## cr1746 ## Source details **Canonical URL:** [cr1746](https://www.imf.org/-/media/files/publications/cr/2017/cr1746.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr1746.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr1746.pdf.json) --- ### INTRODUCTION — Assessment scope and methodology - Assessment completed as part of a Financial Sector Assessment Program (FSAP) by the IMF and the World Bank during 2016. - Reflects the regulatory and supervisory framework in place as of the date of completion of the assessment. - Not an analysis of the state of the banking sector or the crisis management framework (addressed elsewhere in the FSAP). - Prepared by Caio Fonseca Ferreira, IMF and Laura Ard, World Bank. - Methodology: - Conducted in accordance with the revised BCP assessment methodology approved by the Basel Committee. - Rated against the Essential Criteria (EC). - Evidence base included: BCP self-assessment by BRSA, detailed supervisory questionnaire responses, laws (including Banking Law (BL) No. 5411), regulations and decisions, inspection reports, meetings with BRSA staff, senior officials of local banks, an external auditing firm, a credit rating agency; Turkish Treasury representative attended meetings. - Methodology allows alternative means to achieve Core Principle objectives; assessments made on factual situation at completion date with note of initiatives not yet implemented. ### Key institutional findings and judgments - BRSA commitment and progress: - BRSA, as a BCBS member, committed to adoption of BCBS and other international standards. - Implemented, or in process of implementing, all BCBS standards, notably those related to capital adequacy and liquidity, with a high level of compliance. - Since 2011 assessment, BRSA has made significant improvements: better consolidated supervision, organized supervisory colleges, signed important MoUs, removed obstacles for supervision of Turkish banks’ operations in foreign countries. - Supervisory framework strengths: - BL provides a broadly appropriate supervision framework with clear responsibilities and necessary supervisory powers. - Supervisory methodology is comprehensive, grounded on extensive databases and regulation largely in compliance with international standards. - Assessors appreciated cooperation and noted high professionalism and active cooperation from BRSA. ### Areas warranting improvement (selected) - Address legal provisions that undermine supervisory independence. - Provide a deeper risk-assessment focus to supervisory inspections and follow-up. - Enhance the forward-looking component of assessments. - Streamline risk management and corporate governance requirements. - Strengthen the asset-quality examination process and accuracy of classification. - Strengthen the supervisory enforcement regime. - Require recovery plans and develop group resolution plans. - Increase ability to act at an early stage to address unsafe and unsound practices. ### Institutional and market structure — overview - Main supervisors: - BRSA — banking industry, financial leasing, factoring, financial holding companies, electronic money institutions, consumer financing, some payment systems institutions and asset management companies. - CMB — securities markets. - General Directorate of Insurance and the Insurance Supervisory Board under the Undersecretariat of Treasury — insurance sector. - Other authorities: CBRT (monetary authority), MASAK (AML/CFT), SDIF (deposit insurance and bank resolution). - Market structure: - Banks hold over 90 percent of the financial system by asset ownership. - NBFIs small by peer emerging market levels; insurance and pension fund assets constitute less than two percent each of the sector. - Overall financial system about 122 percent of 2015 GDP by assets and has grown significantly faster than GDP since 2008. - Banking system composition (by end-December 2015): - 34 deposit taking banks, - 5 participation banks, - 13 development and investment banks under BRSA supervision. - Capital adequacy and asset quality trends: - Capital adequacy declined over past five years but remains relatively high relative to international standards. - Nonperforming loans (NPLs) broadly constant around some 3 percent of gross lending since 2012. - Deterioration in capital adequacy and returns due to rapid balance-sheet expansion, reorientation to lower margin corporate lending, and a policy induced squeeze on retail credit margins. ### Macroeconomic and external environment (selected) - 2016 domestic outlook drivers: - a 30 percent minimum wage increase; - relaxation of macro prudential regulations; - accommodative monetary and fiscal policies. - Vulnerabilities: - Domestic savings rate low; dependence on external funds. - Inflation remained high and above target. - External sector metrics and risks: - External debt about 60 percent of GDP concentrated in private sector. - Annual financing needs about 27 percent of GDP. - Capital inflows mainly short-tenor and debt creating. - NIIP about -50 percent of GDP. - Net FX reserves US$29 billion. - Current account deficit declined due to oil price decline and slowdown but may rise if these reverse or as U.S. monetary policy normalizes. ### Macroprudential governance and tools - Financial Stability Committee (FSC) composition: Undersecretary of Treasury (chairmanship by Deputy Prime Minister in charge of Undersecretariat), heads of CBRT, BRSA, CMB and SDIF. - 2015 FSB Peer Review: FSC helped promote information sharing and coordinated some measures. - Authorities have broad tools used proactively to slow household leverage and encourage banks to increase core funding. - Further steps: integrate systemic risk assessment and policy framework; improve institutional arrangements and public communication. ### Legal, accounting, auditing, and provisioning framework - Key business laws/dates: Civil Law dated 8/2001; New Turkish Commercial Code (TCC) dated July, 2012; Code of Obligations, 2011; Competition Law No. 4054, 1994; Law on the Protection of the Consumer No. 6502, 2014; Execution and Bankruptcy Code (EBC) of 1932 (amended 2003/4). - Accounting standards: POA issues TAS and TFRS (corresponding to IAS and IFRS). - Loan loss provisioning: - Turkish banks apply BRSA’s REPL instead of impairment requirements of TAS 39/IAS 39. - BRSA planning to apply IFRS 9, including provision rules, from 1 January 2017. - By 2017, banks may recognize provisions per TFRS 9; option to use existing REPL or apply TFRS 9 amendments. - Auditing: - Auditing in compliance with international auditing standards by independent auditors authorized by POA. - External audit activities of banks subject to BL and REAB. ### Payment, settlement, market infrastructure and credit information - Payment and settlement systems well developed with sound legal/regulatory framework; overseers: CBRT and CMB; BRSA responsible for payment services and electronic money. - One credit bureau: Credit Registry Bureau (CRB-KKB), founded 1995. - Risk Center established as part of BAT in 2012; BAT and CRB contract to carry out operations of Risk Center with BRSA approval. ### Financial sector data and transparency - BRSA publishes weekly, monthly, quarterly, annual data on bank and non-bank financial institutions: balance sheet, income statement, loans (consumer, SME), deposits by type and maturity. - Fees and commissions and deposit interest rates and price quotes published to strengthen market discipline. --- ### Crisis management and resolution — high level - Previous FSAP mission findings: BRSA has broad measures; CBRT emergency liquidity framework sound; SDIF "broadly conforming to best international practice." - 2015 FSB Peer Review identified absence of certain resolution powers (bridge banks, bail-in powers, temporary stays of early termination rights) and impediments to cross-border cooperation; lack of recovery and resolution planning. - Authorities working to align Turkish resolution framework with FSB Key Attributes. --- ### Supervisory responsibilities, independence and governance (Principles 1–3) - Principle 1 — Responsibilities, objectives and powers: Assessment Largely Compliant. - BL establishes BRSA responsibilities (Article 93 BL: establishment of confidence and stability, sound operation of credit system, development of financial sector, protection of depositors). - BL allows Board to set prudential standards (art. 43) and grants supervisory access/enforcement powers (art. 96, Articles 67, 71, 106, 107). - Coordination with SDIF via Coordination Committee meeting at least once every three months. - Principle 2 — Independence, accountability, resourcing and legal protection: Assessment Materially Non-compliant. - Legal constraints that may undermine independence: - Article 93 BL: required consultation with related Ministry before putting into force regulatory procedures other than internal regulations. - Article 105 BL: relevant ministry may file lawsuit to cancel BRSA Board regulatory decisions (draft amendment proposes revocation of article 105). - Appointments: Chairman and Board members appointed by Council of Ministers; removal requires Prime Minister approval and law does not require disclosure of reasons. - Accountability and transparency: BRSA must brief Council of Ministers every six months and inform Plans and Budget Commission annually; assessors found no transparent third-party scrutiny ensuring delegated powers exercised appropriately. - Resourcing: - Financing: contributions from supervised institutions; cannot exceed three per ten thousand of total assets; actual ratio substantially below limit. - BRSA staff in supervisory functions grew from approximately 220 in 2013 to 265 in 2015. - Chairman salary equals amount paid to Prime Ministry Undersecretary; Board members' remuneration ninety-five percent of Board Chairman. - Entry-level average compensation higher than private sector; mid/upper management salaries lower than private sector; entry conditions unattractive for mid-career professionals; new hires mostly recent graduates. - Principle 3 — Cooperation and collaboration: Assessment Compliant. - Domestic arrangements: FSC, SRAG (established October 2012), FSEC, Article 98 BL exchange obligations, Coordination Committee with SDIF. - Cross-border cooperation: Article 98 BL legal basis; MoUs signed with supervisory authorities of 34 countries; BRSA conducts on-site inspections in foreign jurisdictions, participates in supervisory colleges. - Confidentiality protections: Article 73 BL establishes professional secrecy. --- ### Licensing, ownership, acquisitions (Principles 4–7) - Principle 4 — Permissible activities: Assessment Compliant. - BL Article 3 defines bank types; Article 4 lists broad permissible activities; Article 60 reserves deposit-taking to BRSA-supervised credit institutions. - Principle 5 — Licensing criteria: Assessment Largely Compliant. - Two-step licensing: establishment permission then operating permission; key criteria include joint stock company, qualified board members, paid-up capital not less than 30 million New Turkish Liras (BRSA announced current minimum paid-up capital should not be less than 300 million USD), submission of work plans, projections and internal control frameworks. - Fit and proper tests: board chairman and members appointed for 5 years renewable once (art. 85 BL); BRSA does not currently impose/assess whether board collectively has sound knowledge of material activities. - Principle 6 — Transfer of significant ownership: Assessment Compliant. - Permission required for holdings reaching 10 %, 20 %, 33 % or 50 % thresholds (Article 18 BL); monthly shareholder structure submissions; Article 155 BL sanctions false information with imprisonment from one year to three years and judicial fine not less than 1,500 days. - Principle 7 — Major acquisitions: Assessment Compliant. - Prior BRSA approval required for most acquisitions and investments; Article 56 BL limits acquisitions in non-credit/financial institutions to 15 % of own funds individually and total not more than 60 % of own funds; excess investments deducted from equity. --- ### Supervisory approach, tools, reporting and enforcement (Principles 8–12) - Principle 8 — Supervisory approach: Assessment Materially Non-compliant. - Methodology documented in Supervisory Manual on Banking Supervision Process (SMBSP); supervisory cycles last one year. - Bank categorization matrix uses Sector Share (SS) and Final Rating (10 worst — 1 best); inspection frequency rules: - "Red": on-site annually. - "Yellow": at least once every two years. - "Green": at least once every three years. - Identified shortcomings: - Inspections focus excessively on compliance rather than forward-looking risk assessment. - CAMELS less deep than Special Inspections (SIs); supervisors may over-rely on ratings without sufficient detailed follow-up. - Possibility of leaving banks without structured supervisory assessment for up to three years according to matrix may be inadequate. - No assessment of resolvability and no mandatory recovery plans yet. - Fragmented communication between audit and enforcement departments may produce inconsistent messages and slow decisions. - Underuse of off-site analyses and top-down stress tests in guiding supervisory action. - Recommendations (assessors’ view): - Develop more profound, forward-looking risk assessments in inspections. - Expand scope and depth of Special Inspections. - Ensure structured supervisory attention to all banks within appropriate timeframes. - Begin assessing resolvability and require recovery plans; finalize BRSA-SDIF legislative proposals. - Integrate off-site stress testing into supervisory decision-making; clarify communication between functions. - Principle 9 — Supervisory techniques and tools: - On-site and off-site functions complementary under RAA; BRSA conducts risk focused supervision (RFS). - Staffing: approximately 75 on-site examiners assigned to bank inspections; 17 examiners for non-bank financial institutions; additional examiners and specialists noted. - Quality assurance focuses on compliance of on-site reports but lacks broader processes to assess effectiveness and integration of on-site and off-site functions. - Recommendations: increase rotation between on- and off-site supervisors; formalize integration and effectiveness assessment; enhance forward-looking component (ICAAP, stress tests); require recovery plans for systemic banks; improve communication policies with bank boards. - Principle 10 — Supervisory reporting: - BRSA authorized to require information at daily, monthly, quarterly, semiannual, annual frequencies (Articles 95 and 96 BL). - Major reporting sets: Surveillance Reporting Set, Basel Reporting Set, Cross Border Organizations Reporting Set, Banks’ Shareholders Reporting Set, Non-Bank Financial Institutions Reporting Set. - Reporting standards based on TFRS; loan loss provisioning uses REPL; BRSA planning IFRS 9 adoption from 1 January 2017. - Data quality controls: electronic checks, warnings, administrative fines per Article 146 (5,000 TL to 15,000 TL for failure to submit; 5,000 TL to 10,000 TL for late submission; 5,000 TL to 15,000 TL for missing/control errors/recurring control errors). - Recommendation: formalize periodic review of information collected to ensure supervisory relevance and avoid redundant reporting. - Principle 11 — Corrective and sanctioning powers: - BRSA has broad remedial powers (Articles 68–71 BL; Article 146 administrative fines) but remedial and corrective measures rarely used in recent periods (one case in last five years); reliance on administrative fines noted. - BRSA can require increases in own funds, suspend profit distribution, increase provisions, sell assets, restrict investments/payments, revoke license, transfer management to SDIF. - Recommendation: use remedial/corrective actions more proactively as early preventive measures; integrate supervision and enforcement; act early based on forward-looking tools even if formal prudential ratios not breached. - Principle 12 — Consolidated supervision: - Legal authority: Article 66 (consolidated ratios), Articles 95–96 (information access), Article 78 (financial holding companies). - ICAAP required on consolidated basis (RICAAP Articles 46–47). - Cross-border operations: 19 banks with foreign operations since 2008; cross-border assets 15.7% of total banking sector assets. - Recommendation: deepen group-wide stress testing and analyses; improve recovery/resolution planning for large banking groups. --- ### Home-host relationships, corporate governance, risk management (Principles 13–15) - Principle 13 — Home-host relationships: Assessment Compliant. - MoUs with authorities of 34 countries; supervisory colleges organized; 52 on-site visits to foreign subsidiaries/branches since 2008. - No comprehensive framework for cross-border crisis cooperation or group resolution plans yet; BRSA and SDIF joint working group formed. - Recommendation: further expand supervisory colleges and develop cross-border crisis coordination and group resolution plans. - Principle 14 — Corporate governance: Assessment Materially Non-compliant. - Legal framework (BL Part 3, RICAAP, RCGB) focuses on board responsibilities for internal systems. - Board must have at least 5 members including general manager; chairman and general manager must be separate. - Minimum of 2 non-executive members required for audit committee; no statutory requirement for a majority non-executive or independent board. - Supervisory assessments often stop short of producing holistic analytical conclusions on board oversight effectiveness. - Specific gaps/recommendations: - Consider amending law to require majority non-executive board composition and minimum independent directors consistent with CMB. - Strengthen audit committee composition; separate risk oversight from audit committee in complex banks; require succession planning and systematic supervisory review of remuneration frameworks. - Principle 15 — Risk management process: Assessment Largely Compliant. - RICAAP requires internal systems, ICAAP (recent and in learning phase), risk appetite statements, model governance, MIS, stress testing, contingency/business continuity. - Stress testing: BRSA conducts top-down macro stress testing (ECB TA 2011 model adapted) over two years; stress tests quarterly; results reported internally twice a year; BRSA does not disclose stress test results to banks. - Concerns: ICAAP and supervisory use early-stage; risk management function stature varies; recommendation to require qualified CROs with sufficient stature in complex banks; expand new-product review to cover material modifications and major acquisitions. --- ### Capital adequacy, credit risk, provisioning and large exposures (Principles 16–19) - Principle 16 — Capital adequacy: Assessment Compliant. - Legal minimum CAR at least 8% (Article 45 BL); Basel-aligned framework implemented; CET1 4.5%, Tier 1 6.0%, Total Capital 8.0% with parallel targeted minimum total capital ratio of 12%. - ICAAP requires banks to maintain capital planning buffer; BRSA can impose Pillar 2 charges. - Systemic add-ons (D-SIB buffer rates): - Group 1 1; - Group 2 1,5; - Group 3 2; - Group 4- empty 3. - Leverage ratio: Regulation on Measurement and Assessment of Leverage Level of Banks (RMAL) sets three-month simple arithmetic average leverage ratio at least three percent. - Internal models for Pillar 1 not yet authorized in practice; no bank uses IRB/AMA for regulatory capital. - Recommendation: consider simplifications for non-systemic banks; evaluate interaction among 12% parallel requirement, capital buffers, and Pillar 2 charges. - Principle 17 — Credit risk: Assessment Materially Non-compliant. - Legal framework comprehensive but major weaknesses in application: - Lack of ongoing, independent credit risk monitoring separate from business line for large exposures and homogeneous portfolios. - Line management credit monitoring generates important source data without independent verification; internal audit cannot replace required independent surveillance. - On-site examiners identified inaccurate classifications; documentation lacked sample sizes, aggregate significance, and extrapolation analysis. - Overlap and blurring between Special Mention and Substandard categories. - REPL allows restructuring of loss credit; draft REPL silent on prohibiting restructuring of permanently impaired assets — assessors recommend explicitly disallowing restructuring of loss credit. - BRSA credit examination process: - Special Inspections (SI) levels and CAMELS/GAR used; SIs numbered 61 in 2014 and 44 in 2015 (total 105 SIs with 70 focused on loan portfolios in 27 banks). - On-site teams examine at least the 200 firms/obligors having the highest level of risk. - Recommendations: - Establish ongoing, independent credit risk management/surveillance unit within banks separate from business line. - Improve examiner write-ups: enumerate sample size and significance; indicate potential extrapolation; include full credit relationship context and provisioning impact; retain documentation for "standard" loans. - Disallow inappropriate restructuring of loss credits. - Principle 18 — Problem assets, provisions and reserves: Assessment Materially Non-compliant. - REPL sets loan classification into five groups with provisioning (%): Group 1/Standard (.5% - 5.0% loans; Off-balance 0% - .20%; Retail w/extension 10%; Retail (other) 0% loans, .20% OBS), Group 2/Special Mention (30-90 days: Loans 2% .4%; Retail 10% .4%), Group 3/Substandard (90-180 days: Loans 20%; Off-balance 20%), Group 4/Doubtful (180-360 days: Loans 50%; Off-balance 50%), Group 5/Loss (>= 360 days: Loans 100%; Off-balance 100%). - Specific provisions net of collateral values; REPL assigns haircuts to collateral. - Banks generally have approximately 75% loan loss coverage on current NPL levels. - REPL does not include write-off rule; draft RAP requires write-off of uncollateralized portion of NPL within max one year after classification in the 5th group. - Draft REPL links non-performing definition to Basel II default and IFRS 9 stage 3; requires expected loan loss provisions per IFRS 9. - Supervisory processes: on-site examiners assess provisioning adequacy; off-site produces Report on Potentially Problematic Loans semiannually. - Assessment conclusion: framework adequate but application and accuracy weak due to examination documentation gaps and classification inconsistencies; overall Principle 18 graded Materially Non-compliant. - Principle 19 — Concentration risk and large exposure limits: Assessment Compliant. - Legal basis: Article 48 BL comprehensive loan definition; Article 54 BL sets single/group exposure limits (25% of own funds for an individual, 20% for bank’s own risk group; Board may increase to 25%); large exposures defined and monitored; aggregation on consolidated basis required. --- ### Related‑party transactions and conflict of interest (Principle 20) - Legal framework: - BL Article 49 defines risk groups and related parties comprehensively. - Article 50 BL prohibits certain loans to board members, general manager, deputy general managers and certain employees but includes exceptions with low limits (e.g., loans not exceed 5 times monthly net remuneration). - Article 54 and RCT and RICAAP set limits and monitoring. - Supervisory practice: - Off-site monitoring via KR202AS and other call reports; on-site examiners evaluate related party exposures. - No explicit provision requiring prior board approval of related party transactions or explicit requirement for approval of write-offs of related party transactions. - Legislation does not explicitly capture non-credit transactions within related-party limitations. - Assessment: Largely Compliant. - Recommendation: expand legislation to explicitly capture all transactions with related parties; require prior board approval for related party transactions and approval/oversight of related party write-offs. --- ### Operational risk, ICAAP, outsourcing, internal controls and audit, financial reporting (Principles 21–29) - Principle 21 — Country and transfer risk: Assessment C. - Principle 22 — Market risk: Assessment C; recommendation to deploy trained specialists to assess stress tests and models. - Principle 23 — Interest rate risk in the banking book: Assessment C; recommend specialized examination procedures. - Principle 24 — Liquidity risk: Assessment C. - BRSA received a “compliant” rating for Basel III LCR regulations. - Recommendation: strengthen BRSA–CBRT liaison on FX liquidity and consider increasing FX LCR target from 80% to 100%. - Principle 25 — Operational risk: Assessment C. - GORM Section VI requires operational risk strategy, policies and procedures; RICAAP Article 53(2) and other articles require measurement and assessment. - Business continuity/testing required at least once a year (RICAAP Article 13). - Outsourcing regulated under RROS; contracts must state scope, fees, responsibilities. - Assessment: Compliant. - Principle 26 — Internal control and internal audit: Assessment C. - BL Articles 23, 29, 30 and RICAAP set internal control, risk management and internal audit obligations. - Recommendation: targeted/specialized examinations of internal audit process to validate audit outputs as early warning indicators. - Principle 27 — Financial reporting and external audit: Assessment C. - Financial reporting requirements (BL Article 39, CPD, REAB) in place; external audit scope and rotation rules set; BRSA can access auditors’ working papers and reject auditors. - Principle 28 — Disclosure and transparency: Assessment C. - Solo and consolidated disclosures per TFRS/TAS required; BRSA publishes Main Banking Indicators quarterly and other bulletins. - Principle 29 — Abuse of financial services / AML-CFT: Assessment Largely Compliant. - Legal framework: Law no. 5549 (AML Law) with 2014 revision; TF Law no. 6415 (16.02.2013); MASAK main authority; BRSA technical arm to MASAK for AML/CFT supervision. - Shortcomings: absent customer acceptance policy, absence of explicit PEPs enhanced due diligence requirement, BRSA not receiving suspicious transactions reports though BRSA should receive reports when incidents are material to safety/soundness or reputation. - Recommendation: include customer acceptance policy, require enhanced due diligence on PEPs, require banks to report suspicious activities to BRSA when material. --- ### Credit monitoring function (line management department/unit) — deficiencies