Monday September 24 2012 - Top 10 Risk Management News

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_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP)

www.risk-compliance-association.com

International Association of Risk and Compliance Professionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com

Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's

agenda, and what is next

George Lekatis President of the IARCP

Dear Member,

As you can read at Number 4 of our list, economic activity has continued to expand at a moderate pace in recent months.

Growth in employment has been slow, and the unemployment rate remains elevated.

Household spending has continued to advance, but growth in business fixed investment appears to have slowed.

The housing sector has shown some further signs of improvement, albeit from a depressed level.

Inflation has been subdued, although the prices of some key commodities have increased recently.

Longer-term inflation expectations have remained stable.

But…

Economic growth might not be strong enough to generate sustained improvement in labor market conditions.

Strains in global financial markets continue to pose significant downside risks to the economic outlook.

http://www.risk-compliance-association.com/

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To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Federal Open Market Committee has agreed to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.

The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.

These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months.

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

Welcome to the Top 10 list.

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Bank for International Settlements

Core principles for effective banking supervision September 2012

The Basel Committee on Banking Supervision has completed its review of the October 2006 Core principles for effective banking supervision and the associated Core principles methodology.

The revised Core Principles were endorsed by banking supervisors at the 17th International Conference of Banking Supervisors held in Istanbul, Turkey, on 13-14 September 2012.

Stress Testing Model Symposium Federal Reserve Bank of Boston

Address by Deputy Governor Matthew Elderfield, to the Irish Funds Industry Association

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2012 Monetary Policy Releases

Information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months. Growth in employment has been slow, and the unemployment rate remains elevated.

Economic Activity, Prices, and Monetary Policy Speech at a Meeting with Business Leaders in Yamaguchi Ryuzo Miyao. Member of the Policy Board

The U.S. Economic Outlook and Implications for Latin America Dennis P. Lockhart President and Chief Executive Officer Federal Reserve Bank of Atlanta Latin American Chamber of Commerce and the World Affairs Council

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Basel ii / iii in Russia The Bank of Russia considers it necessary to create legislative fundamentals in Russia for introducing all the standards of banking regulation and banking supervision established by the Basel Committee on Banking Supervision (BCBS). These include legislation empowering the Bank of Russia to set requirements for credit institutions’ corporate governance, risk and capital management systems, to exercise consolidated supervision, to use professional judgment in supervisory practices, and also to define disciplinary action against members of executive bodies and boards of directors (supervisory boards) for faults in the activity of their credit institutions.

The Importance of Strong Risk Management: Insights From The Examination World By Jason C. Schemmel, Community and Regional supervisory examiner with the Federal Reserve Bank of Richmond

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Islamic finance developments in Pakistan Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Islamic Finance news (IFN) Roadshow 2012, Karachi

Regulatory reform: getting it done Remarks by Mr Stefan Ingves, Governor of Sveriges Riksbank and Chairman of the Basel Committee on Banking Supervision, at the 17th International Conference of Banking Supervisors, Istanbul

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NUMBER 1 Bank for International Settlements

BIS, Core principles for effective banking supervision September 2012

The Basel Committee on Banking Supervision has completed its review of the October 2006 Core principles for effective banking supervision and the associated Core principles methodology.

The revised Core Principles were endorsed by banking supervisors at the 17th International Conference of Banking Supervisors held in Istanbul, Turkey, on 13-14 September 2012.

Both the existing Core Principles and the associated assessment methodology have served their purpose well in terms of helping countries to assess their supervisory systems and identify areas for improvement.

While conscious efforts were made to maintain continuity and comparability to the extent possible, the revised document combines the Core Principles and the assessment methodology into a single comprehensive document.

The revised set of twenty-nine Core Principles has also been reorganised to foster their implementation through a more logical structure, highlighting the difference between what supervisors do and what they expect banks to do:

Principles 1 to 13 address supervisory powers, responsibilities and functions, focusing on effective risk-based supervision, and the need for early intervention and timely supervisory actions.

Principles 14 to 29 cover supervisory expectations of banks, emphasising the importance of good corporate governance and risk management, as well as compliance with supervisory standards.

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Important enhancements have been introduced into the individual Core Principles, particularly in those areas that are necessary to strengthen supervisory practices and risk management.

As a result, certain "additional criteria" have been upgraded to "essential criteria", while new assessment criteria were warranted in other instances.

Close attention was given to addressing many of the significant risk management weaknesses and other vulnerabilities highlighted in the financial crisis.

In addition, the review has taken account of several key trends and developments that emerged during the last few years of market turmoil:

- the need for greater supervisory intensity and adequate resources to deal effectively with systemically important banks;

- the importance of applying a system-wide, macro perspective to the microprudential supervision of banks to assist in identifying, analysing and taking pre-emptive action to address systemic risk; and

- the increasing focus on effective crisis management, recovery and resolution measures in reducing both the probability and impact of a bank failure.

The Committee has sought to give appropriate emphasis to these emerging issues by embedding them into the Core Principles, as appropriate, and including specific references under each relevant Principle.

In addition, sound corporate governance underpins effective risk management and public confidence in individual banks and the banking system.

Given fundamental deficiencies in banks' corporate governance that were exposed during the crisis, a new Core Principle on corporate governance has been added by bringing together existing corporate governance criteria in the assessment methodology and giving greater emphasis to sound corporate governance practices.

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Similarly, the Committee reiterated the key role of robust market discipline in fostering a safe and sound banking system by expanding an existing Core Principle into two new ones dedicated respectively to greater public disclosure and transparency, and enhanced financial reporting and external audit.

As a result of the Committee's review, the number of Core Principles has increased from 25 to 29.

There are a total of 39 new assessment criteria, comprising 34 new essential criteria and 5 new additional criteria.

In addition, 34 additional criteria from the existing assessment methodology have been upgraded to essential criteria that represent minimum baseline requirements for all countries.

A consultative version of the revised Core Principles was issued for public consultation in December 2011.

The Committee appreciates the constructive comments received and thanks those who have taken the time and effort to express their views on the consultative document.

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Core Principles for Effective Banking Supervision (The Basel Core Principles) Executive summary 1. The Core Principles for Effective Banking Supervision (Core Principles) are the de facto minimum standard for sound prudential regulation and supervision of banks and banking systems. Originally issued by the Basel Committee on Banking Supervision (the Committee) in 1997, they are used by countries as a benchmark for assessing the quality of their supervisory systems and for identifying future work to achieve a baseline level of sound supervisory practices. The Core Principles are also used by the International Monetary Fund (IMF) and the World Bank, in the context of the Financial Sector Assessment Programme (FSAP), to assess the effectiveness of countries’ banking supervisory systems and practices. 2. The Core Principles were last revised by the Committee in October 2006 in cooperation with supervisors around the world. In its October 2010 Report to the G20 on response to the financial crisis, the Committee announced its plan to review the Core Principles as part of its ongoing work to strengthen supervisory practices worldwide. 3. In March 2011, the Core Principles Group was mandated by the Committee to review and update the Core Principles. The Committee’s mandate was to conduct the review taking into account significant developments in the global financial markets and regulatory landscape since October 2006, including post-crisis lessons for promoting sound supervisory systems. The intent was to ensure the continued relevance of the Core Principles for promoting effective banking supervision in all countries over time and changing environments.

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4. In conducting the review, the Committee has sought to achieve the right balance in raising the bar for sound supervision while retaining the Core Principles as a flexible, globally applicable standard.

By reinforcing the proportionality concept, the revised Core Principles and their assessment criteria accommodate a diverse range of banking systems.

The proportionate approach also allows assessments of compliance with the Core Principles that are commensurate with the risk profile and systemic importance of a broad spectrum of banks (from large internationally active banks to small, non-complex deposit-taking institutions).

5. Both the existing Core Principles and the associated Core Principles Methodology (assessment methodology) have served their purpose well in terms of helping countries to assess their supervisory systems and identify areas for improvement. While conscious efforts were made to maintain continuity and comparability as far as possible, the Committee has merged the Core Principles and the assessment methodology into a single comprehensive document. The revised set of twenty-nine Core Principles have also been reorganised to foster their implementation through a more logical structure starting with supervisory powers, responsibilities and functions, and followed by supervisory expectations of banks, emphasising the importance of good corporate governance and risk management, as well as compliance with supervisory standards. 6. Important enhancements have been introduced into the individual Core Principles, particularly in those areas that are necessary to strengthen supervisory practices and risk management. Various additional criteria have been upgraded to essential criteria as a result, while new assessment criteria were warranted in other instances.

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Close attention was given to addressing many of the significant risk management weaknesses and other vulnerabilities highlighted in the last crisis. In addition, the review has taken account of several key trends and developments that emerged during the last few years of market turmoil:

- the need for greater intensity and resources to deal effectively with systemically important banks;

- the importance of applying a system-wide, macro perspective to the microprudential supervision of banks to assist in identifying, analysing and taking pre-emptive action to address systemic risk;

- and the increasing focus on effective crisis management, recovery and resolution measures in reducing both the probability and impact of a bank failure.

The Committee has sought to give appropriate emphasis to these emerging issues by embedding them into the Core Principles, as appropriate, and including specific references under each relevant Principle. 7. In addition, sound corporate governance underpins effective risk management and public confidence in individual banks and the banking system. Given fundamental deficiencies in banks’ corporate governance that were exposed in the last crisis, a new Core Principle on corporate governance has been added in this review by bringing together existing corporate governance criteria in the assessment methodology and giving greater emphasis to sound corporate governance practices. Similarly, the Committee reiterated the key role of robust market discipline in fostering a safe and sound banking system by expanding an existing Core Principle into two new ones dedicated respectively to greater public disclosure and transparency, and enhanced financial reporting and external audit.

8. At present, the grading of compliance with the Core Principles is based solely on the essential criteria.

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To provide incentives to jurisdictions, particularly those that are important financial centres, to lead the way in the adoption of the highest supervisory standards, the revised Core Principles will allow countries the additional option of voluntarily choosing to be assessed and graded against the essential and additional criteria.

In the same spirit of promoting full and robust implementation, the Committee has retained the existing four-grade scale of assessing compliance with the Core Principles.

This includes the current “materially non-compliant” grading that helps provide a strong signalling effect to relevant authorities on remedial measures needed for addressing supervisory and regulatory shortcomings in their countries.

9. As a result of this review, the number of Core Principles has increased from 25 to 29. There are a total of 39 new assessment criteria, comprising 34 new essential criteria and 5 new additional criteria. In addition, 34 additional criteria from the existing assessment methodology have been upgraded to essential criteria that represent minimum baseline requirements for all countries.

10. The revised Core Principles will continue to provide a comprehensive standard for establishing a sound foundation for the regulation, supervision, governance and risk management of the banking sector.

Given the importance of consistent and effective standards implementation, the Committee stands ready to encourage work at the national level to implement the revised Core Principles in conjunction with other supervisory bodies and interested parties.

I. Foreword to the review 11. The Basel Committee on Banking Supervision (the Committee) has revised the Core Principles for Effective Banking Supervision (Core Principles).

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In conducting its review, the Committee has sought to balance the objectives of raising the bar for banking supervision (incorporating the lessons learned from the crisis and other significant regulatory developments since the Core Principles were last revised in 2006) against the need to maintain the universal applicability of the Core Principles and the need for continuity and comparability. By raising the bar, the practical application of the Core Principles should improve banking supervision worldwide. 12. The revised Core Principles strengthen the requirements for supervisors, the approaches to supervision and supervisors’ expectations of banks. This is achieved through a greater focus on effective risk-based supervision and the need for early intervention and timely supervisory actions. Supervisors should assess the risk profile of banks, in terms of the risks they run, the efficacy of their risk management and the risks they pose to the banking and financial systems. This risk-based process targets supervisory resources where they can be utilised to the best effect, focusing on outcomes as well as processes, moving beyond passive assessment of compliance with rules. 13. The Core Principles set out the powers that supervisors should have in order to address safety and soundness concerns. It is equally crucial that supervisors use these powers once weaknesses or deficiencies are identified. Adopting a forward-looking approach to supervision through early intervention can prevent an identified weakness from developing into a threat to safety and soundness.

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This is particularly true for highly complex and bank-specific issues (eg liquidity risk) where effective supervisory actions must be tailored to a bank’s individual circumstances. 14. In its efforts to strengthen, reinforce and refocus the Core Principles, the Committee has nonetheless remained mindful of their underlying purpose and use. The Committee’s intention is to ensure the continued relevance of the Core Principles in providing a benchmark for supervisory practices that will withstand the test of time and changing environments. For this reason, this revision of the Core Principles builds upon the preceding versions to ensure continuity and comparability as far as possible. 15. In recognition of the universal applicability of the Core Principles, the Committee conducted its review in close cooperation with members of the Basel Consultative Group which comprises representatives from both Committee and non-Committee member countries and regional groups of banking supervisors, as well as the IMF, the World Bank and the Islamic Financial Services Board. The Committee consulted the industry and public before finalising the text.

General approach 16. The first Core Principle sets out the promotion of safety and soundness of banks and the banking system as the primary objective for banking supervision. Jurisdictions may assign other responsibilities to the banking supervisor provided they do not conflict with this primary objective. 6 It should not be an objective of banking supervision to prevent bank failures.

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However, supervision should aim to reduce the probability and impact of a bank failure, including by working with resolution authorities, so that when failure occurs, it is in an orderly manner. 17. To fulfil their purpose, the Core Principles must be capable of application to a wide range of jurisdictions whose banking sectors will inevitably include a broad spectrum of banks (from large internationally active banks to small, non-complex deposit-taking institutions). Banking systems may also offer a wide range of products or services and the Core Principles are aligned with the general aim of catering to different financial needs. To accommodate this breadth of application, a proportionate approach is adopted, both in terms of the expectations on supervisors for the discharge of their own functions and in terms of the standards that supervisors impose on banks. Consequently, the Core Principles acknowledge that supervisors typically use a risk-based approach in which more time and resources are devoted to larger, more complex or riskier banks. In the context of the standards imposed by supervisors on banks, the proportionality concept is reflected in those Principles focused on supervisors’ assessment of banks’ risk management, where the Principles prescribe a level of supervisory expectation commensurate with a bank’s risk profile and systemic importance. 18. Successive revisions to existing Committee standards and guidance, and any new standards and guidance will be designed to strengthen the regulatory regime. Supervisors are encouraged to move towards the adoption of updated and new international supervisory standards as they are issued.

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Approach toward emerging trends and developments (i) Systemically important banks (SIBs) 19. In the aftermath of the crisis, much attention has been focused on SIBs, and the regulations and supervisory powers needed to deal with them effectively. Consideration was given by the Committee to including a new Core Principle to cover SIBs. However, it was concluded that SIBs, which require greater intensity of supervision and hence resources, represent one end of the supervisory spectrum of banks. Each Core Principle applies to the supervision of all banks. The expectations on, and of, supervisors will need to be of a higher order for SIBs, commensurate with the risk profile and systemic importance of these banks. Therefore, it is unnecessary to include a specific stand-alone Core Principle for SIBs.

(ii) Macroprudential issues and systemic risks 20. The recent crisis highlighted the interface between, and the complementary nature of, the macroprudential and microprudential elements of effective supervision. In their application of a risk-based supervisory approach, supervisors and other authorities need to assess risk in a broader context than that of the balance sheet of individual banks. For example, the prevailing macroeconomic environment, business trends, and the build-up and concentration of risk across the banking

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sector and, indeed, outside of it, inevitably impact the risk exposure of individual banks. Bank-specific supervision should therefore consider this macro perspective. Individual bank data, where appropriate, data at sector level and aggregate trend data collected by supervisors should be incorporated into the deliberations of authorities relevant for financial stability purposes (whether part of, or separate from, the supervisor) to assist in identification and analysis of systemic risk. The relevant authorities should have the ability to take pre-emptive action to address systemic risks. Supervisors should have access to relevant financial stability analyses or assessments conducted by other authorities that affect the banking system. 21. This broad financial system perspective is integral to many of the Core Principles. For this reason, the Committee has not included a specific stand-alone Core Principle on macroprudential issues. 22. In supervising an individual bank which is part of a corporate group, it is essential that supervisors consider the bank and its risk profile from a number of perspectives: on a solo basis (but with both a micro and macro focus as discussed above); on a consolidated basis (in the sense of supervising the bank as a unit together with the other entities within the “banking group”) and on a group-wide basis (taking into account the potential risks to the bank posed by other group entities outside of the banking group). Group entities (whether within or outside the banking group) may be a source of strength but they may also be a source of weakness capable of adversely affecting the financial condition, reputation and overall safety and soundness of the bank.

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The Core Principles include a specific Core Principle on the consolidated supervision of banking groups, but they also note the importance of parent companies and other non-banking group entities in any assessment of the risks run by a bank or banking group. This supervisory “risk perimeter” extends beyond accounting consolidation concepts. In the discharge of their functions, supervisors must observe a broad canvas of risk, whether arising from within an individual bank, from its associated entities or from the prevailing macro financial environment. 23. Supervisors should also remain alert to the movement, or build-up, of financial activities outside the regulated banking sector (the development of “shadow banking” structures) and the potential risks this may create. Data or information on this should also be shared with any other authorities relevant for financial stability purposes.

(iii) Crisis management, recovery and resolution 24. Although it is not a supervisor’s role to prevent bank failures, supervisory oversight is designed to reduce both the probability and impact of such failures. Banks will, from time to time, run into difficulties, and to minimise the adverse impact both on the troubled bank and on the banking and financial sectors as a whole, effective crisis preparation and management, and orderly resolution frameworks and measures are required. 25. Such measures may be viewed from two perspectives: (i) The measures to be adopted by supervisory and other authorities (including developing resolution plans and in terms of information sharing and cooperation with other authorities, both domestic and cross-border, to coordinate an orderly restructuring or resolution of a troubled bank); and

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(ii) Those to be adopted by banks (including contingency funding plans and recovery plans) which should be subject to critical assessment by supervisors as part of their ongoing supervision. 26. To reflect, and to emphasise, the importance of crisis management, recovery and resolution measures, certain Core Principles include specific reference to the maintenance and assessment of contingency arrangements. The existing Core Principle on home-host relationships has also been strengthened to require cooperation and coordination between home and host supervisors on crisis management and resolution for cross-border banks.

(iv) Corporate governance, disclosure and transparency 27. Corporate governance shortcomings in banks, examples of which were observed during the crisis, can have potentially serious consequences both for the bank concerned and, in some cases, for the financial system as a whole. A new Core Principle, focused on effective corporate governance as an essential element in the safe and sound functioning of banks, has therefore been included in this revision. The new Principle brings together existing corporate governance criteria in the assessment methodology and gives greater emphasis to sound corporate governance practices. 28. Similarly, the crisis served to underline the importance of disclosure and transparency in maintaining confidence in banks by allowing market participants to understand better a bank’s risk profile and thereby reduce market uncertainties about the bank’s financial strength. In recognition of this, a new Core Principle has been added to provide more direction on supervisory practices in this area.

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Structure and assessment of Core Principles Structure 29. The preceding versions of the Core Principles were accompanied by a separate assessment methodology that set out the criteria to be used to gauge compliance with the Core Principles. In this revision, the assessment methodology has been merged into a single document with the Core Principles reflecting the essential interdependence of Core Principles and Assessment Criteria and their common usage. The Core Principles have also been reorganised: Principles 1-13 address supervisory powers, responsibilities and functions, and Principles 14-29 cover supervisory expectations of banks, emphasising the importance of good corporate governance and risk management, as well as compliance with supervisory standards. This re-ordering highlights the difference between what supervisors do themselves and what they expect banks to do. For comparability with the preceding version, a mapping table is provided in Annex 1.

