body approving the definition or definitions of default and date of approval for each of those definitions of default; − the date of implementation of each definition of default; − brief description of all changes performed relatively to the last version; − in the case of a credit institution that has the authorisation to use the IRB Approach, the change category assigned, the date of submission to the Central Bank and, if applicable, the date of authorisation by the Central Bank. 8.3. Internal governance requirements for credit institutions applying the IRB Approach 99. A credit institution that uses the IRB Approach should adopt adequate mechanisms and procedures in order to ensure that the definition of default is implemented and used in a correct manner, and should in particular ensure that: − the definition of default and the scope of its application is what is required to be approved by the management board and by senior management of the credit institution in accordance with Article 208 paragraph (1) of the Decision;

[[unofficial translation] − the definition of default is used consistently for the purpose of the own funds requirements calculation and plays a meaningful role in the internal risk management processes by being used at least in the area of monitoring of exposures and in the internal reporting to senior management and management board; − the internal audit unit or another comparable independent auditing unit reviews regularly the robustness and effectiveness of the process used by the credit institution for the identification of default, taking into account in particular the timeliness of the identification of default referred to in items 91 to 93 of these Guidelines; and ensuring that the conclusions of the internal audit’s review and respective recommendations, as well as the measures taken to remedy the identified weaknesses are communicated directly to the supervisory board or the committee designated by it.

[[unofficial translation] ANNEX 3 MAIN INDICES AND RECOGNISED EXCHANGES Table 1: Main indices Index Country / Region Austrian Traded Index Austria BEL 20 Belgium CETOP20 Central Europe CNX 100 India CSI 300 Index China EGX 30 Egypt FTSE 350 UK FTSE All World Europe Europe FTSE All-World Index Global FTSE MIB Italy FTSE Nasdaq Dubai UAE 20 Index UAE FTSE RAFI Emerging Index Emerging markets FTSE Straits Times Index Singapore FTSE/JSE Capped Top 40 South Africa FTSE/JSE Industrial 25 South Africa Hang Seng Mainland 100 Index Hong Kong HDAX Germany IBEX 35 Spain IBOVESPA Brazil ISEQ 20 Ireland KOSPI 100 South Korea MSCI ACWI Index Global MSCI EM 50 Emerging markets NASDAQ-100 USA Nikkei 300 Japan NYSE ARCA China Index China OBX Norway OMX Copenhagen 25 Denmark OMX Helsinki 25 Finland

[[unofficial translation] OMXS60 Sweden Qatar Exchange General Index Qatar S&P 500 USA S&P BSE 100 India S&P Latin America 40 Latin America S&P/ASX 100 Australia S&P/BMV IPC Mexico S&P/NZX 10 New Zealand S&P/TSX 60 Canada SBF 120 France SET 50 Thailand SMI Expanded Switzerland STOXX Asia/Pacific 600 Asia/Pacific STOXX Europe 600 Europe TOPIX Mid 400 Japan TSEC Taiwan 50 Taiwan WIG20 Poland

[[unofficial translation] Table 2: Recognised exchanges on which contracts listed in Article 148 paragraph (8) of the Decision are not traded Regulated market MIC AIAF – MERCADO DE RENTA FIJA XDRF, SEND ATHENS EXCHANGE SECURITIES MARKET XATH BADEN-WUERTTEMBERGISCHE WERTPAPIER­ BOERSE STUC, STUA BOERSE BERLIN BERC, BERA, EQTB, EQTA BOERSE DUESSELDORF DUSC, DUSA BOERSE MUENCHEN MUNC, MUNA BOLSA DE BARCELONA XBAR, SBAR BOLSA DE BILBAO XBIL, SBIL BOLSA DE MADRID XMAD, MERF BOLSA DE VALENCIA XVAL BONDSPOT SECURITIES MARKET RPWC BOURSE DE LUXEMBOURG XLUX BRATISLAVA STOCK EXCHANGE XBRA BUCHAREST STOCK EXCHANGE XBSE BUDAPEST STOCK EXCHANGE XBUD BULGARIAN STOCK EXCHANGE – SOFIA JSC XBUL CBOE EUROPE CCXE CME AMSTERDAM BTAM CYPRUS STOCK EXCHANGE XCYS ELECTRONIC BOND MARKET MOTX ELECTRONIC ETF AND ETC/ETN MARKET – ETFplus ETFP ELECTRONIC SECONDARY SECURITIES MARKET HDAT ELECTRONIC SHARE MARKET MTAA EURONEXT AMSTERDAM XAMS EURONEXT BRUSSELS XBRU EURONEXT DUBLIN XMSM EURONEXT EXPAND XOAS EURONEXT LISBON XLIS EURONEXT OSLO XOSL EURONEXT PARIS XPAR FRANKFURTER WERTPAPIERBOERSE (REGU￾LIERTER MARKT) FRAA, XETA

[[unofficial translation] HANSEATISCHE WERTPAPIERBOERSE HAMBURG (REGULIERTER MARKT) HAMA, HAMM LJUBLJANA STOCK EXCHANGE OFFICIAL MARKET XLJU MALTA STOCK EXCHANGE XMAL, IFSM MARKET FOR INVESTMENT VEHICLES (MIV) MIVX MTS GOVERNMENT MARKET MTSC NASDAQ COPENHAGEN XCSE NASDAQ HELSINKI XHEL NASDAQ ICELAND XICE NASDAQ RIGA XRIS NASDAQ STOCKHOLM XSTO NASDAQ TALLINN XTAL NASDAQ VILNIUS XLIT NIEDERSAECHSISCHE BOERSE ZU HANNOVER (REGULIERTER MARKT) HANA NORDIC GROWTH MARKET NGM XNGM NXCHANGE XNXC PRAGUE STOCK EXCHANGE XPRA RM-SYSTEM CZECH STOCK EXCHANGE XRMZ TRADEGATE EXCHANGE (REGULIERTER MARKT) XGRM VIENNA STOCKEXCHANGE OFFICIAL MARKET (AMTLICHER HANDEL) WBAH WARSAW STOCK EXCHANGE XWAR, WBON, WETP ZAGREB STOCK EXCHANGE XZAG ASX LIMITED XASX CHI-X AUSTRALIA PTY LTD CHIA THE STOCK EXCHANGE OF HONG KONG LIMITED (SEHK) SHKG BOX OPTIONS EXCHANGE LLC XBOX CBOE BYX EXCHANGE, INC. (FORMERLY BATS BYX EXCHANGE, INC.; BATS Y-EXCHANGE, INC.) BATY CBOE BZX EXCHANGE, INC. (FORMERLY BATS BZX EXCHANGE, INC.; BATS EXCHANGE, INC.) BATS CBOE C2 EXCHANGE, INC. C2OX CBOE EDGA EXCHANGE, INC. (FORMERLY BATS EDGA EXCHANGE, INC.; EDGA EXCHANGE, INC.) EDGA CBOE EDGX EXCHANGE, INC. (FORMERLY BATS EDGX EXCHANGE, INC.; EDGX EXCHANGE, INC.) EDGX CBOE EXCHANGE, INC. CBSX

