Instruction No. 003/2022-CSBF of December 20, 2022 on the Capital Requirements for Credit Institutions

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CENTRAL BANK OF MADAGASCAR BANKING AND FINANCIAL SUPERVISION COMMISSION

INSTRUCTION NO. 003/2022-CSBF ON THE CAPITAL REQUIREMENTS FOR CREDIT INSTITUTIONS

The Banking and Financial Supervision Commission (CSBF), Having regard to Law No. 2020-011 of September 1, 2020 on banking law, Having regard to Instruction No. 002/2022-CSBF of December 20, 2022 on the regulatory capital of credit institutions, Having regard to the opinion formulated by the Professional Association of Banks and Financial Institutions,

DECIDES

SECTION 1 - GENERAL PROVISIONS

Article 1: Purpose This instruction aims to establish the regulatory capital requirements for credit institutions, excluding microfinance institutions.

Article 2: Definitions For the purposes of this instruction, the following terms shall mean:

• credit institution, abbreviated as CI, any financial institution referred to in Article 14 of the aforementioned banking law;

• regulatory capital, the capital as defined by Instruction No. 002/2022-CSBF on the regulatory capital of CIs;

• risk-weighted assets, the denominator of the solvency ratio defined in Article 3 below, equivalent to the sum of credit risk-weighted assets and operational and market risks determined in accordance with the provisions of this instruction;

• credit risk, the risk incurred in the event of a counterparty's default;

• market risk, the risk of loss in the value of on-balance sheet or off-balance sheet positions in interest rate and currency derivatives, equities, foreign exchange, and commodities due to market price fluctuations;

• operational risk, the risk of losses resulting from deficiencies or failures attributable to internal procedures, personnel, systems, or external events to CIs, such as internal and external fraud, inappropriate employment practices, workplace safety practices, client and product practices, and commercial practices; business interruptions or system failures; it includes legal risk and excludes strategic and reputational risks;

• retail clientele, the clientele of a CI defined as such by circular of the President of the CSBF;

• small and medium-sized enterprises (SMEs), any enterprise meeting the criteria set by circular of the President of the CSBF;

• partially mutualized guarantee fund, any fund allocated to guarantee certain categories of loans or commitments by signature, and which covers only the risks related to these operations. Only defaults by beneficiaries registered in the guarantee fund trigger its activation. The instruments governing the operation of these funds are communicated to the General Secretariat of the CSBF.

SECTION 2 - MINIMUM REQUIREMENTS

Article 3: Minimum Capital Requirements

3.1. CIs must permanently maintain a minimum ratio, known as the solvency ratio or minimum capital requirement (MCR), between the amount of their regulatory capital defined in Article 2 of this instruction and risk-weighted assets under the conditions set forth in this instruction.

3.2. The MCR is set at a minimum of 8%. It consists of the sum of the following three (3) components:

• a requirement for covering credit risk, determined in accordance with Section 3 of this instruction;
• a requirement for covering operational risk, determined in accordance with Section 4 of this instruction;
• a requirement for covering market risk, determined in accordance with Section 5 of this instruction.

The MCR is calculated according to the following formula:

MCR = [Regulatory Capital / (Credit Risk + Operational Risk + Market Risk)] ≥ 8 %

with

• Regulatory Capital defined by Article 3 of the aforementioned Instruction No. 002/2022-CSBF
• Credit Risk = Net risk-weighted credit risk (Section 3)
• Operational Risk = OCRR (Operating Capital Requirement for Operational Risk defined in Article 7) x 12.5
• Market Risk = MCRR (Market Risk Capital Requirement defined in Article 8) x 12.5

3.3. Basic CET1 capital, as defined by Article 4 of the aforementioned Instruction No. 002/2022-CSBF, must at all times be at least equal to 4.5% of the risk-weighted assets defined in Article 2 of this instruction.

3.4. Tier 1 capital, as defined by Article 3 of the aforementioned Instruction No. 002/2022-CSBF, must at all times be at least equal to 6% of the risk-weighted assets defined in Article 2 of this instruction.

3.5. Basic CET1 capital, as defined by Article 4 of the aforementioned Instruction No. 002/2022-CSBF, must at all times be at least equal to the minimum capital amount fixed for the category of CI in which the institution is licensed.

3.6. The CSBF may prescribe a higher ratio either for a category of CIs or for an institution individually, based on a reasoned decision according to the specific risk profile of the category of institution. The criteria defining the specific risk profile will be set by circular of the President of the CSBF.

