[email protected] The WorldBanksiteresources.worldbank.org/EXTFINANCIALSECTOR/Resources/282884...Back-to-Basics: transparency ... who controls +who takes decisions: Support

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DC Seminar 2008 Oct. Senior Supervisors 1

BankThe World

ComprehensiveComprehensiveConsoliConsolidateddated SupervisionSupervision

((CCSCCS))

Washington, October 2008

J. Gutiérrez G.

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A Few More Challenges than in Solo Bank SupervisionGroups are a fact of life, complex, difficult to supervise risksDrivers: competition, conglomeration cross/sector, complexity, convergence In our countries, most groups come as a mix of economic & financial formsDilemma for Supervision: concentration of economic-financial power Pose politically sensitive inter-disciplinary legal issues & definitions.Cross-border groups add complexity and complicate supervision a lot.Pose delicate coordination issues, both locally and internationally.Complex interplay: investors, shareholders, BoD, management ≠ value setBack-to-Basics: transparency + allocate responsibilities + assertivenessSignificance of Governance: who controls +who takes decisions: Support in systems: control, information, risk mng, audit, complianceCrucial Points for the SeminarCrucial Points for the SeminarTransparency of Structures +Conglomeration Risks +Effectiveness of CapitalOur Resources under stress: impossible to capture & be informed of everythingOnly way out: Risk Based Supervision to make-up for ∆ work load/complexityRationale: Risk Based CCS Need Comprehensive Process Design. But: Different legal & institutional cultures at play coordinate vs. integrateMain Purpose of Seminar: Share Experiences.

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© J. Gutiérrez: 20072

Scope of Topics for the Seminar: Core ThemesScope of Topics for the Seminar: Core ThemesWhat? Why? Scope? How? Purpose? What? Why? Scope? How? Purpose?

Conglomerate Group: Conglomerate Group: Two or more legal entitiesTwo or more legal entities linked via linked via common ownership or controlcommon ownership or control at least at least one of them a Bankone of them a Bank

““ ComprehensiveComprehensive approach to evaluate approach to evaluate the strength of the strength of an entire groupan entire group, , considering all the risksconsidering all the risks that may affect a that may affect a bank, regardless of whether these risks bank, regardless of whether these risks are booked in the bank or are booked in the bank or in related in related entitiesentities „„ (Bank of England, 1998).(Bank of England, 1998).

““ Same rules, same practices, wherever risks are Same rules, same practices, wherever risks are originated, booked, and managed: Convergence originated, booked, and managed: Convergence to mitigate regulatory gaps and asymmetriesto mitigate regulatory gaps and asymmetries. . „„

Propose a Concept What is it?

Summary: Concept““ Comprehensive approach to evaluate the Comprehensive approach to evaluate the strength of an entire groupstrength of an entire group, considering all the , considering all the risks risks that may affect a bankthat may affect a bank, regardless of whether these risks are booked in the bank , regardless of whether these risks are booked in the bank or in related or in related entities entities „„ ((BoEBoE, 1998, 1998) ) „ - ““ Supervise and regulate the risks inherent to financial products in the same manner whatever is the form of financial intermediation used to deliver them, considering the significance of residual unconsolidated conglomeration risks. „ -- “ Same rules, same practices, wherever risks are originated, booked, and managed: Convergence to mitigate regulatory gaps and asymmetries. „

Summary: Topics for DiscussionWhat: Two or more legal entities linked via common ownership or control (providing providing financial services)financial services), at least one of them a bank (cross-sector and/or across border). Scope: Banking, Financial (FC) & Industrial Groups (FIG) = Conglomerate GroupsTerms: Scope of Group – Perimeter of Consolidation – Focal/Locus – Lead CoordinatorWhy: Additional risks of contagion, transparency, autonomy, effectiveness of capitalHow: Consolidated accounting, quantitative regulation, qualitative supervision, MoUPurpose: Essential complement of solo supervision (c.s.q.n) which allows us to:•Understand risks from relationships among legal entities, controllers & their related parties•Assess and track risks of activities wherever: originated, booked, managed, contributing;•Spot advanced indications of trouble and identify routes of contagion for monitoring;•Ascertain integrity, effectiveness, location & transferability of capital vs. materiality of risks;•Have a strategy to respond-mitigate risks to bank from risks from non-bank and controllers;

Feel Free to Interrupt, Comment and Question

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Document cases: focus into conglomeration risks that appear from association to a wider conglomerate group

To Big to: Fail, Manage, Supervise, Stay Out of TroubleThe Challenge

Sub-Groups of Firms and Owners


The Banking-Financial Group

Bank 1 Bank 2 Insurance 1 Securities 1 Other

Ultimate BeneficiaryControllers

Industrial-CommercialUndertakings

Real Estate & HoldingUndertsakings + SPV

Overall Conglomerate Group

AggregatedRAS

CombinedConglomeration

Risks

From

FCFr

om N

FC

TransparencyContagionAutonomy

Effectivess of Capital

Structures under review:• Legal units• Business activities• Ownership/control• Management / Control

• Intragroup transactions & exposures

• Source of capital – Use of debt

• Horizontal Conglomerate Group

A Few More Challenges than in Solo Bank Supervision Groups are a common fact of life in most of our countriesfact of life in most of our countries, complex, difficult to supervise risksDriversDrivers: competition, conglomeration cross/sector, complexity, convergence In our countries, most groups come as a mixmost groups come as a mix of economic & financial formsDilemma for Supervision: concentration of economicconcentration of economic--financial powerfinancial powerPose politically sensitivepolitically sensitive inter-disciplinary legal issues & definitions.CrossCross--border groups add complexityborder groups add complexity and complicate supervision a lot.Pose delicate coordination issuesdelicate coordination issues, both locally and internationally.Complex interplay: investors, shareholders, BoD, management ≠ value setBackBack--toto--BasicsBasics: transparency + allocate responsibilities + assertivenessSignificance of good Governance practiceSignificance of good Governance practice: who controls +who takes decisions: Support in systemsSupport in systems: control, information, risk mng, audit, compliance

Crucial Points for the SeminarCrucial Points for the SeminarTransparency of Structures +Conglomeration Risks +Effectiveness Transparency of Structures +Conglomeration Risks +Effectiveness of Capitalof CapitalOur Resources under stressunder stress: impossible to capture & be informed of everythingOnly way outway out: Risk Based Supervision to make-up for ∆ work load/complexityRationale: Risk Based CCS Need Comprehensive Process Design. But: Different legal & institutional cultures at play coordinate vs. integrateMain Purpose of Seminar: Share Experiences.

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Country Work: Findings of the discovery process

Policy Response: Concepts, powers, responsibilities, risk mitigaPolicy Response: Concepts, powers, responsibilities, risk mitigation tion

Supervisory Process: Practices, integration, risk assessment fraSupervisory Process: Practices, integration, risk assessment framework mework

ConclusionsConclusions

Informal summary of themes for discussing recurrent issues Informal summary of themes for discussing recurrent issues confronted as part of our work in advising countries regarding confronted as part of our work in advising countries regarding implementation of comprehensive consolidated supervision...implementation of comprehensive consolidated supervision...

PRESENTATION OUTLINE Topics & Themes for Discussion

Experiences from Country Work• Different modes of Country engagement (i.e., FSAP) led to an Advisory ServiceAdvisory Service• Common issues detected in many countries: walked through a country case• Engagement is a process, not an event: will go through some of the steps• In most cases: find CCS limited due to several issues to be presented• One of the BCP where countries show less level of compliance • In most cases: conglomeration risksconglomeration risks not well assessed and considered• Will discuss these risks, and how Policy Response/Supervision can solve them

Depth of Policy Issues

• Enrich and make relevant definitions more clear and precise• Broaden powers of Supervisor in crucial areas essential for CCS• Reset the responsibilities of Boards of Directors: in parent and group members• Enable means to mitigate/insulate members banks from conglomeration risks• Capital Deductions of risks excess at different levels and Risk Flanking Policies

Reinforce the Supervisory Process• Expand supervisory practice for CCS: Complement Practice to Complete CCS• Change in Organization: Integration rather than Amalgamation• Change in Risk Assessment Framework: Aggregation from Solo to Group Rating• Two pronged Assessment: Qualitative and Quantitative• Crucial importance of systems: MIS and de-consolidation.

