## 1norea2020002 ## Source details **Canonical URL:** [1norea2020002](https://www.imf.org/-/media/files/publications/cr/2020/english/1norea2020002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1norea2020002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1norea2020002.pdf.json) --- ### Overview - Targeted review of selected aspects in the regulation and supervision of banks in Norway conducted as part of the 2020 Norway Financial Sector Assessment Program (FSAP). - Findings and recommendations are based on the regulatory framework in place and the supervisory practices employed at end-October 2019. - Review focus: - Powers, responsibilities, independence, and resourcing of Finanstilsynet (FSA). - FSA supervisory approach, enforcement powers, and practices. - Key aspects of the prudential framework (capital adequacy, credit risk, related party transactions and large exposures, liquidity and funding risks, operational risk, market risk). - Mechanisms to prevent abuse of financial services (AML/CFT). ### Market structure and key statistics - Financial sector assets: 270 percent of GDP at the end of 2018. - Sector composition of financial assets: - Banks: 52 percent - Mortgage and finance companies: 25 percent - Insurers: 19 percent - State-lending institutions: 4 percent - Banking sector: - Total banks: 141 (Domestic banks: 125; Subsidiaries of foreign banks: 2; Branches of foreign banks: 14) - Branches of foreign banks account for 35 percent of the banking system’s assets. - Savings banks: 97 (of domestic banks) - Capital and profitability: - CET1 capital adequacy ratio: 16.1 percent at end-March 2019. - Pre-tax profits: 1.26 percent of average total assets in 2018. - Return on equity: 11.5 percent. - Asset composition and quality: - Retail lending: 60 percent of banks' total lending (Residential mortgages: 91 percent of retail lending; Unsecured consumer loans: 4 percent). - CRE lending: 40 percent of loans to domestic corporate customers at end of 2018. - NPLs: below one percent overall; NPLs in unsecured consumer lending: 8 percent of the consumer lending portfolio at end-June 2019. - Real estate and household leverage: - Residential real estate price index: risen by 70 percent over a 10-year period. - CRE prices: risen by about 60 percent over the past decade. - Average debt burden of Norwegian households: 231 percent at the end of 2018. - Funding and liquidity: - Market funding: 48 percent of total funding at end-March 2019. - Customer deposits: 40 percent of total funding at end-March 2019. - Covered bonds: about half of market funding at end-March 2019; accounted for 29 percent of banks’ liquid assets at end-March 2019. ### FSA powers, independence, and resources - Strengths and recent enhancements: - Higher regulatory requirements for banks’ capital. - Limits on banks’ credit risks, particularly in real estate lending. - Updates to supervisory modules and development of supervisory risk assessment tools. - New legal framework for AML/CFT. - Some expansion in supervisory resources. - Key constraints and concerns: - MoF sets key prudential regulations, can issue and withdraw bank licenses (delegated to FSA in some cases), sets annual goals for FSA, and can issue instructions to FSA. - MoF can overturn FSA decisions through an appeal process available to supervised entities; all FSA supervisory decisions and measures can be reviewed by the MoF. - FSA expenses are financed by levies on supervised institutions, but the FSA budget is subject to direct control by the MoF, limiting FSA’s ability to increase resources in line with needs and priorities. - Staffing and budget trends: - Number of Permanent Staff: 2016 = 270; 2017 = 276; 2018 = 302; Average Annual Change (percent) = 5.9 - Actual overall FTE: 2016 = 253.5; 2017 = 251; 2018 = 254; Average Annual Change (percent) = 0.1 - Actual FTE - Overall Banking Supervision: 2016 = 57.9; 2017 = 58.1; 2018 = 58.4; Average Annual Change (percent) = 0.5 - FSA budget: 343.3 million NOK in 2015 to 426.3 million NOK in 2019; average annual increase = 4.8 percent. - Recommendations (selected): - Empower the FSA to issue prudential regulations and to decide on granting/withdrawal of bank licenses, transfers of significant ownership, and major acquisitions. (MoF, Government; ¶16, 19, 27) — ST - Limit the powers of the MoF to issue instructions to the FSA and decide on appeals to the FSA supervisory decisions and measures. (MoF, Government; ¶18, 23, 27) — ST - Give the FSA more budgetary autonomy to ensure that it has enough resources to carry out its mandate effectively. (MoF, Government; ¶24−26, 27) — ST - Enact legislative changes to require public disclosure of reasons for removal from office of the FSA board members and director general. ### Supervisory approach, intrusiveness, and corrective actions - Current approach: - Robust supervisory framework focused mostly on large and systemic banks; increased regular offsite analysis for medium and small banks since last FSAP. - Onsite inspections and interaction with banks’ management remain concentrated on systemic and large banks. - Well-established cross-border supervisory cooperation with home authorities of foreign banking entities, including supervisory colleges. - Findings and gaps: - Supervisory approach could be more risk-oriented by giving greater consideration to banks’ risk profiles alongside size. - Increase supervisory activities over medium and small banks with high-risk profiles, including higher frequency of onsite inspections. - Strengthen monitoring and supervision of systemic branches of foreign banks in Norway, especially those receiving low scrutiny from home supervisors. - FSA has limited sanctioning powers; laws do not provide FSA with the power to apply fines except in the case of breaches to the AML act. - Reliance on moral suasion; FSA rarely resorts to formal corrective actions. - Recommendations (selected): - Further consider banks’ risks in planning supervisory activities and increase frequency of onsite inspections of medium and small banks with high risks. (FSA; ¶30, 32, 33, 39) — I - Strengthen monitoring and supervision of systemic foreign bank branches. (FSA; ¶34, 36, 39) — ST - Continue advancing banks’ recovery and resolution planning, particularly for systemic and large banks. (FSA; ¶37, 39) — MT - Grant the FSA legal powers to apply significant fines and sanctions in case of banks’ breaches of legal and prudential requirements. (MoF, Government; ¶43, 45) — ST - Consider establishing a quality assurance or internal audit function to periodically check FSA supervisory processes. ### Capital adequacy and EU transposition implications - Current position: - Norwegian banking system is well capitalized; CET1 ratio 16.1 percent at end-March 2019 (compared to 13.0 percent at end-December 2014 and 7.3 percent at year-end 2008). - Systemwide leverage ratio: 7.6 percent at end-March 2019. - All banks met risk-based capital and leverage ratio minimum requirements at end Q1−2019. - Norway requires Capital Conservation buffer of 2.5 percent and a Countercyclical Capital Buffer (CCyB) that was set at 2 percent at time of mission and increased to 2.5 percent at end-2019. - Leverage ratio buffer: additional 2-percentage point buffer above global minimum leverage ratio of 3 percent (total 5 percent); D-SIBs required to maintain an additional one percentage point buffer. - Concerns from transposition of EU framework: - Adoption of EU CRD IV/CRR will limit authorities' room to maintain more rigorous standards and weakens some existing requirements. - Removal of Basel I floor and introduction of SME supporting factor will reduce banks' capital requirements. - FSA estimate: removal of Basel I floor and introduction of SME factor will increase CET1 ratio by 1.3 percentage points (based on year-end 2018 data). - Recommendations: - Authorities should determine and monitor implications of adoption of EU rules on banks’ capital and use available tools, including Pillar 1 and Pillar 2 measures, to maintain Norwegian banks' capital levels. - Given limited IRB data, stricter model calibration requirements are needed. - The FSA should continue to provide banks with a transparent and detailed description of its Pillar 2 approach and decisions. (MoF, FSA; ¶56) — I ### Credit risk and real estate exposures - Overall: - Credit risk is predominant exposure; real estate exposures represent approximately three-quarters of bank lending. - Residential mortgage lending accounts for approximately 54 percent of banks’ total lending at end-June 2019; home ownership: 77 percent. - Losses on residential real estate loans are low: total loan losses at end-March 2019 around 0.1 percent of average total assets. - Prudential measures and effects: - Temporary prudential regulations governing residential real estate lending adopted in 2015, extended in 2018, and extended further until end-2020 (affordability test, DTI limits, LTV limits, flexibility quotas). - Mortgage regulations appear to have dampened debt growth and house price inflation in areas with high DTI borrowers. - For IRB banks, Norway adopted a 20 percent floor for LGD parameter for exposures secured by residential real estate (global minimum standard: 10 percent). - IRB data limitations: - IRB banks account for approximately 80 percent of assets. - Through-the-cycle historical loan loss data for residential mortgages is extremely scarce or nonexistent. - FSA measures in 2014: minimum PD for mortgage loans of 20 basis points (versus global PD floor of 3 basis points); methodology linking LGD to LTV with LGD floor of 20 percent. - CRE and consumer lending: - CRE: approximately 14 percent of banks’ total lending; about 40 percent of domestic corporate lending. CRE losses less than 1 percent; CRE prices up about 60 percent over past decade. - Consumer lending: 3.6 percent of total lending; growth 10.3 percent (March 31, 2019); NPLs for consumer loans: 8 percent at end-March 2019. - Recommendations (selected): - Develop supervisory guidance on prudential aspects of loan loss provisioning and the valuation of real estate. (FSA; ¶57, 70, 71) — I - Continue oversight of banks’ models and risk management of real estate loans. (FSA; ¶64, 71) — I - Develop specific guidance on CRE exposures and their risk management. (FSA; ¶67, 71) — I - Make temporary prudential residential real estate regulations permanent where they address structural risks. - Require IRB banks to demonstrate IRB data sets for residential real estate and CRE are sufficiently robust or justify adequacy. ### Liquidity and funding risk - Structure and exposures: - Funding mainly from customer deposits and market funding; market funding: 48 percent of total funding at end-March 2019. - Covered bonds: significant portion of funding and liquid assets; about half of market funding and 29 percent of liquid assets at end-March 2019. - High reliance on foreign currency funding (EUR and USD) hedged via swaps. - Regulatory and supervisory framework: - LCR requirement in force since end 2015; minimum LCR in significant currencies since September 30, 2017. - For banks with significant foreign currency exposures: minimum foreign currency LCR of 100 percent; NOK LCR minimum set at 50 percent for those banks. - NSFR is reported quarterly (including in significant currencies) but not yet a binding requirement; authorities plan to implement NSFR according to EU timeline. - Covered bond and HQLA concerns: - Norwegian transposition requires at least 30 percent of liquid assets to be