MINISTRY OF FINANCE AND PUBLIC ADMINISTRATION. Decree-Law No. 104/2007 of 3 April

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1 MINISTRY OF FINANCE AND PUBLIC ADMINISTRATION Decree-Law No. 104/2007 of 3 April The 1990 s were marked by increased financial innovation, particularly due to the evolution and integration of financial markets, IT improvements and scientific progress in financial economics. As a consequence, the banking sector has been implementing gradually more sophisticated risk evaluation techniques, especially as regards credit risk, market risk and operational risk. In this context, some international initiatives have been taken, supported by the objective of achieving financial stability, intended to adjust the capital adequacy regulations to the new reality of the financial services. The latest initiatives on banking activity prudential regulations, aimed at achieving capital sufficiency and competitive neutrality objectives with particular emphasis on those undertaken by the Basel Committee on Banking Supervision have been targeted at ensuring that the level of own funds moves in line with the changes in the risk profile of institutions, broadening the capital adequacy framework confirming the relevance of the supervisory authorities action (at national level and in cooperation with other competent authorities) and increasing market discipline and creating several incentives to reward the institutions capacity to measure, control and manage the risks to which they are exposed. These initiatives have been incorporated into Community law mainly through a recast of the Codified Banking Directive (Directive 2000/12/EC of the European Parliament and of the Council of 20 March), although amendments have also been introduced in the Capital Adequacy Directive (Directive 93/6/EEC of the Council of 15 March), in particular, by means of the publication of Directives No. 2006/48/EC of the European Parliament and of the Council of 14 June and No. 2006/49/EC of the European Parliament and of the Council of 14 June. Overall, these amendments were intended to ensure a minimum convergence of the prudential requirements, while taking into account the specific nature of the European banking systems and 1

2 natural differences in size and complexity between financial institutions and groups. This Decree-Law transposes into Portuguese law Directive 2006/48/EC of the European Parliament and of the Council of 14 June. Banco de Portugal and the Comissão do Mercado de Valores Mobiliários (Securities Market Commission) were heard, optionally. Other entities were optionally heard, such as: Instituto de Seguros de Portugal (Portuguese Insurance Institute), Associação Portuguesa de Bancos (Portuguese Banking Association), Associação Portuguesa de Leasing e Factoring (Portuguese Leasing and Factoring Association), Associação de Sociedades Financeiras para Aquisições a Crédito (Association of Credit-Purchase Financing Companies), Associação Portuguesa das Sociedades Corretoras e Financeiras de Corretagem (Portuguese Brokers and Dealers Association) and Associação Portuguesa de Fundos de Investimento, Pensões e Patrimónios (Portuguese Association of Investment and Pension Funds and Wealth Managing Companies). Therefore: Pursuant to Article 198 (1) (a) of the Constitution, the Government decrees the following: Article 1 Subject matter This Decree-Law transposes into Portuguese law Directive 2006/48/EC of the European Parliament and of the Council of 14 June relating to the taking up and pursuit of the business of credit institutions, amending Directive 2000/12/EC of the European Parliament and of the Council of 20 March. 2

3 Article 2 Definitions For the purposes of this Decree-Law, the following definitions shall apply: a) «Institutions» means credit institutions and investment firms; b) «Parent credit institution in Portugal», means a credit institution which has a credit institution or an entity similar to a credit institution as a subsidiary, in accordance with the definition laid down in Article 130 of the Legal Framework of Credit Institutions and Financial Companies, approved by Decree-Law No. 298/92 of 31 December, hereinafter called RGICSF (Regime Geral das Instituições de Crédito e Sociedades Financeiras), or which holds a participation in such an institution, and which is not itself a subsidiary of another credit institution, or of a financial holding company set up in Portugal; c) «Parent financial holding company in Portugal» means a financial holding company which is not itself a subsidiary of a credit institution, or of a financial holding company set up in Portugal; d) «Parent credit institution in Portugal and in the European Union» means a parent credit institution in Portugal which is not a subsidiary of another credit institution authorised in another Member State, or of a financial holding company set up in another Member State; e) «Parent financial holding company in Portugal and in the European Union» means a parent financial holding company in Portugal which is not a subsidiary of a credit institution authorised in another Member State, or of a financial holding company set up in another Member State; f) «Dilution risk» means the risk that an amount receivable is reduced by means of cash or non-cash credits to the obligor; g) «Operational risk» means the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, and includes legal risk; h) «Authorisation» means the instruments referred to in paragraph 11 th of Article 13 of RGICSF; i) «Competent authorities» means the national authorities which are empowered by law or regulation to supervise credit institutions; 3