[[unofficial translation] CHICAGO STOCK EXCHANGE, INC. XCHI THE INVESTORS EXCHANGE LLC IEXG MIAMI INTERNATIONAL SECURITIES EXCHANGE XMIO MIAX PEARL, LLC MPRL NASDAQ BX, INC. (FORMERLY NASDAQ OMX BX, INC.; BOSTON STOCK EXCHANGE) BOSD NASDAQ GEMX, LLC (FORMERLY ISE GEMINI) GMNI NASDAQ ISE, LLC (FORMERLY INTERNATIONAL SECURITIES EXCHANGE, LLC) XISX NASDAQ MRX, LLC (FORMERLY ISE MERCURY) MCRY NASDAQ PHLX LLC (FORMERLY NASDAQ OMX PHLX, LLC; PHILADELPHIA STOCK EXCHANGE) XPHL THE NASDAQ STOCK MARKET XNAS NEW YORK STOCK EXCHANGE LLC XNYS NYSE ARCA, INC. ARCX AQUA SECURITIES L.P. AQUA ATS-1 MSTX ATS-4 MSPL ATS-6 MSRP BARCLAYS ATS BARX BARCLAYS DIRECTEX BCDX BIDS TRADING, L.P. BIDS CIOI CIOI CITIBLOC CBLC CITICROSS CICX CODA MARKETS, INC CODA CREDIT SUISSE SECURITIES (USA) LLC CAES DEUTSCHE BANK SECURITIES, INC DBSX EBX LLC LEVL INSTINCT X BAML INSTINET CONTINUOUS BLOCK CROSSING SYSTEM (CBX) ICBX INSTINET, LLC (INSTINET CROSSING, INSTINET BLX) XINS INSTINET, LLC (BLOCKCROSS) BLKX JPB-X JPBX J.P. MORGAN ATS (‘JPM-X’) JPMX JSVC LLC (*) LIQUIDNET H2O ATS LIUH

[[unofficial translation] LIQUIDNET NEGOTIATION ATS LIUS LUMINEX TRADING & ANALYTICS LLC LMNX NATIONAL FINANCIAL SERVICES, LLC NFSC POSIT ITGI SIGMA X2 SGMT SPOT QUOTE LLC () SPREAD ZERO LLC () UBS ATS UBSS USTOCKTRADE () VIRTU MATCHIT VFMI XE PJCX ()MIC codes not available on the ISO 10383 – codes list

[[unofficial translation] Table 3: Recognised exchanges on which contracts listed in Article 148 paragraph (8) of the Decision are traded Regulated market MIC ATHENS EXCHANGE DERIVATIVES MARKET XADE BUDAPEST STOCK EXCHANGE XBUD CBOE DERIVATIVES CDEX EUREX DEUTSCHLAND XEUR EURONEXT BRUSSELS DERIVATIVES XBRD EURONEXT COM, COMMODITIES FUTURES AND OPTIONS XEUC EURONEXT EQF, EQUITIES AND INDICES DERIVATIVES XEUE EUROPEAN ENERGY EXCHANGE XEEE, XEER FISH POOL FISH HENEX FINANCIAL ENERGY MARKET – DERIVATIVES MARKET HEDE HUDEX ENERGY EXCHANGE HUDX ICE ENDEX MARKETS NDEX ITALIAN DERIVATIVES MARKET XDMI MATIF XMAT MEFF EXCHANGE XMRV, XMPW, XMFX MERCADO DE FUTUROS E OPCOES MFOX MONEP XMON NASDAQ OSLO NORX NASDAQ STOCKHOLM XSTO NOREXECO NEXO OMIP – POLO PORTUGUES OMIP OSLO BØRS XOSL WARSAW STOCK EXCHANGE/COMMODITIES/POLISH POWER EXCHANGE/COMMODITY DERIVATIVES PLPD WARSAW STOCK EXCHANGE/ FINANCIAL DERIVATIVES WDER

[[unofficial translation] ANNEX 4 LIST OF MOST LIQUID CURRENCIES For the purposes of this Annex, the following currency designations shall apply:

  1. EUR (Euro),
  2. USD (US Dollar),
  3. JPY (Japanese Yen),
  4. GBP (Pound Sterling),
  5. CHF (Swiss Fran),
  6. CAD (Canadian Dollar),
  7. MXN (Mexican Peso),
  8. CNY (Chinese Yuan),
  9. NZD (New Zealand Dollar), 10)RUB (Russian Rubble), 11)HKD (Hong Kong Dollar), 12)SGD (Singapore Dollar), 13)TRY (Turkish Lira), 14)KRW (South Korean Won), 15)SEK (Swedish Krona), 16)ZAR (South African Rand), 17)INR (Indian Rupee),
  10. NOK (Norwegian Krone), 19)BRL (Brazilian Real), 20)AUD (Australian Dollar), 21)DKK (Danish Krone), 22)BGN (Bulgarian Lev), 23)HRK (Croatian Kuna). EUR/USD, EUR/JPY, EUR/GBP, EUR/CHF, EUR/CAD, EUR/MXN, EUR/CNY, EUR/NZD, EUR/RUB, EUR/HKD, EUR/SGD, EUR/TRY, EUR/KRW, EUR/SEK, EUR/ZAR, EUR/INR, EUR/NOK, EUR/BRL, EUR/AUD. USD/JPY, USD/GBP, USD/AUD, USD/CAD, USD/CHF, USD/MXN, USD/CNY, USD/NZD, USD/RUB, USD/HKD, USD/SGD, USD/TRY, USD/KRW, USD/SEK, USD/ZAR, USD/INR, USD/NOK, USD/BRL, USD/DKK, USD/BGN, USD/HRK. JPY/GBP, JPY/CAD, JPY/CHF, JPY/MXN, JPY/CNY, JPY/NZD, JPY/RUB, JPY/HKD, JPY/SGD, JPY/TRY, JPY/KRW, JPY/SEK, JPY/ZAR, JPY/INR, JPY/NOK, JPY/BRL, JPY/DKK, JPY/AUD, JPY/BGN, JPY/HRK. GBP/AUD, GBP/CAD, GBP/CHF, GBP/MXN, GBP/CNY, GBP/NZD, GBP/RUB, GBP/HKD, GBP/SGD, GBP/TRY, GBP/KRW, GBP/SEK, GBP/ZAR, GBP/INR, GBP/NOK, GBP/BRL, GBP/DKK, GBP/BGN, GBP/HRK.