and supervisory expectations - Role and activities: - Credit monitoring is a management line function responsible for identifying and flagging credit risk deterioration; business line responsible for first identification and escalation. - Activities include tracking past due status, system-generated risk rating changes, collateral status, customer limits, Risk Center monitoring, opinion on restructuring, and detection of deteriorating credits. - Reporting and timing: - Unit provides source data on individual deteriorating/NPL credits and NPL trend data to the board via risk management; management reports may have more current classifications than system due to timing. - Important source data generated by credit monitoring (a business line) is reported to BRSA for monitoring and examination. - Internal audit and loan review: - Internal audit conducts loan review; REPL requires quarterly loan portfolio review and documentation for largest 200 loans (or loans above 250.000 TL); BRSA indicated loan review documentation for largest 200 loans usually prepared by internal audit. - Key weaknesses: - No ongoing, independent credit risk monitoring of large individual exposures or homogeneous portfolios. - No independent verification that management identification processes are accurate and timely, that management accurately recognizes its business risk, or that borrower intervention is timely. - Examiners identified inaccurate classifications but reports lacked sample sizes, aggregate significance, or extrapolation assessment. - Regulatory expectations summarized (EC2–EC8): - Boards must approve and regularly review credit risk management strategy (GCM Principle 1). - Procedures for approving new/renewed/refinanced exposures, monitoring, collateral, limits, model validation, stress testing and MIS required (REPL, GCM, RICAAP, GCPRM). - On-site examiners to examine at least the 200 highest risk obligors; specialized examinations to test underwriting, monitoring, early identification and classification. - Assessment conclusion for credit monitoring and credit risk (Principle 17): Materially Non-compliant. --- ### Examination documentation and provisioning process — identified shortcomings - Examination write-ups deficiencies: - Sample sizes and significance of sampled credits not enumerated. - Lack of contextual borrower relationship information (total indebtedness on/off balance sheet, payment history, renewals/restructures, interest capitalization, accrual status, collateral integrity). - Provisioning impact not presented; no documentation retained on review of “standard” loans. - Conclusions focus on internal control rather than higher-level implications for portfolio condition or board/BRSA reporting accuracy. - Provisioning and write-off framework: - REPL provisioning rates as presented (verbatim): - Group 1/Standard (past due period up to 30): Loans: .5% - 5.0%; Off-balance Sheet: O% - .20%; Retail w/extension: 10%; Retail (other): 0% (Loans), .20% (Off-balance) - Group 2/Special Mention (past due period 30 - 90): Loans: 2% .4%; Retail: 10% .4% - Group 3/Substandard (past due period 90 - 180): Loans: 20%; Off-balance Sheet: 20% - Group 4/Doubtful (past due period 180 - 360): Loans: 50%; Off-balance Sheet: 50% - Group 5/Loss (past due period  360): Loans: 100%; Off-balance Sheet: 100% - Draft RAP Article 10(A) requires write-off of uncollateralized portion of NPL within a maximum period of one year after classification in 5th group. - BRSA to publish guideline aligning with BCBS Guidance on Credit Risk and Accounting for the Expected Credit Loss (GACL); draft REPL and RAP aim to incorporate IFRS 9 requirements. - Supervisory powers on provisioning: - BRSA authorized to increase general and special provisioning levels both for a specific bank or a specific loan type for the whole banking sector under draft REPL. --- ### Assessment grades summary (selected) - Principle 1 — Largely Compliant. - Principle 2 — Materially Non-compliant. - Principle 3 — Compliant. - Principle 4 — Compliant. - Principle 5 — Largely Compliant. - Principle 6 — Compliant. - Principle 7 — Compliant. - Principle 8 — Materially Non-compliant. - Principle 9 — (findings and recommendations provided). - Principle 10 — (findings and recommendations provided). - Principle 11 — (findings and recommendations provided). - Principle 12 — (findings and recommendations provided). - Principle 13 — Compliant. - Principle 14 — Materially Non-compliant. - Principle 15 — Largely Compliant. - Principle 16 — Compliant. - Principle 17 — Materially Non-compliant. - Principle 18 — Materially Non-compliant. - Principle 19 — Compliant. - Principle 20 — Largely Compliant. - Principles 21–29 — mix of Compliant, C (Compliant), and Largely Compliant as detailed above (specific grades noted within sections). ### Selected recommended actions (verbatim style and grouped) - Legal and governance: - Subordinate the objective of development of the financial sector to the objective of financial stability in the BL. - Amend legislation to limit Minister involvement (consultation and litigation powers) and introduce third-party checks (transparent consultation, publish BRSA proposals and Ministry comments; require confirmation of appointments by a non-executive body; remove minister permission for lawsuits canceling BRSA regulatory decisions). - Supervisory approach and capacity: - Develop more profound and forward-looking risk assessments in inspections and produce clear views of risks faced and posed by each bank. - Expand scope and depth of special inspections where ratings indicate deeper issues. - Ensure all banks receive structured supervisory attention within appropriate timeframes (avoid up to three-year gaps). - Begin assessing resolvability and require recovery plans; finalize joint BRSA-SDIF legislative proposals. - Improve integration of off-site stress testing and top-down analyses into supervisory decision-making. - Clarify and streamline communication and decision processes between audit and enforcement functions. - Develop policies/processes to assess effectiveness and integration of on-site and off-site functions; consider rotation between them. - Consider establishing at least one annual meeting between supervisors and the bank’s board. - Credit risk, provisioning and monitoring: - Establish ongoing, independent credit risk management/surveillance unit separate from business line to verify line function data and provide independent monitoring of large exposures and homogeneous portfolios. - Require exam reports to enumerate sample size and significance, indicate extrapolation, provide complete loan write-ups, present provisioning impact and retain documentation for standard loans. - Explicitly disallow restructuring of loss credit in REPL (draft REPL permitting restructuring of loss credit should be addressed). - Corporate governance and risk management: - Consider amending law to require majority non-executive board composition and minimum independent directors consistent with CMB. - Expand audit committee membership and ensure independence; separate risk oversight from audit committee in complex banks. - Require CROs with sufficient stature in complex banks; expand new-product governance to include material modifications and major acquisitions. - Market, liquidity, operational risk and models: - Deploy trained specialists to assess stress test approaches and model integrity. - Develop specialized examinations for interest rate risk in the banking book. - Strengthen liaison with CBRT on FX liquidity; consider raising FX LCR target from 80% to 100%. - AML/CFT: - Include customer acceptance policy in CDD framework; require enhanced due diligence on PEPs; require banks to report suspicious activities to BRSA when material to safety/soundness or reputation. - Corrective action and enforcement: - Use remedial and corrective actions proactively as early preventive measures rather than relying primarily on fines. - Integrate supervision and enforcement to support risk-focused, judgment-based supervision and clearer communication with banks. ### Key numerical and factual points (verbatim) - Banks hold over 90 percent of the financial system by asset ownership. - Financial system about 122 percent of 2015 GDP by assets. - NPLs broadly constant around some 3 percent of gross lending since 2012. - By end-December 2015: 34 deposit taking banks; 5 participation banks; 13 development and investment banks. - BRSA staff in supervisory functions: grew from approximately 220 in 2013 to 265 in 2015. - Paid-up capital minimum: not less than 30 million New Turkish Liras (statutory); BRSA announced current minimum paid-up capital should not be less than 300 million USD. - REPL loan review/documentation requirement: largest 200 loans (or loans above 250.000 TL). - Special Inspections: 61 in 2014 and 44 in 2015 (total 105 SIs; 70 focused on loan portfolios in 27 banks). - Net FX reserves: US$29 billion. - External debt: about 60 percent of GDP. - Annual financing needs: about 27 percent of GDP. - NIIP: about -50 percent of GDP. - D-SIB buffer rates: Group 1 1; Group 2 1,5; Group 3 2; Group 4- empty 3. - Leverage ratio requirement: three-month simple arithmetic average leverage ratio at least three percent. - Administrative fines per Article 146: 5,000 TL to 15,000 TL (failure to submit); 5,000 TL to 10,000 TL (late submission); 5,000 TL to 15,000 TL (missing/control errors/recurring control errors). - Article 155 BL sanctions false information in ownership change with imprisonment from one year to three years and judicial fine not less than 1,500 days. - FX LCR target presently discussed at 80% (consideration to increase to 100%). - Publicly traded deposit banks: "10 deposit banks" with "6 of them are large scale banks". - Board sizes for large publicly traded banks range between 9 and 14; examples provided on audit committee and independent member counts. - Assessment methodology revision: BCBS revised BCP methodology in "2012". - BRSA and SDIF formed self-assessment working group in "2013". - Draft RAP and REPL and IFRS 9 adoption date: BRSA planning IFRS 9 including provisions from "1 January 2017". _Italic: Source — IMF–World Bank Detailed Assessment Report (2016), INTRODUCTION and selected sections of cr1746 (PDF chapter)._ ### INTRODUCTION __________________________________________________________________________________ 9 ### INTRODUCTION ### Overview of the assessment - This assessment of the current state of implementation of the Basel Core Principles for Effective Banking Supervision (BCPs) in Turkey was completed as part of a Financial Sector Assessment Program (FSAP) undertaken by the International Monetary Fund (IMF) and the World Bank during 2016. - It reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. - The assessment is not intended to represent an analysis of the state of the banking sector or the crisis management framework, which have been addressed in the broad exercise. - This Detailed Assessment Report has been prepared by Caio Fonseca Ferreira, IMF and Laura Ard, World Bank.1 ### Scope, methodology, and evidence base - The assessment was conducted in accordance with the revised BCP assessment methodology approved by the Basel Committee. - The Turkish supervisory regime was assessed and rated against the Essential Criteria (EC). - The methodology requires assessment to be based on: - (i) legal and other documentary evidence; - (ii) the work of the supervisory authority; and - (iii) its implementation in the banking sector. - Assessors reviewed: - the BCP self-assessment undertaken by BRSA preceding this assessment; - detailed responses to a supervisory questionnaire; - laws governing banking supervision, including the Banking Law (BL), and regulations and decisions on prudential standards and risk management; - inspection reports; - meetings with BRSA staff, senior officials of local banks, an external auditing firm, a credit rating agency; a representative from the Turkish Treasury attended all meetings. - The methodology allows that a country may fulfill compliance criteria differently from suggested approaches if the overriding objectives of each Core Principle are achieved; assessments are made on the factual situation at completion date, with note of regulatory initiatives not yet implemented. ### Key institutional findings and judgments - The Banking Regulation and Supervisory Authority (BRSA), as a BCBS member, is committed to adoption of BCBS and other international standards. - The BRSA has implemented, or is in the process of implementing, all BCBS standards, notably those related to capital adequacy and liquidity, with a high level of compliance. - Since the previous assessment in 2011, the BRSA has made several significant improvements to its supervisory framework and has built a good foundation for banking supervision. - The Banking Law (BL) provides a broadly appropriate supervision framework with clear responsibilities and necessary supervisory powers. - The BRSA’s supervisory methodology is comprehensive, grounded on extensive databases and on regulation largely in compliance with international standards. - The BRSA has improved consolidated supervision, organized supervisory colleges, signed a number of important Memorandum of Understanding (MoUs), and removed obstacles for supervision of Turkish banks’ operations in foreign countries. - The assessors appreciated the cooperation received from the BRSA, noting high professionalism and active cooperation. ### Areas warranting improvement (selected) - Address legal provisions that undermine supervisory independence. - Provide a deeper risk-assessment focus to supervisory inspections and follow-up. - Enhance the forward-looking component of assessments. - Streamline risk management and corporate governance requirements. - Strengthen the asset-quality examination process and the accuracy of classification therein. - Strengthen the supervisory enforcement regime. - Require recovery plans and develop group resolution plans. - Increase the ability to act at an early stage to address unsafe and unsound practices. ### INSTITUTIONAL AND MARKET STRUCTURE—OVERVIEW ### Regulatory and supervisory authorities - Main supervisors: - The Banking Regulation and Supervisory Agency (BRSA) — banking industry, financial leasing, factoring, financial holding companies, electronic money institutions, consumer financing, some payment systems institutions and asset management companies. - The Capital Markets Board of Turkey (CMB) — securities markets. - The General Directorate of Insurance and the Insurance Supervisory Board under the Undersecretariat of Treasury (Treasury) — insurance sector. - Other authorities with roles: - Central Bank of the Republic of Turkey (CBRT) — monetary authority. - Financial Crimes Investigation Board (MASAK) — AML/CFT authority. - Savings Deposit Insurance Fund (SDIF) — deposit insurance and bank resolution authority. ### Market structure and systemic importance of banks - Banks hold over 90 percent of the financial system by asset ownership. - Nonbank financial institutions (NBFIs) are small by peer emerging market levels, with insurance and pension fund assets constituting less than two percent each of the sector. - The overall financial system is about 122 percent of 2015 gross domestic product (GDP) by assets and has been growing significantly faster than GDP since 2008. ### Banking system characteristics and composition - The banking system is of average size, although the proportion of credit financed by non-deposit channels is larger than in peer emerging markets. - Concentration is not significant; market share is roughly equally distributed among private domestic, foreign-owned, and state-owned banks. - Acquisition-based entry by foreign banks in recent years increased their asset ownership share. - By end-December 2015, there are: - 34 deposit taking banks, - 5 participation banks, - 13 development and investment banks under BRSA supervision. ### Capital adequacy and asset quality trends - Capital adequacy has declined over the past five years but remains relatively high in relation to international standards. - Nonperforming loans (NPLs) have been broadly constant around some 3 percent of gross lending since 2012. - The deterioration in capital adequacy and returns owes to: - rapid balance-sheet expansion; - a reorientation of lending towards lower margin corporate lending; - a policy induced squeeze on retail credit margins. ### PRECONDITIONS FOR EFFECTIVE BANKING SUPERVISION ### Macroeconomic and financial sector context (introductory note) - The report proceeds to address preconditions for effective banking supervision, including macroeconomic and financial sector policies (section begins following provided content). *Source: IMF–World Bank Detailed Assessment Report (2016) — INTRODUCTION section of cr1746.* ### 13. The financial sector operates in an uncertain economic environment. Growth is ### 13. The financial sector operates in an uncertain economic environment. Growth is ### Macroeconomic and financial environment - During 2016, domestic demand and growth are expected to remain relatively robust due to: - a 30 percent minimum wage increase; - relaxation of macro prudential regulations; and - accommodative monetary and fiscal policies. - The domestic savings rate is low, creating dependence on external funds and making the economy vulnerable to external shocks. - Inflation has remained high and above target. ### External imbalances and vulnerabilities - Key external sector metrics and risks: - External debt is high (at about 60 percent of GDP) and concentrated in private sector hands. - Annual financing needs are high (about 27 percent of GDP). - Capital inflows are mainly short-tenor and debt creating. - Net international investment position (NIIP) is about -50 percent of GDP. - Net foreign exchange (FX) reserves are US$29 billion. - The current account deficit declined due to the oil price decline and economic slowdown but is expected to rise again if these factors reverse or if term premia and funding costs decompress as the U.S. begins monetary policy normalization. - Conclusion: The external position demands attention. ### Macroprudential governance and tools - Macroprudential policies are coordinated through the Financial Stability Committee (FSC). - FSC composition: heads of major agencies with a stake in financial stability — the Undersecretary of Treasury and the heads of the CBRT, BRSA, CMB and SDIF — under the chairmanship of the Deputy Prime Minister in charge of the Undersecretariat of the Treasury. - The 2015 Financial Stability Board (FSB) Peer Review found that the FSC has: - helped promote information sharing and exchange of views; and - coordinated some policy measures among member institutions. - Authorities have a broad range of tools and have used them proactively and flexibly in recent years to: - slow down the rise in household leverage; and - encourage banks to increase core funding. - Further steps identified to strengthen the framework include: - integrating the systemic risk assessment and policy framework; and - improving institutional arrangements and public communication. ### Legal and business law framework - Business laws and key dates: - Civil Law dated 8/2001. - New Turkish Commercial Code (TCC) dated July, 2012. - Code of Obligations, 2011. - Competition Law, No. 4054, 1994. - Law on the Protection of the Consumer No. 6502, 2014. - Execution and Bankruptcy Code (EBC) of 1932 (amended 2003/4). - The New TCC (promulgated 2012) aims to harmonize Turkish and European Union laws and strengthen foreign economic relations. - New features include increased transparency by requiring stock companies to create a website publishing all data relevant for shareholders (annual and interim financial statements and audit reports). - The New TCC also aimed to reinforce shareholder rights and corporate governance. - Judicial arrangements: - Basic principles of independence of courts and security of judges and public prosecutors are provided in the Constitution. - The Turkish legal system does not provide for special courts for bank/financial sector cases; however, in some big cities specific courts are identified to deal only with banking related cases. ### Accounting, auditing, and provisioning standards - All listed and non-listed companies must apply financial reporting standards issued by the Public Oversight Accounting and Auditing Standards Authority (POA). - POA issues Turkish Accounting Standards (TAS) and Turkish Financial Reporting Standards (TFRS), corresponding respectively to IAS and IFRS issued by the IASB. - Main difference in implementation for Turkish banks: loan loss provisioning. - Turkish banks apply the BRSA’s REPL instead of the impairment requirements of TAS 39 or IAS 39 for loan loss provisioning. - The BRSA is planning to apply IFRS 9, including the provision rules, from 1 January 2017. - By 2017, Turkish banks will be able to recognize provisions for credit losses in accordance with TFRS 9, which the Turkish authorities consider fully compliant with IFRS 9 with the option of the recent amendments to the REPL. - The last amendment entitles banks to use existing provisions of the REPL or to apply TFRS 9. - Auditing: - Auditing of companies is carried out in compliance with international auditing standards by independent auditors who meet professional competence requirements. - Companies subject to independent audit are determined in the TCC. - Companies under the Capital Markets Law or the BL are automatically subject to independent auditing; certain licensed companies (e.g., under the Energy Market Regulatory Authority) and public companies under the Capital Markets Law are subject to independent auditing only if they meet certain criteria. - External auditing firms meeting required criteria are authorized by POA. - External audit activities conducted in banks and other financial institutions are also subject to the BL and REAB. ### Payment, settlement, and market infrastructure - Payment and settlement systems are well developed with a sound legal and regulatory framework and clearly established roles for regulators and overseers. - Overseers of the FMIs in Turkey are the CBRT and the CMB; the BRSA has responsibility for payment services, payment institutions, and electronic money. - The authorities have been systematically reforming the National Payments System (NPS), implementing necessary infrastructure, internal organization arrangements, and strengthening legal and regulatory frameworks. - Several critical NPS objectives have been achieved—most notably as a result of on-going modernization efforts; a conducive legal and regulatory framework and the core components of the NPS are in place. ### Credit information and risk sharing - One credit bureau operates in Turkey: the Credit Registry Bureau (CRB-KKB), founded in 1995 as a private enterprise initiated by The Banks Association of Turkey (BAT) with partnership of 11 leading banks to facilitate exchange of information and documents between credit institutions and financial institutions. - Banking Law no: 5411 Article 73/4 grants special permission to the CRB to collect information from member institutions and to facilitate exchange of this information. - Risk Center: - Established as part of BAT in 2012 to gather risk information about customers of credit institutions and other financial institutions. - BAT and CRB signed a service contract, with the approval of the BRSA, to carry out all operations of the Risk Center in December 2012. ### Financial sector data and transparency - Statistical information availability in the Turkish banking system is extensive. - The BRSA publishes regularly (weekly, monthly, quarterly, annual) data on bank and non-bank financial institutions covering: - balance sheet, income statement, loans, consumer loans, SME loans, as well as deposits by type and maturity. - Fees and commissions faced by financial customers are published on BRSA’s web site as a tool to strengthen market discipline. - Deposit interest rates and price quotes about financial markets are available on a daily basis and are provided by related monetary, banking and financial market regulators. *Source: IMF staff report (excerpts).