Belgium
Financial System Stability Assessment

This financial stability assessment provides an update on the significant regulatory and supervisory developments in the banking and insurance sectors of Belgium since 2006. The Belgian financial system is relatively large with solid capital buffers on aggregate, and the 2008 global financial crisis has had a major impact on the Belgian financial sector. The links between banks and the Belgian sovereign have intensified owing to the crisis, with total exposure of the banking sector to the federal government at 10 percent of banking sector assets in mid-2012.

Abstract

This financial stability assessment provides an update on the significant regulatory and supervisory developments in the banking and insurance sectors of Belgium since 2006. The Belgian financial system is relatively large with solid capital buffers on aggregate, and the 2008 global financial crisis has had a major impact on the Belgian financial sector. The links between banks and the Belgian sovereign have intensified owing to the crisis, with total exposure of the banking sector to the federal government at 10 percent of banking sector assets in mid-2012.

Introduction and Background

A. Macroeconomic and Financial Sector Developments

1. The Belgian financial system is relatively large, concentrated, and interconnected with the rest of the world (Figure 1). The banking system is dominated by four banking groups representing almost three-fourths of consolidated system assets. System assets grew rapidly from 384 percent of GDP in 2000 to 470 percent of GDP in 2007, with growth largely driven by an expansion of investment banking activities financed through the surplus of domestic retail deposits and wholesale funding. Assets of foreign-owned banks account for more than half of the sector. The insurance sector is embedded in the predominant bancassurance model and dominated by a few conglomerates.

Figure 1.
Figure 1.

Belgium: Structural Features of the Financial Sector

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: NBB, SNL database, IMF Working Paper No. 12/10, and IMF staff calculations. In Belgium the four large banks are BNP Fortis, KBC Bank, Belfius Bank, and ING Belgium.

2. The 2008 global financial crisis had a major impact on the Belgian financial sector. The top three Belgian conglomerates were hit hard as funding dried up and capital positions were depleted by massive losses on structured financial products, large write-offs, and provisions. The state provided capital injections and extensive funding and asset guarantees to the three largest banks and several insurers. Since 2008, banks have shed investment banking and asset management activities and shifted focus to a more “traditional” banking model, focused primarily on the domestic market. An initial deleveraging reduced the size of the banking sector to 310 percent of GDP in mid-2012, with a second wave of deleveraging currently under way, albeit at a slower pace. Cross-border claims fell from 300 percent of GDP in 2008 to 58 percent of GDP in mid-2012. The largest remaining exposures are to the Czech Republic, France, Ireland, the United Kingdom, and the United States.

uA01fig02

Belgium Banks’ Principal Foreign Exposures as of June 20121

(In billions of euros)

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: BIS Consolidated Banking Statistics.1Amounts outstanding based on consolidated foreign claims of reporting banks on an ultimate-risk basis.

3. Following a short-lived recovery, growth has slowed significantly since the start of 2012 and is expected to stagnate through 2013 (Figure 2, Table 2). In addition to weak external demand in the European Union (the main trading partner), domestic demand is deteriorating, reflecting higher uncertainty, depressed consumer and business sentiment, and fiscal consolidation. The unemployment rate has begun to edge upward. The general government deficit widened to 3.9 percent of GDP in 2012 and the dynamics of the debt-to-GDP ratio remains tenuous in light of low growth prospects. The government has initiated labor market and pension reforms aimed at boosting the employment rate and potential growth, but implementation is challenging and Belgium’s competitiveness continues to fall.

Figure 2.
Figure 2.

Belgium: Economic Developments

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: Haver Analytics and IMF staff calculations.
Table 2.

Belgium: Baseline—Selected Economic Indicators, 2009–17

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Sources: Data provided by the Belgian authorities, and IMF staff projections.

Contribution to GDP growth.

Defined as in the Excessive Deficit Procedure.

4. Bank-sovereign linkages have intensified due to the crisis. The total exposure of the banking sector to the Belgian government (including exposure to local authorities) has increased substantially since 2008 and stood at 11 percent of banking sector assets in mid-2012, while the contingent fiscal liabilities stemming from the state aid to Dexia, Fortis, and KBC are estimated to have reached 18 percent of GDP. With substantial exposures to the Belgian government and limited fiscal headroom remaining, fiscal consolidation is critical to avoiding a weakening of market confidence and increasing funding costs.

uA01fig03

Sovereign-bank linkages

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

5. The Belgian insurance industry is mature and dominated by a few financial conglomerates. It is a one-fifth the size of the banking sector, accounting for 69 percent of GDP at end-2011 (i.e., €255 billion). The top five life insurers accounted for 71 percent of the total assets, while the top five nonlife insurers held 58 percent of assets in 2011. The industry is dominated by composite insurers that conduct both life and nonlife insurance operations. Nine insurance groups derived, on average, more than 90 percent of their premiums from domestic operations in 2011, while the largest group wrote more than a third of premiums abroad.

6. The asset management industry comprises both UCIT and non-UCIT vehicles. Total assets under management in UCITs stood at 80 percent of GDP (or €293 billion) at mid-2012 and only 4 percent of European market share, with another €250 billion (68 percent of GDP) in assets under management in non-UCIT vehicles (Table 3). Privately managed pension funds remain small.

Table 3.

Belgium: Structure of the Financial Sector

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Sources : National Bank of Belgium and FSMA.

On consolidated basis.

On company basis.

The figure for June 2012 is non-annualised.

uA01fig04

Structure of the Belgian Financial System Assets, 2011

(In percent of total consolidated financial system assets)

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: NBB, FSMA, and IMF staff calculations.

7. Financial market infrastructure is large and cross-border in focus. Euroclear, the largest clearing and settlement system in Europe (with a transaction volume of €580.6 trillion in 2011), is located in Belgium and supervised by the NBB as the lead regulator.1 With €18 trillion worth of securities held in custody, Bank of New York Mellon SA/NV—the country’s sixth largest bank—is a global custodian and asset manager that centers its European business in Brussels. The NBB also coordinates the oversight of the Society for Worldwide Interbank Financial Telecommunications (SWIFT), a systemically important global financial messaging system.

8. A new framework for covered bonds was put in place in 2012 (Appendix I) and two large institutions issued bonds shortly after the law came into place with strong demand.2 The framework provides investors in covered bonds with a range of protections. The framework provides for dedicated on balance sheet structures without the use of separate issuing vehicles, while ensuring a dual recourse to the cover pool and the issuer (i.e., other assets of the issuing bank). Issuance limits mitigate the risk that reliance on covered bonds for funding could, over time, weaken issuers’ resilience in a crisis or their resolvability.

B. Household and Corporate Sector Developments

9. Real estate prices in Belgium have continued to increase prompting concerns about sustainability (Figure 3). Prices have more than doubled in the past decade, and are up by 90 percent in real terms since 2000. Price appreciation has resumed, even in the wake of the recent crisis, outpacing increases in other advanced countries. Various estimates suggest the Belgian housing market is overvalued by 5–20 percent. Nevertheless, prices remain relatively low in Belgium compared with much of the rest of Europe and the supply of properties is limited. The growing demand for housing seems to reflect an immigration-driven increase in the population accompanied by a decline in average household size. Most properties are owner-occupied and real estate turnover is discouraged through high transaction costs.

Figure 3.
Figure 3.

Belgium: Nonfinancial Sector Developments

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Sources: Belgium’s Ministry of Economy, OECD, Haver, Global Property Guide, KBC Bank, Economagic.com, www.numbeo.com, and IMF staff calculations.1/ Loan Affordability Index is calculated as an inverse of mortgage as percentage of average monthly salary. Larger values indicate more affordable housing.2/ Consolidated data not available for Ireland or the UK.

10. Households’ debt and vulnerability to interest rate changes have increased, and the NBB has called for a tightening of mortgage lending standards. At 90 percent of disposable income, household indebtedness is relatively low compared to other advanced economies, while households’ gross and net wealth is amongst the highest in the EU. On average mortgage debt service has remained affordable and roughly constant in the last few years, but about 20 percent of borrowers need to use 50 percent of their disposable income or more to service their mortgage. The share of variable interest rate debt in total household debt has also risen, especially for low-income households, increasing vulnerability to high and widespread unemployment or a disposable income shock.3 Build up of risk in this area should be closely monitored, and authorities should weigh merits of activating specific macroprudential tools if needed.

11. Having entered the recession from a strong financial position, nonfinancial corporations now face competitiveness headwinds. In 2008, profits fell sharply, particularly for sectors exposed to global trade. After a short-lived recovery of corporate financial positions in 2010 and 2011, corporate bankruptcies rates increased significantly in the fall of 2012, with business startups declining by 21 percent year-on-year. Nonfinancial corporate debt on a consolidated basis (i.e., excluding intra-company lending) stood at 87 percent of GDP in Q3 2012, with banks ‘exposure to the sector stable at about a third of total loans in 2007–12.4 Overall, sufficient buffers in the corporate sector helped prevent a severe retrenchment of investment and employment throughout the downturn, but a loss of cost competitiveness will constrain economic rebound.5

C. Implementation of 2006 FSAP Recommendations

12. The authorities have made progress in addressing the recommendations of the 2006 FSAP (Appendix II) but many recommendations in the area of conglomerate supervision and governance remain relevant. The new institutional model is a work in progress and better communication and coordination between supervisory institutions is needed. Improvements are evident in the intensity of banking supervision and the adoption of analytical tools to support system-wide monitoring, including the introduction of an intensive Internal Capital Adequacy Assessment Process (ICAAP) process for determining Pillar II capital requirements, liquidity stress testing for the banking sector, and introduction of macro-financial risk dashboard to monitor systemic and emerging risk. Funding and risk management standards are being improved. Supervisory tools for monitoring group-wide risks need to be upgraded. The crisis management framework, while updated for handling systemic firms, is in need of a further upgrade owing in part to EU-wide developments.

13. Insurance supervision has been significantly strengthened although further work is needed, particularly, in strengthening the solvency framework. Both bank and insurance supervisory frameworks integrate vertical analyses of individual insurers with horizontal review of the sector. The adoption of the new institutional architecture has allowed the FSMA to focus solely on market and business conduct and the adoption of EU directives in the interim has addressed many of the recommendations for the securities sector. The FSMA’s plan to adopt a risk-based approach to conduct supervision must be adequately resourced. Pension regulation and supervision has been strengthened. While pension funds remain the remit of the FSMA, there is currently a debate as to whether this should be the responsibility of the NBB.

