NBB_2017_05 Circular / NBB's Expectations Regarding Regulatory Capital and Liquidity Requirements for Less Significant Credit Institutions

NBB_2017_05 – February 24, 2017 Circular – Page 1/8 boulevard de Berlaimont 14 – BE-1000 Brussels tel. +32 2 221 38 12 – fax + 32 2 221 31 04 company number: 0203.201.340 RPR Brussels www.bnb.be Circular Brussels, February 24, 2017 Reference: NBB_2017_05 your contact person:
Gertjan van Gastel tel. +32 2 221 27 88 – fax +32 2 221 31 04 gertjan.vangastel@nbb.be NBB's Expectations Regarding Regulatory Capital and Liquidity Requirements for Less Significant Credit Institutions Scope This circular applies to less significant Belgian credit institutions as defined by Council Regulation (EU) No 1024/2013 1,2.
Summary/Objectives
This NBB circular provides clarifications on a series of requirements applicable to less significant credit institutions regarding capital and coverage of regulatory liquidity needs. These requirements concern: 1) the recognition of interim profits; 2) dividend distribution; 3) the establishment of a variable remuneration policy; 4) the establishment of an ICAAP and ILAAP report; 5) permission to reduce own funds; 6) prior authorization for the inclusion of Additional Tier 1 capital instruments and Tier 2 capital in regulatory own funds; 7) the treatment of reserves held with central banks according to the liquidity coverage ratio. This circular, which replaces circular NBB_2016_05, will be updated if deemed appropriate. It is therefore not a definitive document. 1 Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions. 2 Branches of credit institutions located outside the EEA are not subject to the capital and liquidity requirements imposed by European Regulation 575/2013 and therefore fall outside the scope of this circular.

Circular – Page 2/8 NBB_2017_05 – February 24, 2017 Madam, Sir, This NBB circular provides clarifications and instructions relating to a series of requirements applicable to less significant credit institutions regarding regulatory own funds and coverage of liquidity needs. It is primarily part of the context of recent decisions taken by the ECB in this area within the framework of the SSM. The following topics are particularly addressed:
x Recognition of interim profits; x Dividend distribution; x Establishment of a variable remuneration policy; x Establishment of an ICAAP and ILAAP report; x Permission to reduce own funds; x Prior authorization for the inclusion of Additional Tier 1 capital instruments and Tier 2 capital in regulatory own funds; x Treatment of reserves held with central banks according to the liquidity coverage ratio. The main objective of the NBB is to maintain an equivalent regime between credit institutions directly subject to ECB supervision and those indirectly subject to it. Consequently, the NBB intends to extend the procedures in force for significant institutions to less significant institutions, taking into account the principle of proportionality. If, for the aforementioned topics, the ECB extends or revises its practices with regard to significant institutions or takes new decisions concerning the procedures for said significant institutions, the NBB will consequently assess whether it is appropriate to update its expectations for less significant institutions.

1. Recognition of interim profits
   Regulation No 575/2013 provides that institutions may, subject to certain conditions and prior authorization from the competent authority 3, include their interim or year-end profits in their Common Equity Tier 1 capital before a formal decision confirming the year's result and its appropriation has been taken.
   In accordance with Article 26, paragraph 2, of Regulation No 575/2013, two conditions must be met for the competent authority to grant its authorization:
   a) the profits in question must have been verified by persons independent of the institution who are responsible for auditing its accounts 4 and it must thus be ensured that these profits have been evaluated in accordance with the principles set out in the applicable accounting framework; and b) the institution has demonstrated to the satisfaction of the competent authority that all foreseeable charges and dividends have been deducted from these profits. 3 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (hereinafter referred to as "Regulation No 575/2013"). 4 This will in this case be the approved statutory auditor appointed to the institution concerned.

