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Unformatted text preview: BANKING PRACTICE The Principal Areas Covered By Prudent Banking Regulations 1 GROUP MEMBERS NO. NAME REGISTRATION NO. 1 OGALLO DANCAN OTIENO D33/2844/2013 2 3 4 5 2 1.0 Criteria for entry This area should specify the basic entry qualifications such as: professional qualifications, experience, financial, banking, and sound ethical standards. The establishment of specific criteria for entry can reduce potential for political interference in licensing process. To further reduce political interference or the influence of specific interest groups, decisions regarding licensing should be delegated to the supervisory unit. 3 2.0 Capital Adequacy Capital adequacy is necessary to absorb unusual losses. Prudential Regulations should state minimum amounts required and maintenance of percentages of total assets or depositors. In either case, the components of what constitutes capitals should be clearly defined. Given that the purpose of capital is to absorb unusual losses, the measurement of capital adequacy should be related to the areas of greatest risk that is assets and offbalance sheet contingencies. Dividend payments should not be permitted if the minimum percentage is not met. 4 3.0 Asset Diversification Banks can increase their returns or reduce their risks, or generally achieve a better combination of risk and return by diversifying their operations. Prudential regulations aim at restricting banks on the basis of geographical or product diversification to prevent the concentration of risk to a single borrower or a related group of borrowers. In some developing countries these restrictions are circumvented by borrowers who borrow through nominees. To avoid this, prudential regulations should specify rules for combining loans to the ultimate user of credit. Lending limits should normally apply to both unsecured and secured credits. 5 3.0 Asset Diversification cont`d Opponents of this limitation argue that lending limits impose an unwarranted constraints on banks in capital short economies or on indigenous banks in systems where foreign owned banks are dominant. Notwithstanding these concerns, the failure to abide by reasonable prudential limits frequently results in banking insolvency and systemic distress. The costs of bank failures invariably outweigh the short-run constraints imposed by lending limits. By imposing a reasonable lending limit, bank supervisors will be sending a strong message that banks must have enough capital to attain a certain scale of operations that will permit them to compete effectively and serve their large customers. 6 4.0 Loan to Insiders A frequent cause of loan problems is credit granted to bank insiders and other connected parties. Such credit may not meet the same standards of appraisal and disbursement conditions as that extended to outside borrowers, and the amount of credit often exceeds prudent levels. Invariably, the close linkages result in losses. Therefore, limits on loans to insiders, including large shareholders and related companies, should be established and enforced. These limits should not only limit the amount of credit extended, but should also require that the terms and conditions of such credit not be on more favorable terms than credit extended to similarly situated outside borrowers. 6 5.0 Permissible or prohibited activities Permissible or prohibited activities. Prudential regulations should detail the permissible activities for banks or conversely the prohibited activities. Such regulations should address whether banks can engage in commercial activities, own equity states in firms or enterprises and participate in nonbanking financial activities. In situations where regulations do not adequately define permitted or prohibited activities, banks may engage in commercial activities or enter lines of business that are unsuitable for financial institutions because of the risks involved and the specialized expertise required. Lack of prohibited activities increases the risks banks assume in their quest for profits and growth. 8 6.0 Asset classification and Provision There is need for banks to systematically and realistically identify their problem assets, establish realistic provisions for potential losses, write-offs, or fully provide for actual losses. One way of accomplishing this is to introduce regulations that require banks to: I. Classify their assets as to quality according to specific criteria II. Define nonperforming assets III. Require the suspension of interest and reversal of previously accrued but uncollected interest on non performing assets IV. Preclude the refinancing or capitalization of interest V. Specify minimum provisions to the reserves for possible losses based on the classification of assets. The percentages established for provisions may in some sense be arbitrary. However, on balance, they will establish some discipline in the credit process and force the banks to more accurately reflect their actual state of affairs. 9 7.0 Submission of false information by borrowers In many cases banks base their decision to lend on the basis of financial and other information presented by borrowers. To strengthen the position of banks in obtaining sound financial information on which to base their credit decision, regulations should make it illegal for a borrower to submit false information to obtain a loan. This would provide a means of recourse within the legal system for the banks to pursue damages. 