Presented by Norman Mataruka Registrar of Banking Institutions: Reserve Bank of Zimbabwe nmataruka@rbz.co.zw July 18, 2012 9/16/2016 1
Financial Sector Stability Financial Stability Continuum Sources of risk to financial sector Current Banking Sector Problems Strengthening financial stability: Early warning systems and macro-prudential Surveillance Safety net: preventive measures Safety net: resolution measures The outlook - more intensive supervision 9/16/2016 2
Financial system stability can be defined as the resilience of the financial system to internal and external shocks, be it economic, financial, political or otherwise. 9/16/2016 3
Financial instability, on the other hand, is manifested through the failures of significant institutions, intense asset price volatility or the collapse of market liquidity and ultimately in a disruption in the payment system. 16-Sep-16 4 9/16/2016 4
Financial stability occurs along a continuum, changing over time and consistent with manifold combinations of its constituent elements. Financial stability is neither a state of equilibrium nor is it ever static but evolves, moving along a continuum - a perpetual state of flux and transformation (Schinasi (2004, p.8)). 9/16/2016 5
Financial Stability Financial Instability 9/16/2016 6
The Reserve Bank is the custodian of monetary policy & its formulation. Monetary transmission can not be efficient if a weak financial system distorts interest rate signals or if the financial markets have ceased to function as some participants do not trust other players. A weak financial system can directly cause a crisis. This can result in capital flight, recession etc. Central banks everywhere take the leading role in crisis resolution, by providing emergency assistance and working out restructuring plans. 9/16/2016 7
The Reserve Bank's direct responsibilities to maintain the financial stability, apart from direct supervisory functions, can be divided into three large areas. Firstly, the Reserve Bank is responsible for analysis of financial system developments and to determine the early signs of possible financial difficulties. Secondly, the Reserve Bank is by definition involved in designing and building up financial system safety nets. Thirdly, we are responsible for regulating the banking system. 9/16/2016 8
Endogenous Institutions based: Financial risk Credit Market Liquidity Interest rate Currency Operational risk Information Technology weaknesses Legal/integrity Reputation risk Business strategy risk Concentration risk Capital adequacy risk Market based: Counterparty risk Asset price misalignment Run on markets Credit Liquidity Contagion Infrastructure based Clearance, payment, settlement Infrastructure fragilities Legal Regulatory Accounting Supervisory Collapse of confidence leading to runs Domino effects Exogenous Macroeconomic disturbances Policy imbalances Event Risk Natural disaster Political events Large business failures 9/16/2016 9
The Reserve Bank has seen the re-emergence of the 2004/5 ghosts in so far as financial sector weaknesses are concerned. We are discovering, through on-site examinations, the same problems which we saw during the mini-banking crisis of 2004/5. 9/16/2016 10
Inadequate capital. Poor board and senior management oversight. High concentration of insider loans to associates and related party interests. High concentration risk on both sides of the balance sheet. Shifting from core banking business to speculative transactions. Mixing non-banking activities and banking business. Abuse of bank holding company structures to evade regulation. Inadequate, incompetent and inexperienced management. Undue influence through shareholding, where the shareholders are the directors and management. Board dominance by a few members. Rapid local and international expansion with no proper internal controls, early warning systems and adequate capacity. 9/16/2016 11
Lack of shareholder support. Poor risk management practices. Poor management information systems. Over reliance on wholesale deposits that are sensitive to market shocks. Poor asset and liability management e.g. excessive investments in fixed assets, commodities, furniture and property as well as equity investments number of companies via the holding company. Unmanageable mismatches between assets and liabilities. Significant unauthorized overdrafts. Disregard of prudential laws and regulations. 9/16/2016 12
Chronic liquidity challenges Critical under-capitalisation Use of borrowed capital and irregular pledge of bank shares as security Concentrated shareholding and abuse of group structures High volume of non-performing loans Gross violation of prudential lending limits Poor board and senior management oversight Inadequate manning levels and skills deficit 9/16/2016 13
Increasing non-performing insider loans Poor management information systems Poor risk management systems and practices especially in regard to strategic, credit, liquidity and operational risks. Abuse of depositors funds Poor financial reporting and creative accounting Failure to publish financial statements Violation of laws and regulations 9/16/2016 14
Another challenge we have noted are the persistent losses which some banks continue to incur. Insignificant interest income These are under threat as they are not able to grow their business organically. The inevitable result is that these banks will end up financing their operations using depositors funds. The table below shows aggregate trends in profitability to 30 March 2012. 9/16/2016 15
