Instruction No. 002/2022-CSBF of December 20, 2022 on the Regulatory Capital of Credit Institutions

[LOGO] BANKY FOIBEN'I MADAGASIKARA COMMISSION DE SUPERVISION BANCAIRE ET FINANCIERE

INSTRUCTION NO. 002/2022-CSBF ON THE REGULATORY CAPITAL OF CREDIT INSTITUTIONS

The Commission for Banking and Financial Supervision (CSBF), Having regard to Law No. 2020-011 of September 1, 2020 on banking law, Having regard to Law No. 2017-026 of February 8, 2018 on microfinance, Having regard to the opinion issued by the Professional Association of Banks (APB), the Professional Association of Microfinance Institutions (APIMF), and financial institutions,

DECIDES

Article 1 - Purpose

The purpose of this instruction is to define the components comprising the Regulatory Capital of credit institutions, which serves as the reference basis for calculating the prudential ratios established by the CSBF, and their conditions for inclusion.

Article 2: Definitions

Under this instruction, the following terms mean:

• credit institution (CI), any financial institution referred to in Article 14 of the aforementioned banking law;

• other banking service provider, any financial institution referred to in Article 23 of the aforementioned banking law;

• microfinance institution (MFI), any financial institution referred to in Article 7 of the aforementioned microfinance law;

• insurance company (IC), any financial institution referred to in Article 192 of Law No. 2020-005 of September 1, 2020 on insurance;

• cross-holding, any reciprocal holding between the reporting CI and another CI, IC, or other banking service provider;

• significant holding, any holding exceeding 10% of the regulatory capital of the reporting CI, held directly or indirectly in the capital of another CI, IC, or other banking service provider, excluding cross-holdings;

• non-significant holding, any holding below 10% of the regulatory capital of the reporting CI, held directly or indirectly in the capital of another CI, IC, or other banking service provider, excluding cross-holdings;

• difference on equity accounting of consolidated entities, the difference between the book value of the securities and the share of the consolidating entity, under the equity method of consolidation. This method is used when a parent company exercises significant influence over other entities;

• acquisition differential, the difference between the book value of the parent's holdings and their revalued amount, recognized upon consolidation as "goodwill" on the asset side, with the corresponding amount recorded in consolidated reserves;

• translation difference on the liability side of consolidated accounts, the difference resulting from converting the balance sheet items of consolidated entities prepared in foreign currencies into the currency of the consolidating entity;

• latent reserve related to hire-purchase or lease-to-own operations, the difference between financial depreciation and accounting depreciation of leased assets under hire-purchase and/or lease-to-own agreements.

Article 3: Regulatory Capital

Regulatory Capital consists of Tier 1 capital and Tier 2 complementary capital.

Tier 1 capital comprises CET1 capital, as provided in Article 4, and Additional Tier 1 (AT1) capital, as provided in Article 6.

Regulatory Capital is calculated on an individual basis and, where applicable, on a consolidated basis.

Article 4: CET1 Capital

CET1 capital is obtained by summing the elements listed in paragraph 4.1 below, less the elements listed in paragraph 4.2 below.

4.1. Included in CET1:

• capital stock and instruments treated as such, meeting the criteria defined in Article 5 of this instruction;
• share premiums or merger premiums actually received, representing the difference between the issue price and the nominal value of the capital instruments mentioned above;
• legal reserve and unrestricted statutory reserves;
• other unrestricted reserves, immediately mobilizable and unrestricted for covering risks or losses, excluding revaluation reserves and differences for fixed assets;
• provisions with a reserve character;
• retained earnings (credit balance);
• unallocated profit from the most recent closed fiscal year, provided it is not subject to reservations by the statutory auditors;
• non-refundable and unallocated funds, in the nature of grants or donations, definitively acquired.

In consolidated calculations, the following are also included:

• the consolidated reserve counterpart of acquisition differentials;
• differences on equity accounting of consolidated entities;
• translation differences on the liability side of consolidated accounts;
• minority interests presented in consolidated accounts as CET1 capital, provided they meet the capital and treated-as-capital inclusion criteria defined in Article 5 of this instruction.