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Our advice is based on a blend of onsite country work and real lOur advice is based on a blend of onsite country work and real life ife supervisory activities (supervisory activities (Bank of SpainBank of Spain) and consists on practical hands) and consists on practical hands--on discussions on processes upon a complex group case.on discussions on processes upon a complex group case.

Case Testof Manual

Onsite

SoftwareCoding

(*)

Software ToR & Specifications for Risk Assessment of Conglomeration Risk

Final Report Documentation

Discussion of Results + Project Concept & Road Map

(post Review Work Plan)Trust Funding (i.e., FIRST)

Review of Regulatory &AccountingFrameworks

BG, FC & FIG

CCS reports and software concept

Review of Supervisory

Practices andAnalysis ofFC Maps

ManualUBPR

CCS ChapterManual ProcDevelopment

TrainingCourse

(*) Out of current scope

Prototyp

e Fin

alization

Interview Protocols andPreparatory Questionnaire

ADVISORY PROCESS

Inventory ofNeeds & Issues

Structured Approach to Assist Country Supervisors

Proposal + Drafting of Amendments toLaw & Regulations

Inventory of Inventory of Common NeedsCommon Needs Found in Practice Found in Practice ……Broaden the scope of related entities to capture excluded material entities/activities;

Expand perimeterExpand perimeter of consolidating entities and the deductions of residual risks inter-group;

Identify ultimate beneficiary owners & controllers to measure related party risk accumulation

Structures of FC evolving to weaker regulated forms/locus obfuscating actual group structure

Complete the criteria & procedures to prepare consolidated accounts (solo IFRS 27)

Augment information: synthesis of consolidation to trace eliminations/changes in reserves;

Detect compensating of loss-provisions-capital at consolidated level not done at solo level;

Require group systems to tag, identify, record and track group related parties and ITE

Evaluate the risks involved in the strategies and business lines of FC;

Understand (examine) group MIS, ICS, RMG, and versatility of systems to visualize contribution

Understand how Bank/FC strategies depend on the goals & strategies of the final parents;

Evaluate effect of controllers financing capital with debt, or issuing unregistered shares;

Assess whether normal lending criteria is overridden under pressure from owners;

Identify whether owners agreeing with owners of other FCs to take on each others’ loans…

…… Opens a Broad Set of Policy Issues to Resolve Opens a Broad Set of Policy Issues to Resolve ……

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1st. Step is to document and supplement the Structures of the Groups(Ownership, Control, Legal, Businesses, Governance) to understand where activities: take place, are booked, decisions made by whom, risks managed..

Group Structures

CommercialCommercialfirmsfirms

Banking Banking InstitutionInstitution

IndustrialIndustrialfirmsfirms


Securities Securities CompanyCompany

InsuranceInsuranceFirmFirm

MixedMixedGroupGroup

FinancialFinancialConglomerateConglomerate


Financial Financial SubsidiarySubsidiary

Ancillary Ancillary SubsidiarySubsidiary

BankingBankingGroupGroup

Common Features in EMG: Crucial role in economy; Frequently Common Features in EMG: Crucial role in economy; Frequently engaged in nonengaged in non--financial activities; Boundaries usually not well defined; financial activities; Boundaries usually not well defined; Concentrated ownership & control; Family connections. Concentrated ownership & control; Family connections.

Map Group Structures Bottom-Up & Top-Down

Co

ng

lo

me

ra

te

Gr

ou

p (C

G) M

os

t c

as

es

:M

ixe

d H

or

izo

nt

al

• Understanding structures crucial to mitigate transparency & contagion risks.• Crucial structures: Ownership, Control, Legal, Business, Management … vs. MIS• Risks not treated at Solo + Consolidate levels: How to mitigate and ring fence• Different Risk Implications Different Risk Aggregation Methodology (RAM)• No anymore a backward looking post accounting recalculation exercise.

Risk Profile of FC = Aggregation of RAS from Solo Financial Firms

Bank 1 Bank 2 Insurance 1 Securities 1 Other

Ultimate BeneficiaryControllers

IndustrialUndertakings

CommercialUndertsakings

Overall Economic Group

AggregatedRAS

CombinedConglomeration

Risks

Overall Net Risk Profile from Aggregation of Solo Firms

From

FCFr

om N

FC



TransparencyContagionAutonomy

Effectivess of Capital

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Country Case A (1)

Banking CapitalHolding

Company

BankCapital

MortgageBank

BankEast

9.15% 7.52%

““ We have one of the most complete and modern banking laws in theWe have one of the most complete and modern banking laws in theregion and perform fully fledged consolidated supervision of banregion and perform fully fledged consolidated supervision of banking king groups using a holding company model groups using a holding company model …… ““

Substance Over Form: Look Through Legal Structures

•1st. Step: ascertain the group structuresgroup structures (several levels and angles): “the Web”.•2nd. Step: identify ultimate beneficiary ownersultimate beneficiary owners (UBO) + their related parties•3rd. Step: discover the scope of the overall economicscope of the overall economic & financial group (real vs. legal)•4th. Step: identify controllers if different from UBOcontrollers if different from UBO (proxies, interlocking directors, …)•5th. Step: map the webmap the web under all dimensions (legal, geographic, economic … ) •6th. Step: identify regulatory & supervisory gapsregulatory & supervisory gaps (powers, duties, responsibilities, tools…)•7th. Step: develop a road maproad map to phase out economic and regulatory reform.

Where take place the (financial) activities of the group?Where take place the (financial) activities of the group?

Where are these booked?Where are these booked?

Which commercial/industrial undertakings?Which commercial/industrial undertakings?

Where/how are these financed?Where/how are these financed?

Disciplined process & procedures for mappingDisciplined process & procedures for mapping

Compilation in Relational Database (Excel?)Compilation in Relational Database (Excel?)

Inquisitive investigation workInquisitive investigation work

Disclosures & NotificationsDisclosures & Notifications

Mapping Stage : Mission (1): Initial set of innocent questions

BackgroundBackground

• Emerging Country with Investment Grade. Several visits, started in 2004.

• Relatively concentrated economic & financial wealth among several groups.

• Recently integrated supervisory agency with strategic & organizational issues

• Initiated road map for migration to risk based supervision inc. PD for CRM

• Legal reform provides power to access controllers of parent & require disclosure

Work Process is Crucial to Enable AdviseWork Process is Crucial to Enable Advise

• Continuous cycles of discovery, assessment and response. Nothing automatic.

• As part of the process of socio-political and economic development (slow?)

• Ultimate game: complete financial markets and institutional framework

• Goal: transparent risks & wealth distribution among different stakeholders

• End road map: transition of closed tight groups’ funding sources to markets

• The incredible journey of discovery of the mapping process

• Main output is been standardized process to tackle and externalize issues

• Includes country questionnaire and road map project concept.

• Implementation slowed due to organizational changes > now FIRST program

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Company

BankCapital

MortgageBank

BankEast

9.15%

Life InsuranceCompany

Another LocalBank

GeneralInsuranceCompany

7.52%

5.58%

Country Case A (2)

““ Our Law only allows us to determine the first level of Our Law only allows us to determine the first level of ownership for natural persons and this group does not have ownership for natural persons and this group does not have any controlling single shareholder any controlling single shareholder …… identified up till nowidentified up till now…“…“

•8st. Step: assess quality and effectiveness of group management control functionsgroup management control functions•9th. Step: review & understand group accounts (financial & managerial, MISgroup accounts (financial & managerial, MIS) •10th. Step: ascertain and right fit the perimeter of consolidationperimeter of consolidation for the financial group•11th. Step: validate the groupvalidate the group’’s accountss accounts•12th. Step: design a long term visionlong term vision: what responses do we expect from the group?•13th. Step: adopt supervisory strategysupervisory strategy (resources, triggers, outcomes) •14th. Step: advocate for new regulatory policiesnew regulatory policies• Continued Cycles: discovery, assessment, response….

Steps are Recurrent along the Road Map Process

How good/effective are the systems in place?How good/effective are the systems in place?

