Instruction No. 16/2016 of August 8 on the Calculation and Requirement of Regulatory Own Funds for Operational Risk

INSTRUCTION NO. 16/2016 of August 8
SUBJECT: CALCULATION AND REQUIREMENT OF REGULATORY OWN FUNDS FOR OPERATIONAL RISK

Whereas it is necessary to regulate the technical specifics regarding the requirement of regulatory own funds provided for in Notice No. 05/2016, of June 22, on the requirement of regulatory own funds for operational risk;

Under the combined provisions of letters d) and f) of paragraph 1 of Article 21.º and letter d) of paragraph 1 of Article 51.º, both of Law No. 16/10, of July 15 – Law of the Bank of Angola, and of Article 88.º of Law No. 12/15, of June 17 – Law of the Bases of Financial Institutions.

I DETERMINE:

1. Definitions
   Without prejudice to the definitions established in the Law of the Bases of Financial Institutions, for the purposes of this Notice, the following are understood:

• Administrative Body: a person or group of persons, elected by the partners or shareholders, tasked with representing the company, deliberating on all matters, and performing all acts to achieve its corporate purpose. This includes, notably, the managers of limited liability companies and the members of the board of directors provided for in Law No. 01/2004, of February 13, Law of Commercial Companies.

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2. Requirement of Own Funds
   Financial Institutions must calculate the requirement of regulatory own funds provided for in Article 4.º of Notice No. 05/2016, of June 22, on the requirement of regulatory own funds for operational risk, based on one of the following methodologies, provided that the specific requirements associated with each are met:
   2.1 Basic Indicator Method, according to the conditions established in Annex I of this Instruction;
   2.2 Standardized Method, according to the conditions established in Annex II of this Instruction, or;
   2.3 Alternative Standardized Method, according to the conditions established in Annex III of this Instruction.

3. Authorization
   3.1 The implementation of the Basic Indicator Method does not require prior authorization from the Bank of Angola.
   3.2 The adoption of the Standardized Method or the Alternative Standardized Method depends on prior authorization from the Bank of Angola, for which purpose the rules established in Annex IV of this Instruction must be respected.

4. Revocation of Authorization
   4.1 The Bank of Angola may revoke the authorization granted if the Institution fails to comply with the requirements for the use of the Standardized Method or the Alternative Standardized Method.
   4.2 For the purpose of the preceding paragraph, the Institution must calculate the requirement of regulatory own funds for coverage of operational risk according to the Basic Indicator Method.

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5. Sanctions
   Non-compliance with the mandatory norms established in this Instruction constitutes an offense punishable under the Law of the Bases of Financial Institutions.

6. Transitional Provisions
   Institutions must comply with the provisions of this Instruction in accordance with the transitional provisions of Notice No. 02/2016, of June 15, on regulatory own funds.

7. Doubts and Omissions
   Doubts and omissions that arise in the interpretation and application of this Instruction will be clarified by the Bank of Angola.

8. Entry into Force
   This Instruction enters into force on the date of its publication.

PUBLISHED
Luanda, on August 8, 2016
THE GOVERNOR
VALTER FILIPE DUARTE DA SILVA

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Annex I
Basic Indicator Method

1. In the calculation of the Basic Indicator Method (BIA), the requirement of own funds for coverage of operational risk corresponds to 15% (fifteen percent) of the average of the last 3 (three) years of the annual exposure indicator, if positive, for which purpose the following formula must be used:

[Formula Image/Placeholder]

Where:
α_i = annual exposure indicator relative to the last 3 (three) years, which must only be considered when positive; N = number of years, of the last 3 (three), in which the parts of the numerator are positive.

2. The annual exposure indicator consists of the algebraic sum of the financial margin with other net revenues, resulting from the current activity of the Institution, with the exception of commissions received for the provision of outsourcing services.

3. For the purposes of calculating the annual exposure indicator mentioned in the preceding paragraph, the following accounts of the Chart of Accounts of Financial Institutions (CONTIF) enumerated in Table 1 must be considered.