4 j) «Home country or Member State and host country or Member State» means the countries or Member States referred to in paragraphs 9 th and 10 th of Article 13 of RGICSF; l) «Subsidiary and parent undertaking» means the legal persons referred to in Article 130 (2) (e) of RGICSF; m) «Financial holding company» means the legal person referred to in Article 130 (2) (b) of RGICSF; n) «Probability of default (PD)» means the probability of default of a counterparty over a one year period; o) «Loss given default (LGD)» means the ratio of the loss on an exposure due to the default of a counterparty to the amount outstanding at default; p) «Conversion factor» means the ratio of the currently undrawn amount of a commitment that will be drawn and outstanding at default to the currently undrawn amount of the commitment; the extent of the commitment shall be determined by the advised limit, unless the unadvised limit is higher; q) «Expected loss (EL)», for the purposes of the Internal Ratings Based Approach, means the ratio of the amount expected to be lost on an exposure from a potential default of a counterparty or dilution over a one year period to the amount outstanding at default; r) «Lending credit institution», for the purposes of Articles 21 to 23, means the institution which has the exposure in question, whether or not deriving from a loan; s) «Credit risk mitigation» means a technique used by a credit institution to reduce the credit risk associated with an exposure or exposures which the credit institution continues to hold; t) «Funded credit protection» means a technique of credit risk mitigation where the credit institution has the right in the event of the default of the counterparty or on the occurrence of other specified credit events related to the counterparty to liquidate, or to obtain, or to retain certain assets or amounts, in order to reduce the amount of the exposure on the said counterparty; u) «Unfunded credit protection» means a technique of credit risk mitigation where the reduction of the credit risk on the exposure of a credit institution derives from the 4

5 undertaking of a third party to pay an amount in the event of the default of the borrower or on the occurrence of other specified credit events; v) «Securitisation» means a transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having the following characteristics: w) Payments in the transaction or scheme are dependent upon the performance of the exposure or pool of exposures; x) The subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme. Article 3 Scope 1 The obligations regarding the minimum level of own funds and the limits to large exposures on an individual basis set out in this Decree-Law shall apply to credit institutions. 2 Every credit institution which is neither a subsidiary in Portugal, nor a parent undertaking, and every credit institution not included in supervision on a consolidated basis pursuant to Article 131 (5) of RGICSF, shall comply with the obligations laid down in Article 100 of RGICSF and in Article 28 on an individual basis. 3 Every credit institution which is neither a subsidiary, nor a parent undertaking, and every credit institution not included in supervision on a consolidated basis pursuant to Article 131 (5) of RGICSF, shall comply with the obligations laid down in Articles 29 to 31 on an individual basis. Article 4 Exclusions 1 Paragraph 1 of the foregoing Article shall not apply to any subsidiary of a credit institution where both the subsidiary and the credit institution are subject to authorisation and supervision by Banco de Portugal, are included in supervision on a consolidated basis pursuant to 5

6 Article 131 of RGICSF and all of the following conditions are cumulatively satisfied: a) There is no impediment to the prompt transfer of own funds or repayment of liabilities by its parent undertaking; b) The parent undertaking satisfies the Banco de Portugal regarding the prudent management of the subsidiary and has declared that it guarantees the commitments entered into by the subsidiary, except when risks in the subsidiary are of negligible interest; c) The risk evaluation, measurement and control procedures of the parent undertaking cover the subsidiary; d) The parent undertaking holds more than 50% of the voting rights or has the right to appoint or remove a majority of the members of the management body or auditing board of the subsidiary. 2 The provisions of the foregoing paragraph shall also apply to the credit institutions that are a subsidiary of a financial holding company, where both are set up in Portugal, provided that the financial holding company is subject to the standards laid down in Article 5 (1). 3 The conditions under which Article 3 (1) shall apply to the Central Mutual Agricultural Credit Bank and to the mutual agricultural credit banks belonging to the Integrated Mutual Agricultural Credit Scheme are established by means of a Notice of the Banco de Portugal. Article 5 Implementation on a consolidated basis 1 Without prejudice to the provisions laid down in Articles 3 and 4, parent credit institutions in Portugal and in the European Union, pursuant to Article 133 of RGICSF and on the basis of their consolidated financial situation, shall comply with the limits to large exposures, the obligations laid down in Articles 7 and 28, and the provisions of Article 100 of RGICSF. 2 Without prejudice to the provisions laid down in Articles 3 and 4, credit institutions controlled by a parent financial holding company set up in Portugal or by a parent financial 6

7 holding company set up in a Member State of the European Union where Banco de Portugal is responsible for supervision on a consolidated basis, pursuant to Article 132 of RGICSF, in accordance with Article 133 of RGICSF and on the basis of the consolidated financial situation of these financial holding companies, shall comply with the limits to large exposures, the obligations laid down in Articles 7 and 28 of this Decree-Law, and the provisions laid down in Article 100 of RGICSF. 3 Where more than one credit institution is controlled by a parent financial holding company in Portugal, the provisions of the foregoing paragraph shall apply only to credit institutions to which supervision on a consolidated basis by Banco de Portugal applies. 4 Subsidiary credit institutions shall comply with the limits to large exposures and apply the provisions laid down in Articles 7 and 28 of this Decree-Law, as well as in Article 100 of RGICSF on a sub-consolidated basis, where such credit institutions, or the respective parent undertaking, where it is a financial holding company, have a credit institution, a financial institution, or an asset management company, within the meaning of Article 2 (5) of Directive 2002/87/EC of the European Parliament and of the Council of 16 December, as a subsidiary in a third country, or hold a participation in such an undertaking. Article 6 Scope of application regarding the disclosure of information 1 Parent credit institutions in Portugal and parent credit institutions in Portugal and in the European Union shall comply with the obligations laid down in Articles 29 to 31 on the basis of their consolidated financial situation. 2 Credit institutions controlled by a parent financial holding company in Portugal or by a parent financial holding company in Portugal and in the European Union shall comply with the obligations laid down in Articles 29 to 31 on the basis of the consolidated financial situation of that financial holding company. 3 Subsidiaries of parent credit institutions in the European Union or of a parent financial holding company in the European Union and which are not considered a parent credit institution in Portugal shall comply with the obligations laid down in Articles 29 to 31 on an individual or 7