4.2. Deducted from CET1:

• the unpaid portion of share capital;
• treasury shares and other CET1 capital instruments issued by the reporting CI and held by it for its own account, valued at net book value;
• retained earnings (debit balance);
• organization costs;
• intangible fixed assets;
• losses pending approval and allocation;
• interim deficit for the current fiscal year;
• the amount of the unallocated profit from the most recent closed fiscal year whose distribution has been decided or is planned;
• supplementary provisions for doubtful debts and for risks and charges recommended by statutory auditors and/or the CSBF, up to their actual establishment or until the recommendation is lifted based on information deemed conclusive by the CSBF;
• acquisition differentials and deferred taxes on the asset side of consolidated accounts;
• cross-holdings in the form of CET1 capital instruments;
• significant holdings in the form of CET1 capital instruments;
• non-significant holdings in the form of CET1 capital instruments, when the total of these holdings exceeds 10% of the CI's regulatory capital. The amount to be deducted from CET1 is determined as follows: (i) total amount of non-significant holdings exceeding 10% of the holding institution's regulatory capital, multiplied by (ii) the percentage of CET1 capital in the total amount of non-significant holdings held;
• the negative amount of other AT1 capital, if applicable.

Article 5: Criteria for Admission of Capital Instruments and Treated-as-Capital Funds into CET1

The criteria for admission into CET1 are as follows:

1. they must be issued directly by the CI and be fully paid up;
2. their subscription has not been directly or indirectly financed by the CI;
3. the paid-up capital is not backed by any security or guarantee from the issuer or a related entity, nor is it subject to any mechanism that enhances the claim's rank legally or economically;
4. they must be subordinated, payable only in the last rank after all other creditors in case of the CI's insolvency or liquidation;
5. they represent an unlimited and variable claim, not fixed or capped;
6. they must represent a claim on residual assets proportional to the issued capital share, after all senior claims are repaid, in case of liquidation;
7. they must be available to absorb any losses at any time to the same extent as ordinary shares;
8. the principal has an indefinite duration and is never repayable outside of liquidation, except for repurchase at the issuer's sole discretion;
9. the CI must not imply at the time of issuance that the instrument will be repurchased, repaid, or cancelled, and statutory or contractual provisions must not contain any clause that could constitute such an obligation or create such an expectation;
10. payments to holders, including undistributed profits, are made from distributable profits; their level is in no way linked to the issue price and is not subject to a contractual cap;
11. profit distribution related to the instruments is in no case mandatory, and non-payment does not constitute a default event;
12. payments are made only after all legal and contractual obligations are met, and payments on senior capital instruments have been made;
13. the paid-up capital is classified as equity under applicable accounting standards;
14. the paid-up capital is clearly and separately stated on the CI's balance sheet;
15. for mutual MFIs, the MFI has the right to refuse repayment of these instruments when repayment would jeopardize compliance with the capital requirements to which it is subject.

Article 6: Additional Tier 1 (AT1) Capital

AT1 capital includes the elements listed in paragraph 6.1 below, less the elements in paragraph 6.2 below.

6.1. Included in AT1:

• financial instruments meeting the criteria defined in Article 7 of this instruction;
• partners' accounts and other resources meeting the criteria defined in Article 7 of this instruction;
• issue premiums for financial instruments included in AT1 capital;
• equipment grants received;
• conditional donations whose potential repayment is subject to compliance with prudential standards and approval by the CSBF General Secretariat;
• fully mutualized guarantee funds and network guarantee funds;
• other mutual guarantee funds and public funds allocated to guarantee categories of credit operations, limited to 8% of the risks they cover;
• latent reserve related to hire-purchase or lease-to-own operations;
• minority interests in consolidated accounts that meet the criteria defined in Article 7 of this instruction.

