AMERICAN COLLEGE

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• AMERICAN COLLEGE
• S K O P J E
•   PRINCIPLES OF BANKING
• Chapter 12
•  Instructror Tome Nenovski, Ph. D.

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12. BANK SUPERVISION

• 12.1. Controlling bank activities by regulatory
  institution
• - Banks are exposed to many different risks
• - Developing internal models for managing risks
• - Banks are most regulated institutions
• - Regulatory Institution (RI) Central bank or
  independent Supervision department

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• 12.1. Controlling bank activities by the
  regulatory institution/2
• - Credit portfolio depends on bank regulations
• - RI controls bank and subjects related to the
  bank (legal entities, physical persons..)
• - Direct (on site) and indirect (off site)
  supervision
• - Bank obligation for delivering documents and
  information to the Regulatory Institution (RI)

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• 12.1. Controlling bank activities by the
  regulatory institution/3
• - RI determines bank risks, ways for managing
  them and the level of bank reserves for covering
  losses that come out from the risks
• - RI methodologies for determining bank
  solvency and capital adequacy
• - RI imposes measures against banks that are
  not adjusted with bank regulation.

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• 12.2. Capital adequacy
• - The main bank activities are conditioned by the
  level of its capital
• 12.2.1. Contents of bank capital
• a) Bank basic capital
• - It consists of
• - Founding capital (book value of common and
  priority shares)
• - Shares premium
• - Reserve fund
• - Not distributed profit
• - Current profit discounted by 50.
  

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• 12.2.1. Contents of bank capital/2
• - Bank basic capital has to be decreased by
• - The amount of not covered bank losses in
  previous years
• - The amount of current losses
• - Goodwill.

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• 12.2.1. Contents of bank capital/3
• b) Guarantee capital (GC) Basic bank capital
  Additional bank capital
• - Additional bank capital
• - Book value of cumulative priority shares
• - Fixed assets revaluation reserves
• - Hybrid capital instruments
• - Subordinated obligations (max. 50 of basic
  bank capital).
• - Additional capital Maximum to the amount of
  basic bank capital
• - GC has to be decreased by bank investment in
  other banks and financial institutions on net
  basis.

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• 12.2. Capital adequacy relations
• - Capital adequacy Adequate level of bank own
  resources conditioned by nature and quantity of
  its financial activities and level of risks
  coming out from those activities
• a) Capital Adequacy (CA) ratio represents
  relation between bank own resources (GC) and
  risk-weighted assets
• b) Bank own resources must not be lower than the
  amount of starting bank capital
• c) Bank is obliged to keep CA to the level not
  lower than 8 (Governor of NBRM can impose higher
  CA rate than 8)

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• 12.3. Credit exposure
• Bank exposure towards one entity (person) and
  related persons contents whole bank balance and
  of-balance receivables from that entity (person),
  investments in securities issued by that entity
  (person) and capital investments in that entity
  (person)
• a) Total bank credit exposure towards one
  subject and related subjects must not exceed 25
  of bank own resources (Total credit exposure)

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• 12.3. Credit exposure/2
• b) Bank credit exposure towards bank subsidiary
  must not exceed 10 of bank own resources
• c) Credit exposure towards one shareholder with
  qualified membership into the bank and subjects
  related to him must not exceed 10 of bank own
  resources
• d) Credit exposure towards persons with special
  rights and responsibilities (members of bank
  Managing Board and Bank revision board) and
  subjects related to them must not exceed 3 of
  bank own resources

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12.3. Credit exposure/3 e) Total bank exposure
towards subjects of paragraphs b), c) and d) must
not exceed 65 of bank own resources f) Credit
exposure towards one subject and related subjects
equal or higher than 10 of bank own resources
represents big exposure g) Total amount of big
credit exposures must not exceed eight times of
bank own resources.
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• 12.4. Related subjects
• - Two or more subjects are related if they
  represent unified risk since one of them directly
  or indirectly controls other or several other
  subjects
• - Two or more subjects without control relation
  represent unified risk because they are related
  in a way that if one has financial problems it
  causes repayment obligation problems to the other
  subject or subjects related to them.

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• 12.5. Risk-weighted assets
• - Risk-weighted assets represents sum of
  separate groups of balanced assets and
  off-balance active positions weighted in
  accordance to their level of risk
• - Risk level is determined by kind of the asset,
  debtor characteristics and type of the
  collateral
• - Different weights for different groups or
  positions

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• 12.5. Risk-weighted assets/2
• a) 0 for
• - Money, gold and deposits at Central bank
• - Money receivables from Central bank and
  Central bank securities
• - Money receivables from domestic Government
• - Money receivables from other countries
  Government (EY, USA, Japan, Swiss, Canada..)
• - Money receivables collateralized by deposited
  money

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• 12.5. Risk-weighted assets/3
• a) 0 for/2
• - Unused unconditionally revocable framework
  credits with term to maturity up to one year
• - Guarantees covered by irrevocable and
  unconditional guarantees issued by the
  Government
• - Covered guarantees, letters of credits and
  other covered off-balanced positions

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• 12.5. Risk-weighted assets/4
• 20 for
• - Money receivables collateralized by citizen
  cheques and gold
• - Money receivables from international financial
  institutions
• - Money receivables from first-class banks
• - Money receivables from domestic and foreign
  non first-class banks with term to maturity up to
  one year
• - Not used framework credits with term to
  maturity up to one year.

