Basic Principles of Banking Supervision

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This handbook explores some of the basic principles of banking supervision. First of all, it addresses the general question of why banks need to be supervised, and sets out the basic aims of supervision. It notes that supervisors seek to ensure that banks are:

  • financially sound
  • well managed, and
  • not posing a threat to the interests of their depositors

And in pursuing these objectives supervisors are trying to form three judgements

  • how much risk is each bank undertaking?
  • what resources are available to manage that risk?
  • whether the identified level of resources is sufficient to balance the risk.

It then examines the nature of banking risk, focussing on credit risk, liquidity risk, yield risk, market risk, operational risk and ownership/management risk. Next, the key areas of prudential supervision are discussed – namely, capital adequacy, liquidity, asset quality, risk concentration, management, and systems and controls.

Furthermore, the need for an effective infrastructure for supervision, not least in respect of the legal and accounting environment, is noted. The legal framework must deal with:

  • business organisation – the formation, ownership, rights and obligations of privately owned enterprise
  • the ownership of property – and in particular the means by which banks to whom collateral is pledged by a borrower can register and, in extremis, enforce their claims
  • insolvency – the circumstances and manner in which an unpaid creditor of an enterprise may call for it liquidation, the process by which that liquidation is to be effected and the priority to be accorded to different classes of creditor

Accounting systems should encompass:

  • an agreed set of accounting standards to be followed by all enterprises in the preparation of their accounts, facilitating the resource allocation process – for example, by enabling banks to undertake informed credit assessments
  • independent review and certification of the accounts prepared by enterprises, undertaken by external auditors
  • public disclosure of audited financial statements

Finally, the relative contributions of off-site and on-site supervision are briefly discussed.

The author notes that the handbook does not seek to prescribe what any country should do, or to promote particular national practices (which maybe mentioned by way of illustration). Rather, it seeks to introduce the nature and concepts of supervision to those for whom the subject may be comparatively unfamiliar.

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