1 Bank for International Settlements (Financial Stability Institute) - Committee of Banking Supervisors of West and Central Africa Khartoum, Sudan, 10 April 2002 CORRECTIVE ACTIONS FOR WEAK BANKS Errol Kruger Deputy Head - Bank Supervision South African Reserve Bank

2 Agenda Assessment of the weakness –Background –General issues and concepts –Identification of weak banks, monitoring the quality of information and preventative measures –Warning signs of bank failure Types of corrective actions Enforcement of corrective actions Summary

3 Assessment of the weakness

4 Background Definition of a “weak bank” –Combination of, or one of: >Inadequate capital or liquidity >Poor asset quality >Poor management >Weak systems and controls Objective of supervisor when dealing with weak banks –Proportionality >Differentiated approach by supervisor to different banks >Some will fail - it is good for some to exit –Competition >Reward competence with market share >Failure for less successful

5 Background (cont.) –Flexibility >Supervisor must exercise discretion and flexibility iin using tool kit To “save” a bank >Save system not shareholders or management Cost of saving a bank >Balance between financial costs of intervention and socio/economic implications

6 General issues and concepts An overall assessment of the situation –What is the problem? –Solvency? –How long until demise? Useful distinctions –Banks with temporary problems vs structural problems Internal vs external causes of weakness –Internal >Strategic >Governance >Fraud

7 General issues and concepts (cont.) –External >Business cycle >Economic environment >Condition of financial markets Importance of contingency planning –Proper plan by supervisor of how to deal with weak bank crisis

8 Identification of weak banks, monitoring the quality of information and preventative measures Supervisory rating systems, eg CAMEL Early warning systems –Statistical based –Trend analysis, peer group analysis –Outliers –Deviations from norms –Qualitative issues

9 Identification of weak banks, monitoring the quality of information and preventative measures (cont.) Channels for information about weaknesses –Regulatory reporting and offsite review >First and most important signal –On-site examinations >Dig deep –Contact with external auditors >Bilateral meetings >Ongoing

10 Identification of weak banks, monitoring the quality of information and preventative measures (cont.) Channels for information about weaknesses (cont.) –Information from internal control or internal auditors >Compliance >Risk management >Prudential meetings –Communication with bank management >Prudential meetings

11 Identification of weak banks, monitoring the quality of information and preventative measures (cont.) Channels for information about weaknesses (cont.) –Contacts with other supervisory authorities >Local and international –Other external sources >Press >Rating agencies

12 Warning signs of a weak bank Weak/uninformed board of directors Poor lending practices Late and inaccurate submission of bank returns and reports Problem of affiliates, related companies or large customers Rapid staff turnover and changes in top management Liquidity problems Deposit rates higher than the market Market gossip and press coverage Public complaints Ostentatious spending Use of political influence

13 Inadequate reporting to top management Over emphasis on performance bonus system Plethora of new products Departure from traditional business - not sticking to the knitting (change of core focus and core competency) High growth Deal makers “Denial mode” Lack of “Hum-Drum” culture Regulatory arrogance and arbitrage Poor quality of board, management and corporate governance Warning signs of a weak bank (cont.)

14 Types of corrective actions

15 Corrective actions Range of corrective measures –Revocation of license >Ultimate sanction –Prompt corrective actions >Regulatory forbearance worsens situation –Informal vs formal nature of corrective action >Informal - work it out with bank >Formal - cease and desist orders –Sanctions in case of non-compliance >Range from fines to revocation

16 Corrective actions (cont.) Determining the nature and seriousness of the weakness >On-site and independent reviews

17 Enforcement of corrective actions

18 Enforcement of corrective actions Formulating an action plan –Involvement of management and controllers / directors –Consultations with other agencies –Should size of the bank affect choice of corrective measures? >Systemic vs non-systemic

19 Enforcement of corrective actions (cont.) Should there be public disclosure of the problem? –No single correct answer, but if disclosure then co-ordinate: >Other regulators >Deposit insurer >Governor of central bank >Minister of Finance >Press >Public >External auditors

20 Enforcement of corrective actions (cont.) Dealing with the following typical problems: –Capital adequacy –Asset quality –Management –Weaknesses in earnings –Liquidity –Weaknesses in systems –Weaknesses due to sensitivity to market developments –Confidence

21 Summary Early identification of distress and quick but co- ordinated and well thought through corrective action is key to resolution of problem bank issues Manage relationships with the various key stakeholders Avoid knee-jerk reactions !!!! But what if corrective actions are not sufficient??? THEN….

22 ……..Resolution Strategies for Weak and Failed Banks