Norm on Interest Rate Risk Management

Resolution No. CD-SIBOIF-1087-4-DIC4-2018 Dated December 4, 2018

NORM ON INTEREST RATE RISK MANAGEMENT

The Board of Directors of the Superintendent of Banks and Other Financial Institutions,

CONSIDERING

I That in accordance with Article 3, items 14 and 17 of Law 316, Law of the Superintendent of Banks and Other Financial Institutions, contained in Law No. 974, Legal Digest of the Nicaraguan Law of Banking and Finance, published in La Gaceta, Official Gazette No. 164, of August 27, 2018, and its reforms, the Board of Directors of the Superintendent is empowered to issue the norms and provisions necessary for the fulfillment of the object of said Law.

II That in accordance with Article 10, item 1 of the aforementioned Law, it corresponds to the Board of Directors of the Superintendent to issue general norms to avoid or correct irregularities or faults in the operations of Financial Institutions that could endanger the interests of depositors, the stability of any bank, or the solidity of the Financial System.

III That in accordance with Article 19, item 12 of the aforementioned Law, it corresponds to the Superintendent of Banks to establish prevention programs that allow for knowledge of the financial situation of the institutions under its supervision.

IV That adverse movements in interest rates caused, in part, by maturity mismatches, yield curves, and basis and optional risks have an effect, on the one hand, on the financial margin; and on the other, on the Economic Value of Capital (EVC) by changing the present value of future cash flows of assets and liabilities subject to interest rate repricing, as well as those not subject to changes when their net present value is altered.

V That in order to avoid or correct irregularities in the operations of Financial Institutions that could endanger the interests of depositors, the stability of any bank, or the solidity of the Financial System, it is necessary to promote a culture of risk management in financial institutions, establishing minimum guidelines to be implemented to carry out the identification, measurement, monitoring, limitation, control, and disclosure of interest rate risk faced in their daily activities.

VI That the effectiveness of interest rate risk management depends largely on adequate follow-up by the Board of Directors and Management, as well as the correct application of policies and procedures in this matter, in accordance with the nature and scale of the activities of financial institutions.

VII That efficient interest rate risk management will allow financial institutions to carry out their activities with risk levels consistent with their operational capacity and capital sufficiency.

In exercise of its powers,

HAS ISSUED,

The following:

Resolution No. CD-SIBOIF-1087-4-DIC4-2018 NORM ON INTEREST RATE RISK MANAGEMENT

CHAPTER I OBJECT, SCOPE, AND DEFINITIONS

Article 1. Object.- The purpose of this Norm is to establish provisions that allow for the prudent management of interest rate risk. To this end, it establishes the obligation for financial institutions to implement a system of identification and measurement, which must reflect the impact on the financial margin and the Economic Value of Capital (EVC); it establishes minimum guidelines to carry out the identification, measurement, monitoring, limitation, and control of interest rate risk and the requirement for adequate follow-up by the Board of Directors and Management, as well as the correct application of policies and procedures in this matter, in accordance with the risk profile of financial institutions.

Article 2. Scope.- The provisions of this Norm are applicable to financial institutions that capture public deposits and are subject to the supervision of the Superintendent of Banks and Other Financial Institutions. Such institutions include the following: a) Banks and financial companies constituted in Nicaragua; and b) Branches of banks and foreign financial companies established in Nicaragua.

In the text that follows, where "bank" is read, it shall be understood as any of the entities to which this Norm applies as provided in this article.

Article 3. Concepts.- For the application of this norm, the concepts indicated in this article, both in uppercase and lowercase, singular or plural, shall have the following meanings:

1. Risk Management: The set of objectives, policies, procedures, and actions that are approved and implemented to identify, measure, monitor, limit, control, report, and reveal the interest rate risk to which the Bank is exposed.

2. Days: Business days.

3. Sources of Interest Rate Risk: The sources of interest rate risk generally originate with the maturity and repricing mismatch between assets, liabilities, and off-balance sheet positions; the risk of non-parallel movements in the yield curve; basis risk; and optional risk.

4. Board of Directors: The main administrative body of Financial Institutions.

5. Superintendent Law: Law No. 316, "Law of the Superintendent of Banks and Other Financial Institutions," published in La Gaceta, Official Gazette, Number: 196 of October 14, 1999.

6. General Banks Law: Law No. 314, "General Law of Banks, Non-Bank Financial Institutions, and Financial Groups," published in La Gaceta, Official Gazette, Numbers: 198, 199, and 200 of October 18, 19, and 20, 1999.