MIS, financial control, and internal audit?MIS, financial control, and internal audit?

What are the contributions of units?What are the contributions of units?

How does group RMG work?How does group RMG work?

Where are decisions taken (who decides)?Where are decisions taken (who decides)?

Which role/tension among different BoD?Which role/tension among different BoD?

Which gaps identified?Which gaps identified?

Formalize Supervisory Strategy.Formalize Supervisory Strategy.

Mapping Stage : Mission (2)

Comments Comments –– Slide not for DistributionSlide not for Distribution

• Initially, low transparency (difficult discovery to assess and advise)

• No single natural ultimate beneficiary owner explicitly licensed

• Implicit understood control by two individuals (spouses)

• But channels of control and ownership structure not well compiled

• Map of financial regulated, non-regulated and vehicles evolving

• Need polish legal definitions and prudential principles for related parties

• At stake: unknown aggregated level of risks with ultimate controllers

• Use of special vehicles (trusts) to download risks in the regulated group

• Related companies issue paper through SPV privately placed into investors

• Proceeds used to reduce bank loans (problem resolved?)

• Risk shifted, but as energy, cannot be destroyed, only temporarily hidden

• Clear and present danger: contagion channel not financial but still clear

• Difficult to establish level of leverage of controllers with financial group

• Difficult to identify and assess source of last strength if capital needed

• Unsubstantiated Location, Effectiveness, & Transferability of Excess Capital

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BusinessMng.Corp.

InvestmentCorp. D

InvestmentCorp. E


Company

BankCapital

MortgageBank

BankEast

2.18%

32.34%

9.15%


Another LocalBank

6.21%

Business &Shares

Incorporated7.68

%

GeneralInsuranceCompany48

%47

.99%

LocalUnregulatedHolding A

LocalUnregulatedHolding B

LocalUnregulatedHolding C

LegalRepresent

ationCompany

??? %

47.99%

48.08%

82.10%

1.41%3.32% 33.35%

7.52%

5.58%

Total = 43.66%

Total = 50.59%

Particpationsin other real

sectorcompanies

Country Case A (3)

““ We cannot obtain completeWe cannot obtain completedisclosure of the ownershipdisclosure of the ownershipstructurestructure…… ““

Process of Continuous Discovery, Assessment, Response

Role and activities of these companies?Role and activities of these companies?

OperationalOperational vs. SPVvs. SPV

Owners, boards, directors?Owners, boards, directors?

Financial statements and inventories?Financial statements and inventories?

Borrowing, paper issued, lenders?Borrowing, paper issued, lenders?

Main assets and investments?Main assets and investments?

A/R and A/P? IntraA/R and A/P? Intra--group transactions?group transactions?

Cash flow and earnings?Cash flow and earnings?

Asset management: what? For whom?Asset management: what? For whom?


Comments Comments ---- Slide not for DistributionSlide not for Distribution

• Misaligned legal provisions: company law, banking law, regulations

• Need to reinforce disclosures of beneficiary ownership & related parties

• Powers required to access supra holding parties, require data & audits

• Assertiveness in addressing lack of transparency in holding structure

• Adopt a maximum aggregated lending limit for related parties

• Fine tune definitions and aggregation rules

• Capital and limits rules at different consolidation levels (1, 2, 3, need more?)

• Enable capital deduction of risk excess with unconsolidated parties

• Protect FC from relationships with controlling group

• Address non participatory-close funds to finance economic group

• Add concepts to improve scope of consolidation (SPV, multigroup, ect)

• Review valuation criteria for investments at solo-consolidated level

• Enable tracking of location of risks and capital across the group

• Require disclosure of ultimate beneficiary owners in a chain of companies

•• Dilemma: how to advise and assist country without knowing theseDilemma: how to advise and assist country without knowing these details?details?

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Mr. ABC Mrs. XYZ ofABC

ABCOrganizationHolding Co.

BusinessMng.Corp.

InvestmentCorp. D

InvestmentCorp. E


Company

OffhsoreUnregulated

Company

OffshoreUnregulated

Company

OffshoreUnregulatedCompany 2

OffhsoreUnregulatedCompany 1

83%

71.3

0%y%

x%

7%16.11%

BankCapital

MortgageBank

BankEast

2.18%

32.34%

9.15%


Another LocalBank

6.21%

Business &Shares

Incorporated

??? %

Spouses

7.68

%

GeneralInsuranceCompany48

%47

.99%

LocalUnregulatedHolding A

LocalUnregulated

Holding B

LocalUnregulatedHolding C

LegalRepresent

ationCompany

??? %

47.99%

48.08%

82.10%

1.41%3.32% 33.35%

7.52%

Unregulated Holdings in an Offshore Center

5.58%

Total = 43.66%

Total = 50.59%

Particpationsin other real

sectorcompanies

Group Chart only shows main financial firms & un-regulated holding companies. It excludes a number of commercial industrial undertakings. The group uses trust vehicles non-participative funds to privately place paper issued by non-financial undertakings (risk of contagion).

Country Case A (3)

““ We have We have reformed againreformed againthe banking law the banking law obtaining more powersobtaining more powers…… ““

Which firms to include in consolidation?Which firms to include in consolidation?

Horizontal group?Horizontal group?

How many levels above the bank?How many levels above the bank?

Powers needed?Powers needed?


Summary Recommendations & Country Work ProgramSummary Recommendations & Country Work Program• Enable process to Map the structure and involvement of FCs in distinct market segments in order to identify those financial institutions that are related to and/or need to be consolidated under a common FC parent.• Develop framework to identify, assess and aggregate risks posed by FCs as precursor to drafting appropriate regulations and reporting relevant data.• Draft revisions to regulations (conforming to existing legislation) to facilitate consolidated supervision, including accounting rules for FC entities (both scope and methods of consolidation) and prudential standards (e.g. reporting requirements, group solvency, limits and disclosure requirements for intra-group transactions, conflicts of interest situations, mitigants of conglomeration risks).• Reengineer current supervisory processes & procedures, including those related to reporting, in order to implement revised supervisory doctrine and regulations.• Participate in the entire supervisory cycle of a financial institution belonging to a FC in order to ensure (as a proof of concept) appropriate implementation of revised processes and procedures, including information flows and coordination mechanisms across different departments of the supervisory agency.• Prepare revisions to existing legal framework (e.g. supervisory powers, definition of FC or economic group), in line with good international practice, to further strengthen the consolidated supervision framework of FCs in the Country.

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This and other cases highlight how conglomeration magnifies This and other cases highlight how conglomeration magnifies traditional banking risks, exposing banking & nontraditional banking risks, exposing banking & non--banking banking units to new risks difficult to spot, quantify and mitigateunits to new risks difficult to spot, quantify and mitigate……

EffectivenessEffectiveness (integrity, location, transferability) of capital + capital based quantitative regulations:Capital put down by investors outside the group net of unconsolidated financial support

TransparencyTransparency: principal concern which affects all the others due to intra-economic-group relationsBeneficiary owners, controllers, organization of management, controls, financial condition.

Contagion:Contagion: among group members, due to intra-group relationships (financial, reputation-al, etc.)Ignite liquidity stress (run on the bank) that leads to Solvency issues (losses for the bank) Channels financial + Non-financial: Identify, monitor, mitigate, contingent plan to contain

AutonomyAutonomy: of bank units versus controllers (home vs. host boards tension)Duties to Firm, Customers, and Supervisors. Abuse of position (i.e.,allocation policies)Conflicts of interest among controllers, investors, retail shareholders, clients, depositors.

