Basel Committee on Banking Supervision

Consolidated supervision relies on effective information sharing between home and host supervisors. Host supervisors’ knowledge of local market conditions and their ability to take supervisory actions and communicate directly with the entities within their jurisdiction can make an essential contribution to the home supervisor’s assessment of the bank. It also allows the home supervisor to monitor, assess and deal with the local risks faced by the bank more effectively and efficiently. Conversely, the home supervisor’s knowledge of the consolidated entity can, at times, contribute to the effective host supervision of the local entity.

Efficient and effective information sharing combined with supervisors building mutual trust and confidence in their respective assessment processes will not only enhance the supervisory process but also help to conserve scarce supervisory resources. It should also help to reduce the overall regulatory burden on banks. Good working relationships are critical in fostering effective two-way information flows and in minimising the costs to banks of operating under different supervisory systems.

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

1. Branches: are operating entities which do not have a separate legal status and are therefore integral parts of the foreign parent bank.
2. 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.
3. Home supervisor: refers to the supervisor that is responsible for the supervisory oversight of a bank on a consolidated basis.
4. Host supervisor: refers to the supervisor that oversees specific entities within the bank. 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.
5. Subsidiaries: are legally independent institutions, wholly owned or majority-owned, by a parent bank.
6. Parent bank: a bank that has branches and/or holds a controlling interest in one or more subsidiaries, either directly or through a holding company structure.

Information-sharing arrangements should focus on information that is relevant for supervisors to carry out their supervisory responsibilities, and such information should be provided in a timely manner. A supervisor should be prepared to explain why it needs certain information when requesting this from another supervisor, to help ensure that the most appropriate information is supplied.

Supervisory information can include: (i) preliminary information needed to approve an authorisation; (ii) regular information required for ongoing supervision; and (iii) exception information required in crisis situations. There are several channels through which the home supervisor can receive information, which, with the consent of the host supervisor and within the laws of the host country, should be capable of flowing:

1. from the foreign subsidiary or branch to the head office or parent bank;
2. from the parent bank or the head office to the home supervisor;
3. from the foreign subsidiary or branch to the host supervisor;
4. from the host supervisor to the home supervisor.

At the time of authorisation, there is an opportunity to establish an understanding between home and host supervisors on what information is required by each party and how it can be provided. In some cases, these understandings take the form of bilateral MOUs or exchanges of letters which outline what each party expects from the relationship. The discussions establishing these understandings often help the parties to appreciate fully the nature of each other's supervisory process, and the comfort that can be taken from it.

Supervisors from other jurisdictions are only one source of prudential information that supervisors may find useful in carrying out their specific responsibilities. Home and host supervisors can obtain much useful information both directly from the banks themselves and from published sources, including Pillar 3 disclosures.

Information required by home supervisors

A home supervisor would generally need information concerning risks that would have a material impact on the bank as a whole.

Home supervisors require two principal types of information: quantitative and qualitative. Home supervisors should distinguish between what information is essential and what is desirable, and between what is or is not material.

Home supervisors should expect parent banks to have relevant information available and to be able to pass it on to them freely. Home supervisors also need to be able to verify that information received from banks in respect of foreign subsidiaries and branches is accurate and to reassure themselves that there are no supervisory gaps.

It is essential for effective consolidated supervision that there are no impediments to the passing of relevant qualitative information to the home supervisor. Host supervisors would therefore be expected to respond freely to any questions posed by a home supervisor and to inform the home supervisor of any areas of concern.

If the home supervisor needs information about a bank’s operation, including non-deposit taking activities, host supervisors are encouraged to assist in providing this information if it cannot be obtained through other supervisory means.

Inspections by home supervisors

A home supervisor may gather on-site information through the following practices:

1. independent on-site examination by a home supervisor, in coordination with the host supervisor at the option of the host supervisor;
2. on-site examination conducted jointly with the host supervisor, where agreed "sensitive portions" of activity are carried out by the host supervisor and evaluated jointly to protect customer confidentiality;
3. on-site examination by a host supervisor in coordination with of a home supervisor;
4. on-site examination by a host supervisor with a copy of the report of the results of the examination being made available to the home supervisor;
5. on-site examination undertaken by an approved external auditor (preferably where the external auditor of the foreign establishment is the same as that of the parent bank) on the basis of detailed instructions from the home supervisor with the concurrence of the host supervisor and with results submitted to both; and
6. on-site examination undertaken by an internal auditor from the bank's head office whose report is made available to the home and/or host supervisor.