[[unofficial translation] AUD/CAD, AUD/CHF, AUD/MXN, AUD/CNY, AUD/NZD, AUD/RUB, AUD/HKD, AUD/SGD, AUD/TRY, AUD/KRW, AUD/SEK, AUD/ZAR, AUD/INR, AUD/NOK, AUD/BRL. CAD/CHF, CAD/MXN, CAD/CNY, CAD/NZD, CAD/RUB, CAD/HKD, CAD/SGD, CAD/TRY, CAD/KRW, CAD/SEK, CAD/ZAR, CAD/INR, CAD/NOK, CAD/BRL. CHF/MXN, CHF/CNY, CHF/NZD, CHF/RUB, CHF/HKD, CHF/SGD, CHF/TRY, CHF/KRW, CHF/SEK, CHF/ZAR, CHF/INR, CHF/NOK, CHF/BRL, CHF/DKK, CHF/BGN, CHF/HRK. MXN/CNY, MXN/NZD, MXN/RUB, MXN/HKD, MXN/SGD, MXN/TRY, MXN/KRW, MXN/SEK, MXN/ZAR, MXN/INR, MXN/NOK, MXN/BRL. CNY/NZD, CNY/RUB, CNY/HKD, CNY/SGD, CNY/TRY, CNY/KRW, CNY/SEK, CNY/ZAR, CNY/INR, CNY/NOK, CNY/BRL. NZD/RUB, NZD/HKD, NZD/SGD, NZD/TRY, NZD/KRW, NZD/SEK, NZD/ZAR, NZD/INR, NZD/NOK, NZD/BRL. RUB/HKD, RUB/SGD, RUB/TRY, RUB/KRW, RUB/SEK, RUB/ZAR, RUB/INR, RUB/NOK, RUB/BRL. HKD/SGD, HKD/TRY, HKD/KRW, HKD/SEK, HKD/ZAR, HKD/INR, HKD/NOK, HKD/BRL. SGD/TRY, SGD/KRW, SGD/SEK, SGD/ZAR, SGD/INR, SGD/NOK, SGD/BRL. TRY/KRW, TRY/SEK, TRY/ZAR, TRY/INR, TRY/NOK, TRY/BRL. KRW/SEK, KRW/ZAR, KRW/INR, KRW/NOK, KRW/BRL. SEK/ZAR, SEK/INR, SEK/NOK, SEK/BRL. ZAR/INR, ZAR/NOK, ZAR/BRL. INR/NOK, INR/BRL. NOK/BRL.

[[unofficial translation] ANNEX 5 GUIDELINES on the calculation of the stress scenario risk measure I. DEVELOPMENT AND APPLICATION OF THE EXTREME SCENARIOS OF FUTURE SHOCK 1.1. Development of extreme scenarios of future shock and their application at risk factor level

  1. A credit institution shall develop the extreme scenarios of future shock for non￾modellable risk factors by applying either of the following methods: – the direct method set out in Part 1.2. of these Guidelines, provided that all of the following conditions are met: a) the credit institution concerned has criteria to determine whether to use the direct method referred to in indent 1 or the stepwise method referred to in indent 2 of this item, and those criteria are consistent over time; b) for the purposes of indent 1 under a), a credit institution documents any change from the direct method referred to in indent 1 to the stepwise method referred to in indent 2 of this item, and vice versa, including a justification of such change; c) the credit institution identifies, for internal monitoring purposes, the extreme scenario of future shock in accordance with the stepwise method referred to in indent 2 on a daily basis for 20 business days preceding each date for which the own funds requirements for market risk are reported; d) the number of losses in the time series of losses referred to in item 2 indent 1 under c), is equal to or greater than 200; – the stepwise method set out in item 3 of these Guidelines. 1.2. Direct method – non-modellable risk factors
  2. Under the direct method, a credit institution shall apply the following steps in the following order: – determine a time series of losses as follows: a) determine, in accordance with Part 1.3. of these Guidelines, the time series of 10 business days returns for the non-modellable risk factor for the stress period determined in accordance with Part 1.12. of these Guidelines; b) apply to the value of the non-modellable risk factor the shocks that correspond to the returns in the time series of 10 business days returns determined in accordance with indent 1 under a) of this item; c) determine the time series of losses by calculating the losses which

[[unofficial translation] would occur if the non-modellable risk factor takes the values obtained in accordance with indent 1 under b) of this item; – calculate the estimate of the right-tail expected shortfall in accordance with item 24 of these Guidelines for the time series of losses obtained in accordance with indent 1 of this item. 3. At the end of the process set out in the item 2 of these Guidelines, a shock leading to the loss equal to the estimate referred to in item 2 indent 2, shall constitute the extreme scenario of future shock for the non-modellable risk factor. 1.3. Stepwise method – non-modellable risk factors 4. Under the stepwise method, a credit institution shall apply the following steps in the following order: – in accordance with Part 1.7. of these Guidelines, determine the time series of 10 business days returns for the non-modellable risk factor for the stress period determined in accordance with Part 1.12.; – determine an upward and a downward calibrated shock from the time series of 10 business days returns referred to in indent 1 of this item in accordance with: a) the historical method set out in Part 1.8. of these Guidelines, where the number of returns in the time series of 10 business days returns referred to in indent 1 of this item is equal to or greater than 200; b) the asymmetrical sigma method set out in Part 1.9. of these Guidelines, where the number of returns in the time series of 10 business days returns referred to in indent 1 f this item is lower than 200 and equal to or greater than 12; c) the fallback method set out in Part 1.10. of these Guidelines, where the number of returns in the time series of 10 business days returns referred to in indent 1 of this item is lower than 12; – for each shock included in the following grid, a credit institution shall calculate the loss that occurs when that shock is applied to the non￾modellable risk factor: where: o CSdown is the downward calibrated shock determined in accordance with indent 2 of this item; o CSup is the upward calibrated shock determined in accordance with indent 2 of this item. 5. The shock which leads to the highest loss, among the shocks included in the grid

[[unofficial translation] referred to in item 4 indent 3, shall constitute the extreme scenario of future shock for the non-modellable risk factor. 1.4. Development and application of the extreme scenarios of future shock at standardised bucket level 6. Where a credit institution calculates a stress scenario risk measure for more than one non-modellable risk factor, it shall determine the extreme scenario of future shock for the non-modellable standardised bucket to which those risk factors belong by applying either of the following methods: – the direct method set out in Part 1.5. of these Guidelines, provided that all of the following conditions are met: a) criteria have been defined to determine whether to use the direct method referred to in Part 1.5. or the stepwise method referred to in Part 1.6., and those criteria are consistent over time; b) for the purposes of indent 1 under a), any change from the direct method to the stepwise method, and vice versa, shall be documented and justified; c) in addition to use of the direct method, the extreme scenario of future shock in accordance with the stepwise method referred to in indent 2 of this item shall be complementarily identified on a daily basis for 20 business days preceding each date for which the capital requirements for market risk are reported; d) the number of losses in the time series of losses referred to item 7 indent 1 under d) is equal to or greater than 200; – the stepwise method set out in Part 1.6. of these Guidelines. 1.5. Direct method – non-modellable standardised buckets 7. When applying the direct method to non-modellable risk factors belonging to non￾modellable standardised buckets, a credit institution shall apply the following steps in the following order: – determine a time series of losses as follows: a) for each non-modellable risk factor within the non-modellable bucket, in accordance with Part 1.7. of these Guidelines, determine the time series of nearest to 10 business days returns for the stress period determined in accordance with Part 1.12. of these Guidelines; b) remove from each time series obtained in accordance with indent 1 under a) of this item, the values corresponding to dates for which not all those time series have a return; c) for each non-modellable risk factor within the non-modellable bucket, apply to the value of the non-modellable risk factor the shocks that correspond to the returns in the corresponding time series obtained in accordance with indent 1 under b) of this item; d) determine the time series of losses by calculating, for each date

