(a) Determining the effectiveness of home country supervision

31. The working group has debated at length the difficulties facing host supervisors in determining whether or not foreign banks in their territories are subject to effective comprehensive consolidated supervision as required by the Minimum Standards. While the Basle Committee's Survey of supervisory practices carried out in 1993-94 has proved useful as a starting point, the responses are subjective, less than comprehensive and are not independently verified. The working group has therefore formulated a set of principles of effective consolidated supervision (see Annex B) which could be used by host supervisors as a checklist for determining whether a home supervisor is meeting the Standards. This has not been a simple task because the techniques used to supervise overseas networks differ from country to country and it is suggested that these principles be debated at the June ICBS in Stockholm.

32. Even if the same checklist is used, arriving at a common assessment of countries' supervisory standards presents practical difficulties. There is no enthusiasm for inviting the private sector, e.g. rating agencies or accounting firms to make such assessments, nor is it felt appropriate for the Basle Committee itself to do so. The Offshore members of the working group have suggested that the Basle Secretariat might conduct analyses of supervisory practices without seeking to make judgements about their adequacy; however, the Basle Committee members of the group have serious reservations about any procedure which could be interpreted as an implicit endorsement by the Basle Committee of decisions taken by individual supervisors, and prefer the idea of an independent observer.

33. Another possibility is that regional group procedures might be used to support the implementation of the Minimum Standards, as the Offshore Group is now doing. Each regional group could be encouraged to endorse the principle of effective consolidated supervision and to work towards its implementation, using the checklist in Annex B. The working group believes that this matter, and the implementation of the Minimum Standards in general, could usefully be taken further at the Stockholm ICBS.

(b) Monitoring supervisory standards in host countries

34. Under the terms of the Minimum Standards, there is also an obligation on host supervisors to exercise effective supervision. Prompted by a desire to encourage its members to fulfil appropriate supervisory standards, the Offshore Group now insists on certain conditions being met by a supervisory authority before it can become a member of the Group. Membership has recently been made partly conditional on a fact-finding visit by an independent observer, who assesses the centre's practices on the basis of the factual check-list reproduced in Annex C. The Offshore Group uses the results to decide whether the standards necessary for full membership of the Group have been met, whether the standards are likely to be met in the next two years (in which case "observer" status may be granted) or whether the application should be rejected outright. The results of the fact-finding exercise are shown to the country being examined so that it would have an opportunity to comment prior to any conclusion being reached. To ensure that the standards are also being met by existing members of the Offshore Group, a process of "rejustification" is envisaged whereby current members would be tested within, say, the next five years. The working group recommends that other regional groups consider the possibility of using a similar checklist as a means of establishing which of their members might be certified as meeting certain general criteria.

35. Conducting such fact-finding visits is not an easy matter for the Offshore Group. Ideally, it would like a home supervisory authority to conduct such visits on its behalf, while leaving the Offshore Group alone to decide whether its criteria have been met or not. It has therefore asked the Basle Committee to assist directly or at least by allowing its Secretariat to act as a "clearing-house" for information collected by its members.

36. The Basle Committee supports the Offshore Group's intention to improve its members' supervisory standards, but does not wish its Secretariat to become directly involved in an exercise of this nature because of the moral hazard involved in appearing to give a "seal of approval". Even for a visit limited to fact-finding, the Committee feels it would inevitably be seen as a key agent in the process. Some of its members question why such visits could not be conducted by an Offshore Group member, by a firm of accountants or by a retired supervisor. The important thing is to ensure consistency of procedure. Others note that the risk of moral hazard could be reduced by using a range of different countries in the verification process. An alternative is that a member of the Offshore Group accompanies a G­10 country representative. In any event, the option should be open to a home supervisor to participate in the fact-finding review if it feels that appropriate.

37. Balancing the pros and cons, the Basle Committee encourages its individual member countries to assist the Offshore Group or another regional group in the fact-finding verification process, but any decision-making regarding membership of a regional group should be left to that group alone. The Committee has also asked its Secretariat to maintain a list of competent persons (for example, retired supervisors) who are available to undertake exercises of this nature.

