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Evaluating the Effectiveness of Financial Supervision

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					Evaluating the Effectiveness of Financial
              Supervision


              Paul J.van Sluijs

                World Bank

            Nairobi, 15-17 May 2006
           Contents
1.   Some observations
2.   FSAP background
3.   Main components of regulatory
     standards
4.   Reviews 2003 and 2006
5.   Gaps in financial sector
     regulation
6.   Strengthening standards     2
1 Some observations
   FSAP: interesting experience for the country to be assessed
    as well as for the assessing experts
   Self assessments should be critically reviewed
   Assessment includes practical application of supervisory
    standards: rule- or principle based
   Application in practice of supervisory rules and regulations
    is difficult to assess
   Stress testing important addition to assessment

   EU used similar approach for new entrants

                                                               3
Relative security
1. Not even “perfect” formal implementation
   of the existing principles or standards and
   codes will ensure financial system
   stability.

2. Not even the most thorough financial
   supervision regime can fully protect
   against risks to the financial system.

                                             4
2 FSAP Background
 Start in 1999 as voluntary program
 Joint effort World Bank and IMF
 75 central banks, supervisory agencies etc
  cooperated
 Based on review in 2003 decision for
  continuation
 Further evaluation in 2006

                                               5
FSAP characteristics
 Financial sector coverage
 Analytical tools:
    FSIs

    Stress testing

    Assessment of standards and codes:

       BCP/CPSIPS/IAISCP/IOSCO
        principles/MFP code
                                          6
3 Main components of regulatory
standards
 Introduction
 (Regulatory preconditions)
 Regulatory governance
 Regulatory practices
 Supervisory practices
 Financial Integrity and Safety Nets



                                        7
Introduction
 Financial sector regulatory standards
  comprise essential, but minimum standards
 Good quality regulation is a key element of
  financial stability
 Regulatory standards are internationally
  adopted and locally implemented
 Cross sector review contributes to review of
  standards

                                             8
Introduction (continued)
Regulatory standards:
 BCP (1997 + 1999; draft revision 2006 )
 IOSCO (1998 + 2003)
 IAIS (2003)


   Common ground
   Some variations in similar risks (e.g. capital/risk
    treatment)
   Some variations arising from intrinsic differences
                                                          9
Introduction (continued)
Main regulatory issues from financial stability viewpoint:
 Regulatory governance: capacity and ability of regulatory
  bodies for sound policies and practices
 Prudential framework: rules, directives etc to govern
  operations of financial firms
 Regulatory practices: practical application of regulatory
  framework
 Financial integrity and safety net arrangements:
  instruments to promote fairness and integrity in operations


                                                            10
(Regulatory preconditions)
BCP (1997)
 Sound and sustainable macro-economic policies
 Well developed public infrastructure
 Effective market discipline
 Procedure for efficient resolution of problems in
  banks
 Mechanisms for providing an appropriate level of
  systemic protection (public safety net)
(Similar preconditions in IAIS CP)
                                                  11
(Regulatory preconditions)
 Preconditions are basis for standards
 Linkages between preconditions and
  regulations, for instance:
    “well developed public infrastructure”

     links with asset valuation, supervisory
     powers, enforcement, collateral,
     licensing, accounting framework

                                               12
Regulatory governance
 Objectives of regulation
 Independence and adequate resources
 Enforcement powers and capabilities
 Clarity and transparency of regulatory
  process
 External participation



                                           13
Prudential framework
 Risk management
 Risk concentration
 Capital requirements
 Corporate governance
 Internal controls




                         14
Regulatory practices
   Group-wide supervision
   Monitoring and on-site supervision
   Reporting to supervisors
   Enforcement
   Cooperation and information sharing
   Confidentiality
   Licensing, ownership transfer and corporate
    control
   Qualifications
                                                  15
Financial Integrity and Safety
Net
 Markets (integrity and financial crime)
 Customer protection
 Information, disclosure and transparency




                                             16
4 Review in 2003 and 2006
   Comprehensive and system wide approach to
    analyzing the financial sector
      Independent review by objective outsiders

      Discuss supervisory matters with experts from
       other countries
      Compare practices

      Benchmarking against international practices

      Testing vulnerabilities in the financial system

      Selection of key issues and priorities for
       improvements
                                                         17
Review in 2003 and 2006
   Points of attention (2003):
      Faster and more thorough understanding

       necessary of legal and regulatory traditions
      Limitations of data availability for stress testing

      Large resource costs for authorities

      Reduction of lag between assessment and report




                                                        18
Review in 2003 and 2006
   FSAP increased depth and breath of coverage of
    financial issues:
      Developing countries: strengthening medium
       term financial system and supervision
          Address legal and regulatory framework

      Emerging countries: non bank sector
       deficiencies in supervision and regulation;
       enforcement and prompt corrective action
      Industrial countries: large and complex
       financial institutions
                                                     19
FSAP review recommendations
(2003)
   Updates necessary for:
      systematically important countries