Level 1 assets excluding covered bonds, allowing high-quality covered bonds to account for a major portion of Level 1 assets. - Concentration of covered bonds in banks’ LCR buffers and limited availability of alternative NOK Level 1 assets. - Supervisory practice gaps: - Few targeted liquidity inspections over last three years (six targeted inspections on market and/or liquidity risks); an increase in targeted inspections planned and realized in 2019. - Liquidity stress testing exists but should be more frequent and include separate analysis by significant currency. - Recommendations: - Introduce NSFR requirements and continue NSFR reporting in significant currencies. (MoF, FSA; ¶79, 83) — ST - Conduct foreign currency liquidity stress tests to check banks’ resilience to shocks in derivatives markets. - Monitor banks’ reliance on covered bonds and ensure adequate liquidity buffers. (FSA; ¶80, 83) — I - Perform more frequent targeted and thematic reviews of banks’ liquidity and funding management. (FSA; ¶81, 83) — I - Require banks to formulate strategy and assess liquidity needs in each significant currency. ### Operational and market risk - Market risk: - Market/trading risk exposure is not material for most banks; market RWAs ≈ 0.5 percent of total RWAs. - Norway not yet updated to latest global market risk standard (FRTB); follows EU roadmap. - Market risk supervisory guidance is thorough, with inspections focused on larger institutions. - Operational risk: - Strong supervisory focus on ICT risks; less focus on non-ICT operational risks. - Regulatory framework and supervisory modules cover outsourcing, ICT, and operational risk; 161 outsourcing notifications received in 2018 (60-day notification requirement). - Recommendations: - Expand operational risk guidance and oversight to take greater account of non-ICT operational risk management. (FSA; ¶89, 91) — ST - Develop specific requirements for outsourcing of risk management and enhance supervisory practice, especially for small banks. ### AML/CFT (financial integrity) - Legal and institutional changes: - New AML/CFT Act and regulation in force October 2018, transposing parts of the fourth and fifth AML Directives and implementing FATF recommendations. - New legal framework strengthens customer due diligence, ongoing monitoring, reporting, and provides legal basis for administrative fines and sanctions. - FSA supervisory developments: - FSA developed risk assessments in 2016, updated in 2018, and a new methodology finalized in Q1 2019. - A risk classification model ranks institutions’ inherent ML/TF risk using over 30 data points; model needs further testing and supplementation. - AML/CFT resources: almost doubled from 5 FTEs in 2014 to about 10.5 FTEs by 2018; five new staff recruited in early 2019; FSA AML/CFT section established April 2019; current FTEs reported as 13,5 in FATF follow-up. - Supervisory activity and FATF findings: - AML/CFT issues covered in 73 inspections over 2014–2018; mostly full-scope inspections rather than targeted/thematic inspections. - FATF follow-up assessment (December 2019) noted improvements but found overall level of effectiveness remains moderate; Norway moved from enhanced to regular follow-up. - FATF recommended increased supervision intensity, better use of sanctioning powers, and improvements in effectiveness across remaining immediate outcomes. - FSA sanctions and enforcement: - Cease and desist orders issued in 2018 and 2019; coercive fines threatened but not always imposed; two administrative fines imposed on banks in 2019. - Recommendations (selected): - Increase frequency of AML/CFT targeted and thematic onsite inspections, including for branches of foreign banks. (FSA; ¶95, 98) — I - Further improve risk-based AML/CFT supervision by enhancing the risk rating model and developing supervisory tools and methodologies. (FSA; ¶93, 98) — I - Continue to use new sanctioning powers and review their effectiveness. ### Related party transactions and large exposures - Legal framework updates and limitations: - Financial Institutions Act updated to revise definition of related parties but still does not include shareholders unless they have controlling interests. - Framework requires related party transactions to be in accordance with ordinary business terms between independent parties but specifies only credit and guarantees. - Large exposures: - Regulatory framework consistent with and in some respects exceeds global minimums; primary limit on large exposures is 25 percent of a bank’s Tier 1 capital (exceptions exist). - Large exposures regulation repealed from December 31, 2019 and replaced by framework based on CRR/CRD IV with national discretions continued. - Recommendations: - Expand the legal definition of related parties to include all significant shareholders and expand scope of related party framework to include all transactions with related parties. (MoF, FSA; ¶72, 76) — MT - Amend Financial Institutions Act so it is not limited to transactions related only to credit exposures and provision of guarantees. ### Key prioritized recommendations (selected from Table 1 summary) - Empower the FSA to issue prudential regulations and to decide on granting/withdrawal of bank licenses, transfers of significant ownership, and major acquisitions. (MoF, Government; ¶16, 19, 27) — ST - Limit powers of the MoF to issue instructions to the FSA and decide on appeals to FSA supervisory decisions and measures. (MoF, Government; ¶18, 23, 27) — ST - Give the FSA more budgetary autonomy. (MoF, Government; ¶24−26, 27) — ST - Further consider banks’ risks in planning supervisory activities and increase onsite inspections for medium and small banks with high risks. (FSA; ¶30, 32, 33, 39) — I - Grant the FSA legal powers to apply significant fines and sanctions for breaches of legal and prudential requirements. (MoF, Government; ¶43, 45) — ST - Introduce NSFR requirements and continue NSFR reporting in significant currencies. (MoF, FSA; ¶79, 83) — ST - Develop guidance on loan loss provisioning and valuation of real estate, and develop guidance on CRE exposures. (FSA; ¶57, 67, 70, 71) — I - Increase frequency of AML/CFT targeted and thematic inspections and enhance AML/CFT risk rating and supervisory tools. (FSA; ¶93, 95, 98) — I *Source: Executive Summary of the 2020 Norway FSAP targeted review (based on regulatory framework and supervisory practices as of end-October 2019).* ### EXECUTIVE SUMMARY____________________________________________________________________________6 ### EXECUTIVE SUMMARY ### Overview - This note presents a targeted review of selected aspects in the regulation and supervision of banks in Norway conducted as part of the 2020 Norway Financial Sector Assessment Program (FSAP). - Findings and recommendations are based on the regulatory framework in place and the supervisory practices employed at end-October 2019. - The review focuses on: - Powers, responsibilities, independence, and resourcing of Finanstilsynet (FSA). - FSA supervisory approach, enforcement powers, and practices. - Key aspects of the prudential framework (capital adequacy, credit risk, related party transactions and large exposures, liquidity and funding risks, operational risk, market risk). - Mechanisms to prevent abuse of financial services (AML/CFT). ### FSA powers, independence, and resources - Strengths and recent enhancements: - Higher regulatory requirements for banks’ capital. - Limits on banks’ credit risks, particularly in real estate lending. - Updates to supervisory modules and development of supervisory risk assessment tools. - A new legal framework for Anti-Money Laundering and Countering the Financing of Terrorism (AML/CFT). - Some expansion in supervisory resources. - Key findings and concerns: - The Ministry of Finance (MoF) plays a major role in financial regulation and operational supervisory issues: sets key prudential regulations, can issue and withdraw bank licenses (delegated to FSA in some cases), sets annual goals for FSA, and can issue instructions to FSA. - The MoF can overturn FSA decisions through an appeal process available to the financial industry. - FSA expenses are financed by levies on supervised institutions, but the FSA budget is subject to direct control by the MoF, limiting the FSA’s ability to increase resources in line with needs and priorities. - Policy recommendations: - Empower the FSA to issue prudential regulations and to decide on: granting/withdrawal of bank licenses, transfers of significant ownership, and major acquisitions. (MoF, Government; ¶16, 19, 27) — ST - Limit the powers of the MoF to issue instructions to the FSA and decide on appeals to the FSA supervisory decisions and measures. (MoF, Government; ¶18, 23, 27) — ST - Give the FSA more budgetary autonomy to ensure that it has enough resources to carry out its mandate effectively. (MoF, Government; ¶24−26, 27) — ST ### Supervisory approach, intrusiveness, and corrective actions - Current approach: - Robust supervisory framework focused mostly on large and systemic banks. - Increased regular offsite analysis for medium and small banks since the last FSAP. - Onsite inspections and interaction with banks’ management remain concentrated on systemic and large banks. - Well-established cross-border supervisory cooperation with home authorities of foreign banking entities, including supervisory colleges. - Findings and suggestions: - Supervisory approach could be more risk-oriented by giving greater consideration to banks’ risk profiles alongside size. - Increase supervisory activities over medium and small banks with high-risk profiles, including higher frequency of onsite inspections. - Strengthen monitoring and supervision of systemic branches of foreign banks in Norway, especially those receiving low scrutiny from home supervisors. - Continue advancing banks’ recovery and resolution planning, particularly for systemic and large banks. - Consider granting the FSA legal powers to apply significant fines and sanctions for breaches of legal and prudential requirements. - Policy recommendations: - Further consider banks’ risks in planning supervisory activities and increase the frequency of onsite inspections of medium and small banks with high risks. (FSA; ¶30, 32, 33, 39) — I - Strengthen monitoring and supervision of systemic foreign bank branches. (FSA; ¶34, 36, 39) — ST - Continue to advance work on banks’ recovery and resolution planning, particularly for systemic and large banks. (FSA; ¶37, 39) — MT - Grant the FSA legal powers to apply significant fines and sanctions in case of banks’ breaches of legal and prudential requirements. (MoF, Government; ¶43, 45) — ST ### Capital adequacy and related implications of EU transposition - Situation and strengths: - Norwegian banking system is well capitalized. - All Norwegian banks maintain risk-based capital and leverage ratios above minimum requirements (including capital buffers). - Strong asset quality, stable and sustained profitability, and retention of earnings have contributed to strong capital buffers. - Concerns with forthcoming EU framework adoption: - Norway’s adoption of the EU framework (as part of the EEA agreement) will limit authorities' room to maintain more rigorous standards and weakens some existing requirements. - Removing the Basel I floor and introducing the SME supporting factor will reduce banks' capital requirements. - Policy recommendations: - Authorities should determine and monitor the implications of the adoption of the EU rules on banks’ capital. - Authorities are encouraged to use available tools, including Pillar 1 and Pillar 2 measures, to maintain Norwegian banks' capital levels. - Given limited data for estimation and validation of IRB models and reduced risk weights over time, stricter model calibration requirements are needed. - The FSA should continue to provide banks with a transparent and detailed description of its Pillar 2 approach and decisions. - Monitor the implications of the transposition of the EU rules on banks’ capital and take actions to maintain strong capital levels. (MoF, FSA; ¶56) — I ### Credit risk and real estate exposure - Findings: - Credit risk, particularly in real estate lending, is the predominant risk exposure among Norwegian banks. - Temporary prudential regulations governing residential real estate lending appear to have successfully dampened debt growth and house price inflation. - Dearth of historical loan loss data for banks using the Internal Ratings-Based (IRB) approach warrants continued enhancements in oversight of banks’ modeling and risk management practices for real estate lending. - Policy recommendations: - Develop supervisory guidance on prudential aspects of loan loss provisioning and the valuation of real estate. (FSA; ¶57, 70, 71) — I - Continue oversight of banks’ models and risk management of real estate loans. (FSA; ¶64, 71) — I - Develop specific guidance on commercial real estate (CRE) exposures and their risk management. (FSA; ¶67, 71) — I - Make temporary prudential regulations governing residential real estate lending permanent where they address structural risks. ### Liquidity and funding risk - Findings: - Scope to strengthen prudential oversight of banks’ liquidity beyond monitoring of compliance with the Liquidity Coverage Ratio (LCR). - The Net Stable Funding Ratio (NSFR), currently reported by banks, should be introduced as a requirement according to the EU framework timeline. - Banks rely on the swap market to hedge considerable foreign currency funding. - Banks’ reliance on covered bonds to meet liquidity and funding requirements is significant; covered bonds are used in LCR buffers and cross-holdings among banks are prevalent. - Policy recommendations: - Introduce NSFR requirements and continue NSFR reporting in significant currencies. (MoF, FSA; ¶79, 83) — ST - Conduct foreign currency liquidity stress tests to check banks’ resilience to shocks in derivatives markets. - Monitor banks’ reliance on covered bonds in their liquidity and funding, and ensure they have adequate liquidity buffers. (FSA; ¶80, 83) — I - Perform more frequent targeted and thematic reviews of banks’ liquidity and funding management. (FSA; ¶81, 83) — I ### Operational and market risk - Findings: - Operational risk guidance and oversight could be expanded to take greater account of non-ICT operational risk management. - Policy recommendation: - Expand operational risk guidance and oversight to take greater account of non-ICT operational risk management. (FSA; ¶89, 91) — ST ### AML/CFT (Financial integrity) - Progress and findings: - FSA has strengthened its AML/CFT supervisory approach and the legal framework has been updated. - There is scope to continue expanding supervisory resources and activities in AML/CFT. - The FSA should increase AML/CFT onsite inspections of banks, including branches of foreign banks, particularly in the form of targeted and thematic inspections. - The FSA should continue to use the new sanctioning powers under the new AML act and review their effectiveness. - The FSA could further improve its risk-based approach by enhancing its risk classification model and developing AML/CFT supervisory tools and methodologies. - Policy recommendations: - Increase the frequency of AML/CFT targeted and thematic onsite inspections. (FSA; ¶95, 98) — I - Further improve the risk-based approach to AML/CFT supervision by enhancing the risk rating model and developing relevant supervisory tools and methodologies. (FSA; ¶93, 98) — I ### Related party transactions and large exposures - Findings: - Norway’s legal framework for related party transactions has been updated to correct previously identified deficiencies, including a revised definition of related parties. - The revised definition still does not include shareholders unless they have controlling interests. - The framework requires transactions with related parties to be in accordance with ordinary business terms between independent parties, but it specifies only credit and guarantees. - Policy recommendation: - Expand the legal definition of related parties to include all significant shareholders and expand the scope of the related party framework to include all transactions with related parties. (MoF, FSA; ¶72, 76) — MT ### Key recommendations (Table 1 summary) - Empower the FSA to issue prudential regulations, and to decide on: granting/withdrawal of bank licenses, transfers of significant ownership, and major acquisitions. (MoF, Government; ¶16, 19, 27) — ST - Limit the powers of the MoF to issue instructions to the FSA and decide on appeals to the FSA supervisory decisions and measures. (MoF, Government; ¶18, 23, 27) — ST - Give the FSA more budgetary autonomy to ensure that it has enough resources to carry out its mandate effectively. (MoF, Government; ¶24−26, 27) — ST - Further consider banks’ risks in planning supervisory activities and increase the frequency of onsite inspections of medium and small banks with high risks. (FSA; ¶30, 32, 33, 39) — I - Strengthen monitoring and supervision of systemic foreign bank branches. (FSA; ¶34, 36, 39) — ST - Continue to advance work on banks’ recovery and resolution planning, particularly for systemic and large banks. (FSA; ¶37, 39) — MT - Grant the FSA legal powers to apply significant fines and sanctions in case of banks’ breaches of legal and prudential requirements. (MoF, Government; ¶43, 45) — ST - Develop specific guidance on prudential aspects related to loan loss provisioning and the valuation of real estate. (FSA; ¶57, 70, 71) — I - Continue oversight of banks’ models and risk management of real estate loans. (FSA; ¶64, 71) — I - Develop specific guidance on CRE exposures and their risk management. (FSA; ¶67, 71) — I - Expand the legal definition of related parties to include all significant shareholders and the scope of the related party framework to include all transactions with related parties. (MoF, FSA; ¶72, 76) — MT - Introduce NSFR requirements and continue NSFR reporting in significant currencies. (MoF, FSA; ¶79, 83) — ST - Monitor the implications of the transposition of the EU rules on banks’ capital and take actions to maintain strong capital levels. (MoF, FSA; ¶56) — I - Monitor banks’ reliance on covered bonds in their liquidity and funding, and ensure they have adequate liquidity buffers. (FSA; ¶80, 83) — I - Perform more frequent targeted and thematic reviews of banks’ liquidity and funding management. (FSA; ¶81, 83) — I - Expand operational risk guidance and oversight to take greater account of non-ICT operational risk management. (FSA; ¶89, 91) — ST - Increase the frequency of AML/CFT targeted and thematic onsite inspections. (FSA; ¶95, 98) — I - Further improve the risk-based approach to AML/CFT supervision by enhancing the risk rating model and developing relevant supervisory tools and methodologies. (FSA; ¶93, 98) — I *Source: Executive Summary of the 2020 Norway FSAP targeted review (based on regulatory framework and supervisory practices as of end-October 2019).* ### 4. This note is structured as follows. The next two sections of this part discuss the market ### 1norea2020002 - 4. This note is structured as follows. The next two sections of this part discuss the market ### B. Market Structure - Financial sector assets totaled 270 percent of GDP at the end of 2018. - Sector composition of financial assets: - Banks: 52 percent - Mortgage and finance companies: 25 percent - Insurers: 19 percent - State-lending institutions: 4 percent - Banking sector structure: - Total banks: 141 - Domestic banks: 125 - Subsidiaries of foreign banks: 2 - Branches of foreign banks: 14 - Domestic banks by type: - Savings banks: 97 - Commercial banks: remainder - Branches of foreign banks account for 35 percent of the banking system’s assets. - After 2017 branchification of the second largest bank, three of the four largest banks are branches of foreign banks. - Largest banks and insurance companies are part of financial conglomerates. - Capital adequacy and profitability: - CET1 capital adequacy ratio: 16.1 percent at end-March 2019 (more than doubled during the period to reach this level). - Pre-tax profits: 1.26 percent of average total assets in 2018 (rose to same level as pre-international financial crisis years). - Return on equity: 11.5 percent during same period. - Asset composition and quality: - Retail lending: 60 percent of banks' total lending - Residential mortgages: 91 percent of retail lending - Unsecured consumer loans: 4 percent of retail lending - Commercial real estate (CRE) lending: 40 percent of loans to domestic corporate customers at end of 2018. - Nonperforming loans (NPLs): below one percent overall. - NPLs in unsecured consumer lending: 8 percent of the consumer lending portfolio at end-June 2019. - Real estate valuations and household leverage: - Overall residential real estate price index: risen by 70 percent over a 10-year period (with higher appreciation in Oslo). - CRE prices: risen by about 60 percent over the past decade. - Average debt burden of Norwegian households: 231 percent at the end of 2018 (up 3 percentage points from the previous year). - Funding and liquidity: - Market funding: 48 percent of total funding at end-March 2019. - Customer deposits: 40 percent of total funding at end-March 2019. - Covered bonds: about half of market funding at end-March 2019; accounted for 29 percent of banks’ liquid assets at end-March 2019. - Market funding components: senior bonds, covered bonds, short-term market funding including interbank debt. - Increased reliance on covered bonds contributes to longer maturities and favorable prices but creates systemic risk via cross-ownership among banks and interlinkages with the housing market. ### C. Institutional Setting - Legal and regulatory framework: - Norwegian rules largely derived from EU legislation and transposed into Norwegian law as an EEA member, sometimes requiring Joint Committee adaptation. - Draft laws proposed by the Ministry of Finance (MoF), approved by the Cabinet (King in Council), then submitted to Parliament. - Powers to issue regulations usually given to the Cabinet, often delegated to the MoF; in some cases further delegated to the FSA in the form of circulars. - Key institutions and roles: - Financial Supervisory Authority (FSA): - Designated by the Financial Supervision Act as the financial sector supervisor. - Government agency responsible for supervision of banks, other credit institutions, payment institutions, insurance companies, pension funds, securities and investment firms, and audit firms. - Resolution authority in Norway; decisions of significance for financial stability are taken by the MoF. - Charged with ensuring supervised entities safeguard the interests and rights of consumers (Section 3 of the Financial Supervision Act). - Norges Bank: - Central bank; objectives and functions set out in section 1−2 of the Central Bank Act. - Objectives include maintaining monetary stability, promoting stability of the financial system, promoting an