Circular 9/2010 of the Bank of Spain amending Circular 3/2008 on the determination and control of minimum own funds for credit institutions

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Circular 9/2010, of December 22, from the Bank of Spain, to credit institutions, amending Circular 3/2008, of May 22, to credit institutions, on the determination and control of minimum own funds. (BOE of December 30)

Circular 3/2008, of May 22, to credit institutions, on the determination and control of minimum own funds (hereinafter, CBE 3/2008), constituted the final development, within the scope of credit institutions, of the legislation on own funds and consolidated supervision of financial entities dictated from Law 36/2007, of November 16, which modifies Law 13/1985, of May 25, on investment coefficients, own funds, and information obligations of financial intermediaries and other norms of the financial system, and which also includes Royal Decree 216/2008, of February 15, on own funds of financial entities. With it, the process of adapting Spanish credit institution legislation to European Community Directives 2006/48/EC of the European Parliament and of the Council of June 14, on access to the activity of credit institutions and its exercise (recast), and 2006/49/EC of the European Parliament and of the Council of June 14, on the capital adequacy of investment service firms and credit institutions (recast), was completed.

The technical complexity and the detail in which these directives enter into matters of solvency advised that the Law and the aforementioned Royal Decree, as befits norms of their rank, empowered the Bank of Spain, as the supervisory body, to effectively transpose the technical details of said directives to a very large extent. In fact, in many cases, the Law and the Royal Decree only arbitrate basic principles, leaving to the Bank the complete development of the technical specifications established in the articles, and especially in the different annexes of the aforementioned directives.

Commission Directive 2009/27/EC of April 7 and Commission Directive 2009/83/EC of July 27 modify certain annexes of the aforementioned Directives 2006/48/EC and 2006/49/EC, with respect to technical provisions relating to risk management.

To the extent that the annexes of the now-modified directives were transposed through CBE 3/2008, the reform of those annexes obliges to modify, as necessary, the corresponding provisions of the Circular. Therefore, the basic object of this Circular is to transpose the aforementioned Commission directives.

Thus, the Circular comes to modify isolated norms of CBE 3/2008 relating to the calculation of own fund requirements for credit risk, both for the standard method and for the internal ratings-based method, to credit risk mitigation, to securitization, to the treatment of counterparty risk and the trading book, and to information obligations to the market.

On the other hand, European Parliament and Council Directive 2009/111/EC of September 16 also modifies those same Directives 2006/48/EC and 2006/49/EC, in this case with respect to banks affiliated to a central body, certain elements of own funds, large exposures, the supervisory regime, and crisis management, and, in addition, has introduced other modifications in various technical provisions contained in the annexes of Directive 2006/48/EC.

In particular, regarding liquidity risk, this Directive, through its Annex V, establishes a series of provisions aimed at strengthening internal organization, risk management, and internal control, and the supervision of this area. A similar provision refers to the control of risks derived from securitization transactions. The importance of these requirements to ensure the solidity of our credit institutions advises, until the transposition process of Directive 2009/111/EC is completed, now initiated through a Bill recently sent to the Congress of Deputies, to incorporate them, through an annex to CBE 3/2008 itself, as a Guide addressed to the same entities and supervised groups to which that Directive is addressed. The adoption of this Guide is carried out in exercise of the power of the Bank of Spain referred to in letter d) of paragraph 1 of Article 10 bis of Law 13/1985, of May 25, without the need for specific motivation, given that the Guide coincides with the technical criteria established in the Directive itself. It is convenient that they appear as an annex to the Circular insofar as, although not legally binding, they serve to guide and favor compliance with its own norms regarding having solid internal governance procedures.

Likewise, this modification of the Circular is taken advantage of to correct detected errors and introduce some technical and drafting improvements in the original text.

Among these technical improvements, those resulting from adopting the criteria established by the European Banking Supervisory Committee in the guides it has been publishing on the application of banking directives stand out, including: the elimination of any allowance on own shares that must be deducted from calculable capital, and the possibility to fully filter the value variations experienced by the portfolio of debt securities accounted for at fair value as available-for-sale assets, following here the majority practice of European Union countries, in order to avoid excessive fluctuations in calculable own funds.