NBB_2017_05 – February 24, 2017 Circular – Page 3/8 For the evaluation of compliance with these conditions, reference is made to Articles 2 and 3 of Delegated Regulation No 241/2014, which specify what is meant by foreseeable charges and dividends 5.
To demonstrate to the NBB that the conditions are met, the credit institution must submit detailed documentation. Less significant credit institutions must rely on the provisions of ECB Decision/2015/4, which describes the procedure for significant institutions 6. In particular, the following will be provided:
a) an audit report or a comfort/limited review letter signed by the approved statutory auditor, covering the verification of profits, in accordance with Article 4 of ECB Decision/2015/4. b) a letter detailing the elements of the net profit calculation method as described in the annex to ECB Decision/2015/4 and in accordance with Article 5, paragraph 1, of that decision.
A less significant credit institution wishing to include interim or year-end profits before a formal decision confirming the year's result has been taken must submit these two documents to the NBB. The NBB considers that all requirements for the recognition of interim or year-end profits as Common Equity Tier 1 capital are met if the notifying credit institution has provided the aforementioned documents. However, the NBB reserves the right, at any time, if it finds that the documents provided do not meet the aforementioned requirements or contain erroneous data and/or calculations, to refuse the inclusion of interim or year-end profits in Common Equity Tier 1 capital. Authorization for the recognition of interim profits is valid until the end of the current financial year concerned, unless negative value adjustments require a reduction in interim profits. If an institution wishes to obtain recognition of interim profits for a higher amount, it must submit a new request to the NBB.
2. Dividend distribution
Credit institutions are requested to adopt a dividend distribution policy that allows them to strengthen their own funds in accordance with minimum regulatory capital requirements. These capital requirements are:
x the so-called Pillar 1 requirements as set out in Article 92 of Regulation No 575/2013 and in Articles 95 and 96 of the Banking Law (overall Common Equity Tier 1 capital buffer requirement) 7. x the so-called Pillar 2 requirements referred to in Articles 149 and 150 of the Banking Law, imposed following the application of the Supervisory Review and Evaluation Process (SREP).
Part Ten of Regulation No 575/2013 and Articles 412 and 413 of the Banking Law set a progressive introduction period for capital requirements. Institutions must at all times meet capital requirements taking into account this progressive introduction period.
5 Commission Delegated Regulation (EU) No 241/2014 of 7 January 2014 supplementing Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to regulatory technical standards for own funds requirements for institutions (hereinafter referred to as "Delegated Regulation No 241/2014").
6 European Central Bank Decision (EU) 2015/656 of 4 February 2015 on the conditions under which credit institutions may include their interim or year-end profits in Common Equity Tier 1 capital in accordance with Article 26(2) of Regulation (EU) No 575/2013 (ECB/2015/4) (hereinafter referred to as "ECB Decision/2015/4").
7 Law of 25 April 2014 on the status and supervision of credit institutions (hereinafter referred to as "Banking Law").

