Core principles for effective banking supervision
9 April 1997
The Basle Core Principles have been drawn up by the Basle Committee in close collaboration with the supervisory authorities in fifteen emerging market countries and have benefited from broad consultation with many other supervisory authorities throughout the world.
The Principles represent the basic elements of an effective supervisory system. They are comprehensive in their coverage, addressing the preconditions for effective banking supervision, licensing and structure, prudential regulations and requirements, methods of ongoing banking supervision, information requirements, formal powers of supervisors and cross-border banking.
The Basle Core Principles are intended to serve as a basic reference for supervisory and other public authorities worldwide to apply in the supervision of all the banks within their jurisdictions. Following due consultation, supervisory authorities throughout the world will be invited to make a formal endorsement of the Core Principles, not later than October 1998. Endorsement will include an undertaking to review current supervisory arrangements against the Principles and to set a time-table for addressing any material deficiencies. The speed with which changes can be introduced will vary, depending on whether the supervisory authorities already possess the necessary statutory powers. Where legislative changes are required, national legislators will be requested to give urgent consideration to the changes necessary to ensure that the Principles can be applied in all material respects.
In parallel with the Basle Core Principles, the Basle Committee will also shortly release for information a three-volume Compendium of its existing recommendations, guidelines and standards. This has been prepared in order to supplement the Principles, which contain crossreferences to the Compendium documents where appropriate.
The text of the Principles can be obtained from the BIS Web Site on the Internet at http://www.bis.org with effect from 9th April, from national supervisory authorities or from the Basle Committee Secretariat at the Bank for International Settlements. The Compendium will be available later in April.
9th April 1997
Notes for editors
1. The Basle Committee on Banking Supervision is a Committee of banking supervisory authorities which was established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and the United States. It usually meets at the Bank for International Settlements in Basle, where its permanent Secretariat is located.
2. The Basle Committee has been working in this field for many years, both directly and through its many contacts with banking supervisors in every part of the world. In the last year it has been examining how best to expand its efforts aimed at strengthening prudential supervision in all countries by building on its relationships with countries outside the G-10 as well as on its earlier work to enhance prudential supervision in its member countries. The Committee has prepared two documents for release:
- a comprehensive set of Core Principlesfor effective banking supervision (The Basle Core Principles) applicable in both G-10 and non-G-10 countries; and,
- a Compendium of the existing Basle Committee recommendations, guidelines and standards.
Both documents have been endorsed by the G-10 central bank Governors. They are being submitted to the G-7 and G-10 Finance Ministers in preparation for the Denver Summit in the hope that they will provide a useful mechanism for strengthening financial stability in all countries.
3. In developing the Principles, the Basle Committee has worked closely with non-G-10 supervisory authorities . The document has been prepared in a group containing representatives from the Basle Committee and from Chile, China, the Czech Republic, Hong Kong, Mexico, Russia and Thailand. Eight other countries (Brazil, Hungary, India, Indonesia, Korea, Malaysia, Poland and Singapore) were also closely associated with the work. The drafting of the Principles benefited moreover from broad consultation with a larger group of individual supervisors, both directly and through the regional supervisory groups. The IMF and the World Bank have seen and commented on the work at various intermediate stages.
4. The Basle Core Principles are being released for consultation . Comments are invited by 16th June 1997. At the end of the comment period, the document will be finalised, hopefully in advance of the IMF and World Bank annual meetings in Hong Kong in late September 1997.
5. National agencies should apply the Principles in the supervision of all banks within their jurisdictions. The Principles are minimum requirements and in many cases may need to be supplemented by other measures designed to address particular conditions and risks in the financial systems of individual countries.
6. The Basle Core Principles are intended to serve as a basic reference for supervisory and other public authorities in all countries and internationally . It will be for national supervisory authorities, many of which are actively seeking to strengthen their current supervisory regime, to use the attached document to initiate a programme designed to address any deficiencies as quickly as is practical within their legal authority. It is suggested that the IMF, the World Bank and other interested organisations use the Principles in assisting individual countries to strengthen their supervisory arrangements in connection with their work aimed at promoting overall macroeconomic and financial stability.