7. LIBOR Rate: LIBOR (London Inter-Bank Offered Rate) is understood as the interest rate at which banks in the London interbank market are willing to lend Eurodollars. This rate is used as an index to set the price of loans for the best commercial clients.

8. Accounting Framework: Refers to the Accounting Framework applicable to banking and financial institutions.

9. Substantial Positions: Substantial positions are understood as positions (assets or liabilities) in foreign currency that represent five percent (5%) or more of the total consolidated assets or liabilities.

10. Prime Rate: Index of the interest rate market of the United States of America, used to set the price of short-term loans for the best commercial clients.

11. Basis Risk: Basis risk is when certain liabilities are repriced with one index and assets with another index.

12. Interest Rate Risk: Interest rate risk is the exposure of the bank's financial condition to adverse movements in interest rates. Sudden changes in interest rates have an effect, on the one hand, on the financial margin; and on the other, on the Economic Value of Capital (EVC) by changing the present value of future cash flows of assets and liabilities subject to interest rate repricing (variable rate), as well as those not subject to changes (fixed rate) when their net present value is altered.

13. Optional Risk: Optional risk is when debtors pay off their credits early, when there are early redemptions of time deposits without maturity, and in those financial instruments where there is an early redemption clause by the issuer.

14. Superintendent: Superintendent of Banks and Other Financial Institutions, a state body responsible for authorizing, supervising, monitoring, and auditing the constitution and operation of Banks, Non-Bank Financial Institutions, and Financial Groups, governed by Law No. 316, "Law of the Superintendent of Banks and Other Financial Institutions" published in La Gaceta, Official Gazette, No. 196 of October 14, 1999.

CHAPTER II PRINCIPLES OF INTEREST RATE RISK MANAGEMENT

Article 4. Duties of the Board of Directors.- The Board of Directors is responsible, at a minimum, for the following functions:

1. Understanding the nature and level of interest rate risk taken by the bank;
2. Development and implementation of policies for the prudent management of interest rate risk;
3. Approving strategies to ensure prudent management of said risk;
4. Establishing risk tolerance limits for interest rate risk, including specific limits and key policies regarding how to mitigate said risk;
5. Clearly identifying the officials and/or committees responsible for interest rate risk management and ensuring that there is sufficient technical capacity to perform said work;
6. Ensuring that there is a clear segregation of functions to avoid conflicts of interest between the risk-taking areas and the area responsible for administering interest rate risk; and
7. Ensuring that bank management takes the necessary actions to identify, measure, monitor, and control said risk.

Article 5. Duties of Management.- The Bank's Management is responsible, at a minimum, for the following functions:

1. Development and implementation of procedures as established in the policies dictated by the Board of Directors;
2. Ensuring that interest rate risk management is carried out at all times following the guidelines dictated by the Board of Directors;
3. Ensuring that there is the capacity to control the implementation and maintenance of management reports and other systems that identify, measure, monitor, and control interest rate risks;
4. Establishing the necessary internal controls regarding the interest rate risk management process;
5. Assigning adequate resources to the interest rate risk management instances.
6. Keeping the Bank's Board of Directors informed; and
7. Sending the Interest Rate Risk Measurement Report to the Superintendent.

Article 6. Risk Management Process.

1. For an effective interest rate risk management process, the following fundamental elements must exist, at a minimum: a. Policies and procedures to control and limit interest rate risks, including those responsible for managing said risk and the instruments approved to mitigate said risk. b. A system that allows the Bank to identify and measure interest rate risk. c. A system that allows for monitoring and timely and precise information on interest rate risk exposures. d. Internal controls and review and audit systems that ensure the integrity of the overall risk management processes.

2. In general, but depending on the complexity and range of activities to which the bank is dedicated, these must have interest rate risk measurement systems that capture and evaluate the effects of interest rate changes on the financial margin and the economic value of capital. These systems must include all substantial interest rate positions of the Bank and consider all relevant repricing and maturity data, including: a. Current balance and contractual interest rate linked to instruments and investment portfolios; b. Principal payments, interest adjustment dates, maturities; c. Interest rate index (LIBOR Rate, PRIME Rate, etc.) used for repricing and the maximum and minimum caps on interest rates; and d. That the risk measurement system include well-documented assumptions and techniques, which must be reviewed at least annually.

Article 7. Identification and Measurement of Interest Rate Risk.- Timely identification and measurement are key conditions for interest rate risk management. The internal system adopted by each bank will depend on the nature and range of activities to which it is dedicated. However, it must, at a minimum, reflect the impact on the financial margin insofar as it could result in lower financial income, lower profit levels, lower capital adequacy, and lower liquidity. As well as, evaluate the impact on the Economic Value of Capital (EVC) to identify potential future problems in the bank's profitability and capitalization.

