## 1lsoea2020001 ## Source details **Canonical URL:** [1lsoea2020001](https://www.imf.org/-/media/files/publications/cr/2020/english/1lsoea2020001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1lsoea2020001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1lsoea2020001.pdf.json) --- ### Preface and mission scope - Mission from IMF AFRITAC South (AFS) visited Maseru on March 4-14, 2019, at the request of the Central Bank of Lesotho (CBL). - Mission comprised Ms. Alicia Novoa (Expert). - Objectives: - Review progress in implementation of Basel II and select elements of Basel III. - Review and help finalize CBL Draft Guidelines to banks for Pillar 1. - Provide direction on Pillar 2 Supervisory Review and Evaluation Process (SREP) and banks' Internal Capital Adequacy Assessment Process (ICAAP). - Review current Guideline to banks for ICAAP and assess changes needed in Pillar 3 disclosure regime. - Discuss implementation of select elements of Basel III relevant to Lesotho. - Activities: - Focused training sessions for Banking Supervision Division (BSD) staff on risks, risk management, governance, Pillar 2 SREP and ICAAP, and revised Pillar 3 framework. - Meetings with Governor Dr. A.R. Matlanyane, Mrs. P. Tau (Acting Director of the Banking Supervision and Financial Stability Department and Head of BSD), section heads, supervisors, and on-site and off-site bank examiners. ### Executive summary — key findings and assessment - Mission was a follow up to March 2017 AFS mission; designed to further assist CBL with Basel II and selected Basel III elements. - Main objectives reiterated: finalize Draft Guidelines on Pillar 1; assist implementation of Pillar 2 (SREP, ICAAP); evaluate Pillar 3 disclosure requirements; discuss adoption of select Basel III capital definition elements. Findings on banking system and capitalization: - Banking system remains concentrated and largely foreign owned. - Three major banks are subsidiaries of South African banks; the fourth, Lesotho PostBank, is fully owned by the Government of Lesotho. - All four banks appear comfortably capitalized with an average Capital Adequacy Ratio (CAR) of 18 percent as at December 2018. - This CAR level is well in excess of the minimum 8 percent required by the Financial Institutions Act (FIA) of 2012 and would facilitate implementation of Basel III capital requirements assuming capital is exclusively equity. Progress and readiness: - BSD drafted guidelines for Pillar 1 (capital requirements, credit, operational, market risks), Pillar 2 ICAAP, stress testing and SREP, and a guideline on basic Pillar 3 disclosures. - Banks were requested to submit a first draft ICAAP report by June 2018; all four banks submitted first draft ICAAP reports by end-2018 and received some written feedback from BSD by the mission visit. - Mission recommends immediate issuance of final Pillar 1 guideline(s) with full adherence to Basel III capital definition and requirements. - CBL should implement Pillar 1 standardized approaches by January 1, 2020. BSD considered implementation by Q3 2020, but mission found CBL ready to finalize Pillar 1 Guidelines shortly to make them effective on January 1, 2020. - BCBS post-crisis reforms and new standardised approaches for credit and operational risks could be considered for adoption by CBL in due time; most become effective for Committee members by January 1, 2022. Pillars 2 and 3: - Progressive implementation of Pillars 2 and 3 will help address supervisory concerns and BSD supervisory practice deficiencies. - Implementation of Pillar 2 during 2020 should be followed by smooth implementation of Pillar 3 requirements by end-2020. Supervisory capacity and challenges: - Major challenge: supervisor’s progress in the Pillar 2 learning curve and strengthening of supervisory approach. - CBL’s 2010 Risk-Based Supervision (RBS) Framework should be reviewed to leverage Pillar 2 ICAAP and SREP; CBL will need TA for this. - Skills enhancement of supervisory staff is high priority. Over the last three years BSD staff comprised eight persons and the Head of Banking Supervision. - Need to invest in ongoing capacity building and add new skills (e.g., finance and IFRS). Banks’ readiness and other priorities: - Banks’ simplicity of business and comfortable capital positions facilitate migration; domestic bank will require supervisory handholding to progress into Pillar 2. - All four banks likely need to fine-tune information systems to meet Pillar 3 disclosure requirements. - BSD must monitor potential need for new capital as Basel II implementation may affect banks’ behavior and strategies. - No urgency seen to implement Basel III capital buffer or Leverage Ratio (LR); capital conservation buffer could restrict parents repatriating capital but no urgency to set buffer before minimum Basel III requirements materialize. - LR could be implemented later once other capital requirements are bedded down. - Capital enhancements should be CBL’s priority; limited CBL resources preclude developing a Basel III-type liquidity framework simultaneously, but CBL must remain alert to liquidity difficulties. ### Summary of main recommendations (selected with priorities and time frames preserved) - 1. Finalize Guideline(s) for banks on Basel II Pillar 1, adopting the definition and prescriptions for capital set by Basel III, as guided by the mission. Priority: High. Suggested Time frame: June 2019. - 2. Guideline(s) on Pillar 1 to go out to banks for consultation. Priority: High. Suggested Time frame: July 2019. - 3. Bankś send written comments on the Guideline(s) on Pillar 1; CBL conduct workshops with the banks. Priority: High. Suggested Time frame: August 2019. - 4. CBL to conduct a QIS-like calculation applying Basel II/III capital rules to the balance sheets of the four banks - at the consolidated level - as of June 30, 2019, to anticipate likely impact of Basel II implementation. Priority: High. Suggested Time frame: September 2019. - 5. CBL to issue Final Guideline(s) for banks on Basel II Pillar 1. Priority: High. Suggested Time frame: October 2019. - 6. Bankś parallel-run to come to an end. Priority: High. Suggested Time frame: December 31, 2019. - 7. Final Guideline(s) on Basel II Pillar 1 to become effective. Priority: High. Suggested Time frame: January 1, 2020. - 8. First quarter-end Pillar 1 