8 sub-consolidated basis. 4 The conditions under which this Article shall apply to the Central Mutual Agricultural Credit Bank and to mutual agricultural credit banks belonging to the Integrated Mutual Agricultural Credit Scheme are established by means of a Notice of the Banco de Portugal. Article 7 Own funds requirements 1 Credit institutions are required to provide own funds which are at all times more than or equal to the sum of the following own funds requirements: a) For credit risk and dilution risk in respect of all of their business activities, with the exception of their trading book business and illiquid assets if deducted from own funds, 8% of the total of their risk-weighted exposure amounts, calculated in accordance with this Decree-Law and by means of a Notice of the Banco de Portugal; b) In respect of their trading book business, for position risk, settlement and counterparty risk and, for large exposures exceeding such limits, the own funds requirements determined in accordance with Decree-Law No. 103/2007 of 3 April and by means of a Notice of the Banco de Portugal; c) In respect of all of their business activities, for foreign-exchange risk and commodities risk, the own funds requirements determined by means of a Notice of the Banco de Portugal; d) In respect of all of their business activities, for operational risk, the own funds requirements determined in this Decree-Law and by means of a Notice of the Banco de Portugal; 2 The calculations to verify the compliance, by credit institutions, with the obligations laid down in the foregoing paragraph, shall be carried out not less than twice each year, and the results and any component data required shall be communicated to the Banco de Portugal. 8

9 Article 8 Approaches to the calculation of own funds requirements for credit risk To calculate the amount of own funds requirements to cover credit risk and dilution risk, credit institutions may apply the Standardised Approach, laid down in Articles 10 to 13, or if authorised by the Banco de Portugal in accordance with Article 14, the Internal Ratings Based Approach (IRB Approach) set out in Articles 14 to 20. Article 9 Risk exposures The exposure value of an asset item and the exposure value of an off-balance sheet item shall be established by means of a Notice of the Banco de Portugal. Article 10 Exposure classes of the Standardised Approach 1 Each exposure shall be assigned to one of the following exposure classes: a) central governments or central banks; b) regional governments or local authorities; c) administrative bodies and non-commercial undertakings; d) multilateral development banks; e) international organisations; f) institutions; g) corporates; h) retail portfolio; i) claims secured on real estate property; j) past due items; 9

10 l) items belonging to regulatory high-risk categories; m) claims in the form of mortgage or public sector bonds; n) securitisation positions; o) claims in the form of collective investment undertakings (CIU); p) other items. 2 To be eligible for the retail portfolio, an exposure shall meet the following conditions: a) the exposure shall be either to an individual person or persons, or to a small or medium sized entity; b) the exposure shall be one of a significant number of exposures with similar characteristics such that the risks associated with such lending are substantially reduced; c) the total amount owed to the credit institution and parent undertakings and its subsidiaries, including any past due exposure, by the obligor client or group of connected clients, but excluding claims secured on residential real estate collateral, shall not exceed EUR 1 million. d) Leasing transactions, with the exception of the respective residual value, entered into with individual persons or with a small or medium sized entity shall be eligible for the retail portfolio. e) Securities shall not be eligible for the retail portfolio. Article 11 Risk weights of the Standardised Approach 1 Risk-weighted exposure amounts shall be determined on the basis of risk weights to be defined by means of a Notice of the Banco de Portugal. 2 The application of risk weights shall be based on the exposure class to which the exposure is assigned and its credit quality. 3 Credit quality may be determined by reference to the credit assessments of External Credit Assessment Institutions, hereinafter called ECAIs, in accordance with the provisions of Articles 12 and 13 or the credit assessments of Export Credit Agencies, in accordance with the terms to 10