The methods for calculating minimum capital requirements are illustrated in Annex 1.

Article 4: Application on an Individual or Consolidated Basis Compliance with the provisions of this instruction is carried out on an individual or consolidated basis, according to the following conditions:

• on an individual basis for each CI;
• on a consolidated basis, for those required to prepare consolidated accounts under international accounting standards, as they exercise exclusive control, joint control, or significant influence over other legal entities.

Consolidation rules are those defined by the Accounting Plan for CIs.

SECTION 3 - DETERMINATION OF CREDIT RISK

Article 5: Weightings and Conversion Factors for Credit Risks Credit risks consist of all asset items and off-balance sheet commitments exposed to counterparty default risk, subject to weightings and conversion factors under the conditions set forth below.

Credit risks to be taken into account for a given counterparty include assets held with third parties, credit commitments in any form, including subordinated loans, exposures to trading or investment securities, receivables related to these various items, and given off-balance sheet commitments.

5.1. The following assets are included in the risk base, subject to the following fixed weightings:

a) 0% for

• cash holdings in Ariary and foreign currencies;
• claims on the Malagasy State;
• claims on Banky Foiben'i Madagasikara;
• claims on borrowers assimilated to sovereigns, listed in Annex 2;
• claims on multilateral development banks listed in Annex 3;
• claims on public bodies outside central administrations backed by formal guarantees from the Malagasy State;
• claims on decentralized public authorities when both of the following conditions are met:
  • the authority has the power to levy taxes;
  • the authority's budget is approved by the State;

b) 20% for claims on CIs, except CIs in resolution;

c) 50% for

• mortgage loans secured by a first-ranking mortgage, or by several mortgages, all held by the reporting institution, on a residential property that is or will be occupied or rented by the borrower, and intended entirely for housing;
• other mortgage loans financing residential properties, meeting the conditions defined in the preceding paragraph and subject to several mortgages all held by the reporting institution. The 50% weighting applies to the outstanding amount of the aforementioned loans up to the market value of the concerned property or properties, determined based on a duly reasoned and updated expert report every 3 years;

e) 75% for

• financing of commercial buildings secured by a first-ranking mortgage or several mortgages all held by the reporting institution on the financed building, up to 70% of the property's market value, determined based on two independent expert reports updated every 3 years;
• loans to retail clientele as defined in Article 2 of this instruction;
• hire-purchase claims up to the market value of the financed asset;

f) 85% for loans to SMEs as defined in Article 2 of this instruction;

g) 100% for claims and other assets not covered by other provisions of this instruction, namely:

• claims on public bodies outside central administrations not backed by formal guarantees from the Malagasy State;
• loans not subject to a specific weighting and excluding doubtful, disputed, and litigious claims;
• the portion of outstanding residential or commercial mortgage financing guaranteed by mortgages, for the amount exceeding the limits set for taking mortgage guarantees into account;
• operations on dedicated private and public funds;
• immobilized claims;
• receivable accounts not linked to a counterparty;
• miscellaneous debtor and clearing asset accounts;
• net debtor balances of the following items:
  • branches and agencies;
  • clearing and values-to-be-compensated accounts;
• securities portfolio accounts when not linked to a counterparty:
  • trading portfolio;
  • investment securities;
• subordinated loans;
• fixed assets;

h) 150% for claims on CIs in resolution governed by banking law No. 2020-011.

5.2. The following asset items, subject to a variable weighting based on a rating, are included in the risk base as follows:

a) claims on multilateral development banks, other than those eligible for the 0% weighting above, based on their rating, which must be updated at least every 18 months:

External Rating of Counterparty	Weighting
AAA to AA-	20%
A+ to A-	30%
BBB+ to BBB-	50%
BB+ to B-	100%
Below B-	150%
Unrated	50%

In case of failure to update ratings, the applicable weighting is 100%, except for multilateral development banks with a rating below B- which remain weighted at 150%.

b) claims on foreign States and Central Banks of foreign countries as well as bilateral public aid agencies, based on the country risk classification published by the Organisation for Economic Co-operation and Development (OECD) on its website within the framework of the Export Credits Arrangement:

OECD Rating	Weighting
0 or 1 or unrated high-income country	0%
2	20%
3	50%
4, 5 or 6	100%
7	150%

c) claims on foreign credit institutions, based on their rating:

• in case of an external rating, the following weightings apply:

External Rating of Counterparty	Weighting
AAA to AA-	20%
A+ to A-	30%
BBB+ to BBB-	50%
BB+ to B-	100%
Below B-	150%

