Banking Supervisor. Promoting Best Practices for Banking Supervision

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1 Journal of the 44 Banking Supervisor Promoting Best Practices for Banking Supervision January - March, 2016 Challenges for Banking Regulation and Supervision Juan Pedro Cantera, Vice-President of the Board of Directors (ASBA) We are pleased to share with you this new edition of the Journal of the Banking Supervisor with a renewed Editorial note. The objective of this quarterly publication is to present the most current and relevant documents in the field of banking regulation and supervision practices, as well as to invite its readers to reflect upon the factor of global risks and their potential effects on the financial markets of the Americas. This note addresses some of the challenges for the region s financial regulation and supervision, offering alternatives for action in support of public economic and financial public policies designed to manage the impact of the financial turbulence in global markets, the decrease in the price of commodities, and the potential demand decrease from key commercial partners. Furthermore, in the opinion of the Association s members, stated in a recent survey, the fall in the price of oil, the probable increase in the reference interest rate by the U.S. Federal Reserve, and the depreciation of the region s currencies versus the United States dollar, would also have a substantial impact on their financial markets. Also, the challenges related to the adoption of new regulation in line with international standards, the impact of new technologies and business models, the exit of financial entities from regional markets due to the fear of potential sanctions that may arise for not complying with the regulatory framework (de-risking), were commented. Finally, concern was expressed about the risks that could derive from the adjustment in sovereign ratings. In an economic contraction environment stemming from a decreased demand for commodities from commercial partners, credit structuring in currencies other than local ones, an increase of unemployment rates, and lower internal demand, credit risk would be increased, generating a deterioration of loan portfolios. The latter would affect the capacity of the banking sector to generate income; thus, to strengthen its capital position. Both effects could reinforce each other leading the industry to a lower dynamism that would affect the region s economies. In contrast with the past, these risks can be mitigated taking advantage of the region s financial stability strengths reflected on adequate liquidity and solvency levels of the banking sector as well as of the central bank reserves. Tel. +52 (55) , Fax +52 (55) asba@asbasupervision.org ASSOCIATION OF SUPERVISORS OF BANKS OF THE AMERICAS

2 BANKING SUPERVISION REVISIONS TO THE STANDARDIZED APPROACH FOR CREDIT RISK: ARE THE PROPOSED DRIVERS APPLICABLE IN THE AMERICAS? Association of Supervisors of Banks of the Americas. March, Read more: The proposal to revise the Standardized Approach for credit risk reduces reliance on external credit ratings and replaces them with a limited number of risk drivers, that improve risk sensitivity through appropriate weighting for each type of exposure. In relation to its applicability in the Americas, this document finds that the portfolio structure in the region is comprised of commercial, consumer and mortgage loans. In general, countries in the region do not use the same loan classification as that used in the Basel Committee s proposal, which could affect comparability between jurisdictions and the implementation of stress testing at a regional level. While the Committee seeks to propose a more risk-sensitive methodology, the revised Standardized Approach for credit risk remains quite rigid, since it is based on fixed parameters for determining risk weights for exposures, which in turn limits risk sensitivity. Moreover, the proposal is perceived as primarily intended for a complex banking environment, which does not take into consideration some peculiarities of the banking system in the region. COMPLIANCE/REGULATORY RISK ( DE-RISKING ) IN FINANCIAL ACTIVITY IN THE AMERICAS Association of Supervisors of Banks of the Americas. March, Read more: As a result of the recent financial crisis, the banking industry is facing new regulatory requirements which represent higher compliance costs. Against this backdrop, the response of financial institutions has been redirecting their business models. One of these strategies is de-risking, under which financial institutions cease or significantly reduce business lines in order to avoid compliance or regulatory risk. In the Americas, most supervisory authorities, who participated in this study, consider that there is a de-risking process in their jurisdiction. This is mainly due to regulatory requirements for the prevention of money laundering and terrorist financing and know your customer (KYC) risks. The most affected business lines are remittances, trade finance, and correspondent banking. In addition, the paper points out that bank holding companies established in developed economies are reducing their operations with banks in emerging economies, in what is known as blanket solution. 2

