Framework for assessment

At the request of the HKMA, we reviewed five key components of its bank supervision process:

Ø organisational structure;

Ø supervisory tools and techniques;

Ø supervisory policies and guidelines;

Ø human resources; and

Ø the quality and volume of information.

None of these components operate independently, separate from the others. Instead, they are linked and these linkages are critical to effective supervision. We have therefore considered each component in context, as it relates to the development of a supervisory philosophy and its embodiment and articulation in a strategic plan, policies and procedures. In addition, we have considered each component in terms of its implementation through supervisory monitoring (e.g. licensing activities, off-site surveillance and on-site examinations) and supervisory responses to weaknesses. The execution of all of these tasks, through the HKMA’s organisational structure and operations support, has also been considered.

These elements of the bank supervision process form the basis for all of this section’s comparative analyses, and are summarised below (see Chart 2.3.1):

Chart 2.3.1 Framework of assessment

SUPERVISORY FRAMEWORK 1. Strategic planning

2. Policy formulation

4. Supervisory responses

Banking sector safe, sound, competitive efficient and

stable A.Licensing

activities

B. Off-site surveillance

C. On-site examination

5. Organisational structure and operations support 3. Supervision monitoring

Source: KPMG/Barents analysis

2.3.1 Development of supervisory philosophy and strategic plan

A strategic plan is a tool that the bank supervisor can use to ensure that its mission is understood within the agency and publicly, and that personnel consistently pursue it at all levels. It usually sets forth the supervisor’s mission or philosophy and the goals or objectives that must be met to carry out that mission. A strategic plan is supported by appropriate action plans to achieve those goals over the strategic planning period⁵² and a method for tracking actual performance against action plans.

Developing the strategic plan is generally a senior management activity, with assistance as necessary from mid-level managers to establish the various action plans and monitoring methodologies. The planning process encourages a broad and common understanding of the supervisor’s goals and communicating the plan within the agency shows all personnel the role they play in effective supervision. Public dissemination of the supervisor’s mission and goals enables the financial institutions that are supervised, the political groups to which the supervisor is accountable and the general public, to gain an understanding of the supervisor’s role in the stability of the country’s banking sector.

2.3.2 Formulation of policies and procedures

Policies and procedures to carry out the goals and objectives set forth in the strategic plan are also critical supervisory tools. They include policies and procedures governing direct supervisory activities, such as:

Ø licensing new banks;

Ø permitting banks to engage in new activities or offer new products;

Ø permitting combinations of banks;

Ø providing guidance to banks on what the supervisor deems to be unsafe or unsound;

Ø assessing the condition of individual banks and of the banking system; and

Ø initiating, pursuing and following up on corrective actions.

They also include policies and procedures governing the supervisor’s internal operations. These range from hiring and training new personnel, to assessing how changes in the banking sector are affecting the skills needs of supervisory staff, to ensuring that all policies and procedures are consistently and fairly applied. There should also be procedures for reassessing all policies and procedures periodically, to ensure that they are substantively adequate and consistent with one another and the supervisor’s strategic goals.

52 As a general rule, most supervisory authorities have established a three to five year time horizon in their strategic planning process.

Policies and procedures related to direct supervisory activities should be disclosed to banks and to the general public. As with the strategic plan, disclosure enables the public to gain a better understanding of the supervisor’s role. More importantly, informing banks of the supervisor’s expectations and of the consequences for failure to meet them is an effective supervisory technique for encouraging voluntary compliance.

2.3.3 Supervisory monitoring

Supervisory monitoring provides the basis through which supervisory policies and procedures are implemented. Monitoring is used to identify and assess the risks within individual banks and the banking sector, and typically occurs on entry or combination (through licensing), as products or locations of activities are expanded (also through licensing), and throughout the life of each bank (through off-site surveillance and on-site examinations).

Successful supervisory monitoring depends on the quality and volume of information collected for analysis, whether the information is collected through a licensing application, routine periodic financial performance reports, a full scope or targeted on-site examination, or discussions with institution management. Supervisory tools such as examination and licensing manuals, standardised application documents, standardised financial return forms and standardised examination reports ensure that information is collected and analysed consistently, throughout the supervisory agency and across the banking system.

The type and amount of information collected depends on the type of monitoring activity. For example, prior to granting a new banking licence, the supervisor may require:

Ø detailed plans by the applicant on how it will manage the business and the internal control environment they propose to establish;

Ø sufficient information to gauge the depth of management expertise;

Ø standard financial data; and

Ø biographical and financial information on the proposed owners.

Information collected and analysed for off-site surveillance typically includes routine periodic financial performance reports submitted by each institution. Important non-financial information, such as changes in management, external auditors or controlling shareholder(s), can be obtained through discussions with institution management, periodic evaluation of internal and external audit reports and from local sources or other regulators.

On-site examinations give the supervisor an opportunity to test the quality and scope of supervisory information submitted by each institution via periodic returns. They also permit the supervisor to collect information on and assess more subjective aspects of an

institution’s condition, such as the quality of its risk management and internal control functions.

2.3.4 Supervisory responses

Taking action to ensure that weaknesses identified during supervisory monitoring activities are corrected is another critical technique for implementing direct supervisory policies and procedures. In most cases, the range of actions that may be taken is established within the legal framework governing the supervisor’s activities. The most radical measures include restricting an institution’s powers, revoking its licence or closure. The supervisor should have the flexibility to choose among varied responses in any given situation, but should assure that institutions with similar problems are treated consistently. The supervisory response chosen should reflect the severity of the weaknesses identified and the supervisor’s assessment of management’s capability to correct them in a reasonable time.

2.3.5 Organisational structure and operations support

Effective supervision requires sufficient and qualified supervisory staff, an organisational structure that clearly promotes the supervisory goals, adequate management information systems to allow prompt and effective use of supervisory information and quality control mechanisms to ensure that staff achieve consistent application of policies and procedures.

Supervisory staff have responsibilities as varied as collecting and analysing financial information, developing policies and procedures, pursuing corrective actions initiated by the supervisor and communicating the supervisor’s strategic plan, its goals and objectives, to the public. To ensure that it has sufficient and qualified staff, the supervisor must consider:

Ø its staffing needs (in terms of number and capabilities);

Ø the expertise of its staff (including training through in-house courses or outside sources); and

Ø its staff compensation and retention.

Supervisory management information systems are another important support component.

Management information system needs can be divided into two major sub-systems:

Ø financial data or return information; and

Ø supervisory activity information.

Both systems need to be integrated to provide the supervisor with complete information about the risk profile of each institution and its financial performance. The financial data or return information system should collect data by institution. It should provide the supervisor with the ability to manipulate this data, including:

Ø ratio generation and modelling;

Ø comparable information for various time horizons for one institution and for a comparison group; and

Ø aggregate data for the entire sector.

The supervisory activity information system should collect data derived from all supervisory activities by individual institution, including information relating to the risk profile of the institution, supervisory responses, planning information (such as budgeted and actual work days) and other non-quantitative information of a confidential nature collected by the supervisor. The overall system should have capabilities that allow analysts to correlate and analyse information by institution and for the sector.

Operations support also includes assuring that staff achieve consistent application of policies and procedures. This requires close co-ordination between policy designers and implementing units, training of staff in new policies, and tools and testing for adherence with policies and procedures. Testing can be accomplished through a formal quality assurance function with a clearly defined framework and set of supervisory standards and processes, against which the quality of work completed can be judged. While the form of compliance with those standards and processes is important, the overriding focus of the function should relate to matters of substance.