LoopholesLoopholes regulatory arbitrage opportunities (across sectors and cross-country) MoUInconsistency of legislation, standards, practices, cultures, approach;Different prudential rules among FC units and across national jurisdiction

Conglomeration Risks Debilitated Effectiveness of Quantitative Regulation

At Last! We know the additional risks

Transparency: Possibility that membership to a broader group obfuscates obfuscates standard supervisory indicatorsstandard supervisory indicators overstating group profits or capital when these are lower & actual net group risks higher…difficult to obtain accurate picture of its structure and risk profile difficult to work-out or wind-down if problems…Contagion: Possibility that problems arising in other group members may group members may contaminatecontaminate the financial & operational position of the banking members of a group compromising its viability …behavior reaction of third parties because association.Autonomy: Possibility that subsidiary boards are taken up by parent executives, and the interests of its clients/minority shareholders are suborned to the parent, raising conflicts of interest & profit-loss allocation issues…… multiplicity of different roles in dealing with clients… sharing of client information across units Moral Hazard: gain access to status: safety net + too big to fail and be supervised.Abuse of Economic Power: concentration less competition less efficiency

Framework to Conceptualize and Assess Residual Conglomeration Risks• Sum of solo risk profiles likely ≠ risk of conglomerate Capital Risk Matrix• Assessment and aggregation of residual risks above official group• Effectiveness of institutional pillars: governance, management, and control

Residual risks net of effectiveness of management & controls @ group levelRisk aggregation from solo to group adding up residual risks as assessed.

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The inventory of common findings encountered opens a broad The inventory of common findings encountered opens a broad set of policy issues to the authorities which we assist to set of policy issues to the authorities which we assist to approach and resolve as part of our engagement approach and resolve as part of our engagement ……

Country WorkCountry Work

Policy ResponsePolicy Response

Supervisory ProcessSupervisory Process

ConclusionsConclusions

Move Forward CCS Agenda Process of Discovery + Assessment + Response

••Mitigate Conglomeration Risks Mitigate Conglomeration Risks ……••Preserve Effectiveness of Regulation Preserve Effectiveness of Regulation ……••Complete Prudential Framework Complete Prudential Framework ……••Advance Structural Reforms: Policy vs. PoliticsAdvance Structural Reforms: Policy vs. Politics••Complete Financial Markets Complete Financial Markets ……••Reallocate Risks Transparently Reallocate Risks Transparently ……••Select the SupervisorySelect the Supervisory--Regulatory Architecture Regulatory Architecture so as to: 1) Optimize monitoring, response and so as to: 1) Optimize monitoring, response and coordination capacities: 2) Minimize regulatory coordination capacities: 2) Minimize regulatory arbitrage, restrict extending subsidized safety net.arbitrage, restrict extending subsidized safety net.

•Policy Response to Mitigate Conglomeration Risks and Preserve the Effectiveness of Prudential Regulation and Capital Further Emphasis in Making More Transparent the Effects of Intra-Group Relations and Associations.

•Need to Complete the Traditional Set of Quantitative Prudential Regulations which may not be Sufficiently Effective or not be Well Applied (Form vs. Substance)

•Crucial Steps Consider Structural Reform Issues: Status of Market vs. Institutional reform; Availability of instruments for long term saving and risk management;Access to finance vs. financing consumers and home buyers;Concentration Risk into Economic Groups vs. Risk DiversificationConcentration Risk into Economic Groups vs. Risk DiversificationContribution of Groups to Economic and Financial Development

•Develop a Vision of What Supervision Expects to Accomplish•Ingrain that Vision into Higher Economic Policy Reform Agenda•Overall Purpose: Complete Financial Markets Rendering Financial …Intermediation: More Effective, Less Concentrated, More Transparent•Reset the Expectations, Role and Responsibility of the Board of parent/lead •Reorient the Approach of Supervision:

•Strategy on How More Effectively Achieve Purpose

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Based on a good mapping of structures and issues, the priority becomes to strengthening the legal framework, providing powers to improve regulation and supervision, including…

Set principles for Set principles for permissiblepermissible corporate & ownership corporate & ownership structuresstructures

Recalibrate: scope of CCS + perimeter of accounting consolidation

Require mandatory disclosures of beneficiary owners & related interests

Set CCS responsibilities of board members for parent +regulated entities

Review rules for inter-company, related party and connected exposures

Define capital structures-instruments and deductions of risk excess

Broaden approach, orientation and depth of group wide supervision

Depth of Policy Issues Common Findings Lead to Broad Policy Issues

Policy Response to Resolve the Issues ConfrontedPolicy Response to Resolve the Issues ConfrontedKeep in Mind: Accounting Consolidation ≠ Consolidated Supervision

••Ostrich Policy ResponseOstrich Policy Response: Lookout but not to the Top or to the Side of the Group!!!: Lookout but not to the Top or to the Side of the Group!!!Broaden powers in laws

• interpretation stance, presumption capacity, prohibition of structures• access to data, premises, management and controllers of affiliates

Enrich legal definitions (in laws also?) •flexibility to determine the group’s scope if material risks untreated

Expand Licensing the Scope: approval of structures & group functions•Models: integrated, parent-subsidiary; holding company; horizontal group•Banking group; Financial conglomerate; Mix-Activity group…

Align regulatory frameworks: banking, financial, economic groupsbanking, financial, economic groups• Close Gaps between banking, NBFI & non-financial groups:

Coordinate Converge Integrate• Improve Disclosure and Notification Requirements• Strengthen Rigor of Accounting Framework: beyond IFRS • Adopt Qualitative Standards for Governance and Flanking Policies• Revamp Supervisory Approach and Processes:

Coordinate Converge Integrate practices

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Without resolving these issues and gaps, any efforts to promote stability, and sound and safe banking, may be ineffective, exacerbating the myopia of policy makers, official supervisors

Groups: Economic, MixedGroups: Economic, Mixed--Activity, Financial and Banking Groups.Activity, Financial and Banking Groups.

Ownership vs. Control: Ownership vs. Control: rules vs. rules vs. standards to presume controlstandards to presume control..

Align standards in lawsAlign standards in laws: accounting, corporate, banking, securities..: accounting, corporate, banking, securities..

Unified Decision: via common control (power to govern)Unified Decision: via common control (power to govern)

PresumptionPresumption of Control and Significant Influence of Control and Significant Influence (beyond IAS?)(beyond IAS?)

Acting in concertActing in concert to exert control (one or more persons)to exert control (one or more persons)

Undo other restrictions to scope the group & related parties Undo other restrictions to scope the group & related parties ……Affiliates, Associated, MultiAffiliates, Associated, Multi--group Cos., Instrumental, Qualified Participation, group Cos., Instrumental, Qualified Participation, Significant Participation, Unconsolidated Companies, MixedSignificant Participation, Unconsolidated Companies, Mixed--activity and Horizontal activity and Horizontal Groups, Beneficiary Owners, Interlocking Directorship or ManageGroups, Beneficiary Owners, Interlocking Directorship or Management ment ……

Enrich (Legal) Definitions Enrich and Complement Legal Definitions

Compilation of Local vs. Best Practice DefinitionsCompilation of Local vs. Best Practice Definitions

Collecting relevant legal and regulatory definitions:

•Joint Forum, Basel, EU Directives, Selected Develop Countries, IFRS…

• Do we have them in our system? Where promulgated? Which gaps do we have?

GroupGroup: Entities which are subject to “unified decision” or “maintain a participation” are part of the same group (whether financial or not).

••FCFC: A group is a FC when: a) dominant is a regulated entity, activities take mainly in the financial sector, and at least one of the dependants is a regulated entity; b) at least one belongs to the banking sector and another to the securities or insurance; c) significant aggregated activities of the banking and security.

• Banking Group:Banking Group: If only banks, then is a banking group. If more than banks, then FC where parent needs to be identified or lead entity (+ horizontal groups(+ horizontal groups)

••Beyond AccountingBeyond Accounting: the definition of the scope of a group for the purposes of consolidated supervision may differ from the scope of accounting consolidation

Develop a CCS Glossary (see Example Provided)Develop a CCS Glossary (see Example Provided)

Question: Question: Where should these definitions be: Law or Regulations?Where should these definitions be: Law or Regulations?

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Review existing powers and expand the authorities provided to Supervisors to exert discretion in interpreting substance vs. form, set standards and require parent responses & actions…

Licensing of owners (deterministic conditions): at which level to stop, 5% or below?at which level to stop, 5% or below?

Extension to ultimate natural beneficiary owners at mixed-holding Co. level

Deal with Non-beneficiary ownership (Depository of ADR, Trusts): how & what to do?how & what to do?

Licensing of group and ownership structure: right to force intermediate holding?right to force intermediate holding?

Presumption of affiliation (and relationship) and its criteria: how to codify?how to codify?

