## sbrsnpgea

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### Executive Summary — Overview and Purpose
- Assesses progress in strengthening prudential standards for banks and remaining gaps in implementing the international reform agenda.
- Distills lessons from assessments of national financial sector oversight frameworks and compliance with the Basel Core Principles for Effective Banking Supervision (BCP).
- Uses two complementary strategies: textual analysis (text mining) of assessment reports and analysis of the grades in the BCP assessments, including their evolution and association with bank fragility.
- Each year the IMF provides, on average, TA to more than 70 countries on financial sector prudential issues.

### Executive Summary — High-level Findings
- Jurisdictions have made steady progress implementing major regulatory reforms, especially in capital and liquidity regulation:
  - "Capital and liquidity regulation, in particular, have been strengthened across the board."
- Progress in enhancing banking supervision has been slower:
  - Many countries lack independent bank supervisors with a clear financial stability mandate and appropriate set of powers.
  - The institutional setting for supervision is strongly associated with bank soundness and stability.
- Governance and risk management show some improvement; supervisory techniques and tools are developing and becoming more forward looking, but substantial improvements remain necessary in many jurisdictions.
- Frameworks for management of problem assets need urgent improvements:
  - Common deficiencies: classification and provisioning standards, definition of problem assets, and supervisory oversight—affecting capital adequacy, market discipline, and integrity of supervisory reporting.
- Supervision of related party transactions is a concern and may warrant more guidance from international bodies.

### COVID-19 Reflections — Lessons and Implications (Box 1)
- Pandemic reinforced lessons from the 2008 GFC: importance of adequate capital, sufficient liquidity, comprehensive risk coverage, governance quality, effective risk management, proactive supervision, and early intervention.
- Observations on buffers and policy frameworks:
  - Basel III intended to create reserves usable in stress, but "preliminary observations suggest that in practice, these buffers might not have worked fully as intended" because banks appear more reluctant to use buffers than expected.
  - Local understandings and interpretations of the framework vary across jurisdictions and could have influenced outcomes.
- Supervisory capacity and data challenges:
  - Protracted uncertainty increased need for comprehensive data and firm-level monitoring.
  - Jurisdictions with inadequate data, poor information systems, or insufficient supervisory capacity may be impaired in their ability to gauge and address the crisis' impact.
- Forward-looking supervisory approaches critical:
  - Strengthen risk-based techniques, stress-testing, and other analytical tools.
  - Supervisors need powers, credibility, clear mandates, transparent accountability, sufficiency of skills and resources to maintain market confidence during crises.

### Proportionality and Postcrisis Reforms (Box 1 and Box 2)
- Post-GFC reforms aimed to:
  - strengthen firms’ resilience;
  - make systemically important banks resolvable without meaningful market disruptions;
  - reduce interconnectedness;
  - increase derivative market transparency;
  - strengthen oversight of nonbank institutions.
- Basel III significantly improved capitalization and liquidity of the banking sector.
- Macroprudential dimension introduced tools such as capital and liquidity buffers to be activated or released through the business cycle.
- Proportionality considerations:
  - Adapt international standards to local complexity, legal/institutional frameworks, and development stage without weakening minimum prudential requirements.
  - Examples of proportional implementation include Switzerland (five-tier classification), The Bahamas (simplified Basel III definition with stringent minimum), and the United States (proportional allocation of supervisory resources).
- Guiding principles for proportional implementation (selected):
  - Adaptations should be clearly justified and preserve international minimum thresholds.
  - Tailoring must consider pronounced local risk features; jurisdictional frameworks may need to go beyond international requirements.
  - Proportional, risk-based supervision should ensure minimum intensity of supervision for all segments, including onsite work.
  - As financial systems deepen, national frameworks should evolve toward international standards.

### Methodological Approach and Coverage (Box 2)
- Paper analyzes 47 BCP assessments completed between 2012 and 2019; all assessments followed the 2012 BCP methodology and covered 18 AEs and 29 EMDEs (two entries covered euro area and CEMAC representing 25 countries).
- Textual analysis steps:
  - Step 1: Identify most common weaknesses for each principle.
  - Step 2: Map assessor comments to identified weaknesses.
  - Step 3: Calculate simple statistics to observe prevalence of weaknesses.
- Complementary econometric analyses use data on 8,590 banks from 26 countries (Fitch Connect database) to relate banks’ fragility to a country’s BCP compliance.
- Econometric focus on three Core Principles: CP1 (Supervisory Powers, Responsibilities and Functions), CP2 (Independence, Accountability, Resourcing, and Legal Protection of Supervisors), CP14 (Corporate Governance).
- Rationale: CP1, CP2, and CP14 are foundational for supervision and have sufficient variation for regression analysis.

### Key Findings — Institutional Setting for Oversight
- Minimum international requirements largely set out in CP1 and CP2.
- BCBS 2012 updates emphasized primary mandate of supervisors should be safety and soundness, operational independence, resource allocation reflecting systemic risks, and expanded list of supervisory powers.
- Supervisors need strong mandates, sufficient independence, appropriate resources, and a full suite of tools including stress testing and early intervention.

### Key Findings — Most Prevalent Institutional Weaknesses
- Lack of operational independence is the most common challenge:
  - Appointments and dismissal procedures often lack defined criteria or transparency.
  - Government influence on decision making and requirements for political approval constrain supervisory actions.
  - Lack of budgetary autonomy persists; budgets sometimes controlled at political level even when funded by industry fees.
- Other frequent weaknesses:
  - Lack of resources (insufficient staff, compensation, specialized skills).
  - Absence of a clear mandate for financial stability or primacy of safety and soundness.
  - Deficiencies in access to group information, inability to raise prudential limits, limited corrective powers.
- Specific issues noted: appointments and dismissal vulnerabilities; government and industry influence; low staff complement and weak resource planning; low compensation; gaps in laws/regulation affecting supervisory powers.

### Inadequate Supervisory Powers (Section 6)
- Availability and capacity of supervisors:
  - Staffing issues: staff shortages, insufficient skills, inadequate compensation, weak resource planning.
  - Staff shortages attributed to high turnover and expanded responsibilities.
  - Lack of budget autonomy limits ability to increase staff or offer credible compensation.
- Institutional mandates and legal powers:
  - About half of assessed countries had mandates not clearly defined or expanded to require support for developmental objectives, creating potential conflicts with prudential objectives.
  - Common missing powers: intervene before breach of minimum requirements, obtain information, revoke licenses, prevent licenses to unfit parties.
  - Example: In Canada, the Ministry of Finance can override prudential judgement of the supervisor in certain key areas (IMF 2020a).
- Empirical evidence:
  - "One grade higher compliance with CP1 (CP2) translates into a 93 (100) percent higher Z-score, respectively (Annex Table 3)."
  - Relationship weaker for systemically large banks and foreign-owned banks where the local authority is the host supervisor.

### Capital and Liquidity Regulation (Prudential Regulations)
- Capital and liquidity are cornerstones of stability; Basel III required more and higher-quality capital and liquidity buffers.
- BCP principles addressing these: CP16 (capital) and CP24 (liquidity).
- Flexibility during COVID-19 allowed release of countercyclical capital buffer and use of capital conservation buffer.
- Persistent deficiencies:
  - About half of assessed countries have weaknesses in capital rules (limited risk coverage, absence of additional loss absorbance for systemically important banks, prudential adjustments not ensuring capital quality).
  - Not all supervisors can adjust capital levels for individual banks or system to reflect risk profiles; Pillar 2 implementation remains challenging.
  - Example: 2017 BCP assessment of Japan noted lack of a Pillar 2 capital framework (IMF 2017).
- Liquidity issues:
  - Nearly a quarter of jurisdictions are considered NC or MNC with CP24.
  - Weaknesses include inappropriate quantitative limits, failure to address foreign currency liquidity, inadequate definition of liquid assets, lack of consolidated-level requirements.
  - Supervisory weaknesses: failure to ensure sound liquidity strategies, insufficient onsite inspections, weak guidelines, lack of contingency plans.

