Consolidated Supervision of Banking Groups OSFI International Advisory Group 3rd SEACEN-OSFI Seminar on Consolidated Supervision Hosted by the State Bank of Vietnam May 5 - 9, 2008 Da Nang, Vietnam Leo Querel International Advisory Group 附件一

2 Discussion Points Consolidated Supervision what, why, origins Types of Corporate Groups Containing Banks Candidates for Consolidated Supervision Key issues in the supervision of banking groups with cross-border establishments

3 What is Consolidated Supervision? “A quantitative and qualitative assessment of the strength of those business groups which contain banks (and other regulated financial institutions) in order to identify and evaluate all the risks to which these banks are exposed”

4 Why is Consolidated Supervision Necessary? Many banks carry on activities through subsidiaries/affiliates Many banks are themselves subsidiaries and exposed to risks arising from the influence exercised over them by their parent

5 Why is Consolidated Supervision Necessary? An essential tool of banking supervision Not an alternative to normal supervision of individual licensed banks – complements “solo” supervision

6 Why is Consolidated Supervision Necessary? Financial supervision is not fully effective unless all the risks inherent to banks and affiliated FIs (i.e. the entire “banking” group) are identified, assessed, and if necessary, limited

7 Origins of Consolidated Supervision The Basel Committee on Banking Supervision promoted consolidated supervision in the 1970’s focus was on international banking groups aim was to ensure that entire bank - branches, subsidiaries and joint ventures - is subject to supervision Committee has issued much useful guidance

8 More Recent Developments Greater emphasis on both domestic and international banking groups: the Basel Committee’s Core Principles for Effective Banking Supervision (BCPs – Principles 24 and 25) IMF/World Bank’s Financial Sector Stability Assessment Program (FSAP) European directives requiring EU countries to conduct consolidated supervision and impose common standards

9 Basel Committee’s (BCBS)Core Principles Principle 24: Consolidated Supervision An essential element of banking supervision is that supervisors supervise the banking group on a consolidated basis, adequately monitoring and, as appropriate, applying prudential norms to all aspects of the business conducted by the group worldwide Principle 25: Home-Host Relationships Cross-border consolidated supervision requires cooperation and information exchange between home supervisors and the various other supervisors involved, primarily host banking supervisors. Banking supervisors must require the local operations of foreign banks to be conducted to the same standards as those required of domestic institutions

10 Types of Corporate Groups Containing Banks Differ in terms of structure, activities and complexity However, all have an inherent relationship between parent and subsidiary companies and inter- company relationships which may allow one company to exercise significant influence over a second company, often without having control

11 Types of Corporate Groups Containing Banks Definitions of parent and subsidiary companies differ between countries subsidiaries: >50% vs. control For bank supervisors, control is more relevant regardless of size determine indirect control through long & complicated chains of ownership consider partnerships and joint ventures

12 Types of Corporate Groups Containing Banks Exercise of influence (associated companies)? ownership (direct/indirect) of  20% of shares/voting rights Participations  20%  50% votes < 20% with significant influence

13 Banking groups Financial conglomerates Mixed activity groups Types of Corporate Groups Containing Banks

14 Banking Groups Where a licensed bank establishes or acquires subsidiaries (or takes participations) in order to carry on particular activities Why operate through subsidiaries? legal, regulatory, commercial or fiscal Could be headed by a bank or a non-trading holding company

15 Banking Groups Consolidate the non-trading holding company? generally yes, if: >50% of consolidated assets or revenue relate to banking or other financial activities (<50% - mixed activity group)

16 Banking Groups The majority of the group entities are likely to be banks or companies carrying on specialised banking or financial activities: Consumer credit Financial leasing Issuing drafts, travellers’ cheques etc. Issuing guarantees

17 eg: Trading in money market instruments, securities, foreign exchange, etc. Money broking Portfolio management and advice Safekeeping and administration of securities Managing property, providing data processing services Banking Groups

18 Financial Conglomerates “Financial conglomerate” has a special meaning for the Basel Committee: “any group of companies under common control whose main activities consist of providing services in at least two different financial sectors - banking, securities or insurance” Combined banking/securities groups are quite common. It is therefore convenient to use “financial conglomerate” to describe only those groups which include an insurance company (EU definition).

19 Mixed Activity Groups Groups of commercial or industrial companies which also own a bank Less than 50% of total group business relates to banking

20 Mixed Activity Groups Bank supervisors do not apply prudential ratios to mixed groups or monitor them through reports Sometimes these groups contain a banking sub-group which can (and should) be supervised on a consolidated basis

Is there an XYZ Banking Group? Is the XYZ Group a Financial Conglomerate?