prudential reports to be submitted by the banks to the CBL. Priority: High. Suggested Time frame: March 31, 2020. - 9. Issue enhanced Guideline for banks on Basel II Pillar 2 ICAAP, and internal Guideline for supervisors on Pillar 2 SREP, developing an internal process to set up additional capital requirements based on risks not covered in Pillar 1, as guided by the mission. Priority: High. Suggested Time frame: March 2020. - 10. Banks to submit first complete Board-approved ICAAPs. Priority: High. Suggested Time frame: June 2020. - 11. Issue Guideline for banks on Basel II Pillar 3 as recommended by the mission. Priority: High. Suggested Time frame: Q3 2020. - 12. Banks first Pillar 3 disclosures submitted to the CBL. Priority: High. Suggested Time frame: Financial year ending on Dec. 31, 2020. - 13. Banks’ complete set of audited annual financial statements – including Pillar 3 disclosures - made available to the public on the bankś and on the CBĹ s websites. Priority: High. Suggested Time frame: Financial year ending on Dec. 31, 2020. - 14. CBL to hold one-on-one meetings with banks on their implementation of IFRS 9 ECL provisions and their prudential treatment. Priority: High. Suggested Time frame: Q3 2020. TA may be required. - 15. CBL to initiate the process necessary to obtain any amendment to the FIA that may be necessary to give the CBL an increased ability to make prudential rules without having to seek outside approvals or future amendments to the Act. Priority: High. Suggested Time frame: 2020. - 16. CBL to revisit implementation of a Capital Conservation Buffer, a Leverage Ratio, and Basel III Liquidity Standards. Priority: Medium. Suggested Time frame: Q2 2021. - 17. CBL to review its 2010 RBS Framework to upgrade it, to feed it with Basel II Pillar 2 results. Priority: Medium. Suggested Time frame: Mid-2020. A TA may be required. - 18. CBL to get prepared for challenging IFRS in force in the banks (e.g., IFRS 9), and their prudential treatment for capital purposes. Priority: High. Suggested Time frame: Mid-2020. A TA may be required. ### Banking sector snapshot and key statistics (preserve exact figures) - Number of banks: four commercial banks offering traditional personal and corporate banking services. - Total assets of the four banks: about USD 1.2 billion as of December 2018, representing 48 percent of the countrý s GDP as of that date. - Total staff complement of the four banks: around 1700 (at December 2016 level). - Ownership structure: - Three banks are subsidiaries of South African banks; the fourth, Lesotho PostBank, fully government-owned. - The three foreign banks together accounted for 92 percent of banking sector assets and 91 percent of total deposits, as of December 2018. - Foreign subsidiaries exposure: balances held with South African banks increased by about 70 percent over December 2016–December 2018. - Sector growth (December 2016–December 2018): - Total banking assets increased by about 33 percent. - Loans and advances increased by 17 percent. - Total liabilities increased by 24 percent; deposits went up by 39 percent. - Capital increased by 28 percent due to increased retained earnings. - Net income increased by 6 percent. - Concentration: largest foreign bank held about 53 percent of total banking sector assets, 56 percent of total loans to customers and 54 percent of total deposits as of December 2018. - Regulatory CAR: around 18 percent as at the end of December 2018 (figures calculated by BSD as per Basel I; Basel II figures not available at time of visit; mission encouraged CBL to conduct a QIS-like calculation of capital). ### Asset and liability structure (selected metrics as of December 2018) - Deposits ranged from 73 percent to 83 percent of liabilities across the four banks. - Loans to customers varied from 30 percent to 48 percent of total assets. - The domestic bank held loans equal to 48 percent of its total assets (highest rate). - Balances due from banks in South Africa represented between 10 percent and 41 percent of assets. - Balances due from local banks represented between 1 percent and 50 percent of assets. - The share of foreign assets at banks in South Africa was larger than the combined amount of cash, deposits with the CBL and treasury bills. - Loan composition: - Personal loans make up 58 percent of the four banks' lending portfolios. - Mortgages make up 20 percent of the four banks' lending portfolios. ### Government-owned bank (Lesotho PostBank) — size, risks, and supervisory needs - Total assets almost doubled to about USD 102 million during December 2016–December 2018. - The bank's CAR was 16 percent (as per Basel II) as of December 2017. - This level of capital still provides for a good buffer above the minimum legal capital of 8 percent. - The bank submitted its first ICAAP report in mid-2018; it resubmitted a second draft ICAAP report late in 2018 at the CBL's request. - Operational shifts and risks: - Expanded into retail and business, focusing more on micro, small and medium enterprises. - Issuing unsecured personal loans and increasing credit risk appetite to achieve higher market share. - Deposits predominantly overnight and demand, majority government-owned deposits; seeks to grow deposits outside Government to dilute concentration risk. - Liquidity policy mandates additional capital held for liquidity purposes, above the Basel II capital requirement. - Statutory limitation: the bank is limited to increase capital up to the amount of its annual operating profits—this could erode headroom between the bank’s capital and Basel II capital requirements over time. - Supervisory implication: will necessitate supervisory handholding, guidance on risk understanding/management, and planning/provisioning for regulatory capital under Basel requirements. ### Regulatory framework, liquidity rules, and accounting/audit issues - Legal base: CBL powers set in the Financial Institutions Act (FIA) of 2012; FIA contains language and methodology belonging to the Basel I framework. - Key regulatory instruments: CBL 2010 Risk-based Supervision (RBS) Framework and 2016 Risk Management Regulation. - Liquidity requirements: - Banks must maintain a minimum reserve for liquidity of 3 percent of aggregated deposits, balances due to local and foreign banks, and other borrowed money (excluding funds from the