Technical improvements resulting from our own experience in the application of the current Circular have also been incorporated, among which it is worth mentioning the clarification of the criteria applicable regarding the exemption of individual requirements for subsidiaries or parent companies of a consolidatable group of credit institutions (which motivated a specific interpretative agreement already made public by the Bank of Spain), the practical identification of public sector entities subject to special weighting, and the clarification of the weighting regime for tangible assets received as payment in kind.

Consequently, in exercise of the powers granted, the Governing Board of the Bank of Spain, on the proposal of the Executive Commission, and in agreement with the Council of State, has approved this Circular, which contains the following norms:

Single Norm

The following modifications are introduced in Circular 3/2008, of May 22, from the Bank of Spain, to credit institutions, on the determination and control of minimum own funds [1]:

1. The following wording is given to the first paragraph of paragraph 1 of the first norm:

«1. The provisions of this Circular shall apply to consolidatable groups and subgroups of credit institutions, as defined in Article 8 of Law 13/1985, of May 25, on investment coefficients, own funds, and information obligations of financial intermediaries (hereinafter, Law 13/1985), and in paragraphs 2, 3, and 8 of the Second Norm, as well as to individual Spanish credit institutions, whether integrated or not into a consolidatable group or subgroup of credit institutions.»

2. In the fifth norm:

a) Letter b) of paragraph 2 is drafted as follows:

«b) There is no, nor is it foreseeable that there will be, any relevant practical or legal impediment to the immediate transfer of own funds to the subsidiary or to the reimbursement of its third-party liabilities by the parent company. To prove compliance with this requirement regarding potential legal impediments, the entity must provide a sufficient legal opinion and, regarding practical ones, an express declaration from the subsidiary's governing body, considering their current or future existence unlikely.»

b) The first paragraph of letter d) of paragraph 2 and its point i) are modified according to the following wording:

«d) Either the third-party risks with the subsidiary are insignificant, or the parent company carries out prudent management of the subsidiary and has declared itself guarantor of the commitments entered into by the subsidiary. For these purposes:

i) Third-party risks with a subsidiary shall be understood as insignificant when they do not exceed 2% of those of the group, measured as the average held over the last three years, provided that in the last year they do not exceed 5% of those. However, the Bank of Spain may accept, upon request by the group, a higher percentage, taking into account the characteristics of the subsidiary's creditor collective and the importance of minority shareholder participation in it. It may also require a lower percentage when the exemption is requested for several subsidiaries that, considered together, raise the considered third-party risks above double the aforementioned percentages.»

c) Paragraph 4 is modified, which remains with the following wording:

«4. In the calculation of the credit and counterparty risk requirements applicable to credit institution subsidiaries and in the others applicable according to the preceding paragraphs 2 and 3, the following shall not be taken into account:

– The deductions of own funds mentioned in paragraph 4 of the Ninth Norm, without prejudice to the weighting of non-deducted assets according to the norms of chapter four.

– The exposures, which do not refer to instruments calculable as own funds, referred to in paragraph 4 of the Fifteenth Norm.

In the calculation of limits to large exposures, exposures to other entities of the consolidatable group shall not be taken into account.»

d) The following wording is given to letter c) of paragraph 5:

«c) In the calculation of limits to large exposures, exposures to other entities of the consolidatable group shall not be taken into account.»

e) The following wording is given to letter a) of paragraph 6:

«a) There is no, nor is it foreseeable that there will be, any relevant practical or legal impediment to the immediate transfer of own funds by the subsidiary to the parent or to the reimbursement to the parent of the liabilities for which the subsidiary is debtor. To prove compliance with this requirement regarding potential legal impediments, the parent must provide, in the case of Spanish subsidiaries or those domiciled in the European Union, a sufficient legal opinion and, regarding practical impediments, an express declaration from the parent's governing body, considering their current or future existence unlikely; in the case of subsidiaries in third countries, declarations, in the same sense, from the competent authorities of the country where the subsidiary is domiciled and from the governing body of the subsidiary shall also be required.»

