Courtney Christie-VeitcH CARTAC Update on Basel II Implementation in the Caribbean: Convergence of BCPs and Basel II Credit Union Regulator’s Meeting and Workshop Kingstown, St. Vincent August 20-22, 2014 Courtney Christie-VeitcH CARTAC

Background: The BCPs Core Principles for Effective Banking Supervision: Flexible and globally applicable Based on the concept of proportionality Minimum standards for sound prudential regulation and supervision for banks and banking systems and benchmark for Credit Union Supervision Originally issued by BCBS in 1997 Uses Used by countries to assess the quality of supervisory systems Used to identify future work to achieve baseline level for sound supervisory practices Used by IMF and World Bank for FSAP purposes

Background: The BCPs Structure of BCPs Supervisory powers, responsibilities and functions Objectives Independence Powers Responsibilities Prudential regulations and requirements/Supervisory expectations of banks Adequate Capital to cover risks Good corporate governance Good risk management processes and internal controls Compliance with supervisory standards

Prudential Supervision and Regulation Core Principles 1 – 13 Supervisory Functions Supervisory Responsibilities Supervisory Powers

Basel Core Principles Supervisory Powers, Responsibilities and Functions Clear responsibilities and objectives for each authority involved in supervision of banks/groups Legal powers to authorize banks, conduct ongoing supervision, address compliance with laws, undertake timely corrective actions to address safety and soundness concerns Principle 1: Responsibilities, objectives and powers Operational independence, transparent processes, sound governance, autonomous budgeting processes, adequate resources Legal protection for supervisors Principle 2: Independence, accountability, resourcing and legal protection for supervisors Legal framework for cooperation and collaboration Regulations and other arrangements to facilitate cooperation and collaboration Arrangements reflect the need to protect confidential information Principle 3: Cooperation and collaboration

Basel Core Principles Supervisory Powers, Responsibilities and Functions Clearly defined permissible activities Use of word “bank” controlled Principle 4: Permissible Activities Power to set licensing criteria Power to reject firms that do not meet established criteria Min. criteria: assessment of ownership structure and governance, fitness and propriety of board and senior mgn on a solo and group basis; assess strategic and operational plans; internal controls, risk management, projected financial positions Obtain prior consent from home supervisors for foreign operations Principle 5: Licensing Criteria Supervisory power to review, reject and impose prudential conditions on any proposals to transfer significant ownership / controlling interests held directly or indirectly in existing banks or other parties Principle 6: Transfer of significant ownership

Basel Core Principles Supervisory Powers, Responsibilities and Functions Supervisory power to approve or reject major acquisition or investments Power to impose prudential conditions on major acquisitions Include establishment of cross border operations and Determine that structures /affiliations do not expose banks to undue risk or hinder supervision Principle 7: Major Acquisition Requirements for supervisors to develop and maintain forward looking assessment of risk profile of banks and banking groups, proportionate to systemic importance Framework to identify, assess and address risks from banks and banking systems Framework for early intervention and plans in place to take actions for early intervention/resolve of problem banks in an orderly manner Principle 8: Supervisory approach Supervisors uses appropriate range of techniques and tools to conduct supervision Deploys supervisory resources on a proportionate basis, based on risk profile and systemic importance of banks Principle 9: Supervisory techniques and tools

Basel Core Principles Supervisory Powers, Responsibilities and Functions Supervisor collects, reviews and analyze prudential reports and returns from banks on solo and consolidated basis Supervisor independently verifies reports through onsite examinations or use of external experts Principle 10: Supervisory reporting Principle 11: Corrective and sanctioning powers Supervisor acts at an early stage to address unsafe and unsound practices or activities that could pose risks to banks or banking systems Supervisor has and uses adequate range of supervisory tools to bring about timely corrective actions Ability to revoke or recommend revocation of banking licence Principle 12: Consolidated Supervision Supervision of banking group on a consolidated basis Adequately monitor and apply prudential standards to all aspects of business conducted by banking group worldwide Principle 13: Home-host relationships Home and host supervisors share information on cross-border banking groups for ongoing supervision and effective handling of crisis situations Supervisors require local operations of foreign banks to be conducted to the same standards as domestic banks.

