Resolution SBS No. 0041-2005: Approves the Regulation for the Administration of Credit Foreign Exchange Risk

Lima, January 14, 2005
S.B.S. Resolution
No. 41- 2005

The Superintendent of Banking and Insurance

CONSIDERING:

That, Resolution SBS No. 808-2003 dated May 28, 2003 approved the Regulation for the Evaluation and Classification of Debtors and the Requirement of Provisions, hereinafter referred to as the Regulation;

That, the Regulation established evaluation criteria for granting credit, stating that such granting is determined by the applicant's payment capacity, which in turn is defined fundamentally by their cash flow and credit history; and that, regarding commercial credits, one must consider, among other factors, the ability to meet obligations amid foreign exchange variations;

That, furthermore, the Regulation establishes as parameters in the classification of the debtor primarily the debtor's cash flow, in which the possible effects of financial risks related to currency mismatches must be considered;

That, it is necessary to establish guidelines for the use of minimum prudential standards regarding the granting of foreign currency credits, as an additional component to define payment capacity;

That, adequate control of credit foreign exchange risk will improve the perception of country risk within the economy as a whole;

That, paragraph 4 of Article 132 of the General Law of the Financial System and the Insurance System and Organic Law of the Superintendency of Banking and Insurance, Law No. 26702 and its amendments, hereinafter the General Law, establishes that constituting generic and specific portfolio provisions, individual or preventive global provisions by groups or categories of credits, for the eventuality of unpaid credits, and constituting other provisions and charges to results, regarding positions affected by various market risks, constitutes a way to attenuate risks for the saver;

That, through Resolution SBS No. 895-98 dated September 1, 1998, the Accounting Manual for Companies of the Financial System was approved, hereinafter the Accounting Manual;

That, it is necessary to adapt the Accounting Manual to the new guidelines in order to reflect the real economic-financial situation of companies;

Being in accordance with the opinion of the Adjunct Superintendencies of Banking, Legal Advice, and Risks, as well as the Economic Studies Management;

And, in exercise of the powers conferred by paragraphs 7, 9, and 13 of Article 349 of the General Law;

RESOLVES:

Article First.- Approve the Regulation for the Administration of Credit Foreign Exchange Risk, which forms an integral part of this Resolution.

Article Second.- Modify the Accounting Manual for Companies of the Financial System, as indicated in the attached Annex.

Article Third.- This Resolution takes effect from the day following its publication in the Official Gazette “El Peruano”, except for what is stated in the Final and Transitional Provisions.

Register, communicate, and publish.

JUAN JOSÉ MARTHANS LEÓN
Superintendent of Banking and Insurance

REGULATION FOR THE ADMINISTRATION OF CREDIT FOREIGN EXCHANGE RISK

CHAPTER I: GENERAL PROVISIONS

Article 1st.- Scope
This standard applies to multiple-operation companies included in letter A of Article 16 of the General Law, to financial leasing companies, to the Development Finance Corporation (COFIDE), to the National Bank, and to the Agricultural Bank, hereinafter referred to as the companies.

Article 2nd.- Definitions
For the application of this Regulation, the following definitions shall be considered:
a) Credit Foreign Exchange Risk: Possibility of suffering losses derived from debtors' failure to pay their credit obligations due to mismatches between their net foreign currency exposures. b) Administration of credit foreign exchange risk: Part of the process consisting of identifying, measuring, controlling, and reporting credit risk that considers credit losses associated with changes in the exchange rate. c) Risk Control Manual: Document containing policies and procedures for the identification and administration of risks. It includes, among others, preventive mechanisms to detect the risks the company faces and limits per risk. d) Internal methodology: Ordered process developed internally by companies that allows quantifying the risk of an exposure subject to value changes over time. e) Debtor identification: Process of evaluating debtors through the company's internal methodology to determine whether they are exposed or not to credit foreign exchange risk according to the company's own standards. It is estimated that the evaluation of exposure to credit foreign exchange risk must be adequately supported in the credit file of a debtor to be considered identified.

Article 3rd.- Responsibility of Companies and their Boards of Directors
Companies must adopt a credit foreign exchange risk control system for foreign currency placements that identifies, measures, controls, and reports their exposure levels appropriately, and includes permanent evaluation of control mechanisms, as well as corrective actions or improvements required, as appropriate. In this sense, it shall be the responsibility of the Board of Directors or equivalent body to establish and comply with policies and procedures to identify and appropriately administer the credit foreign exchange risk the company faces and to ensure that Management adopts necessary measures to monitor and control these risks. Such responsibility includes compliance with the provisions contained in this Regulation.