For the measurement of interest rate risk, management must measure based on a probable range of potential changes in rates, including significant stress test situations, which is an impact of +/-200 basis points for foreign currency exposures and +/-300 basis points for national currency, provided that the latter represents more than 5% in assets or liabilities. For supervisory purposes and without prejudice to the internal systems adopted by each bank, these must send monthly the Interest Rate Risk Measurement Report to measure the impact on the financial margin and the economic value of capital (EVC) as defined in Article 8 of this Norm.

The reports of interest rate risk exposures generated by the bank's internal systems must be reviewed by the Board of Directors and must include at least the following:

1. Summary of aggregate exposures;
2. Compliance reports with the limits established by the Board of Directors and with policies in general;
3. Key assumptions, for example, the behavior of non-maturing liabilities and information on early payments of credit portfolios or other assets;
4. Results of stress tests;
5. Summary of findings of internal and external audits, on policies and procedures and the suitability of identification and measurement systems.

Article 8. Corrective Actions.- Banks must maintain a level of capital consistent with the interest rate risk they have taken. Banks with material weaknesses in their interest rate risk management processes, or with high exposures of said risk relative to the Bank's capital, must take the necessary corrective actions to remedy the weaknesses and reduce the aforementioned exposures. The actions to be taken will include, among others, injecting fresh capital, strengthening interest rate risk management, improving information and measurement systems for said risk, reducing exposure levels, or some combination of the foregoing actions depending on each situation. The foregoing, without prejudice to the Superintendent's power to order the implementation of preventive measures as established in Article 82 of the General Banks Law.

Article 9. Monthly Interest Rate Risk Report.- Without prejudice to the internal interest rate risk measurement system adopted by each bank, these must submit to the Superintendent, within the first twenty (20) days following the close of each month, the Interest Rate Risk Measurement Report, which is based on the following concepts:

1. To quantify the impact on the financial margin: a. To measure the impact of an increase or decrease of 200 (foreign currency) / 300 (national currency) basis points on the financial margin, a maturity and repricing report of assets and liabilities of four (4) time bands will be used: up to 30 days, from 31 to 90 days, from 91 to 180 days, and from 181 to 360 days, contained in Annex 1, which becomes an integral part of this norm. b. Banks must include in each band the face value of the principal of interest rate-sensitive assets and liabilities that mature (in the case of fixed rate) or reprice (in the case of variable rate) in that period as applicable, and the residual maturity will be used, that is, the remaining days until the asset or liability matures. Amounts of overdue portfolio and in judicial collection must be excluded from said calculation as defined in the Accounting Framework. c. The book value balance of liabilities without maturity date and sensitive to interest rates will be included according to the following table:

Time Band	Interest-bearing Demand	Savings
0-30 days	50%	20%
31-90 days	10%
91-180 days	10%
181-360 days	10%

In the case of time deposits without a maturity date, the book value of the liability must be included in the respective time band in which the interest rate reprices, as established in the contract.

d. Assets without a maturity date and sensitive to interest rates will be included at 100% in the first time band (0-30 days).

e. Off-balance sheet creditor positions sensitive to interest rates will be included in the item "other interest rate-sensitive assets" and off-balance sheet debtor positions sensitive to interest rates will be included in the item "other interest rate-sensitive liabilities," without prejudice that there are other assets and liabilities within the balance sheet that must be located under said items.

f. Once the maturities and repricings of assets and liabilities are assigned, the gap between them will be quantified for each time band. Each gap will be multiplied by the percentage of remaining days in the year after the maturity or repricing, and by the increase or decrease of 200 (F.C.) / 300 (N.C.) basis points to determine the impact on the financial margin. The sum of the impacts in each gap and in both currencies will give the total impact on the financial margin. In turn, this total impact will be divided by the annualized financial margin to determine the percentage risk of the financial margin.

For the purpose of what is established in the previous paragraph, remaining days in the year after maturity or repricing is understood as the result of adding the midpoint of a given time band and the remaining days of the subsequent time bands; and the percentage of remaining days is understood as the result of dividing the remaining days in the year after maturity or repricing by the days in a year (360 days).