Requirement of information to/on related parties and obligations to notify

Access to examine related parties (or request audit) at or above mixed holding level

Screen (Limit) certain structures and transactions: regime of notification/approval

Response: Willingness and Assertiveness in Using Powers and Enforce Rules

See Joint Forum PrinciplesSee Joint Forum Principles

Broaden Powers Authority to Investigate, Review, Require Information

Joint Forum: Principles for Fit & Proper Licensing (1999)Joint Forum: Principles for Fit & Proper Licensing (1999)

1. In order to assist in ensuring that the regulated entities within financial conglomerates are operated prudently and soundly, fitness and propriety or other qualification tests should be applied to managers and directors of other entities in a conglomerate if they exercise a material or controlling influence on the operations of regulated entities.

2. Shareholders whose holdings are above specified thresholds and/or who exert a material influence on regulated entities within that conglomerate should meet the fitness, propriety or other qualification tests of supervisors.

3. Fitness, propriety or other qualification tests should be applied at the authorization stage and thereafter, on the occurrence of specified events.

4. Supervisors’ expectations are that the entities will take the measures necessary to ensure that fitness, propriety or other qualification tests are met on a continuous basis.

5. Where a manager or director deemed to exercise a material influence on the operations of a regulated entity is, or has been, a manager or director of another regulated entity within the conglomerate, the supervisor should endeavor to consult the supervisor of the other regulated entity as part of the assessment procedure.

6. Where a manager or director deemed to exercise a material influence on the operations of a regulated entity is, or has been, a manager or director of an unregulated entity within the conglomerate, the supervisor should endeavor to consult with the supervisors of other regulated entities that have dealings with the unregulated entity as part of the assessment procedure.

7. Supervisors should communicate with the supervisors of other regulated entities within the conglomerate when managers, directors or key shareholders are deemed not to meet their fitness, propriety or other qualification tests.

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BoD’s members of regulated entities integrated in the perimeter of a FC made responsible for organizing themselves in such a manner as to be able at all times on a consolidated basis to…

Keep own funds and solvency margins considering relevant risks exposures

Implement capital adequacy assessment policies & strategy to comply with above

Observe quantitative limits for risk concentrations at solo and FC levels

Observe limits for intra-group transactions, including in horizontal groups

Report these transactions whether eliminated or not for CCS purposes

Have commensurate RMG & ICS processes to govern/monitor all risks of FC

Operate systems to identify, aggregate & quantify capital deductions

Ability to disclose relevant beneficiary owners & their parties as per by-laws

Submit financials, systems and controls to consolidated I/E audit review

Apply above to FHC, Mix-HC or Horizontal group under dominant influence

Reset BoD Responsibilities Major Responsibilities of the Parent BoD

•The legal provisions enabling consolidated supervision, and implementing regulations, have to shift to the BoD of a group parent entity the responsibility of complying with the standards. Normally, these detailed responsibilities are capture at the level of a law, rather than in regulations. Crucial among these are:

•Disclosures in annual reports of approach, strategy & main policies, for RMS

•Annual attestation by SMG of parent regarding effectiveness in policies and processes for group RMG, with endorsement by the BoD

• Risk ratings and results of IAF for major units & effectiveness of controls/data

•Means to facilitate group wide CCS, including provide to (lead) Supervisor:

details on group members financial & parent (scope & perimeter)

including close linked persons to the above & to related parties & insiders

management structure of group and key risk reporting lines

Intra-group support arrangements (formal, policies, procedures)

Intra-group transactions IGT across group and with close links

Identification of situations requiring risk deduction from capital

• Notification of breaches to prudential standards and internal policies

• Situations and circumstances having a potential material impact (minimum %)

• Early consultation on changes to operations leading to shift in group risk profile

• Prior approval of establishment or acquisition of local/abroad activities/entities.

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Better in law that in regulation, standards rules needed to specify with certainty the deductions from capital to each levelof conglomeration (solo level 1, bank group level 2, CG level 3)

Deferred tax assets and deferred tax liabilities

Investments unconsolidated, excess of limits, lending to finance capital

Holdings of own capital investments inc. bought forward & option-able

Capitalized expenses, goodwill and provisioning deficits

Surplus and Deficits of employer-sponsored defined benefits funds

Eligible capital instruments in unconsolidated group members:Up to the support directly/indirectly with funding by consolidated financial group, orIn the same proportion in which is self controlled by consolidated group members.

See Joint Forum PrinciplesSee Joint Forum Principles

Capital Deductions Deductions of Risk Excess at Each Conglomeration Level

The Joint The Joint ForumForum´́ss Capital Adequacy Principles (1999)Capital Adequacy Principles (1999)

1. Detect and provide for situations of double or multiple gearing, i.e. where the same capital is used simultaneously as a buffer against risk in two or more legal entities;

2. Detect and provide for situations where a parent issues debt and down-streams the proceeds in the form of equity, which can result in excessive leverage;

3. Include a mechanism to detect and provide for the effects of double, multiple or excessive gearing through unregulated holding companies that have participations in dependants or affiliates engaged in financial activities;

4. Include a mechanism to address the risks being accepted by unregulated entities within a financial conglomerate that are carrying out activities similar to the activities of entities regulated for solvency purposes (e.g., leasing, factoring and re-insurance);

5. Address the issue of participations in regulated dependants (and in unregulated dependants covered by principle 4.) and ensure that the treatment of minority and majority interests is prudentially sound.

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To ring fence a financial-banking group from excessive risks with non consolidated entities that are its affiliates (shareholders, related parties, etc.) in other sectors …

Bank Xor Banking Group X

Corporation Yor Non-Financial

Group Y

Bank X owns60% of 1,000 = 600

Corp. Y owns40% of 5,000 = 2,000

1 2 32,000 2,000 2,000 40% 5,000 Bank X

600 600 600 60% 1,000 Corp. Y1,700 900 - 2,300 1,500 600

A Shares of Bank X in the books of Corp. Y 2,000 2,000 2,000 B.1 Exposure of Group Bank X to Corp. Y 2,300 1,500 600 B.2 Assigment to GBX of shares held by Y 1,200 1,200 1,200 B. Limit of Deduction: Max. of [B.1; B.2] 2,300 1,500 1,200 C Deduction: Min. of [A; B] 2,000 1,500 1,200

Owned by Unconsolidated Corp. of GroupTotal of Exposures

60% of 2,000 owed by Corp. YMax. of exposure or shares assigned

Min. Shares owned or above

Total

Capital Entity% ControlSpanish Norm Example 1

Sum of Exposures

Shares of Bank X held by Corp. YExposures of Bank X to Corp. Y

Shares of YCredits to Y

Cases

Minimize Piramization Crucial at Level 3 and beyond (Basel II, Part 1)

Think on it asthe consolidated

position of allentities part of

the non financial

group

think on it asthe consolidated

position of allentities part ofthe financial

group How to deal with it only applying IAS 27 and 28?How to deal with it only applying IAS 27 and 28?

•Major goal of group-wide capital adequacy requirements is to eliminate any inappropriate intra-group creation of own funds, such as double or multiple gearing, or excessive leveraging.

How is financed capital in the FC/BC invested by the unconsolidaHow is financed capital in the FC/BC invested by the unconsolidated group ? ted group ?

•Eligible capital instruments issued by group units subject to special treatment:

Held as investment by a vehicle subject to consolidation, only if:

Parent/group did not fund the acquisition

Risk and rewards of investment are borne primary by third parties

Parent can prove buy/sell decisions made independently of issuer

Decisions made on best interest of risk holding parties

Risks to group considered in the group capital assessment process

Inclusion of direct investment shares of a bank by a SPV (trust):

Such as a share-based employee remuneration scheme, only eligible if:

Shares issued to the SPV are ordinary shares of a bank

Eligible amount matches equivalent expense charge in PLA

Ordinary shares issued cannot be converted into cash payment

For level 2 banking group and level 3 FC the above SPV excluded

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Since the dealings with related entities and parties are at the root of conglomeration risks may need also qualitative measures to minimize (contagion) conglomerations risks …

Enhanced group risk management: how to specify practices expected?how to specify practices expected?

Formal policies and processes to govern dealing with related parties

Limited support to related entities and parties: at which levels?at which levels?