Government and the CBL). - Liquid assets cannot go below 25 percent of these same liabilities. - Reserve balance and liquid assets must be computed daily and reported to the CBL weekly. - These 2016 requirements apply to all banks at individual and consolidated levels. - Accounting and audit practices: - Banks must prepare annual financial statements as per full IFRS; December 31 is the uniform year-end. - Financial statements are not published in full by the banks or on the CBL’s website. - Audit practice concern: a Big 4 audit firm conducts audit work but a small domestic audit firm issues and signs the Auditor’s Report—raising concerns about compliance with ISA and IFRS. - Supervision of foreign subsidiaries: good home-host relationships with the South African Reserve Bank (SARB) are critical; BSD should review its Memorandum of Understanding with the SARB. ### Implementation status and timelines for Basel II/Basel III elements - Pillar 1: - CBL will implement the Standardized Approaches to Basel II Pillar 1 risks. - Pillar 1 capital requirements Guideline(s) should be finalized shortly and become effective on January 1, 2020. - Full adherence to Basel III’s definition and requirements of capital will be applied. - The first Basel II quarterly prudential returns should be submitted by the banks as of March 31, 2020. - Pillar 2: - Implementation has commenced; in December 2017 the CBL issued a Guideline for banks on their ICAAPs. - Guideline risks being treated as a compliance format rather than conveying CBL expectations on ICAAPs as part of Pillar 2 SREP. - Banks were requested to submit first complete draft ICAAP documents in June 2018; all four banks submitted drafts. - CBL issued a Guideline for stress testing (December 2017) and an internal Guideline on the SREP (November 2018). - Pillar 2 should be implemented progressively during 2020 with Board-approved ICAAPs by June 30, 2020. - Pillar 3: - CBL issued a Guideline with basic disclosures in December 2017; it needs enhancement to align with the revised Pillar 3 framework. - Initially mandate selective Basel III disclosures on capital components and other prudential metrics to be published with banks’ audited financial statements for the financial year ending December 31, 2020. - Banks should place full audited financial statements and Pillar 3 Prudential report/disclosures on their websites. ### Pillar 2, Pillar 3, buffers, leverage, and liquidity considerations - Pillar 2: - Expected outcomes: improved risk management, governance, and capital planning within banks; stronger supervisory capabilities and SREP. - Implementation approach: progressive implementation during 2020. - Deliverable: formal Board-approved ICAAP documents submitted no later than June 30, 2020. - Pillar 3: - Enhance Guideline to adhere to revised Basel III Pillar 3 and introduce minimum disclosure templates (e.g., CC1, CC2, KM1, LI1, LI2, LIA from BCBS March 2017 framework). - Require Pillar 3 reports to be published with audited annual financial statements and placed on banks’ websites for the year ending December 31, 2020. - Capital buffers and leverage: - Mission does not see grounds for implementing any Basel III capital buffer at this time. - Supports considering a capital conservation buffer later, but sees no urgency to set it before minimum Basel III capital requirements materialize. - Countercyclical buffer: premature at this time. - Leverage ratio: no urgency to introduce now; aim to implement in due course after other capital elements are bedded down. - Liquidity: - CBL is not putting Basel III liquidity rules in place as part of Basel II implementation. - Recommendation: focus on migrating to Basel II before seeking to adopt Basel III liquidity standards, given Lesotho’s environment with no secondary market for liquidity. - All three foreign subsidiaries rely on parents for liquidity support; government-owned bank expects government support if needed. ### Supervisory capacity, staffing, training needs, and IFRS 9 implications - BSD staffing: - Total staff at BSD consists of 9 persons out of which 3 have less than 3 years of working experience in the Division. - BSD has limited resources to deliver effective risk-based supervision and handle the work resulting from implementing Basel II. - Training and secondments: - IMF TA missions can assist but cannot substitute for on-the-job training. - Mission encourages short and medium-term secondments and aid funding with regional/non-regional supervisors; BSD already has home-host relationship with SARB. - Staff retention is a concern as banks may recruit supervisors. - IFRS 9: - IFRS 9 became effective in 2018, introducing significant challenges to banks and the CBL. - CBL did not require banks to estimate the impact of IFRS 9 ECL model on accounting provisions and prudential capital, nor had it made its own estimate. - Impact will become evident in annual financial statements as of December 31, 2018. - Supervisor needs to understand IFRS 9 ECL issues and prudential treatment, including national discretion for transitional arrangements to phase-in full impact on regulatory capital. - CBL needs to upgrade BSD skills by incorporating IFRS and finance experts and may require TA in the very short-run. ### Mission findings, gap analysis, and priority actions - Progress: very good progress in drafting guidelines and banks’ draft ICAAP submissions. - Gap: CBL has not conducted a Basel I–Basel II gap analysis of prudential capital; mission recommends a QIS-like calculation as of June 30, 2019. - Expectation: reasonable to expect a reduction from the 2018 Basel I sector-wide capital level of 18 percent, although to a level still above the legal minimum 8 percent. - ICAAP and stress testing: ICAAP Guideline should emphasize fit-for-purpose ICAAPs, integrate stress testing, and guide banks on examining future capital under adverse scenarios; supervisors must integrate ICAAP analysis into RBS. - TA and legal amendments: CBL will necessitate TA in the very short-run to enhance RBS, supervisory practices, and to pursue legislative amendments to the FIA to expand prudential rule-making flexibility. - Audit and disclosure: CBL should address audit malpractice concerns and improve transparency by ensuring audited financial statements and required disclosures are published. _Italic: Source: 