[[unofficial translation] corresponding to a value in the time series obtained in accordance with indent 1 under c) of this item, the loss that would occur if the non￾modellable risk factors in the non-modellable bucket takes the values included in those time series for that date; – they shall calculate the estimate of the right-tail expected shortfall in accordance with item 24 of these Guidelines for the time series of the losses obtained in accordance with indent 1 of this item. 8. The scenario of shocks leading to a loss equal to the estimate of the right-tail expected shortfall obtained in accordance with item 7 indent 2, shall constitute the extreme scenario of future shock for the non-modellable bucket. 1.6. Stepwise method – non-modellable standardised buckets 9. When applying the stepwise method to non-modellable risk factors belonging to non-modellable standardised buckets, a credit institution shall determine the extreme scenario of future shock by applying the following steps in the following order: – for each non-modellable risk factor within the non-modellable standardised bucket, in accordance with Part 1.7., determine the time series of 10 business days returns for the stress period determined in accordance with Part 1.12. of these Guidelines; – for each non-modellable risk factor within the non-modellable standardised bucket, determine an upward and a downward calibrated shock from the corresponding time series of 10 business days returns referred to in indent 1 of this item in accordance with: a) the historical method set out in Part 1.8. of these Guidelines, where the number of returns in all the time series of 10 business days returns referred to in indent 1 of this item corresponding to the non-modellable risk factors in the non-modellable bucket is equal to or greater than 200; b) the asymmetrical sigma method set out in Part 1.9. of these Guidelines, where the condition set out in indent 2 under a) of this item for using the historical method is not met, and the number of returns in all the time series of 10 business days returns referred to in indent 1 of this item corresponding to the non-modellable risk factors in the non￾modellable bucket is equal to or greater than 12; c) the fallback method set out in Part 1.10. of these Guidelines, where there is at least one non-modellable risk factor in the non-modellable bucket for which the number of returns in the time series of 10 business days returns referred to in indent 1 of this item is lower than 12; – calculate both of the following items: a) the loss corresponding to a scenario where the corresponding upward calibrated shock determined in accordance with indent 2 of this item, multiplied by a parameter β, is applied to each risk factor in the non￾modellable bucket;

[[unofficial translation] b) the loss corresponding to a scenario where the corresponding downward calibrated shock determined in accordance with indent 2 of this item, multiplied by a parameter β, is applied to each risk factor in the non-modellable bucket. For the purposes of indent 3 of this item, the upward and downward calibrated shocks shall be multiplied by the parameter β in two cases, with β = 1 and β = ⅘. 10.The scenario of shocks leading to the highest loss among those calculated in accordance with item 9 indent 3, shall constitute the extreme scenario of future shock for the non-modellable standardised bucket. 1.7. Determination of the time series of 10 business days returns 11.A credit institution shall determine the time series of 10 business days returns for the stress period in relation to a given non-modellable risk factor by applying the following steps in the following order: – determine the time series of observations for the non-modellable risk factor for the stress period and include in that time series only one observation per business day that shall represent actual market data; – extend the time series referred to in indent 1 of this item by including the observations available within the period of 20 business days following the stress period; where the reference date for the calculation of the stress scenario risk measure is less than 20 business days after the end of the stress period, those observations that are available from the end of the stress period to the reference date shall be include; – in relation to each date Dt, for which there is an observation in the time series resulting from indent 1 of this item, excluding the last observation, among the dates with an observation in the extended time series referred to in indent 2, the date Dt′ following Dt that minimises the following value shall be determined: where: o Dt is the date for which there is an observation in the time series referred to in indent 1, excluding the last observation, o Dt′ is a date following Dt with an observation in the extended time series referred to in indent 2 of this item; o the difference Dt′ – Dt is expressed in business days; – for each date Dt, for which there is an observation in the time series resulting from indent 1 of this item, excluding the last observation, determine the corresponding 10 business days return by determining the return for the non￾modellable risk factor over the period between the date Dt′ of the observation

[[unofficial translation] and the date minimising the value v in accordance with indent 3 of this item, and subsequently rescaling it to obtain a return over a 10 business days period by multiplying the return with:

  • For the purposes of indent 3 of this item, where there is more than one date minimising that value, the date Dt′ shall be the date among those minimising that value that occurred later in time. 12.The time series referred to in item 11 indent 1, shall at least include the observations that were used for calibrating the scenarios of future shocks referred to in Article 468 of this Decision, where that risk factor was previously assessed to be modellable in accordance with Article 470 of this Decision. 1.8. Downward and upward calibrated shock with the historical method 13.Under the historical method, a credit institution shall determine the downward calibrated shock from a time series of 10 business days returns for a non￾modellable risk factor in accordance with the following formula: where: o Ret denotes the time series of 10 business days returns of the non￾modellable risk factor o ESLeft(Ret) is the estimate of the left-tail expected shortfall for the time series Ret calculated in accordance with item 23 of these Guidelines; o N is the number of returns in the time series Ret. 14.A credit institution shall determine the upward calibrated shock from a time series of 10 business days returns for a non-modellable risk factor with the historical method in accordance with the following formula: where: o Ret denotes the time series of 10 business days returns of the non￾modellable risk factor, o ESRight(Ret) is the estimate of the right-tail expected shortfall for the

[[unofficial translation] time series Ret calculated in accordance with item 24 of these Guidelines; o N is the number of returns in the time series Ret. 1.9. Downward and upward calibrated shock with the asymmetrical sigma method 15.Under the asymmetrical sigma method, a credit institution shall determine the downward and upward calibrated shock from a time series of 10 business days returns for a non-modellable risk factor by applying the following steps in the following order: – determine the median of the returns within the time series, and split the 10 business days returns comprised in that time series into the following two subsets: a) the subset of 10 business days returns the value of which is equal to or lower than the median; b) the subset of 10 business days returns the value of which is greater than the median; – for each subset referred in indent 1 of this item, a credit institution shall compute the mean of the 10 business days returns in the subset; – a credit institution shall determine the downward calibrated shock in accordance with the following formula: downward calibrated shock where: o Ret denotes the time series of 10 business days returns of the non￾modellable risk factor; o Reti is the i-th return in the 10 business days returns time series Ret; o m is the median of the 10 business days returns time series Ret; o denotes the mean of the 10 business days returns computed in accordance with indent 2 of this item on the subset identified in accordance with indent 1 under a) of this item; o Ndown is the number of 10 business days returns in the subset determined in accordance with indent 1 under a) of this item; o N is the number of returns in the 10 business days returns time series Ret; o CES = 3; – A credit institution shall determine the upward calibrated shock in accordance with the following formula:

[[unofficial translation] upward calibrated shock where: o Ret denotes the time series of 10 business days returns of the non￾modellable risk factor; o Reti is the i-th return in the 10 business days returns time series Ret; o m is the median of the 10 business days returns time series Ret; o denotes the mean of the 10 business days returns computed in accordance with indent 2 on the subset determined in accordance with indent 1 under b) of this item; o Nup is the number of returns in the subset determined in accordance with indent 1 under b) of this item; o N is the number of returns in the 10 business days returns time series Ret; o CES = 3. 1.10. Downward and upward calibrated shock with the fallback method 16.Under the fallback method, a credit institution shall determine the downward and upward calibrated shock from the time series of 10 business days returns for a non-modellable risk factor by applying one of the methodologies set out in Part 1.10. of these Guidelines. 17.Where the non-modellable risk factor is equal to one of the risk factors defined in Subsection 1, Section 3, Subtitle 2, Title IV, Part Three of this Decision, a credit institution shall determine the downward and upward calibrated shock by applying the following steps in the following order: – they shall identify the risk-weight assigned to that risk factor in accordance with Subtitle 2, Title IV, Part Three of this Decision; – they shall multiply that risk-weight by where LH is the liquidity horizon of the non-modellable risk factor referred to in Article 469 of this Decision; – the downward and upward calibrated shock shall be the result of indent 2 of this item. 18.Where the non-modellable risk factor is a point of a curve or a surface and it differs from other risk factors as defined in Subsection 1, Section 3, Subtitle 2, Title IV, Part Three of this Decision only in relation to the maturity dimension, a credit institution shall determine the downward and upward calibrated shocks by