3. In the Eighth Norm:

a) The following wording is given to the third paragraph of letter d) of paragraph 1 and a new fourth paragraph is added to said letter d):

«To the extent that entities do not integrate the cited percentages of these goodwill items into their calculable own funds, or integrate them only partially (whether because they only calculate them for some participations or risks, or because they only calculate part of the total of the goodwill accounted for, or both circumstances), the value of the asset or, which is the same, the exposure to be considered, both for the purposes of credit risk requirements and for the deductions provided in the Ninth and Tenth Norms or for the limits to large exposures, shall only take into account the gross amounts of the goodwill that have contributed to increasing own funds. That is, only the amount resulting from multiplying the total amount of accounted goodwill by the proportion that the effectively calculated goodwill represents over the total that, at most, could have been calculated according to this letter. The possibility contemplated in this paragraph is entirely free for entities, although it must be communicated to the Bank of Spain, while it remains, together with the declarations of calculable own funds provided in chapter thirteen, through an annex with the calculations and adjustments made regarding this matter.

Entities also have the option not to integrate any amount of the goodwill referred to in this letter that arises from debt securities accounted for at fair value as available-for-sale assets. In that case, and provided they communicate their intention to the Bank of Spain in advance, entities may also cease to assimilate the losses generated by said debt securities to negative results, as provided in the second paragraph of letter a) of paragraph 1 of the Ninth Norm. In such communication, the permanent nature of the adopted option shall be indicated, although, exceptionally, entities may request the Bank of Spain, for duly justified reasons, the subsequent modification of said option.»

b) Letter h) of paragraph 1 is modified according to the following wording:

«h) The part of share capital corresponding to non-voting shares and redeemable shares whose duration is not less than that provided in letter j) for standard subordinated financings, regulated in the second section of chapter I of title IV and in the third section of chapter II of title XIV of Royal Legislative Decree 1/2010, of July 2, approving the consolidated text of the Capital Companies Law.»

c) Letter f) of paragraph 5 is modified according to the following text:

«f) Non-voting, redeemable, or preferred shares, or values analogous to preferred participations issued by foreign companies, and subordinated financings, whose issuer is a credit institution or a financial entity subject by its nature to specific own fund requirements, which, although they do not have the conditions of the preceding letter e), meet the following requirements:

i) The financing is calculable as own funds of the entity itself, according to the specific norms of the country where it was authorized, and it is a country of the European Economic Area or another with requirements internationally equivalent to those established in the Community directives on this matter. To this end, the entity requesting the verification referred to in the following paragraph 6 must provide a sufficient legal opinion.

ii) The financing can be effectively calculated by the subsidiary within the limits that the specific norms of the country where it was authorized establish in each case.

iii) They do not lead to significant excesses of own funds measured against the requirements that the consolidation of the issuer generates in the group. For the calculation of these significant excesses, the following shall be considered:

a) The own funds of the subsidiary accounted for in its books, calculated in accordance with what is provided in this Circular and that would be calculable for the determination of the own funds of the consolidatable group.

b) The requirements of the subsidiary calculated in accordance with what is provided in this Circular.

Unless expressly authorized by the Bank of Spain, a significant excess shall be understood as one exceeding 25% of said requirements.

In addition, the parent entity of the group must commit, in the event of early amortization (or of the request for the same to the subsidiary's supervisor) of any of these elements, to communicate it to the Bank of Spain at least one month in advance (or immediately, in case of request).»

4. In the Ninth Norm:

a) Letter b) of paragraph 1 receives the following wording:

«b) The shares, contributions, or other values calculable as own funds of the credit institution or the group, which are held by it or by any consolidatable entity, even those held through persons acting on behalf of any of them; and those that have been the object of any operation or commitment that harms their effectiveness to cover losses of the entity or the group. In particular, those bought on forward and those sold to third parties with an open repurchase option to an entity of the group, or with a forward repurchase commitment by an entity of the group, shall be deducted, as well as long positions in equity swap operations on own shares and synthetic purchases of own shares, understanding by synthetic purchase the combination of a bought call option and a sold put option with the same exercise price and expiration date. In these cases, the deduction shall be made by the value at which the underlying shares would be recorded in the books, without prejudice to the losses that may result from the movement in the price of the derivative.

Likewise, financings to third parties whose object is the acquisition of shares, contributions, or other values calculable as own funds of the entity that granted them or of other entities of its consolidatable group shall be deducted.

