Circular PPB-2006-17-CPB: Management of Interest Rate Risk Related to Non-Trading Activities, Liquidity Risk Management, and Sectoral Concentration Risk Management

Prudential Policy
12-14 Rue du Congrès | 1000 Brussels t +32 2 220 52 43 | f +32 2 220 54 96 | www.cbfa.be Brussels, December 20, 2006

CIRCULAR PPB-2006-17-CPB to financial companies, credit institutions, liquidation bodies and bodies assimilated to liquidation bodies

SUBJECT: management of interest rate risk related to activities other than trading; management of liquidity risk; and management of sectoral concentration risk

Madam,
Sir,

Articles 20 and 43 of the Law of 22 March 1993 on the supervision and status of credit institutions provide that these institutions must implement, in a proactive and prospective manner, a risk management structure and a level of own funds that are adapted to the risk profile of their activities.

Article 46 of this same Law further provides that it is the responsibility of the Banking, Finance and Insurance Commission (CBFA) to verify that the provisions of the aforementioned articles are respected and that the management of the institution is sound and prudent. In this regard, without prejudice to other themes that may be clarified by circular in the future, the CBFA considers it useful to extend the corpus of principles necessary for adequate risk management to the following areas: the management of interest rate risk related to activities other than trading; the management of liquidity risk; and, the management of sectoral concentration risk.

These principles will serve, on the one hand, as a guideline for institutions in the implementation of the new capital adequacy framework provided for in Title XII – dealing with Pillar II – of the CBFA Regulation of 17 October 2006 on own funds, and, on the other hand, as general evaluation criteria during the examinations conducted by the CBFA within the framework of its prudential assessment process.

This circular applies to Belgian credit institutions, branches in Belgium of credit institutions subject to the law of States that are not members of the European Economic Area, and financial companies as defined in Article 49, §1, 2° of the Law of 22 March 1993. Chapter 2 relating to liquidity risk management applies, however, also to branches in Belgium of credit institutions subject to the law of Member States of the European Economic Area. It is useful to note that this circular is also fully applicable to liquidation bodies and bodies assimilated to liquidation bodies as defined in Article 23, §§ 1 and 7 of the Law of 2 August 2002.

12-14 Rue du Congrès | 1000 Brussels t +32 2 220 52 43 | f +32 2 220 54 96 | www.cbfa.be PPB-2006-17-CPB - 2

It is structured as follows:

• Chapter 1 deals with the management of interest rate risk inherent in activities other than trading,
• Chapter 2 concerns the management of liquidity risk, and
• Chapter 3 covers the management of sectoral concentration risk.

Each of these sections has been developed according to three common pillars:

• A principle of proportionality according to which the risk management elements implemented by institutions must at all times be adapted to the nature, volume, and complexity of their activities,
• An approach to the risks involved along two axes: qualitative and quantitative, and
• A definition, for prudential purposes, of the notion of outliers.

The qualitative axis mentioned above incorporates general principles of good risk management. The quantitative axis, which determines the materiality of the risks involved, lists, among other things, the specific information elements intended for the CBFA for the monitoring of these risks.

Both are applicable, for all three chapters, to all institutions falling within the scope of this circular on a solo and consolidated basis.

Specific provisions regarding reporting requirements have, however, been provided for by each chapter1. Reference should therefore be made to them for greater precision.

Without prejudice to these specific provisions, the consolidation perimeter to be considered in this context is that generally defined for the application of Title XII of the Regulation of 17 October 2006 on own funds. Indeed, the CBFA expects institutions to consider integrated risk management within their group, including those related to their insurance companies. However, given the technical prerequisites this entails, the CBFA currently leaves institutions the possibility, depending on their internal policy in this matter, to include or not include data related to their insurance activities within the schemes required by the different chapters of this circular. In order to ensure appropriate monitoring of reporting by the CBFA, institutions are therefore asked to clearly indicate their intention in this matter when communicating by March 31, 2007 (cf. infra).

It is the responsibility of the administrative bodies of each institution to ensure the implementation of an adequate risk management system, requiring a set of effective integrated measures, adapted to the organization and functioning of the institution and conforming to the principles of sound and prudent management. Institutions are therefore expected to take the necessary measures to complete or improve their policies and practices in accordance with the principles of this circular.

1 Note that for reporting related to liquidity risk, the CBFA expects it to always be established on a solo and consolidated basis.

12-14 Rue du Congrès | 1000 Brussels t +32 2 220 52 43 | f +32 2 220 54 96 | www.cbfa.be PPB-2006-17-CPB - 3

The implementation of the principles thus stated is distributed according to the following schedule:

• From the date of publication of the text for organizational and management aspects. Institutions will inform the CBFA by letter, by March 31, 2007, of the effective adaptation of their policies and risk management procedures in light of this circular. The CBFA is aware that in some cases, the implementation of the principles set out in this document may require significant organizational interventions or considerable time for implementation. Therefore, for these aspects, the institutions concerned are invited to communicate the schedule they have established to achieve their objectives in this matter within reasonable timeframes, taking into account the nature, size, and complexity of their activities.
• Beginning of 2008 for periodic reporting requirements. This concretely means that the CBFA wishes to obtain initial reporting on these matters for the situation as of March 31, 2008. The current reporting schemes will be reviewed and updated via a specific decree.

A copy of this is transmitted to your approved statutory auditor or approved auditor.

We ask you to accept, Madam, Sir, the expression of our very distinguished consideration.

The President,
E. Wymeersch.

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