Central Bank of Tunisia Circular No. 2018-06 to Banks and Financial Institutions dated June 5, 2018

Tunis, June 5, 2018 CIRCULAR TO BANKS AND FINANCIAL INSTITUTIONS No. 2018-06 Subject: Capital adequacy standards. The Governor of the Central Bank of Tunisia, Having regard to Law No. 2016-35 of April 25, 2016 establishing the status of the Central Bank of Tunisia; Having regard to Law No. 2016-48 of July 11, 2016 concerning banks and financial institutions; Having regard to Law No. 94-117 of November 14, 1994 reorganizing the financial market; Having regard to Circular No. 91-24 of December 17, 1991 concerning the division, hedging, and monitoring of commitments, as amended and supplemented by subsequent texts; Having regard to Circular No. 2006-19 of November 28, 2006 concerning internal control; Having regard to Circular No. 2011-06 of May 20, 2011 concerning the strengthening of good governance rules in credit institutions; Having regard to Circular No. 2016-01 of February 8, 2016 concerning the foreign exchange market and instruments for hedging foreign exchange and interest rate risks; Having regard to Circular No. 2017-06 of July 31, 2017 concerning accounting, prudential, and statistical reporting to the Central Bank of Tunisia; Having regard to Opinion No. 4 of the Compliance Monitoring Committee dated April 12, 2018, as provided for in Article 42 of Law No. 2016-35 of April 25, 2016 establishing the status of the Central Bank of Tunisia; Decides:

Article 1 This circular defines the capital adequacy standards to be complied with by banks and financial institutions, hereinafter referred to as "subjected establishments", and sets out their calculation methods. The standards covered by the provisions of this circular relate to solvency, concentration, and risk division.

TITLE I: Capital Funds Article 2 Net capital funds consist of core net capital funds and supplementary capital funds. Article 3 Core net capital funds consist of the sum of:

1. social capital or endowment;
2. share premiums, merger premiums, and contribution premiums linked to capital;
3. reserves other than revaluation reserves;
4. social fund allocated from results;
5. carried forward credit balance;
6. net result after dividend distribution for the last closed financial year. These elements are reduced by:

• the unpaid portion of social capital or unremitted endowment;
• treasury shares held directly or indirectly through subsidiaries, evaluated at their book value;
• net non-performing assets after amortization;
• pending loss results awaiting approval;
• carried forward debit balance.
• participations held in other subjected establishments located in Tunisia and in assimilated establishments located abroad, evaluated at their net book value.

Core net capital funds may additionally include profits determined at interim dates, provided that:

• they are calculated after accounting for all related expenses and provisions for amortization, reserves, and value corrections;
• they are calculated net of foreseeable corporate income tax and advance dividends or dividend forecasts; and
• they are verified by statutory auditors. Article 4 Supplementary capital funds consist of supplementary capital funds of the first level and supplementary capital funds of the second level. a) Supplementary capital funds of the first level include:

1. revaluation reserves;
2. non-refundable subsidies;
3. collective provisions as defined in Article 10 bis of Circular No. 91-24, up to a limit of 1.25% of weighted credit risks referred to in the first paragraph of Article 11 of this circular;
4. unrealized capital gains on investment securities with a 55% haircut applied to the positive difference calculated, security by security, between market price and acquisition cost;
5. Funds from the issuance of securities, particularly those with indefinite duration, as well as those from loans, under certain conditions:

• these funds can only be repaid at the borrower's initiative and with prior approval from the Central Bank of Tunisia. No early repayment can be requested before the expiration of a five-year period, except where replaced by capital funds of equal or better quality;

• the issuance or loan contract grants the subjected establishment the right to defer interest payments. The remuneration of these funds must not exceed 250 basis points compared to that of a government bond. Compliance with this limit is assessed based on prevailing market conditions at the time of issuance;

• the lender's claims on the subjected establishment are subordinated to those of all other creditors and must be effectively collected;