Assessment 30. The Core Principles establish a level of sound supervisory practice that can be used as a benchmark by supervisors to assess the quality of their supervisory systems. They are also used by the IMF and the World Bank, in the context of the Financial Sector Assessment Programme (FSAP), to assess the effectiveness of countries’ banking supervisory systems and practices. 31. This revision of the Core Principles retains the previous practice of including both essential criteria and additional criteria as part of the assessment methodology.

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Essential criteria set out minimum baseline requirements for sound supervisory practices and are of universal applicability to all countries. An assessment of a country against the essential criteria must, however, recognise that its supervisory practices should be commensurate with the risk profile and systemic importance of the banks being supervised. In other words, the assessment must consider the context in which the supervisory practices are applied. The concept of proportionality underpins all assessment criteria even if it is not always directly referenced. 32. Effective banking supervisory practices are not static. They evolve over time as lessons are learned and banking business continues to develop and expand. Supervisors are often swift to encourage banks to adopt “best practice” and supervisors should demonstrably “practice what they preach” in terms of seeking to move continually towards the highest supervisory standards. To reinforce this aspiration, the additional criteria in the Core Principles set out supervisory practices that exceed current baseline expectations but which will contribute to the robustness of individual supervisory frameworks. As supervisory practices evolve, it is expected that upon each revision of the Core Principles, a number of additional criteria will migrate to become essential criteria as expectations on baseline standards change. The use of essential criteria and additional criteria will, in this sense, contribute to the continuing relevance of the Core Principles over time. 33. In the past, countries were graded only against the essential criteria, although they could volunteer to be assessed against the additional

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criteria too and benefit from assessors’ commentary on how supervisory practices could be enhanced. In future, countries undergoing assessments by the IMF and/or the World Bank can elect to be graded against the essential and additional criteria. It is anticipated that this will provide incentives to jurisdictions, particularly those that are important financial centres, to lead the way in the adoption of the highest supervisory standards. As with the essential criteria, any assessment against additional criteria should recognise the concept of proportionality as discussed above. 34. Moreover, it is important to bear in mind that some tasks, such as a correct assessment of the macroeconomic environment and the detection of the build-up of dangerous trends, do not lend themselves to a rigid compliant/non-compliant structure. Although these tasks may be difficult to assess, supervisors should make assessments that are as accurate as possible given the information available at the time and take reasonable actions to address and mitigate such risks. 35. While the publication of the assessments of jurisdictions affords transparency, an assessment of one jurisdiction will not be directly comparable to that of another. First, assessments will have to reflect proportionality. Thus, a jurisdiction that is home to many SIBs will naturally have a higher hurdle to obtain a “Compliant” grading10 versus a jurisdiction which only has small, non-complex deposit-taking institutions. Second, with this version of the Core Principles, jurisdictions can elect to be graded against essential criteria only or against both essential criteria and additional criteria.

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Third, assessments will inevitably be country-specific and time - dependent to varying degrees. Therefore, the description provided for each Core Principle and the qualitative commentary accompanying the grading for each Core Principle should be reviewed in order to gain an understanding of a jurisdiction’s approach to the specific aspect under consideration and the need for any improvements. Seeking to compare countries by a simple reference to the number of “Compliant” versus “Non-Compliant” grades they receive is unlikely to be informative. 36. From a broader perspective, effective banking supervision is dependent on a number of external elements, or preconditions, which may not be within the direct jurisdiction of supervisors. Thus, in respect of grading, the assessment of preconditions will remain qualitative and distinct from the assessment (and grading) of compliance with the Core Principles. 37. Core Principle 29 dealing with the Abuse of Financial Services includes, among other things, supervision of banks’ anti-money laundering/combating the financing of terrorism (AML/CFT) controls. The Committee recognises that assessments against this Core Principle will inevitably, for some countries, involve a degree of duplication with the mutual evaluation process of the Financial Action Task Force (FATF). To address this, where an evaluation has recently been conducted by the FATF on a given country, FSAP assessors may rely on that evaluation and focus their own review on the actions taken by supervisors to address any shortcomings identified by the FATF. In the absence of any recent FATF evaluation, FSAP assessors will continue to assess countries’ supervision of banks’ AML/CFT controls.

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Consistency and implementation 38. The banking sector is only a part, albeit an important part, of a financial system and in conducting this review of its Core Principles, the Committee has sought to maintain consistency, where possible, with the corresponding standards for securities and insurance (which have themselves been the subject of recent reviews), as well as those for anti-money laundering and transparency. Differences will, however, inevitably remain as key risk areas and supervisory priorities differ from sector to sector. In implementing the Core Principles, supervisors should take into account the role of the banking sector in supporting and facilitating productive activities for the real economy.

II. The Core Principles 39. The Core Principles are a framework of minimum standards for sound supervisory practices and are considered universally applicable. The Committee issued the Core Principles as its contribution to strengthening the global financial system. Weaknesses in the banking system of a country, whether developing or developed, can threaten financial stability both within that country and internationally. The Committee believes that implementation of the Core Principles by all countries would be a significant step towards improving financial stability domestically and internationally, and provide a good basis for further development of effective supervisory systems. The vast majority of countries have endorsed the Core Principles and have implemented them. 40. The revised Core Principles define 29 principles that are needed for a supervisory system to be effective.

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Those principles are broadly categorised into two groups: the first group (Principles 1 to 13) focus on powers, responsibilities and functions of supervisors, while the second group (Principles 14 to 29) focus on prudential regulations and requirements for banks. The original Principle 1 has been divided into three separate Principles, while new Principles related to corporate governance, and disclosure and transparency, have been added. This accounts for the increase from 25 to 29 Principles. 41. The 29 Core Principles are:

Supervisory powers, responsibilities and functions • Principle 1 – Responsibilities, objectives and powers: An effective system of banking supervision has clear responsibilities and objectives for each authority involved in the supervision of banks and banking groups. A suitable legal framework for banking supervision is in place to provide each responsible authority with the necessary legal powers to authorise banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns.

• Principle 2 – Independence, accountability, resourcing and legal protection for supervisors: The supervisor possesses operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources, and is accountable for the discharge of its duties and use of its resources. The legal framework for banking supervision includes legal protection for the supervisor.

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• Principle 3 – Cooperation and collaboration: Laws, regulations or other arrangements provide a framework for cooperation and collaboration with relevant domestic authorities and foreign supervisors.

These arrangements reflect the need to protect confidential information.

• Principle 4 – Permissible activities: The permissible activities of institutions that are licensed and subject to supervision as banks are clearly defined and the use of the word “bank” in names is controlled.

• Principle 5 – Licensing criteria: The licensing authority has the power to set criteria and reject applications for establishments that do not meet the criteria.

At a minimum, the licensing process consists of an assessment of the ownership structure and governance (including the fitness and propriety of Board members and senior management) of the bank and its wider group, and its strategic and operating plan, internal controls, risk management and projected financial condition (including capital base).

Where the proposed owner or parent organisation is a foreign bank, the prior consent of its home supervisor is obtained.

• Principle 6 – Transfer of significant ownership: The supervisor has the power to review, reject and impose prudential conditions on any proposals to transfer significant ownership or controlling interests held directly or indirectly in existing banks to other parties.

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• Principle 7 – Major acquisitions: The supervisor has the power to approve or reject (or recommend to the responsible authority the approval or rejection of), and impose prudential conditions on, major acquisitions or investments by a bank, against prescribed criteria, including the establishment of cross-border operations, and to determine that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.

• Principle 8 – Supervisory approach: An effective system of banking supervision requires the supervisor to develop and maintain a forward-looking assessment of the risk profile of individual banks and banking groups, proportionate to their systemic importance; identify, assess and address risks emanating from banks and the banking system as a whole; have a framework in place for early intervention; and have plans in place, in partnership with other relevant authorities, to take action to resolve banks in an orderly manner if they become non-viable.

• Principle 9 – Supervisory techniques and tools: The supervisor uses an appropriate range of techniques and tools to implement the supervisory approach and deploys supervisory resources on a proportionate basis, taking into account the risk profile and systemic importance of banks.

• Principle 10 – Supervisory reporting: The supervisor collects, reviews and analyses prudential reports and statistical returns from banks on both a solo and a consolidated basis, and independently verifies these reports through either on-site examinations or use of external experts.

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• Principle 11 – Corrective and sanctioning powers of supervisors: The supervisor acts at an early stage to address unsafe and unsound practices or activities that could pose risks to banks or to the banking system.

The supervisor has at its disposal an adequate range of supervisory tools to bring about timely corrective actions.

This includes the ability to revoke the banking licence or to recommend its revocation.

• Principle 12 – Consolidated supervision: An essential element of banking supervision is that the supervisor supervises the banking group on a consolidated basis, adequately monitoring and, as appropriate, applying prudential standards to all aspects of the business conducted by the banking group worldwide.

• Principle 13 – Home-host relationships: Home and host supervisors of cross-border banking groups share information and cooperate for effective supervision of the group and group entities, and effective handling of crisis situations. Supervisors require the local operations of foreign banks to be conducted to the same standards as those required of domestic banks.

Prudential regulations and requirements • Principle 14 – Corporate governance: The supervisor determines that banks and banking groups have robust corporate governance policies and processes covering, for example, strategic direction, group and organisational structure, control

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environment, responsibilities of the banks’ Boards and senior management, and compensation.

These policies and processes are commensurate with the risk profile and systemic importance of the bank.

• Principle 15 – Risk management process: The supervisor 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 and to assess the adequacy of their capital and liquidity in relation to their risk profile and market and macroeconomic conditions.

This extends to development and review of contingency arrangements (incuding robust and credible recovery plans where warranted) that take into account the specific circumstances of the bank.

The risk management process is commensurate with the risk profile and systemic importance of the bank.

• Principle 16 – Capital adequacy: The 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 the markets and macroeconomic conditions in which it operates.

The supervisor defines the components of capital, bearing in mind their ability to absorb losses.

At least for internationally active banks, capital requirements are not less than the applicable Basel standards.

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• Principle 17 – Credit risk: The supervisor determines that banks have an adequate credit risk management process that takes into account their risk appetite, risk profile and market and macroeconomic conditions.

This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate credit risk (including counterparty credit risk) on a timely basis.

The full credit lifecycle is covered including credit underwriting, credit evaluation, and the ongoing management of the bank’s loan and investment portfolios.

• Principle 18 – Problem assets, provisions and reserves: The supervisor determines that banks have adequate policies and processes for the early identification and management of problem assets, and the maintenance of adequate provisions and reserves.

• Principle 19 – Concentration risk and large exposure limits: The supervisor determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate concentrations of risk on a timely basis.

Supervisors set prudential limits to restrict bank exposures to single counterparties or groups of connected counterparties.

• Principle 20 – Transactions with related parties: In order to prevent abuses arising in transactions with related parties and to address the risk of conflict of interest, the supervisor requires banks to enter into any transactions with related parties on an arm’s length basis; to monitor these transactions; to take appropriate steps to control or

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mitigate the risks; and to write off exposures to related parties in accordance with standard policies and processes.

• Principle 21 – Country and transfer risks: The supervisor determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate country risk and transfer risk in their international lending and investment activities on a timely basis.

• Principle 22 – Market risks: The supervisor determines that banks have an adequate market risk management process that takes into account their risk appetite, risk profile, and market and macroeconomic conditions and the risk of a significant deterioration in market liquidity.

This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate market risks on a timely basis.

• Principle 23 – Interest rate risk in the banking book: The supervisor determines that banks have adequate systems to identify, measure, evaluate, monitor, report and control or mitigate interest rate risk in the banking book on a timely basis.

These systems take into account the bank’s risk appetite, risk profile and market and macroeconomic conditions.

• Principle 24 – Liquidity risk: The supervisor sets prudent and appropriate liquidity requirements (which can include either quantitative or qualitative requirements or both) for banks that reflect the liquidity needs of the bank.

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The supervisor determines that banks have a strategy that enables prudent management of liquidity risk and compliance with liquidity requirements.

The strategy takes into account the bank’s risk profile as well as market and macroeconomic conditions and includes prudent policies and processes, consistent with the bank’s risk appetite, to identify, measure, evaluate, monitor, report and control or mitigate liquidity risk over an appropriate set of time horizons.

At least for internationally active banks, liquidity requirements are not lower than the applicable Basel standards.

• Principle 25 – Operational risk: The supervisor determines that banks have an adequate operational risk management framework that takes into account their risk appetite, risk profile and market and macroeconomic conditions.

This includes prudent policies and processes to identify, assess, evaluate, monitor, report and control or mitigate operational risk on a timely basis.

• Principle 26 – Internal control and audit: The supervisor determines that banks have adequate internal control frameworks to establish and maintain a properly controlled operating environment for the conduct of their business taking into account their risk profile.

These include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding the bank’s assets; and appropriate independent internal audit and compliance functions to test adherence to these controls as well as applicable laws and regulations.

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• Principle 27: Financial reporting and external audit: The supervisor determines that banks and banking groups maintain adequate and reliable records, prepare financial statements in accordance with accounting policies and practices that are widely accepted internationally and annually publish information that fairly reflects their financial condition and performance and bears an independent external auditor’s opinion.

The supervisor also determines that banks and parent companies of banking groups have adequate governance and oversight of the external audit function.

• Principle 28 – Disclosure and transparency: The supervisor determines that banks and banking groups regularly publish information on a consolidated and, where appropriate, solo basis that is easily accessible and fairly reflects their financial condition, performance, risk exposures, risk management strategies and corporate governance policies and processes.

• Principle 29 – Abuse of financial services: The 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.

42. The Core Principles are neutral with regard to different approaches to supervision, so long as the overriding goals are achieved.

They are not designed to cover all the needs and circumstances of every banking system. Instead, specific country circumstances should be more

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appropriately considered in the context of the assessments and in the dialogue between assessors and country authorities.

43. National authorities should apply the Core Principles in the supervision of all banking organisations within their jurisdictions.

Individual countries, in particular those with advanced markets and banks, may expand upon the Core Principles in order to achieve best supervisory practice.

44. A high degree of compliance with the Core Principles should foster overall financial system stability; however, this will not guarantee it, nor will it prevent the failure of banks. Banking supervision cannot, and should not, provide an assurance that banks will not fail. In a market economy, failures are part of risk-taking.

45. The Committee stands ready to encourage work at the national level to implement the Core Principles in conjunction with other supervisory bodies and interested parties.

The Committee invites the international financial institutions and donor agencies to use the Core Principles in assisting individual countries to strengthen their supervisory arrangements.

The Committee will continue to collaborate closely with the IMF and the World Bank in their monitoring of the implementation of the Committee’s prudential standards.

The Committee also remains committed to further enhancing its interaction with supervisors from non-member countries.

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NUMBER 2

Stress Testing Model Symposium

Federal Reserve Bank of Boston

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Note: You MUST download the excellent presentations at: http://www.bostonfed.org/StressTest2012/index.htm

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The Federal Reserve and Board of Governors are organizing a symposium on best practices and challenges as they relate to stress testing.

The goal of the symposium is to improve our understanding of how to develop a robust stress testing framework.

Some of the questions that will be discussed include what are the top three "must have" elements of a robust stress testing framework? What type of scenarios should the supervisory and company-run stress test consider?

What are quantitative approaches to modeling pre-provision net revenue by business line?

Notes:

As part of the central bank, the Federal Reserve Bank of Boston promotes sound growth and financial stability in New England and the nation.

The Bank contributes to local communities, the region, and the nation through its high-quality research, regulatory oversight, and financial services, and through its commitment to leadership and innovation.

The Boston Fed, the First District of the Federal Reserve System, serves the New England region - Connecticut [except Fairfield County], Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont.

http://www.bostonfed.org/StressTest2012/index.htm

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NUMBER 3

Address by Deputy Governor Matthew Elderfield, to the Irish Funds Industry Association

Thank you very much, IFIA, for the invitation to speak at this year's conference. IFIA plays an important role in the Irish international financial services sector and it is my pleasure to be here today to share some thoughts about the regulatory agenda for the funds industry.

Before I do that, can I take a moment to acknowledge the significant contribution that has been made by Gary Palmer, as the outgoing CEO of IFIA, to the growth and success of the funds industry in this country and to thank him publicly for the good working relationship he developed with the Central Bank. Let me also welcome Gary’s successor and say that I look forward to maintaining a good dialogue with Pat Lardner: indeed, that has already begun.

IFIA is an important representative body because the funds industry is an important sector for Ireland. You are all well versed on the key statistics that illustrate this, in terms of assets under management (€1.2 trillion) or number of employees in the sector (some 12,000 or so).

One statistic that is not so readily accessible – and required a bit of digging around – is the number of investors in Irish regulated funds or funds supported by Irish fund administrators.

There are in fact over 1.3 million such investors – a very significant number indeed.

That shows the importance of the Irish market place in providing a service to investors across Europe and the world.

And, indeed, it shows the important responsibility that we both have – as industry and regulator – in ensuring high standards of investor protection.

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These investors place trust in the Irish system of regulation and our reputation for maintaining high standards is vital to the success of the international financial services sector including the funds industry.

The key message I have for you today is that getting the regulatory framework right for investor protection is important for the reputation of the IFSC and the success of the funds industry.

I want to explain that we have an opportunity to revisit and improve that framework in Europe and domestically, with respect to our regulatory processes, and by enhancing our approach to supervision.

The starting point for approaching regulation of the fund sector should be an acceptance that funds are different.

The traditional concerns of the prudential supervisor do not apply to the funds industry.

Nor do the traditional consumer protection issues relating to the sales process apply directly: these are not relevant to the fund or funds service provider per se, but are picked up elsewhere in terms of the regulatory framework applying to investment firms and intermediaries.

Instead, our concern is one of investor protection along a number of dimensions: ensuring that the investment that is available has an appropriate risk profile for the type of customer involved; ensuring adequate disclosure to investors so they can make an informed choice about risk. addressing operational risks related to valuation or protection of assets; and, reducing the risk of fraud and other financial crime problems.

There is also a new dimension to funds regulation, going beyond investor protection and considering the systemic risks posed by particular aspects of the sector, which I will return to at the end of these remarks.

This different regulatory focus correctly argues for a different supervisory approach.

This involves clear standards around investment products, which as you know are mostly set at a European level.

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As a supervisor, it means the focus of effort is on the authorisation process and ensuring robust arrangements are in place regarding the approval of new funds and ensuring adequate disclosure.

Our supervisory model is also designed to place the emphasis of our work on the fund service providers – both administrators and custodians – rather than on the individual funds themselves.

Bearing this supervisory model in mind, let’s explore the individual elements and consider what changes are afoot - and what scope there is to re-engineer the current regulatory framework.

European Developments

It is right that we should start at the European level.

The EU is of ever increasing importance to the funds industry.

The volume of initiatives from Europe in financial services generally, but with respect to funds in particular, seems at times overwhelming.

The structure of regulation and standard-setting in Europe has undergone fundamental changes, with the advent of the European supervisory authorities including ESMA.

And the rules that now emerge from Europe tend to have direct binding effect on financial services firms, rather than being transposed and sometimes modified by national authorities.

The trend is for more Europe, affecting more parts of financial services regulation, with less national discretion.

This means that engagement in Europe is more important than ever.

At the Central Bank of Ireland our strategy has been to develop specialist policy teams responsible for key areas of European directives and regulations, to invest more time in the European and international policy-making processes, to be more focused in our goals and to get in early, trying to influence European developments while they are still at the formative stage.

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It is important that industry also raises its game on engagement in Europe and I would encourage IFIA to carefully re-examine its strategy for European advocacy to ensure it is having maximum impact.

The need for engagement is immediate and pressing – and in the short term Ireland will have a central role to play as Presidency of the EU in the first half of 2013.