1lsoea2020001 (IMF AFRITAC South mission report)._ ### Preface ................................................................................................................ ### 1lsoea2020001 - Preface ................................................................................................ ### Preface and mission scope - Mission from IMF AFRITAC South (AFS) visited Maseru on March 4-14, 2019, at the request of the Central Bank of Lesotho (CBL). - Mission comprised Ms. Alicia Novoa (Expert). - Objectives: - Review progress in implementation of Basel II and select elements of Basel III. - Review and help finalize CBL Draft Guidelines to banks for Pillar 1. - Provide direction on Pillar 2 Supervisory Review and Evaluation Process (SREP) and banks' Internal Capital Adequacy Assessment Process (ICAAP). - Review current Guideline to banks for ICAAP and assess changes needed in Pillar 3 disclosure regime. - Discuss implementation of select elements of Basel III relevant to Lesotho. - Activities: - Focused training sessions for Banking Supervision Division (BSD) staff on risks, risk management, governance, Pillar 2 SREP and ICAAP, and revised Pillar 3 framework. - Meetings with Governor Dr. A.R. Matlanyane, Mrs. P. Tau (Acting Director of the Banking Supervision and Financial Stability Department and Head of BSD), section heads, supervisors, and on-site and off-site bank examiners. ### Acknowledgements - Mission expressed appreciation to the Governor, Acting Director, BSD staff for participation and cooperation. ### AFRITAC South (AFS) context - AFS provides TA and training to Angola, Botswana, Comoros, Eswatini, Lesotho, Madagascar, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Zambia, and Zimbabwe. - AFS donors include the European Union, Switzerland, Germany, China, Mauritius, the United Kingdom, Netherlands, European Investment Bank, and Australia. ### Glossary (selected acronyms preserved) - AFS IMF’s Regional Technical Assistance Center for Southern Africa (AFRITAC South) - BCBS Basel Committee on Banking Supervision - BSD Banking Supervision Division - CAR Capital Adequacy Ratio - CBL Central Bank of Lesotho - ECL Expected Credit Losses - FIA Financial Institutions Act of 2012 - ICAAP Internal Capital Adequacy Assessment Process - IFRS International Financial Reporting Standard - IMF International Monetary Fund - LR Leverage Ratio - MoU Memorandum of Understanding - RBS Risk-based Supervision - SA Standardised Approach - SARB South African Reserve Bank - SREP Supervisory Review and Evaluation Process - SRP Supervisory Review Process - TA Technical Assistance --- ### Executive Summary — key findings and assessment - Mission was a follow up to March 2017 AFS mission; designed to further assist CBL with Basel II and selected Basel III elements. - Main objectives reiterated: finalize Draft Guidelines on Pillar 1; assist implementation of Pillar 2 (SREP, ICAAP); evaluate Pillar 3 disclosure requirements; discuss adoption of select Basel III capital definition elements. Findings on banking system and capitalization: - Banking system remains concentrated and largely foreign owned. - Three major banks are subsidiaries of South African banks; the fourth, Lesotho PostBank, is fully owned by the Government of Lesotho. - All four banks appear comfortably capitalized with an average Capital Adequacy Ratio (CAR) of 18 percent as at December 2018. - This CAR level is well in excess of the minimum 8 percent required by the Financial Institutions Act (FIA) of 2012 and would facilitate implementation of Basel III capital requirements assuming capital is exclusively equity. Progress and readiness: - BSD drafted guidelines for Pillar 1 (capital requirements, credit, operational, market risks), Pillar 2 ICAAP, stress testing and SREP, and a guideline on basic Pillar 3 disclosures. - Banks were requested to submit a first draft ICAAP report by June 2018; all four banks submitted first draft ICAAP reports by end-2018 and received some written feedback from BSD by the mission visit. - Mission recommends immediate issuance of final Pillar 1 guideline(s) with full adherence to Basel III capital definition and requirements. - CBL should implement Pillar 1 standardized approaches by January 1, 2020. BSD considered implementation by Q3 2020, but mission found CBL ready to finalize Pillar 1 Guidelines shortly to make them effective on January 1, 2020. - BCBS post-crisis reforms and new standardised approaches for credit and operational risks could be considered for adoption by CBL in due time; most become effective for Committee members by January 1, 2022. Pillars 2 and 3: - Progressive implementation of Pillars 2 and 3 will help address supervisory concerns and BSD supervisory practice deficiencies. - Implementation of Pillar 2 during 2020 should be followed by smooth implementation of Pillar 3 requirements by end-2020. Supervisory capacity and challenges: - Major challenge: supervisor’s progress in the Pillar 2 learning curve and strengthening of supervisory approach. - CBL’s 2010 Risk-Based Supervision (RBS) Framework should be reviewed to leverage Pillar 2 ICAAP and SREP; CBL will need TA for this. - Skills enhancement of supervisory staff is high priority. Over the last three years BSD staff comprised eight persons and the Head of Banking Supervision. - Need to invest in ongoing capacity building and add new skills (e.g., finance and IFRS). Banks’ readiness and other priorities: - Banks’ simplicity of business and comfortable capital positions facilitate migration; domestic bank will require supervisory handholding to progress into Pillar 2. - All four banks likely need to fine-tune information systems to meet Pillar 3 disclosure requirements. - BSD must monitor potential need for new capital as Basel II implementation may affect banks’ behavior and strategies. - No urgency seen to implement Basel III capital buffer or Leverage Ratio (LR); capital conservation buffer could restrict parents repatriating capital but no urgency to set buffer before minimum Basel III requirements materialize. - LR could be implemented later once other capital requirements are bedded down. - Capital enhancements should be CBL’s priority; limited CBL resources preclude developing a Basel III-type liquidity framework simultaneously, but CBL must remain alert to liquidity