* ### 24. The banking supervisor works closely with the deposit insurer and central bank on ### cr1746 - 24. The banking supervisor works closely with the deposit insurer and central bank on ### Crisis management and resolution framework - Previous FSAP mission: BRSA has a broad range of measures to mitigate bank vulnerabilities; CBRT’s framework for emergency liquidity provision is sound; SDIF is "broadly conforming to best international practice." - 2015 FSB Peer Review findings: - Absence of certain resolution powers (bridge banks, bail-in powers, temporary stays of early termination rights) may impede timely and cost-effective resolution of the largest banks. - Impediments to cross-border cooperation can challenge effective resolution of banks with cross-border operations. - Lack of recovery and resolution planning requirements undermines resolution preparedness. - Authorities informed the mission they are working to align the Turkish resolution framework with the FSB Key Attributes for Resolution Regimes. ### Principle 1 — Responsibilities, objectives and powers (Assessment: Largely Compliant) - Legal framework and institutional responsibilities: - Banking Law No. 5411 (BL) establishes BRSA as responsible for supervision and regulation of banks and related entities. - Other relevant authorities: CBRT; MASAK; Treasury; SDIF; CMB. - Responsibilities of each entity are described as "well established with small room for overlap or regulatory gap." - Primary objectives and potential conflicts: - Article 93 BL: BRSA responsible "for the establishment of confidence and stability in financial markets, the sound operation of the credit system, the development of the financial sector and the protection of the rights and interests of depositors". - Article 94 BL includes development objectives (profitability, competitiveness, integration of professionals, preparing regulations). - Comment: BL does not explicitly subordinate financial sector development to financial stability; some BRSA decisions (e.g., loan loss provisions, loan restructuring rules) might be interpreted as primarily supporting financial development objectives rather than stability. - Powers to set prudential standards: - BL (art. 43): Board can set different minimum/maximum ratios for individual banks or groups, change calculation/reporting periods, set ratios not otherwise specified—applicable consolidated and non-consolidated. - Board may publish best-practice guidelines; principle of proportionality applies. - Supervisory access and enforcement: - BL empowers BRSA to access banks’ boards, management, staff, records; require consolidated and non-consolidated information; access parent banks, domestic/foreign subsidiaries, branches, representative offices (art. 96). - Foreign banks in Turkey subject to same rules as domestic banks. - Remedial and enforcement powers include a wide range of corrective measures, license revocation, or transfer of management/control to SDIF (Articles 67, 71, 106, 107). - Coordination with SDIF: - Regular exchange of information; Coordination Committee meets at least once every three months; protocols allow joint database access within confidentiality principles. - Key legal thresholds and triggers: - Article 67 lists conditions for remedial action (liquidity, profitability, capital adequacy, asset quality deterioration, violations, weak internal controls, management incompetence). - Article 71 lists intervention conditions (failure to implement measures, activities endangering depositors or financial stability, obligations not met, liabilities exceeding assets, fraudulent use by dominant partners/managers). ### Principle 2 — Independence, accountability, resourcing and legal protection (Assessment: Materially Non-compliant) - Legal independence and constraints: - Article 82 BL: BRSA has administrative and financial autonomy; must employ adequate personnel. - Constraints that may undermine independence in practice: - Article 93 BL: BRSA must consult related Ministry (Deputy Prime Minister) before putting into force regulatory procedures other than internal regulations. - Article 105 BL: relevant ministry may file a lawsuit to cancel BRSA Board regulatory decisions (authorities say draft amendment proposes revocation of article 105). - Appointments: Chairman and Board members appointed by Council of Ministers; removal requires Prime Minister approval and law does not require disclosure of reasons. - Accountability and transparency: - BRSA must brief Council of Ministers every six months; inform Plans and Budget Commission annually. - Article 97 BL: publish quarterly reports and regular aggregated performance reports. - Assessors did not find evidence of transparent third-party scrutiny to ensure delegated powers are exercised appropriately. - Governance and decision-making: - BRSB (7 members) is decision-making organ; Chairman administers and represents Agency; Board sets strategy, budget, and takes major decisions (licenses, ownership changes, severe measures). - Operational flows: enforcement department analyzes findings and proposes actions to Board. - Professionalism, ethics and legal protection: - Professional and Ethical Principles regulate impartiality, conflicts of interest, confidentiality, outside activities, gifts, post-employment restrictions. - Article 92 BL: professional staff cannot assume duties in a bank they supervised for at least two years after leaving BRSA. - Article 104 BL: lawsuits against Chairman/Board/staff for actions taken in good faith require Minister or Chairman permission; legal fees for defense financed from Agency budget. - Resourcing: - Financing: contributions from supervised institutions; cannot exceed three per ten thousand of total assets; Board sets the rate and actual ratio is substantially below the limit. - BRSA staff in supervisory functions: grew from approximately 220 in 2013 to 265 in 2015. - Staffing and recruitment: - Senior management and professional staff employed under contracts exempting remuneration from Civil Servants Law. - Chairman salary = amount of financial and social rights paid to Prime Ministry Undersecretary; Board members' remuneration = ninety-five percent of the Board Chairman. - Non-contractual personnel follow public sector salary scales; entry-level average compensation higher than private sector; mid/upper management salaries lower than private sector. - Entry conditions are not attractive for mid-career professionals; new hires mostly recent graduates. - Training, technology, travel: BRSA has regular training program; memberships to Reuters/Bloomberg; buys specialized hardware/software; travel budget claimed adequate for supervisory work and participation in supervisory colleges. - Assessment comments and recommended legislative changes (assessors’ view): - Shortcomings that may allow political influence: Council of Ministers appointments without independent confirmation; required ministerial consultation before regulations; Prime Minister approval for removals without disclosure; ministerial permission to sue Board members; ministry ability to file suit to cancel BRSA regulations. - Suggested improvements: limit Minister involvement; introduce third-party checks (more transparent regulatory consultation; publish BRSA proposals and Ministry comments); require confirmation of BRSB appointments by a nonexecutive body; remove minister permission for lawsuits to cancel BRSB regulatory decisions. - Accountability: implement third-party scrutiny to ensure delegated powers are properly used. - Resourcing: improve attractiveness of entry conditions for mid-career professionals. ### Principle 3 — Cooperation and collaboration (Assessment: Compliant) - Domestic cooperation arrangements: - Financial Stability Council (FSC): Treasury plus heads of CBRT, BRSA, CMB, SDIF; chaired by Deputy Prime Minister; created in 2011 to identify systemic risks and coordinate macroprudential policy. - Systemic Risk Assessment Group (SRAG): established October 2012; BRSA acts as secretariat; meets at least four times a year; minutes reported to FSC. - Financial Sector Commission (FSEC): representatives from BRSA, Ministry of Finance, Treasury, CBRT, CMB, SDIF and other entities; meets once every six months; briefs Council of Ministers. - Article 98 BL: BRSA, Treasury Undersecretary, State Planning Organization Undersecretary, SDIF, CBRT to exchange views on monetary, credit and banking policies; provides for joint database access. - Coordination Committee (BRSA and SDIF) meets quarterly to ensure cooperation in bank resolution. - Protocols exist for information sharing with Treasury, CMB, SDIF, CBRT, MASAK, Social Security Institution, TÜRKSAT A.Ş., Central Registration Institution, Competition Authority. - Evidence those arrangements operate in practice. - Cross-border and foreign cooperation: - Article 98 BL provides legal basis for cooperation with foreign supervisors. - BRSA has signed MoUs with supervisory authorities of 34 countries; discussions underway with 5 additional countries. - Article 98 allows cooperation absent an MoU subject to BRSB approval and reciprocity. - BRSA conducts on-site inspections in foreign jurisdictions where Turkish banks operate; shares findings with foreign supervisors; participates in supervisory colleges; acts as host observer in some colleges. - Confidentiality protections: - Article 73 BL establishes professional secrecy over supervisory information; BRSA requires confidentiality commitments and MoUs/agreements include confidentiality clauses. - BRSA will not share confidential information if it believes the counterparty will not maintain confidentiality. - Recovery and resolution planning: - SDIF is resolution authority; BRSA initiates resolution and can transfer a failed bank to SDIF. - No ex ante recovery and resolution planning framework currently; BRSA and SDIF have formed a joint working group developing proposals and legislative amendments to introduce recovery and resolution planning. ### Principle 4 — Permissible activities (Assessment: Compliant) - Definition of "bank": - BL Article 3 defines bank as deposit banks, participation banks and development and investment banks. - Permissible activities: - Article 4 BL lists broad banking activities (accepting deposits/participation funds, granting loans, payment and collection transactions, correspondent banking, commercial bills, safekeeping, payment instruments, FX transactions, trading money market instruments, trading precious metals and stones, derivatives intermediation, trading capital market instruments, repurchase agreements, underwriting/intermediation, factoring, leasing, insurance agency, private pension services, etc.). - BL allows “other activities to be determined by the Board” (mostly advisory and operational support). - Use of the word "bank": - Article 150 BL: prohibited for unlicensed legal persons to use “bank” or expressions creating impression of deposit-taking; penalties include imprisonment, fines, closure of business places. - Deposit-taking reserved: - Article 60 BL: only BRSA-supervised credit institutions may accept deposits or participation funds; unauthorized acceptance punishable. - Public listing of licensed banks: - List of licensed banks and branches published regularly on BRSA website; permissions published in Official Gazette (Article 10 BL). ### Principle 5 — Licensing criteria (Assessment: Largely Compliant) - Authority and process: - BRSA is both licensing and supervisory authority (Article 6 BL). - Licensing is two-step: establishment permission then operating permission; on-site examinations are used in the assessment. - Key licensing criteria (Article 7 BL and RTSPIO): - Must be established as joint stock company. - Board members must meet qualifications and professional experience. - Envisaged fields of activity must be in harmony with planned financial, managerial, organizational structure. - Paid-up capital not less than 30 million New Turkish Liras (BRSA announced current minimum paid-up capital should not be less than 300 million USD). - Transparent and open partnership structure; no obstacle to consolidated supervision. - Submit work plans, projections (including capital adequacy), budget plan for first three years, activity program including internal control, risk management, internal audit. - Foreign bank branches: - Conditions include no prohibition in home country; home supervisor must not have negative views; paid-in capital for Turkey not less than required; board members qualified; activity program and transparent partnership structure; BRSA requires "no objection" letter from home supervisor (but does not determine whether home supervisor practices global consolidated supervision). - Operating permission prerequisites include: - Capital paid in cash; payment of at least one fourth of system entrance fee equivalent to ten percent of minimum capital to SDIF; compliance with corporate governance; required personnel and technical infrastructure; managers meeting fit and proper criteria. - Fit and proper tests: - Board chairman and members appointed for 5 years renewable once (art. 85 BL); removal reasons specified in law but disclosure of reasons not required. - Suitability criteria for board/management (education, experience, not bankrupt, no heavy imprisonment, etc.) assessed via documentation (RSMOD). - BRSA does not currently impose/assess whether board collectively has sound knowledge of material activities the bank intends to pursue. - Monitoring new entrants: - Monitoring between establishment and operation permission; on-site supervisors follow up recommendations; once operating, standard supervision applied (including assessing performance relative to business plan). - Assessment comments: - To be fully compliant: BRSA should (i) impose and assess that the board has collective sound knowledge of material activities; (ii) for cross-border operations determine whether home supervisor practices global consolidated supervision. ### Principle 6 — Transfer of significant ownership (Assessment: Compliant) - Definitions: - "Control" defined in Article 3 BL. - "Qualified shares" (significant ownership) defined as shares representing directly/indirectly 10% or more of capital or voting rights, or privilege to appoint board members even if below 10%. - Authorization thresholds and requirements: - Article 18 BL requires BRSA permission for acquisitions that result in holdings of 10 %, 20 %, 33 % or 50 % of capital; assignments that change those thresholds; transfer/issue of preferential shares with board appointment rights; transfers of shares of legal entities owning 10 % or more of a bank. - Permission may be conditioned on acquirer meeting founder qualifications. - Transfers without permission result in shareholder rights (other than dividends) being exercised by SDIF. - Ongoing disclosure: - Banks submit detailed shareholders structure monthly; additional surveillance report semiannually for qualified legal entity shareholders. - Sanctions: - Article 155 BL: false information in ownership change can lead to imprisonment from one year to three years and judicial fine not less than 1,500 days. ### Principle 7 — Major acquisitions (Assessment: Compliant) - Prior approval for investments: - All bank investments (except trading operations) require BRSA approval. - Cross-border investments require BRSA approval (art. 14 BL, art. 9 RTSPIO); feasibility study required for foreign investments (detailed three-year projections, costs/benefits). - Domestic participations/establishments require prior permission (art. 8 RTSPIO). - Exemptions: trading-purpose share purchases, shares acquired solely to collect/recover receivables, participation in capital increases. - Limits: - Article 56 BL limits acquisition of shares in non-credit/financial institutions to 15 % of own funds individually and total not more than 60 % of own funds; excess investments deducted from equity for capital adequacy. - Supervisory criteria and practice: - BRSA evaluates feasibility studies, verifies corporate governance, capital/liquidity adequacy, large exposures, management and internal systems; may require MoU with host supervisor; assesses ability to gather information and conduct supervision. - Assessment comment: - Supervisors should more extensively and formally consider effectiveness of supervision in host countries. ### Principle 8 — Supervisory approach (Assessment: Materially Non-compliant) - Supervisory methodology: - BRSA uses a dynamic risk-focused approach documented in the Supervisory Manual on Banking Supervision Process (SMBSP); supervisory cycles last one year. - Main players: audit departments (on-site inspections, special inspections, CAMELS), off-site department (financial indicators, surveillance), enforcement department (formal communications, proposals to Board). - Planning and bank categorization: - Planning inputs: supervisory rating and systemic importance. - Banks mapped to categories "red", "yellow", "green" using matrix of Sector Share (SS) and Final Rating (10 worst — 1 best). Matrix rules: - If SS ≥ 3: Final Rating 10–6 → Red; 4–5 → Red; 3–2–1 → Yellow - If 3 > SS ≥ 0,5: Final Rating 10–6 → Red; 4–5 → Yellow; 3–2–1 → Green - If 0,5 > SS: Final Rating 10–6 → Yellow; 4–5 → Green; 3–2–1 → Green - Inspection frequency: - "Red": on-site annually. - "Yellow": at least once every two years. - "Green": at least once every three years. - BRSA explains that in practice largest banks are examined annually despite matrix allowing otherwise. - Supervisory cycle phases and tools: - Identification of Risk Areas (IRA): short initial assessment using existing information (risk matrix, CAMELS, ICAAP, past inspections, off-site reports) to set supervision plan and special inspections (SI). - Special Inspections (SI): detailed on-site inspections in three levels (internal evaluations adequacy; BRSA best-practice benchmarking; transaction sampling). Number of SIs: 61 in 2014 and 44 in 2015; total 105 SIs with 70 focused on loan portfolios in 27 banks. - CAMELS rating: guided by nearly five hundred questions in General Assessment Report (GAR) Annex; produces financial structure and rating report, risk matrix, risk profile and ICAAP assessment opinion. - Complementary analyses: legal, AML/CFT, follow-up on supervisory findings, consumer complaints; thematic reviews as needed. - Off-site supervision: monthly and quarterly surveillance reports (e.g., "Monthly Report of Follow-Up of Compliance with Legal Limits", "Monthly Report of Ratios Follow-Up", "Monthly Report"); top-down stress tests; sectoral reports (Weekly Banking Sector Report, Potential Non-Performing Loans Report, Monthly Key Indicators Report, Banking Sector Outlook, Stress Test Report, Country Risk Report, Credit Bureau Individual Credit Rating Results Report). - Identified shortcomings in practice: - Inspections show an "excessive compliance nature" — focus on regulatory compliance rather than developing a clear, forward-looking view of bank-specific risks and implications for broader supervisory action. - CAMELS process is comprehensive but by nature less deep than SIs; supervisors may over-rely on ratings without sufficient detailed follow-up; some issues addressed only during ratings may warrant special inspection. - Possibility of leaving banks without structured supervisory assessment for up to three years (per matrix) "seems inadequate." - BRSA has not started to assess resolvability of banks; no requirement yet for recovery plans. - Fragmented communication responsibilities between audit and enforcement departments may produce inconsistent messages to banks and slow decisions. - Off-site analyses and top-down stress tests are underutilized in guiding supervisory action. - Forward-looking elements and gaps: - ICAAP is the primary forward-looking element (three-year capital projections under scenarios) but process is still in a learning phase; bank reports and supervisory scrutiny need development. - CAMELS and risk matrix lack explicit forward-looking component. - BRSA not yet assessing bank resolvability; working group with SDIF is formulating legislative amendments to include resolvability assessment and recovery/resolution planning. - Assessment comments and recommendations (assessors’ view): - Supervision methodology is comprehensive and documented, but practical implementation needs improvement: - Develop more profound and forward-looking risk assessments in inspections, producing clear views of risks faced and posed by each bank. - Expand scope and depth of special inspections where issues identified in ratings warrant deeper analysis. - Ensure all banks receive structured supervisory attention within appropriate timeframes (avoid up to three-year gaps). - Begin assessing resolvability and require recovery plans; finalize joint BRSA-SDIF legislative proposals. - Improve integration of off-site stress testing and top-down analyses into supervisory decision-making. - Clarify and streamline communication and decision processes between audit and enforcement functions to ensure consistent, timely supervisory messages. *Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1746.pdf* ### conclusions tend to focus mostly on compliance issues and do not identify and make ### cr1746 - conclusions tend to focus mostly on compliance issues and do not identify and make ### Supervisory techniques and tools (Principle 9) - Findings: - Supervision composed of on-site and off-site functions aiming to complement each other under RAA; BRSA conducts risk focus supervision (RFS). - On-site supervisors frequently perform comprehensive loan portfolio reviews, compliance with accounting standards, consolidated group analysis, information systems analysis, and alignment with legislation. - Staffing: approximately 75 on-site examiners assigned to bank inspections; 17 examiners assigned to non-bank financial institutions; 29 examiners for specific examinations (customer complaints, alleged criminal activities, etc.); 8 in internal review team; 13 on-site examiners in Risk Management and Financial Consumer Relations Departments; 50 examiners not in audit departments responsible for specific inspections; other experts (law, IT) available when necessary. - Off-site supervision performed by 22 supervisors (average 3 banks per banking expert); produces periodic reports and stress tests. - Quality assurance system (article 7 of RAA) focuses on individual on-site inspection procedures and report compliance but lacks broader policies/processes to assess effectiveness and integration of on-site and off-site functions. - Limited deep exchange and joint analyses between on-site and off-site supervisors; work conducted largely in parallel. - Recommendations / Observations: - Develop policies and processes to assess effectiveness and integration of on-site and off-site functions and address identified weaknesses. - Increase rotation between on- and off-site supervisors to improve integration. - Enhance forward-looking components: deeper analysis of ICAAP results, greater role for stress test results, explicit incorporation of expected trends in ratings methodology. - BRSA should not over-rely on ratings process alone; periodically expand special inspections to issues currently only addressed during ratings. - Require banks, particularly systemic ones, to develop recovery plans and have BRSA assess resolvability. - Improve communication: consider policy establishing at least one annual meeting between supervisors and the bank’s board; formal discussion of stress testing with banks; clarify sharing responsibilities between audit and enforcement departments. ### Supervisory reporting (Principle 10) - Findings: - BRSA authorized (Articles 95 and 96 of BL) to require solo and consolidated information across frequencies (daily, monthly, quarterly, semiannually, annually). - Major reporting sets: - Surveillance Reporting Set (daily/weekly/monthly/quarterly/semiannual/annual) — includes daily stock volumes of major on/off balance sheet items, securities portfolio details, transaction-based derivatives details, custody service details, FX transaction volumes; weekly reports on FX position, consumer loan types/volumes, liquidity positions; monthly reports include balance sheet, income statement, loan portfolio details, subsidiaries, securities issuance, general ledger, related parties, positions with other financial institutions. - Basel Reporting Set — own funds, capital adequacy, LCR, subforms for credit/market/operational risk; “Detailed Credit Risk Assessment Form-AKRİF” prepared on-site due to size. - Cross Border Organizations Reporting Set — quarterly info on foreign subsidiaries/off-shore branches (balance sheet, P/L, loans, derivatives, capital adequacy, FX position). - Banks’ Shareholders Reporting Set — financial tables, shareholders list and ratios for domestic and foreign shareholders. - Non-Bank Financial Institutions Reporting Set — quarterly monitoring info. - Reporting standards based on TFRS (Turkish transposition of IFRS); loan loss provisioning uses REPL; BRSA planning IFRS 9 adoption from 1 January 2017 (banks may choose REPL or amended REPL by 2017). - Data quality controls: formal/logical/mathematical checks via electronic data transfer system; completed reporting sets locked; warnings for expected reports, latencies, consistency errors; administrative fines for late/missing/erroneous reports (Article 146 fines: 5,000 TL to 15,000 TL for failure to submit; 5,000 TL to 10,000 TL for late submission; 5,000 TL to 15,000 TL for missing information/control errors/recurring control errors). - BRSA periodically reviews information collected but process could be better structured; data sets frequently updated as new needs arise. - Recommendations / Observations: - Formalize periodic review of information collected to ensure continued supervisory relevance and avoid redundant reporting. - Continue ensuring comparability of consolidated/solo data and quality assurance checks; maintain capacity to verify supervisory returns via on-site checks and external experts. ### Corrective and sanctioning powers (Principle 11) - Findings: - BRSA raises supervisory concerns via meetings and written reports; remedial measures addressed to bank Boards with required rehabilitation plans and regular progress reports. - Despite broad legal powers (Articles 68–71 BL; Article 146 administrative fines), remedial and corrective measures rarely used in recent periods (one case in last five years); BRSA relies more on administrative fines. - Supervisory review process is lengthy and skewed toward compliance validation rather than supporting supervisory judgments and early-action measures. - BRSA may require a bank to increase own funds, suspend profit distribution, increase provisions, sell assets, restrict/new investments/payments, revoke operating permissions, transfer management to SDIF (Article 71). - BRSA can impose sanctions on individuals (Article 69, 110, 147), revoke signing authority (Article 26), require removal/appointment of board members. - Coordination with SDIF: Coordination Committee meets at least once every three months (Article 100); BRSA notifies SDIF when corrective measures required enabling resolution planning. - Recommendations / Observations: - Use remedial and corrective actions more proactively as early preventive measures rather than relying primarily on fines. - Integrate supervision and enforcement to support risk-focused, judgment-based supervision and clearer communication with banks. - Incorporate forward-looking tools (ICAAP, stress tests) more heavily into decision-making and act early to restore weak banks even before prudential ratios breached. ### Consolidated supervision (Principle 12) - Findings: - Legal authority for consolidated supervision: Article 66 (consolidated ratios), Articles 95–96 (information access), Article 78 (financial holding companies). - Consolidated financial statement requirements: quarterly (financial subsidiaries) and semi-annually (financial and non-financial subsidiaries). - Regular monitoring of intra-group transactions via monthly call reports; banks report names of real/legal persons in own risk group monthly. - ICAAP required on consolidated basis (RICAAP Articles 46–47); ICAAP should consider risks from parent company or subsidiaries including reputational risk. - BRSA conducts periodic on-site inspections of foreign branches/subsidiaries; since 2008 there are 19 banks with foreign operations including 60 subsidiaries; total assets of cross-border operations amount to 15.7% of total assets of banking sector. - On-site consolidated analysis limited by depth of CAMELS ratings and ICAAP being at early stage; limits ability to fully understand group-wide risks. - Recommendations / Observations: - Deepen analyses and strengthen techniques (e.g., group-wide stress testing) to monitor risks from non-banking and foreign activities and parent entities. - Improve recovery and resolution planning for large banking groups once legal powers available; consider scenarios where shocks originate from non-banking entities or parent groups. ### Home-host relationships (Principle 13) - Findings: - BRSA has signed MoUs with supervisory authorities of 34 countries; 19 MoUs with countries where Turkish banks operate; these foreign operations represent 77% of total assets of Turkish banks operating abroad. - BRSA organized its first supervisory college for a large Turkish bank with host authorities from 6 countries; plans additional colleges. - BRSA authorized to cooperate even without MoU (Article 98 BL) subject to reciprocity and BRSB permission. - BRSA conducted 52 on-site visits to foreign subsidiaries/branches since 2008 (19 subsidiaries, 6 off-shore branches, 27 on-shore branches of 11 banks); since 2011 BRSA conducted 39 on-site visits to foreign subsidiaries/branches operating in Turkey (20 subsidiaries, 16 branches in 13 countries). - No comprehensive framework for cross-border crisis cooperation or group resolution plans; BRSA and SDIF established joint working group to analyze potential changes to resolution regime and legislative amendments; banks have not been required to develop recovery plans and resolvability assessments not yet performed by supervisors. - Recommendations / Observations: - Further improve home-host coordination, expand supervisory colleges for banks with material cross-border operations. - Develop a framework for cross-border crisis cooperation and coordination; develop group resolution plans and require recovery plans where appropriate. ### Corporate governance (Principle 14) - Findings: - Corporate governance embedded in BL (Part 3) and implemented via RICAAP and Regulation on the Corporate Governance Principles of Banks (RCGB). - Board responsibilities (Article 23 BL): establish/ensure internal control, risk management, internal audit systems, and financial reporting systems; board must have at least 5 members including general manager; chairman of board and general manager must be separate. - Minimum of 2 non-executive members required for audit committee; no statutory requirement for majority of board to be non-executive or independent. - Audit committee duties include supervision of internal control, risk management, internal audit, financial reporting. Often audit committee also acts as risk committee; in complex banks separate risk committees exist. - BRSA approves board and senior management appointments and reviews qualifications; checklists used. - Supervisory assessments (on- and off-site, CAMELS/GAR, ICAAP) examine governance elements but often stop short of analytical, narrative conclusions linking findings to board oversight effectiveness. - Only 3 special examinations focused on governance elements in 2014/15. - No requirement for succession planning; remuneration committee not universally mandated (Guideline on Best Compensation Practices recommends but not mandatory); three largest banks have remuneration committees. - Assessment / Issues: - Materially Non-compliant overall due to supervisory assessments not producing holistic, cross-cutting, and analytical conclusions on corporate governance effectiveness and board oversight. - Specific gaps: - No statutory requirement for majority non-executive/independent board membership; risk of boards being majority-executive with only 2 non-executives. - Audit committee minimum of 2 members considered too few; chair sometimes is chairman of board (conflict of interest). - Lack of regular, holistic cross-cutting corporate governance reviews leveraging on- and off-site inputs. - Absence of explicit requirement for succession planning and systematic supervisory review of remuneration frameworks. - Recommendations: - Consider amending banking legislation to require majority non-executive board composition with minimum independent directors consistent with CMB definition. - Strengthen audit committee composition: expand membership, require independent membership and separation of audit and risk oversight in complex banks. - Institute regular, structured, cross-cutting corporate governance reviews that draw analytical conclusions linking supervisory findings to board effectiveness. - Require succession planning for key management roles and explicit supervisory review of remuneration frameworks and disclosures. ### Risk management process (Principle 15) - Findings: - Legal framework: BL Articles 29 and 31 require internal systems (internal control, risk management, internal audit); RICAAP sets procedures/principles for internal systems and ICAAP. - ICAAP obligations and forward-looking capital assessment embedded in RICAAP; ICAAP is recent and both banks and supervisors are in a learning phase. - Risk appetite, culture, policies and limits required by RICAAP (Articles 5, 35, 38, 39, 42, 45); risk limits must be board-approved and communicated; risk limits reviewed at least annually. - Supervisory tools: SMRAC and CAMELS/GAR include criteria for assessment across risk types (credit, operational, strategic, reputational, liquidity, interest rate, market, country/transfer, concentration, residual, model, counterparty). - Model governance: communiqués and guidelines for IRB, AMA, market risk models (CIRB, CAMA, CMR-RMM, GAVA, GAPA); validation required (Article 58 RICAAP); internal audit and independent validation responsibilities defined. - Information systems: RICAAP Article 11 requires adequate MIS; FSASP supports supervisory cycle; IT audit experts conduct examinations. - Stress testing: banks must maintain stress testing programs; BRSA conducts top-down macro stress testing (ECB TA 2011 model adapted) with baseline and adverse scenarios over two years assessing GDP growth, FX rates, interest rates, unemployment; stress tests quarterly, reported internally twice a year; BRSA does not disclose stress test results to banks. - Contingency and business continuity: RICAAP Article 13 and GORM require business continuity plans, tested at least once a year; included in ICAAP reporting. - Risk management function organization: risk management departments required under board; some banks have CRO positions but not universally; concerns that senior manager level may lack stature of a CRO in complex banks. - Assessment / Issues: - Largely Compliant overall but: - ICAAP and supervisory use are early-stage; quality of bank submissions and supervisory scrutiny need further development. - Require banks of greater complexity to have qualified CROs with sufficient stature and authority. - Expand new-products review to explicitly cover material modifications to existing products and major acquisitions; require restriction if controls/resources insufficient. - Recommendations: - Strengthen supervisory review and use of ICAAP and stress tests in decision-making. - Require explicit CRO role and disclosure/board approval if CRO removed; ensure CRO independence and stature commensurate with bank complexity. - Expand new-product governance and approval procedures to include material modifications and major acquisitions. ### Capital adequacy (Principle 16) - Findings: - Legal minimum CAR of at least 8% (Article 45 BL); BRSA can increase minimum CAR or set different ratios per bank. - Basel-aligned framework implemented via ROF and RCA; minimum CET1 4.5%, Tier 1 6.0%, Total Capital 8.0% with parallel targeted minimum total capital ratio of 12%. - Banks required to maintain capital planning buffer above minimums via ICAAP (RICAAP Articles 55, 60); BRSA can increase capital requirements for Pillar 2 risks (Article 60 RICAAP). - Systemic add-ons: D-SIB buffer groups with buffer rates — Group 1 1; Group 2 1,5; Group 3 2; Group 4- empty 3 (Domestic Systemically Important Banks (D-SIBs) Buffer rates (%)). - Countercyclical capital buffer process established; national component currently set at zero; banks to obtain foreign component values from Basel site. - Leverage ratio: Regulation on Measurement and Assessment of Leverage Level of Banks (RMAL) sets three-month simple arithmetic average leverage ratio at least three percent; BRSA may set different leverage ratios. - Internal models for Pillar 1 not yet authorized in practice; regulatory approvals required (CIRB, CAMA, CMR-RMM) and no bank currently uses IRB/AMA for regulatory capital. - BRSA has capacity and regulations to impose specific capital charges and requires forward-looking ICAAP and stress testing for capital planning. - Assessment / Issues: - Compliant overall. - Consider simplifying framework to improve enforceability and reduce compliance burden, especially for non-systemic banks (e.g., restrictions on diversification benefits, limited model use where not authorized). - Evaluate interaction among 12% parallel requirement, capital buffers, and Pillar 2 charges to avoid redundancy or erosion of Pillar 2 effectiveness. ### Credit risk (Principle 17 — introduction and structures) - Findings: - Legal framework: Article 23 BL (board responsibility), Articles 48, 50 (loan definitions), Articles 51–52 (credit administration and monitoring). - Guideline on Credit Management of Banks (GCM) requires processes consistent with risk appetite, risk profile, systemic importance and capital strength; Guideline on Counterparty Credit Risk Management (GCPRM) exists. - Organizational structure described: - Credit Risk Oversight organized in two-fold manner: 1. Credit Risk Management unit (directly under board/audit committee) — conducts portfolio/exposure surveillance, sets internal/legal/sector limits, monitors NPL figures (received from credit review department), analyzes trends and macro conditions, designs risk rating systems, policies, model development for credit approval, model validation review. Does not evaluate individual credits for internal classification; relies on credit review/monitoring unit for individual credit classifications. - Credit monitoring and individual credit evaluation function described as separate (implied within GCM and supervisory observations), with potential organizational issues regarding independence between credit origination and monitoring. - Recommendations / Observations: - Ensure robust segregation between credit risk oversight and line credit monitoring functions; strengthen independent credit monitoring at individual credit and portfolio levels (see detailed BCP 17 discussion). - Continue to enforce GCM requirements on organizational structure, MIS, collateral management, and conflict-of-interest avoidance in credit units. *International Monetary Fund — cr1746 (extracts from PDF chapter).* ### 2. Credit Monitoring Function (line management department/unit) ### 2. Credit Monitoring Function (line management department/unit) ### Role and positioning - This unit is a management line function as are the marketing and underwriting functions. - The credit monitoring function represents management’s execution of their responsibility to monitor the business risk they put on the books of the bank. - The business line is the party responsible for first identifying and flagging credit risk deterioration to allow early intervention and possible rectification. - In general, once a credit hits NPL status, it is sent to the loan work-out unit for more active management. ### Credit monitoring activities (start at loan inception) - Past due status of the borrowers - Change in system generated risk ratings - Collateral status and coverage - Customer limits - Risk Center monitoring for developing borrower(s) trends - Opines on restructuring loans - Deteriorating credit as detected from past due information ### Reporting, data provision, and timing issues - The unit provides source data on, inter alia, individual deteriorating/NPL credits and NPL trend data on homogeneous credits to the board via the risk management function. - Management reports may have more current (and different) classifications of credit than the system generates due to the timing of information input to the system. - Important source data (identification of deteriorating credits that have not yet reached an NPL status—as well as special mention credit and status of NPLs) is generated by the credit monitoring unit which is a business line management function. This information is also reported to the BRSA for monitoring and examination purposes. ### Internal audit and loan review responsibilities - Internal audit plays an important role in the credit risk management framework; audits determine whether the credit process is consistent with board approved policies and procedures and the accuracy of management reports, and board and audit committee reports. - Loan review is the most prevalent activity in the internal audit plan(s). - According to REPL, banks are required to review their loan portfolio in terms of classification at least quarterly and they are required to document those reviewed for the largest 200 loans (or the ones above 250.000 TL). - The BRSA indicated that the loan review documentation for the largest 200 loans is usually prepared by internal audit. ### Key organizational weaknesses and independence issues - The credit risk management oversight (line management function) and credit risk management function and the organization therein create loopholes in the independence and integrity of credit risk monitoring and reporting to bank boards and the BRSA. - Observations: - The board has established a (credit) risk management unit that complies with the letter of the law and provides high level trend and other analysis information. - There is no ongoing, independent credit risk monitoring of large individual exposures or homogeneous portfolios. - There is no independent verification (i.e., independent loan review function) that determines that: 1) management identification processes are accurate and timely, 2) management, itself, is accurately recognizing its business risk, and 3) timely borrower intervention is activated. - This critical input forms the basis of important MIS going to the board. - Examiners have identified important, clearly inaccurate classifications of credit, but the examination reports did not consistently indicate the size of the sample reviewed, how significant the aggregate inaccurately classified credit was to the total portfolio, or if findings could be extrapolated to the entire portfolio. ### Regulatory expectations and supervisory assessment (EC2–EC8 summary) - EC2: The supervisor determines that a bank’s Board approves, and regularly reviews, the credit risk management strategy and significant policies and processes for assuming, identifying, measuring, evaluating, monitoring, reporting and controlling or mitigating credit risk and that senior management implements the credit risk strategy approved by the Board. - GCM Principle 1 requires the board to determine, in writing, and approve credit strategies and periodically review financial and economic indicators used in establishing the credit strategy. - The BRSA conducts onsite review through CAMELS/GAR methodology and may conduct specialty examinations (corporate, commercial, SME loans) to test management implementation of board-established risk appetite and strategies. - EC3: The supervisor requires such policies and processes establish an appropriate and properly controlled credit risk environment, including items (a) through (g). - a) Policies for assuming credit risk without undue reliance on external assessments: Article 52(1) of BL requires banks to measure credit risk; regularly analyze and monitor the financial standing of the counterparty; obtain the necessary information and documents; and establish the relevant procedures. - b) Procedures for approving new, renewed, and refinanced exposures and approval authorities: Principles 11, 13 and 23 of GCM set parameters; Principle 13 requires assessment and approval functions. - Restructured Credit: REPL Article 11 allows restructuring for temporary liquidity problems, prescribes monitoring of restructured credits for at least six months in the Third, Fourth, Fifth groups, continues provisioning at group rates, allows credits to be restructured twice with the second time providing that 20% of the existing principal is collected each year, and prescribes a timeframe for write-off once certain conditions are met. Restructured credit facilities may be transferred and posted to the “Account of Loan Facilities Renewed and Subject to Redemption Plan” at the end of this period, providing that at least fifteen percent (15%) of the total amount of receivables is repaid, and they are traced and pursued in the same group for at least six months, and the repayments are not delayed. The draft REPL extends the monitoring period to one year before consideration of a classification change. - c) Continued analysis of borrower ability/willingness and monitoring of documentation, covenants, collateral, and asset grading: Article 52 of the BL and GCM principles 1–3, 15, 17, 24, 25 and 26 set parameters; CCRM sets procedures for credit risk mitigation techniques; REPL presents terms and conditions for asset classification. - Loan Classification System per REPL (minimum): - Special Mention (“close monitoring”) – > 30 up to 90 days - Substandard (“limited collectability”) - > 90 up to 180 days (provisioning: 20%) - Doubtful - > 180 days to 1 year (50%) - Loss - > over 1 year (100%) - Credits classified substandard and worse are considered nonperforming. - Classification definitions are unclear and substantially overlapping, particularly Special Mention and Substandard, leading to blurring and potential under-provisioning. - d) MIS for accurate and timely identification, aggregation and reporting: RICAAP Article 11 and GCM Principles 6–8 require effective information systems; results of internal system analysis to be shared regularly with senior management and audit committee. - e) Prudent and appropriate credit limits: RICAAP Article 5 requires boards set appropriate risk appetite and limits commensurate with risk appetite, capital, and management resources, with effective communication. - f) Exception tracking and reporting: Paragraph 14 of GCM addresses identifying and reporting exceptions; Paragraph 59 requires risk management units to assess and report frequency of credit exceptions. - g) Controls around models and validation: BCP 27, EC 3 detail BRSA requirements for model validation as per GFVM; GCPRM Paragraph 7 stipulates senior management awareness of limitations of internal CCR models. - EC4: Banks are required to have policies and processes to monitor the total indebtedness of entities; Article 107 of GCM requires foreign exchange risk exposure of customers in other banks to be considered. CAMELS/GAR gathers aggregate customer indebtedness (on and off-balance sheet) during certain specialized examinations, but write-ups often do not clearly depict the nature and volume of other related exposures. - EC5: Article 50 of the BL requires loans to be extended on an arm’s length basis and that loan conditions cannot vary in favor of the borrower. - EC6: Article 5(1) of Regulation on Credit Transactions by Banks (RCT) provides that powers for extension of credit rest with the board, which may delegate to a credit committee or headquarters. Article 5(2) caps delegation at up to 10 percent and up to 1 percent of own funds respectively. - EC7: Articles 65, 66, 95 and 96 of the BL grant the BRSA full access to information in the credit and investment portfolios and to bank officers involved in credit risk. - EC8: Article 43(4) of RICAAP requires banks to have stress testing programs including firm-wide stress testing and for each material risk type, including credit risk. Principle 27 of GCM requires stress testing and scenario analysis and analysis of current and future capital requirements for credit risk; GCPRM principle 7 gives guidance on CCR stress testing. ### BRSA credit examination process - Management and risk control over credit operations are evaluated through CAMELS review/GAR methodology, with the possibility of specialty examinations (corporate, commercial, SME loans). - Specialized examinations provide opportunity to assess effectiveness of credit underwriting, monitoring, early identification and classification processes, and risk management oversight mechanisms. - Review of a sample of 4 special examinations was undertaken by the assessor team; further detail is in EC3 and EC 3 references. ### Assessment conclusion - Assessment of Principle 17: Materially Non-compliant. - Comment: The legal framework for credit risk is generally comprehensive and assigns responsibility to the board and prescribes a controlled credit risk environment. However, several issues exist within the framework and its application that compromise effectiveness, notably organizational design that creates loopholes in independence and integrity of credit risk monitoring and reporting to bank boards and the BRSA. *Source: cr1746 - 2. Credit Monitoring Function (line management department/unit).* ### 1. The framework design does not require ongoing, independent (from the business ### cr1746 - 1. The framework design does not require ongoing, independent (from the business ### Lack of independent, ongoing credit risk monitoring - The framework design does not require ongoing, independent (from the business line) credit risk monitoring of large individual exposures or homogeneous portfolios. - Important source data (e.g., identification of deteriorating credits, level of (accurately) classified assets, status of restructured credits, etc.) is generated by a line management function (credit monitoring) without independent verification that: - 1) management identification processes are accurate and timely, - 2) management is well informed of the risk it is running and is upholding board prescribed underwriting standards, and therefore, accurately conveying its business risk, and - 3) timely borrower intervention is activated. - The (unverified) information generated by the line function is used by risk management functions for audit committee and board reporting and is likely reported to the BRSA for monitoring and examination purposes. - The internal audit function, while important, is not designed to perform ongoing surveillance in the manner of an independent credit risk management unit and cannot replace such a function within banks. ### Examination process findings and limitations - Examiners identified clearly inaccurate classifications of credit in inspection samples, indicating potential issues in 1 and 2 above, but: - There was no clear indication of the size of the sample of reviewed credits. - There was no indication of how significant the aggregate inaccurately classified credit was to the total portfolio. - There was no indication if such findings could be extrapolated to the entire portfolio. - Credit classification definitions, particularly in the special mention and substandard categories, are overlapping; examiners and bankers fluidly move credits among these categories, compromising the depiction of the bank’s risk profile and impacting provisioning and financial statement accuracy. - The manner in which examiners write up credits during special examination does not clearly depict the nature and volume of other related exposures in the given bank to put the overall borrower relationship in context. ### Specific deficiencies in examination write-ups (Assessor Observations) - Of the credits reviewed and featured in examination reports, the exam team identified important deficiencies in a bank’s classification and lack of accuracy. - Review of examination reports highlighted: - Size and significance of the group credits sampled and reviewed was not enumerated. - A number of credits were re-classified by the examiners, but: - No indication of the relative significance of the findings relative to the total portfolio. - No indication if findings could be extrapolated to the rest of the portfolio. - No indication if expansion of the credit sample was warranted. - Loan write-ups were incomplete: missing total indebtedness breakout for significant on/off balance sheet exposures; missing context of total credit relationship (payment history, number of renewals/restructures, interest capitalization, nonaccrual status, collateral position and integrity of estimated values). - Due to limited information, it was difficult to assess accuracy of final classification. - Provisioning impact was not presented. - No documentation retained on review of “standard” loans to substantiate reasonableness of maintaining standard classification. - Overall conclusions in reports focused on internal control issues rather than higher-level implications for condition and management of the credit portfolio. - Missed opportunities to identify linkages to: - Management’s understanding of their business and credit risk and ability to identify deterioration proactively. - Implications for internal systems: function, role, and independence of credit risk management. - Inputs to evaluate corporate governance of the bank. - Accuracy of information conveyed to the board and the BRSA. - BRSA indicated these linkages, while not explicitly presented in reports, are inputs to CAMELS risk rating and the risk matrix/profile used to set supervisory priorities. ### Regulatory framework, REPL and disclosure requirements - Principle 18: Problem assets, provisions and reserves. The supervisor determines that banks have adequate policies and processes for early identification and management of problem assets, and the maintenance of adequate provisions and reserves. - EC1: Laws, regulations or the supervisor require banks to formulate policies and processes for identifying and managing problem assets and require regular review by banks of their problem assets and asset classification, provisioning and write-offs. - Relevant statutory and regulatory provisions: - Articles 52 and 53 of the BL require regular analysis and monitoring of borrower financial standing and policies regarding monitoring of loans under follow-up and loan loss provisions. - The Regulation on the Procedures and Principles for the Evaluation of Loans and Other Receivables (REPL) sets rules on classification of loans (into five groups) and criteria for loan loss provisioning. - Article 12(9) of REPL requires banks to prepare an exclusive