This will be a big responsibility and will involve a number of complicated and high-profile portfolios, such as banking union and resolution and MIFID II.

And in the funds industry there will also be important portfolios, including UCITS V and UCITS VI.

We expect the AIFMD to have mostly completed the EU legislative process by the time our Presidency begins, although certain technical standards will remain to be issued.

The finalisation of Level II requirements for the sector is imminent and some important issues remain unresolved.

The ball is currently in the Commission's court. A lot of disappointment has been expressed that some of the issues that were heavily debated in ESMA - and where we believe sensible proposals were reached - have been revisited and changed.

I can understand that sense of frustration.

For example, we think it's important to recognise that the business model of the funds industry involves a significant degree of delegation and outsourcing of activity.

We hope that the final Level II text being developed by the Commission reflects the very reasonable concerns that have been expressed by stakeholders and regulators in this area.

In terms of UCITS V, there is still considerable debate on the appropriate liability regime for custody.

I think it should be accepted that there will be alignment of the liability regime in UCITS V with the standards in AIFMD.

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Given the substantial obligations which depositories will be asked to comply with under AIFMD, we believe that UCITS V should mirror these requirements, no more, no less.

Also, the Central Bank will seek to ensure that Ireland’s rigorous but streamlined approach to the licensing and supervision of depositories is reflected in UCITS V.

On UCITS VI, we are at an earlier stage in the process of consultation. One central area of debate will be whether to revisit the types of assets eligible for investment in the UCITS structure.

Our initial thinking at the Central Bank is that it would be inappropriate to restrict the current set of eligible assets or to impose general restrictions on OTC derivative instruments.

However, the current “no look through rule” does deserve further examination in relation to particular areas such as indices, where we have seen the eligible asset restrictions arguably being circumvented.

ESMA has already done some good work in its recent guidelines on the use of indices, but there may be more that can be done.

We can also expect the output from the debate on shadow banking and systemic risk in the money market funds industry to feature heavily in UCITS VI.

As I mentioned, I will come back to this topic of shadow banking a bit later.

Domestic Developments

Europe will clearly be the main driver of the regulatory framework for the funds industry in Ireland.

But there is also, as you know, a domestic regulatory framework in place that is not derived from EU law and which in many cases predates it.

The implementation of the AIFMD provides an opportunity to revisit this framework.

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We are working hard on AIFMD implementation with the goal of providing certainty to industry as soon as possible.

My colleague Gareth Murphy, who spoke to you last year, is chairing a working group on AIFMD implementation involving representatives from the Department of Finance and industry.

We will be consulting publicly on proposals very shortly.

This process provides an opportunity to revisit our domestic framework for non-UCITS funds.

Let me take a little time to explain our approach and highlight one or two issues under active discussion.

We believe it is important to use the implementation of the AIFMD as an opportunity for a systematic rethink of our non-UCITS regime.

Our current domestic regime has evolved piecemeal over many years in response to particular concerns and without any relevant EU standards to refer to.

We now need to be prepared - in light of the implementation of this major piece of European legislation - to re-examine those elements of the existing domestic framework.

Our approach will be informed by the principals included in the Taoiseach's strategy for the international financial services sector, namely the need to carefully re-examine the case for domestic standards which exceed EU requirements, in terms of establishing that they are in the public interest.

We are prepared to retain additional domestic standards if we believe the public interest test is met.

But our starting point is of a rigorous case-by-case reassessment of the existing domestic framework to see whether these domestic requirements need to be retained.

For example, one issue under discussion is whether we should establish a new category of fund based purely on the minimum standards of the AIFMD.

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This would provide a clear choice of a fund that is being managed in a way fully compliant with the relevant EU standards for pass-porting fund management without any additional domestic requirements on the fund, except as directly required by existing Irish law.

This would be a major initiative and we want to see the matter very fully considered before we decide on it.

As an alternative, or perhaps even in addition, we are also undertaking a rigorous reassessment of our non-UCITS qualifying investor regime.

To what extent should the domestic standards for the QIF regime be adjusted to reflect the AIFMD?

We are itemising the differences between the AIFMD requirements and the QIF regime for funds and reviewing each in turn.

For example, our current domestic regime sets specific requirements on directed brokerage programmes.

These requirements can be dis-applied in light of AIFMD where rules on conflicts of interest, best execution and annual account disclosure provide adequate comfort to investors.

This would seem to be a sensible area for potential adjustment.

There are a number of other areas to be considered, which will each be examined in turn.

The introduction of the directive also provides an opportunity to revisit the promoter regime for non-UCITS.

The AIFMD now imposes significant requirements on fund managers, which would appear to meet many of the objectives of our current domestic promoter framework.

We also believe there may be scope for us to provide additional guidance on what we expect of directors when a fund runs into financial or operational difficulties.

In that context, we plan to consult on proposals to remove the current promoter regime at least for qualifying investor non-UCITS.

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I should caution that our domestic framework for non-UCITS will remain in place where we believe it is in the public interest to do so.

But we're serious about rigorously and systematically challenging ourselves as to which particular provisions are indeed appropriate to retain.

This is a very big job. While we will have done a lot of work before going to consultation, we will not have finalised our views on all these matters.

We will present what we hope will be seen to be a well-considered approach, but we are very much open to submissions.

Our public consultation will offer you a real opportunity to challenge any aspect of the envisaged approach. I urge you to take that opportunity.

Before I finish on the question of domestic regulation let me say a word about the important role that industry bodies can play in supporting good standards.

I would like to commend IFIA and the funds industry more generally for rising to the challenge of developing its corporate governance code for fund service providers.

This has helped raise standards in a pragmatic and sensible way.

It has helped improve governance in the industry and provided a practical framework regarding the number of directors at funds.

You will have noted that a leading funds jurisdiction was heavily and prominently criticised for its approach to multiple directorship.

By tackling this issue head-on in its corporate governance code, IFIA has helped bolster the international reputation of the Irish fund sector.

I should note that we will be revisiting our existing statutory codes for banks and insurance companies next year.

We will use that process to review the success and take-up of the IFIA code.

Also on the horizon, MIFID II will be coming into force before too long and will be prompting a reassessment of corporate governance standards

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for investment firms, which of course would include a number of fund service providers.

Authorisation

If the starting point of the regulatory model for funds is about getting the rulebook right - both in Europe and here in Ireland - it is equally important to get the process of reviewing fund applications right.

I tend to get very good feedback from industry sources about the quality of our authorisation and approval process for funds, not just here in Dublin but when I speak to industry participants in London and New York as well.

But we think there is scope to get better yet.

Mindful of industry expectations and also of the need to ensure an effective and efficient use of resources, the Central Bank regularly reassesses its internal processes and turnaround times for fund authorisations.

However, in this area, we still rely extensively on manual processes and handling hard copies of documents.

We want to move towards the receipt of information in electronic format.

And we want to develop automated workflow processes to make us more efficient.

This is not just a matter of automating existing processes, but of challenging ourselves to ensure our process is as efficient as possible.

We want to decompose the "as is" process for funds authorisation and rigorously assess it, challenging its individual component parts, before constructing our "to be" process under this re-engineering exercise.

Our intention is to engage closely with industry and to seek your advice: tell us which aspects of the current process could work even better.

I caution that it will take a little time to implement these changes.

We don't want to rush and destabilise the current platform which is working well.

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But we are committed to making improvements in efficiency without loss of effectiveness.

These improvements go hand-in-hand with the introduction of online reporting by individual funds which we consulted on in June.

The industry itself can play its part in improving the authorisation process.

Sometimes the quality of applications can be uneven and incomplete.

At other times some stakeholders - often those highly inventive and over-exuberant lawyers - can test the boundaries of what is an acceptable interpretation of European law without giving sufficient consideration to the difficult legal and policy questions involved.

The funds industry continues to grow. Innovation is a key feature of its progress. Change is a positive driving force for all of us.

While there will always be a natural tension between financial regulation and product innovation, the Central Bank is committed to proper and active engagement with industry to resolve issues.

We regularly take stock of our approach, drawing on the output of quarterly meetings with IFIA, bi-lateral engagement with law firms and regular contact with fund promoters and investment managers at home and abroad.

And we press matters with our colleagues in Europe when necessary.

Supervision

What then of our approach after authorisation, namely to supervision?

In our view, the structure of the industry here in Ireland and the risks that it poses to the Central Bank’s objectives means that the principal (but not exclusive) focus of our supervisory effort should be on the fund service providers.

These are the management companies, fund administrators and custodians that are so important in ensuring the key elements of investor protection, such as accuracy of valuation and safeguarding of assets.

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Indeed, it is impractical (or at least prohibitively expensive) to have close supervisory engagement with all individual funds.

This supervisory model is reflected in our PRISM system, which is the new framework for risk-based supervision that the Central Bank has implemented for all firms operating in the Irish financial services sector.

PRISM operates by calculating an impact categorisation of our more than 10,000 regulated entities to allow us to decide on the level of engagement and therefore resources we will apply to any individual firm.

Under PRISM, fund service providers tend to have a higher impact categorisation, with more subsequent engagement from supervisors (and will therefore pay more).

As part of the introduction of the PRISM process there have been a few structural changes in the way Supervision is operated by the Central Bank.

On the ground, the differences you will note if your firm is in this category are more effective liaison with your direct supervisory team as well as more frequent on-site visits with yourselves by my staff.

I will be asking my supervisors to look more closely at where those investor protection and financial stability risks I talked about earlier exist, including challenging assumptions that lie behind business models and strategies in the sector and the governance, systems and controls that underpin them.

In contrast, each individual fund, in itself, has a limited potential impact on financial stability and investors in the event of failure - and so, each of the more than 5,000 funds domiciled in this jurisdiction - cannot and should not expect the same level of supervisory engagement as afforded to the fund service providers.

Our supervisory model, however, does provide capacity for us to react to triggers and problems that emerge in individual funds as well as random spot-checks.

We will also increasingly rely on the use of our thematic supervisory tool, namely examining a specific issue across a cross-section of institutions.

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Shadow Banking

While individual funds may be low impact entities in our supervisory model, the funds industry is of course a high impact sector viewed collectively.

This is not just a question of investor protection.

Increasingly, the interest of the international regulatory community is directed at the level of systemic risk posed by particular parts of the funds industry, namely money market funds.

The backdrop to this interest is the risk of investor runs on money market funds as a result of a threat of breaking the buck and the onward impact of such a run on the markets in which those money market funds are invested.

As you are no doubt aware, this is clearly on the regulatory agenda at the G20, in IOSCO, at the European Commission and also in the US at the SEC.

A few concluding thoughts on the regulatory agenda in this area.

My first high-level message, is that the industry in Ireland must be prepared for change.

During the financial crisis, investor runs on MMFs led to a disruption in the flow of finance to the real economy and necessitated dramatic interventions by public financial authorities.

The Central Bank believes that regulatory reform should focus on the need to reduce the probability of investor runs, to curb implicit support from sponsors and to reduce the need for support from the taxpayer.

In order to avoid disruptive industry shifts, my preference is for international alignment between Europe and the US in this area.

It appears that the SEC will not be driving further regulatory reform in the short term.

European action may be needed to drive matters forward. IOSCO also has an important role to play.

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But it is critically important that the U.S. perspective continues to be articulated and heard.

The optimal outcome remains a shared perspective across the Atlantic on reducing the risk of runs in this sector and we must do everything we can to ensure that we can continue to move towards that goal.

What action should Europe take now?

Market conditions in European Prime MMFs which are earning negative yields may pre-empt the conclusions of the FSB and other policy decision-makers.

As you know, some promoters are contemplating new structures where investors earn negative returns.

We should see how this plays out and in particular the investor response to the structures that the promoters offer.

In the meantime, consultation exercises on this very question are well advanced and the Central Bank has actively engaged in this debate.

Having regard for the experience of MMFs during the financial crisis and more importantly for the low risk appetite of MMF investors for capital losses, the Central Bank’s view is that a mandatory switch from constant net asset value to variable net asset value does not adequately address the fundamental problem of whether an investor run on a money market fund may take place - though we would acknowledge it may affect the dynamic of that run.

Substantial reform can be achieved through a range of measures such as capital buffers, dilution levies for exiting investors and tighter liquidity measures.

Indeed, it would appear that one of the recommendations of IOSCO - which was mandated by the FSB to look at MMFs as part of the Shadow Banking system - is to seek tighter rules on the liquidity of MMFs so as to ensure that there is enough liquidity to meet redemptions.

It is worth noting that the SEC addressed this with their MMF reforms in 2010.

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The other key issue exposed by the financial crisis was that investors expected sponsors to support MMFs where assets show excessive volatility to the downside.

This in turn put pressure on the liquidity position of the sponsoring institution which was invariably a bank with access to a central bank liquidity window.

Future reform of the MMF industry should ensure that any insurance that this ‘recourse to sponsor’ provides is properly charged to MMF investors.

In this regard, one of the other IOSCO recommendations is likely to be the mandatory requirement of gates as a redemption tool, which to our thinking would be sensible.

Where support from a sponsor is implicit it should be made explicit, though it is worth acknowledging that this may have implications for the capital requirements of the sponsor.

Whatever the detail of the reforms for money market funds, change is coming and it will be significant.

As I said, my key message is to engage in the debate and be prepared to adapt.

Conclusion

The more than 1.3 million investors who rely on the Irish fund sector highlight the need for robust standards of investor protection in our market.

Funds may be different from other financial services sectors, but it is still vitally important to get the right regulatory framework in place so that investor protection is assured.

This will improve the reputation of Ireland as an international financial services sector and support the success of the funds industry.

There is an opportunity to re-examine the different elements of that regulatory framework for investor protection: the standards in place at a European level and domestic level, the processes the Central Bank uses to

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authorise new funds, the supervisory framework applied to the sector, and the emerging standards relating to Shadow Banking.

As I have explained, the Central Bank is committed to a level of high engagement with Europe in crafting that framework - and to rigorously reassessing our domestic framework, processes and supervisory approach.

We would encourage IFIA and the Irish fund sector to play its part in this process by contributing to the regulatory dialogue at the European and Irish level, by offering constructive ideas to address the changing regulatory priorities of the post financial crisis world, and by maintaining high standards of practice in the Irish market that ensure a continued reputation for high standards of investor protection.

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NUMBER 4

2012 Monetary Policy Releases

Information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months.

Growth in employment has been slow, and the unemployment rate remains elevated.

Household spending has continued to advance, but growth in business fixed investment appears to have slowed.

The housing sector has shown some further signs of improvement, albeit from a depressed level.

Inflation has been subdued, although the prices of some key commodities have increased recently.

Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.

The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.

Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.

The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.

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The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.

These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months.

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Jerome H. Powell; Sarah Bloom Raskin; Jeremy C. Stein; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen. Voting against the action was Jeffrey M. Lacker, who opposed additional asset purchases and preferred to omit the description of the

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time period over which exceptionally low levels for the federal funds rate are likely to be warranted.

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NUMBER 5

Economic Activity, Prices, and Monetary Policy Speech at a Meeting with Business Leaders in Yamaguchi Ryuzo Miyao. Member of the Policy Board

Introduction Thank you for giving me this opportunity to exchange views with people representing Yamaguchi Prefecture, who have taken time to be here despite their busy schedules. Allow me to also express my gratitude for your cooperation with the activities of the Bank of Japan's Shimonoseki Branch. Today I will review economic activity and prices in Japan, whose economy is heading toward recovery despite the effects of the global economic slowdown, and then discuss the Bank's monetary policy. My concluding remarks will touch briefly on the economy of Yamaguchi Prefecture. Following my speech, I would like to listen to your views on the actual situation of the local economy and your candid opinions.

I. Recent Developments in Economic Activity and Prices A. Overview After the turn of the year, economic activity in Japan started picking up moderately; domestic demand has been firm, supported mainly by reconstruction-related demand and policy effects. While overseas economies as a whole are still in a deceleration phase, domestic economic activity has also been firm. Domestic demand -- including private consumption, public investment, and housing investment -- has been improving and this improvement has compensated for a delay in recovery in production and exports due to a

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slowdown in external demand. As for the outlook, while Japan's economy is expected to return to a moderate recovery path as domestic demand remains firm and overseas economies emerge from their deceleration phase, there is an increasing risk that a recovery in overseas economies will be delayed, which warrants attention. I will first review the recent developments in overseas economies, followed by the current situation of and the outlook for Japan's economy.

B. Overseas Economies Economic sentiment, mainly in the corporate sector, has become cautious globally, and there is an increasing risk that the slowdown in the global economy will be a protracted one. In the European economy, particularly in Spain, Italy, and other peripheral countries, an adverse feedback loop encompassing the fiscal situation, the financial system, and the real economy has been operating, and a sense of stagnation has been increasing as a whole. In addition, given that a decline in demand in peripheral countries has started to affect household and business sentiment in core countries such as Germany, partly through a decline in intra-regional exports, and that long-term interest rates in Spain and Italy have remained high, there appears to be an increasing risk that economic recovery will be delayed. As for the European debt problem, since the Greek crisis that began in May 2010, for more than two years a process has continued in which governments respond only intermittently to pressure from the markets. If this process continues into the future, stagnation in peripheral countries might start to feed back into core countries and the stagnation in the European economy might become even more prolonged and aggravated, weighing on the global economy. This is a matter of concern.

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Looking at the background of this problem from a longer-term perspective, we need to recognize the merits and demerits of the single-currency euro in the 13 years since its introduction. On the merit side, one can point out that the absence of foreign exchange risks within the region and reduced transaction costs stimulated intra-regional trade and investment, and that the converging low level of interest rates in member countries for more than ten years induced an expansion in economic activity. On the demerit side, one can point out that the converging low level of interest rates encouraged loose fiscal spending, and this, together with an optimistic economic outlook, led to a bubble in the real estate market. In addition, necessary structural reforms, including labor market reform aimed at containing labor costs, did not progress and the disparity in competitiveness within the region was left unaddressed. In a sense, we can say that the European debt problem represents the surfacing of the demerits accumulated over a period of more than ten years, so it should not be a surprise that the resolution of the problem will take a long time. Having said this, with an aim of resolving the problem as quickly as possible, it is necessary for European leaders to respond appropriately to the challenges, such as improving fiscal conditions in peripheral countries and enhancing growth in Europe, as well as to present a specific roadmap for the longer-term challenges of forming a banking union, issuing Eurobonds, and pursuing fiscal integration, and thereby dispelling uncertainties regarding the euro zone economies. In this regard, while some gradual achievements have been made, the European leaders are expected to show further leadership. While the U.S. economy has been recovering moderately, supported by accommodative financial conditions, the pace of the recovery seems to be slowing somewhat.