7. Supervisory authorities throughout the world will be encouraged to make a formal endorsement of the final version of the Basle Core Principles. The members of the Basle Committee and the banking supervisory authorities of the fifteen countries that have participated in their drafting all agree with the content of the document.
8. The chairpersons of eleven regional supervisory groups are supportive of the Basle Committee's efforts. Most of these groups plan to discuss the Core Principles at meetings to be held over the next few months. They will all actively promote the consultation process among their membership and it is hoped that these groups will be in a position to confirm their general support by the time the comment process has been concluded.
9. Implementation of the Principles will involve carrying out a review of existing supervisory arrangements and, where these are inconsistent in any material respect with the Principles, establishing a time frame for addressing the deficiencies. The Principles have been designed to be verifiable by supervisors, their regional groups, and the market at large. Implementation of the Principles will be surveyed by the Basle Committee and reviewed at the International Conference of Banking Supervisors in October 1998 and bi-annually thereafter.
10. The Basle Committee believes that achieving consistency with the Core Principles by every country will be a significant step in the process of improving financial stability domestically and internationally. The speed with which this objective will be achieved will vary. In many countries, substantive changes in the legislative framework and in the powers of supervisors will be necessary because many supervisory authorities do not at present have the statutory authority to implement all of the Principles. In such cases, the Basle Committee believes it is essential that national legislators give urgent consideration to the changes necessary to ensure that the Principles can be applied in all material respects. The need for new legislation will be taken into account by the Basle Committee in monitoring progress towards implementation.
11. The Basle Committee will continue to pursue its standard-setting activities in key risk areas and in key elements of banking supervision as it has done in documents such as those reproduced in the Compendium. The Basle Core Principles will serve as a reference point for future work to be done by the Committee and, where appropriate, in cooperation with other organisations. The Committee stands ready to encourage work at the national level to implement the Principles in conjunction with other supervisory bodies and interested parties. Finally, the Committee is committed to strengthening its interaction with supervisors from non-G-10 countries and maintaining its considerable investment in technical assistance and training.
12. The twenty-five Core Principles are set out below.
LIST OF CORE PRINCIPLES FOR EFFECTIVE
Preconditions for Effective Banking Supervision
1. An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary, including provisions relating to authorisation of banking establishments and their ongoing supervision; powers to address compliance with laws as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Licensing and Structure
2. The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word "bank" in names should be controlled as far as possible.
3. The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the bank's ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organisation is a foreign bank, the prior consent of its home country supervisor should be obtained.
4. Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties.
5. Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.
Prudential Regulations and Requirements
6. Banking supervisors must set minimum capital requirements for banks that reflect the risks that the banks undertake, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basle Capital Accord.
7. An essential part of any supervisory system is the independent evaluation of a bank's policies, practices and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.
8. Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.
9. Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers.
10. In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm's-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.
11. Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining adequate reserves against such risks.
12. Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposures, if warranted.
13. Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor and control all other material risks and, where appropriate, to hold capital against these risks.
14. Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls as well as applicable laws and regulations.
15. Banking supervisors must determine that banks have adequate policies, practices and procedures in place, including strict "know-your-customer" rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.
Methods of Ongoing Banking Supervision
16. An effective banking supervisory system should consist of some form of both on-site and off-site supervision.
17. Banking supervisors must have regular contact with bank management and thorough understanding of the institution's operations.
18. Banking supervisors must have a means of collecting, reviewing and analysing prudential reports and statistical returns from banks on a solo and consolidated basis.
19. Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.
20. An essential element of banking supervision is the ability of the supervisors to supervise the banking organisation on a consolidated basis.
21. Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.
Formal Powers of Supervisors
22. Banking supervisors must have at their disposal adequate supervisory measures to bring about corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way.
23. Banking supervisors must practice global consolidated supervision, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by banking organisations worldwide, primarily at their foreign branches and subsidiaries.
24. A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.
25. Banking supervisors must require the local operations of foreign banks to be conducted to the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.
9th April 1997