## cr18324 ## Source details **Canonical URL:** [cr18324](https://www.imf.org/-/media/files/publications/cr/2018/cr18324.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18324.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18324.pdf.json) --- ### Mission purpose, context, and timeline - Mission period: April 30-May 11, 2018. - At the request of Bank of Lao P.D.R. (BoL), an MCM technical assistance (TA) mission visited Vientiane, Lao P.D.R. - Project financing: FIRST financed project. - Main objective: assist the Banking Supervision Department (BSD) of the BoL in implementing risk-based supervision (RBS) of banks. - RBS manual status: "substantially complete" and anticipated to be formally approved by end-2018. - Recommendation on approval: Do not delay approval and full implementation of RBS methods pending approval of the amended banking law — the manual's methods are flexible enough to work with the existing banking law, with any necessary revisions to follow enactment of amendments. ### Immediate outputs and high-level recommendations - Assisted BSD staff in identifying risks, measuring and evaluating impact on banks’ condition, and formulating conclusions and ratings for two pilot banks. - Emphasized need for significant capacity building: examiners must improve analytical and report-writing skills to explain and defend assessments. - Advised continuation of hands-on training using actual bank data from off-site returns and on-site examinations. - High-level recommendations (priority and timeframe summaries): - Formally approve RBS manual and supporting tools (Priority: High; Timeframe: ST). - Continue practical application of RBS methods to strengthen risk-focused analysis and examination skills of BSD staff (Priority: High; Timeframe: Ongoing). - Prepare and utilize Institutional Profile (IP) and Risk Assessment Summary (RAS) for all banks (Priority: High; Timeframe: ST). - Incorporate peer group benchmarks in analysis and commentary in IP and RAS documents (Priority: High; Timeframe: ST). - Develop an internal BoL policy establishing appropriate criteria for scope and frequency of on-site examinations (Priority: High; Timeframe: ST). - Apply RBS tools to plan and conduct on-site examinations (Priority: High; Timeframe: Ongoing). ### Examination reports, ROX format, and analytical quality - Findings on pilot ROX: - The two pilot ROX provided to the mission lacked adequate analyses of risks and did not contain the recommended matrix summarizing major risks. - Reports contained multiple appendices of spreadsheets showing data for multiple years and multiple quarters. - Improvement opportunities and recommendations: - Show only a few key ratios, thoughtful risk analysis, and concise year-end data in the body of reports; retain detailed supporting data in workpapers. - Continue using the new ROX format, placing emphasis on analysis of risks rather than recitation of data and compliance. - Make reports more concise by limiting use of appendices and placing detailed reference data in workpapers. - Focus guidance: reports must focus on “condition, cause, and consequence” — the most important risks, their severity and trends, and the likely consequences if left unchecked. ### Examination scheduling, planning, and sampling - Jan/Jun-2018 BSD plan criteria for scheduling: - (i) asset size in banking system, - (ii) off-site CAELS rating, - (iii) interval since the last on-site examination, - (iv) extent of unresolved issues. - Progress and needs: - BSD is implementing risk-focused methods on an introductory basis, though scope and intervals of examinations need improvement. - Suggested policy actions: - Adopt an internal policy specifying maximum desired interval between full-scope inspections for systemic/non-systemic banks and problem/non-problem banks. - Introduce periodical reviews (e.g. semiannual) of examination scheduling with adjustments on a quarterly or biannual basis considering current issues and available resources. - Planning note: select one or two additional pilot banks for inspection with TA experts assisting to plan examinations and review ROX afterward. ### CAMELS/CAELS ratings and benchmarking - Current practice: - BSD staff assign specific CAMELS component ratings based largely on benchmark ranges; overall ratings are preliminary with most banks rated 2 (“good”) or 3 (“fair” or “medium”). - Development needs and approach: - Desire to assign ratings using a matrix of finite ranges. - A more comprehensive set of key ratios has been adopted and benchmark data is still being refined and tested. - Over time, general ranges will be developed to provide a better starting point, but more practice and guidance are needed for examiners to assign ratings holistically. - Note: CAELS stands for Capital, Asset Quality, Earnings, Liquidity, and Sensitivity to Market Risk. ### Off-site / on-site communication and coordination - BSD intra-departmental communication is improving. - Off-site staff aim to prepare quarterly updates to IP and RAS for all banks once initial IP and RAS are prepared for all banks. - Off-site and on-site examiners are communicating more frequently before and after on-site examinations. - Off-site management will communicate any significant change in risk profile immediately horizontally (on-site and licensing colleagues) and vertically (Director General of Supervision). - Recommendation: Off-site and on-site teams should cooperate with other divisions such as licensing and legal for effective implementation of RBS. ### Specific supervisory practices and requests - Bank Business Plan Evaluation: - Business plans are evaluated as part of license applications; primary focus should be “reasonableness,” with onus on the bank to substantiate reasonableness. - Analysis should consider whether projected growth