2011 2012 March June September December March Total Profits 44,383,984.29 64,749,117.98 86,030,800.20 126,322,209.60 27,505,973.15 No. of Banks Making Profits 16 15 16 18 15 Total Losses (6,365,912.57) (37,415,412.05) (26,896,539.82) (40,315,332.00) (12,833,972.94) No. of Banks Making Losses 9 10 9 7 10 Total Industry Profit 38,018,071.72 27,333,705.93 59,134,260.38 86,006,877.60 14,672,000.20 9/16/2016 16
YES OR NO? 9/16/2016 17
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Banking Supervision Insurance Supervision Securities Regulation Consolidated Supervision Corporate Governance Operational Independence and Accountability Country and Market Risk Supervisory Authority (Independence, Accountability, Resources, Powers, Protection) Regulatory oversight of Securities companies Risk Management Process Group-wide Supervision Supervisory Powers, Resources and Capacity Operational Independence, Accountability and Resources Risk-assessment and Management Effective use of inspection, enforcement and compliance 9/16/2016 19
Was not proactive in dealing with emerging risks Did not sufficiently question business activities of regulated institutions In some cases, supervision: Did not keep up with the changing business environment Did not follow through lacked skepticism 9/16/2016 20
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Internal Governance & Risk Management Market Confidence/ Discipline Economic & Market Conditions Financial Sector Performance SUPERVISION and Regulation 9/16/2016 22
Intrusive Comprehensive Adaptive Skeptical and Proactive Credible Follow-through 9/16/2016 23
The will to act The ability to act High Quality Supervision 9/16/2016 24
Clear Mandate Operational Independence Accountability 9/16/2016 25
Strong Authority Adequate Resources Internal Organization Forwardlooking Strategy Interagency Collaboration 9/16/2016 26
Troubled bank resolution framework Legislative framework for winding up a bank Enhanced regulations on corporate governance and internal control of banks Regulations on bank holding companies Consolidated supervision regulations and cooperation with other regulatory agencies Legal protection of supervisors 9/16/2016 27
The harsh lessons from the 2004/5 crisis have underlined the need to better understand the key vulnerabilities in the financial system. 2012 witnessing declining capital, liquidity, profitability, increasing loan losses and economic down turn The Reserve Bank has successfully implemented several analytical tools, including early warning systems, stress testing and macro-prudential analysis to enhance vulnerability analysis of the financial sector 9/16/2016 28
Early warning systems help in estimating the impact of external factors on the financial systems, for example how vulnerable the banking sector is to decline in exports or to worsening market sentiment. The Reserve Bank s statistics cover the key financial soundness indicators fairly well and significant resources have been dedicated to improve it analytical skills over the last couple of years. 9/16/2016 29
Macroprudential analysis undertakes to broaden vulnerability analysis to a variety of economic indicators, using the stress testing models. We have had a revealing experience with stress testing as illustrated below. 9/16/2016 30
Assessment Factors (Risk Exposures) Credit Interest Rate Forex Liquidity Combined Mi* Mo** Ma*** Mi Mo Ma Mi Mo Ma Mi Mo Ma Mi Mo Ma No. of banks 7 1 1 1 0 0 0 0 0 11 0 0 6 2 2 * Minor shock, ** Moderate shock, *** Major shock 9/16/2016 31
In safe guarding financial sector stability the other major challenge for the central bank is to build up a robust financial safety net. A full-fledged financial safety net consists of two major pillars: crisis prevention and crisis resolution. Continuous analysis of financial system developments and early warning indicators, importance of strong owners and sound risk management in banks, high liquidity and capital requirements these basic principles are a necessity. 9/16/2016 32
A technique used to promote effective oversight of the banking sector is risk based examinations. The Reserve Bank adopted RBS in 2006, which has been recognised in the Basel Core Principles as a growing supervisory practice of determining supervisory programs and allocating resources considering the risks 9/16/2016 33
Review bank s compliance with legislation, regulations, reports Scope and frequency of on-site-ex would be the same for all banks irrespective of risk management process, internal control, or size of a bank In reality tended to spend more time on large banks than small ones 9/16/2016 34
Under RBS supervisory resources are allocated where needed most based on assessment of risks Assessment of the likelihood that a given bank will experience severe financial difficulties And the impact of this event would have on the financial system Assessment process tends not to be highly quantitative and rely on supervisory judgment 9/16/2016 35
Supervisors identify a bank s key activities and assess inherent risk (credit, operational, liquidity..), quality of risk management, direction of risk Overall net risk is determined the probability that the bank will experience severe financial difficulties 9/16/2016 36
