## _cr11233 ## Source details **Canonical URL:** [_cr11233](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11233.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11233.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11233.pdf.json) --- ### Summary Compliance with the Basel Core Principles — Key overall findings - High level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). - Crisis revealed serious deficiencies in risk measurement and risk management at major banks and weaknesses in supervisors’ ability to identify and have deficiencies rectified. - Financial Services Authority (FSA) has put correct response in place; process still at an early stage. - Effective implementation of planned work program needed to achieve full compliance. - Programs for enhancing supervision of capital and liquidity are the most advanced. - Shortcomings remain in: - the prudential mandate; - the supervisory approach, techniques, and reporting; - data quality; - supervisory organization’s shift from reactive processes to proactive, prudential-outcome–centered supervision. - Supervisory Enhancement and Core Prudential Programs (SECPP/CPP) expected to overcome shortcomings but: - insufficient time has elapsed for SECPP/CPP to become adequately embedded; - achieving cohesive implementation will be challenging. - Authorities strongly committed to supervisory reform programs and cultural change; ongoing focused leadership required. - New macro-prudential overlay initiatives must not detract from core supervisory tasks. ### Organizational reform and macro‑prudential overlay - Major changes proposed by government risk introducing uncertainty. - Potential benefits: greater focus on systemic linkages and resolvability. - Risks and cautions: - Newness of some concepts—expectations should be reasonable. - Unclear interaction of new micro- and macro-prudential mandates in practice. - Poor implementation and resourcing of macro-prudential efforts could detract from supervisory effectiveness. - Reputation of program depends on credible supervision of smaller- and medium-sized firms as well as major firms. ### Introduction, scope, methodology, and timing - Assessment completed as part of IMF FSAP undertaken January–March 2011; reflects framework as of completion. - Not intended to assess merits of proposed structural reforms by U.K. authorities or Independent Commission on Banking. - Focused on major banks and banking groups, in line with BCP methodology. - U.K. authorities assessed according to Core Principles Methodology (Basel Committee, October 2006). - Grading system: compliant; largely compliant; materially noncompliant; noncompliant. - Essential and additional assessment criteria used (EC and AC). ### Institutional, macroeconomic setting and market structure - Bank balance sheets amount to approximately five times GDP. - Market composition: - Six main banks and building societies plus important foreign banks and some 180 smaller banks and building societies. - FSA identified some eight very-high-impact banks and approximately 35–50 high-impact deposit takers. - Concentration: - The five largest banks, the largest building society, and the largest foreign bank together account for close to 90 percent of retail deposits. - Crisis impacts: - Losses from structured products, off-balance sheet vehicles, mortgage and business-lending asset quality problems, over-reliance on short-term wholesale funding. - Some medium-sized banks and building societies failed; two large banks required material injections of public money; one remains in majority temporary state ownership. - Independent Banking Commission (Vickers) to report by end-September 2011. ### Economic outlook and policy context - IMF central scenario: real GDP growth of 2 percent in 2011, rising gradually to 2.5 percent in the medium term. - GDP growth unexpectedly turned negative again in Q4 2010. - BoE operates under price-stability mandate; inflation currently well above the 2 percent target; IMF central projection forecasts steady decline. - Authorities negotiated pay and lending framework with major banks around January 2011 including: - commitments on pay linked to performance, limits on bonus pools, greater pay transparency; - commitments on capital/resources to support specific targets for increased gross new lending to businesses, including SMEs; - BoE to monitor and report on performance against lending commitments. - Caution: ensure sound risk management is not neglected while pursuing lending targets. ### Risks facing the U.K. banking system - Household indebtedness is high and could be adversely affected by interest rate increases or an economic slowdown. - Downside risks to asset quality remain; level of new impairments has trended down over the past year. - Government austerity program in place; short-term growth impact uncertain. - Significant exposures to commercial real estate; prices rebounded after a 40 percent decline, but risks remain. - Material indirect exposure to vulnerable Euro-zone economies. - Substantial wholesale funding maturities for major U.K. banks over coming one to two years; FSA reported banks have plans to manage that risk. ### Mitigating developments and capital/liquidity trends - Tier 1 capital for U.K. banking system rose from the 8 percent range on average over 2005–2007 to some 12 percent at mid-2010. - Banks have enhanced short-term liquidity; some have made material progress reducing structural reliance on wholesale funding. ### Preconditions for effective supervision - Public infrastructure, business laws, accounting/auditing and legal professions well developed. - IFRS used by U.K. listed companies; non-listed may use U.K. GAAP. - FRC oversight of auditing; Auditing Practices Board and Accounting Standards Board set standards harmonized with international standards. - Use of section 166 “skilled persons” reports increased but from a low base; more in-depth investigations feasible. - FSA seeking greater professional skepticism from auditors; auditors have statutory duty to inform FSA of material concerns. ### Organizational and governance findings (CP 1 and related) - FSA’s mandate initially lacked explicit prudential objective until 2010; re-interpretation to “intensive and intrusive” and “judgment based” underway. - Statutory qualifiers in FSMA (e.g., maintaining competitiveness, minimizing impact of FSA actions) may have undercut prudential supervision. - ‘Contributing to financial stability’ added to regulatory objectives in 2010; too soon to observe impact. - FSA enjoys operational independence; Chairman appointed for five-year term but legislation allows removal by HMT with no explicit grounds and no public disclosure requirement. - Staffing changes: - FSA staff increased from around 2,500 in early 2008 to nearly 3,900 today. - Supervisory team for a major bank consists of some 15–20 FTEs; for a major foreign bank 5–10 FTEs (previously 4–6). - Major bank division staffing rose from some 140 to 260; specialist resource staff rose from 100 to 200. - Section 166 reports used approximately 175 times in 2010. - Staff turnover around 10 percent overall. ### Resourcing, data, and cooperation implications - Assessors believe further increase in human resources required to: - enable full implementation of planned enhancements; - perform more proactive detailed reviews of key risk areas; - implement macro-prudential overlay without drawing resources away from core prudential work. - Legacy systems issues and fragmented data/silos identified; remediation and efficiency opportunities exist. - Mechanisms for information sharing among authorities in place; cooperation reported to be working well post-crisis. ### Licensing, approvals, and fit‑and‑proper processes (CPs 2–5) - FSA runs a comprehensive and effective licensing and approvals structure. - Strong focus on ‘fit and proper’ for overseers, Board members, and senior management. ### Capital adequacy and stress testing (CP 6) - FSA enhanced quantity and quality of capital; capital rules compliant with Basel and European