Catalog

	Table of Contents
p. 31 of 58 BACK | NEXT Purpose and Structure of the Toolkit Part One: Introduction and Overview Part Two: Preconditions and Infrastructure for Financial Sector Development Part Three: Financial Regulation and Supervision I. Financial Stability, Development and Institutional Design II. Financial Regulation: General Principles III. Financial Regulatory Structure IV. Banking Regulation A. International Standards B. Guidance and Recommendations V. Bank Insolvency and Depositor Protection VI. Securities and Derivatives Regulation VII. Insurance and Pensions Regulation VIII. Regulation of Financial Conglomerates Part Four: Regional Financial Integration Part Five: ADB's Intervention in the Financial Sector Bibliography Glossary and List of Abbreviations Acknowledgements

Financial Sector Legal and Regulatory Toolkit : Part Three: Financial Regulation and Supervision : IV. Banking Regulation

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A. International Standards

1. Core Principles for Effective Banking Supervision
2. Other International Standards
3. Implementation

In the area of banking regulation and supervision, the Basel Committee on Banking Supervision, composed of the G-10 central bank governors, has been most active, especially with its Core Principles for Effective Banking Supervision [ PDF ]. Released in September 1997 and revised in 2006, this document, prepared in close cooperation with non-G-10 supervisory authorities, is intended to serve as a basic reference for supervisory and other public authorities in all countries and internationally.

Prior to the development of its Core Principles, the Basel Committee has historically been most active in establishing internationally agreed minimum standards for adequate capitalization of financial institutions. These standards should constitute a minimum floor in this respect: capitalization standards applied in practice need to be higher if the risks are higher because of vulnerabilities to external disturbances, a history of weak macroeconomic performance, or undeveloped financial markets.

As a result of the global financial crisis, the Basel Committee is currently focused on revising capital standards and developing standards for liquidity and leverage. Overall, the G-20 has tasked the FSF and the Basel Committee to ensure that the standards being developed reduce procyclicality in the financial sector and enhance financial stability and transparency.

Core Principles for Effective Banking Supervision

Essentially, the Basel Committee has prepared a list of twenty-five basic principles that should underlie the banking supervisory policies and structures. These principles are then enumerated in a compendium of existing Basel Committee documents which are cross-referenced in the Core Principles [ PDF ] and are intended to expand upon them and explain their application and are to be periodically updated, as additional documents are released. In addition, a methodology for implementation has been produced. Detailed guidance in the implementation of the Core Principles is in turn provided through the Basel Committee's compilation of its on-going pronouncements over the years.

While these Principles are very instructive in terms of coverage and issues, they nonetheless must be implemented by domestic authorities individually.

As a precondition, an effective system of banking supervision requires the delineation of clear objectives and responsibilities for those involved, along with operational independence and adequate resources. This should be established as part of the legal framework for banking supervision, which should also provide for authorization and on-going supervision of banking organizations; adequate regulatory powers; and legal arrangements for confidentiality and information sharing between supervisors. The legal framework must clearly define permissible activities of banks and restrict the use of the term to regulated entities, with clear requirements for licensing and changes in ownership, whether through merger or transfer.

In terms of the twenty-five Core Principles themselves, they are divided into three sections:

• Objectives, independence, powers, transparency, and cooperation (Principle 1);
• Regulation of banking activities (Principles 2 through 18 and 22)
• Role of banking supervisors (Principles 19 to 21 and Principles 23 to 25)

Powers and responsibilities for prudential regulation must include appropriate minimum capital requirements; and appropriate evaluation of banks' lending, investment, asset quality evaluation, and loan provisioning policies. In addition, supervisors must ensure the existence of adequate management information systems and compliance with limits on exposures to single or groups of related borrowers. Such supervision must extend to requirements to prevent connected lending and other non-arm's length transactions. Beyond credit risk monitoring, supervisors must monitor banks' market risk systems as one aspect of banks' overall risk management systems—an especially difficult task in volatile markets with thin banking experience. Adequate internal controls also must be ensured, including appropriate "know-your-customer" (KYC) mechanisms and ethical standards to prevent money-laundering and financial crime.

Beyond initial systems, ongoing supervision requires both on-site and off-site monitoring, including regular contact with bank management to provide a thorough understanding of each institution's operations. This must include both piecemeal and consolidated information collection and analysis, along with independent validation of information supplied by supervised institutions. Consolidated supervision of banking groups is essential. In order for such ongoing supervision to be effective, each bank must maintain adequate records drawn up in accordance with consistent accounting standards and practices, preferably of an international standard.

In order to be effective in their supervisory efforts, supervisors must have adequate powers to bring about timely corrective action in circumstances where banks fail to meet prudential requirements outlined above. This should include the ability to revoke banking licenses in extreme cases.

Finally, because of the increasingly cross-border nature of banking activities and the greater risks that such activities lead to in the international financial system, banking supervisors must practice global consolidated supervision over their authorized internationally active banking organizations. A key component of this is contact and information - sharing with other supervisors, especially host country supervisors. Host country supervisors in turn must require local operations of foreign banks to be conducted to the same high standards as required for domestic institutions.

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Other International Standards

In addition to the Basel Core Principles, the FSF has included a number of other Basel Committee documents in its Compendium. These are divided into five categories:

1. General. In addition to the Core Principles, this includes standards for customer due diligence for banks and the Core Principles methodology to be used for assisting in the implementation of and assessing compliance with the Core Principles.
2. Capital adequacy. The 2004 Basel II Capital Accord, which superseded the 1988 Basel Accord, and its various amendments and modifications with respect to market risks.
3. Cross-border supervision. This includes the Basel Concordat (Basel Committee, Minimum Standards for the Supervision of International Banking Groups and their Cross-border Establishments (July 1992) [ PDF ]; Basel Committee & Offshore Group of Banking Supervisors, The Supervision of Cross-border Banking (October 1996)) and its subsequent development.
4. Disclosure and transparency. Guidance with respect to bank transparency and accounting.
5. Risk management. Guidance on management of credit risk, interaction with highly leveraged institutions such as hedge funds, operational risk, internal control systems, electronic banking and electronic money, interest rate risk, and derivatives.

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Implementation

A review in December 2002 [ PDF ] based on the assessments undertaken under the FSAP in the area of banking supervision reached a number of key conclusions:

• Effective supervision and full compliance are not possible unless the preconditions for effective supervision are met, namely
  1. stable macroeconomic policies,
  2. well-developed legal and judicial infrastructure,
  3. effective market discipline,
  4. procedures for effective resolution of banks, and
  5. effective safety nets.
  Unfortunately, these are not actually included in the Basel Core Principles.



• Independence of the supervisory authority, as expressed in Basel Core Principle 1, is important.
• Improvement in compliance is especially needed in relation to credit policies and connected lending.
• Loan evaluation and provisioning practices tend to be weaker than the rules, placing doubt on capital adequacy issues; consolidation is also often weak.

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