efficient and secure payment system. - Has executive and advisory authority for monetary policy and promotion of financial stability; acts as lender of last resort. - Økokrim: national authority for investigation and prosecution of economic and environmental crime and Norway’s Financial Intelligence Unit (FIU). - Recent legislative changes: - Financial Institutions Act entered into force January 2016. - Act on the Norwegian Banks’ Guarantee Fund and amendments to the Financial Institutions Act passed March 2018 and entered into force January 2019 (transpose EU Bank Recovery and Resolution Directive and Deposit Guarantee Directive). - New AML act and regulation came into force October 2018, transposing parts of the fourth and parts of the fifth AML Directive (directive 2015/849) and implementing FATF recommendations. ### SUPERVISORY OBJECTIVES, POWERS, INDEPENDENCE, AND RESOURCES #### A. Supervisory Objectives and Powers - Legal objectives: - Section 3 of the Financial Supervision Act assigns the FSA responsibility to ensure supervised entities operate appropriately and in accordance with law and provisions. - Norges Bank objectives include executive and advisory roles for monetary, credit, and foreign exchange policy; lender of last resort; promotion of an efficient payment system. - Overlapping responsibilities and coordination: - MoF is macroprudential authority; FSA and Norges Bank advise on macroprudential measures. - Both Norges Bank and the FSA publish financial stability reports. - FSA’s financial stability analysis supports risk-based supervision, monitoring macroeconomic developments and systemic trends, evaluating and recommending macroprudential measures. - Both institutions have supervisory responsibilities in the payment system: FSA supervises individual institutions; Norges Bank responsible for the whole system, settlement and clearing oversight. - Division of regulatory powers: - MoF sets minimum key prudential requirements; Financial Institutions Act gives MoF power to set prudential regulations. - FSA assesses banks’ risks and enforces laws and regulations set by MoF. - FSA has limited prudential powers (stipulated by the Financial Institutions Act or delegated) such as issuing regulations in accounting, external and internal audit and control, outsourcing, and reporting. - FSA may issue guidelines or prudential guidance in circular letters (do not have same legal status as laws and regulations). - MoF often asks FSA to prepare or propose new regulations; final MoF regulations do not always reflect FSA advice. - Supervisory measures available to FSA: - Under Financial Institutions Act (section 14−6), FSA can issue measures against institutions that do or are likely to fall short of minimum prudential requirements or buffers, including: - changing organization, management, control and strategies; - holding capital in excess of minimum requirements; - reducing business risks or changing business activities; - reducing asset-liability mismatches; - curbing scope of performance-related remuneration; - limiting dividend payouts. - Under Financial Supervision Act (Section 4), FSA can order supervised entities to: - arrange audits or internal control in accordance with FSA rules; - restrict credit to a customer to a lower amount than the statutory minimum; - alter composition of the control committee; - rectify matters where an institution’s bodies fail to discharge duties according to law; - rectify any inappropriate investment of the institution’s funds. - Limitations and appeal process: - All FSA supervisory decisions and measures can be reviewed by the MoF. - Supervised entities can complain or appeal to the MoF; MoF can rule in favor or against the FSA decision. - Over the last five years, 13 bank-related FSA decisions were appealed to the MoF (including pillar 2 requirements, changes to IRB model requirements, exemptions from prudential requirements, and licensing decisions). - MoF has accepted two appeals where it ruled against the FSA’s decisions; many appeals still pending and some take a long time to be reviewed due to technical nature. - The setup risks subjecting appeals to nontechnical considerations and could hamper effectiveness of supervisory oversight; consideration should be given to ensure appeals are decided by specialized independent bodies. - Licensing and revocation powers: - Applications for banking licenses are reviewed by the FSA; MoF has ultimate power to decide on granting a license. - In practice, MoF decides on applications of major importance or precedent-setting cases; FSA makes recommendations. - FSA decides on other cases under powers delegated by MoF. - Power to revoke a banking license given to MoF under Financial Institutions Act (Section 3−7); these powers are delegated to the FSA for licensing powers delegated by MoF to the FSA. - MoF is responsible for decisions on significant changes in banks’ ownership (qualifying holdings), but these powers are delegated to the FSA except for cases of significance or principal character and for institutions of material importance. - Acquisitions of a qualifying holding in a financial institution in non-EEA countries also require authorization by the MoF. #### B. Supervisory Independence - Governance and appointments: - FSA governed by a non-executive board and managed by a director general. - FSA board appointed by MoF for four years; consists of five persons plus two alternates plus two staff members; Norges Bank has an observer on the board. - Director General appointed by the King in Council (Cabinet) for six-year terms. - Financial Supervision Act does not specify cases and conditions for dismissal of FSA Board members and Director General. - Civil Servant Act (Section 15) applies to appointment and dismissal of director general and staff; dismissal in cases of gross negligence or improper behavior. - No obligation to publicly disclose reason of removal from office, unlike Basel Core Principles requirement (BCP 2–EC2). - Areas where operational independence may be compromised: - MoF powers that may influence FSA: - set annual goals to the FSA and issue instructions; - review and reverse FSA supervisory decisions and actions; - set and define FSA’s budget and total resources. - Authorities indicate MoF competence based on constitutional principles governing relationships between legislative and executive branches; these principles apply to all state agencies but could compromise FSA operational independence and ability to fulfill mandate. - MoF control of priorities and resources: - MoF issues annual letter of allocation to the FSA setting budget, goals, and priorities for upcoming year; letter forms basis of FSA’s annual workplan and may include additional tasks throughout year. - Goals and priorities represent MoF priorities which often, but not always, concur with FSA’s goals and priorities. - Additional tasks include requests for studies, drafting legislation, and reports on operational issues. - Example where priorities might differ: regulatory sandbox being established by FSA in line with MoF expectations. - MoF instructions and examples: - MoF can instruct FSA on dealing with prudential and operational supervisory issues and there have been examples in recent years: - 2016 letter from MoF expressed views on how FSA should handle pillar 2 requirements, requesting more predictability and transparency in calculation models and methods. - In insurance, FSA decided to reduce maximum interest rate of technical provisions in life insurance but MoF instructed FSA not to reduce that rate. - FSA may suggest amendments to laws and regulations which MoF may choose not to act upon. *Prepared by Rachid Awad (IMF) and William Coen (IMF external expert), with contributions from Maksym Markevych (IMF) for the section on financial integrity.* ### 24. The FSA is subject to a transparent and thorough accountability framework. The FSA ### The FSA is subject to a transparent and thorough accountability framework. ### Accountability and reporting - The FSA reports to the MoF and the Parliament through published annual reports; annual reports cover performance, operations, and resource spending. - Confidential issues are covered in separate annual and ad hoc reports. - The FSA prepares four-year strategic plans setting main objectives and immediate goals. - Annual plan of operations sets measures and tasks to support each operational goal in the strategy. - The FSA provides the MoF: - a separate report on its performance and achievements within each operational goal set in the strategy; and - other regular and ad hoc reports in a number of areas. ### Supervisory resources and budgeting - The budget of the FSA is under the direct control of the MoF. - The FSA prepares an annual budget proposal based on its assessment of required supervisory resourcing and staffing; the MoF decides on the budget and sets limits to FSA’s total resources as part of the government budget, subject to parliamentary approval. - The budget is covered in full by levies from supervised entities in accordance with Section 9 of the Financial Supervision Act. - The budget is granted on condition of use in accordance with goals and priorities given in the government budget and the letter of allocation. - The FSA may present proposals to the MoF to allocate funds to new areas to cover increases in expenditures beyond FSA control; such changes are usually submitted by the MoF to the Parliament for approval. - The FSA periodically assesses existing skills and projected requirements; additional support options suggested include external benchmarking exercises and independent resource evaluation. ### Constraints from letters of allocation and budget authorizations - Letters of allocation have repeatedly indicated expectations to operate under tighter budgets going forward and to include reform on reducing bureaucracy and creating efficiencies (such as more reliance on automated and IT tools) as integral to budgetary procedures. - Expenses exceeding the FSA’s operating budget must be authorized by the MoF and must be offset by savings over the next five years. - Management of some budget line items requires authorization by the MoF; some authorizations are delegated yearly to the FSA while others remain with the ministry. These authorizations limit FSA autonomy and flexibility in budget management. - Specific delegation notes (2019 letter of allocation): - budget authorization delegated to the FSA for entering into agreements to purchase services within the year’s appropriations; - the lease for office premises is not delegated to the FSA; - budget authorization required by the MoF for transfer of unused appropriations from one year to the other and reallocation from operating expenses to major equipment purchases and maintenance. ### Staffing and resource trends (Table 2 — FSA staffing resources) - Number of Permanent Staff: 2016 = 270; 2017 = 276; 2018 = 302; Average Annual Change (percent) = 5.9 - Actual overall FTE: 2016 = 253.5; 2017 = 251; 2018 = 254; Average Annual Change (percent) = 0.1 - Actual FTE - Overall Banking Supervision: 2016 = 57.9; 2017 = 58.1; 2018 = 58.4; Average Annual Change (percent) = 0.5 - Of which (2016 / 2017 / 2018 / Average Annual Change (percent)): - Bank Supervision: 19.7 / 18.5 / 18.5 / -3.1 - Licensing and crisis management: 5.4 / 6.3 / 8.1 / 24.3 - Solvency / models: 8.2 / 8.6 / 7.3 / -5.2 - Data and Analysis: 9.8 / 10.2 / 8.7 / -5.4 - Macroeconomic Surveillance: 6.7 / 7.6 / 8.7 / 15.3 ### Budget