requirements. - Interim capital regime promulgated from 2009; individual capital targets and capital guidance set above minima. - Robust stress testing for major banks instrumental in setting capital buffers. - Observed capital metrics: - ICG target ranges for eight very high-impact banks: from 110 percent to 198 percent of their pillar 1 minimum. - For approximately 180 smaller and medium-sized deposit takers: median ICG between 150 percent and 175 percent of minimum; about 15 percent of firms in each of the 100 percent to 125 percent and 125 percent to 150 percent ranges; some 40 percent of smaller and mid-sized deposit takers have ICG levels above 175 percent with half of these being above 200 percent. - Major banks’ Tier I ratio: 2007 around 8 percent; risen to the 12 percent average (10 percent to 14 percent range). - Current core tier 1 range for the four main banks: 9 percent to 11 percent. - Concerns: model assessment rigor and resources for model validation and replication. ### Advances in processes to relate capital to risk - Processes more advanced due to longstanding focus on stress testing and Pillar 2. - Risk: inadequate assurance of robustness of banks’ underlying processes (loan classification, impairment determination, valuation of complex products) and models could lessen stress testing effectiveness. - Recommendation: enhance in-depth assessments with more transaction testing and on-site detailed work as part of ‘deep-dive’ and peer theme reviews. ### Credit risk oversight (CP 8) - Finding: FSA needs materially enhanced focus on credit risk with more regular proactive reviews of portfolio quality. - Data needs: more granular data from banks operating credit risk models for integrity assessment and peer analysis. - Implementation priorities: - Develop and implement overall enhancement strategy as a priority. - Expand detailed reviews and address resource constraints to enable priority work. - Reviews to consider quality of risk management, provisioning and governance. - More transaction testing on a select basis required. - Use of more skilled persons’ reports as short-term partial bridge. - Proceed with proposals to enhance FSA data and analytical tools. - Assessment for CP 8: Materially noncompliant — Core Prudential Program for credit risk not fully rolled out; full roll out expected to be completed by end-2012. ### Problem assets, provisions and reserves (CP 9) - Finding: focus placed on capital rather than provisioning and reserves. - Assessment: Compliant — legal and procedural frameworks exist but supervisory practice is bank-reliant with few hard on-site checks. - Note: new EU rules following revised IAS39 (EL-driven) expected to require a change. ### Market risk and IRRBB (CP 13, CP 16) - FSA demonstrates necessary skills and understanding of market risk and IRRBB; increased risk specialist resources. - Remaining needs: increase proactive deep-dive reviews and peer analysis; enhance assurance of market risk measurement, management and governance. - Assessment: Largely compliant. ### Liquidity risk (CP 14) - FSA made major successful efforts to ensure very high-impact banks increase liquidity; capabilities for assessment and intervention well advanced. - New liquidity regime BIPRU 12 introduced end-2009; reporting and individual liquidity assessments in force June 2010; international standards expected by 1 January 2015. - Supervisory tools: ILAS/ILAA, Contingency Funding Plans, Supervisory Liquidity Review Process (SLRP), liquidity DashBoard, scorecard and reporting forms (FSA047, FSA048, FSA054). - Deep-dive liquidity reviews typically 3–4 people over 2–3 months; initial coverage of major banks and some high-risk banks; roll-out expected to be finalized within several years. - Assessment: Largely compliant. - Recommended action plan related to liquidity and supervisory strengthening (selected): - Continue roll out of the new approach beyond major banks. - Develop integrated multi-year plan for enhanced supervision including: - more on-site and in-depth reviews; - more peer benchmarking; - desired coverage model more frequent; - amendments to risk-rating framework to be more discriminating, proactive, and forward-looking; - inclusion of Core Prudential Program extension to a range of banks beyond very high-impact; - inclusion of risk-model changes and tightening specialist-supervisor linkages; - improving reporting of results to banks for clear messages; - determining resource requirements and reasonable timeframe; - ensuring macro-prudential overlay does not detract from enhanced micro-prudential work. - Start materially enhanced in-depth review of credit risk in 2011. - By end-2011, review adequacy of specialist resources. - Implement planned roll out of new liquidity approach beyond major banks. ### Supervisory approach, techniques, and reporting (CPs 19–21) - Overall supervisory approach enhancement has started but needs continued rigorous embedding and augmentation with in-depth reviews and a consistently-proactive review strategy. - Key observations: - ARROW risk assessment process is complex and does not adequately discriminate among risks at major banks. - Forward-looking element in ratings under-developed. - Better integration of specialist work into supervision and more peer analysis needed. - Without more detailed verification, assurance given by current assessments of risk management and governance may not be adequate. - Degree of detailed review in parts of Core Prudential Program not yet implemented (e.g., review of risk management and governance). - Assessment: Materially noncompliant for CP 19. - Recommendations (selected): - Increase number and frequency of detailed deep-dives (on-site equivalent work). - Do not rely on S166 reports as substitute for proactive supervisory deep-dives; S166 may be interim measure. - Improve integration of specialist activities and links between CPP modules. - Revamp ARROW to be more discriminating and forward-looking; provide clearer guidance and criteria for rating judgments. - Enhance peer analysis availability and consistency of messaging to Boards and CEOs. - Design comprehensive multi-year program for enhanced supervision with specific timetables and resource plans. ### Corrective and remedial powers (CP 23) - FSA identifies problems requiring remedial action but could improve linking of interventions to seriousness of issues; supervisory approach still moving from reactive to proactive. - Recommendation: implement an early intervention framework to ensure consistent forcefulness and escalation from informal to formal stages. - Tools: remedial action plans, capital add-ons, power to impose conditions on authorizations, ability to levy fines. - Special resolution: FSA can declare a bank nonviable and trigger Special Resolution Regime (SRR) conducted by BoE; used once successfully for a medium-sized building society. ### Consolidated and cross‑border supervision (CPs 24–25) - United Kingdom applies consolidated supervision; FSA applies rules on consolidated basis from CRD and Financial Conglomerates Directive. - Gap: FSA has no legal power directly over parent holding company of banking group. - Consequence: formal remedial action may need to be through authorized firms in group which may not be sufficiently significant. - FSA has no direct authority to approve acquisitions by parent holding companies of banks. - Cooperation: extensive MOUs and informal arrangements; effective home-host arrangements essential under EU single-passport rules. - Assessment: Largely compliant for consolidated supervision; recommendation to amend legislation to give FSA powers over holding companies as a priority. ### Supervisory reporting, data quality and systems (CP 21 and SUP 15.6) - SUP 15.6 sets standards around accuracy, completeness and timeliness; non-compliance can lead to fines or enforcement. - FSA has power to require information (FSMA section 165) and can require skilled person reports (section 166). - Observed issues: - GABRIEL system on lighter range compared with other