[[unofficial translation] applying the following steps in the following order: – from those risk factors defined in Subsection 1, Section 3, Subtitle 2, Title IV, Part Three of this Decision differing from the non-modellable risk factor only in the maturity dimension, a credit institution shall identify the risk factor that is the closest in the maturity dimension to the non-modellable risk factor; – they shall identify the risk-weight assigned in accordance with Subsection 1, Section 3, Subtitle 2, Title IV, Part Three of this Decision to the risk factor identified in accordance with indent 1 of this item; – that risk-weight shall be multiplied by where LH is the liquidity horizon of the non-modellable risk factor referred to in Article 469 of this Decision; – the downward and upward calibrated shock shall be the result of indent 3 of this item. 19.Where the non-modellable risk factor does not meet the conditions set out in items 17 and 18 of these Guidelines, a credit institution shall determine the corresponding downward and upward calibrated shocks by selecting a risk factor that meets the conditions set out in item 20 of these Guidelines and apply the method set out in item 21 of these Guidelines to that selected risk factor. 20.The risk factor to be selected in accordance with item 19 of these Guidelines shall meet all of the following conditions: – it belongs to the same broad risk factor category and broad sub-category of risk factors referred to in Article 469 of this Decision of the non-modellable risk factor; – it is of the same nature as the non-modellable risk factor; – it differs from the non-modellable risk factor for features that do not lead to an underestimation of the volatility of the non-modellable risk factor, including under stress conditions; – its time series of 10 business days returns referred to in item 21 indent 1 of these Guidelines, contains at least 12 returns. 21.Under the method referred to item 19 of these Guidelines, a credit institution shall apply the following steps in the following order: – for the selected risk factor, in accordance with item 22 of these Guidelines, determine the time series of 10 business days returns for the stress period determined in accordance with Part 1.12. of these Guidelines; – determine the downward and upward calibrated shocks for the selected risk factor with: a) the historical method set out in Part 1.8. of these Guidelines, where the number of returns in the time series of 10 business days returns for the selected risk factor referred to in indent 1 of this item is equal to or greater than 200;

[[unofficial translation] b) the asymmetrical sigma method set out in Part 1.9. of these Guidelines, where the number of returns in the time series of 10 business days returns for the selected risk factor referred to in indent 1 of this item is lower than 200; – determine the downward calibrated shock for the non-modellable risk factor by multiplying the downward shock for the selected risk factor determined in accordance with indent 2 of this item by: where is one of the following, depending on which method has been used to determine the downward calibrated shock for the selected risk factor in accordance with indent 2 of this item: a) the number of returns in the time series of 10 business days returns for the selected risk factor referred to in indent 1 of this item, where the downward calibrated shock for the selected risk factor was determined using the historical method; b) the number of returns in the subset determined in accordance with item 15 indent 1 under a) where the downward calibrated shock for the selected risk factor was determined using the asymmetrical sigma method; – determine the upward calibrated shock for the non-modellable risk factor by multiplying the upward shock for the selected risk factor determined in accordance with indent 2 of this item by where: is one of the following, depending on which method has been used to determine the upward calibrated shock for the selected risk factor in accordance with indent 2 of this item: a) the number of returns in the time series of 10 business days returns for the selected risk factor referred to in indent 1 of this item, where the credit institution used the historical method for determining the upward calibrated shock for the selected risk factor; b) the number of returns in the subset determined in accordance with item 15 indent 1 under b), where the credit institution used the asymmetrical sigma method for determining the upward calibrated shock for the selected risk factor. 22.By way of derogation from item 21 indent 2 under a) of these Guidelines, where a credit institution applies the method referred to in item 19 of these Guidelines to all non-modellable risk factors in a non-modellable standardised bucket, it shall determine the upward and downward shocks for all the corresponding selected risk factors in accordance with either of the following:

[[unofficial translation] – the historical method set out in Part 1.8. of these Guidelines, where the number of returns in the time series of 10 business days returns referred to in item 21 indent 1 of these Guidelines, is equal to or greater than 200 for all the selected risk factors; – the asymmetrical sigma method set out in Part 1.9. of these Guidelines, where the condition referred to in indent 1 of this item for applying the historical method is not met. 1.11. Estimators of the expected shortfall 23.The estimate of the left-tail expected shortfall of a time series X shall be calculated in accordance with the following formula: where: o N is the number of observations in the time series, o α = 2.5 %, o [α ×N] denotes the integer part of the product α ×N, o X(i) denotes the i-th smallest observation in the time series X. 24.A credit institution shall calculate the estimate of the right-tail expected shortfall of a time series X in accordance with the following formula: where is the estimate of left-tail expected shortfall for the time series – X in accordance with item 23 of these Guidelines. 1.12. Determination of the stress period 25.A credit institution shall determine the stress period for the non-modellable risk factors in a broad category of risk factors by identifying the 12-month observation period maximising the value obtained in accordance with following formula: where: o i denotes the broad risk factor category; o j is the index denoting the non-modellable risk factors or the non-modellable standardised buckets for which the credit institution calculates the stress scenario risk measure belonging to the broad risk factor category I; o RSSj is the rescaled stress scenario risk measure for the non-modellable risk factor or the non-modellable standardised bucket j calculated in accordance

[[unofficial translation] with Part 4.1. of these Guidelines. 26.By way of derogation from item 25 of these Guidelines, a credit institution may determine the stress period for the non-modellable risk factors in a broad risk factor category by identifying the 12-month observation period maximising the partial expected shortfall measure PESRS;i referred to in Article 467 paragraph (1) of this Decision. Where a credit institution applies this derogation, it shall provide evidence that the stress period identified represents a period of financial stress for its non-modellable risk factors. A credit institution shall take into account how its portfolio is exposed to the non-modellable risk factors in the broad category of risk factors. 27.When determining the stress period, a credit institution shall use an observation period starting at least from 1 January 2007. 28.A credit institution shall review the stress period identified at least with a quarterly frequency. 1.13. Computation of the losses 29.A credit institution shall calculate the loss corresponding to a scenario of future shock applied to one or more non-modellable risk factors by calculating the loss on the portfolio of positions for which they calculate the capital requirements for market risk in accordance with the alternative internal model approach set out in Subtitle 3, Title IV, Part Three of this Decision, and that occurs if that scenario of future shock is applied to that non-modellable risk factor or those non-modellable risk factors in a standardised bucket, and all other risk factors remain unchanged. 30.A credit institution shall calculate the loss corresponding to a scenario of future shock applied to one or more non-modellable risk factors by using the pricing methods used in the risk measurement model. 31.By way of derogation from item 30 of these Guidelines, where a credit institution cannot calculate the loss for some financial instruments or commodities included in the portfolio referred to in item 29 of these Guidelines, corresponding to a scenario of future shock applied to one or several non-modellable risk factors by using their pricing methods, it shall apply the following steps in the following order: – identify those financial instruments or commodities and the cause of the failure of the pricing calculation; – use sensitivity-based pricing methods to reflect the change in the price of those financial instruments or commodities due to changes in the non￾modellable risk factors in this scenario of future shock. 32.By way of derogation from item 30 of these Guidelines, a credit institution may, only for the purpose of determining the stress period in accordance with item 25 of these Guidelines, calculate the loss corresponding to a scenario of future shock