### Governance and Risk Management (Sections 5 and 6)
- Corporate governance added as CP14 (BCP 2012); CP15 enhanced risk management expectations.
- Jurisdictions have progressed in updating regulatory frameworks; supervisory practice often needs enhancement.
- Persisting weaknesses:
  - Execution gaps: good rules but poor execution, limited board interaction, insufficient supervisory powers and staff.
  - Supervision of related-party risks poor; narrow or absent definitions of related parties.
  - Risk management supervision often fails to deliver clear guidance; weaknesses include strategy and policy, oversight, model governance, contingency plans, specialized skills, definitions, board approval, reporting, legal framework, exposure limits.

### Problem Assets and Credit Risk (Section 5)
- Credit risk is primary banking risk; pre-GFC incurred loss provisioning led to "too little, too late" provisioning.
- New expected credit loss accounting introduced but COVID-19 increased implementation difficulty due to forecasting uncertainty.
- Finding: processes and policies to identify and manage problem assets fall short of agreed standards in more than 30 percent of assessed jurisdictions.
- CP18 (problem assets, provisions, reserves) is among the least-observed BCPs.
- Common weaknesses, especially in EMDEs:
  - Weak asset classification and provisioning policies.
  - Inadequate criteria to avoid evergreening.
  - Low frequency of supervisory reviews.
  - Inadequate definitions of nonperforming loans, restructuring, forbearance.
  - Weak collateral valuation policies.
- Recommendation: address problem-asset management deficiencies to restore banking sector health after major credit shocks.

### Related Party Risks (Section 5)
- Related party activities affect credit risk, governance, and control and can be a channel for abuse.
- More than half of jurisdictions assessed were rated MNC or NC on related party supervision; it is the second least well-observed BCP.
- Legal weaknesses:
  - Unduly narrow definitions of related parties, inconsistent definitions across texts.
- Supervisory practice weaknesses:
  - Failure to monitor or require reporting of related party exposures, leaving authorities unsighted on concentration risks and ultimate beneficial owners.
- COVID-19 heightens vulnerability where related party practices are weak.

### Supervisory Approach, Practices, and Techniques (Section 5)
- Post-GFC emphasis on intrusive supervision with conclusive enforcement.
- Risk-based supervision (RBS) adoption widespread; jurisdictions differ in RBS models.
- Forward-looking techniques improving: stress testing, peer group review, business model analysis.
- Data quality concern: insufficient or low-quality data is a concern in nearly two-thirds of IMF staff assessments.
- Timely intervention and corrective action:
  - About a third of jurisdictions have meaningful weaknesses in corrective action frameworks.
  - Missing powers in some supervisors: authority to resolve a bank, revoke license, sanction individuals, raise prudential standards.
  - Observed supervisory delays due to poor systems, complex legal processes, or external overturning of decisions.
  - Behavioral issues: lack of assertiveness cited in more than one-fifth of assessments; delayed intervention in nearly a tenth of cases.

### Implementation Momentum and Policy Consistency
- Strong commitment to post-GFC reform agenda; capital and liquidity adoption strengthened systems.
- Some dilution and delays observed; COVID-19 prompted extended transitional timetables and postponed implementations.
- Recommendation: regain implementation momentum and maintain consistent implementation of outstanding reforms.
- IMF role: continue support via surveillance and technical assistance.

### Econometric Analysis — Hypothesis, Model, and Data
- Testable hypothesis: whether BCP compliance correlates with higher bank soundness on average, and whether association differs by bank size and ownership.
- Model: OLS pooled cross-sectional with time controls; dependent variable ln(Z_score).
- Z_score defined as: Z_score = (ROA + (E/A)) / std.(ROA) using five-year window.
- Main explanatory variable: BCP compliance grade on 1–4 scale (NC=1, MNC=2, LC=3, C=4).
- Bank-level controls (lagged 1 year): bank size (total assets), equity ratio, ROA, overhead costs to total assets, liquid assets to total assets, commercial bank indicator.
- Country-level controls: GDP, GDP per Capita and GDP per Capita Growth, inflation, rule of law (World Bank WGI).
- Heterogeneity:
  - Large banks: total assets ≥ 10 percent of a country’s GDP (robust to 5 percent threshold).
  - Foreign-owned classification: foreign subsidiaries versus domestic banks.
- Sample: 8,590 banks from 26 countries (Fitch Connect and IMF Standards and Codes Database BCP assessments).

### Sample Distribution (Annex Table 1 — exact figures)
- Albania: 6, 0.07
- Austria: 30, 0.35
- Azerbaijan: 10, 0.12
- Bahrain: 11, 0.13
- Bulgaria: 8, 0.09
- China: 71, 0.83
- Democratic Republic of Congo: 3, 0.03
- Denmark: 49, 0.57
- Georgia: 8, 0.09
- Germany: 1,256, 14.62
- Guatemala: 3, 0.03
- Hong Kong SAR: 5, 0.06
- Iceland: 5, 0.06
- India: 49, 0.57
- Ireland: 4, 0.05
- Italy: 206, 2.4
- Japan: 137, 1.59
- Kazakhstan: 11, 0.13
- Norway: 78, 0.91
- Russian Federation: 408, 4.75
- Singapore: 6, 0.07
- South Africa: 7, 0.08
- Switzerland: 229, 2.67
- Turkey: 7, 0.08
- United Kingdom: 56, 0.65
- United States: 5,927, 69
- Total: 8,590, 100

### Selected Descriptive Statistics (Annex Table 2 — exact figures)
- Z-score: Observations 8,590; mean 131.116; median 67.04; min 2.56; max 1,257.13; Std. Dev. 202.90
- Bank size (millions of USD): Observations 8,590; mean 3,663.33; median 239.51; min 4.07; max 3,367,898; Std. Dev. 54,384.43
- Equity to total assets: Observations 8,590; mean 0.12; median 0.10; min 0.00; max 0.999; Std. Dev. 0.08
- Return on assets: Observations 8,590; mean 0.01; median 0.01; min −0.28; max 0.59; Std. Dev. 0.02
- Overhead costs to total assets: Observations 8,590; mean 0.04; median 0.03; min 6.64E-05; max 0.997; Std. Dev. 0.06
- Liquid assets to total assets: Observations 8,590; mean 0.13; median 0.09; min 3.08E-05; max 10.13; Std. Dev. 0.13
- Commercial bank (D): Observations 8,590; mean 0.72; median 1; min 0; max 1; Std. Dev. 0.45
- Large bank (≥ 10% GDP): Observations 8,590; mean 0.003; median 0; min 0; max 1; Std. Dev. 0.06
- Large bank (≥ 5% GDP): Observations 8,590; mean 0.006; median 0; min 0; max 1; Std. Dev. 0.08
- Foreign bank (2013): Observations 2,527; mean 0.0800; median 1; min 0; max 1; Std. Dev. 0.27
- Country-level (26 observations) examples:
  - GDP (bill USD): mean 1,943.49; median 370.82; min 12.75; max 16,710.46; Std. Dev. 3,795.21
  - GDP per capita: mean 30,192.62; median 28,006.98; min 397.34; max 90,132.35; Std. Dev. 25,632.30
  - GDP per capita growth: mean 2.02; median 1.75; min −22.86; max 8.01; Std. Dev. 2.44
  - Inflation rate: mean 1.97; median 1.84; min −28.81; max 8.10; Std. Dev. 3.29
  - Rule of law index: mean 0.67; median 0.42; min −1.45; max 2.10; Std. Dev. 1.14
  - CP1 compliance: mean 3.23; median 3; min 1; max 4; Std. Dev. 0.76
  - CP2 compliance: mean 2.50; median 2.5; min 1; max 4; Std. Dev. 0.65
  - CP14 compliance: mean 2.92; median 3; min 1; max 4; Std. Dev. 0.74

