NOVEMBER 2010 (REVISED)

CENTRAL BANK OF CYPRUS BANKING SUPERVISION AND REGULATION DIVISION DIRECTIVE TO BANKS ON THE COMPUTATION OF PRUDENTIAL LIQUIDITY IN ALL CURRENCIES NOVEMBER 2010 (REVISED)

DIRECTIVE TO BANKS ON THE COMPUTATION OF PRUDENTIAL LIQUIDITY IN ALL CURRENCIES 1. INTRODUCTION The Central Bank of Cyprus by virtue of the powers vested in it under sections 23 and 41(2) of the Banking Law of 1997, as subsequently amended, prescribes in the present Directive the method and the manner for the computation of prudential liquidity in all currencies, to be observed by the banks listed in the attached appendix. Furthermore, part 7 of the present Directive refers to basic principles for the management of liquidity risk, which the banks are obliged to follow. 2. INSTRUCTIONS FOR THE COMPLETION OF THE TABLE ANALYSIS OF ASSETS AND LIABILITIES BY RESIDUAL MATURITY Irrespective of the bank s internal procedures for managing liquidity risk, the Central Bank imposes minimum prudential liquidity ratios, based on the bank s on and off balance sheet assets and liabilities and contingent liabilities and claims, in accordance with their contractual maturity. The method and manner for the computation of the net positions in all currencies (total liabilities plus contingent liabilities plus commitments minus total assets) in every maturity band are explained in the instructions for the completion of the table Analysis of assets and liabilities by residual maturity which are attached herewith. The net positions in each time band shall be evaluated by the Central Bank, after classifying to the time band sight to 7 days : (a) 50% of standby credit facilities with first class banking institutions, subject to the prior approval of the Central Bank of Cyprus (b) special government bonds acquired in accordance with Law 118(I) 2009 and bonds acquired through reverse repo agreements, as long as they satisfy all 1

the required conditions for their pledging as collateral for Eurosystem monetary policy credit operations as well as for the provision of intraday credit. The bonds shall be classified net of value adjustments (haircuts). It is clarified that the part of the bonds pledged as collateral for existing liabilities to the European Central Bank or that has been pledged to secure other bank liabilities shall not be included in this time band. 3. LIQUIDITY MISMATCH RATIOS BETWEEN ASSETS AND LIABILITIES (1) Banks shall calculate liquidity mismatch ratios between assets and liabilities, for the sight to 7 days and sight to 1 month time bands, in accordance with the calculation set out in the attached tables. The maximum allowable maturity mismatch ratios (deficit) between assets and liabilities for the time bands sight to 7 days and sight to 1 month, are set at -10% and -25% respectively. The percentages are calculated against total customer deposits in all currencies; whereas the negative sign of the ratios denotes that the restriction relates to the percentage by which total liabilities may exceed total assets. (2) In addition to the requirements in paragraph (1) above, relating to the maximum allowable mismatch ratios, banks are required to maintain a minimum liquid assets ratio (stock liquidity ratio) of 20%, being the ratio of liquid assets as listed in point (a) below, to the liabilities listed in point (b) below, subject to the provisions of points (c) and (d) below. (a) Liquid assets included in the calculation of the liquid assets ratio comprise: i. Cash ii. Central Bank and other bank balances maturing in a period up to 1 month iii. The balance of the minimum reserve account maintained with the Central Bank of Cyprus iv. Credit claims that can be used as collateral for Eurosystem monetary policy credit operations as well as for the provision of intraday credit, as defined in the Monetary Policy Implementation (Instruments & Procedures) Directive of 2007 ( Monetary 2

