___ Bank of Mozambique ___

Administration

Circular No. 05/SCO/2013

Maputo, December 31, 2013

SUBJECT: Stress Tests

Stress tests play a relevant role in internal capital and liquidity planning, in order to ensure the capacity of credit institutions to absorb adverse shocks.

Given that the implementation of stress tests by credit institutions, as provided for in Article 3 of Notice No. 20/GBM/2013 on the Supervisory Review Process, is subject to review and assessment by the Bank of Mozambique, in accordance with Article 4 of the same notice, the Bank of Mozambique determines:

I. Definition and Scope

1. This Circular applies to all credit institutions subject to the supervision of the Bank of Mozambique.

2. In addition to the provisions of this Circular, credit institutions must also observe, where applicable, the provisions on stress tests contained in the Circulars on the Internal Capital Adequacy Assessment Process (ICAAP) and on concentration risk.

3. For the purposes of this Circular, a stress test is understood as a risk management technique aimed at assessing the potential effects resulting from changes in risk factors based on exceptional but plausible events in the financial conditions of a credit institution.

4. In the design and implementation of stress tests, the characteristics, size, and level of complexity of credit institutions must be taken into account, as well as their nature, the risks inherent to the activities they undertake, and the policy for managing those risks.

5. Stress tests must be conducted on an individual or consolidated basis in the case of consolidating credit institutions located in Mozambique. The Bank of Mozambique may determine, on a case-by-case basis, that, in addition to consolidated reporting, individual reporting must also be carried out.

II. Material Risks

1. The stress tests to be conducted by credit institutions must consider, at least, the following types of risk, provided that their materiality is demonstrated:

• Credit risk;
• Operational risk;
• Interest rate risk;
• Exchange rate risk;
• Counterparty risk in financial derivatives;
• Concentration risk;
• Banking book interest rate risk;
• Liquidity risk (associated with the execution of margin calls in stressed situations);
• Liquidity risk (market and funding);
• Reputational risk;
• Compliance risk;
• Strategic risk;
• Information technology risk; and
• Correlation risk (among the different types of risk).

2. Credit institutions must consider all material risks in their stress tests, even those not identified in point 1 of this chapter. Provided that their immateriality is duly justified to the Bank of Mozambique, some of the risks described in that point may be exempted from the stress tests.

III. Typology and Frequency of Stress Tests

1. All credit institutions must include in their risk management sensitivity analyses, under their financial conditions, of the variation of a single risk factor, understood as impact assessments.

2. Additionally, scenario tests (or analyses) must be conducted and included in their risk management, understood as joint impact assessments of multiple risk factors on their financial conditions.

3. Considering the typologies defined in points 1 and 2 of this chapter, the reporting of stress tests (and the self-assessment provided for in point 9 of Chapter IV) regarding sensitivity analysis will have a semi-annual frequency, and those regarding scenario analysis an annual frequency, with the results of the stress tests referencing the following dates:

a) December 31, for scenario analyses; and b) June 30 and December 31, for sensitivity analyses.

4. Without prejudice to the provisions of the previous point, the Bank of Mozambique may request the conduct of ad hoc stress tests, if it considers that economic or other conditions justify it.

5. The calibration of stress tests, particularly regarding the risk factors considered and the definition of the magnitude of shocks, is the responsibility of the credit institutions, and their respective results must be reported in accordance with point 3 of this chapter.

6. Notwithstanding the previous point, the Bank of Mozambique may issue guidelines for conducting scenario and sensitivity analyses, particularly regarding the risk factors to consider and the definition of the magnitude of shocks, which will be sent to credit institutions within 15 days after the reference dates mentioned in point 3 of this chapter. It is emphasized that stress tests developed in this manner should not be considered as substitutes for the stress tests defined by credit institutions for internal risk assessment and management.

IV. Approach to Stress Tests

1. The ultimate responsibility for incorporating stress tests into the credit institution's risk management lies with the governing body. However, that body may functionally delegate some of its competencies, within the scope of stress tests, to management (or other relevant organizational structures).

2. The delegation referred to in the previous point must be duly documented. Even in the event of functional delegation of competencies, the ultimate responsibility remains with the governing body.

3. The type of stress tests conducted, their respective assumptions and results, the specific vulnerabilities detected, and the prescribed corrective measures must be reported regularly to the governing body.