report containing views about loans that exceed TL 250,000 and, in any case, the largest top 200 loans, on a quarterly basis or in case of occurrence of any risk event. - Article 16(10) and (12) of the Communiqué on Financial Statements and Their Disclosures to be Announced to Public by Banks (CPD) requires disclosure of amounts of write-offs and policies/procedures on write-offs. - REPL does not include parameters for write-offs; the draft REPL specifies write-off criteria in relation to IFRS 9 requirements. - Draft REPL features (as communicated by BRSA): - Keeps five group classification. - Entry and exit criteria of sub-groups are elaborated. - Definition of non-performing loans is linked to the Basel II default definition and stage 3 of IFRS 9. - Forbearance is defined as a cross-cutting category based on EBA ITS dated 20.02.2015. - Criteria for reclassification from non-performing to performing loans is determined. - Write-off criteria are laid down by considering IFRS 9 requirements. - Expected loan loss provisions are required to be recognized in compliance with IFRS 9. - Banks are required to review loans on a quarterly basis or in case of occurrence of any risk event for re-classification purposes. - Banks are required to document assessments regarding the largest 200 loans or the loans exceeding TL 500.000. ### On-site examination procedures and EC2–EC4 findings - EC2: Supervisor determines adequacy of a bank’s policies and processes for grading, classifying, and provisioning; reviews may be conducted by external experts with supervisor review of their work. - On-site examiners assess objectivity and adequacy of internal procedures and internal controls necessary for independent inspection of bank lending, taking into account factors including: - Effectiveness of internal rating system, - Whether internal procedures and MIS allow board and management to obtain timely and appropriate information, - Compliance of internal procedures for monitoring and classification with relevant legislation, - Whether findings of internal audit and internal control groups about problem assets are sufficiently taken into account by management, - Robustness of collateral data used for capital adequacy calculations, - Adequacy of provisioning levels relative to regulatory requirements and the bank’s risk profile, - Accuracy of loan classification based on a sufficiently large examination sample. - Loan selection for full scope examinations considers multiple sources and criteria (loan reports, list categorized in the second group pursuant to REPL, list of loans past due, off-site potential problem loans report, previous BRSA reports, list of obligors classified in 2nd group by other banks, list of restructured/rescheduled loans). - On-site team examines at least the 200 firms/obligors having the highest level of risk in the total loan portfolio. - Notes to financial statements prepared according to CPD and audited by external auditors include information on grading/classification and loan loss provisioning levels; this information is reviewed for consistency and used as input during on-site exams. - EC3: The supervisor determines that the bank’s system for classification and provisioning takes into account off-balance sheet exposures. - REPL covers rules for classification and provisioning of all off-balance sheet items; draft regulation does likewise. - On-site examiners evaluate classification and provisioning adequacy for off-balance items, taking into account factors such as reimbursed non-cash loans, ratio of reimbursed non-cash loans to total non-cash loan portfolio, past due days of the obligor with respect to cash loans, and concentration risk in off-balance sheet items. - EC4: The supervisor determines that banks have appropriate policies and processes to ensure that provisions and write-offs are timely and reflect realistic repayment and recovery expectations, taking market and macroeconomic conditions into account. - Minimum provisioning rates are determined according to loan categories. - Articles 6(3) and 6(4) of REPL require banks to consider financial and macroeconomic factors including sectoral and firm specific conditions and to base calculations on reasonable and supportable assumptions. - Article 10(8) of REPL allows banks to make higher provisions than the minimum rates in Article 8. - REPL authorizes BRSB to set higher levels of general and special provisions taking into account sectoral and country risks. - The draft REPL requires banks to recognize loan loss provisions consistent with IFRS 9. ### Policy implications and recommendations (implicit in findings) - Establish an ongoing, independent credit risk management/surveillance unit separate from the business line to verify line function data and provide independent monitoring of large exposures and homogeneous portfolios. - Require exam reports to: - Enumerate the size and significance of sampled credits and the aggregate significance relative to the total portfolio. - Indicate whether sample findings can be extrapolated or whether sample expansion is warranted. - Provide complete loan write-ups that include total indebtedness (on/off balance sheet), payment history, renewal/restructure history, interest capitalization, accrual status, collateral position and valuation integrity. - Present provisioning impact and retain documentation supporting the review of "standard" loans. - Explicitly link examination findings to management adequacy, internal systems, corporate governance, accuracy of information to board and BRSA, and supervisory risk ratings (CAMELS) to support corrective actions. - Explicitly disallow restructuring of loss credit in REPL (draft REPL is theoretically allowing restructuring of loss credit; the practice should be explicitly addressed/disallowed). *cr1746 - 1. The framework design does not require ongoing, independent (from the business* ### 9. The BRSB is authorized to increase general and special provisioning levels both for a ### 9. The BRSB is authorized to increase general and special provisioning levels both for a ### Provisioning and write-off framework - The REPL does not include a rule on write-offs. - Write-off criteria are laid down in draft Regulation on the Procedures and Principles for Accounting Practices and Retention of Documents by Banks (RAP) by considering IFRS 9 requirements (opened for public consultation). - Article 10(A) of the draft RAP requires banks to write-off the uncollateralized portion of their non-performing loans within a maximum period of one year after their classification in the 5th group. - The BRSA will publish a guideline in alignment with the Guidance on Credit Risk and Accounting for the Expected Credit Loss (GACL) published by the BCBS so that the GACL will be incorporated into the national regulatory framework. - Within the context of IFRS 9 and the GACL, forward looking information and macroeconomic factors are to be taken into account by banks in provisioning. - Under the draft REPL the BRSB is authorized to increase general and special provisioning levels both for a specific bank or a specific loan type for the whole banking sector. ### Current provisioning requirements (as presented) - Group 1/Standard (past due period up to 30): - Loans: .5% - 5.0% - Off-balance Sheet: O% - .20% - Retail w/extension: 10% - Retail (other): 0% (Loans), .20% (Off-balance) - Group 2/Special Mention (past due period 30 - 90): - Loans: 2% .4% - Retail: 10% .4% - Group 3/Substandard (past due period 90 - 180): - Loans: 20% - Off-balance Sheet: 20% - Group 4/Doubtful (past due period 180 - 360): - Loans: 50% - Off-balance Sheet: 50% - Group 5/Loss (past due period  360): - Loans: 100% - Off-balance Sheet: 100% - Additional notes on provisioning figures: - Specific provisions are made net of collateral values. REPL assigns a haircut to collateral values depending on the item. - Export trade 0%. - General provision is 2.5% for group SME credits that have had their loans extended, for group-cash commercial corporate = 5%. - Retail loans carry a higher provisioning rate due to efforts to slow credit growth in this area. General provisions for retail loans excl mortgages and credit cards = 4%. Provisioning requirements go up to 10% for group retail loans that have been extended. ### Collateral valuation and coverage - Requirements for valuation of collateral are specified in CCRM and GFVM. - Banks ensure that adequate collateral underpins the preponderance of their credit exposures, sometimes to the extent of over-collateralizing. Real estate composes the majority of the collateral. - Banks use firms approved by the BRSA to value real estate. Underlying collateral must be revalued once a credit exposure is classified as NPL. - In general, banks have approximately 75% loan loss coverage on current NPL levels. - Observations and gaps: - Historical and statistical support for standard (general) and special mention loan categories is not substantiated by accumulated experience. - It is not clear if appraised values, within a range, are being realized upon the sale of the properties or if provisioned amounts are adequately covering loss experience on classified loans. - Clear parameters should be established for periodic valuation of underlying collateral on NPL exposures. ### Supervisory processes: on-site and off-site - On-site examination teams: - Assess adequacy of provisioning levels with respect to regulatory requirements in REPL. - Consider write-offs and loan sales in examination of NPL portfolios. - Analyze internal policies, procedures and practices of the bank with respect to write-offs and asset sales. - Assess accuracy of loan classifications and adequacy of provisioning with respect to REPL and the bank’s risk profile and credit risk management system. - Off-site supervision: - Produces early warning information regarding the loan portfolio. - Produces a Report on Potentially Problematic Loans on a semiannual basis. A loan is considered potentially problematic if it meets any of: - classified as NPL by any bank, - classified as NPL by any non-bank financial institution, - classified as NPL by the on-site examination team (based on information received), - transferred to an asset management company. - The Report on Potentially Problematic Loans is used by on-site examiners in analysis and sample selection. - Reporting and data access: - REPL requires banks to record, classify, monitor, and asses their loans in alignment with Article 4 of the REPL. - Banks must prepare an exclusive report containing views about loans that exceed TL 250,000 and, in any case, the largest top 200 loans, on a quarterly basis or in case of any significant risk event. - Draft REPL requires banks to document assessments regarding the largest 200 loans or loans exceeding TL 500.000. - Banks submit off-site call reports on asset classification, asset quality and provisioning. The monthly detailed loan report (KR202AS) provides customer level details including loan classification, loan type (cash, non-cash), sector, collateral, date of default, and provision amount. - BRSA has access to detailed CRB data which includes scoring information of debtors. Asset management companies report acquired portfolios on a quarterly basis. - Supervisors always have access to banks’ records and staff when required. ### Collateral valuation rules and credit risk mitigation - Articles 9 and 10 of REPL set requirements pertaining to collateral including valuation and applicable haircuts when computing special provisions. Valuation of collaterals is based on TAS. - REPL lays down specific requirements to value real estate lien on properties. Banks must assess collateral value in the incidence of a risk event or within reasonable intervals (article 10(1)(c)). - CCRM enumerates guidelines on valuation of collateral. Guideline on Fair Value Measurement (GFVM) provides principles for calculating fair value of financial instruments classified as risk mitigants, credit derivatives or collaterals. - Banks must have monitoring and control procedures for valuation and risk of loss of effectiveness of credit risk mitigation. - Draft REPL requires banks to value loan collateral for calculation of loan loss provisions based on the net realizable value of the collateral (which factors prevailing market conditions). Real estate collateral must be revalued at the time loans are classified as NPL. Valuations of real estate collateral are subject to principles set out in the RCA. ### Definitions, classification and monitoring (EC9–EC12 highlights) - REPL defines problem assets taking into account past due days and credit worthiness of the obligor. The draft REPL links the Basel II default definition and stage 3 of IFRS 9 to the definition of non-performing loans. - Loans classified as special mention performing loans are mapped to 2nd stage of IFRS 9; banks are required to recognize life-time expected loss for this group and establish systems for closely monitoring 2nd group loans (Article 18(4) of draft regulation). - Examiners review homogeneous credits based on delinquency status, portfolio and market trends, and review banks’ internal risk rating models, if used. Draft REPL permits group assessment of loans that have immaterial balances and homogeneous characteristics. - Supervisor access to information: - Supervisor obtains information on a regular basis and requires banks to have adequate documentation to support classification and provisioning levels. - Banks are obliged to submit the monthly detailed loan report (KR202AS) and off-site call reports; BRSA also has CRB scoring data access. - Thresholds for individual assessment: - Banks must prepare reports on loans exceeding TL 250,000 and the largest top 200 loans (quarterly or upon risk event). Draft REPL requires documentation for largest 200 loans or loans exceeding TL 500.000. - Sector-level monitoring and macroprudential actions: - Credit concentration risk and trends are monitored by loan types, geography and industry through monthly sector overview and loan reports. - Non-performing loans by segment, sectors, provisioning rates, loans under follow up and restructured loans are monitored. - Overview of sector risks and trends are presented to the BRSA Board and committees such as FSC and CC. Example macroprudential measures: increasing minimum payment ratios of credit cards, maturity restriction for consumer loans, loan to value ratio for housing and vehicle loans, increasing risk weights for capital adequacy, increasing general provision ratios. ### Supervisory powers and enforcement (EC7) - On-site supervisors can instruct banks to reclassify assets and/or set aside additional provisions when classifications are inaccurate or provisions inadequate (based on Article 4 of REPL). - Insufficient provisioning or misclassification of assets are breaches leading to financial penalty according to Article 146(1)(i) and 148(1)(b) respectively. - Pursuant to Articles 67 and 68 of the BL, BRSA can require banks to set aside higher provisions as corrective measures if asset quality deterioration weakens financial structure. - Article 37 of BL permits the BRSB to take necessary measures where financial statements are mispresented; BRSB may require banks to set aside additional provisions if provisioning presented in audited financial statements is determined insufficient by BRSA examiners. ### Assessment of Principle 18 - Overall assessment: Materially Non-compliant - Comments: - Framework for credit classification and provisioning is generally adequate. - Accuracy of asset classification by banks, and the integrity of reporting to boards and the BRSA, is called into question due to reclassifications assigned by on-site examiners and the lack of documentation therein. - Loan write-ups require more support and context and need to present nature of collateral and provision impact. - Examination conclusions focus more on internal control issues rather than higher level implications for the condition and management of the credit portfolio. - Given the lack of documented focus on implications of important bank processes, the examination exercise missed opportunity to identify important linkages with and [text truncated in source]. *Source: IMF staff report excerpt (cr1746).* ### conclusions on: ### conclusions on: ### Credit risk management, collateral valuation, and information accuracy - Management’s understanding of their business and credit risk, ability to identify deterioration proactively – thereby allowing for early intervention. - Implications for internal systems => function, role, and independence of credit risk management – thereby validating the systems that the bank’s board and the BRSA depends upon in order to effectively oversee the institution. As well, these systems are key to the exercise of risk based supervision by the BRSA. - Inputs to evaluate corporate governance of the bank. - Accuracy of information conveyed to the board and the BRSA. - The historical and statistical support for standard (general) and special mention loan categories is not substantiated by accumulated experience. - It is not clear if appraised values, within a range, are being realized upon the sale of the properties or if provisioned amounts are adequately covering loss experience on classified loans. - Clear parameters should be established for periodic valuation of underlying collateral on NPL exposures. ### Principle 19 — Concentration risk and large exposure limits: summary assessment - Principle statement: The supervisor determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate concentrations of risk on a timely basis. Supervisors set prudential limits to restrict bank exposures to single counterparties or groups of connected counterparties. - Assessment of Principle 19: Compliant. - Comments: The legal framework addressing concentration risk and large exposures limits is generally in line with international standards. The definition of connected parties is comprehensive. The BRSA examines and monitors various exposures including, inter alia, large exposures, concentrations by sector, product, customer, and risk group. ### EC1 — Comprehensive bank-wide view of concentration risk - Legal and regulatory basis: - Article 48 of the BL contains a very comprehensive definition of a loan which includes both on and off balance sheet exposures. - RICAAP article 35(4) requires banks to have effective risk management systems for key risks, including concentration risks. - GMCR is a principle based guideline explaining best practices for management of concentration risk within RICAAP. - GCM directs that credit risk management processes should address concentration risk and diversification in credit strategies and policies. - Bank requirements per guidance: - Banks must identify exposures to single or connected counterparties across markets, sectors, supply chains, partnerships, guarantor relationships and geographic region or activity fields and capture both on- and off-balance sheet positions, assets and liabilities, on consolidated and non-consolidated basis. - Banks are required to specify personnel and units responsible for management of concentration risk and have written policies and procedures for active monitoring, control and mitigation. - Supervisory processes: - Concentration risk is an important focus of the CAMELS review/GAR methodology process, captured in ICAAP and the supervisory review, and feeds into the supervisory cycle risk matrix. ### EC2 — Information systems to identify and aggregate concentrations - Requirements and guidance: - GCM Principle 8 and GMCR Principle 3 require information and data management systems to monitor exposures by customer, group, sub-portfolios, firm-wide, on- and off-balance sheet, and to report concentrations to senior management and relevant units. - Banks’ information systems must meet standards set in RITEA. - Supervisory practice: - Special examinations and on-site credit portfolio examinations evaluate aggregation systems for concentrations; examiners pick up total customer relationship exposures and identify system issues. - Banks’ retail and corporate loans systems (including monitoring loan limits) are audited by external auditors and results are submitted to BRSA; identified deficiencies are taken into account during regular on-site examinations. - CAMELS review/GAR methodology requires supervisors to address concentration risk in counterparty, product, sector and geographical region groupings. ### EC3 — Thresholds, limits, communication and Board reporting - Bank practices: - Concentration risk addressed via strategic planning, business objectives, counterparty-specific, portfolio, product limits and position objectives, and risk oversight mechanisms. - GMCR requires banks to set limits to manage concentration risks; Paragraphs 47 and 48 of GMCR require timely, accurate and comprehensive reporting to senior management and boards. - RICAAP requires communication of the bank’s system of limits and risk appetite throughout the bank. - Supervisory review: - Risk concentrations are captured in ICAAP which is reviewed by the BRSA. - Onsite credit risk examination process (CP 17, 18) issues surrounding risk identification and implications for broader risk management processes could affect supervisory identification, monitoring and control of concentration risk. ### EC4 — Supervisor obtains data to review concentrations (sectoral, geographical, currency) - Reporting and data received: - Surveillance call reports include sector, geography and currency information and risk concentration on customer basis (KR202AS-monthly). - Monthly summary call reports on country risk and currency concentration (UL200AS, UL211AS) enable off-site evaluation of on and off-balance sheet concentration risk. - Single and group exposures (close to or in excess of 20% of regulatory capital for related party and 25% for other individual or group exposure); large exposures; top 25, 50 and 100 exposures are received. - Supervisory analysis: - Supervision reports and reviews include concentrations in loan portfolio, sectoral, geographical, currency accumulations; findings compared against peer group and sector positions and used in banks’ risk assessment reports. - Regulatory requirements: - Minimum regulatory requirements for loan concentrations determined by laws and regulations include banks own risk group, major owners, large exposures (KS100AS and KS100UK), real estate (GS100AS, real estate limits). - Article 12(9) of REPL requires banks to prepare an exclusive report containing views about loans that exceed TL 250,000 and, in any case, the largest top 200 loans, on a quarterly basis or in case of occurrence of any risk event. ### EC5 — Definition of “group of connected counterparties” - Legal provisions: - Article 49 of the BL defines four risk groups: (a) group of counterparties unconnected with the bank, (b) related parties (those connected with the bank), (c) group of connected counterparties of state owned banks and (d) group of connected counterparties of state owned non-bank enterprises. - Article 49 states that “the BRSA shall set the principles and procedures of implementation of this Article and principles and procedures to be applicable to the identification of the (natural) and legal persons to be included in the same risk group ....”