difficulties. --- ### Summary of Main Recommendations (selected, preserving exact priorities and time frames) - 1. Finalize Guideline(s) for banks on Basel II Pillar 1, adopting the definition and prescriptions for capital set by Basel III, as guided by the mission. Priority: High. Suggested Time frame: June 2019. - 2. Guideline(s) on Pillar 1 to go out to banks for consultation. Priority: High. Suggested Time frame: July 2019. - 3. Bankś send written comments on the Guideline(s) on Pillar 1; CBL conduct workshops with the banks. Priority: High. Suggested Time frame: August 2019. - 4. CBL to conduct a QIS-like calculation applying Basel II/III capital rules to the balance sheets of the four banks - at the consolidated level - as of June 30, 2019, to anticipate likely impact of Basel II implementation. Priority: High. Suggested Time frame: September 2019. - 5. CBL to issue Final Guideline(s) for banks on Basel II Pillar 1. Priority: High. Suggested Time frame: October 2019. - 6. Bankś parallel-run to come to an end. Priority: High. Suggested Time frame: December 31, 2019. - 7. Final Guideline(s) on Basel II Pillar 1 to become effective. Priority: High. Suggested Time frame: January 1, 2020. - 8. First quarter-end Pillar 1 prudential reports to be submitted by the banks to the CBL. Priority: High. Suggested Time frame: March 31, 2020. - 9. Issue enhanced Guideline for banks on Basel II Pillar 2 ICAAP, and internal Guideline for supervisors on Pillar 2 SREP, developing an internal process to set up additional capital requirements based on risks not covered in Pillar 1, as guided by the mission. Priority: High. Suggested Time frame: March 2020. - 10. Banks to submit first complete Board-approved ICAAPs. Priority: High. Suggested Time frame: June 2020. - 11. Issue Guideline for banks on Basel II Pillar 3 as recommended by the mission. Priority: High. Suggested Time frame: Q3 2020. - 12. Banks first Pillar 3 disclosures submitted to the CBL. Priority: High. Suggested Time frame: Financial year ending on Dec. 31, 2020. - 13. Banks’ complete set of audited annual financial statements – including Pillar 3 disclosures - made available to the public on the bankś and on the CBĹ s websites. Priority: High. Suggested Time frame: Financial year ending on Dec. 31, 2020. - 14. CBL to hold one-on-one meetings with banks on their implementation of IFRS 9 ECL provisions and their prudential treatment. Priority: High. Suggested Time frame: Q3 2020. TA may be required. - 15. CBL to initiate the process necessary to obtain any amendment to the FIA that may be necessary to give the CBL an increased ability to make prudential rules without having to seek outside approvals or future amendments to the Act. Priority: High. Suggested Time frame: 2020. - 16. CBL to revisit implementation of a Capital Conservation Buffer, a Leverage Ratio, and Basel III Liquidity Standards. Priority: Medium. Suggested Time frame: Q2 2021. - 17. CBL to review its 2010 RBS Framework to upgrade it, to feed it with Basel II Pillar 2 results. Priority: Medium. Suggested Time frame: Mid-2020. A TA may be required. - 18. CBL to get prepared for challenging IFRS in force in the banks (e.g., IFRS 9), and their prudential treatment for capital purposes. Priority: High. Suggested Time frame: Mid-2020. A TA may be required. --- ### I. Introduction: Purpose of the Mission (high-level) - Mission designed to assist authorities in implementing Basel II and select Basel III elements; follow up to March 2017 mission. - Evaluated CBL progress in drafting and issuing final guidelines for Basel II; assessed banks’ first draft ICAAP submissions and supervisory assessment; assessed capital requirements progress. - Provided focused seminars to BSD staff on Pillars 1, 2 and 3, and highlighted BCBS revisions to standardized approaches. - Emphasized developing supervisory capabilities to critically assess banks’ ICAAPs, challenge capital adequacy, and to incorporate IRRBB and concentration risk into SREP/SRP and RBS. - Recommended immediate issuance of final Pillar 1 Guideline(s) and proposed granular timeline for Pillars 2 and 3 implementation. ### II. Regulatory framework for banks and Basel II implementation — Banking sector snapshot and metrics - Number of banks: four commercial banks offering traditional personal and corporate banking services. - Total assets of the four banks: about USD 1.2 billion as of December 2018, representing 48 percent of the countrý s GDP as of that date. - Total staff complement of the four banks: around 1700 (at December 2016 level). - Ownership structure: - Three banks are subsidiaries of South African banks; the fourth, Lesotho PostBank, fully government-owned. - The three foreign banks together accounted for 92 percent of banking sector assets and 91 percent of total deposits, as of December 2018. - Foreign subsidiaries exposure: balances held with South African banks increased by about 70 percent over December 2016–December 2018. - Sector growth (December 2016–December 2018): - Total banking assets increased by about 33 percent. - Loans and advances increased by 17 percent. - Total liabilities increased by 24 percent; deposits went up by 39 percent. - Capital increased by 28 percent due to increased retained earnings. - Net income increased by 6 percent. - Concentration: largest foreign bank held about 53 percent of total banking sector assets, 56 percent of total loans to customers and 54 percent of total deposits as of December 2018. - Regulatory CAR: around 18 percent as at the end of December 2018 (figures calculated by BSD as per Basel I; Basel II figures not available at time of visit; mission encouraged CBL to conduct a QIS-like calculation of capital). *Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1lsoea2020001.pdf* ### 15. Customer deposits are the predominant liability of the banks while loans to ### 1lsoea2020001 - 15. Customer deposits are the predominant liability of the banks while loans to ### Asset and liability structure of banks - Deposits ranged from 73 percent to 83 percent of liabilities across the four banks, as of December 2018. - Loans to customers varied from 30 percent to 48 percent of total assets as of December 2018. - The domestic bank held loans equal to 48 percent of its total assets (highest rate). - Balances due from banks in South Africa represented between 10 