Seventh High Level Meeting for
the middle east & North Africa region
on
Strengthening Financial Sector Supervision and Current Regulatory Priorities
Jointly Organized by the Financial stability institute and
the Arab Monetary Fund in Collaboration with the Institute of International finance
Speech by
H.E. Dr. Abdulrahman Al-Hamidy
Vice Governor
Saudi Arabian Monetary Agency(SAMA)
Abu Dhabi, United Arab Emirates, 26-27 October 2011
Current Priorities in the Regulation and Supervision of the financial sector: A Regional perspective
Distinguished Participants,
It is my pleasure to be here today to share with you my thoughts on the “Current Priorities in the Regulation and Supervision of the Financial Sector” from a regional perspective. But before I take-up this topic, let me acknowledge the excellent collaboration between the Financial Stability Institute, Arab Monetary Fund and the Institute of International Finance in jointly organizing this event. This High Level Meeting has now become an annual feature of the FSI program in the GCC region and it provides an effective forum to deliberate on important and relevant issues. I am confident that this initiative will contribute significantly in updating regional supervisors and industry practitioners on the latest international developments in banking regulation and supervision.
Let me say at the outset that fortunately the economies and the financial systems in our region had been largely remained unaffected from the global financial crisis. In Saudi Arabia, our banking system has stayed sound and stable during the financial crisis and our banking institutions remained liquid, highly capitalized and profitable. This was because they were not materially exposed to the subprime Collateralized Debt Obligations (CDOs) and structured products or to hedge fund assets which were at the centre of the financial crisis. The Saudi banks also did not suffer from the liquidity crunch in the global financial markets and our domestic interbank market continued to function smoothly.
In the aftermath of the global financial crisis, several initiatives to strengthen the financial regulation and supervision have been taken by the Financial Stability Board and international standards setting bodies including the Basel committee. In this regard, a wide-ranging reforms agenda has been worked out which is aimed at building a stronger global financial system and providing a framework for its effective oversight. A number of such initiatives have already been finalized and a lot more is in the offing. Let me briefly highlight some major reform areas:
1. Basel-III Capital rules: The Basel-III revised capital rules are aimed at raising the level and quality of capital in banks. The full implementation of Basel-III is expected to raise the common equity capital to a minimum of 7% of risk-weighted assets (including a 2.5% capital conservation buffer) as compared to existing level of 2% under Basel-II. In addition, there are certain changes to capital definitions and risk weights as well as introduction of counter-cyclical capital buffer and leverage ratio which will result into even higher level of effective capital requirement;
2. Basel-III Liquidity rules: The new liquidity rules under Basel-III has introduced the concepts of a short term (30 days) Liquidity Coverage Ratio (LCR) and a long term (one year) Net Stable Funding Ratio (NSFR). The monitoring period for these ratios starts in 2012 whereas the implementation will be in a phased manner starting in 2015 and 2018 respectively after studying any potential unintended impacts of the LCR and NSFR;
3. Systemically Important Financial Institutions(SIFIs): The proposed framework for SIFIs (or G-SIBs i.e. Global Systemically Important Banks) contains a number of proposals to achieve greater loss absorbency, more intense supervision and stronger resolution of such institutions. The framework calls for action in five areas including: (i) improvements to resolution regimes to ensure that any financial institutions can be resolved without disruptions to the financial system and without taxpayer support; (ii) a requirement that SIFIs have additional loss absorption capacity beyond the Basel-III standards to reflect the greater risks that these institutions pose to the global financial system; (iii) more intensive supervisory oversight for financial institutions which may pose systemic risk; (iv) stronger robustness standards for core financial infrastructure to reduce contagion risks from the failure of individual institutions; and (v) peer review by FSB of the effectiveness and consistency of national policy measures for G-SIBs;
4. Shadow Banking: The proposals relating to shadow banking are aimed at monitoring and, where appropriate, addressing the risks arising from the shadow banking system. Shadow banking is described as "credit intermediation involving entities and activities outside the regular banking system". It covers a range of entities such as finance, mortgage and leasing companies and hedge, private equity and money market funds. From a regional perspective, it is an important area to be looked into as it has the potential to contribute to systemic risk, both directly and through its interconnectedness with the regular banking system;
5. Compensation Practices: FSB Principles and Standards on Compensation Practices are meant to streamline the compensation practices of banks. FSB is closely monitoring the implementation of these Principles and Standards as poor compensation practices is deemed to be one of the factors which led to global financial crisis;
6. Thematic and Peer Reviews: Both FSB and the Basel Committee have conducted a number of thematic and peer reviews. These included the reviews on compensation practices, risk disclosures, mortgage underwriting practices, deposit insurance, stress testing, etc. These reviews are complemented by country reviews that follow up on recommendations from IMF-World Bank FSAP assessments. The purpose of such reviews is to help ensure timely and consistent implementation of international financial standards and to assess whether the standards are producing the desired results.