10 8.0 Scope, Frequency and content of the audit Programme Depositors, investors, and creditors of a bank should have reliable and timely information so as to make informed decisions when transacting with a bank. Therefore regulations should:I. II. III. Empower supervisors to establish auditing standards and minimum disclosure requirements Provide a means for disseminating information that is complete, timely and uniform thus permitting comparison, informed decision making and market discipline. Empower supervisors to appoint and dismiss auditors. 11 9.0 Enforcement Powers Bank supervisors should be given powers to enforce actions at intermediate stages These powers should include: I. power to remove management or directors II. power to fine individuals as well as institutions, for criminal acts or violations of banking regulations III. civil money penalties on individuals who engage in unsound and unsafe banking practices IV. the right to restrict or suspend dividend payments V. power to withhold branch or other corporate approvals VI. cease and desist authority VII. power to impose financial liability against bank directors for losses incurred due to illegal acts carried out by the bank for example violations of the lending limit that result in loss. 12 10.0 Treatment of Problem and Failed Banks • In a bankruptcy situation, bank supervisors should be given special powers to declare banks insolvent, close banks, and place them into receivership, in the interest of speed, and of depositors. 13 11.0 Deposit Protection Schemes The primary objective of deposit insurance is to avert bank runs and protect the stability of the banking system. Another purpose is to protect small depositors and promote competition by encouraging the creation of small banks. However, deposit insurance suffers from moral hazard in that it might encourage bank supervisors, bank owners, and bank customers to have a false sense of security and lead to the taking of imprudent and unacceptable risks. 14 12.0 Commercial Laws The laws governing debt recovery, bankruptcy and other commercial aspects must be designed in such a way that they take into account the needs of banks in terms of debt recovery, liquidations speed etc. 15 13.0 Problems facing bank supervision Bank supervisory problems include: I. II. III. IV. V. Conflicting public policy goals, Political interference, Lack of political will to take appropriate action, organizational weaknesses such as understaffing and inadequate compensation, Poor leadership and divided supervisory responsibilities. . Problems may also arise from examination methodologies that focus on technical compliance with laws and regulations pension of interest and reversal of previously accrued but uncollected interest on non performing assets 16 13.0 Problems facing bank supervision cont`d Preclude the refinancing or capitalization of interest Specify minimum provisions to the reserves for possible losses based on the classification of assets. The percentages established for provisions may in some sense be arbitrary. However, on balance, they will establish some discipline in the credit process and force the banks to more accurately reflect their actual state of affairs. 17 Roles of on-site examination and off-site monitoring The roles of on-site examination and off-site monitoring can be summarized in the following three points, all of which the Bank considers indispensable to achieve its goals in a responsible manner. i) Contribute to maintaining the stability of the financial system, by monitoring the business conditions and asset quality of individual correspondent financial institutions, and feeding the Bank's findings back to these institutions, to require them to take necessary steps. 18 Roles of on-site examination and off-site monitoring cont`d ii) Building upon i) above, continuously monitor potential risks (including types, magnitude and distribution among correspondent financial institutions) and analyze the mechanisms by which such risks manifest themselves and are transferred within the financial system with a particular emphasis on the fund settlement systems, taking appropriate actions to other parties to prevent materialization of such risks where necessary. Contribute to the overall activities of the Bank, by making the above-mentioned information available to the Bank's credit extension to correspondent financial institutions (including the activation of the "lender of last resort" role), and for smoother and more stable functioning of the payment and settlement systems which the Bank either operates or participates in. 19 Roles of on-site examination and off-site monitoring cont`d The Bank carries out on-site examination by visiting the premises of financial institutions based on the contracts with them, in order to grasp their business operations and the state of the property. The Bank contributes to the stability of the financial system by examining financial institutions' risk management processes as well as reaching an informed judgment on their business activities and financial conditions, and, when necessary, urging improvement, through on-site examinations. 