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The real GDP growth rate for the April-June 2012 quarter (seasonally adjusted; the annualized growth rate compared with the previous quarter) rose to only 1.7 percent, and growth decelerated in domestic demand, including private consumption, business fixed investment, and housing investment. While economic indicators since July have been mixed, what concerns me is that there seem to be signs of weakening in the buoyant corporate sector, which has been supporting the recovery in the household sector. Let me amplify this point. In the household sector, private consumption has been firm on the back of moderate improvement in employment and income, and housing starts and sales have shown signs of bottoming out, while a balance-sheet adjustment has been progressing as seen in a gradual decline in the ratio of debt to disposable income. On the other hand, in the corporate sector, sluggishness in exports and deterioration in business confidence have become apparent, reflecting the European debt problem and a slowdown in the Chinese economy. So far, given that corporate profits and business fixed investment have been firm and the household sector has been generally solid, it seems that the recovery mechanism originating from the corporate sector remains active. However, I recognize that attention should be paid to the possibility that employment and business fixed investment will be hampered by a further worsening in business confidence, thereby leading to an economic slowdown. As for a future risk to the U.S. economy, in addition to a delayed economic recovery in Europe and China, I would point to the "fiscal cliff" problem. While a cut in fiscal spending and expiration of a tax reduction are downside factors for economic activity, the range and size of the factors

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are highly uncertain at present, and are factored into the U.S. economic outlook differently by private research institutions. Some point out that because of uncertainty associated with the problem, firms have already been deferring investment and new hiring, and we need to be alert to how the situation will evolve going forward. In the meantime, in U.S. financial markets, stock prices have bounced back to a level prior to the Lehman shock, and long-term interest rates -- despite rising somewhat – have generally been hovering at low levels. As for the Asian emerging economies, a decelerated pace of growth has become somewhat protracted due to the recent slowdown in exports to Europe, but the economies are likely to pick up the pace of growth led by China. Attention should be paid, however, to the possibility that the timing of a recovery will be delayed to the autumn or later. As for the Chinese economy, the effects of the authorities' policy measures have started to emerge, including an increase in new lending and the bottoming out in housing prices, but future economic indicators need to be monitored carefully, since stagnation in the European economy has been spreading to the Chinese economy through trade and concern over an increase in inventories has not been dispelled. As for the NIEs and the ASEAN economies, domestic demand has been strong, but it is a matter of concern that indicators related to exports and production have recently been sluggish or deteriorating in economies like South Korea and Taiwan. I believe that a key to the future of these economies will be whether China regains its pace of growth and their exports recover. From a longer-term perspective regarding the sound development of the global economy, it is critical that the Asian emerging economies maintain a balance between economic growth and price stability.

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In particular, for China -- which is expected to lead the global economy together with the United States -- careful attention should be paid to future developments, including whether economic policy management is maintained smoothly following the appointment of the new Chinese leadership.

C. Economic Activity and Prices in Japan In Japan, economic activity as a whole has been picking up moderately, with domestic demand improving mainly due to reconstruction-related demand and policy effects, which has compensated for a delay in recovery in production and exports due to a slowdown in external demand. The real GDP growth rate (seasonally adjusted; the annualized growth rate compared with the previous quarter) was high at 5.5 percent in the January-March 2012 quarter and maintained steady growth in the April-June quarter at 1.4 percent. To elaborate on this, amid the continued slowdown in overseas economies, a pick-up in exports has been slowing and production -- affected by the slowdown in exports -- has also been relatively weak. As for domestic demand, public investment has continued to increase and business fixed investment has been on a moderate increasing trend with improvement in corporate profits. Private consumption has continued to increase moderately due partly to the effects of measures to stimulate demand for automobiles, and housing investment has generally been picking up. At the same time, there are signs of concern. There is some inventory stockpiling on the back of the continued slowdown in exports and production; machinery orders, a leading indicator of business fixed investment, have shown signs of weakening; the coincident index in the Indexes of Business Conditions has been shifting from "improving" to "weakening"; and indicators of business sentiment are showing signs of weakening.

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While the economy as a whole has been improving, causes for concern seem to have increased in number. As for the outlook, Japan's economy is expected to return to a moderate recovery path as domestic demand remains firm and overseas economies emerge from their deceleration phase. Such a scenario can be confirmed in the forecasts of the majority of the Policy Board members; in terms of the median forecast as of July 2012, real GDP was projected to grow at 2.2 percent in fiscal 2012 and 1.7 percent in fiscal 2013. These forecasts are associated with upside and downside risks, and I am paying greater attention to the downside risks, as follows. First, there is a risk of overseas economies slowing further. As I have already mentioned, the risk that the economic slowdown in Europe, the United States, and Asia will become protracted has increased somewhat, and if the slowdown actually becomes protracted, it will weaken Japan's move toward a self-sustaining recovery in which increases in exports and production lead to an increase in income and spending. Second, there is a risk of further appreciation of the yen. While a positive case can be made for yen appreciation to a certain extent, excessive appreciation will worsen the competitiveness and profits of exporting firms again and act as a headwind against firms. If a trend of falling stock prices intensifies, together with the trend of yen appreciation, then firms' and households' confidence will deteriorate and currently solid business fixed investment plans and private consumption will be contained, which will weigh on Japan's economic recovery. Third, there is a risk related to the first and second risks: a risk that the timing of recovery in exports and production will be delayed and the transition from domestic demand to external demand will not occur as

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expected. Since subsidies for environmentally friendly cars have already used a large portion of the budget and growth in reconstruction-related demand is likely to slow down from the second half of fiscal 2012 onward, we need to carefully monitor whether external demand will recover by compensating for a slowdown in domestic demand. In addition, attention should be paid to whether ambitious business fixed investment plans will be steadily implemented and whether the moderate improving trend in employment and income conditions will be maintained. In the meantime, consumer prices (all items less fresh food; on a year-on-year basis) have so far been hovering around 0 percent in 2012. A baseline scenario for the outlook for prices is that the year-on-year rate of change in consumer prices will hover around 0 percent for the time being, and subsequently increase moderately as aggregate supply and demand balance improves. In the forecasts of the majority of the Policy Board members, in terms of the median forecast as of July 2012, the year-on-year rate of increase in consumer prices was projected to be 0.2 percent in fiscal 2012 and 0.7 percent in fiscal 2013. While there are also upside and downside risks to prices, I am paying greater attention to downside risks, given that concern over the economic outlook has been increasing and a decline in commodity prices during the first half of fiscal 2012 will put downward pressure on prices for the time being. Attention should also be paid to the effects of the continued low short-term inflation expectations on future price developments.

II. Monetary Policy A. Conduct of Monetary Policy Let me now discuss the Bank's efforts to enhance monetary easing.

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The Bank introduced comprehensive monetary easing in October 2010, and has subsequently been enhancing monetary easing. Comprehensive monetary easing comprises three measures: the virtually zero interest rate policy of maintaining the uncollateralized overnight call rate at around 0 to 0.1 percent; purchases of financial assets through the Asset Purchase Program (hereafter the Program); and the clarification of the policy time horizon, that is, the clarification that such measures will remain in place until the Bank judges that price stability is in sight. At the February 2012 Monetary Policy Meeting, to further clarify the Bank's stance toward overcoming deflation, it introduced "the price stability goal in the medium to long term." That is an inflation rate the Bank judges as consistent with price stability sustainable in the medium to long term. At present, "the Bank judges 'the price stability goal in the medium to long term' to be within a positive range of 2 percent or lower in terms of the year-on-year rate of change in the CPI and, more specifically, sets a goal at 1 percent for the time being." On this basis, the Bank will continue pursuing powerful easing until it judges that the 1 percent goal is in sight. The Program was established with the aim of encouraging a decline in longer-term interest rates and various risk premiums mainly through the purchase of financial assets. The Bank established the Program on its balance sheet and has been purchasing various financial assets, such as government securities, commercial paper (CP), corporate bonds, exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs) as well as conducting the fixed-rate funds-supplying operation against pooled collateral. Since its establishment, the total size of the Program has been increased from time to time.

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It was expanded further in February and April this year, and at present the Bank is scheduled to increase the outstanding amount of the Program to about 65 trillion yen by around end-2012 and to about 70 trillion yen by around end-June 2013, thereby pursuing powerful monetary easing. In particular, for asset purchases, the total size has expanded from 5 trillion yen at the time of introduction to 45 trillion yen, and the purchase of long-term government bonds has increased substantially from 1.5 trillion yen to 29 trillion yen. At the April Monetary Policy Meeting, the Bank decided to extend the remaining maturity of government bonds and corporate bonds to be purchased under the Program from "one to two years" to "one to three years." In addition, in July, with the aim of ensuring that the target outstanding amount of the Program is met, the Bank removed the minimum bidding yield (previously 0.1 percent per annum) for outright purchases of treasury discount bills and CP, and revised the composition of the Program. The outstanding amount of the Program as of August 20, 2012 stood at about 58 trillion yen, and a further increase of about 12 trillion yen will be necessary by around end-June 2013. The Bank will continue to steadily increase the outstanding amount of the Program as scheduled. Under such powerful monetary easing, market interest rates have been at extremely low levels. The overnight call rate has been at a level below 0.1 percent, yields of government bonds with remaining maturities up to three years are around 0.1 percent, and yields on 10-year government bonds are at the extremely low level of around 0.8 percent. As for firms' funding costs, the average contracted interest rates on new bank loans and discounts have declined to about 1 percent and spreads of corporate bonds and CP have been stable at low levels.

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As a result, financial conditions viewed from the fund-raising side have been accommodative.

B. Monetary Policy and Long-Term Interest Rates In considering the effects of such monetary easing, let me summarize the relationship between monetary policy and long-term interest rates. This is also important for understanding the background of the current historic low levels of long-term interest rates in advanced countries. Let us recall how long-term interest rates are determined. Long-term interest rates are considered to be determined mainly by two factors: first, the forecast of future short-term interest rates, and second, an extra interest rate required for risk associated with long-term bond investment. Regarding the first factor, if the future economic growth rate or the future inflation rate is forecasted to increase, for example, then the future path of short-term interest rates will rise accordingly and one can expect a higher return by investing repeatedly in short-term bonds. As a result, demand for long-term bonds will decline and prices of the bonds will fall and yields will increase. As for the second factor, long-term bond investment is associated with risks. It might become necessary to exchange bonds for cash before maturity is reached, and in such a case there will be uncertainty about the selling price. As compensation for taking such risks, an extra yield -- the risk premium or term premium -- is required and the long-term interest rate will rise to that extent.

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Based on such a mechanism, let me summarize the effects of a central bank's asset purchases, more specifically purchases of long-term government bonds, in two parts. First, there is the effect through the aforementioned risk premium, which focuses on supply and demand in asset markets. This effect is called the "portfolio balance channel." When a central bank purchases government bonds in the bond market and absorbs the amount of bonds in circulation, the bond price will rise and the yield will decline. In this case, as the price change is due to the supply and demand factor, the risk premium will decrease and long-term interest rates or longer-term interest rates in general will fall. Second, there is the effect through the risk-neutral forecast of future short-term interest rates. If an implementation or announcement of a nontraditional policy action of asset purchases is interpreted as a signal that a central bank's economic and price forecasts have worsened further, then the forecasted duration of a zero interest rate might lengthen and the future path of short-term interest rates will decline, and longer-term interest rates -- mainly in the short- to medium-term zone -- will decline accordingly. Or if a central bank's asset purchases are received as a signal that a central bank's future policy stance has changed -- for example, a central bank takes more aggressive policy responses in the face of developments in economic activity and prices, or there is an adjustment in the policy goal -- the forecasted path of short-term interest rates will decline, and longer-term interest rates -- mainly in the short- to medium-term zone -- will decline accordingly. Both of these effects encourage a decline in longer-term interest rates.

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What is more important, however, is whether such a decline leads to an improvement in a wider range of financial conditions and, through an increase in spending, eventually stimulates economic activity and prices. If such transmission mechanism is forecasted to work, then it will put upward pressure on long-term interest rates in terms of both effects. Let me elaborate on this point. As one effect of a decline in longer-term interest rates due to government bond purchases, it is expected that confidence will improve among investors, firms, and households, thereby encouraging a shift of investment from government bonds and other safe assets to a wider range of risk assets, such as corporate bonds, equities, and overseas assets, and this in turn will lower risk premiums of these assets and increase asset prices. This can be considered a portfolio balance effect in a broad sense and means an improvement in wide-ranging financial conditions. In such a situation, demand for government bonds will decline and there will be a certain amount of upward pressure on term premiums of government bonds (that is, a rise in the extra interest rate required for risk associated with long-term bond investment). In addition, if spending is forecasted to increase with a longer and variable time lag, thereby stimulating economic activity and prices, it will shift upward the forecast path of short-term interest rates, steepen the yield curve, and put upward pressure on long-term interest rates (that is, a rise in the forecast of future short-term interest rates). While encouraging a decline in longer-term interest rates on one hand and expecting a rise in long-term interest rates in the longer run on the other hand seems contradictory at first glance, in fact it is nothing of the kind. Then, how should we understand the fact that long-term interest rates in advanced countries have been hovering at historic low levels? It seems

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that a declining trend in these countries' long-term interest rates involves the effects of powerful monetary easing, including asset purchases. More recently, the trend of risk aversion on the back of concern over a slowdown in the global economy and the European debt problem has been further encouraging a decline in long-term interest rates. Some say that a 1 percent yield on 10-year government bonds in the United States and Europe is quite low, based on a general recognition of the long-term potential growth rate and inflation expectations. In the United States, the level of the target policy interest rate in the longer run is expected to be about 4 percent, according to the economic projections by Federal Open Market Committee (FOMC) members. If such views are correct, this can be interpreted to mean that risk aversion, or a preference for safety, in the government bond markets has been firmly maintained. And this might work as a headwind for what I mentioned earlier, the transmission mechanism of stimulating economic activity and prices through the portfolio balance effect in a broad sense. Naturally, greater attention is warranted as to whether the current sources of concern regarding the slowdown in the global economy and the European debt problem will return to normal or continue to weigh on the global economy and cause further deterioration.

C. The Need to Strengthen Growth Potential For Japan's economy to overcome deflation and return to a sustainable growth path, both support from the financial side and efforts to strengthen growth potential are necessary. Thus far, I have discussed support from the financial side. To strengthen growth potential, it is important for every member of society, from his or her standpoint, to make positive efforts steadily to

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boost growth potential. Such steps will also help increase the stimulative effect of powerful monetary easing on economic activity and prices. Of course, to genuinely strengthen growth potential, a certain period of time is necessary, since such efforts need to occur in concert with other measures, including implementation of economic and fiscal structural reforms. This is obvious even without citing the example of Europe, and if growth potential increases through the simultaneous pursuit of aggressive efforts from the financial side to overcome deflation and economic and fiscal structural reforms, it will lead to favorable effects on the fiscal side, including an increase in tax revenue. In this regard, in July 2012, the government compiled the Comprehensive Strategy for the Rebirth of Japan, which prioritizes key issues. These comprise policy packages such as the "Green Growth Strategy" (aimed at realizing an innovative energy and environment-oriented society), the "Health/Life Science Growth Strategy" (aimed at achieving a society with the world's leading health and medical care and welfare), and the "Agriculture, Forestry and Fisheries Revitalization Strategy" (which seeks to double the vitality of regions driven by agriculture, forestry and fisheries). The government has presented specific strategies and their timetable. In addition, bills related to the comprehensive reform of the social security and taxation systems passed recently in both the House of Representatives and the House of Councillors, marking an important step forward in maintaining public confidence in medium- to long-term fiscal sustainability. The Bank has also been implementing the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth, and has been supporting financial institutions' individual initiatives.

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The measure provides long-term funds for up to four years at a low interest rate -- currently 0.1 percent -- to financial institutions carrying out lending and investment in growth areas, and was launched in June 2010 with the initial ceiling on the outstanding amount of loans at 3 trillion yen. Subsequently, the Bank introduced a new lending arrangement for the measure, through which it extends loans to financial institutions for their equity investment and asset-based lending (ABL) without conventional collateral or guarantees. This year, the Bank increased the ceiling for the outstanding amount of loans under the main rules for the measure from 3 trillion yen to 3.5 trillion yen, and established special rules for another new lending arrangement for small-lot investments and loans as well as for a new U.S. dollar lending arrangement. The current outstanding balance of the total loans disbursed by the Bank, including those extended under the special rules, is approximately 3.3 trillion yen. The Bank will continue to do its utmost to contribute to strengthening the foundations for economic growth. I have now discussed recent monetary policy in Japan. In the actual conduct of monetary policy, the outlook for economic activity and prices should be carefully examined and, if judged necessary, meticulous and decisive measures should be taken. The Bank will continue to steadily pursue powerful monetary easing by increasing the outstanding amount of the Asset Purchase Program as scheduled. The Bank will strive to conduct proper monetary policy, and closely monitor developments in international financial markets and do its utmost to ensure the stability of the financial system in Japan.

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Concluding Remarks: The Economy of Yamaguchi Prefecture My conclusion will touch on the economy of Yamaguchi Prefecture. In my view, the economy of Yamaguchi Prefecture enjoys a number of competitive advantages. The first is its location, since it is close to other East Asian countries where demand has been expanding markedly. Second, it enjoys a concentration of basic materials industries with growth potential -- mainly the chemical industry, which accounts for more than 40 percent of the industrial production index. And third, the prefecture has the nation's highest labor productivity, mainly in basic materials industries. Recently the region has experienced a series of negative events, such as accidents at the plants of major chemical manufacturers, together with the withdrawal and closure of factories of several electronics components manufacturers. On the positive side, however, amid concern over the hollowing out of domestic industries due partly to the appreciation of the yen at the national level, firms in the prefecture as a whole -- comprising mainly manufacturers -- have maintained their vigorous investment stance. In fact, the Bank's Shimonoseki Branch's Tankan (Short-Term Economic Survey of Enterprises in Japan), released on July 2, showed that the business fixed investment plan of Yamaguchi Prefecture's firms for fiscal 2012 was likely to maintain a substantially higher growth rate than that of Japan as a whole. The prefecture recorded a year-on-year growth rate of 12.4 percent, compared with Japan's a year-on-year growth rate of 4.0 percent. In fiscal 2011, the business fixed investment plan of the prefecture's firms also exceeded that of Japan.

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As specific examples of this, in fields related to chemicals, next-generation energy, and medical care, there have been moves among local firms to pursue overseas expansion in existing fields with potential for an increase in global demand in the medium to long term, and some local firms are actively conducting additional investment to increase capacity or research and development in high-value-added areas with potential for growth. For example, in connection with the growing need for energy conservation by firms and households, small and medium-sized construction firms have entered the geothermal air-conditioning business. An increasing number of firms have been making such moves. I expect that local firms, by utilizing their characteristics and strengths, will proceed with reforms to nurture new areas with potential for growth, achieving further development. In addition, Yamaguchi Prefecture enjoys extremely bountiful resources for tourism, with numerous attractive sightseeing areas as well as scenic spots and historic sites, and many excellent structures, including the historic Kintai Bridge, which harmonizes beautifully with its surrounding natural landscape. Efforts are proceeding to draw on these ample resources for tourism, mainly by the prefectural government and cities, and thereby promote the tourism industry. I expect that by coordinating its regional characteristics and strengths, the tourism industry will generate further momentum.

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NUMBER 6

The U.S. Economic Outlook and Implications for Latin America Dennis P. Lockhart President and Chief Executive Officer Federal Reserve Bank of Atlanta Latin American Chamber of Commerce and the World Affairs Council

Key points

Federal Reserve Bank of Atlanta President Dennis Lockhart says that in the 1980s, during the so-called "lost decade" in Latin America, many countries experienced economic turmoil, with low growth, high inflation, and financial crises.

The region's real GDP growth averaged about 2 percent.

After this lost decade, most Latin American policymakers began to pursue more prudent macroeconomic and fiscal policies, opening their economies to global markets and trade.

Lockhart says this policy transformation has strengthened the economic ties between the United States and Latin America.

Latin American countries showed impressive resilience during and since the financial crisis of 2008, coming through this period without severe downside effects.

However, Lockhart notes that several Latin American countries have experienced sizeable capital flows that have uniquely challenged their economies.

Lockhart says that the recovery in the United States has seen weak growth and high unemployment—attributable, at least partly, to fundamental imbalances that have not yet been corrected.

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There is a risk to monetary policy being employed too aggressively and without effect to address economic problems that can be resolved only by fiscal reforms.

