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Monday September 24 2012 - Top 10 Risk Management News
 

Monday September 24 2012 - Top 10 Risk Management News

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Monday September 24 2012 - Top 10 Risk Management News

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    Monday September 24 2012 - Top 10 Risk Management News Monday September 24 2012 - Top 10 Risk Management News Document Transcript

    • Page |1 International Association of Risk and Compliance Professionals (IARCP) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the weeks agenda, and what is next George Lekatis President of the IARCPDear Member,As you can read at Number 4 of our list, economic activity hascontinued to expand at a moderate pace in recent months.Growth in employment has been slow, and the unemployment rateremains elevated.Household spending has continued to advance, but growth in businessfixed investment appears to have slowed.The housing sector has shown some further signs of improvement, albeitfrom a depressed level.Inflation has been subdued, although the prices of some key commoditieshave increased recently.Longer-term inflation expectations have remained stable.But…Economic growth might not be strong enough to generate sustainedimprovement in labor market conditions.Strains in global financial markets continue to pose significant downsiderisks to the economic outlook. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |2To support a stronger economic recovery and to help ensure thatinflation, over time, is at the rate most consistent with its dual mandate,the Federal Open Market Committee has agreed to increase policyaccommodation by purchasing additional agency mortgage-backedsecurities at a pace of $40 billion per month.The Committee also will continue through the end of the year its programto extend the average maturity of its holdings of securities as announcedin June, and it is maintaining its existing policy of reinvesting principalpayments from its holdings of agency debt and agency mortgage-backedsecurities in agency mortgage-backed securities.These actions, which together will increase the Committee’s holdings oflonger-term securities by about $85 billion each month through the end ofthe year, should put downward pressure on longer-term interest rates,support mortgage markets, and help to make broader financial conditionsmore accommodative. The Committee will closely monitor incoming information on economicand financial developments in coming months.If the outlook for the labor market does not improve substantially, theCommittee will continue its purchases of agency mortgage-backedsecurities, undertake additional asset purchases, and employ its otherpolicy tools as appropriate until such improvement is achieved in acontext of price stability.Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |3Bank for International SettlementsCore principles for effective bankingsupervisionSeptember 2012The Basel Committee on Banking Supervisionhas completed its review of the October 2006Core principles for effective bankingsupervision and the associated Core principlesmethodology.The revised Core Principles were endorsed bybanking supervisors at the 17th InternationalConference of Banking Supervisors held in Istanbul, Turkey, on 13-14September 2012.Stress Testing ModelSymposiumFederal Reserve Bank of BostonAddress by Deputy Governor MatthewElderfield, to the Irish Funds IndustryAssociation _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |42012 Monetary Policy ReleasesInformation received since the FederalOpen Market Committee met inAugust suggests that economicactivity has continued to expand at amoderate pace in recent months.Growth in employment has been slow,and the unemployment rate remains elevated.Economic Activity, Prices, and Monetary PolicySpeech at a Meeting with Business Leaders in YamaguchiRyuzo Miyao. Member of the Policy BoardThe U.S. Economic Outlook and Implications forLatin AmericaDennis P. LockhartPresident and Chief Executive OfficerFederal Reserve Bank of AtlantaLatin American Chamber of Commerce and the WorldAffairs Council _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |5Basel ii / iii in RussiaThe Bank of Russia considers it necessary to create legislativefundamentals in Russia for introducing all the standards of bankingregulation and banking supervision established by the Basel Committeeon Banking Supervision (BCBS).These include legislation empowering the Bank of Russia to setrequirements for credit institutions’ corporate governance, risk andcapital management systems, to exercise consolidated supervision, to useprofessional judgment in supervisory practices, and also to definedisciplinary action against members of executive bodies and boards ofdirectors (supervisory boards) for faults in the activity of their creditinstitutions.The Importance of StrongRisk Management: InsightsFrom The ExaminationWorldBy Jason C. Schemmel, Community and Regional supervisory examinerwith the Federal Reserve Bank of Richmond _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |6Islamic finance developments in PakistanKeynote address by Mr Kazi Abdul Muktadir,Deputy Governor of the State Bank of Pakistan,at the Islamic Finance news (IFN) Roadshow 2012,KarachiRegulatory reform: getting it doneRemarks by Mr Stefan Ingves, Governor of SverigesRiksbank and Chairman of the Basel Committee onBanking Supervision, at the 17th InternationalConference of Banking Supervisors, Istanbul _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |7NUMBER 1Bank for International SettlementsBIS, Core principles for effective bankingsupervisionSeptember 2012The Basel Committee on Banking Supervisionhas completed its review of the October 2006Core principles for effective bankingsupervision and the associated Core principlesmethodology.The revised Core Principles were endorsed bybanking supervisors at the 17th InternationalConference of Banking Supervisors held in Istanbul, Turkey, on 13-14September 2012.Both the existing Core Principles and the associated assessmentmethodology have served their purpose well in terms of helping countriesto assess their supervisory systems and identify areas for improvement.While conscious efforts were made to maintain continuity andcomparability to the extent possible, the revised document combines theCore Principles and the assessment methodology into a singlecomprehensive document.The revised set of twenty-nine Core Principles has also been reorganisedto foster their implementation through a more logical structure,highlighting the difference between what supervisors do and what theyexpect banks to do:Principles 1 to 13 address supervisory powers, responsibilities andfunctions, focusing on effective risk-based supervision, and the need forearly intervention and timely supervisory actions.Principles 14 to 29 cover supervisory expectations of banks, emphasisingthe importance of good corporate governance and risk management, aswell as compliance with supervisory standards. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |8Important enhancements have been introduced into the individual CorePrinciples, particularly in those areas that are necessary to strengthensupervisory practices and risk management.As a result, certain "additional criteria" have been upgraded to "essentialcriteria", while new assessment criteria were warranted in otherinstances.Close attention was given to addressing many of the significant riskmanagement weaknesses and other vulnerabilities highlighted in thefinancial crisis.In addition, the review has taken account of several key trends anddevelopments that emerged during the last few years of market turmoil: - the need for greater supervisory intensity and adequate resources to deal effectively with systemically important banks; - the importance of applying a system-wide, macro perspective to the microprudential supervision of banks to assist in identifying, analysing and taking pre-emptive action to address systemic risk; and - the increasing focus on effective crisis management, recovery and resolution measures in reducing both the probability and impact of a bank failure.The Committee has sought to give appropriate emphasis to theseemerging issues by embedding them into the Core Principles, asappropriate, and including specific references under each relevantPrinciple.In addition, sound corporate governance underpins effective riskmanagement and public confidence in individual banks and the bankingsystem.Given fundamental deficiencies in banks corporate governance that wereexposed during the crisis, a new Core Principle on corporate governancehas been added by bringing together existing corporate governancecriteria in the assessment methodology and giving greater emphasis tosound corporate governance practices. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |9Similarly, the Committee reiterated the key role of robust marketdiscipline in fostering a safe and sound banking system by expanding anexisting Core Principle into two new ones dedicated respectively togreater public disclosure and transparency, and enhanced financialreporting and external audit.As a result of the Committees review, the number of Core Principles hasincreased from 25 to 29.There are a total of 39 new assessment criteria, comprising 34 newessential criteria and 5 new additional criteria.In addition, 34 additional criteria from the existing assessmentmethodology have been upgraded to essential criteria that representminimum baseline requirements for all countries.A consultative version of the revised Core Principles was issued for publicconsultation in December 2011.The Committee appreciates the constructive comments received andthanks those who have taken the time and effort to express their views onthe consultative document. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 10Core Principles for Effective Banking Supervision (The BaselCore Principles)Executive summary1. The Core Principles for Effective Banking Supervision (CorePrinciples) are the de facto minimum standard for sound prudentialregulation and supervision of banks and banking systems.Originally issued by the Basel Committee on Banking Supervision (theCommittee) in 1997, they are used by countries as a benchmark forassessing the quality of their supervisory systems and for identifyingfuture work to achieve a baseline level of sound supervisory practices.The Core Principles are also used by the International Monetary Fund(IMF) and the World Bank, in the context of the Financial SectorAssessment Programme (FSAP), to assess the effectiveness of countries’banking supervisory systems and practices.2. The Core Principles were last revised by the Committee in October2006 in cooperation with supervisors around the world.In its October 2010 Report to the G20 on response to the financial crisis,the Committee announced its plan to review the Core Principles as part ofits ongoing work to strengthen supervisory practices worldwide.3. In March 2011, the Core Principles Group was mandated by theCommittee to review and update the Core Principles.The Committee’s mandate was to conduct the review taking into accountsignificant developments in the global financial markets and regulatorylandscape since October 2006, including post-crisis lessons for promotingsound supervisory systems.The intent was to ensure the continued relevance of the Core Principlesfor promoting effective banking supervision in all countries over time andchanging environments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 114. In conducting the review, the Committee has sought to achieve theright balance in raising the bar for sound supervision while retaining theCore Principles as a flexible, globally applicable standard.By reinforcing the proportionality concept, the revised Core Principlesand their assessment criteria accommodate a diverse range of bankingsystems.The proportionate approach also allows assessments of compliance withthe Core Principles that are commensurate with the risk profile andsystemic importance of a broad spectrum of banks (from largeinternationally active banks to small, non-complex deposit-takinginstitutions).5. Both the existing Core Principles and the associated Core PrinciplesMethodology (assessment methodology) have served their purpose wellin terms of helping countries to assess their supervisory systems andidentify areas for improvement.While conscious efforts were made to maintain continuity andcomparability as far as possible, the Committee has merged the CorePrinciples and the assessment methodology into a single comprehensivedocument.The revised set of twenty-nine Core Principles have also been reorganisedto foster their implementation through a more logical structure startingwith supervisory powers, responsibilities and functions, and followed bysupervisory expectations of banks, emphasising the importance of goodcorporate governance and risk management, as well as compliance withsupervisory standards.6. Important enhancements have been introduced into the individualCore Principles, particularly in those areas that are necessary tostrengthen supervisory practices and risk management.Various additional criteria have been upgraded to essential criteria as aresult, while new assessment criteria were warranted in other instances. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 12Close attention was given to addressing many of the significant riskmanagement weaknesses and other vulnerabilities highlighted in the lastcrisis.In addition, the review has taken account of several key trends anddevelopments that emerged during the last few years of market turmoil: - the need for greater intensity and resources to deal effectively with systemically important banks; - the importance of applying a system-wide, macro perspective to the microprudential supervision of banks to assist in identifying, analysing and taking pre-emptive action to address systemic risk; - and the increasing focus on effective crisis management, recovery and resolution measures in reducing both the probability and impact of a bank failure.The Committee has sought to give appropriate emphasis to theseemerging issues by embedding them into the Core Principles, asappropriate, and including specific references under each relevantPrinciple.7. In addition, sound corporate governance underpins effective riskmanagement and public confidence in individual banks and the bankingsystem.Given fundamental deficiencies in banks’ corporate governance that wereexposed in the last crisis, a new Core Principle on corporate governancehas been added in this review by bringing together existing corporategovernance criteria in the assessment methodology and giving greateremphasis to sound corporate governance practices.Similarly, the Committee reiterated the key role of robust marketdiscipline in fostering a safe and sound banking system by expanding anexisting Core Principle into two new ones dedicated respectively togreater public disclosure and transparency, and enhanced financialreporting and external audit.8. At present, the grading of compliance with the Core Principles is basedsolely on the essential criteria. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 13To provide incentives to jurisdictions, particularly those that areimportant financial centres, to lead the way in the adoption of the highestsupervisory standards, the revised Core Principles will allow countries theadditional option of voluntarily choosing to be assessed and gradedagainst the essential and additional criteria.In the same spirit of promoting full and robust implementation, theCommittee has retained the existing four-grade scale of assessingcompliance with the Core Principles.This includes the current “materially non-compliant” grading that helpsprovide a strong signalling effect to relevant authorities on remedialmeasures needed for addressing supervisory and regulatory shortcomingsin their countries.9. As a result of this review, the number of Core Principles has increasedfrom 25 to 29.There are a total of 39 new assessment criteria, comprising 34 newessential criteria and 5 new additional criteria.In addition, 34 additional criteria from the existing assessmentmethodology have been upgraded to essential criteria that representminimum baseline requirements for all countries.10. The revised Core Principles will continue to provide a comprehensivestandard for establishing a sound foundation for the regulation,supervision, governance and risk management of the banking sector.Given the importance of consistent and effective standardsimplementation, the Committee stands ready to encourage work at thenational level to implement the revised Core Principles in conjunctionwith other supervisory bodies and interested parties.I. Foreword to the review11. The Basel Committee on Banking Supervision (the Committee) hasrevised the Core Principles for Effective Banking Supervision (CorePrinciples). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 14In conducting its review, the Committee has sought to balance theobjectives of raising the bar for banking supervision (incorporating thelessons learned from the crisis and other significant regulatorydevelopments since the Core Principles were last revised in 2006) againstthe need to maintain the universal applicability of the Core Principles andthe need for continuity and comparability.By raising the bar, the practical application of the Core Principles shouldimprove banking supervision worldwide.12. The revised Core Principles strengthen the requirements forsupervisors, the approaches to supervision and supervisors’ expectationsof banks.This is achieved through a greater focus on effective risk-basedsupervision and the need for early intervention and timely supervisoryactions.Supervisors should assess the risk profile of banks, in terms of the risksthey run, the efficacy of their risk management and the risks they pose tothe banking and financial systems.This risk-based process targets supervisory resources where they can beutilised to the best effect, focusing on outcomes as well as processes,moving beyond passive assessment of compliance with rules.13. The Core Principles set out the powers that supervisors should have inorder to address safety and soundness concerns.It is equally crucial that supervisors use these powers once weaknesses ordeficiencies are identified.Adopting a forward-looking approach to supervision through earlyintervention can prevent an identified weakness from developing into athreat to safety and soundness. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 15This is particularly true for highly complex and bank-specific issues (egliquidity risk) where effective supervisory actions must be tailored to abank’s individual circumstances.14. In its efforts to strengthen, reinforce and refocus the Core Principles,the Committee has nonetheless remained mindful of their underlyingpurpose and use.The Committee’s intention is to ensure the continued relevance of theCore Principles in providing a benchmark for supervisory practices thatwill withstand the test of time and changing environments.For this reason, this revision of the Core Principles builds upon thepreceding versions to ensure continuity and comparability as far aspossible.15. In recognition of the universal applicability of the Core Principles, theCommittee conducted its review in close cooperation with members ofthe Basel Consultative Group which comprises representatives from bothCommittee and non-Committee member countries and regional groupsof banking supervisors, as well as the IMF, the World Bank and theIslamic Financial Services Board.The Committee consulted the industry and public before finalising thetext.General approach16. The first Core Principle sets out the promotion of safety andsoundness of banks and the banking system as the primary objective forbanking supervision.Jurisdictions may assign other responsibilities to the banking supervisorprovided they do not conflict with this primary objective.6 It should not be an objective of banking supervision to prevent bankfailures. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 16However, supervision should aim to reduce the probability and impact ofa bank failure, including by working with resolution authorities, so thatwhen failure occurs, it is in an orderly manner.17. To fulfil their purpose, the Core Principles must be capable ofapplication to a wide range of jurisdictions whose banking sectors willinevitably include a broad spectrum of banks (from large internationallyactive banks to small, non-complex deposit-taking institutions).Banking systems may also offer a wide range of products or services andthe Core Principles are aligned with the general aim of catering todifferent financial needs.To accommodate this breadth of application, a proportionate approach isadopted, both in terms of the expectations on supervisors for thedischarge of their own functions and in terms of the standards thatsupervisors impose on banks.Consequently, the Core Principles acknowledge that supervisors typicallyuse a risk-based approach in which more time and resources are devotedto larger, more complex or riskier banks.In the context of the standards imposed by supervisors on banks, theproportionality concept is reflected in those Principles focused onsupervisors’ assessment of banks’ risk management, where the Principlesprescribe a level of supervisory expectation commensurate with a bank’srisk profile and systemic importance.18. Successive revisions to existing Committee standards and guidance,and any new standards and guidance will be designed to strengthen theregulatory regime.Supervisors are encouraged to move towards the adoption of updated andnew international supervisory standards as they are issued. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 17Approach toward emerging trends and developments(i) Systemically important banks (SIBs)19. In the aftermath of the crisis, much attention has been focused onSIBs, and the regulations and supervisory powers needed to deal withthem effectively.Consideration was given by the Committee to including a new CorePrinciple to cover SIBs.However, it was concluded that SIBs, which require greater intensity ofsupervision and hence resources, represent one end of the supervisoryspectrum of banks.Each Core Principle applies to the supervision of all banks.The expectations on, and of, supervisors will need to be of a higher orderfor SIBs, commensurate with the risk profile and systemic importance ofthese banks.Therefore, it is unnecessary to include a specific stand-alone CorePrinciple for SIBs.(ii) Macroprudential issues and systemic risks20. The recent crisis highlighted the interface between, and thecomplementary nature of, the macroprudential and microprudentialelements of effective supervision.In their application of a risk-based supervisory approach, supervisors andother authorities need to assess risk in a broader context than that of thebalance sheet of individual banks.For example, the prevailing macroeconomic environment, businesstrends, and the build-up and concentration of risk across the banking _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 18sector and, indeed, outside of it, inevitably impact the risk exposure ofindividual banks.Bank-specific supervision should therefore consider this macroperspective.Individual bank data, where appropriate, data at sector level andaggregate trend data collected by supervisors should be incorporated intothe deliberations of authorities relevant for financial stability purposes(whether part of, or separate from, the supervisor) to assist inidentification and analysis of systemic risk.The relevant authorities should have the ability to take pre-emptive actionto address systemic risks.Supervisors should have access to relevant financial stability analyses orassessments conducted by other authorities that affect the bankingsystem.21. This broad financial system perspective is integral to many of the CorePrinciples. For this reason, the Committee has not included a specificstand-alone Core Principle on macroprudential issues.22. In supervising an individual bank which is part of a corporate group, itis essential that supervisors consider the bank and its risk profile from anumber of perspectives: on a solo basis (but with both a micro and macrofocus as discussed above); on a consolidated basis (in the sense ofsupervising the bank as a unit together with the other entities within the“banking group”) and on a group-wide basis (taking into account thepotential risks to the bank posed by other group entities outside of thebanking group).Group entities (whether within or outside the banking group) may be asource of strength but they may also be a source of weakness capable ofadversely affecting the financial condition, reputation and overall safetyand soundness of the bank. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 19The Core Principles include a specific Core Principle on the consolidatedsupervision of banking groups, but they also note the importance ofparent companies and other non-banking group entities in anyassessment of the risks run by a bank or banking group.This supervisory “risk perimeter” extends beyond accountingconsolidation concepts.In the discharge of their functions, supervisors must observe a broadcanvas of risk, whether arising from within an individual bank, from itsassociated entities or from the prevailing macro financial environment.23. Supervisors should also remain alert to the movement, or build-up, offinancial activities outside the regulated banking sector (the developmentof “shadow banking” structures) and the potential risks this may create.Data or information on this should also be shared with any otherauthorities relevant for financial stability purposes.(iii) Crisis management, recovery and resolution24. Although it is not a supervisor’s role to prevent bank failures,supervisory oversight is designed to reduce both the probability andimpact of such failures.Banks will, from time to time, run into difficulties, and to minimise theadverse impact both on the troubled bank and on the banking andfinancial sectors as a whole, effective crisis preparation and management,and orderly resolution frameworks and measures are required.25. Such measures may be viewed from two perspectives:(i) The measures to be adopted by supervisory and other authorities(including developing resolution plans and in terms of informationsharing and cooperation with other authorities, both domestic andcross-border, to coordinate an orderly restructuring or resolution of atroubled bank); and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 20(ii) Those to be adopted by banks (including contingency funding plansand recovery plans) which should be subject to critical assessment bysupervisors as part of their ongoing supervision.26. To reflect, and to emphasise, the importance of crisis management,recovery and resolution measures, certain Core Principles include specificreference to the maintenance and assessment of contingencyarrangements.The existing Core Principle on home-host relationships has also beenstrengthened to require cooperation and coordination between home andhost supervisors on crisis management and resolution for cross-borderbanks.(iv) Corporate governance, disclosure and transparency27. Corporate governance shortcomings in banks, examples of whichwere observed during the crisis, can have potentially seriousconsequences both for the bank concerned and, in some cases, for thefinancial system as a whole.A new Core Principle, focused on effective corporate governance as anessential element in the safe and sound functioning of banks, hastherefore been included in this revision.The new Principle brings together existing corporate governance criteriain the assessment methodology and gives greater emphasis to soundcorporate governance practices.28. Similarly, the crisis served to underline the importance of disclosureand transparency in maintaining confidence in banks by allowing marketparticipants to understand better a bank’s risk profile and thereby reducemarket uncertainties about the bank’s financial strength.In recognition of this, a new Core Principle has been added to providemore direction on supervisory practices in this area. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 21Structure and assessment of Core PrinciplesStructure29. The preceding versions of the Core Principles were accompanied by aseparate assessment methodology that set out the criteria to be used togauge compliance with the Core Principles.In this revision, the assessment methodology has been merged into asingle document with the Core Principles reflecting the essentialinterdependence of Core Principles and Assessment Criteria and theircommon usage.The Core Principles have also been reorganised: Principles 1-13 addresssupervisory powers, responsibilities and functions, and Principles 14-29cover supervisory expectations of banks, emphasising the importance ofgood corporate governance and risk management, as well as compliancewith supervisory standards.This re-ordering highlights the difference between what supervisors dothemselves and what they expect banks to do. For comparability with thepreceding version, a mapping table is provided in Annex 1.Assessment30. The Core Principles establish a level of sound supervisory practicethat can be used as a benchmark by supervisors to assess the quality oftheir supervisory systems.They are also used by the IMF and the World Bank, in the context of theFinancial Sector Assessment Programme (FSAP), to assess theeffectiveness of countries’ banking supervisory systems and practices.31. This revision of the Core Principles retains the previous practice ofincluding both essential criteria and additional criteria as part of theassessment methodology. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 22Essential criteria set out minimum baseline requirements for soundsupervisory practices and are of universal applicability to all countries.An assessment of a country against the essential criteria must, however,recognise that its supervisory practices should be commensurate with therisk profile and systemic importance of the banks being supervised.In other words, the assessment must consider the context in which thesupervisory practices are applied.The concept of proportionality underpins all assessment criteria even if itis not always directly referenced.32. Effective banking supervisory practices are not static.They evolve over time as lessons are learned and banking businesscontinues to develop and expand.Supervisors are often swift to encourage banks to adopt “best practice”and supervisors should demonstrably “practice what they preach” interms of seeking to move continually towards the highest supervisorystandards.To reinforce this aspiration, the additional criteria in the Core Principlesset out supervisory practices that exceed current baseline expectationsbut which will contribute to the robustness of individual supervisoryframeworks.As supervisory practices evolve, it is expected that upon each revision ofthe Core Principles, a number of additional criteria will migrate tobecome essential criteria as expectations on baseline standards change.The use of essential criteria and additional criteria will, in this sense,contribute to the continuing relevance of the Core Principles over time.33. In the past, countries were graded only against the essential criteria,although they could volunteer to be assessed against the additional _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 23criteria too and benefit from assessors’ commentary on how supervisorypractices could be enhanced.In future, countries undergoing assessments by the IMF and/or theWorld Bank can elect to be graded against the essential and additionalcriteria.It is anticipated that this will provide incentives to jurisdictions,particularly those that are important financial centres, to lead the way inthe adoption of the highest supervisory standards.As with the essential criteria, any assessment against additional criteriashould recognise the concept of proportionality as discussed above.34. Moreover, it is important to bear in mind that some tasks, such as acorrect assessment of the macroeconomic environment and the detectionof the build-up of dangerous trends, do not lend themselves to a rigidcompliant/non-compliant structure.Although these tasks may be difficult to assess, supervisors should makeassessments that are as accurate as possible given the informationavailable at the time and take reasonable actions to address and mitigatesuch risks.35. While the publication of the assessments of jurisdictions affordstransparency, an assessment of one jurisdiction will not be directlycomparable to that of another.First, assessments will have to reflect proportionality.Thus, a jurisdiction that is home to many SIBs will naturally have a higherhurdle to obtain a “Compliant” grading10 versus a jurisdiction which onlyhas small, non-complex deposit-taking institutions.Second, with this version of the Core Principles, jurisdictions can elect tobe graded against essential criteria only or against both essential criteriaand additional criteria. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 24Third, assessments will inevitably be country-specific and time -dependent to varying degrees.Therefore, the description provided for each Core Principle and thequalitative commentary accompanying the grading for each CorePrinciple should be reviewed in order to gain an understanding of ajurisdiction’s approach to the specific aspect under consideration and theneed for any improvements. Seeking to compare countries by a simplereference to the number of “Compliant” versus “Non-Compliant” gradesthey receive is unlikely to be informative.36. From a broader perspective, effective banking supervision isdependent on a number of external elements, or preconditions, whichmay not be within the direct jurisdiction of supervisors.Thus, in respect of grading, the assessment of preconditions will remainqualitative and distinct from the assessment (and grading) of compliancewith the Core Principles.37. Core Principle 29 dealing with the Abuse of Financial Servicesincludes, among other things, supervision of banks’ anti-moneylaundering/combating the financing of terrorism (AML/CFT) controls.The Committee recognises that assessments against this Core Principlewill inevitably, for some countries, involve a degree of duplication withthe mutual evaluation process of the Financial Action Task Force(FATF).To address this, where an evaluation has recently been conducted by theFATF on a given country, FSAP assessors may rely on that evaluation andfocus their own review on the actions taken by supervisors to address anyshortcomings identified by the FATF.In the absence of any recent FATF evaluation, FSAP assessors willcontinue to assess countries’ supervision of banks’ AML/CFT controls. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 25Consistency and implementation38. The banking sector is only a part, albeit an important part, of afinancial system and in conducting this review of its Core Principles, theCommittee has sought to maintain consistency, where possible, with thecorresponding standards for securities and insurance (which havethemselves been the subject of recent reviews), as well as those foranti-money laundering and transparency.Differences will, however, inevitably remain as key risk areas andsupervisory priorities differ from sector to sector. In implementing theCore Principles, supervisors should take into account the role of thebanking sector in supporting and facilitating productive activities for thereal economy.II. The Core Principles39. The Core Principles are a framework of minimum standards for soundsupervisory practices and are considered universally applicable.The Committee issued the Core Principles as its contribution tostrengthening the global financial system.Weaknesses in the banking system of a country, whether developing ordeveloped, can threaten financial stability both within that country andinternationally.The Committee believes that implementation of the Core Principles by allcountries would be a significant step towards improving financialstability domestically and internationally, and provide a good basis forfurther development of effective supervisory systems.The vast majority of countries have endorsed the Core Principles andhave implemented them.40. The revised Core Principles define 29 principles that are needed for asupervisory system to be effective. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 26Those principles are broadly categorised into two groups: the first group(Principles 1 to 13) focus on powers, responsibilities and functions ofsupervisors, while the second group (Principles 14 to 29) focus onprudential regulations and requirements for banks.The original Principle 1 has been divided into three separate Principles,while new Principles related to corporate governance, and disclosure andtransparency, have been added.This accounts for the increase from 25 to 29 Principles.41. The 29 Core Principles are:Supervisory powers, responsibilities and functions• Principle 1 – Responsibilities, objectives and powers:An effective system of banking supervision has clear responsibilities andobjectives for each authority involved in the supervision of banks andbanking groups.A suitable legal framework for banking supervision is in place to provideeach responsible authority with the necessary legal powers to authorisebanks, conduct ongoing supervision, address compliance with laws andundertake timely corrective actions to address safety and soundnessconcerns.• Principle 2 – Independence, accountability, resourcing andlegal protection for supervisors:The supervisor possesses operational independence, transparentprocesses, sound governance, budgetary processes that do not undermineautonomy and adequate resources, and is accountable for the dischargeof its duties and use of its resources.The legal framework for banking supervision includes legal protection forthe supervisor. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 27• Principle 3 – Cooperation and collaboration:Laws, regulations or other arrangements provide a framework forcooperation and collaboration with relevant domestic authorities andforeign supervisors.These arrangements reflect the need to protect confidential information.• Principle 4 – Permissible activities:The permissible activities of institutions that are licensed and subject tosupervision as banks are clearly defined and the use of the word “bank” innames is controlled.• Principle 5 – Licensing criteria:The licensing authority has the power to set criteria and rejectapplications for establishments that do not meet the criteria.At a minimum, the licensing process consists of an assessment of theownership structure and governance (including the fitness and proprietyof Board members and senior management) of the bank and its widergroup, and its strategic and operating plan, internal controls, riskmanagement and projected financial condition (including capital base).Where the proposed owner or parent organisation is a foreign bank, theprior consent of its home supervisor is obtained.• Principle 6 – Transfer of significant ownership:The supervisor has the power to review, reject and impose prudentialconditions on any proposals to transfer significant ownership orcontrolling interests held directly or indirectly in existing banks to otherparties. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 28• Principle 7 – Major acquisitions:The supervisor has the power to approve or reject (or recommend to theresponsible authority the approval or rejection of), and impose prudentialconditions on, major acquisitions or investments by a bank, againstprescribed criteria, including the establishment of cross-borderoperations, and to determine that corporate affiliations or structures donot expose the bank to undue risks or hinder effective supervision.• Principle 8 – Supervisory approach:An effective system of banking supervision requires the supervisor todevelop and maintain a forward-looking assessment of the risk profile ofindividual banks and banking groups, proportionate to their systemicimportance; identify, assess and address risks emanating from banks andthe banking system as a whole; have a framework in place for earlyintervention; and have plans in place, in partnership with other relevantauthorities, to take action to resolve banks in an orderly manner if theybecome non-viable.• Principle 9 – Supervisory techniques and tools:The supervisor uses an appropriate range of techniques and tools toimplement the supervisory approach and deploys supervisory resourceson a proportionate basis, taking into account the risk profile and systemicimportance of banks.• Principle 10 – Supervisory reporting: The supervisor collects, reviews and analyses prudential reports andstatistical returns from banks on both a solo and a consolidated basis, andindependently verifies these reports through either on-site examinationsor use of external experts. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 29• Principle 11 – Corrective and sanctioning powers ofsupervisors:The supervisor acts at an early stage to address unsafe and unsoundpractices or activities that could pose risks to banks or to the bankingsystem.The supervisor has at its disposal an adequate range of supervisory toolsto bring about timely corrective actions.This includes the ability to revoke the banking licence or to recommendits revocation.• Principle 12 – Consolidated supervision:An essential element of banking supervision is that the supervisorsupervises the banking group on a consolidated basis, adequatelymonitoring and, as appropriate, applying prudential standards to allaspects of the business conducted by the banking group worldwide.• Principle 13 – Home-host relationships:Home and host supervisors of cross-border banking groups shareinformation and cooperate for effective supervision of the group andgroup entities, and effective handling of crisis situations. Supervisorsrequire the local operations of foreign banks to be conducted to the samestandards as those required of domestic banks.Prudential regulations and requirements• Principle 14 – Corporate governance:The supervisor determines that banks and banking groups have robustcorporate governance policies and processes covering, for example,strategic direction, group and organisational structure, control _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 30environment, responsibilities of the banks’ Boards and seniormanagement, and compensation.These policies and processes are commensurate with the risk profile andsystemic importance of the bank.• Principle 15 – Risk management process:The supervisor determines that banks have a comprehensive riskmanagement process (including effective Board and senior managementoversight) to identify, measure, evaluate, monitor, report and control ormitigate all material risks on a timely basis and to assess the adequacy oftheir capital and liquidity in relation to their risk profile and market andmacroeconomic conditions.This extends to development and review of contingency arrangements(incuding robust and credible recovery plans where warranted) that takeinto account the specific circumstances of the bank.The risk management process is commensurate with the risk profile andsystemic importance of the bank.• Principle 16 – Capital adequacy:The supervisor sets prudent and appropriate capital adequacyrequirements for banks that reflect the risks undertaken by, and presentedby, a bank in the context of the markets and macroeconomic conditionsin which it operates.The supervisor defines the components of capital, bearing in mind theirability to absorb losses.At least for internationally active banks, capital requirements are not lessthan the applicable Basel standards. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 31• Principle 17 – Credit risk:The supervisor determines that banks have an adequate credit riskmanagement process that takes into account their risk appetite, riskprofile and market and macroeconomic conditions.This includes prudent policies and processes to identify, measure,evaluate, monitor, report and control or mitigate credit risk (includingcounterparty credit risk) on a timely basis.The full credit lifecycle is covered including credit underwriting, creditevaluation, and the ongoing management of the bank’s loan andinvestment portfolios.• Principle 18 – Problem assets, provisions and reserves:The supervisor determines that banks have adequate policies andprocesses for the early identification and management of problem assets,and the maintenance of adequate provisions and reserves.• Principle 19 – Concentration risk and large exposure limits:The supervisor determines that banks have adequate policies andprocesses to identify, measure, evaluate, monitor, report and control ormitigate concentrations of risk on a timely basis.Supervisors set prudential limits to restrict bank exposures to singlecounterparties or groups of connected counterparties.• Principle 20 – Transactions with related parties:In order to prevent abuses arising in transactions with related parties andto address the risk of conflict of interest, the supervisor requires banks toenter into any transactions with related parties on an arm’s length basis;to monitor these transactions; to take appropriate steps to control or _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 32mitigate the risks; and to write off exposures to related parties inaccordance with standard policies and processes.• Principle 21 – Country and transfer risks:The supervisor determines that banks have adequate policies andprocesses to identify, measure, evaluate, monitor, report and control ormitigate country risk and transfer risk in their international lending andinvestment activities on a timely basis.• Principle 22 – Market risks:The supervisor determines that banks have an adequate market riskmanagement process that takes into account their risk appetite, riskprofile, and market and macroeconomic conditions and the risk of asignificant deterioration in market liquidity.This includes prudent policies and processes to identify, measure,evaluate, monitor, report and control or mitigate market risks on a timelybasis.• Principle 23 – Interest rate risk in the banking book:The supervisor determines that banks have adequate systems to identify,measure, evaluate, monitor, report and control or mitigate interest raterisk in the banking book on a timely basis.These systems take into account the bank’s risk appetite, risk profile andmarket and macroeconomic conditions.• Principle 24 – Liquidity risk:The supervisor sets prudent and appropriate liquidity requirements(which can include either quantitative or qualitative requirements orboth) for banks that reflect the liquidity needs of the bank. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 33The supervisor determines that banks have a strategy that enablesprudent management of liquidity risk and compliance with liquidityrequirements.The strategy takes into account the bank’s risk profile as well as marketand macroeconomic conditions and includes prudent policies andprocesses, consistent with the bank’s risk appetite, to identify, measure,evaluate, monitor, report and control or mitigate liquidity risk over anappropriate set of time horizons.At least for internationally active banks, liquidity requirements are notlower than the applicable Basel standards.• Principle 25 – Operational risk:The supervisor determines that banks have an adequate operational riskmanagement framework that takes into account their risk appetite, riskprofile and market and macroeconomic conditions.This includes prudent policies and processes to identify, assess, evaluate,monitor, report and control or mitigate operational risk on a timely basis.• Principle 26 – Internal control and audit:The supervisor determines that banks have adequate internal controlframeworks to establish and maintain a properly controlled operatingenvironment for the conduct of their business taking into account theirrisk profile.These include clear arrangements for delegating authority andresponsibility; separation of the functions that involve committing thebank, paying away its funds, and accounting for its assets and liabilities;reconciliation of these processes; safeguarding the bank’s assets; andappropriate independent internal audit and compliance functions to testadherence to these controls as well as applicable laws and regulations. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 34• Principle 27: Financial reporting and external audit:The supervisor determines that banks and banking groups maintainadequate and reliable records, prepare financial statements in accordancewith accounting policies and practices that are widely acceptedinternationally and annually publish information that fairly reflects theirfinancial condition and performance and bears an independent externalauditor’s opinion.The supervisor also determines that banks and parent companies ofbanking groups have adequate governance and oversight of the externalaudit function.• Principle 28 – Disclosure and transparency: The supervisor determines that banks and banking groups regularlypublish information on a consolidated and, where appropriate, solo basisthat is easily accessible and fairly reflects their financial condition,performance, risk exposures, risk management strategies and corporategovernance policies and processes.• Principle 29 – Abuse of financial services:The supervisor determines that banks have adequate policies andprocesses, including strict customer due diligence rules to promote highethical and professional standards in the financial sector and prevent thebank from being used, intentionally or unintentionally, for criminalactivities.42. The Core Principles are neutral with regard to different approaches tosupervision, so long as the overriding goals are achieved.They are not designed to cover all the needs and circumstances of everybanking system. Instead, specific country circumstances should be more _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 35appropriately considered in the context of the assessments and in thedialogue between assessors and country authorities.43. National authorities should apply the Core Principles in thesupervision of all banking organisations within their jurisdictions.Individual countries, in particular those with advanced markets andbanks, may expand upon the Core Principles in order to achieve bestsupervisory practice.44. A high degree of compliance with the Core Principles should fosteroverall financial system stability; however, this will not guarantee it, norwill it prevent the failure of banks. Banking supervision cannot, andshould not, provide an assurance that banks will not fail. In a marketeconomy, failures are part of risk-taking.45. The Committee stands ready to encourage work at the national levelto implement the Core Principles in conjunction with other supervisorybodies and interested parties.The Committee invites the international financial institutions and donoragencies to use the Core Principles in assisting individual countries tostrengthen their supervisory arrangements.The Committee will continue to collaborate closely with the IMF and theWorld Bank in their monitoring of the implementation of theCommittee’s prudential standards.The Committee also remains committed to further enhancing itsinteraction with supervisors from non-member countries. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 36NUMBER 2Stress Testing ModelSymposiumFederal Reserve Bank of Boston__________________________________________________Note: You MUST download the excellent presentations at:http://www.bostonfed.org/StressTest2012/index.htm__________________________________________________The Federal Reserve and Board of Governors are organizing asymposium on best practices and challenges as they relateto stress testing.The goal of the symposium is to improve ourunderstanding of how to develop a robust stress testingframework.Some of the questions that will be discussed include what are the topthree "must have" elements of a robust stress testing framework? Whattype of scenarios should the supervisory and company-run stress testconsider?What are quantitative approaches to modeling pre-provision net revenueby business line?Notes:As part of the central bank, the Federal Reserve Bank of Boston promotessound growth and financial stability in New England and the nation.The Bank contributes to local communities, the region, and the nationthrough its high-quality research, regulatory oversight, and financialservices, and through its commitment to leadership and innovation.The Boston Fed, the First District of the Federal Reserve System, servesthe New England region - Connecticut [except Fairfield County], Maine,Massachusetts, New Hampshire, Rhode Island, and Vermont. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 37NUMBER 3Address by Deputy Governor MatthewElderfield, to the Irish Funds IndustryAssociationThank you very much, IFIA, for the invitation tospeak at this years conference. IFIA plays animportant role in the Irish international financialservices sector and it is my pleasure to be here today to share somethoughts about the regulatory agenda for the funds industry.Before I do that, can I take a momentto acknowledge the significantcontribution that has been made byGary Palmer, as the outgoing CEO ofIFIA, to the growth and success of the funds industry in this country andto thank him publicly for the good working relationship he developedwith the Central Bank. Let me also welcome Gary’s successor and say thatI look forward to maintaining a good dialogue with Pat Lardner: indeed,that has already begun.IFIA is an important representative body because the funds industry is animportant sector for Ireland. You are all well versed on the key statisticsthat illustrate this, in terms of assets under management (€1.2 trillion) ornumber of employees in the sector (some 12,000 or so).One statistic that is not so readily accessible – and required a bit ofdigging around – is the number of investors in Irish regulated funds orfunds supported by Irish fund administrators.There are in fact over 1.3 million such investors – a very significantnumber indeed.That shows the importance of the Irish market place in providing aservice to investors across Europe and the world.And, indeed, it shows the important responsibility that we both have – asindustry and regulator – in ensuring high standards of investor protection. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 38These investors place trust in the Irish system of regulation and ourreputation for maintaining high standards is vital to the success of theinternational financial services sector including the funds industry.The key message I have for you today is that getting the regulatoryframework right for investor protection is important for the reputation ofthe IFSC and the success of the funds industry.I want to explain that we have an opportunity to revisit and improve thatframework in Europe and domestically, with respect to our regulatoryprocesses, and by enhancing our approach to supervision.The starting point for approaching regulation of the fund sector should bean acceptance that funds are different.The traditional concerns of the prudential supervisor do not apply to thefunds industry.Nor do the traditional consumer protection issues relating to the salesprocess apply directly: these are not relevant to the fund or funds serviceprovider per se, but are picked up elsewhere in terms of the regulatoryframework applying to investment firms and intermediaries.Instead, our concern is one of investor protection along a number ofdimensions: ensuring that the investment that is available has anappropriate risk profile for the type of customer involved; ensuringadequate disclosure to investors so they can make an informed choiceabout risk. addressing operational risks related to valuation or protectionof assets; and, reducing the risk of fraud and other financial crimeproblems.There is also a new dimension to funds regulation, going beyond investorprotection and considering the systemic risks posed by particular aspectsof the sector, which I will return to at the end of these remarks.This different regulatory focus correctly argues for a different supervisoryapproach.This involves clear standards around investment products, which as youknow are mostly set at a European level. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 39As a supervisor, it means the focus of effort is on the authorisation processand ensuring robust arrangements are in place regarding the approval ofnew funds and ensuring adequate disclosure.Our supervisory model is also designed to place the emphasis of our workon the fund service providers – both administrators and custodians –rather than on the individual funds themselves.Bearing this supervisory model in mind, let’s explore the individualelements and consider what changes are afoot - and what scope there is tore-engineer the current regulatory framework.European DevelopmentsIt is right that we should start at the European level.The EU is of ever increasing importance to the funds industry.The volume of initiatives from Europe in financial services generally, butwith respect to funds in particular, seems at times overwhelming.The structure of regulation and standard-setting in Europe hasundergone fundamental changes, with the advent of the Europeansupervisory authorities including ESMA.And the rules that now emerge from Europe tend to have direct bindingeffect on financial services firms, rather than being transposed andsometimes modified by national authorities.The trend is for more Europe, affecting more parts of financial servicesregulation, with less national discretion.This means that engagement in Europe is more important than ever.At the Central Bank of Ireland our strategy has been to develop specialistpolicy teams responsible for key areas of European directives andregulations, to invest more time in the European and internationalpolicy-making processes, to be more focused in our goals and to get inearly, trying to influence European developments while they are still atthe formative stage. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 40It is important that industry also raises its game on engagement inEurope and I would encourage IFIA to carefully re-examine its strategyfor European advocacy to ensure it is having maximum impact.The need for engagement is immediate and pressing – and in the shortterm Ireland will have a central role to play as Presidency of the EU in thefirst half of 2013.This will be a big responsibility and will involve a number of complicatedand high-profile portfolios, such as banking union and resolution andMIFID II.And in the funds industry there will also be important portfolios,including UCITS V and UCITS VI.We expect the AIFMD to have mostly completed the EU legislativeprocess by the time our Presidency begins, although certain technicalstandards will remain to be issued.The finalisation of Level II requirements for the sector is imminent andsome important issues remain unresolved.The ball is currently in the Commissions court. A lot of disappointmenthas been expressed that some of the issues that were heavily debated inESMA - and where we believe sensible proposals were reached - havebeen revisited and changed.I can understand that sense of frustration.For example, we think its important to recognise that the business modelof the funds industry involves a significant degree of delegation andoutsourcing of activity.We hope that the final Level II text being developed by the Commissionreflects the very reasonable concerns that have been expressed bystakeholders and regulators in this area.In terms of UCITS V, there is still considerable debate on the appropriateliability regime for custody.I think it should be accepted that there will be alignment of the liabilityregime in UCITS V with the standards in AIFMD. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 41Given the substantial obligations which depositories will be asked tocomply with under AIFMD, we believe that UCITS V should mirror theserequirements, no more, no less.Also, the Central Bank will seek to ensure that Ireland’s rigorous butstreamlined approach to the licensing and supervision of depositories isreflected in UCITS V.On UCITS VI, we are at an earlier stage in the process of consultation.One central area of debate will be whether to revisit the types of assetseligible for investment in the UCITS structure.Our initial thinking at the Central Bank is that it would be inappropriateto restrict the current set of eligible assets or to impose generalrestrictions on OTC derivative instruments.However, the current “no look through rule” does deserve furtherexamination in relation to particular areas such as indices, where we haveseen the eligible asset restrictions arguably being circumvented.ESMA has already done some good work in its recent guidelines on theuse of indices, but there may be more that can be done.We can also expect the output from the debate on shadow banking andsystemic risk in the money market funds industry to feature heavily inUCITS VI.As I mentioned, I will come back to this topic of shadow banking a bitlater.Domestic DevelopmentsEurope will clearly be the main driver of the regulatory framework for thefunds industry in Ireland.But there is also, as you know, a domestic regulatory framework in placethat is not derived from EU law and which in many cases predates it.The implementation of the AIFMD provides an opportunity to revisit thisframework. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 42We are working hard on AIFMD implementation with the goal ofproviding certainty to industry as soon as possible.My colleague Gareth Murphy, who spoke to you last year, is chairing aworking group on AIFMD implementation involving representativesfrom the Department of Finance and industry.We will be consulting publicly on proposals very shortly.This process provides an opportunity to revisit our domestic frameworkfor non-UCITS funds.Let me take a little time to explain our approach and highlight one or twoissues under active discussion.We believe it is important to use the implementation of the AIFMD as anopportunity for a systematic rethink of our non-UCITS regime.Our current domestic regime has evolved piecemeal over many years inresponse to particular concerns and without any relevant EU standards torefer to.We now need to be prepared - in light of the implementation of this majorpiece of European legislation - to re-examine those elements of theexisting domestic framework.Our approach will be informed by the principals included in theTaoiseachs strategy for the international financial services sector, namelythe need to carefully re-examine the case for domestic standards whichexceed EU requirements, in terms of establishing that they are in thepublic interest.We are prepared to retain additional domestic standards if we believe thepublic interest test is met.But our starting point is of a rigorous case-by-case reassessment of theexisting domestic framework to see whether these domestic requirementsneed to be retained.For example, one issue under discussion is whether we should establish anew category of fund based purely on the minimum standards of theAIFMD. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 43This would provide a clear choice of a fund that is being managed in away fully compliant with the relevant EU standards for pass-porting fundmanagement without any additional domestic requirements on the fund,except as directly required by existing Irish law.This would be a major initiative and we want to see the matter very fullyconsidered before we decide on it.As an alternative, or perhaps even in addition, we are also undertaking arigorous reassessment of our non-UCITS qualifying investor regime.To what extent should the domestic standards for the QIF regime beadjusted to reflect the AIFMD?We are itemising the differences between the AIFMD requirements andthe QIF regime for funds and reviewing each in turn.For example, our current domestic regime sets specific requirements ondirected brokerage programmes.These requirements can be dis-applied in light of AIFMD where rules onconflicts of interest, best execution and annual account disclosureprovide adequate comfort to investors.This would seem to be a sensible area for potential adjustment.There are a number of other areas to be considered, which will each beexamined in turn.The introduction of the directive also provides an opportunity to revisitthe promoter regime for non-UCITS.The AIFMD now imposes significant requirements on fund managers,which would appear to meet many of the objectives of our currentdomestic promoter framework.We also believe there may be scope for us to provide additional guidanceon what we expect of directors when a fund runs into financial oroperational difficulties.In that context, we plan to consult on proposals to remove the currentpromoter regime at least for qualifying investor non-UCITS. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 44I should caution that our domestic framework for non-UCITS will remainin place where we believe it is in the public interest to do so.But were serious about rigorously and systematically challengingourselves as to which particular provisions are indeed appropriate toretain.This is a very big job. While we will have done a lot of work before goingto consultation, we will not have finalised our views on all these matters.We will present what we hope will be seen to be a well-consideredapproach, but we are very much open to submissions.Our public consultation will offer you a real opportunity to challenge anyaspect of the envisaged approach. I urge you to take that opportunity.Before I finish on the question of domestic regulation let me say a wordabout the important role that industry bodies can play in supporting goodstandards.I would like to commend IFIA and the funds industry more generally forrising to the challenge of developing its corporate governance code forfund service providers.This has helped raise standards in a pragmatic and sensible way.It has helped improve governance in the industry and provided a practicalframework regarding the number of directors at funds.You will have noted that a leading funds jurisdiction was heavily andprominently criticised for its approach to multiple directorship.By tackling this issue head-on in its corporate governance code, IFIA hashelped bolster the international reputation of the Irish fund sector.I should note that we will be revisiting our existing statutory codes forbanks and insurance companies next year.We will use that process to review the success and take-up of the IFIAcode.Also on the horizon, MIFID II will be coming into force before too longand will be prompting a reassessment of corporate governance standards _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 45for investment firms, which of course would include a number of fundservice providers.AuthorisationIf the starting point of the regulatory model for funds is about getting therulebook right - both in Europe and here in Ireland - it is equallyimportant to get the process of reviewing fund applications right.I tend to get very good feedback from industry sources about the qualityof our authorisation and approval process for funds, not just here inDublin but when I speak to industry participants in London and NewYork as well.But we think there is scope to get better yet.Mindful of industry expectations and also of the need to ensure aneffective and efficient use of resources, the Central Bank regularlyreassesses its internal processes and turnaround times for fundauthorisations.However, in this area, we still rely extensively on manual processes andhandling hard copies of documents.We want to move towards the receipt of information in electronic format.And we want to develop automated workflow processes to make us moreefficient.This is not just a matter of automating existing processes, but ofchallenging ourselves to ensure our process is as efficient as possible.We want to decompose the "as is" process for funds authorisation andrigorously assess it, challenging its individual component parts, beforeconstructing our "to be" process under this re-engineering exercise.Our intention is to engage closely with industry and to seek your advice:tell us which aspects of the current process could work even better.I caution that it will take a little time to implement these changes.We dont want to rush and destabilise the current platform which isworking well. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 46But we are committed to making improvements in efficiency without lossof effectiveness.These improvements go hand-in-hand with the introduction of onlinereporting by individual funds which we consulted on in June.The industry itself can play its part in improving the authorisationprocess.Sometimes the quality of applications can be uneven and incomplete.At other times some stakeholders - often those highly inventive andover-exuberant lawyers - can test the boundaries of what is an acceptableinterpretation of European law without giving sufficient consideration tothe difficult legal and policy questions involved.The funds industry continues to grow. Innovation is a key feature of itsprogress. Change is a positive driving force for all of us.While there will always be a natural tension between financial regulationand product innovation, the Central Bank is committed to proper andactive engagement with industry to resolve issues.We regularly take stock of our approach, drawing on the output ofquarterly meetings with IFIA, bi-lateral engagement with law firms andregular contact with fund promoters and investment managers at homeand abroad.And we press matters with our colleagues in Europe when necessary.SupervisionWhat then of our approach after authorisation, namely to supervision?In our view, the structure of the industry here in Ireland and the risks thatit poses to the Central Bank’s objectives means that the principal (but notexclusive) focus of our supervisory effort should be on the fund serviceproviders.These are the management companies, fund administrators andcustodians that are so important in ensuring the key elements of investorprotection, such as accuracy of valuation and safeguarding of assets. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 47Indeed, it is impractical (or at least prohibitively expensive) to have closesupervisory engagement with all individual funds.This supervisory model is reflected in our PRISM system, which is thenew framework for risk-based supervision that the Central Bank hasimplemented for all firms operating in the Irish financial services sector.PRISM operates by calculating an impact categorisation of our more than10,000 regulated entities to allow us to decide on the level of engagementand therefore resources we will apply to any individual firm.Under PRISM, fund service providers tend to have a higher impactcategorisation, with more subsequent engagement from supervisors (andwill therefore pay more).As part of the introduction of the PRISM process there have been a fewstructural changes in the way Supervision is operated by the CentralBank.On the ground, the differences you will note if your firm is in this categoryare more effective liaison with your direct supervisory team as well asmore frequent on-site visits with yourselves by my staff.I will be asking my supervisors to look more closely at where thoseinvestor protection and financial stability risks I talked about earlier exist,including challenging assumptions that lie behind business models andstrategies in the sector and the governance, systems and controls thatunderpin them.In contrast, each individual fund, in itself, has a limited potential impacton financial stability and investors in the event of failure - and so, each ofthe more than 5,000 funds domiciled in this jurisdiction - cannot andshould not expect the same level of supervisory engagement as affordedto the fund service providers.Our supervisory model, however, does provide capacity for us to react totriggers and problems that emerge in individual funds as well as randomspot-checks.We will also increasingly rely on the use of our thematic supervisory tool,namely examining a specific issue across a cross-section of institutions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 48Shadow BankingWhile individual funds may be low impact entities in our supervisorymodel, the funds industry is of course a high impact sector viewedcollectively.This is not just a question of investor protection.Increasingly, the interest of the international regulatory community isdirected at the level of systemic risk posed by particular parts of the fundsindustry, namely money market funds.The backdrop to this interest is the risk of investor runs on money marketfunds as a result of a threat of breaking the buck and the onward impactof such a run on the markets in which those money market funds areinvested.As you are no doubt aware, this is clearly on the regulatory agenda at theG20, in IOSCO, at the European Commission and also in the US at theSEC.A few concluding thoughts on the regulatory agenda in this area.My first high-level message, is that the industry in Ireland must beprepared for change.During the financial crisis, investor runs on MMFs led to a disruption inthe flow of finance to the real economy and necessitated dramaticinterventions by public financial authorities.The Central Bank believes that regulatory reform should focus on theneed to reduce the probability of investor runs, to curb implicit supportfrom sponsors and to reduce the need for support from the taxpayer.In order to avoid disruptive industry shifts, my preference is forinternational alignment between Europe and the US in this area.It appears that the SEC will not be driving further regulatory reform in theshort term.European action may be needed to drive matters forward. IOSCO alsohas an important role to play. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 49But it is critically important that the U.S. perspective continues to bearticulated and heard.The optimal outcome remains a shared perspective across the Atlantic onreducing the risk of runs in this sector and we must do everything we canto ensure that we can continue to move towards that goal.What action should Europe take now?Market conditions in European Prime MMFs which are earning negativeyields may pre-empt the conclusions of the FSB and other policydecision-makers. As you know, some promoters are contemplating new structures whereinvestors earn negative returns.We should see how this plays out and in particular the investor responseto the structures that the promoters offer.In the meantime, consultation exercises on this very question are welladvanced and the Central Bank has actively engaged in this debate.Having regard for the experience of MMFs during the financial crisis andmore importantly for the low risk appetite of MMF investors for capitallosses, the Central Bank’s view is that a mandatory switch from constantnet asset value to variable net asset value does not adequately address thefundamental problem of whether an investor run on a money market fundmay take place - though we would acknowledge it may affect the dynamicof that run.Substantial reform can be achieved through a range of measures such ascapital buffers, dilution levies for exiting investors and tighter liquiditymeasures.Indeed, it would appear that one of the recommendations of IOSCO -which was mandated by the FSB to look at MMFs as part of the ShadowBanking system - is to seek tighter rules on the liquidity of MMFs so as toensure that there is enough liquidity to meet redemptions.It is worth noting that the SEC addressed this with their MMF reforms in2010. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 50The other key issue exposed by the financial crisis was that investorsexpected sponsors to support MMFs where assets show excessivevolatility to the downside.This in turn put pressure on the liquidity position of the sponsoringinstitution which was invariably a bank with access to a central bankliquidity window.Future reform of the MMF industry should ensure that any insurance thatthis ‘recourse to sponsor’ provides is properly charged to MMF investors.In this regard, one of the other IOSCO recommendations is likely to bethe mandatory requirement of gates as a redemption tool, which to ourthinking would be sensible.Where support from a sponsor is implicit it should be made explicit,though it is worth acknowledging that this may have implications for thecapital requirements of the sponsor.Whatever the detail of the reforms for money market funds, change iscoming and it will be significant.As I said, my key message is to engage in the debate and be prepared toadapt.ConclusionThe more than 1.3 million investors who rely on the Irish fund sectorhighlight the need for robust standards of investor protection in ourmarket.Funds may be different from other financial services sectors, but it is stillvitally important to get the right regulatory framework in place so thatinvestor protection is assured.This will improve the reputation of Ireland as an international financialservices sector and support the success of the funds industry.There is an opportunity to re-examine the different elements of thatregulatory framework for investor protection: the standards in place at aEuropean level and domestic level, the processes the Central Bank uses to _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 51authorise new funds, the supervisory framework applied to the sector, andthe emerging standards relating to Shadow Banking.As I have explained, the Central Bank is committed to a level of highengagement with Europe in crafting that framework - and to rigorouslyreassessing our domestic framework, processes and supervisoryapproach.We would encourage IFIA and the Irish fund sector to play its part in thisprocess by contributing to the regulatory dialogue at the European andIrish level, by offering constructive ideas to address the changingregulatory priorities of the post financial crisis world, and by maintaininghigh standards of practice in the Irish market that ensure a continuedreputation for high standards of investor protection. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 52NUMBER 42012 Monetary Policy ReleasesInformation received since the FederalOpen Market Committee met inAugust suggests that economicactivity has continued to expand at amoderate pace in recent months.Growth in employment has been slow, and the unemployment rateremains elevated.Household spending has continued to advance, but growth in businessfixed investment appears to have slowed.The housing sector has shown some further signs of improvement, albeitfrom a depressed level.Inflation has been subdued, although the prices of some key commoditieshave increased recently.Longer-term inflation expectations have remained stable.Consistent with its statutory mandate, the Committee seeks to fostermaximum employment and price stability.The Committee is concerned that, without further policyaccommodation, economic growth might not be strong enough togenerate sustained improvement in labor market conditions.Furthermore, strains in global financial markets continue to posesignificant downside risks to the economic outlook.The Committee also anticipates that inflation over the medium termlikely would run at or below its 2 percent objective. To support a stronger economic recovery and to help ensure thatinflation, over time, is at the rate most consistent with its dual mandate,the Committee agreed today to increase policy accommodation bypurchasing additional agency mortgage-backed securities at a pace of $40billion per month. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 53The Committee also will continue through the end of the year its programto extend the average maturity of its holdings of securities as announcedin June, and it is maintaining its existing policy of reinvesting principalpayments from its holdings of agency debt and agency mortgage-backedsecurities in agency mortgage-backed securities.These actions, which together will increase the Committee’s holdings oflonger-term securities by about $85 billion each month through the end ofthe year, should put downward pressure on longer-term interest rates,support mortgage markets, and help to make broader financial conditionsmore accommodative. The Committee will closely monitor incoming information on economicand financial developments in coming months.If the outlook for the labor market does not improve substantially, theCommittee will continue its purchases of agency mortgage-backedsecurities, undertake additional asset purchases, and employ its otherpolicy tools as appropriate until such improvement is achieved in acontext of price stability.In determining the size, pace, and composition of its asset purchases, theCommittee will, as always, take appropriate account of the likely efficacyand costs of such purchases. To support continued progress toward maximum employment and pricestability, the Committee expects that a highly accommodative stance ofmonetary policy will remain appropriate for a considerable time after theeconomic recovery strengthens.In particular, the Committee also decided today to keep the target rangefor the federal funds rate at 0 to 1/4 percent and currently anticipates thatexceptionally low levels for the federal funds rate are likely to bewarranted at least through mid-2015. Voting for the FOMC monetary policy action were: Ben S. Bernanke,Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke;Dennis P. Lockhart; Sandra Pianalto; Jerome H. Powell; Sarah BloomRaskin; Jeremy C. Stein; Daniel K. Tarullo; John C. Williams; and Janet L.Yellen. Voting against the action was Jeffrey M. Lacker, who opposedadditional asset purchases and preferred to omit the description of the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 54time period over which exceptionally low levels for the federal funds rateare likely to be warranted. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 55NUMBER 5Economic Activity, Prices, andMonetary PolicySpeech at a Meeting with Business Leaders in YamaguchiRyuzo Miyao. Member of the Policy BoardIntroductionThank you for giving me this opportunity to exchange views with peoplerepresenting Yamaguchi Prefecture, who have taken time to be heredespite their busy schedules.Allow me to also express my gratitude for your cooperation with theactivities of the Bank of Japans Shimonoseki Branch.Today I will review economic activity and prices in Japan, whoseeconomy is heading toward recovery despite the effects of the globaleconomic slowdown, and then discuss the Banks monetary policy.My concluding remarks will touch briefly on the economy of YamaguchiPrefecture. Following my speech, I would like to listen to your views onthe actual situation of the local economy and your candid opinions.I. Recent Developments in Economic Activity and PricesA. OverviewAfter the turn of the year, economic activity in Japan started picking upmoderately; domestic demand has been firm, supported mainly byreconstruction-related demand and policy effects.While overseas economies as a whole are still in a deceleration phase,domestic economic activity has also been firm.Domestic demand -- including private consumption, public investment,and housing investment -- has been improving and this improvement hascompensated for a delay in recovery in production and exports due to a _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 56slowdown in external demand.As for the outlook, while Japans economy is expected to return to amoderate recovery path as domestic demand remains firm and overseaseconomies emerge from their deceleration phase, there is an increasingrisk that a recovery in overseas economies will be delayed, which warrantsattention.I will first review the recent developments in overseas economies,followed by the current situation of and the outlook for Japans economy.B. Overseas EconomiesEconomic sentiment, mainly in the corporate sector, has becomecautious globally, and there is an increasing risk that the slowdown in theglobal economy will be a protracted one.In the European economy, particularly in Spain, Italy, and otherperipheral countries, an adverse feedback loop encompassing the fiscalsituation, the financial system, and the real economy has been operating,and a sense of stagnation has been increasing as a whole.In addition, given that a decline in demand in peripheral countries hasstarted to affect household and business sentiment in core countries suchas Germany, partly through a decline in intra-regional exports, and thatlong-term interest rates in Spain and Italy have remained high, thereappears to be an increasing risk that economic recovery will be delayed.As for the European debt problem, since the Greek crisis that began inMay 2010, for more than two years a process has continued in whichgovernments respond only intermittently to pressure from the markets.If this process continues into the future, stagnation in peripheralcountries might start to feed back into core countries and the stagnationin the European economy might become even more prolonged andaggravated, weighing on the global economy.This is a matter of concern. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 57Looking at the background of this problem from a longer-termperspective, we need to recognize the merits and demerits of thesingle-currency euro in the 13 years since its introduction.On the merit side, one can point out that the absence of foreign exchangerisks within the region and reduced transaction costs stimulatedintra-regional trade and investment, and that the converging low level ofinterest rates in member countries for more than ten years induced anexpansion in economic activity.On the demerit side, one can point out that the converging low level ofinterest rates encouraged loose fiscal spending, and this, together with anoptimistic economic outlook, led to a bubble in the real estate market.In addition, necessary structural reforms, including labor market reformaimed at containing labor costs, did not progress and the disparity incompetitiveness within the region was left unaddressed.In a sense, we can say that the European debt problem represents thesurfacing of the demerits accumulated over a period of more than tenyears, so it should not be a surprise that the resolution of the problem willtake a long time.Having said this, with an aim of resolving the problem as quickly aspossible, it is necessary for European leaders to respond appropriately tothe challenges, such as improving fiscal conditions in peripheralcountries and enhancing growth in Europe, as well as to present aspecific roadmap for the longer-term challenges of forming a bankingunion, issuing Eurobonds, and pursuing fiscal integration, and therebydispelling uncertainties regarding the euro zone economies.In this regard, while some gradual achievements have been made, theEuropean leaders are expected to show further leadership.While the U.S. economy has been recovering moderately, supported byaccommodative financial conditions, the pace of the recovery seems to beslowing somewhat. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 58The real GDP growth rate for the April-June 2012 quarter (seasonallyadjusted; the annualized growth rate compared with the previous quarter)rose to only 1.7 percent, and growth decelerated in domestic demand,including private consumption, business fixed investment, and housinginvestment.While economic indicators since July have been mixed, what concerns meis that there seem to be signs of weakening in the buoyant corporatesector, which has been supporting the recovery in the household sector.Let me amplify this point.In the household sector, private consumption has been firm on the backof moderate improvement in employment and income, and housing startsand sales have shown signs of bottoming out, while a balance-sheetadjustment has been progressing as seen in a gradual decline in the ratioof debt to disposable income.On the other hand, in the corporate sector, sluggishness in exports anddeterioration in business confidence have become apparent, reflectingthe European debt problem and a slowdown in the Chinese economy.So far, given that corporate profits and business fixed investment havebeen firm and the household sector has been generally solid, it seems thatthe recovery mechanism originating from the corporate sector remainsactive.However, I recognize that attention should be paid to the possibility thatemployment and business fixed investment will be hampered by a furtherworsening in business confidence, thereby leading to an economicslowdown.As for a future risk to the U.S. economy, in addition to a delayedeconomic recovery in Europe and China, I would point to the "fiscalcliff" problem.While a cut in fiscal spending and expiration of a tax reduction aredownside factors for economic activity, the range and size of the factors _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 59are highly uncertain at present, and are factored into the U.S. economicoutlook differently by private research institutions.Some point out that because of uncertainty associated with the problem,firms have already been deferring investment and new hiring, and weneed to be alert to how the situation will evolve going forward.In the meantime, in U.S. financial markets, stock prices have bouncedback to a level prior to the Lehman shock, and long-term interest rates --despite rising somewhat – have generally been hovering at low levels.As for the Asian emerging economies, a decelerated pace of growth hasbecome somewhat protracted due to the recent slowdown in exports toEurope, but the economies are likely to pick up the pace of growth led byChina.Attention should be paid, however, to the possibility that the timing of arecovery will be delayed to the autumn or later.As for the Chinese economy, the effects of the authorities policymeasures have started to emerge, including an increase in new lendingand the bottoming out in housing prices, but future economic indicatorsneed to be monitored carefully, since stagnation in the Europeaneconomy has been spreading to the Chinese economy through trade andconcern over an increase in inventories has not been dispelled.As for the NIEs and the ASEAN economies, domestic demand has beenstrong, but it is a matter of concern that indicators related to exports andproduction have recently been sluggish or deteriorating in economies likeSouth Korea and Taiwan.I believe that a key to the future of these economies will be whether Chinaregains its pace of growth and their exports recover.From a longer-term perspective regarding the sound development of theglobal economy, it is critical that the Asian emerging economies maintaina balance between economic growth and price stability. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 60In particular, for China -- which is expected to lead the global economytogether with the United States -- careful attention should be paid tofuture developments, including whether economic policy management ismaintained smoothly following the appointment of the new Chineseleadership.C. Economic Activity and Prices in JapanIn Japan, economic activity as a whole has been picking up moderately,with domestic demand improving mainly due to reconstruction-relateddemand and policy effects, which has compensated for a delay in recoveryin production and exports due to a slowdown in external demand.The real GDP growth rate (seasonally adjusted; the annualized growthrate compared with the previous quarter) was high at 5.5 percent in theJanuary-March 2012 quarter and maintained steady growth in theApril-June quarter at 1.4 percent.To elaborate on this, amid the continued slowdown in overseaseconomies, a pick-up in exports has been slowing and production --affected by the slowdown in exports -- has also been relatively weak.As for domestic demand, public investment has continued to increaseand business fixed investment has been on a moderate increasing trendwith improvement in corporate profits.Private consumption has continued to increase moderately due partly tothe effects of measures to stimulate demand for automobiles, and housinginvestment has generally been picking up.At the same time, there are signs of concern.There is some inventory stockpiling on the back of the continuedslowdown in exports and production; machinery orders, a leadingindicator of business fixed investment, have shown signs of weakening;the coincident index in the Indexes of Business Conditions has beenshifting from "improving" to "weakening"; and indicators of businesssentiment are showing signs of weakening. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 61While the economy as a whole has been improving, causes for concernseem to have increased in number.As for the outlook, Japans economy is expected to return to a moderaterecovery path as domestic demand remains firm and overseas economiesemerge from their deceleration phase.Such a scenario can be confirmed in the forecasts of the majority of thePolicy Board members; in terms of the median forecast as of July 2012,real GDP was projected to grow at 2.2 percent in fiscal 2012 and 1.7percent in fiscal 2013.These forecasts are associated with upside and downside risks, and I ampaying greater attention to the downside risks, as follows.First, there is a risk of overseas economies slowing further.As I have already mentioned, the risk that the economic slowdown inEurope, the United States, and Asia will become protracted has increasedsomewhat, and if the slowdown actually becomes protracted, it willweaken Japans move toward a self-sustaining recovery in whichincreases in exports andproduction lead to an increase in income and spending.Second, there is a risk of further appreciation of the yen.While a positive case can be made for yen appreciation to a certain extent,excessive appreciation will worsen the competitiveness and profits ofexporting firms again and act as a headwind against firms.If a trend of falling stock prices intensifies, together with the trend of yenappreciation, then firms and households confidence will deteriorate andcurrently solid business fixed investment plans and private consumptionwill be contained, which will weigh on Japans economic recovery.Third, there is a risk related to the first and second risks: a risk that thetiming of recovery in exports and production will be delayed and thetransition from domestic demand to external demand will not occur as _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 62expected. Since subsidies for environmentally friendly cars have alreadyused a large portion of the budget and growth in reconstruction-relateddemand is likely to slow down from the second half of fiscal 2012 onward,we need to carefully monitor whether external demand will recover bycompensating for a slowdown in domestic demand.In addition, attention should be paid to whether ambitious business fixedinvestment plans will be steadily implemented and whether the moderateimproving trend in employment and income conditions will bemaintained.In the meantime, consumer prices (all items less fresh food; on ayear-on-year basis) have so far been hovering around 0 percent in 2012.A baseline scenario for the outlook for prices is that the year-on-year rateof change in consumer prices will hover around 0 percent for the timebeing, and subsequently increase moderately as aggregate supply anddemand balance improves.In the forecasts of the majority of the Policy Board members, in terms ofthe median forecast as of July 2012, the year-on-year rate of increase inconsumer prices was projected to be 0.2 percent in fiscal 2012 and 0.7percent in fiscal 2013.While there are also upside and downside risks to prices, I am payinggreater attention to downside risks, given that concern over the economicoutlook has been increasing and a decline in commodity prices duringthe first half of fiscal 2012 will put downward pressure on prices for thetime being.Attention should also be paid to the effects of the continued lowshort-term inflation expectations on future price developments.II. Monetary PolicyA. Conduct of Monetary PolicyLet me now discuss the Banks efforts to enhance monetary easing. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 63The Bank introduced comprehensive monetary easing in October 2010,and has subsequently been enhancing monetary easing.Comprehensive monetary easing comprises three measures: the virtuallyzero interest rate policy of maintaining the uncollateralized overnight callrate at around 0 to 0.1 percent; purchases of financial assets through theAsset Purchase Program (hereafter the Program); and the clarification ofthe policy time horizon, that is, the clarification that such measures willremain in place until the Bank judges that price stability is in sight.At the February 2012 Monetary Policy Meeting, to further clarify theBanks stance toward overcoming deflation, it introduced "the pricestability goal in the medium to long term."That is an inflation rate the Bank judges as consistent with price stabilitysustainable in the medium to long term.At present, "the Bank judges the price stability goal in the mediumto long term to be within a positive range of 2 percent or lower in terms ofthe year-on-year rate of change in the CPI and, more specifically, sets agoal at 1 percent for the time being."On this basis, the Bank will continue pursuing powerful easing until itjudges that the 1 percent goal is in sight.The Program was established with the aim of encouraging a decline inlonger-term interest rates and various risk premiums mainly through thepurchase of financial assets.The Bank established the Program on its balance sheet and has beenpurchasing various financial assets, such as government securities,commercial paper (CP), corporate bonds, exchange-traded funds (ETFs),and Japan real estate investment trusts (J-REITs) as well as conductingthe fixed-rate funds-supplying operation against pooled collateral.Since its establishment, the total size of the Program has been increasedfrom time to time. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 64It was expanded further in February and April this year, and at present theBank is scheduled to increase the outstanding amount of the Program toabout 65 trillion yen by around end-2012 and to about 70 trillion yen byaround end-June 2013, thereby pursuing powerful monetary easing.In particular, for asset purchases, the total size has expanded from 5trillion yen at the time of introduction to 45 trillion yen, and the purchaseof long-term government bonds has increased substantially from 1.5trillion yen to 29 trillion yen.At the April Monetary Policy Meeting, the Bank decided to extend theremaining maturity of government bonds and corporate bonds to bepurchased under the Program from "one to two years" to "one to threeyears."In addition, in July, with the aim of ensuring that the target outstandingamount of the Program is met, the Bank removed the minimum biddingyield (previously 0.1 percent per annum) for outright purchases of treasurydiscount bills and CP, and revised the composition of the Program.The outstanding amount of the Program as of August 20, 2012 stood atabout 58 trillion yen, and a further increase of about 12 trillion yen will benecessary by around end-June 2013.The Bank will continue to steadily increase the outstanding amount ofthe Program as scheduled.Under such powerful monetary easing, market interest rates have been atextremely low levels.The overnight call rate has been at a level below 0.1 percent, yields ofgovernment bonds with remaining maturities up to three years are around0.1 percent, and yields on 10-year government bonds are at the extremelylow level of around 0.8 percent.As for firms funding costs, the average contracted interest rates on newbank loans and discounts have declined to about 1 percent and spreads ofcorporate bonds and CP have been stable at low levels. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 65As a result, financial conditions viewed from the fund-raising side havebeen accommodative.B. Monetary Policy and Long-Term Interest RatesIn considering the effects of such monetary easing, let me summarize therelationship between monetary policy and long-term interest rates.This is also important for understanding the background of the currenthistoric low levels of long-term interest rates in advanced countries.Let us recall how long-term interest rates are determined.Long-term interest rates are considered to be determined mainly by twofactors: first, the forecast of future short-term interest rates, and second,an extra interest rate required for risk associated with long-term bondinvestment.Regarding the first factor, if the future economic growth rate or the futureinflation rate is forecasted to increase, for example, then the future path ofshort-term interest rates will rise accordingly and one can expect a higherreturn by investing repeatedly in short-term bonds.As a result, demand for long-term bonds will decline and prices of thebonds will fall and yields will increase.As for the second factor, long-term bond investment is associated withrisks.It might become necessary to exchange bonds for cash before maturity isreached, and in such a case there will be uncertainty about the sellingprice.As compensation for taking such risks, an extra yield -- the risk premiumor term premium -- is required and the long-term interest rate will rise tothat extent. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 66Based on such a mechanism, let me summarize the effects of a centralbanks asset purchases, more specifically purchases of long-termgovernment bonds, in two parts.First, there is the effect through the aforementioned risk premium, whichfocuses on supply and demand in asset markets.This effect is called the "portfolio balance channel."When a central bank purchases government bonds in the bond marketand absorbs the amount of bonds in circulation, the bond price will riseand the yield will decline.In this case, as the price change is due to the supply and demand factor,the risk premium will decrease and long-term interest rates orlonger-term interest rates in general will fall.Second, there is the effect through the risk-neutral forecast of futureshort-term interest rates.If an implementation or announcement of a nontraditional policy actionof asset purchases is interpreted as a signal that a central bankseconomic and price forecasts have worsened further, then the forecastedduration of a zero interest rate might lengthen and the future path ofshort-term interest rates will decline, and longer-term interest rates --mainly in the short- to medium-term zone -- will decline accordingly.Or if a central banks asset purchases are received as a signal that acentral banks future policy stance has changed -- for example, a centralbank takes more aggressive policy responses in the face of developmentsin economic activity and prices, or there is an adjustment in the policygoal -- the forecasted path of short-term interest rates will decline, andlonger-term interest rates -- mainly in the short- to medium-term zone --will decline accordingly.Both of these effects encourage a decline in longer-term interest rates. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 67What is more important, however, is whether such a decline leads to animprovement in a wider range of financial conditions and, through anincrease in spending, eventually stimulates economic activity and prices.If such transmission mechanism is forecasted to work, then it will putupward pressure on long-term interest rates in terms of both effects.Let me elaborate on this point.As one effect of a decline in longer-term interest rates due to governmentbond purchases, it is expected that confidence will improve amonginvestors, firms, and households, thereby encouraging a shift ofinvestment from government bonds and other safe assets to a wider rangeof risk assets, such as corporate bonds, equities, and overseas assets, andthis in turn will lower risk premiums of these assets and increase assetprices.This can be considered a portfolio balance effect in a broad sense andmeans an improvement in wide-ranging financial conditions.In such a situation, demand for government bonds will decline and therewill be a certain amount of upward pressure on term premiums ofgovernment bonds (that is, a rise in the extra interest rate required for riskassociated with long-term bond investment).In addition, if spending is forecasted to increase with a longer andvariable time lag, thereby stimulating economic activity and prices, it willshift upward the forecast path of short-term interest rates, steepen theyield curve, and put upward pressure on long-term interest rates (that is, arise in the forecast of future short-term interest rates).While encouraging a decline in longer-term interest rates on one handand expecting a rise in long-term interest rates in the longer run on theother hand seems contradictory at first glance, in fact it is nothing of thekind.Then, how should we understand the fact that long-term interest rates inadvanced countries have been hovering at historic low levels? It seems _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 68that a declining trend in these countries long-term interest rates involvesthe effects of powerful monetary easing, including asset purchases.More recently, the trend of risk aversion on the back of concern over aslowdown in the global economy and the European debt problem hasbeen further encouraging a decline in long-term interest rates.Some say that a 1 percent yield on 10-year government bonds in theUnited States and Europe is quite low, based on a general recognition ofthe long-term potential growth rate and inflation expectations.In the United States, the level of the target policy interest rate in thelonger run is expected to be about 4 percent, according to the economicprojections by Federal Open Market Committee (FOMC) members.If such views are correct, this can be interpreted to mean that riskaversion, or a preference for safety, in the government bond markets hasbeen firmly maintained.And this might work as a headwind for what I mentioned earlier, thetransmission mechanism of stimulating economic activity and pricesthrough the portfolio balance effect in a broad sense.Naturally, greater attention is warranted as to whether the current sourcesof concern regarding the slowdown in the global economy and theEuropean debt problem will return to normal or continue to weigh on theglobal economy and cause further deterioration.C. The Need to Strengthen Growth PotentialFor Japans economy to overcome deflation and return to a sustainablegrowth path, both support from the financial side and efforts tostrengthen growth potential are necessary.Thus far, I have discussed support from the financial side.To strengthen growth potential, it is important for every member ofsociety, from his or her standpoint, to make positive efforts steadily to _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 69boost growth potential. Such steps will also help increase the stimulativeeffect of powerful monetary easing on economic activity and prices.Of course, to genuinely strengthen growth potential, a certain period oftime is necessary, since such efforts need to occur in concert with othermeasures, including implementation of economic and fiscal structuralreforms.This is obvious even without citing the example of Europe, and if growthpotential increases through the simultaneous pursuit of aggressive effortsfrom the financial side to overcome deflation and economic and fiscalstructural reforms, it will lead to favorable effects on the fiscal side,including an increase in tax revenue.In this regard, in July 2012, the government compiled the ComprehensiveStrategy for the Rebirth of Japan, which prioritizes key issues.These comprise policy packages such as the "Green Growth Strategy"(aimed at realizing an innovative energy and environment-orientedsociety), the "Health/Life Science Growth Strategy" (aimed at achievinga society with the worlds leading health and medical care and welfare),and the "Agriculture, Forestry and Fisheries Revitalization Strategy"(which seeks to double the vitality of regions driven by agriculture,forestry and fisheries).The government has presented specific strategies and their timetable.In addition, bills related to the comprehensive reform of the socialsecurity and taxation systems passed recently in both the House ofRepresentatives and the House of Councillors, marking an important stepforward in maintaining public confidence in medium- to long-term fiscalsustainability.The Bank has also been implementing the Fund-Provisioning Measure toSupport Strengthening the Foundations for Economic Growth, and hasbeen supporting financial institutions individual initiatives. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 70The measure provides long-term funds for up to four years at a lowinterest rate -- currently 0.1 percent -- to financial institutions carrying outlending and investment in growth areas, and was launched in June 2010with the initial ceiling on the outstanding amount of loans at 3 trillion yen.Subsequently, the Bank introduced a new lending arrangement for themeasure, through which it extends loans to financial institutions for theirequity investment and asset-based lending (ABL) without conventionalcollateral or guarantees.This year, the Bank increased the ceiling for the outstanding amount ofloans under the main rules for the measure from 3 trillion yen to 3.5trillion yen, and established special rules for another new lendingarrangement for small-lot investments and loans as well as for a new U.S.dollar lending arrangement.The current outstanding balance of the total loans disbursed by the Bank,including those extended under the special rules, is approximately 3.3trillion yen.The Bank will continue to do its utmost to contribute to strengthening thefoundations for economic growth.I have now discussed recent monetary policy in Japan.In the actual conduct of monetary policy, the outlook for economicactivity and prices should be carefully examined and, if judged necessary,meticulous and decisive measures should be taken.The Bank will continue to steadily pursue powerful monetary easing byincreasing the outstanding amount of the Asset Purchase Program asscheduled.The Bank will strive to conduct proper monetary policy, and closelymonitor developments in international financial markets and do itsutmost to ensure the stability of the financial system in Japan. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 71Concluding Remarks: The Economy of Yamaguchi PrefectureMy conclusion will touch on the economy of Yamaguchi Prefecture.In my view, the economy of Yamaguchi Prefecture enjoys a number ofcompetitive advantages.The first is its location, since it is close to other East Asian countrieswhere demand has been expanding markedly.Second, it enjoys a concentration of basic materials industries withgrowth potential -- mainly the chemical industry, which accounts formore than 40 percent of the industrial production index.And third, the prefecture has the nations highest labor productivity,mainly in basic materials industries.Recently the region has experienced a series of negative events, such asaccidents at the plants of major chemical manufacturers, together withthe withdrawal and closure of factories of several electronics componentsmanufacturers.On the positive side, however, amid concern over the hollowing out ofdomestic industries due partly to the appreciation of the yen at thenational level, firms in the prefecture as a whole -- comprising mainlymanufacturers -- have maintained their vigorous investment stance.In fact, the Banks Shimonoseki Branchs Tankan (Short-TermEconomic Survey of Enterprises in Japan), released on July 2, showed thatthe business fixed investment plan of Yamaguchi Prefectures firms forfiscal 2012 was likely to maintain a substantially higher growth rate thanthat of Japan as a whole.The prefecture recorded a year-on-year growth rate of 12.4 percent,compared with Japans a year-on-year growth rate of 4.0 percent.In fiscal 2011, the business fixed investment plan of the prefectures firmsalso exceeded that of Japan. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 72As specific examples of this, in fields related to chemicals,next-generation energy, and medical care, there have been moves amonglocal firms to pursue overseas expansion in existing fields with potentialfor an increase in global demand in the medium to long term, and somelocal firms are actively conducting additional investment to increasecapacity or research and development in high-value-added areas withpotential for growth.For example, in connection with the growing need for energyconservation by firms and households, small and medium-sizedconstruction firms have entered the geothermal air-conditioningbusiness.An increasing number of firms have been making such moves.I expect that local firms, by utilizing their characteristics and strengths,will proceed with reforms to nurture new areas with potential for growth,achieving further development.In addition, Yamaguchi Prefecture enjoys extremely bountiful resourcesfor tourism, with numerous attractive sightseeing areas as well as scenicspots and historic sites, and many excellent structures, including thehistoric Kintai Bridge, which harmonizes beautifully with its surroundingnatural landscape.Efforts are proceeding to draw on these ample resources for tourism,mainly by the prefectural government and cities, and thereby promote thetourism industry.I expect that by coordinating its regional characteristics and strengths,the tourism industry will generate further momentum. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 73NUMBER 6The U.S. Economic Outlook and Implications forLatin AmericaDennis P. LockhartPresident and Chief Executive OfficerFederal Reserve Bank of AtlantaLatin American Chamber of Commerce and the WorldAffairs CouncilKey pointsFederal Reserve Bank of Atlanta President Dennis Lockhart says that inthe 1980s, during the so-called "lost decade" in Latin America, manycountries experienced economic turmoil, with low growth, high inflation,and financial crises.The regions real GDP growth averaged about 2 percent.After this lost decade, most Latin American policymakers began topursue more prudent macroeconomic and fiscal policies, opening theireconomies to global markets and trade.Lockhart says this policy transformation has strengthened the economicties between the United States and Latin America.Latin American countries showed impressive resilience during and sincethe financial crisis of 2008, coming through this period without severedownside effects.However, Lockhart notes that several Latin American countries haveexperienced sizeable capital flows that have uniquely challenged theireconomies.Lockhart says that the recovery in the United States has seen weak growthand high unemployment—attributable, at least partly, to fundamentalimbalances that have not yet been corrected. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 74There is a risk to monetary policy being employed too aggressively andwithout effect to address economic problems that can be resolved only byfiscal reforms.The SpeechThanks to the Latin American Chamber of Commerce and the WorldAffairs Council of Atlanta for the opportunity to speak about the state ofeconomic relations between the United States and Latin America.Thanks also to Georgia Power for providing this outstanding venue.Let me begin by saying that the Atlanta Fed has a strong connection toLatin America.Our supervision and regulation team oversees branches and subsidiariesof a number of Latin American banks in our district, particularly inMiami.Our research department monitors the economic performance of theeconomies of the region, and our economists interact with colleaguesincluding central bank officials in Latin America.Last October, for instance, our chief economist and I attended aconference sponsored by the Banco Central de Chile and later visited thecentral bank of Brazil. I will relate impressions from that trip in amoment.The Atlanta Fed leads the retail payments operations of the FederalReserve System.Our FedGlobal ACH service executes small ticket money transfers fromU.S. banks to banks in some 35 countries, including 12 in Latin America.Our first international partner was the central bank of Mexico.Through our Directo a México program, we help Mexican authoritiesreach underserved and unbanked consumer markets. In addition, our _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 75community and economic development team does outreach work herewith immigrants from Latin America.Finally, and very significantly, our international cash operation in Miamisends and receives U.S. dollar banknotes working with Latin Americancentral banks and commercial banks in the region. More later on this, too.All of these programs are under the umbrella of our Americas Centerinitiative, headed by Stephen Kay. I also have a deep personal interest inthe region, where I had many business ties in my previous career.The title of this speech is "The U.S. Economic Outlook and Implicationsfor Latin America," but I would like to expand the idea of my talk toinclude the experience of Latin America and implications for the UnitedStates. I think the world can learn much from the path taken by manyLatin American countries since the 1980s.There has been great progress economically in recent years in LatinAmerica.As these economies have stabilized and matured, the economic tiesbetween the United States and Latin America have grown.It is my view that the policy reforms and the resulting transformationsweve seen in the economies of the region contain important lessons forthe rest of the world.Latin America, 1980s and nowIll begin by looking back at the 1980s, the so-called "lost decade" inLatin America, and contrast the regions economies then to today.The 1980s was a time of economic turmoil, with low growth, high inflation,and financial crises—more specifically, sovereign debt crises. Its quite adifferent picture today.The region is now far more stable.Most countries of the region now pursue economic policies resulting in _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 76higher growth and price stability. Democratic governance is the norm.In the 1980s, Latin Americas real GDP growth averaged around 2 percent.From 2004 through 2011, annual GDP growth averaged 4.5 percent.And during the recent global financial crisis, the regions economiesproved resilient, with a relatively shallow decline followed by a rapidrecovery.By the 1980s, many countries had spent years pursuing protectionistimport-substitution industrial policies that essentially closed theircountries to global markets.Today, we see far more open economies, with countries reaping the gainsfrom trading in global markets.You may recall that during the 80s, inflation was endemic in the region.Inflation got to 132 percent in Mexico in 1987 and more than 3,000 percentin Argentina in 1989.We can contrast that to the relative price stability that we see today, with aregion-wide consumer price inflation averaging 5.5 percent a year overthe past five years.Inflation targeting is a common practice, and many of the regions centralbanks have achieved a high degree of credibility.As I said, the 1980s was also a period of debt crises, particularly externaldebt crises involving obligations to foreign banks.The external imbalances were born of deep fiscal problems.In the 1980s, governments ran large budget deficits, and public debtrelative to GDP soared.Governments relied on foreign dollar-denominated financing at a timewhen governments could not issue debt in their own currencies. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 77International reserves covered less than a fifth of total foreign debt.Today, it is a different story.Most countries in the region have moved toward fiscal balance, debtlevels are far lower, local currency capital markets are deeper, and somegovernments are able to sell local currency-denominated securities toforeign investors.The ratio of international reserves to total foreign debt rose to about 70percent last year, approximately five times the average in the 1980s.Personal recollectionsI have personal recollections from the 80s.For calendar year 1987, I was in charge of Citicorps efforts to organize adebt-for-equity swap program involving a number of "restructuringcountries" (as they were called) in Latin America.These countries included Mexico, Chile, Argentina, and Brazil.The idea of a debt-equity swap was that a government would allow andfacilitate the exchange of its sovereign or private external debt forshareholdings in domestic firms and assets.In effect, the debt would be the currency with which a lender could buystock in a local company. After such a transaction, some of the countrysexternal debt would be extinguished.In some countries of Latin America, this program was politicallyunpopular. There was resistance to what opponents of the schemeconsidered handing over the patrimony of the country at a bargain price.For this brief period—1987—I was immersed in the policy debates andpolitics of sovereign debt restructuring.Restructuring is the end-of-the-road measure undertaken when a country _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 78and its government are severely overextended.I came away from this experience with two broad observations:First, nations control their destinies by implementing and sustaininggood policies.External factors beyond a countrys control can deliver shocks to aneconomy, but for the most part, domestic policy decisions determine acountrys economic fate.And second, the worlds capital markets "vote," in effect, every day on acountrys policies.Sovereignty does not mean a government can dictate terms to the world.Policymakers are compelled to respect the power and opinion ofinvestors.Ties between the United States and Latin America In the wake of the lost decade, Latin American policymakers, generallyspeaking, have pursued more prudent macroeconomic and fiscal policiesand opened their economies to global capital markets and trade.This policy transformation has made possible a considerablestrengthening of economic ties between the United States and LatinAmerica.Trade between the United States and Latin America has grown rapidly.About a fifth of U.S. imports now come from Latin America, up fromaround 15 percent in the 1980s.And the share of U.S. exports going to Latin America has risenconsiderably, from an average of 15 percent of all U.S. exports in the 80sto nearly 25 percent.In the southeastern United States, a significant portion of merchandiseexports go to Latin America. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 79Around half of merchandise exports from Florida and Mississippi arebound for Latin America, around a third of exports from Louisiana, andabout a fifth of exports from Georgia, Tennessee, and Alabama.Last year, the flow of U.S. direct investment in Latin America rose to $84.5billion, and direct investment from Latin America into the United Stateswas $18.4 billion.I mentioned earlier the movement of U.S. dollar cash we manage in theAtlanta Fed branch in Miami. In 2011, we shipped $1.7 billion in U.S.currency to Brazil, with the primary demand coming from touristsplanning to travel to the United States.Spending by Brazilians in Florida has made quite an impression on theirhosts. Florida Trend magazine named Brazil as "Floridian of the Year" in2011, acknowledging the 1.5 million Brazilians who visited Florida,second only to the number of Canadian visitors to Florida.Brazilians also represented 12 percent of foreign buyers of real estate inSouth Florida last year, second only to Venezuelans.We also see growing cash transactions with Panama, where the canal isbeing expanded to accommodate ships that are nearly three times largerthan current vessels transiting the canal.Rail, port, and distribution facilities throughout the United States arebeing upgraded to handle larger vessels and more cargo that will resultfrom the canal expansion.And one more point about how the north-south relationship in ourhemisphere has changed: in the 1980s, most Latin American economieswere reliant on foreign capital.Today, many countries are capital exporters. Brazil is the fourth largestholder of U.S. Treasury Securities, with more than $200 billion inTreasuries as of June 2012, after China, Japan, and the major oil exportersas a group. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 80Trade, capital flows, and decoupling Not long ago it was fashionable to talk of the decoupling of certainemerging market economies from advanced economies.The notion was that major countries like Brazil are sufficientlyindependent economically to be unaffected by developments in advancedeconomies—the United States and Europe, for example.There is some reality in this claim.During and since the financial crisis of 2008 and the recession in thiscountry that followed, Latin America demonstrated impressive resilience.There was some contagion, but on balance Latin America came throughthis period without severe downside effects.In percentage terms, real GDP contraction in Latin America in 2009 wasless than half of that in advanced economies.And the following years recovery was much stronger.For many countries in South America, the economic output fell for onlytwo quarters.At the same time, several countries of Latin America have been on thereceiving end of sizeable capital flows that have brought uniquechallenges.When I visited Chile and Brazil last fall, I heard a lot about the volatility ofportfolio investment capital flows that swing with the appetite of globalinvestors for emerging market risk and risk in general.Economists and central bankers expressed a lot of concern about how tomanage their monetary affairs in an environment characterized by strongcapital inflows that drive their exchange rate higher and fuel creditexpansion that in turn causes a boom in asset prices. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 81Then these forces can come to sudden stops followed by a reversal ofcapital flows, falling asset prices, and credit contraction because ofshrinking collateral for loans.My central bank colleagues from Latin America did not talk ofdecoupling. Rather, they described their challenge of avoiding aboom-bust cycle as a result of hot money flows in a risk on-risk off world.The export trade of Latin America is also affected by demand conditionshere in the United States and the rest of the world.Beyond direct exports to the United States, we have seen how in recentyears South American commodity exports to emerging Asia have soared.Argentina, Brazil, Chile, and Peru are the leading exporters ofcommodities to emerging Asia, and China is now Brazils top tradingpartner.The boom has contributed to strong economic growth in the exportingcountries, but as global growth has slowed, so has demand for thesecommodity exports, and commodity prices have fallen.Most Latin American countries, through openness to capital flows andtrade, are more and more integrated into the global economy.This is, on balance, a good thing, but it brings policy challenges in theirpursuit of macroeconomic stability and consistent growth.ConclusionLet me recap. The Latin American story—in the simplest terms—goessomething like this: Latin America got into trouble in the 80s because ofbad policy decisions.The region suffered what some have called a lost decade. Since then, thegovernments of most Latin countries have pursued sound policies, and asa result these countries have progressed economically and theireconomies continue to perform rather well. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 82This history suggests to me there exist certain basic realities—behavingalmost like physics—that cannot be long ignored or avoided.Consistent and sustained good economic performance needs afoundation of sound fundamentals.These fundamentals include good fiscal management—especially debtmanagement—and monetary policy that supports growth whiledelivering control of inflation.Add to these the maintenance of an open economy that accepts andbenefits from trade and capital flows from the rest of the world.It is my sense that the countries of Latin America have mostly learnedthese lessons.I dont believe the United States or other mature economies are immuneto these realities—these physics, so to speak.The U.S. economy has been in a technical recovery since the summer of2009. The recovery to date has seen weak growth and persistently highunemployment.By any number of measures, the strength of the recovery has been andremains disappointing.Some commentators have warned that the United States, along withEurope and Japan, could be experiencing our own lost decade.Just last week, an article in the Financial Times argued the world ishalfway there.Fridays New York Times ran an article referring to Europes lost decade.I will leave it to economic historians to arrive at a verdict on this question,but certainly our current expansion is not on the track we would wish. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 83Real personal income (excluding government transfer payments) is still1.5 percent below what it was before the recession in late 2007.As of July, there are more than 4½ million fewer payroll jobs than inNovember of 2007. Most of these job losses were in the private sector.The share of unemployed workers who have been out of a job for morethan 27 weeks has fluctuated between 40 and 50 percent over the entirecourse of the recovery.I think this condition can be attributed, at least in part, to fundamentalimbalances that have not yet been corrected, a situation that presentsformidable challenges for monetary policymakers.There is a risk to monetary policy being employed too aggressively andwithout effect to address economic problems that can be resolved only byfiscal reforms that involve making tough choices about the allocation ofpublic resources.Monetary policy can exert a powerful positive influence on an economy,but as Chairman Bernanke has pointed out, monetary policy is not apanacea.We should applaud sound policy decisions and effective policyimplementation where we see it.Again, I commend many of the governments and central banks of LatinAmerica for having chosen this path. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 84NUMBER 7Basel ii / iii in RussiaThe Bank of Russia considers it necessary to create legislativefundamentals in Russia for introducing all the standards of bankingregulation and banking supervision established by the Basel Committeeon Banking Supervision (BCBS).These include legislation empowering the Bank of Russia to setrequirements for credit institutions’ corporate governance, risk andcapital management systems, to exercise consolidated supervision, to useprofessional judgment in supervisory practices, and also to definedisciplinary action against members of executive bodies and boards ofdirectors (supervisory boards) for faults in the activity of their creditinstitutions.In order to implement the provisions of Basel II, the Bank of Russia willcarry out work in 2012-2014 to draft banking regulation and supervisoryrules envisaging approaches to credit risk assessment based on internalratings.The Bank of Russia will also cooperate with credit institutions in draftingand introducing internal capital adequacy assessment procedures.In order to introduce new international requirements for capital qualityand adequacy and maintain the required level of liquidity as stipulated bythe BCBS documents adopted in 2010 (Basel III) and supported by theG20 leaders at their summit in Seoul in November 2010, the Bank ofRussia intends to take the following measures:– make amendments to the regulations to review the structure ofregulatory capital and introduce requirements for the adequacy of capitalcomponents; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 85–set requirements for building capital buffers, introducing the leverageindicator defined as the ratio between capital and the total value of assetsand off-balance sheet items that are not weighted by risk;– introduce two liquidity ratios: the short-term liquidity coveragestandard defined as the ratio of liquid assets to net cash outflow over thenext 30 calendar days in a market stress scenario, and the net stablefunding standard determined as the ratio of available reliable sources offunding with a maturity of at least one year to the required amount ofstable funding in a stress scenario.In 2013-2014, the Bank of Russia will define approaches for banks tocreate the counter-cyclical capital buffers as an instrument to limitsystemic risks.In order to implement these approaches, additional indicators of riskgrowth in the Russian financial system are intended to be developed.Measures are planned in 2012-2014 to work out criteria for classifyingbanks as systemically important, and also define regulatory requirementsfor their activity, taking into account the proposals developed by theBCBS jointly with the Financial Stability Board (FSB) for global sys-temically important financial institutions.While developing corresponding criteria for Russian banks, the Bank ofRussia will take into account the specifics of the domestic market forbanking services, and also the work being carried out by the BCBS andthe FSB to adapt the proposed approaches to the regulation of nationalsystemically important banks.With regard to international recommendations on compliance with FSBprinciples and standards relating to compensation (remuneration), theBank of Russia will implement them taking into account the specificrequirements of national legislation.In order to reduce the administrative burden on banks, measures areplanned to unify supervisory requirements for the sustainability of creditinstitutions and the requirements for their participation in the deposit _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 86insurance system by making corresponding amendments to legislation.In order to increase the transparency of Russian credit institutions, theywill be required to disclose information to the public on the qualificationsand work experience of their top managers.Measures will be required to statutorily establish the duty of shareholdersand persons exerting indirectly (through third parties) material influenceon decisions taken by the credit institutions’ management bodies,including third parties, to provide information to credit institutions forthe disclosure of the ownership structure.These would include cases where the shares of credit institutions are keptby nominal holders.Measures are planned to further develop the legislative framework ofcredit institutions’ affiliated parties to increase the transparency of theownership structure of credit institutions.In particular, it will be necessary to stipulate the duty of all affiliatedparties of credit institutions to provide information on them and be heldresponsible for their failure to comply with this requirement.Work will be continued to legislatively improve merger and acquisitionprocesses.Amendments will be made to the legislation to stipulate a possibility forlegal entities (including credit institutions) with different forms of incor-poration to participate in the reorganisation of credit institutions, whichwill give an additional stimulus to raise their capitalisation through re-structuring.The policy towards integration into the world financial market should beconducted taking into account national interests, the real level ofdevelopment and the competitiveness of the Russian banking sector.The ban on opening foreign bank branches will remain as a necessarymeasure for maintaining the competitiveness of Russian banks in the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 87domestic market for banking services and the Bank of Russia willcontinue its participation in drafting the corresponding federal law.The Bank of Russia will participate in work to draft laws aimed atproviding additional protection for creditors and consumers of financialservices, including the improvement of the law on pledge and thedevelopment of legislation on consumer credit.At the same time, work will continue to implement measures forimproving the financial literacy of the population with respect to banking.Measures to increase the transparency of credit institutions as a result ofthe use of International Financial Reporting Standards (IFRS) in theiractivities are an important step towards raising the efficiency of thebanking sector and boosting clients’ confidence in banks.With this in mind, these tasks should be resolved through theimplementation of Federal Law No. 208-FZ, dated 27 July 2010, ‘OnConsolidated Financial Statements’, under which credit institutions arerequired to draw up, submit and publish consolidated financialstatements.For its part, the Bank of Russia considers it necessary to encourage creditinstitutions to be conservative enough in making fair value measurementsunder the IFRS standards and, if necessary, will use banking regulationand supervisory powers to adjust the measurements, proceeding fromprudential approaches.The Bank of Russia will further study approaches and measures formaintaining the systemic stability of the banking sector.The Bank of Russia will continue to upgrade its macroprudential analysistools by calculating banking sector financial soundness indicators,among other things, and posting them on the IMF website, and to assesssystemic risk by conducting stress tests.In order to better protect the banking system and credit institutions’creditors, including bank depositors, and reduce the risks of abuses by _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 88credit institutions’ managers and owners, work will continue to improvethe mechanisms of liquidation procedures at banks.These measures will include the assignment of criminal responsibility tothe heads of credit institutions, and also persons responsible foraccounting and other records, for deliberately entering false data intodocuments regulating civil rights and duties, accounting and otherrecords and reports on the economic activities of a credit institution, andalso for making corrections that distort the substance of these documents,if these actions are taken in pursuit of personal gain or in one’s personalinterest and inflict damage on citizens, organisations or the state. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 89The Central Bank of the Russian FederationBanking LegislationIntroductionThe Central Bank of the Russian Federation(Bank of Russia) was founded on July 13,1990, on the basis of the Russian RepublicBank of the State Bank of the USSR.Accountable to the Supreme Soviet of theRSFSR, it was originally called the StateBank of the RSFSR.On December 2, 1990, the Supreme Soviet of the RSFSR passed the Lawon the Central Bank of the RSFSR (Bank of Russia), which declared theBank of Russia a legal entity and the main bank of the RSFSR,accountable to the Supreme Soviet of the RSFSR.The law specified the functions of the bank in organising moneycirculation, monetary regulation, foreign economic activity andregulation of the activities of joint-stock and co-operative banks.In June 1991, the Statute of the Central Bank of the RSFSR (Bank ofRussia), accountable to the Supreme Soviet of the RSFSR, was approved.In November 1991, when theCommonwealth of IndependentStates was founded and Unionstructures dissolved, theSupreme Soviet of the RSFSRdeclared the Central Bank of theRSFSR to be the only body of state monetary and foreign exchangeregulation in the RSFSR.The functions of the State Bank of the USSR in issuing money and settingthe ruble exchange rate were transferred to it. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 90The Central Bank of the RSFSR was instructed to assume before January1, 1992, full control of the assets, technical facilities and other resources ofthe State Bank of the USSR and all its institutions, enterprises andorganisations.On December 20, 1991, the State Bank of the USSR was disbanded and allits assets, liabilities and property in the RSFSR were transferred to theCentral Bank of the RSFSR (Bank of Russia), which several months laterwas renamed the Central Bank of the Russian Federation (Bank ofRussia).In 1991-1992 an extensive network of commercial banks was created in theRussian Federation under Bank of Russia guidance throughcommercialisation of the specialised banks’ branches.The disbandment of the State Bank of the USSR was followed by changesin the chart of accounts, the establishment of a network of Central Bankcash settlement centres and their provision with computer technology.The Central Bank began to buy and sell foreign exchange in the currencymarket it established and to set and publish the official exchange rates offoreign currencies against the ruble.In December 1992, as a result of the establishment of a single centralisedfederal treasury system, the Bank of Russia was no longer required toprovide cash services for the federal budget.The Bank of Russia carries out its functions, which were established bythe Constitution of the Russian Federation (Article 75) and the Law "Onthe Central Bank of the Russian Federation (Bank of Russia)" (Article 22),independently from the federal, regional and local government structures.In 1992-1995, to maintain stability of the banking system, the Bank ofRussia set up a system of supervision and inspection of commercialbanks and a system of foreign exchange regulation and foreign exchangecontrol. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 91As the agent of the Ministry of Finance, it organised the governmentsecurities market, known as the GKO market, and began to participate inits operations.In 1995, the Bank of Russia stopped extending loans to finance the federalbudget deficit and centralised loans to individual sectors of the economy.To override the consequences of the 1998 financial crisis, the Bank ofRussia took steps towards restructuring the banking system in order toimprove the performance of commercial banks and increase theirliquidity.Insolvent banks were removed from the banking services market, usingthe procedures established by the applicable law.Of great importance for the post-crisis recovery of the banking sector wasthe creation of the Agency for Restructuring Credit Institutions (ARCO)and the Inter-Agency Co-ordinating Committee for Banking SectorDevelopment in Russia (ICC).Thanks to the effective measures implemented by the Bank of Russia,ARCO and ICC, by the middle of 2001 Russia’s banking sector had on thewhole overcome the aftermath of the crisis.The Bank of Russia monetary policy was designed to maintain financialstability and create conditions conducive to sustainable economicgrowth.The Bank of Russia promptly reacted to any change in the real demandfor money and took steps to stimulate positive economic dynamics, cutinterest rates, damp down inflationary expectations and slow the inflationrate.As a result, the ruble gained somewhat in real terms and financial marketstability increased. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 92Due to the balanced monetary and exchange rate policies pursued by theBank of Russia, the country’s international reserves have grown and therehave been no sharp fluctuations in the exchange rate.The efforts made by the Bank of Russia with regard to the paymentsystem were designed to increase its reliability and efficiency for financialand economic stability.To make the Russian payment system more transparent, the Bank ofRussia introduced reports on payments by credit institutions and its ownregional branches, which took into account international experience,methodology and practice of surveillance over payment systems.In 2003, the Bank of Russia launched a project designed to improvebanking supervision and prudential reporting by introducinginternational financial reporting standards (IFRS).The project provides for the implementation of a set of measures,including measures to ensure credit institutions’ credible accounting andreporting, raise requirements for the content, amount and periodicity ofinformation to be published, and introduce accounting and reportingstandards matching international good practice.In addition, measures are to be taken to disclose information on the realowners of credit institutions, exercise control over their financial positionand raise requirements for credit institutions’ executives and theirbusiness reputation.There are some problems to which the Bank of Russia pays specialattention.One of them is that specific risks connected with the dynamics of theprices of some financial assets and the price situation on the real estatemarket have begun to play an increasingly important role recently.The practice of lending to related parties led to high risk concentrationsin some banks, compelling the Bank of Russia to upgrade the methods of _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 93banking regulation and supervision by making greater emphasis onsubstantive (risk-oriented) supervision.Fictitious capitalisation of banks is another matter of serious concern forthe Bank of Russia.To prevent banks from using all sorts of schemes designed to artificiallyovervalue or undervalue the required ratios, the Bank of Russia in 2004issued a number of regulations, including the Regulation "On theProcedure for Creating Loan Loss Reserves by Credit Institutions" andthe Instruction "On Banks’ Required Ratios."As the number of credit institutions extending mortgage loans to thepublic increased, in 2003 the Bank of Russia issued the Ordinance "OnConducting a One-off Survey of Mortgage Lending," which set theprocedure for compiling and presenting data on housing mortgage loansextended by credit institutions.With the adoption of the Federal Law "On Mortgage Securities," creditinstitutions which ensured the observance of the requirements for theprotection of investors’ interests received the lawful opportunity torefinance their claims on mortgage loans by issuing mortgage securities.In pursuance of the Federal Law "On the Central Bank of the RussianFederation (Bank of Russia)" and Federal Law "On MortgageSecurities," the Bank of Russia issued the Instruction "On the RequiredRatios for Credit Institutions Issuing Mortgage-Backed Bonds," whichspecified the calculation and established the values of the required ratiosand the values and methodology of calculating additional required ratiosfor credit institutions issuing mortgage-backed bonds.In December 2003, the Federal Law "On Insurance of Personal BankDeposits in the Russian Federation" was adopted.The law stipulated the legal, financial and organisational framework forthe mandatory personal bank deposits insurance system, and also thepowers, procedure for the establishment and operation of an institution _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 94implementing mandatory deposit insurance functions and set theprocedure for paying deposit compensation.At present, an overwhelming majority of banks participate in the depositinsurance system. They account for almost 100% of total personaldeposits placed in Russian banks.In April 2005, the Russian Government and Bank of Russia adopted theBanking Sector Development Strategy for the Period up to 2008, adocument which set as the main objective of banking sector developmentin the medium term (2005-2008) the enhancement of the banking sector’sstability and efficiency.The principal goals of banking sector development are as follows: - increasing the protection of interests of depositors and othercreditors of banks; - enhancing the effectiveness of the banking sector’s activity inaccumulating household and enterprise sector funds and transformingthem into loans and investments; - making Russian credit institutions more competitive; - preventing the use of credit institutions in dishonest commercialpractices and illegal activities, especially the financing of terrorism andmoney laundering; - promoting the development of the competitive environment andensuring the transparency of credit institutions; - building up investor, creditor and depositor confidence in thebanking sector. The banking sector reform will help implement Russia’smedium-term social and economic development programme (2005-2008),especially its objective to end the raw materials bias of the Russian _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 95economy by rapidly diversifying it and utilising its competitiveadvantages. At the next stage (2009-2015), the Russian Government and Bank ofRussia will attach priority to effectively positioning the Russian bankingsector on international financial markets.Banking LegislationBanking legislation is a branch of law representing a system of statutoryacts regulating banking activities.The legal regulation of banking activities is exercised by the Constitutionof the Russian Federation, Civil Code of the Russian Federation, FederalLaw No. 86-FZ, dated July 10, 2002, ‘On the Central Bank of the RussianFederation (Bank of Russia)’ (hereinafter referred to as the Bank ofRussia Law), Federal Law No. 395-1, dated December 2, 1990, ‘On Banksand Banking Activities,’ and other federal laws and Bank of Russiaregulations.Point g of Article 71 of the Constitution of the Russian Federationstipulates that the Russian Federation has the jurisdiction over thefinancial, currency, credit and customs regulation, the issue of money andthe fundamentals of the price policy.This provision signifies that the legal regulation of banking activities mayonly be conducted at the federal level.Part 2 of Article 75 of the Constitution of the Russian Federation laysdown the principle of the Bank of Russia being independent from otherstate bodies when performing its basic function to protect the rouble andensure its stability.The Bank of Russia Law spells out the principle of the Bank of Russiaindependence, stipulating that the Bank of Russia performs the functionsand exercises the powers established by the Constitution of the RussianFederation and the Bank of Russia Law independently from other federalbodies of state power, regional authorities and local governments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 96The Bank of Russia Law establishes the legal status of the Bank of Russia,the size of its authorised capital, the procedure for creating the NationalBanking Board and management bodies and their principal functions;settles the relations between the Bank of Russia and the bodies of statepower and local governments and the relations between the Bank ofRussia and credit institutions; spells out the principles of organisingnon-cash settlements and cash circulation; sets out the principles ofimplementing the monetary policy and designated its instruments; listsBank of Russia operations and transactions; establishes the powers inregard of banking regulation and supervision, and formulates theprinciples of organising the Bank of Russia and its accountability andaudit.Article 4 of the Bank of Russia Law lists the functions performed by theBank of Russia.Article 7 of the Bank of Russia Law stipulates that in regard of the mattersrelated to its competence by this Federal Law and other federal laws theBank of Russia issues in the form of ordinances, regulations andinstructions statutory acts binding upon the federal bodies of state power,regional authorities, local governments and all legal entities and naturalpersons.With few exceptions, Bank of Russia statutory acts should be registeredaccording to the procedure established for the state registration ofstatutory legal acts of the federal bodies of executive power.In addition to issuing its own regulations, the Bank of Russia takes anactive part in other forms of the legislative process, because under the lawthe drafts of federal laws and statutory legal acts of the federal bodies ofexecutive power concerning the performance by the Bank of Russia of itsfunctions should be submitted to the Bank of Russia for considerationand approval.Another basic federal law regulating banking activities is the Federal Law‘On Banks and Banking Activities’, which defines major terms used in thelegal regulation of banking, such as ‘credit institution,’ ‘bank,’ ‘non-bankcredit institution,’ ‘banking group,’ etc. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 97This Federal Law determines the components of the Russian bankingsystem, lists banking operations and other transactions, describes thespecifics of credit institution operations on the securities market and setsthe procedure for registering credit institutions and licensing bankingactivities and the procedure for opening credit institution branches andrepresentative offices.It formulates the principles of the relationships between creditinstitutions and their customers and between credit institutions and thestate, lists the grounds for the revocation of a banking licence, lays downthe principles of ensuring the soundness of credit institutions, establishesthe banking secrecy regime and anti-monopoly restrictions for creditinstitutions and sets out the principles of organising the savings businessin the Russian Federation.The passage of Federal Law No. 40-FZ, dated February 25, 1999, ‘OnInsolvency (Bankruptcy) of Credit Institutions’ (hereinafter referred to asthe Insolvency Law) was a major step forward in building in Russia acivilised credit institution insolvency (bankruptcy) system meeting thegenerally accepted international standards.The Insolvency Law sets the procedure for carrying out credit institutioninsolvency (bankruptcy) prevention measures, declaring creditinstitutions insolvent (bankrupt) and subsequently liquidating them.The relations connected with credit institution insolvency (bankruptcy)prevention that are not regulated by the Insolvency Law are regulated byother federal laws and Bank of Russia statutory acts issued in pursuanceof these laws.The relations connected with credit institution insolvency (bankruptcy)that are not regulated by the Insolvency Law are regulated by FederalLaw No. 127-FZ, dated October 26, 2002, ‘On Insolvency (Bankruptcy),’and Bank of Russia regulations in cases stipulated by the Insolvency Law.Under the Insolvency Law, a credit institution is considered incapable ofmeeting creditors’ pecuniary claims and (or) making compulsorypayments if it has failed to exercise these duties for 14 days after they are _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 98due and (or) the value of the credit institution’s property (assets) is notenough to allow it to meet its obligations to creditors and (or) makecompulsory payments.The Insolvency Law pays special attention to the bankruptcy preventionmeasures conducted before the revocation of a banking licence. Thesemeasures are as follows: — the financial rehabilitation of the credit institution; — the appointment of the provisional administration to the creditinstitution; — the reorganisation of the credit institution. The legal regulation of the system of measures aimed at anti-moneylaundering and counter-terrorism financing is implemented pursuant toFederal Law No. 115-FZ, dated August 7, 2001, ‘On Countering theLegalisation (Laundering) of Criminally Obtained Incomes and TerroristFinancing’ (hereinafter referred to as the Anti-money Laundering Law).The Anti-money Laundering Law contains criteria for the volume ofoperations subject to mandatory control, lists these operations anddetermines the organisations conducting operations with money or otherproperty that should inform an authorised agency about these operations,which include credit institutions, among other.Taking into consideration that capital may be laundered in manydifferent ways, these organisations are required to conduct internalcontrol for detecting operations subject to mandatory control and otheroperations with money or other property, in regard of which theseorganisations have the suspicion that these operations are conducted withthe objective of money laundering or financing terrorism.The Anti-money Laundering Law also stipulates that the provision to theauthorised agency of information and documents by organisationsconducting operations with money or other property according to the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 99procedure established by this Federal Law does not constitute a breach ofofficial, banking, tax or commercial secrets.The Anti-money Laundering Law was passed in compliance with theConvention on Laundering, Search, Seizure and Confiscation of theProceeds from Crime, signed in Strasbourg, France, and ratified byFederal Law No. 62-FZ, dated May 28, 2001.To boost public trust in the banking system, stimulate growth inorganised savings and reduce the risks taken by banks when building along-term resource base, Russia passed Federal Law No. 177-FZ, datedDecember 23, 2003, ‘On Insurance of Household Deposits with RussianBanks’.This Federal Law lays down the legal, financial and organisationalprinciples of operating the compulsory household bank deposit insurancesystem (hereinafter referred to as the deposit insurance system),establishes the competence of and the procedure for creating anorganisation performing compulsory deposit insurance functions(hereinafter referred to as the Deposit Insurance Agency), sets theprocedure for paying deposit compensation and regulates relationsamong banks, the Deposit Insurance Agency, the Bank of Russia and thefederal executive power bodies within the deposit insurance system.This Federal Law specifies the following basic principles of building andoperating the deposit insurance system: — the participation in the deposit insurance system is compulsory forbanks; — the deposit insurance system serves to mitigate the risk of adverseconsequences for depositors in the event of the banks’ failure to meettheir obligations; — the deposit insurance system is transparent; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 100 — the deposit insurance fund accumulates regular insurancecontributions made by the banks participating in the deposit insurancesystem. There are two insured events when an individual is entitled to depositcompensation from the Deposit Insurance Agency: — the revocation (cancellation) of the Bank of Russia banking licencefrom a bank in compliance with the Federal Law on Banks and BankingActivities; — the imposition by the Bank of Russia, pursuant to applicablefederal legislation, of a ban on the satisfaction of bank creditors’ claims. Federal Law No. 96-FZ, dated July 29, 2004, ‘On Bank of RussiaPayments on Household Deposits with Bankrupt Banks Uncovered bythe Compulsory Deposit Insurance System’, was a logical addition to thedeposit insurance system built in Russia. As the establishment of the deposit insurance system created the riskof financial instability for the banks that have not joined this system as aresult of the loss of customer and investor confidence and the eventualoutflow of deposits to the participating banks, this Federal Law extendedto the depositors of the non-member banks guarantees similar to thoseenjoyed by the depositors of the member banks. Under the law,compensation to depositors of the non-member banks is paid from Bankof Russia funds. Thus, the passing of this Federal Law became a major step forward inboosting confidence in the banking system as a whole. To ensure the implementation of the single state foreign exchangepolicy and stability of the Russian currency and domestic foreignexchange market, which are the factors of the country’s economicprogress and successful international economic cooperation, Russiapassed Federal Law No. 173-FZ, dated December 10, 2003, ‘On ForeignExchange Regulation and Control’ (hereinafter referred to as the ForeignExchange Regulation Law). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 101The Foreign Exchange Regulation Law defines foreign exchangeoperations. In addition, it separates the powers of the federal governmentand the Bank of Russia relating to the regulation of foreign exchangeoperations.On January 1, 2007, the restrictions on foreign exchange operationsbetween residents and non-residents (the requirements that suchoperations are routed through special accounts and that a certain amountof money is deposited when foreign exchange operations are conducted,the prohibition to buy domestic securities for foreign currency, thepreliminary registration of a resident account (deposit) opened with abank outside Russia and the compulsory sale of a part of foreign currencyearnings) were lifted.Residents and non-residents may now make settlements on operationswith domestic and foreign securities in rubles or foreign currency.At the same time, the Foreign Exchange Regulation Law (Article 11)retains the requirement that foreign exchange and cheques, includingtraveller’s cheques, denominated in foreign currency are bought throughauthorised banks only.To boost the domestic foreign exchange market and prevent capital flightfrom Russia, the Foreign Exchange Regulation Law retains therequirement for residents to repatriate foreign and domestic currency(Article 19).Federal Law No. 218-FZ, dated December 30, 2004, ‘On Credit Histories’,has an important role to play in arranging credit relations and building amodern economy.The purpose of this Federal Law is to create and legalise conditions forthe compiling, processing, storage and disclosure by credit bureaus ofinformation about how borrowers meet their obligations under loan(credit) agreements, give creditors and borrowers more protection byreducing overall credit risk and enhance the efficiency of creditinstitutions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 102The Federal Law on Credit Histories is designed to allow banks to cutcosts when assessing their borrowers’ creditworthiness and, consequently,reduce the price of loans they extend.A major role in implementing this Federal Law is played by the Bank ofRussia, whose division, the Central Catalogue of Credit Histories,performs the function of a single information centre informing users freeof charge in what credit bureau they can find information about anindividual credit history maker.In addition to the borrowers, creditors and the Central Catalogue ofCredit Histories, the credit bureaus participate in the exchange ofinformation about how borrowers meet their obligations to creditors.The principal objective of the credit bureaus is to accumulate informationcharacterising the borrower’s payment discipline in regard of thefulfilment of the loan (credit) agreements and eventually this informationforms the credit histories of legal entities and natural persons, which maybe subsequently passed to the persons who have received permission toget a credit report for the conclusion of a loan (credit) agreement.Measures to be implemented by the Bank of Russia to upgradethe banking system and banking supervision in 2012 and in 2013and 2014In order to upgrade the banking system and banking supervision in2012-2014, the Bank of Russia will focus on implementing measuresstipulated by the Strategy of Russian Banking Sector Development until2015 that are intended to increase the quality of banks’ activity andmaintaining the stability of the Russian banking sector.The banking sector will face increased competition (both intrasectoraland intersectoral) in the most lucrative segments of the banking servicesmarket.This will lead credit institutions to raise their capitalisation. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 103The consolidation of the banking sector is also expected to intensify, andnew, larger banking structures will emerge.At the same time, the diversification of the banking business and bankingincome will develop further, including as a result of the introduction ofnew technologies and the improvement of bank risk management andbanking regulation.Measures will be taken to reduce risk concentration, including riskconcentration per borrower (or group of related borrowers), investment,area of activity, and industry. Banks are expected to develop bankingproducts that generate an income from fee in order to keep their incomesstable.Credit institutions will pay close attention to the development of theirlong-term resource base, in which household deposits will play anincreasingly important role.These trends are expected to improve the accessibility of bankingservices both for individuals and organisations.Tougher competition and measures to develop banking regulation andbanking supervision will increase transparency and market discipline inthe banking sector.As a result, credit institutions will increasingly focus on their long-termperformance, make more rational decisions and build effectivemanagement systems, including risk management systems.As part of its efforts to improve banking regulation and bankingsupervision, the Bank of Russia will continue in 2012-2014 its work to raisethe quality of bank capital and assets, limit the level of risks, including thelevel of their concentration, and increase the reliability of creditinstitutions’ accounting and reporting.The development of substantive risk-based approaches that take thedomestic and international experience into account will be a keyinstrument in the sphere of banking regulation and banking supervision. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 104Measures to improve banking supervision and increase its qualityenvisage: - identifying bank risks, taking into account the prospects of the economy and the financial sector, and developing an early response system; - using differentiated approaches to supervision, taking into account the systemic importance, profile and level of risks, and also the level of credit institutions’ transparency; - carrying out supervisory measures to reduce risk concentration, including exposure to affiliated parties; - developing supervision on a consolidated basis; - developing cooperation with government regulatory and control agencies, including foreign supervisors, in order to exchange information.Measures are envisaged to develop a system of control to be exercised bythe Bank of Russia’s head office over the situation in the banking sector,especially at systemically important credit institutions.The Bank of Russia considers it necessary to create legislativefundamentals in Russia for introducing all the standards of bankingregulation and banking supervision established by the Basel Committeeon Banking Supervision (BCBS).These include legislation empowering the Bank of Russia to setrequirements for credit institutions’ corporate governance, risk andcapital management systems, to exercise consolidated supervision, to useprofessional judgment in supervisory practices, and also to definedisciplinary action against members of executive bodies and boards ofdirectors (supervisory boards) for faults in the activity of their creditinstitutions.In order to implement the provisions of Basel II, the Bank of Russia willcarry out work in 2012-2014 to draft banking regulation and supervisoryrules envisaging approaches to credit risk assessment based on internalratings. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 105The Bank of Russia will also cooperate with credit institutions in draftingand introducing internal capital adequacy assessment procedures.In order to introduce new international requirements for capital qualityand adequacy and maintain the required level of liquidity as stipulated bythe BCBS documents adopted in 2010 (Basel III) and supported by theG20 leaders at their summit in Seoul in November 2010, the Bank ofRussia intends to take the following measures: - make amendments to the regulations to review the structure of regulatory capital and introduce requirements for the adequacy of capital components; - set requirements for building capital buffers, introducing the leverage indicator defined as the ratio between capital and the total value of assets and off-balance sheet items that are not weighted by risk; - introduce two liquidity ratios: the short-term liquidity coverage standard defined as the ratio of liquid assets to net cash outflow over the next 30 calendar days in a market stress scenario, and the net stable funding standard determined as the ratio of available reliable sources of funding with a maturity of at least one year to the required amount of stable funding in a stress scenario.In 2013-2014, the Bank of Russia will define approaches for banks tocreate the counter-cyclical capital buffers as an instrument to limitsystemic risks.In order to implement these approaches, additional indicators of riskgrowth in the Russian financial system are intended to be developed.Measures are planned in 2012-2014 to work out criteria for classifyingbanks as systemically important, and also define regulatory requirementsfor their activity, taking into account the proposals developed by theBCBS jointly with the Financial Stability Board (FSB) for global sys-temically important financial institutions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 106While developing corresponding criteria for Russian banks, the Bank ofRussia will take into account the specifics of the domestic market forbanking services, and also the work being carried out by the BCBS andthe FSB to adapt the proposed approaches to the regulation of nationalsystemically important banks.With regard to international recommendations on compliance with FSBprinciples and standards relating to compensation (remuneration), theBank of Russia will implement them taking into account the specificrequirements of national legislation.In order to reduce the administrative burden on banks, measures areplanned to unify supervisory requirements for the sustainability of creditinstitutions and the requirements for their participation in the depositinsurance system by making corresponding amendments to legislation.In order to increase the transparency of Russian credit institutions, theywill be required to disclose information to the public on the qualificationsand work experience of their top managers.Measures will be required to statutorily establish the duty of shareholdersand persons exerting indirectly (through third parties) material influenceon decisions taken by the credit institutions’ management bodies,including third parties, to provide information to credit institutions forthe disclosure of the ownership structure. These would include caseswhere the shares of credit institutions are kept by nominal holders.Measures are planned to further develop the legislative framework ofcredit institutions’ affiliated parties to increase the transparency of theownership structure of credit institutions.In particular, it will be necessary to stipulate the duty of all affiliatedparties of credit institutions to provide information on them and be heldresponsible for their failure to comply with this requirement.Work will be continued to legislatively improve merger and acquisitionprocesses. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 107Amendments will be made to the legislation to stipulate a possibility forlegal entities (including credit institutions) with different forms of incor-poration to participate in the reorganisation of credit institutions, whichwill give an additional stimulus to raise their capitalisation through re-structuring.The policy towards integration into the world financial market should beconducted taking into account national interests, the real level ofdevelopment and the competitiveness of the Russian banking sector.The ban on opening foreign bank branches will remain as a necessarymeasure for maintaining the competitiveness of Russian banks in thedomestic market for banking services and the Bank of Russia willcontinue its participation in drafting the corresponding federal law.The Bank of Russia will participate in work to draft laws aimed atproviding additional protection for creditors and consumers of financialservices, including the improvement of the law on pledge and thedevelopment of legislation on consumer credit.At the same time, work will continue to implement measures forimproving the financial literacy of the population with respect to banking.Measures to increase the transparency of credit institutions as a result ofthe use of International Financial Reporting Standards (IFRS) in theiractivities are an important step towards raising the efficiency of thebanking sector and boosting clients’ confidence in banks.With this in mind, these tasks should be resolved through theimplementation of Federal Law No. 208-FZ, dated 27 July 2010, ‘OnConsolidated Financial Statements’, under which credit institutions arerequired to draw up, submit and publish consolidated financialstatements.For its part, the Bank of Russia considers it necessary to encourage creditinstitutions to be conservative enough in making fair value measurementsunder the IFRS standards and, if necessary, will use banking regulation _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 108and supervisory powers to adjust the measurements, proceeding fromprudential approaches.The Bank of Russia will further study approaches and measures formaintaining the systemic stability of the banking sector.The Bank of Russia will continue to upgrade its macroprudential analysistools by calculating banking sector financial soundness indicators,among other things, and posting them on the IMF website, and to assesssystemic risk by conducting stress tests.In order to better protect the banking system and credit institutions’creditors, including bank depositors, and reduce the risks of abuses bycredit institutions’ managers and owners, work will continue to improvethe mechanisms of liquidation procedures at banks.These measures will include the assignment of criminal responsibility tothe heads of credit institutions, and also persons responsible foraccounting and other records, for deliberately entering false data intodocuments regulating civil rights and duties, accounting and otherrecords and reports on the economic activities of a credit institution, andalso for making corrections that distort the substance of these documents,if these actions are taken in pursuit of personal gain or in one’s personalinterest and inflict damage on citizens, organisations or the state.In the course of inspections, which the Bank of Russia will conduct in2012-2014, special at tention will be paid to the inspection of credit in-stitutions of systemic importance to the banking sector of the RussianFederation and its regions, along with the inspection of credit institutionsthat conduct highly risky operations and credit institutions that are nottransparent enough.The inspections will focus on assessing bank risks (credit and marketrisks, liquidity and concentration risks, including risk concentration onthe owners’ business), the systems of their management, and theidentification of doubtful transactions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 109In order to achieve the best results in the inspection of credit institutions(their branches), the Bank of Russia will continue the on-goingmonitoring of the process of arranging and holding inspections and thecoordination of work for conducting these inspections. Special attentionwill be paid to formulating risk-based assignments for the inspections ofcredit institutions.The improvement of the inspection organisation’s structure, whichenvisages measures to centralise the Bank of Russia’s inspecting activityby 2014, will help make inspections more effective.Regulatory support for inspections will be improved, taking into accountinternationally-accepted approaches, and the Bank of Russia’s measuresto implement the Strategy of Russian Banking Sector Development until2015.The Bank of Russia is legislatively empowered to set requirements forcredit institutions to develop internal control procedures to prevent thelegalisation (laundering) of criminally obtained incomes and thefinancing of terrorism.In light of this, special attention will be paid to risk-based approachesused by credit institutions to identify customers, their representatives,beneficiaries, and also to monitor operations for the provision of servicesto customers. –participate in carrying out a plan to create an international financialcentre in Moscow; –participate, jointly with the Federal Financial Markets Service, inimproving approaches towards regulating the activity of clearing or-ganisations and central counterparties; – participate in upgrading the legislation regulating depositoryactivities, and recognise the concept of a foreign nominal holder; – participate in upgrading the legislation regulating the organisationof exchange trade; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 110 – make arrangements for the inclusion of the Russian rouble insettlement currencies of the Continuous Linked Settlement (CLS) system; – participate, jointly with the Ministry of Finance, in efforts to furtherliberalise the government securities market by making amendments toBank of Russia’s regulations and other instructions allowing theplacement and circulation of government securities on stock exchangesin accordance with their rules; – participate in upgrading the legislation to define the status of theprecious metal account; – participate in upgrading the legislation regulating the terms andconditions of the issue and circulation of the certificates of deposit andsavings certificates. – improve the legislative and contractual base regulating repotransactions in the Russian market.Measures to be implemented by the Bank of Russia to improvethe Russian payment system in 2012 and in 2013 and 2014In 2012-2014, the Bank of Russia will carry out measures to develop andupgrade the Russian payment system for the purpose of ensuring thestable functioning of Russia’s financial system.The Bank of Russia will take measures to implement Federal Law No.161-FZ, dated 27 June 2011, ‘On the National Payment System’.In particular, work will be carried out to draft a Strategy for theDevelopment of the National Payment System stipulating measures toensure the stable functioning of the national payment system, increase itseffectiveness and competitiveness, improve the Bank of Russia paymentsystem, develop infrastructural and intersystem interaction betweenparticipants in the national payment system, and also enhanceaccessibility and the security of payment services, including with the useof innovative payment instruments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 111In order to follow up with this federal law, the Bank of Russia will developregulations in 2012 to cover the following areas: –the regulation of the Bank of Russia payment system; – the regulation of payment systems, as well as supervision andoversight in the national payment system; –measures to ensure the smooth operation of payment systems andinformation protection (security) in money remittances.In order to ensure the development of the national payment system, theBank of Russia will participate in the work of the Technical Committeeon Financial Operations Standards to continue creating a nationalstandard of cashless settlements based on the ISO 20022 methodologyand introducing it into the national payment system.Basic measures to develop the Bank of Russia payment system will focuson improving the Bank of Russia system of real-time gross settlements(BESP).It will especially focus on expanding settlement services provided tocredit institutions, as well as financial market participants, the FederalTreasury and Bank of Russia divisions, including a broader format of theBESP system operation.It will also increase the operational efficiency and automation of intradayliquidity management procedures.The implementation of these measures will create conditions for loweringthe risks and costs incurred by payment system participants. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 112NUMBER 8The Importance of StrongRisk Management: InsightsFrom The ExaminationWorldBy Jason C. Schemmel, Community and Regional supervisory examinerwith the Federal Reserve Bank of RichmondIntroductionIn 1995, the Board of Governors of the Federal Reserve System issued SR95-51, which instructed examiners to begin assigning a formal supervisoryrating to the adequacy of an institution’s risk management processes.Examiners had always emphasized the importance of sound riskmanagement processes, but this guidance heralded an era of heightenedawareness in light of new technologies, product innovation and rapidlychanging banking markets.Examiners continue to assess and consider factors such as profitability,asset quality and capital adequacy when assigning supervisory ratings,but these indicators, to a large degree, tell a story about the past.At the heart of risk management is the concept of looking toward thefuture, as being able to identify, measure, monitor and control risksbefore they spread is critical to the conduct of safe and sound banking,regardless of the size and complexity of the institution.Analysis of banking performance during the recession of 2007–2009indicates that banks with strong forward-looking risk mitigationstrategies weathered the recession more successfully than other banks,even those taking identical risks (see “Weathering the Storm: A CaseStudy of Healthy Fifth District State Member Banks Over the RecentDownturn” in the summer 2012 edition of S&R Perspectives).These successful institutions all possessed the key elements of a riskmanagement framework, including: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 113 - An active board of directors and senior management team - Policies, procedures and risk limits governing all activities that are clearly communicated throughout the organization - Timely and accurate management information systems (MIS) - Strong internal controlsTo understand the risk management challenges currently facing our statemember banks, we asked key members of the Federal Reserve Bank ofRichmond’s Community and Regional (C&R) management team toidentify areas that are(1) Consistently cited in reports of examination as risk managementweaknesses or(2) Expected to receive heightened attention in the near future. Thisarticle reinforces existing supervisory guidance and expectations anddiscusses the most commonly cited examination issues related to themanagement of credit, liquidity, market, operational, and legal andreputational risks.Properly addressing these matters will improve the prospects of early riskdetection and help to prevent losses.Credit RiskC&R relationship managers and subject matter experts alike expressedconcern over three areas: new product lines, home equity lines of credit(HELOC) and appraisal review.New Product LinesInterviews with bankers during examinations over the previous 12–24months revealed that many management teams and boards of directorsintend to reduce future reliance on real estate lending by expanding intocommercial lending.The number of bankers that stated this intention is striking and indicatesthe potential for fierce competition for commercial business. In fact, _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 114several banks have reported recent solicitations from third partiesattempting to negotiate participation in syndicated commercial loans.Prior to expanding into commercial lending, or any new product line, itwill be critical for banks to properly research the product and ensure italigns with the bank’s strategic plan and the risk appetite of the board ofdirectors.Banks that venture into commercial lending are expected to have theappropriate expertise on staff to underwrite and monitor the credits.Moreover, the lending staff must be guided by robust policies, proceduresand risk limits.As was the case in the late 1990s, intense competition for commercial loancustomers often leads to significant easing of both loan terms andfront-end financial analysis.Discipline was — and will be — a key success factor.Existing supervisory guidance stresses: - The importance of using formal forward-looking analysis in the loan approval process - The value of assessing alternative or “downside” scenarios - The dangers of unduly weighting the short-term benefit of attracting or retaining customers through price concessions while giving insufficient consideration to potential longer-term consequences1Additionally, exceptions to approved underwriting and pricing policiesshould be rare, properly approved, aggregated and actively monitored bysenior management.HELOCsThere is considerable concern among C&R credit risk specialists that,unlike many other real estate loans, the losses in HELOC portfolios haveyet to fully materialize. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 115Many of the loans originated from 2003 to 2007 are approaching the end oftheir draw periods and will soon convert from interest-only to amortizingloans or have principal due as a balloon payment.Observations from recent examinations indicate that banks withsignificant concentrations of HELOCs have not fully identified andmeasured the potential impact of these events.Institutions with significant exposure to HELOCs should ensure thatthey are adhering to effective account management practices.These include: - Periodically refreshing credit scores on customers - Periodically assessing utilization rates - Periodically assessing payment patterns, including borrowers who make only minimum payments or those who rely on the line to keep payments current - Using reasonably available tools to determine the payment status of senior liens associated with junior liens - Obtaining updated information on the collateral’s value when market factors indicate a deterioration in value since origination or when the borrower’s payment performance deterioratesMeasurement of this data will allow bankers to identify customers whomay default when loan terms change and facilitate the creation ofeffective workout solutions.Data procured from this analysis should also be incorporated into theinstitution’s allowance for loan and lease losses (ALLL) methodology.Appraisal ReviewExaminers continue to observe appraisal review practices that areinconsistent with supervisory guidance.Too often, appraisal reviews only consist of checklists used by thereviewer to determine compliance with federal regulations. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 116While determining compliance with regulations is surely critical, it ismerely one aspect of the appraisal review process.Just as important is an evaluation of whether the methods, assumptionsand data sources in the appraisal (or evaluation) are appropriate andwell-supported.An institution’s policies and procedures for reviewing appraisals andevaluations should address, at a minimum, the following:Staff members who review appraisals and evaluations should beindependent of both the property being valued and the loan productionstaff.Reviewers should also possess the requisite expertise to perform a reviewcommensurate with the level of risk and complexity in the transaction.The depth of review should be appropriate for the risk and complexity ofthe transaction and property, but always be sufficient to ensure themethods, assumptions and conclusions within the appraisal andevaluation are reasonable and well-supported.Staff within the institution should have clear written guidance on how toresolve deficiencies uncovered during a review.All reviews should be thoroughly documented and placed withinappropriate credit files.Liquidity RiskAll financial institutions, regardless of size and complexity, should have aformal contingency funding plan (CFP) that clearly sets out the strategiesfor addressing liquidity shortfalls in emergency situations.C&R relationship managers indicated that most banks have institutedsome form of CFP; however, many banks continue to struggle with thedetails.In general, the CFPs reviewed during examinations do not adequatelyaddress a sufficient range of liquidity stress events. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 117The narrative section of the CFP should contain a thorough description ofany liquidity event — or combination of events — that could adverselyimpact the bank’s liquidity.The events may be institution-specific or arise from external factors.Examples include, but are not limited to, the inability to fund assetgrowth; the inability to renew or replace a maturing funding source;unexpected deposit runoff; or financial market dislocations.Additionally, CFPs frequently are not robust enough with regard to thevarious stages and levels of stress severity that can occur during acontingent liquidity event.The narrative section should fully describe the stages of each event, itsseverity and its expected duration.Stress events should be modeled with sufficient severity to providemanagement and the board of directors with enough information toascertain the durability of the bank’s liquidity position.Moreover, the duration of the event is a critical factor in accuratelymeasuring potential funding gaps and available funding sources.Some events may be temporary while others may be longer-term.In either case, the event should ultimately be modeled through itsconclusion.Designing the CFP in this fashion affords the opportunity to identifyearly-warning indicators for each stage, assess potential funding needs atvarious points in a developing crisis and specify action plans.Market RiskProper measurement of market risk requires regularly assessing thereasonableness of assumptions that underlie an institution’s exposureestimates.C&R subject matter experts have observed repeated weaknesses in threeareas related to model assumptions: documentation, sensitivity testingand corporate governance. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 118Key model assumptions such as asset prepayments, nonmaturity depositprice sensitivity and deposit decay rates are often unsupported andundocumented.Inputs for these assumptions typically have a material impact on themodel’s output; therefore, it is critical to ensure they are accurate.Assumptions should be specific to the bank and based on an appropriatelevel of empirical evidence.The decisions made and the rationale behind them should then bethoroughly documented.To aid in determining which assumptions exert the greatest impact onmeasurement results, banks should periodically perform sensitivitytesting.Doing so will provide valuable insight into how to allocate scarceresources, i.e., the most critical assumptions should be given the mostattention. When actual experience differs significantly from pastassumptions and expectations, institutions should use a range ofassumptions to appropriately reflect this uncertainty.Finally, banks should develop a comprehensive governance system foractively monitoring and regularly updating key underlying assumptions.This system should include oversight by representatives from any majorbusiness line that can directly or indirectly influence the bank’s marketrisk exposure.Deliberations from these meetings and the rationale behind changes tokey assumptions should be thoroughly documented in meeting minutes.Operational RiskC&R operational risk specialists have identified two areas of concern astechnology is increasingly integrated into the business of banking:information security and vendor management. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 119Information SecurityOne of the most common operational risk deficiencies cited duringexaminations over the last 18 months relates to information security.It remains a challenge for all banks, regardless of size, because of thecomplex interconnectivity between the bank, its customers and itsvendors.The proliferation of mobile devices and electronic payment channels hasincreased the opportunities for hackers to compromise bank systems andsteal critical data.Therefore, strong internal controls surrounding access management areessential, including a robust risk assessment process; effectiveprocedures for administering, logging and monitoring critical systems;and independent validation of controls through audits or penetrationtesting.Vendor ManagementNot surprisingly, the increase in technological banking solutions has ledto an increase in outsourcing.The scope of activities outsourced, however, has not been limited totraditional activities such as core processing and now may includeinterest rate risk modeling, stress testing or loan loss mitigationstrategies.Recent examinations indicate that vendor management practices areoften not keeping pace with the growing volume and scope ofoutsourcing activities, particularly in the areas of due diligence andservice provider oversight.Due diligence prior to engagement should fully consider the provider’sability to meet the institution’s needs.Institutions should consider the provider’s technical and industryexpertise, operations and controls, and financial condition. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 120Once a contract has been signed, the institution must implement anoversight program to monitor each service provider’s controls, conditionsand performance.The oversight program should be commensurate with the risk of theoutsourced relationship and be thoroughly documented for use in futurecontract negotiations, termination issues and contingency planning.Legal and Reputational RiskFinally, C&R operational risk specialists expressed concern with theproliferation of social networking platforms and their potential effect onbanks’ legal and reputational risks.A social networking service is an online service, platform or site thatfacilitates the building of social relations among people who sharecommon interests, activities or relationships.Their use has exploded as companies attempt to reach customers withadvertising and to generate business intelligence for future sales orcustomer service.Social networks pose several risks to banking organizations, including thepotential disclosure of nonpublic personal information (NPI),disinformation or derogatory information, and security threats such asviruses or social engineering.Any of these or similar events could result in significant lawsuits ordamage to the institution’s reputation.Banks are encouraged to develop sound social connectivity policies thatgovern the use of social media by employees and to provide adequatetraining to employees on those policies.The use of social media should also be considered in the institution’sinformation technology risk assessment.ConclusionThe current recession has been longer and deeper than any since theGreat Depression, and institutions facing severe earnings pressures maybe tempted to reduce resources dedicated to risk management. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 121But evidence suggests that strong risk management, not historicalfinancial performance, is the common denominator of successfulcommunity banks.Institutions should remain vigilant in order to identify risks that couldnegatively affect the bank and take appropriate action to measure,monitor and control them. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 122NUMBER 9Islamic finance developments in PakistanKeynote address by Mr Kazi Abdul Muktadir,Deputy Governor of the State Bank of Pakistan,at the Islamic Finance news (IFN) Roadshow 2012,KarachiDistinguished guests, ladies and gentlemen!Assalam-u-alikum and a very good morning.It is my great pleasure to welcome you all in this IFN road show.I would like to congratulate and thank Redmoney for organizing the showin Pakistan, which is one of the fastest growing Islamic finance marketsacross the globe.Such events not only enhance Islamic finance awareness and stimulate itsdemand but also provide a platform to Islamic finance stakeholders toshare their experiences and insights about this fast emerging segment ofthe financial system.I hope that today’s discussions and deliberations would help inaddressing the key challenges being faced by the industry and contributetowards sustaining the growth momentum.Ladies & Gentlemen! Since the inception of modern Islamic finance in1960’s, Islamic banking has evolved from its relatively modest size to avibrant industry with an increasing global footprint.With a size of US$1.35 trillion (according to Global Islamic FinanceReport 2012) and annual growth rate of more than 20 percent, the Islamicfinancial industry now comprises 430 Islamic banks and financialinstitutions and around 191 conventional banks having Islamic bankingwindows operating in more than 75 countries. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 123The relative resilience and stability of the industry during the financialcrisis and its flexibility and responsiveness to changing business needshas helped the industry to establish itself as a viable financial system.The tremors and aftershocks of the financial crisis are still on either in theform of European debt crisis and/or weakening global economic outlookand the policy makers are still looking for answers to fix these issues.Islamic finance, with its roots in a moral economic model that supportsproductive economic activity and discourages excessive leveraging andimprudent risk taking, can play an important role in rebuilding thefinancial system.I believe that this is high time for Islamic economists and scholars tohighlight the inherent strengths and potential of Islamic finance inaddressing the existential challenges faced by the global financial andeconomic systems.Ladies & Gentlemen! The evolution of Islamic finance industry inPakistan has followed the same trajectory as global Islamic financialindustry; with growth mainly intensifying over the last decade.Despite having introduced landmark changes during 1980s includingamendment in the Banking Companies Ordinance, enactment ofMudaraba Companies and Mudarabas (Floatation and Control)Ordinance etc, efforts for transformation of financial system to ShariahCompliant met with limited success only.This was primarily due to unavailability of adequate infrastructure andlack of trained human resources.Learning from past experience, Islamic banking was re-launched in 2002with a more practical and gradual approach that allowed Islamic banks tooperate in parallel with conventional banks.This time we also introduced a comprehensive Shariah complianceframework to ensure that the operations of Islamic banks are inconformity with the Shariah principles; this was necessary to give _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 124confidence to the consumers about Shariah permissibility of Islamicbanks’ business and operations.The approach has proved a mega success as the industry growing fromscratch in 2002 now constitutes over 8 percent of the country’s bankingsystem with a network of 964 branches and over 500 windows across thecountry.The future outlook is also positive; the Islamic finance industry with itsrapidly growing acceptability both amongst the providers and users offinancial services, is likely to increase its share in the banking system to 15percent during next five years.Encouragingly, the sustained growth of Islamic banking in the countryduring the last decade has also started catalyzing growth anddevelopment of Islamic capital markets, Mutual funds and Takafulcompanies etc; presently we have 5 Takaful operators, about 30 Islamicmutual funds.We have an effective coordination mechanism with SECP – the capitalmarkets and NBFIs’ regulator – and I am sure that the non-bankingIslamic financial services industry would also be growing in tandem withthe Islamic banking industry.Ladies & Gentlemen! The State Bank of Pakistan fully owns the Islamicbanking industry and has been taking a number of initiatives tostrengthen the legal, regulatory and Shariah compliance framework,create awareness amongst the masses and build the industry’s HRcapacity.I will share a few with this audience today.The development and issuance of sovereign Sukuk for the domesticmarket, which is an important liquidity management instrument was along outstanding demand of the industry.The SBP in collaboration with the industry and the Federal Governmentdeveloped sovereign Sukuk and you would be pleased to know that _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 125during last two years sovereign Sukuk of Rs.369 billion (USD 4 billionapprox) have been issued that has largely addressed the liquiditymanagement issue of the industry.The regular issuance of the Sukuk, almost on quarterly basis, hasimproved market confidence and tradability of the Sukuk.To improve transparency and bring standardization in IBIs’ profitdistribution and pool management practices, we have developed acomprehensive profit distribution and pool management framework inconsultation with the industry.The framework will be issued most probably within this month and willbe instrumental in improving public confidence in Islamic bankinggenerally and profit distribution policies and practices of IBIsparticularly.Similarly to further strengthen the Shariah governance in IBIs, we are inthe process of developing a comprehensive Shariah Governanceframework.The framework will explicitly define the roles and responsibilities ofdifferent organs of IBIs including the Board of Directors, ShariahAdvisors/Committees and Executive Management for ensuring Shariahcompliance.Presently Shariah compliance is perceived to be the responsibility of theShariah Advisors only whereas Board of Directors and ExecutiveManagement assume no such responsibility.This we believe is contrary to the corporate governance principles asunless the BOD and management are not fully aware of the Shariahnon-compliance risk, it would be difficult for the Shariah Advisor todevelop an effective Shariah compliance mechanism in IBIs.The proposed framework will fix these and other similar issues. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 126Further, the SBP, in collaboration with the industry, will also bedeveloping the strategic plan for the industry for the next five years ie2013–2017.The plan will make a detailed assessment of the earlier plan (2007–2012)as well as the existing environment and will set the strategic direction forthe industry.This is an important project which would define the strategies and actionplans to move the industry to the next level of growth and SBP wouldexpect active and meaningful involvement of the industry in developmentof the plan.Ladies & Gentlemen! As you all know that SBP has been at the forefrontof the initiatives and programs for creating awareness.Being the host of today’s program is a part of its efforts to improve publicunderstanding of Islamic banking and minimize their apprehensions andconfusions.While seminars, conferences, workshops are being organized across thecountry on regular basis, we will soon be launching a mass mediacampaign to create awareness about Islamic banking.The campaign we believe will be instrumental in enhancing publicawareness and allaying their apprehensions and confusions about Islamicfinance and thus would give further boost to the growth momentum.Lastly, I would reiterate my optimism about the growth prospects of theindustry; I believe the growth momentum will not only be sustained butwill gather further strength as we will see some more key players enteringthe market with aggressive expansion plans in very near future.The challenge will however be to develop suitably qualified and trainedHR to man this growth; while SBP will be further intensifying its efforts tobuild the industry’s HR capacity through its regular and specializedtraining programs, the IBIs would also have to significantly increase theirinvestment in HR development. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 127Another challenge would be diversification of assets mix and tapingnon-traditional sectors like agriculture and SMEs to deploy the growingdeposit base in productive avenues.Presently the IBIs’ exposure in these sectors is nominal that needs to beincreased significantly, which would not only improve their reputeamongst the masses but would also provide them an attractive avenue todevelop and expand their assets portfolios.SBP would be willing to provide necessary support to IBIs to buildportfolios in these non-traditional but strategically important sectors.My thanks and appreciation again to Redmoney for organizing this eventand I hope such collaborations will continue in future.I wish all the foreign delegates to have pleasant stay in Karachi and a safejourney back home.Thank you. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 128NUMBER 10Regulatory reform: getting it doneRemarks by Mr Stefan Ingves, Governor of SverigesRiksbank and Chairman of the Basel Committee onBanking Supervision, at the 17th InternationalConference of Banking Supervisors, IstanbulIntroductionGood morning and welcome to the 17th International Conference ofBanking Supervisors.Let me start by thanking our hosts - the Central Bank of the Republic ofTurkey and the Turkish Banking Regulation and Supervision Agency.I would like to thank in particular Governor Erdem Başçi, ChairmanMukim Öztekin and of course the staff of both organisations for doingsuch an outstanding job of hosting this ICBS.We have benefited tremendously from your presence on the Committeesince 2009 and we look forward to returning to this historic city for futuremeetings and conferences.Finally, let me thank Deputy Prime Minister Ali Babacan for hisinsightful remarks.This ICBS will focus on the challenges we are facing to improvesupervisory practices, building on what we have learned in the recentpast.The starting point for such improvements and the foundation of all banksupervisory frameworks is the Core Principles for Effective BankingSupervision, which will be the topic of discussion on this first day of theICBS.We have also organised several panel and workshop discussions toexamine and debate the most recent policy responses to the financialcrisis and other supervisory and market developments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 129A critical aspect of these policies is their full and timely implementationand we will have the opportunity to discuss the challenges that arise inthis regard.The conferences themesLet me say a few words about these two main topics. In conducting its review of the Core Principles, the Committee hassought to raise the bar for banking supervision by incorporating thelessons learned from the crisis and other significant regulatorydevelopments.At the same time, we have remained mindful of the fact that the CorePrinciples are applied on a global basis and that we need to maintaincontinuity and comparability.Given the worldwide application of the Core Principles, it is of utmostimportance that the revisions we have made are well understood andimplemented with, at a minimum, the same rigour as the previous set ofprinciples.The two co-chairs of the Basel Committee group that was responsible forthe revisions - Sabine Lautenschläger of the Deutsche Bundesbank andTeo Swee Lian of the Monetary Authority of Singapore - will co-chair apanel discussion on the revised Core Principles.This is a topic of great relevance for all of us, so I know this discussionwill be of great interest to everyone here.Regarding policy responses to the financial crisis - the second theme ofthe ICBS - there is always a danger of believing we have learned "all thereis to learn" or that "this couldnt happen to me".On the one hand, the root causes of financial crises are always very similaralthough they can differ in their manifestation.For example, in my own country - Sweden - and in many other countriesaround the globe, I have seen different crises evolve and one commonelement has been excessive credit extended by banks that did not fullyappreciate the risks. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 130On the other hand - and I can tell you this from first-hand experiencehaving been through too many financial crises for my liking -overconfidence and supervisory complacency are extremely dangerousand we must continually be alert to guard against these risks.Tomorrows workshops and panel discussion on what the crisis hastaught us are indeed timely.While a single day is not sufficient to address all of our challenges, thereflections of an impressive cast of speakers will offer a wide range ofdifferent perspectives on topical issues.These issues include: 1. The implications of non-financial sector leverage for banks and bank supervision; 2. Basel III implementation; 3. Liquidity standards and risk management; 4. Corporate governance, disclosure and transparency; and 5. Systemically important banks.The common thread here is the universal applicability of the lessons wehave drawn.The relevance of these topics is not limited to only certain jurisdictions ortypes of banks.Some will call this "back to basics" and rightly so.The label we choose to apply is not important; what is important is thatwe get the regulation right and that we are diligentin implementing ourstandards.The Committees work on implementation Having learned this lesson, the Committee now devotes considerableresources to monitoring implementation of the rules and standardsagreed by its members. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 131Our work no longer stops once we issue a press release announcing newregulatory standards.From the Basel Committees perspective, one of the most enduringlessons we as supervisors have learnt is that full, timely and consistentimplementation is not a bonus - it is an imperative. So what have we done to put this commitment into practice? Almost oneyear ago, the Committee agreed on a process and framework to reviewmembers implementation of Basel III.The review framework is intended to provide additional incentives formember jurisdictions to fully implement the standards within thetimelines agreed.Let me briefly review its key elements.There are three levels of review:The first level is the timely adoption of Basel III. We have been regularlyreporting on member countries progress in implementing rules in theirlocal jurisdictions in accordance with agreed timetables.The second level is to ensure consistency of domestic regulations with theinternational minimum requirements. This is a line-by-line review of localrules with the Committees standards, conducted by teams of peersupervisors.The third level of review consists of an analysis of the outcomes of theBasel III implementation.It extends the first two levels of analyses to supervisory implementation atthe bank level.One cannot overstate what a significant step this is, as we for the first timehave teams of global supervisors travelling to individual banks andcomparing notes at a very detailed level across borders.This, more than anything, is symbolic of the big step the Committee istaking to get implementation right. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 132Perhaps most importantly, the results of this work will be public, so therewill be complete transparency for all about how our rules are beingapplied in practice.In the past year, the Committee has published two standalone reportsdetailing its members progress in adopting the Basel III rules and wehave also prepared a report to the G20 Leaders that provided an update onimplementation.In a couple of weeks, we will issue Level 2 assessment reports for the firstthree jurisdictions under review: the European Union, Japan and theUnited States.Our next assessment will soon begin and this will review SingaporesBasel III rules; this will be followed by reviews of Switzerland and China.We are currently conducting Level 3 assessments on the calculation ofrisk-weighted assets and expect to publish our findings around the end of2012.The revised Core Principles and the Basel III rules were designed toachieve safer and sounder financial systems, whether big or small,complex or not.After considerable consultation with supervisors, bankers and otherinterested parties from around the world, the rules and standards havebeen developed and now need to be put into practice.Financial stability issues know no borders.We are keenly aware that the roots of the recent financial crisis arereplicable anywhere in the world and we know that risk will flow towherever it is underpriced.We know - and I have seen first-hand from my days at the IMF - that therisk of cross-border contagion rises exponentially with an increase incross-border banking activity and increasingly international financialmarkets.Our global banking foundation is therefore much firmer when we acttogether in implementing sound prudential standards. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 133In that regard, I would like to spend a few minutes updating you on theCommittees current and future work agenda for developing regulatorystandards.Current and future agenda I will start with the global liquidity rules, which are a much debatedtopic.The Basel III liquidity framework, which was published in December2010, forms an essential part of the Basel III package and continues to beone of the most important items on the Committees agenda.When we published the rules, the Committee said it would carefullyassess whether there would be any unintended consequences.Some banks told us this careful approach has given rise to unnecessaryuncertainty and has hindered their efforts to work toward managing to thenew standards.The Committees governing body of Central Bank Governors and Headsof Supervision therefore directed the Committee to finalise any revisionsaround the end of this year and we are on track to deliver.The Basel III liquidity rules represent the first ever global framework toensure a bank maintains an adequate stock of liquidity and operates witha prudent funding structure.The Committee is therefore taking a careful and deliberate approach toreviewing the rules.But let me remind you that our goal is to raise the bar.It is designed to have an impact on banks and markets: that is notunintended.The rules are already having the desired effect as we have seen animprovement in risk management and in liquidity at many banks.In Sweden, for example, the four major banks all had liquidity coverageratios below 100% when they started reporting their LCR. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 134They have since improved their liquidity management and positions andcurrently all four meet the new standards.OTC derivativesI would also like to say a few words about another of the Committeeshigh priorities and this relates to the broader global reform forover-the-counter derivatives markets.The financial crisis exposed major weaknesses of OTC derivativesmarkets, namely counterparty credit risk and a lack of transparency andthe attendant effects of contagion risk and spillover.A package of reforms agreed by the G20 Leaders aims to address thesedeficiencies, for example, by moving OTC trades towards centralclearing.The Basel Committee plays a key role in ensuring that banks adequatelycapitalise counterparty credit risk exposures, whether those exposuresrelate to other banks or to central counterparties (CCPs).For example, in December 2010 we published enhanced capital rules forbank exposures to counterparty credit risk arising from non-centrallycleared derivatives.More recently, we issued interim capital rules for bank exposures toCCPs.These rules will both take effect at the start of next year although workwill continue over the course of 2013 to ensure that the capitalisation rulesfor bank exposures to CCPs reflect risks in an appropriate manner andprovide incentives for banks to move derivatives trades towards centralclearing.Another OTC derivatives market reform in which the Committee isinvolved is the development of global standards on margin requirementswhich are intended to mitigate contagion and spillover effects.A consultative paper on this topic was published in July and we hope thiswork, which is being conducted in collaboration with other standardsetters, will lead to updated proposals that we can consider by the end ofthis year. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 135SecuritisationAllow me to say a few words about the Committees ongoing work relatedto the regulatory treatment of securitisations, on which we will soonpublish a consultative proposal.The performance of securitisation exposures and the central role theyplayed during the recent financial crisis were a key motivation for theCommittee to perform a broader review of its securitisation framework forregulatory capital requirements.Our objectives are to make capital requirements more prudent andrisk-sensitive; to mitigate mechanistic reliance on external credit ratings;and to reduce cliff effects.The Committee is well aware of the trade-off between the risk posed bysecuritisation and its function as an important tool for bank funding andliquidity.Now that there are signs of revival of the securitisation markets, it isimportant to finalise prudent and risk-sensitive solvency rules forsecuritisations as soon as possible.Fundamental review of the trading bookThe Committees proposals to revamp the securitisation framework are assweeping as our fundamental review of the trading book rules.The Basel 2.5 modifications adopted in 2009 resulted in a substantialincrease in capital requirements for certain securitisations and structuredcredit products.But these modifications were largely built on the existing regulatorydefinitions and framework.At around the same time, the Committee commenced a fundamentalreview of trading book capital requirements.That review resulted in the publication of a conceptual paper this pastMay. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 136That paper set out a revised market risk framework and proposed anumber of specific measures to improve trading book capitalrequirements.These proposals reflect the Committees increased focus on achieving aregulatory framework that can be implemented consistently bysupervisors and which achieves comparable levels of capital acrossjurisdictions.The consultation period ended last week.Once the Committee has reviewed the responses it has received, itintends to release for comment a more detailed set of proposals to amendthe Basel III framework.We also plan on conducting a quantitative impact study based on thoseproposals.Global and Domestic Systemically Important Banks In the time remaining, I would like to say a few words about theCommittees work with respect to global and domestic systemicallyimportant banks.Last year, the Basel Committee issued final rules for global systemicallyimportant banks (G-SIBs), which were endorsed by the G20 Leaders attheir November 2011 meeting.The G20 Leaders also asked the Committee and the Financial StabilityBoard to work on extending the G-SIFI framework to domesticsystemically important banks (D-SIBs). G-SIBs will be subject to an additional loss absorbency requirement overand above the Basel III requirements that are being introduced for allinternationally active banks.This additional requirement is intended to limit the cross-border negativeexternalities on the global financial system and economy associated withthe most globally systemic banking institutions.But similar externalities can apply at a domestic level: indeed, from adomestic perspective, they can be even larger. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 137While not all D-SIBs are significant from a global perspective, the failureof such a bank could have a much greater impact on its domesticfinancial system and economy than that of a non-systemic institution.Against this backdrop, the Basel Committee has developed a set ofprinciples on the assessment methodology and the higher lossabsorbency requirement for D-SIBs.The proposed framework takes a complementary perspective to theG-SIB framework by focusing on the impact that the distress or failure ofbanks will have on the domestic economy.However, the proposed D-SIB framework will take a principles-basedapproach, in contrast to the prescriptive approach of the G-SIBframework.This will allow an appropriate degree of national discretion in theassessment and application of policy tools in order to accommodate thestructural characteristics of individual jurisdictions.The D-SIB principles, which will be published in the coming weeks,require countries to adopt a framework for assessing the systemicimportance of their banks on a domestic basis by January 2016.This is consistent with the phase-in arrangements for the G-SIBframework and means that national authorities will establish a D-SIBframework in advance of that deadline.The Basel Committee will introduce a strong peer review process for theimplementation of the principles. This will help ensure that appropriateand effective frameworks for D-SIBs are in place across differentjurisdictions.Simplicity in our rulesI will finish my review of the Committees current work by saying a fewwords about a topic that pervades our current efforts - and that issimplicity. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 138Basel III, with its straightforward, non-risk-based measure of capital toassets and the frameworks rules for a streamlined capital structure aretwo good examples.This mindset has become ingrained in other efforts, such as theCommittees current review of the securitisation framework and theoperational risk framework.More broadly, the Committee is also reviewing the broader Baselframework to determine whether the rules strike the appropriate balancebetween regulatory complexity and risk sensitivity.The aim of this work is identify areas where we could reduce the level ofcomplexity or where comparability could be improved.Special acknowledgmentBefore concluding, let me make a special acknowledgement of someonewho very well may be the most widely known person in the room today,and who is attending the ICBS for the last time.As many of you know, Jonathan Fiechter will be retiring from the IMF ina month or so, and I would be remiss if I did not acknowledge thesignificant contribution he has made to the work of the Basel Committee,its working groups, regional groups of banking supervisors and nationalsupervisors themselves.Even though he is currently not a supervisor himself, he has beenunfailing in his support of effective regulation and strong supervision. So,Jonathan, on behalf of everyone here, we thank you and wish you the verybest for the future.ConclusionLet me bring my remarks to a close as we have a stimulating programmeahead of us and, therefore, I will not keep you waiting.The Basel Committee is leading on two very important efforts: the first isto fine-tune the regulatory framework and develop policy responses that _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 139firstly respond to the lessons of the crisis, and then keep pace as marketsand institutions evolve.The second is ensure that the agreed-upon policy responses areimplemented fully, consistently and globally.That is the reality check.We believe, as do the G20 Leaders, that these reforms are the right onesfor making progress towards improved financial stability, growth andsustainable economic development.With this in mind let us make sure that the discussions today andtomorrow are fruitful and will help you and your organisations achievethese important goals.NotesStefan IngvesStefan Ingves is Chairman of the Executive Board and Governor of theRiksbank. Mr Ingves is a member of the ECB General Council and amember of the Board of Directors of the Bank for InternationalSettlements (BIS).He was appointed Chairman of the Basel Committee on BankingSupervision in 2011.He also chairs the Advisory Technical Committee of the EuropeanSystemic Risk Board.In addition, Mr Ingves is Sweden’s governor in the InternationalMonetary Fund.Mr Ingves has previously been Director of the Monetary and FinancialSystems Department at the International Monetary Fund, DeputyGovernor of the Riksbank and General Director of the Swedish BankSupport Authority.Prior to that he was Under-Secretary and Head of the Financial MarketsDepartment at the Ministry of Finance. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 140Stefan Ingves holds a PhD in economics.Stefan Ingves term of office is six years from 1 January 2006.The General Council of the Riksbank has appointed Stefan Ingves asGovernor of the Riksbank for an additional term of office of six years,from and including 1 January 2012. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 141Certified Risk and Compliance Management Professional(CRCMP) Distance learning and online certification program.Companies like IBM, Accenture etc.consider the CRCMP a preferredcertificate. You may find more if yousearch (CRCMP preferred certificate)using any search engine.The all-inclusive cost is $297.What is included in the price:A. The official presentations we use in our instructor-led classes(3285 slides)The 2309 slides are needed for the exam, as all the questions are based onthese slides. The remaining 976 slides are for reference.You can find the course synopsis at:www.risk-compliance-association.com/Certified_Risk_Compliance_Training.htmB. Up to 3 Online ExamsYou have to pass one exam.If you fail, you must study the official presentations and try again, but youdo not need to spend money. Up to 3 exams are included in the price.To learn more you may visit:www.risk-compliance-association.com/Questions_About_The_Certification_And_The_Exams_1.pdfwww.risk-compliance-association.com/CRCMP_Certification_Steps_1.pdf _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 142C. Personalized Certificate printed in full color.Processing, printing, packing and posting to your office or home.D. The Dodd Frank Act and the newRisk Management Standards (976slides, included in the 3285 slides)The US Dodd-Frank Wall Street Reformand Consumer Protection Act is the mostsignificant piece of legislation concerningthe financial services industry in about 80years.What does it mean for risk andcompliance management professionals? Itmeans new challenges, new jobs, newcareers, and new opportunities.The bill establishes new risk management and corporate governanceprinciples, sets up an early warning system to protect the economy fromfuture threats, and brings more transparency and accountability.It also amends important sections of the Sarbanes Oxley Act. Forexample, it significantly expands whistleblower protections under theSarbanes Oxley Act and creates additional anti-retaliation requirements.You will find more information at:www.risk-compliance-association.com/Distance_Learning_and_Certification.htm _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com