1. Under the first of the four Minimum Standards, it is required that all international banks be supervised by a home country authority that capably performs consolidated supervision. The purpose of this Annex, and in particular the checklist in paragraphs 6 and 7 below, is to provide examples of some of the principles and factors that could be taken into account in making a judgement about effective consolidated supervision.
2. There can be no single set of criteria to determine whether or not a home supervisor is performing "effective consolidated supervision", since supervisory techniques differ from country to country, due to institutional, historical, legal or other factors. The concepts of consolidated supervision can, however, be defined, namely as a group-wide approach to supervision whereby all the risks run by a banking group are taken into account, wherever they are booked. In other words, it is a process whereby a supervisor can satisfy himself about the totality of a banking group's activities, which may include non-bank companies and financial affiliates, as well as direct branches and subsidiaries.
3. One of the prime reasons why consolidated supervision is critical is the risk of a damaging loss of confidence if an associated enterprise gets into difficulties. This so-called risk of contagion goes well beyond legal liability. Consolidated supervision helps protect the integrity of, and confidence in the group, both supervised and unsupervised elements. More directly, the purpose of consolidated supervision is essentially threefold:
- to support the principle that no banking operation, wherever located, should escape supervision altogether;
- to prevent double-leveraging of capital; and
- to ensure that all the risks incurred by a banking group, no matter where they are booked, are evaluated and controlled on a global basis.
4. It is important to draw a distinction between accounting consolidation, which is a mechanical process, and the concept of consolidated supervision, which is qualitative as well as quantitative. The drawing up of consolidated accounts facilitates consolidated supervision but is not necessarily sufficient. Consolidated accounting may, for example, be inappropriate when the nature of the business or the nature of the risks are markedly different, but that does not mean that the risks should be ignored. Moreover, some risks need to be monitored at local level too. Liquidity concerns, for one, can be considered on a market-by-market (or currency-by-currency) basis, though a group liquidity spectrum would need to include at least the main funding centres. Market risk is another risk that the supervisor may decide should not necessarily be consolidated: that decision would depend on whether the bank manages its market risks centrally or regionally. Moreover, if a bank is operating in jurisdictions subject to controls on capital flows, offsetting of market (and other) risks through consolidation would not necessarily be prudent.
5. In reaching a decision as to the effectiveness of the consolidated supervision conducted by a home supervisor, the host supervisor will also need to take account of his own supervisory capabilities. If he has limited resources, greater demands will be placed on the home supervisor than if host supervision is strong. The host also has to judge the extent to which its supervision complements that of the home supervisor, or whether there are potential gaps. Accordingly, one host supervisor may decide that a given country is conducting effective consolidated supervision, whereas another host supervisor with different capabilities may decide that it is not. Nonetheless, there are certain common factors on which host supervisors will base their decisions. The checklist below is designed to assist in that decision-making process.
6. Does the home country supervisor have adequate powers to enable it to obtain the information needed to exercise consolidated supervision, for example:
- does the bank in question have its own routine for collecting and validating financial information from all its foreign affiliates, as well as for evaluating and controlling its risks on a global basis?
- does the home supervisor receive regular financial information relating both to the whole of the group, and to the material entities in the group (including the head office) individually?
- is the home supervisor able to verify that information (e.g. through inspection, auditors' reports or information received from the host authority)?
- is there access to information on intra-group transactions, not only with downward affiliates but also if appropriate with sister companies or non-bank affiliates?
- does the home supervisor have the power to prohibit corporate structures that deliberately impede consolidated supervision?
7. Which of the following procedures does the home country supervisor have in place to demonstrate its ability to capably perform consolidated supervision:
- adequate control of authorisation, both at the entry stage and on changes of ownership?
- adequate prudential standards for capital, credit concentrations, asset quality (i.e. provisioning or classification requirements), liquidity, market risk, management controls, etc?
- off-site capability, i.e. systems for statistical reporting of risks on a consolidated basis and the ability to verify or to have the reports verified?
- the capability to inspect or examine entities in foreign locations?
- arrangements for a frequent dialogue with the management of the supervised entity?
- a track record of taking effective remedial action when problems arise?