percent and 41 percent of assets, as of December 2018. - Balances due from local banks represented between 1 percent and 50 percent of assets, as of December 2018. - The share of foreign assets at banks in South Africa was larger than the combined amount of cash, deposits with the CBL and treasury bills. ### Liquidity monitoring and supervisory priorities - The CBL monitors banks’ liquidity positions regularly. - Given limited resources, the mission views that making capital enhancements should be the CBL priority, since the CBL would not be able to develop a Basel III-type liquidity framework concomitant with the implementation of Basel II. ### Loan concentration and credit risk - Bank lending concentration: - Personal loans make up 58 percent of the four banks' lending portfolios. - Mortgages make up 20 percent of the four banks' lending portfolios. - Banks remain significantly exposed to the financial health of private households. - Under IFRS 9 Expected Credit Losses (ECL) the quality of loans could reveal under provisioning for bad loans; the CBL monitors NPLs and provisions but must remain vigilant about the impact of the new provisions model on prudential capital. ### Government-owned bank (Lesotho PostBank) — size, risks, and supervisory needs - Total assets almost doubled to about USD 102 million during December 2016–December 2018. - The bank's CAR was 16 percent (as per Basel II) as of December 2017. - This level of capital still provides for a good buffer above the minimum legal capital of 8 percent. - The bank submitted its first ICAAP report in mid-2018; it resubmitted a second draft ICAAP report late in 2018 at the CBL's request. - Operational shifts and risk profile: - Operations expanded from under/un-banked rural and urban areas into retail and business, focusing more on micro, small and medium enterprises. - The bank has been issuing unsecured personal loans and increasing its credit risk appetite to achieve higher market share. - Deposits are predominantly overnight and demand, majority government-owned deposits; the bank seeks to grow deposits outside Government to dilute concentration risk. - Liquidity policy mandates additional capital held for liquidity purposes, above the Basel II capital requirement. - Statutory limitation: the bank is limited to increase capital up to the amount of its annual operating profits—this could erode headroom between the bank’s capital and Basel II capital requirements over time. - Supervisory implication: from a prudential perspective, the government-owned bank will necessitate supervisory handholding, guidance on risk understanding/management, and planning/provisioning for regulatory capital under Basel requirements. ### Regulatory framework and supervisory capacity - Legal and regulatory base: - The CBL’s powers are set in the Financial Institutions Act (FIA) of 2012. - The FIA contains language and methodology belonging to the Basel I framework; unless amended by Parliament, it poses limitations to the CBL’s flexibility in supervisory processes. - Key regulatory instruments: - CBL 2010 Risk-based Supervision (RBS) Framework and 2016 Risk Management Regulation. - Current regulations address Basel I risk-based capital requirements, lending limits, asset classification and provisioning, minimum local assets, merger and transfers of assets and liabilities, foreign currency exposure limits, consolidated supervision, liquidity management and corporate governance. - Liquidity requirements: - Banks must maintain a minimum reserve for liquidity of 3 percent of aggregated deposits, balances due to local and foreign banks, and other borrowed money (excluding funds from the Government and the CBL). - Liquid assets cannot go below 25 percent of these same liabilities. - Reserve balance and liquid assets must be computed daily and reported to the CBL weekly. - These 2016 requirements apply to all banks at individual and consolidated levels. - Accounting and audit practices: - Banks must prepare annual financial statements as per full IFRS; December 31 is the uniform year-end. - Financial statements are not published in full by the banks or on the CBL’s website. - Banks must have annual financial statements audited in accordance with ISA; the mission found a local practice where a Big 4 audit firm conducts audit work but a small domestic audit firm issues and signs the Auditor’s Report—raising concerns about compliance with ISAs and IFRS. - Supervision of foreign subsidiaries and staff retention: - Good home-host relationships with the South African Reserve Bank (SARB) are critical given the dominance of South African subsidiaries. - The BSD should review its Memorandum of Understanding with the SARB to ensure it is an effective supervisory instrument. - CBL-trained staff may be sought by the private sector as Basel II is implemented; the CBL must remain alert to retain skilled supervisors. ### Implementation of Basel II (status, timelines, and supervisory implications) - Pillar 1: - The CBL will implement the Standardized Approaches to Basel II Pillar 1 risks. - Pillar 1 capital requirements Guideline(s) should be finalized shortly and become effective on January 1, 2020. - Full adherence to Basel III’s definition and requirements of capital will be applied. - The first Basel II quarterly prudential returns should be submitted by the banks as of March 31, 2020. - Pillar 2: - Implementation has commenced; in December 2017 the CBL issued a Guideline for banks on their ICAAPs. - The Guideline does not convey the CBL’s expectations on ICAAPs as part of Pillar 2 SREP and is more inclined toward formats and descriptions, risking that banks may treat ICAAP as a compliance document. - Banks were requested to submit their first complete draft ICAAP documents in June 2018; all four banks submitted drafts, with the government-owned bank requested to resubmit a draft in late 2018. - The CBL issued a Guideline for stress testing (December 2017) and an internal Guideline on the SREP (November 2018). - The ICAAP must be the work of the banks and the responsibility of each bank’s Board; external help should be limited to guidance only. - Pillar 3: - In December 2017 CBL issued a Guideline for banks with basic disclosures for Pillar 3; it needs enhancement to align with the revised Pillar 3 framework. - Initially, the CBL