and revenue rates are reasonable for existing economic conditions, market competition for planned products/services, and management’s experience/probable ability to execute the proposed strategy. - Business plans also reviewed during on-site examinations or when material changes are proposed; operations and performance evaluated against the business plan (primarily the annual budget) with management expected to explain material deviations. - Loan Review Sampling: - Current BSD practice: selection relies on examiner judgment with an informal target to review not less than 50 percent for different categories of loans (for example, one-half of large loans, one-half of NPL’s, one-half of loans to related parties). - Best international practice: no universal minimum sample size; focus on (a) loans that pose the greatest risk to capital, and (b) enough other loans to support accurate conclusions about the lending function and credit risk. - Supervisory priorities: evaluate large loans and concentrations of credit, non-performing loans (individually if large or collectively if smaller), loans to related parties (directors, executive officers, major shareholders), and a representative sample of new loans and new loan products; consider cross-sectoral trends and issues as well. - Definition: A ‘large loan’ is defined as an exposure that is 10% or more of capital. ### Training, outreach, and capacity building - Training needs and actions: - All BSD staff should be trained in RBS methods now that the RBS manual and tools are largely final and being tested on a pilot basis. - The mission conducted an introductory RBS training session for most BSD staff; BSD managers requested more training for future TA. - Optimal results achieved through working with actual data and building capacity via learning-by-doing. - Outreach: - After formal approval of the RBS manual by BoL, BSD plans to conduct an information seminar for bankers to explain RBS application, expectations for bankers in managing risks, and BoL responses to poor risk management or excessive risks. - The mission will assist in preparing materials for the seminar. - Recommendation: BSD staff should prepare a draft presentation for the bankers’ informational seminar; the next mission can offer input for content and clarity. ### Legal and regulatory framework - BoL is revising/updating the legal framework with TA from the World Bank, focusing initially on the central bank law, then on the banking law, other financial sector laws, and regulations. - BSD staff recognize the need for amendments to the banking law and regulations to properly support RBS and note that RBS is a necessary prerequisite for the Basel-II capital framework. - Recommendation: The legal and regulatory frameworks should be properly reviewed and drafted to ensure support for the RBS. ### Appropriate responses, corrective measures, and policy development - RBS reveals risks that may be within regulatory limits but excessive relative to a bank’s capital strength and managerial capacities; RBS reveals both condition and cause so effective responses can be applied. - Responses of BoL will determine the ultimate effectiveness of RBS; once excessive risks are identified, responses must be prompt and proportional. - Effective responses and corrective measures must be firm, fair, and prompt. - Feedback loop: major findings should be discussed with top managements of banks and medium significance findings should also be brought to their attention; adequate follow up for systematically important issues must be timely. - Recommendation: BSD should develop a formal policy for applying response and corrective measures. The policy and a supporting manual should be underpinned by the amended banking law. ### Future TA priorities requested and agreed - Continue “hands-on” training using actual data; BoL senior management expressed a desire for more TA on a peripatetic basis. - Transition to RBS from compliance-based supervision requires extensive capacity building and hands-on training for all BSD staff, especially during early implementation stages. - Future TA needs requested by BSD and agreed by the mission: - a. Provide input to BSD for developing an effective reporting framework to BoL senior management incorporating FSIs and risk assessment summaries - b. Assist with identification and monitoring of systemic risks based on RBS principles and using FSIs - c. Provide further ‘hands-on’ training for preparing well-written ROX - d. Provide appropriate training for all BSD staff in the use of RBS methods including consolidated supervision concepts - e. Assist BSD staff in drafting an appropriate policy for response/corrective measures - f. Assist BSD staff in developing content for a bankers’ informational seminar on RBS *Source: cr18324 - Preface (IMF TA mission report, April 30-May 11, 2018).* ### Preface................................................................................................................. ### PREFACE ### Mission purpose and context - At the request of Bank of Lao P.D.R. (BoL), a Monetary and Capital Markets Department (MCM) technical assistance (TA) mission visited Vientiane, Lao P.D.R., during the period April 30-May 11, 2018. - This mission is part of a FIRST financed project. - Main objective: further assist the Banking Supervision Department (BSD) of the BoL in implementing risk-based supervision (RBS) of banks. - The mission held discussions with senior management and staff from the BSD. ### Key engagements and cooperation - The mission worked with off-site and on-site teams analyzing data for two pilot banks. - BSD staff provided sanitized data (no names or other confidential identifiers) for pilot-case work. - The mission expresses gratitude to BoL management and staff for cooperation and hospitality. ### Immediate