Prudential Supervision and Regulation Core Principles 14 – 29 Compliance with Supervisory Standards Risk Management Corporate Governance

Basel Core Principles Prudential Regulations and Requirements Supervisor determines that banks and banking groups have robust corporate governance policies covering strategic direction group and organizational structure, control environment, responsibilities of the banks ’board and senior management and compensation Policies and processes are commensurate with risk profile and systemic importance of the bank Principle 14: Corporate Governance Supervisors determines that banks have a comprehensive risk management process (including effective board and senior management oversight), to identify, measure, evaluate, monitor, report and control or mitigate all material risks on a timely basis Comprehensive RM process to assess the adequacy of their capital and liquidity in relation to their risk profile and market and macroeconomic conditions RM process to develop and review contingency arrangements and recovery plans RM process commensurate with risk profile and systemic importance of the bank Principle 15: Risk Management Process Supervisor sets prudent and appropriate capital adequacy requirements for banks that reflect the risks undertaken by, and presented by, a bank in the context of market and macroeconomic conditions in which it operates Supervisors defines components of capital bearing in mind loss absorbency Capital requirements should not be less that applicable Basel Standards Principle 16: Capital Adequacy

Basel Core Principles Prudential Regulations and Requirements Supervisor determines that banks have an adequate credit risk management process that takes into account risk appetite, risk profile and market and macroeconomic conditions CRMP takes into account prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate credit risk on a timely basis. Policies and processes should cover credit life cycle i.e. underwriting, evaluation, management of loan and investment portfolios Principle 17: Credit Risk Supervisor determines that banks have adequate policies and processes for the early identification and management of problem assets Policies and processes for the maintenance of adequate provisions and reserves Principle 18: Problem assets, provisions and reserves Supervisors determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate concentrations of risks on a timely basis Supervisors set prudential limits to restrict bank’s exposures to single counter parties or groups of connected counterparties. Principle 19: Concentration risk and large exposure limits

Basel Core Principles Prudential Regulations and Requirements Supervisor determines that banks enter into arrangements with related parties on an arms length basis Supervisors ensures that banks monitor related party transactions and take appropriate steps to control or mitigate the risks and write off exposures to related parties in accordance with standard policies and procedures Principle 20: Transactions with related parties Supervisor determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate country risk in their international lending and investment activities on a timely basis Principle 21: Country and Transfer Risks Supervisors determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate market risks, taking into account risk appetite, risk profile and market and macroeconomic conditions and the risk of a significant deterioration in market liquidity Principle 22: Market Risks

Basel Core Principles Prudential Regulations and Requirements Supervisor determines that banks have an adequate risk management framework that takes into account their risk appetite, risk profile and market and macroeconomic conditions Supervisors determine that banks have prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate interest rate risk in the banking book on a timely basis Principle 23: Interest Rate Risk in the Banking Book Supervisor sets prudent and appropriate liquidity requirements (qualitative or quantitative) that reflects liquidity needs of the bank Supervisor determines that banks have a strategy that enables prudent management of liquidity risks and compliant with liquidity requirements Banks strategy takes into account its risk profile as well as market and macro economic conditions Supervisors determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate liquidity risk over an appropriate set of time horizons and should not be lower than applicable Basel Standards Principle 24: Liquidity Risk Supervisors determines that banks have adequate policies and processes to identify, assess, evaluate, monitor, report and control or mitigate operational risks, taking into account risk appetite, risk profile and market and macroeconomic conditions. Principle 25: Operational Risk

Basel Core Principles Prudential Regulations and Requirements Supervisor determines that banks have adequate internal control frameworks to establish and maintain an properly control operating environment for the conduct of business taking into account risk profile. Clear arrangements for delegating authority and responsibilities Separation of functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities Safeguarding the bank’s assets Appropriate independent internal audit and compliance functions to test adherence to applicable laws, regulations, as well as internal processes. Principle 26: Internal control and audit Supervisor determines that banks and banking group maintain adequate and reliable records, prepare financial statements in accordance with accounting policies and practices, widely accepted internationally Supervisor determines that banks annually publishes information that fairly reflects their financial conditions and performance and bears an independent external auditor’s opinion Supervisors determines that banks and parent companies have adequate oversight and governance of the external audit function. Principle 27: Financial reporting and external audit

Basel Core Principles Prudential Regulations and Requirements Supervisor determines that banks and banking groups regularly publishes information on a consolidated and solo basis, that is easily accessible and fairly reflects their: financial condition, performance, risk exposure, risk management strategies and corporate governance policies and procedures. Principle 28: Disclosure and Transparency 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 Supervisors determines that banks have adequate policies and processes to identify, assess, evaluate, monitor, report and control money laundering and terrorism financing activities. Principle 29: Abuse of Financial Services

The Basel Capital Framework Basel I 1988 Accord – Credit Risk and Operational Risk 1996 – Market Risk Amendment 8% capital adequacy ratio (one size fits all) Focus on micro prudential monitoring Most Caribbean jurisdictions are currently operating under the 1988 standard Basel II 2006 International Convergence of Capital Measurement and Capital Standards: A Revised Framework Three Pillars : Minimum Capital Requirements (Pillar I) Supervisory review process (Pillar II) Market discipline (Pillar III) Basel III Effective 1 January 2013 Improve banks/banking sector's ability to absorb shocks arising from financial and economic stress Improve risk management and governance Improve market discipline/Strengthen transparency and disclosures.