11 be established by means of a Notice of the Banco de Portugal. 4 In respect of exposures to institutions, the Banco de Portugal shall establish by means of a Notice the method to be adopted for the purposes of calculating risk-weighted exposure amounts: whether the method based on the credit quality of the central government of the jurisdiction in which the institution is incorporated, or the method based on the credit quality of the counterparty institution. 5 With the exception of the exposures giving rise to positive own funds items in the form of the items referred to in paragraphs (a) to (h) of Article 57 of Directive 2006/48/EC of the European Parliament and of the Council of 14 June, the Banco de Portugal, for the purposes of the provisions laid down in paragraph 1, may assign a 0% risk weight to the exposures of a credit institution to a counterparty which is its parent undertaking, its subsidiary or a subsidiary of its parent undertaking, provided that the following conditions are met: a) the counterparty is an institution or a financial holding company, financial institution, asset management company or ancillary services company subject to appropriate prudential requirements; b) the counterparty is included in the same consolidation as the credit institution on a full basis; c) the counterparty is subject to the same risk evaluation, measurement and control procedures as the credit institution; d) the counterparty is established in Portugal; and e) there is no current or foreseen material practical or legal impediment to the prompt transfer of own funds or repayment of liabilities from the counterparty to the credit institution. Article 12 Recognition of ECAIs 1 The use of credit assessments of ECAIs depends on the recognition by the Banco de Portugal of such ECAIs. 2 The recognition of an ECAI as eligible depends on the Banco de Portugal being satisfied 11

12 that its credit assessment methodology complies with the requirements of objectivity, independence, ongoing review and transparency, and that the resulting credit assessments meet the requirements of credibility and transparency. 3 If an ECAI has been recognised as eligible by the competent authorities of another Member State, the Banco de Portugal may also recognise the ECAI as eligible without carrying out its own evaluation process. 4 The Banco de Portugal shall make publicly available an explanation of the characteristics of the recognition process and a list of eligible ECAIs. Article 13 Mapping 1 The Banco de Portugal shall determine, by means of an Instruction, in an objective and consistent manner, with which of the credit quality steps the relevant credit assessments of an eligible ECAI are to be associated. 2 When the competent authorities of another Member State have made a determination, the Banco de Portugal may recognise that determination without carrying out its own determination process. 3 The use of ECAI credit assessments shall be consistent and in accordance with conditions to be defined by means of a Notice of the Banco de Portugal. 4 The Banco de Portugal may authorise credit institutions to use unsolicited credit assessments. 5 Unsolicited credit assessments shall be those resulting from a process not initiated by the issuer. Article 14 Internal Ratings Based Approach Permission process 12

13 1 Without prejudice to the provisions laid down in Article 27, credit institutions may be permitted to calculate their risk-weighted exposure amounts using the Internal Ratings Based Approach (IRB Approach), provided that permission has been given by the Banco de Portugal. 2 Permission shall be given only if the Banco de Portugal is satisfied that the credit institution s systems for the management and rating of credit exposures are sound and implemented with integrity and that, taking into account the standards defined by means of a Notice of the Banco de Portugal, meet the following conditions: a) provide for a meaningful assessment of obligor and transactions characteristics, a meaningful differentiation of risk and accurate and consistent quantitative estimates of risk; b) internal ratings and default and loss estimates used in the calculation of own funds requirements and associated systems and processes play an essential role in the risk management and decision-making process, and in internal capital allocation and corporate governance functions of the credit institution; c) the credit institution has a credit risk control unit responsible for its rating systems that is appropriately independent and free from undue influence; d) the credit institution collects and stores all relevant data to provide effective support to its credit risk measurement and management process; e) the credit institution documents its rating systems and the rationale for their design and validates its rating systems. 3 A credit institution applying for the use of the IRB Approach shall demonstrate that it has been using rating systems that are broadly in line with the requirements set out by means of a Notice of the Banco de Portugal, for internal risk measurement and management for at least three years prior to its application for authorisation to use the IRB Approach. 4 A credit institution applying for the use of own estimates of LGD and/or conversion factors shall demonstrate that it has been estimating and employing own estimates of LGD and/or conversion factors in a manner that is consistent with the minimum requirements set out by means of a Notice of the Banco de Portugal, for at least three years prior to its application for authorisation to use own estimates of LGD and/or conversion factors. 13

14 Article 15 Implementation of the IRB Approach 1 Without prejudice to the provisions laid down in Article 20, credit institutions shall implement the IRB Approach for all exposures. 2 Subject to the approval of the Banco de Portugal, credit institutions may carry out a sequential implementation of the IRB Approach across the different exposure classes referred to in the following Article, within the same business unit, across different business units in the same group or for the use of own estimates of LGD or conversion factors for the calculation of risk weights for exposures to corporates, institutions, central governments and central banks. 3 In the case of the retail portfolio, implementation may be carried out sequentially by institutions across categories of exposures to which the different correlations set out by means of a Notice of the Banco de Portugal correspond. 4 Sequential implementation shall be carried out within a reasonable period of time to be agreed with the Banco de Portugal and shall not be used with the purpose of achieving reduced minimum own funds requirements. 5 Credit institutions using the IRB Approach for any exposure class, or in the case of the retail portfolio across the categories of exposures to which the different correlations set out by means of a Notice of the Banco de Portugal correspond, in respect of a business unit, shall cover all exposures belonging to that class, or retail risk category, of that business unit. 6 Without prejudice to the provisions laid down in Article 34 (4), credit institutions using the IRB Approach for any exposure class shall at the same time use the IRB Approach for the equity exposure class. 7 Without prejudice to the provisions laid down in the foregoing paragraphs and in Article 20, credit institutions which have obtained permission to use the IRB Approach shall not revert to the use of the Standardised Approach, except for demonstrated good cause and subject to the approval of the Banco de Portugal. 8 Without prejudice to the provisions laid down in paragraphs 1 to 6 and in Article 20, credit institutions which have obtained permission under Article 17 (5) to use own estimates of LGDs and conversion factors, shall not revert to the use of LGD values and conversion factors referred to in Article 17 (4), except for demonstrated good cause and subject to the approval of the Banco 14

