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April 03, 2018

IMF published staff report and selected issues report in the context of the 2018 Article IV consultation with Luxembourg. The assessment reveals that the banking system has strong capital and liquidity buffers. The four large domestically oriented banks have better profit performance than European banks on average. They have passed on lower rates to domestic borrowers while lending spreads have remained broadly constant and nonperforming loans (NPLs) low.

Directors encouraged the authorities to continue enhancing regulation and supervision, in line with the 2017 Financial Sector Assessment Program (FSAP) recommendations. They stressed the importance of continuing to strengthen the oversight of investment funds, closely engage with relevant foreign regulators, and develop system-wide methodologies for liquidity stress testing. Directors advised increasing on site bank inspections and stressed the importance of rigorous supervision of cross-border exposures of foreign-oriented banks and of the authorities’ ongoing commitment to reinforce the oversight of nonbank holding companies. Directors encouraged further strengthening of macro-prudential oversight, including by publishing the substance of the macro=financial risk analysis of the systemic risk committee. They recommended further addressing risks related to anti-money laundering and combating the financing of terrorism.

The staff report emphasizes that appropriate resolution plans for the most important banks established in Luxembourg should be finalized. With the upcoming EU harmonized reporting on the maturity ladder, the supervision of large intragroup exposures will be strengthened as recommended in the 2017 FSAP. In the context of the review of the CRR/CRD-IV/BRRD/SRMR, the authorities remain attached to the objective of further risk reduction in the banking sector. The national authorities considered it crucial that institutions, including local subsidiaries, maintain sufficient levels of own funds and eligible liabilities to allow for a smooth implementation of resolution strategies. With respect to Brexit, the report highlights certain uncertainties as UK is an important trading partner, especially for financial services. Brexit could disrupt Luxembourg’s delegation model for portfolio management of investment funds. However, Luxembourg could benefit from relocation of financial institutions. Several insurance companies and a few banks have already announced relocation of activities to Luxembourg. The Brexit process may also have implications for the location of financial activity required within the EU to enjoy passporting rights. Furthermore, the report highlights that regulation and supervision need to be upgraded to deal with fintech risks as developments in this area may pose new challenges to financial stability. Regulatory and supervisory arrangements will need to keep pace with fintech developments.

The selected issues report examines the impact of monetary policy on Luxembourg. Banks have remained profitable and interest margins stable, while fee and commission income from fund and other activity has been healthy. The investment fund industry has benefited from various factors such as portfolio re-balancing, search for yield, and other market developments leading to strong inflows into various classes of investment funds. Scenario analysis suggests that the fund industry could be adversely impacted by sharp interest rate increases and that, because of interconnections, the banking system would also be affected. Margins of some banks could also decline when interest rates normalize. Against this backdrop, it is important to implement all 2017 FSAP recommendations that will contribute to making the financial system more resilient to shocks, including those arising from faster-than-expected monetary policy normalization.

 

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Keywords: Europe, EU, Luxembourg, Banking, Insurance, Securities, Article IV, FSAP, Brexit, Asset Management, IMF

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