Basel Committee on Banking Supervision

Consolidated supervision is critical to the prudential objective of promoting the safety and soundness of banks and the banking system. Consolidated supervision helps protect the integrity of, and confidence in, the banks including both supervised and unsupervised elements. The purpose of consolidated supervision is threefold: (i) to ensure that all banking operations, wherever located, are subject to appropriate supervision; (ii) to prevent double-leveraging of capital; and (iii) to evaluate and control all the risks incurred by a bank globally, no matter where they are booked.

Effective supervision of international bank depends on effective supervision at both the local and the consolidated level. Effective cooperation between home and host supervisors is a central prerequisite to ensure that no banking operation, domestic or foreign, escapes oversight and that supervision is adequate.

The following terms are used throughout this chapter and have the meaning given below:

1. Booking branch: refers to a branch of a foreign bank where the branch has no meaningful mind and management in the jurisdiction in which it is licensed. Often, such branches are nothing more than “brass plates”, with only basic administrative services being supplied by a local agent who may provide such services to several banks. The management of the branch may be located in an office in the home jurisdiction of the head office or in an office located in a third jurisdiction, which may or may not be subject to supervision. The key distinction between booking branches and shell banks is that the former are part of an existing bank that is regulated by a home country supervisor.
2. Branches: are operating entities which do not have a separate legal status and are therefore integral parts of the foreign parent bank.
3. Consolidated supervision: is a group-wide approach to supervision whereby all the risks run by a bank are considered, wherever they are booked. It is a process by which a supervisor can satisfy themselves about the totality of a bank’s activities, which may include non-bank companies and financial affiliates, as well as direct branches and subsidiaries.
4. Holding company: refers to a company which is not itself a bank but which can be an industrial or commercial company, or a company whose assets mainly consist of shares in banks. These holding companies may also include intermediate non-bank holding companies or other non-banking companies.
5. Home supervisor: refers to the supervisor that is responsible for the supervisory oversight of a bank on a consolidated basis.
6. Host supervisor: refers to the supervisor that oversees specific entities within the bank in a jurisdiction other than the bank’s home jurisdiction. Host supervisors may have different interests in relation to the supervision of the group as a whole depending on whether the group has material risk exposures in the host jurisdiction and whether it poses a systemic risk to the host jurisdiction.
7. Joint ventures: are legally independent institutions incorporated in the country where their principal operations are conducted and controlled by two or more parent institutions, most of which are usually foreign and not all of which are necessarily banks. While the pattern of shareholdings may give effective control to one parent institution, with others in a minority, joint ventures are, most typically, owned by a collection of minority shareholders.
8. Parallel-owned banks: are defined as banks licensed in different jurisdictions that, while not being part of the same financial group for regulatory consolidation purposes, have the same beneficial owner(s), often share common management and interlinked businesses, and are not subject to consolidated supervision. The owner(s) may be an individual or a family, a group of private shareholders, or a holding company or other entity that is not subject to banking supervision.1 Parallel banking relationships may exist, unknown to the supervisors of the parallel banks.
9. Shell banks2: are banks that have no physical presence (ie meaningful mind and management)3 in the country where they are incorporated and licensed, and are not affiliated to any financial services group that is subject to effective consolidated supervision. The mind and management are located in another jurisdiction, often located in the offices of an associated entity or sometimes in a private residence. Typically, a shell bank maintains nothing but a registered agent in its country of incorporation, with the agent having little or no knowledge of the day-to-day operations of the bank, and simply providing an address for legal service in the jurisdiction. Such structures are a particular feature of some offshore centres.
10. Solo supervision: refers to the supervision of a single legal entity, as opposed to consolidated supervision, which refers to broader group oversight.
11. Subsidiaries: are legally independent entities, wholly owned or majority-owned, by a bank.

Banks may have interests in various types of foreign banking operations, including branches, subsidiaries and joint ventures. Banks may also have minority participations in foreign banking or non-banking companies, other than those in joint ventures, which may form part of their overall foreign banking operations.

Challenges to consolidated supervision may arise from banks’ foreign subsidiaries, participations and joint ventures, as they: (i) are legally independent from their parent institutions; and (ii) come under the jurisdiction of the country in which they are incorporated, which may have different features from those applying to the parent institution.