Directive ), as subsequently amended or replaced and that in accordance with para. 3.5.4 of the Instructions and Explanations for Completing the Table analysing Assets and Liabilities by Residual Maturity, have been classified in the time band sight to 7 days. v. The amount of readily liquefiable investments as described in para. 3.6.1 of the abovementioned Instructions. (b) The liabilities included in the calculation of the liquid assets ratio comprise: i. Total customer deposits, irrespective of maturity. ii. All liabilities which do not fall under the definition of point b (i) above and are payable within the next 12 months. Included in the said liabilities are commitments and contingencies which are expected to result in outflows within the next 12 months, as recognised and reported in the respective time bands of Table 2 of the Directive. iii. In the case of commitments that relate to unutilised credit lines to connected persons (banks and non-banks) or to other banks, the respective amounts shall not be included within liabilities, but instead they shall be deducted from the liquid assets on the basis of the following percentages: 1. for credit lines to connected persons (banks and nonbanks) 100% 2. for credit lines to other banks 50% Table 1 shall include specific reference of such amounts deducted. (c) With respect to liened (blocked) funds, held as collateral for credit facilities granted, the lower between the liened (blocked) funds and outstanding credit facility balance shall be excluded from the total liabilities which are included in point (b) above. Such amounts are separately disclosed in Table 1. (d) Credit facilities enjoyed by the bank, secured by liquid assets as described in point (a) above, shall be deducted from the total liabilities and liquid assets, as defined for the purposes of the liquid assets ratio. 3

The amount to be deducted should be the lower of the credit facilities and the relevant pledged assets. 4. MONITORING OF THE LIQUIDITY RATIOS The maintenance of the above ratios should be monitored by the banks on a daily basis. In cases where the bank s mismatch ratios are not maintained at the prescribed level or are expected not to be maintained in the near future, the bank concerned must notify the Central Bank of Cyprus immediately, communicating also the corrective measures it intends to take in order to comply with the prescribed ratios. 5. ANALYSIS OF LARGE DEPOSITS Deposits, including deposits and loans from other banks, which exceed 1% of total deposit liabilities must be reported in Table 3. Any liabilities under sale and repurchase agreements (Repo/ reverse repo agreements) should be excluded. In cases where there are no deposits which exceed 1% of total deposits, the ten largest deposits should be reported. In cases where the same depositor has more than one deposits or where depositors are connected persons (as defined in the Directive for the calculation of the capital requirements and large exposures of banks of 2006 and 2007 as subsequently amended) these deposits should be aggregated and regarded as deposits of a single person for the purposes of completing Table 3. 4

6. PRINCIPLES FOR THE MANAGEMENT OF LIQUIDITY RISK 1 The following principles are considered to be key elements for the management of liquidity risk. The Board of Directors of each bank should implement these principles, having regard to the nature, size and complexity of operations of its individual bank. As regards branches of foreign banks, the Central Bank of Cyprus requires that these operate in the context of these principles on the basis of proportionality. In the case that the liquidity management is centralised at a branch s Head Office, the Central Bank of Cyprus expects that, in line with the home regulatory requirements and/or internal policies, liquidity management will be exercised on the basis of the same principles as the ones laid down in this section of the Directive and will ensure that the branch has, on a continuous basis, sufficient liquidity to meet the regulatory ratios prescribed in this Directive as well as its funding needs both at normal and stressed times. In evaluating the adequacy and appropriateness of the policies and procedures for the management of liquidity risk by a branch of a foreign bank in Cyprus, the Central Bank of Cyprus, may co-operate and exchange information with the branch s home supervisor. a) The Board of Directors of each bank is responsible for the formulation of a strategy and for the setting up of principles for the management of liquidity risk, on a daily basis, in both normal and stressed times. These should be suited to the bank s risk profile and level of risk tolerance as defined by the Board. In addition, the Board should ensure that an adequate level of long-term funding is in place. The bank should establish mechanisms to inform the Board of Directors regularly of the liquidity situation of the bank and promptly in case there are any material changes in its current or prospective liquidity position. b) The bank should have an adequate internal mechanism in place for the fair allocation of liquidity risk to all business units contributing to this risk through 1 These principles are based on the paper issued by the Basel Committee «Principles for Sound Liquidity Management and Supervision, September 2008» [http://www.bis.org/publ/bcbs144.htm] as well as on the paper issued by CEBS «Second Part of CEBS s Technical Advice to the European Commission on Liquidity Risk Management» issued on 18 September 2008 [http://www.c- ebs.org/getdoc/7aae0f3b-6925-4ef8-b4d6-1bbaab899acc/cebs%e2%80%99s-technical- ADVICE-ON-LIQUIDITY-RISK-MANAGEME.aspx]. 5