. - BRSA has covered these elements in the RCT, prescribing norms for identifying risk groups and aggregating various types of cash and noncash exposures. - Article 49 requires banks to include in the same risk group natural and legal persons that have surety, guarantee or similar relationships where the insolvency of one will lead to the insolvency of the other. ### EC6 — Prudential limits to control large credit exposures - Legal limits and definitions: - Article 54 of the BL sets limits to amount of loans to be granted to a single or group of connected counterparties. - Article 48 provides a comprehensive definition of a loan, both on and off balance sheet. - Article 49 provides a comprehensive definition of “risk group” or group of connected parties. - The total amount of loans to be extended by a bank to a real or a legal person or a risk group shall not be more than 25 %of its own funds. For the bank’s own risk group, the limit shall be set at 20%. The Board may increase this rate up to 25% or to lower it back down to the legal limit. - Loans made available to a real or legal person or a risk group that are equal to or exceed 10% of own funds shall be considered large loans and the total of such loans shall not exceed 8 times of the own funds according to the article 54(4). - Pursuant to Article 43 of the BL, all ratios and limits in the BL are required to be calculated by parent banks on a solo and consolidated basis. Article 54 of the BL states that these limits are calculated on consolidated basis by parent banks. - Article 20 of the GMCR requires banks to measure, monitor, and report concentrations of risk. - Supervisory monitoring: - In GAR, supervisor examines thresholds and specific limits for all types of exposures including off-balance sheet risks, reviews reporting to senior management, and reviews compliance with bank policies and internal and regulatory limits. - The General Risk Limits (KS100AS-KS100UK) reports are used for monitoring compliance with the above limits and if any deficiencies are observed, necessary actions are taken by BRSA depending on the nature of incompliance. ### EC7 — Stress testing and concentration risk - Requirements: - RICAAP 43 requires banks to establish and operate a stress testing program to measure their material risks and vulnerabilities. - GST Principle 12 requires banks to stress test portfolios and business units to identify risk concentrations across their book. - GMCR Principle 3 emphasizes concentration risk stress testing, including identification and measurement of hidden concentrations. - Reference: - See BCP 8, EC 5 for further expansion on stress testing. ### Additional criteria AC1 - Requirements: - a) ten per cent or more of a bank’s capital is defined as a large exposure; and - b) twenty-five per cent of a bank’s capital is the limit for an individual large exposure to a private sector non-bank counterparty or a group of connected counterparties. - Minor deviations from these limits may be acceptable, especially if explicitly temporary or related to very small or specialized banks. ### Principle 20 — Transactions with related parties: summary and findings - Principle statement: In order to prevent abuses arising in transactions with related parties and to address the risk of conflict of interest, the supervisor requires banks to enter into any transactions with related parties on an arm’s length basis; to monitor these transactions; to take appropriate steps to control or mitigate the risks; and to write off exposures to related parties in accordance with standard policies and processes. ### EC1 — Definition of “related parties” - Legal basis and scope: - The definition of related parties is sufficiently comprehensive to capture relevant real and legal persons within the scope of the bank. - BL article 49: a bank and its qualified shareholders, members of its board of directors and its general manager as well as the undertakings they control individually or jointly, directly or indirectly or participate with unlimited responsibility or where they are members of board of directors or general manager constitute a risk group including the bank. - Jointly-controlled undertakings shall be included in the risk group of each shareholder that controls together these undertakings. - Risk groups include real and legal persons who have surety, guarantee or similar relationships where the insolvency of one will lead to the insolvency of the other. - By authority given in this article, BRSA may extend the risk group definition to include legal or real persons that may have material effects on the solvency of the risk group. - Specific prohibitions and thresholds: - Article 50 of the BL prohibits banks from granting cash or non-cash (OBS) loans, purchasing bonds or similar securities to: - a) members of the board of directors, general manager, deputy general managers and employees that are authorized to extend loans; their spouses and children under their custody; and the undertakings where they individually or jointly own twenty-five percent or more of the capital, - b) employees other than those mentioned in sub-paragraph (a) and their spouses and children under their guardianship, - c) funds, associations, unions or foundations established by or for their employees. - Article 50 further directs that the prohibitions above will not apply to the loans made available to the board members and employees and family members thereof of the bank that do not exceed 5 times their monthly total net remuneration and credit in the form of check book and credit cards may not be granted over 3 times monthly total net remuneration. The total of these loans is very small in size. - For banks majority owned, separately or jointly by Treasury Undersecretariat, Privatization Administration or administrations subject to the general budget or annexed budget (i.e., State owned), these are considered a risk group together with their affiliated companies. The non-bank state economic enterprises or other public institutions and enterprises that are majority owned by the Privatization Administration shall constitute a risk group together with companies in which they own or influence management and supervision. ### EC2 — Arm’s length terms for related-party transactions - Requirements and findings: - BL article 50 directs that loans to natural and legal persons in the bank’s risk group requires approval of two thirds majority of the board of directors’ members and that the loan conditions shall not differ from the loans made available to other persons and groups and from market conditions, in favor of the borrower. - GCM principle 3, paragraph 28 states approval processes and workflows for credits extended to the bank risk group should be separately determined. - While Article 48 provides a comprehensive definition of “loan”, it does not include other non-credit transactions within the limitations addressing related parties. - Recommendation: Legislation should be expanded to explicitly capture all transactions, including loans, within the parameters of related party limits and requirements. ### EC3 — Board approval, conflict of interest, and write-offs - Requirements and findings: - Article 50 stipulates decisions for loan extensions to natural and legal persons in the bank’s risk group are required to be made by two thirds majority of the board of directors’ members and that loan conditions should not differ from market conditions in favor of the borrower. - There is no explicit provision that requires prior approval of related party transactions by the bank’s board. - No explicit provision requires approval (prior or post) of write-off of related party transactions. The assessor team was informed that no such write offs have occurred in the recent past. - According to Article 51 of the BL, bank personnel authorized to extend loans cannot take [text ends in source]. *Source: cr1746 - conclusions on:* ### part in the evaluation and decision-making phases for the loan transactions involving ### cr1746 - part in the evaluation and decision-making phases for the loan transactions involving ### Related‑party exposures and governance (Principle 20: selected ECs) - EC4 — Supervisor determines banks have policies/processes preventing persons benefiting from a transaction and/or their related risk group from participating in granting/managing the transaction. - Article 7(2)(s) of RICAAP: bank audit committee must monitor whether personnel receiving bank credit participates in decision making, including related credit to the person’s risk group; appropriate communication channels to the audit committee are required. - GCM paragraph 78: board establishes structure/practices preventing shareholders, management or others from intervening in credit assessment. - GCM principle 26, paragraph 156: banks should assign qualified staff for monitoring credits, covering collateral/guarantee conditions and establishing monitoring structures that avoid conflicts of interest. - RCT: provisions for identification of natural persons and legal entities in the bank’s risk group. - Related party exposures are examined in loan review during CAMELS on‑site supervision. - EC5 — Limits, capital treatment and collateralization for related‑party exposures. - BL article 54(1): total amount of loans by a bank to a natural or legal person or a risk group shall not exceed 25% of the bank’s own funds; applied as 20% for the bank’s risk group. BRSB may increase to 25% or lower it to the legal limit (in practice, no increase to 25% has been granted). - Paragraph 54: total loans to all shareholders with more than 1% share and their risk groups limited to no more than 50% of own funds. - Articles 50 and 51 authorize BRSA to deduct excesses from own funds or require additional own funds equal to the amount of such loans. - RCT article 13: calculation of credit exposures for limits to risk groups shall be on a consolidated basis – including affiliates subject to consolidation. - EC6 — Identification, monitoring, reporting, independent review and escalation of exceptions. - BL assigns board responsibility for internal systems including risk management and internal audit; Article 51 prohibits bank personnel authorized to extend loans from participating in evaluation/decision phases for loans involving themselves, spouses, children or related risk group. - GCM principle 3, paragraph 28: require separate, independent approval processes and work flows for credits to the bank’s risk group. - Article 7(2)(s) of RICAAP: audit committee monitoring and communication channels for related‑credit issues. - CAMELS review/GAR methodology examines related party exposures as part of loan review; examiners evaluate thresholds and limits for all exposures. - FSAID 2914 reviews ratio of loans to related parties to regulatory capital and this assessment affects asset quality component of CAMELS. - Note: issues in onsite examination process for credit risk (CP 17, 18) may affect supervisory process for related party transactions. - EC7 — Supervisor obtains/reviews aggregate exposures to related parties. - Off‑site monitoring via monthly call reports: KR105AS (risk group names), HS200AS (shareholders), IS200AS (affiliates/subsidiaries). - Main surveillance call reports: KR202AS (loans to related party), MS200AS (transactions with related party in financial sector), BD101GS (derivative transactions with related party), KS100AS (related party risk limits — exposure to bank’s own risk group shall not exceed 20% of regulatory capital). - Banks disclose transactions with their own risk group in external audit reports quarterly (Article 22 of CPD). - Annual intragroup transactions report for consolidated supervision covering transactions among affiliates, controlling shareholders, other partnerships; supervision teams assess this in examinations. - Assessment of Principle 20: Largely Compliant. - Comments: - Legal/regulatory framework generally comprehensive; off‑site department regularly monitors reporting; examiners evaluate related party exposures onsite. - No explicit provision requiring prior board approval of related party transactions or explicit requirement on approval (prior or post) of write‑offs of related party transactions. - Legislation does not explicitly capture non‑credit transactions within related‑party limitations; recommendation to expand legislation to capture all transactions (including loans) within related party limits/requirements. - A draft revision of the BL being prepared may revoke article 50(a and b) to allow board member borrowing and address related party “transactions”; assessment team cautions BRSA against relaxing related party risk parameters and advises caution in widening scope for such exposures. *Italic: Source — IMF staff report excerpt (cr1746) contained in provided PDF content.* ### Section VI of GORM gives requirements for building strategy, policies and procedures ### Section VI of GORM gives requirements for building strategy, policies and procedures ### Overview and purpose - Section VI of GORM gives requirements for building strategy, policies and procedures regarding operational risk and provides "an example of determining operational risk strategy, policies and procedures and corporate strategy of a bank." - Article 35 requires that "operational risk management process begins with the determination of the overall strategies and long-term objectives of a bank." - Article 36 requires "all business units to develop supplementary policies and procedures specific to their business based on and in consistence with the corporate operational risk management framework." - GORM paragraph 4: banks should consider GORM principles "in accordance with their capital adequacy, risk profile and risk appetite." - Operational risk management should be "commensurate with the organizational structure, size, complexity, risk profile and business line." ### Legal and supervisory framework - RICAAP Article 53(2): "all banks are required to implement a measurement and assessment process to cover Pillar 1 risks including operational risk." - RICAAP Article 5(2): Board responsibilities include determination and approval of "policies, procedures, strategy for each risk type (including operational risk) and also identification of risk appetite." - RICAAP Article 8(2): senior management duty "to implement the strategies and policies approved by the Board." - RICAAP Article 13: business continuity management and plan requirements (see EC4). - RICAAP Article 21(3): internal audit review of information systems including electronic information system and electronic banking services. - RICAAP Article 57(1) and Article 63(5): internal audit to review adequacy of the system and processes and accuracy of ICAAP data and send findings to BRSA. - GORM paragraphs referenced: 7, 35, 36, 44, 45, 59–62, 70–71. ### Board oversight and governance (EC2) - Supervisor requires banks’ strategies, policies and processes for operational risk (including risk appetite) "to be approved and regularly reviewed by the banks’ Boards." - Board oversight responsibilities include ensuring "these policies and processes are implemented effectively." - GORM Principle 3: board to approve and review "a risk appetite and tolerance statement on the basis of general and sub factors (e.g., business line, product, unit) for operational risk" and "establish the system and processes for implementing these functions." - GORM paragraph 45 requires "regular reporting to the Board on overall status of operational risk in the bank, any particular risk areas or weaknesses, likely impact of major events on the bank’s operational risks, etc." - Supervisory practice: BRSA evaluates whether reporting and monitoring processes enable the Board to review limits, policies, procedures and processes concerning operational risk; GAR examiners evaluate whether "policies, procedures and work flow diagrams are up to date and approved by Board of Directors." ### Implementation, integration, and management by senior management (EC3) - The Board is required to "establish, approve and periodically review the operational risk framework (GORM Principle 2)." - Strategies, policies and procedures are part of the operational risk framework (GORM paragraph 7). - Operational risk management process steps: determine overall strategies and long-term objectives; identify associated inherent risks; "establish an operational risk management strategy and develop an operational risk management framework appropriate to all these strategies" (GORM 35). - GORM presents "an operational example of what such a process may be in paragraph 36." - Monitoring: "Monitoring process of the operational risk, should be integrated with the bank’s routine activities and in this context the operational risk potential of each business line should be assessed" and assessment should consider "the frequency and nature of changes in the operating environment" (GORM 44). - ICAAP requirements: banks must provide "detailed information regarding identification, measurement, control and risk appetite of operational risk within their ICAAP reports." These are assessed through CAMELS review/GAR and off-site BRSA audit teams. ### Operational risk profile and supervisory assessment - BRSA considers the level of operational risk in the system to be "moderate." - Major sources of operational losses: "fraud and human error." - BRSA considers "the sophistication of the operational risk management systems in a bank" relative to "the size, complexity, and nature of a bank’s activities and systems." - Banks are required to "track their loss history over time." Operational loss history/risk must be conveyed through banks’ ICAAP reports. - Banks use either "the BIA or STA approach to calculate capital charges." - Overall operational risk is assessed largely through "the CAMELS review/GAR process" where examiners review policies, processes and strategies across units and consider factors including "banks size, nature, complexity, capital strength, risk appetite and risk profile." - Operational risk is a specific focus element in the preparation of the risk matrix, using the "SMRAC procedures." ### Business continuity and disaster recovery (EC4) - RICAAP Article 13: banks "must establish a business continuity management structure approved by the board of directors" to ensure sustainability of activities or minimize operational, financial, legal and reputational costs. - GORM Principle 10: banks need a "business continuity plan to be able to continue their activities on an ongoing basis and limit losses in the event of severe business disruption." - GORM paragraph 71: negative condition scenarios should be assessed for "financial, operational and reputational impact" and inform "recovery priorities and objectives." - GORM paragraph 70: continuity plans should address plausible events such as damage or loss of accessibility to facilities, telecommunication or IT infrastructures, events affecting human resources, or broader disruptions to the financial system. - Continuity plans "should be tested periodically including preparation of an impact analysis" (GORM paragraph 71). - RICAAP Article 13: "All the disaster recovery and business continuity plans are tested at least once in a year." - Supervisory review: GAR examiners check whether a business continuity plan is "approved by Board of Directors," "tested by the bank," and "contains the policies, responsibilities and duties during business disruption cases." ### IT, technology risk and capacity (EC5) - BRSA uses the framework explained in "CP9/EC3" for identifying, assessing, monitoring and managing technology risks. - GORM paragraphs 59–62: special section on "IT capacity and security and change of IT systems, facilities and equipment." - BRSA requires banks to receive an "IT audit every 2 years by the bank’s external auditor." - BRSA resources: IT specialists review external audit IT reports, conduct examinations, and participate in CAMELS onsite examinations and MIS reviews as needed. - GAR questions are "relatively high level" and answers are derived primarily from external audit IT reports or referred to BRSA’s IT department. ### Information systems, operational risk data and reporting (EC6 and EC7) - EC6 expectations: supervisor determines banks have appropriate and effective information systems to: - a) "monitor operational risk;" - b) "compile and analyze operational risk data;" and - c) "facilitate appropriate reporting mechanisms at the banks’ Boards, senior management and business line levels that support proactive management of operational risk." - BRSA uses the framework in "CP9/EC3" for technology risk and references EC2 for board reporting requirements. - RICAAP Article 21(3) and Article 57(1) / Article 63(5): internal audit obligations to review information systems and ICAAP data and report findings to BRSA. - GORM paragraphs 59–62: IT capacity, security and change provisions. - EC7: supervisor requires banks have "appropriate reporting mechanisms to keep the supervisor apprised of developments affecting operational risk at banks in their jurisdictions." *Source: cr1746 - Section VI of GORM gives requirements for building strategy, policies and procedures* ### Section IV of RCA is about calculation of RWA for operational risk for regulatory capital. ### cr1746 - Section IV of RCA is about calculation of RWA for operational risk for regulatory capital. ### Operational risk reporting and RWA calculation - The calculations are submitted to BRSA via two annual supervisory reports: OR500YS/OR500YK. - The reporting mechanisms for operational risk are viewed through the CAMELS review process/GAR methodology by on-site BRSA examiners. - During relevant special examinations, examiners are required to evaluate systems and reporting (e.g., existence of a system for reporting operational risks on SME, corporate, commercial loans regarding incorrect operations, abuse, suspicious financial transactions). - Review of sample special examinations revealed issues and deficiencies in these areas that were cited and communicated in reports and to bank management. - Banks must report their operational loss history to the BRSA. ### ICAAP, Pillar 1 and Pillar 2 reporting - Banks are required to send their ICAAP reports to BRSA once in a year since 2013. - ICAAP reports must provide sufficient information about both Pillar 1 and Pillar 2 risks. - All banks must give information about identification, measurement, management, control, risk appetite and risk limits in ICAAP reports. - All ICAAP reports are evaluated by BRSA. ### Outsourcing risk management (EC8, RROS and BL requirements) - Outsourcing risk management program must cover: - conducting appropriate due diligence for selecting potential service providers; - structuring the outsourcing arrangement; - managing and monitoring the risks associated with the outsourcing arrangement; - ensuring an effective control environment; - establishing viable contingency planning. - Outsourcing policies and processes require comprehensive contracts and/or service level agreements with clear allocation of responsibilities between provider and bank. - BL Article 35: before outsourcing certain allowable activities, banks must prepare a written report (when required) containing probable risks of outsourcing, management of such risks, and expected benefits and costs. - RROS Article 5(1) obliges banks contracting outsourcing services to: - a) Identify needed outsourcing services in each relevant area; - b) Studies for necessary transformation, internal regulation, infrastructure and training at the stage of transition to outsourcing services; - c) Coordination of responsibilities concerning supervision, measurement and evaluation, reporting and security in connection with outsourcing services; - d) Risks that may have arisen from receiving outsourcing activities and a contingency plan to be implemented in case of interruptions or delays in services along with management of these risks and substitutability of received outsourcing services; - e) The impact of outsourced areas on internal control, internal audit, and risk management to be done by the bank for operations and process related thereof. - RROS Article 7: contracts between banks and outsourcing service providers must explicitly state subject matter, scope and term of outsourcing services, fees, and responsibilities of the parties. - BRSA examines compliance to these regulations via GAR annex questions and FSAID 2495 requires on-site teams to assess effective monitoring and controlling systems of operational risk arising from outsourcing activities. - GAR module indicates examiner sources: Due diligence activities; Outsourcing contracts; Activities to manage and monitor risk arising from outsourcing; Contingency plans; Policies and processes about outsourcing activities. ### Supervisor-level identification of common exposures (AC1) - The supervisor regularly identifies common points of exposure to operational risk or potential vulnerability (e.g., outsourcing of key operations by many banks to a common service provider or disruption to providers of payment and settlement activities). ### Assessment summary for operational risk oversight - Assessment of Principle 25: Compliant. - Comments: Oversight of operational risk is anchored in RICAAP and expanded in GORM; supervisory process explicitly addresses operational risk through ICAAP evaluation and GAR process, and as part of MIS evaluation and controls during specialized examinations. ### Internal control and internal audit (Principle 26) — framework and findings - Principle 26: supervisor determines banks have adequate internal control frameworks covering delegation of authority, separation of functions, reconciliation, safeguarding assets, and independent internal audit and compliance. - Essential legal and regulatory sources: BL (Articles 23, 29, 30), RICAAP, RCGB, RFS approach defined in RAA Article 5. - BL Article 30 requires banks to: - (i) ensure execution of activities in compliance with legislation, internal regulations and banking ethics; - (ii) secure integrity and reliability of accounting and reporting systems and timely information via continuous control activities; - (iii) ensure functional separation of duties and sharing of powers/responsibilities regarding payments, reconciliation, safeguarding assets and controlling liabilities; - (iv) identify and evaluate risks and prepare infrastructure to manage such risks; - (v) construct an adequate network for information exchange. - Internal control checks required to be carried out by internal control department reporting to board. - RICAAP expands obligations for independent internal audit and compliance functions; ICAAP examinations review quality of risk management, internal control and internal audit pursuant to section 4 of GAA. - CAMELS/GAR process addresses internal systems, controls and internal audit; special inspections check internal controls where relevant. - Assessment of Principle 26: Compliant. - Comments: Legal framework comprehensive; recommendation that targeted or specialized examinations of internal audit process could enhance validation of internal audit outputs as early warning indicators. ### Internal control essential criteria highlights (EC1–EC5) - EC1: Laws/regulations require internal control frameworks; BL Articles 23, 29, 30 and RICAAP set obligations for adequate and efficient internal control, risk management and internal audit systems. - EC2: Supervisor assesses balance, skills and authority of back office, control functions and operational management; GAR process reviews sufficiency, effectiveness and frequency of training and follow-up on internal control/audit findings. - EC3: Compliance function independence: RICAAP Article 5(1) assigns board responsibility; Article 4(2) requires internal systems linked directly to board; banks generally have separate compliance units directly connected to board. - EC4/EC5: Internal audit independence, resources, access and methodology: RICAAP Articles 5(2)(ç), 22(3)(c), 23, 26, 27 and Article 7(2)(o) establish detailed requirements on resources, independence, reporting lines, access, risk-based audit planning, and authority to assess outsourced functions. - On-site examiners evaluate internal audit via CAMELS/GAR; audit findings factor into the “M” rating. ### Financial reporting and external audit (Principle 27) — framework and findings - Principle 27: supervisor determines banks maintain adequate records, prepare financial statements in accordance with widely accepted accounting policies, and publish information with independent external auditor’s opinion. - EC1: BL Article 39 requires financial reports to be signed by chairman, audit committee members, general manager, deputy GM responsible for financial reporting and relevant unit manager, declaring compliance with financial reporting legislation. BL Article 37 requires accurate accounting and clear, reliable and comparable financial reports. - Two notable differences between TFRS implementation and IFRS in banks: 1) consolidated accounts capture financial subsidiaries but not nonfinancial subsidiaries; 2) loan loss provisions reflect BRSA’s requirements. Banks will be required to implement upcoming IFRS 9 in line with specified timeframe. - EC2: BL Article 39(2), REAB Article 4(2) and Article 4(4) require annual full-scope audits and quarterly limited audits (March, June, September) and annual audit as of end-December in alignment with TSAs (Turkish translation of ISAs). - EC3: BRSA published GFVM (guidance) for fair value measurement and requires model validation and independent review; GFVM