For on-site inspections of a bank’s foreign operations:

1. the home supervisor should notify the host supervisor of its intention to visit a specified branch or foreign subsidiary within the host supervisor’s jurisdiction;
2. the home supervisor should explain to the host supervisor the purpose of the visit and what aspects of the branch or foreign subsidiary it intends to examine;
3. the host supervisor should be able to obtain an undertaking from the home supervisor that information obtained in the course of the visit will be used for specific supervisory purposes and, to the maximum extent possible under applicable laws, will not be passed to third parties without the host supervisor's prior consent;
4. the host supervisor should advise the home supervisor if access to any types of information is normally restricted (eg information on individual customers), and the home supervisor should indicate where exceptions are needed;
5. the host supervisor should have the option to accompany the home supervisor during inspections; and
6. where relevant, the host supervisor should advise the home supervisor of procedures necessary to comply with local/host country legislation and, where necessary or appropriate, assist in ensuring that these procedures are correctly followed to expedite the examination.

Where a home supervisor, during an on-site inspection in a host country, detects a serious criminal violation of home country law, the home supervisor may be under a strict legal obligation to pass the information immediately to the appropriate law enforcement authorities in its home country. In these circumstances, the home supervisor should inform the host supervisor of the action it intends to take.

The host supervisor has a legitimate need to obtain relevant information - especially information related to a bank’s risk profile and its ability to manage these risks - regarding the bank that may have a significant impact on the foreign subsidiary operating in its jurisdiction, subject to the general principles of relevance, materiality and proportionality.

There are three types of information the home supervisor may provide which can assist the host supervisor to exercise effective host country supervision. First, the host supervisor will be interested in information specific to the local office that it supervises. Second, the host supervisor needs to be informed about the overall framework of supervision in which the bank operates, ie the specific techniques being used by the home supervisor. Third, it is important that to the extent possible the host supervisor be aware of any significant problem that arises in the head office or in the group, especially if the local operation is one that is significant in the jurisdiction of the host supervisor.

Through its relationship with the parent bank, a home supervisor may obtain information which reveals a problem in an overseas office. An early sharing of information in such cases may be important in enabling a potential problem to be resolved before it becomes serious. The home supervisor should therefore consult the host supervisor in such cases and the latter should report back on its findings. It is essential that the home supervisor inform the host supervisor immediately if the former has reason to suspect the integrity of the local operation, the quality of its management or the quality of internal controls being exercised by the parent bank.

Host supervisor awareness of the regulatory requirements applied by the home supervisor can improve the host supervisor's ability to supervise a local entity and, where appropriate, to assist in reinforcing these regulatory requirements. A home supervisor should also include all host supervisors on its regular mailing list for sharing relevant information.

Where a bank has operations in at least one country other than its home country, the implementation of internal model approaches may require it to obtain approval for its use of certain approaches from relevant host country supervisors on an individual or sub- consolidated basis, as well as from its home country supervisor in respect of consolidated supervision.

The extent and type of information sharing will depend on the Basel Framework approach being followed by the home and host country, as well as the approaches which the banks concerned are taking for their global and local operations.1 More information might, for example, be shared when advanced approaches are adopted by banks and validated by supervisors in both the home and host jurisdictions. The degree of centralisation or decentralisation of the bank’s processes will be another key factor influencing the extent and type of information sharing.

Home and host supervisors may obtain and share factual and judgemental information with one another. Judgemental information includes supervisory examination reports and assessments of rating systems. Factual information can include information on:

1. the supervisory approach and processes of a supervisor (eg approaches to supervisory review of IRB approaches);
2. a particular entity in the bank (eg choice of Basel Framework approach, relevant details on qualitative and quantitative aspects of the implementation timeline for the bank); and
3. the bank as a whole (eg implementation plans for the bank, details on methodology, qualitative and quantitative aspects at the group level that also form part of an entity’s approach in the host country).

There are a variety of supervisory responsibilities for banks that use internal models, including: (i) initial approval and validation of “advanced” approaches (eg IRB) under Pillar 1; (ii) the supervisory review process under Pillar 2; and (iii) ongoing assessments to verify that banks are applying the standards properly and that the conditions for advanced approaches continue to be met. The degree and nature of cooperation between supervisors may differ across these different supervisory responsibilities. Whatever arrangements are employed, banks have an important role to play in assisting the effective and efficient cross-border implementation efforts of supervisors. The following principles aim to promote closer practical cooperation between supervisors.

