MFSA issues Circular to Credit Institutions of Credit Risks

Two Annexes designed to regulate Credit Institutions

Mr. Steve Muscat Azzopardi | Published on 15 Jan 2019

MFSA-Credit Risk

The MFSA has issued two annexes to Banking Rule BR/09 on the adoption of measures addressing credit risks when assessing the quality of asset portfolios of credit institutions which required banks to increase their non-distributable reserves through retained earnings as an additional layer against credit risk. 

Credit Institution Clarifications for Connected Clients

The first Annex is aimed at providing clarification with regards to the treatment of "connected clients". Annex 1 identified that a group of two or more connected clients are to constitute a single risk rather that separate risks per individual client. The provisions of Regulation 575/2013 (CRR), identify two types of interconnection which may lead to clients being considered to be connected - clients that are directly or indirectly interconnected by a control relationship, such as:

  •     Holding the majority of the shareholders’ or members’ voting rights in another entity
  •     Right or ability to appoint or remove a majority of the members of the administrative, management or supervisory body of another entity
  •     Right or ability to exercise a dominant influence over another entity pursuant to a contract, or provisions in memoranda or articles of association
  •     Power to decide on the strategy or direct the activities of an entity
  •     Power to decide on crucial transactions, such as the transfer of profit or loss
  •     Right or ability to coordinate the management of an entity with that of other entities in pursuit of a common objective (e.g. where the same natural persons are involved in the management or board of two or more entities)
  •     Holding more than 50% of the shares of capital of another entity
  •     And clients that are interconnected by some form of economic dependency such as direct economic dependencies like supply chain links or dependence on large customers. 
     

Economic dependency shall be assessed in accordance with a number of criteria listed in Annex I which are non-exhaustive; or a common main source of funding in the form of credit support, potential funding or direct, indirect or reciprocal financial assistance where the funding problems of one client are likely to spread to another on account of a one-way or two-way dependency on the same funding source. In such situations, credit institutions must identify all control relationships among their clients and keep a record of such relationships. Additionally, any potential economic depending amongst clients must be investigated and documented accordingly. 

Limiting Risks for Credit Institutions

The second Annex sets limits and manages risks from exposures to shadow banking entities. Shadow banking entities are generally not subject to the same standards of regulation as credit institution and thus, do not provide the same level of protection to investors’ investment from internal failures and, moreover, shadow banking entities do not have access to central banks’ liquidity facilities. Credit institutions shall establish an internal framework to identify, manage, control and mitigate the risks arising from exposures to shadow banking entities. Additionally, credit institutions must set an aggregate limit relative to their eligible capital and tighter limits on their individuals to their exposures to shadow banking entities. The updated Banking Rule BR/09 came in force and is effective as of the 11th of January 2019.



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