      Countries evolving at a rapid pace

   Selection of key topics per update
   For developing countries: focus on medium term
    and structural issues
   AML/CFT issues to be included
   Possible basis for TA
   Promote publication on a voluntary basis
                                                     20
FSAP findings: areas for
improvement (2003)
For BCP:
 Credit policies and connected lending
 Provisioning practices in practice weaker than on
  paper
 Increase attention for country, market, fc and
  interest rate risk
 Remedial action
 Large and complex financial institutions
 Consolidation of accounts and supervision on a
  consolidated basis
                                                    21
 AML/CFT issues
FSAP evaluation 2006
Some issues:
 Better understanding key linkages
 Discussions with authorities and support
  institutional changes
 Not all systemic countries assessed
 FSIs generally not used in a meaningful manner
 Quality of data needs to be emphasised
 Stress testing needs further development
 Cross border issues need more attention
 Surveillance and technical assistance            22
6 Gaps in financial sector
        regulation




                             23
Conclusions (2004)
 Average level of implementation of
  regulatory components across sectors
  broadly satisfactory
 Implementation in industrial countries
  better than in emerging and developing
  countries
 Level of implementation across sectors is
  correlated

                                              24
Conclusions (2004)
 High level of implementation in particular
  for legal foundation of regulator
 Prudential area: capital, solvency and
  margin requirements prescribed across
  sectors
 Licensing process and entry standards
  largely adequate in most countries

                                               25
Where are the Gaps?
A. Regulatory Governance
B. Regulatory practices
C. Prudential framework
D. Financial Integrity and Safety Net




                                        26
A. Regulatory governance
   Lack of formal and informal independence
   Ill-defined accountability arrangements
   Different categories of deposit taking institutions
    under different laws and regulators
   Regulatory forbearance is a problem in some
    countries
   Ill-defined oversight responsibilities in case of
    regulators and SRO”s
   Lacking legal protection of supervisors and clarity
    of regulatory powers
                                                      27
B. Regulatory practices
 In many cases robust regulatory standards
  but weaker regulatory practices
 Consolidated supervision and – regulation
  needs more attention
 Shortcomings in regulatory data and
  reporting, including consolidated reporting


                                                28
B. Regulatory practices
(continued)
 Limited powers to enforce regulations and
  impose sanctions
 Inadequate cooperation between home and
  host supervisors
 Lack of clear definition of “control”
 (Quality of management, administration and
  internal control??)

                                           29
C. Prudential framework
   Strong focus on prudential regulation, but:
      Deficiencies in oversight and monitoring

       of country risk
      Insufficient requirements for connected

       lending
      Weaknesses corporate governance in
       particular in banking and insurance

                                              30
C. Prudential framework
(continued)
Sector specific issues:
 Banking: Credit risk management, loan
  classification and provisioning, large exposures,
  country and transfer risk
 Asset quality regulation in insurance
 Monitoring and inspection systems ensuring
  compliance with capital and prudential
  requirements
 Collective investment schemes: improvement
  needed of information, asset valuation and pricing
  of units                                          31
D. Financial integrity and safety
net
In general differences along sectoral lines:
 Content and timeliness of disclosure
 Protection of minority shareholders
 Accounting and auditing issues
 Procedures for winding up insurers and
  securities forms missing
 Weak AML efforts

                                               32
Strengthening regulatory
       standards
Strengthening regulatory
standards
Challenges from three factors:
 Diversity of financial systems a.o.
   Ownership

   Role government

   Competition

   Intermediation patterns




                                        34
Strengthening regulatory
standards
   Cross-sectoral and cross border issues a.o.
     Linkages in financial sector growing

     Role of international financial centers

     Role of off-shore centers

     Cross-sector and cross-border financial groups

     Arbitrage possibilities across sectors

     Different cross-sector and cross-border capital
      calculations
     Cross country differences in preconditions and
      governance
                                                        35
Strengthening regulatory
standards
   Objectives and design of regulatory
    standards a.o.
      Regulatory issues and components more
       linked to system-wide financial stability
      Interrelationships among key components
       of regulatory standards more explicit
      Improve standards on information
       disclosure

                                              36
Issues for standards setters
 Diversity in financial systems require
  diversity in regulatory standards?
 More focus on preconditions
 Cross-sectoral and cross-border issues
 Guidance on regulatory governance issues
 Information exchange arrangements



                                             37
Issues for country authorities
 Greater attention to preconditions
 Periodic review of governance in regulatory
  bodies
 Periodic self assessment of regulatory
  standards
 Attention for cross-sector and cross-border
  issues
 Attention for system-wide issues

                                            38
Sources:

* Financial Sector Assessment Program – Review, lessons and issues
going forward
          IMF/World Bank February 2003

* Report on the evaluation of the Financial Sector Assessment
Program
          IMF January 2006

* Financial Sector Regulation: Issues and Gaps
          IMF August 2004



                                                                     39

				
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