their operations. This allocation aims at providing incentives to the relevant units (through a transfer pricing system in relation to the liquid assets they utilise or generate) to adequately address liquidity risk arising as a result of their operations. c) The bank must have an appropriate management structure in place to execute effectively the strategy and policies for the management of liquidity risk. This structure should provide for the segregation of duties between operational and monitoring functions. The bank should have sufficient and well trained staff as well as appropriate internal control systems evaluated by the Internal Audit function as to their adequacy and effectiveness. d) The bank must have adequate information systems for measuring, monitoring and controlling liquidity risk, and for the production of relevant reports on a timely basis to the bank s Board of Directors, Senior Management and other appropriate personnel. The adequacy of this system should be reviewed regularly. e) For liquidity risk management purposes, the liquidity of a particular asset should be determined in accordance with its liquidity-generating capacity and value and not in accordance with its accounting treatment or classification to the trading book or banking book. There should also be adequate diversification of liquid assets. f) When using netting arrangements, which aim, among other things, to mitigate liquidity risk, the bank should address all legal or operational factors possibly affecting the enforcement of such netting arrangements. g) The bank should take into account possible liquidity inflows or outflows which may occur either in normal or in stressed times, as a result of specific clauses included in contracts, as well as contingent liabilities because of documentation or reputation risk. The bank should particularly consider the contingent liabilities stemming from Special Purpose Vehicles (SPVs) it has set up. 6

h) The bank should have policies in place for the measurement and management of its funding needs and the availability of assets which can be used as collateral to obtain funding, in both normal and stressed times. It should also determine the minimum level of unencumbered collateral that should be available at all times to face unexpected funding needs. i) In order to ensure the proper management of its cash and liquid assets, the bank should take into account the procedures and processes of different payment and settlement systems in which it participates as well as their impact on its funding intra-day levels and needs at both local entity and consolidated levels. This should be the case in both normal and stressed times and banks should contribute towards the smooth functioning of payment and settlement systems. j) The bank should set up processes for the ongoing measurement and monitoring of its funding requirements, developing assumptions for the volatility of its deposits as well as the projected variations in the size of its assets and liabilities. Special attention should be given to the monitoring of sources of unexpected liquidity demands under stressed conditions. In addition, the bank should measure and take into account contingent flows stemming from off-balance sheet items. The assumptions underlying the calculations for the purposes of managing liquidity, as well as the methodology for measuring and monitoring funding needs, should be assessed regularly, to ensure that they continue to apply and are in line with the bank s risk appetite and risk tolerance. k) The bank should conduct stress tests in order to assess the impact of extreme but plausible stress scenarios on its liquidity, taking into account current or contemplated mitigants. The bank should calculate the expected liquidity inflows and outflows under alternative scenarios of varying degrees of severity, taking into account both internal and external factors. The scenarios underlying assumptions should be reviewed regularly whereas the results of the scenarios should be evaluated by senior management and utilised in the setting up of policies, limits and contingency funding plans, when appropriate. 7

l) The bank should have a contingency funding plan. The plan should be reviewed and tested regularly in order to minimise possible delays resulting from legal or operational constraints and to ensure the availability of counterparties for effecting the required transactions. m) The bank should maintain adequate liquidity buffers, consisting of cash and other, highly liquid, unencumbered assets. These liquidity buffers should be sufficient to enable the bank to weather liquidity stress for a minimum period of 1 month, without requiring adjustments to its business model. n) The bank should regularly reassess market access for the raising of funds and should maintain a well diversified funding base. The bank should ensure diversification with regard to liquidity providers, types of funding (secured or unsecured), marketplaces, products, geographic distribution, currency and maturity. o) The bank should adequately disclose information regarding liquidity risk both in normal and stressed times. The nature, depth and frequency of the information disclosed should be appropriate for its different stakeholders (liquidity providers, counterparties, investors, rating agencies etc.) 8