### Regression Results (Annex Table 3 — selected coefficients, dependent variable ln[Z-score]; standard errors in parentheses)
- CP1 (Responsibilities, Objectives, and Powers)
  - Compliance with CP1 (All): 0.933*** (0.067)
  - Compliance with CP1 (By Bank Size): 0.972*** (0.070)
  - Compliance with CP1 (By Foreign Ownership): 0.799*** (0.102)
  - Large bank (D) × CP1 compliance: −0.762** (0.334)
  - Large bank (D) coefficient (By Bank Size): 2.558** (1.069)
  - Foreign bank (D) × CP1 compliance: −0.672*** (0.146)
  - Foreign bank (D) coefficient (By Foreign Ownership): 2.028*** (0.520)
  - Adjusted R2: 0.26 (All), 0.26 (By Bank Size), 0.19 (By Foreign Ownership)
- CP2 (Independence, Accountability, Resourcing, and Legal Protection for Supervisors)
  - Compliance with CP2 (All): 1.002*** (0.089)
  - Compliance with CP2 (By Bank Size): 1.042*** (0.091)
  - Compliance with CP2 (By Foreign Ownership): 0.822*** (0.131)
  - Large bank (D) × CP2 compliance: −0.883*** (0.335)
  - Large bank (D) coefficient (By Bank Size): 1.939** (0.860)
  - Foreign bank (D) × CP2 compliance: −0.278** (0.119)
  - Foreign bank (D) coefficient (By Foreign Ownership): 0.473 (0.359)
  - Adjusted R2: 0.25 (All), 0.26 (By Bank Size), 0.19 (By Foreign Ownership)
- CP14 (Corporate Governance in Banks)
  - Compliance with CP14 (All): −0.027 (0.088)
  - Compliance with CP14 (By Bank Size): −0.080 (0.094)
  - Compliance with CP14 (By Foreign Ownership): 0.023 (0.143)
  - Large bank (D) × CP14 compliance: 0.774*** (0.293)
  - Large bank (D) coefficient (By Bank Size): −2.872*** (0.959)
  - Foreign bank (D) × CP14 compliance: 0.347 (0.236)
  - Foreign bank (D) coefficient (By Foreign Ownership): −1.333* (0.708)
  - Adjusted R2: 0.24 (All), 0.24 (By Bank Size), 0.17 (By Foreign Ownership)
- Observations: 8,590 (All and By Bank Size); 2,527 (By Foreign Ownership)
- Significance: * p < 0.10, ** p < 0.05, *** p < 0.01
- Note: Large bank denotes total assets ≥ 10% GDP. Foreign bank indicates a foreign subsidiary. Controls include ln[TA], equity ratio, ROA, overhead costs to TA, liquid assets to TA, commercial bank (D), GDP, GDP per capita (level and growth), inflation, rule of law.

### Interpretation and Caveats (Econometrics)
- Coefficients indicate correlations between ln(Z-score) and BCP compliance, not necessarily causal effects.
- Endogeneity concerns remain (omitted variable bias, reverse causality).
- Sample concentration in AEs, particularly the United States, tested via robustness checks (dropping US banks preserves overall conclusions).
- Clustering standard errors at the country level is limited by only 26 clusters; robustness checks clustering at country level preserve the bulk of results.

### IMF Role, TA, and Priorities
- IMF staff will continue support through TA and FSAPs, and surveillance promoting sound institutional settings for supervisors: adequacy of skills and resources; unambiguous mandates.
- Efforts focus on building supervisory capacity in:
  - traditional areas: risk-based supervision, corporate governance, credit risk;
  - new risks: fintech, cyber risks, climate change.
- Advice guided by proportionality principles and shaped to jurisdictional context and pandemic effects.

### Monetary and Capital Markets TA by Topic (Figure 8 — exact shares)
- Debt mgmt and capital mkt dev: 11%
- Financial sector stability review: 2%
- Supervision and regulation issues: 47%
- Central bank operations and monetary: 34%
- Other financial sector issues: 6%

### Conclusions — Priorities
- Strengthen institutional setup for oversight: clear mandates, transparency, sufficiency of powers, skills, and resources.
- Ensure effective supervision and enforcement to translate strengthened regulations into prudential outcomes.
- Urgent action to improve problem-asset frameworks: classification, provisioning, supervisory oversight.
- Enhance data, information systems, and supervisory analytical capacity to support forward-looking supervision.
- Increase supervisory focus on related party risks and consider additional international guidance.
- Regain implementation momentum for outstanding reform agenda consistent with international standards and proportionality.

*Source: sbrsnpgea (IMF PDF).*

### Executive Summary ������������������������������������������������������������������������������������������������������

Executive Summary

### Overview and purpose
- Assesses progress in strengthening prudential standards for banks and remaining gaps in implementing the international reform agenda.
- Distills lessons from assessments of national financial sector oversight frameworks and compliance with the Basel Core Principles for Effective Banking Supervision (BCP).
- Uses two complementary strategies: textual analysis (text mining) of assessment reports and analysis of the grades in the BCP assessments, including their evolution and association with bank fragility.

### Key high-level findings
- Jurisdictions have made steady progress implementing major regulatory reforms, especially in capital and liquidity regulation:
  - "Capital and liquidity regulation, in particular, have been strengthened across the board."
- Progress in enhancing banking supervision has been slower:
  - Many countries still lack independent bank supervisors with a clear financial stability mandate and appropriate set of powers.
  - The institutional setting for supervision is strongly associated with bank soundness and stability (cites: Laeven and Ratnovski 2014, Davis and Obasi 2009).
- Governance and risk management show some improvement; supervisory techniques and tools are developing and becoming more forward looking, but substantial improvements remain necessary in many jurisdictions.
- Frameworks for management of problem assets need urgent improvements:
  - Common deficiencies include classification and provisioning standards, definition of problem assets, and supervisory oversight—affecting capital adequacy, market discipline, and integrity of supervisory reporting.
- Supervision of related party transactions is a concern and may warrant more guidance from international bodies.

### Role of IMF and assessment tools
- FSAP assessments and IMF technical assistance (TA) support implementation and proportional adaptation of international standards:
  - The IMF periodically assesses oversight frameworks through the Financial Sector Assessment Program (FSAP).
  - "Each year the IMF provides, on average, TA to more than 70 countries on financial sector prudential issues."
- Standards assessments are independent, granular, and comprehensive, making them well suited to assess reform implementation and identify country-specific challenges.

### Lessons and implications from COVID-19 (Box 1 reflections)
- The pandemic reinforces many lessons from the 2008 global financial crisis (GFC) and tests the adequacy of reforms:
  - Importance of adequate capital, sufficient liquidity, and comprehensive risk coverage of the regulatory framework.
  - Relevance of quality of governance, effective risk management, and proactive supervision and early intervention.
- Observations on buffers and policy frameworks:
  - Basel III capital and liquidity framework intended to create reserves usable in stress, but "preliminary observations suggest that in practice, these buffers might not have worked fully as intended" because banks in most jurisdictions appear more reluctant to use buffers than expected.
  - Local understandings and interpretations of design and flexibility of the framework vary across jurisdictions and could have influenced outcomes.
- Supervisory capacity and data challenges:
  - Protracted uncertainty from the pandemic has challenged risk management and decision making, increasing the need for comprehensive data and firm-level monitoring.
  - Jurisdictions with inadequate data, poor information systems, or insufficient supervisory capacity may be impaired in their ability to gauge and address the crisis' impact.
- Forward-looking supervisory approaches are critical:
  - Strengthening risk-based techniques, stress-testing, and other analytical tools positions authorities to identify vulnerable institutions and appropriate policy options.
  - Supervisors need powers, credibility, clear mandates, transparent accountability, sufficiency of skills and resources to maintain market confidence during crises.

