Assessment Experience

A review of FSAP experience with BCP assessments reveals areas of strengths and weak­nesses (see table 5.1). Notwithstanding better overall performance of industrialized


Table 5.1. Observance of Basel Core Principles for Effective Banking Supervision

Core principle (number and main topic)

Issues raised by assessors

1.1 Framework for supervisory authority/ objectives

Fragmented responsibilities; unclear role of external auditors

1.2. Independence

Political interference in licensing and remedial measures; forbearance; insufficient legal protection; weak autonomy; insufficient staffing.

1.3. Legal framework

Insufficient basis for cooperation and information exchange, also with foreign supervisors.

1.4. Enforcement powers

Legal basis inadequate or overly rigid; forbearance, court intervention, need to consult political authorities.

1.5. Legal protection

Rules on legal protection not explicit, inadequate or absent; no rules on legal expenses; accountability concerns.

1.6. Information sharing

Lack of legal basis or formal agreements; rigid confidentiality constraints, MOUs not implemented in practice.

2. Permissible activities

No authority to act against unauthorized banks; laws unclear on licensing requirements; no protection of the word "bank."

3. Licensing criteria

Reputation of managers not tested; inadequate fit and proper tests, refusal to grant license can be appealed at Ministry of Finance; foreign supervisors not contacted; political interference.

4. Ownership

Prior supervisory approval not required; no fit and proper test for shareholders; no definition of significant ownership, nor qualitative criteria to determine ownership.

5. Investment criteria

No approval authority; inadequate definitions of investments requiring approval; no criteria for impairment of supervision resulting from acquisitions.

6. Capital adequacy policies

No calculation on a consolidated basis; no market risk charges, inadequate risk weightings, inappropriate capital components.

7. Credit policies

Insufficient supervisory guidance on credit policies; no rules on arm’s length lending; unclear board and management responsibility for credit policies; no dissemination of policies to staff; insufficient supervisory monitoring.

8. Loan evaluation

Insufficiently rigorous loan classification and provisioning rules, insufficient monitoring, no cash flow based assessment, rules too lenient on use of collateral, restructured or evergreened loans, no tax deductibility for specific provisions, off-balance sheet items not included.

9. Large exposures

Exposures not reported/monitored on a consolidated basis, inadequate and/or overly rigid criteria to establish group connections.

10. Connected lending

Regulations absent or without sufficient legal basis; inadequate/overly rigid definitions of connectedness.

11. Country risk

Absence of regulations, usually because banks have little or no exposure.

12. Market risk

Absence of regulations, or inconsistency with Basel guidance, usually because banks have little or no exposure; no supervision on a consolidated basis, weak or no enforcement.

13. Other risks

Absence or inadequacy of rules on risk management, absence of guidelines on interest rate, liquidity and operational risk; inadequate supervisory capacity.

14. Internal control

Inadequate or no standards, unclear responsibilities of management for internal controls, examination mandate inadequate, no rules on corporate governance.

15. Anti-Money laundering

Inadequate or no legal framework.

16. On-site and off-site supervision

Inadequate frequency of visits, staff shortages, insufficient skills, no risk-based supervision, unclear objectives.

17. Contacts with bank management

Insufficient frequency, no clear procedure to maintaining contact.

18. Off-site supervision

No supervision on a consolidated basis, reporting framework not set by supervisor, non-bank affiliates not covered, inaccurate reporting.

19. Validation of information

Inadequate response to weak audits, no control over external auditors, insufficient frequency of inspections.

20. Consolidated supervision

No requirements on consolidation or consolidated supervision, no legal basis to require consolidated reporting, scope of consolidation too limited, e. g., not covering non-bank affiliates, no reporting of related interests.

Table 5.1. (continued)

Core principle (number and main topic)

Issues raised by assessors

21. Accounting

Standards do not comply with IAS, supervisor has no authority to set bank accounting standards.

22. Remedial measures

Insufficient legal basis, enforcement ineffective, forbearance, limited range of measures, proactive action not possible, court intervention.

23. Global consolidation

Scope too limited, no supervision on a consolidated basis, insufficient authority to oversee foreign banks, insufficient information exchange and MoUs.

24. Host country supervision

No formal arrangements for contacts with home supervisors, little contact in practice, confidentiality constraints.

25. Supervision of foreign establishments

Insufficient exchange of information, insufficient MoUs, no inspection authority for foreign supervisors.

Source: IMF 2004a.

countries, similarities in relative strengths and weaknesses exist across all country income groups (industrialized, developing, and emerging). It is significant to note that, in all countries, the broad area of credit risk management has relatively low rates of compliance. Principles relating to the overall foundation for supervision (i. e., the legal and regulatory framework, licensing, and supervisory practices) are relatively well observed when com­pared with the principles on credit policies, loan evaluation, and risks related to country, market, and other variables. These are areas that affect banks’ condition most directly, and their relatively low observance is a matter of concern.

Two crucial areas that are also relatively weak are those of capital adequacy and con­solidated supervision. The two areas are connected because, in a number of cases, capital adequacy systems were considered noncompliant or materially noncompliant because capital adequacy was not calculated on a consolidated basis. Also, other prudential stan­dards, such as those related to loan quality and other prudential standards, are much less meaningful if supervision is not exercised on the basis of consolidated reports, accounts, and implementation of remedial action. The principle on anti-money-laundering is also among those that are insufficiently implemented in many countries.

The experience of assessments to date indicates that developing countries generally show lower levels of compliance with the BCPs, whereas many transition countries have intermediate levels of compliance. Advanced economies generally satisfy the precondi­tions more robustly and achieve the highest level of compliance overall. Compliance with the BCPs is positively correlated with observance of the preconditions and the stage of development of the financial sector.

In general, the main areas of weakness identified by assessments of observance of the BCPs relate to supervisory independence, legal protection for supervisors, and informa­tion sharing with other supervisors. Compliance with respect to the principles on credit policies and connected lending, as well as the practices relating to loan classification and provisioning, also appears to be low. Consolidated supervision, especially for large complex financial institutions, is another area of weakness that has been identified in

assessments performed to date. The rules on anti-money-laundering and combating the financing of terrorism (AML-CFT) need to be more strongly implemented, as do prompt and effective remedial measures. Finally, systems for managing country risk and market risk were identified as needing improvement in many countries that were assessed.

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