The following will be discussed in this chapter: Why and how should banks be regulated? how a bank earns profit? safety and soundness, CAMELS, what are banking regulations? potential problems in bank, criticality of banking system, investment banks,...
Session: FOURTEEN MBF-705 LEGAL AND REGULATORY ASPECTS OF BANKING SUPERVISION OSMAN BIN SAIF Revision session SECTION Why and How Should Banks Be Regulated? • • The health of the economy and the effectiveness of monetary policy depend on a sound financial system Through supervising and regulating financial institutions, the State Bank is better able to make policy decisions Why and How Should Banks Be Regulated? (Contd.) • • Bank supervision involves monitoring and examining the condition of banks and their compliance with laws and regulations If a bank under the State Bank’s jurisdiction is found to have problems or be noncompliant, the State Bank may use its authority to request that the bank correct the problems Why and How Should Banks Be Regulated? (Contd.) • Bank regulation includes issuing specific regulations and guidelines to govern the operations, activities and acquisitions of banking organizations How a Bank earns Profit? • • • Just like any other business, a bank earns money so that it can run its operations and provide services First, customers deposit their money in a bank account The bank provides safe storage and pays interest on customers’ deposits The bank is required to keep a percentage of deposits in reserve as cash in its vault or in an account at The State Bank How a Bank earns Profit? (Contd.) • • • The bank can lend the rest to qualified borrowers Potential borrowers may wish to buy a house or a new car; However, they may not have enough money to pay the full price at one time Instead of waiting to save the money to pay for a new house, which could take years, they take out a loan from a bank Borrowers are charged interest on the loan – a bank’s primary source of income Safety and Soundness • • Two major focuses of banking supervision and regulation are the safety and soundness of financial institutions and compliance with consumer protection laws To measure the safety and soundness of a bank, an examiner performs an on-site examination review of the bank's performance based on its management and financial condition, and its compliance CAMELS • • The Banking Supervisor/examiner uses the CAMELS rating system to help measure the safety and soundness of a bank Each letter stands for one of the six components of a bank’s condition: – capital adequacy, – asset quality, – management, 10 Other Types of Regulations(Contd.) • • • Lending Regulations – Consumer protection – Debt collection – Credit cards – Lending limits Central bank regulations Regulation of bank affiliates and holding companies 43 • • SECTION 2: REGULATING BANK CAPITAL ADEQUACY 44 CAPITAL ADEQUACY • • Capital requirement (also known as Regulatory capital or Capital adequacy) is the amount of capital a bank or other financial institution has to hold as required by its financial regulator This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets 45 CAPITAL ADEQUACY (Contd.) • • • These requirements are put into place to ensure that these institutions not take on excess leverage and become insolvent Capital requirements govern the ratio of equity to debt, recorded on the right side of a firm's balance sheet They should not be confused with reserve requirements, which govern the left side of 46 a bank's balance sheet in particular, the Regulations • • A key part of bank regulation is to make sure that firms operating in the industry are prudently managed The aim is to protect the firms themselves, their customers and the economy, by establishing rules to make sure that these institutions hold enough capital to ensure continuation of a safe and efficient market and able to withstand any foreseeable problems 47 Regulations (Contd.) • • The main international effort to establish rules around capital requirements has been the Basel Accords, published by the Basel Committee on Banking Supervision housed at the Bank for International Settlements This sets a framework on how banks and depository institutions must calculate their capital 48 Regulations (Contd.) • • In 1988, the Committee decided to introduce a capital measurement system commonly referred to as Basel I This framework has been replaced by a significantly more complex capital adequacy framework commonly known as Basel II • After 2012 it was replaced by Basel III • Another term commonly used in 49the Regulations (Contd.) • • The capital ratio is the percentage of a bank's capital to its risk-weighted assets Weights are defined by risk-sensitivity ratios whose calculation is dictated under the relevant Accord Basel II requires that the total capital ratio must be no lower than 8% 50 Regulations (Contd.) • • Each national regulator normally has a very slightly different way of calculating bank capital, designed to meet the common requirements within their individual national legal framework Most developed countries implement Basel I and II and now III , stipulate lending limits 51 • BASEL I 52 Basel I • • • Basel I is the round of deliberations by central bankers from around the world, and in 1988 The Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of minimum capital requirements for banks This is also known as the 1988 Basel Accord, and was enforced by law in 53 the Group of Ten (G-10) countries in Basel I (Contd.) • • • Basel I is now widely viewed as outmoded The world has changed as financial conglomerates, financial innovation and risk management have developed, and a more comprehensive set of guidelines, known as Basel II, are in the process of implementation by several countries Basel III was developed in response to 54 the financial crisis Background • • The Committee was formed in response to the messy liquidation of a Cologne-based bank (Herstatt Bank) in 1974 On 26 June 1974, a number of banks had released Deutsche Mark (German Mark) to the Herstatt Bank in exchange for dollar payments deliverable in New York 55 Main framework • Basel I, that is, the 1988 Basel Accord, is primarily focused on credit risk and appropriate Risk Weighting of Assets • 56 THANK YOU ... measure the safety and soundness of a bank Each letter stands for one of the six components of a bank’s condition: – capital adequacy, – asset quality, – management, 10 What are Banking Regulations?... primary source of income Safety and Soundness • • Two major focuses of banking supervision and regulation are the safety and soundness of financial institutions and compliance with consumer protection... bank failures; – Avoid Misuse of Banks—to reduce the risk of banks being used for criminal purposes, e.g laundering the proceeds of crime; – To Protect Banking Confidentiality; – Credit Allocation—to