• the issuance or loan contract stipulates that unpaid debt and interest can absorb losses, enabling the subjected establishment to continue its operations. b) Supplementary capital funds of the second level include funds from the issuance of securities or subordinated loans that, without meeting the conditions listed in point 5 of a) of this article, fulfill the following conditions:

• initial duration is five years or more; if no maturity is fixed, the debt can only be repaid upon a five-year notice or with the approval of the Governor of the Central Bank of Tunisia for early repayment. The Governor may authorize early repayment provided the request is initiated by the issuer and the solvency of the subjected establishment is not adversely affected;

• the loan contract does not contain a clause stipulating that, under specified circumstances other than the liquidation of the subjected establishment, the debt must be repaid before the agreed maturity;

• in the event of liquidation of the subjected establishment, these securities or loans can only be repaid after settlement of all other existing debts at the date of liquidation or contracted for its needs. Only effectively collected funds are taken into account. The amount included in capital funds is progressively reduced over the last five years prior to maturity, according to a pre-established plan duly communicated to the Central Bank of Tunisia. Article 5 Subordinated claims referred to in point 5 of a) and point b) of Article 4, held on subjected establishments located in Tunisia and assimilated establishments located abroad, are deducted from the corresponding component of supplementary capital funds.

The corresponding component of capital funds refers to the component for which capital funds would be eligible if issued by the subjected establishment itself. Article 6 Supplementary capital funds can only be included in the calculation of net capital funds up to the amount of core net capital funds. Supplementary capital funds of the second level can only be included in the calculation of net capital funds up to 50% of the amount of core net capital funds. Article 7 The amount exceeding prudential participation standards referred to in Article 75 of Law No. 2016-48 concerning banks and financial institutions is deducted from core net capital funds, under the following conditions: a. The portion exceeding 15% of net capital funds, from the amount of individual participations (direct or indirect) held in the capital of entities for which subjected establishments must respect this threshold. b. The portion exceeding 60% of net capital funds, from the total amount of direct or indirect participations held in the capital of entities for which subjected establishments are required to respect this threshold. This amount is reduced, where applicable, by the excess amount referred to in point (a) above. Participations covered by this article are taken into account at their net book value. Participations that have already been deducted from capital funds in accordance with Article 3 of this circular do not enter into the calculation of the standards referred to in points a) and b) of this article. Article 8 Subjected establishments must have clear, effective, and comprehensive strategies and processes to evaluate and permanently maintain the level and quality of their internal capital funds that they deem appropriate to cover current or potential risks.

To this end, they must prohibit, subject to their capital fund deductions, any non-transparent practice that could impair the quality of their capital funds and in particular:

• The financing of any capital increase operation by the subjected establishment using its own resources.
• The allocation, by subsidiaries of the subjected establishment, of funds entrusted to them for management by the subjected establishment, to participate in capital increase operations in other subjected establishments.

TITLE II: Solvency Standards Article 9 Subjected establishments must permanently comply with:

• A solvency ratio that cannot be less than 10%, calculated as the ratio between net capital funds as defined in Title I of this circular and risk-weighted assets as defined by Article 10 below.
• A Tier I ratio that cannot be less than 7%, calculated as the ratio between core net capital funds as defined by Article 3 after deductions provided by Article 7 of this circular and risk-weighted assets as defined by Article 10 below. Article 10 Risk-weighted assets equal the sum of the following aggregates:
• The amount of weighted credit risks as defined below in Section I of Chapter I of this title, including the amount of counterparty risks on derivative instruments as defined in Section II of Chapter I of this title.
• The amount of operational risks, determined by multiplying by 12.5 the capital requirement for these risks calculated in accordance with Chapter II of this title.
• The amount of market risks, determined by multiplying by 12.5 the capital requirement for these risks calculated in accordance with Chapter III of this title.