15 de Portugal. Article 16 Exposure classes of the IRB Approach 1 Each exposure shall be assigned to one of the following exposure classes: a) central governments or central banks; b) institutions; c) corporates; d) retail portfolio; e) equity; f) securitisation positions; g) other non-credit obligation assets. 2 The following exposures shall be treated as exposures to central governments and central banks: a) exposures to regional governments, local authorities or public sector entities which are treated as exposures to central governments under the Standardised Approach, including churches and religious communities provided that the conditions set out by means of a Notice of the Banco de Portugal are complied with; b) exposures to multilateral development banks and international organisations which attract a risk weight of 0% under the Standardised Approach; 3 The following exposures shall be treated as exposures to institutions: a) exposures to regional governments and local authorities which are not treated as exposures to central governments under the Standardised Approach; b) exposures to public sector entities which are treated as exposures to institutions under the Standardised Approach; c) exposures to multilateral development banks and international organisations which do 15

16 not attract a risk weight of 0% under the Standardised Approach. 4 To be eligible for the retail portfolio, exposures shall meet the following criteria: a) they shall be either to an individual person, or to a small or medium sized entity, provided in the latter case that the total amount owed to the credit institution and parent undertakings and its subsidiaries, including any past due exposure, by the obligor client or group of connected clients, but excluding exposures secured on residential real estate collateral, shall not exceed EUR 1 million; b) they are treated by the credit institution in its risk management consistently over time and in a similar manner; c) they are not managed individually; d) they each represent one of a significant number of similarly managed exposures. 5 Leasing transactions, with the exception of the respective residual value, entered into with individual persons or with small or medium sized entities shall be eligible for the retail portfolio. 6 The following exposures might be classed as equity exposures: a) non-debt exposures conveying a subordinated claim similar to that of shares; b) debt exposures the economic substance of which is similar to the exposures specified in subparagraph (a) above. 7 Within the corporate exposure class, credit institutions shall separately identify as specialised lending exposures, exposures which possess the following characteristics: a) the exposure is to an entity which was created specifically to finance and/or operate physical assets; b) the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate; c) the primary source of repayment of the obligation is the income generated by the assets being financed. 8 Any credit obligation not assigned to the exposure classes referred to in subparagraphs (a), (b) and (d) to (f) of paragraph 1 shall be assigned to the exposure class referred to in subparagraph (c) of that paragraph. 16

17 9 The exposure class referred to in subparagraph (g) of paragraph 1 shall include the residual value of leased properties if not included in the lease exposure. 10 The methodology used by the credit institution for assigning exposures to different exposure classes shall be appropriate and consistent. Article 17 IRB Approach parameters 1 The risk-weighted exposure amounts under the IRB Approach shall be calculated according to the provisions set out by means of a Notice of the Banco de Portugal. 2 The calculation of risk-weighted exposure amounts shall be based on the following parameters: PD, LGD, maturity (M) and exposure value of the exposure. 3 Credit institutions shall estimate PD for the exposure classes set out in subparagraphs (a) to (e) of paragraph 1 of the foregoing Article, according to the provisions laid down in Article 14 and by means of a Notice of the Banco de Portugal, and notwithstanding the alternative approaches applicable to specialised lending exposures and to the equity exposure class. 4 For retail portfolio, credit institutions shall provide their own estimates of LGDs and conversion factors in accordance with Article 14 and by means of a Notice of the Banco de Portugal. 5 Notwithstanding Article 27, credit institutions may, provided that permission has been granted by the Banco de Portugal, estimate LGDs for the exposure classes of subparagraphs (a) to (c) of paragraph 1 of the foregoing Article, or use LGDs defined by means of a Notice of the Banco de Portugal. 6 The risk-weighted exposure amounts for securitised exposures shall be calculated in accordance with Article 24. Article 18 Exposures in the form of collective investment undertakings 17