The international regulatory reforms currently taking shape at global level will have a significant impact on the regulatory and supervisory practices in our region. The process of implementation is well underway at national and regional levels, but much still lies ahead of us. The regional regulators will have to revisit their regulatory frameworks to realign them, where-ever needed, with emerging international financial standards. I would like to highlight few areas requiring attention of the regional supervisors:
§ First, the new capital and liquidity standards developed by the Basel Committee have been designed to substantially raise the quality, quantity and international consistency of bank capital and liquidity; constrain the build-up of leverage and maturity mismatches; and introduce capital buffers above the minimum requirements that can be drawn upon in bad times. The regional supervisors may need to look into the requirements of Basel-III and plan for its implementation. Let me also emphasize that Basel-III has specified the minimum level of capital and implementation timeline, and we should aspire to impose higher standards beyond the minimum requirements;
§ Second, shadow banking has the potential to contribute to the systemic risk and needs to be monitored closely. This may require a review of the mandate of non-bank financial institutions and activities undertaken by them and the arrangements for their regulatory oversight. In particular, we need to focus on the regulation of banks’ interactions with shadow banking entities and strengthening the regulatory oversight of the shadow banking system in whatever form it exists;
§ Third, the implementation of new rules need to be supported by strong and enhanced risk based supervision of individual banks. Strong supervision is needed to ensure that banks operate with capital levels, liquidity buffers and risk management practices that are commensurate with the risks taken. It must also address the consequences of financial innovation or risks of regulatory arbitrage that regulations cannot fully capture;
§ Fourth, the regional financial institutions and markets are increasingly becoming linked to each other as well as to the global financial markets. They are susceptible to greater risks of contagion and spillovers from the international financial markets. Thus, they will be affected by any adverse developments at the global level. So the regional supervisors will not just have to keep an eye on national and regional developments but also on the global developments. They are expected to respond swiftly to any such developments to ensure stability of their national financial systems;
§ Fifth, the regional supervisors have to learn from each other’s experiences to deal with common issues. In this regard, a well-structured system of multilateral cooperation has already been put in place at the Arab League and GCC levels. These forums should be effectively used to promote supervisory cooperation and sharing of supervisory experiences;
§ Sixth, there are a number of SIFIs operating in the region. The effective resolution of troubled SIFIs will require clear mandates and capacity for the supervisors. This will also require coordination and exchange of supervisory information with home supervisors. Therefore, the supervisors should do advanced planning and work out mechanisms for dealing with any potential troubled institutions;
§ Seventh, an effective macro-prudential supervisory framework at national level needs to be complemented by a region-wide understanding of the common financial stability issues. We have many commonalities in our financial systems and thus a common understanding on major issues will lead us to maintain financial stability in the region. This may require, inter alia, a closer co-operation between supervisory authorities on those issues;
§ Lastly, Supervisors have to keep their regulatory frameworks and supervisory approaches continuously updated in line with international standards and best practices. This is necessary to keep pace with the regional and global market developments and contain the potential systemic risks.