Soundness of the Financial System and Potential Risks

A. Financial Crisis and Policy Response

14. The authorities’ response to the 2008 crisis was prompt and forceful, but potential spillovers and execution risks remain (Table 4, Appendix III). Capital injections and government guarantees, combined with market pressure, set a stage for major restructuring of the Belgian financial sector. Crisis intervention has proved stabilizing (Figure 4). The intervened institutions are in different stages of recovery and deleveraging is well advanced across the sector. Most banks have successfully returned to funding markets and in some cases they have been able to raise new equity. Nevertheless, several groups remain reliant on public support and difficult market conditions could challenge their ability to maintain the planned pace of deleveraging through further asset disposals. Unwinding the state support will take time, and success ultimately depends on restoring financial stability across the euro area.

Table 4.

Belgium: Financial Sector State Support (2012)

(In euro billions, unless indicated otherwise)

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Source: NBB and IMF staff calculations.

The full amount of guarantees committed in 2012 are included.

Discontinued guarantees and repaid capital investments.

Figure 4.
Figure 4.

Belgium: Financial Market Indicators

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Sources: Bloomberg and Thomson Reuters DataStream.1Stock market index compiled by Thomson Reuters Datastream for the share prices of EU financial intermediaries.2iTraxx Senior Financials index for 5-year credit default swaps for a sample of 25 large European financial institutions.

15. The dismantling of the Dexia Group is a long-term and complex process requiring continued vigilance by authorities. The restructuring entails substantial operational and financial implications for the entities of the former group, and utilizes significant state guarantees to secure the financing of the legacy assets. Recent steps taken by the Belgian and French governments were important to stabilize the group and have reduced the burden on the Belgian state.6 The execution of the restructuring plan will require intensive supervisory and government oversight, as well as close coordination with the French authorities, to prevent contagion and minimize future fiscal costs.

B. Vulnerabilities Analysis7

16. Domestic economic challenges remain sources of continued uncertainty as the banking sector consolidates (Figure 5). Banks have struggled for profitability since the crisis, and structural costs remain high.8 As the restructuring of the sector comes to an end, further efficiency gains might be difficult to achieve due to the natural wage drift and growth of operating expenses. Interest margins are likely to come under pressure in response to greater reliance on more costly term deposits and longer maturity bonds (in lieu of wholesale funding), as well as limited pricing power in an increasingly saturated domestic lending market with sovereign interest rate-indexed lending rates adjusting downward. In turn, weaker earnings capacity and lower investment returns will constrain banks’ ability to maintain existing capital buffers under the forthcoming new capital requirements and replenish capital in case of renewed macro-financial shocks.

Figure 5.
Figure 5.

Belgium: Banking Sector Developments

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: National Bank of Belgium and IMF staff calculations.1The LLP-to-NPL ratio denotes the stock of loan loss provisions (LLPs) as a percentage of non-performing loans (NPLs). The amount of risk-weighted assets (RWAs) is shown as a percentage of total assets. Leverage is defined as the ratio of total assets to CET1 (multiple). All values are calculated as an average for Belgium’s six largest banks, weighted by the relative size of their loan book.2NFC and household deposits and loans corrected for the securitization.3Corrected for the securitization.

17. A wide and stable deposit base and the strategic re-orientation of the banking sector toward the domestic market helped avoid a decline in credit supply. A 25 percent fall in aggregate bank assets since 2007—owing to a drop of exposures outside Belgium by over 40 percent—has increased the banks’ focus on their home markets, where the overall level of impairments has remained relatively modest so far. However, a weak economic environment and higher unemployment will affect debt servicing capacity and affordability, which might lead to deterioration in asset quality over the medium term. Faced with excess liquidity from a high level of domestic savings, banks have incentive to increase investment yields and intragroup funding arrangements within conglomerate structures. This underscores the importance of robust intragroup exposure reporting and conglomerate supervision.

18. Aggregate capitalization of the banking system compares favorably to other major international banking systems. Supervisory action, deleveraging, and improved risk management following the crisis have pushed banks toward stronger capital positions and enhanced short-term liquidity. Tier 1 capital for the Belgian banking system has risen from 11.5 percent of risk-weighted assets in 2008 to 13.4 percent mid-2012 (Table 5). Leverage ratios, with regulatory capital at 6.2 percent of total assets for the system (and 6.1 percent for the group of six largest banks), compare favorably to European peers.

Table 5.

Belgium: Financial Soundness Indicators for the Banking Sector1

(In percent unless indicated otherwise)

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Sources: National Bank of Belgium.

Consolidated data. Data are based on the IAS/IFRS reporting scheme.

Deposits booked at amortized cost only.

Unconsolidated data.

19. Liquidity and funding pressures have abated for the time being. Banks have made material progress in reducing their dependence on wholesale funding and collateralized central bank repos, and liquidity buffers are comfortable in most large banks. Stricter liquidity regulation by the NBB introduced in 2011 has been conducive to greater focus on liquidity risk management. At the same time, measures taken by the Eurosystem to support the liquidity position of euro area banks eased investor concerns but have led to an increase in asset encumbrance in several large banks. Access to wholesale funding could become more difficult should market’s perception of sovereign risk deteriorate.

20. Banks’ exposures to vulnerable euro area sovereigns have declined significantly since the onset of the crisis in Europe (Figure 6). Both sovereign and private claims on Greece, Portugal, Spain, and Italy have declined and have been replaced with exposures to the Belgian sovereign. Exposures to Ireland, in particular through group holdings, remain small but important, as are exposures to Central and Eastern Europe (Box 1).

Figure 6.
Figure 6.

Belgium: International Exposures of Belgian Banks, 2007–12

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: BIS Consolidated Banking Statistics, December 2012. Amounts outstanding are based on consolidated foreign claims of BIS reporting banks on an ultimate-risk basis.

21. Some banks also have significant exposures to banks abroad suggesting the risk of outward and inward spillovers (Figure 6). Network analysis, which tracks the reverberation of a credit event or liquidity squeeze throughout the banking system via direct linkages in the interbank market, indicates that the banking system’s largest direct vulnerability is to the realization of extreme credit and funding shocks to banks in France, Germany, and the Netherlands.9 Not surprisingly, given the size of the U.K. and U.S. banking sectors, shocks to banks in the United States and the United Kingdom would have an even greater, albeit second-round, impact on stability in Belgium, as shocks to these systems would trigger distress across a number of countries. In turn, an extreme credit and funding shock in Belgium would have important outward effects on the banking systems in Luxembourg, the Netherlands, and the Czech Republic (Box 2).

Outward Spillovers from Belgium Financial Sector

Belgian banks deleveraged massively since the onset of the crisis, mainly by reducing cross-border exposures. Exposures of Belgian banks to Central and Eastern Europe decreased by about 22 percent since end 2007 primarily through the disposal of foreign subsidiaries. The exposure to the Czech Republic remained high and relatively stable, with an almost equal split between loans and government securities, while banks deleveraged in the rest of the region; exposures to Turkey and Russia dropped most significantly.

Continued deleveraging would have important spillover effects in Central and Eastern Europe—the most important external market for Belgian banks. So far, however, the impact on financial intermediation has been relatively subdued. In the longer run, reduced parent funding may lead to a more sustainable business model in host countries based on an increased reliance on local savings. Host countries could also be hit by a renewed market distress should local subsidiaries come under pressure to upstream liquidity to parents, for example through disposals of local government securities, or if losses were to be recorded from mark-downs of Belgian securities held by local subsidiaries.

uA01fig05

Belgium Banks Main Exposures on Emerging Europe

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: BIS Consolidated Banking Statistics. Amounts outstanding based on consolidated foreign claims of reporting banks on an ultimate-risk basis.

Belgium is home to three key parts of global financial market infrastructure, the failure of which would have serious and widespread cross-border implications. Euroclear Bank operates one of the largest securities settlement systems worldwide with a daily average settlement value of around €1.1 trillion, providing settlement services for securities from 44 markets in 53 currencies. Euroclear Bank services the largest global banks with triparty repo arrangements to secure their interbank funding. Bank of New York Mellon SA/NV is the European subsidiary of the global custodial bank (designated a global systemically important institution). The institution provides clearing and collateral management, asset servicing, and treasury management to institutional clients, with the Belgian subsidiary acting as a processing center for the group’s global custody activities outside the U.S. The NBB coordinates the oversight of SWIFT, which plays a vital role in the day-to-day operational conduct of financial transactions. Although SWIFT is neither a payment system nor a settlement system, a large number of systemically important firms depend on SWIFT for their daily messaging, so that SWIFT itself is of systemic importance.

uA01fig06

Selected European Countries: Domestic Credit

(In percent of GDP)

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Sources: International Financial Statistics, IMF, and Economic Intellengience Unit.

Network Analysis of Spillover Risk for the Belgian Banking System1

Network analysis was conducted to identify financial systems of systemic importance to Belgium, as well as the main financial systems that could be affected by spillovers from Belgium. The methodology assumes the manifestation of extreme tail risks (i.e., the failure of the banking system of a country) and illustrates the relative importance of systemic linkages across countries through the global banking network.2 Spillovers are modeled by (i) estimating the “domino effects” triggered by the default of a banking system’s interbank obligations (credit shock); (ii) looking at the effects of a credit-plus-funding event, where the default of a banking system also leads to a liquidity squeeze for those countries exposed to funding from the defaulting system (i.e., the credit shock is compounded by a funding shock and associated fire sale losses).

uA01fig07

Spillovers to Belgium’s Banking System: Credit and Funding Shock

(impairment as percent of regulatory capital)

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Sources: IMF staff calculations

The analysis is based on bilateral exposures of banking systems across 18 countries and their capital level data at end-September 2012. A consistent definition of capital (total regulatory capital) is used for all countries. The simulation presented in the analysis refers only to interbank exposures. Key assumptions are that (i) for the credit shock, a loss given default of 100 percent is assumed on interbank exposures based on the difficulty of recovering assets at the time of bank failures, and (ii) for the funding shock, a withdrawal of 35 percent is assumed on interbank funding and a haircut of 50 percent is assumed on forced asset sales. Overall, the results are sensitive to these shock assumptions; however the relative importance of systemic countries remains the same.

uA01fig08

Spillovers from Belgium’s Banking System: Credit and Funding Shock

(impairment as percent of regulatory capital)

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: IMF staff calculations

The United States and the United Kingdom represent, by far, the biggest potential risk to the Belgian banking system, albeit indirectly, followed closely by France. The impact of a credit-only or credit and funding shock through the interbank markets of these three countries would be extreme, resulting in a complete or near complete depletion of regulatory capital. In addition, the Belgian banking system is also particularly vulnerable to credit and funding shocks from Germany and the Netherlands. The system is much less exposed to extreme tail shocks from other major economies, which would generate impairments of less than 50 percent of total capital even if those banking systems were to fail.

An extreme credit and funding shock in Belgium would affect Luxembourg, the Netherlands, and the Czech Republic most. The impact of a credit only or credit and funding shock from Belgium, propagated through the interbank markets, would be important, although confined to less than 25 percent of regulatory capital in these countries. The impact on other financial systems considered in this analysis would be relatively minor.