• in the absence of an external rating, the CI will rate the counterparty in tranches, according to the following classification and criteria:

Counterparty Credit Risk Assessment	Tranche A*	Tranche B**	Tranche C***
Standard Coefficient	40%	75%	150%
Weighting for short-term exposure risks	20%	50%	150%

• A banking counterparty is classified in Tranche A when it meets or exceeds the minimum capital requirements and conservation buffers established by its supervisory authority. ** A banking counterparty is classified in Tranche B when it meets or exceeds the minimum capital requirements, excluding buffers, established by its supervisory authority. *** A banking counterparty is classified in Tranche C when it does not comply with the minimum capital requirements in force in its jurisdiction. Classification in Tranche C is also justified if the Statutory Auditor has issued an adverse audit opinion on the latest verified financial statements or expressed substantial doubts regarding the counterparty's ability to continue as a going concern, or based on any other negative information regarding the counterparty's ability to honor its commitments.

• in the absence of an external rating or elements allowing tranche internal rating, or in the event of failure to update the rating, the applicable weighting is 100%.

5.3. Doubtful, disputed, and litigious claims (CDL), as defined in the instruction on risk provisioning, on all types of assets, are included in the risk base for the portion not covered by eligible collateral and guarantees as defined in paragraph 6.2 of this instruction and by specific provisions, applying the following weightings:

• 150% of the uncovered amount of claims for which specific provisions are less than 20% of that amount;
• 100% of the uncovered amount of claims for which said provisions are between 20% and 50% of that amount;
• 50% when said provisions are greater than 50% of the uncovered amount.

Each CI shall submit, as an annex to the monthly report, a summary statement of doubtful claims on the loan portfolio and other assets, listing outstanding amounts by exposure type and weighting, indicating:

• the gross amount of CDLs, i.e., the capital amount plus accrued and due interest (a);
• the amount of eligible collateral and guarantees retained in accordance with paragraph 6.2 of this instruction (b);
• the portion not covered by eligible collateral and guarantees [(a)-(b)];
• specific provisions for impairment losses established on CDLs.

5.4. Off-balance sheet items are converted into "credit risk equivalent" based on their potential risk level as defined according to the model set by circular of the President of the CSBF, applying the following conversion factors:

• 100% of the amount for high-risk commitments;
• 50% for medium-risk commitments;
• 20% for moderate-risk commitments;
• 10% for low-risk commitments.

The amounts thus determined are assigned the weightings applicable to the counterparty or the nature of the concerned asset.

Article 6: Deductible Elements from Credit Risks

6.1. The following items are deducted from the elements referred to in Article 5 above, under the corresponding heading: a) amounts deducted from regulatory capital in application of the relevant instruction, notably additional provisions to be set aside; b) impairment provisions on asset items as well as reserved income; c) all outstanding amounts covered by a partially mutualized guarantee fund or similar resources, when the ratio between the funds thus held and the guaranteed outstanding amounts is at least equal to the ratio set in Article 3 of this instruction. Otherwise, the deduction is limited to the amount that, relative to the guarantee fund, is covered by it according to the ratio set in Article 3 of this instruction.

6.2. Eligible guarantees for risk mitigation referred to in Article 5 of this instruction and deductible from the risks they cover are as follows:

a) guarantees deductible up to 100% of their amount:

• funds held as collateral for claims or commitments by the reporting institution such as security deposits and reserved provisions;
• guarantees issued by the Malagasy State;
• pledge of securities issued by the Malagasy State or Banky Foiben'i Madagasikara and held under the control of the beneficiary institution, notably by deposit on its books or notification to the issuer;
• pledge of securities issued by States or Central Banks of countries in categories 0 and 1 or high-income and unrated in the OECD country risk classification, provided the securities are held under its control;

b) guarantees deductible up to 80% of their amount:

• blocked deposits or pledged in favor of the institution in another CI;
• guarantees issued by multilateral development banks eligible for a 0% weighting or by other international lenders with prior CSBF approval. In case of risk sharing, the 80% ratio applies to the risk portion borne by the guarantors;

c) guarantees deductible according to the weighting applicable to the guarantor under the provisions of Article 5 of this instruction, with express approval from the General Secretariat of the CSBF:

• guarantees received from CIs and foreign credit institutions;
• blocked deposits or pledged in favor of the CI in a foreign credit institution;
• guarantees from multilateral development banks not eligible for 0%;
• guarantees issued by bilateral public aid agencies.