jurisdictions. - FSA relies on banks’ MIS; risks in comparing and storing inconsistent data and data quality concerns. - Information systems remain basic; heavily supplemented by ad-hoc reporting for major banks. - TARDIS and ARI systems operate for alerts; no organized early warning system apparent. - Assessment: Largely compliant for SUP 15.6; SUP practices technically met but at low level of completeness and efficiency. ### Accounting, disclosure, auditors and market discipline (CP 22) - FRC sets governance guidelines via U.K. Corporate Governance Code; Walker Report recommendations implemented in part. - Disclosure: - Annual disclosures enhanced by Pillar 3. - Frequency of bank financial disclosures varies; regular disclosures related to market risk, liquidity risk and credit concentrations appear less than in some other major markets. - FSA does not publish extracts from regulatory returns; assessors recommend it should. - FSA publishes annual Financial Risk Outlook (replaced starting in 2011 by Prudential Risk Outlook and Conduct Risk Outlook). - BoE publishes twice-yearly financial stability reports. - Auditor engagement: - FSA initiated periodic meetings with external audit firms; supervisors of high-impact banks to meet auditors at least annually. - Concerns about audit quality and need for more professional skepticism. ### Use of skilled person reports and deep‑dives (section 166) - Use of s.166 reports increased for banks: - Number of S166 reports related to prudential issues across 2008, 2009 and 2010: 6, 13 and 23 respectively. - For banks average S166 cost around £0.3 million to £0.5 million; range £30k to £1,100k. - S166 reports for prudential matters remain limited; not a substitute for full supervisory deep-dives. ### Implementation timing, authorities’ response and resource planning - Authorities (HMT, BoE, FSA) welcome IMF review; note transition to new regulatory structure begun. - Authorities state FSA responded to crisis and made good progress; supervisory reform programs will take time to fully implement. - Prudential Regulation Authority (PRA) intended approach: forward-looking, combine resilience policies, supervisory assessments and interventions, and mechanisms to support resolution. - PRA supervisory approach for systemically important banks includes: - analysis of financial position; - ongoing evaluation of business model, capital and liquidity plans, governance and culture, risk management and controls; - stress testing against a range of possible future states; - regular assessment of resolvability and resolution plans; - regular contact between firm senior management and senior PRA management; - early and proactive supervisory interventions under Proactive Intervention Framework. - Authorities agree additional supervisory resources likely required; FSA and BoE assessing resource requirements via PRA operating model design. ### Key numeric and timing items (preserved exactly) - Assessment period: FSAP undertaken January–March 2011. - IMF central scenario: real GDP growth of 2 percent in 2011, rising gradually to 2.5 percent in the medium term. - GDP growth unexpectedly turned negative again in Q42010. - Bank balance sheets amount to approximately five times GDP. - FSA staff increased from around 2,500 in early 2008 to nearly 3,900 today. - Supervisory team sizes: major bank 15–20 FTEs; major foreign bank 5–10 FTEs; previous 4–6. - Major bank division staffing rose from some 140 to 260; specialist resource staff from 100 to 200. - Section 166 reports used approximately 175 times in 2010 (and S166 bank counts: 6, 13, 23 for 2008, 2009, 2010 respectively). - ICG target ranges for eight very high-impact banks: from 110 percent to 198 percent of their pillar 1 minimum. - For approximately 180 smaller and medium-sized deposit takers: median ICG between 150 percent and 175 percent of minimum; about 15 percent of firms in each of the 100 percent to 125 percent and 125 percent to 150 percent ranges; some 40 percent have ICG levels above 175 percent with half of these being above 200 percent. - Major banks’ Tier I ratio: 2007 around 8 percent; risen to the 12 percent average (10 percent to 14 percent range). - Current core tier 1 range for the four main banks: 9 percent to 11 percent. - Commercial real estate prices rebounded after a 40 percent decline. - Proposed reorganization legislation targeted for adoption by the beginning of 2013. - New liquidity international standard proposed implementation date: 1 January 2015. - CPP rollout: complete cycle for VHI banks targeted in the next 18–24 months. - Core Principle grading context (aggregate): Compliant (C) – 17, Largely compliant (LC) – 10, Materially noncompliant (MNC) – 3, Noncompliant (NC) – None. ### Priority policy recommendations (extracted) - Clarify statutory mandates and practical interaction of micro- and macro-prudential mandates; specify any early intervention mandates by parliament. - Ensure clarity and cohesion in implementing “intensive and intrusive” judgment-based supervisory approach focused on material deficiencies and prompt corrective action. - Rigorously update resource needs (quality and quantity), including data and analytical systems; assess synergies with BoE as part of reorganization planning. - Implement integrated multi-year plan for enhanced supervision with: - more on-site and in-depth reviews; - expanded peer benchmarking and more frequent coverage; - amendments to risk-rating framework to be forward-looking and discriminating; - extension of Core Prudential Program beyond very high-impact firms; - tighter links between specialist and supervisory staff. - Prioritize legislative amendment to give FSA (or successor PRA) powers over parent holding companies of banking groups. - Proceed with materially enhanced in-depth review of credit risk starting in 2011. - By end-2011 review adequacy of specialist resources and implement planned roll out of liquidity approach beyond major banks. - Develop a well-articulated, judgment-based, prompt intervention framework and enhance inter-authority arrangements with lessons from prior resolution experience. *Italic: IMF assessment text as provided in the source content.* ### 1. Summary Compliance with the Basel Core Principles—Detailed Assessments .........22 ### 1. Summary Compliance with the Basel Core Principles—Detailed Assessments ### Key overall findings - The United Kingdom has a high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). - The crisis revealed serious deficiencies in risk measurement and risk management at major banks, and weaknesses in supervisors’ ability to identify and have deficiencies rectified. - The Financial Services Authority (FSA) has put the correct response in place and has made as much progress as possible since the crisis, but the process is still at an early stage. - Many examples of high-quality initiatives were observed; effective implementation of the already planned work program is needed to achieve full compliance. - Programs for enhancing supervision of capital and liquidity are the most advanced. - Shortcomings remain in: - the prudential mandate; - the supervisory approach, techniques, and reporting; - data quality; - the supervisory organization’s shift from reactive processes to proactive, prudential-outcome–centered supervision. - The Supervisory Enhancement and Core Prudential Programs (SECPP) are expected to overcome these shortcomings, but: - insufficient time has elapsed for SECPP to become adequately embedded; - achieving cohesive implementation will be challenging. - Authorities are strongly committed to supervisory reform programs and the cultural change necessary; ongoing focused leadership will be required. - New initiatives to add a macro-prudential overlay in a new organizational structure are being developed and must not detract from core supervisory tasks. ### Organizational reform and macro-prudential overlay - Major changes in regulatory and supervisory organization proposed by the government risk introducing uncertainty. - Potential benefits: greater