should mandate selective Basel III disclosures on capital components and other prudential metrics to be published with banks’ audited financial statements for the financial year ending December 31, 2020, subject to internal review and control processes equivalent to audited financial statements. - Banks’ preparedness: - All four banks have been working on Basel II implementation with the CBL during the last two years and participated in QIS exercises in August 2016 and May 2017. - Banks are likely preparing for a 2019 full compliance and would support January 1, 2020 as a feasible date for Pillar 1 to become effective. - Banks should submit Pillar 3 basic disclosures as of December 31, 2018, by the end of March 2019. - Supervisory capacity: - CBL supervisory staff is becoming more prepared but supervisors need to advance their analytical, forward-looking, risk-based skills. - The CBL’s RBS framework requires a critical review as ICAAPs and SREPs unfold. ### Mission findings and key recommendations - Progress and planning: - The mission evaluated CBL progress towards Basel II and commends very good progress: draft guidelines for Pillar 1 (credit, operational risk March 2018; market risk November 2018), Pillar 2 ICAAP and stress testing (December 2017), SREP (November 2018), and Pillar 3 basic disclosures (December 2017). - Completion of Basel II implementation was extended out to Q1 2020, with no precise effective date for the country. - Gap analysis and QIS recommendation: - The CBL has not conducted a Basel I–Basel II gap analysis of prudential capital or produced estimates—critical to anticipate the likely impact of Basel II implementation. - The mission recommends the CBL run a QIS-like calculation applying Basel II/III capital requirements to the balance sheets of the four banks, at the consolidated level, as of June 30, 2019, to inform final Guidelines and anticipate adjustments. - It would be reasonable to expect a reduction from the 2018 Basel I sector-wide capital level of 18 percent, although to a level still above the legal minimum 8 percent, due to Basel II’s risk-sensitivity and banks’ higher-risk exposures (e.g., unsecured personal and mortgage lending). - ICAAP and stress testing: - The ICAAP Guideline should emphasize that ICAAP is fit-for-purpose, integrate explicit roles for stress testing, and guide banks on examining future capital under adverse scenarios. - The Supervisor must integrate ICAAP analysis into the broader supervisory work and use findings methodically in the RBS processes to determine supervisory intensity. - Supervisory enhancements and TA needs: - The CBL will necessitate technical assistance (TA) in the very short-run to enhance its RBS framework, supervisory practices, risk culture, and on- and off-site supervisory work to make them genuinely risk-based rather than compliance-like. - The CBL should pursue legislative amendments with some urgency to empower it to make regulations on supervisory matters beyond Basel I constraints. - Audit and disclosure practices: - The CBL should address the malpractice identified in audit arrangements that could undermine compliance with ISA and IFRS, and improve transparency by ensuring audited financial statements and required disclosures are published. *Source: 1lsoea2020001* ### 39. Arguably, Pillar 2 will provide the greatest opportunity to improve the strength and ### 1lsoea2020001 - 39. Arguably, Pillar 2 will provide the greatest opportunity to improve the strength and ### Pillar 2 and supervisory strengthening - Pillar 2 will provide the greatest opportunity to improve the strength and resilience of the banks in Lesotho, and the quality of the CBL supervision. - Expected outcomes as banks progress in their ICAAPs: - Risk management, governance processes and capital planning within the banks will evolve. - Supervisors' capabilities and SREP will become stronger through implementing Pillar 2, gaining rigor in risk assessments and views. - Implementation approach: - A progressive implementation of Pillar 2 will help achieve these objectives and encourage banks to build up existing risk management and capital assessment practices, including improving local boards' and managements' understanding of Lesotho’s issues and risks for foreign subsidiaries. - Timing and deliverables: - Pillar 2 should be implemented progressively, during 2020. - First, formal (not draft), Board-approved ICAAP documents to be submitted to the CBL no later than by June 30, 2020. ### Pillar 3 — disclosure requirements and transparency - Current status: - The CBL issued a Guideline with basic disclosure requirements for Pillar 3. - Recommended enhancements: - The Guideline should better adhere to the key disclosure principles and practices of the revised Basel III Pillar 3, and introduce some minimum disclosure templates related essentially to Basel III’s capital definition and requirements to improve transparency and rigor of disclosures. - Initially suggested templates include CC1 (Composition of Regulatory Capital), CC2 (Reconciliation of Regulatory Capital to Balance Sheets), KM1-Key Metrics and, LI1, LI2 and LIA (linkages between financial statements and prudential exposures) of the BCBS’s “Standards-Pillar 3 Disclosure Requirements – Consolidated and Enhanced Framework” (March 2017). - Publication and control expectations: - The CBL must ensure that banks’ Pillar 3 reports/disclosures published with the banks’ audited annual financial statements are made available on the banks’ websites and subject, at a minimum, to the same level of internal review and control processes as the audited financial statements. - As part of Basel II implementation, Pillar 3 disclosure requirements could become effective and mandatory for publishing with the banks’ audited annual financial statements for the year ending on December 31, 2020. - The CBL must require banks to place their full audited financial statements on their websites together with their Pillar 3 Prudential report/disclosures. ### Capital buffers, leverage ratio, and capital policy timing - Capital conservation buffer and countercyclical buffer: - The mission does not see grounds for implementing any Basel III capital buffer at this time. - The mission concurs with the 2017 mission that there are strong arguments for the CBL to include a capital conservation