   
The
September 2009 edition of the International
Association of Potential, New and Sitting Members of the Board of
Directors (IAMBD)
newsletter
Dear Members,
This month we will discuss:
1. The new role of the Board of Directors for the implementation
of the Basel ii Framework - Basel ii Amendment.
2.
What is changing in the European Union - the new regulatory and
supervisory environment.
Enhancements to the Basel II framework, July 2009
Supplemental Pillar 2 Guidance (Supervisory review process)
B. Board and senior management oversight
It is the
responsibility of the board of directors and senior management
to define the institution's risk appetite and to ensure that the
bank's risk management framework includes detailed policies that
set specific firm-wide prudential limits on the bank's activities,
which are consistent with its risk taking appetite and capacity.
In order to
determine the overall risk appetite, the board and senior
management must first have an understanding of risk exposures on a
firm-wide basis.
To achieve this understanding, the appropriate members of senior
management must bring together the perspectives of the key
business and control functions.
In order to develop an
integrated firm-wide perspective on risk,
senior management must overcome
organisational silos
between business lines and share information on market
developments, risks and risk mitigation techniques.
As the banking industry has moved increasingly towards
market-based intermediation, there is a greater probability that
many areas of a bank may be exposed to a common set of products,
risk factors or counterparties.
Senior management should establish a risk management process that
is not limited to credit, market, liquidity and operational risks,
but incorporates all material risks.
This includes reputational, legal and strategic risks, as well as
risks that do not appear to be significant in isolation, but when
combined with other risks could lead to material losses.
The
board of directors and senior management should possess sufficient
knowledge of all major business lines to ensure that appropriate
policies, controls and risk monitoring systems are effective.
They should have the necessary expertise to understand the capital
markets activities in which the bank is involved - such as
securitisation and off-balance sheet activities - and the
associated risks.
The
board and senior management should remain informed on an on-going
basis about these risks as financial markets, risk management
practices and the bank's activities evolve. In addition, the board
and senior management should ensure that accountability and lines
of authority are clearly delineated.
With respect to new or complex products and activities, senior
management should understand the underlying assumptions regarding
business models, valuation and risk management practices.
In addition,
senior management should evaluate the potential risk exposure if
those assumptions fail.
Before embarking on new activities or introducing products new to
the institution, the board and senior management should identify
and review the changes in firm-wide risks arising from these
potential new products or activities and ensure that the
infrastructure and internal controls necessary to manage the
related risks are in place.
In this review, a bank should also consider the possible
difficulty in valuing the new products and how they might perform
in a stressed economic environment.
A
bank's risk function and its chief risk officer (CRO) or
equivalent position should be independent of the individual
business lines and report directly to the chief executive officer
(CEO) and the institution's board of directors.
In addition, the risk function should highlight to senior
management and the board risk management concerns, such as risk
concentrations and violations of risk appetite limits.
House of Lords
European Union Committee - The future of EU financial regulation
and supervision
Summary of Conclusions
Financial supervision in the EU: an introduction
We note that under the existing Treaty there is likely to be
little opportunity to provide any EU supervisory body with the
power to issue binding rulings or decisions on national
supervisors.
The establishment of any EU body with supervisory authority and
far-reaching micro-prudential supervisory roles and powers to
mobilise fiscal resources in the event of crisis, or passing such
powers to the European Central Bank, is difficult if not
impossible whilst national governments bail-out financial
institutions
While we recognise the benefits of further harmonisation, we
believe that the establishment of a single supervisory authority
can not happen unless there is a facility or burden-sharing
arrangements on the bail-out of financial institutions at an EU
level. In addition, the institution of any single EU supervisory
authority would require substantial revision of the EC Treaty
The
reform of macro-prudential supervision
We conclude that a new body at the EU level to assess
macro-prudential systemic risks, arising from financial
institutions and markets, should be supported.
There must be structures in place to strengthen the likelihood of
macro-prudential risk warnings from any EU-wide body leading to
mitigation of risk by national supervisory bodies
We conclude that the Government differs from many witnesses,
including M de Larosière, in its version of the role, powers and
structure of a new EU-wide macro-prudential body.