focus on systemic linkages of major firms and their resolvability. - Risks and cautions: - Newness of some concepts—expectations should be reasonable. - Unclear how new objectives for prudential regulation and interaction of new micro- and macro-prudential mandates will work in practice. - Poor implementation and resourcing of macro-prudential efforts could detract from improving supervisory effectiveness. - Reputation of supervisory and regulatory program depends on credible supervision of smaller- and medium-sized firms as well as major firms. ### Introduction and scope of the assessment - Assessment completed as part of an IMF Financial Sector Assessment Program (FSAP) undertaken January–March 2011; reflects the regulatory and supervisory framework in place as of completion of the assessment. - Not intended to assess merits of proposed structural reforms by U.K. authorities or the Independent Commission on Banking. - Assessment focused on major banks and banking groups, in line with BCP methodology. ### Information and methodology used - U.K. authorities agreed to be assessed according to the Core Principles Methodology issued by the Basel Committee in October 2006. - Compliance assessed qualitatively using essential and additional assessment criteria: - Essential criteria (EC) gauge full compliance. - Additional criteria (AC) are suggested best practices and are commented on but not reflected in grading. - Four-part grading system: compliant; largely compliant; materially noncompliant; noncompliant. - Team reviewed laws, rules, guidance, and practices; held extensive meetings with FSA, Bank of England (BoE), Her Majesty’s Treasury (HMT), and private-sector participants; used a comprehensive self-assessment provided by the authorities. - Standards evaluated in the context of the U.K. financial system’s sophistication and complexity; expectations were high given London’s role as a premier global financial center. ### Institutional and macroeconomic setting and market structure - Bank balance sheets amount to approximately five times GDP. - The U.K. allows banc-assurance; leading U.K. banks are among the most complex internationally. - Market composition: - Six main banks and building societies plus important foreign banks and some 180 smaller banks and building societies. - FSA identified some eight very-high-impact banks and approximately 35–50 high-impact deposit takers (banks and building societies), based on FSA rating criteria. - Concentration and deposits: - The five largest banks, the largest building society, and the largest foreign bank together account for close to 90 percent of retail deposits. - Crisis impacts and structural change: - Banks faced losses from structured products, off-balance sheet vehicles, mortgage and business-lending asset quality problems, and over-reliance on short-term wholesale funding. - Strategic concentrations (e.g., commercial real estate) contributed to asset quality problems. - Mergers occurred before and during the crisis; concentration in the banking sector has increased. - A number of medium-sized banks and building societies failed; two large banks required material injections of public money, one remains in majority temporary state ownership. - Authorities conducted major stress tests and participated in European stress tests. - Independent Banking Commission (Vickers Commission) established to review concentration and structural changes; to report to government by end-September 2011. ### Economic outlook and policy context - IMF central scenario envisages real GDP growth of 2 percent in 2011, rising gradually to 2.5 percent in the medium term. - GDP growth unexpectedly turned negative again in Q42010. - BoE operates under a price-stability mandate; inflation is currently well above the 2 percent target, but IMF central projection forecasts a steady decline. - Authorities negotiated a framework relating to pay and lending with major banks around January 2011; framework includes: - commitments on pay linked to performance, limits on bonus pools, greater pay transparency; - commitments to have capital and resources to support specific targets for increased gross new lending to businesses, including specific increases to small- and medium-sized businesses; - BoE to monitor and report on performance against lending commitments. - Caution: banks and regulators must ensure sound risk management is not neglected in pursuit of lending targets. ### Risks facing the U.K. banking system - Household indebtedness is high and could be adversely affected by interest rate increases or an economic slowdown. - Downside risks to asset quality remain, though level of new impairments has trended down over the past year. - Government austerity program is in place; short-term growth impact is uncertain. - Significant exposures to commercial real estate; prices rebounded after a 40 percent decline, but risks remain. - Material indirect exposure to vulnerable Euro-zone economies. - Substantial wholesale funding maturities for major U.K. banks over the coming one to two years; FSA reported they all have plans to manage that risk. ### Mitigating developments and capital/liquidity trends - Tier 1 capital for the U.K. banking system rose from the 8 percent range on average over 2005–2007 to some 12 percent at mid-2010. - Actions by authorities, market pressures, and crisis experience have led banks to enhance short-term liquidity. - Some banks have made material progress in longer-term programs to reduce structural liquidity reliance on wholesale funding. ### Preconditions for effective banking supervision - Public infrastructure supporting banking supervision is well developed. - Government identified areas where arrangements between authorities did not work as well as desired; a major restructuring has been proposed and implementation has already started. - Business laws (contract, bankruptcy, property) are well developed; independent judiciary operates under common law and statute law. - Accounting, auditing, and legal professions are long established, well resourced and well regulated. - International Financial Reporting Standards (IFRS) are used by U.K. listed companies; non-listed companies can use U.K. GAAP, substantially harmonized with IFRS. - Oversight of the auditing profession through the Financial Reporting Council (FRC); Auditing Practices Board and Accounting Standards Board set U.K. auditing and accounting standards, harmonized with international standards. - Prudential authorities use accounting and audit professions and other skilled persons to conduct investigations on their behalf (“section 166 reports”); number of these procedures has increased in the last two years but from a very low base—there is room to do more in-depth investigations. - FSA has begun to express a desire that auditors exercise more professional skepticism and do more work in areas important for the prudential framework (e.g., valuation of complex products); auditors have a statutory duty to inform the FSA of concerns of material significance. - Authorities have begun to deepen relations with auditors, which had lapsed somewhat over the preceding decade. *Source: 1. Summary Compliance with the Basel Core Principles—Detailed Assessments* ### 20. The Financial Reporting Council (FRC) sets governance guidelines for listed ### _cr11233 - 20. The Financial Reporting Council (FRC) sets governance guidelines for listed ### U.K. Corporate Governance Code (FRC) - The FRC sets governance guidelines for listed companies with premium listing through the U.K. Corporate Governance Code (formerly the Combined Code). - The Code contains broad principles and more specific provisions. - Listed companies are required to report on how they have applied the main principles of the Code, and either to confirm that they have complied with the Code's provisions, or where they have not, to provide an explanation. - In May 2010, the FRC issued a new edition of the Code, which will apply to financial years beginning on or after June 29, 2010. ### Walker Report and