Risk Report 2008 - Dexia

1 Risk Report2008 PILLAR III OF BASEL IIContactDexia SADexia Tower Place Rogier 11 1210 Brussels BelgiumTour Dexia 1, passerelle des Refl ets La D fense 2 TSA 12203 92919 La D fense Cedex FranceIBAN BE61-0682-1136-2017 BIC GKCCBEBB RPM Brussels VAT BE RelationsE-mail: Brussels: (32) 2 213 57 49 Phone Paris: (33) 1 58 58 85 97 Contents 3 1. Risk Management Objectives and 6 Mission and 6 Risk Governance and 6 Dexia Risk 10 2. Own Funds and capital 11 Own 11 capital requirements by Type of 12 capital 14 Significant Banking 15 3.

2 Credit 16 Credit Risk Management and 16 Credit Risk 20 Impairment, Past-Due and Related 22 Credit Risk Mitigation 24 AIRB 27 Standardized 43 Counterpart Risk on 44 Pillar II Credit 45 4. Market and ALM 48 Market 48 ALM 5. Operational 56 Operational Risk Management and 56 Basel II 57 6. Other 59 Behavioural 59 Business 59 Strategic 60 Reputation 60 Model 61 Pension 61 Specific Insurance 62 7. Focus on Equity 63 Basel II Treatment and Accounting 63 Equity 63 Dexia Risk Report 2008 Pillar III of Basel II Page 1/72 Gains or 64 8.

3 Focus on Securitization 65 Objectives and Roles of 65 Basel II Treatment and Accounting 65 Securitization Activity as 66 Securitization Activity as 69 Dexia Risk Report 2008 Pillar III of Basel II Page 2/72 Appendix List of 71 Introduction Basel II framework Basel II refers to the revision of the 1988 regulatory framework defining the capital requirements for banking institutions. The main objectives of the new capital agreement ( Basel II framework ) put in place by the Basel Committee on Banking Supervision are to improve the regulatory framework in order i) to further strengthen the soundness and stability of the international banking system ii) to promote the adoption of stronger risk management practices by the banking industry and iii) to prevent any competitive regulatory inequality among internationally active banks.

4 In order to achieve these objectives, the Basel II framework is based on three pillars: The first pillar minimum capital requirements defines the way banking institutions calculate their regulatory capital requirements in order to cover credit risk, market risk and operational risk. The revised framework provides different approaches for calculating credit risk (3 approaches: Standardized, Foundation Internal Rating-Based and Advanced Internal Rating-Based), market risk (2 approaches: Standardized Approach and Internal Model Approach) and operational risk (3 approaches: Basic Indicator Approach, Standardized Approach and Advanced Measurement Approach).

5 The second pillar supervisory review provides the national regulators with a framework to help them in assessing the adequacy of banks internal capital to be used to cover credit risk, market risk and operational risk but also other risks not identified in the first pillar such as concentration risk. The third pillar market discipline encourages market discipline by developing a set of qualitative and quantitative disclosures which will allow market participants to make a better assessment of capital , risk exposure, risk assessment processes, and hence the capital adequacy of the institution.

6 The requirements of the third pillar are fulfilled by this publication. Dexia is closely involved in the consultations at national and international level on the amendments to the capital Requirement Directive, in particular with respect to the reinforcement of European supervision. Basel II Implementation Pillar I Credit Risk AIRB Approach approval The Dexia homologation application file was successfully presented for final decision to the Management Board of the Banking, Finance and Insurance Commission by December 18, 2007.

7 Consequently, since January 1, 2008, Dexia has been authorized to use the Advanced Internal Rating-Based Approach (AIRB Approach) for the determination of its regulatory capital requirements under Basel II Pillar I for credit risk and for the calculation of its solvency ratios. This acceptance is applicable to all entities and subsidiaries consolidated within the Dexia Group, which are established in a Member State of the European Union and subject to the capital Requirement Directive. This approval was obtained after some efforts both on methodological aspects internal models were largely redesigned in order to make them Basel II compliant and on IT systems which also had to be improved in order to cope with the entire series of Basel II requirements relating to data collection, consolidation and calculation.

8 Dexia Risk Report 2008 Pillar III of Basel II Page 3/72 Dexia has also decided to maintain a Standardized Approach for some portfolios for which this approach is specifically authorized by the Basel II framework , such as small business units, non-material portfolios, portfolios corresponding to activities in run-off or to be sold or portfolios and entities for which Dexia has adopted a phased rollout of the AIRB Approach. Market Risk In terms of market risk, Dexia calculates its capital requirements on the basis of the Internal Model Approach for general interest rate risk and foreign exchange risk and the Standardized Approach for specific interest rate risk and equity risk (general as well as specific risk).

9 In the future, Dexia intends to switch to the Internal Model Approach for equity risk. Operational Risk For operational risk, Dexia applies the Standardized Approach. In this regard, an information file was submitted to the Regulator in June 2007. Incident reporting is now at cruising speed and the Risk and Control Self-Assessment (RCSA) process covers the entire bank, including foreign subsidiaries and branches. COREP The COREP (COmmon solvency ratio REPorting European Basel II reporting which includes prudential information on credit risk, market risk and operational risk quantitative disclosures) is produced thanks to close collaboration between the various entities of the Group.

10 Its implementation implied important improvements in terms of data quality and technical resources due to the variety of national formats. Deadlines for producing the data were gradually reduced over the year; a further shortening of these deadlines in line with the European harmonization is to be considered as a major challenge in 2009. Pillar II The Basel II reform is not limited to the calculation of the statutory capital in relation to credit risk, market risk and operational risk. Pillar II requires banks to demonstrate an appropriate capital adequacy process ensuring the risk profile is matched by adequate capital .