18 1 Where exposures in the form of a CIU meet the criteria set out by means of a Notice of the Banco de Portugal and the credit institution is aware of all of the underlying exposures of the CIU, the credit institution shall look through to those underlying exposures in order to calculate risk-weighted exposure amounts and expected loss amounts in accordance with the IRB Approach. 2 Where the credit institution does not meet the conditions for using the IRB Approach, or if the provisions of the foregoing paragraph do not occur, risk-weighted exposure amounts and expected loss amounts shall be calculated in accordance with the approaches set out by means of a Notice of the Banco de Portugal. Article 19 Expected loss amounts 1 The expected loss amount shall be calculated according to the provistions set out by means of a Notice of the Banco de Portugal. 2 The calculation of expected loss amounts shall be based on the same input figures of PD, LGD and the exposure value for each exposure as being used for the calculation of riskweighted exposure amounts. 3 Where credit institutions use own estimates of LGDs, expected loss shall be the credit institution s best estimate of expected loss for the defaulted exposure. Article 20 Derogation from the IRB Approach 1 Credit institutions permitted to use the IRB Approach, subject to the approval of the Banco de Portugal, may use the Standardised Approach for the following cases: a) central governments and central banks and institutions exposures, where the number of material counterparties is limited and it would be unduly burdensome for the credit institution to implement a rating system for these counterparties; 18

19 b) exposures in non-significant subsidiaries or branches, in accordance with the provisions to be set out by means of a Notice of the Banco de Portugal; c) exposure classes that are immaterial in terms of size and perceived risk profile, in accordance with the provisions to be set out by means of a Notice of the Banco de Portugal; d) exposures of a credit institution to a counterparty which is its parent undertaking, its subsidiary or a subsidiary of its parent undertaking provided that the counterparty is an institution or a financial holding company, financial institution, asset management company or ancillary services undertaking subject to appropriate prudential requirements; e) equity exposures to entities whose credit obligations qualify for a 0% risk weight for the purposes of the Standardised Approach; f) where an exposure to an institution is in the form of minimum reserves required by the European Central Bank or by the central bank of a Member State, under the terms to be defined by means of a Notice of the Banco de Portugal. 2 For the purposes of subparagraph (c) above, the equity exposure class of a credit institution shall be considered material if its aggregate value exceeds, on average, over the preceding year, 10% of the credit institution s own funds, or 5% if the number of those equity exposures is less than 10 individual holdings. Article 21 Credit risk mitigation Credit institutions using the Standardised Approach or using the IRB Approach, but not using in the latter case their own estimates of LGD and conversion factors, may recognise credit risk mitigation in accordance with Articles 22 and 23, in the calculation of risk-weighted exposure amounts, or, as relevant, expected loss amounts. Article 22 19

20 Requirements for the recognition of credit risk mitigation 1 The techniques used to provide the credit protection together with the actions and steps taken and procedures and policies implemented by the credit institution shall be such as to result in credit protection arrangements which are legally effective and enforceable in all relevant jurisdictions. 2 The lending credit institution shall take all appropriate steps to ensure the effectiveness of the credit protection arrangement and to address related risks. 3 In the case of funded credit protection, to be eligible for recognition the assets relied upon shall be sufficiently liquid and their value over time sufficiently stable to provide appropriate certainty as to the credit protection achieved. 4 The Banco de Portugal shall regulate by means of a Notice the requirements to be complied with by the assets mentioned in the foregoing paragraph. 5 In the case of funded credit protection, the lending credit institution shall have the right to liquidate or retain, in a timely manner, the assets from which the protection derives in the event of default, insolvency or bankruptcy of the obligor, or other credit event set out in the transaction documentation and, where applicable, of the custodian holding the collateral. 6 The degree of correlation between the value of the assets relied upon for protection and the credit quality of the obligor shall not be undue. 7 In the case of unfunded credit protection, to be eligible for recognition the party giving the undertaking shall be sufficiently reliable, and the protection agreement legally effective and enforceable in the relevant jurisdictions, to provide appropriate certainty as to the credit protection achieved. 8 The Banco de Portugal shall regulate by means of a Notice the entities and agreements referred to in the foregoing paragraph. 9 Credit risk mitigation shall not lead to a risk-weighted amount or to an expected loss amount higher than an equal exposure but in relation to which there is no credit risk mitigation. Article 23 20

21 Enabling clause Where the requirements of the foregoing Article are met, the calculation of risk-weighted exposure amounts and expected loss amounts may be modified, in accordance with the provisions to be set out by means of a Notice of the Banco de Portugal. Article 24 Securitisation Own funds requirements applicable to securitisation transactions shall be determined in accordance with the provisions to be set out by means of a Notice of the Banco de Portugal. Article 25 Minimum own funds requirements for operational risk 1 Own funds requirements for operational risk shall be determined according to the following approaches: Basic Indicator Approach, Standardised Approach or Advanced Measurement Approach, hereinafter called AMA. 2 The Banco de Portugal may allow credit institutions to use a combination of the approaches referred to in the foregoing paragraph as set out by means of a Notice. 3 Without prejudice to the provisions of the foregoing paragraph, credit institutions that use the Standardised Approach shall not revert to the use of the Basic Indicator Approach, except for demonstrated good cause and subject to approval by the Banco de Portugal. 4 Without prejudice to paragraph 2 above, credit institutions that use the AMA shall not revert to the use of the other approaches set out in paragraph 1, except for demonstrated good cause and subject to approval by the Banco de Portugal. Article 26 21