Efficiency and Effectiveness Optimize the use of limited supervisory resources by focusing attention on genuine areas of risk The Reserve Bank is actually able to conduct an examination in a week. Clarity and Consistency Incorporate a sound, consistent framework for supervisory decision based on risk 9/16/2016 37
Flexibility Enable on-site ex and other supervisory actions to be tailored to risk of a specific bank or situation Compatible with the flexibility in Basel II and other forms of principlebased regulations 9/16/2016 38
Forward looking Enable supervisors to be more proactive by placing more emphasis on early detection of emerging risk on both the bank and system level 9/16/2016 39
Supervision of Financial Conglomerates Cooperation and coordination among supervisors in the domestic market and internationally. 9/16/2016 40
Permit cooperation where possible Adherence to core standards with non-discriminatory treatment of domestic and foreign creditors Coordination Agreement on procedures for rapid and predictable resolution Framework for burden sharing and allocation of responsibilities 9/16/2016 41
No policy and no supervision can prevent the possibility of financial distress in any particular financial institution. What the public policy can do is to minimize the likelihood of systemic crisis. Crisis resolution is the key to avoid systemic disturbance. The ultimate policy choice for the authorities is to find the balance between the public sector and private sector solution from the one hand and between the pre-determined schedule and ad hoc approach from the other hand. 9/16/2016 42
Options available for the authorities in many other countries: Emergency liquidity support (not available currently in Zimbabwe) In our case, the private sector resolution is preferable (mergers and acquisitions). But this approach rests upon a few strong fundamentals. 9/16/2016 43
Winding-down of the troubled institution is generally the preferred approach. I would like to stress that as an essential element of the safety net, the Deposit Insurance Corporation, has proved its usefulness already. The Fund will reimburses all depositors within legal limits, when a bank is liquidated. The DPB also needs to be capitalised 9/16/2016 44
Another option would be the central bank to take the lead as an honest broker and bring together all private and official parties concerned. Ideally, that would result in design of ad hoc private solution in a form of merger, acquisition or emergency support (ZABG case). The role of central bank is effectively the application of moral suasion. 9/16/2016 45
However, one can and should not wholly dismiss the need for direct public intervention should it become necessary, after writing down capital of the troubled institution. 9/16/2016 46
What is intensive risk based supervision: proactive and adaptive supported by a deep understanding of business model /strategy of the financial institution Results (outcome)-oriented supervisory style - addressing weaknesses before they become serious 9/16/2016 47
Tighten regulation (Basel II / III, Systemically Important Financial Institutions Framework) Better supervision Widen the regulatory/monitoring perimeter 9/16/2016 48
Address data/information gaps to facilitate market discipline/supervision Establish effective resolution regimes (domestic and cross border) Infrastructure to deal with interconnected, complex institutions Focus on systemic risk and macro-prudential policies Ensure capitalization levels are commensurate with the operating environment and risk profile of banks 9/16/2016 49
Enhance cross-border crisis preparation and management Broader role for Multi-Disciplinary Financial Stability Committee in surveillance and promoting regulatory cooperation (Securities Commission, Insurance and Pension Fund, Deposit Protection Board and Reserve Bank) Eliminate regulatory arbitrage opportunities. 9/16/2016 50
Prudential regulation (probability of failure) More and better quality bank capital (greater loss absorption) Better risk recognition for market/counterparty risk Capital conservation buffer Non-risk based leverage ratio More bank liquidity and stable funding Better supervision (probability of failure) More intensive supervision Proactive and adaptive to changing conditions Capacity and willingness to act Mandate, resources, independence, accountability Effective resolution (cost of failure) Special resolution regimes for orderly wind down, at national and global levels Recovery and resolution plans (living wills) Arrangements for burden sharing by creditors 9/16/2016 51 51
Regulation/ supervision (probability of failure) Systemic capital and liquidity surcharges Systemic levies (for banks and non-banks) More intensive supervision of SIFIs in line with systemicness Resolvability (cost of failure) Effective national resolution schemes for SIFIs Cross-border resolution-burden-sharing regimes for global SIFIs Living wills (resolution plans to wind-down SIFIs if they fail) Bail-in able debt at a point of nonviability Structural measures (subsidiarization/size-scope limits) Market infrastructure (impact of failure) OTC derivatives clearance through central counterparties (CCPs) to limit contagion Repo markets (collateral, margining practices) Credit rating agencies (greater oversight, less mechanistic use of ratings) Countercyclicality (impact on economy) Countercyclical capital charges Forward looking loan-loss provisioning Fair-value accounting Macro-prudential policies against cycles and systemic risk 9/16/2016 52 52
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