### Specific areas requiring further action
- Institutional setting for oversight:
  - Establish independent supervisors with clear financial stability mandates and appropriate powers.
  - Ensure institutional elements—mandates, accountability, powers, skills, resources—are in place to support credible decision making and communication in crises.
- Problem-asset frameworks:
  - Improve classification and provisioning standards, define problem assets consistently, and strengthen supervisory oversight to preserve capital adequacy and reporting integrity.
- Supervision effectiveness:
  - Enhance enforcement capacity so strengthened regulations translate into sound prudential outcomes.
  - Continue developing forward-looking supervisory techniques and tools.
- Related party transactions:
  - Increase supervisory focus and consider additional guidance from international bodies.

### Conclusions and priorities
- The international reform agenda has enhanced minimum prudential standards, notably in capital and liquidity regulation, but effective supervision and enforcement must accompany regulations to ensure a sound prudential framework.
- Renewed efforts are needed to strengthen the institutional setup for oversight and the effectiveness of supervision to ensure risks to financial stability are appropriately monitored and addressed in a timely manner.
- Post-COVID-19 priorities likely include reinforcing capital and liquidity usability, improving problem-asset frameworks, enhancing data and supervisory analytical capacity, and ensuring credible supervisory institutions.

*Source: Executive Summary, sbrsnpgea - Executive Summary*

### Box 1. Reflections on COVID-19 Impact (continued)

### Box 1. Reflections on COVID-19 Impact (continued)

### Postcrisis Prudential Reforms and Minimum Standards for Regulation and Supervision
- Post-GFC regulatory and supervisory standards were strengthened across all dimensions to address flaws including inappropriate incentives for managers; deficiencies in techniques to understand, manage, and price risks; and corporate governance weaknesses.
- Reforms aimed to:
  - strengthen firms’ resilience;
  - make systemically important banks resolvable without meaningful market disruptions;
  - reduce interconnectedness in the financial system;
  - increase the transparency of derivative markets;
  - strengthen oversight and regulation of nonbank institutions.
- Basel III significantly improved the capitalization and liquidity of the banking sector.
- The regulatory response also includes:
  - standards and guidelines strengthening risk management and corporate governance of banks;
  - a revised, global framework for large exposures;
  - improved treatment of problem assets and expected loan loss provisions;
  - enhanced disclosure requirements;
  - increased expectations regarding the quality of internal and external audit;
  - better aligning compensation practices with long-term risks.
- Macroprudential dimension: introduced tools that can be activated or released through the business cycle such as capital and liquidity buffers that are built up during the upswing of a business cycle and are therefore available to be drawn down in times of stress.
- Supervisory initiatives post-GFC emphasized more comprehensive, intrusive, and forward-looking supervision, including:
  - early remedial actions;
  - raised bar for risk data aggregation and risk reporting;
  - increased use of stress testing programs and forward-looking tools;
  - consolidated supervision and financial conglomerates focus;
  - heightened supervisory focus on systemically important financial institutions;
  - strengthened coordination arrangements between supervisors and their foreign and domestic peers.
- The Basel Committee on Banking Supervision (BCBS) revised the BCP in 2012 to enhance supervisory practices and risk management and corporate governance expectations (BCBS 2012a). The revision emphasized a systemwide, macro perspective, greater supervisory intensity and resources for systemically important banks, and focus on crisis management, recovery, and resolution measures.
- COVID-19 response by BCBS:
  - one-year deferral of the implementation timeline of the outstanding Basel III standards;
  - suspended consultation on all policy initiatives;
  - postponed all outstanding jurisdictional assessments planned in 2020.
- International community consensus: act consistently with international standards, and not roll back reforms or compromise the underlying objectives of existing international standards.
  - Footnote/link in source: https://www .fsb .org/ 2020/ 04/ COVID -19 -pandemic -financial -stability -implications -and -policy -measures -taken/ . The Basel Committee has also reaffirmed its expectation of full, timely, and consistent implementation of all Basel III standards, in a revised timeline. https:// www .bis .org/ press/ p200327 .htm.

### Proportionality Considerations when Adopting International Standards
- All jurisdictions can benefit from the international reform agenda, but many standards were primarily designed for large, internationally active financial institutions; suitability for smaller institutions with less-complex business models has been questioned.
- Proportionality concept: consider specific characteristics of the financial system (complexity, nature of institutions, financial depth, legal and institutional frameworks) when implementing international standards.
- Regulatory and supervisory proportionality aims to match level of intervention to policy goals; balances regulatory complexity with system or institution complexity.
- Proportionality is not weakening prudential standards; regulatory principles critical for financial stability are also necessary for financial development.
- IMF support: when providing TA or assessing compliance with international standards, IMF staff consider the context, risk profile and systemic importance of institutions, and stages of development and complexity of financial systems (IMF 2014b; Ferreira, Jenkinson, and Wilson 2019).

### Building a Proportional Prudential Framework
- Limits to adjustments: while local circumstances matter, adaptations to international standards must preserve minimum prudential requirements to promote trust and constrain regulatory arbitrage.
- Core principle assessments show proportionality is widely used in implementing prescriptive regulatory standards (for example, capital and liquidity).
- Examples of proportional implementations:
  - Switzerland: five-tier classification ranging from a framework super-equivalent to Basel III for the most systemic banks to a simplified approach for the smallest well capitalized and liquid banks (IMF 2019b).
  - The Bahamas: simplified Basel III definition of regulatory capital for all banks while applying a stringent, super-equivalent minimum requirement (IMF 2019c).
  - United States and other countries: use proportionality in allocating supervisory resources and setting expectations on corporate governance, risk management, stress testing, and recovery plans (IMF 2020b).
- Systemically important institutions subject to heightened standards and scrutiny.

### Box 2 — Guiding Principles for Proportional Implementation of International Standards
- The IMF experience providing TA and assessing compliance suggests the following guiding principles:
  - Adaptations or partial implementation of international standards should be considered only when there are clear reasons and benefits for doing so. While proportionality considerations are key and international standards might need to be adapted to ensure the effectiveness of the prudential framework in the local context, changes need to be clearly justified.
  - Adjustments should keep the rigor of and reflect international minimum thresholds. Although international standards may need to be adapted to better suit specific circumstances, focus should be in reducing disproportional compliance costs. Changes should not result in less-rigorous prudential frameworks that lead to less-resilient financial institutions or promote riskier behavior. In particular, capital and liquidity buffers should be commensurate with the minimum amounts established by international standards.
  - Tailoring must consider whether features of the risk environment are more pronounced in certain jurisdictions. When there are relevant risks not appropriately addressed by international standards, the national framework should go beyond international requirements. Should a jurisdiction be prone or subject to factors such as market illiquidity, high volatility, or the problematic enforcement of claims and the execution of collateral above the level embedded in international standards, more-stringent prudential measures may be needed than the international standard provides.
  - A proportional and risk-based approach to supervision should ensure additional focus and resources for weaker and more systemically important institutions. However, all segments of the financial markets require a minimum intensity of supervision, including onsite work, to identify weaknesses which cannot be easily detected via reporting and offsite surveillance.
  - While some financial systems and institutions may merit simpler standards, due consideration should be taken of the fundamental weaknesses identified during the GFC, including, but not limited to:
    - (1) higher and better quality capital buffers,
    - (2) liquidity buffers to avoid destabilizing fire sales and the need for intervention by public authorities,
    - (3) a greater systemwide or macroprudential perspective in the microprudential supervision of financial institutions,
    - (4) efforts to make systemically important institutions resolvable to mitigate moral hazard and avoid costly bailouts,
    - (5) sound corporate governance and risk management, and
    - (6) a legal and operational framework for financial sector oversight to allow supervisors to take preventative measures at an early stage, even when no minimum regulatory threshold has yet been breached.
  - As financial systems deepen and become more complex, the regulatory and supervisory framework should evolve toward international standards. While tough but simpler prudential approaches might be considered, as the financial system develops the national regulatory framework should also evolve to address new risks and realize the benefits of deeper financial markets. Similarly, the evolution of the financial system needs to be matched by enhanced supervisory capacity.
  - Local rules and supervisory practices should meet the expectations of the core principles even when the full set of international standards are not applicable. The core principles are universally applicable and represent the de facto minimum standard for sound prudential regulation and supervision.