paragraphs 23, 29 and 35 detail model validation, audit review, and reporting of significant valuation differences. - EC4: Scope of external audit set by REAB Article 4; BRSA can require special purpose external audits; TSA 320 (Turkish version of ISA 320) regulates use of materiality in audits. - EC5: External audit scope covers loan portfolio, loan loss provisions, non-performing assets, valuations, trading and securities activities, derivatives, securitizations, consolidation and internal controls over financial reporting as per REAB Article 4 and Article 17. - EC6: BRSA has power to reject/rescind appointment of external auditor under BL Articles 15 and 33; BRSA may publish names of acceptable audit firms and remove firms from list when inadequate. ### External audit additional criteria and supervisory interaction - EC7: Auditor rotation rules under RIA Article 26(1)(ç): external audit firms and auditors are not allowed to undertake audits for entities they audited for seven years within the last ten years for firms and five years within the last seven years for auditors, followed by a three-year cooling off period. - EC8: BRSA started meeting with external auditors in February 2015 (first meeting included 4 international firms and two domestic firms); on-site teams also meet frequently with external auditors. - EC9: BL Article 33(2) requires external auditors to promptly notify BRSA if they detect matters that may endanger existence of bank or evidence of severe violations; such notification does not violate confidentiality. - AC1: Supervisor has power to access external auditors’ working papers where necessary. - Assessment of Principle 27: Compliant. - Comments: Procedures for financial reporting and external audit are well established; BRSA conducts review of valuation procedures and models as part of onsite process. ### Disclosure and transparency (Principle 28) - Principle 28: supervisor determines banks regularly publish information that fairly reflects financial condition, performance, risk exposures, risk management strategies and governance. - EC1: BL Article 37, RAP Article 10, RAP Article 14 and CPD Articles 1 and 4(4) require solo and consolidated quarterly and annual public disclosures in line with TASs and TFRSs. - EC2: BL Article 40 requires annual report contents; RPPAP, RAP, CPD and CDRM specify disclosure parameters including composition of financial statements (CPD Article 4) and Pillar III-aligned risk management disclosures (CDRM, in force March 2016). - EC3: CCFS requires consolidated financial statements disclosure on web sites; CPD Article 4(2) requires disclosure of capital structure and parties with qualified shares; related-party disclosures consistent with TAS 24. - EC4: Disclosure standards enforcement: of 52 banks (as of December 2015), 16 publicly traded banks’ disclosure standards are reviewed by Public Disclosure Platform; BRSA evaluates timeliness and content of audit/annual reports and Pillar III disclosures. - EC5: BRSA publishes “Main Banking Indicators” quarterly via internet since June 2014 and provides interactive daily, weekly and monthly bulletins and tailor-made reports. - Assessment of Principle 28: Compliant. - Comments: Banks required to disclose under TFRS/TAS; nonfinancial disclosure requirements adequate; BRSA evaluates timeliness and content of disclosures. ### Abuse of financial services / AML-CFT framework (Principle 29) — laws, roles and supervisory practice - Principle 29: supervisor determines banks have adequate policies/processes including strict CDD rules to prevent misuse for criminal activities. - Legal framework: Law no. 5549 on Prevention of Laundering Proceeds of Crime (AML Law) with last revision in 2014; Law no. 6415 on Prevention of Financing of Terrorism (TF Law) adopted on 16.02.2013; money laundering offense in Article 282 of Turkish Criminal Law. - FIU: MASAK established; duties and powers in Article 19 of AML Law and Article 16 of TF Law. MASAK is main supervisory authority for AML/CFT; collects/analyzes data, receives STRs, coordinates inspections. - BRSA role: technical arm to MASAK for AML/CFT supervision; BRSA on-site teams examine adequacy/effectiveness of banks’ policies, procedures, workflows, HR and internal controls; GAR module has specific AML/CFT questions. - Recent BRSA actions: Commission of 4 senior bank examiners to coordinate AML/CFT examinations; Supervisory Manual on AML/CFT Issues (SMAMLCFT) prepared; on-site examiners required to make AML/CFT-related risk assessment following manual sections: Organizational Structure, Compliance, Training, Internal/External Audit, Reporting, Process Audits, Retention of Documents, Secrecy. ### AML/CFT examination activity (summary table from source) - 2014: 23 banks — General Compliance with laws and regulations regarding AML/CFT - 2015: 11 banks — General Compliance with laws and regulations regarding AML/CFT - 2014: 18 banks — Examinations related to violations of Suspicious Transactions Reporting, CDD, Training-Internal Systems-Other Measures - 2015: 16 banks — Examinations related to violations of Suspicious Transactions Reporting, CDD, Training-Internal Systems-Other Measures - Findings of examinations are followed up by MASAK and shared with BRSA management as requested. ### AML/CFT essential criteria highlights (EC1–EC13) and findings - EC1: Duties and powers for supervision of banks’ internal controls and criminal-activity obligations established in AML Law and TF Law; MASAK coordinates inspections and BRSA participates as technical arm. - EC2: CDD/AML obligations set out in AML Law, TF Law, ROM, ROC and ROT; MASAK’s “Guidance on the Supervision of Obligation” (2010) provides check-lists. - BRSA inspects: staff sufficiency and qualifications for AML/CFT; adequacy of IT framework; authorization and responsibilities of compliance officer; adequacy of board-approved AML/CFT policy; written criteria for detection of suspicious transactions; internal audit special audits on AML/CFT; follow-up on internal audit findings; adequacy of internal assessment reports; group-level policy documents and home country supervision of parent company. - EC3: Banks are required to report suspicious activities only to MASAK per Article 4 of AML Law (banks do not report STRs to BRSA). - EC4: BRSA informs MASAK when it becomes aware of suspicious transactions (ROM Article 40); MASAK transmits to judicial/other authorities. - EC5: CDD program essential elements per ROM/ROC: - a) customer acceptance policy: not explicitly mentioned in regulation; - b) customer identification, verification and due diligence including beneficial ownership: covered by ROM (mainly chapter 3); - c) monitoring and recognizing unusual/suspicious transactions: covered by ROM chapter 4; - d) enhanced due diligence on high-risk accounts with escalation to senior management: covered in ROC Articles 12 and 13; - e) enhanced due diligence on politically exposed persons (PEPs): not defined in regulation; BRSA/MASAK note PEPs are indirectly subject to other obligations (ROM Articles 18, 20, 25); - f) record retention rules: AML Law Article 8 requires documents, books and records retention for eight years from last record date and identification documents kept for eight years from last transaction date. - EC6: Correspondent banking measures: ROM Article 23 requires enhanced due diligence, assessing respondent institution’s AML/CFT system, obtaining reliable public information, senior manager approval before new correspondent relationships, and prohibition on relationships with shell banks. - EC7: ROM and ROC require appropriate risk management systems to monitor customer transactions and identify/report suspicious transactions; BRSA assesses internal systems and controls as part of ratings. - EC8: MASAK is the authority empowered to sanction financial institutions for AML/CFT non-compliance; administrative fines and judicial penalties specified in AML Law Articles 13 and 14; ROM Article 39(2) extends fines for CDD and STR failures; TF Law Articles 14 and 15 set freezing compliance and penal sanctions; MASAK may refer violations to public prosecutor. - BRSA can implement administrative penalties under BL for non-AML-specific failures (e.g., failure to submit data, records keeping, false statements, non-factual accounting, embezzlement) and can refer criminal activity to public prosecutor. - EC9: Requirements for internal audit and external experts to evaluate AML/CFT policies (RICAAP); ROC requires compliance officers and monitoring processes; MASAK regulations include screening of senior management; ROC Chapter 6 requires ongoing staff training on AML/CFT. - EC10: ROM and ROC require reporting of STRs via compliance officers and institutional policies/procedures for STRs and internal controls; obligors send institutional policies to MASAK for adequacy evaluation; ROC Articles 24 and 28 require reporting detailed information on staff training and internal control activities. - EC11: AML Law Article 10 provides protection from civil and criminal liability for persons reporting suspicious activity in good faith. - EC12: MASAK authorized to exchange information domestically and with foreign counterparts and sign MoU (AML Law Article 12); MASAK member of Egmont Group since 1998; BRSA authorized under BL Article 98 to cooperate and exchange information with supervisory counterparts; MASAK and BRSA have a protocol on information exchange and working arrangements. - EC13: MASAK is primary authority with specialist resources; MASAK conducted workshops and training: 6 workshops in 2014 with 64 participants from supervisory bodies; 5 workshops with 490 participants from obligors; BRSA maintains AML/CFT expert team for inspections, manuals and dissemination. ### AML/CFT assessment and supervisory comments - Assessment of Principle 29: Largely Compliant. - Comments: - Assessment limited to BRSA activities and applicable regulation; did not include MASAK-coordinated inspections and other activities. - Framework includes CDD rules and STR procedures but has shortcomings: - CDD requirements should include a customer acceptance policy identifying business relationships that banks will not accept based on identified risks. - Framework should require enhanced due diligence on politically exposed persons (PEPs). - Framework should require banks to report to the BRSA suspicious activities and incidents of fraud when such activities/incidents are material to the safety and soundness or reputation of the bank. *International Monetary Fund — cr1746, Section IV (excerpt provided).* ### 1. Responsibilities, objectives ### 1. Responsibilities, objectives ### Responsibilities, objectives and powers - The BL provides a broadly appropriate framework for regulating and supervising banks. - The BL provides clear responsibilities and adequate powers to the BRSA. - There is a lack of appropriately defined hierarchy among the objectives of financial stability and development of the financial sector which may cause potential conflicts and be harmful to the safety and soundness of banks. - Some BRSA decisions (e.g., differentiations in loan loss provisions and loan restructuring rules) might be interpreted as rules that aim primarily to support financial development objectives; such measures might affect the reputation of the supervisors and convey the message of forbearance. - Recommendation: "the objective of development of the financial sector should be explicitly subordinated to financial stability in the BL" to be fully compliant with this principle. ### Independence, accountability, resourcing and legal protection for supervisors - The legal protection of the supervisor is broadly adequate. - The BL establishes the BRSA as an independent body but contains provisions that might undermine independence in practice. - Identified channels that may accommodate political influence: - i) the appointments of the Chair and Board members are made by the Council of Ministers without any confirmation process by any other independent body; - ii) before putting into force regulatory procedures the BRSA needs, by law, to consult the related Ministry; - iii) the Prime Minister approves the removal of members of the Board, if conditions specified in the BL are met, without publishing the reasons; - iv) the relevant minister may permit lawsuit against board members; and - v) the BL allows the relevant ministry to file a lawsuit for the cancelation of the Boards regulatory decisions (art. 105). - These channels of political influence, particularly considering the large role played by state-owned banks in Turkey, might cause conflicts of interest that might undermine financial stability. - Recommendations: - Amend the legislation to limit the cases that require the Minister’s involvement. - Establish a third party to perform a stronger role in the checks and balances framework, such as: - making regulatory consultation procedures more transparent, so that BRSA proposals and Ministry comments are published; - introducing a process for appointments for the BRSA to be confirmed by a non-executive government body; - removing the related minister permission for lawsuits for the cancelation of the BRSB regulatory decisions. - Accountability framework issues: - Despite periodic briefings from the BRSA to the Council of Ministers, assessors did not see evidence of a third party ensuring that powers delegated to the BRSA are exercised appropriately and that operations are effective and in line with its mandate and objectives. - Resourcing: - Entry conditions to the BRSA are not attractive for the hiring of mid-career professionals and provide practical constraints in the event of a shortfall in experience levels. ### Cooperation and collaboration - Legal provisions as well as operational frameworks for cooperation and collaboration with domestic and foreign authorities are in place. - Protections on confidentiality appear appropriate. - Regarding the lack of processes for recovery and resolution planning, the assessors do not see their absence as reflecting a lack of collaboration between authorities. - See also CP9. ### Permissible activities - The BL provides clear definitions of activities that are only permitted to be conducted by registered banks, including taking deposits from the public. ### Licensing criteria - Provisions in the laws and regulations related to licensing and the process followed by the BRSA provide a comprehensive framework to assess the adequacy of new registrations for banks, including foreign bank branches. - The BRSA seems to have a broadly sound process to assess applications in practice. - To maintain full compliance the BRSA needs to additionally: - i) impose requirements and assess if the bank’s board has a collectively sound knowledge of the material activities the bank intends to pursue; and - ii) for cross-border banking operations, determine whether the home supervisor practices global consolidated supervision. ### Transfer of significant ownership - The power given to the supervisor by laws and regulations as well as the current procedures provide broadly sound control and oversight regarding significant ownership of a bank and a controlling company. ### Major acquisitions - The regulatory framework subjects major acquisitions and investments by banks and controlling companies to prior approval by the BRSA. - The BRSA has well established supervisory practices to limit and monitor risks arising from such activities. - Recommendation: Supervisors should consider more extensively and formally the effectiveness of supervision in host countries. ### Supervisory approach - The BRSA has an established and comprehensive methodology to supervise banks, documented in a number of manuals and leveraging comprehensive databases and a broadly appropriate regulatory framework. - Practical implementation shortcomings to be addressed: - Inspections need to develop a more profound and forward-looking risk assessment nature, producing a clear view of the risks faced by and posed by the bank; current conclusions tend to focus mostly on compliance issues and do not identify and make clear if there is need for broader and more forceful supervisory action. - Supervisors need to derive and highlight the implications of specific findings for the broader risk assessment of the bank. - The BRSA should not take excessive comfort from the fact that issues are analyzed during the ratings process; as currently applied the ratings process is not deep enough to generate firm and actionable conclusions. - From time to time, the scope of special inspections needs to encompass issues that are currently addressed only during the ratings phase. - The BRSA needs to enhance the forward-looking components of its assessments: Results of the ICAAP need to be more thoroughly analyzed and discussed with banks; stress tests results should play a larger role in the assessment framework; the ratings methodology could explicitly incorporate the expected trend for each component. - Banks, particularly the systemically important ones, should be required to develop recovery plans and the BRSA should assess their resolvability. - The BRSA is already developing actions to address some of the above issues and assessors encourage continued work to improve process efficiency. ### Supervisory techniques and tools - The BRSA employs an array of tools and techniques to carry out its supervisory responsibilities. On-site and off-site functions are relevant and well developed. - Different departments share findings but work seems to be conducted in parallel with little coordination; departments do not seem to have joint projects and supervisors do not exchange views beyond written reports. - As required by EC1, the BRSA should develop policies and processes to assess the effectiveness and integration of on-site and off-site functions, and to address any weaknesses identified. - Increasing rotation between on- and off-site supervisors could help integration. - Communication with banks could be improved: - The BRSA should consider setting policies establishing at least one annual meeting between supervisors and the board of the bank. - The end of the CAMELS rating process might be an appropriate occasion to explain to the board the views and concerns of the BRSA. - Important analyses such as stress testing exercises could be more clearly discussed with banks. ### Supervisory reporting - The regulatory framework requires banks and controlling companies to periodically submit a broad range of information. - Regulatory and supervisory processes exist to ensure accuracy and comparability of submitted returns. - Developed procedures for analyzing collected information and feeding into supervisory activities are in place. - Recommendation: The BRSA could consider formalizing the process of periodic review of the information collected, to determine that it remains appropriate and satisfies its needs. ### Corrective and sanctioning powers of supervisors - The BRSA has available an appropriate range of supervisory tools to use when a bank is not complying with regulations or represents a risk for the financial sector. - In practice, remedial and corrective actions provided for in the law are rarely used at an early stage as a preventative measure. - The BRSA seems to rely more heavily on administrative fines whose scope of application is more clearly defined in the BL than on taking early actions requiring supervisory judgment. - Evidence of BRSA actions requiring banks to make adjustments existed but had limited scope (e.g., classification of particular loan operations); evidence was not observed of supervisors addressing broader concerns from a deepening and expansion of the initial review. - The supervisory review process within the BRSA seems to play a role towards limiting the issues that supervisors raise with banks; the current process seems relatively skewed towards validation of compliance processes and thus constrains active supervisory judgments and decisions. - Consideration could be given to integration of supervision and enforcement, particularly in terms of communication with financial institutions, to support a more risk focused and less compliance based supervisory approach. - To become fully compliant the BRSA needs to incorporate the results of forward looking tools more heavily in its decision making process and act at an early stage to restore weak banks and correct examples of unsound practices, even if formal prudential ratios haven’t been breached. ### Consolidated supervision - The regulatory and reporting framework provides a broadly appropriate structure for monitoring and assessing risks to banks from non-banking and foreign banking operations in banking groups. - Current limitations of the CAMELS rating and ICAAP processes mean the BRSA should make further effort to monitor and manage risks arising from nonbanking and foreign activities or parent entities of a financial group. - The BRSA should deepen analyses and strengthen techniques, such as group-wide stress testing, to monitor and assess these risks. - Important to further improve the group-wide strategic view of the banking group operations and risks. - Authorities should further improve the recovery and resolution planning of large banking groups particularly once the necessary power is given to the supervisor by the expected new legislation. Such planning should also consider scenarios where shocks originate from non-banking entities or parent groups. - Despite shortcomings reflected in other principles (CP 8 and 9), the assessors considered this principle compliant. ### Home-host relationships - The BRSA has made vast efforts to improve home-host relationships during the last few years, including organizing colleges, signing a number of important MoUs and removing obstacles that weakened supervision of Turkish banks’ operations in several countries. - Considering some Turkish banks hold material operations abroad, it is important to improve the relationship even further. - Essential to develop a framework for cross-border crisis coordination with relevant host authorities and the development of resolution plans that pay special attention to cross border issues. ### Corporate governance - The legal framework for corporate governance is extensive but very heavily focused on board responsibilities regarding internal systems (risk management, internal control, internal audit). - Examination processes (GAR and specialized examinations) check board approvals, internal structures, and processes which reflect on the governance function. - The BRSA approves board and senior management appointments and reviews the appointments process of the bank. - Supervisory processes consistently stop short of drawing conclusions, in analytical, narrative form, on the implications findings have for critical areas directly linked to the examined area (e.g., management oversight of business areas, adequacy of risk management and internal audit’s role, integrity of MIS up to the board level, and board oversight). - As a result, supervisory observations are not easily collected to form a cross-cutting, substantiated view on corporate governance and adequacy of internal systems, which impacts the degree of confidence the BRSA should place in systems that inform the board and itself. - Board composition concerns: - There is no requirement for the majority of the board to be composed of non-executive members; the legal framework could permit boards with a majority of executive directors with only the 2 nonexecutives as currently required. - Practically, 10 out of 53 banks are listed and must fall under the CMB Communique on governance which requires a majority of independent directors. - Recommendation: Consider upgrading legislation requiring the board to be composed of a majority of nonexecutive members, and ideally, with a certain minimum of independent individuals. (The definition of “independent” should be consistent with that used by the CMB in its Communiqué on Corporate Governance.) - Audit committee recommendations: - Audit committee membership should be expanded; a minimum of 2 members is considered too few to execute duties robustly. - In some banks the chair of the audit committee is also the chairman of the board, which does not reflect best practice and potentially represents a conflict of interest. - The committee should be expanded and composed of all independent directors. - Risk management oversight responsibility should be separated from the audit committee, particularly in more complex institutions. - Need for more regular cross-cutting assessments of corporate governance in a holistic manner leveraging examination results, offsite information, and information from enforcement actions. - Recommendation: The BRSA should develop a more comprehensive corporate governance regulation that completes elements already in guidelines and regulation; this instrument could be a focal point of supervisory corporate governance reviews. ### Risk management process - The RICAAP forms part of the core of the BRSA’s regulatory framework for risk management. - Given that the ICAAP is a relatively recent requirement, banks are still developing their approach and implementing important systems; banks and supervisors are in a learning phase. - The quality of banks’ reports and the scrutiny by supervisors will need to develop further before the results can be more reliably and extensively used. - Recommendation: Commensurate with size and complexity, banks should be specifically required to have qualified CROs with sufficient stature, position and authority within the organization to oversee risk management activities; the level of senior manager may not provide the necessary stature to challenge high level risk decisions and processes. - Product evaluation: - While there are comprehensive requirements for evaluation of new products, parameters should be expanded to explicitly address material modifications to existing products and major acquisitions. - Banks should be directed to restrict such products or activities if they do not have the necessary controls, management, and resources to manage related risks. *Source: cr1746 - 1. Responsibilities, objectives* ### 16. Capital adequacy C The BRSA has adopted the various components of Basel II, ### 16. Capital adequacy C The BRSA has adopted the various components of Basel II, ### Capital adequacy — framework and supervisory practice - The BRSA has adopted the various components of Basel II, 