XYZ Bank Consolidated for Banking Supervision Purposes: Fully Consolidated Companies Shown in Dark Green

23 Key Considerations Each country needs to tailor its techniques of consolidated supervision to its own circumstances It cannot be tackled without adequate legal powers for supervisors

24 Key Considerations A statutory requirement for banks to publish audited consolidated accounts improves transparency and is very desirable However, supervisors should not rely solely on published accounts, but introduce their own confidential consolidated prudential reports for banking groups

25 Key Powers To obtain information from banks’ affiliates, which is needed for bank supervision To obtain consolidated prudential reports from banks To apply prudential requirements to banks on a consolidated basis, e.g. ratios and limits

26 Key Powers To approve banks’ new investments in subsidiaries, associates etc., at home and abroad To disclose confidential information to other financial regulators when this is needed for supervisory purposes To approve changes in the ownership or control of banks

27 The Candidates for Consolidated Supervision Domestic banking groups Local banks which belong to international banking groups Banks which belong to financial conglomerates Banks which belong to non-financial (mixed activity) groups Note: some banks fall into more than one category

28 Crucial First Step Ask the banks about their ownership and control links with all other entities: subsidiaries, parent companies, shareholders, sister companies, associates etc. Organise this information as a pyramid Gather Information and Identify the Candidates

29 Crucial First Step Decide if the bank is a candidate - and what kind Obtain details of the group’s business units and how these are managed Find out which group entities are regulated by another authority and to what extent Gather Information and Identify the Candidates

30 Techniques of Consolidated Supervision Quantitative: Consolidated prudential reports Consolidated capital adequacy requirements and large exposure limits Limits on intra-group exposure

31 Techniques of Consolidated Supervision Qualitative: Part of risk-based supervision Evaluation of the business risks, internal controls, organisation and management of banking groups

32 Domestic Banking Groups If a bank has at least one subsidiary which is a bank or other financial institution: apply consolidated supervision from the bank downwards agree with the bank those subsidiaries whose assets, liabilities and off- balance sheet items are to be included in the bank’s consolidated prudential reports The Candidates for Consolidated Supervision

33 Domestic Banking Groups If a bank has at least one subsidiary which is a bank or other financial institution (cont’d) : notify the bank of its required consolidated capital ratio, limits on consolidated large exposures, FX position, etc. impose (or review existing) limits on the bank’s exposures to related companies analyse management structure of group, main business units, evaluate risk management and internal controls The Candidates for Consolidated Supervision

34 Not necessary/appropriate to consolidate “upwards” to include foreign parent bank Assess whether the home country supervisor practises global consolidated supervision Obtain from the home supervisor any information needed for a full understanding of the bank’s activities Local Banks Which Belong to International Banking Groups The Candidates for Consolidated Supervision

35 When necessary, share information with the home supervisor (subject to confidentiality safeguards) Consider agreeing a memorandum of understanding with the home supervisor Local Banks Which Belong to International Banking Groups The Candidates for Consolidated Supervision

36 Advise home supervisor of any remedial action taken towards the bank Allow home supervisor access to the bank for safety and soundness purposes Local Banks Which Belong to International Banking Groups The Candidates for Consolidated Supervision

37 If the bank’s immediate parent is a bank, take same steps as for banking groups If the bank is a subsidiary of an insurance or securities company: establish contact with the other regulators consider information-sharing arrangements consider agreeing with the others on a coordinator Banks Within Financial Conglomerates The Candidates for Consolidated Supervision

38 Mixed groups cannot be supervised in the same ways as financial institutions because: these groups carry on significant non-financial activities supervisors may lack expertise to assess non- financial businesses no legal powers for supervisors to inspect unregulated group entities Banks Belonging to Mixed Groups (Not Financial Conglomerates) The Candidates for Consolidated Supervision

39 At a minimum, supervisors should: have legal powers to obtain information they need for supervision purposes, perhaps via supervised group banks understand the nature and scale of a group’s business Banks Belonging to Mixed Groups (Not Financial Conglomerates) The Candidates for Consolidated Supervision

40 At a minimum, supervisors should (cont’d): meet representatives of the group management establish how the bank fits into a group’s strategy and the potential impact which the group’s non-financial activities may have on the bank Banks Belonging to Mixed Groups (Not Financial Conglomerates) The Candidates for Consolidated Supervision

41 Membership of a mixed group can be a source of strength - as well as risk - for a bank This process has much in common with the standard evaluation of bank shareholders Banks Belonging to Mixed Activity Groups The Candidates for Consolidated Supervision

42 Key issues in the supervision of banking groups with cross-border establishments Information access Difficulties in obtaining information required to undertake effective consolidated supervision Limitations on cross-border on-site inspections by home supervisors Host supervisors may have difficulty obtaining information from home supervisors

43 Key issues in the supervision of banking groups with cross-border establishments Effective home and host supervision Different/varied levels of supervisory effectiveness Gaps in supervision (shell branches, parallel- owned banks or sister/affiliated/related institutions with common ownership, and parent institutions incorporated in under- regulated jurisdictions)

44 Final Thoughts Consolidated supervision is not a substitute for the solo (unconsolidated) supervision of banks Consolidated supervision means more than consolidated prudential reports and ratios Supervision of the banking group on a consolidated basis goes beyond accounting consolidation. There is a group-wide approach to supervision whereby all risks taken on by the banking group are taken into account wherever they are booked. Both accounting consolidation and consolidated supervision are key aspects in the supervision of banking groups.

45 Thank - you