Table 1 – Annual exposure indicator
Account Description
5.10.10.10 Financial margin
5.10.10.20.10.20 Results from liquidity investments
5.10.10.20.10.30.10 Results from trading of securities and financial instruments held for trading
5.10.10.20.10.40.10 Results from financial instruments in speculation and arbitrage
5.10.10.60 Results from foreign exchange operations
5.10.10.80 Results from provision of financial services

4. The calculation of the annual exposure indicator must be performed based on audited information of the Institutions. If audited information is not available, Institutions may use, on a temporary basis, estimates of results, and the calculation must be redone when audited data become available.

5. In the case of a new Institution, the annual exposure indicator must be 0 (zero) in the first year and, from that year onwards, consider the existing history.

6. In the case of the acquisition of a new activity segment, the calculation of the exposure indicator must consider the results of that activity in the last 3 (three) years, using audited information, when available, or estimates of results.

7. Any subsequent positive or negative results after the closure or sale of an activity segment must be considered in the calculation of the annual exposure indicator.

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Annex II
Standardized Method

1. In the calculation of the Standardized Method, the requirement of regulatory own funds for coverage of operational risk corresponds to the average of the last 3 (three) years of the sum of the exposure indicators of each activity segment duly weighted by the respective risk, taking into consideration Table 3 – Activity Segments and Associated Risk Factors, for which purpose the following formula must be used:

[Formula Image/Placeholder]

Where:
α_i,j = exposure indicator, in a given year i, for each of the eight (j) activity segments; β_j = risk factor (fixed percentage) for each of the eight (j) activity segments.
N = number of years, of the last three, in which the parts of the numerator are greater than 0 (zero).

2. The exposure indicator must be calculated according to the conditions described in number 2 of Annex I.

3. The risk-weighted exposure indicator for a given activity segment may, in a given year, be negative, a situation that may compensate for positive exposure indicators associated with the other activity segments.

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Table 3 – Activity Segments and Associated Risk Factors
Activity Segment | Risk Weight (β_j) | List of Activities --- | --- | --- Corporate Finance | 18% | • Firm underwriting of financial instruments and/or placement of financial instruments on a firm commitment basis

• Services related to firm underwriting
• Investment advisory
• Corporate advisory on capital structures, industrial strategy and related issues, as well as advisory services, and services in the field of mergers and acquisitions of companies
• Investment analysis and financial analysis and other forms of generic recommendations related to operations on financial instruments
  Trading and Sales | 18% | • Proprietary trading
• Intermediation in money markets
• Reception and transmission of orders related to one or more financial instruments
• Execution of orders on behalf of clients
• Placement of financial instruments without firm commitment
• Operation of multilateral trading systems
  Payment and Settlement | 18% | • Payment operations
• Issuance and management of payment instruments
  Commercial Banking | 15% | • Reception of deposits and other repayable funds
• Loans
• Financial leasing
• Provision of guarantees and assumption of commitments
  Agency Services | 15% | • Safekeeping and administration of financial instruments on behalf of clients, namely custody and related services, such as treasury/collateral management Retail Banking | 12% | • Reception of deposits and other repayable funds;
• Loans
• Financial leasing
• Provision of guarantees and assumption of other commitments
  Retail Brokerage | 12% | • Reception and transmission of orders related to one or more financial instruments
• Execution of orders on behalf of clients
• Placement of financial instruments without firm commitment
  Asset Management | 12% | • Portfolio management
• Other forms of asset management

Institutions wishing to implement the Standardized Method on an individual and consolidated basis must consider the following minimum requirements:
a) develop and document specific policies and criteria for allocating the exposure indicator among the activity segments identified in Table 3 – Activity Segments and Associated Risk Factors. b) the specific policies and criteria for allocating the exposure indicator among the activity segments must be in compliance with the following guiding principles:
i. all activities must be allocated among the activity segments identified in Table 3 – Activity Segments and Associated Risk Factors, so that each activity corresponds to only one segment and none is excluded;
ii. any activity that cannot be directly classified into the activity segments defined in Table 3 – Activity Segments and Associated Risk Factors, but that represents a support function, must be classified into the activity segment it supports. If that activity is support for more than one activity segment, objective allocation criteria must be used;
iii. in the case of an activity that cannot be classified into a specific activity segment, it must be classified into the activity segment to which the highest percentage corresponds;
iv. Institutions may use internal pricing methods if they wish to allocate the exposure indicator to two or more activity segments, provided that the global exposure indicator is not undervalued;
v. the allocation of activity segments, for the purposes of determining the requirement of regulatory own funds for coverage of operational risk, must be consistent with the categories used for credit and market risks;
vi. the specific policies and criteria for allocation into activity segments must be duly documented, and be sufficiently clear and detailed to allow an external entity to replicate the process of mapping the activity segments;
vii. processes for identifying activity segments for new products or activities must be defined;
viii. the administrative body is responsible for defining and reviewing the specific policies and criteria for allocating the annual exposure indicator among the activity segments identified in Table 3 – Activity Segments and Associated Risk Factors;
ix. management staff with leadership responsibilities are responsible for ensuring that the policies and processes mentioned above are effectively implemented;
x. the process of identifying activity segments must be subject to independent review.
c) the specific policies and criteria for allocating the annual exposure indicator among the activity segments must be reviewed and adjusted whenever significant changes arise in the current activity of the Institution or a new activity segment begins.