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• 12.5. Risk-weighted assets/5
• c) 50 for
• - Money receivables from local governments,
  state owned funds and agencies
• - Unused unconditionally revocable framework
  credits with term to maturity of over one year
• - Performing guarantees

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• 12.5. Risk-weighted assets/6
• d) 100 for
• - All other assets
• - Uncovered letters of credit and guarantees,
  confirmed letters of credit and other off-balance
  positions
• - All unmentioned off-balance assets connected
  with potential bank obligations.
•  

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• 12.5. Risk-weighted assets/7
• - Risk-weighed assets Sum of weighed balance
  and off-balance assets minus
• - Amount of uncovered loss from previous years
• - Capital investment in other bank and non bank
  financial institutions on net-basis
• - Loss created during current year.

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• 12.6. Open foreign exchange position
• - Open foreign exchange position represents net
  balance between active and passive foreign
  exchange balance positions counted for each
  foreign currency that appears in bank balance
• - Open foreign exchange position by separate
  currency can amount to 20 of bank GC (30 for
  euro)
• - Aggregate (active or passive) open foreign
  exchange position can amount 50 of bank GC

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• 12.7. Credit classification
• - Bank assets and off-balance active positions
  classification from the aspect of losses could
  appear if client does not fulfill its obligations
  towards the bank
• - Bank is obliged to develop system for
  identification, measuring, following and
  controlling its credit risk and country risk it
  is exposed to
• - Bank is obliged to classify active balance and
  off-balance positions according to their risk and
  to estimate the amount of potential losses.
•  

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• 12.7. Credit classification/2
• - The contents of assets and off-balance active
  positions (credit exposure) that are subject to
  classification is defined by RI decision
• - Money, bank deposits with Central bank, non
  material investments, natural wealth, working
  means, inventories and fixed assets are not
  subject to classification
•  

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• 12.7. Credit classification/3
• - Bank criteria for estimating risk of its credit
  exposure (legal entities)
• Clients financial condition
• Clients cash flaw derived by using bank credit
• Collateral
• Clients credit history
• Clients character
• Clients total credit exposure towards banking
  system in the country
• Country risk (in the case of foreign client).
•  

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• 12.7. Credit classification/4
• - Bank criteria for estimating risk of its credit
  exposure (physical persons)
• a) Revenue resources
• b) Revenue resources stability
• c) Total client financial power
• d) Client integrity.
• - Five risk categories A, B, C, D and E

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12.7. Credit classification/5 - Five credit risk
categories A, B, C, D and E A Criticized
credits ( good realization, but with weaknesses
in documentation) B Credits under supervision
(with considerable lacks) C Non standard
credits (negatively classified) D - Suspicious
credits (big possibility not to be paid off) E
Bad loans (non collective credits). - Credits
classified in D and E are considered as not
functional
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• 12.7. Credit classification/6
• - Special reserve calculation for securing from
  potential credit risks
• 0 of total credit exposure classified in A
• 10 of total credit exposure classified in B
• 25 of total credit exposure classified in C
• 50 of total credit exposure classified in D
• 100 of total credit exposure classified in E.
• Bank obligation - each three months to classify
  credit exposure.

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• 12.8. Special reserve
• Bank forms special reserve for securing potential
  losses created by certain risk assets and off-
  balance active positions calculated in accordance
  to risk credit classification
• Special reserve represents bank expenditure
• Bank is obliged to calculate special reserve at
  the moment of extending credit exposure
• To the end of each quarter bank is obliged to
  calculate special reserve to its total credit
  exposure.

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• 12.8. Bank classification (CAMELS criteria)
• Capital adequacy
• Assets quality
• Management quality
• Earnings record
• Liquidity position
• Sensitivity to market.

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• 12.8. Bank classification (CAMELS criteria)/2
• a) Successful work
• b) Satisfactory work
• c) Good work
• d) Work on the edge
• e) Unsatisfactory work.

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• 12.9. Supervision standards Basel II
• New capital accord A need for better bank risk
  estimating and management
• Three pillars
• 1) Minimum capital request
• a) No changes in GC determination
• b) Changes in risk-weighed assets calculation
• - Include operative risk, market risk and
  country risk in
• capital base (adequacy)
  calculation
• - Three possible approaches for credit risk
  calculation
• 1) Simplified standardized approach
• 2) Standardized approach
• 3) Internal Rating Based Approach

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• 2) Supervision analysis and estimation
• - Strengthening supervision role in analyzing
  bank models (techniques) for determining capital
  adequacy
• 3) Market discipline
• - Basic information and date bank need to be
  stated regularly.

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• KEY (CRUTIAL) WORDS (TERMS)
• Bank supervision
• Regulatory institution
• Basic capital
• Guarantee capital
• Capital adequacy
• Credit exposure
• Risk-weighted assets
• Open foreign exchange position

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• KEY (CRUTIAL) WORDS (TERMS)
• Related subjects
• Credit classification
• Special reserve
• CAMELS
• New capital accord
• Internal rating

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• CHECKING QUESTIONS
• Which regulatory institution controls bank
  activities?
• Define direct (on site) and indirect (off site)
  supervision
• What does bank basic capital consist of?
• What does bank guarantee capital consist of?
• Define capital adequacy.
• What is a limit for total and what is a limit for
  big credit exposure?
• How many times big credit exposures can exceed
  bank guarantee capital?
• Define risk-weighed assets.

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• CHECKING QUESTIONS
• 9. Define bank open foreign exchange position.
• 10. Define related subjects from bank point of
  view.
• 11. What is bank criteria for estimating its
  credit exposure towards legal entities?
• 11. What is bank criteria for estimating its
  credit exposure towards physical persons?
• 12. How many credit risk categories are there?
• 13. Which categories of credits are considered
  non-functional?
• 14. What is bank special reserve created for?
• 15. Define CAMELS criteria.
• 16. Enumerate three pillars of Basel New capital
  accord.

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Consult www.nbrm.gov.mk Bank supervision for
needed information on the presented topics.