Circular – Page 4/8 NBB_2017_05 – February 24, 2017 The sum of the capital requirements applicable at the end of the progressive introduction period determines the "fully loaded capital ratio". To this end, the aforementioned Pillar 1 and Pillar 2 requirements are fully covered, including the Common Equity Tier 1 capital buffers defined in Articles 95 and 96 of the Banking Law. The NBB wishes institutions to progress now and continuously towards compliance with the fully loaded capital ratio. It is indeed important to take into account the difficult macroeconomic context likely to weigh on the profitability of future financial years. Consequently, the NBB will apply the ECB recommendation 8 on dividend distribution policies for significant institutions by requiring less significant institutions to comply with the dividend distribution provisions contained in this recommendation and to adopt a dividend distribution policy that meets these provisions. ECB Recommendation/2016/44 distinguishes three categories of credit institutions: credit institutions that already comply with the fully loaded capital ratio (category 1), credit institutions that do not yet comply with the fully loaded capital ratio but meet the currently applicable capital ratio (category 2), and credit institutions that have a capital shortfall (category 3). x Category 1 credit institutions may distribute dividends but must do so prudently, in order to continue to meet all capital requirements, even in the event of a deterioration in the economic and financial situation; x Category 2 credit institutions may distribute dividends while ensuring a linear progression 9 towards compliance with the fully loaded capital ratio, and must do so prudently, in order to continue to meet all capital requirements, even in the event of a deterioration in the economic and financial situation; x Category 3 credit institutions should not distribute dividends. The credit institution is requested to determine each year the fully loaded capital ratio it would be required to meet, as well as the ratio applicable according to the transitional provisions and its current situation, in order to place itself in one of the three aforementioned categories.
3. Establishment of a variable remuneration policy
Less significant credit institutions must adopt a prudent and forward-looking approach when making decisions regarding their institution's remuneration policy. The NBB insists that less significant institutions carefully examine the potential negative impact of the remuneration policy on maintaining the soundness of their institution's own funds, taking into account in particular the transitional provisions of Regulation (EU) No 575/2013 (CRR) and Directive 2013/36/EU (CRD IV). Consequently, in determining attributable variable remuneration, and notably the use of malus and clawback provisions, the NBB recommends that less significant institutions follow a policy that does not undermine the principle of prudent – at least linear – progression towards compliance with the fully loaded capital ratio. 8 European Central Bank Recommendation of 13 December 2016 on dividend distribution policies (ECB/2016/44) (hereinafter "ECB Recommendation/2016/44"). 9 Concretely, this means in practice that for 4 years from 31 December 2014, credit institutions must in principle successively retain an amount equivalent to at least 25%, 50%, 75% then 100% of the difference between the level of own funds at the end of the financial year and the total level of own funds required for the Common Equity Tier 1 capital ratio, the Tier 1 capital ratio and the total capital ratio.

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4. Establishment of an ICAAP and ILAAP report
In accordance with Article 94 of the Banking Law, every credit institution must have a forward-looking policy for managing the institution's capital and liquidity requirements. x Regarding the management of capital requirements, less significant institutions must annually submit to the NBB quantitative documentation on the Internal Capital Adequacy Assessment Process (ICAAP) in accordance with circular PPB-2007-15-CPB-CPA 10. The institution also keeps an internal ICAAP file available to the NBB, which describes the strategies and procedures on the basis of which the less significant institution can assess and ensure the level, type, and distribution of internal capital it deems appropriate to cover on an ongoing basis the risks to which it is, or could be, exposed. At the express request of the NBB, institutions must communicate their internal ICAAP file. x Regarding the management of liquidity requirements, the NBB expects institutions to communicate, at its express request, their internal documentation on their liquidity adequacy or their ILAAP file. x The NBB also requests that the ICAAP and/or ILAAP file be communicated at the start of the analysis or monitoring of the adequacy of the procedures and systems put in place by the institution. The NBB also expects institutions to communicate without delay all relevant information not included in the internal documentation or the ICAAP and ILAAP file. In this context, the NBB asks less significant credit institutions to ensure, when drafting their ICAAP and ILAAP files, that they follow the EBA guidelines (https://www.eba.europa.eu/-/eba-publishes-final-guidelines-on-icaap-and-ilaap-information), which provide clarifications on the information that competent authorities collect from less significant credit institutions concerning the Internal Capital Adequacy Assessment Process (ICAAP) and the Internal Liquidity Adequacy Assessment Process (ILAAP). These guidelines are intended to facilitate the consistent implementation of the supervisory authorities' assessment of ICAAP and ILAAP documentation, as well as the assessment of the reliability of capital and liquidity estimates made by institutions within the framework of the Supervisory Review and Evaluation Process (SREP) following the establishment of the criteria and methodologies specified in the EBA guidelines on common procedures and methodologies for SREP. The NBB planned, during the 1st quarter of 2017, to convert the EBA guidelines concerning ICAAP and ILAAP into a specific circular to further clarify the NBB's expectations on these guidelines.
5. Prior authorization for the reduction of own funds
Regulation No 575/2013 provides that institutions are required to obtain prior authorization from the competent authority to reduce their own funds (see Article 77(a) for Common Equity Tier 1 capital instruments and Article 77(b) for Additional Tier 1 capital instruments and Tier 2 capital instruments). The conditions under which the competent authority may authorize the institution to reduce its own funds are set out in Article 78 of Regulation No 575/2013. 10 Circular on prudential expectations regarding the institution's own assessment process.