3 BANKING SUPERVISION LESSONS FROM THE CRISIS: ENDING TOO BIG TO FAIL Speech by Mr. Neel Kashkari, President. Federal Reserve Bank of Minneapolis. February, Read more: While significant progress has been made to strengthen the financial system, Mr. Kashkari believes the Act did not go far enough. The biggest banks are still too big to fail (TBTF) and continue to pose a significant, ongoing risk to the economy. The Federal Reserve Bank of Minneapolis is launching a major initiative to develop an actionable plan to end TBTF. Markets make mistakes; that is unavoidable in an innovative economy. But these mistakes cannot be allowed to endanger the rest of the country. Large banks must similarly be able to make mistakes even very big mistakes without requiring taxpayer bailouts and without triggering widespread economic damage. Regulatory reforms since the crisis have focused both on making banks safer and on creating tools to resolve troubled banks by imposing losses on creditors without destabilizing the economy. Given the enormous costs that would be associated with another financial crisis, and the lack of certainty about whether these new tools would be effective in dealing with one, Mr. Kashkari believes that bolder, transformational options should be considered. FINANCIAL STABILITY GOVERNANCE TODAY: A JOB HALF DONE Andrew Large. Group of Thirty. December, Read more: Enormous efforts have been made to ensure that we never experience a repeat of the economic and financial crisis of Supervision of the financial services industry has been radically overhauled. Banks are safer and better capitalized. Structural reforms have reduced risk taking, and the policy approach has developed significantly. Yet as time passes, the urgency of finding ways to underpin financial stability is challenged by the search for growth. Some of the reasons we should still be concerned include the following. First, the last crisis was exacerbated by high volumes of debt. However, overall debt levels are not only much the same as they were, but global debt has increased considerably since Second, both quantitative easing and regulatory initiatives may have alleviated the discomfort, but they have also had damaging unintended consequences (i.e. interest rate and asset price distortions). Third, how can we be confident that in the event of a systemic crisis caused by rampant herd behavior, the state will not be forced to come to the rescue after all. 3

4 BANKING SUPERVISION BENEFITS AND COSTS OF BANK CAPITAL Jihad Dagher, Giovanni Dell Ariccia, Luc Laeven, Lev Ratnovski, and Hui Tong. International Monetary Fund. March, Read more: This paper assesses the benefits of bank capital in terms of its ability to absorb losses. The paper measures these benefits against the yardstick of how much capital would have been needed to avoid imposing losses on bank creditors or resorting to public recapitalizations. The paper also looks at the welfare costs of tighter capital regulation. Considering some caveats, the paper reaches the following conclusions: (i) capital in the range of percent of risk-weighted assets would have been sufficient to absorb losses in the majority of past banking crises in advances economies; (ii) institutional and regional factors may lead to variations in the appropriate levels of capital and loss-absorption capacity across jurisdictions; (iii) the short-term costs of transitioning to higher capital standards might be substantial and much higher than long-term costs; (iv) tighter requirements on banks may provide stronger incentives for regulatory arbitrage and increase the risk that activities might migrate to unregulated or less regulated financial intermediaries. In that context, it is essential to widen the perimeter of prudential and macroprudential regulation. MINIMUM CAPITAL REQUIREMENTS FOR MARKET RISK Bank for International Settlements. January, Read more: The purpose of the revised market risk framework is to ensure that the standardized and internal model approaches to market risk deliver credible capital outcomes and promote consistent implementation of the standards across jurisdictions. The key features of the revised framework include: (i) a revised boundary between the trading book and banking book; (ii) a revised internal models approach for market risk; (iii) a revised standardized approach for market risk; (iv) a shift from value-atrisk to an expected shortfall measure of risk under stress; (v) incorporation of the risk of market illiquidity. 4