*Source: sbrsnpgea - Box 1. Reflections on COVID-19 Impact (continued), sbrsnpgea - Box 1. Reflections on COVID-19 Impact (continued).*

### Box 2. Guiding Principles for Proportional Implementation

### Box 2. Guiding Principles for Proportional Implementation of International Standards (continued)

### Methodological approach
- The IMF closely monitors and encourages the implementation of reforms through surveillance and TA.
- Article IV surveillance and FSAP closely follow the implementation of reforms in member jurisdictions and make recommendations to enhance compliance with internationally agreed standards.
- The IMF has formally adopted the BCP as standards that it will assess in its surveillance work, alongside the World Bank, for emerging and developing and economies (EMDEs).
- Since 2006, more than 100 jurisdictions have been assessed.
- This paper draws on the results of BCP assessments to evaluate progress in the implementation of reforms.
- The paper analyzes the 47 BCP assessments completed between 2012 and 2019 to identify achievements as well as areas where more progress is warranted.
- All the assessments followed the 2012 BCP methodology and covered 18 AEs and 29 EMDEs. Two entries covered euro area and CEMAC (Central African Economic and Monetary Community), which represent 25 countries.
- The textual analysis process:
  - Step 1: Identify the most common weaknesses found in complying with each principle.
  - Step 2: Develop a mapping process that links specific expressions in the BCP comments with the weaknesses previously identified.
  - Step 3: Calculate simple statistics to observe the relative prevalence of each weakness.
- Comments provided by assessors are geared toward explaining grades and providing recommendations; they are intentionally biased toward pointing out weaknesses and generating constructive recommendations rather than recording strengths.

### Coverage and complementary analyses
- Complementary econometric analyses use data on 8,590 banks from 26 countries drawn from a standardized cross-country Fitch Connect database to relate banks’ fragility to a country’s BCP compliance.
- The econometric analysis focuses on three Core Principles: Supervisory Powers, Responsibilities and Functions (CP1); Independence, Accountability, Resourcing, and Legal Protection of Supervisors (CP2); and Corporate Governance (CP14).
- Due to data constraints, the econometric analysis is restricted to the 26 countries listed in Annex Table 1.
- Rationale for focusing on CPs 1, 2, and 14:
  - They are particularly informative about the institutional set up for supervision and governance of banks.
  - They build the foundations for compliance with other CPs.
  - They have sufficiently high variation in BCP grades in the regression sample to enable meaningful econometric testing.
  - Foundational nature reduces concern about biases from double jeopardy or overlapping issues.

### High-level findings from BCP assessments
- BCP assessments indicate that countries have made substantial progress in implementing Basel capital and liquidity standards.
- Principles linked with capital and liquidity standards have a relatively high level of compliance.
- Other areas show lower degrees of compliance:
  - Effective corporate governance.
  - Risk management.
  - Treatment of problem assets.
- Many countries show substantial weaknesses in the institutional framework for supervision and lack of powers and effective supervisory processes to identify and take timely corrective actions.

### Institutional setting for financial sector oversight — key findings
- Minimum international requirements for the institutional framework for bank supervision are largely set out in CP1 (responsibilities, objectives, and powers) and CP2 (independence, accountability, resourcing, and legal protection for supervisors).
- The BCBS’s 2012 review of the BCPs updated expectations to emphasize:
  - Primary mandate of supervisors should be safety and soundness.
  - More guidance on operational independence.
  - Resource allocation must consider systemic risks posed by banks.
  - An expanded list of required supervisory powers, including safeguards against industry or government influence.
- Supervisors need strong and unambiguous mandates, sufficient independence, appropriate resources, and a full suite of tools and powers to identify and address risks proactively, including regular stress testing and early intervention.

### COVID-19 implications
- The COVID-19 pandemic emphasized the need for a strong institutional framework.
- Central banks and supervisors had to respond quickly to preserve financial stability and mitigate the risk that temporary liquidity strains could impair the normal function of the financial system.
- Response required balancing:
  - Encouraging banks to restructure loans and use flexibility embedded in accounting standards and prudential framework.
  - Maintaining confidence in the banking system by ensuring losses are not hidden and prudential standards are not relaxed.
- Supervisors with clear safety and soundness mandates and appropriate shielding from political pressures are better positioned due to established higher credibility.
- Deficiencies in staff resources, relevant skills, and information technology capacity to operate remotely exacerbated some authorities’ ability to manage the pandemic’s impact effectively.

### Most prevalent institutional weaknesses
- Lack of operational independence is the most common challenge faced by supervisors.
  - Supervisory independence was often impaired by appointments and dismissal procedures that either lacked a defined criterion or were not transparent.
  - Government influence on decision making was a common constraint; in some jurisdictions, governing bodies were skewed toward government ministers or appointees.
  - Some supervisory decisions required political approval or were subject to review and potential overturning by political authorities.
  - Lack of budgetary autonomy persists in some countries; budget amounts and allocations controlled at political level even when supervisors are funded by industry fees.
  - Interference can be indirect or a potential concern (example noted where Ministerial directions to a supervisor could be a matter of potential concern).
- Other frequent weaknesses:
  - Lack of resources (insufficient staff, compensation, specialized skills).
  - Absence of a clear mandate for financial stability or lack of primacy of safety and soundness.
  - Deficiencies in access to group information, inability to raise prudential limits, and limited corrective powers.
- Specific common issues identified in assessments:
  - Appointments and dismissal vulnerabilities.
  - Government and industry influence.
  - Low staff complement and weak resource planning.
  - Low compensation and gaps in staff skills.
  - Objectives not clear, objectives not published, joint mandate roles not clearly defined.
  - Gaps in laws/regulation affecting supervisory powers.

_Italic: Source: Box 2. Guiding Principles for Proportional Implementation_

### 6. Inadequate Supervisory Powers

### 6. Inadequate Supervisory Powers

### Availability and capacity of supervisors
- Staffing issues frequently observed: staff shortages, insufficient supply of needed skills, inadequate staff compensation, and weak resource planning.
- Staff shortages attributed to high turnover and expanded responsibilities that strained existing resources.
- Lack of budget autonomy linked to staff shortages and limited ability to increase staff or offer credible compensation packages.

### Institutional mandates and legal powers
- Unclear mandates undermine supervisory decision-making: about half of assessed countries had mandates that were not clearly defined or were expanded to require support for developmental objectives, creating potential conflicts with prudential objectives.
- Common gaps in legal powers of supervisors included missing powers to:
  - intervene or carry out remedial action before the breach of minimum requirements,
  - obtain information,
  - revoke a license,
  - prevent a license from being granted or transferred to parties not deemed to be fit and proper.
- Example: In Canada, the Ministry of Finance can override the prudential judgement of the supervisor (Office of the Superintendent of Financial Institutions) in certain key areas, though this has not yet been a practical concern (IMF 2020a).

