Risk Assessment And Oversight The FSAP Experience

David Marston

Monetary and Financial Systems Department International Monetary Fund

Contents

Part I

Financial sector evolving.

Part II

Evolving risk assessment architecture

Part III

FSAPs — what have we found?

Implications for Basel II

Part I

Financial intermediation continues to evolve—

new complexities.

New dimensions

Capital Movements

Cross border activity

Conglomerates

Risk transfer

Free flow of Capital

0

20

40

60

80

100

120

140

160

180

200

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

0

10

20

30

40

50

60

70

80

90

100

Members that have accepted Article VIII (left axis)

Percent of IMF membership (right axis)

Article VIII Acceptance, 1945–2004

Source: IMF, Annual Reports on Exchange Arrangements and

Exchange Restrictions

With increased cross border activity

Foreign Ownership of Bank Assets

Foreign Asset Growth

0

10

20

30

40

1995 2001 2002

Noth America Europe Middle East Latin America

Often conducted via conglomerates

1995 2000

Size Average Asset Size (bn US$)

Conglomerates (%)

Average Asset Size

(bn US$)

Conglomerates (%)

Number Assets Number Assets

Top 500 41.8 72.1 646.3 59.6 80.1

Top 250 310.79 69.2 80.7 657.7 72.2 83.6

Top 100 340.37 85.0 86.8 699.0 89.0 91.7

Top 50 379.72 88.0 89.4 769.5 92.0 94.2

Source: De Nicoló et al. (2003a), original data from Worldscope.

Risks are increasingly managed off-balance sheet/ offshore

While still concentrated in G-7, growing in all regions

Distribution of OTC derivatives Market Activity

Apr-98 Apr-01 Apr-05

G7 1247 1389 2398

Other Regions

Latin America 4 8 9

Middle East 2 3 4

Asia & Pacific 187 191 287

Africa 6 8 11

Europe 239 264 378

Total 1685 1863 3087

Other structural issues exist

Dollarization/ euroization is increasing especially in Central America and Central and Eastern European countries.

State Banks still a feature of the landscape

Percent of Bank Assets Government Owned

EthiopiaAlbania

IndiaMauritius

BangladeshNorway

EgyptGhana

BurundiTonga

BhutanGreece

IndonesiaJamaicaSierra Leone

Sri LankaMontserrat

TunisiaLesotho

RomaniaMalawi

NepalIsrael

MoroccoQatarBrazilTaiwanSt. Kitts and Nevis

LithuaniaSlovenia

MaldivesDominicaCzech Republic

BelarusGermany

SeychellesRussia

St. Vincent and the GrenadinesTurkey

MexicoLiechtenstein

UruguayThailandKenya

KoreaArgentina

PolandCroatia

ZambiaSuriname

PortugalVenezuela

BarbadosGuyana

SwedenCambodia

Trinidad and TobagoItaly

ChileSwitzerland

ParaguayPhilippines

PanamaSolomon Islands

GuatemalaMacau

NigeriaFrance

TajikistanMoldova

VanuatuSalvador, El

LuxembourgNetherlands

AustriaCyprus

LatviaPeruHungary

JapanHonduras

NicaraguaMan, Isle ofMacedoniaFinlandIcelandBelgium

0 20 40 60 80 100

O

Comptroller of the Currency

Administrator of National Banks

Source: Barth and Nolle (2003)

Part II

Risk Assessment Architecture

Stake holders have responded to the increased complexities

Standard setters—a host of initiatives

Basel II

BCP revision

Solvency II

Insurance Core principles

Insurance Cornerstones

IOSCO Core Principles

FATF 40 +

IASB—fair value etc

Stakeholders

National Authorities—catching up

Increased number of Unified Supervisory agencies

Capacity building—early warning systems; consolidated supervision; stress testing

Cross border information sharing—MOUs

Increased participation in international standard setting.

IFIs have also responded

Asian Crises of 10 years ago was defining period.

FSAP introduced in 1998 and has become the main instrument of Fund financial sector surveillance

What is an FSAP?

A comprehensive diagnostic framework aimed at:

Identifying financial system strengths, vulnerabilities and risks.

Assessing observance and implementation of relevant international standards

Analyzing overall Financial Stability Helping identify appropriate policy

responses.

Country Participation

120 countries - 81 complete, 19 under way and 20 planned

14 updates requested, 10 initiated

IFIs in the Global Oversight Architecture

BCBS

IAIS

CPSS

IFAC

FATF OECD

IMF

MEMBERS

IMF/WB

FSAP

Part III

FSAPs—what have we found regarding Risks and Oversight arrangements?

FSAP results-old issues/new dimensions

Credit Risk= 95%

Governance= 67%

Supervisory Resources=50%

Conglomerates= 30%

Credit Risk:

In 95% of FSAPs credit risk remains the primary source of vulnerability; direct FX risk is minimal; though, interest rate risks important in some countries

The nuance to credit risk is that unhedged credit risk is a major solvency issues especially significantly dollarized/euroized countries.

FSAP results

Governance

Nuance to Governance now related to problems associated with corporate governance in SOEs.

Conglomerates

Conglomerate issues: 30% percent of FSAPs called for increased supervisory attention to cross-ownership and conglomerates—Now more than consolidated supervision; safety net complications arise vis-à-vis branches versus subsidiaries; TBT fail; TBT supervise issues

Supervisory resources:

Independence and accountability of supervisors

Supervisory data and reporting systems especially for effective consolidated supervision and to assess risk management practice in banks

Adequacy of AML/CFT frameworks

Main Findings – Banking (BCP Assessments)

TOP FIVE AREAS OF NON-COMPLIANCE

42

44

46

48

50

52

%A

GE

OF

AS

SE

SS

EE

S

Market Risk

Liquidity, Interest Rate and Operational Risk

Country Risk

Consolidated Supervision

Anti-Money Laundering

Main Findings – Insurance (ICP Assessments)

TOP FIVE AREAS OF NON-OBSERVANCE

0

10

20

30

40

50

60

70

80

% O

F A

SS

ES

SE

ES

Corporate Governance

Derivatives and OBS

Internal Controls

Market Conduct

Investment/Risk Mgmt Strategy

Main Findings – Securities (IOSCO CP Assessments)

TOP FIVE AREAS OF NON-

IMPLEMENTATION

0

10

20

30

40

50

60

70

% O

F A

SS

ES

SE

ES

Independence of Regulators

Enforcement Mandate

Resources and Capacity

Secondary Markets Operation Rules

Bankruptcy Procedures for Intermediaries

Part IV—Basel II implications

Supervisory challenges remain vis-à-vis existing risks

A strong supervisory process and framework is vital to Basel II readiness

Basel II Requirements Pillar I

Data and Specialized Supervisory Resources for Validation

Risk assessment capacity

Pillar II

Risk assessment capacity

Strong supervisory arrangements/powers

Pillar III

Formal powers of supervisors

Accounting/ Information Requirements

Relevant CP’s for Basel II

% observance

Advanced Developing Transition

Capital adequacy 95 55 74

Assets evaluation and provisions 84 58 79

Country risk 84 24 32

Market risk 95 31 42

Other risks 95 36 47

Consolidated Supervision 95 27 16

Information requirements 99 67 73

Formal supervisory powers 89 53 64

AVERAGE 92 44 54

Issues going forward

Interest in Basel II is an opportunity to strengthen supervisory frameworks and risk management.

Prioritization—strengthening Pillar II is critical

Effective collaboration—home/host;understanding national discretion; learning from each other

Thank you