Provisions to use common brand names and distribute products

Arrangements to participate in group operations: which permissible?which permissible?

Process and systems to monitor a range of intra-group limits: which?which?

Regime of Approvals, Prior Consultations and Notifications: which?which?

Ring-Fencing Flanking Policies to Mitigate Conglomeration Risks

•Two possible channels of contagion among group members

•Financial and non-financial channels.

•Intra-group transactions are the most common source of financial contagion.

••NonNon--financial sources of contagionfinancial sources of contagion emanate from a variety of relationships:

use of common brand name

distribution of common products

use of common networks, operational infrastructure and systems.

Intra-group transactions (IGT) are those by a regulated entity in a FC with any other undertaking in the FC. However, IGT go beyond transactions with members of the group and include also transactions with natural or legal persons linked to the undertakings within the group by close links, even though such persons are not members of the group, and, consequently, not members of the FC.

Prudential standards and regulations should provide for both quantitative limits and qualitative requirements with regard to a broad range of IGT (whether these are eliminated or not in consolidation) with a broad range of members and related persons, including appropriate policies and internal processes and systems to code, identify, track and aggregate, as well as limit these IGT at various levels.

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As a result of our work, we have compiled good practices identified in different countries into a pro-forma template (Process) for CCS, including detailed Procedures…

Country Work

Policy Response

Supervisory Process

Conclusions

Presentation Outline

Risk Capital (Andrew Kuritzkes)How Little Do We Know About Risks

+ Add Conglomeration Risks 6%

46%

18%

12%

18% Market

Credit

A/L

Ope

Buss

de Nicolo (IMF) About Financial Conglomerates:

1.- No lower risk of failure than smaller firms

2.- Large FC appear at least as risky as specialized firms

Issues for DiscussionIssues for Discussion

• Consolidated Supervision vs. Consolidated Regulation: are both the same?are both the same?• Risk: constraining supervision to check compliance with traditional regulations.• Their Organization, Processes and Systems + Responsibilities…

Web Map: Scope Perimeter Exclusions Channels of ContagionQualitative: Activities Management Controls FirewallsQuantitative: Capital Inter-group Concentrations Within Limits

• Our Organization, Processes and Systems + Accountabilities…Challenges to Supervision and Supervisory Response: Risk Focus.Risk Focus.At Solo Level At Group Level Coordination IntegrationCentral Contract Point Support Means Strategy Processes

• Risk Assessment Framework: Compliance with Form vs. Risk Substance• Components Process Procedures Criteria: Assessment + Grading• Aggregation Solo Group Conglomeration Methodology• Strategy for Follow Up Coordination Across Sectors Cross Border

• Sense of Purpose What Do we Try to Achieve and Why?• Complete Financial Systems Achieve Policy Goals Redistribute Risk

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CCS Process (1)

Depending on our respective supervisory cultures, some of us tend to exaggerate, or rely too much in, a particular tool or manner of performing consolidated supervision ..

Need to balance emphasis and approachbalance emphasis and approach: qualitative vs. quantitative

Design a process to aggregate risk assessmentsprocess to aggregate risk assessments from solo to total group

Procedures, work plans and control questionnaires (test step by steptest step by step)

Relational database to support mapping history interfaced risk bureau

Duality: financial vs. management accounts & systems (contributioncontribution)

Identify, understand & assess group control functions (test & trusttest & trust)

Understand Group vs. Solo tensions: who, where, how decisions takenwho, where, how decisions taken

For those who have a hammer every problem is a nail

Framework for Risk Based Focusing on RisksFramework for Risk Based Focusing on Risks

•Risk Focused Supervisory Techniques (conceptualize risk) Shift away from stop and go exams into assessing processesShift focus also to assess business line’s risk management, MIS, controlsStrive for better and effective use of scarce our resources

•Change in Examination Processes: Overall cycle strategy (tools and outcomes) Specialized dedicated (resident) team monitoring the “kitchen“ (corporate

center)“full scope“ vs. moving plan of “ target examinations“ as per strategyLeverage parent and group central functions: audit, control, risk mng.Conceptualize key vulnerabilities and risk and focus on themSpecialized teams: EDP/MIS, credit risk, operational, treasury & CMTA

•The larger the Group … the larger the Challenges to Supervision: Transparency and support in the group’s MIS: timely flow of relevant infoNumber of jurisdictions, entities and locations: true coordination Where is the activity conducted, booked, and risks managedWho takes the decisions and based on which incentives and criteria

•Supervisory response to complexity: coordination and enhanced info sharing:Increase scrutiny of overseas activities: group audit and risk managementEffective protocol of coordination home-host across sector and cross border

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All Procedures have the same structure including specific All Procedures have the same structure including specific control points to guide/elicit to grade the rating of managemencontrol points to guide/elicit to grade the rating of management t and control elements that mitigate conglomeration risks and control elements that mitigate conglomeration risks ……

Quantitative AssessmentMapping the Economic GroupEconomic GroupMapping Beneficiary Owners & Related PartiesBeneficiary Owners & Related PartiesMapping ControllersControllers if different from aboveMapping ActivitiesActivities and Mng. StructureMng. StructureDetermine and Prove the GroupGroup’’s Scopes ScopeReview Accounting ConsolidationAccounting Consolidation & ControlsPerform Financial Assessment/AnalysisFinancial Assessment/AnalysisValidate Eligible CapitalEligible CapitalTest Sufficiency of CCS CaRCCS CaRProbe Compliance Compliance with Other Prudential NormsGenerate Data InputData Input to Supervisory SystemVisualize Effectiveness/Location of Group CapitalEffectiveness/Location of Group CapitalAnalyze Contribution Contribution to Risk and Return

Qualitative AssessmentUnderstand strategystrategy of economic group (s).Understand role in strategyrole in strategy of financial unit (s).Idem. role played by member banksmember banksUnderstand Management Model & OrganizationUnderstand Management Model & OrganizationAscertain Acquisition ProcessAcquisition Process & Related IssuesAssess Group Management Accounts SystemsGroup Management Accounts SystemsEvaluate Group Financial ControlGroup Financial Control ProcessesReview MIS/MIS/Σ at Group LevelReview GroupGroup/Σ Internal AuditInternal Audit FunctionIdem. GroupGroup/Σ Risk ManagementRisk Management FunctionAttest External Audit ProgramAudit ProgramFactor Within & Across BorderWithin & Across Border H.H. IssuesConclude Rating + Post Cycle Strategy ResponseConclude Rating + Post Cycle Strategy Response

Detailed Procedures Testing & Installing Procedures is a Process not Event

Sample Objective, Elements under Assessment and Step 1 Offered in Notes

Objective: To determine the organizational structure of the group and understand how itoperates, including how decisions are taken and where, which committees operate at groupand local level, the role of any centralized functions and how common business streams are managed, including the effectiveness of communication flows as well as the clarity ofreporting and accountability lines at play.

Drivers of the Assessment Elements Assessed (Process designed include: policies, procedures and

practices) Process is Adequate

Execution is Efficient

Controls are Effective

MIS are Appropriate

1 Balanced tension: local vs. central governance & management arrangements

2 Levels of business decentralization vs. depth of centralized control functions

3 Understandable & viable dual management/reporting structures well formalized.

4 Clear focus of the Organization: legal entity vs. business lines, and its implications

5 Compatible systems & controls, including processes: standardization/reconciliation

6 Strength of centralized group functions: audit, RMG, treasury, other relevant.

7 Recap of relevant issues brought from the assessment of significant solo issues

1. How are organized the boards of the subsidiaries and which is the role played by the parent in

enabling good governance and oversight of their activities (i.e., responsibilities; departments and group functions involved; reporting lines; channels used to implement control and oversight)?