1 Prepared by Serkan Arslanalp and Oana Nedelescu.2 Marco Espinosa-Vega and Juan Solé, 2010, “Cross-border Financial Surveillance: A Network Perspective,” IMF Working Paper 10/105 (Washington: International Monetary Fund). See also Global Financial Stability Report, Chapter 2, “Assessing the Systemic Implications of Financial Linkages,” April 2009 (Washington: International Monetary Fund) for an illustration of analysis and description of simulation algorithm.

22. Several Belgian insurers have not fully recovered from the global financial crisis and continue to be challenged by economic uncertainty in Europe. Government support was extended to a few insurers to maintain the stability of the industry in 2008. The industry’s solvency position has continued to weaken, however, and prospects for recovery are dampened by the legacy of high guaranteed returns. Insurers hold high levels of government bonds (€104 billion, or 40 percent of total assets, of which €60 billion were in Belgian government bonds).

23. The financial condition of insurance firms has generally been sound but pressure points have emerged (Figure 7). The solvency margins computed under the current Solvency I regime tend to underestimate risks and there is a serious concern that solvency risks have built up both in Belgium and in Europe overall. A prolonged low-interest rate environment would adversely impact the earnings and claims-paying capacity of the sector over the medium term. Low interest rates heighten the re-investment risk for new funds generated from premiums, but also increase the present value of future claims, which could give rise to critical asset-liability mismatches and reserve deficiencies. Insurers have been gradually shifting towards contracts that offer lower guarantees, but the average guaranteed rate of return still stood at 3.25 percent at end–2010.10 The demand for life policies has been eroded by households’ preference for liquidity and is reinforced by tax treatment favoring savings deposits in banks. Nonlife insurers have taken measures to improve their underwriting discipline, but remain susceptible to investment risks.

Figure 7.
Figure 7.

Belgium: Insurance Financial Soundness Indicators

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: NBB and IMF staff calculations. Box plots include the mean (red dot) and the 25th and 75th percentiles (grey box, with the change of shade indicating the median). Bar charts in the bottom panel show medians.

24. Insurers also face liquidity risks, as experienced in the crisis. A weakening of confidence can lead to surrender of policies and in the case of Belgian insurers there are few penalties for early surrender. The move to lower guaranteed rates also increases the risks of surrenders by policyholders. While intragroup transactions can assist in managing risk and liquidity to the benefit of all entities within group structures, there are risks. Liquidity management through asset swaps and transfers or through liquidity transformation transactions has boosted return for insurers but may underestimate the liquidity needs of insurers in the longer term.

C. Bank Stress Testing

25. The financial sector is still susceptible to several risks (Appendix IV):

  • A new or prolonged recession in the euro area and persistently low interest rates. The growth outlook is uncertain, partly due to near-term fiscal tightening in a few advanced economies. The effect of bank deleveraging and fiscal consolidation could be larger than envisaged. Growth concerns keep interest rates low and further erode the risk bearing capacity of banks and insurers.

  • Renewed political uncertainty impact on market confidence. A re-intensification of market concern regarding adverse loops between banks and sovereign stress would widen sovereign and bank spreads, increase bank funding costs, and weaken external demand.

  • A sharp downturn in the housing market. Model-based estimates of misalignment suggest that home prices are 5–20 percent above their equilibrium levels, leaving banks vulnerable to losses.

26. Stress testing was used to assess banking system’s resilience in the face of further shocks.11 The stress tests considered the sector’s vulnerability to a renewed economic contraction, including a substantial rise in unemployment, a further depreciation of real estate prices, and rising funding pressures. The impact of rising sovereign risk, upcoming regulatory reforms, behavioral changes of banks, and the ongoing implementation of some restructuring plans were also examined.

Solvency risk

27. Solvency stress tests were based on mid-2012 data. The two-pronged approach covered more than 90 percent of total assets of the domestic banking sector, excluding foreign branches, on a solo and consolidated basis (Table 5.1, Appendix V):

  • A bottom-up balance sheet stress tests conducted by banks themselves in collaboration with the FSAP team and NBB staff based on prudential data following the guidelines provided by the FSAP team (“BU exercise”); and

  • A cross-validation of results by a top-down balance sheet stress test in collaboration with NBB staff based on the FSAP team’s assumptions about macrofinancial linkages (“TD exercise”).

28. Two adverse macro scenarios were used—a severe and short-term “double-dip recession” and a protracted “slow-growth scenario” (Figure 8). The first scenario comprises a shock of two standard deviations of real GDP growth from the IMF-projected baseline over the first two years with a subsequent recovery to baseline growth path during the final three years of the five-year forecast together with a flattening of sovereign yield curve.12 In the latter scenario, a similar cumulative deviation from the baseline is distributed over the entire forecast horizon as a result of assumed continued shocks to demand, amid rising inflation expectations and a concomitant parallel shift in the sovereign yield curve. The severity of these shocks is consistent with FSAP stress testing exercises in other European countries.

Figure 8.
Figure 8.

Belgium: Macroeconomic Assumptions Under Different Stress Test Scenarios

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Sources: National Bank of Belgium; and IMF staff estimates.
uA01fig09

Stress Test Results—CET1 Capital Hurdle Rate

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

29. The stress test results suggest a significant erosion of the capital base under stress, which is concentrated in a few institutions (Figure 9).13 Under the BU approach, the Common Equity Tier 1 (CET1) capital ratio declines by 4.2 percentage points and 3.5 percentage points under the double-dip and slow-growth scenarios, respectively, while remaining on aggregate above the relevant hurdle rates throughout the forecast horizon. The findings are similar for the TD exercise.14 Given solid capital buffers, only a few institutions fall below the capital hurdle rate, by an amount that could reach up to 3.6 percent of the aggregate CET1 for the sector.

Figure 9.
Figure 9.

Belgium: Solvency Stress Test Results—CET1 Hurdle Rate

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: NBB and IMF staff estimates. The sample of banks included in the stress test differs between the two approaches. The top-down exercise includes 42 banks on solo basis (Groups 1-4), representing 93 percent of the banking sector (excluding foreign branches), whereas the bottom-up exercise comprises the six largest banks (Group 1) on a consolidated basis, covering 90 percent of the sector. Box plots include the mean (yellow dot), the 25th and 75th percentiles (grey box, with the change of shade indicating the median), and the 10th and 90th percentiles (whiskers). The red line indicates the Basel III hurdle rate.

30. The results indicate a high sensitivity of banks to higher loan impairments, valuation losses from rising sovereign risk, and the impact of regulatory changes on risk-weighted assets (RWAs) and capital. The impact of these risk drivers on solvency is mitigated by historically robust credit conditions and significant balance sheet reduction allowing banks to maintain existing provisioning levels. Some larger banks in the system appear more affected even under baseline conditions. Uncertainty about the valuation of some portfolios (such as legacy assets acquired as a result of past activities abroad) could negatively affect banks’ internal projections of future performance under stress. Although the macroeconomic scenarios embodied a relatively moderate shock to residential and commercial real estate prices, single factor sensitivity tests confirmed banks’ vulnerability to a more severe decline.15 Some banks also maintain significant exposures to hard-to-value credit portfolios and stress tests do not fully capture this vulnerability.

31. Sovereign risk is material and significantly affects overall results. Market-implied valuation haircuts of more than five percent on Belgium, and more than 10 percent on higher yield euro area sovereigns, were applied to all on- and off-balance sheet exposures at mid-2012 prices. This factor reduces CET1 capital in the system by more than €4.6 billion or 10.4 percent under the adverse scenarios.16

uA01fig10

Solvency Stress Test: Risk Drivers

(In percentage points, cumulative changes in CET1 over 2012-2017)

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Sources: NBB and IMF staff calculations.

Liquidity risk

32. Most large banks have considerably improved their liquidity position over the last four years (Figure 10). Funding structures have become more favorable overall, in spite of a rising asset encumbrance relative to the amount of short-term liabilities. Banks have reduced wholesale funding, but remain dependent on market-sensitive nonbank institutional and corporate deposits totaling about one-third of the deposit base. The revised calibration of the LCR announced in January 2013 resulted in significant improvement of banks’ ratios in comparison to the original calibration.17 Most banks have access to sufficient stable sources of funding due to a large deposit base, with the average Net Stable Funding Ratio (NSFR) at 112 percent. Although only four of the six largest banks pass the test, all exhibit NSFR ratios higher than 95 percent—just five percentage points shy of the 100 percent pass mark.18

Figure 10.
Figure 10.

Belgium: Liquidity Indicators and Stress Test Results

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

Source: NBB, EBA, and IMF staff calculations. Box plots include the mean (yellow dot), the 25th and 75th percentiles (grey box, with the change of shade indicating the median), and the 10th and 90th percentiles (whiskers). Ratios are capped at 400 percent, both for the calculation of the averages and in the charts.

33. The stress test results within the national liquidity framework (NBB Liquidity Ratio) show that most banks are able to support a shock to cash outflows (Figure 9). The regulatory liquidity stress test ratio suggests that Belgian banks have enough liquid assets to withstand a week-long net cash outflows (on a solo and consolidated basis), with the average NBB liquidity ratio of 263 percent (against a norm of 100 percent). Extending the risk horizon to one month shows that overall liquidity shortage would remain concentrated in a very few institutions. The liquidity shortfall remains small at 0.5 percent of eligible assets. The withdrawal of contingent intragroup funding and higher liquidity risk from a moderate increase in sovereign risk do not change the results markedly. However, intragroup funding by larger institutions to their foreign parents remains significant—despite the introduction of a 100 percent of own funds limit in 2011—and places a premium on sufficient liquidity buffers at Belgian subsidiaries.

Policy recommendations

34. The stress test results point to the need for a thematic review of identified vulnerabilities and supervisory follow-up. The authorities should continue to carefully assess the impact of further spread compression, interest rate shocks, and the gradual deterioration of credit quality at some banks; and expedite the consolidation process to restore confidence in the domestic banking sector. Banks’ capital buffers should be further strengthened with a view of forthcoming Basel III requirements. For liquidity risk, the close alignment of the Basel III LCR and the Belgian liquidity ratio suggests that the current liquidity regime should be preserved (and liquidity buffers maintained) before the LCR is fully adopted and phased in at the European level in 2018.

35. Going forward, the authorities should enhance and embed the stress testing in the macroprudential policy and surveillance framework. The systematic integration of both TD and BU stress testing into the supervisory framework will help inform the assessment of the financial soundness of individual firms and encourage greater involvement of supervisors in financial stability analysis. Besides the risks discussed above, other sources of vulnerability also require more granular prudential information and supervisory review, such as intragroup transactions within conglomerates under severe stress conditions or vulnerabilities from real estate overvaluation.