4. Stress tests must be actively integrated into the institution's risk management. In particular, credit institutions must demonstrate to the Bank of Mozambique how the results of stress tests are taken into account in internal decision-making processes, notably in defining the risk profile and exposure limits, as support for evaluating strategic options, and in the capital and liquidity planning and management process.

5. Credit institutions must have a technological infrastructure and information systems adequate to the complexity of the techniques used and the scope of the implemented stress tests.

6. Credit institutions must ensure the quality, integrity, and representativeness of the data used.

7. Without prejudice to the provisions of point 12 of this chapter, credit institutions, in the context of conducting stress tests, must:

a) Test the effectiveness of risk mitigation strategies; b) Consider, whenever relevant, the interaction and second-order effects of the system ("feedback effects"); c) Take into account the relationship between asset liquidity (and their respective valuation) and liquidity in funding markets, especially in a crisis context; and d) Consider that correlations between risks may change during periods of stress.

8. Credit institutions must, based on the results of their respective stress tests, identify the specific vulnerabilities to which they are subject and establish a set of corrective measures, in order to ensure that the level of own funds is adequate to the risks to which they are exposed.

9. Without prejudice to the provisions of the Circular on the Internal Capital Adequacy Assessment Process, credit institutions must conduct a self-assessment that must include, at least, the following elements:

a) Identification and description of detected vulnerabilities; b) Potential impact on the adequacy of own funds; c) Potential impact on the liquidity position and the funding gap; d) Relevance of detected vulnerabilities, considering the size and quality of the impacts, and their respective justification; e) Proposed corrective measures and their justification (including, if applicable, an analysis of their viability during crisis periods); f) Changes introduced in the stress tests since the previous report; and g) Other information considered relevant.

10. Credit institutions may consider, among others, the following corrective measures:

a) Reduction of the risk level; b) Strengthening of provisions; c) Use of risk reduction techniques; d) Reduction of exposures to specific sectors, countries, regions, or portfolios; e) Redefinition of the funding policy; f) Change in the pricing policy; g) Development of a contingency plan; and h) Strengthening of the own funds level.

11. The corrective measures proposed by credit institutions to address vulnerabilities detected through stress tests are subject to prior assessment by the Bank of Mozambique. Although it is up to credit institutions to propose and adopt the corrective measures they deem appropriate, the Bank of Mozambique may require the adoption of specific corrective measures.

12. Credit institutions must review the implemented stress tests to ensure their adequacy and consistency with external, economic, and financial conditions and the institution's risk profile. This review must also cover data quality, information systems, and their respective documentation.

13. The review referred to in the previous point must be conducted regularly and independently.

V. Submission of Information to the Bank of Mozambique

1. Stress test exercises must be documented appropriately and comprehensively, including types of stress tests and their respective objectives, frequency of conduct, responsibility and reporting lines, methodological details, results and main identified vulnerabilities, and the set of planned corrective measures (and their respective viability in crisis situations).

2. The submission of the informational elements referred to in the previous point must be coordinated with the self-assessment referred to in point 9 of Chapter IV, and both must be sent to the Bank of Mozambique through the reporting templates attached, for each of the stress tests conducted, as well as any additional information, in a format considered appropriate by the credit institutions.

3. Whenever institutions intend to introduce new stress tests or when significant changes are recorded to the implemented tests (either at the level of calibration and associated procedures, or at the level of results), the following informational elements must be submitted, in addition to the self-assessment provided for in point 9 of Chapter IV:

a) General aspects regarding stress tests:
i. Designation and brief description (including objectives/motivation) of the stress test;
ii. Frequency of conduct of the stress test; and
iii. Date of the last review and last change of the stress test;

b) Technical aspects regarding stress tests:
i. Type of stress test;
ii. Underlying assumptions and scenarios;
iii. Description of the risk factors considered and the shocks introduced to simulate adverse events (as well as the direction, duration, and intensity of these shocks); and
iv. Results of the stress tests;

c) Organizational aspects:
i. Persons responsible for the development and construction of the stress tests;
ii. Persons responsible for defining and implementing the corrective measures;
iii. Reporting lines among the various areas involved in the stress tests.

4. The stress tests conducted by credit institutions must enable the Bank of Mozambique to ensure that solvency and liquidity levels are adequate, that relevant specific vulnerabilities are identified, that credit institutions have the capacity to absorb the impact of adverse events, and that they have means to address those vulnerabilities and any potential adverse events.