The following control points can provide further basis to understanding the scope, adequacy and effectiveness of current practices: Degree of centralization of the mng. model Level & scope of autonomy of subsidiaries Functional & reporting lines formalized Nomination of board members and officers Composition of local boards & committees Centralized functions at group level

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As group becomes more complex, it becomes essential to work through the group’s MIS, as well as validating the data inputs and outputs of the core group control functions, to visualize…

Group accounts (financial & managerial): custody, control, processes, reconciliation

Integrity of the accounting consolidation process and its results (the kitchen)

Adequacy of the management accounting system and the related MISmanagement accounting system and the related MIS

Dimensions and richness of MIS to visualize contributionMIS to visualize contribution: financial, risk, return

Coding, tracking, aggregating, reporting large and intra-group exposures (ITEsITEs)

Scope and breath of information package to board, committees and SMGinformation package to board, committees and SMG

Effectiveness of control functionsEffectiveness of control functions (IAF+RMG) in reviewing above processes & outputsSee Joint Forum ITE Practices

Transparent Information Transparent Information Standard Returns vs. De-Consolidation

Joint Forum Best Practices: Risk Concentrations and Intra-Group Transactions & Exposures (ITEs)

1. Supervisors to take steps, directly or through regulated entities, to provide that conglomerates have adequate RMG processes in place to MNG group-wide risk concentrations, including those for ITE, for the conglomerate as a whole.

2. Where necessary supervisors consider appropriate measures, such as reinforcing these processes with supervisory limits.

3. Supervisors to monitor material risk concentrations and ITEs on a timely basis, as needed, through regular reporting or by other means to help form a clear understanding of the risk concentrations and ITEs of group and financial conglomerate.

4. Supervisors to encourage public disclosure of risk concentrations and ITEs.

6. Supervisors to cooperate closely with one another to ascertain each other’s concerns and coordinate as deemed appropriate any supervisory action relative to ITEs and risk concentrations within and across the group.

7. Supervisors to deal effectively and appropriately with material risk concentrations and ITEs that are considered to have a detrimental effect on the regulated entities, either directly or through an overall detrimental effect on the group

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CCS within a RBS approach leads to considering methods to aggregCCS within a RBS approach leads to considering methods to aggregate ate risks from solo entity to consolidating group, and from this to risks from solo entity to consolidating group, and from this to the wide the wide economic group adding conglomeration risks assessed in supervisieconomic group adding conglomeration risks assessed in supervisionon……

Risk aggregation with and without quantitative measures:Risk Metrics: Portfolio Theory to the Service of Science (OK!, but data & modeling issues) Proxies of risk quantity and risk direction ± compensating management and controlsRisk Assessment Systems (RAS) to aggregate risk from activity to business unit to solo bank

Aggregation of the risks not captured in consolidated supervision:Neutralization (deduction from CCS capital) ± Ring Fencing MeasuresConceptualize those risks (transparency, contagion, autonomy, effectiveness of capital)Similar intuitive qualitative measurement compensated by governance, mng. and controls

Follow up CAAP Qualitative Risk-Capital Matrix Differentiated levels of operating % CaR (i.e., BoE trigger and threshold levels)

See sample in notes

From Solo to Group RAS Qualitative Summary of Risks Assessment @ Group

SIMPLE SIMPLE –– INTUITIVE INTUITIVE –– CLEAR CLEAR –– COMPREHENSIVE COMPREHENSIVE –– UNDERSTOOD UNDERSTOOD -- PUBLICPUBLIC

High Acceptable Improve Inadequate

Low Normal Normal Stepped SteppedMedium Normal Stepped High HighHigh Stepped High High ExtremeExtreme Stepped High Extreme Extreme

Quality and Effectivess of Mng. & Controls

Net Risk Assessnent

Agg

rega

te

Qua

ntity

of

Inhe

rent

R

isk

Hi gh Acceptabl e Improve InadequateNormal Normal Normal Stepped SteppedStepped Normal Stepped High HighHi gh Stepped High High ExtremeExtreme Stepped High Extreme Extreme

CCS Risk Assessment NoteEffecti veness of Management and Control s

Level of Quanti tati ve

Congl omerati on Ri sks Assessed

Combi nati on of Quanti tati ve and Qual i tati ve Notes of

Normal Stepped High ExtremeNormal Normal Normal Stepped SteppedStepped Normal Stepped High HighHigh Stepped High High ExtremeExtreme Stepped High Extreme Extreme

Summary Aggregation of Solo and Conglomeration Risks

Solo Aggregated Risk

Conglomeration Risk

From Aggregated SoloNet Financial Risks

From CCS Assessment ofNet Conglomeration Risks

Post Assessment SupervisoryStrategies and Remediation Plan asper adfopted Supervisory Policies

Post Assessment SupervisoryStrategies and Remediation Plan asper adfopted Supervisory Policies,including MoU andf CoordinatedPlans with other Supervisors

At Solo and CC Levels:Monitor Normal Risk ProfilesReview Stepped Risk Profiles

Contain High Risk ProfilesResolve High Risk Profiles

Supervisory Strategy andResponse Plan for all

Significan Units


Significan Units

Ratin

g Crit

eria

Calib

rated

to Co

untry

RAS

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Summary Summary of elements of elements

O vera ll G rade: Extrem e

N orm al Stepped H igh Extrem eTran sparencyC on tagionA utonom yC ap .Effectiveness

Ca lib ratio n R ule:No rm al R isks g raded as Stepped ? (One)Step ped R isks g raded as H igh ? (One)H igh All oth er com binations excep t if under Norm al or SteppedExtr em e R isks g raded as Extrem e ? (Tw o)

C onglom eratio n R isk s

A ggregation of C onglo m eration R isks

Bring G rades from the A ssessm en t Schedu lle

H i gh A ccep tab l e I m p ro ve I n ad eq u a teN o rm al N o rm a l N o rm al S tepped SteppedS tep p ed N o rm a l Stepped Hig h Hig hH i gh S tepped H ig h Hig h E xtrem eExtr e m e Stepped H ig h E xtrem e E xtrem e

C C S R isk A sse ssm e nt N o teEf f ecti ven e ss o f M an agem en t an d Co n tro l s

Leve l o f Qu an ti ta ti ve

Co n gl o m er ati o n R i sk s A sse ssed

Co m b i n ati o n o f Qu an ti ta ti v e an d Qu al i ta ti v e N o tes o f

W o rk P rocedu res are p art o f th e ev olv in g CCS Section o f the R B SM an ual

W o rk P rocedu res are p art o f th e ev olv in g CCS Section o f the R B SM an ual

Qualitative Notes grad ing theAdequacy, E ffectiveness and Integrityof M anageem nt and Control E lem entsAssigned as per each of the W orkingProcedures w hich include Ob jectives,In form ation Needs, Control Pointsand V isitation Protocols. TheQuantitive CCS Assessm ent feeds intothis through the Group Accounts(m ainly).

Quantitative Notes for theRisks o f Conglom erationw hich net o f M & C w ill beadded to Net R isk aggregatedfrom Solo levels fortrad itional financial risks.

Conglom eration R isksNet o f the AssessedEffectiveness of M & C to yield aNet CCS R isk Assessm ent

O verall A ssessm ent of M & C E ffectiveness Im prove

H igh A ccep tab le Im pro ve Inad equateG rou p S tra tegyA cqu isitionM n g. O rgan ization

G rou p A ccou n ts 1

F in an cia l C on trolM ISG rou p R M GIn terna l A ud itE xtern al A u ditC ross B order Sup .