evolution and staffing implications - FSA budget increased from 343.3 million NOK in 2015 to 426.3 million NOK in 2019; average annual increase = 4.8 percent. - The FSA budget proposed is subject to cuts, including efficiency cuts, imposed by the MoF and the Government. - The FSA was subject to a hiring freeze during 2014−16 applied to all public agencies. - While overall staffing resources increased over the last three years, actual resources spent on banking supervision remained stable (see Table 2). - Turnover rate is relatively low; challenges exist in recruiting and retaining staff with legal and modelling expertise and retaining high-performing young employees with 3−5 years of experience. - Authorities note that requests for more resources must be considered within overall government budget priorities. ### Recommendations to strengthen FSA powers, independence, and budgetary autonomy - Explore options to strengthen FSA powers, improve operational independence, and increase budgetary autonomy while ensuring robust accountability. Specific recommendations: - Grant the FSA the power to make prudential regulations, particularly in relation to micro-prudential supervisory issues. - Make the FSA responsible for deciding on all applications for bank licenses, transfer of significant ownership in banks, and major acquisitions as well as for deciding on the revocation of bank licenses. - Limit the powers of the MoF to issue instructions to the FSA and decide on appeals to the FSA supervisory decisions and measures. - Give the FSA more autonomy in determining and managing its budgetary resources and ensure that it is given the needed resources to effectively carry out its mandate. - Enact legislative changes that would require the public disclosure of the reasons for the removal from office of the FSA board members and director general. *Source: Norway Financial Sector Assessment content unit (excerpt) — 1norea2020002* ### 37. While the existing supervisory activities and the supervisory coordination with the ### 1norea2020002 - 37. While the existing supervisory activities and the supervisory coordination with the ### Supervisory oversight of systemic foreign bank branches - Findings: - Existing supervisory activities and supervisory coordination with home authorities of systemic foreign bank branches is welcome. - Direct involvement of the FSA in supervising these branches could be further expanded. - Those branches represent a significant risk to financial stability, particularly in stress conditions, and are generally covered by Norway’s financial safety net arrangements. - Recommendations: - The FSA should increase its monitoring of those systemic branches and its supervisory oversight of their activities, including through onsite supervision. - This is particularly relevant for systemic branches where the activities of the home supervisor over the branch may not address adequately the systemic relevance of the branches from Norway’s perspective. ### Recovery planning and resolution planning - Findings: - Section 20 of the Financial Institutions Act (effective January 2019) requires banks to have recovery plans and requires the FSA to prepare a resolution plan for each institution. - The FSA had requested large banks to prepare recovery plans before the law entered into effect and published guidelines on recovery planning in June 2019. - Banks’ recovery plans are typically assessed on a periodic basis depending on the SREP category of the institution and are evaluated during onsite inspections. - If the FSA deems the plan insufficient, it may require the institution to make changes. - In 2019, the FSA assessed the recovery plans of several mostly large institutions and provided written feedback in a number of cases. - As to resolution plans, the FSA has so far prepared a draft resolution plan only for the largest DSIB and presented it to the supervisory college in September. - The FSA plans to proceed with developing resolution plans for other systemically important and large institutions as a priority. - Numeric detail on recovery plan assessment frequency (footnote): - Banks recovery plans are assessed with written feedback to the institution, with the following frequency: annually for SREP category 1 institutions, every other year for SREP category 2 institutions, and at least every third year for SREP category 3 and 4 institutions. - All banks are required to have recovery plans starting January 2019 except banks with total assets below NOK 5 billion which are required to have a recovery plan from January 2020. ### Quality assurance and internal audit of supervisory processes - Findings: - The FSA has thorough supervisory processes and procedures but does not have a quality assurance or an internal audit function to periodically check and enhance the effectiveness of its supervisory tools. - The FSA is a member of the three European supervisory authorities EBA, ESMA, and EIOPA and participates in independent peer reviews among European national supervisory authorities. - The FSA is subject to reviews by the office of the Auditor General (mostly annual internal audits of the FSA accounts) or by the MoF based on self-assessment reports from the FSA or third-party reviews. - While these reviews are useful, they may not provide a comprehensive assessment of FSA processes. - Recommendation: - Consider establishing a quality assurance function that performs a more comprehensive assessment of the FSA processes to improve practices and address findings or gaps. ### Supervisory approach and specific recommendations (paragraphs 40–41) - Findings: - The FSA supervisory approach is generally sound and its supervisory process is thorough, but there is scope for further improvement. - Recommendations (explicit list): - Further take into account the risk profile of banks in planning and performing its supervisory activities by ensuring that: - Medium and small banks with relatively high-risk profiles are subject to increased scrutiny, particularly in regard to onsite inspection. - The intensity of the supervisory activities related to large banks take into account the differences in the risk profiles of these banks. - Strengthen monitoring and host supervision of systemic foreign bank branches given their impact on financial stability. - Continue the work on reviewing banks’ recovery plans and drafting resolution plans, particularly for systemic and large banks. - Consider establishing a quality assurance or internal audit function to oversee the quality and consistency of its supervisory approach and continuously improve its supervisory procedures and processes. - Resourcing note: - While some recommendations may be partially implemented by reprioritizing current resources, effective implementation would also require additional resources. - Granting further budget autonomy to the FSA would better allow it to manage its budget based on its resource needs and effectively increase the breadth of its supervisory activities. ### Corrective action framework and processes - Legal powers and scope (findings): - The Financial Supervision Act provides the FSA powers to require banks to enact changes in internal controls, maintain a higher capital ratio than the minimum requirement, reduce credit risk to particular customers, rectify matters due to failure of the institution’s bodies, or correct inappropriate bank investments or activities. - The Financial Institutions Act provides the FSA powers to require banks to change their organization and management, curtail or change their business and reduce their risks, change their remuneration policies, and limit dividend payout policies. - Conditions to apply powers in the Financial Institutions Act seem linked mostly to cases where the bank falls below capital requirements; it is not clear to which extent these powers can be applied for weaknesses or unsound practices that have not resulted in a breach to minimum capital requirements. - Early intervention tools: - The Act requires an institution to notify the FSA in case of actual or likely infringements to the requirements in the near future. - The FSA’s tools include initiating measures in the recovery plan, drawing up an action plan to restore the institution's position, drawing up plans for negotiating the restructuring of the institution's debt. - For significant deterioration or serious infringements or administrative irregularities, the FSA may require changes to the composition of the board or senior management and may appoint a temporary administrator. - The FSA may—after approval by the MoF—adopt a decision to write down or convert own funds. - If these measures prove insufficient, the MoF may adopt resolution or winding up proceedings according to sections 20-15 and 20-29 of the Act. - Limits on corrective and sanctioning powers: - The FSA does not have the power to revoke bank licenses except where delegated by the MoF. - All supervisory decisions and corrective measures of the FSA can be appealed to the MoF. - The FSA has very limited sanctioning powers; the laws do not provide the FSA with the power to apply fines except in the case of breaches to the AML act. - A daily fine can be applied by the MoF (power currently delegated to the FSA) during the period in which the bank is in breach, but the amount is normally limited and cannot be imposed once a bank has rectified the situation. - Use of moral suasion: - The FSA prefers moral suasion and rarely resorts to formal corrective actions. - Review of supervisory files suggests the FSA is not assertive enough in requests for corrective measures. - Reliance on moral suasion may cause delays in timely and appropriate corrective actions; some bank cases suggest the FSA can be more proactive. - Recommendations (paragraph 46–47): - Review the legal framework to enable the FSA to: - Apply significant fines and sanctions in case of banks’ breaches of legal and prudential requirements. - Take some corrective actions and measures directly, such as withdrawing bank licenses, or taking some intervention measures (such as writing down or converting own funds) without the need to get MoF approval. - The FSA should take a more active approach in using its corrective powers when banks’ weaknesses and problems persist to avoid delays caused by reliance on moral suasion. ### Prudential regulations and framework — Capital adequacy - Findings on system capitalisation: - The Norwegian banking system is currently well-capitalized. - Common Equity Tier 1 (CET1) ratio was 16.1 percent (end-March 2019) compared to 13.0 percent at end-December 2014 and 7.3 percent at year-end 2008. - The end-March 2019 systemwide leverage ratio was 7.6 percent, virtually unchanged from a year earlier. - All Norwegian banks met the risk-based capital and leverage ratio minimum requirements at the end of Q1−2019. - Regulatory alignment with Basel III: - The Norwegian regulatory capital framework is consistent with the minimum Basel III global standards for CET1, Additional Tier 1 (AT1), and Tier 2 risk-based capital ratios and the leverage ratio. - Norwegian regulations require all banks to maintain a Capital Conservation buffer of 2.5 percent and a Countercyclical Capital Buffer (CCyB), which was set at 2 percent at the time of the mission and was increased to 2.5 percent at end-2019. - In addition to the global minimum leverage ratio of 3 percent, Norwegian banks are subject to a 2-percentage point leverage ratio buffer for a total leverage ratio requirement of 5 