D. Insurance Stress Testing

36. The insurance stress testing assessed the capital adequacy under different shocks to single risk factors affecting both investment and underwriting performance. In the insurance sector, macro-financial linkages often vary by different business lines as well as technical factors influencing the pricing and reserving of insurance products. Thus, the stress test comprised single factor shocks to a selected set of risk drivers that were directly inferred—or reasonably sensitive—to the general economic scenarios examined in the banking sector stress test. The impact of general conditions affecting risk factors, such as rising sovereign risk and upcoming regulatory reforms, was also examined to reflect future transition from the current Solvency I to Solvency II standard.

Solvency risk

37. Stress testing of insurer solvency was undertaken as a bottom-up exercise using a combination of single factor shocks affecting each capital component. The stress test covered the six largest insurers (Ageas, AXA Belgium, Belfius Insurance, Ethias, KBC, P&V - Vivium Group), comprising more than 70 percent of the insurance sector, and was conducted by insurers themselves in collaboration with the FSAP team and NBB staff. The NBB defined market developments under two adverse scenarios (mild and severe) together with a mass lapse event in the life business and the realization of the largest probable maximum losses (PML) on a single (man-made or natural) catastrophic tail event. Firms calculated the overall capital impact by aggregating the individual impact of these shocks, using a correlation approach. The own funds available after the scenarios occurring are then compared with the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR), subject to eligibility conditions.19

38. The impact of individual stress scenarios was calculated for Solvency I, solvency standard in the latest EU quantitative impact study (QIS 5), and a full “market-consistent valuation” (MCV) method. Even though the current regulatory regime is based on Solvency I, the absence of risk-based elements makes it unsuitable for the quantification of the capital impact of economic shocks. Equally, elements (i.e., the illiquidity premium) of QIS 5 dampen by construction the economic impacts of spread and interest rate movements. The MCV overcomes these valuation concerns and allows for a more realistic capital assessment.

39. Insurers’ capital levels are sufficient under the current regulatory regime but vulnerabilities are apparent when a more risk-based solvency framework is applied. With the exception of one firm, all insurers exceeded the Solvency I hurdle under both the mild and severe adverse scenarios. The results suggest that hidden reserves (i.e., net unrealized capital gains or losses in excess of unrealized capital gains included in the statutory solvency margin), were sufficient to buffer the impact of shocks to market risks as well as an escalation of underwriting risks. While a few insurers exhibit sufficient capital buffers when measured using the more risk-sensitive valuation methods, most firms are likely to experience a significant decline in solvency ratios in response to rising asset-liability mismatches, higher credit spreads, and a general increase of sovereign risk. Assuming full market consistent valuation, the sector was severely undercapitalized under both stress scenarios, calling into question some business models if the low interest rate environment persists over the medium term. It is important to note that the stress test was much stricter than the valuation being discussed currently for future Solvency II regime in the EU since it did not include any mitigating factors (i.e., illiquidity premiums, swap rates or matching adjustments) and was based on a pure risk-free discount rate.

uA01fig11

Insurance Stress Test Results

Citation: IMF Staff Country Reports 2013, 124; 10.5089/9781484362877.002.A001

40. The solvency position of insurers is significantly impacted by sovereign risk. The market-implied valuation haircuts used for the banking sector stress test have also been applied to all direct and indirect exposures of insurers at mid-2012 prices. These decrease the QIS-5 solvency ratio with weighted solvency components (SCRs) by 45 and 54 percentage points under the mild and severe adverse scenarios, respectively (and between 30 and 46 percentage points without using a correlation approach for aggregating risk factors).

Liquidity risk

41. Liquidity risk could further amplify solvency pressures on insurers within conglomerate structures under a more risk-sensitive valuation standard. A rise in credit spreads in tandem with greater market uncertainty will put a premium on the asset liquidity of insurers’ investment portfolio. In particular, insurers that are part of a conglomerate might find it expedient to transfer their liquid assets in exchange for illiquid ones from the banking operations potentially increasing the expected yield of their assets. However, the stress test shows limited tolerance for liquidity risk in particular for those insurers that experience a significant capital shortfall in the baseline and adverse scenarios.

Policy recommendations

42. Authorities are encouraged to apply an economic balance sheet approach in assessing the solvency position of insurers under stress on a regular basis. The stress tests can inform a thematic review of key individual and system-wide vulnerabilities of insurers to specific events and risk factors and help integrate stress testing with the prudential supervision of insurers. Such an analysis, if based on a MCV standard, would allow the NBB to determine the extent to which dampeners used in Solvency II could distort the picture of the actual solvency position of insurers.20

43. Developing a medium-term strategy for consolidation in the insurance sector is warranted. For insurers that are overly exposed to adverse but plausible shocks, contingency plans should be prepared by both insurance companies and the authorities. For groups and conglomerates, increasing focus should be placed on potential secondary effects in situations where scenarios cause financial strain, i.e. the impact of rating downgrades and spillover and contagion effects between different legal entities within groups and conglomerates via intragroup transactions.

Financial Stability Framework

44. In the aftermath of the crisis, the regulatory and supervisory structure has been reorganized and the authorities took a number of steps to strengthen the oversight framework. The new architecture, effective since April 2011, replaced the integrated regulator (the Commission Bancaire, Financière et des Assurances, CBFA) and allocated the prudential supervision of financial institutions to the NBB and the responsibility for ensuring market conduct and consumer protection to the FSMA.21 All bank and prudential insurance supervision staff moved to the NBB. The primary driver of the new structure was to leverage the synergies between the NBB’s responsibility to safeguard financial stability and prudential supervision, allowing the new FSMA to focus on market regulation and consumer protection.

45. The new institutional architecture remains a work in progress. Formalization of the arrangements for cooperation and coordination between the NBB and the FSMA is ongoing. Reliance on a highly detailed set of provisions in a Royal Decree is no substitute for guidance governing cooperation and coordination at all levels, including assigning responsibilities for communication and coordination within the institutions, defining objectives and areas of mutual concern, and developing a set of objectives and tracking mechanisms for technical staff on information sharing and joint engagements. To this end, a broad MOU on cooperation between NBB and FSMA came into effect in March 2013, supplementing already existing MOU in relation to Financial Markets Infrastructure.22 Implementation of this MOU will over time improve the effectiveness of the new regulatory architecture.

46. Financial stability risks underscore the need for more intensive and intrusive supervision. Promoting a supervisory culture in which the “will to act” is both expected and rewarded will be key to managing the challenges still present in the rapidly transforming system.

47. Belgium is in the process of designing a comprehensive macroprudential policy framework. A comprehensive methodology was formulated in 2011 to identify domestic systemically important financial institutions (banks, insurance companies, and holding companies). The NBB can impose supplementary reporting and prudential requirements, the operational aspects of which are yet to be clarified together with a broader application of RRPs. The NBB and FSMA have broad instruments to monitor and address the cyclical part of the systemic risk.

48. The NBB is best placed to become the designated macroprudential authority. The authorities are still debating the optimal structure and governance for macroprudential oversight. While there is no “one size fits all” model for the macroprudential construct, there is growing recognition that the macroprudential authority should have willingness to act in a timely manner while having sufficient powers to identify, assess, and mitigate systemic risks.23 Given its broad supervisory mandate, its statutory financial stability objective, and extensive regulatory powers, the NBB is best placed to become the designated macroprudential authority.24 Ongoing EU-wide policy discussions and the launch of the SSM will have an impact on the toolkit ultimately available to national authorities, which should ideally be able to effectively tackle domestic systemic risks. Adequate accountability mechanism would need to be designed while periodic consultations should take place with other relevant authorities, such as the FSMA and the MOF, to ensure a holistic view and effective coordination across policies to address systemic risks.

A. Banking Supervision

49. Belgium has a high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). This level of compliance, achieved in a challenging environment, was facilitated by structural changes and regulatory reforms, made in response to the financial crisis, which introduced new supervisory powers and re-oriented supervisory practices.

50. The NBB deploys high quality risk-based supervisory practices—which it is building upon through well conceived initiatives and reforms—but baseline supervisory intensity and allocation of resources warrant improvement. Some enhancements to risk oversight, such as an annual risk review, are already in place and are being underpinned by a focused action plan that will improve analytical processes and substance. The NBB should use its new tools to identify the minimum adequate level of supervisory attention for each institution according to that institution’s risk profile. Further, the NBB should proceed with planned enhancements to peer group cluster analysis, which will help develop a baseline program to establish minimum supervisory interaction with a firm while improving risk-focused allocation of resources.

51. The large exposure regime should be strengthened. At present national regulation permits smaller banks to extend exposures up to a limit of 100 percent of own funds, if the exposure itself is €150 million or less. As a result, smaller banks may become vulnerable to concentration risk. There is also no requirement for the banks’ senior management or board to take the credit decision when an exposure exceeds a certain limit. This deficiency should be remedied as oversight or direct approval by the Board promotes a group-wide view of risk important in view of prevailing conglomerate structures. The NBB should execute plans to enhance governance requirements for groups, by stating more explicitly what is expected of the parent company in respect of coordinating and controlling the group in a holistic way.

52. The NBB is actively engaged with counterparts and participates in supervisory colleges for its systemically important financial institutions. The supervisor has undertaken joint projects, joint risk assessments, and joint decision making with key foreign counterparts and is using the supervisory college environment to focus on risk management and adequate distribution of capital within groups.

53. Direct engagement by supervisors with the bank boards should be enhanced. The regulations require boards to approve risk management strategies and the ICAAP on at least an annual basis. While the NBB assesses the board, it should engage more directly with the full board to challenge board members’ appreciation of the risks, the implementation of risk management, and adequacy of capital, and to ensure the board is discharging its role effectively. This type of frequent and close engagement will enhance the NBB’s oversight of risk management, especially in areas that are often less transparent in a large group. Examples include intragroup exposures and related party transactions, which are more complex in a large group and where conflicts of interest need to be closely managed by the board.

54. The authorities are reviewing the desirability and feasibility of introducing structural measures to limit bank activities.25 In response to a request from the MOF, the NBB has presented its provisional views on potential measures that seek to improve the stability of the Belgian financial system and improve bank resolvability The NBB is tasked with finalizing its proposals before the 2013 summer break. The NBB has also been invited to formulate for the beginning of May 2013 proposals for interim measures in order to limit the exposure of depositors to the risks resulting from trading activities performed by financial institutions for their own account.26 In parallel, the authorities should continue the comprehensive evaluation of the business models of important banks and expand the RRP pilot project conducted in 2012, which would usefully inform any further decisions to improve the sustainability and resolvability of financial institutions.