INSTRUCTIONS AND EXPLANATIONS FOR COMPLETING THE TABLE ANALYSING ASSETS AND LIABILITIES BY RESIDUAL MATURITY 1.0. GENERAL 1.1. The prudential liquidity return, set out in the attached Table 1 and the accompanying analysis Tables 2 and 3, also attached, should be submitted to the Central Bank on a quarterly basis (end of March, June, September and December), by the 21 st day of the month following the end of each quarter. 1.2. The Total column of Table 2 should include assets and liabilities as valued in accordance with International Accounting Standards, unless otherwise stated. 1.3. Assets and liabilities should be classified in the various time bands according to their remaining period to maturity. In case where there is no fixed maturity date for any claims or obligations, these shall be classified in the various time bands according to the accounting concept of prudence i.e. obligations classified in the time band sight to 7 days while claims classified in the time band over 12 months. An exemption from these two rules applies in relation to ECB Eligible credit claims as defined in paragraph 3.5.4 below and readily liquefiable investments, as defined in paragraph 3.6.1 below, which are classified in the time band sight to 7 days, irrespective of their maturity date. Future revenue and expenses should not be included in the various time bands analyses e.g. unearned interest included in future instalments of fixed term loans as well as unearned interest included in hire purchase loan instalments. Accrued interest should be included as part of the item to which it relates. 1.4. Setting-off debit balances against credit balances and vice versa is not allowed. Specific guidelines with respect to the classification of assets and liabilities are described in paragraphs 2 and 3 below. 9

2.0. LIABILITIES 2.1. Deposits Deposits shall be entered into the various time bands according to the time remaining from the reporting date until their earliest repayment date. 2.1.1. Sight (demand) deposits shall be classified in the time band sight to 7 days. 2.1.2. Savings deposits shall be classified in the time band sight to 7 days with the exception of minors savings deposits which shall be classified in the appropriate time band according to the date on which they may be withdrawn. 2.1.3. Notice deposits shall be classified in the various time bands according to their notice period. However, in cases where notice of withdrawal has been given, the amount involved should be classified in the appropriate time band according to the period remaining until the withdrawal of the deposit. Fixed deposits shall be allocated to the various time bands according to their remaining period to maturity. Minors fixed deposits shall be classified in the appropriate time band according to the date on which they may be withdrawn. 2.1.4. Liened deposits utilised as collateral for credit facilities shall be classified in the appropriate time band according to the duration of the lien, and beyond that, according to their maturity. 2.1.5. Margin accounts against letters of credit shall be classified in the 8 days to 1 month time band. 2.1.6. Overdue fixed deposits, which have not been renewed, shall be classified in the sight to 7 days time band. 2.1.7. Fiduciary deposit accounts from banks belonging to the same group as the reporting bank, shall be included within customer deposits, as long as the 10

beneficiaries of the said deposits are customers of the banking group and the bank can identify them and is in a position to classify them in accordance with ESA 95 (European System of national and regional Accounts in the Community). 2.2. Amounts due to the Central Bank Amounts due to the Central Bank shall be classified in the various time bands according to their maturity. 2.3. Amounts due to local and overseas banks Amounts due to local and overseas banks shall be classified in the various time bands according to their maturity. Fiduciary deposit accounts from banks, that do not fall under the provisions of paragraph 2.1.7., are classified in this category. 2.4. Financial Derivatives Liabilities in relation to financial derivatives (e.g. currency swaps) shall be classified in the various time bands according to the value and date of outflows expected to arise in respect of these items, and, where options exist, the value of outflows expected to become payable. 2.5. Loan capital Loan capital shall be entered into the various time bands according to its remaining maturity and its terms of issue. 2.6. Other liabilities 2.6.1. Provisions for liabilities and charges Provisions for liabilities and charges shall be classified in the various time bands according to their maturity. Provisions in relation to employee pensions and provident funds shall be classified in the time band over 12 months. 11