The deduction shall apply regardless of the purpose of the acquisition and even if the acquired values remain integrated in the trading portfolio or the acquisition occurs as a consequence of market-making activity.»

b) The following wording is given to the first paragraph of letter e) of paragraph 1:

«e) Participations in insurance or reinsurance entities, or in entities whose main activity consists of holding participations in insurance entities, in the sense indicated in the first paragraph of paragraph 3 of Article 47 of the Code of Commerce, or when, directly or indirectly, 20% or more of the voting rights or capital of the participated entity is held.»

c) The following wording is given to letter i) of paragraph 1:

«i) In the case of entities that calculate risk-weighted positions according to the internal ratings-based method, in accordance with the second section of chapter four of this Circular:

– The negative balance resulting from subtracting a) impairment corrections and provisions for risks, less b) expected losses for risks against companies, institutions, central governments, central banks, and retail risks, for specialized financing risks when the entity does not meet the minimum requirements established for PD estimates in the second section of chapter four of this Circular and for the dilution risk of acquired receivables. Expected losses from equity, nor securitized exposures, nor their provisions, shall not be included in this calculation.

– The amounts of expected losses from equity risks whose exposures are calculated by the PD/LGD method and/or by the simple method for the available-for-sale portfolio, in accordance with the second section of chapter four of this Circular.»

5. Paragraph 2 of the Eleventh Norm receives the following wording:

«2. The following shall not be calculable as second-tier own funds of entities and groups:

a) The excess of standard subordinated financings and redeemable shares calculable as second-tier own funds that grant cumulative rights to dividend payment, over 50% of the basic own funds of the entity or group.

b) The excess of second-tier own funds over 100% of the basic own funds of the entity or group, in the part that said excess has not been eliminated according to what is established in letter a) of this paragraph.

However, second-tier own funds that exceed the limits cited in the preceding letters of this paragraph may be included among auxiliary own funds. In any case, the excess of auxiliary own funds with respect to the own fund requirements required of the entity for price and exchange risks shall not be counted as own funds.»

6. Number i) of letter c) of paragraph 2 of the Fourteenth Norm is modified according to the following text:

«i) Off-balance sheet accounts shall be excluded, as well as the total amount of exposures secured by residential real estate that benefit from a weighting of 35% according to what is indicated in the Sixteenth Norm.»

7. The following wording is given to letter e) of paragraph 4 of the Fifteenth Norm:

«e) That there is currently no, nor is it foreseeable that there will be in the future, any material or legal impediment to the immediate transfer of own funds or to the reimbursement of liabilities of the counterparty to the credit institution. To this end, they must provide the Bank of Spain with the documentation referred to in letter b) of paragraph 2 of the Fifth Norm.»

8. In the Sixteenth Norm:

a) Paragraph 5 is modified, according to the following wording:

«5. When the competent authorities of a third country that applies supervision and regulation provisions at least equivalent to those applied in the European Union assign a risk weighting lower than that indicated in the preceding paragraphs of this Norm to exposures to their central government and central bank that are denominated and financed in the local currency of said third country, credit institutions may weight such exposures in the same way, provided that the Bank of Spain, upon request, duly motivated, by an entity or an association representing credit institutions, verifies and declares, for these purposes, the equivalence of the cited provisions. For these purposes, entities must provide, along with the request:

a) Information accrediting that supervision and regulation provisions at least equivalent to those of the European Union are applied in the affected country. To this end, it may provide an internal or external legal opinion in which those provisions or at least the most relevant ones to appreciate local solvency requirements are described sufficiently, with indication of the appropriate sources.

b) Accreditation, through the appropriate declaration of the local supervisor or regulator, that the supervision and regulation provisions of each of the countries subject to the request establish a weighting of 0% for the exposures in question, indicating the exceptions or conditions that such provisions establish.

The Bank of Spain will publish on its Internet website a list of countries on which it has verified equivalence according to what is provided in the preceding paragraph.»

b) Paragraph 8 is modified as follows:

«8. When the competent authorities of a country of the European Economic Area or of a third country that applies supervision and regulation provisions at least equivalent to those applied in the European Union grant exposures to regional administrations and local authorities the same treatment as exposures to their central government, credit institutions may weight their exposures with those regional administrations and local authorities in the same way; if it is a third country, such treatment may be applied provided that the Bank of Spain,