Principle 1: the home supervisor is responsible for the oversight of the implementation of internal models approaches for a bank on a consolidated basis.

For situations where the home and host supervisors adopt different approaches, the home supervisor will have the final determination on such matters as they relate to the group on a consolidated basis. This does not mean that the home supervisor will necessarily perform all of the assessment and analysis. In exercising its responsibilities, the home supervisor may seek input from host supervisors, particularly where a foreign subsidiary in the host country is material to the group or the foreign subsidiary’s business differs significantly from that of the parent bank.

A range of Pillar 2 methodologies reflecting varying approaches in different jurisdictions may be organised at a group-wide level. The responsibility for Pillar 2 assessments of a consolidated bank rests with the home supervisor who is expected to take a consolidated view of Pillar 2. However, depending on the organisation of the bank and the importance of activities within the host country, host supervisors may provide important input into the home supervisor’s assessment of Pillar 2 for the consolidated bank. Home supervisors should seek host supervisor’s input, where appropriate.

Bank subsidiaries in host countries must also meet host supervisor requirements for Pillar 2.2 Home and host supervisors are strongly encouraged to work hard to reconcile, to the extent possible, differences that arise due to using different Pillar 2 approaches or where materially different Pillar 2 conclusions are reached.

Principle 2: host supervisors, particularly where banks operate in subsidiary form, have requirements that need to be understood and recognised.

In each jurisdiction, banks operating in subsidiary form must satisfy the supervisory and legal requirements of the host jurisdiction. Certain jurisdictions may also have relevant requirements in the case of foreign bank branches.

Host supervisors have an interest in accepting the methods and approval processes that the bank uses at the consolidated level, to reduce the compliance burden and avoid regulatory arbitrage. However, host supervisors have other legitimate interests which may prevent them from recognising for use at the sub-consolidation level an approach approved at the group level, for example, limitations imposed by their legal obligations, or situations where the home supervisor does not perform effective comprehensive consolidated supervision.

The amount and frequency of information sharing will be influenced by the significance of the entity concerned. Home and host supervisors may have different perspectives on whether a particular entity is significant or, in the case of a home supervisor, may lack detailed knowledge regarding the significance of a subsidiary locally. It is therefore necessary for supervisors to communicate on the issue of significance and develop an understanding on the appropriate amount and frequency of information sharing. In such discussions, supervisors may wish to consider factors such as the size and importance of the entity both to the group as a whole and in the local market. Significance can depend not only on overall market share but also on the extent of an entity’s activities in a specialised market sector. Ultimately, this must be a matter of judgment by home and host supervisors, but it is important that adequate information sharing takes place even in relation to entities not considered to be significant.

Principle 3: where a bank uses internal models, there will need to be enhanced and pragmatic cooperation among supervisors with legitimate interests. The home country supervisor should lead this coordination effort.

As needed, the home supervisor should be responsible for organising practical cooperation between supervisors responsible for the material operations of the bank. This includes holding discussions with the senior management of the group about their implementation plans, communicating these plans as necessary to relevant host supervisors and agreeing with them the work to be undertaken by each supervisor.

The home supervisors should coordinate information requests to reduce burden on the bank (particularly where the requests are detailed). Banks should be kept well informed about supervisory information-sharing arrangements and brought into discussions where appropriate. The nature and structure of these arrangements will vary depending on factors such as the market practice in the jurisdictions in which foreign subsidiaries operate, their size and risk profile, geographic location, etc. If a host supervisor has concerns about the availability of relevant information at the foreign subsidiary, these concerns should be relayed to the home supervisor so that they can help to resolve them.

The home supervisor should also develop an appropriate communication strategy with the relevant host supervisors, supplementing existing cooperation agreements where necessary. As a practical matter, the frequency and scope of communication between supervisors will vary depending on the materiality of operations within the host country.

Agreements on cooperation and exchange of information should be recorded on whatever basis best suits individual supervisors. Some supervisors may opt for formal arrangements (like MOUs or other bilateral agreements), while others may prefer less formal communication strategies.

Flexibility in the format of information sharing (eg oral or written) is important and supervisors may need to discuss approaches that work best in their circumstances. Formal arrangements, written communication and informal sharing such as conference calls or meetings are all useful. Written communication may be necessary in certain circumstances. For example, when a home supervisor is asked to share a summary assessment of consolidated systems and methodologies relevant to a local jurisdiction and a description of the work that it has performed. Written information exchange can take various forms, such as exchange of supervisory documents or of mutually agreed minutes of joint meetings. What is appropriate will depend on the significance of the entity, existing relationships and the extent to which home supervisors and host supervisors have done work on Basel Framework implementation.