CHAPTER II
REQUIREMENTS FOR THE IDENTIFICATION, ADMINISTRATION, AND ALLOCATION OF PROVISIONS FOR CREDIT FOREIGN EXCHANGE RISK

Article 4th.- Minimum Requirements
Companies must establish explicit internal procedures to qualify, grant, and monitor direct and indirect credits, as well as financial leasing operations, in foreign currency, which include at least:
a) The identification of debtors exposed and not exposed to credit foreign exchange risk derived from currency mismatches between their income and their obligations. b) The requirements that the client must meet to qualify for a foreign currency credit and the exclusion criteria for credit operations perfectly covered against credit foreign exchange risk. c) Performing a measurement of the effect of an exchange rate shock on the payment capacity of the debtor portfolio, at least with an annual periodicity whose source of information is up-to-date. The exchange rate shock assumptions must, at least, assume two real depreciation scenarios, one with 10% and another with 20% respectively as a minimum. d) Supervised companies must take corrective actions on the credit rating or credit conditions in cases where they identify debtors whose payment capacity is substantially affected as a result of exposure to foreign exchange risk. The procedures must differentiate the treatment for each type of credit granted in foreign currency (corporate, large enterprises, medium-sized enterprises, small enterprises, MES, revolving and non-revolving consumer, and housing mortgage). 3

Article 5th.- Risk Unit.
The Company's Risk Unit must be responsible, among other functions, for verifying and informing compliance with the policies and procedures established regarding the identification and administration of credit foreign exchange risk, participating in the design and permanent adaptation of the organization and functions manual, proposing measurements, policies, and procedures for the control of this risk. The Risk Unit is also responsible for informing the Board of Directors (at least semiannually) and the corresponding decision-making areas about the evaluation of credit foreign exchange risk, for which it will prepare a report containing at least the following:
a) Summary of the aggregated exposure of the company's portfolio to credit foreign exchange risk, distinguishing by type of credit and indicating what percentage of identified clients represents of the total portfolio; b) Summary of the results of measurements of potential losses associated with the foreign exchange risk of the company's debtors; these measurements must be sensitive to exposure to risk and available exchange rate information; c) Report on the sufficiency of the internal qualification and rating processes to capture the effect of credit foreign exchange risk and the monitoring of the internal qualifications and ratings of those debtors identified as exposed; and, d) Actions adopted on the observations and recommendations of internal auditors and this Superintendency regarding the management of credit foreign exchange risk.

This Unit must ensure that the reports issued to the Board of Directors are available to this Superintendency.

Article 6th.- Reports and Submission of Information
The Risk Unit must ensure the adequate identification of debtors exposed and not exposed to credit foreign exchange risk and their correct reporting in Annex No. 6 of the Accounting Manual – Debtor Credit Report, in accordance with what is indicated in the attached Annex.

Article 7th.- Provision Requirements
A provision will be applied to direct credits and financial leasing operations in foreign currency in addition to what is provided by Resolution SBS No. 808-2003, which will be accounted for in accordance with what is stated in the attached Annex. This provision will be only for debtors classified as normal according to Resolution SBS No. 808-2003. Additional provisions do not apply to operations covered by self-liquidating guarantees nor to Mivivienda mortgage credits for the portion covered by the Mivivienda Fund. For operations covered by very quick realization guarantees, the additional provision will be 0.25%, for foreign currency credits covered with other preferred guarantees, the provision will be 0.5%, and 1% for the rest of the direct debt in foreign currency. However, if the company complies with the provisions stated in Articles 4th, 5th, and 6th of this Regulation, those operations belonging to identified debtors will be exempt from the requirement of additional provisions.

Article 8th.- Additional Prudential Measures
This Superintendency, as a product of supervision of compliance with this Regulation, may require the inclusion of debtors exposed to credit foreign exchange risk not included in the initial identification.

CHAPTER III
EXTERNAL COLLABORATORS

Article 9th.- Internal Audit
The Internal Audit Unit must evaluate compliance with the policies and procedures established by the company for carrying out operations affected by credit foreign exchange risk, and the valuation policies, procedures, and methodologies established internally by the company. Such evaluation must be included in the permanent activities of the Annual Internal Audit Plan.

CHAPTER IV
FINAL AND TRANSITIONAL PROVISIONS

Article 10th.- Constitution of Provisions.
The provision requirements according to Article 7th of this standard will enter into force starting July 1, 2006.

Article 11th.- Adaptation Period for DCR Reporting.
Companies will have until June 30, 2005 to adapt their systems to the reporting of Annex No. 6 of the Accounting Manual as provided by Article 6th.