2.6.2. Other liabilities Other liabilities shall be classified in the various time bands according to their remaining maturity. Other liabilities for which there is no specific maturity date shall be classified in the time band sight to 7 days. Where accrued interest cannot be included as part of the item to which it relates, it shall be classified into the various time bands according to the remaining maturity of the underlying deposits. However, if this is not possible, accrued interest payable shall be analysed in time bands on the basis of the following percentages: 15% in the time band sight to 7 days 10% in the time band 8 days to 1 month 75% in the time band 3 months to 12 months Interbranch and suspense accounts, standing in credit balance, shall be classified in the time band sight to 7 days. 2.6.3. Capital and Reserves Capital and reserves shall be entered into the time band over 12 months. 2.7. Contingent Liabilities Only those contingent liabilities which the bank expects to be called on a specific date shall be entered into the various time bands, and after deducting any inflows arising from the above on the basis of their expected repayment schedule. 2.8. Commitments The full amount of commitments for which there is an agreed drawdown date (or dates), e.g. capital commitments for the purchase of fixed assets, approved loans etc. shall be entered into the various time bands. In addition, any inflows arising 12

from the above on the basis of their repayment schedule, should be classified with a negative sign. Commitments for which there is no agreed drawdown date, e.g. unutilised limits on overdrafts and other facilities, it is difficult to determine their exact classification in the various time bands. For this reason, only 15% of the total value of such commitments shall be allocated to the time band sight to 7 days. For the purposes of calculating the liquidity mismatch ratios, commitments that concern unutilised credit lines to connected persons (banks and non-banks) or to other banks, are classified in the time band sight to 7 days, on the basis of the following percentages: (i) for credit lines to connected persons (banks and non-banks) 100% (ii) for credit lines to other banks 50% 3.0. ASSETS 3.1. Cash and cash equivalents Cash and cash equivalents shall be classified in the time band sight to 7 days. 3.2. Balances with Central Banks 3.2.1. Minimum Reserve account The Minimum Reserve account shall be analysed in the various time bands according to the remaining maturity of the underlying deposits for which it is maintained. 3.2.2. Other debit balances with Central Banks Other debit balances with the Central Bank shall be analysed in the various time bands according to their remaining maturity. 13

3.3. Amounts due from local banks Balances with banks in Cyprus shall be entered into the various time bands according to their remaining maturity. 3.4. Amounts due from foreign banks Balances with overseas banks shall be classified in the various time bands according to their remaining maturity. 3.5. Loans and advances to customers Total loans and advances to customers are reported at book value gross of provisions. The part of loans and advances that relates to non performing loans or other loans that would have been classified as non-performing had they not been fully collateralised, shall be classified in the Overdue column, The overdue amount of loans and advances that present arrears up to 3 months is classified in the Overdue column, whereas the remaining part of these loans and advances is classified into the various time bands, depending on the payment date. The remaining loans and advances are analysed as follows: 3.5.1. Fixed-term loans Fixed-term loans shall be analysed into the various time bands in accordance with the maturity pattern of outstanding instalments as these have been set by their repayment programme. Unearned interest included in the outstanding instalments should not be analysed into the various time bands. 3.5.2. Short term advances and bills discounted Short-term advances and bills discounted shall be analysed into the various time bands on the basis of their remaining maturity and in accordance with the agreed terms. 14

3.5.3. Overdraft balances and similar accounts Overdraft balances and similar account balances shall not be analysed into the various time bands, although they should be included in the Total column. Unauthorised excesses on overdrafts should be reported in the Overdue column. 3.5.4. ECB Eligible Credit Claims Credit claims that can be used as collateral for Eurosystem monetary policy credit operations as well as for the provision of intraday credit, as defined in the Monetary Policy Implementation (Instruments & Procedures) Directive of 2007 ( Monetary Directive ), as subsequently amended or replaced and that have been included in the pool of assets pledged in favour of the Central Bank shall be classified in the column sight to 7 days. It is clarified that items pledged as collateral corresponding to existing obligations towards the European Central Bank shall be analysed according to the duration of the relevant credit transaction. 3.5.5. Provisions Provisions for doubtful debts are classified, with a negative sign, in the Total column and Overdue column and shall not be analysed into the various time bands. 3.6. Investments 3.6.1. Readily Liquefiable Investments Investments which are readily liquefiable or that can be used in repurchase agreements or used as collateral for Eurosystem monetary policy credit operations as well for the provision of intraday credit, shall be classified in the time band sight to 7 days. The following are defined to be immediate liquidity investments: 15