Ca libr atio n R ule:H igh All h ig h , m ax. to Im prove: ? (Two)Accep table E lem ents g raded to Im prove: ? (Th ree)Im p ro ve (n eed o f) All oth er com binations except if H igh or Acceptable pro filesInadequate Graded as In adequate ? (Th ree)1 Including resu lts of Quan titative CCS for Mapping , Scope, and Accounting Con solidation

Bring N otes from the A ssessm en t Schedu lle

M anagem ent and C ontro lsQ ualitative E lem en ts o f C C S

Aggregation o f CCS R isks Net o fCom pensating M anagem ent & Contro l (M & C) Elem ents

Risk Aggregation (1) Conceptualize Conglomeration Risks

Controls

Risks

Net Risk

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Keep it simple, intuitive, flexible, appealing, comprehensive, bur enable audit trial to support group supervisory strategy …

High Acceptable Improve Inadequate

Low Normal Normal Stepped SteppedMedium Normal Stepped High HighHigh Stepped High High ExtremeExtreme Stepped High Extreme Extreme

Quality and Effectivess of Mng. & Controls

Net Risk Assessnent

Agg

rega

te

Qua

ntity

of

Inhe

rent

R

isk

Hi gh Acceptabl e Improve InadequateNormal Normal Normal Stepped SteppedStepped Normal Stepped High HighHi gh Stepped High High ExtremeExtreme Stepped High Extreme Extreme

CCS Risk Assessment NoteEffecti veness of Management and Control s

Level of Quanti tati ve

Congl omerati on Ri sks Assessed

Combi nati on of Quanti tati ve and Qual i tati ve Notes of

Normal Stepped High ExtremeNormal Normal Normal Stepped SteppedStepped Normal Stepped High HighHigh Stepped High High ExtremeExtreme Stepped High Extreme Extreme

Summary Aggregation of Solo and Conglomeration Risks

Solo Aggregated Risk

Conglomeration Risk

From Aggregated SoloNet Financial Risks

From CCS Assessment ofNet Conglomeration Risks

Post Assessment SupervisoryStrategies and Remediation Plan asper adfopted Supervisory Policies

Post Assessment SupervisoryStrategies and Remediation Plan asper adfopted Supervisory Policies,including MoU andf CoordinatedPlans with other Supervisors

At Solo and CC Levels:Monitor Normal Risk ProfilesReview Stepped Risk Profiles

Contain High Risk ProfilesResolve High Risk Profiles


Significan Units


Significan Units

Ratin

g Crit

eria

Calib

rated

to Co

untry

RAS

Risk Aggregation (2)Connect Solo & Group Assessment + Add Conglomeration

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The challenges posed by CCS to restoring and complementing the effectiveness of quantitative regulations and capital are broad and complex…

Country WorkCountry Work

Policy ResponsePolicy Response

Supervisory ProcessSupervisory Process

ConclusionConclusion

Presentation Outline

•The concentration of economic and financial power that goes along the process of industrial conglomeration originates groups of pressure whose objectives and incentives may conflict at moments with the goals of society for stability, transparency and fairness in distributing the benefits accrued from economic and political development.

•Ultimately, as supervisors, we would like to develop a vision of where we want to take financial supervision in terms of fulfilling its duties to the society, and fit the goals of that long term vision and our supervisor strategy to advocate, influencing and proposing official policies for advancing multiple economic and political agendas to mitigate risksfrom excess concentration of economic power and financial wealth to realign financial contracts shifting undue risks from depositors to foster transition and development of local capital market to attract capital to accelerate economic development and to expand access to financial services.

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Complete supervision, approaching it from a topComplete supervision, approaching it from a top--down group perspective, down group perspective, identifying and mitigating the conglomeration risks that originaidentifying and mitigating the conglomeration risks that originate for the te for the bank within its economic group regardless of where they are bookbank within its economic group regardless of where they are bookeded……

Focus of CCS is the bank within its (economic) group, not the group per seScope includes parent, controllers, their related interests and parties (effectiveness of capital)Assess risks to stability from conglomeration risks (transparency, contagion, autonomy).

CCS is a process of continued discovery, assessment, and responseNOT ONLY: Legal – Regulatory – Accounting – Banking – Instantaneous – Not easy to Solve.Beyond the formality of rules based on principles (RBS) to identify and respond to risks.Judicious exercise of judgment in interpreting situations based on substance, not in form.

Scope & depth of law/regulation: crucial to enable CCS to mitigate risksBroad legal scope to capture Financial-Industrial Groups and Financial Conglomerates.Rich definitions to capture special purpose vehicles and unregulated entities beyond bankingFramework to coordinate FI supervisors enabling convergence of regulation and practicesInstitutional Issues: Integration (political & time consuming) vs. Lead Coordinator.

Conclusions (1) Must Complete Effectiveness of Supervision with CCS

Comprehensive approach to evaluate the Comprehensive approach to evaluate the strength strength of an entire groupof an entire group, considering all the , considering all the risks that risks that may affect a bankmay affect a bank, regardless of whether these , regardless of whether these risks are booked in the bank risks are booked in the bank or in related entities or in related entities „„ ((BoEBoE, 1998, 1998) ) „

“ Same rules, same practices, wherever risks are originated, booked, and managed: Convergence to mitigate regulatory gaps and asymmetries.

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TopTop--down CCS vs. Myopia: The strength of the group does not down CCS vs. Myopia: The strength of the group does not necessarily end or start in the banking group. Its economic necessarily end or start in the banking group. Its economic group can be a source of strength or a deadly weakness group can be a source of strength or a deadly weakness ……

Top-down CCS vs. (political) MyopiaThe economic group does not end in the banking group Address FC and FIGDelicate political issues: powerful concentration of economic and financial wealthTransparency of Structures: Bº Owners, controllers, business vs. legal, management (decisions)

Process & Framework (to discover, to assess, and to respond)…Risk assessment and aggregation from solo to group level including conglomeration risksWho owns? Who controls? Who takes decisions? Where are risks originated & booked?Group MIS & Control Functions: crucial to assess contribution to risk, earnings, capital

Requires Organizational Changes within Supervision:Dedicated central manager for the full group (specialized resources to front line supervision)Actual coordination of supervisory programs and exchange of information (cultural issues)Within the Groups: Supervise-able structures and ring fencing + Enhance control functions

Conclusions (2) Scope of CCS May Need Broadening

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Restore effectiveness of supervision by strengthening CCS including: readying legal framework, providing essential powers, and developing a supervisory process made of qualitative & quantitative standards…

Legal framework providing broad authority, principles & obligations to BoD:Authority, access to assess, exchange of information & coordination among supervisors (MoU)

Accounting Consolidation and Group Audit with flexibility to adapt IFRS to ad-hoc cases: Scope of group membership, perimeter of consolidation, exclusions…Techniques, valuation, building in supervisory filters to compensate implementing IFRS…

Quantitative Regulations (are necessary but not sufficient)Capital Adequacy (deductionsdeductions, location, transferability, leverage):unconsolidated risksRisk limits (large exposures, related parties, OREO, investment): limits to inter/intra-groupMarket risk and group trading / brokering (intra-inter group): accounting profit making

Qualitative Standards (Internal Governance & Group Functions)F&P licensing of: persons, group, management, extended to controlling FHC or Mixed HCGroup functions: audit, risk asset review, financial control, risk mng., complianceRing-fencing measures @ contagion risk: common branding, distribution, group operationsBusiness Conduct & Disclosure to Clients (risks of products) @ autonomy + contagion risks.Regime of Reporting, Notifications, Disclosures, Pre-Consultations and Approvals

Conclusions (3) Overall Effectiveness of CCS = Weakest Component

Some Essential Elements of RegulationSome Essential Elements of Regulation……

•Purpose and framework of consolidated supervision: what & how?what & how?

•Authority required to supervise on a group wide basis: powers + discretion? powers + discretion?

•Scope of groups subject to group wide supervision: banking vs. economic?banking vs. economic?

• Sectoral vs Group Wide supervision: coordination or integration?coordination or integration?

•Principles regarding permissible/prohibited group structures: which not?which not?

•Perimeter of consolidation: same or different from accounting consolidation?same or different from accounting consolidation?

•Consolidating methods: IFRS plus & cons vs. more prudent supervisory rules?IFRS plus & cons vs. more prudent supervisory rules?

•Capital rules & calculating methods: different at different levels (solo, group)?different at different levels (solo, group)?

•Capital deductions: weak elements, risk excess, immaterial assets, leverage?weak elements, risk excess, immaterial assets, leverage?

•Measurement of capital adequacy: methods for mixed (activity) groups?methods for mixed (activity) groups?

•Qualitative flanking +risk governance standards: rule based vs. discretion?rule based vs. discretion?

•Group responsibilities for parent & holding BoD: what needed and where set?what needed and where set?

•Regime of reporting, notifications, approvals, disclosures, consultation: needed?needed?

•Tools for ring fencing and implementing flanking policies: what if large failure?what if large failure?

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Many Thanks for Your Attention … with our wishes that topics and content attracted your interest …

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Documents

[email protected] The WorldBanksiteresources.worldbank.org/EXTFINANCIALSECTOR/Resources/282884...Back-to-Basics: transparency ... who controls +who takes decisions: Support