20 Responsibilities Off-site Supervision works on developing an effective risk- based approach that continuously monitors different types and developments of risks facing banks while assessing the extent to which banks are affected by current events. Furthermore, it works on enhancing the early warning system, which allows the CBE to take proactive measures to ensure the safety and soundness of the Banking Sector. The role of Off-site supervision is divided into three main functions: On-going surveillance, Management Information System (MIS) and Corporate Borrowers Monitoring. 21 Offsite supervision The Off-site supervision applies the relationship manager concept whereby each team of relationship managers is responsible for monitoring and controlling individual banks by applying different techniques to enhance the analysis and assessment of banks and ensure that banks are in compliance with rules and regulations set by the CBE. The main source of information is the financial and prudential returns periodically received from banks, along with other periodic statements such as Central Credit Registry – CCR reports and shareholders statements. These periodic returns and statements could be supplemented by further information requested from banks on ad-hoc basis if deemed necessary. 22 Offsite supervision cont`d The department also receives data and information from multiple sources such as audited financial statements from external auditors, (which have to be ratified and approved by CBE prior setting the bank's General Assembly meeting according to article (84) of law no. 88 year 2003), reports from other regulatory bodies, market information, On-site inspection reviews. Moreover, periodic meetings with banks' senior management and directors take place on regular basis. 23 Offsite supervision cont`d Full-fledged reviews, analysis, and assessment of the bank's risk profile including but not limited to CAMELS, SWOT and peer analysis…etc. The process encompasses the review and assessment of financial statements, periodic capital adequacy ratio, liquidity, and market and credit risk reports. The Off-Site department helps identify the scope of the OnSite inspection by detecting the most relevant and prioritized risk areas that should be examined based on reports from the Off-Site as well as several different departments. Upon the completion of the on-site inspection the department receives and follows-up with banks' Corrective Action Plan (CAP) that include bank's remarks on the findings and issues raised by the inspection along with given time frames for their rectification 24 Tools to ensure the quality and timeliness of data requested The Banking Supervision Sector has developed a number of tools to ensure the quality and timeliness of data requested, thus facilitating and reinforcing its supervisory actions in a risk-based supervisory system. Furthermore, the department produces several reports that address and asses various risks, some of the most prominent reports include: 1. The Bank Risk Profile; a report that covers each bank's detailed financial information, risk analysis and relevant trends. In addition to each bank's comparison to its peer group. 25 Tools to ensure the quality and timeliness of data requested cont`d The CAMELS report, which is used to measures the strengths and weaknesses of a given bank, based on both quantitative and qualitative factors. Moreover, different analysis takes place on the model such as peer and trend analysis, noting that the inspection teams are provided with the results of this report as part of the data that is presented to the On-site department during the preinspection phase for the purpose of validation. Stress Testing Reports; As part of the assessment process, standard as well as ad-hoc stress testing is conducted periodically to assess potential adverse scenarios related to perceived volatility of loss events that could negatively affect banks. 26 Tools to ensure the quality and timeliness of data requested cont`d In view of these reports, if any evolving problems are detected and identified in any of the reports produced by the department, the bank is contacted for prompt rectification of these problems in a timely manner or unscheduled inspection visits may be conducted. 27 Management Information System (MIS) The main responsibility of the MIS unit is to develop and upgrade the reporting systems as well as the on-going surveillance reports (Financial & Regulatory). These reports are risk focused and in line with the International and Financial Accounting Standards (IFRS). It also produces wide range of reports and information that serve different departments within the CBE as well as other external governmental authorities concerning the Banking Sector. Moreover, MIS consolidates data for the banking sector and provides data support for the on-going surveillance process. 28 Monitoring of large corporate borrowers and their connected parties Corporate Borrowers Monitoring Unit's prime objective is to act as an early warning tool to detect any weaknesses in large corporate exposures and to ensure that these exposures are in line with CBE regulatory requirements as well as the prudent credit extension practices. Central Bank of Egypt Banking supervision sector. It also aims to measure concentration risk within various sectors and industries as well as examine banks' credit exposures and resilience to adverse conditions. 29 ...
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  • Spring '14
  • Lishenga
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