5 BANKING SUPERVISION HOW BLOCKCHAIN COULD CHANGE THE FINANCIAL SYSTEM Peter Olson and David Wessel. Brookings. February, Read more: The technology sustaining bitcoin and other cryptocurrencies both the software protocols that make them work and a distributed ledger innovation known as the blockchain may prove to be an enduring development, allowing a payment system to operate in an entirely decentralized way, without intermediaries such as banks. This could turn out to be a highly disruptive technology, one that challenges the dominance of the big players in payment systems and that significantly reduces the cost of financial transactions and the speed with which they are completed. But the evolving technology faces risks and obstacles. These problems include hacking attacks on bitcoin wallets, governance challenges, threats to consumer protection, money-laundering concerns, resistance from entrenched financial institutions and raised regulatory eyebrows. VIRTUAL CURRENCIES AND BEYOND: INITIAL CONSIDERATIONS Dong He, Karl Habermeier, Ross Leckow, Vikram Haksar, Yasmin Almeida, Mikari Kashima, Nadim Kyriakos-Saad, Hiroko Oura, Tahsin Saadi Sedik, Natalia Stetsenko, and Concepcion Verdugo-Yepes. International Monetary Fund. March, Read more: New technologies are driving transformational change in the global economy. An important development in this process has been the emergence of virtual currencies (VCs). VC schemes are private sector systems that facilitate peer-to-peer exchange bypassing traditional central clearinghouses. VCs offer many potential benefits, including greater speed and efficiency in making payments and transfers, particularly across borders. At the same time, VCs pose considerable risks as potential vehicles for money laundering, terrorist financing, tax evasion and fraud. The development of effective regulatory responses to VCs is still at an early stage. VCs are difficult to regulate as they cut across the responsibilities of different agencies at the national level, and operate on a global scale. Many are opaque and operate outside of the conventional financial system, making it difficult to monitor their operations. Some initial regulatory responses have included issuing warnings to consumers, imposing licensing requirements on certain VC market participants and prohibiting financial institutions from dealing in VCs. 5

6 RESEARCH AND ANALYSIS WORLD ECONOMIC OUTLOOK - SUBDUED DEMAND, DIMINISHED PROSPECTS International Monetary Fund. January, Read more: Global growth, currently estimated at 3.1% in 2015, is projected at 3.4% in 2016, and 3.6% in A modest and uneven recovery is expected in advanced economies, with a gradual further narrowing of output gaps. The scenario for emerging market and developing economies is diverse but in many cases challenging. Three key transitions continue to influence the global outlook: (i) the gradual slowdown and rebalancing of economic activity in China, away from investment and manufacturing toward consumption and services; (ii) lower prices for energy and other commodities; and (iii) a gradual tightening in monetary policy in the United States, in the context of a resilient U.S. recovery as several other major advanced economy central banks continue to ease monetary policy. ECONOMIC AND SOCIAL PANORAMA OF THE COMMUNITY OF LATIN AMERICAN AND CARIBBEAN STATES 2015 Economic Commission for Latin America and the Caribbean. January, Read more: World economic growth has slowed, reaching 2.4% in Behind this result was the slowdown of developing economies and in particular China, which for the first time since 1990 exhibited a growth below 7%. In addition, the prices of metals and agricultural products have shown a cumulative decline of 50% and 30%, respectively, since In the region, the contraction in economic activity was due to the slowdown in the economies of South America. In particular, this result was influenced by the negative growth in Brazil and Venezuela during The projections for 2016 have been revised downwards, commodity prices are expected to experience negative variations, but in a smaller magnitude than in the past. 6

7 RESEARCH AND ANALYSIS HOW HAVE CENTRAL BANKS IMPLEMENTED NEGATIVE POLICY RATES? Morten Bech and Aytek Malkhozov. Bank for International Settlements. March, Read more: Several central banks around the world have introduced unconventional policies to provide additional monetary stimulus. Four central banks in Europe and the Bank of Japan have move their policy rates into negative territory. The motivations behind the decisions differed across jurisdictions, leading to differences in policy implementation. So far, the evidence shows that modestly negative rates transmit through money markets and other interest rates in the same way that positive rates do. However, the exception would be retail deposit rates and some mortgage rates, which have perversely increased. Looking ahead, there is great uncertainty about the behavior of individuals and institutions if rates were to decline further into negative territory or remain negative for a prolonged period. THE RESILIENCE OF BANKS INTERNATIONAL OPERATIONS Patrick McGuire and Goetz von Peter. Bank for International Settlements. March, Read more: This paper examines the role that banks structure and funding mix played in the resilience of their balance sheets in the years following the financial crisis. To explore the factors driving the balance sheet contractions in the wake of the crisis, the authors decomposed their variation across affiliate groups into three sources. They find that contractions were larger for: (i) banks operating in troubled economies and offshore centers (host country effect); (ii) banks which, at a consolidated level, were more exposed to the financial crisis (nationality effect); and (iii) affiliates with a fragile funding mix. In this latter case, local claims funded by local liabilities made balance sheets more resilient. By contrast, affiliates that relied more on non-core liabilities, such as interbank, cross-border and cross-currency funding, experienced larger balance sheet contractions. 7