22 Calculation methods of own funds requirements for operational risk 1 Under the Basic Indicator Approach, own funds requirements for operational risk shall be a certain percentage of a relevant indicator. 2 Under the Standardised Approach, for each business line, credit institutions shall calculate own funds requirements for operational risk as a certain percentage of a relevant indicator, and the total requirement shall be the sum of own funds requirements across all individual business lines. 3 The use of the Standardised Approach depends on the prior authorisation of the Banco de Portugal. 4 Without prejudice to the provisions laid down in the following Article, the use of the AMA, based on their own operational risk measurement systems, depends on the authorisation of the Banco de Portugal. 5 The Banco de Portugal shall regulate by means of a Notice the provisions of this Article. Article 27 Joint approval processes for IRB approach and AMA 1 In the case of applications for the permissions referred to in Article 14 (1), Article 17 (5), Article 26 (4), or for the use of internal model approach for the purposes of calculating exposure values regarding the counterparty credit risk of derivative instruments, repurchase transactions, securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions, submitted by an European Union parent credit institution and its subsidiaries, or jointly by the subsidiaries of an European Union parent financial holding company, the competent authorities shall work together, in full consultation, to decide whether or not to grant the permission sought and to determine the terms and conditions, if any, to which such permission should be subject. 2 An application as referred to in the foregoing paragraph shall be submitted only to the competent authority responsible for the exercise of supervision on a consolidated basis of European Union parent credit institutions or credit institutions controlled by European Union 22

23 parent financial holding companies, which shall forward the complete application to the other competent authorities without delay. 3 The competent authorities shall, without prejudice to the provisions laid down in paragraph 5, reach a joint decision on the application within six months. This period shall begin on the date of receipt of the complete application by the competent authority. 4 The decision referred to in the foregoing paragraph shall be set out in a document containing the fully reasoned decision which shall be provided to the applicant by the competent authority referred to in paragraph 2. 5 In the absence of a joint decision, the competent authority referred to in paragraph 2 shall make its own decision on the application. This decision shall be set out in a document containing the fully reasoned decision and shall take into account the views and reservations of the other competent authorities. 6 The decision referred to in the foregoing paragraph shall be provided to the applicant and the other competent authorities. 7 The decisions referred to in paragraphs 3 and 5 shall be recognised as determinative and applied by the competent authorities in the Member States concerned. Article 28 Credit institutions assessment process 1 Credit institutions shall have in place sound, effective and complete strategies and processes to assess and maintain on an ongoing basis the amounts, types and distribution of internal capital that they consider adequate to cover the nature and level of the risks to which they are or might be exposed. 2 The strategies and processes referred to in the foregoing paragraph shall be subject to regular internal review to ensure that they remain comprehensive and proportionate to the nature, scale and complexity of the activities of the credit institution concerned; account shall be taken of the technical criteria set out in the Annex to this Decree-Law, which is an integral part thereof. 23

24 Article 29 Public disclosure of information 1 Without prejudice to the provisions laid down in the following Article, credit institutions shall publicly disclose the information to be defined by means of a Notice of the Banco de Portugal. 2 The information laid down in the foregoing paragraph shall be disclosed on an annual basis at a minimum and the deadlines for publication shall be set by means of a Notice of the Banco de Portugal. 3 Recognition by the Banco de Portugal of the instruments and methodologies relating to the IRB Approach, credit risk mitigation techniques and AMA, is dependent on the public disclosure by credit institutions, of the information referring to those instruments and methodologies. 4 Credit institutions shall adopt a formal policy to comply with the disclosure requirements laid down in the foregoing paragraphs and have policies for assessing the appropriateness of their disclosures, including the respective verification and frequency. 5 Credit institutions may determine the appropriate medium, location and means of verification to comply effectively with the disclosure requirements laid down in paragraphs 1 and 4 of this Article. 6 Credit institutions should, if requested, explain in writing their internal rating decisions to non-financial corporations, and the administrative costs of the explanation have to be at an appropriate rate to the size of the loan. Article 30 Derogations 1 Notwithstanding Article 29, credit institutions may omit one or more items of information classified as confidential, in accordance with the criteria to be set out by means of a 24

25 Notice of the Banco de Portugal. 2 In the cases foreseen in the foregoing paragraph, the credit institution concerned, when disclosing information, shall state in its disclosures the fact that the specific items of information are not disclosed, the reason for non-disclosure, and publish more general information about the subject matter of the disclosure requirements. 3 The requirements set out in the foregoing Article are deemed to have been complied with when the credit institutions make equivalent disclosures under accounting, listing or other requirements, provided that credit institutions indicate where they can be found. Article 31 Powers granted to the Banco de Portugal The Banco de Portugal is empowered to established by means of Notices stricter requirements regarding the frequency, medium and location for the disclosure of information, as well as the means of verification that are not included in the financial statements. Article 32 Minimum thresholds for own funds requirements under the IRB apprach and AMA 1 Credit institutions authorised to use the IRB Approach shall, during the first, second and third twelve-month periods after 31 December 2006, provide own funds which are more than or equal to the amounts indicated in paragraphs 3 to 5. 2 Credit institutions authorised to use the AMA shall, during the second and third twelvemonth periods after 31 December 2006, provide own funds which are more than or equal to the amounts indicated in paragraphs 4 and 5. 3 For the first twelve-month period referred to in paragraph 1, the amount of own funds shall be 95% of the total minimum amount of own funds that would be required to be held during that period by the credit institution under the prudential regulations in force on 31 December