Let me also share with you our experiences at SAMA for implementation of the international financial standards. SAMA has always been proactive in introducing international best practices in the Saudi Banking System. The major supervisory initiatives recently taken by SAMA to strengthen the regulatory and supervisory framework in Saudi Arabia include, inter alia, the following:
i. Strengthening of the corporate governance culture in banks thereby requiring them to put in place a robust corporate governance structure clearly defining the roles and responsibilities of the board, its committees and the senior management as well as putting in place well-defined policies and systems. These complement the existing strong supervisory rules on fit and proper and limits on compensation of directors;
ii. Full implementation of all the pillars of Basel-II framework effective 1st January 2008. This required banks to manage their risks on a comprehensive and holistic basis. Basel-II's stringent requirements have encouraged banks to invest in developing models and systems, collecting historical loss data, establishing key risk indicators for various business areas, strengthening risk management systems and capacity building of staff in using models and implementing various policies and procedures. It may be of interest for you to know that on average, Saudi banks have maintained capital levels of around 17%, mostly in form of tier 1 core capital, since 2008;
iii. SAMA has effectively used the Pillar 2 requirements of Basel-II in strengthening risk management practices in Saudi banks. Banks are required to identify, monitor and manage risks and allocate capital for various Pillar 2 risks such as liquidity, interest rate, strategic, and reputational risks. The Internal Capital Adequacy Assessment Plan(ICAAP) document prepared annually by the banks provides a useful information about the risk profile of a bank. The ICAAP process is continuing to evolve as an effective supervisory tool;
iv. Banks are required to ensure that they have adequate policies, procedures and systems to identity, monitor and manage credit risk. Also, many banks are planning to eventually move to the advanced approaches of Basel-II. Over the past years, these banks have invested in comprehensive internal rating systems and methodologies that require establishing data bases containing financial and qualitative information for borrowers. Such internal models would allow banks to calculate Probability of Default, Loss Given Default and Exposure at Default information and to use such information for calculating a capital charge. For retail banking, banks are using sophisticated scoring models that permit the use of internal ratings on a portfolio basis. Furthermore, banks have invested in systems to collect information on default history of individual customers and of portfolios’ underlying collaterals and behavior of loan losses;
v. SAMA has encouraged Banks to create a National Data Pool, which will collect quantitative financial data on borrowings by corporate customers and on their default histories. This will provide Probability of Default and Loss Given Default information at the national level that could be used by banks for bench marking and validating their own internal data or for use as proxy for their internal rating systems;
vi. SAMA also requires banks to conduct stress testing of their portfolios against various stress scenarios and require banks to develop methodologies and systems for conducting stress tests. For this purpose, SAMA has issued detailed Rules to banks which are in line with best international practices;
vii. SAMA has recently notified to banks its plans for implementation of Basel-III. Preliminary indications are that Saudi banks will have no difficulty to meet Basel-III capital adequacy and liquidity targets. Hence, the transition to Basel-III will be in line with the time frame set out by the Basel Committee;
viii. SAMA has also taken several other actions for implementation of various standards recently issued by FSB and BCBS as part of the international regulatory reforms. Such actions included, inter alia, the implementation of FSB Principles and Standards on Compensation Practices, BCBS Principles for Sound Stress Testing, BCBS Principles for Sound Liquidity Risk Management, Enhancements and Revisions to Basel-II Framework, BCBS Principles on Corporate Governance, etc.;
ix. SAMA has also participated in the Quantitative Impact Studies(QIS) and thematic and peer reviews conducted by FSB and BCBS. We have also participated actively in the deliberations of these bodies as well as their working groups and committees.
Looking ahead, we as the supervisors should continue to encourage banks to understand the value of investing in systems and human resources to build up their capacity to manage the risks effectively. We will be particularly challenged to develop human resource pools that are well trained and are equipped with skills, knowledge and experience in latest supervisory methods and techniques. Nevertheless, a major lesson learnt from the financial crisis is that the advanced risk methodologies and models may not work effectively unless complemented with sound professional judgment and common sense. Therefore, the use of pragmatic and common sense approaches coupled with quantitative risk models can provide a solid foundation for managing risks.
In conclusion, the notion that markets are self correcting and will take care of weaknesses in management or in supervisory practices has once again proved wrong. Risks will never go away: they will mutate and continue to challenge us. While there has been great strides in risk management practices, risk managers need to think creatively about potential risks. Our goal particularly in this region is to remain vigilant and ahead of the curve. We must not follow blindly but adopt international standards and best practices that suits our environment and needs. We should be working together to build a strong coalition for implementation of regulatory reforms.
I hope you will have very insightful deliberations during these two days to learn about the current reforms in regulatory arena. I wish you a successful event.
Thank you for your attention.
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