8 RESEARCH AND ANALYSIS THREE THINGS TO KNOW ABOUT THE IMPACT OF LOW OIL PRICES ON LATIN AMERICA Harold Trinkunas. Brookings. February, Read more: Latin America holds some of the world s largest reserves of oil, with key states supplying an important part of the global oil market. Crude oil prices have fallen significantly over the past couple of years from over $100 per barrel to less than $30. That has focused attention on the hardest-hit large producers, such as Colombia, Ecuador, Mexico, and Venezuela, where the economic, social, and even political consequences are most dramatic. Some large energy importers will undoubtedly benefit, and some large producers are in deep trouble. But for many oil producers, a combination of a diversified economy will limit the damage for 2015 and Three things to keep in mind as when assessing the impact of low oil prices in the region are: (i) the role of energy, in particular oil, in the economy of Latin American states; (ii) the mechanisms available to states to hedge against the decline in oil prices; and (iii) the impact of low oil prices on Latin America s oil companies. IT S EL NIÑO!: ECONOMIC IMPACT IN THE ANDEAN REGION Lucía Martín. Inter-American Development Bank. February, Read more: The Andean countries are particularly vulnerable to the climate phenomenon called El Niño (FEN), manifesting itself with extensive flooding in Ecuador, Peru, and Bolivia. At the same time, the Andean Highlands experience droughts, and Colombia and Venezuela suffer rainfall deficits. There is a high probability that the FEN will be the most important since 1998, whose major effects would be felt from November 2015 until the second quarter of This document seeks to estimate the potential impact of FEN on productive activity and prices in the Andean Region. If proved correct, these estimates indicate that a normal to extraordinary FEN could reduce GDP between 0.6% and 1.7% in the Andean countries. Peru and Ecuador would be the most affected countries, with impacts above 1.5% in GDP; while in the case of Bolivia and Colombia, the effect would be around 0.5%. On the price side, an extraordinary FEN could cause increases in the price level ranging between 1 and 5%. This analysis is supported considering the damage during the FEN events that took place in and , called Meganiños. 8

9 RESEARCH AND ANALYSIS WHAT IS DRIVING BRAZIL S ECONOMIC DOWNTURN? European Central Bank. February, Read more: Brazil s economic situation has deteriorated significantly in recent years. The downturn of the non-energy commodity price cycle revealed the underlying structural weaknesses in the Brazilian economy. These weaknesses include a burdensome tax system, a sizeable informal sector, poor infrastructure, limited competition, the high costs of starting a business and high tariff rates. The shift in global financial market sentiment amid the US Federal Reserve s announcement that it would wind down asset purchases (the taper tantrum ) in May 2013 had a significant impact on the Brazilian economy. Global market sentiment suddenly turned against vulnerable emerging market economies with high external and fiscal imbalances, such as Brazil. Model estimates suggest that the recent downturn in Brazil is, to a large extent, driven by a combination of domestic factors and lower commodity prices. 9

10 CONTRIBUTIONS FROM OUR MEMBERS AND NEWS First National Survey on Financial Services - Results Report Autoridad de Supervisión del Sistema Financiero. Bolivia. Read more: The Implementation of LCR (Liquidity Coverage Ratio) in Brazil Banco Central do Brasil. Read more: Standardized Approach Provisions for the Residential Mortgage Portfolio Superintendencia de Bancos e Instituciones Financieras. Chile. Read more: Report on Credit Conditions for Companies According to Size 2015 Superintendencia de Bancos e Instituciones Financieras. Chile. Read more: Harmonization and Actualization of the Law Centrale Bank van Curaçao en Sint Maarten. Read more: Evaluation of the Interconnection Between Deposit Entities in El Salvador through Network Analysis Banco Central de Reserva de El Salvador. Read more: Single Supervisory Mechanism and the Role of National Authorities Banco de España. Read more: 10