4. Institutions wishing to implement the Standardized Method must also comply with the following additional requirements in terms of organizational and internal control:
   a) have an operational risk management function, responsible for implementing policies and procedures to identify, assess, monitor, control, and report operational risk;

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b) ensure the classification, through a set of objective and duly documented criteria, of operational risk events into the activity segments identified in Table 3 Activity Segments and Associated Risk Factors, according to the types of operational risk events indicated in Table 4 Operational Risk Categories; c) ensure, if applicable, the integration of the operational risk measurement system into current risk management procedures; d) ensure, if applicable, sufficient documentation of the operational risk measurement and management system, including procedures that ensure its efficiency and corrective measures to be taken in case of non-compliance; e) ensure, if applicable, that the internal validation processes of the operational risk measurement system function adequately and that the data flows and processes associated with that system are transparent, up-to-date, and available.

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Table 4 – Operational Risk Categories
Operational Risk Category | Operational Risk Events --- | --- Internal Fraud | • Losses resulting from acts intended to commit fraud, misappropriation of assets, or circumvention of laws, regulations, or corporate policies, with the exception of acts related to differentiation/discrimination, involving at least one internal party of the company External Fraud | • Losses resulting from acts intended to commit fraud, misappropriation of assets, or circumvention of laws by a third party Employment Practices and Workplace Safety | • Losses resulting from acts that are not in compliance with laws or labor, health, or safety agreements, as well as from the payment of personal damages or acts related to differentiation/discrimination Clients, Products, and Business Practices | • Losses resulting from the intentional or negligent breach of a professional obligation towards specific clients (including fiduciary and suitability requirements) or from the nature or design of a product Damage to Physical Assets | • Losses resulting from damage or prejudice caused to physical assets by natural disasters or other events Business Disruption and System Failures | • Losses resulting from the disruption of business activities or system failures Execution, Delivery, and Process Management | • Losses resulting from failures in the processing of operations or in the management of processes, as well as from relations with commercial counterparties and vendors

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Annex III
Alternative Standardized Method

1. In the calculation of the Alternative Standardized Method, the requirement of regulatory own funds for coverage of operational risk consists of the sum:
   a) of the alternative exposure indicators of the last 3 (three) years, duly weighted by risk (15%) and multiplied by the factor (3.5%), for the activity segments of retail banking and commercial banking; b) of the exposure indicators of the last 3 (three) years, duly weighted by risk (18%), for the other activity segments of the Institution.

2. The following formula must be used in the Alternative Standardized Method:

[Formula Image/Placeholder]

Where:
R_OA_RB = requirement of regulatory own funds for coverage of operational risk for retail banking according to the Alternative Standardized Method; R_OA_CB = requirement of regulatory own funds for coverage of operational risk for commercial banking according to the Alternative Standardized Method;

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α_i,j = annual exposure indicator, in a given year i, for the remaining six (j) activity segments; α_i,j_alt = alternative exposure indicator, in a given year i, for the respective activity segment; 3.5%; N = number of years, of the last three, in which the parts of the numerator are greater than 0 (zero).

3. The annual exposure indicator must be calculated according to the conditions described in number 2 of Annex I, considering the activity segments presented in Table 3 – Activity Segments and Associated Risk Factors.