Principle 4: wherever possible, supervisors should avoid performing redundant and uncoordinated approval and validation work to reduce the implementation burden on banks, and to conserve supervisory resources.

For initial and on-going validation and approval, there is likely to be a need for cooperation between home and host supervisors because the nature of complex bank structures increases the likelihood that different techniques will be used in different jurisdictions.

The Pillar 1 approval of a credit risk rating system for an IRB capital calculation involves many bank functions. In any given bank, some of these functions will be carried out at the group level, while others will be performed at the level of the individual entity. It is desirable for supervisors to coordinate their activities, as far as possible, to reflect the organisation and management structure of a bank, to improve efficiency and thereby reduce the implementation burden on both banks and supervisors.

The degree of integration in a bank’s risk management, the extent to which a bank uses a common approach, the availability of data and other factors (such as legal responsibilities), are likely to inform the nature of cross-border arrangements. Where “mind and management” are centralised or where techniques are consistently applied across the bank, the home supervisor will probably be better placed to lead approval work. In such circumstances, the host supervisor may choose to rely entirely on approval work conducted by the home supervisor. Conversely, where there is limited integration, where one or more entities within the group are using different techniques, or where an entity located in the host country manages a global business line, the host supervisor may be better placed to lead the approval work regarding those techniques or operations. In this case, the home supervisor will need to maintain a sufficient level of information about the bank and its operations in the host country to meet its responsibilities under the relevant standards.

Certain aspects of a model’s local implementation, including information about assumptions and key parameters used in the local systems and processes, may not be reviewed as part of the home supervisor’s evaluation due to materiality issues. The host supervisor may need to consider this in its own review work in the local jurisdiction. Host supervisors should rely on the work performed by home supervisors to the extent possible. To gain assurance that inputs are appropriate and that the foreign subsidiary is adequately capitalised given its risk profile, a host supervisor may in limited or rare cases need to perform additional complementary testing. Such complementary testing is likely to apply in practice primarily to significant foreign subsidiaries.

Principle 5: in allowing for the use of internal models approaches, supervisors should communicate the respective roles of home and host supervisors as clearly as possible to bank with significant cross-border operations. The home supervisor should lead this coordination effort in cooperation with the host supervisors.

The home supervisor should lead the development and communication of a supervisory plan. The level of detail contained within such a plan should be flexible and tailored to the individual circumstances of a bank. Host country supervisors should satisfy themselves that this communication is received by the entities that they supervise.

Information that could be exchanged by the home and host supervisors on a case-by-case basis include:

1. Decisions regarding internal models’ approvals, including any conditions or limitations attached, plus the reasoning behind the decision.
2. The home or host supervisor’s summary assessments of the bank’s global or local (as relevant) systems and processes, and the work undertaken by the home/host supervisor to arrive at its assessment.
3. Reviews of banks’ internal models’ systems and processes. Where models are used locally, this could also include reviews of local risk management processes, such as loan rating methodologies.
4. The results of any bank’s self-assessments of compliance against the relevant standards.
5. If the home supervisor plans to conduct on-site visits to host jurisdictions for model review purposes (eg where locally developed models, or models adapted from group models, are used), these plans and the time schedule for the proposed visits should be communicated in advance so that a coordinated validation plan can be developed.
6. In appropriate circumstances, relevant sections of examination reports should be shared to the extent they report specifically on internal models’-related reviews. Home/host supervisors could indicate in these reports whether they have concerns about the bank’s/foreign subsidiaries’ internal models’-related methodologies, systems or processes.
7. Recognising that approaches to Pillar 2 may differ between home and host jurisdictions, it may be necessary for home and host supervisors to discuss Pillar 2 issues that are directly applicable to the foreign subsidiary (eg when work at the consolidated level such as stress testing is applicable to Pillar 2 at the local level).
8. In the case of banks using the standardised approach to credit risk, home/host supervisor’s assessments of external credit rating agencies, including their assessment criteria and whether they accept unsolicited ratings, could be shared if available. This would help home/host supervisors to judge whether they should recognise the same agencies for the bank/foreign subsidiaries, if such agencies operate in that jurisdiction.