The Speech Thanks to the Latin American Chamber of Commerce and the World Affairs Council of Atlanta for the opportunity to speak about the state of economic relations between the United States and Latin America. Thanks also to Georgia Power for providing this outstanding venue. Let me begin by saying that the Atlanta Fed has a strong connection to Latin America. Our supervision and regulation team oversees branches and subsidiaries of a number of Latin American banks in our district, particularly in Miami. Our research department monitors the economic performance of the economies of the region, and our economists interact with colleagues including central bank officials in Latin America. Last October, for instance, our chief economist and I attended a conference sponsored by the Banco Central de Chile and later visited the central bank of Brazil. I will relate impressions from that trip in a moment. The Atlanta Fed leads the retail payments operations of the Federal Reserve System. Our FedGlobal ACH service executes small ticket money transfers from U.S. banks to banks in some 35 countries, including 12 in Latin America. Our first international partner was the central bank of Mexico. Through our Directo a México program, we help Mexican authorities reach underserved and unbanked consumer markets. In addition, our

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community and economic development team does outreach work here with immigrants from Latin America. Finally, and very significantly, our international cash operation in Miami sends and receives U.S. dollar banknotes working with Latin American central banks and commercial banks in the region. More later on this, too. All of these programs are under the umbrella of our Americas Center initiative, headed by Stephen Kay. I also have a deep personal interest in the region, where I had many business ties in my previous career. The title of this speech is "The U.S. Economic Outlook and Implications for Latin America," but I would like to expand the idea of my talk to include the experience of Latin America and implications for the United States. I think the world can learn much from the path taken by many Latin American countries since the 1980s. There has been great progress economically in recent years in Latin America. As these economies have stabilized and matured, the economic ties between the United States and Latin America have grown. It is my view that the policy reforms and the resulting transformations we've seen in the economies of the region contain important lessons for the rest of the world.

Latin America, 1980s and now I'll begin by looking back at the 1980s, the so-called "lost decade" in Latin America, and contrast the region's economies then to today. The 1980s was a time of economic turmoil, with low growth, high inflation, and financial crises—more specifically, sovereign debt crises. It's quite a different picture today. The region is now far more stable. Most countries of the region now pursue economic policies resulting in

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higher growth and price stability. Democratic governance is the norm. In the 1980s, Latin America's real GDP growth averaged around 2 percent. From 2004 through 2011, annual GDP growth averaged 4.5 percent. And during the recent global financial crisis, the region's economies proved resilient, with a relatively shallow decline followed by a rapid recovery. By the 1980s, many countries had spent years pursuing protectionist import-substitution industrial policies that essentially closed their countries to global markets. Today, we see far more open economies, with countries reaping the gains from trading in global markets. You may recall that during the '80s, inflation was endemic in the region. Inflation got to 132 percent in Mexico in 1987 and more than 3,000 percent in Argentina in 1989. We can contrast that to the relative price stability that we see today, with a region-wide consumer price inflation averaging 5.5 percent a year over the past five years. Inflation targeting is a common practice, and many of the region's central banks have achieved a high degree of credibility. As I said, the 1980s was also a period of debt crises, particularly external debt crises involving obligations to foreign banks. The external imbalances were born of deep fiscal problems. In the 1980s, governments ran large budget deficits, and public debt relative to GDP soared. Governments relied on foreign dollar-denominated financing at a time when governments could not issue debt in their own currencies.

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International reserves covered less than a fifth of total foreign debt. Today, it is a different story. Most countries in the region have moved toward fiscal balance, debt levels are far lower, local currency capital markets are deeper, and some governments are able to sell local currency-denominated securities to foreign investors. The ratio of international reserves to total foreign debt rose to about 70 percent last year, approximately five times the average in the 1980s.

Personal recollections I have personal recollections from the '80s. For calendar year 1987, I was in charge of Citicorp's efforts to organize a debt-for-equity swap program involving a number of "restructuring countries" (as they were called) in Latin America. These countries included Mexico, Chile, Argentina, and Brazil. The idea of a debt-equity swap was that a government would allow and facilitate the exchange of its sovereign or private external debt for shareholdings in domestic firms and assets. In effect, the debt would be the currency with which a lender could buy stock in a local company. After such a transaction, some of the country's external debt would be extinguished. In some countries of Latin America, this program was politically unpopular. There was resistance to what opponents of the scheme considered handing over the patrimony of the country at a bargain price. For this brief period—1987—I was immersed in the policy debates and politics of sovereign debt restructuring. Restructuring is the end-of-the-road measure undertaken when a country

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and its government are severely overextended. I came away from this experience with two broad observations: First, nations control their destinies by implementing and sustaining good policies. External factors beyond a country's control can deliver shocks to an economy, but for the most part, domestic policy decisions determine a country's economic fate. And second, the world's capital markets "vote," in effect, every day on a country's policies. Sovereignty does not mean a government can dictate terms to the world. Policymakers are compelled to respect the power and opinion of investors.

Ties between the United States and Latin America In the wake of the lost decade, Latin American policymakers, generally speaking, have pursued more prudent macroeconomic and fiscal policies and opened their economies to global capital markets and trade. This policy transformation has made possible a considerable strengthening of economic ties between the United States and Latin America. Trade between the United States and Latin America has grown rapidly. About a fifth of U.S. imports now come from Latin America, up from around 15 percent in the 1980s. And the share of U.S. exports going to Latin America has risen considerably, from an average of 15 percent of all U.S. exports in the '80s to nearly 25 percent. In the southeastern United States, a significant portion of merchandise exports go to Latin America.

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Around half of merchandise exports from Florida and Mississippi are bound for Latin America, around a third of exports from Louisiana, and about a fifth of exports from Georgia, Tennessee, and Alabama. Last year, the flow of U.S. direct investment in Latin America rose to $84.5 billion, and direct investment from Latin America into the United States was $18.4 billion. I mentioned earlier the movement of U.S. dollar cash we manage in the Atlanta Fed branch in Miami. In 2011, we shipped $1.7 billion in U.S. currency to Brazil, with the primary demand coming from tourists planning to travel to the United States. Spending by Brazilians in Florida has made quite an impression on their hosts. Florida Trend magazine named Brazil as "Floridian of the Year" in 2011, acknowledging the 1.5 million Brazilians who visited Florida, second only to the number of Canadian visitors to Florida. Brazilians also represented 12 percent of foreign buyers of real estate in South Florida last year, second only to Venezuelans. We also see growing cash transactions with Panama, where the canal is being expanded to accommodate ships that are nearly three times larger than current vessels transiting the canal. Rail, port, and distribution facilities throughout the United States are being upgraded to handle larger vessels and more cargo that will result from the canal expansion. And one more point about how the north-south relationship in our hemisphere has changed: in the 1980s, most Latin American economies were reliant on foreign capital. Today, many countries are capital exporters. Brazil is the fourth largest holder of U.S. Treasury Securities, with more than $200 billion in Treasuries as of June 2012, after China, Japan, and the major oil exporters as a group.

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Trade, capital flows, and decoupling Not long ago it was fashionable to talk of the decoupling of certain emerging market economies from advanced economies. The notion was that major countries like Brazil are sufficiently independent economically to be unaffected by developments in advanced economies—the United States and Europe, for example. There is some reality in this claim. During and since the financial crisis of 2008 and the recession in this country that followed, Latin America demonstrated impressive resilience. There was some contagion, but on balance Latin America came through this period without severe downside effects. In percentage terms, real GDP contraction in Latin America in 2009 was less than half of that in advanced economies. And the following year's recovery was much stronger. For many countries in South America, the economic output fell for only two quarters. At the same time, several countries of Latin America have been on the receiving end of sizeable capital flows that have brought unique challenges. When I visited Chile and Brazil last fall, I heard a lot about the volatility of portfolio investment capital flows that swing with the appetite of global investors for emerging market risk and risk in general. Economists and central bankers expressed a lot of concern about how to manage their monetary affairs in an environment characterized by strong capital inflows that drive their exchange rate higher and fuel credit expansion that in turn causes a boom in asset prices.

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Then these forces can come to sudden stops followed by a reversal of capital flows, falling asset prices, and credit contraction because of shrinking collateral for loans. My central bank colleagues from Latin America did not talk of decoupling. Rather, they described their challenge of avoiding a boom-bust cycle as a result of hot money flows in a risk on-risk off world. The export trade of Latin America is also affected by demand conditions here in the United States and the rest of the world. Beyond direct exports to the United States, we have seen how in recent years South American commodity exports to emerging Asia have soared. Argentina, Brazil, Chile, and Peru are the leading exporters of commodities to emerging Asia, and China is now Brazil's top trading partner. The boom has contributed to strong economic growth in the exporting countries, but as global growth has slowed, so has demand for these commodity exports, and commodity prices have fallen. Most Latin American countries, through openness to capital flows and trade, are more and more integrated into the global economy. This is, on balance, a good thing, but it brings policy challenges in their pursuit of macroeconomic stability and consistent growth.

Conclusion Let me recap. The Latin American story—in the simplest terms—goes something like this: Latin America got into trouble in the '80s because of bad policy decisions. The region suffered what some have called a lost decade. Since then, the governments of most Latin countries have pursued sound policies, and as a result these countries have progressed economically and their economies continue to perform rather well.

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This history suggests to me there exist certain basic realities—behaving almost like physics—that cannot be long ignored or avoided. Consistent and sustained good economic performance needs a foundation of sound fundamentals. These fundamentals include good fiscal management—especially debt management—and monetary policy that supports growth while delivering control of inflation. Add to these the maintenance of an open economy that accepts and benefits from trade and capital flows from the rest of the world. It is my sense that the countries of Latin America have mostly learned these lessons. I don't believe the United States or other mature economies are immune to these realities—these physics, so to speak. The U.S. economy has been in a technical recovery since the summer of 2009. The recovery to date has seen weak growth and persistently high unemployment. By any number of measures, the strength of the recovery has been and remains disappointing. Some commentators have warned that the United States, along with Europe and Japan, could be experiencing our own lost decade. Just last week, an article in the Financial Times argued the world is halfway there. Friday's New York Times ran an article referring to Europe's lost decade. I will leave it to economic historians to arrive at a verdict on this question, but certainly our current expansion is not on the track we would wish.

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Real personal income (excluding government transfer payments) is still 1.5 percent below what it was before the recession in late 2007. As of July, there are more than 4½ million fewer payroll jobs than in November of 2007. Most of these job losses were in the private sector. The share of unemployed workers who have been out of a job for more than 27 weeks has fluctuated between 40 and 50 percent over the entire course of the recovery. I think this condition can be attributed, at least in part, to fundamental imbalances that have not yet been corrected, a situation that presents formidable challenges for monetary policymakers. There is a risk to monetary policy being employed too aggressively and without effect to address economic problems that can be resolved only by fiscal reforms that involve making tough choices about the allocation of public resources. Monetary policy can exert a powerful positive influence on an economy, but as Chairman Bernanke has pointed out, monetary policy is not a panacea. We should applaud sound policy decisions and effective policy implementation where we see it. Again, I commend many of the governments and central banks of Latin America for having chosen this path.

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NUMBER 7

Basel ii / iii in Russia

The Bank of Russia considers it necessary to create legislative fundamentals in Russia for introducing all the standards of banking regulation and banking supervision established by the Basel Committee on Banking Supervision (BCBS). These include legislation empowering the Bank of Russia to set requirements for credit institutions’ corporate governance, risk and capital management systems, to exercise consolidated supervision, to use professional judgment in supervisory practices, and also to define disciplinary action against members of executive bodies and boards of directors (supervisory boards) for faults in the activity of their credit institutions. In order to implement the provisions of Basel II, the Bank of Russia will carry out work in 2012-2014 to draft banking regulation and supervisory rules envisaging approaches to credit risk assessment based on internal ratings. The Bank of Russia will also cooperate with credit institutions in drafting and introducing internal capital adequacy assessment procedures. In order to introduce new international requirements for capital quality and adequacy and maintain the required level of liquidity as stipulated by the BCBS documents adopted in 2010 (Basel III) and supported by the G20 leaders at their summit in Seoul in November 2010, the Bank of Russia intends to take the following measures: – make amendments to the regulations to review the structure of regulatory capital and introduce requirements for the adequacy of capital components;

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–set requirements for building capital buffers, introducing the leverage indicator defined as the ratio between capital and the total value of assets and off-balance sheet items that are not weighted by risk; – introduce two liquidity ratios: the short-term liquidity coverage standard defined as the ratio of liquid assets to net cash outflow over the next 30 calendar days in a market stress scenario, and the net stable funding standard determined as the ratio of available reliable sources of funding with a maturity of at least one year to the required amount of stable funding in a stress scenario. In 2013-2014, the Bank of Russia will define approaches for banks to create the counter-cyclical capital buffers as an instrument to limit systemic risks. In order to implement these approaches, additional indicators of risk growth in the Russian financial system are intended to be developed. Measures are planned in 2012-2014 to work out criteria for classifying banks as systemically important, and also define regulatory requirements for their activity, taking into account the proposals developed by the BCBS jointly with the Financial Stability Board (FSB) for global sys-temically important financial institutions. While developing corresponding criteria for Russian banks, the Bank of Russia will take into account the specifics of the domestic market for banking services, and also the work being carried out by the BCBS and the FSB to adapt the proposed approaches to the regulation of national systemically important banks. With regard to international recommendations on compliance with FSB principles and standards relating to compensation (remuneration), the Bank of Russia will implement them taking into account the specific requirements of national legislation. In order to reduce the administrative burden on banks, measures are planned to unify supervisory requirements for the sustainability of credit institutions and the requirements for their participation in the deposit

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insurance system by making corresponding amendments to legislation. In order to increase the transparency of Russian credit institutions, they will be required to disclose information to the public on the qualifications and work experience of their top managers. Measures will be required to statutorily establish the duty of shareholders and persons exerting indirectly (through third parties) material influence on decisions taken by the credit institutions’ management bodies, including third parties, to provide information to credit institutions for the disclosure of the ownership structure. These would include cases where the shares of credit institutions are kept by nominal holders. Measures are planned to further develop the legislative framework of credit institutions’ affiliated parties to increase the transparency of the ownership structure of credit institutions. In particular, it will be necessary to stipulate the duty of all affiliated parties of credit institutions to provide information on them and be held responsible for their failure to comply with this requirement. Work will be continued to legislatively improve merger and acquisition processes. Amendments will be made to the legislation to stipulate a possibility for legal entities (including credit institutions) with different forms of incor-poration to participate in the reorganisation of credit institutions, which will give an additional stimulus to raise their capitalisation through re-structuring. The policy towards integration into the world financial market should be conducted taking into account national interests, the real level of development and the competitiveness of the Russian banking sector. The ban on opening foreign bank branches will remain as a necessary measure for maintaining the competitiveness of Russian banks in the

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domestic market for banking services and the Bank of Russia will continue its participation in drafting the corresponding federal law. The Bank of Russia will participate in work to draft laws aimed at providing additional protection for creditors and consumers of financial services, including the improvement of the law on pledge and the development of legislation on consumer credit. At the same time, work will continue to implement measures for improving the financial literacy of the population with respect to banking. Measures to increase the transparency of credit institutions as a result of the use of International Financial Reporting Standards (IFRS) in their activities are an important step towards raising the efficiency of the banking sector and boosting clients’ confidence in banks. With this in mind, these tasks should be resolved through the implementation of Federal Law No. 208-FZ, dated 27 July 2010, ‘On Consolidated Financial Statements’, under which credit institutions are required to draw up, submit and publish consolidated financial statements. For its part, the Bank of Russia considers it necessary to encourage credit institutions to be conservative enough in making fair value measurements under the IFRS standards and, if necessary, will use banking regulation and supervisory powers to adjust the measurements, proceeding from prudential approaches. The Bank of Russia will further study approaches and measures for maintaining the systemic stability of the banking sector. The Bank of Russia will continue to upgrade its macroprudential analysis tools by calculating banking sector financial soundness indicators, among other things, and posting them on the IMF website, and to assess systemic risk by conducting stress tests. In order to better protect the banking system and credit institutions’ creditors, including bank depositors, and reduce the risks of abuses by

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credit institutions’ managers and owners, work will continue to improve the mechanisms of liquidation procedures at banks. These measures will include the assignment of criminal responsibility to the heads of credit institutions, and also persons responsible for accounting and other records, for deliberately entering false data into documents regulating civil rights and duties, accounting and other records and reports on the economic activities of a credit institution, and also for making corrections that distort the substance of these documents, if these actions are taken in pursuit of personal gain or in one’s personal interest and inflict damage on citizens, organisations or the state.

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The Central Bank of the Russian Federation Banking Legislation

Introduction

The Central Bank of the Russian Federation (Bank of Russia) was founded on July 13, 1990, on the basis of the Russian Republic Bank of the State Bank of the USSR. Accountable to the Supreme Soviet of the RSFSR, it was originally called the State Bank of the RSFSR. On December 2, 1990, the Supreme Soviet of the RSFSR passed the Law on the Central Bank of the RSFSR (Bank of Russia), which declared the Bank of Russia a legal entity and the main bank of the RSFSR, accountable to the Supreme Soviet of the RSFSR. The law specified the functions of the bank in organising money circulation, monetary regulation, foreign economic activity and regulation of the activities of joint-stock and co-operative banks. In June 1991, the Statute of the Central Bank of the RSFSR (Bank of Russia), accountable to the Supreme Soviet of the RSFSR, was approved. In November 1991, when the Commonwealth of Independent States was founded and Union structures dissolved, the Supreme Soviet of the RSFSR declared the Central Bank of the RSFSR to be the only body of state monetary and foreign exchange regulation in the RSFSR. The functions of the State Bank of the USSR in issuing money and setting the ruble exchange rate were transferred to it.

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The Central Bank of the RSFSR was instructed to assume before January 1, 1992, full control of the assets, technical facilities and other resources of the State Bank of the USSR and all its institutions, enterprises and organisations. On December 20, 1991, the State Bank of the USSR was disbanded and all its assets, liabilities and property in the RSFSR were transferred to the Central Bank of the RSFSR (Bank of Russia), which several months later was renamed the Central Bank of the Russian Federation (Bank of Russia). In 1991-1992 an extensive network of commercial banks was created in the Russian Federation under Bank of Russia guidance through commercialisation of the specialised banks’ branches. The disbandment of the State Bank of the USSR was followed by changes in the chart of accounts, the establishment of a network of Central Bank cash settlement centres and their provision with computer technology. The Central Bank began to buy and sell foreign exchange in the currency market it established and to set and publish the official exchange rates of foreign currencies against the ruble. In December 1992, as a result of the establishment of a single centralised federal treasury system, the Bank of Russia was no longer required to provide cash services for the federal budget. The Bank of Russia carries out its functions, which were established by the Constitution of the Russian Federation (Article 75) and the Law "On the Central Bank of the Russian Federation (Bank of Russia)" (Article 22), independently from the federal, regional and local government structures. In 1992-1995, to maintain stability of the banking system, the Bank of Russia set up a system of supervision and inspection of commercial banks and a system of foreign exchange regulation and foreign exchange control.

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As the agent of the Ministry of Finance, it organised the government securities market, known as the GKO market, and began to participate in its operations. In 1995, the Bank of Russia stopped extending loans to finance the federal budget deficit and centralised loans to individual sectors of the economy. To override the consequences of the 1998 financial crisis, the Bank of Russia took steps towards restructuring the banking system in order to improve the performance of commercial banks and increase their liquidity. Insolvent banks were removed from the banking services market, using the procedures established by the applicable law. Of great importance for the post-crisis recovery of the banking sector was the creation of the Agency for Restructuring Credit Institutions (ARCO) and the Inter-Agency Co-ordinating Committee for Banking Sector Development in Russia (ICC). Thanks to the effective measures implemented by the Bank of Russia, ARCO and ICC, by the middle of 2001 Russia’s banking sector had on the whole overcome the aftermath of the crisis. The Bank of Russia monetary policy was designed to maintain financial stability and create conditions conducive to sustainable economic growth. The Bank of Russia promptly reacted to any change in the real demand for money and took steps to stimulate positive economic dynamics, cut interest rates, damp down inflationary expectations and slow the inflation rate. As a result, the ruble gained somewhat in real terms and financial market stability increased.