Holding companies

Supervisory challenges can also arise out of structural features of international banks. For example, the existence of a holding company either at the head, or in the middle, of such groups may impede adequate supervision. Problems may arise where such holding companies have substantial liabilities to the international banking system.

Where holding companies are at the head of groups that include separately incorporated banks operating in different countries, the authorities responsible for supervising those banks should coordinate their supervision of those banks, considering the overall structure of the group.

Where a bank is the parent company of a group that contains intermediate holding companies, the home supervisor should ensure that such holding companies and their subsidiaries are covered by adequate supervision. Alternatively, the home supervisor should not allow the parent bank to operate such intermediate holding companies.

Effective supervision of banks’ foreign operations requires an appropriate allocation of responsibilities between home and host supervisors and for contact and cooperation between them.

Home supervisors are responsible for the consolidated supervision of banks, while host supervisors are responsible for the supervision on a solo or sub-consolidated basis of entities operating in their jurisdiction. The responsibilities of home and host supervisors are both complementary and overlapping.

Where the home supervisor imposes conditions on a bank’s foreign operations, such conditions should be communicated to the host supervisor. Home supervisors should inform host supervisors when problems arise in a parent bank which are likely to affect its foreign operations. Host supervisors should ensure that the home supervisor is informed immediately of any serious problems which arise in a parent bank’s foreign operations. The consultations between host and parent/home supervisors in the context of the authorisation process should focus solely on prudential issues and have no relevance to freedom of entry or other competitive issues.

In cases where host supervision is inadequate, the home supervisor should either extend its supervision, to the degree that it is practicable, or it should discourage the parent bank from continuing its operations in that jurisdiction.

Host supervisors should exercise caution in approving applications for banking licences from foreign entities which are not subject to prudential supervision in their home country, or joint ventures for which there is no clear responsibility by a parent company. In such circumstances, any authorisation should be contingent on the host authority’s capacity to act as the home supervisor.

Problems may arise where the host supervisor considers that supervision of the parent institutions of a foreign bank operating in its territory is inadequate or non-existent. In such cases, the host supervisor should discourage or prohibit the activities in its territory of such foreign operations. Alternatively, the host supervisor could impose specific conditions governing the conduct of the business of such activities.

A bank’s foreign subsidiaries, participations and joint ventures can increase a parent bank’s leverage if the capital adequacy of these entities is considered separately from that of the parent institution, or if the minimum capital requirements in a host jurisdiction are significantly lower than the home jurisdiction. The supervisor must consider a bank’s capital adequacy on a consolidated basis. This includes all assets of foreign operations in which a bank has a controlling interest. That is, consolidation should be applied to a bank’s foreign branches and its wholly owned and majority-owned foreign subsidiaries.

The allocation of responsibilities for the supervision of the solvency and liquidity of banks’ foreign operations between home and host supervisors will depend upon the type of operation concerned. For liquidity, the host supervisor has responsibility for monitoring the liquidity of the foreign bank’s activities in its jurisdiction; the home supervisor has responsibility for monitoring the liquidity of the bank as a whole and of the bank’s operations in its home jurisdiction.

Within the framework of consolidated supervision, home supervisors have a general responsibility for overseeing the liquidity control systems employed by banks and for ensuring that these systems and the overall liquidity position of such groups are adequate. However, full consolidation may not always be practicable as a technique for supervising liquidity, because of differences in local regulations and markets, and the complications of banks operating in different time zones and different currencies. Home supervisors should consult with host supervisors to ensure that the latter are aware of the overall systems within which the foreign banks are operating. Host supervisors have a duty to ensure that the home supervisor is immediately informed of any serious liquidity inadequacy in a parent bank’s foreign operations.

Home and host supervisors should be responsible jointly for the supervision of banks’ foreign exchange operations and positions. It is particularly important for parent banks to have in place systems for monitoring their group’s overall foreign exchange exposure and for home supervisors to monitor those systems. Host supervisors should be able to monitor the foreign exchange exposure of foreign operations in their jurisdiction and should inform themselves of the nature and extent of the supervision of these activities by the home supervisor.

Consolidated supervision must include all foreign branches, immediate holding company, offices, subsidiaries, affiliates and joint ventures of a bank. Branches are not legally independent of their head offices and their activities should be aggregated with those of the parent bank for supervisory purposes.