Los Laureles Nº 214 - Lima 27 - Peru Tel. : (511)2218990 Fax : (511) 4417760

ANNEX
MODIFICATIONS TO THE ACCOUNTING MANUAL FOR COMPANIES OF THE FINANCIAL SYSTEM

I. Chapters III "Chart of Accounts" and IV "Description and Dynamics of Accounts" of the Accounting Manual for Companies of the Financial System are modified, as follows:

1. Incorporate into account 1409 "(Provisions for Credits)" the following analytical accounts:
   1409.01.05 (Provisions for credit foreign exchange risk)
   1409.02.05 (Provisions for credit foreign exchange risk)
   1409.03.05 (Provisions for credit foreign exchange risk)
   1409.04.05 (Provisions for credit foreign exchange risk)

2. Substitute the description of account 1409 "(Provisions for Credits)" according to the following text:
   "In this account, generic and specific provisions for direct credits are recorded in accordance with the provisions issued in the Regulation for the Evaluation and Classification of Debtors and the Requirement of Provisions. Likewise, provisions for credit foreign exchange risk will be recorded in accordance with the provisions issued by this Superintendency. Provisions must be constituted in the same currency in which the credits originating them were agreed upon. In analytical accounts 1409.01.04, 1409.02.04, 1409.03.04, and 1409.04.04, provisions constituted by the difference between the present value of future flows of refinanced and restructured credits, as applicable, and the net book value of provisions will be recorded."

3. Substitute in the Dynamics of account 1409, the Credit part, according to the following text:
   CREDITS: "- By the constitution of provisions in accordance with what is provided in the Regulation for the Evaluation and Classification of Debtors and the Requirement of Provisions.

• By the provisions constituted by the difference between the present value of future flows of debt and the net book value of provisions.
• By the constitution of provisions for credit foreign exchange risk.
• By the increase in the updating of balances in foreign currency.

Los Laureles Nº 214 - Lima 27 - Peru Tel. : (511)2218990 Fax : (511) 4417760

4. Incorporate into account 4302 "Provisions for Uncollectible Credits" the following analytical accounts:
   4302.01.05 Provisions for credit foreign exchange risk
   4302.02.05 Provisions for credit foreign exchange risk
   4302.03.05 Provisions for credit foreign exchange risk
   4302.04.05 Provisions for credit foreign exchange risk

5. Substitute the description of account 4302 "Provisions for Uncollectible Credits" according to the following text:
   "In this account, charges for generic and specific provisions for direct credits are recorded in accordance with the provisions issued in the Regulation for the Evaluation and Classification of Debtors and the Requirement of Provisions. Likewise, provisions for credit foreign exchange risk will be recorded in accordance with the provisions issued by this Superintendency. In analytical accounts 4302.01.04, 4302.02.04, 4302.03.04, and 4302.04.04, provisions constituted by the difference between the present value of future flows of refinanced and restructured credits, as applicable, and the net book value of provisions will be recorded."

6. Substitute in the Dynamics applicable to accounts: 4301, 4302, 4303, 4304, and 4305, according to the following text:
   DEBITS: "- By the charge of the provision for devaluation of investments.

• By the charge for the constitution of provisions in accordance with what is provided in the Regulation for the Evaluation and Classification of Debtors and the Requirement of Provisions.
• By the provisions constituted by the difference between the present value of future flows of debt and the net book value of provisions.
• By the constitution of provisions for credit foreign exchange risk.
• By the charge of the provision for uncollectible debtors by intermediation and accounts receivable.
• By the charge of the provision for devaluation of realizable and adjudicated assets.
• By the charge of the provision for devaluation of assets out of use.
• By the charge of the provision for contingencies.
• By the constitution of provisions for country risk."

Los Laureles Nº 214 - Lima 27 - Peru Tel. : (511)2218990 Fax : (511) 4417760

II. Annex No. 6 "Debtor Credit Report" of the Accounting Manual is modified, as follows:

1. Incorporate field A-24 in the debtor identification data, according to the following description:
   A-24 Credit Foreign Exchange Risk Indicator
   For any person reported, place, as applicable, according to the methodology developed by each entity:
   0 Debtor whose exposure to Credit Foreign Exchange Risk has not been identified 1 Debtor identified as not exposed to Credit Foreign Exchange Risk 2 Debtor identified as exposed to Credit Foreign Exchange Risk

2. Modify the description of field B-09 in the debtor balance data according to the following description:
   B-09 Special Account Condition
   Record the corresponding type:
   01 Short-term financings that provide 1% (Resolution SBS No. 808-2003) 02 Credits with substitution of credit counterparty (Resolution SBS No. 808- 2003) 03 Credits considered in the generic provisions regime based on internal methodology (Resolution SBS No. 808-2003) 04 Guarantees registered in Public Registries 05 Guarantees that have registry blocking 11 Credits exposed to credit foreign exchange risk 12 Credits not exposed to credit foreign exchange risk 13 Credits whose exposure to credit foreign exchange risk has not been identified 06 Others