55. Maintaining and improving national capacity to monitor and safeguard financial stability will remain important even after the launch of the single supervisory mechanism (SSM) in the euro area (Box 3). The NBB will continue to be responsible for supervision in a transition phase. While the activation of the SSM and other banking union building blocks should result in a significant transfer of authority and responsibility to the European Central Bank (ECB), operational supervisory responsibilities at a national level could remain significant for the time being. Supervisory functions that will remain at the NBB will need adequate support, and so will the decision making on banking matters for institutions supervised by the ECB. The importance of the conglomerate model in Belgium will necessitate very close contact between the ECB and NBB in operational matters and in decision making as insurance and market conduct supervision will remain at the national level. It thus remains important to press ahead with further improvements to the supervisory practices and framework in Belgium.

The Impact of the Banking Union on Belgium

A draft agreement announced by the EU Council on December 14, 2012 on the adoption of the SSM represents a major step toward a banking union in the euro area and will have a significant impact on the supervisory landscape in Belgium. As currently foreseen, the SSM will come into effect March 2014 (or one year after the legislation enters into force, whichever is later). The ECB would have authority to supervise all banks in participating countries, but for the moment plans to exercise direct supervision only over “significant” institutions for the EU, a member state, or in terms of cross-border activities, or to those institutions requiring ESM financial assistance.1 Preliminary estimates by the authorities indicate that 90 of the 106 Belgian credit institutions, representing over 95 percent of the banking system’s assets, will be supervised by the ECB, with operational details for national supervisors yet to be determined. Both the ECB and national authorities will be able to make use of macro-prudential instruments.

Belgian authorities and market participants see important benefits stemming from the SSM. The SSM could facilitate a more integrated supervisory oversight of banks operating in several countries, provide a level field for participating institutions, and reduce home biases and excessive ring fencing by national regulators. Together with other building blocks of the banking union, notably a common resolution framework, it could eventually address the negative feedback loop between sovereign and bank risks.

Important tasks lie ahead in the implementation of the SSM:

  • Much remains to be done for the SSM to become effective. The draft legislation is yet to be finalized; there is a need for further clarification of the respective roles for the ECB and national authorities, both in the transition period and in the future steady state; while the supervisory capacity at the ECB is yet to be created.

  • Given the importance of conglomerates and the bancassurance model in Belgium, the current synergies in the supervision of the banks, insurance, and other nonbank financial activities could be diluted. In the new setup, it will be important to ensure close coordination and linkages between the supervisory functions that will remain at the NBB (insurance and non-SSM banks) and the ECB bank supervision.

  • Home-host relations will be affected, in the Belgian context, raising challenges for organizing a dialogue with non-EU countries and non-euro area countries that opt to remain outside the SSM. Ensuring effective coordination with hosts outside the SSM and their meaningful participation in the decision-making processes will be important.

  • The degree of success in creating a common deposit insurance system and adopting a single resolution mechanism, with appropriate backstops, is likely to determine the extent to which key objectives of the banking union are achieved and the bank-sovereign feedback loop is weakened.

1Banks are considered significant if (i) their assets exceed €30 billion, (ii) the ratio of total assets to GDP of the home member state exceeds 20 percent, or (iii) national competent authorities consider it significant.

B. Insurance Supervision

56. The authorities have made significant progress since the last FSAP, but scope remains for further strengthening the regulation and supervision of the insurance sector. The authorities have implemented strengthened solvency requirements for life insurers with exposures to legacy portfolios and enhanced the risk management requirements for insurers. The NBB has improved its supervisory framework, integrating vertical analyses of individual insurers with horizontal reviews of the insurance sector, leveraging its macroeconomic competencies. Going forward, a regular review of the practical implementation of the new institutional structure is needed to ensure that the overall supervisory objectives for the insurance sector are effectively achieved. A more principles-based approach in delegating legal authority to the NBB to issue enforceable rules would facilitate supervisory discretion within the parameters set by the law. The NBB should be empowered to take immediate recovery measures notwithstanding an appeal by an insurer. Further, the NBB should articulate clear policies to deal with potential conflicts in supervisory objectives, e.g., between financial stability and prudential safeguards for policyholders.

57. The updated regulatory framework has a relatively high level of observance with the Insurance Core Principles (ICPs), although there are gaps. The NBB’s decision to enhance the current solvency regime ahead of the implementation of Solvency II in the EU is welcome and should contribute to a more robust evaluation of insurers’ risks. Further improvements in the NBB’s risk-based supervision could be achieved through the formulation of an appropriate baseline supervisory program; internal policies for inspecting functions outsourced by insurers; and review of the effectiveness of contributions of external auditors and the role of actuaries. It is critical that the NBB is adequately resourced to achieve the appropriate supervisory intensity and effectiveness.

58. The authorities are advised to review current conduct-of-business regulation and supervision. There is scope to raise the level of professionalism of intermediaries to deter unhealthy competition arising from more than 17,000 of them. The FSMA proposal to adapt the EU Markets in Financial Instruments Directive 2 to insurers and insurance intermediaries, is welcome. The FSMA should be empowered to establish enforceable rules on handling of claims and proper policy servicing by insurers; group market conduct requirements; and combating and reporting insurance fraud by intermediaries. The FSMA needs to strategize a risk-based approach to deal with the large population of regulated entities and ensure adequate resources for its supervisory strategy.

C. Conglomerates Supervision27

59. The Belgian authorities have been prudent in their supervisory approach for financial conglomerates (FCs), within the constraints of the EU-wide framework. To the extent possible, the NBB and its supervisory predecessor chose to apply the stricter regulatory regimes allowed under the EU legislation (i.e., consolidated banking supervision) in order to preserve stronger supervisory powers and tools over FCs. However, the Belgian framework also incorporates the shortcomings of the EU framework, including limited supervisory powers and tools applicable to FCs headed by mixed financial holding companies (MFHCs), as well as weaknesses in the conglomerate-wide capital and liquidity measurement and requirements. A planned revision of the relevant EU directives would address some of the existing gaps in supervisory powers and tools at the level of MFHCs, while other changes will depend on further EU-wide changes.

60. The NBB should put in place a more comprehensive approach to conglomerate supervision. Individualized sectoral strategies and programs currently in place may hide conglomerate-wide specific risks such as contagion and conflict of interest, and could misguide the overall aggregation and evaluation of risks. A more comprehensive and consistent approach is needed to detect multiple leveraging of capital, monitor intragroup transactions and exposures, and group-wide concentrations. The development of a uniform set of expectations regarding all FCs, elaborated internally within the NBB as a baseline for supervision of this type of group, is recommended, together with an improvement in the risk scorecards for the insurance and the securities sectors will enhance the assessment of cross-sectoral risks.

61. More active supervisory involvement is necessary to complement self-reporting and auditors’ checks. While the governance guidelines applicable to FCs are relatively comprehensive, the NBB should ensure that they are consistently applied to address conflicts of interests within the group and should conduct more validation and back testing to strengthen integrity within the self-reporting and audit check mechanisms. The overall assessment of the internal control and risk management would be also enhanced though a better articulation of the supervisory processes, such as the internal capital adequacy assessment reporting by the group, more frequent on-site reviews, and discussions with the board and management, as well as with internal and external auditors. This would promote greater use of available supervisory data for ongoing supervision, benchmarking across conglomerates, and forward-looking cross sectoral risk assessments, including identification of build-up of risks at an early stage. Formalizing cooperation between the NBB and FSMA will enhance effectiveness of conglomerate supervision.

D. Securities Markets and Regulation28

62. A full International Organization of Securities Commission (IOSCO) Principles assessment was not undertaken. The mission focused instead on an evaluation of product regulation, the adequacy of the new regulatory structure and compliance with the new IOSCO principles, including systemic risk monitoring. The FSMA’s future work should build on its existing work in relation to investor education and protection initiatives. It should give priority to resourcing the execution of its newly designed programs.

63. Formal structures are needed to embed important processes relating to identifying and managing emerging and systemic risks. The FSMA is building its skills and competency in monitoring and analyzing market developments in Belgium and developments regionally and globally which affect Belgium. It should ensure it builds on these competencies to drive timely responses to emerging and systemic risks. The FSMA will benefit from developing formal structures around risk identification and collaboration with the NBB. An Emerging Risk Committee should be established with formal collaboration protocols with the NBB.

E. Soundness and Oversight of Market Infrastructures29

64. Euroclear Bank was the subject of a full Committee on Payment and Settlement Systems (CPSS)/IOSCO Principles for Financial Market Infrastructures assessment in the context of the EU FSAP.30 The EU FSAP assessment revealed that important risk measures have been taken to reduce systemic risk, but some of them need further improvement to fully observe these recently adopted international standards. Euroclear Bank has recently substantially improved the quality of its collateral and liquidity management frameworks. In anticipation of the emerging international regulatory standards and frameworks on recovery and resolution of FMIs, Euroclear Bank has developed recovery plans and plans for the orderly winding down of its operations. It should take measures to be operationally ready for their implementation. Operational risk is well-controlled. Contingency plans and back-up facilities are in place to allow for timely recovery of operations and completion of the settlement process. Going forward, it should upgrade risk management policies and practices to reduce any potential unsecured credit exposures to participants and other linked securities settlement systems.

65. Euroclear Bank is subject to regulation, supervision, and oversight of the NBB and FSMA, but cooperation with the Luxembourg authorities should be improved. The legal framework provides the Belgian authorities with sufficient powers to obtain timely information and induce change. However, as Euroclear Bank offers similar settlement and banking services to the Luxembourg based Clearstream Bank Luxembourg, closer cooperation with the Luxembourg authorities is needed to ensure a level playing field in the implementation of risk management measures in line with the CPSS/IOSCO principles. Such cooperation already exists in relation to the interoperability link (the “bridge”). Given the importance of these FMIs to global financial stability, reinforcing and broadening of the scope of this cooperation, with the involvement of the ECB, would allow the Belgian and Luxembourg authorities to coordinate their recommendations and to seek their parallel implementation in both entities. Upon the implementation of the SSM, both Clearstream Bank and Euroclear Bank will come under the ECB umbrella, potentially leveling the playing field.

66. The Belgian, French, and Dutch authorities cooperate effectively on national securities depositories. Their national securities depositories share a common settlement platform provided by the Euroclear Group, and are subject to regulation, supervision and oversight by their respective national authorities. Crisis management frameworks are in place and are regularly tested and updated.

F. Crisis Management and Safety Nets31

67. The Belgian institutional setup for crisis management is largely appropriate, but adoption of explicit coordination arrangements would be beneficial. The authorities are encouraged to strengthen the mandate of the NBB as the resolution authority, building on the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions.32 While the new supervisory architecture was designed to avoid regulatory arbitrage and a duplication of tasks between authorities, consideration should be given to reviving the crisis preparation and management MOUs in place before the institutional changes were introduced. The establishment of a cross-institutional Coordination Group would offer a suitable platform for joint risk assessments and scenario analyses, coordination of crisis management simulations related to operational process and enhanced policy coordination needed in case of financial distress. The latter is particularly important in situations where the need for public support cannot be a priori excluded.