board-level governance enhancements - The Walker Report (November 2009) reviewed U.K. corporate governance requirements for banks and other financial institutions and made a number of recommendations. - Recommendations to strengthen the role of Boards included: - having enhanced expertise; - separating the roles of chair and CEO; - setting up risk committees of the Board separate from audit committees. - These recommendations are being implemented by U.K. banks. - A number of Walker Report recommendations have been adopted by the FRC as applying to all listed companies. - The FSA has used the Walker Report recommendations as its best practice standard in reviewing banks’ governance arrangements. ### Market discipline and disclosure - The United Kingdom has an extensive presence of institutional investors and high involvement of major rating agencies and analysts. - Authorities should review the adequacy of disclosure. - Mechanisms that support market discipline include a system of regular disclosure by public companies. - For banks, annual disclosures have been materially enhanced through the additional annual disclosures mandated by Pillar 3 of the Basel Capital Accord, which applies to banks of all sizes. - Frequency of bank financial disclosures varies: some banks make quarterly financial disclosures and some half-yearly. - Regular financial statement disclosures related to market risk, liquidity risk and credit concentrations appear to be less than in some other major markets. - The FSA does not itself publish extracts from regulatory returns; assessors recommend that it should. - The FSA publishes an annual Financial Risk Outlook (replaced starting in 2011 by a Prudential Risk Outlook and Conduct Risk Outlook). - The BoE publishes twice-yearly financial stability reports. - Overall, disclosure is less than in other leading markets and the authorities should review the adequacy of disclosure. ### Supervisory and regulatory architecture (tripartite system) - Since creation of the FSA in 1998, the U.K. has operated a ‘tripartite’ system involving the BoE, Her Majesty’s Treasury (HMT) and the FSA, with responsibilities set out in a public MOU. - Under these arrangements, the FSA’s responsibilities included prudential regulation and supervision of authorized firms including banks and other deposit takers, and regulation of markets; it also had conduct of business regulation and consumer protection responsibilities. - The FSA regulated about 16,000 firms including about 235 deposit-taking organizations (banks and building societies). - The BoE’s tripartite role prior to 2009 related to oversight of payment systems, maintaining a broad view of the system, and acting as a lender-of-last-resort (LOLR). - Amendments to the Banking Act have given the BoE resolution authority over banks. - The HMT’s role included responsibility for the institutional structure of regulation and legislation, accounting to parliament for management of serious problems in the financial sector and authorization of support operations beyond the normal framework. ### Regulatory approach, lessons from the crisis, and reforms - Prior to the crisis the FSA operated a principles-based regulatory approach (also referred to as a “light touch”) and a risk-based supervision philosophy. - Authorities later indicated supervisors had placed too much confidence in banks’ internal risk management and governance systems; FSA engagement had been neither as frequent nor as probing as required. - Criticisms existed of how tripartite arrangements worked in practice during early stages of the crisis, including coordination and information sharing. - The Turner Review (March 2009) set out enhancements to FSA policies and practices for prudential regulation and supervision, including internal governance and oversight improvements, and emphasized: - the need for higher levels and quality of capital; - much more focus on adequate liquidity; - focus on resolvability of systemically-important financial institutions. - Implementation of Turner Review recommendations related to the FSA started immediately. - 2010 government white paper proposed major changes: - Split FSA into (i) a prudential regulator (PRA) regulating banks, banking groups, insurance companies and larger broker-dealers, and (ii) a consumer and markets authority (CPMA) taking over conduct of business mandate and prudential regulation of smaller dealers, asset managers, financial advisors, etc. - The PRA to become a semi-autonomous subsidiary of the BoE with BoE authority over certain macro-prudential tools. - Legislation implementing these changes is to be in place by year-end 2012. - FSA and BoE to start shadow implementation beginning early in 2011, to the extent permitted by existing law. ### Crisis management and safety nets (policy actions and facilities) - The failure of Northern Rock exposed gaps in the legal framework for bank resolution and prompted emergency action including the Banking (Special Provisions) Act (2008). - Key policy actions: - September 2007: BoE acted as LOLR to Northern Rock, following consultation with HMT and the FSA. - February 2008: Parliament passed the Banking (Special Provisions) Act, providing resolution tools later enacted permanently in the 2009 Banking Act; powers were used in resolution of Northern Rock and of Bradford and Bingley. - April 2008: BoE, in coordination with HMT and the Debt Management Office (DMO), launched the Special Liquidity Scheme (SLS) to swap high-quality mortgage-backed and other securities for U.K. treasury bills for up to three years. - October 2008 measures at the crisis height: - The guarantee on bank deposits was raised from £35,000 to £50,000. - The Government Recapitalization Scheme (GRS) launched; government made capital investments in Royal Bank of Scotland and Lloyds/Halifax Bank of Scotland; a holding company, U.K. Financial Investments Limited (U.K.FI), was set up to manage investments. - The Credit Guarantee Scheme (CGS) launched to guarantee new issuances of short-term or medium-term debt securities by eligible institutions. - January 2009: - Asset Protection Scheme (APS) to insure/guarantee participating banks’ toxic assets (ultimately, only Royal Bank of Scotland (RBS) participated). - Asset Purchase Facility (APF) in which the BoE would buy high-quality assets financed by issuance of treasury bills and DMO cash-management operations; in March 2009 the Monetary Policy Committee (MPC) began a program of asset purchases for monetary policy purposes (quantitative easing) under the APF. - Footnote: On November 15, 2010, the BoE announced that it would withdraw immediately the never-tapped facility to purchase bonds issued by banks under the government’s CGS. - February 2009: Banking Act 2009 passed establishing a permanent regime for resolution of distressed banks and building societies: - The Special Resolution Regime (SRR) provided the BoE (bridge bank resolutions and private sector rescues) and HMT (temporary public ownership) with resolution tools involving mandatory transfers of property and forced changes to capital structure pre-insolvency. - The trigger for resolution is a determination by the FSA that a bank breaches its conditions of authorization (including operating without adequate resources and that no other options than resolution are available). - The Act modified arrangements for liquidation and administration of insolvent banks and building societies and enhanced BoE’s role in payment system oversight. - The resolution regime was used successfully in the resolution of a moderate sized building society in 2009 (Dunfermline Building Society). ### Main Findings — Objectives, independence, powers, transparency, and cooperation (CP 1) - As an integrated regulator, the FSA benefited from synergies from a broad view of the financial system and all aspects of firms’ operations (safety and soundness and market conduct). - Assessors observed lack of clarity about how the FSA intended to meet its very-generally-worded mandate: - Prudential objectives were not