The solvency of branches is indistinguishable from that of the parent bank. While there is a general responsibility on the host supervisor to monitor the financial soundness of foreign branches, supervision of solvency is primarily a matter for the home supervisor. The capital requirements imposed by certain host supervisors on foreign branches operating in their jurisdiction do not negate this principle. They exist firstly to oblige foreign branches that set up business in those countries to make and to sustain a certain minimum investment in them, and secondly, to help equalise competitive conditions between foreign branches and domestic banks.

For liquidity purposes, the initial presumption should be that primary responsibility for supervising branch liquidity rests with the host supervisor. Host supervisors will often be best equipped to supervise liquidity as it relates to local practices and regulations and the functioning of their domestic markets. At the same time, the liquidity of all foreign branches will always be a matter of concern to the home supervisor, since a branch’s liquidity is frequently controlled directly by the parent bank and cannot be viewed in isolation from that of the bank. Home supervisors need to be aware of parent banks’ control systems and need to consider calls that may be made on the resources of parent banks by their foreign branches. Host and home supervisors should always consult each other if there are any doubts about where responsibilities for supervising the liquidity of foreign branches should lie.

The supervision of subsidiaries’ solvency is a joint responsibility of both home and host supervisors. Host supervisors have responsibility for supervising the solvency of all foreign subsidiaries operating in their jurisdiction. At the same time, home supervisors, in the context of consolidated supervision of the bank, need to assess whether a parent institution’s solvency is being affected by the operations of its foreign subsidiaries. Home supervision on a consolidated basis is needed for two reasons: (i) because the solvency of banks cannot be adequately judged without considering all their foreign operations; and (ii) because parent banks cannot be indifferent to the situation of their foreign subsidiaries.

Primary responsibility for supervising subsidiaries’ liquidity should rest with the host supervisor. Home supervisors should consider any standby or other facilities granted, and any other commitments by parent banks to these subsidiaries. Host supervisors should inform the home supervisor of the importance they attach to these facilities and commitments, to ensure that they are fully considered in the supervision of the parent bank. Where the host supervisor has difficulties in supervising the liquidity (especially in foreign currency) of subsidiaries, it should inform the home supervisor so that appropriate arrangements can be agreed to ensure adequate supervision.

For minority participations and joint ventures, no single parent institution may have primary responsibility, since none has a controlling interest. In such cases, the home supervisor should ensure that the capital of the parent bank is adequate to sustain its commitment to these minority interests. This assessment is best undertaken on a case-by-case basis, considering the degree of effective control exercised by the parent bank and the extent of its involvement in the management of the activities. However, some countries may choose to consolidate such holdings on a pro rata basis.

For joint ventures, the supervision of solvency should generally be primarily the responsibility of the authorities in the country of incorporation. Some banks which are shareholders in consortium banks, may have commitments to these entities beyond the legal commitments which arise from their shareholdings. In this case, these commitments must be considered by the home supervisors of the shareholder banks when supervising their solvency. Depending on the pattern of shareholdings in joint ventures, and particularly when one bank is a dominant shareholder, there can also be circumstances in which the supervision of their solvency should be the joint responsibility of the authorities in the country of incorporation and the home supervisors of the shareholder banks.

For joint ventures, primary responsibility for supervising liquidity should rest with the authorities in the country of incorporation. The home supervisor of shareholders in joint ventures should consider any standby or other facilities granted, and any other commitments by shareholder banks to those ventures. The authorities in the country of incorporation of joint ventures should inform the home supervisors of shareholder banks of the importance they attach to these facilities and commitments, to ensure that they are fully considered in the supervision of the shareholder bank.

Where groups contain both banks and non-bank entities, there should be liaison between the banking supervisors and any authorities which have responsibilities for supervising these non-banking entities, particularly where the non-banking activities are of a financial nature.

The benefit of establishing booking branches is to allow a bank to conduct certain types of non-resident business in a foreign jurisdiction without the expense of establishing a full foreign branch. These branches have been used to avoid certain domestic restrictions on business in other jurisdictions,4 or to provide a contingency arrangement in case there is an increase in the regulatory burden in another jurisdiction that can be mitigated by such a structure. Usually, no local operations are originated in the branch.