26 4 For the second twelve-month period referred to in paragraph 1, the amount of own funds shall be, at least, 90% of the total minimum amount of own funds that would be required to be held during that period by the credit institution, under the prudential regulations in force on 31 December For the third twelve-month period referred to in paragraph 1, the amount of own funds shall be, at least, 80% of the total minimum amount of own funds that would be required to be held by the credit institution under the prudential regulations in force on 31 December Compliance with the requirements of paragraphs 1 to 5 shall be on the basis of amounts of own funds fully adjusted to reflect differences in the calculation of own funds under the prudential regulations in force on 31 December 2006 and the calculation of own funds under this Decree-Law and respective regulations. Article 33 Transitional derogations from the Standardised Approach 1 Until 1 January 2008 credit institutions may treat the Articles constituting the Standardised Approach as being replaced by the prudential regulations in force on 31 December Where credit institutions exercise the discretion referred to in the foregoing paragraph: a) the prudential regulations in force on 31 December 2006 shall be applied in the calculation of the denominator of the solvency ratio. b) credit derivatives shall be included in the list of full risk items under the prudential regulations in force on 31 December 2006, relating to the solvency ratio. 3 Where credit institutions exercise the discretion referred to in paragraph 1: a) Articles 21 to 23 shall not apply. b) Specific requirements on the disclosure of information shall not apply, under conditions to be defined by means of a Notice of the Banco de Portugal. 4 Where credit institutions exercise the discretion referred to in paragraph 1, own funds requirements for operational risk shall be reduced by the percentage representing the ratio of the 26

27 value of the credit institution s exposures calculated in accordance with paragraph 1 to the total value of its exposures. 5 Where a credit institution calculates risk-weighted exposure amounts for all of its exposures in accordance with paragraph 1, the prudential regulations in force on 31 December 2006 relating to large exposures may apply. 6 Until 1 January 2008, where credit institutions exercise the discretion referred to in paragraph 1, Articles 28 to 31 of this Decree-Law and Article 116-A of RGICSF shall not apply. 7 Until 31 December 2011, credit institutions may set the number of days past due up to a figure of 180 for exposures to the entities referred to in subparagraph (c) of paragraph 1 of Article 10. Article 34 Transitional derogations from the IRB Approach requirements 1 For credit institutions applying for the use of the IRB Approach before 1 January 2010, the three-year use requirement prescribed in Article 14 (3) may be reduced to a period no shorter than one year until 31 December 2009, subject to the approval of the Banco de Portugal. 2 For credit institutions applying for the use of own estimates of LGD and/or conversion factors, the three-year use requirement prescribed in Article 14 (4) may be reduced to two years until 31 December Until 31 December 2010, the exposure weighted average LGD for all retail exposures secured by residential properties and not benefiting from guarantees from central governments, shall not be lower than 10%. 4 Until 31 December 2017, the credit institutions having their head office in Portugal and their European Union subsidiaries may exempt from the IRB treatment equity exposures held at 31 December For the purposes of the foregoing paragraph, the exempted position shall be measured as the number of shares as of 31 December 2007 and any additional share arising directly as a result of owning those holdings, as long as they do not increase the proportional share of 27

28 ownership in a participated company. 6 To the exposures referred to in paragraph 4 shall be applied the Standardised Approach. Article 35 Transitional derogations from the operational risk requirements Until 31 December 2012, a credit institution using the Standardised Approach referred to in Article 26 (2) may apply a percentage of 15% to the business line trading and sales, provided that the respective relevant indicator represents, at least, 50% of the total of the relevant indicators for all of its business lines. Article 36 Composition of own funds 1 The Banco de Portugal shall define by means of a Notice the rules on the composition of the own funds of institutions subject to its supervision. 2 When defining the rules referred to in the foregoing paragraph, the Banco de Portugal determines whether credit institutions subject to supervision on a consolidated basis, pursuant to Article 131 of RGICSF, or to the supplementary supervision provided for in Decree-Law No. 145/2006 of 31 July, and subject to own funds requirements on an individual basis, may or may not, for the purposes of calculating their own funds on an individual basis, deduct the items, mentioned in the Notice referred to in paragraph 1 of Article 96 of RGICSF, held in credit institutions, financial institutions, insurance or reinsurance undertakings or insurance holding companies included in the said consolidation or supplementary supervision. 3 In the definition referred to in paragraph 1 the following shall be observed: a) For the institutions that calculate the risk-weighted exposure amounts according to the IRB Approach, laid down in Articles 14 to 20 of this Decree-Law, the expected loss amounts, deducted from the sum of value adjustments and provisions related to these 28

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