Chapter I: Credit Risk and Counterparty Risk on Derivative Instruments Section I: Credit Risk Article 11 The amount of weighted credit risks is calculated by multiplying the incurred risks on balance sheet and off-balance sheet items by corresponding weighting factors as fixed by Article 12 below. Incurred risks on the same beneficiary refer to the total facilities granted regardless of form (credits, leasing operations, participations, current account contributions, guarantees by signature, etc.) after deduction:

• of provisions and reserved fees established to cover risks or for the depreciation of securities affected per client;
• of guarantees received from the State, subjected establishments, insurance companies, and guarantee funds; and
• of security deposits or financial assets that can be liquidated without affecting their value, with the exception of the subjected establishment's own securities. Article 12 Weighting factors applied to asset and off-balance sheet items are fixed as follows: A) 0% Factor

1. Cash and cash equivalents
2. Claims on the Central Bank of Tunisia
3. Direct facilities to the Tunisian State
4. Securities received under repurchase agreements, issued or guaranteed by the Tunisian State

B) 20% Factor

1. Balance sheet commitments

• Facilities to subjected establishments located in Tunisia  Claims on subjected establishments  Bonds other than subordinated bonds held on subjected establishments
• Facilities to banks and assimilated financial institutions located abroad  Claims on banks and assimilated financial institutions located abroad with a remaining maturity of one year or less.  Bonds of banks and assimilated financial institutions located abroad with a remaining maturity of one year or less other than subordinated bonds.
• Claims on local and regional administrations.
• Syndicated loans granted to foreign governments.

2. Off-balance sheet commitments

• Guarantees, avals, and other guarantees given to subjected establishments located in Tunisia.
• Financing commitments given to subjected establishments located in Tunisia.
• Signature commitments to banks and assimilated financial institutions located abroad maturing within the next 12 months.
• Documentary credits to or for the order of banks and assimilated financial institutions located abroad  Acceptances payable  Confirmation of documentary credits
• Counter-guarantees received from subjected establishments located in Tunisia.
• Counter-guarantees received from banks and assimilated financial institutions located abroad.
• Issuance of confirmed documentary credits to the clientele when the goods subject to said credits serve as collateral.

C) 50% Factor

1. Balance sheet commitments

• Housing credits granted to the clientele and staff as provided for in Article 35 ter of Circular No. 87-47 of December 23, 1987 concerning the procedures for granting, monitoring, and refinancing credits.
• Real estate leasing operations.

2. Off-balance sheet commitments

• Aval or substitute line for treasury bills to the clientele.
• Public contract guarantees to the clientele.
• Customs guarantees to the clientele.
• Issuance of confirmed documentary credits to the clientele without the goods subject to said credits serving as collateral.
• Unutilized notified housing credits to the clientele and staff. D) 100% Factor

1. Balance sheet commitments

• Facilities to banks and assimilated financial institutions located abroad with a remaining maturity of more than one year.  Claims on banks and assimilated financial institutions located abroad with a remaining maturity of more than one year.  Bonds of banks and assimilated financial institutions located abroad with a remaining maturity of more than one year other than subordinated bonds.

• Credits to the clientele  Non-performing credits including non-performing housing and real estate leasing credits  Movable leasing  Participatory loans and current account contributions  Other credits to the clientele

• Staff credits other than housing credits

• Securities portfolio other than those held on subjected establishments and assimilated establishments located abroad  Commercial securities portfolio  Investment securities portfolio

• Net fixed assets after amortization

• Other asset items

2. Off-balance sheet commitments

• Guarantees, avals, and other guarantees given to the clientele  Guaranteed bonds  Public contract guarantees1  Guarantees for credit repayment granted by subjected establishments to the clientele.  Other signature commitments to the clientele
• Documentary credits to the clientele  Acceptances payable related to foreign trade financing  Issuance of irrevocable documentary credits
• Financing commitments given to the clientele  Unutilized notified credits to the clientele other than housing credits  Confirmed credit lines  Other financing commitments to the clientele  Unpaid participations
• Other signature commitments to banks and assimilated financial institutions located abroad