(c) Other cross-border banking concerns

38. The joint working group has considered a number of issues posed by so-called "shell branches", defined in this paper as booking offices licensed in one centre but effectively managed or controlled from another jurisdiction. Where the managing or controlling jurisdiction is neither the home or host country, there is concern that in some cases shell branches may not be subject to effective supervision. These branches may not be supervised by the licensing jurisdiction or by the host jurisdiction of the managing/controlling office, or by the home country either.

39. The working group believes that the supervision of any branch is of necessity part of the consolidated supervision exercised by the home supervisor and that this problem should be addressed by strict application of the Minimum Standards. The host supervisor that licenses a shell branch also has responsibility for ensuring that there is effective supervision of that shell branch. No banking operation should be permitted without a licence, and no shell office should be licensed without ascertaining that it will be subject to effective supervision. In the event that any host supervisor receives an application to license a new shell branch that will be managed in another jurisdiction, that supervisor should take steps to notify both the home supervisor and the supervisor in the jurisdiction where the shell branch will be managed. Before approving the shell branch, the host supervisor should be aware of how the home country supervisor, either through its own means or with the assistance of the licensing supervisor and the supervisor in the country where the branch is managed, will ensure the effective supervision of the branch.

40. Indeed, all the supervisors involved in the creation of shell branches i.e. the home supervisor, the host supervisor (licensing authority) and the authority from whose jurisdiction the branch is managed and controlled, should ensure that each of their fellow colleagues is consulted on the structure that is to be established. For example, home supervisors should not authorise their banks to establish or acquire offices in any host jurisdiction without satisfying themselves in advance that such offices will be subject to appropriate supervision. If any authority believes that a supervisory gap exists, they should discuss the matter with the other relevant supervisors with a view to ensuring that the operations of shell branches are brought under effective oversight. Ultimately, it is the responsibility of the home supervisor to assure that any supervisory gap is closed. Where the home authority wishes to inspect on-site, they should be permitted to examine the books of the shell branch wherever they are kept. The working group believes that in no case should access to these books be protected by secrecy requirements in the country that licenses the shell branch. If the home supervisor does not wish to undertake an on-site examination, there should be no constraints on internal and external audits. In either case, if any supervisor, in the course of a regular examination or review of activities booked in a shell branch, happens to notice any unusual activity requiring further investigation, it should notify each of the other supervisors involved.

41. The working group is also concerned about parallel-owned banks, where a bank set up in one jurisdiction has the same ownership as a bank in another jurisdiction but where the one is not a subsidiary of the other. Such "sister" institutions are not subject to consolidated supervision but at the same time an inter-relationship exists and it could well be that funds are switched from one to the other if a problem arises. The working group recommends that home or host supervisors be vigilant to ensure that operations of this type become subject to consolidated supervision, if necessary by enforcing a change in group structure as indicated by the Minimum Standards.

42. A third problem that deserves attention can arise in the case of parent institutions incorporated in under-regulated financial centres which undertake cross-border operations without effective home-country supervision in their country of incorporation. These risks are compounded if the parent is an unsupervised holding company, a trust holding or a bank that does not have a single parent. There is a clear potential for abuse by stand-alone banks incorporated in under-regulated financial centres for unlawful or unauthorised banking activity in other jurisdictions. Any home supervisor that licenses a banking entity has a responsibility to monitor its operations on a worldwide basis and no entity should be allowed to use the word "bank" in its name if it is not conducting banking activities and being supervised as a bank. The working group believes the Basle Committee should advise all host countries to be extremely cautious about approving the establishment of cross-border operations by banks incorporated in under-regulated financial centres, and even more cautious about accepting other financial institutions conducting banking activities from those centres. Similarly, all supervisors, even if they act predominantly as hosts, need to guard against the threat to their good name from rogue overseas activities by banks or non-banks incorporated in their centres.

43. The potential supervisory gaps set out in this section are not exhaustive. There may, for example, be instances of brass-plate subsidiaries or banks owned by non-bank holding companies. These situations should be addressed by strict application of the Minimum Standards.

October 1996