6.2. Deducted from AT1:

• AT1 capital instruments issued by the CI and held by it for its own account, valued at net book value;
• cross-holdings in the form of AT1 capital instruments;
• AT1 capital instruments held in CIs, ICs, and other banking service providers where the institution holds significant holdings other than those mentioned above;
• AT1 capital instruments held in CIs, ICs, and other banking service providers where the institution holds non-significant holdings whose total amount exceeds 10% of its regulatory capital. The deduction amount is determined as follows: (i) total amount of non-significant holdings exceeding 10% of the holding institution's capital, multiplied by (ii) the percentage of AT1 capital instruments in the total amount of non-significant holdings held;
• the negative amount of Tier 2 complementary capital, if applicable.

When AT1 is negative after deductions, the negative amount must be subtracted from CET1.

Article 7: Criteria for Admission of Financial Instruments, Partners' Accounts, and Other Resources into Additional Tier 1 (AT1) Capital

The financial instruments, partners' accounts, and other resources referred to in paragraph 6.1 are admitted to AT1 provided they meet all the following criteria:

1. they must be subject to a contract or prospectus of issuance;
2. they must be fully paid up;
3. they must have an indefinite duration;
4. they cannot be subject to a redemption option before a minimum period of 5 years, initiated exclusively by the issuer and with prior CSBF approval;
5. they cannot contain any contractual clause creating a strong incentive for early redemption, such as interest rate step-ups or other remuneration forms based on time or the CI's situation;
6. their repayment is subordinated to that of all liabilities, except for elements included in ordinary shares and treated-as-capital funds admitted to CET1;
7. they cannot be held, financed, or guaranteed by the CI;
8. the borrowing CI must have the right to defer or cancel the payment of interest and/or other remuneration on the instruments if its financial situation requires it, without this constituting a default event;
9. interest payments or any other remuneration attached to the instruments must be charged against distributable profits;
10. the principal and unpaid interest or other remuneration attached to the instruments may be used to absorb potential losses.

Article 8: Tier 2 Complementary Capital

Tier 2 capital includes the elements listed in paragraph 8.1 below, less the elements listed in paragraph 8.2 below.

8.1. Included in Tier 2:

• subordinated loans and other financial instruments meeting the criteria defined in Article 9 of this instruction;
• partners' accounts and other resources meeting the criteria defined in Article 9 of this instruction;
• issue premiums for financial instruments admitted to Tier 2;
• minority interests in the form of financial instruments admitted to Tier 2;
• revaluation reserves and differences for fixed assets, subject to validation by the statutory auditor.

8.2. Deducted from Tier 2:

• Tier 2 capital instruments issued by the CI and held by it for its own account;
• cross-holdings in the form of Tier 2 capital instruments;
• Tier 2 capital instruments held in CIs, ICs, and other banking service providers where the institution holds significant holdings, other than those mentioned above;
• Tier 2 capital instruments held in CIs, ICs, and other banking service providers where the institution holds non-significant holdings whose total amount exceeds 10% of its regulatory capital. The deduction amount is determined as follows: (i) total amount of non-significant holdings exceeding 10% of the holding CI's regulatory capital, multiplied by (ii) the percentage of Tier 2 capital instruments in the total amount of non-significant holdings.

When Tier 2 capital is negative after deductions, the negative amount must be subtracted from AT1.

Article 9: Criteria for Admission of Subordinated Loans, Other Financial Instruments, Partners' Accounts, and Other Resources into Tier 2 Complementary Capital

The subordinated loans, other issued financial instruments, partners' accounts, and all other resources referred to in paragraph 8.1 are admitted to Tier 2 provided they meet all the following criteria:

1. they must be subject to a contract or prospectus of issuance;
2. they are issued and paid up;
3. they are not held for own account by any of the following entities:

• the CI or its subsidiaries;
• a company in which the CI holds a direct or indirect participation of 20% or more of its voting rights or capital through a control link;

4. they are not directly or indirectly financed by the CI;

5. they have an initial maturity of at least 5 years, without any interest step-up based on time or the CI's situation creating a strong incentive for early redemption;

6. early redemption is not permitted or can only occur after a minimum period of 5 years, at the sole initiative of the CI and after CSBF approval;

7. they rank below depositors and other unsecured creditors of the CI; repayment of principal and interest in case of CI liquidation is subordinated to the repayment of all other debts, except for financial instruments included in CET1 capital;

8. they do not benefit from any security or guarantee from the following entities that would enhance their rank relative to depositors and other unsecured creditors of the CI:

• the CI or its subsidiaries,
• the parent company of the CI or its subsidiaries;

9. when issued through an entity included in the consolidation scope, the CI may immediately utilize the proceeds from these instruments without limitation and in a form that satisfies the conditions set forth in this article.