11 CONTRIBUTIONS FROM OUR MEMBERS AND NEWS The BIS International Banking Statistics: Structure and Analytical Use Banco de España. Read more: Resolution of Central Counterparties: An Approximation Within a Post Crisis Environment Banco de España Read more: Recent Advances in Regulation and Supervision Comisión Nacional de Bancos y Seguros. Honduras. Read more: Technical Contribution of the CNBV Comisión Nacional Bancaria y de Valores. Mexico. Read more: Adapting Peruvian Regulation to Basel III: New Guidelines on Subordinated Debt Superintendencia de Banca, Seguros y AFP. Peru. Read more: 11

12 ASBA EVENTS Institutional Events LXXVII ASBA s Board of Directors Meeting May 19-20, Miami, USA. LXXVIII ASBA s Board of Directors Meeting August 11-12, Buenos Aires, Argentina. International Participation Policy and Implementation Meeting on Interest Rate Risk in the Banking Book and the Revised Standardized Approach for Credit Risk April 27-28, Sao Paulo, Brazil. II Forum of Financial Information Meeting May 04-07, Lisbon, Portugal. Event for Financial Regulators in Latin America May 17-18, Buenos Aires, Argentina. XXXIV Annual Conference - Caribbean Group of Banking Supervisors May 19-21, Kingston, Jamaica. Meeting of the Basel Consultative Group May 24-25, Basel, Switzerland. 16th Annual International Conference on Policy Challenges for the Financial Sector June 01-03, Washington, D.C., USA. Meeting of the Association of Private Banks of Uruguay with Financial Regulators June 31-July Montevideo, Uruguay. 12

13 ASBA EVENTS VI Meeting on Financial Stability July 14-15, Mexico City, Mexico. Regional Dialogue, Public Sector - Private Sector September 2-3, Washington, D.C., USA. Financial Stability and Stress Test September 13-15, Port of Spain, Trinidad & Tobago. Training Bank Analysis and Examination School April 11-15, Jamaica. Read more: Policy and Implementation Meeting on Interest Rate Risk in the Banking Book and the Revised Standardized Approach for Credit Risk April 27-28, Brazil. Read more: Market Risk Analysis May 16-20, Chile. Read more: Supervisory Practices and Pillar 2 (Only in Spanish) May 23-27, Paraguay. Read more: Financial Crimes Detection June 20-24, Mexico. Supervision of Operational Risk June 27 - July 1, 2016 Curaçao 13

14 Although these challenging conditions find the region s financial markets with appropriate levels of financial strength, it is necessary to take actions to avoid the transmission of risks to the financial sector and, in case this happens, to mitigate their impacts keeping them from having a systemic reach. Certainly, the combination of economic and financial management policies is fundamental. However, supervisors have the opportunity to support the implementation of these policies through a closer surveillance over the quality of assets, verifying that loan-loss reserves are realistic and that the sector s capital is consistent with its risks level, as well as closely monitoring risk management practices, especially, credit and liquidity risk. A prudent approach from supervisors should facilitate an adequate balance between the gradual implementation of international standards - that strengthen the regulatory framework and manage the impact of new risks - and the need for the sector to keep a competitive position in times of lower income and limited growth perspectives. These actions would better protect the region s financial stability. Subscribe to Our Journal or send us Comments and Suggestions: us at asba@asbasupervision.org or Call +52 (55) Visit Our Website at: Follow us on Twitter: DISCLAIMER / COPYRIGHT Published by the Association of Supervisors of Banks of the Americas (ASBA). Its headquarters are located at C. Picacho Ajusco #238 Int. 601 Col. Jardines en la Montaña, Mexico City, Zip Code 14210, Mexico. To subscribe to this Newsletter send an to asba@asbasupervision.org or call (5255) Reproduction in whole or in part is prohibited without prior permission from ASBA. The information has been obtained by ASBA from sources deemed as reliable and, in most cases, publicly available or provided by an Associate Member. However, given the possibility of human and/or mechanical error from our sources, ASBA does not guarantee the accuracy, adequacy or completeness of any information. ASBA is not responsible for errors, omissions, or the results from using such information. The opinions and assertions contained in articles and documents published by individual authors are the sole responsibility of the authors, and do not represent the opinion of the Association of Supervisors of Banks of the Americas, its Board of Directors or the General Secretariat. ASBA reserves the right to release documents to the supervisory community in the Region, and it does not receive any payment for doing so.