It appeared to us that the Government's thinking on those
important issues was less than fully developed.
We recommend the Government clarify its thinking and proposals
speedily in order to contribute most effectively to the
discussions on the development of a new macro-prudential
supervisory structure
The
reform of micro-prudential supervision
Colleges of supervisors provide a useful forum of cooperation
between supervisors and their existence is possible within the
current Treaty.
We welcome the move to expand colleges to all cross-border EU
banks and agree provisions for meetings of core supervisors are
necessary to maximise efficiency of supervisory cooperation.
We recommend that while the Level 3 Committees exist (in their
current form) they should provide guidance on the role of
colleges. Such guidance should be provided on a flexible basis to
ensure colleges are adaptable to differing and changing
circumstances
Level 3 Committees, or a similar coordinating and standard-setting
body, are well-placed to lend consistency to the work of colleges
of supervisors and currently play an effective role in the
supervisory structure of the EU.
We welcome the Committees playing a linking role between any
macro-prudential supervisory structure, national supervisors and
colleges of supervisors as envisaged in the first stage of the de
Larosière proposals. This role can in principle be accomplished
under the current Treaty
The treaty and fiscal issues create significant problems for the
proposal to upgrade Level 3 Committees into Authorities. However,
the de Larosière report made a powerful case for reform when it
identified weaknesses and failures of micro-prudential supervision
of financial services in the single market (see paragraphs 165-166
of the de Larosière report).
We agree that a debate on the powers of any new body is crucial
for the reform of the structure and process of EU supervision.
There is a need to reconcile the limitations of the EC Treaty and
the location of fiscal authority with the need to improve upon
micro-prudential supervision of the single market.
We
recommend the Government set out in further detail its own
proposals for achieving this
We agree that the question of whether the new Authorities should
remain as three separate institutions or merged into two or one
institution is not the relevant issue.
It will be crucial to establish close working procedures in all
proposals, but still have an understanding of particularities of
the three areas of banking, securities and insurance.
The proposal of the UK Government should begin an important debate
over what structure any coordinating supervisory body at EU level
should take
The creation of colleges of supervisors and the increase of the
role of the Level 3 Committees in providing a forum for
cooperation and information sharing between national supervisors
are to be welcomed. They offer pragmatic steps to greater
coordination of supervision within the EU that do not require
Treaty amendment or provide difficulties over the location of
supervisory authority
Home-host country supervision
The call for increased powers for the host supervisor must not
lead to a retreat from the single market and the emergence of
protectionism.
We recommend that there should be no shift of power to the host
country supervisor. Colleges of supervisors must provide an
effective forum in which legitimate concerns and responsibilities
of home and host supervisors can be resolved within the clear
framework of a single market in financial services. It is clear
that there are difficulties in achieving this, and it remains a
matter of real concern to us .
The
role of the EU in global supervision and regulation
The IMF's surveillance role should be expanded, whilst a
well-resourced FSF/FSB should continue to operate as an
international standard setting body helping mitigate the risks
outlined by the IMF
We recommend the Government to work towards an EU statement at G20
meetings and the Commission to coordinate EU regulation with
international responses.
The EU can play a leading role in producing well-considered
reforms that can provide a standard for global solutions, as long
as it recognises that all regulation must be in coordination with
global initiatives
State aid in the financial crisis
We welcome the flexible, rapid and pragmatic approach demonstrated
by the Commission in applying state aid rules
We recommend the Commission to be vigilant in their assessment of
restructuring plans in order to minimise the threat to the single
market posed by state aid. The Commission must ensure that a
viable time-based exit strategy is produced and followed for those
institutions that receive state aid. State aid should be the
exception and not the norm
The definition of regulation and supervision
We
observed an inconsistency among our witnesses in the use of the
terms regulation and supervision, which were often used
interchangeably.
Supervision has to do with monitoring and enforcement, and
regulation with rule making.
