CMF Publishes Regulations Under Basel Framework in Chile
CMF has issued new regulations as part of the implementation process of Basel III standards in Chile. Among these are the regulations to determine the credit, market, and operational risk weighted assets (RWAs) for banks, along with the disclosure requirements for banks under Pillar 3 of the Basel III framework. Yet other regulations concern minimum requirements and conditions to be met by preference shares and bonds without a fixed maturity date and minimum requirements and conditions to be met by subordinated bonds under the General Banking Act. CMF also published Chapters 21-6, 21-7, 21-8, 21-20, 21-2, and 21-3 of its Updated Compilation of Rules for Banks (RAN), in addition to the regulatory reports evaluating the impact of these regulations and the frequently asked questions and presentations on these regulations.
Regulation on Determination of Risk-Weighted Assets
The General Banking Act mandated CMF to establish standardized methodologies to determine risk-weighted assets of banking companies as a rule subject to a favorable agreement from the Board of the Central Bank of Chile. It also provided that CMF could authorize banks to use their own methodologies to determine risk-weighted assets. However, this first version of the regulation restricts to the use of the foundation model for credit risk. CMF has published Chapters 21-6, 21-7, and 21-8 of RAN. These chapters define the methodologies for calculating credit risk-weighted assets, market risk-weighted assets, and operational risk weighted assets, respectively. Furthermore, Chapter 21-20 states the provisions regarding the promotion of market discipline and financial transparency through the disclosure of significant, timely information. The key points covered in the regulations include the following:
- Prior to the amendment to the General Banking Act, the calculation of risk-weighted assets was based on the Basel I standard and considered only credit risk, with six categories of assets established in the law. The new standard is more sensitive to credit risk and includes, in addition to credit risk, market, and operational risks.
- The standard allows for a reduction in credit risk-weighted assets by considering credit risk mitigants, such as compensation agreements, financial guarantees, and balance-sheet compensation.
- The Basel III simplified standard model is used for the calculation of market risk-weighted assets, which stipulates four types of risks: interest rate, foreign currency, stock prices, and commodities. A specific risk is incorporated within the interest rate and stock price risk, aimed at measuring idiosyncratic aspects of the issuer.
- Operational risk weighted assets are calculated with the unique standard method allowed by Basel III, which includes two components. The first component is a business indicator, prepared with information from the financial statements of each bank and reflecting the scale of operations of the institution. The second component is an adjustment factor based on the operating losses incurred by the institution over the last 10 years.
In March 2019 CMF, in coordination with the Central Bank of Chile and in line with the measures adopted by regulators at the international level, decided to postpone by one year the implementation of the calculation of risk-weighted assets and to provisionally keep the general regulatory framework in force until November 30, 2021. Thus, from December 01, 2021, credit, markets, and operational risk-weighted assets must be calculated according to the new regulations.
Regulation on Pillar 3 Disclosure
The regulation establishes, among other aspects, the type and criteria of information to be disclosed, adoption of principles of disclosure of Basel III, the forms and tables to be used, and periodicity of the information for each of the established requirements. Banking entities must publish their Pillar 3 document independently or alongside their financial statements, reporting each of the tables and forms established in the regulation. Chapter 21-20 of RAN establishes that banking institutions must publish the Pillar 3 reports quarterly. The regulations will come into effect after December 01, 2022 and the first publication of the Pillar 3 document must be made with information referring to the January-March 2023.
Regulation on Hybrid Instruments
Regarding hybrid instruments for the constitution of effective equity, the requirements established for the issuance of preferred shares, bonds without fixed maturity (Additional Tier 1 capital or AT1), and subordinated bonds (Tier 2 capital, T2) seek to provide alternative modalities of regulatory capital to absorb losses when the capital of the issuing bank decreases under pre-established conditions. This may facilitate the recovery of solvency levels or avoid the resolution of a bank. Any issuance that does not meet the conditions established in these standards cannot be accounted for as effective equity by banks. For subordinated bonds, Chapter 9-6 of the RAN is replaced by a new one, which complements and adjusts the current requirements to align them with Basel III. Comments received throughout the public consultation period focused on the Chapter on preferred shares and bonds without fixed maturity, while the Chapter on subordinated bonds remained unchanged. The main adjustments were to
- Clarify that AT1 and T2 issuances made by foreign subsidiaries will not be part of the effective equity.
- Clarify that the different loss-absorption mechanisms, their characteristics, and the partiality of the conversion mechanism.
- Modify aspects related to the credit classification of AT1 instruments.
- Specify that the accounting aspects of such issues will be laid out in the Compendium of Accounting Standards for Banks.
It is estimated that there would be no need for banks to issue AT1 capital during the first year of implementation of the regulations. This is because most banks keep high levels of basic capital and subordinated bonds (T2), and the latter can be used to compute as AT1 during the transitional period. For subordinated bonds, the major change corresponds to issuances by subsidiaries executed prior to the effective date of this regulation, which will no longer be recognized in consolidated effective equity as instructed in Chapter 21-1 of the RAN. These issuances must be phased out of the parent company's effective equity within 10 years. Although CMF announced the postponement of the beginning of the implementation of the Basel III requirements in Chile by a year, these regulations came into force as of December 01, 2020, notwithstanding any transitional provisions established in the law and informed by CMF.
- Press Release on Regulations on RWAs and Pillar 3 Disclosure
- Press Release on Regulation on Hybrid Instruments
- Regulatory Reports, Chapters of RAN, FAQs, and Presentations (in Spanish)
Effective Date: December 01, 2020/December 01, 2022
Keywords: Americas, Chile, Banking, Basel, Regulatory Capital, Pillar 3, Disclosures, Reporting, Operational Risk, Credit Risk, Market Risk, General Banking Act, CMF
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