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Due to the balanced monetary and exchange rate policies pursued by the Bank of Russia, the country’s international reserves have grown and there have been no sharp fluctuations in the exchange rate. The efforts made by the Bank of Russia with regard to the payment system were designed to increase its reliability and efficiency for financial and economic stability. To make the Russian payment system more transparent, the Bank of Russia introduced reports on payments by credit institutions and its own regional branches, which took into account international experience, methodology and practice of surveillance over payment systems. In 2003, the Bank of Russia launched a project designed to improve banking supervision and prudential reporting by introducing international financial reporting standards (IFRS). The project provides for the implementation of a set of measures, including measures to ensure credit institutions’ credible accounting and reporting, raise requirements for the content, amount and periodicity of information to be published, and introduce accounting and reporting standards matching international good practice. In addition, measures are to be taken to disclose information on the real owners of credit institutions, exercise control over their financial position and raise requirements for credit institutions’ executives and their business reputation. There are some problems to which the Bank of Russia pays special attention. One of them is that specific risks connected with the dynamics of the prices of some financial assets and the price situation on the real estate market have begun to play an increasingly important role recently. The practice of lending to related parties led to high risk concentrations in some banks, compelling the Bank of Russia to upgrade the methods of

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banking regulation and supervision by making greater emphasis on substantive (risk-oriented) supervision. Fictitious capitalisation of banks is another matter of serious concern for the Bank of Russia. To prevent banks from using all sorts of schemes designed to artificially overvalue or undervalue the required ratios, the Bank of Russia in 2004 issued a number of regulations, including the Regulation "On the Procedure for Creating Loan Loss Reserves by Credit Institutions" and the Instruction "On Banks’ Required Ratios." As the number of credit institutions extending mortgage loans to the public increased, in 2003 the Bank of Russia issued the Ordinance "On Conducting a One-off Survey of Mortgage Lending," which set the procedure for compiling and presenting data on housing mortgage loans extended by credit institutions. With the adoption of the Federal Law "On Mortgage Securities," credit institutions which ensured the observance of the requirements for the protection of investors’ interests received the lawful opportunity to refinance their claims on mortgage loans by issuing mortgage securities. In pursuance of the Federal Law "On the Central Bank of the Russian Federation (Bank of Russia)" and Federal Law "On Mortgage Securities," the Bank of Russia issued the Instruction "On the Required Ratios for Credit Institutions Issuing Mortgage-Backed Bonds," which specified the calculation and established the values of the required ratios and the values and methodology of calculating additional required ratios for credit institutions issuing mortgage-backed bonds. In December 2003, the Federal Law "On Insurance of Personal Bank Deposits in the Russian Federation" was adopted. The law stipulated the legal, financial and organisational framework for the mandatory personal bank deposits insurance system, and also the powers, procedure for the establishment and operation of an institution

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implementing mandatory deposit insurance functions and set the procedure for paying deposit compensation. At present, an overwhelming majority of banks participate in the deposit insurance system. They account for almost 100% of total personal deposits placed in Russian banks. In April 2005, the Russian Government and Bank of Russia adopted the Banking Sector Development Strategy for the Period up to 2008, a document which set as the main objective of banking sector development in the medium term (2005-2008) the enhancement of the banking sector’s stability and efficiency. The principal goals of banking sector development are as follows:

- increasing the protection of interests of depositors and other creditors of banks;

- enhancing the effectiveness of the banking sector’s activity in

accumulating household and enterprise sector funds and transforming them into loans and investments;

- making Russian credit institutions more competitive; - preventing the use of credit institutions in dishonest commercial

practices and illegal activities, especially the financing of terrorism and money laundering;

- promoting the development of the competitive environment and

ensuring the transparency of credit institutions; - building up investor, creditor and depositor confidence in the

banking sector. The banking sector reform will help implement Russia’s

medium-term social and economic development programme (2005-2008), especially its objective to end the raw materials bias of the Russian

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economy by rapidly diversifying it and utilising its competitive advantages.

At the next stage (2009-2015), the Russian Government and Bank of

Russia will attach priority to effectively positioning the Russian banking sector on international financial markets.

Banking Legislation Banking legislation is a branch of law representing a system of statutory acts regulating banking activities. The legal regulation of banking activities is exercised by the Constitution of the Russian Federation, Civil Code of the Russian Federation, Federal Law No. 86-FZ, dated July 10, 2002, ‘On the Central Bank of the Russian Federation (Bank of Russia)’ (hereinafter referred to as the Bank of Russia Law), Federal Law No. 395-1, dated December 2, 1990, ‘On Banks and Banking Activities,’ and other federal laws and Bank of Russia regulations. Point g of Article 71 of the Constitution of the Russian Federation stipulates that the Russian Federation has the jurisdiction over the financial, currency, credit and customs regulation, the issue of money and the fundamentals of the price policy. This provision signifies that the legal regulation of banking activities may only be conducted at the federal level. Part 2 of Article 75 of the Constitution of the Russian Federation lays down the principle of the Bank of Russia being independent from other state bodies when performing its basic function to protect the rouble and ensure its stability. The Bank of Russia Law spells out the principle of the Bank of Russia independence, stipulating that the Bank of Russia performs the functions and exercises the powers established by the Constitution of the Russian Federation and the Bank of Russia Law independently from other federal bodies of state power, regional authorities and local governments.

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The Bank of Russia Law establishes the legal status of the Bank of Russia, the size of its authorised capital, the procedure for creating the National Banking Board and management bodies and their principal functions; settles the relations between the Bank of Russia and the bodies of state power and local governments and the relations between the Bank of Russia and credit institutions; spells out the principles of organising non-cash settlements and cash circulation; sets out the principles of implementing the monetary policy and designated its instruments; lists Bank of Russia operations and transactions; establishes the powers in regard of banking regulation and supervision, and formulates the principles of organising the Bank of Russia and its accountability and audit. Article 4 of the Bank of Russia Law lists the functions performed by the Bank of Russia. Article 7 of the Bank of Russia Law stipulates that in regard of the matters related to its competence by this Federal Law and other federal laws the Bank of Russia issues in the form of ordinances, regulations and instructions statutory acts binding upon the federal bodies of state power, regional authorities, local governments and all legal entities and natural persons. With few exceptions, Bank of Russia statutory acts should be registered according to the procedure established for the state registration of statutory legal acts of the federal bodies of executive power. In addition to issuing its own regulations, the Bank of Russia takes an active part in other forms of the legislative process, because under the law the drafts of federal laws and statutory legal acts of the federal bodies of executive power concerning the performance by the Bank of Russia of its functions should be submitted to the Bank of Russia for consideration and approval. Another basic federal law regulating banking activities is the Federal Law ‘On Banks and Banking Activities’, which defines major terms used in the legal regulation of banking, such as ‘credit institution,’ ‘bank,’ ‘non-bank credit institution,’ ‘banking group,’ etc.

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This Federal Law determines the components of the Russian banking system, lists banking operations and other transactions, describes the specifics of credit institution operations on the securities market and sets the procedure for registering credit institutions and licensing banking activities and the procedure for opening credit institution branches and representative offices. It formulates the principles of the relationships between credit institutions and their customers and between credit institutions and the state, lists the grounds for the revocation of a banking licence, lays down the principles of ensuring the soundness of credit institutions, establishes the banking secrecy regime and anti-monopoly restrictions for credit institutions and sets out the principles of organising the savings business in the Russian Federation. The passage of Federal Law No. 40-FZ, dated February 25, 1999, ‘On Insolvency (Bankruptcy) of Credit Institutions’ (hereinafter referred to as the Insolvency Law) was a major step forward in building in Russia a civilised credit institution insolvency (bankruptcy) system meeting the generally accepted international standards. The Insolvency Law sets the procedure for carrying out credit institution insolvency (bankruptcy) prevention measures, declaring credit institutions insolvent (bankrupt) and subsequently liquidating them. The relations connected with credit institution insolvency (bankruptcy) prevention that are not regulated by the Insolvency Law are regulated by other federal laws and Bank of Russia statutory acts issued in pursuance of these laws. The relations connected with credit institution insolvency (bankruptcy) that are not regulated by the Insolvency Law are regulated by Federal Law No. 127-FZ, dated October 26, 2002, ‘On Insolvency (Bankruptcy),’ and Bank of Russia regulations in cases stipulated by the Insolvency Law. Under the Insolvency Law, a credit institution is considered incapable of meeting creditors’ pecuniary claims and (or) making compulsory payments if it has failed to exercise these duties for 14 days after they are

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due and (or) the value of the credit institution’s property (assets) is not enough to allow it to meet its obligations to creditors and (or) make compulsory payments. The Insolvency Law pays special attention to the bankruptcy prevention measures conducted before the revocation of a banking licence. These measures are as follows:

— the financial rehabilitation of the credit institution; — the appointment of the provisional administration to the credit

institution; — the reorganisation of the credit institution. The legal regulation of the system of measures aimed at anti-money

laundering and counter-terrorism financing is implemented pursuant to Federal Law No. 115-FZ, dated August 7, 2001, ‘On Countering the Legalisation (Laundering) of Criminally Obtained Incomes and Terrorist Financing’ (hereinafter referred to as the Anti-money Laundering Law). The Anti-money Laundering Law contains criteria for the volume of operations subject to mandatory control, lists these operations and determines the organisations conducting operations with money or other property that should inform an authorised agency about these operations, which include credit institutions, among other. Taking into consideration that capital may be laundered in many different ways, these organisations are required to conduct internal control for detecting operations subject to mandatory control and other operations with money or other property, in regard of which these organisations have the suspicion that these operations are conducted with the objective of money laundering or financing terrorism. The Anti-money Laundering Law also stipulates that the provision to the authorised agency of information and documents by organisations conducting operations with money or other property according to the

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procedure established by this Federal Law does not constitute a breach of official, banking, tax or commercial secrets. The Anti-money Laundering Law was passed in compliance with the Convention on Laundering, Search, Seizure and Confiscation of the Proceeds from Crime, signed in Strasbourg, France, and ratified by Federal Law No. 62-FZ, dated May 28, 2001. To boost public trust in the banking system, stimulate growth in organised savings and reduce the risks taken by banks when building a long-term resource base, Russia passed Federal Law No. 177-FZ, dated December 23, 2003, ‘On Insurance of Household Deposits with Russian Banks’. This Federal Law lays down the legal, financial and organisational principles of operating the compulsory household bank deposit insurance system (hereinafter referred to as the deposit insurance system), establishes the competence of and the procedure for creating an organisation performing compulsory deposit insurance functions (hereinafter referred to as the Deposit Insurance Agency), sets the procedure for paying deposit compensation and regulates relations among banks, the Deposit Insurance Agency, the Bank of Russia and the federal executive power bodies within the deposit insurance system. This Federal Law specifies the following basic principles of building and operating the deposit insurance system:

— the participation in the deposit insurance system is compulsory for banks;

— the deposit insurance system serves to mitigate the risk of adverse

consequences for depositors in the event of the banks’ failure to meet their obligations;

— the deposit insurance system is transparent;

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— the deposit insurance fund accumulates regular insurance contributions made by the banks participating in the deposit insurance system.

There are two insured events when an individual is entitled to deposit

compensation from the Deposit Insurance Agency: — the revocation (cancellation) of the Bank of Russia banking licence

from a bank in compliance with the Federal Law on Banks and Banking Activities;

— the imposition by the Bank of Russia, pursuant to applicable

federal legislation, of a ban on the satisfaction of bank creditors’ claims. Federal Law No. 96-FZ, dated July 29, 2004, ‘On Bank of Russia

Payments on Household Deposits with Bankrupt Banks Uncovered by the Compulsory Deposit Insurance System’, was a logical addition to the deposit insurance system built in Russia.

As the establishment of the deposit insurance system created the risk

of financial instability for the banks that have not joined this system as a result of the loss of customer and investor confidence and the eventual outflow of deposits to the participating banks, this Federal Law extended to the depositors of the non-member banks guarantees similar to those enjoyed by the depositors of the member banks. Under the law, compensation to depositors of the non-member banks is paid from Bank of Russia funds.

Thus, the passing of this Federal Law became a major step forward in

boosting confidence in the banking system as a whole. To ensure the implementation of the single state foreign exchange

policy and stability of the Russian currency and domestic foreign exchange market, which are the factors of the country’s economic progress and successful international economic cooperation, Russia passed Federal Law No. 173-FZ, dated December 10, 2003, ‘On Foreign Exchange Regulation and Control’ (hereinafter referred to as the Foreign Exchange Regulation Law).

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The Foreign Exchange Regulation Law defines foreign exchange operations. In addition, it separates the powers of the federal government and the Bank of Russia relating to the regulation of foreign exchange operations. On January 1, 2007, the restrictions on foreign exchange operations between residents and non-residents (the requirements that such operations are routed through special accounts and that a certain amount of money is deposited when foreign exchange operations are conducted, the prohibition to buy domestic securities for foreign currency, the preliminary registration of a resident account (deposit) opened with a bank outside Russia and the compulsory sale of a part of foreign currency earnings) were lifted. Residents and non-residents may now make settlements on operations with domestic and foreign securities in rubles or foreign currency. At the same time, the Foreign Exchange Regulation Law (Article 11) retains the requirement that foreign exchange and cheques, including traveller’s cheques, denominated in foreign currency are bought through authorised banks only. To boost the domestic foreign exchange market and prevent capital flight from Russia, the Foreign Exchange Regulation Law retains the requirement for residents to repatriate foreign and domestic currency (Article 19). Federal Law No. 218-FZ, dated December 30, 2004, ‘On Credit Histories’, has an important role to play in arranging credit relations and building a modern economy. The purpose of this Federal Law is to create and legalise conditions for the compiling, processing, storage and disclosure by credit bureaus of information about how borrowers meet their obligations under loan (credit) agreements, give creditors and borrowers more protection by reducing overall credit risk and enhance the efficiency of credit institutions.

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The Federal Law on Credit Histories is designed to allow banks to cut costs when assessing their borrowers’ creditworthiness and, consequently, reduce the price of loans they extend. A major role in implementing this Federal Law is played by the Bank of Russia, whose division, the Central Catalogue of Credit Histories, performs the function of a single information centre informing users free of charge in what credit bureau they can find information about an individual credit history maker. In addition to the borrowers, creditors and the Central Catalogue of Credit Histories, the credit bureaus participate in the exchange of information about how borrowers meet their obligations to creditors. The principal objective of the credit bureaus is to accumulate information characterising the borrower’s payment discipline in regard of the fulfilment of the loan (credit) agreements and eventually this information forms the credit histories of legal entities and natural persons, which may be subsequently passed to the persons who have received permission to get a credit report for the conclusion of a loan (credit) agreement.

Measures to be implemented by the Bank of Russia to upgrade the banking system and banking supervision in 2012 and in 2013 and 2014

In order to upgrade the banking system and banking supervision in 2012-2014, the Bank of Russia will focus on implementing measures stipulated by the Strategy of Russian Banking Sector Development until 2015 that are intended to increase the quality of banks’ activity and maintaining the stability of the Russian banking sector. The banking sector will face increased competition (both intrasectoral and intersectoral) in the most lucrative segments of the banking services market. This will lead credit institutions to raise their capitalisation.

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The consolidation of the banking sector is also expected to intensify, and new, larger banking structures will emerge. At the same time, the diversification of the banking business and banking income will develop further, including as a result of the introduction of new technologies and the improvement of bank risk management and banking regulation. Measures will be taken to reduce risk concentration, including risk concentration per borrower (or group of related borrowers), investment, area of activity, and industry. Banks are expected to develop banking products that generate an income from fee in order to keep their incomes stable. Credit institutions will pay close attention to the development of their long-term resource base, in which household deposits will play an increasingly important role. These trends are expected to improve the accessibility of banking services both for individuals and organisations. Tougher competition and measures to develop banking regulation and banking supervision will increase transparency and market discipline in the banking sector. As a result, credit institutions will increasingly focus on their long-term performance, make more rational decisions and build effective management systems, including risk management systems. As part of its efforts to improve banking regulation and banking supervision, the Bank of Russia will continue in 2012-2014 its work to raise the quality of bank capital and assets, limit the level of risks, including the level of their concentration, and increase the reliability of credit institutions’ accounting and reporting. The development of substantive risk-based approaches that take the domestic and international experience into account will be a key instrument in the sphere of banking regulation and banking supervision.

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Measures to improve banking supervision and increase its quality envisage:

- identifying bank risks, taking into account the prospects of the economy and the financial sector, and developing an early response system;

- using differentiated approaches to supervision, taking into account the systemic importance, profile and level of risks, and also the level of credit institutions’ transparency;

- carrying out supervisory measures to reduce risk concentration, including exposure to affiliated parties;

- developing supervision on a consolidated basis; - developing cooperation with government regulatory and

control agencies, including foreign supervisors, in order to exchange information.

Measures are envisaged to develop a system of control to be exercised by the Bank of Russia’s head office over the situation in the banking sector, especially at systemically important credit institutions.

The Bank of Russia considers it necessary to create legislative fundamentals in Russia for introducing all the standards of banking regulation and banking supervision established by the Basel Committee on Banking Supervision (BCBS).

These include legislation empowering the Bank of Russia to set requirements for credit institutions’ corporate governance, risk and capital management systems, to exercise consolidated supervision, to use professional judgment in supervisory practices, and also to define disciplinary action against members of executive bodies and boards of directors (supervisory boards) for faults in the activity of their credit institutions.

In order to implement the provisions of Basel II, the Bank of Russia will carry out work in 2012-2014 to draft banking regulation and supervisory rules envisaging approaches to credit risk assessment based on internal ratings.

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The Bank of Russia will also cooperate with credit institutions in drafting and introducing internal capital adequacy assessment procedures. In order to introduce new international requirements for capital quality and adequacy and maintain the required level of liquidity as stipulated by the BCBS documents adopted in 2010 (Basel III) and supported by the G20 leaders at their summit in Seoul in November 2010, the Bank of Russia intends to take the following measures:

- make amendments to the regulations to review the structure of regulatory capital and introduce requirements for the adequacy of capital components;

- set requirements for building capital buffers, introducing the leverage indicator defined as the ratio between capital and the total value of assets and off-balance sheet items that are not weighted by risk;

- introduce two liquidity ratios: the short-term liquidity coverage

standard defined as the ratio of liquid assets to net cash outflow over the next 30 calendar days in a market stress scenario, and the net stable funding standard determined as the ratio of available reliable sources of funding with a maturity of at least one year to the required amount of stable funding in a stress scenario.

In 2013-2014, the Bank of Russia will define approaches for banks to create the counter-cyclical capital buffers as an instrument to limit systemic risks. In order to implement these approaches, additional indicators of risk growth in the Russian financial system are intended to be developed. Measures are planned in 2012-2014 to work out criteria for classifying banks as systemically important, and also define regulatory requirements for their activity, taking into account the proposals developed by the BCBS jointly with the Financial Stability Board (FSB) for global sys-temically important financial institutions.