### Empirical evidence on institutional setting
- Econometric analysis suggests that the better a jurisdiction meets CP1 and CP2, the less fragile its banks typically are.
- Quantified finding: "One grade higher compliance with CP1 (CP2) translates into a 93 (100) percent higher Z-score, respectively (Annex Table 3)."
- The inverse relationship between supervisory independence and incidence of non-performing loans documented by Fraccaroli, Sowerbutts, and Whitworth (2019).
- Subsample analysis indicates the relationship is considerably weaker for systemically large banks and for foreign-owned banks where the local authority is the host supervisor, highlighting supervision challenges for large and complex institutions and the role of the home supervisor.

### Capital and liquidity (Prudential regulations)
- Capital and liquidity identified as cornerstones of stability for individual banks and the financial system; inadequate buffers increase probability and impact of banking crises.
- Basel III reforms addressed capital computation methods, calibration and risk coverage of standards, and eligible instruments, requiring banks to hold more and higher quality capital and ensure liquidity buffers.
- BCP principles addressing these areas: capital (CP16) and liquidity (CP24), including expectations on planning, risk management, contingency arrangements, and stressed scenarios.
- Supervisors expected to have powers and discretion to set standards above agreed minimums to reflect local circumstances; only Basel member jurisdictions required to meet full Basel standards for internationally active banks.
- Flexibility of capital and liquidity framework proved invaluable during the COVID-19 pandemic: supervisors could release the countercyclical capital buffer (where previously applied) and encourage use of the capital conservation buffer.
- Despite reforms, many frameworks have deficiencies:
  - About half of the assessed countries have weaknesses in their capital rules (limited risk coverage, absence of additional loss absorbance for systemically important banks, prudential adjustments not ensuring quality of regulatory capital).
  - Not all supervisors have the power to adjust required levels of capital for individual banks or the banking system to be commensurate with risk profiles.
  - Even where powers exist, many supervisors lack processes or capacity to effectively challenge banks’ internal capital assessment and require additional capital for unaccounted risks (Pillar 2 implementation remains challenging).
  - Example: 2017 BCP assessment of Japan noted the lack of a Pillar 2 capital framework and the benefits that adding one would bring (IMF 2017).
- Liquidity deficiencies:
  - Nearly a quarter of jurisdictions are considered NC or MNC with CP24 (on liquidity risk).
  - Most weaknesses arise from inappropriate quantitative limits that fail to address foreign currency liquidity needs, do not define liquid assets appropriately, or are not imposed on a consolidated level.
  - Common supervisory weaknesses: failure to determine whether banks have sound strategies, policies, and processes to manage liquidity risk; insufficient onsite inspections; weak or absent supervisory guidelines; lack of contingency plans.
  - In some jurisdictions there is no explicit requirement for supervisors to conduct separate analysis of liquidity risk strategy and monitoring for each significant currency or to evaluate banks’ ability to transfer liquidity across jurisdictions and legal entities.

### Corporate governance and risk management
- Governance failures were a primary factor in the GFC; weak governance and risk management left institutions vulnerable to unidentified and unchecked risks.
- New and revised standards:
  - Corporate governance added as a new principle (CP14) under the BCP 2012 methodology.
  - BCBS Corporate Governance Principles for Banks (2015) emphasize boards’ responsibility for strategy and enterprisewide risk management.
  - Risk management principle enhanced (CP15) with heightened expectations regarding banks’ policies, processes, and risk governance.
- Jurisdictions have made significant progress incorporating revised governance standards into national regulation; advanced economies generally successful in updating regulatory frameworks though supervisory practice often needs enhancement.
- Progress has consolidated improvements in the quality of internal controls and supervisory approaches have been reoriented to embed governance and risk management.
- Persisting weaknesses in implementation and supervisory practice:
  - Execution gaps: good regulatory frameworks but poor execution, limited/no interaction with boards, limited supervisory powers, insufficient staff resources.
  - Supervision of related-party risks has been poor; a significant flaw is the absence of or overly narrow definitions of related parties’ transactions.
  - Risk management supervision often fails to deliver clear guidance to the industry; weaknesses include strategy and policy, oversight, supervisory practice, model governance, contingency plans, specialized skills, definitions, board approval, reporting, legal framework, exposure limits.

*Source: sbrsnpgea - 6. Inadequate Supervisory Powers (IMF PDF).*

### 5. Weaknesses in Risk Management Supervision

### 5. Weaknesses in Risk Management Supervision

### Governance and Corporate Governance Supervision
- Regulatory gaps specific to corporate governance affected up to half the assessed jurisdictions.
- Gaps included weak supervisory powers: failure to establish or assess fit and proper standards and lack of supervisory power to remove unfit board members or executive management.
- Regulatory gaps also included lack of guidance to firms on supervisors’ expectations, or complete exclusion of some sectors of banks from any corporate governance standards.
- Empirical result: one grade higher assessment of CP14 compliance is typically associated with substantially sounder large banks; one grade higher compliance with CP14 translates into a 77 percent higher Z-score of systemically large banks.
- Finding: supervisory attention to the quality of internal governance of an institution is beneficial for the institution’s performance.

### Credit Risk and Problem Assets
- Credit risk permeates banking activities (banking book, trading book, on- and off-balance sheet); loans are the largest source of credit risk for most banks.
- Historical drivers of serious bank problems: undue relaxation of credit origination standards, poor risk management, lack of attention to changing counterparty circumstances.
- Post-GFC loan loss provisioning: pre-GFC incurred loss approach led to “too little, too late” provisioning; recognition delay increased procyclicality.
- Accounting change: new standards based on expected credit losses were developed to address the provisioning weakness.
- COVID-19 implementation challenge: unprecedented uncertainty about the pandemic’s impact made reliable forecasts of expected credit losses difficult; expected credit loss methodologies could trigger substantial provision increases in abrupt shocks.
- Supervisory responses: guidance to banks, encouragement to use flexibility in accounting standards to restructure loans and avoid inappropriate classification of viable firms; Basel Committee adjusted transitional arrangements for regulatory treatment of expected credit loss accounting to provide greater phasing flexibility.
- Finding: processes and policies to identify and manage problem assets fall short of agreed standards in more than 30 percent of the assessed jurisdictions.
- CP18 (problem assets, provisions, reserves) is among the least-observed BCPs.
- Common weaknesses, particularly in EMDEs:
  - Weaknesses of policies and procedures for asset classifications and provisioning.
  - Inadequate criteria and lack of processes to avoid evergreening of loans.
  - Low frequency of supervisory reviews.
  - Inadequate definitions of nonperforming loans, loan restructuring, and forbearance.
  - Weak policies and processes for collateral valuation.
- Adverse effects: these weaknesses call into question the integrity of reporting to supervisors, adversely affect capital adequacy, and hamper appropriate risk assessment and control of credit risk exposure.
- Recommendation: address deficiencies in management of problem assets as a necessary step to restore banking sector health after major credit shocks like the COVID-19 pandemic; national authorities and standard setters need to provide clear guidance and expectations to firms.

### Related Party Risks
- Related party activities touch credit risk, governance, and control, and can be a channel for abuse of a bank or banking system.
- Supervisory expectations for related party risk were refreshed in the revised BCP methodology and in the revision of standards for supervision of financial conglomerates.
- Many jurisdictions pay little or no attention to related party risks: more than half of jurisdictions assessed were rated MNC or NC in relation to the agreed international principle for regulation and supervision of this risk.
- It is the second least well observed BCP, following the CP related to independence and resources of the supervisor.
- Common legal framework weaknesses:
  - Definitions of related party were unduly narrow, not covering related banks and/or close relatives of directors/executive management/major shareholders.
  - Definitions scattered across different texts and sometimes conflicting.
- Supervisory practice weaknesses:
  - Failure to monitor or require reporting, leaving authorities unsighted on concentration risks and ultimate beneficial owner activities.
- Risk: for jurisdictions with weak related party practices, the COVID-19 pandemic heightens vulnerability for banks.