[[unofficial translation] applied to one or more non-modellable risk factors using sensitivity-based pricing methods. A credit institution shall demonstrate that the price changes that are not captured by the sensitivity-based pricing methods would not modify the stress period identified by the credit institution. II. REGULATORY EXTREME SCENARIO OF FUTURE SHOCK 2.1. Determination of the regulatory extreme scenario of future shock 33.The regulatory extreme scenario of future shock referred to in Article 476 shall be a shock leading to the maximum loss that may occur due to a change in the non￾modellable risk factor where such maximum loss is finite. 34.Where the maximum loss referred to in item 33 of these Guidelines is not finite, a credit institution shall determine the regulatory extreme scenario of future shock by applying the following steps in the following order: – use an expert-based approach using qualitative and quantitative information available to identify a loss due to a change in the value taken by the non￾modellable risk factor that will not be exceeded with a level of certainty equal to 99,95% on a 10 business-day horizon in a future period of financial stress equivalent to the stress period identified for the non-modellable risk factor. When doing so, the skewness and the excess kurtosis shall be taken into account that may characterise the returns of the non-modellable risk factor in a period of financial stress and any distributional or statistical assumptions taken for identifying that loss shall be justified; – a credit institution shall multiply the loss obtained in accordance with indent 1 of this item by: where LHadj = max (20,LH), and where LH is the liquidity horizon for the non￾modellable risk factor or for the risk factors within the non-modellable standardised bucket referred to in Article 469 of this Decision; – identify the regulatory extreme scenario of future shock as the shock leading to the loss resulting from indents 1 and 2 of this item. 35.Where a credit institution calculates a stress scenario risk measure for more than one non-modellable risk factor as referred to in Article 476 of this Decision, the regulatory extreme scenario of future shock referred to in Article 476 of this Decision shall be a scenario leading to the maximum loss that may occur due to a change in the values taken by those non-modellable risk factors. 36.By way of derogation of item 35 of these Guidelines, where a stress scenario risk measure is calculated for more than one non-modellable risk factor as referred to in Article 476 of this Decision and the maximum loss referred to in item 35 of

[[unofficial translation] these Guidelines is not finite, a credit institution shall determine the regulatory extreme scenario of future shock by applying the following steps in the following order: – use an expert-based approach using qualitative and quantitative information available to identify a loss due to a change in the values taken by the non￾modellable risk factors that will not be exceeded with a level of certainty equal to 99,95% on a 10 business-day horizon in a future period of financial stress equivalent to the stress period for the non-modellable risk factors. When doing so, the skewness and the excess kurtosis shall be taken into account that may characterise the returns of the non-modellable risk factors in a period of financial stress and any distributional or statistical assumptions taken for identifying that loss shall be justified; – multiply the loss obtained in accordance with indent 1 of this item by: where LHadj = max (20,LH), and where LH is the liquidity horizon for the non￾modellable risk factors referred to in Article 469 of this Decision; – identify the regulatory extreme scenario of future shock as the scenario leading to the loss resulting from indents 1 and 2 of this item. III. CIRCUMSTANCES UNDER WHICH A STRESS SCENARIO RISK MEASURE FOR MORE THAN ONE NON-MODELLABLE RISK FACTOR MAY BE CALCULATED 3.1. Circumstances for the calculation of a stress scenario risk measure for more than one non-modellable risk factor 37.The circumstances under which a credit institution may calculate a stress scenario risk measure for more than one non-modellable risk factor as referred to in Article 476 of this Decision shall be the following: – the risk factors belong to the same standardised bucket; – the modellability of those risk factors was assessed by determining the modellability of the standardised bucket. IV. AGGREGATION OF THE STRESS SCENARIO RISK MEASURES 4.1. Aggregation of the stress scenario risk measures 38.For the purposes of aggregating the stress scenario risk measures as referred to in Article 476 of this Decision, a credit institution shall, for each stress scenario risk measure it has computed, determine the corresponding rescaled stress

[[unofficial translation] scenario risk measure as follows: – where the extreme scenario of future shock for a single risk factor has been determined in accordance with the stepwise method set out to in Part 1.3. of these Guidelines, the corresponding rescaled stress scenario risk measure shall be calculated in accordance with the following formula: where: o RSS is the rescaled stress scenario risk measure for the non-modellable risk factor, o SS is the stress scenario risk measure for the non-modellable risk factor, LHadj = max (20, LH), and where LH is the liquidity horizon referred to in Article 469 of this Decision for the non-modellable risk factor, o κ is the non-linearity coefficient for the non-modellable risk factor calculated in accordance with Part 4.2. of these Guidelines; – where a stress scenario risk measure for more than one risk factor has been determined by determining an extreme scenario of future shock in accordance with the stepwise method set out in Part 1.6. of these Guidelines for a non￾modellable standardised bucket comprising those risk factors, the corresponding rescaled stress scenario risk measure shall be calculated in accordance with the following formula: where: o RSS is the rescaled stress scenario risk measure for the non-modellable standardised bucket, o SS is the stress scenario risk measure for the non-modellable standardised bucket, LHadj = max (20, LH), and where LH is the liquidity horizon referred to in Article 469 of this Decision for the risk factors within the non-modellable standardised bucket, o κ is the non-linearity coefficient for the non-modellable standardised bucket calculated in accordance with Part 4.3. of these Guidelines; – where the extreme scenario of future shock for a single risk factor has been determined in accordance with the direct method set out in Part 1.2. of these Guidelines, the corresponding rescaled stress scenario risk measure shall be calculated with the following formula: where:

[[unofficial translation] o RSS is the rescaled stress scenario risk measure for the non-modellable risk factor, o SS is the stress scenario risk measure for the non-modellable risk factor, LHadj = max (20, LH), and where LH is the liquidity horizon referred to in Article 469 of this Decision; o for the non-modellable risk factor in a non-modellable standardised bucket, o UCF is the uncertainty compensation factor to be calculated in accordance with Part 4.5. of these Guidelines; – where a stress scenario risk measure for more than one risk factor has been determined by determining an extreme scenario of future shock in accordance with the direct method set out in Part 1.5. of these Guidelines for the non￾modellable bucket comprising those risk factors, the corresponding rescaled stress scenario risk measure shall be calculated in accordance with the following formula: where: o RSS is the rescaled stress scenario risk measure for the non-modellable standardised bucket, o SS is the stress scenario risk measure for the non-modellable standardised bucket, LHadj = max (20, LH), and where LH is the liquidity horizon referred to in Article 469 of this Decision for the risk factors within the non-modellable bucket, o UCF is the uncertainty compensation factor to be calculated in accordance with Part 4.5. of these Guidelines; – where a credit institution has determined a stress scenario risk measure by determining a regulatory extreme scenario of future shock in accordance with Part 2.1. of these Guidelines, the corresponding rescaled stress scenario risk measure shall be calculated in accordance with the following formula: where: o RSS the rescaled stress scenario risk measure, o SS is the stress scenario risk measure. 39. A credit institution shall aggregate the stress scenario risk measures in accordance with the following formula:

[[unofficial translation] where: o ICSR denotes the set of non-modellable risk factors or non-modellable standardised buckets for which a stress scenario risk measure has been determined that was classified as reflecting idiosyncratic credit spread risk only, in accordance with item 40 of these Guidelines; o k is an index denoting the non-modellable risk factors or non-modellable standardised buckets belonging to ICSR; o EIR denotes the set of non-modellable risk factors or non-modellable standardised buckets for which a stress scenario risk measure has been determined that was classified as reflecting idiosyncratic equity risk only, in accordance with item 41 of these Guidelines; o l is an index denoting the non-modellable risk factors or non-modellable standardised buckets belonging to EIR; o OR denotes a non-modellable risk factor or non-modellable standardised bucket for which institutions determine a stress scenario risk measure that was neither classified as reflecting idiosyncratic credit spread risk only, in accordance with item 40 of these Guidelines, nor idiosyncratic equity risk only, in accordance with item 41 of these Guidelines; o j is an index denoting the non-modellable risk factors or non-modellable standardised buckets belonging to OR; o RSSk ; RSSl ; RSSj are respectively the rescaled stress scenario risk measures for the non-modellable risk factors or the non-modellable standardised buckets k, l, j calculated in accordance with item 38 of these Guidelines; o ρ=0.6 40.The non-modellable risk factors that a credit institution classifies as reflecting idiosyncratic credit spread risk only shall meet all of the following conditions: – the nature of the risk factor is such that it reflects idiosyncratic credit spread risk only; – the value taken by the risk factor is not driven by systematic risk components; – the correlation among risk factors is negligible; – a credit institution performs and documents the statistical tests used to verify the condition set out in indent 3 of this item. 41.The non-modellable risk factors that a credit institution classifies as reflecting idiosyncratic equity risk only shall meet all of the following conditions: – the nature of the risk factor is such that it reflects idiosyncratic equity risk only; – the value taken by the risk factor is not driven by systematic risk components; – the correlation among risk factors is negligible; – a credit institution performs and documents the statistical tests used to verify the condition set out in indent 3 of this item. 4.2. Non-linearity coefficient for a single risk factor

[[unofficial translation] 42.Where the stress scenario risk measure for which a credit institution is determining the non-linearity coefficient has been determined for a single risk factor, such non-linearity coefficient shall be determined as follows: – where the extreme scenario of future shock for the non-modellable risk factor does not coincide with either the downward calibrated shock or the upward calibrated shock determined in accordance with item 4 indent 2 of these Guidelines, a credit institution shall set κ=1 for that non-modellable risk factor; – where the extreme scenario of future shock for the non-modellable risk factor coincides with the downward calibrated shock determined in accordance with item 4 indent 2 of these Guidelines, the non-linearity coefficient shall be calculated in accordance with the following formula: where: o kmin= 0.9 o kmax=5 o ɸ is the estimate of the tail parameter for the non-modellable risk factor calculated in accordance with Part 4.4. of these Guidelines; o loss0 is the loss that occurs when the downward shock CSdown determined in accordance with item 4 indent 2 of these Guidelines is applied to the non-modellable risk factor; o loss-1 is the loss that occurs when a downward shock equal to 4 5 ×CSdown is applied to the non-modellable risk factor, where CSdown is the downward shock determined in accordance with item 4 indent 2 of these Guidelines; o loss+1 is the loss that occurs when a downward shock equal to 6 5 ×CSdown is applied to the non-modellable risk factor, where CSdown is the downward shock determined in accordance with item 4 indent 2 of these Guidelines; – where the extreme scenario of future shock for the non-modellable risk factor coincides with the upward calibrated shock determined in accordance with item 4 indent 2 of these Guidelines, a credit institution shall calculate the non￾linearity coefficient in accordance with the following formula: where: o kmin= 0.9; o kmax=5; o ɸ is the estimate of the tail parameter for the non-modellable risk factor calculated in accordance with Part 4.4. of these Guidelines; o loss0 is the loss that occurs when the upward shock CSup determined in accordance with item 4 indent 2 of these Guidelines is applied to the

[[unofficial translation] non-modellable risk factor; o loss-1 is the loss that occurs when an upward shock equal to 4 5 ×CSup is applied to the non-modellable risk factor, where CSup is the upward shock determined in accordance with item 4 indent 2 of these Guidelines; o loss+1 is the loss that occurs when an upward shock equal to 6 5 ×CSup is applied to the non-modellable risk factor, where CSup is the upward shock determined in accordance with item 4 indent 2 of these Guidelines; 4.3. Non-linearity coefficient for a bucket 43.Where the stress scenario risk measure for which a credit institution is determining the non-linearity coefficient has been determined for a non￾modellable standardised bucket, the non-linearity coefficient shall be determined as follows: – where the extreme scenario of future shock does not correspond to a scenario identified in accordance with item 9 indent 2 of these Guidelines, where the value of the parameter β referred to in 9 indent 3 of these Guidelines is set equal to 1, a credit institution shall set the non-linearity coefficient κ=1 for that non-modellable bucket; – where the extreme scenario of future shock is a scenario where the corresponding downward shock determined in accordance with item 9 indent 2 of these Guidelines is applied to each risk factor in the non-modellable bucket, the non-linearity coefficient shall be calculated in accordance with the following formula: where: o kmin= 0.9; o kmax=5; o ɸmedian is the median of the estimates of the tail parameters calculated in accordance with Part 4.4. of these Guidelines for each of the risk factors within the bucket; o loss0 is the loss occurring when the corresponding downward shock determined in accordance with item 9 indent 2 of these Guidelines, is applied to each risk factor in the non-modellable bucket; o loss-1 is the loss occurring when the corresponding downward shock determined in accordance with item 9 indent 2, multiplied by 4 5 is applied to each risk factor in the non-modellable bucket; o loss+1 is the loss occurring when the corresponding downward shock determined in accordance with item 9 indent 2 of these Guidelines,

[[unofficial translation] multiplied by 𝟔𝟔 𝟓𝟓 is applied to each risk factor in the non-modellable bucket; – where the extreme scenario of future shock is a scenario where the corresponding upward shock determined in accordance with item 9 indent 2 of these Guidelines, is applied to each risk factor in the non-modellable bucket, a credit institution shall calculate the non-linearity coefficient in accordance with the following formula: where: o kmin= 0.9; o kmax=5; o ɸmedian is the median of the estimates of the tail parameters calculated in accordance with Part 4.4. of these Guidelines for each of the risk factors within the bucket; o loss0 is the loss occurring when the corresponding upward shock determined in accordance with item 9 indent 2 of these Guidelines, is applied to each risk factor in the non-modellable bucket, o loss-1 is the loss occurring when the corresponding upward shock determined in accordance with item 9 indent 2, multiplied by 4 5 is applied to each risk factor in the non-modellable bucket; o loss+1 is the loss occurring when the corresponding upward shock determined in accordance with item 9 indent 2 of these Guidelines, multiplied by 6 5 is applied to each risk factor in the non-modellable bucket; 4.4. Calculation of the estimate of the tail parameter 44.A credit institution shall calculate the estimate of the tail parameter for a given non-modellable risk factor as follows: – where a credit institution used the historical method set out in Part 1.8. of these Guidelines for determining the downward and upward calibrated shock of that non-modellable risk factor and the extreme scenario of future shock is the downward calibrated shock, it shall calculate the estimate of the tail parameter in accordance with the following formula:

[[unofficial translation] where: o α = 2.5%; o Ret is the time series of 10 business days returns for the non￾modellable risk factor used in the historical method set out in Part 1.8. of these Guidelines; o Ret(i) represents the i-th smallest return in the time series Ret; o [α ×N] denotes the integer part α ×N; o is the estimate of the left-tail expected shortfall for the time series Ret calculated in accordance with item 23 of these Guidelines; – where a credit institution used the historical method set out in Part 1.8. of these Guidelines for determining the downward and upward calibrated shock of that non-modellable risk factor and the extreme scenario of future shock is the upward calibrated shock, it shall calculate the estimate of the tail parameter in accordance with the following formula: where: o α = 2.5%; o Ret is the time series of 10 business days returns for the non-modellable risk factor used in the historical method set out in Part 1.8. of these Guidelines, o - Ret(i) represents the i-th smallest return in the time series Ret; o [α ×N] denotes the integer part of α ×N, o is the estimate of the right-tail expected shortfall for the time series Ret calculated in accordance with item 23 of these Guidelines; – in all other cases the estimate of the tail parameter shall be set at ɸ = 1.04 4.5. Calculation of the uncertainty compensation factor 45.Where the stress scenario risk measure, for which a credit institution is determining the uncertainty compensation factor, has been determined for a single risk factor, the uncertainty compensation factor shall be equal to: where N is the number of losses in the time series referred to in item 2 indent 1 under c) from which the extreme scenario of future shock has been determined for the non-modellable risk factor in accordance with that Article.

[[unofficial translation] 46.Where the stress scenario risk measure for which a credit institution is determining the uncertainty compensation factor has been determined for a non￾modellable standardised bucket, the uncertainty compensation factor shall be equal to: where N is the number of losses in the time series referred to in item 7 indent 1 under d), from which the extreme scenario of future shock has been determined for the non-modellable bucket in accordance with that Article. V. QUALITATIVE REQUIREMENTS 5.1. Documentation of the criteria and methods 47.For the purposes of developing extreme scenarios of future shock, determining the regulatory extreme scenario of future shock, and aggregating the stress scenario risk measures, the set of internal policies referred to in Article 474 paragraph (1) item 5) of this Decision, shall include documentation of any information necessary to demonstrate that the applicable criteria and methods laid down in this Decision are complied with, in particular in relation to criteria on the application of choices, assumptions made, conditions, required steps for applying the derogations, and justifications, where applicable.

ANNEX 6 LIST OF APPROPRIATELY DIVERSIFIED INDICES Index Country/Region

  1. STOXX Asia/Pacific 600 Asia/Pacific
  2. ASX100 Australia
  3. ATX Austria
  4. ATX Prime Austria
  5. BEL20 Belgium
  6. SaoPaulo – Bovespa Brazil
  7. TSX60 Canada
  8. CETOP20 Index Central Europe
  9. CSI 100 Index China
  10. CSI 300 Index China
  11. FTSE China A50 Index China
  12. Hang Seng Mainland 100 China China
  13. OMX Copenhagen 25 Denmark
  14. OMX Copenhagen Benchmark Denmark
  15. FTSE RAFI Developed 1000 Developed Markets
  16. CECE Composite Index EUR Eastern Europe
  17. FTSE RAFI Emerging Markets Emerging Markets
  18. MSCI Emerging Markets 50 Emerging Markets
  19. Cboe Eurozone 50 Europe
  20. DJ Euro STOXX 50 Europe
  21. FTSE All World Europe Europe
  22. FTSE Euro 100 Europe
  23. FTSE Eurofirst 100 Europe
  24. FTSE Eurofirst 300 Europe
  25. FTSE Eurofirst 80 Europe
  26. FTSE Eurotop 100 Europe
  27. MSCI Euro Europe
  28. MSCI Europe Europe
  29. MSCI Pan-Euro Europe
  30. NTX New Europe Blue Chip Europe
  31. S&P Euro Europe
  32. S&P Europe 350 Europe
  33. STOXX All Europe 100 Europe
  34. STOXX All Europe 800 Europe
  35. STOXX Europe 50 Europe

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 714 Index Country/Region 36. STOXX Europe 600 Europe 37. STOXX Europe 600 Equal Weight Europe 38. STOXX Europe Lrg 200 Europe 39. STOXX Europe Mid 200 Europe 40. STOXX Europe Small 200 Europe 41. STOXX Select Dividend 30 Europe 42. OMXH25 Finland 43. CAC40 France 44. Cboe France 40 France 45. SBF 120 France 46. Cboe Germany 40 Germany 47. DAX Germany 48. HDAX Germany 49. MDAX Germany 50. SDAX Germany 51. FTSE RAFI All World Global 52. MSCI World Index Global 53. Athens General Greece 54. FT ASE Large Cap Greece 55. Hang Seng Hong Kong 56. Hang Seng China Enterprises Hong Kong 57. NIFTY 50 India 58. S&P BSE 100 India 59. ISEQ 20 Ireland 60. Cboe Italy 40 Italy 61. FTSE MIB Italy 62. Nikkei225 Japan 63. Nikkei300 Japan 64. TOPIX 400 Japan 65. TOPIX Core 30 Japan 66. S&P Latin America 40 Latin America 67. FTSE Bursa Malaysia KLCI Malaysia 68. FTSE Bursa Malaysia Top100 Malaysia 69. MSE Share Index Malta 70. INMEX Index Mexico 71. IPC Index Mexico 72. AEX Netherlands 73. AMX Netherlands 74. Cboe Netherlands 25 Netherlands

[[unofficial translation]

Decision on Capital Adequacy of Credit Institutions (OGM 65/25) 715 Index Country/Region 75. NZSE50 New Zealand 76. Cboe Norway 25 Norway 77. OBX Norway 78. OBXP Norway 79. mWIG40 Poland 80. WIG20 Poland 81. MSCI Singapore Free Index Singapore 82. Straits Times Index Singapore 83. FTSE JSE Top 40 South Africa 84. Cboe Spain 35 Spain 85. IBEX35 Spain 86. Cboe Sweden 30 Sweden 87. OMX Stockholm 30 Sweden 88. Cboe Switzerland 20 Switzerland 89. SMI Switzerland 90. SMI MID Switzerland 91. SET 50 Thailand 92. Cboe UK 100 UK 93. FTSE 100 UK 94. FTSE AIM 100 UK 95. FTSE AIM UK 50 UK 96. FTSE Fledgling UK 97. FTSE mid-250 UK 98. FTSE Small Cap UK 99. Dow Jones Ind. Av. USA 100. NASDAQ 100 USA 101. S&P 500 USA

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