68. Progress has been made in the area of recovery planning. Authorities are requesting recovery plans from the domestic systemically important banks and systemically relevant financial market infrastructures. Going forward, the development of resolution plans should ensue, where relevant in cooperation with international peers, while a legal requirement needs to be created for the formulation of RRPs for all firms that are of systemic importance, including for insurers.

69. The framework for orderly resolution has been enhanced, but weaknesses remain. The NBB can utilize a range of measures to intervene proportionally should a bank breach the law or prudential regulations. The emergency liquidity assistance framework functioned adequately, while the government was able to support banking system via guarantees and public recapitalization. While appropriate at the height of the crisis, the introduction of better options for loss allocation could be now considered, such as ‘bail-in’ tools foreseen by the draft EU Bank Recovery and Resolution Directive. A procedure to transfer assets and liabilities of, or shares in, systemically important firms (introduced in 2010) should be revised to reduce the uncertainty and mitigate potential stability risks entailed in the ex ante judicial review. In addition, it would be desirable to broaden the scope of such powers to holding companies and nonsystemic situations, with the latter allowing for more cost effective resolution strategies. Finally, powers of special inspectors should be strengthened, with the aim to either restore the institution or prepare it for orderly liquidation.

70. The liquidation framework should allow for rapid transfer of critical operations. Bankruptcy proceedings are based on corporate bankruptcy procedures and appear ill suited to address the specific features of credit institutions. The liquidation processes should be enhanced to provide for the rapid transfer of critical operations (e.g. payments, custody, clearing and settlement systems) to a third party, under the oversight of the resolution authority, while the remainder of the estate is dealt with in accordance with the general regime.

71. The deposit guarantee scheme needs to be revamped. Protection is provided by a two-tier system comprised of the Protection Fund for Deposits and Financial Instruments (established as an autonomous public institution with legal personality) and the Special Protection Fund for Deposits and Life Insurance (operating under the Belgian Treasury). The creation of a segregated fund, financed via ex ante industry contributions and with robust arrangements for back-up funding, would increase transparency and allow for prompt and cost-effective payouts. The current resources of both existing funds should be folded into the new scheme. A sufficiently ambitious minimum target fund size should be set, eventually allowing the fund to absorb a simultaneous default of multiple midsized institutions. Going forward, authorities are encouraged to exclude shares issued by cooperative corporations from future coverage under the deposit guarantee scheme and to consider the introduction of depositor preference. The recalibrated deposit insurance scheme should be allowed to contribute funding to resolution actions, up to the amount of its distributions in case of a deposit payout.

G. Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)

72. In line with the relevant IMF Board decisions, a full reassessment of Belgium’s AML/CFT framework is required. Belgium was last assessed in 2005 by the Financial Action Task Force (FATF), a new assessment by the FATF is tentatively scheduled in September 2014. Although outside the 18-month timeframe, under the circumstances the planned FATF assessment is acceptable for the purposes of the current FSAP.33 The 2005 assessment found that, overall, Belgium’s AML/CFT framework largely complied with the standard. This was, in particular, the case with respect to the criminalization of money-laundering and terrorist financing. Shortcomings were nevertheless identified, notably with respect to the supervision of nonbank financial institutions, transparency of beneficial ownership and control of legal entities, regulation of designated nonfinancial businesses and professions, and to the freezing of terrorist assets. Since 2005, it appears that the authorities took steps to address the shortcomings identified in the assessment report. As reported by Belgium to the FATF, these steps include measures to reinforce the framework for the freezing of terrorist assets (2006), and the adoption of a new AML/CFT law (2010).

73. The NBB’s current practice in integrating AML/CFT processes into overall supervisory process was examined in the course of the BCP assessment. The mission was unable to conclude that AML/CFT compliance is sufficiently embedded in the supervisory framework. Specifically, it is unclear how monitoring of compliance is undertaken for those smaller banks that are subject to on-site inspections only infrequently.

Basel Core Principles for Effective Banking Supervision

A. Background

1. The Belgian financial system is relatively large, concentrated, and interconnected, with solid capital buffers on aggregate. Post 2008, an initial deleveraging significantly reduced the size of the system, with a second, slower wave of deleveraging, currently underway. Four dominant banking groups represent almost ¾ of consolidated system assets. Assets of foreign-owned banks account for over half of the sector. The links between banks and the Belgian sovereign have intensified due to the crisis, with total exposure of the banking sector to the federal government at 10 percent of banking sector assets in mid-2012. Tier 1 capital ratio has risen from 11.6 percent of risk-weighted assets in 2008 to 14.8 percent in mid 2012 on aggregate, comparing favorably to other major international banking systems.

2. Domestic economic challenges and sovereign risk perceptions remain sources of continued uncertainty as the banking sector consolidates. The outlook for economic growth remains weak. Banks have struggled for profitability since the crisis, and structural costs remain high. A wide and stable deposit base has limited rollover risks and strategic re-orientation of the banking sector towards the domestic markets has prevented a disproportionate decline in credit supply. There are, however, downside risks to asset quality, even though the overall level of impairments has remained relatively benign so far.

3. The regulatory and supervisory regime has been re-organized in 2011. The new architecture replaced the integrated regulator (the CBFA) and allocated the prudential supervision of financial institutions to the NBB and the responsibility for ensuring market conduct and consumer protection to the FSMA. All bank and insurance supervision staff moved to the NBB.

B. NBB Approach to Supervision

4. Belgium has a well developed public infrastructure supporting effective banking supervision. Belgium has a complete system of business laws, consistently enforced. The Belgian legal system is based on civil law. The legislative branch is composed of a parliament with two chambers (Chamber and Senate). Belgium has a constitutional monarchy whereby the King is the head of state and of the executive branch. The judicial branch is independent with a hierarchy of courts, the most senior of which is the Court of Cassation, the supreme judicial court. As a member of the EU, much domestic legislation, including banking regulation, derives from EU regulations, directives and decisions, which are frequently updated to keep pace with international standards.

5. Belgium has a high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). This high level of compliance has been achieved in a challenging environment with persisting elevated stress and vulnerabilities. Added to this are the forthcoming higher regulatory standards, most notably in capital and liquidity. These conditions put a premium on both the quality of risk management practices within the banks themselves and the supervisory oversight conducted by the authorities. In addition to substantial regulatory changes, the supervisory authorities have also had to adjust to the challenges of transition wrought by re-design of the regulatory architecture and the move of prudential supervision to the central bank.

6. The NBB deploys high-quality supervisory practices—which it is building upon through well conceived initiatives and reforms—but there are weaknesses in its supervisory process. The NBB has already instituted some enhancements to its risk oversight, such as an annual risk review, and is executing a focused but multi-faceted plan of improvements. These projects will integrate processes, create greater flexibility in data handling and strengthen analysis at firm specific and horizontal levels.

C. Assessment Challenges

7. This assessment provides an update on the significant regulatory and supervisory developments in the banking sector of Belgium since 2004. The assessment is carried under the BCP methodology of 2006. It reflects the regulatory and supervisory framework in place at the time of the assessment. Importantly, it is not intended to assess the merits of the important policy and implementation issue regarding several aspects of the international regulatory framework that are yet to be decided in international fora, the EU, and in Belgium, ranging from the finalization of Basel III implementation in Europe to the potential creation of a Single Supervisory Mechanism. An assessment of the effectiveness of banking supervision requires a review of the legal framework, both generally and as specifically related to the financial sector, and detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. In line with the BCP methodology, the assessment focused on the major banks and banking groups, and their regulation and supervision, given their importance to the system.

D. Preconditions for Effective Supervision

8. The preconditions for effective supervision (a stable macroeconomic environment, sound legal and accounting framework, and effectiveness of procedures for the efficient resolution of problems in the securities market) appear to be in place in Belgium.

E. Main Findings

Objectives independence, powers, transparence, and cooperation (CP 1)

9. The NBB has a clear legal power to conduct prudential supervision. Similarly the NBB has a legal mandate to detect threats to financial stability. The legal mandate does not, however, clarify the relationship between the discharge of the NBB’s supervisory function and of its financial stability function and how the balance of priorities should be achieved should a potential conflict emerge. It is recommended that greater legal clarity be provided, should a revision to the NBB Organic Law be undertaken, and that the NBB should develop and publish a mission statement of its objectives irrespective of legal changes.

10. The NBB has clear lines of accountability, transparency and separate funding when acting in its supervisory capacity. There is no evidence of interference with the operational independence of the supervisor. Supervisory resources are stretched and this is of concern given the continued stress within the financial system and the importance of planned enhancements to practices and processes that the NBB is urgently seeking to roll out. The NBB is encouraged to scrutinize its plans to determine that it has robustly adequate resource to deliver its multiple supervisory projects and day-to-day supervisory practice. Contingency planning in resource is also important as there may be demands arising from major EU developments such as the Banking Union and from the possibility of crisis issues re-emerging in supervised institutions.

11. The NBB operates within a clear and balanced legal framework. The NBB Organic Law and Banking Law cover authorization and ongoing standards of supervision. Additionally, the NBB enjoys a range of remedial measures that allow for an appropriate degree of proportionality in its approach to breaches of laws and regulations. The Banking Law (Article 57) usefully takes into consideration that there may be a necessity for swift action in urgent situations. The extensive powers to authorize the disposal of the assets or liabilities of an institution are balanced by the need to obtain ratification of such measures through a Royal Decree. Appropriate legal protections have been put in place in respect of banking supervision and supervisors.

12. The general framework for exchange of information is well articulated but coordination at a domestic level is yet to be fully put in place. The NBB’s international relationships are supported by operational agreements and are working fluently. Domestic working level cooperation needs to be underpinned and promoted by an MOU to ensure the modalities of cooperation between the NBB and the FSMA. Amendments to the Twin Peaks Law to rectify drafting oversights in relation to the gateway for the exchange of information between the FSMA and the NBB, which were planned for the end of 2012, are also desirable and should be concluded.

Licensing and structure (CPs 2–5)

13. The legal framework for authorization, on-going standards for supervision and for permissible activities is clearly stated. Both the NBB and the FSMA have legal responsibility for ensuring that the public is not misled into placing deposits with nonauthorized institutions. The NBB is to be commended on its thorough and thoughtful review of fit and proper policies and practices, which ought to confirm that fit and proper standards must be met on a continuous basis. The widening of the formal scope of application of the fit and proper assessment to include key personnel such as the heads of compliance, internal audit and risk management, in cases where these individuals do not form part of the senior management is, similarly, good practice.

14. The change of control of a credit institution and a major acquisition by a credit institution is, broadly, well governed by the laws. The NBB has comprehensive legal powers surrounding the governance and scrutiny of major acquisitions by supervised firms, in particular for systemically relevant institutions. For nonsystemic firms, however, it is recommended that the NBB establish either pre-notification or pre-approval thresholds for acquisitions in nonfinancial entities.