### Supervisory Approach, Practices, and Techniques
- Post-GFC consensus: supervision must be intrusive, with conclusive enforcement; BCPs and additional BCBS/FSB guidance reinforce this.
- Examples of guidance and frameworks cited: framework for dealing with weak banks (early remedial actions); forward-looking tools and stress testing; risk data aggregation and reporting; principles for supervision of financial conglomerates.
- Risk-based supervision (RBS) adoption:
  - Most jurisdictions have moved or are moving to RBS approaches as required by BCPs.
  - No single RBS model; jurisdictions differ in risk assessment methodologies.
  - Potential problem: disproportionate resource focus on the largest institutions can lead to inadequate minimum oversight of smaller banks, creating aggregate systemic risk.
- Forward-looking supervisory techniques improving: stress testing, peer group review, business model analysis.
  - Stress testing and business model analysis help identify shocks firms can withstand and inform targeted supervisory attention and policy options.
- Data quality concern: effectiveness of techniques relies on quality and reliability of supervisory data.
  - Finding: insufficient or low-quality data—by type, granularity, frequency, or inconsistency—is a concern in nearly two-thirds of IMF staff assessments.
  - Little difference between advanced and developing jurisdictions in active verification of supervisory data.

### Timely Intervention, Corrective Action, and Crisis Preparedness
- Timely intervention and corrective action are critical; identifying weaknesses without appropriate action is supervisory failure.
- Finding: about a third of jurisdictions have meaningful weaknesses in their framework for corrective actions.
- Missing powers noted in some supervisors: authority to resolve a bank or revoke its license, inability to sanction individuals, and inability to raise prudential standards for banks.
- Observed supervisory delays despite powers to act, caused by:
  - Poorly designed internal systems, complex/burdensome legal systems.
  - Poor legal processes and arbitrary reversal of supervisory decisions by external authorities.
- Behavioral issues: lack of assertiveness or willingness to act cited in more than one-fifth of assessments (examples: mild actions, not escalating sanctions, taking no corrective actions).
- Delayed intervention found in nearly a tenth of cases, associated with lack of a clear framework to activate and process concerns.
- Recommendation: strengthen quality of supervisory process, ensure full and graduated set of powers, remove procedural bottlenecks, and enhance assertiveness and timeliness of supervisory actions.

### Implementation Momentum and Policy Consistency
- Strong commitment to the post-GFC reform agenda; adoption of capital and liquidity standards has substantially strengthened financial systems.
- Observation: finalized standards increasingly lag original implementation timetables; some dilution of standards observed.
- COVID-19 response: need to reprioritize led several international bodies to extend transitional timetables for new standards; many countries have postponed implementation of new prudential standards, including outstanding pieces of Basel III.
- Recommendation: regain implementation momentum when possible; consistent implementation of the outstanding reform agenda remains critical.
- International coordination stance: international community agreed to act consistently with international standards, and not roll back reforms or compromise underlying objectives of existing international standards.
- Note: an effective prudential framework may require proportionate adaptation to reflect scale, sophistication, local market features, quality of information, and supervisory capacity.
- IMF role: continue to provide support to effective implementation through surveillance and technical assistance.

*Source: sbrsnpgea - 5. Weaknesses in Risk Management Supervision*

### Conclusions

### Conclusions

### Institutional setting for supervision
- A strong institutional setting for supervision is the foundation for a sound financial system.
- Assessments indicate widespread need to enhance institutional arrangements for supervisory processes, including:
  - clear mandates and a transparent system of accountability;
  - sufficiency of powers, skills, and resources.
- When institutional elements are in place, supervisors can meet their primary objective of supporting a safe and sound financial system.

### Regulatory reform, supervisory techniques, and capacity building
- Regulatory reform requires strong supervision and enforcement to achieve full effectiveness.
- Noted supervisory technique developments:
  - increasing use of risk-based supervision (RBS);
  - forward-looking techniques from stress testing;
  - peer group approaches to business model analysis.
- Ongoing challenges in some countries:
  - inadequate data;
  - poor information systems;
  - lack of supervisory capacity to adopt new analytical techniques.
- Continued efforts are needed to enhance supervisory capacity in traditional areas and to address new risks: financial innovation, climate change, and cyber threat.

### Governance, risk management, related-party risks, and crisis lessons
- Lessons from the GFC: consequences of poor governance, weak risk management, and lack of timely supervisory action.
- Financial stresses from the COVID-19 pandemic will test governance, risk management, and related-party channels again.
- IMF programs and technical assistance (TA) have been used to require reforms and address weaknesses in governance, risk management, and related parties.
- Notable lack of supervisory focus on related party risks suggests a role for the international community to amplify guidance or regulations.
- The pandemic may have intensified the risk of abuse of banks through related party channels, as credit needs apply equally to connected counterparties and other borrowers, and banks may lack ability to establish appropriate terms or deny credit.

### Problem-asset management and provisioning
- The COVID-19 pandemic makes it urgent to enhance frameworks for management of problem assets.
- Weaknesses in asset classification and provisioning frameworks are pervasive in many countries and adversely affect:
  - bank capital adequacy;
  - market discipline;
  - integrity of reporting to supervisors;
  - appropriate risk assessment and control of a bank’s credit risk exposure.
- National authorities and standard setters need to renew efforts to build a sound and internationally harmonized framework for problem-asset management that can address pandemic-related challenges.

### IMF support, priorities, and proportionality
- IMF staff will continue to provide active support through TA and FSAPs.
- Surveillance and TA work will promote the importance of a sound institutional setting for financial sector supervision, including:
  - adequacy of skills and resources;
  - unambiguous mandates for financial sector supervisors as highlighted in international standards.
- Efforts will focus on building supervisory capacity in:
  - traditional areas: risk-based supervision, corporate governance, credit risk;
  - new risks to financial stability: fintech, cyber risks, climate change.
- Advice will be guided by the proportional approach and principles outlined in the paper (Box 2), shaped to jurisdictional context and accounting for effects of the COVID-19 pandemic.

### Basel Core Principles (BCP) summary
- The BCP are standards issued by the BCBS for sound prudential regulation and supervision of banks (BCBS 2012).
- The BCP were originally issued in 1997 and refreshed in 2006 and 2012.
- BCP structure:
  - 29 high-level principles divided between supervisory actions and supervisory expectations of banks.
  - Principles 1–13: supervisory powers, responsibilities, functions, risk-based supervision, early intervention, timely supervisory actions.
  - Principles 14–29: supervisory expectations of banks, corporate governance, risk management, compliance with supervisory standards.
- Assessment grades: compliant (C), largely compliant (LC), materially noncompliant (MNC), noncompliant (NC).
- BCP methodology is founded on proportionality and applies to all supervisory authorities and all types of banking entities.
- BCP allow supervisors to adapt processes to size, complexity, and risk profile of supervised institutions.

### Econometric analysis — testable hypothesis and data
- Testable hypothesis: whether BCP compliance correlates with higher bank soundness on average, and whether association differs by bank size and ownership (domestic vs. foreign owned).
- Model: OLS pooled cross-sectional with time controls. Dependent variable Z_score transformed as ln(Z_score).
- Z_score definition: Z_score = (ROA + (E/A)) / std.(ROA) using five-year window. Higher Z-score indicates lower overall bank risk.
- Main explanatory variable X1j: BCP compliance grade on 1–4 scale (NC=1, MNC=2, LC=3, C=4).
- Bank-level controls (lagged 1 year): bank size (total assets), capitalization (equity ratio), profitability (ROA), cost efficiency (overhead costs to total assets), liquidity (liquid assets to total assets), bank specialization (commercial bank indicator).
- Country-level controls: GDP, GDP per Capita and GDP per Capita Growth, inflation, rule of law (World Bank WGI).
- Heterogeneity definitions:
  - Large banks: banks with total assets ≥ 10 percent of a country’s GDP (robust to 5 percent threshold).
  - Foreign-owned classification: foreign subsidiaries versus domestic banks; ownership info from Fitch Connect (latest year) with backward extrapolation when needed.
- Sample: combines IMF Standards and Codes Database BCP assessments (2013–2017) with Fitch Connect bank data and World Bank macro data.
- Estimation sample comprises 8,590 banks from 26 countries.