explicitly mentioned in the statutory mandate and regulatory objectives. - Key planning and accountability documents and public statements did not draw out the key role of prudential regulation in maintaining market confidence and protecting consumers. - Lack of adequate tools within the FSA to monitor the use of resources allocated to various parts of regulatory objectives or to monitor outcomes at a high level related to various parts of the mandate did not appear robust. - Certain statutory qualifiers (such as desirability of maintaining the competitive position of the United Kingdom, and the need to minimize the impact of FSA actions) may have been understood in ways that undercut adequate prudential supervision and regulation. - ‘Contributing to financial stability’ was added to the regulatory objectives in 2010 and the FSA published its board-approved strategy to comply with the new regulatory objective; it is too soon to observe the impact of this change. - The expression of regulatory objectives in the new structure was under discussion at the time of assessment; clarity about parliament’s intention will be important. - The FSA enjoys operational independence in day-to-day decisions and sets its own budget to meet regulatory objectives; it operates a comprehensive consultation and decision-making process on its rules and commits to formally assess costs and benefits of new initiatives. - The Chairman of the FSA is appointed for a five-year term, but legislation allows for removal by HMT with no explicit grounds required and no explicit requirement for public disclosure of reasons for removal (this has never happened in practice). ### Resourcing, data, and cooperation - The FSA materially increased resources in the past two years to implement a more ‘intensive and intrusive’ regulatory and supervisory process, but assessors believe a further increase in human resources will be required. - Resources in supervision and specialist support resources in various risk areas have been markedly increased. - Some newly launched processes are not embedded and parts of new processes are at an early stage of roll-out, making steady state resource requirements difficult to assess. - Assessors’ strong sense: additional resources for prudential regulation and supervision (some combination of enhanced skills and additional people) are required to: - (i) enable the FSA to implement fully the planned enhancements; - (ii) deal with recommendations such as a more proactive detailed review of key risk areas; - (iii) implement the new macro overlay without drawing resources away from core prudential work. - Other enhancements needed include improved information reporting from banks and availability of more detailed data for effective peer analysis (important for supervision of small- and medium-sized banks and large banks). - Legacy systems issues exist; they may need remediation and may also offer opportunities for efficiencies. - Mechanisms are in place for information sharing and cooperation among authorities; while there were issues at the beginning of the crisis, authorities report cooperation is working well and assessors saw evidence of that in practice. - As the new structure is implemented, building new coordination and cooperation mechanisms (e.g., to deal with potential conflict between macro-prudential and micro-prudential measures) will be important, and these mechanisms must work well on an ongoing basis. ### Licensing, approvals, and fit-and-proper processes (CPs 2–5) - The FSA runs a comprehensive and effective licensing and approvals structure. - A key part of supervisory methodology is ensuring overseers of authorized firms, and persons in positions of significant influence such as Board members and senior management, are ‘fit and proper.’ - Assessors observed the comprehensive nature of that process and the importance the FSA places on it. ### Prudential regulation and requirements (CPs 6–18) - The FSA has put considerable effort into enhancing the quantity and quality of capital in banks; this is showing results. - Capital rules are compliant with Basel and European requirements. - The FSA promulgated an interim capital regime starting in 2009, based on total capital, Tier1 and Core Tier1 expectations in normal and stressed conditions. - The FSA has built on setting individual capital targets, and now capital guidance, for banks above the minimum. - Robust stress testing for major banks is instrumental in the FSA setting further capital buffers for major banks above normal FSA individual capital guidance. - Banks are operating with material cushions above the guidance and buffers; bank capital levels have risen, as has the level of Core Tier 1. - Further consideration is occurring in various international and U.K. fora about appropriate levels for very high-impact banks on an ongoing basis. - The crisis revealed severe shortcomings in certain bank risk measurement and risk management practices and supervisory oversight was not always effective in identifying and remedying those weaknesses. - The FSA has responded with measures to enhance risk measurement, risk management, risk governance and supervisory assessment and intervention via a multi-stage supervisory enhancement program. - Sustained leadership is required to ensure continued implementation and achievement of real judgment-based intensive supervision, including prompt intervention based on detailed supervisory work. - Banks are undertaking major risk management and risk governance improvements; strategies are correct but execution is challenging and completion of enhancements is expected by end-2012. *Italic: IMF assessment text as provided in the source content.* ### 41. Processes to relate capital to risk are more advanced. This is in no small measure ### Processes to relate capital to risk are more advanced ### Advances in capital-risk linkage - Processes to relate capital to risk are more advanced, in no small measure due to the FSA’s longstanding focus on stress testing and on a robust Pillar 2 process. - Risk: inadequate assurance of the robustness of banks’ underlying processes (loan classification, impairment determination, valuation of complex products) and of models could lessen the true effectiveness of stress testing. - Recommendation: build on FSA processes that enhance in-depth assessments with more transaction testing and ‘on-site’ detailed work as part of ‘deep-dive’ and peer theme reviews. ### Credit risk oversight (CP 8) - Finding: The FSA needs to materially enhance its focus on credit risk at a more detailed level, with more, regular and proactive reviews of the quality of banks’ portfolios. - Data/analytical needs: require more granular data from the banks operating credit risk models so the FSA can assess integrity of those processes and conduct effective peer analysis. - Implementation priorities: - Develop and implement an overall enhancement strategy as a priority. - Expand current detailed reviews and address resource constraints to enable priority work to be identified and undertaken as soon as possible. - Reviews should consider quality of banks’ risk management, provisioning and governance processes. - More transaction testing on a select basis is required. - Areas of exposure with potential material problems need more proactive attention. - Use of more skilled persons’ reports could be a short-term partial bridge. - Proceed with proposals to enhance FSA data and analytical tools for peer analysis. ### Liquidity risk assessment (CPs referenced in text) - FSA capabilities for liquidity risk assessment and effective intervention are well advanced and have shown results. - Actions taken: updated guidance that pre-dated BCBS global regulatory initiatives, intense supervision and specialist involvement for major banks, sound liquidity stress testing approaches, and assessments of banks’ liquidity contingency plans. - Tools: new supervisory tools and reporting developed and being rolled out more generally. - Outcome: liquidity positions of major banks have improved. - Next