SECTION 4 - CAPITAL REQUIREMENT FOR OPERATIONAL RISK (OCRR)

Article 7: Determination of the OCRR CIs are required to calculate a specific capital requirement to cover their operational risks.

The capital requirement for operational risk is determined by applying a flat rate of 15% to the average positive net banking product (NBP) of the last three closed financial years, according to the following formula:

OCRR = 0.15 x [(NBP_{n-3} + NBP_{n-2} + NBP_{n-1}) / 3]

Where n: Current financial year NBP: Net Banking Product

When NBP is negative, the average is calculated based on the positive NBPs of the other years.

SECTION 5 - CAPITAL REQUIREMENT FOR MARKET RISK (MCRR)

Article 8: Determination of the MCRR CIs are required to calculate a specific capital requirement to cover their market risks.

The capital requirement for market risk is determined based on the CI's foreign exchange positions.

The requirement is calculated by applying the 8% solvency ratio to the higher amount of the sum of short foreign exchange positions and the sum of long foreign exchange positions defined by the instruction on foreign exchange positions, according to the following formula:

MCRR = 0.08[Max (ΣLong FX positions, ΣShort FX positions)]*

SECTION 6 - ADDITIONAL REQUIREMENTS

Article 9: Conservation Buffer 9.1. In addition to the capital requirements defined in Article 3 of this instruction, CIs must permanently maintain a conservation buffer of their capital equal to 2.5% of their risk-weighted assets, which must consist of basic CET1 capital.

Given the obligation to establish this conservation buffer, CIs must at all times comply with the following requirements:

• basic CET1 capital must be at least equal to 7% of risk-weighted assets;
• Tier 1 capital must be at least equal to 8.5% of risk-weighted assets;
• regulatory capital must be at least equal to 10.5% of risk-weighted assets.

9.2. Failure to comply with the requirements set in paragraph 9.1 above does not constitute an offense subject to disciplinary measures but requires the establishment or restoration of this conservation buffer when the set level is not met, by limiting profit distribution according to a variable percentage set in paragraph 9.3 below depending on the extent of the shortfall, without prejudice to other measures that the CSBF may require.

9.3. CIs that do not maintain the capital conservation buffer must retain the percentage of their distributable profits according to the following table:

CET1 Level relative to risk-weighted assets	Distributable profits to be retained
Between 4.5% and 5.125%	100%
> 5.125% and ≤ 5.75%	80%
> 5.75% and ≤ 6.375%	60%
> 6.375% and < 7%	40%
≥ 7%	0%

Article 10: Leverage Ratio CIs must maintain a leverage ratio of at least 3% between their Tier 1 capital and the total of their on-balance sheet assets, valued at net book value, and their off-balance sheet commitments, converted into "credit risk equivalent" in accordance with Article 5.4 of this instruction, according to the following formula:

Leverage Ratio = [Tier 1 Capital / (Total On-Balance Sheet Assets + Off-Balance Sheet Commitments in Credit Equivalent)] ≥ 3 %

The leverage ratio measures the adequacy of a CI's overall capital level relative to the size and growth of its assets.

The reporting procedures, reporting template, and effective date of the provisions relating to the leverage ratio are set by circular of the President of the CSBF.

SECTION 7 - MISCELLANEOUS AND FINAL PROVISIONS

Article 11: Reporting Obligations For the application of this instruction, CIs submit a declaration to the General Secretariat of the CSBF, prepared as of the date of the periodic accounting closing and attached thereto, according to the template set by circular of the President of the CSBF.

The monthly declaration is based on regulatory capital validated by the CSBF and risk elements from the monthly reported accounting position.

For newly licensed institutions, the first declaration must be submitted within one (1) month from the date of commencement of operations. This declaration must be accompanied by the opening balance sheet prepared according to the template provided by the Accounting Plan for CIs.

Article 12: Derogation The CSBF may authorize a CI to temporarily derogate from the provisions of this instruction, granting it a deadline to regularize its situation.

Article 13: Sanctions When a CI fails to comply with the provisions of this instruction, the CSBF may issue an injunction requiring it to submit within a specified timeframe all measures or an action plan intended to regularize its situation.

If the CI fails to comply with the injunction, the CSBF may impose one or more disciplinary and financial sanctions provided for by the banking law.

It is strictly prohibited for a CI to distribute dividends to its shareholders if the institution does not comply with the minimum requirements defined in Section 2 and the provi-