Prudential regulation and requirements (CPs 6–18)

15. Belgian banks have undergone considerable stress over recent years and have increased the level and, importantly, the quality of capital in CET1. The Tier 1 capital ratios range between 11.5 percent and 20.6 percent for the systemically important banks as at March 2012. The capital ratios in these banks have a high share of CET1, which has been gradually increasing, despite severe stress from the crisis requiring state intervention and support. There has also been a run off of Tier 2 instruments in anticipation of Basel III implementation. Nonetheless, increased minimum capital adequacy requirements under Basel III will continue to be challenging for some banks due to a stricter definition of capital, deductions from the capital base etc.

16. The NBB’s approach to Pillar 2 is well developed using a scorecard as the primary tool for risk analysis, taking into account qualitative and quantitative measures. At least annually, the NBB determines the minimum capital adequacy requirements for all banks on a forward looking basis. The SREP and ICAAP analysis are main inputs into the process and, if available, outputs from banks’ economic capital models. Stress testing probes the resilience of capital buffers.

17. Senior management of the bank must submit an annual self assessment of the control environment to the NBB. The external auditor provides a factual evaluation of management’s self assessment but this is not a positive assurance on the design and effectiveness of controls. As a result, the external auditor’s report will not necessarily identify any hidden build-up of risks or provide a positive assurance on the quality of risk management. Without on-site review the NBB should place limited reliance on this report, which it uses as an input to activities, such as the ICAAP.

18. Annual meetings with the full Board of Directors should form an integral component of the NBB’s standard supervision practice. Annual meetings between the NBB and the full Board (including nonexecutive independent directors) should be mandatory for all banks. The meeting will help the NBB assess the role of the Board in overseeing management to ensure that policies, processes and systems are implemented effectively at all decision levels. Currently there are frequent meetings with Board members, but there is room for formalizing a minimum supervisory standard.

19. Large exposure limits have been strengthened recently but warrant further overhaul for small institutions. EU legislation calculates exposures as net of eligible credit risk mitigation and sets a hard limit of 25 percent of own funds for an exposure to an individual or connected group of counterparties. Recent EU amendments (Directive 2009/111/EC), affect smaller firms with own funds below €600 million permitting a limit of 25 percent of own funds or €150 million, whichever is the higher, for exposures to institutions. The sum of exposures to all connected clients that are not institutions must not exceed 25 percent of own funds, however. Where €150 million is the higher limit, the value of the exposure shall not exceed a reasonable limit to be determined by credit institutions, though must not be higher than 100 percent of the credit institution’s own funds.

20. Liquidity regime is well embedded. The systemic banks must report liquidity daily in addition to a weekly meeting and monthly liquidity stress test. While the definition of eligible liquid assets is broader than the Basel LCR definition, the run-off assumptions for liabilities are more stringent. The stress test was introduced in 2009 as an observation ratio with full implementation from 2011. The liquidity stress test will help smooth the transition to Basel LCR for banks in 2015. The authorities are advised to keep the current regime in place until a full implementation of LCR in the EU to preserve banks’ liquidity buffers.

21. The requirements for managing interest rate risk in the banking book are well established in the regulatory framework. The NBB has made strong efforts to implement new standards and has embedded interest rate risk in its core work. Interest rate risk stress test ratios require banks to hold sufficient capital to cover economic value losses related to adverse structural interest rate changes prescribed by the NBB. While the ratios provide a consistent measure of interest rate risk across banks, the ratios do not always fully capture bank specific risks. When evaluating minimum capital ratios, interest rate risk is taken into account as a Pillar 2 risk.

Methods of ongoing banking supervision (CPs 19–20)

22. The supervisory staff are conducting high quality risk based supervision both on and off-site. The NBB has sound analytical processes that it is refreshing and deepening and which will emphasize forward looking perspectives. The new tools should further support the dialogue between the institutions and the supervisors. Continued incorporation of insurance risk within the global group risk assessments is important and should also be enhanced, as planned. The NBB has restructured on-site supervision and ensured effective coordination with the off-site teams.

23. The NBB applies a comprehensive supervisory program to the systemic firms but must ensure that “globally balanced supervisory planning” covers all supervised firms. The NBB needs a risk based approach to its supervisory process to ensure that each institution systematically receives the appropriate intensity of supervisory attention proportionate to its profile. Such a plan should provide a structured framework to guide decision making in terms of which actions should be postponed or performed less frequently, and which institutions should be affected when new or urgent priorities emerge that demand the reallocation of scarce supervisory resource.

Reporting, accounting and disclosure (CPs 21 -22)

24. In Belgium, the external auditor of a bank is accredited by the NBB. The external auditor is accredited directly by the NBB if satisfying standards for independence, experience, competence and organization. The external auditor provides an audit opinion on the financial accounts (six monthly and annually) as well as regarding the self assessment performed by management annually on the internal control environment and on the reliability of prudential returns.

25. Under NBB rules, banks are required to report on a solo and, if part of a group, consolidated basis. Belgium accounting rules (Belgium GAAP) apply on a solo basis and IFRS on a consolidated basis if they have to produce consolidated accounts according to EU directives. Banks submit quarterly prudential returns of key data such as capital adequacy, balance sheet, earnings etc. Liquidity is reported more frequently on a monthly basis.

Corrective and remedial powers of supervisors (CP 23)

26. The NBB enjoys a broad range of powers for corrective and remedial measures and there is evidence that the NBB is able and ready to use such remedies. On occasion, the threat of using these powers was sufficient to obtain the desired outcome. The NBB is examining the possibility of making its disciplinary powers more graduated, in particular through the use of fines.

Consolidated and cross border banking supervision (CPs 24–25)

27. The NBB has the necessary legal powers and has implemented regulatory structures to facilitate consolidated supervision. Given the significance of cross border activities for the systemic groups in Belgium, the NBB has focused on work within the EU supervisory colleges. The NBB is actively using the college environment to test out the quality of risk focused management within groups as well as to ensure an adequate distribution of capital within the group.

28. The NBB places great value on and is strongly motivated to contribute to and participate in home-host relationships as fully and as effectively as possible. Cooperation arrangements and MOUs are in place with all relevant jurisdictions. Home and host relationships are critical to the successful supervisory oversight of the financial system in Belgium. While EU legislation imposes requirements including joint assessment and decision making processes on EU supervisory colleges, the quality of execution depends on the supervisory authorities.

29. Table 1 offers a principle-by-principle summary of the assessment results, while recommendations to improve compliance with the BCPs are summarized in Table 2.

Table 1.

Summary Compliance with the BCPs

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Table 2.

Recommendations to Improve Compliance with the BCPs

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F. Authorities’ Response to the Assessment

30. The NBB can subscribe to the general conclusions and the main findings as laid down in this report. The NBB is satisfied with the overall high level of compliance with the 2006 Banking Core Principles and appreciates that recognition has been given to the challenging environment is which the NBB currently performs its supervisory tasks. The challenges stem from the continued crisis conditions and the relatively recent integration of prudential supervision into the NBB, formerly a task performed by the CBFA. During the mission, the NBB had the opportunity to explain the initiatives/reforms underway as a response to these challenges and to indicate how well advanced some of them already are. Discussions with the IMF were thus also a fruitful sounding board for the NBB and we will take into account the advice and recommendations to continue work in this respect.

31. For some of the Banking Core Principles, mainly those for which the NBB received a downgrade, we provide here some more extensive comments to the IMF’s assessment or we indicate our future plans to meet the IMF’s recommendations.

BCP 1: Objectives, independence, powers, transparency, and cooperation

32. The NBB will reconsider the adequacy of the supervisory resources in order to achieve the appropriate supervisory intensity and effectiveness in the course of 2013.

BCP 4: Transfer of significant ownership

33. The obligation for a credit institution to inform the supervisory authority of any material adverse development (affecting the criteria under which the assessment of the suitability of a major shareholder is made) will be provided soon, on the occasion of the next Banking Law’s modification.

BCP 5: Major acquisitions

34. The right of pre-approval by the NBB of a major acquisition by a credit institution in the nonfinancial sector will be provided soon, on the occasion of the next Banking Law’s modification.

BCP 6: Capital adequacy

35. We agree with the conclusion relating to the deduction of insurance company but underline that the regulation will be adapted as from 1 January 2013 on.

36. With regard to the deduction of credits to shareholders that have been used to subscribe capital instruments, we underline that the current regulation is fully in line with the Basel 3 framework and notably the eligibility criterion 11 for common equity tier 1 which states that “the instrument is directly issued and paid-in and the bank can not directly or indirectly have funded the purchase of the instrument.

37. This last criterion is new with regard to the conditions that the instrument must be directly issued and the bank can not directly or indirectly have funded the purchase of the instrument. As these conditions are new, the NBB has introduced a transitional measure for the deduction of existing credits at the end of December 2010 in line with the transitional measures of the Basel 3 framework. In the meantime, existing credits that are not deducted from own funds are taken into consideration in the pillar 2 decision relating to capital add-ons set by NBB, meaning that the full amount of these credits must be covered by common equity tier 1. All new credits that have been granted since end 2010 have been deducted from common equity tier 1.

38. With regard to the transparency issue, we will follow the new European regulation transposing the Basel 3 framework that requires each bank to disclose the impact of any transitional measures to the market (see article 470 of the current draft CCR) from the entry into force of this regulation and the guidelines that EBA will issue with regard to disclosure on own funds (see EBA consultation paper EBA/CP2012/04 Consultation paper on draft implementing standards on disclosure for own funds).

39. In addition to the Basel criterion 11, the current Belgian regulation provides also for the deduction of credits to shareholders when they are not granted at market conditions and when there is no evidence that the shareholders have sufficient revenues on an ongoing basis, other than the distributions on the capital instruments held, to support the payment of interest and repayment of the funding.

40. In conclusion, we consider that the issue of credits to shareholders does not constitute a reason for a downgrade and that the NBB is compliant with principle 6 from 1 January 2013 on (when the insurance participations will be deducted from tier 1 and tier 2).

BCP 7: Risk management

41. The NBB plans to review its internal governance framework, including risk management, starting in the autumn of 2013. At that moment, we will take into account the IMF’s recommendations regarding the Board’s oversight role for risk management and on how to integrate risk management and capital setting better.

BCP 8: Credit risk

42. We largely agree with the assessment but it is unclear whether BCP 8 requires the regulation to prohibit some credit to shareholders because conflicts of interest may arise (and have arisen in the past). The management of conflicts of interest between the bank and the shareholders is already regulated by the provisions of company law and the guidelines of the NBB on internal governance. On the basis of these guidelines, each institution must define a policy relating to conflicts of interest which shall be subject to the scrutiny of the NBB. We agree that these legal provisions and guidelines are not necessary sufficient but NBB has clarified the own funds regulation in order to be able to deduct some transactions made between the bank and its shareholders from the own funds (see above for BCP 6).