step: plan to extend detailed assessments to a wider range of high-impact banks needs to proceed expeditiously. ### Market risk and IRRBB - The FSA demonstrates necessary skills and understanding of market risk and IRRBB across major and smaller/mid-sized banks; assessors saw excellent supervisory reviews. - Benefit: recent material increase in FSA risk specialist resources. - Remaining needs: - Increase number of proactive deep-dive reviews and amount of peer analysis based on improved reporting. - Enhance assurance of market risk measurement, risk management and risk governance. - Issue framed as deficiency in overall supervisory approach (CP 19) rather than market risk technical capability. - Implementation: core prudential program enhancement framework for assessing risk measurement and governance in the eight very-high-impact banks will start being implemented over the next 18-24 months, and will be rolled out more broadly subsequently. ### Methods of ongoing banking supervision (CPs 19–21) - Overall supervisory approach enhancement has started but needs to be continued with rigor, adequately embedded, and materially augmented to incorporate more detailed, in-depth reviews and a consistently-proactive review strategy. - Key points: - ARROW risk assessment process is complex and does not seem to adequately discriminate among risks at major banks. - A forward-looking element in ratings is under-developed. - Better integration of specialist work into the supervision program and more peer analysis is needed. - Without more detailed verification, assurance given by current assessments of risk management and governance may not be adequate. - Degree of detailed review in parts of the Core Prudential Program not yet implemented (such as review of risk management and governance) is unclear. - Need better integration of review results with risk ratings and feedback to bank Boards. - Ensure management and oversight processes monitor whether staff judgments in the new ‘intensive and intrusive’ approach are those desired. ### Senior management oversight practices - Senior FSA management has committed more time to oversight of key risks; major issues are escalated through a “Watch list” to the Senior Executive team. - Introduced regular direct contact between senior FSA team and CEOs of the United Kingdom’s largest firms. - Limitation: these high-level judgmental overlays are not a sustainable substitute for necessary enhancements and carry risks. ### Accounting and disclosure (CP 22) - Finding: Banks’ public disclosure can be improved in comparability, relevance, scope, and timeliness. - FSA openness: considering disclosing nonconfidential firm-level prudential returns (balance sheet and income statement, loans and investments (sectoral information), asset quality (past-dues, nonperforming loans, charge offs), funding structure, capital structure, and off-balance sheet exposures). - Auditor engagement: FSA has initiated periodic meetings with external audit firms; Supervisory Enhancement Program requires supervisors of high-impact banks to meet auditors at least annually. - Concern: FRC and the FSA have expressed concerns about the quality of audits, including need for more professional skepticism. ### Corrective and remedial powers of supervisors (CP 23) - Finding: FSA identifies problems requiring remedial action but could improve linking of interventions to seriousness of issues; supervisory approach still moving from reactive to proactive. - Recommendation: implement an early intervention framework to ensure appropriate and consistent forcefulness in interventions and to ensure escalation from informal to formal stages reinforces intrusiveness. - Benefit from centralization: a more centralized way to capture detail on informal and formal interventions in high-impact firms (separate from enforcement actions) would enhance consistency and senior monitoring. - Desired framework: a well-articulated, judgment-based, prompt intervention framework (not necessarily with pre-set triggers) dealing with: - actions to address material issues of controls, governance or risk management that could lead to serious problems; and - actions closer to point of nonviability or breach of threshold conditions. - Tools: FSA has remedial action plans, ability to set capital add-ons, formal power to impose conditions on a bank's authorization, and ability to levy fines. - Consistency issue: use of these tools does not appear as consistent or clear as desired. - Special resolution: FSA can declare a bank nonviable and trigger special resolution process conducted by the BoE; this process has been used once in the resolution of a medium-sized building society. - Recommendation: in designing a prompt intervention framework and enhancing inter-authority arrangements, consider lessons learned from that experience. ### Consolidated and cross-border banking supervision (CPs 24–25) - Framework: United Kingdom applies consolidated supervision; FSA applies a variety of rules on a consolidated basis derived from the Capital Requirements Directive and Financial Conglomerates Directive. - Scope: group supervision includes highest U.K. parent entity and all entities below in the United Kingdom and outside; in some situations extends to highest parent in another EU member state; includes regulated and nonregulated entities. - Consolidated rules include group-wide systems and controls, group-wide risk management, consolidated capital and liquidity standards, connected lending, and large exposure limits; solo bank requirements also apply. - Powers: certain FSA powers (collect information, require a skilled person report) apply to authorized and non-authorized entities in the group and collection extends to entities above the parent entity. - Gap: existing legislation for consolidated supervision needs strengthening; FSA has no legal power directly over the parent holding company of the banking group. - Consequence: formal remedial action may need to be through authorized firms in the group, which might not be possible if those firms are not sufficiently significant. - FSA has no direct authority to approve acquisitions by parent holding companies of banks (would have authority if the bank in the group was making the acquisition or the target was another FSA-authorized entity); could be problematic if target is not a U.K. firm. - At time of assessment, U.K. government was consulting on extending FSA powers over unregulated holding companies. - Cooperation: FSA has extensive MOUs and informal arrangements with other home and host supervisors and appropriate legal powers to share and keep information confidential. - Host supervision note: under EU single-passport rules, host-country does not supervise branches except for liquidity; effective home-host arrangements are essential. ### Summary assessment excerpts (selected CP gradings and comments) - Core Principle 1.1 Responsibilities and objectives: graded MNC — statutory mandates open to very considerable ranges of interpretation; supervisory change to ‘intensive and intrusive,’ ‘judgment-based’ underway with full impact over next two years. - Core Principle 1.2 Independence, accountability and transparency: graded LC — reasons for removal of head not specified in legislation; assessors sense additional resources for prudential regulation and supervision are required. - Core Principle 5 Major acquisitions: graded C — power to review acquisitions does not extend to acquisitions by parent holding companies of banks. - Core Principle 6 Capital adequacy: graded LC — strengthening quantity and quality of capital is occurring; assessments of use of advanced models by banks are not sufficiently detailed. - Core Principle 7 Risk management process: graded LC — comprehensive enterprise-wide risk measurement and risk management remains a challenge for some major banks; programs to relate capital to risk are well advanced. - Core Principle 8 Credit risk: graded MNC — assessment needs to be enhanced to include sufficient, timely, proactive, and in-depth reviews and some transaction testing; Core Prudential Program for credit risk not fully rolled out; full roll out expected to be completed by end-2012. - Core Principle 9 Problem assets, provisions, and reserves: graded C — focus is placed on capital and not on provisioning and reserves; new EU rules, following revised IAS39 (EL-driven), will require a change. - Core Principle 11 Exposure to related parties: graded LC — FSA relies on general rules supplemented by supervisor discretion; related-party transactions not sufficiently considered. - Core Principle 13 Market risks: graded LC — need more proactive cross-system, in-depth reviews linked to enhanced specialist resources; full compliance affected by weaknesses in supervisory approach (CP 19). *Source: IMF staff assessment text from the provided PDF chapter/section.