Clive Maxwell, Director for Financial Stability at HM Treasury,
described regulation as "actual hard rules that are written down"
and supervision as "the application of those rules to a particular
firm or group of firms and going in there and making sure that
they are following those rules" .
An example of regulation is the EU's Capital Requirements
Directive (CRD), which transposes the Basel II rules into EU law.
These rules are applied by the UK national supervisor, the
Financial Services Authority (FSA). The FSA ensures that financial
institutions are adhering to the capital rules set out in the CRD.
The purpose of regulation and supervision
The pursuit of financial stability is the common goal of both
regulation and supervision.
Regulation should aim to safeguard a stable financial system,
whilst also offering protection to consumers. Rules should be as
simple and clear as possible, to avoid both confusion and
loopholes.
However, more regulation is not necessarily better. Hastily
applied regulation addressing a newsworthy problem can often cause
more harm than good. The quality of regulation is therefore more
crucial than the quantity.
Professor Goodhart told us that what makes sense for the
institution individually frequently makes no sense at all for the
system as a whole.
For example, if an institution runs into difficulties, its normal
response is to cut back on new loans. If every institution does
this the whole system can implode.
Regulation must therefore work in the interests of the whole
system rather than individual institutions.
Regulation within the EU must also support the development of the
single market.
Irregularity in the implementation of regulations across the 27 EU
Member States can undermine the effectiveness of the single market
in financial services.
Supervision should ensure that a bank or financial institution
subject to regulation follows the rules correctly and uniformly,
that they adequately manage their risks and that they adhere to
certain minimum standards.
It should also
examine the system of banks and financial institutions as a whole
to detect risks affecting the entire system.
Supervisors can issue binding decisions and impose penalties on
those institutions that do not adhere to the rules.
The
work of a supervisory body usually consists of four separate
roles:
Licensing-the granting of permission for a financial institution
to operate within its jurisdiction;
Oversight-the monitoring of asset quality, capital adequacy,
liquidity, internal controls and earnings;
Enforcement-the application of monetary fines or other penalties
to those institutions which do not adhere to the regulatory
regime; and
Crisis management-including the institution of deposit insurance
schemes, lender of last resort assistance and insolvency
proceedings.
A distinction is now made between macro- and micro-prudential
supervision.
Macro-prudential supervision
is the analysis of trends and imbalances in the financial system
and the detection of systemic risks that these trends may pose to
financial institutions and the economy.
The focus of macro-prudential supervision is the safety of the
financial and economic system as a whole, the prevention of
systemic risk.
Micro-prudential supervision
is the day-to-day supervision of individual financial
institutions.
The focus of micro-prudential supervision is the safety and
soundness of individual institutions as well as consumer
protection.
The same or a separate supervisor can carry out these two
functions.
If different supervisors carry out these functions they must work
together to provide mechanisms to counteract macro-prudential
risks at a micro-prudential level.
Because micro-prudential supervision monitors the degree to which
the banks abide by the rules, there is a connection between
regulation and supervision, since the very process of supervision
is subject to regulation.
For example, the adequacy of capital, a key element that
supervisors assess to determine the health of the bank, is
described in detailed rules.
Throughout the report, we refer back to the definitions of
regulation and supervision and their functions to assess the value
of proposals for reform.
Dear Potential, New or Sitting Members of the Board of Director,
You have the duty to prudently represent the interests of the
shareholders.
You have to understand the needs and desires of employees,
customers and regulators.
You have to do your best to understand the risks in your
organization, and to exercise oversight.
Year after year, you have to do more, and you have more
responsibilities.
Our Mission: To help you make informed business decisions in good
faith.
Our International Association provides networking, training,
certification, alerts and updates you can use.
Best Regards,
George Lekatis
President of the International Association of Potential, New and
Sitting Members of the Board of Directors (IAMBD)
General Manager, Compliance LLC
1200 G Street NW Suite 800, Washington DC 20005, USA
Tel: (202) 449-9750
Email:
lekatis@members-of-the-board-association.com
Web:
www.members-of-the-board-association.com
HQ: 1220 N. Market Street Suite 804, Wilmington DE 19801, USA Tel:
(302) 342-8828
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