percent. - Financial institutions identified as domestic systemically important banks (D-SIBs) are required to maintain this level plus an additional leverage ratio buffer requirement of one percentage point. - Authorities require all banks to maintain a Systemic Risk Buffer (SRB). - Adoption of EU framework and implications: - As a signatory to the EEA agreement, Norway has elected to adopt the EU’s regulatory capital framework (CRD IV/CRR) as the basis for its regulatory capital framework. - Adopting the EU framework and relinquishing the ability to adopt more rigorous standards represent a weakening of existing requirements. - The EU framework transposes Basel III into EU law but includes provisions that deviate and fall below BCBS global minimum standards (example: SME supporting factor reducing risk weight for exposures to SMEs; removal of Basel I “output floor”). - Once adopted, Norway will be restricted from adopting standards that exceed EU framework terms and will be required to relinquish certain prudential measures that depart from CRD IV/CRR. - Assessment of impact and FSA estimate: - The FSA estimates that the removal of Basel I floor and the introduction of the SME factor will lower risk-weighted assets (without a commensurate decrease in risk) resulting in an increase in the CET1 ratio by 1.3 percentage points (based on year-end 2018 data). - The FSA has not performed a comprehensive assessment of all discretions and areas under the EU framework that may collectively affect banks’ capital adequacy. - Box 2: Current situation and planned changes (key bullets): - Banks are subject to minimum capital requirements and buffers; the capital conservation buffer and minimum requirements are set in accordance with international requirements. - The SRB level is justified by a less diversified economy, relatively strong cyclical fluctuations and high household debt levels. - The SRB and the DSIB buffer are cumulative and apply to all exposures. - The countercyclical buffer was set at 2 percent in October 2019 but was increased to 2.5 percent at end-2019. - All banks must meet a minimum leverage ratio requirement of 3 percent, as well as a leverage ratio buffer of 2 percent; DSIBs must meet an additional leverage buffer requirement of 1 percent. - Expected changes: The EU CRR/CRD IV framework transposition into the EEA is expected to enter into force in beginning 2020; SME supporting factor will be introduced and the Basel I floor for IRB banks will be removed, leading to an increase in regulatory capital ratios of around 1.3 percentage points without a commensurate reduction in risk. - Authorities’ mitigants: The FSA is exploring ways to strengthen requirements for IRB models and Pillar 2 to reduce the impact of the new weaker requirement. - MoF proposals (consultation until September 2019): increase the SRB by 1.5 percent for all institutions (applied only on domestic exposures compared with the current SRB of 3 percent which applies to all exposures), and introduce risk weight floors of 20 percent for residential mortgage exposures and 35 percent for CRE exposures. - Additional notes: - The MoF has circulated for comment proposals including an increase in the SRB requirement and introduction of a risk weight floor for real estate loans, but it is not clear to what extent these would effectively counteract the reduction in capital requirements from adopting the EU framework. - The FSA places substantial reliance on Pillar 2 capital adequacy measures and has issued guidance (circular 12/2016) describing its approach to Pillar 2, recently updated to detail computation of various Pillar 2 components. - The Pillar 2 approach includes prescriptive (concentration risks using Herfindahl Hirschman index (HHI) benchmarks) and principles-based elements. - Recommendation: - The FSA should continue to thoroughly explain and communicate its Pillar 2 approach and decisions to banks, continue refining the approach, and maintain thorough dialogue with banks about the Internal Capital Assessment Adequacy Process (ICAAP) to ensure banks understand differences between their ICAAP assessments and Pillar 2 capital requirements. *Source: IMF staff report content (excerpts provided in the source PDF).* ### 56. Given the relatively high and robust capital requirements and the thorough Pillar 2 ### 56. Given the relatively high and robust capital requirements and the thorough Pillar 2 ### B. Credit Risk - Credit risk is the predominant risk exposure among Norwegian banks and real estate exposures represent approximately three-quarters of bank lending. - Supervisory requirements governing credit risk management, internal controls and oversight are applied on a proportionate basis. - With the exception of specified guidance on prudential aspects related to loan loss provisioning and the valuation of real estate collateral, the FSA’s supervisory guidance is considered thorough. ### Prudential guidance gaps - Prudential guidance on loan loss provisioning and the valuation of real estate collateral is lacking. - Banks in Norway rely on an accounting standard (IFRS 9) for guidance on estimating loan loss provisions. - IFRS 9 came into effect on January 1, 2018 for the large Norwegian banks. - It will apply to all financial institutions in Norway from January 1, 2020. - Prudential guidance on the valuation of real estate collateral does not exist; banks rely on a commonly available model that takes account of recent property sales to estimate collateral value. ### Residential Mortgages - Home ownership in Norway is comparatively high and housing finance represents a substantial portion of overall bank lending and total bank assets. - Home ownership: 77 percent. - Residential mortgage lending accounts for approximately 54 percent of banks’ total lending at end June 2019. - Norway’s tax policy provides strong incentives for home buying and financing (e.g., income tax deductibility of interest paid on mortgage debt, favorable capital gains tax on the sale of real estate, and reduced wealth tax valuation of real estate holdings). - Vulnerabilities: persistently high household debt and a steady climb in house prices (cited by Norges Bank and the FSA). - Losses on residential real estate loans are low. - Total loan losses at end-March 2019 were around 0.1 percent of average total assets. - Losses on loans for the corporate lending market and the personal customer market were respectively 0.2 percent and 0.1 percent of total loans at end-2018. - Temporary prudential requirements governing residential real estate lending: - Adopted in 2015, extended in 2018, and extended further until end-2020. - Includes an affordability test, debt-to-income (DTI) limits, loan-to-value (LTV) limits, and flexibility quotas. - For banks using the IRB approach for calculating regulatory capital for credit risk, Norway has adopted a 20 percent floor for the loss-given-default (LGD) parameter for exposures secured by residential real estate (global minimum standard: 10 percent). ### Effect of mortgage regulations - The mortgage regulations appear to have dampened debt growth and house price inflation in areas with high DTI borrowers. - More stringent regulations have been necessary and had desired effects, but they are insufficient alone; continued prudent regulatory and supervisory oversight is warranted. - FSA’s credit risk modules: - Provide quantitative guidance for assessing credit risk exposure and qualitative guidance for systems managing and controlling credit risk. - Designed primarily for large institutions and applied to smaller firms on a proportionate basis. - Lack specified guidance on prudential aspects related to loan loss provisioning and the valuation of real estate collateral. ### Box 3 — Prudential Limits (summary) - Borrower-Based Measures (selected items and dates) - Debt-to-annual income: Less than 5 times (Residential Mortgages, 2017); Less than 5 times (Unsecured Consumer Lending, 2019). - Debt servicing capacity: To afford a 5 percent interest rate increase (Residential Mortgages, 2015); To afford a 5 percent interest rate increase (Unsecured Consumer Lending, 2019). - Loan-to-value (LTV): Less than 85 percent (60 percent for second home in Oslo) (Residential Mortgages, 2015 (2017)). - Principal repayments: At least 2.5 percent for loans with LTV > 60 percent (Residential Mortgages, 2016); Five years maximum (Unsecured Consumer Lending, 2019). - Flexibility Quota (speed limit): 10 percent (8 percent for homes in Oslo) (Residential Mortgages, 2017); 5 percent (Unsecured Consumer Lending, 2019). - Box 3 continued — policy actions: - Residential mortgages: current regulation extended until end-2020; FSA recommended (i) reduce DTI limit from 5 times income to 4.5; (ii) reduce flexibility quota from 10 percent (8 percent for Oslo) to 5 percent; and make mortgage regulations permanent. MoF decided in November 2019 to keep limits unchanged until end-2020. - Unsecured consumer lending: New guidelines in 2017; uneven adoption led to binding regulation issued in February 2019, effective May 2019. - Capital-Related Measures: - Residential mortgages: 2014 FSA circular calibrated IRB banks’ PD and LGD models; combined with MoF portfolio-level LGD floor of 20 percent, average risk weights increased (above 20 percent, previously 10-15 percent). A risk weight floor of 20 percent on residential real estate exposures has been proposed in MoF discussions. - CRE lending: standardized approach risk weight of 100 percent for CRE; a risk weight floor of 35 percent on CRE exposures has been proposed in MoF discussions. ### IRB data limitations - Banks using IRB account for approximately 80 percent of assets in the Norwegian banking system. - Challenge: IRB banks must use long-term historical loan loss data to estimate PD and LGD for residential mortgages, but through-the-cycle historical data is extremely scarce if not nonexistent. - Consequences: data limitation could impair robust estimation of regulatory capital, pricing, risk management, and capital allocation. - FSA measures in 2014: - Minimum PD for mortgage loans of 20 basis points (versus global PD floor of 3 basis points). - Methodology for estimating LGDs for mortgages linked to exposure’s LTV that cannot result in LGD less than 20 percent. - FSA evaluates ongoing need for stricter IRB requirements. ### Commercial Real Estate (CRE) - CRE represents approximately 14 percent of banks’ total lending and accounts for about 40 percent of total domestic lending to corporates. - CRE loan losses: - Less than 1 percent of total loans in recent years and virtually nonexistent in 2018. - CRE property values have steadily increased (especially in Oslo); increase from already high levels is deemed a vulnerability because CRE prices are more cyclically sensitive than house prices and CRE loan losses have historically exceeded residential loan losses. - Authorities’ actions: - 2018 FSA comprehensive thematic review and stress test of banks’ CRE exposures (eleven Norwegian banks and foreign branches participated). - Review concluded banks would incur small losses when price falls are limited to 33 percent (aligned with banks’ LTV requirements), but significantly higher losses with higher price declines. - Current regulatory capital treatment: risk weight of 100 percent for CRE exposures under standardized approach. - MoF consulting on adjustments to capital requirements for CRE exposures, including a 35 percent minimum portfolio-level risk weight floor for foreign branches operating in