BCP 10: Large exposure limits

43. The NBB will examine whether to use the national discretion to set a stricter limit on large exposures within smaller institutions when transposing Capital Requirements Directive, Fourth Iteration (CRD IV).

BCP 12: Country and transfer risks

44. We largely agree with the assessment but underline that the current guidelines of the NBB relating to credit risk management and concentration risk ensure already the compliance with the main principles applicable to the management of country risk (notably obligation to define a policy approved by the board, to set limits, to monitor the evolution of the exposures and the risks, to have an adequate provisioning policy and process). Adding specific guidance on country risk would be mainly a repetition of what is already included in the current guidelines on credit risk and concentration risk.

BCP 16: Interest rate risk in the banking book

45. Interest rate risk has been recognized as one of the priorities in the NBB’s Risk Review 2013. As explained to the IMF, the NBB has set up since 2012 an extensive program to further develop its supervision regarding interest rate risk that runs throughout its different supervision departments. When rolling out this program, the NBB will consider how the recommendations in this field can be translated into the NBB’s practice.

BCP 17: Internal control and audit

46. It is unclear whether the actual BCP 17 requires that the supervisor should be satisfied as to the effectiveness of the internal controls. The June 2012 BCBS document requires the internal audit function to provide independent assurance on the quality and effectiveness of a bank’s internal control.

47. If the supervisor should be satisfied as to the effectiveness of the internal controls, several options could be examined:

  • The Bank could require the internal audit function to adhere to the IIA’s International Professional Practices Framework (Practice Advisory 2130-1) and to the recently published principles of the BCBS document about the internal audit function in banks;

  • The Bank could require the external auditors to give positive assurance on the design and effectiveness of the internal controls. As for internal controls over financial reporting, a reference could be made to PCAOB standard AS 5 (there is no equivalent in the IAASB suite of standards), for the other internal controls reference could be made to ISAE 3000. This standard is under revision and would require the Bank to describe in detail what is expected and what constitutes an acceptable internal control framework;

  • It could be envisaged that positive assurance is obtained through on-site inspections performed by the Bank. This could be dealt with in the context of the NOVA project (aiming at a harmonization of and consistency in methods across the supervisory departments). It should however not be expected that such a positive assurance will be obtained on a yearly basis for all supervised institutions and regarding their complete internal control system.

48. We consider that obtaining, in a systematic and sufficiently documented way, comfort as to the design and effectiveness of internal controls is indeed necessary. The report by the external auditor is only one of the building blocks for the control by the NBB and its importance should therefore not be overestimated.

49. To summarize, in our opinion, comfort should be obtained through a pre-defined combination of senior management’s self-assessment (as approved by the Board), ICAAP reporting, input from the internal auditors (cf. recent BCBS document about the internal audit function in banks) and from the external auditor, as well as NBB on-site inspections to test these different inputs. This combination is currently the case. We agree however that the process for integrating these different building blocks and for steering the interaction between them could be made somewhat stricter. We will also enhance our own quality assurance on the input of the external auditor. The NBB will include this work when designing baseline supervision (see also BCP 20).

BCP 20: Supervisory techniques

50. We overall agree with the assessment but like to offer some additional inputs to the points contained in the detailed assessment:

  • Supervisory action and planning is generally based on priorities and oriented to high risk institutions. We confirm the need to better document choices and to present supervisory planning and realized actions on the basis of a formally agreed and sector wide methodology;

  • Pressure is put on team members to strengthen the internal documentation process, to systematically introduce standard presentation, including comparison to peers, in order to make risk assessment more comprehensive and ensure level playing field;

  • The ongoing development of a enhanced scorecard system will strengthen the structured dialogue both with the institutions concerned and with their approved commissioners and the competent supervisory authorities, notably via the colleges of supervisors, will drive the decision making process, and will be systematically used and included in periodic reporting to the Board;

  • This enhanced scorecarding will facilitate clustering on a more refined and risk-focused basis and will lead to a more balanced and risk based supervisory planning and subsequent appropriate assignment of staff.

51. At the time of closing the FSAP mission, the NBB has already started work to implement a baseline supervision approach. We are in the process of identifying the different clusters and as result of this process, we have to define a baseline supervision even for the low risk institutions.

BCP 21: Supervisory reporting

52. The European Implementing Technical Standards (ITSs) on reporting, currently prepared by the EBA in the context of the future CRD IV, will shorten the remittance dates for prudential returns. These standards will become directly applicable in Belgium.

International Association of Insurance Supervisors (IAIS) Insurance Core Principles

A. Background

53. This assessment provides an update on the significant regulatory and supervisory developments in the insurance sector of Belgium since 2006. It is benchmarked against the ICPs issued by the IAIS in October 2011. The assessment is based solely on the laws, regulations and other supervisory requirements and practices that are in place at the time of the assessment.

54. The supervisory architecture in Belgium has been overhauled with the implementation of the Twin Peaks structure in April 2011. The NBB is in charge of the micro- and macro-prudential supervision of insurers, while the FSMA is responsible for registering the intermediaries and for supervising the conduct of business by insurers and intermediaries. This assessment covers the both the NBB and FSMA.

55. The Belgian insurance industry is mature and concentrated. It is relatively small compared to the banking sector: assets held by banks are five times of those held by insurers as at September 2011. Although there are 92 direct insurers, the industry is dominated by the 23 composite insurers that conduct both life and nonlife insurance operations, accounting for more than 90 percent of total industry assets. In 2011, the top five life insurers accounted for 71 percent of the assets while the top five nonlife insurers held 58 percent of the assets. The top three insurance groups held more than 60 percent of the total assets as at end-2011.

56. Belgian insurers were adversely affected by the global financial crisis and continue to confront challenges related to legacy portfolios and economic uncertainties in Europe. Government support was extended to a few insurers to maintain the stability of the industry in 2008. Nevertheless, the insurance industry’s solvency position has continued to weaken since 2009, and life insurers have significant exposures to guaranteed high returns in part of their legacy portfolios. Insurers held high levels of government bonds (€104 billion), accounting for 41 percent of assets as at end-2011, of which €59.6 billion were in Belgian government bonds. Investments in corporate bonds represent 23 percent of total assets. While insurers have been gradually shifting toward contracts that offer lower guarantees, some of the new contracts offer more policy options, increasing the risks of surrenders by policyholders. The demand for life policies has been eroded by households’ stronger preference for liquidity. Nonlife insurers have taken measures to improve their underwriting performance but they remain susceptible to investment risks.

B. Preconditions for Effective Securities Regulation

57. The preconditions for effective insurance supervision are in place in Belgium. The macroeconomic, fiscal and legal frameworks of Belgium are partly shaped by its membership in the European Union (EU). The legal system in Belgium is developed and the independence of the judiciary is respected. Accounting, auditing and actuarial standards adopted are in line with international best practices. The NBB publishes comprehensive macroeconomic statistics on its website. The regulated stock exchange (Euronext) is subject to investor protection and governance rules, information disclosure requirements and supervision by the FSMA. Belgium’s corporate governance system is in line with the Organization for Economic Cooperation and Development’s Principles of Corporate Governance. The legal framework for consumer protection is well established and policyholders of traditional life policies (except for group insurance related to employee benefits) are covered by the Deposit Guarantee Scheme up to €100,000 per policyholder since 2008. The financial markets in Belgium offer a broad range of instruments that facilitate insurers’ asset-liability management.

C. Main Findings

58. The Belgian authorities have made significant progress in updating the insurance regulatory regime and supervisory practice since 2006. The authorities have implemented the Flashing Light Provisions to strengthen the solvency requirements of life insurers with exposures to legacy portfolios and enhanced the risk management requirements for insurers. The NBB has introduced a supervisory framework that integrates vertical analyses of individual insurers with horizontal review of the insurance sector, while leveraging on its macroeconomic competencies. Checks-and-balances in the supervisory process have been enhanced through the separation of vertical and horizontal supervision as well as offsite review and onsite inspections.

59. There is scope for strengthening the supervisory structure and the legal capacity of the NBB. The Twin Peaks structure establishes clear supervisory mandates and enhances checks-and-balances. A key success factor is effective communication and coordination. A regular review of the practical implementation of the Twin Peaks is needed to ensure that the overall supervisory objectives for the insurance sector are effectively achieved. A more principles-based approach in delegating legal authority to the NBB to issue enforceable rules would facilitate supervisory discretion within the parameters set by the law. The NBB should be empowered to take immediate recovery measures not withstanding an appeal by an insurer. There are merits in articulating clear policies to deal with potential conflicts in supervisory objectives, e.g., between financial stability and prudential safeguards for policyholders.

60. The updated regulatory framework has a high level of observance with the ICPs, supported by robust prudential supervision. The majority of the downgrades reflect gaps in the regulatory framework, i.e.; scope of the fit and proper requirements; duties of directors particularly with respect to policyholders; public disclosures; updating the prudential standards for asset-liability management and realistic contingency plans. The NBB’s decision to enhance the current solvency regime ahead of the implementation of Solvency II is welcome, and should contribute to the longer-term sustainability of insurers. Further improvements could be achieved through: a) the formulation of an appropriate baseline supervisory program; b) internal policies for inspecting functions outsourced by insurers; and c) review of the effectiveness of contributions of external auditors and the role of actuaries.

61. The authorities are advised to review current conduct-of-business (COB) regulation and supervision. Although training and qualification requirements imposed by the FSMA complies with the EU IMD directive, there is scope to enhance the level of professionalism of intermediaries through more robust training requirements and appropriate supervisory measures to deter unhealthy competition arising from more than 17,000 intermediaries. The FSMA proposes to adapt the Markets in Financial Instruments Directive 2 (MiFID 2) to insurers and insurance intermediaries, aimed at providing a cross-sectoral and comprehensive framework for COB regulation. The FSMA should be empowered to establish enforceable rules on: a) handling of claims and proper policy servicing by insurers; b) market conduct requirements at the group level; and c) combating and reporting insurance fraud by intermediaries.

62. It will be important that the NBB and the FSMA are adequately resourced to effectively discharge their supervisory mandates. The NBB is advised to regularly review its resource planning to achieve the appropriate supervisory intensity and effectiveness and an appropriate baseline program. Going forward, there are also significant resource implications arising from the implementation of Solvency II and supervision of complex cross-border insurance groups/conglomerates. The FSMA needs to strategize an appropriate risk-based supervisory approach to deal with the large population of regulated entities and ensure adequate resources to implement the strategy.

63. Table 3 offers a principle-by-principle summary of the assessment results, while recommendations to improve observance of the ICPs are summarized in Table 4.

Table 3:

Summary of Compliance with the ICPs

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