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Liquidity risk and performance of banking system. Bancassurance: an insurance concept from a Irish perspective. This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate market risks on a timely basis. Principle 23 — Interest rate risk in the banking book: The supervisor determines that banks have adequate systems to identify, measure, evaluate, monitor, report and control or mitigate interest rate risk 33 in the banking book on a timely basis.
Principle 24 — Liquidity risk: The supervisor sets prudent and appropriate liquidity requirements which can include either quantitative or qualitative requirements or both for banks that reflect the liquidity needs of the bank. The supervisor determines that banks have a strategy that enables prudent management of liquidity risk and compliance with liquidity requirements.
At least for internationally active banks, liquidity requirements are not lower than the applicable Basel standards. Principle 25 — Operational risk: The supervisor determines that banks have an adequate operational risk management framework that takes into account their risk appetite, risk profile and market and macroeconomic conditions. This includes prudent policies and processes to identify, assess, evaluate, monitor, report and control or mitigate operational risk 34 on a timely basis.
Principle 26 — Internal control and audit: The supervisor determines that banks have adequate internal control frameworks to establish and maintain a properly controlled operating environment for the conduct of their business taking into account their risk profile.
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The supervisor also determines that banks and parent companies of banking groups have adequate governance and oversight of the external audit function. Principle 28 — Disclosure and transparency: The supervisor determines that banks and banking groups regularly publish information on a consolidated and, where appropriate, solo basis that is easily accessible and fairly reflects their financial condition, performance, risk exposures, risk management strategies and corporate governance policies and processes.
Principle 29 — Abuse of financial services: The supervisor determines that banks have adequate policies and processes, including strict customer due diligence rules to promote high ethical and professional standards in the financial sector and prevent the bank from being used, intentionally or unintentionally, for criminal activities. The activities of authorising banks, ongoing supervision and corrective actions are elaborated in subsequent principles. This standard refers to a governance structure composed of a board and senior management.
The Committee recognises that there are significant differences in the legislative and regulatory frameworks across countries regarding these functions.
Some countries use a two-tier board structure, where the supervisory function of the board is performed by a separate entity known as a supervisory board, which has no executive functions. Other countries, in contrast, use a one-tier board structure in which the board has a broader role. Owing to these differences, this document does not advocate a specific board structure.
The former are addressed by this Principle, and the latter are addressed in Principle To some extent the precise requirements may vary from risk type to risk type Principles 15 to 25 as reflected by the underlying reference documents. The Committee does not consider implementation of the Basel-based framework a prerequisite for compliance with the Core Principles, and compliance with one of the regimes is only required of those jurisdictions that have declared that they have voluntarily implemented it.
Principle 17 covers the evaluation of assets in greater detail; Principle 18 covers the management of problem assets. Credit risk may result from the following: on-balance sheet and off-balance sheet exposures, including loans and advances, investments, inter-bank lending, derivative transactions, securities financing transactions and trading activities. Counterparty credit risk includes credit risk exposures arising from derivative contracts and other financial instruments. Connected counterparties may include natural persons as well as a group of companies related financially or by common ownership, management or any combination thereof.
Related party transactions include on-balance sheet and off-balance sheet credit exposures and claims, as well as, dealings such as service contracts, asset purchases and sales, construction contracts, lease agreements, derivative transactions, borrowings, and write-offs. The term transaction should be interpreted broadly to incorporate not only transactions that are entered into with related parties but also situations in which an unrelated party with whom a bank has an existing exposure subsequently becomes a related party.
Country risk is the risk of exposure to loss caused by events in a foreign country.
Transfer risk is the risk that a borrower will not be able to convert local currency into foreign exchange and so will be unable to make debt service payments in foreign currency. Interest rate risk in the trading book is covered under Principle The Committee has defined operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The definition includes legal risk but excludes strategic and reputational risk.
In assessing independence, supervisors give due regard to the control systems designed to avoid conflicts of interest in the performance measurement of staff in the compliance, control and internal audit functions.
For example, the remuneration of such staff should be determined independently of the business lines that they oversee. The Committee is aware that, in some jurisdictions, other authorities, such as a financial intelligence unit, rather than a banking supervisor, may have primary responsibility for assessing compliance with laws and regulations regarding criminal activities in banks, such as fraud, money laundering and the financing of terrorism. In such jurisdictions, the banking supervisor cooperates with such authorities to achieve adherence with the criteria mentioned in this Principle.
The Core Principles are neutral with regard to different approaches to supervision, so long as the overriding goals are achieved. They are not designed to cover all the needs and circumstances of every banking system. Instead, specific country circumstances should be more appropriately considered in the context of the assessments and in the dialogue between assessors and country authorities.
A high degree of compliance with the Core Principles should foster overall financial system stability; however, this will not guarantee it, nor will it prevent the failure of banks. Banking supervision cannot, and should not, provide an assurance that banks will not fail. In a market economy, failures are part of risk-taking. The Committee stands ready to encourage work at the national level to implement the Core Principles in conjunction with other supervisory bodies and interested parties.
The Committee invites the international financial institutions and donor agencies to use the Core Principles in assisting individual countries to strengthen their supervisory arrangements. The Committee also remains committed to further enhancing its interaction with supervisors from non-member countries. An effective system of banking supervision needs to be able to effectively develop, implement, monitor and enforce supervisory policies under normal and stressed economic and financial conditions.
Supervisors need to be able to respond to external conditions that can negatively affect banks or the banking system. There are a number of elements or preconditions that have a direct impact on the effectiveness of supervision in practice.
These preconditions are mostly outside the direct or sole jurisdiction of banking supervisors. Where supervisors have concerns that the preconditions could impact the efficiency or effectiveness of regulation and supervision of banks, supervisors should make the government and relevant authorities aware of them and their actual or potential negative repercussions for supervisory objectives. Supervisors should work with the government and relevant authorities to address concerns that are outside the direct or sole jurisdiction of the supervisors.