Norway. - Supervisory guidance gap: FSA provides specific guidance on residential mortgage loans and consumer credit but only broad guidance on corporate lending and no specified guidance related to CRE exposures. ### Consumer Lending - Consumer lending (unsecured consumer loans and credit cards) represents 3.6 percent of total lending and just under 4 percent of Norwegian household debt. - Growth and NPLs: - Consumer loan growth: 10.3 percent (March 31, 2019). - General credit growth: 5.5 percent. - Non-performing loans (NPLs) for consumer loans: 8 percent at end-March 2019. - NPLs for total lending: less than 1 percent at end-March 2019. - Regulatory response: - FSA published guidelines on prudent consumer lending practices in June 2017. - Uneven adoption led MoF in February 2019 to establish regulations on consumer lending practices effective May 2019 and remaining in force until end-December 2020 (requirements include debt service capacity, DTI limits, maximum maturity loan term of five years, and flexibility quotas). - Supervisory guidance need: FSA’s credit risk modules are thorough overall but lack specified guidance on prudential aspects related to loan loss provisioning, which is of paramount importance for unsecured lending. ### Recommendations (Credit Risk and Lending) - The FSA should develop specific guidance on: - (i) prudential aspects related to loan loss provisioning; and - (ii) the valuation of real estate in line with the relevant Basel guidance and the related EBA guidelines. - The MoF should at a minimum make key elements of the prevailing mortgage regulations and consumer lending requirements a permanent feature of the Norwegian regulatory framework. - The FSA should require banks to demonstrate that their IRB data sets for residential real estate loans and for CRE exposures are sufficiently robust and include through-the-cycle data or to justify why existing data sets are adequate. - The FSA should develop specified guidance on CRE exposures, and the management and control of credit risk related to CRE exposures similar to the level of granularity provided in its guidance for residential real estate and consumer loans. ### C. Related Party Transactions and Large Exposures - Legal framework updates: - Norway’s Financial Institutions Act 2015 has been updated to correct previously identified deficiencies, including a revised definition of related parties. - The revised definition still does not include shareholders unless they have controlling interests. - The framework requires related party transactions to be in accordance with ordinary business terms between independent parties but is limited to credit and guarantees to employees and officers. - Supervisory resourcing concern: - Unclear whether sufficient supervisory resources are available to review banks’ quarterly reports and validate reporting processes. - FSA communicates expectations to banks but places great reliance on banks’ regulatory reporting; uncertainty whether FSA commits (or has) necessary resources to review and rigorously validate reports. - Large exposures framework: - Regulatory framework governing large exposures is consistent with and in some respects exceeds global minimum requirements. - Large exposures regulation was repealed from December 31, 2019 and replaced by framework based on CRR/CRD IV regulation; previous national discretions have been continued in Norwegian CRR/CRD IV regulation. - Primary limit on large exposures is 25 percent of a bank’s Tier 1 capital, though exceptions exist (e.g., 100 percent for interbank exposures of very small banks). - Trading book exposures exception remains: can go beyond 100 percent if covered by additional capital (implements CRR article 395 (5) and 397). These rules follow from CRR and cannot be removed via national discretion. ### Recommendations (Related Party Transactions and Large Exposures) - Amend the relevant section of the Financial Institutions Act to expand the definition of related parties to include all shareholders (regardless of whether they have controlling interests). - Amend the Financial Institutions Act so that it is not limited to transactions related only to credit exposures and provision of guarantees. *IMF mission findings and recommendations as presented in the source content.* ### 77. Norwegian banks depend to a significant extent on market funding and their liquid ### 1norea2020002 - 77. Norwegian banks depend to a significant extent on market funding and their liquid ### Liquidity funding structure and currency exposures - Funding consists mainly of customer deposits and market funding; market funding has a significant share particularly in the largest banks. - The term of market funding has increased over the past few years. - Covered bonds represent a significant portion of banks’ funding and of their liquid assets. - Banks have high reliance on foreign currency funding (particularly in EUR and USD) and have currency mismatches that they typically hedge using foreign currency swaps. ### Regulatory framework and supervisory modules for liquidity - The Financial Institutions Act and the regulation on sound liquidity management establish the main liquidity risk management requirements and the actions the FSA can take to address gaps. - The FSA developed two onsite supervisory modules regarding liquidity: one for liquidity and funding risk levels and one for liquidity risk management and controls. - Most risk indicators in the module for liquidity and funding risk levels are monitored by the FSA based on mandatory monthly and quarterly reporting and used in the SREP-process and reviews of banks’ recovery plans. - Minimum quantitative liquidity prudential requirements mirror the EU CRD IV and CRR. - The LCR requirement has been in force since end 2015 and shall be met at all times on solo and consolidated level. - Minimum requirements for LCR in significant currencies have applied since September 30, 2017. - For banks with significant exposures in foreign currencies (mainly EUR and USD), there is a minimum LCR requirement in foreign currencies of 100 percent. - For those banks with LCR requirements in foreign currency, they also have a minimum NOK LCR requirement set at 50 percent. - All banks and banking groups report their NSFR on a quarterly basis, including NSFR in significant currencies, but NSFR reporting is given less weight in a supervisory context. - There is currently no minimum NSFR requirement in Norway, but authorities plan to implement the requirement in accordance with the EU process or earlier. Banks with an NSFR below 100 percent are flagged and closely monitored. - The FSA monitors quarterly the average remaining maturity of a bank's market funding beyond one year and compares it to peer groups, reflecting NSFR’s one-year horizon. ### Covered bonds and LCR composition risks - The EU LCR framework includes high-quality covered bonds as Level 1 HQLA in some cases—criteria noted include high credit rating (i.e., at least AA- or 10 percent risk weight) and minimum issue size of EUR 500 million—as Level 1 HQLA under EU transposition. - Under the Basel LCR framework, qualifying covered bonds rated AA- or higher are Level 2A assets with a haircut of 15 percent. - EU framework also subjects high-quality covered bonds to a cap (cannot represent more than 70 percent of the HQLA) and a minimum haircut of 7 percent. - Norwegian regulations transposing LCR require at least 30 percent of liquid assets to be Level 1 assets excluding covered bonds, allowing high-quality covered bonds to account for a major portion of Level 1 assets. - Figure evidence (end Q2-2019) shows a high concentration of covered bonds in banks’ LCR buffers. - Limited availability of LCR level 1 eligible NOK assets other than covered bonds is due to the low volume of outstanding Norwegian government bonds and the risk weighting of Norwegian municipality bonds (only qualified for level 2). - The FSA encourages banks to conduct liquidity stress tests based on severe price falls in the housing market and increased default ratios for mortgage loans; the FSA has performed stress tests given a 30 percent price fall in the housing market on Group 1 and Group 2 banks. ### Supervisory practices, stress testing, and gaps - Liquidity risk management (strategies, policies, limits) and funding strategies are primarily assessed during on-site inspections (full inspections and targeted inspections). - There were very few targeted inspections focusing on liquidity risk management aspects over the last three years; specifically, six targeted inspections on market and/or liquidity risks over the last three years. - These risk areas were included in six more comprehensive inspections in larger banks; targeted liquidity and market risk inspections are normally not conducted in smaller institutions, but these areas were included within twenty general inspections conducted in smaller banks over the last three years. - FSA inspection plan for 2019 included a significant increase in targeted onsite inspections on liquidity and market risks; FSA reported all these inspections realized by end-November 2019. - The FSA relies on banks’ liquidity and funding stress tests in its assessments; a liquidity stress test was developed with Norges Bank in 2018 but needs to be more frequent and included in ongoing off-site monitoring. - Banks are expected to conduct stress tests covering both bank-specific and market stress scenarios; findings should be reflected in liquidity strategy, risk framework, contingency and funding plans. - The FSA does not require banks to include the level of currency mismatches in each significant currency as part of stress tests, nor to separately analyze strategy and liquidity needs for each significant currency. - The FSA does not require banks to conduct a separate analysis of their strategy and liquidity needs for each significant currency. ### Recommendations on liquidity - Enhance prudential liquidity risk management regulations by: - Requiring banks to formulate a strategy and assess their liquidity needs in each significant currency. - Requiring liquidity stress tests in each significant currency (particularly foreign currencies). - Introducing NSFR as a binding requirement, and continuing reporting of NSFR in significant currencies. - Monitor banks’ reliance on covered bonds in liquidity and funding, and the implications of the more lenient treatment in the EU framework; ensure banks have adequate liquidity buffers to cover risks associated with cross-ownership of covered bonds and interaction with the real estate market. - Further strengthen supervisory processes and practices by performing more frequent targeted and thematic reviews over liquidity and funding risk management. ### Market risk - Market/trading risk exposure is not material for most Norwegian banks; market RWAs represent approximately 0.5 percent of total RWAs. - A bank with a trading portfolio of less than five percent of total assets and a gross exposure less than EUR 15 million is exempted from calculating capital for market risk. - Only 6 banks report market risk; other banks treat trading exposures through a banking book treatment for capital purposes, typically risk-weighted at 100 percent. - Norway’s regulations follow the EU framework; Norwegian legislation is not yet updated to take account of the latest global market risk standard (FRTB), which will be adopted based on the EU roadmap and timeline. - FSA supervisory guidance on market risk is thorough; current