Circular – Page 6/8 NBB_2017_05 – February 24, 2017 Less significant institutions may thus:
1) replace the reduced, repaid or repurchased own funds instruments by issuing new instruments of equal or higher quality, under viable conditions taking into account the institution's potential earnings; or
2) demonstrate that, despite their decrease, own funds continue to meet all applicable regulatory requirements.
The repurchase of Additional Tier 1 capital instruments and Tier 2 capital instruments occurring less than five years from their issue date is limited (i) to circumstances where there is a change in the regulatory classification of the instruments concerned, which was not reasonably foreseeable at the issue date ("regulatory call") and which results in their exclusion from own funds, or (ii) in the event of a significant change, which was not reasonably foreseeable at the issue date, in the tax treatment of said instruments ("tax call") (Article 78(4) of Regulation No 575/2013). Institutions are invited to consult the European Banking Authority's Monitoring report on Additional Tier 1 instruments, which examines in more detail the conditions for a repurchase of such own funds instruments due to changes in their regulatory classification or tax treatment 11.
Article 27 of Delegated Regulation No 241/2014 provides clarifications on the meaning of the words "viable taking into account the institution's potential earnings" used in Article 78, paragraph 1(a) of Regulation No 575/2013, as well as Article 29 of Delegated Regulation No 241/2014, which provides further details on the conditions for repayment, reduction or repurchase of own funds instruments for market making purposes (paragraph 3) or for remitting them to employees of institutions as part of their remuneration (paragraph 4).
When carrying out reductions, repayments or repurchases of Common Equity Tier 1 capital instruments, Additional Tier 1 capital instruments or Tier 2 capital instruments, less significant institutions are requested to first submit a request to the NBB as indicated in Article 29 of Delegated Regulation No 241/2014, the content of which is specified in Article 30 of said regulation. Article 31 of this regulation adds that the institution is required to submit the request at least three months before the date on which the planned operations will be announced to the holders of the instruments. The NBB may, on a case-by-case basis and in exceptional circumstances, authorize a shorter period 12. During its evaluation, the NBB will notably verify that the institution will continue to maintain a linear progression towards compliance with the fully loaded capital ratio at the end of the transitional period, in accordance with what is described in section 2 of this circular concerning dividend distribution. As provided for in Article 28 of the aforementioned delegated regulation, it is only after obtaining the NBB's agreement that institutions may announce such operations of reduction, repayment or repurchase of the concerned own funds instruments to their respective holders and deduct the corresponding amounts from their own funds items. After deducting these amounts, the institution may effectively proceed with the announced operations. 11 https://www.eba.europa.eu/documents/10180/950548/EBA+Report+on+the+Additional+Tier+1+instruments+-+May+2015.pdf 12 For less significant credit institutions in the form of a cooperative society, cf. Article 32 of Delegated Regulation No 241/2014.