2. To quantify the impact on the Economic Value of Capital:

a. To measure the impact of an increase or decrease of 200 (foreign currency) / 300 (national currency) basis points on the EVC, a maturity and repricing report of assets and liabilities of thirteen (13) time bands will be used: up to 30 days, from 31 to 90 days, from 91 to 180 days, from 181 to 360 days, from 1 to 2 years, from 2 to 3 years, from 3 to 4 years, from 4 to 5 years, from 5 to 7 years, from 7 to 10 years, from 10 to 15 years, from 15 to 20 years, and more than 20 years, contained in Annex 2, which becomes an integral part of this norm.

b. Banks must include in each band the face value of the principal of interest rate-sensitive assets and liabilities that mature (in the case of fixed rate) or reprice (in the case of variable rate) in that period as applicable, and the residual maturity will be used, that is, the remaining days until the asset or liability matures. Amounts of overdue portfolio and in judicial collection must be excluded from said calculation as defined in the Accounting Framework.

c. The book value balance of liabilities without maturity date and sensitive to interest rates will be included according to the following table:

Time Band	Interest-bearing Demand	Savings
0-30 days	50%	20%
31-90 days	10%
91-180 days	10%
181-360 days	10%
1-2 years	15%	12.5%
2-3 years	15%	12.5%
3-4 years	10%	12.5%
4-5 years	10%	12.5%
5-7 years
7-10 years
10-15 years
15-20 years
More than 20 years
TOTAL	100%	100%

In the case of time deposits without a maturity date, the book value of the liability must be included in the respective time band in which the interest rate reprices, as established in the contract.

d. Once the maturities and repricings are assigned, as well as the repricing assumptions in the case of liabilities without a maturity date, in the time bands, these amounts will be multiplied by the following risk weights established below, which are designed to reflect the sensitivity of the positions to a change of 200 (foreign currency) and 300 (national currency) basis points in interest rates. The result of this multiplication would give an estimate of the change in the value of the asset or liability before the aforementioned interest changes.

Time Band	200bp	300bp
0-30 days	0.08%	0.12%
31-90 days	0.32%	0.48%
91-180 days	0.72%	1.08%
181-360 days	1.43%	2.13%
1-2 years	2.77%	4.14%
2-3 years	4.49%	6.75%
3-4 years	6.14%	9.21%
4-5 years	7.71%	11.55%
5-7 years	10.15%	15.24%
7-10 years	13.26%	19.89%
10-15 years	17.84%	26.76%
15-20 years	22.43%	33.63%
More than 20 years	26.03%	39.03%

e. The sum of the weighted positions in the asset and those of the liability in the different currencies across all time bands is divided by the bank's equity to measure the percentage variation due to interest rate change.

CHAPTER III TRANSITIONAL AND FINAL PROVISIONS

Article 10. Maintenance of Documents.- The documents that serve as the basis for the calculations of the Monthly Interest Rate Risk Report must be kept in file available to the Superintendent for a period of twelve months, counted from the date of the corresponding report.

Article 11. Modification of Annexes.- The Superintendent is authorized to update the annexes of this Norm, informing the Board of Directors of the Superintendent about said update.

Article 12. Repeal.- The Norm on Interest Rate Risk Management, contained in Resolution No. CD-SIBOIF-337-1-ENE26-2005, dated January 26, 2005, published in La Gaceta, Official Gazette No. 44, of March 3, 2005, and the Norm of Reform of Annexes I and II of the Norm on Interest Rate Risk Management, contained in Resolution No. CD-SIBOIF-523-1-FEB27-2008, dated February 27, 2008, published in La Gaceta, Official Gazette No. 63, of April 4, 2008, are repealed.

Article 13. Transitional.- The provisions established in this norm govern from January 1, 2019; however, for the purposes of implementing IFRS 1 - First-time Adoption of International Financial Reporting Standards, financial institutions must apply these provisions to the first financial statements generated during the transition period, referred to in the regulations governing the matter on the implementation of the Accounting Framework.

Article 14. Validity.- This Norm will enter into force upon its notification, without prejudice to its subsequent publication in La Gaceta, Official Gazette.

ANNEX I FINANCIAL ENTITY: MONTH: 00/01/1900 CURRENCY:

Up to 30 Days	From 31 to 90 Days	From 91 to 180 Days	From 181 to 360 Days
-	-	-	-
1102.01.01+1102.01.08	-	-	-
1102.02.01+1102.02.08	-	-	-
1102.03.01 + 1102.03.08 + 1102.04.01 + 11.02.04.08	-	-	-
1201	-	-	-
1204 + 1804	-	-	-
1207	-	-	-
1401+ 1402+ 1403	-	-	-
1503	-	-	-
1504	-	-	-
-	-	-	-
-	-	-	-
2101.01.01	-	-	-
2102	-	-	-
2103.01.01 + 2103.02.01 + 2103.03.01	-	-	-
2104	-	-	-
2105	-	-	-
2106	-	-	-
2107	-	-	-
2201+ 2202+