practice includes: - Inspections focusing on market risk for larger institutions. - For smaller banks, market risk review is part of the overall assessment; simplified SREP every year for all banks but market risk is not covered in detail in simplified SREP. - Detailed SREP with written feedback performed every year for systemically important banks, every other year for other large banks, and every third year (or depending on risk assessment) for smaller banks. ### Operational risk: laws, guidance, and practices - Regulatory framework covers a wide range of laws and regulations, including: - Financial Supervision Act (LOV-1956-12-07-1), Article 4c (outsourcing) - Financial Institutions Act (LOV-2015-04-10-17) - Money laundering Act (LOV-2018-06-01-23) - Regulations on capital requirements (FOR-2006-12-14-1506) - CRR/CRDIV regulations (FOR-2014-08-22-1097) - Financial Undertakings regulations (FOR-2016-12-09-1502) - Regulations on use of information and communication technology (FOR-2003-05-21-630) - Various prudential regulations, including prudential reports and public disclosure requirements. - FSA’s supervisory guidance on operational risk includes an operational risk module used together with the "Module for assessment of corporate governance, management and control." - The module gauges institutions’ operational risk levels and sets out FSA expectations for effective management and control; the FSA verifies boards have approved relevant documents and uses questionnaires, supervisory-based assessments, meetings and correspondence with banks and ICT providers. - Operational risk issues (including AML/CFT) were assessed in most of the FSA’s 2018 on-site inspections; as part of SREP, the FSA evaluates whether operational risk profiles and risk appetite are consistent with capital strength. - The FSA views operational risk as having increased in recent years and has required banks to hold additional Pillar 2 capital. - There remains strong supervisory focus on ICT risks, with less focus on non-ICT operational risks; the FSA has adopted enhancements on information systems for monitoring and analysis, reporting to the supervisor, and outsourcing. - Outsourcing oversight: - Banks must provide a 60-day notification prior to outsourcing specific functions, describing the function and the bank’s risk assessment; in 2018, the FSA received 161 notifications. - Upcoming potential legislation may contain detailed rules on outsourcing. - No specific requirements for outsourcing of risk management nor enhanced supervisory practice based on guidance especially for small banks. ### Recommendations on operational risk - Develop specific requirements for the outsourcing of risk management and enhanced supervisory practice based on the guidance, especially for small banks. - Expand operational risk guidance and oversight to take greater account of non-ICT operational risk management. ### Financial integrity and AML/CFT supervision - A new AML/CFT Act and regulation came into force in October 2018, transposing relevant EEA legislation corresponding to the EU’s fourth and parts of the fifth AML Directive (directive 2015/849) and implementing a number of FATF recommendations. - The new legal framework: - Sets clearer requirements for supervised entities to carry out risk assessments and implement risk-based approaches. - Sets stricter requirements for customer due diligence, additional examinations and ongoing monitoring based on risk assessments. - Strengthens reporting requirements (including on suspicious transactions) and introduces a legal basis for supervisors to impose administrative fines and sanctions; expands criminal liability. - The FSA developed a first risk assessment of supervised entities in 2016, updated in 2018, and finalized a new version with new methodology in the first quarter of 2019. - A third national risk assessment was developed in 2018 with FSA input. - A risk classification model has been developed to rank institutions’ inherent ML/TF risk using over 30 data points or risk factors; the model needs further testing and the FSA should supplement it with additional information and judgment. - Resources and organization: - Between 2014 and 2018, the FSA almost doubled its AML/CFT resources to about 10.5 FTEs. - Five new staff members were recruited in early 2019 to enhance supervisory capacity. - A new section for AML and payment institutions was established in April 2019 to centralize AML/CFT supervision and handle licensing of payment and e-money institutions and virtual currency providers. - AML/CFT inspections: - AML/CFT issues were covered in 73 inspections over banks, credit and financing institutions during 2014-2018. - Inspections increased over the years but were mostly through standard full scope inspections rather than targeted inspections; AML-only inspections of banks (including foreign branches) were very few during the last three years and there were no thematic AML/CFT inspections over the last few years. - With restructuring and increased resources, the FSA plans to increase thematic AML/CFT inspections from 2019. *Source: IMF country report content provided.* ### 96. The cooperation between the FSA and Norway’s FIU, Økokrim, has been enhanced to ### 96. The cooperation between the FSA and Norway’s FIU, Økokrim, has been enhanced to ### Cooperation between the FSA and Økokrim - Cooperation was formalized through signing of an MoU between the two agencies that laid the ground for coordinating their activities and actions. - The FSA and Økokrim exchange information for the purpose of individual inspections as well as on higher-level operational and strategic issues. - Ongoing collaboration exists on new developments related to supervised entities and emerging threats and concerns. - The FSA uses the information received from Økokrim in calibrating its supervisory priorities and informing its supervisory activities, particularly onsite inspections. ### FATF assessments and findings - The latest FATF follow-up assessment was completed in December 2019 and was focused on effectiveness. - The assessment noted that Norway has worked to improve the effectiveness of its national framework to combat money laundering and terrorist financing; Norway was moved from the enhanced to the regular follow-up process. - The report noted that Norway is now achieving high or substantial levels of effectiveness on five of the 11 key areas identified by the FATF as immediate outcomes of an effective framework to combat money laundering and terrorist financing. - The FATF report concluded that Norway must focus on strengthening its effectiveness on the remaining immediate outcomes, including measures to ensure appropriate supervision, monitoring and regulation of financial institutions and lawyers, real estate agents and other non-financial entities, and to ensure that the proceeds of crime are confiscated. - Historical context from the 2014 mutual evaluation: - The 2014 mutual evaluation concluded strategic technical compliance shortcomings and rated the level of effectiveness of AML/CFT supervision and preventive measures as moderate. - The 2014 report noted banks, particularly the largest, are exposed to high risk of ML and that supervisors did not adequately understand ML/TF risks. - Supervisory activities were limited and focused on technical compliance checklists rather than effectiveness; supervisors did not have a wide enough range of powers to sanction, and no sanctions other than written warnings had been applied. - Significant weaknesses were identified regarding beneficial ownership of bank accounts’ holders, politically exposed persons, wire transfers, correspondent banking and ongoing monitoring; concerns were raised over the quantity and quality of suspicious transaction reports, which predominantly related to cash-based transactions. - Legal reforms and technical compliance: - Adoption of a new AML Act and Regulations in 2018 led to higher ratings on 20 (out of 40) FATF Recommendations. - Norway is currently compliant or largely compliant with 35 recommendations. - Technical compliance of measures regarding customer due diligence, record keeping, politically exposed persons, internal controls and group-wide programs for foreign branches and subsidiaries were strengthened. - The powers of supervisors have been enhanced and administrative sanctions and bans on managers can be imposed for breaches of the AML Act’s requirements. - FATF’s 2019 follow-up assessment noted: - The FSA has initiated specialized AML/CFT inspections, with a focus on high-risk institutions. - An AML/CFT component is now included in all standard inspections and has been expanded. - The FSA has established and implemented risk classification models and supervisory modules to support its AML/CFT supervision. - The assessors noted the scope, intensity and frequency of FSA supervision is insufficient and not always commensurate to the level of risk identified. - The FSA gradually increased its resources dedicated to AML/CFT, from 5 full time equivalents (FTEs) in 2014 to current 13,5 FTEs. - FATF concluded there has been insufficient progress on AML/CFT supervision, and the level of effectiveness remains moderate. - Areas for improvement include: enhancing FSA’s supervisory methodology and resources; adjusting supervisory activities proportionate to the level of ML/TF risks, particularly in branches of foreign banks; determining the frequency of inspections for higher-risk banks according to a policy or supervision manual; and taking actions to address identified breaches of the AML Act, including by using the newly granted sanctioning powers. ### FSA supervisory actions and sanctions - The FSA has found weaknesses in AML/CFT frameworks involving: - adequacy of risk assessments, - effectiveness of customer due diligence policies and processes, - handling of high-risk customers and activities, - policies for correspondent and respondent banking relationships, - adequacy of AML/CFT resources. - A number of cease and desist orders were issued in 2018 and 2019 to require supervised entities to correct their situation; the FSA threatened to impose coercive fines if orders were not complied with. - The FSA reported that coercive fines were not imposed due to adequate follow-up from the entities in question. - Two administrative fines were imposed on banks in 2019. - The report suggests it would be useful to review the effectiveness of the current approach to corrective actions and the extent to which it can be enhanced by taking a more active stance in applying sanctions and fines. ### Recommendations - Progress has been made in enhancing the AML/CFT legal and regulatory framework and the FSA supervisory approach, but more actions are needed to increase FSA supervisory resources and oversight. Specific recommendations for the FSA: - Increase its AML/CFT onsite inspections over banks, including branches of foreign banks, particularly in the form of targeted and thematic inspections. - Further improve its risk-based approach to AML/CFT by enhancing its risk classification model to ensure its reliability as an indicator of ML/TF risks and by developing its AML/CFT supervisory tools and methodologies. - Continue to use the new sanctioning powers as appropriate and review the effectiveness of their use, with a view to ensure a more active approach in dealing with AML/CFT weaknesses and deficiencies. *International Monetary Fund* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1norea2020002.pdf_