In the case of booking branches managed or controlled directly from a home jurisdiction, the home supervisor should have access to the information it needs for effective consolidated supervision, including any branch books and records.5

Booking branches managed or controlled from a third jurisdiction, that is neither the home jurisdiction nor the jurisdiction in which they are licensed, may raise supervisory concerns. Mind and management may be located within a supervised branch, a subsidiary of the parent bank, a sister institution or an unsupervised non-bank institution in the third jurisdiction.

Home and host supervisors must be satisfied that the Core principles for effective banking supervision (BCP) can extend to all parts of such banking structures. One mechanism for minimising any supervisory gaps in the on-going supervision of banks with booking branches is a formal understanding between (a) the home supervisor, (b) the host supervisor and (c) the third supervisor in the jurisdiction where mind and management of the booking branch is located. The understanding should outline the primary responsibility of the home supervisor for consolidated supervision and the responsibilities of each of the other supervisors, to ensure that the whole bank is effectively supervised on a consolidated basis. The understanding should also cover sharing of prudential information among the supervisors, so that there will be no impediments to information flows to the head office, and to the home and host supervisors for effective supervision.

The following principles should be considered in the supervision of booking branches:

1. The authorisation process for booking branches should be fully in accordance with the Core Principles. The prior consent of the home supervisor should be obtained, so that it is aware of the existence of the booking branch, has the option to voice any concerns, and is able to confirm that it will include the branch in its ongoing consolidated supervision. If there are conditions attached to the licence of the booking branch, this information should be communicated to the home supervisor.
2. The licensing authority should require the parent bank to formally declare how the branch will be managed, controlled and audited, and confirm that these procedures are in line with the normal oversight procedures for foreign branches. This should include information on where books and records will be kept and the names of all those directly linked to its management. This information should be shared with the home supervisor. The third supervisor should also be made aware that mind and management of the booking branch will be located in its jurisdiction.
3. The bank’s head office should accept responsibility for risk management on a global basis, including any activities through the booking branch, even if risk management for the branch is carried out in the third jurisdiction.
4. The jurisdiction that licenses the booking branch should perform its obligations under the Core Principles as a host supervisor. It should carry out off-site supervision of the operation through annual interviews with management and the regular (eg quarterly) receipt of comprehensive supervisory returns and other relevant information. It should also carry out, either itself or through a delegated agent, on- site examination in the third jurisdiction where mind and management is located. On-site examinations should cover (at least) the quality of management and controls, and local currency liquidity management (if any). For this purpose, there should be no restrictions on the host supervisor in accessing supervisory information in the third jurisdiction.
5. The home supervisor should have primary responsibility for the consolidated supervision of the bank, including the activities of the booking branch. The third supervisor may perform limited supervision of the activities carried out in the booking branch, eg checking for compliance with policy, controls and processes, and aggregate statistics summarising safety and soundness of the activities.

Booking branches with mind and management exercised by an unregulated entity in a third country cannot be supervised effectively and should be prohibited.

In a limited number of cases, banks have also established booking subsidiaries. Such operations are used mainly for private banking or fiduciary relationships. The purpose of incorporating a subsidiary is to segregate the risk of the locally incorporated entity from that of the parent institution. Generally, the business of booking subsidiaries is run from the host jurisdiction. Booking subsidiaries are separate legal entities and there is no reason why they should be permitted to be managed from a jurisdiction other than the home or host, as there are increased operational and legal risks. All booking subsidiaries should be supervised within the full home and host responsibilities and relationships strictly in accordance with the Core Principles.

Supervisors should not approve the establishment of booking subsidiaries where mind and management is located solely in a third jurisdiction.

Parallel-owned banking structures may be established for a variety of reasons, including to:

1. take advantage of different tax arrangements;
2. avoid legal restrictions in some countries on the ownership of foreign subsidiaries by domestic banks; or
3. diversify risk outside countries that are considered economically or politically unstable.

In some cases, the motivation may be an attempt to evade regulatory constraints or consolidated supervision from the home country.

