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    IMF Publishes Reports on 2019 Article IV Consultation with Luxembourg

    May 10, 2019

    IMF published its staff report and selected issues report under the 2019 Article IV consultation with Luxembourg. The IMF Directors welcomed the progress in implementing the 2017 Financial Stability Assessment Program (FSAP) recommendations while emphasizing efforts to further enhance the oversight of the highly interconnected financial sector. Directors noted the need to continue to strengthen the supervision of banks’ large cross-border exposures, complete resolution plans for less systemic banks, and implement Luxembourg’s component of the euro area credit register. They also welcomed the recent measures to enhance macro-prudential surveillance and encouraged the authorities to expand the macro-prudential policy toolkit by introducing the borrower-based mortgage lending limits.

    The staff report highlights that the financial sector remained profitable in 2018, despite recent bouts of volatility in global financial markets. The banking system is highly capitalized and liquid, with the overall tier 1 capital ratio above 25% and a median Liquidity Coverage Ratio of 174%. Asset quality of banks remained high, with the overall non-performing loans (NPL) ratio of about 1% in the third quarter of 2018—among the lowest in the euro area. Overall, the banks in Luxembourg are more efficient and have larger capital and liquidity buffers than an average EU bank. Rising operational costs—including those related to regulatory compliance as well as investment in new technology—have increased profitability risk, especially for smaller banks. The results of liquidity stress tests run by CSSF (the authority responsible for financial regulation in Luxembourg) suggest that most banks have sufficient buffers to counterbalance severe deposit outflows. Additionally, solvency stress tests indicate that the banking system remains resilient to severe macro shocks. While low profitability and high available-for-sale positions could lead a few small banks to breach minimum capital requirements under severe stress conditions, systemic implications are unlikely.

    The financial system remains strongly interconnected, both globally and domestically, with the investment funds from Luxembourg being major players worldwide. Financial linkages with the rest of the world represent the bulk of assets and liabilities of the domestic financial sector. While financial stress in the investment fund sector remained contained, there are growing vulnerabilities, partly due to increased common risk-taking strategies. Investment funds maintained large exposures to sovereign debt and increased their holdings of securities issued outside the euro area. The report also discusses the steps that the authorities took to enhance regulation and supervision in line with past staff advice and emphasizes that the authorities should continue to follow up on the 2017 FSAP recommendations:

    • Recent efforts to strengthen supervision of investment funds, such as the issuance of specific guidance on substance requirements in the context of delegated activities, are welcome. Progress is also being made on providing guidance on liquidity stress testing in coordination with ESMA. The authorities should continue to engage with regulators in jurisdictions where delegated portfolio and risk management are prominent. Furthermore, they should continue to enhance macro-prudential-based surveillance of the sector, including by closely monitoring liquidity and maturity mismatches and market risks emanating from the common risk-taking behaviors.
    • Efforts to strengthen the supervision of banks’ large cross-border exposures should continue. The recent increase in resources dedicated to reviewing existing waivers for large exposure limits is welcome. The authorities should also reinforce the oversight of non-bank holding companies of banks in line with the upcoming European approach. Building on recent progress, appropriate resolution plans for the less systemic banks should be completed. While a contingent framework of emergency liquidity assistance is in place, efforts to finalize some operational modalities as specified in the 2017 FSAP should continue.
    • Macro-prudential oversight appears to be working well but should be strengthened. To signal a tighter macro-prudential stance, the authorities appropriately announced the introduction of a 0.25% countercyclical capital buffer to be implemented by January 2020. They took steps to standardize the reporting of borrower-related indicators and are planning to publish the substance of the risk dashboard this year. The institutional framework for macro-prudential policy could be reinforced.
    • Governance arrangements should be upgraded by enshrining in legislation the operational independence of CSSF and the supervisory body for the insurance sector (Commissariat aux Assurances, or CAA), further aligning the code of conduct for non-executive members of the BCL Supervisory Board to best practices and introducing codes of conduct for the members of the non-executive boards of CSSF and CAA. 

    The IMF staff notes that steps taken to address risks in the real estate market are welcome, but the authorities should continue to monitor these risks closely and take further action as needed. Efforts to standardize the reporting of borrower-related indicators and the activation of the countercyclical capital buffer are steps in the right direction to enhance the monitoring and mitigation of risks in the real estate market. Challenges arising from the developments in fintech should continue to be addressed following a risk-based approach. Although the fintech developments could bring efficiency gains and new business opportunities to the financial sector, they could also increase operational, cyber, and compliance risks. To encourage innovation while minimizing the risks, regulatory and supervisory arrangements should keep pace with the fintech developments in a technology-neutral approach. The recent initiative to close gaps in the legal framework on blockchain is a step in the right direction.

    The selected issues report covers details about the pension system in Luxembourg. The key topics covered in the report include cross-country comparison of key variables related to the pension system and IMF’s baseline projections of Luxembourg’s pension system over the long run under a no-policy-change scenario.


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    Keywords: Europe, Luxembourg, Banking, Insurance, Securities, NPL, FSAP, Article IV, Systemic Risk, Macro-Prudential Policy, Stress Testing, Capital Requirements, Fintech, Governance, CAA, CSSF, BCL, IMF

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