Article 10: Discount Applicable to Subordinated Loans and Other Financial Instruments Admissible in Tier 2

The amount of subordinated loans and other financial instruments admissible in Tier 2, with a maturity of 5 years or more, is reduced by an annual discount of 20% during the 5 years preceding their final maturity, as follows:

Remaining Maturity	Percentage of Inclusion
5 years and more	100%
4 to 5 years	80%
3 to 4 years	60%
2 to 3 years	40%
1 to 2 years	20%
Less than 1 year	0%

If the subordinated loan contract provides for interest capitalization, capitalized interest must be subject to contractual stipulations stating that:

• their subordination rank is identical to the principal;
• their repayment maturity is at least 5 years;
• an annual discount of 20% is applied to the amount of capitalized interest during the 4 years preceding the final maturity set for their payment.

Article 11: Regulatory Capital of Microfinance Institutions (MFIs) Constituted as a Network

The regulatory capital of MFIs constituted as a network must be calculated on a consolidated basis for the entire network and on an individual basis for each affiliated MFI.

For the calculation of consolidated capital of an MFI network, reciprocal capital transactions must be eliminated to exclude, in particular, contributions from the head structure to affiliated MFIs.

Repayment of affiliated MFIs' share capital can only be made if the MFI's situation permits compliance with prudential standards.

Article 12: CSBF Competence

The CSBF may oppose the inclusion of certain elements in a CI's regulatory capital if it deems that the conditions defined by this instruction are not satisfactorily met.

The concerned CI is notified of the CSBF's referral by the CSBF General Secretary. Until the CSBF rules, the elements in question cannot be included in regulatory capital.

CIs must submit to the CSBF General Secretariat for validation the contracts and documents mentioned in the first point of paragraphs 7.1 and 9.1 of this instruction.

Article 13: Periodic Declarations

Declarations are prepared annually based on figures finalized at the end of each fiscal year and certified by the statutory auditor. They are sent to the CSBF General Secretariat as an annex to the end-of-year accounting documents and no later than June 30 of the following fiscal year.

A special declaration must be made in case of a change in capital amount or in case of an event that increases or decreases the regulatory capital amount by 10% or more. The special declaration must be prepared based on interim accounts finalized at the end of the month following the modification or event mentioned above. The CSBF General Secretariat may require certification by the statutory auditor when the situation justifies it. Upon validation by the CSBF General Secretariat, it notifies the concerned institution for the calculation of applicable prudential ratios.

A special declaration must also be made at each periodic closing to account for any interim deficit results recorded.

The declaration procedures and the declaration template are subject to a circular from the CSBF President.

Article 14: Transitional Provisions

For already approved CIs, the first declaration must be made based on accounts finalized as of December 31, 2022.

For newly approved institutions, the first declaration must be made within one (1) month from the date of commencement of operations. This declaration must be accompanied by the opening balance sheet prepared according to the model provided by the CI Accounting Plan.

Article 15: Sanctions

When a CI fails to comply with the provisions of this instruction, the CSBF may issue an injunction requiring it to submit, within a specified deadline, measures or an action plan to regularize its situation.

If the CI fails to comply with the injunction, the CSBF may impose one or more disciplinary sanctions and pecuniary sanctions provided for by the banking law.

Article 16: Entry into Force

This instruction enters into force upon its notification to the APB, APIMF, financial institutions, and its publication on the Banky Foiben'i Madagasikara website. It repeals the provisions of Instruction No. 001/2000-CSBF of February 1, 2000 on available capital of CIs.

Done in Antananarivo, on December 20, 2022 For the Commission for Banking and Financial Supervision,

[Signature] THE PRESIDENT, Henri Edmond RABARIJOHN