Even though a close relationship may exist between the parallel banks, they are not members of a defined bank that is subject to consolidated supervision. Consequently, parallel-owned banking structures present greater risk for supervisors who may be unaware of the nature and extent of any relationships and transactions between the banks that may have an impact on its safety and soundness. This opaqueness may also provide an incentive to the controllers to use the banks to provide undisclosed support mechanisms or to mask the true risks within the group. Finally, problems encountered in one bank may cause a loss of confidence in the parallel entity, even if there are no transactional links.

Given the supervisory issues that may arise with parallel-owned banking structures, there is a presumption that in principle such structures should not be permitted.

The characteristics listed below are indicators that a domestic bank may be directly or indirectly controlled by a person or group of persons that also controls a foreign bank through a parallel structure. If a bank exhibits one or more of these characteristics, the supervisors should conduct additional inquiries to ascertain whether a parallel-owned banking structure is in fact in place:

1. An individual, or group of individuals acting in concert, that controls a foreign bank also controls any class of voting shares of a domestic bank.
2. Persons owning or controlling the shares of a domestic bank receive financing from, or arranged by, a foreign bank and use shares of the domestic bank as collateral for this financing.
3. A domestic bank has adopted particular or unique policies or strategies similar to those of a foreign bank, such as common or joint marketing strategies, sharing of customer information, cross-selling of products, or linked websites.
4. An officer or director of a domestic bank either serves as an officer or director of a foreign bank,6 controls a foreign bank, or is a member of a group of individuals acting in concert or with common ties that control a foreign bank.
5. There is an unusually high level of reciprocal correspondent banking and other facilities between a domestic bank and a foreign bank.
6. The name of a domestic bank is the same as, or is similar to, that of a foreign bank.

With a parallel-owned banking structure, there are two or more “home” supervisors, but none of these supervisors performs consolidated supervision of the entire bank. It is not feasible or practical to require any supervisor acting alone to gather the necessary supervisory information on all related foreign parallel banks in the group, especially if parts of the structure in foreign countries are opaque. This makes it difficult for a supervisor to apply prudential norms to its domestic bank, without an understanding of how it will be affected by the overall financial position and risks of the entire bank.

The risks associated with parallel-owned banking structures stem primarily from the possibility that officers or directors of one of the parallel banks will expose the bank, either intentionally or unintentionally, to higher risks through transactions with related parallel banks. There is a risk that transactions may not be conducted at arms-length, or that the relationship may be used to fabricate the financial position of one or more of the institutions. For instance, the following may result:

1. One parallel bank may seek to evade legal and other regulatory lending limits by carrying out transactions through its related parallel bank, thereby increasing concentration risk.
2. Assets, earnings and losses may be artificially allocated between parallel banks. Similarly, low-quality assets and problem loans can be shifted between parallel banks to manipulate earnings or losses and to avoid regulatory scrutiny.
3. Capital can be generated artificially through stock purchase loans from one parallel bank to the other. As a result, capital for one of the parallel banks is increased even though there is no external capital injection into either bank.
4. One of the parallel banks may be the conduit or participant in a transaction that violates local law or the laws of a foreign country, or that is designed to benefit one of the banks, to the detriment of the other.
5. One bank that experiences financial difficulties may pressure the related institution to provide liquidity or other support in excess of legal limits or prudential norms.
6. Money-laundering concerns may be heightened, especially when the foreign parallel bank is situated in a country where anti-money laundering standards are not robust.

While legislation in some countries may not allow the supervisor to reject a bank licence application simply because a parallel bank will be created, the presumption should be that where it is not possible to close supervisory gaps, applications for new parallel banks should be refused. Where the supervisor does not have the power in law or in practice to prevent the creation of a parallel bank, it should seek to limit the risk by minimising the supervisory gap whenever such a structure is created.

When assessing an application for a bank licence, the licensing authority should require the applicant to provide information about the ownership structure so that it can determine whether the beneficial owners already control a bank or banks in other jurisdictions. It may be helpful to require the beneficial owners to make a declaration to this effect. The supervisor should seek to understand how the bank would fit within the group structure and should obtain information about the other banking operations.

Factors that can lead supervisors to the conclusion that a corporate structure hinders effective consolidated supervision include:

1. complexity that prevents a clear view of the entire business of the group;
2. an inability to clearly identify ultimate ownership;
3. group companies operating in jurisdictions where secrecy provisions limit access to information;
4. significant parts of the group business being conducted in jurisdictions where supervision and regulation are weak; and
5. the absence of a natural home base for the group.