Comparison between Basel II and the Basel Core Principles (Revised and 2006 Versions) Supervisory powers, responsibilities and functions Prudential Regulations Requirements Capital adequacy, Governance, internal controls and risk management BCP 2006 Revised in response to the financial crisis BCPs increased from 25 to 29 Strengthen supervisory practice and risk management BCP 2011 Minimum capital standards Supervisory review process / governance internal control and risk management Market discipline – disclosure and transparency Basel II

Supervisory Powers, Responsibilities and Functions BCP 2006 Objectives, independence, powers, transparency and cooperation (CP1) BCP 2011 Responsibilities, objectives and powers (CP1) Independence, accountability, resourcing and legal protection for supervisors (CP2) Cooperation and collaboration (CP3) Basel II Powers to set minimum capital for individual banks (solo and consol) based on risk (pillar I) Powers to request prudential information and bank’s own self assessments/ICAAP (pillar II) Require and encourage Market Discipline / Transparency and Disclosure Requirements (pillar III)

Supervisory Powers, Responsibilities and Functions BCP 2006 CP2: Permissible activities CP3: Licensing criteria CP4: Transfer of significant ownership CP5: Major acquisitions CP19: supervisory Approach CP20: Supervisory techniques CP21 Supervisory reporting BCP 2011 CP4: Permissible activities CP5: Licensing Criteria CP6: Transfer of significant ownership CP7 Major Acquisitions CP8 Supervisory Approach CP9: Supervisory techniques and tools CP10 Supervisory Reporting Basel II Pillar II – Supervisory Review Process Risk-based supervision Process for assessing overall capital adequacy Strategy to maintain capital levels even under stressed conditions Supervisors can impose higher capital for risk exposures as appropriate Banks self assessment / ICAAP Key risks not covered under pillar 1

Supervisory Powers, Responsibilities and Functions BCP 2006 CP23: Corrective and remedial powers of supervisors CP24: Consolidated Supervision CP25: Home-host relationships BCP 2011 CP11: Corrective and sanctioning powers of supervisors CP12: Consolidated Supervision CP13: Home-host relationships Basel II Pillar II – Supervisory Review Process Require prompt corrective actions Sanctioning powers under SRP Consolidated supervision Home –host relationships /Supervisory colleges

Prudential Regulations and Requirements BCP 2006 CP14: Corporate Governance CP15: Risk Management Process CP16: Capital Adequacy CP17: Credit Risk CP18: Problem Assets, Provisions and Reserves BCP 2011 CP7: Risk management process CP6: Capital Adequacy CP8: Credit Risk CP9: Problem Assets, provisions and reserves Basel II Pillar II – Supervisory Review Process – ICAAP risk management section Pillar I – Capital Adequacy (credit, market and operational risks) Pillar I - Credit Risk Pillar I – Problem Assets, Provisions and Reserves (credit and investments)

Prudential Regulations and Requirements BCP 2006 CP19: Concentration risk and large exposure limits CP20: Transactions with related party CP21: Country and Transfer risks CP22: Market Risk CP23: Interest Rate Risk in the Banking Book BCP 2011 CP10: Large exposure limits CP11: Exposure to related party CP12: Country and Transfer risks CP13: Market Risk CP16: Interest Rate Risk in the Banking Book Basel II Pillar I – Market Risk Pillar II – SRP/ICAAP Pillar II risks – Concentration risks, Large Exposure / single name limits, exposures to related party, country risks / geography concentration, balance sheet profile/business lines Pillar II risks – IRRBB

Prudential Regulations and Requirements BCP 2006 CP14: Liquidity risk CP15: Operational risk CP17: Internal Control and Audit CP22: Accounting and Disclosure CP18: Abuse of financial services BCP 2011 CP24: Liquidity risk CP25: Operational risk CP26: Internal control and audit CP27: Financial reporting and external audit CP28: Disclosure and transparency CP29: Abuse of financial services Basel II Pillar I risk – Operational risk Pillar II – SRP/ICAAP Pillar II risks – Liquidity risk SRP/ICAAP – Governance, Internal Control and Risk Management Pillar III – Market Discipline Accounting and disclosure Abuse of financial services

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