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While developing corresponding criteria for Russian banks, the Bank of Russia will take into account the specifics of the domestic market for banking services, and also the work being carried out by the BCBS and the FSB to adapt the proposed approaches to the regulation of national systemically important banks. With regard to international recommendations on compliance with FSB principles and standards relating to compensation (remuneration), the Bank of Russia will implement them taking into account the specific requirements of national legislation. In order to reduce the administrative burden on banks, measures are planned to unify supervisory requirements for the sustainability of credit institutions and the requirements for their participation in the deposit insurance system by making corresponding amendments to legislation. In order to increase the transparency of Russian credit institutions, they will be required to disclose information to the public on the qualifications and work experience of their top managers. Measures will be required to statutorily establish the duty of shareholders and persons exerting indirectly (through third parties) material influence on decisions taken by the credit institutions’ management bodies, including third parties, to provide information to credit institutions for the disclosure of the ownership structure. These would include cases where the shares of credit institutions are kept by nominal holders. Measures are planned to further develop the legislative framework of credit institutions’ affiliated parties to increase the transparency of the ownership structure of credit institutions. In particular, it will be necessary to stipulate the duty of all affiliated parties of credit institutions to provide information on them and be held responsible for their failure to comply with this requirement. Work will be continued to legislatively improve merger and acquisition processes.

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Amendments will be made to the legislation to stipulate a possibility for legal entities (including credit institutions) with different forms of incor-poration to participate in the reorganisation of credit institutions, which will give an additional stimulus to raise their capitalisation through re-structuring. The policy towards integration into the world financial market should be conducted taking into account national interests, the real level of development and the competitiveness of the Russian banking sector. The ban on opening foreign bank branches will remain as a necessary measure for maintaining the competitiveness of Russian banks in the domestic market for banking services and the Bank of Russia will continue its participation in drafting the corresponding federal law. The Bank of Russia will participate in work to draft laws aimed at providing additional protection for creditors and consumers of financial services, including the improvement of the law on pledge and the development of legislation on consumer credit. At the same time, work will continue to implement measures for improving the financial literacy of the population with respect to banking. Measures to increase the transparency of credit institutions as a result of the use of International Financial Reporting Standards (IFRS) in their activities are an important step towards raising the efficiency of the banking sector and boosting clients’ confidence in banks. With this in mind, these tasks should be resolved through the implementation of Federal Law No. 208-FZ, dated 27 July 2010, ‘On Consolidated Financial Statements’, under which credit institutions are required to draw up, submit and publish consolidated financial statements. For its part, the Bank of Russia considers it necessary to encourage credit institutions to be conservative enough in making fair value measurements under the IFRS standards and, if necessary, will use banking regulation

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and supervisory powers to adjust the measurements, proceeding from prudential approaches. The Bank of Russia will further study approaches and measures for maintaining the systemic stability of the banking sector. The Bank of Russia will continue to upgrade its macroprudential analysis tools by calculating banking sector financial soundness indicators, among other things, and posting them on the IMF website, and to assess systemic risk by conducting stress tests. In order to better protect the banking system and credit institutions’ creditors, including bank depositors, and reduce the risks of abuses by credit institutions’ managers and owners, work will continue to improve the mechanisms of liquidation procedures at banks. These measures will include the assignment of criminal responsibility to the heads of credit institutions, and also persons responsible for accounting and other records, for deliberately entering false data into documents regulating civil rights and duties, accounting and other records and reports on the economic activities of a credit institution, and also for making corrections that distort the substance of these documents, if these actions are taken in pursuit of personal gain or in one’s personal interest and inflict damage on citizens, organisations or the state. In the course of inspections, which the Bank of Russia will conduct in 2012-2014, special at tention will be paid to the inspection of credit in-stitutions of systemic importance to the banking sector of the Russian Federation and its regions, along with the inspection of credit institutions that conduct highly risky operations and credit institutions that are not transparent enough. The inspections will focus on assessing bank risks (credit and market risks, liquidity and concentration risks, including risk concentration on the owners’ business), the systems of their management, and the identification of doubtful transactions.

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In order to achieve the best results in the inspection of credit institutions (their branches), the Bank of Russia will continue the on-going monitoring of the process of arranging and holding inspections and the coordination of work for conducting these inspections. Special attention will be paid to formulating risk-based assignments for the inspections of credit institutions. The improvement of the inspection organisation’s structure, which envisages measures to centralise the Bank of Russia’s inspecting activity by 2014, will help make inspections more effective. Regulatory support for inspections will be improved, taking into account internationally-accepted approaches, and the Bank of Russia’s measures to implement the Strategy of Russian Banking Sector Development until 2015. The Bank of Russia is legislatively empowered to set requirements for credit institutions to develop internal control procedures to prevent the legalisation (laundering) of criminally obtained incomes and the financing of terrorism. In light of this, special attention will be paid to risk-based approaches used by credit institutions to identify customers, their representatives, beneficiaries, and also to monitor operations for the provision of services to customers.

–participate in carrying out a plan to create an international financial centre in Moscow;

–participate, jointly with the Federal Financial Markets Service, in

improving approaches towards regulating the activity of clearing or-ganisations and central counterparties;

– participate in upgrading the legislation regulating depository

activities, and recognise the concept of a foreign nominal holder; – participate in upgrading the legislation regulating the organisation

of exchange trade;

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– make arrangements for the inclusion of the Russian rouble in

settlement currencies of the Continuous Linked Settlement (CLS) system; – participate, jointly with the Ministry of Finance, in efforts to further

liberalise the government securities market by making amendments to Bank of Russia’s regulations and other instructions allowing the placement and circulation of government securities on stock exchanges in accordance with their rules;

– participate in upgrading the legislation to define the status of the

precious metal account; – participate in upgrading the legislation regulating the terms and

conditions of the issue and circulation of the certificates of deposit and savings certificates.

– improve the legislative and contractual base regulating repo

transactions in the Russian market.

Measures to be implemented by the Bank of Russia to improve the Russian payment system in 2012 and in 2013 and 2014

In 2012-2014, the Bank of Russia will carry out measures to develop and upgrade the Russian payment system for the purpose of ensuring the stable functioning of Russia’s financial system. The Bank of Russia will take measures to implement Federal Law No. 161-FZ, dated 27 June 2011, ‘On the National Payment System’. In particular, work will be carried out to draft a Strategy for the Development of the National Payment System stipulating measures to ensure the stable functioning of the national payment system, increase its effectiveness and competitiveness, improve the Bank of Russia payment system, develop infrastructural and intersystem interaction between participants in the national payment system, and also enhance accessibility and the security of payment services, including with the use of innovative payment instruments.

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In order to follow up with this federal law, the Bank of Russia will develop regulations in 2012 to cover the following areas:

–the regulation of the Bank of Russia payment system; – the regulation of payment systems, as well as supervision and

oversight in the national payment system; –measures to ensure the smooth operation of payment systems and

information protection (security) in money remittances. In order to ensure the development of the national payment system, the Bank of Russia will participate in the work of the Technical Committee on Financial Operations Standards to continue creating a national standard of cashless settlements based on the ISO 20022 methodology and introducing it into the national payment system. Basic measures to develop the Bank of Russia payment system will focus on improving the Bank of Russia system of real-time gross settlements (BESP). It will especially focus on expanding settlement services provided to credit institutions, as well as financial market participants, the Federal Treasury and Bank of Russia divisions, including a broader format of the BESP system operation. It will also increase the operational efficiency and automation of intraday liquidity management procedures. The implementation of these measures will create conditions for lowering the risks and costs incurred by payment system participants.

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NUMBER 8

The Importance of Strong Risk Management: Insights From The Examination World

By Jason C. Schemmel, Community and Regional supervisory examiner with the Federal Reserve Bank of Richmond

Introduction

In 1995, the Board of Governors of the Federal Reserve System issued SR 95-51, which instructed examiners to begin assigning a formal supervisory rating to the adequacy of an institution’s risk management processes.

Examiners had always emphasized the importance of sound risk management processes, but this guidance heralded an era of heightened awareness in light of new technologies, product innovation and rapidly changing banking markets.

Examiners continue to assess and consider factors such as profitability, asset quality and capital adequacy when assigning supervisory ratings, but these indicators, to a large degree, tell a story about the past.

At the heart of risk management is the concept of looking toward the future, as being able to identify, measure, monitor and control risks before they spread is critical to the conduct of safe and sound banking, regardless of the size and complexity of the institution.

Analysis of banking performance during the recession of 2007–2009 indicates that banks with strong forward-looking risk mitigation strategies weathered the recession more successfully than other banks, even those taking identical risks (see “Weathering the Storm: A Case Study of Healthy Fifth District State Member Banks Over the Recent Downturn” in the summer 2012 edition of S&R Perspectives).

These successful institutions all possessed the key elements of a risk management framework, including:

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- An active board of directors and senior management team

- Policies, procedures and risk limits governing all activities that are clearly communicated throughout the organization

- Timely and accurate management information systems (MIS)

- Strong internal controls

To understand the risk management challenges currently facing our state member banks, we asked key members of the Federal Reserve Bank of Richmond’s Community and Regional (C&R) management team to identify areas that are

(1) Consistently cited in reports of examination as risk management weaknesses or

(2) Expected to receive heightened attention in the near future. This article reinforces existing supervisory guidance and expectations and discusses the most commonly cited examination issues related to the management of credit, liquidity, market, operational, and legal and reputational risks.

Properly addressing these matters will improve the prospects of early risk detection and help to prevent losses.

Credit Risk

C&R relationship managers and subject matter experts alike expressed concern over three areas: new product lines, home equity lines of credit (HELOC) and appraisal review.

New Product Lines

Interviews with bankers during examinations over the previous 12–24 months revealed that many management teams and boards of directors intend to reduce future reliance on real estate lending by expanding into commercial lending.

The number of bankers that stated this intention is striking and indicates the potential for fierce competition for commercial business. In fact,

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several banks have reported recent solicitations from third parties attempting to negotiate participation in syndicated commercial loans.

Prior to expanding into commercial lending, or any new product line, it will be critical for banks to properly research the product and ensure it aligns with the bank’s strategic plan and the risk appetite of the board of directors.

Banks that venture into commercial lending are expected to have the appropriate expertise on staff to underwrite and monitor the credits.

Moreover, the lending staff must be guided by robust policies, procedures and risk limits.

As was the case in the late 1990s, intense competition for commercial loan customers often leads to significant easing of both loan terms and front-end financial analysis.

Discipline was — and will be — a key success factor.

Existing supervisory guidance stresses:

- The importance of using formal forward-looking analysis in the loan approval process

- The value of assessing alternative or “downside” scenarios

- The dangers of unduly weighting the short-term benefit of attracting or retaining customers through price concessions while giving insufficient consideration to potential longer-term consequences1

Additionally, exceptions to approved underwriting and pricing policies should be rare, properly approved, aggregated and actively monitored by senior management.

HELOCs

There is considerable concern among C&R credit risk specialists that, unlike many other real estate loans, the losses in HELOC portfolios have yet to fully materialize.

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Many of the loans originated from 2003 to 2007 are approaching the end of their draw periods and will soon convert from interest-only to amortizing loans or have principal due as a balloon payment.

Observations from recent examinations indicate that banks with significant concentrations of HELOCs have not fully identified and measured the potential impact of these events.

Institutions with significant exposure to HELOCs should ensure that they are adhering to effective account management practices.

These include:

- Periodically refreshing credit scores on customers

- Periodically assessing utilization rates

- Periodically assessing payment patterns, including borrowers who make only minimum payments or those who rely on the line to keep payments current

- Using reasonably available tools to determine the payment status of senior liens associated with junior liens

- Obtaining updated information on the collateral’s value when market factors indicate a deterioration in value since origination or when the borrower’s payment performance deteriorates

Measurement of this data will allow bankers to identify customers who may default when loan terms change and facilitate the creation of effective workout solutions.

Data procured from this analysis should also be incorporated into the institution’s allowance for loan and lease losses (ALLL) methodology.

Appraisal Review

Examiners continue to observe appraisal review practices that are inconsistent with supervisory guidance.

Too often, appraisal reviews only consist of checklists used by the reviewer to determine compliance with federal regulations.

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While determining compliance with regulations is surely critical, it is merely one aspect of the appraisal review process.

Just as important is an evaluation of whether the methods, assumptions and data sources in the appraisal (or evaluation) are appropriate and well-supported.

An institution’s policies and procedures for reviewing appraisals and evaluations should address, at a minimum, the following:

Staff members who review appraisals and evaluations should be independent of both the property being valued and the loan production staff.

Reviewers should also possess the requisite expertise to perform a review commensurate with the level of risk and complexity in the transaction.

The depth of review should be appropriate for the risk and complexity of the transaction and property, but always be sufficient to ensure the methods, assumptions and conclusions within the appraisal and evaluation are reasonable and well-supported.

Staff within the institution should have clear written guidance on how to resolve deficiencies uncovered during a review.

All reviews should be thoroughly documented and placed within appropriate credit files.

Liquidity Risk

All financial institutions, regardless of size and complexity, should have a formal contingency funding plan (CFP) that clearly sets out the strategies for addressing liquidity shortfalls in emergency situations.

C&R relationship managers indicated that most banks have instituted some form of CFP; however, many banks continue to struggle with the details.

In general, the CFPs reviewed during examinations do not adequately address a sufficient range of liquidity stress events.

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The narrative section of the CFP should contain a thorough description of any liquidity event — or combination of events — that could adversely impact the bank’s liquidity.

The events may be institution-specific or arise from external factors. Examples include, but are not limited to, the inability to fund asset growth; the inability to renew or replace a maturing funding source; unexpected deposit runoff; or financial market dislocations.

Additionally, CFPs frequently are not robust enough with regard to the various stages and levels of stress severity that can occur during a contingent liquidity event.

The narrative section should fully describe the stages of each event, its severity and its expected duration.

Stress events should be modeled with sufficient severity to provide management and the board of directors with enough information to ascertain the durability of the bank’s liquidity position.

Moreover, the duration of the event is a critical factor in accurately measuring potential funding gaps and available funding sources.

Some events may be temporary while others may be longer-term.

In either case, the event should ultimately be modeled through its conclusion.

Designing the CFP in this fashion affords the opportunity to identify early-warning indicators for each stage, assess potential funding needs at various points in a developing crisis and specify action plans.

Market Risk

Proper measurement of market risk requires regularly assessing the reasonableness of assumptions that underlie an institution’s exposure estimates.

C&R subject matter experts have observed repeated weaknesses in three areas related to model assumptions: documentation, sensitivity testing and corporate governance.

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Key model assumptions such as asset prepayments, nonmaturity deposit price sensitivity and deposit decay rates are often unsupported and undocumented.

Inputs for these assumptions typically have a material impact on the model’s output; therefore, it is critical to ensure they are accurate.

Assumptions should be specific to the bank and based on an appropriate level of empirical evidence.

The decisions made and the rationale behind them should then be thoroughly documented.

To aid in determining which assumptions exert the greatest impact on measurement results, banks should periodically perform sensitivity testing.

Doing so will provide valuable insight into how to allocate scarce resources, i.e., the most critical assumptions should be given the most attention. When actual experience differs significantly from past assumptions and expectations, institutions should use a range of assumptions to appropriately reflect this uncertainty.

Finally, banks should develop a comprehensive governance system for actively monitoring and regularly updating key underlying assumptions.

This system should include oversight by representatives from any major business line that can directly or indirectly influence the bank’s market risk exposure.

Deliberations from these meetings and the rationale behind changes to key assumptions should be thoroughly documented in meeting minutes.

Operational Risk

C&R operational risk specialists have identified two areas of concern as technology is increasingly integrated into the business of banking: information security and vendor management.

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Information Security

One of the most common operational risk deficiencies cited during examinations over the last 18 months relates to information security.

It remains a challenge for all banks, regardless of size, because of the complex interconnectivity between the bank, its customers and its vendors.

The proliferation of mobile devices and electronic payment channels has increased the opportunities for hackers to compromise bank systems and steal critical data.

Therefore, strong internal controls surrounding access management are essential, including a robust risk assessment process; effective procedures for administering, logging and monitoring critical systems; and independent validation of controls through audits or penetration testing.

Vendor Management

Not surprisingly, the increase in technological banking solutions has led to an increase in outsourcing.

The scope of activities outsourced, however, has not been limited to traditional activities such as core processing and now may include interest rate risk modeling, stress testing or loan loss mitigation strategies.

Recent examinations indicate that vendor management practices are often not keeping pace with the growing volume and scope of outsourcing activities, particularly in the areas of due diligence and service provider oversight.

Due diligence prior to engagement should fully consider the provider’s ability to meet the institution’s needs.

Institutions should consider the provider’s technical and industry expertise, operations and controls, and financial condition.

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Once a contract has been signed, the institution must implement an oversight program to monitor each service provider’s controls, conditions and performance.

The oversight program should be commensurate with the risk of the outsourced relationship and be thoroughly documented for use in future contract negotiations, termination issues and contingency planning.

Legal and Reputational Risk

Finally, C&R operational risk specialists expressed concern with the proliferation of social networking platforms and their potential effect on banks’ legal and reputational risks.

A social networking service is an online service, platform or site that facilitates the building of social relations among people who share common interests, activities or relationships.

Their use has exploded as companies attempt to reach customers with advertising and to generate business intelligence for future sales or customer service.

Social networks pose several risks to banking organizations, including the potential disclosure of nonpublic personal information (NPI), disinformation or derogatory information, and security threats such as viruses or social engineering.

Any of these or similar events could result in significant lawsuits or damage to the institution’s reputation.

Banks are encouraged to develop sound social connectivity policies that govern the use of social media by employees and to provide adequate training to employees on those policies.

The use of social media should also be considered in the institution’s information technology risk assessment.

Conclusion

The current recession has been longer and deeper than any since the Great Depression, and institutions facing severe earnings pressures may be tempted to reduce resources dedicated to risk management.

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But evidence suggests that strong risk management, not historical financial performance, is the common denominator of successful community banks.

Institutions should remain vigilant in order to identify risks that could negatively affect the bank and take appropriate action to measure, monitor and control them.

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NUMBER 9

Islamic finance developments in Pakistan Keynote address by Mr Kazi Abdul Muktadir, Deputy Governor of the State Bank of Pakistan, at the Islamic Finance news (IFN) Roadshow 2012, Karachi

Distinguished guests, ladies and gentlemen! Assalam-u-alikum and a very good morning. It is my great pleasure to welcome you all in this IFN road show. I would like to congratulate and thank Redmoney for organizing the show in Pakistan, which is one of the fastest growing Islamic finance markets across the globe. Such events not only enhance Islamic finance awareness and stimulate its demand but also provide a platform to Islamic finance stakeholders to share their experiences and insights about this fast emerging segment of the financial system. I hope that today’s discussions and deliberations would help in addressing the key challenges being faced by the industry and contribute towards sustaining the growth momentum. Ladies & Gentlemen! Since the inception of modern Islamic finance in 1960’s, Islamic banking has evolved from its relatively modest size to a vibrant industry with an increasing global footprint. With a size of US$1.35 trillion (according to Global Islamic Finance Report 2012) and annual growth rate of more than 20 percent, the Islamic financial industry now comprises 430 Islamic banks and financial institutions and around 191 conventional banks having Islamic banking windows operating in more than 75 countries.