outputs and focus - Assisted BSD staff in identifying risks, measuring and evaluating impact on banks’ condition, and formulating conclusions and ratings for two pilot banks. - Emphasized need for significant capacity building: examiners must improve analytical and report-writing skills to explain and defend assessments. - Advised continuation of hands-on training using actual bank data from off-site returns and on-site examinations. ### Timeline and legal/regulatory context - RBS manual is substantially complete and anticipated to be formally approved by end-2018. - Recommendation: Do not delay approval and full implementation of RBS methods pending approval of the amended banking law — the manual's methods are flexible enough to work with the existing banking law, with any necessary revisions to follow enactment of amendments. ### Next steps signaled by the mission - Continue practical application of RBS methods beyond pilot banks to a wider group of banks as an incremental process requiring additional TA. - BSD plans an informational seminar for bankers to explain RBS methods, expectations, and measures BoL will take to address weaknesses and mitigate risks. - Drafting an internal BoL policy for applying appropriate responses and corrective/enforcement actions was recommended as an appropriate next step. ### Main recommendations (high-level highlights from Table 1) - Formally approve RBS manual and supporting tools (Priority: High; Timeframe: ST). - Continue practical application of RBS methods to strengthen risk-focused analysis and examination skills of BSD staff (Priority: High; Timeframe: Ongoing). - Prepare and utilize Institutional Profile (IP) and Risk Assessment Summary (RAS) for all banks (Priority: High; Timeframe: ST). - Incorporate peer group benchmarks in analysis and commentary in IP and RAS documents (Priority: High; Timeframe: ST). - Develop an internal BoL policy establishing appropriate criteria for scope and frequency of on-site examinations (Priority: High; Timeframe: ST). - Apply RBS tools to plan and conduct on-site examinations (Priority: High; Timeframe: Ongoing). *Source: cr18324 - Preface (IMF TA mission report, April 30-May 11, 2018).* ### 23. Risk-based examination reports must provide more analysis. The two pilot ROX ### 23. Risk-based examination reports must provide more analysis. The two pilot ROX ### Examination reports: findings and improvements - The two pilot ROX provided to the mission lacked adequate analyses of risks and did not contain the recommended matrix summarizing major risks. - The reports contained multiple appendices of spreadsheets showing data for multiple years and multiple quarters. - Improvement opportunity: examination reports can be significantly improved if only a few key ratios, thoughtful risk analysis, and concise year-end data is shown in the body of reports with detailed supporting data retained in the workpapers. - Recommendation: Continue using the new ROX format, placing emphasis on analysis of risks rather than recitation of data and compliance; make reports more concise by limiting use of appendices and placing detailed reference data in workpapers. ### Focus on “condition, cause, and consequence” - Examination reports must focus on the most important risks, their severity and trends, and the likely consequences if left unchecked to enable effective action by bank boards, managers, and BoL senior management. - BSD has requested further assistance working with actual data to build capacity, strengthen staff analytical skills, and achieve the desired quality of examination reports. - Recommendation: Emphasize analysis of risks rather than recitation of data and compliance; make reports more concise by limiting appendices and placing detailed reference data in workpapers. ### Examination scheduling - For Jan/Jun-2018 BSD developed a plan using four main criteria: (i) asset size in banking system, (ii) off-site CAELS rating, (iii) interval since the last on-site examination, and (iv) extent of unresolved issues. - Progress: BSD is implementing risk-focused methods on an introductory basis, though scope and intervals of examinations need improvement. - Suggested policy actions: - Adopt an internal policy specifying maximum desired interval between full-scope inspections for systemic/non-systemic banks and problem/non-problem banks. - Introduce periodical reviews (e.g. semiannual) of examination scheduling with adjustments on a quarterly or biannual basis considering current issues and available resources. - Planning note: Planning actual on-site examinations using RBS methods is a valuable learning-by-doing exercise; BSD may select one or two additional pilot banks for inspection with TA experts assisting to plan examinations and review ROX afterward. ### CAMELS Ratings - Current practice: BSD staff assign specific CAMELS component ratings based largely on benchmark ranges; overall ratings are preliminary with most banks rated 2 (“good”) or 3 (“fair” or “medium”). - Development needs: - Desire to assign ratings using a matrix of finite ranges. - A more comprehensive set of key ratios has been adopted and benchmark data is still being refined and tested. - Over time, general ranges will be developed to provide a better starting point, but more practice and guidance are needed for examiners to assign ratings holistically. - Note: CAELS stands for Capital, Asset Quality, Earnings, Liquidity, and Sensitivity to Market Risk. ### Communication between off-site and on-site - BSD intra-departmental communication is improving. - Off-site staff aim to prepare quarterly updates to IP and RAS for all banks once initial IP and RAS are prepared for all banks. - Off-site and on-site examiners are communicating more frequently before and after on-site examinations. - Off-site management