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6. Prior authorization for the inclusion of Additional Tier 1 capital instruments and Tier 2 capital instruments in regulatory own funds
To be considered regulatory own funds, Additional Tier 1 capital instruments and Tier 2 capital instruments must meet a number of eligibility criteria set out in Articles 52 (Additional Tier 1 capital instruments) and 63 (Tier 2 capital instruments) of Regulation No 575/2013.
The NBB expects less significant institutions to submit the request for prior authorization for the inclusion of Additional Tier 1 capital instruments and Tier 2 capital instruments in regulatory own funds at least 6 weeks before the issue date of the instruments concerned. The documentation required to obtain prior authorization must be in the form of a standard prior notification letter, signed by the CEO, and include the following elements:
a. a self-assessment regarding compliance with the requirements set out in Regulation No 575/2013; b. the contractual documents relating to the issue concerned 13.
For a first issue of Additional Tier 1 capital instruments and/or Tier 2 capital instruments, the NBB will examine the request before the issue date (in particular based on the self-assessment carried out by the institution), and will make observations if necessary. If the NBB's observations are not taken into account, the inclusion of Additional Tier 1 capital instruments and/or Tier 2 capital instruments in regulatory own funds will not be authorized. In any event, the NBB must have previously authorized the inclusion of the instruments in the institution's regulatory own funds. The authorization for inclusion in regulatory own funds granted by the NBB for the first issue is sufficient for recurring issues without significant changes to the issue agreement. However, institutions are required to notify the NBB of these recurring issues before their issue date. In the event of non-compliance with the eligibility provisions set out in Regulation No 575/2013, the instruments are, as a reminder, not recognizable as regulatory own funds. An institution that intends to issue an instrument with complex or new characteristics, or that wishes to be reassured that the instrument is eligible as a capital instrument, is invited to ask the NBB to examine compliance with the conditions provided, based on the self-assessment already carried out by the institution. With regard to Additional Tier 1 capital instruments, institutions may usefully consult the aforementioned European Banking Authority Monitoring report, which includes an analysis of several clauses appearing in the terms and conditions of Additional Tier 1 capital instrument issues 14. Obtaining prior authorization from the NBB for the inclusion of Additional Tier 1 capital instruments and/or Tier 2 capital instruments in regulatory own funds does not relieve the institution of the obligation to also obtain authorization to reduce its own funds if a replacement of capital instruments is envisaged. 13 Note that the European Banking Authority will develop a standard model for AT1 instrument issue contracts. 14 https://www.eba.europa.eu/documents/10180/950548/EBA+Report+on+the+Additional+Tier+1+instruments+-+May+2015.pdf

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7. Treatment of reserves held with central banks according to the liquidity coverage ratio
In accordance with the NBB Regulation of 26 July 2016, the Regulation of 2 June 2015 on the liquidity of credit institutions ceased to be in force on 1 October 2016. Belgian credit institutions are consequently required to comply with the liquidity coverage requirement provided for in Article 412, paragraphs 1 to 3, of Regulation No 575/2013 and Title I of Delegated Regulation No 2015/61. In this context and in accordance with Article 416, paragraph 1, of Regulation No 575/2013 as well as Article 10, paragraph 1, point b) iii), of Commission Delegated Regulation 2015/61 of 10 October 2014, the National Bank of Belgium, in its capacity as competent authority for less significant institutions, and the ECB have reached a consensus 15 defining the conditions for withdrawing reserves held by credit institutions with Eurosystem central banks as liquid assets in the liquidity coverage ratio. It has been agreed that:
(1) Only the portion of reserves held with Eurosystem central banks that exceeds the average daily required reserves is considered withdrawable at any time during periods of stress and can thus be declared under Article 416, paragraph 1, point a), of Regulation (EU) No 575/2013, and is eligible as Level 1 liquid assets as defined in Article 10, paragraph 1, point b), of Commission Delegated Regulation 2015/61. Each day t, reserves held that exceed the average daily required reserves are eligible as Level 1 assets. "Average daily required reserves" means the amount of mandatory reserves to be held during a maintenance period, in accordance with European Central Bank Regulation (EC) No 1745/2003 of 12 September 2003 concerning the application of minimum reserves 16, divided by the number of days in the respective maintenance period. If the balance of reserves held is greater than the average daily required reserves, these reserves are eligible as Level 1 assets. (2) Term deposits held with Eurosystem central banks are considered Level 1 liquid assets for recognition in the liquidity coverage ratio if these term deposits can be included as collateral for Eurosystem credit operations, including the marginal lending facility. A copy of this is sent to the auditor(s), approved auditor(s) of your institution. Please accept, Madam, Sir, our distinguished greetings. Jan Smets Governor 15 Cf. ECB communication 30/09/2015: https://www.bankingsupervision.europa.eu/banking/letterstobanks/html/index.en.html 16 Modified by subsequent regulations.