Supervisors should also, as part of their normal business, adopt measures to address the effects of such concerns on the efficiency or effectiveness of regulation and supervision of banks. Sound macroeconomic policies mainly fiscal and monetary policies are the foundation of a stable financial system.
Without sound policies, imbalances such as high government borrowing and spending, and an excessive shortage or supply of liquidity, may arise and affect the stability of the financial system.
Suspending Suspicious Transactions
Further, certain government policies 37 may specifically use banks and other financial intermediaries as instruments, which may inhibit effective supervision. Examples of such policies include accumulation of large quantities of government securities; reduced access to capital markets due to government controls or growing imbalances; degradation in asset quality after loose monetary policies; and government-directed lending or forbearance requirements as an economic policy response to deteriorating economic conditions.
In view of the impact and interplay between the real economy and banks and the financial system, it is important that there exists a clear framework for macroprudential surveillance and financial stability policy formulation. Such a framework should set out the authorities or those responsible for identifying systemic and emerging risks in the financial system, monitoring and analysing market and other financial and economic factors that may lead to accumulation of systemic risks, formulating and implementing appropriate policies, and assessing how such policies may affect the banks and the financial system.
It should also include mechanisms for effective cooperation and coordination among the relevant agencies. A well developed public infrastructure needs to comprise the following elements, which, if not adequately provided, can contribute to the weakening of financial systems and markets, or frustrate their improvement:. Effective crisis management frameworks and resolution regimes help to minimise potential disruptions to financial stability arising from banks and financial institutions that are in distress or failing.
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A sound institutional framework for crisis management and resolution requires a clear mandate and an effective legal underpinning for each relevant authority such as banking supervisors, national resolution authorities, finance ministries and central banks. The relevant authorities should have a broad range of powers and appropriate tools provided in law to resolve a financial institution that is no longer viable and where there is no reasonable prospect of it becoming viable.
There should also be agreement among the relevant authorities on their individual and joint responsibilities for crisis management and resolution, and how they will discharge these responsibilities in a coordinated manner. This should include the ability to share confidential information among one another to facilitate planning in advance to handle recovery and resolution situations and to manage such events when they occur. Deciding on the appropriate level of systemic protection is a policy question to be addressed by the relevant authorities, including the government and central bank, particularly where it may result in a commitment of public funds.
Supervisors will have an important role to play because of their in-depth knowledge of the financial institutions involved. In handling systemic issues, it is necessary to balance several factors: addressing the risks to confidence in the financial system and contagion to otherwise sound institutions and, minimising the distortion to market signals and discipline.
A key element of the framework for systemic protection is a system of deposit insurance. Provided such a system is transparent and carefully designed, it can contribute to public confidence in the system and thus limit contagion from banks in distress. Effective market discipline depends, in part, on adequate flows of information to market participants, appropriate financial incentives to reward well managed institutions, and arrangements that ensure that investors are not insulated from the consequences of their decisions. Among the issues to be addressed are corporate governance and ensuring that accurate, meaningful, transparent and timely information is provided by borrowers to investors and creditors.
Market signals can be distorted and discipline undermined if governments seek to influence or override commercial decisions, particularly lending decisions, to achieve public policy objectives. In these circumstances, it is important that, if governments or their related entities provide or guarantee the lending, such arrangements are disclosed and there is a formal process for compensating financial institutions when such loans cease to perform.
The Core Principles are mainly intended to help countries assess the quality of their systems and to provide input into their reform agenda.
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In order to achieve objectivity and comparability of compliance with the Core Principles in the different country assessments, 38 supervisors and assessors should refer to this assessment methodology, which does not eliminate the need for both parties to use their judgment in assessing compliance. Such an assessment should identify weaknesses in the existing system of supervision and regulation, and form a basis for remedial measures by government authorities and banking supervisors.
The aim of assessments is, however, not for ranking supervisory systems. Please refer to BCP Although Committee members individually collaborate in assessment missions, these are conducted primarily by the IMF and the World Bank. However, the Committee, together with the Financial Stability Institute, is prepared to assist in other ways, for example by providing training.
The Committee has issued guidelines for performing self-assessments: Conducting a supervisory self-assessment — practical application, Basel, April The regular reports by the IMF and the World Bank on the lessons drawn from assessment experiences as part of FSAP exercises constitute a useful source of information which has been used as an input to improve the Principles. In order to achieve full objectivity, compliance with the Core Principles is best assessed by suitably qualified external parties consisting of two individuals with strong supervisory backgrounds who bring varied perspectives so as to provide checks and balances; however, experience has shown that a recent self-assessment is a highly useful input to an outside party assessment.
A fair assessment of the banking supervisory process cannot be performed without the genuine cooperation of all relevant authorities. The process of assessing each of the 29 Core Principles requires a judgmental weighing of numerous elements that only qualified assessors with practical, relevant experience can provide.
The assessment requires some legal and accounting expertise in the interpretation of compliance with the Core Principles; these legal and accounting interpretations must be in relation to the legislative and accounting structure of the relevant country. They may also require the advice of additional legal and accounting experts, which can be sought subsequent to the on-site assessment.
The assessment must be comprehensive and in sufficient depth to allow a judgment on whether criteria are fulfilled in practice, not just in theory. Laws and regulations need to be sufficient in scope and depth, and be effectively enforced and complied with. Their existence alone does not provide enough indication that the criteria are met. The primary objective of an assessment should be the identification of the nature and extent of any weaknesses in the banking supervisory system and compliance with individual Core Principles.
While the process of implementing the Core Principles starts with the assessment of compliance, assessment is a means to an end, not an objective in itself.