### Sample distribution and descriptive statistics (exact figures preserved)
- Annex Table 1 — Banks Distribution per Economy (Number of Banks, Percent of Total):
  - Albania: 6, 0.07
  - Austria: 30, 0.35
  - Azerbaijan: 10, 0.12
  - Bahrain: 11, 0.13
  - Bulgaria: 8, 0.09
  - China: 71, 0.83
  - Democratic Republic of Congo: 3, 0.03
  - Denmark: 49, 0.57
  - Georgia: 8, 0.09
  - Germany: 1,256, 14.62
  - Guatemala: 3, 0.03
  - Hong Kong SAR: 5, 0.06
  - Iceland: 5, 0.06
  - India: 49, 0.57
  - Ireland: 4, 0.05
  - Italy: 206, 2.4
  - Japan: 137, 1.59
  - Kazakhstan: 11, 0.13
  - Norway: 78, 0.91
  - Russian Federation: 408, 4.75
  - Singapore: 6, 0.07
  - South Africa: 7, 0.08
  - Switzerland: 229, 2.67
  - Turkey: 7, 0.08
  - United Kingdom: 56, 0.65
  - United States: 5,927, 69
  - Total: 8,590, 100

- Annex Table 2 — Selected descriptive statistics (Observations, Mean, Median, Min, Max, Std. Dev.):
  - Z-score: 8,590; mean 131.116; median 67.04; min 2.56; max 1,257.13; Std. Dev. 202.90
  - Bank size (millions of USD): 8,590; mean 3,663.33; median 239.51; min 4.07; max 3,367,898; Std. Dev. 54,384.43
  - Equity to total assets: 8,590; mean 0.12; median 0.10; min 0.00; max 0.999; Std. Dev. 0.08
  - Return on assets: 8,590; mean 0.01; median 0.01; min −0.28; max 0.59; Std. Dev. 0.02
  - Overhead costs to total assets: 8,590; mean 0.04; median 0.03; min 6.64E-05; max 0.997; Std. Dev. 0.06
  - Liquid assets to total assets: 8,590; mean 0.13; median 0.09; min 3.08E-05; max 10.13; Std. Dev. 0.13
  - Commercial bank (D): 8,590; mean 0.72; median 1; min 0; max 1; Std. Dev. 0.45
  - Large bank (≥ 10% GDP): 8,590; mean 0.003; median 0; min 0; max 1; Std. Dev. 0.06
  - Large bank (≥ 5% GDP): 8,590; mean 0.006; median 0; min 0; max 1; Std. Dev. 0.08
  - Foreign bank (2013): 2,527; mean 0.0800; median 1; min 0; max 1; Std. Dev. 0.27
  - Country-level (26 observations) examples:
    - GDP (bill USD): mean 1,943.49; median 370.82; min 12.75; max 16,710.46; Std. Dev. 3,795.21
    - GDP per capita: mean 30,192.62; median 28,006.98; min 397.34; max 90,132.35; Std. Dev. 25,632.30
    - GDP per capita growth: mean 2.02; median 1.75; min −22.86; max 8.01; Std. Dev. 2.44
    - Inflation rate: mean 1.97; median 1.84; min −28.81; max 8.10; Std. Dev. 3.29
    - Rule of law index: mean 0.67; median 0.42; min −1.45; max 2.10; Std. Dev. 1.14
    - CP1 compliance: mean 3.23; median 3; min 1; max 4; Std. Dev. 0.76
    - CP2 compliance: mean 2.50; median 2.5; min 1; max 4; Std. Dev. 0.65
    - CP14 compliance: mean 2.92; median 3; min 1; max 4; Std. Dev. 0.74

### Regression estimation results (Annex Table 3) — selected coefficients (dependent variable ln[Z-score], standard errors in parentheses)
- CP1 (Responsibilities, Objectives, and Powers)
  - Compliance with CP1 (All): 0.933*** (0.067)
  - Compliance with CP1 (By Bank Size): 0.972*** (0.070)
  - Compliance with CP1 (By Foreign Ownership): 0.799*** (0.102)
  - Large bank (D) × CP1 compliance: −0.762** (0.334)
  - Large bank (D) coefficient (By Bank Size): 2.558** (1.069)
  - Foreign bank (D) × CP1 compliance: −0.672*** (0.146)
  - Foreign bank (D) coefficient (By Foreign Ownership): 2.028*** (0.520)
  - Adjusted R2: 0.26 (All), 0.26 (By Bank Size), 0.19 (By Foreign Ownership)

- CP2 (Independence, Accountability, Resourcing, and Legal Protection for Supervisors)
  - Compliance with CP2 (All): 1.002*** (0.089)
  - Compliance with CP2 (By Bank Size): 1.042*** (0.091)
  - Compliance with CP2 (By Foreign Ownership): 0.822*** (0.131)
  - Large bank (D) × CP2 compliance: −0.883*** (0.335)
  - Large bank (D) coefficient (By Bank Size): 1.939** (0.860)
  - Foreign bank (D) × CP2 compliance: −0.278** (0.119)
  - Foreign bank (D) coefficient (By Foreign Ownership): 0.473 (0.359)
  - Adjusted R2: 0.25 (All), 0.26 (By Bank Size), 0.19 (By Foreign Ownership)

- CP14 (Corporate Governance in Banks)
  - Compliance with CP14 (All): −0.027 (0.088)
  - Compliance with CP14 (By Bank Size): −0.080 (0.094)
  - Compliance with CP14 (By Foreign Ownership): 0.023 (0.143)
  - Large bank (D) × CP14 compliance: 0.774*** (0.293)
  - Large bank (D) coefficient (By Bank Size): −2.872*** (0.959)
  - Foreign bank (D) × CP14 compliance: 0.347 (0.236)
  - Foreign bank (D) coefficient (By Foreign Ownership): −1.333* (0.708)
  - Adjusted R2: 0.24 (All), 0.24 (By Bank Size), 0.17 (By Foreign Ownership)

- Observations: 8,590 (All and By Bank Size), 2,527 (By Foreign Ownership)
- Significance notation: * p < 0.10, ** p < 0.05, *** p < 0.01
- Note: Large bank denotes total assets ≥ 10% GDP. Foreign bank indicates a foreign subsidiary. Additional controls include ln[TA], equity ratio, ROA, overhead costs to TA, liquid assets to TA, commercial bank (D); country controls include GDP, GDP per capita (level and growth), inflation, rule of law.

### Interpretation and caveats
- Estimated coefficients are correlations between ln(Z-score) and BCP compliance, not necessarily causal.
- Despite rich covariates, endogeneity concerns remain (omitted variable bias, reverse causality).
- Sample concentration in AEs, and the US accounting for the largest chunk of the sample, was tested via robustness checks (dropping US banks preserves overall conclusions).
- Clustering standard errors at the country level is problematic with only 26 clusters, though a robustness check clustering at country level preserves the bulk of results.

### Monetary and Capital Markets Technical Assistance by Topic (Figure 8) — Percent of total TA (exact shares)
- Debt mgmt and capital mkt dev: 11%
- Financial sector stability review: 2%
- Supervision and regulation issues: 47%
- Central bank operations and monetary: 34%
- Other financial sector issues: 6%

*Source: IMF staff.*

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_Source: https://www.imf.org/-/media/files/publications/dp/2021/english/sbrsnpgea.pdf_