buffer as part of Basel III implementation, even as a tool to limit the ability of the South African parent banks to move capital out of their subsidiaries in Lesotho; however, the mission sees no urgency in setting a capital conservation buffer before the minimum Basel III capital requirements materialize. - It would be premature to consider a countercyclical buffer in Lesotho at this time. - Leverage ratio: - The mission does not see urgency for the CBL to introduce a leverage ratio under Basel III at this very time. - Rationale: the case for a leverage ratio to complement a risk-weighted capital regime is not strong for banks operating in Lesotho that undertake traditional banking activities and whose risk-weighted assets are more reflective of their total on and off-balance sheet assets. - Recommendation: aim to implement a leverage ratio in due course, but not until the other capital elements have been bedded down. - Vigilance on capital movements: - The mission flagged that the CBL must remain very vigilant as to South African parent banks moving capital outside the country, and as to all banks, including the government-owned bank, observing the restrictions placed by the FIA on dividend distributions. ### Liquidity, securitization, counterparty and market risk standards - Liquidity standards: - The CBL is not putting liquidity rules in place as part of its Basel II implementation. - Recommendation: focus on migrating to Basel II before seeking to adopt the Basel III liquidity standards that do not lend themselves well to Lesotho’s environment, where there is no secondary market that banks can use to obtain liquidity. - Observations: All three foreign subsidiaries rely on their parents’ support if under liquidity stress; the government-owned bank expects government support if needed. Banks do not have large lending books relative to deposits, but the CBL must remain alert to liquidity difficulties, even in foreign subsidiaries, to take early action as appropriate. - Other BCBS revisions: - The CBL has the option to incorporate BCBS revisions to the securitization framework, counterparty credit risk, and market risk requirements at a later date; there is no immediate need to rush these as the activities are either not present (securitization) or at a very low level in Lesotho banks. - The mission sensitized the CBL on recent revisions to the standardized approaches for credit, market and operational risks and recommended the CBL keep abreast and consider them in due time. ### Supervisory capacity, staffing, training, and IFRS 9 - BSD staffing and capability constraints: - Total staff at BSD consists of 9 persons out of which 3 have less than 3 years of working experience in the Division. - BSD has limited resources to deliver effective risk-based supervision and handle the work resulting from implementing Basel II; the integrity of BSD’s core supervisory activities may still be at risk. - BSD staff training and skills upgrade must be a top priority for the CBL’s activities and budget. - Training and secondments: - IMF TA missions can assist the BSD but cannot substitute for on-the-job training. - The mission encourages the CBL to pursue opportunities (e.g., short and medium-term secondments and aid funding) with other regional and non-regional supervisors to allow BSD staff to participate in on- and off-site supervision, particularly on Pillar 2 work. Note: the CBL already maintains an ongoing home-host supervisor relationship with the SARB. - Staff retention should be reinforced as banks often recruit supervisors. - IFRS 9 implementation: - IFRS 9 became effective in 2018, introducing significant challenges to both banks and the CBL. - The CBL did not require banks to estimate the impact of IFRS 9 ECL model on their accounting provisions and prudential capital, and had not made its own estimate or discussed effects in advance with banks. - The impact will become evident in banks’ annual financial statements as of December 31, 2018, when the ECL model became effective. - The Supervisor needs to understand issues related to IFRS 9 ECL model for provisions and their prudential treatment as regulated by the Basel Committee, including national discretion for a transitional arrangement to phase-in full impact on regulatory capital. - The CBL needs to upgrade the BSD’s skills by incorporating some IFRS and finance experts and may require TA in the very short-run. ### Key observations and prioritized recommendations - Progress and constraints: - The CBL has made very good progress in its migration to Basel II: drafting activities, consultations with banks, and submission of banks’ first draft ICAAP reports. - Constraints: CBL has a very small supervisory staff limiting the speed of migration; banks are resource constrained though they do not offer complex products or operate outside the country and appear comfortably capitalized. - Pillar 1: - Pillar 1 of Basel II should be ready to become effective on January 1, 2020. - The mission supports immediate finalization and issuance of final Pillar 1 Guideline(s) to become effective on January 1, 2020. - The CBL is adopting Basel III’s definition and prescription of capital and current approaches for credit and operational risks. - Pillar 2 timeline and tools: - Pillar 2 to progress during 2020 with Board-approved ICAAPs by June 30, 2020. - Enhance ICAAP Guideline to banks and supervisors’ Guideline on SREP to address weaknesses in banks’ risk management, corporate governance, and BSD supervisory skills. - Pillar 3 and transparency: - Enhance Pillar 3 Guideline to align with revised Pillar 3; require publication with audited annual financial statements for year ending December 31, 2020, and placement on banks’ websites. - CBL must rectify shortcomings in enforcing disclosure requirements and maintain its own website up-to-date. - Staffing and legal framework: - Be mindful of the small number of BSD staff when planning supervisory change. - BSD needs to prepare for IFRS challenges; TA is envisaged to train supervisors and review regulations. - The FIA may require amendments to enable CBL to gain necessary prudential regulatory powers; the mission recommends pursuing amendments to the FIA as a matter of some urgency. *Source: 1lsoea2020001* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1lsoea2020001.pdf_