will communicate any significant change in risk profile immediately horizontally (on-site and licensing colleagues) and vertically (Director General of Supervision). - Recommendation: Off-site and on-site teams should cooperate with other divisions such as licensing and legal for effective implementation of RBS. ### Specific requests from BSD - BSD requested mission feedback to help explain rationale for actions and conclusions to BoL senior management. a. Bank Business Plan Evaluation - Business plans are evaluated as part of license applications; primary focus should be “reasonableness,” with onus on the bank to substantiate reasonableness. - Analysis should consider whether projected growth and revenue rates are reasonable for existing economic conditions, whether planned products/services already exist in the market and how the bank will compete, and the experience/probable ability of bank management to execute the proposed strategy. - Business plans are also reviewed during on-site examinations or when material changes are proposed; operations and performance are evaluated against the business plan (primarily the annual budget) with management expected to explain material deviations. b. Loan Review Sampling - Current BSD practice: selection relies on examiner judgment with an informal target to review not less than 50 percent for different categories of loans (for example, one-half of large loans, one-half of NPL’s, one-half of loans to related parties). - Best international practice: no universal minimum sample size; focus on (a) loans that pose the greatest risk to capital, and (b) enough other loans to support accurate conclusions about the lending function and credit risk. - Supervisory priorities: evaluate large loans and concentrations of credit, non-performing loans (individually if large or collectively if smaller), loans to related parties (directors, executive officers, major shareholders), and a representative sample of new loans and new loan products; consider cross-sectoral trends and issues as well. - Definition: A ‘large loan’ is defined as an exposure that is 10% or more of capital. ### Training BSD staff and informing bankers - Training needs: - All BSD staff should be trained in RBS methods now that the RBS manual and tools are largely final and being tested on a pilot basis. - The mission conducted an introductory RBS training session for most BSD staff; BSD managers requested more training for future TA. - Optimal results achieved through working with actual data and building capacity via learning-by-doing. - Outreach: - After formal approval of the RBS manual by BoL, BSD plans to conduct an information seminar for bankers to explain RBS application, expectations for bankers in managing risks, and BoL responses to poor risk management or excessive risks. - The mission will assist in preparing materials for the seminar. - Recommendation: BSD staff should prepare a draft presentation for the bankers’ informational seminar; the next mission can offer input for content and clarity. ### Supporting framework for effective RBS — Banking law and prudential regulations - BoL is revising/updating the legal framework with TA from the World Bank, focusing initially on the central bank law, then on the banking law, other financial sector laws, and regulations. - BSD staff recognize the need for amendments to the banking law and regulations to properly support RBS and note that RBS is a necessary prerequisite for the Basel-II capital framework. - Recommendation: The legal and regulatory frameworks should be properly reviewed and drafted to ensure support for the RBS. ### Appropriate responses and corrective measures - RBS methods reveal risks that may be within regulatory limits but excessive relative to a bank’s capital strength and managerial capacities; RBS reveals both condition and cause so effective responses can be applied. - Responses of BoL will determine the ultimate effectiveness of RBS; once excessive risks are identified, responses must be prompt and proportional. - Effective responses and corrective measures must be firm, fair, and prompt. - Feedback loop: major findings should be discussed with top managements of banks and medium significance findings should also be brought to their attention; adequate follow up for systematically important issues must be timely. - Recommendation: BSD should develop a formal policy for applying response and corrective measures. The policy and a supporting manual should be underpinned by the amended banking law. ### Capacity building and future TA - Continued “hands-on” training using actual data: - BoL senior management expressed a desire for more TA on a peripatetic basis. - Transition to RBS from compliance-based supervision requires extensive capacity building and hands-on training for all BSD staff, especially during early implementation stages. - To date, TA has focused on concepts, manual, and tools; going forward emphasis must be on practical application, learning-by-doing, and informational outreach. - Future TA needs requested by BSD and agreed by the mission: - a. Provide input to BSD for developing an effective reporting framework to BoL senior management incorporating FSIs and risk assessment summaries - b. Assist with identification and monitoring of systemic risks based on RBS principles and using FSIs - c. Provide further ‘hands-on’ training for preparing well-written ROX - d. Provide appropriate training for all BSD staff in the use of RBS methods including consolidated supervision concepts - e. Assist BSD staff in drafting an appropriate policy for response/corrective measures - f. Assist BSD staff in developing content for a bankers’ informational seminar on RBS *IMF staff mission report excerpt* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18324.pdf_