a) All items that are eligible as collateral for Eurosystem monetary policy credit operations as well as for the provision of intraday credit, as defined in the Monetary Directive, as subsequently amended or replaced. This category includes off-balance sheet items, such as special government bonds acquired in accordance with the Issuance of Special Government Bonds Law of 2009 and bonds acquired through reverse repo agreements, as long as they satisfy all the required conditions for their pledging as collateral for Eurosystem monetary policy credit operations as well as for the provision of intraday credit. Off-balance sheet items shall be presented as adjusting items in Table 1 of the appendix. It is clarified that items pledged as collateral for existing credit operations shall be analysed according to the maturity of the said operations. b) All government and non-government debt securities which do not fall under category (a) above, but bear the following characteristics: Minimum Long-term credit rating A- of Standard and Poor s or equivalent; with issuer established in a country within the European Economic Area, the Group of Ten or Australia and traded in regulated markets of countries within the European Economic Area, the Group of Ten or Australia. c) Shares listed in regulated markets of countries within the European Economic Area, the Group of Ten or Australia. d) Mutual funds traded in regulated markets of countries within the European Economic Area, the Group of Ten or Australia. 16

The above items shall be classified in the time band sight to 7 days, at their market value after applying the following haircuts: a) For categories 3.5.4 and 3.6.1., the banks shall deduct the haircuts in accordance with the Monetary Directive, as subsequently amended or replaced. The banks should classify the above items in the time band sight to 7 days, at their net value after deducting the applicable haircuts. b) For the debt securities described in (b) above 20%. c) For the shares listed in regulated markets of countries within the European Economic Area, the Group of Ten or Australia 40%. d) For mutual funds negotiated in regulated markets of countries within the European Economic Area, the Group of Ten or Australia the haircuts applicable shall depend on the composition of the investments of the said funds. A haircut of 20% should be applied to the portion invested in debt securities and 40% to the portion invested in shares. It is clarified that items pledged and corresponding to existing obligations to the European Central Bank or pledged for other existing bank obligations shall be analysed in accordance with the duration of the said obligations. For the purposes of reconciling the total of readily liquefiable investments classified in the time band sight to 7 days to the respective items in the bank s balance sheet, the column Total will include investments at their balance sheet value, before applying any haircuts and before accounting for any difference stemming from a potentially different (i.e. other than market value) valuation basis employed for the balance sheet. 3.6.2 Other investments Investments which fall outside the scope of paragraph 3.6.1. above, shall be classified according to their remaining time to maturity or, in the case of investments in shares, in the time band over 12 months. 17

3.6.3. Investments in group undertakings Investments in the share or loan capital of subsidiary and associated companies shall be classified in the time band over 12 months. 3.7. Financial Derivatives Assets in relation to financial derivatives are classified in the various time bands according to the date and value of the inflows arising from them or, in the case of options, the inflows expected to be received by the bank. 3.8. Other assets 3.8.1. Drafts, Cheques and Bills bought These items shall be classified according to the remaining time for their collection. 3.8.2. Fixed Assets Fixed assets owned and used by the reporting bank for the conduct of its business shall be entered into the time band over 12 months. Assets acquired in satisfaction of debts shall be entered into the time band over 12 months except those which have already been sold by the reporting date and which shall be entered into the various time bands according to the time remaining until receipt of their sale proceeds. 3.8.3. Other remaining Assets Other remaining assets shall be classified in the various time bands according to their maturity. Prepayments and items without fixed maturity date shall be entered into the time band over 12 months. The amount of any called up share capital not paid shall be entered in the various time bands according to the time remaining until its receipt. 18

In the case where accrued income receivable cannot be classified as part of the items to which it relates, it shall be entered into the various time bands according to the time remaining until it becomes due. If, however, this is not possible accrued interest receivable shall be analysed into the various time bands according to the following percentages: 10% in the time band 8 days to 1 month 30% in the time band over 1 month to 3 months 60% in the time band 3 months to 12 months It is clarified that accrued interest receivable in respect of overdraft accounts is not analysed in the various time bands since the balances of the said accounts are not analysed in the various time bands. Inter-branch and suspense items, standing in debit balance shall be classified in the time band sight to 7 days. 19