The supervisor may discuss the licence application with the supervisor(s) of the related foreign parallel bank(s) and seek their views. If possible, the discussion should consider how the whole structure is going to be supervised. In granting the licence application, the supervisor may impose one or more of the following conditions to obtain the necessary comfort that a parallel-owned banking structure is supervisable on a consolidated basis:

1. enforce a change in the group structure to facilitate more effective supervision;
2. require the bank to agree to an arrangement for supervisory coordination;
3. place restrictions on the bank’s ability to engage in transactions with the foreign parallel bank;
4. place restrictions on the extent to which the parallel banks can establish a shared management process;
5. require written agreement from the beneficial owners of the parallel banks to provide, on demand, relevant information needed for understanding the operations and risks of the entire parallel bank; and/or
6. prevent one bank from acting as a collecting agent for deposits directed towards the parallel institution.

On approval, the bank should be required to make available to supervisors for their review and examination, the following:

1. the bank’s policy of interaction with the foreign parallel bank(s); and
2. the extent of its exposure to and transactions with the foreign parallel bank.

Steps should be taken to limit the risks posed by parallel banks and to ensure that they are subject to adequate supervision. Several supervisory approaches may be considered.

A key mechanism in the supervision of parallel-owned banking structures is supervisors working together to ensure adequate understanding and oversight of the entire group. The foreign supervisor should endeavour to cooperate and share information on the conditions of the bank and its compliance with banking laws and regulations.

Supervisors will need certain information to assess the risk arising from the parallel bank structure. The supervisor is likely to obtain such information only by working closely with the foreign supervisor. This information includes:

1. strategy, management, organisation and activities of the parallel-owned banking structure;
2. inter-company and related transactions;
3. adequacy of supervision conducted by the foreign supervisor, and
4. political, legal, or economic events in the foreign country.

On-site examination of the domestic parallel bank should be a significant part of the supervisory programme for the parallel bank. It may be helpful for the supervisor to communicate with the supervisor responsible for the foreign parallel bank prior to an examination to find out if there are issues and concerns with the operations of the foreign parallel bank that may have a bearing on the domestic parallel bank. The on-site and off-site programme should include a specific review of inter-company and related transactions, including transactions covered by applicable regulation.

An alternative approach to supervising a parallel-owned banking structure is for one supervisor (ideally the supervisor of the largest business unit) to act as a lead supervisor, for supervising the structure on a consolidated basis. Where adopted, this approach requires the agreement of fellow supervisors and the relevant institutions concerned to facilitate supervision by the lead supervisor who does not have jurisdiction over the foreign parallel banks.

A lead supervisor approach is not workable in many jurisdictions because:

1. Legal impediments and privacy considerations may prevent the lead supervisor from accessing all necessary supervisory information from the foreign parallel banks.
2. Normal supervisory procedures (especially cross-border on-site examination) may not be possible from either a legal or practical perspective.
3. Depositors and creditors of the foreign parallel banks may look to the lead supervisor (and the central bank if not the same) as liquidator or lender of last resort, generating moral hazard and reputation risk issues.
4. Budget issues may arise when supervisory resources are channelled to supervise and conduct inspections of foreign parallel banks that do not pay assessments to the lead supervisor.
5. It may not be possible to grant reciprocal arrangements for foreign supervisors to inspect the banks in the lead supervisor’s country.
6. It may not be possible to grant appropriate enforcement powers to the lead supervisor over all banks in the group.

To mitigate the risk from the parallel bank structure on the domestic bank, the supervisor may impose a change in the group structure to facilitate more effective supervision, restrict the domestic bank’s ability to engage in transactions with the foreign parallel bank, or limit joint management. The supervisor should try to impose any such restrictions at the earliest opportunity. This can be most easily done the next time the bank needs supervisory approval for any of its actions, eg changes in ownership.

Where the supervisor of a parallel bank concludes that there is inadequate access to information about material parts of the parallel-owned banking structure, and co-operation with the foreign supervisor will not sufficiently mitigate the risk of the parallel bank structure, it should seek to ring-fence the operations of the domestic bank. This entails limiting the exposure of the domestic bank to its related parallel banks and other members of the corporate group.