4. The alternative exposure indicator regarding the activity segments of retail banking or commercial banking consists of the algebraic sum of the total nominal amount of loans and accounts receivable of the respective activity segments.

5. For the purposes of calculating the alternative exposure indicator of the activity segment of retail banking (R_OA_RB), the results present in the CONTIF accounts enumerated in Table 5 – Alternative Exposure Indicator of Retail Banking must be considered.

Table 5 – Alternative Exposure Indicator of Retail Banking (R_OA_RB)
Account Description
1.70 Credits
1.80 Other values

6. For the purpose of calculating the alternative exposure indicator of the activity segment of commercial banking (R_OA_CB), the results present in the CONTIF accounts enumerated in Table 6 – Alternative Exposure Indicator of Commercial Banking must be considered.

Table 6 – Alternative Exposure Indicator of Commercial Banking (R_OA_CB)
Account Description
1.70 Credits
1.80 Other values

7. The calculation of the alternative exposure indicator must be performed based on audited information. If audited information is not available, Institutions may use, on a temporary basis, estimates of results, and the calculation must be redone when audited data become available.

8. In the case of the acquisition of a new activity segment of retail banking and/or commercial banking, the calculation of the alternative exposure indicator must consider the values of that activity in the last 3 (three) years, using audited information, when available, or estimates of results.

9. Institutions wishing to implement the Alternative Standardized Method on an individual and consolidated basis must consider the following minimum requirements:
   a) conduct their activities mainly in the activity segments of retail banking and/or commercial banking, complying with the following requirements:
   i. the activity segments of retail banking and/or commercial banking must account for at least 90% (ninety percent) of the financial intermediation results of the Institution in the sense of CONTIF in the year preceding the request; and

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ii. the Institution must demonstrate that a significant proportion of its activity segments of retail banking and/or commercial banking include loans with a high probability of default and that the Alternative Standardized Approach provides a more adequate basis for assessing operational risk.
b) the requirements for allocation into activity segments provided for in number 4 of Annex II must be observed, considering for this purpose only two groups of activity segments, namely, activity segment of retail banking and commercial banking, and other activity segments.

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Annex IV
Application Process

Institutions or financial groups wishing to request authorization from the Bank of Angola for the use of the Standardized Method or the Alternative Standardized Method as a means of calculating the requirement of regulatory own funds for the coverage of operational risk, must follow the following process:

1. Submit the request in writing to the Bank of Angola, specifying the following aspects:
   a) the method to which they are applying, i.e., Standardized Method or Alternative Standardized Method, and indication of situations involving the participation of other competent authorities for the exercise of supervision; b) statement of the reasons for the request; c) person responsible for contacts with the Bank of Angola in this regard.

2. Together with the letter mentioned in the preceding number, the Institution must submit the following documentation:
   a) opinion of the supervisory body of the Institution, duly dated and signed, regarding the truthfulness and adequacy of the information sent; b) opinion of the external auditor of the Institution, duly dated and signed, regarding the truthfulness and adequacy of the information sent; c) general framework elements of the Institution or financial group:
   i. detail of the activity developed by each legal entity covered and with a summary table, for example, in terms of contribution to assets or, if applicable, in terms of risk-weighted assets;
   ii. statement of the corporate governance structure with description of the functions of the various areas involved in risk management;
   iii. description of reporting structures, with specification of the degree of detail and frequency of reporting performed within the various areas involved in risk management;
   iv. planning of human and material resources used, with special emphasis on IT and internal audit means;
   v. self-assessment of the capacity to ensure compliance with the requirements provided for in Notice No. 02/2016, of June 15, on regulatory own funds on an individual basis and, if applicable, consolidated, considering the use of the method to which they are applying for the calculation of the requirement of regulatory own funds for coverage of operational risk.

3. Additionally, and together with the preceding numbers, the Institution must submit the following information:
   a) allocation of the requirement of regulatory own funds for operational risk among legal entities of the group, if applicable; b) explanation of the method of calculating the exposure indicator for the different activity segments in each legal entity; c) general information on the technological structure supporting operational risk management; d) specific policies and criteria for:

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i. allocation of the exposure indicator among the different activity segments, with indication of review procedures and introduction of any adjustments;
ii. classification of loss information within the different activity segments and types of operational risk events