Article 13 Unless otherwise provided by the guarantee deed, public contract bank guarantees that have not resulted in the issuance of a release order or return of said guarantee deed cease, if they are not subject to litigation or claims for realization, to be taken into account in the calculation of incurred risks upon expiration of the following periods:

• 6 months after the deadline for submitting tender dossiers to contracts, in the case of provisional guarantees;
• 24 months from the date of issuance of the pledge deed, in the case of final guarantees securing supply contracts;
• 60 months from the date of issuance of the pledge deed, in the case:  final guarantees securing construction contracts;  final guarantees securing study contracts;  guarantees for advance payment restitution;  retention money guarantees. However, these guarantees must be reintegrated into the incurred risk calculation at a 100% factor if the administration requests their realization after the expiration of the aforementioned periods. Article 14 Items that have been deducted from capital funds in accordance with Title I of this circular are excluded from the calculation of incurred risks for credit risks covered by this section. Section II: Counterparty Risks on Derivative Instruments Article 15 Counterparty risk on derivative instruments is the risk that a counterparty defaults before the final settlement of all cash flows related to this operation. Derivative instruments covered by this circular are hedging instruments against foreign exchange and interest rate risks provided for in Circular No. 2016-01 concerning the foreign exchange market and instruments for hedging foreign exchange and interest rate risks. Counterparty risk on derivative instruments covers exposures on banking portfolio and trading portfolio elements as defined in Article 20 of this circular.

Article 16 Risk-weighted assets result from multiplying the risk-exposed value by weighting factors defined in Article 12 based on counterparty category. The risk-exposed value is determined by multiplying the notional amount of the derivative contract by the following weights based on initial duration:

Initial Duration	Interest Rate Contracts	Foreign Exchange Contracts
≤ 1 year	0.5 %	2 %
1 year < maturity ≤ 2 years	1 %	5 %
Per additional year	1 %	3 %

Chapter II: Operational Risks Article 17 The capital requirement for operational risks equals 15% of the average net banking product calculated over the last three financial years. When, for a given financial year, the net banking product is zero or negative, it is not taken into account in the three-year average calculation. The average net banking product is the sum of strictly positive net banking products, divided by the number of financial years for which the net banking product is strictly positive. Chapter III: Market Risks Section I: General Provisions Sub-section I: Definitions Article 18 Market risks are defined as the risk of losses on balance sheet and off-balance sheet positions following market price variations. They cover:  risks related to instruments linked to interest rates and equity securities of the trading portfolio as defined in Article 20; and  foreign exchange risk incurred for all balance sheet and off-balance sheet items. Article 19 The capital requirement for market risks must cover the following risks:

• Trading portfolio market risks which include:  Bond risk or interest rate risk, as defined below in Section II of this chapter.  Price variation risk on equity securities, as defined below in Section III of this chapter.
• Foreign exchange risk, as defined below in Section IV of this chapter.
• Settlement/delivery risk, whether from the trading portfolio or banking portfolio as covered in Section V of this chapter. Article 20 For the purposes of this circular, the trading portfolio, as opposed to the banking portfolio, consists of positions on financial instruments held with the intention of trading or for hedging other elements of the trading portfolio. To be included in the trading portfolio, financial instruments must be free of clauses limiting their tradability or hedging capabilities. Financial instrument refers to any contract creating a financial asset for one party and a financial liability or equity instrument for another party. Financial instruments include both spot financial instruments and derivative instruments. Positions held for trading purposes are those taken with a view to being sold in the short term and/or with the intention of benefiting from favorable short-term price movements or locking in arbitrage profits. They include proprietary positions, client-related activity positions, and market-making activity positions as defined in Circular No. 2016-01. Article 21 Subjected establishments must have clearly defined policies and procedures to determine positions to be included and excluded from their trading portfolio. These policies and procedures must be duly documented, and compliance must be subject to periodic internal audit at least once a year. Article 22 Trading intention is demonstrated based on policies and procedures implemented by each subjected establishment to manage its positions or portfolios under the following conditions: a)