5. In accordance with the provisions of letters a) and b) of point 3 of Chapter II:

a) Institutions must report the required elements of sensitivity analyses, with reference dates of December 31 and June 30, by the end of the following February and August months, respectively. b) Institutions must report the required elements of scenario analyses, with a reference date of December 31, by the end of the following February month. Considering the principle of proportionality, an interim report will be required from some institutions within 45 days after the reference date, and, following interactions with the Bank of Mozambique, a final report by the end of February. Such selected credit institutions will be informed in the last quarter of the year preceding the conduct of the stress tests.

6. Stress tests falling under point 5 will have their own reporting deadlines, defined on a case-by-case basis by the Bank of Mozambique.

VI. Clarifications

Doubts arising from the interpretation and application of this Circular must be submitted to the Banking Supervision Department of the Bank of Mozambique.

VII. Entry into Force

This Circular enters into force on January 1, 2014.

BANK OF MOZAMBIQUE
Portfolio of Supervision and Accounting

Joana J. D. Matsombe
(Administrator)

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Annex to Circular No. 05/SCO/2013

Table 1 - General aspects regarding the stress test
Designation
Brief description
Objectives
Frequency of conduct
Date of last review
Date of last change
Scope
Incidence (type of risk)

Table 2 - Changes introduced in the stress test since the previous report

Table 3 - Changes introduced in the stress test since the previous report

Table 4 - Organizational aspects regarding the stress test
Persons responsible for the development and construction of the stress tests
Persons responsible for defining and implementing the corrective measures
Reporting lines among the various areas involved in the stress tests

Table 5, Part 1 - Technical aspects regarding the stress test
Type of stress test (*)
Description of Risk Factor(s)
Description of assumed assumptions and shocks introduced to simulate adverse events
In case of sensitivity analysis, characterization of shocks ()
Current situation (Year x)
Year x+1
Year x+2
Year x+3
In case of scenario analysis, characterization of shocks ()	Variable 1	Variable 1	...	Variable n
Current situation (Year x)
Year x+1
Year x+2
Year x+3

• Sensitivity analysis; Scenario test; Other (in this case, specify which)
  Annual variation in percentage

Table 5, Part 2 (Credit Risk) - technical aspects regarding the stress test (information on results)
	Impact on:
Stress test results for year x+1	Asset value*	Operational results*	Minimum own funds requirements*	Other relevant variables*
Risk class 1
...
Risk class y
Total
	Impact on:
Stress test results for year x+2	Asset value*	Operational results*	Minimum own funds requirements*	Other relevant variables*
Risk class 1
...
Risk class y
Total
	Impact on:
Stress test results for year x+3	Asset value*	Operational results*	Minimum own funds requirements*	Other relevant variables*
Risk class 1
...
Risk class y
Total

• Annual variation in percentage

Table 5, Part 3 (Summary) - technical aspects regarding the stress test (information on results)
	Impact on:
Stress test results for year x+1	Asset value*	Operational results*	Minimum own funds requirements*	Other relevant variables*	Other relevant variables*	Other relevant variables*
Dimension 1
...
Dimension y
Total
	Impact on:
Stress test results for year x+2	Asset value*	Operational results*	Minimum own funds requirements*	Other relevant variables*	Other relevant variables*	Other relevant variables*
Dimension 1
...
Dimension y
Total
	Impact on:
Stress test results for year x+3	Asset value*	Operational results*	Minimum own funds requirements*	Other relevant variables*	Other relevant variables*	Other relevant variables*
Dimension 1
...
Dimension y
Total

Note: institutions must disaggregate the results obtained through stress tests considering the entirety of their activity, by relevant business dimensions

• annual variation in percentage

Table 6 - Detected vulnerabilities
#	Designation	Description	Potential impact on the adequacy of own funds	Justification of the option taken	Proposed corrective measures*	Justification of proposed measures
1
2
3
4
5
...
n

Reduction of the risk level; Strengthening of provisions; Use of risk reduction techniques; Reduction of exposures to specific sectors, countries, regions, or portfolios; Redefinition of the funding policy; Change in the pricing policy; Development of a contingency plan; Strengthening of the own funds level; Other (in this case, specify which).