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The relative resilience and stability of the industry during the financial crisis and its flexibility and responsiveness to changing business needs has helped the industry to establish itself as a viable financial system. The tremors and aftershocks of the financial crisis are still on either in the form of European debt crisis and/or weakening global economic outlook and the policy makers are still looking for answers to fix these issues. Islamic finance, with its roots in a moral economic model that supports productive economic activity and discourages excessive leveraging and imprudent risk taking, can play an important role in rebuilding the financial system. I believe that this is high time for Islamic economists and scholars to highlight the inherent strengths and potential of Islamic finance in addressing the existential challenges faced by the global financial and economic systems. Ladies & Gentlemen! The evolution of Islamic finance industry in Pakistan has followed the same trajectory as global Islamic financial industry; with growth mainly intensifying over the last decade. Despite having introduced landmark changes during 1980s including amendment in the Banking Companies Ordinance, enactment of Mudaraba Companies and Mudarabas (Floatation and Control) Ordinance etc, efforts for transformation of financial system to Shariah Compliant met with limited success only. This was primarily due to unavailability of adequate infrastructure and lack of trained human resources. Learning from past experience, Islamic banking was re-launched in 2002 with a more practical and gradual approach that allowed Islamic banks to operate in parallel with conventional banks. This time we also introduced a comprehensive Shariah compliance framework to ensure that the operations of Islamic banks are in conformity with the Shariah principles; this was necessary to give

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confidence to the consumers about Shariah permissibility of Islamic banks’ business and operations. The approach has proved a mega success as the industry growing from scratch in 2002 now constitutes over 8 percent of the country’s banking system with a network of 964 branches and over 500 windows across the country. The future outlook is also positive; the Islamic finance industry with its rapidly growing acceptability both amongst the providers and users of financial services, is likely to increase its share in the banking system to 15 percent during next five years. Encouragingly, the sustained growth of Islamic banking in the country during the last decade has also started catalyzing growth and development of Islamic capital markets, Mutual funds and Takaful companies etc; presently we have 5 Takaful operators, about 30 Islamic mutual funds. We have an effective coordination mechanism with SECP – the capital markets and NBFIs’ regulator – and I am sure that the non-banking Islamic financial services industry would also be growing in tandem with the Islamic banking industry. Ladies & Gentlemen! The State Bank of Pakistan fully owns the Islamic banking industry and has been taking a number of initiatives to strengthen the legal, regulatory and Shariah compliance framework, create awareness amongst the masses and build the industry’s HR capacity. I will share a few with this audience today. The development and issuance of sovereign Sukuk for the domestic market, which is an important liquidity management instrument was a long outstanding demand of the industry. The SBP in collaboration with the industry and the Federal Government developed sovereign Sukuk and you would be pleased to know that

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during last two years sovereign Sukuk of Rs.369 billion (USD 4 billion approx) have been issued that has largely addressed the liquidity management issue of the industry. The regular issuance of the Sukuk, almost on quarterly basis, has improved market confidence and tradability of the Sukuk. To improve transparency and bring standardization in IBIs’ profit distribution and pool management practices, we have developed a comprehensive profit distribution and pool management framework in consultation with the industry. The framework will be issued most probably within this month and will be instrumental in improving public confidence in Islamic banking generally and profit distribution policies and practices of IBIs particularly. Similarly to further strengthen the Shariah governance in IBIs, we are in the process of developing a comprehensive Shariah Governance framework. The framework will explicitly define the roles and responsibilities of different organs of IBIs including the Board of Directors, Shariah Advisors/Committees and Executive Management for ensuring Shariah compliance. Presently Shariah compliance is perceived to be the responsibility of the Shariah Advisors only whereas Board of Directors and Executive Management assume no such responsibility. This we believe is contrary to the corporate governance principles as unless the BOD and management are not fully aware of the Shariah non-compliance risk, it would be difficult for the Shariah Advisor to develop an effective Shariah compliance mechanism in IBIs. The proposed framework will fix these and other similar issues.

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Further, the SBP, in collaboration with the industry, will also be developing the strategic plan for the industry for the next five years ie 2013–2017. The plan will make a detailed assessment of the earlier plan (2007–2012) as well as the existing environment and will set the strategic direction for the industry. This is an important project which would define the strategies and action plans to move the industry to the next level of growth and SBP would expect active and meaningful involvement of the industry in development of the plan. Ladies & Gentlemen! As you all know that SBP has been at the forefront of the initiatives and programs for creating awareness. Being the host of today’s program is a part of its efforts to improve public understanding of Islamic banking and minimize their apprehensions and confusions. While seminars, conferences, workshops are being organized across the country on regular basis, we will soon be launching a mass media campaign to create awareness about Islamic banking. The campaign we believe will be instrumental in enhancing public awareness and allaying their apprehensions and confusions about Islamic finance and thus would give further boost to the growth momentum. Lastly, I would reiterate my optimism about the growth prospects of the industry; I believe the growth momentum will not only be sustained but will gather further strength as we will see some more key players entering the market with aggressive expansion plans in very near future. The challenge will however be to develop suitably qualified and trained HR to man this growth; while SBP will be further intensifying its efforts to build the industry’s HR capacity through its regular and specialized training programs, the IBIs would also have to significantly increase their investment in HR development.

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Another challenge would be diversification of assets mix and taping non-traditional sectors like agriculture and SMEs to deploy the growing deposit base in productive avenues. Presently the IBIs’ exposure in these sectors is nominal that needs to be increased significantly, which would not only improve their repute amongst the masses but would also provide them an attractive avenue to develop and expand their assets portfolios. SBP would be willing to provide necessary support to IBIs to build portfolios in these non-traditional but strategically important sectors. My thanks and appreciation again to Redmoney for organizing this event and I hope such collaborations will continue in future. I wish all the foreign delegates to have pleasant stay in Karachi and a safe journey back home. Thank you.

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NUMBER 10

Regulatory reform: getting it done

Remarks by Mr Stefan Ingves, Governor of Sveriges Riksbank and Chairman of the Basel Committee on Banking Supervision, at the 17th International Conference of Banking Supervisors, Istanbul

Introduction

Good morning and welcome to the 17th International Conference of Banking Supervisors.

Let me start by thanking our hosts - the Central Bank of the Republic of Turkey and the Turkish Banking Regulation and Supervision Agency.

I would like to thank in particular Governor Erdem Başçi, Chairman Mukim Öztekin and of course the staff of both organisations for doing such an outstanding job of hosting this ICBS.

We have benefited tremendously from your presence on the Committee since 2009 and we look forward to returning to this historic city for future meetings and conferences.

Finally, let me thank Deputy Prime Minister Ali Babacan for his insightful remarks.

This ICBS will focus on the challenges we are facing to improve supervisory practices, building on what we have learned in the recent past.

The starting point for such improvements and the foundation of all bank supervisory frameworks is the Core Principles for Effective Banking Supervision, which will be the topic of discussion on this first day of the ICBS.

We have also organised several panel and workshop discussions to examine and debate the most recent policy responses to the financial crisis and other supervisory and market developments.

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A critical aspect of these policies is their full and timely implementation and we will have the opportunity to discuss the challenges that arise in this regard.

The conference's themes

Let me say a few words about these two main topics.

In conducting its review of the Core Principles, the Committee has sought to raise the bar for banking supervision by incorporating the lessons learned from the crisis and other significant regulatory developments.

At the same time, we have remained mindful of the fact that the Core Principles are applied on a global basis and that we need to maintain continuity and comparability.

Given the worldwide application of the Core Principles, it is of utmost importance that the revisions we have made are well understood and implemented with, at a minimum, the same rigour as the previous set of principles.

The two co-chairs of the Basel Committee group that was responsible for the revisions - Sabine Lautenschläger of the Deutsche Bundesbank and Teo Swee Lian of the Monetary Authority of Singapore - will co-chair a panel discussion on the revised Core Principles.

This is a topic of great relevance for all of us, so I know this discussion will be of great interest to everyone here.

Regarding policy responses to the financial crisis - the second theme of the ICBS - there is always a danger of believing we have learned "all there is to learn" or that "this couldn't happen to me".

On the one hand, the root causes of financial crises are always very similar although they can differ in their manifestation.

For example, in my own country - Sweden - and in many other countries around the globe, I have seen different crises evolve and one common element has been excessive credit extended by banks that did not fully appreciate the risks.

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On the other hand - and I can tell you this from first-hand experience having been through too many financial crises for my liking - overconfidence and supervisory complacency are extremely dangerous and we must continually be alert to guard against these risks.

Tomorrow's workshops and panel discussion on what the crisis has taught us are indeed timely.

While a single day is not sufficient to address all of our challenges, the reflections of an impressive cast of speakers will offer a wide range of different perspectives on topical issues.

These issues include:

1. The implications of non-financial sector leverage for banks and bank supervision;

2. Basel III implementation;

3. Liquidity standards and risk management;

4. Corporate governance, disclosure and transparency; and

5. Systemically important banks.

The common thread here is the universal applicability of the lessons we have drawn.

The relevance of these topics is not limited to only certain jurisdictions or types of banks.

Some will call this "back to basics" and rightly so.

The label we choose to apply is not important; what is important is that we get the regulation right and that we are diligentin implementing our standards.

The Committee's work on implementation

Having learned this lesson, the Committee now devotes considerable resources to monitoring implementation of the rules and standards agreed by its members.

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Our work no longer stops once we issue a press release announcing new regulatory standards.

From the Basel Committee's perspective, one of the most enduring lessons we as supervisors have learnt is that full, timely and consistent implementation is not a bonus - it is an imperative.

So what have we done to put this commitment into practice? Almost one year ago, the Committee agreed on a process and framework to review members' implementation of Basel III.

The review framework is intended to provide additional incentives for member jurisdictions to fully implement the standards within the timelines agreed.

Let me briefly review its key elements.

There are three levels of review:

The first level is the timely adoption of Basel III. We have been regularly reporting on member countries' progress in implementing rules in their local jurisdictions in accordance with agreed timetables.

The second level is to ensure consistency of domestic regulations with the international minimum requirements. This is a line-by-line review of local rules with the Committee's standards, conducted by teams of peer supervisors.

The third level of review consists of an analysis of the outcomes of the Basel III implementation.

It extends the first two levels of analyses to supervisory implementation at the bank level.

One cannot overstate what a significant step this is, as we for the first time have teams of global supervisors travelling to individual banks and comparing notes at a very detailed level across borders.

This, more than anything, is symbolic of the big step the Committee is taking to get implementation right.

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Perhaps most importantly, the results of this work will be public, so there will be complete transparency for all about how our rules are being applied in practice.

In the past year, the Committee has published two standalone reports detailing its members' progress in adopting the Basel III rules and we have also prepared a report to the G20 Leaders that provided an update on implementation.

In a couple of weeks, we will issue Level 2 assessment reports for the first three jurisdictions under review: the European Union, Japan and the United States.

Our next assessment will soon begin and this will review Singapore's Basel III rules; this will be followed by reviews of Switzerland and China.

We are currently conducting Level 3 assessments on the calculation of risk-weighted assets and expect to publish our findings around the end of 2012.

The revised Core Principles and the Basel III rules were designed to achieve safer and sounder financial systems, whether big or small, complex or not.

After considerable consultation with supervisors, bankers and other interested parties from around the world, the rules and standards have been developed and now need to be put into practice.

Financial stability issues know no borders.

We are keenly aware that the roots of the recent financial crisis are replicable anywhere in the world and we know that risk will flow to wherever it is underpriced.

We know - and I have seen first-hand from my days at the IMF - that the risk of cross-border contagion rises exponentially with an increase in cross-border banking activity and increasingly international financial markets.

Our global banking foundation is therefore much firmer when we act together in implementing sound prudential standards.

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In that regard, I would like to spend a few minutes updating you on the Committee's current and future work agenda for developing regulatory standards.

Current and future agenda

I will start with the global liquidity rules, which are a much debated topic.

The Basel III liquidity framework, which was published in December 2010, forms an essential part of the Basel III package and continues to be one of the most important items on the Committee's agenda.

When we published the rules, the Committee said it would carefully assess whether there would be any unintended consequences.

Some banks told us this careful approach has given rise to unnecessary uncertainty and has hindered their efforts to work toward managing to the new standards.

The Committee's governing body of Central Bank Governors and Heads of Supervision therefore directed the Committee to finalise any revisions around the end of this year and we are on track to deliver.

The Basel III liquidity rules represent the first ever global framework to ensure a bank maintains an adequate stock of liquidity and operates with a prudent funding structure.

The Committee is therefore taking a careful and deliberate approach to reviewing the rules.

But let me remind you that our goal is to raise the bar.

It is designed to have an impact on banks and markets: that is not unintended.

The rules are already having the desired effect as we have seen an improvement in risk management and in liquidity at many banks.

In Sweden, for example, the four major banks all had liquidity coverage ratios below 100% when they started reporting their LCR.

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They have since improved their liquidity management and positions and currently all four meet the new standards.

OTC derivatives

I would also like to say a few words about another of the Committee's high priorities and this relates to the broader global reform for over-the-counter derivatives markets.

The financial crisis exposed major weaknesses of OTC derivatives markets, namely counterparty credit risk and a lack of transparency and the attendant effects of contagion risk and spillover.

A package of reforms agreed by the G20 Leaders aims to address these deficiencies, for example, by moving OTC trades towards central clearing.

The Basel Committee plays a key role in ensuring that banks adequately capitalise counterparty credit risk exposures, whether those exposures relate to other banks or to central counterparties (CCPs).

For example, in December 2010 we published enhanced capital rules for bank exposures to counterparty credit risk arising from non-centrally cleared derivatives.

More recently, we issued interim capital rules for bank exposures to CCPs.

These rules will both take effect at the start of next year although work will continue over the course of 2013 to ensure that the capitalisation rules for bank exposures to CCPs reflect risks in an appropriate manner and provide incentives for banks to move derivatives trades towards central clearing.

Another OTC derivatives market reform in which the Committee is involved is the development of global standards on margin requirements which are intended to mitigate contagion and spillover effects.

A consultative paper on this topic was published in July and we hope this work, which is being conducted in collaboration with other standard setters, will lead to updated proposals that we can consider by the end of this year.

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Securitisation

Allow me to say a few words about the Committee's ongoing work related to the regulatory treatment of securitisations, on which we will soon publish a consultative proposal.

The performance of securitisation exposures and the central role they played during the recent financial crisis were a key motivation for the Committee to perform a broader review of its securitisation framework for regulatory capital requirements.

Our objectives are to make capital requirements more prudent and risk-sensitive; to mitigate mechanistic reliance on external credit ratings; and to reduce cliff effects.

The Committee is well aware of the trade-off between the risk posed by securitisation and its function as an important tool for bank funding and liquidity.

Now that there are signs of revival of the securitisation markets, it is important to finalise prudent and risk-sensitive solvency rules for securitisations as soon as possible.

Fundamental review of the trading book

The Committee's proposals to revamp the securitisation framework are as sweeping as our fundamental review of the trading book rules.

The Basel 2.5 modifications adopted in 2009 resulted in a substantial increase in capital requirements for certain securitisations and structured credit products.

But these modifications were largely built on the existing regulatory definitions and framework.

At around the same time, the Committee commenced a fundamental review of trading book capital requirements.

That review resulted in the publication of a conceptual paper this past May.

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That paper set out a revised market risk framework and proposed a number of specific measures to improve trading book capital requirements.

These proposals reflect the Committee's increased focus on achieving a regulatory framework that can be implemented consistently by supervisors and which achieves comparable levels of capital across jurisdictions.

The consultation period ended last week.

Once the Committee has reviewed the responses it has received, it intends to release for comment a more detailed set of proposals to amend the Basel III framework.

We also plan on conducting a quantitative impact study based on those proposals.

Global and Domestic Systemically Important Banks

In the time remaining, I would like to say a few words about the Committee's work with respect to global and domestic systemically important banks.

Last year, the Basel Committee issued final rules for global systemically important banks (G-SIBs), which were endorsed by the G20 Leaders at their November 2011 meeting.

The G20 Leaders also asked the Committee and the Financial Stability Board to work on extending the G-SIFI framework to domestic systemically important banks (D-SIBs).

G-SIBs will be subject to an additional loss absorbency requirement over and above the Basel III requirements that are being introduced for all internationally active banks.

This additional requirement is intended to limit the cross-border negative externalities on the global financial system and economy associated with the most globally systemic banking institutions.

But similar externalities can apply at a domestic level: indeed, from a domestic perspective, they can be even larger.

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While not all D-SIBs are significant from a global perspective, the failure of such a bank could have a much greater impact on its domestic financial system and economy than that of a non-systemic institution.

Against this backdrop, the Basel Committee has developed a set of principles on the assessment methodology and the higher loss absorbency requirement for D-SIBs.

The proposed framework takes a complementary perspective to the G-SIB framework by focusing on the impact that the distress or failure of banks will have on the domestic economy.

However, the proposed D-SIB framework will take a principles-based approach, in contrast to the prescriptive approach of the G-SIB framework.

This will allow an appropriate degree of national discretion in the assessment and application of policy tools in order to accommodate the structural characteristics of individual jurisdictions.

The D-SIB principles, which will be published in the coming weeks, require countries to adopt a framework for assessing the systemic importance of their banks on a domestic basis by January 2016.

This is consistent with the phase-in arrangements for the G-SIB framework and means that national authorities will establish a D-SIB framework in advance of that deadline.

The Basel Committee will introduce a strong peer review process for the implementation of the principles. This will help ensure that appropriate and effective frameworks for D-SIBs are in place across different jurisdictions.

Simplicity in our rules I will finish my review of the Committee's current work by saying a few words about a topic that pervades our current efforts - and that is simplicity.

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Basel III, with its straightforward, non-risk-based measure of capital to assets and the framework's rules for a streamlined capital structure are two good examples. This mindset has become ingrained in other efforts, such as the Committee's current review of the securitisation framework and the operational risk framework. More broadly, the Committee is also reviewing the broader Basel framework to determine whether the rules strike the appropriate balance between regulatory complexity and risk sensitivity. The aim of this work is identify areas where we could reduce the level of complexity or where comparability could be improved.

Special acknowledgment

Before concluding, let me make a special acknowledgement of someone who very well may be the most widely known person in the room today, and who is attending the ICBS for the last time.

As many of you know, Jonathan Fiechter will be retiring from the IMF in a month or so, and I would be remiss if I did not acknowledge the significant contribution he has made to the work of the Basel Committee, its working groups, regional groups of banking supervisors and national supervisors themselves.

Even though he is currently not a supervisor himself, he has been unfailing in his support of effective regulation and strong supervision. So, Jonathan, on behalf of everyone here, we thank you and wish you the very best for the future.

Conclusion Let me bring my remarks to a close as we have a stimulating programme ahead of us and, therefore, I will not keep you waiting. The Basel Committee is leading on two very important efforts: the first is to fine-tune the regulatory framework and develop policy responses that

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firstly respond to the lessons of the crisis, and then keep pace as markets and institutions evolve. The second is ensure that the agreed-upon policy responses are implemented fully, consistently and globally. That is the reality check. We believe, as do the G20 Leaders, that these reforms are the right ones for making progress towards improved financial stability, growth and sustainable economic development. With this in mind let us make sure that the discussions today and tomorrow are fruitful and will help you and your organisations achieve these important goals.

Notes Stefan Ingves

Stefan Ingves is Chairman of the Executive Board and Governor of the Riksbank. Mr Ingves is a member of the ECB General Council and a member of the Board of Directors of the Bank for International Settlements (BIS).

He was appointed Chairman of the Basel Committee on Banking Supervision in 2011.

He also chairs the Advisory Technical Committee of the European Systemic Risk Board.

In addition, Mr Ingves is Sweden’s governor in the International Monetary Fund.

Mr Ingves has previously been Director of the Monetary and Financial Systems Department at the International Monetary Fund, Deputy Governor of the Riksbank and General Director of the Swedish Bank Support Authority.

Prior to that he was Under-Secretary and Head of the Financial Markets Department at the Ministry of Finance.

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Stefan Ingves holds a PhD in economics.

Stefan Ingves' term of office is six years from 1 January 2006.

The General Council of the Riksbank has appointed Stefan Ingves as Governor of the Riksbank for an additional term of office of six years, from and including 1 January 2012.

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Monday September 24 2012 - Top 10 Risk Management News

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