2.5 and III according to the framework established by the Basel Committee. - Capital is calculated on a consolidated and solo basis for all banks. - The BRSA has the authority to impose additional capital requirements on individual banks, as deemed necessary. - The BRSA has applied the three Basel ratios (common equity tier 1, tier 1 and total capital) as well as: - countercyclical capital requirements, - systemically important bank capital add-ons, - a “capital planning buffer” that provides a forward looking nature to the capital regulation. - Recommendation: As the BRSA gain experience with the ICAAP, it should consider simplifications to the framework to improve its enforceability and reduce banks’ compliance burden, particularly for non-systemically important banks. - Possible simplifications to consider include restrictions on diversification benefits and use of models for credit, market and operational risk that have not been authorized for the Pillar 1 capital charge. - The BRSA should evaluate interaction with other requirements such as the 12% parallel capital charge and the Basel capital buffers to prevent the effectiveness of the Pillar 2 regime from being damaged by another more stringent requirement that in practice makes the Pillar 2 charges irrelevant. ### 17. Credit risk — grade: MNC - Legal framework is generally comprehensive: establishes board responsibility, requires a framework for banks’ credit business, and prescribes a properly controlled credit risk environment. - Identified weaknesses compromise effectiveness and application: - The framework does not require ongoing, independent (from the business line) credit risk monitoring of large individual exposures or homogeneous portfolios. - Important source data (e.g., identification of deteriorating credits, level of (accurately) classified assets, status of restructured credits) is generated by a line management function (credit monitoring) without independent verification that: 1. management identification processes are accurate and timely, 2. management is well informed of the risk and is upholding board-prescribed underwriting standards, 3. timely borrower intervention is activated. - Information from the line function is used by risk management for audit committee and board reporting and likely reported to the BRSA for monitoring and examination. - Internal audit is not designed to play an ongoing surveillance role equivalent to an independent credit risk management unit and cannot replace that function. - Onsite exam findings: - Examiners have identified important, clearly inaccurate classifications of credit; documentation lacks clarity on sample size, aggregate significance, and extrapolation to the entire portfolio. - Credit classification definitions, particularly in the special mention and substandard categories, are overlapping; bankers and examiners fluidly move credits among these categories. - Such movement compromises the depiction of the bank’s risk profile and impacts provisioning levels and financial statement accuracy. - REPL-related issue: - The REPL explicitly allows restructuring of loss credit. The draft REPL is silent on prohibiting restructuring of permanently impaired/nonbankable assets. Recommendation: this practice should be explicitly addressed (disallowed). - Exam write-ups do not clearly depict the nature and volume of other related exposures that would provide context to overall borrower relationships. ### 18. Problem assets, provisions, and reserves — grade: MNC - Framework for credit classification and provisioning is generally adequate. - Concerns about accuracy of asset classification by banks and integrity of reporting to boards and the BRSA due to reclassifications by onsite examiners and lack of documentation. - Loan write-ups require more support and context, including presentation of collateral nature and provision impact. - Examination conclusions focus on internal control issues rather than implications for the condition and management of the credit portfolio. - Missed opportunities in examinations to identify linkages with: - management’s understanding of their business and credit risk and ability to identify deterioration proactively, - implications for internal systems (function, role, independence of credit risk management) that validate systems used by boards and BRSA, - inputs to evaluate corporate governance, - accuracy of information conveyed to the board and the BRSA. - Historical/statistical support for standard (general) and special mention loan categories is not substantiated by accumulated loss experience. - It is not clear if appraised values are realized upon sale of properties or if provisioned amounts adequately cover loss experience on classified loans. - Recommendation: establish clear parameters for periodic valuation of underlying collateral on NPL exposures. ### 19. Concentration risk and large exposure limits — grade: C - Legal framework is generally in line with international standards. - Definition of connected parties is comprehensive. - BRSA examines and monitors exposures including large exposures, concentrations by sector, product, customer, and risk group. ### 20. Transactions with related parties — grade: LC - Legal and regulatory framework for related parties is comprehensive. - Offsite department receives and regularly monitors reporting from banks; onsite review for related parties is well structured. - Gaps identified: - No explicit provision requires prior approval of related party transactions by the bank’s board. - No explicit provision requires approval (prior or post) of write-off of related party transactions. - Legislation does not include other non-crediting transactions within limitations addressing related parties; legislation should be expanded to explicitly capture all transactions, including loans, within related party limits and requirements. - A draft revision of the BL is being prepared that may revoke article 50 (a and b) to allow board member borrowing and will address related party “transactions” as well. - Recommendation/caution: the assessment team cautions BRSA on relaxing related party risk parameters and advises caution in widening scope for such exposures given historical problems in distressed bank situations. ### 21. Country and transfer risks — grade: C - BRSA guidance adequately captures country and transfer risk. - Banks are expected to establish country risk parameters and systems for monitoring exposures, including indirect foreign-exchange risk and indirect country risk. - Country risk is evaluated through the CAMELS review process and via the risk matrix of the bank. ### 22. Market risk — grade: C - BRSA has adopted comprehensive regulation and guidance to direct banks to identify, measure, and monitor market risk exposures, including valuation, stress testing, and model use. - These elements are addressed through the CAMELS rating/GAR methodology and during the ICAAP review. - Current limitation: specialist expertise is not deployed to evaluate scenarios or calculation details of stress testing exercises. - Examiners review models used to measure market risk but depend substantially on banks’ model validation processes. - Recommendation: deploy trained specialists to assess stress test approaches and mathematical integrity; enhance examiner expertise in model evaluation. ### 23. Interest rate risk in the banking book — grade: C - Supervision addressed through ICAAP review, stress testing inputs, and captured via the GAR process onsite though not to the depth of a special examination. - Specialized examinations for interest rate risk are not yet conducted. - Recommendations: - Develop specialized examination procedures for interest rate risk where increasing or high risk areas are identified. - Use specialized expertise to evaluate scenarios and assumptions in complex stress testing and to review model validations during onsite examinations or as an offsite exercise. ### 24. Liquidity risk — grade: C - Comprehensive framework for liquidity regulation, monitoring, and assignment of bank responsibilities; in some cases more rigorous than international benchmarks. - Wide range of tools for monitoring liquidity and funding experience. - CAMELS review/GAR methodology addresses liquidity; specialized examinations conducted when trend or strategy changes detected. - BRSA received a “compliant” rating in a Regulatory Consistency Assessment of its Basel III LCR regulations. - Onsite review shortcomings: - Conclusions regarding liquidity, funding stability, and management processes often stopped short of considering other balance sheet areas, growth trends, asset quality, and management processes. - Examination documents should capture and clearly convey these issues to support supervisory observations, especially given some banks may have tight liquidity positions including relatively high loan to deposit ratios. - Central bank actions: the CBRT has taken steps to support strengthening of foreign currency funding. - Recommendation: strengthen liaison between the BRSA and the CBRT on monitoring and management of foreign liquidity risk. - Recommendation: consider increasing the ultimate target for the FX LCR from 80% to 100% to further strengthen management of liquidity risk. ### 25. Operational risk — grade: C - Oversight anchored in RICAAP and expanded in the GORM which comprehensively addresses relevant aspects. - Supervisory process addresses operational risk through evaluation of ICAAP reports, GAR process, and MIS evaluation and controls during specialized examinations. ### 26. Internal control and audit — grade: C - Legal framework is comprehensive for internal systems and internal audit requirements. - Review of internal audit is part of the onsite (GAR) process each supervisory cycle. - Recommendation: conduct targeted or specialized examinations of the internal audit process, leveraging GAR results and specialized examination inputs to enhance validation of the function. - BRSA validation is important to maintain or increase confidence in audit outputs as early warning indicators. ### 27. Financial reporting and external audit — grade: C - Procedures for financial reporting and external audit are well established. - Accounting standards closely follow IFRS; provisioning standards set to dovetail with implementation of IFRS 9. - Valuation procedures for financial assets are comprehensive. - BRSA reviews valuation procedures and valuation models during onsite examinations. - Parameters for banks’ external audit processes are well established. ### 28. Disclosure and transparency — grade: C - Banks required to disclose financial statements according to TFRS and TAS (Turkish versions of IFRS and IAS) on both solo and consolidated bases. - Disclosure requirements for nonfinancial information are adequate. - BRSA regularly evaluates timeliness and content of external audit/annual reports for compliance with regulatory parameters and Pillar III disclosures. ### 29. Abuse of financial services — grade: LC - Assessment scope limited to applicable regulation and BRSA activities; did not include MASAK coordinated inspections and other activities. - AML law and related regulations form framework to prevent abuse of financial services, including CDD rules and procedures to report suspicious transactions, but shortcomings exist. - Recommendations: - CDD requirements should include a customer acceptance policy that identifies business relationships the bank will not accept based on identified risks. - Require enhanced due diligence on politically exposed persons. - Require banks to report to the BRSA suspicious activities and incidents of fraud when such activities/incidents are material to the safety and soundness or reputation of the bank. ### Recommended actions (selected highlights) - Principle 1: Subordinate the objective of development of the financial sector to the objective of financial stability in the BL. - Principle 2: Review legislation to limit Minister’s involvement with BRSA activities; improve accountability framework; create alternative arrangements to hire experienced experts when needed. - Principle 5: Impose requirements and assess whether bank boards have collective sound knowledge of material activities; determine whether home supervisor practices global consolidated supervision for cross-border operations. - Principle 8: Develop more profound risk assessment nature for inspections; produce clear view on risks faced and posed by the bank; incorporate special inspections and forward-looking tools (ICAAP results, stress tests) more thoroughly; require banks to develop recovery plans; assess resolvability. - Principle 9: Develop policies/processes to assess integration of on-site and off-site functions; consider integrating supervisory and enforcement functions; improve communication with banks, including at least one annual meeting between supervisors and the bank board. - Principle 11: Incorporate forward looking tools more heavily in BRSA decision making and act early to restore weak banks and correct unsound practices even if formal prudential ratios have not been breached. - Principle 12: Monitor and manage risks from nonbanking and foreign activities; deepen group-wide stress testing; improve recovery and resolution planning for large banking groups. - Principle 13: Develop framework for cross-border crisis coordination and resolution plans addressing cross-border issues. - Principle 14: Develop more comprehensive corporate governance regulation or primary law changes; expand independent director requirements and provide a comprehensive definition of independent; expand minimum number of independent directors on audit committee; separate risk management responsibilities from audit committee and require risk management committees where warranted; enhance examination conclusions in special reviews. *Source: cr1746 - 16. Capital adequacy C The BRSA has adopted the various components of Basel II,* ### conclusions to comment upon the integrity and independent of ### conclusions to comment upon the integrity and independent of ### Executive summary of supervisory findings and integrity concerns - Examinations and supervisory processes need stronger substantiation of conclusions on corporate governance, internal systems, management oversight and capacity, MIS and board reporting. - Recommendation to "Develop a cross-cutting, more holistic assessment methodology for corporate governance" to leverage GAR and special examination results, offsite information, and enforcement action information. - Need to "Upgrade written conclusions and write ups of credits classified during the examination process" to clearly substantiate context and cross-area implications (management oversight, risk management accuracy, corporate governance, financial statement accuracy). - Examiners should "Present additional relevant information in examiner loan write ups to further substantiate the overall credit relationship, the creditworthiness of the borrower and its impact on the overall credit exposure, and further support for the credit re-classification." - Develop historical and statistical support for required provisioning levels and "Develop clear parameters for periodic valuation of underlying collateral on NPL exposures." ### Principle-specific recommendations (selected) - Principle 15 - "Require banks, commensurate with their size and activities, to have qualified CROs with sufficient stature, position and authority within the organization." - Concern: "the current level of senior manager as head of risk management (as enumerated in law) may not provide the stature necessary to challenge high level risk decisions and processes." - Principle 17 - "Evaluate and revise the relevant legislative and practical aspects of banks’ credit risk monitoring and risk management organizational arrangements." - Address "the independence and integrity of the internal credit risk rating process and the need for independent verification of line management ratings and actions and the functions’ ability to generate early warning information." - "Evaluate the implications of the current structure on the integrity and accuracy of monitoring and reporting to bank boards and the BRSA." - "Evaluate and revise the definition of credit classifications, particularly the special mention and substandard categories, making them more concise and clear cut." - "Enumerate the BRSA’s position on rebooking of charged off credit in the REPL." - Principle 18 - "Upgrade written conclusions and write ups of credits classified during the examination process" and "Substantiate findings in credit areas where no re-classifications were determined necessary by the examiner(s)." - Principle 20 - "Enumerate explicit legal provisions that require *prior* approval of related party transactions by the bank’s board as well as board approval of related party exposures that are written off the bank’s books." - "Expand the requirements surrounding related parties to capture all transactions with related parties, not just loans." - "Exercise caution on relaxing related party risk parameters and possible revocation of parameters surrounding board member borrowings." - Principle 22 - "Deploy trained specialists to assess banks’ stress test approaches and the mathematical integrity therein and to leverage resulting advice/input on specialized exams." - "Enhance examiner expertise in the area of model evaluation to provide added assurance to the BRSA on the integrity of models used by banks." - Principle 23 - "Develop specialized examination procedures for interest rate risk in the banking book." - "Deploy specialized expertise with which to evaluate scenarios and assumptions used for more complex stress testing as well as to review model validations during onsite examinations or, as an offsite exercise." - Principle 24 - "Expand written analysis during liquidity/funding risk examinations to capture the impact of and relation to of other areas of the balance sheet, growth trends, asset quality, and management processes, etc. to support higher level conclusions." - "Strengthen liaison between the BRSA and the CBRT on the monitoring and management of foreign liquidity risk." - "Consider increasing the ultimate target for the FX LCR from 80% to 100% to further strengthen the management of liquidity risk." - Principle 29 - "Include in the CDD framework a customer acceptance policy that identifies business relationships that the bank will not accept based on identified risks and enhanced due diligence on politically exposed persons." - "Require banks to report to the BRSA suspicious activities and incidents of fraud when such activities/incidents are material to the safety and soundness or reputation of the bank." ### Authorities’ response (paragraphs 25–58) — commitments and observations - Paragraph 25: BRSA thanks IMF, World Bank, and FSAP mission; "BRSA intends to fully utilize the assessment outcome" and "has already started on some of the mission team’s recommendations and plans to work on the remaining recommendations under an appropriate timetable." - Paragraph 26: Notes that "since the assessments conducted in 2006 and 2011, the bar of the standards has been raised by BCBS (the BCP methodology was revised in 2012). This assessment, consequently, is not appropriate for comparison with either previous assessments or other countries’ assessments." - Paragraph 27: "BRSA has prepared a list of action points towards increasing compliance with the Basel Core principles for effective banking supervision." - Principles 1–2 (Responsibilities, Objectives and Powers; Independence and Accountability) - Paragraph 28: BRSA will "review the current objectives and consider subordinating the objective of development of the financial sector to the objective of financial stability in BL." - Paragraph 29: "There is an ongoing process of drafting an amendment to BL that proposes the revocation of article 105 which enables related ministry to file a lawsuit to revoke BRSB’s regulatory decisions." - Paragraph 30: "BRSA will review its alternatives regarding the transparent scrutiny of its activities in relation to its objectives and responsibilities without hindering its independence and autonomy." - Principles 8–9 (Supervisory Approach, Techniques and Tools) - Paragraph 31: BRSA agrees supervision products "need to have explicit and clear narratives about supervisory view on the risks faced by banks" and "has already developed actions and started to revise its supervisory manuals and processes as part of an established ongoing improvement framework." - Paragraph 32: "BRSA will enhance forward-looking components of its supervisory framework by incorporating an expected trend element for each CAMELS component and risk type within its ratings and risk assessment methodology." BRSA plans "to fully incorporate the results of ICAAP and stress tests to its supervisory framework." - Paragraph 33: In 2013, BRSA and SDIF established a working group for self-assessment of resolution procedures relative to the FSB Key Attributes; "a draft legislation has been prepared" and "joint task group" is reviewing technical details including recovery planning and resolvability assessment. - Paragraph 34: On-site and off-site functions are organized under different departments with formal and informal communication; enforcement departments are separate and all supervisory findings are communicated formally by enforcement departments. - Paragraph 35: "BRSA will review its alternatives in order to further improve coordination and integration among its on-site, off-site examination and enforcement functions." - Paragraph 36: On-site examiners "are in constant dialogue with banks management" and BRSA "will consider establishing periodic meetings between supervisors and the board of the bank." - Corporate Governance (Principle 14) - Paragraph 37: Turkish banking legislation is "one-tier structure" with minimum 2 non-executive board members; in practice "the majority of domestic systemically important banks do have more than 2 independent members." This aligns with paragraph 47 of the Basel Committee "Guideline on Corporate Governance Principles of Banks" (July 2015). - Paragraph 38: RICAAP Article 6 defines non-executive members similar to CMB Communiqués. - Paragraph 39: CMB’s Communiqué requires majority non-executive directors and independent directors at least one thirds of total members; qualifications similar to RICAAP. - Paragraph 40: "10 deposit banks in Turkish Banking Industry are publicly traded (6 of them are large scale banks)." - Paragraph 41: Publicly traded banks must include "Corporate Governance Principles Compliance Report" in annual reports disclosing board structure and independence. - Paragraph 42: "Number of board members of the large scaled publicly traded banks range between 9 and 14." Five of these banks have 2 members and one has 5 members in their audit committee; five large banks have 3 independent members and one has 5 independent members; chairman is non-executive in all cases. - Paragraph 43–44: Reiterates board independence expectations and BRSA communications via RICAAP, RCGB and best practice guidelines. - Paragraph 45: BRSA "will review its current regulatory framework for Corporate Governance and will consider expanding the qualifications of the collective board, reviewing its definition of 'non-executive/independent member', expanding the minimum number of directors on the audit committee and explicitly requiring banks to establish risk committees." - Paragraph 46–48: Special Inspections and CRRE processes examine governance; BRSA "will enhance its examination procedures for corporate governance issues" and "will also consider conducting holistic assessment for corporate governance in an appropriate time frame." - Credit risk and loan supervision (Principles 17–18) - Paragraph 49: Credit risk management has four key parts: "active board and senior management oversight over credit function, adequate loan policies and procedures, adequate credit risk measurement, monitoring and MIS, adequate internal control and internal audit functions over loan activities." - Paragraph 51: GCM requires segregation of duties into marketing, underwriting and monitoring. - Paragraph 52: Banks required to have information systems for credit monitoring by customer, group and portfolio; GCM Principle 7 requires reliable data and periodic validation. - Paragraph 54: REPL requires loan portfolio review at least quarterly and documentation for the largest 200 loans (or the ones above 250.000 TL); "The loan review documentation for the largest 200 loans is usually prepared by internal audit." - Paragraph 55: "In 2014 and 2015, 70 Special Inspections were conducted in 27 banks." - Paragraph 56–57: BRSA will review organizational arrangements to improve independence and effectiveness of credit risk management and "is planning to increase the standardization in examiner loan write-up" and "will consider reviewing current definition of credit classifications in order to make them more concise and clear cut." - Paragraph 58: BRSA reiterates issuance of best practice guidelines and regulatory changes and commits to "taking the remaining recommendations of FSAP mission in the Report into consideration for future arrangements towards increasing compliance with the Basel Core principles for effective banking supervision." ### Key numerical and factual points (verbatim) - "Develop a cross-cutting, more holistic assessment methodology for corporate governance" - CRO stature recommendation tied to Principle 15 - FX LCR target consideration: "from 80% to 100%" - Publicly traded deposit banks: "10 deposit banks" with "6 of them are large scale banks" - Board size for large publicly traded banks: "range between 9 and 14" - Audit committee composition examples: "Five of these banks have 2 members and one of them has 5 members in their audit committee." - Independent board members in large banks: "five of the large scaled publicly traded banks have 3 and one of them has 5 independent members." - REPL loan review threshold: "largest 200 loans (or the ones above 250.000 TL)" - Special Inspections: "In 2014 and 2015, 70 Special Inspections were conducted in 27 banks." - Historical reference: assessment methodology revised in "2012" by BCBS; self-assessment working group formed in "2013." _Attribution: cr1746 - conclusions to comment upon the integrity and independent of_ --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1746.pdf_