* ### 14. Liquidity risk ### 14. Liquidity risk ### Findings and supervisory assessment - The FSA has made major and successful efforts to ensure that very high-impact banks increase their liquidity, and to enhance FSA supervision. - Further efforts are required, including detailed drill-down supervisory work for high-impact banks, as per current plans. - Core Principle grading context (aggregate): Compliant (C) – 17, Largely compliant (LC) – 10, Materially noncompliant (MNC) – 3, Noncompliant (NC) – None (note: CP 1 is divided into six components for this analysis.) ### Related supervisory deficiencies and linkages to other core principles - The assessment highlights several supervisory weaknesses that affect liquidity oversight and broader prudential supervision: - The need for more in-depth reviews to ensure supervisors understand banks, and their risk management and governance capabilities. - The need to comprehensively shift to more proactive rather than reactive review strategy to confirm inherent risk, risk management, and governance assessments. - The need to rectify deficiencies in the ARROW framework. - The need to improve communication, including: - increasing clarity in the communication of key supervisor messages to banks; - enhancing assurances that there is coherence between supervisory assessments and Board-level communications of the most important issues; and - ensuring all material issues are brought together in a Board-level wrap-up with senior FSA participation at major banks at least once a year. ### Recommended action plan related to liquidity and supervisory strengthening - 14 Liquidity risk: Continue with the planned roll out of the new approach beyond major banks. - 19 Supervisory approach / 20 Supervisory techniques: Develop an integrated multi-year plan for enhanced supervision, including: - more on-site and in-depth reviews; - more peer benchmarking; - a desired coverage model that is more frequent; - amendments to the risk-rating framework so that it is more discriminating, proactive, and forward looking; - inclusion of the Core Prudential Program and its extension to a range of banks beyond those that are very high-impact (ultimately, all banks need a degree of more in-depth proactive reviews); - inclusion of risk-model changes; - tightening specialist-supervisor linkages and linkages between new initiatives (e.g., stress testing of capital and liquidity); - improving reporting of results to banks, so that they get clear messages of the most important matters that need to be dealt with; - determining resource requirements for this new model and a reasonable timeframe; - ensuring the new macro-prudential overlay does not detract from delivering on this enhanced micro-prudential core work. - 8 Credit Risk: Develop a strategy for materially enhanced in-depth review of credit risk, resource adequately and execute, starting in 2011. Proceed with additional data gathering and analytics to permit better peer analysis. Consider multi-year plan to extend this approach as necessary. In the short term do more in-depth reviews of commercial real estate exposures either using FSA staff or skilled persons (Section 166 reports). - 21 Supervisory reporting: Develop a comprehensive plan to enhance prudential reporting. - 6 Capital adequacy: Change the policy and provide adequate resources to conduct more in-depth reviews of credit, market and AMA models. Implement the announced policy to proactively review the more important models on some cycles, even if there are no changes that would trigger a reactive review. Consider extending this beyond the 10 most important system-wide models. - 24 Consolidated supervision: Amend legislation to give FSA powers over holding companies of parent banks as a priority. - 25 Home host: Work to enhance colleges and home host information sharing within the current framework. ### Authorities’ response and intended reforms - Paragraphs 59–67 summarize the U.K. authorities’ response: - The U.K. authorities (HM Treasury, the BoE and the FSA) welcome the IMF review and note it comes as transition to a new regulatory structure begins. - The assessment is against a particularly high standard and is a point-in-time assessment; some reforms in train are not fully embedded. - The authorities state the FSA has responded to the crisis and made good progress on initiatives to enhance prudential requirements and impose a more intensive supervisory strategy; supervisory reform programs will take time to fully implement. - The authorities believe that supervisory judgments and actions since the crisis have been effective in identifying emerging risks in good time and that the FSA’s supervisory approach is currently closer to compliance than the IMF concluded. - The Prudential Regulation Authority’s (PRA) intended approach will be forward-looking and will direct supervisory intervention to reduce major risks to financial stability. The PRA will combine policies on firms’ resilience, supervisory assessments and interventions, and policies and mechanisms to support resolution. - The PRA’s supervisory approach for banks posing greater risk to system stability will include: - analysis of a bank’s financial position; - ongoing evaluation of a bank’s business model, capital and liquidity plans, governance and culture, risk management and controls, to understand key risks to financial stability; - stress testing against a range of possible future states of the world; - regular assessment of a firm’s resolvability and the state of its resolution plans; - regular contact between a firm’s senior management and senior PRA management; - early and proactive supervisory interventions under the Proactive Intervention Framework designed to reduce risks to the stability of the system. - The authorities agree additional supervisory resources are likely required to continue to deliver and augment planned enhancements and to develop the new macro-prudential overlay. The FSA and the Bank of England are assessing resource requirements through designing the PRA’s operating model, including defining the desired intensity of supervisory assessments and how the macro-prudential overlay will work. ### Implementation timing and resourcing highlights - Recommended near-term and time-bound items: - Start materially enhanced in-depth review of credit risk in 2011. - By end-2011, review adequacy of specialist resources in light of then-current and expected demands. - Implement planned roll out of the new liquidity approach beyond major banks (timeline tied to multi-year Core Prudential Program and reorganization efforts). - Resource assessment: The authorities are assessing resource requirements through the process of designing the PRA’s operating model to determine supervisory intensity, macro-prudential overlay design, and identify efficiency savings through simplifying supervisory processes. *Source: _cr11233 - 14. Liquidity risk* ### 70. Table 3 below offers the detailed principle-by-principle assessment. It provides a ### _cr11233 - 70. Table 3 below offers the detailed principle-by-principle assessment. It provides a ### Principle 1 — Objectives, autonomy, powers, and resources (overview) - Objective: clear responsibilities and objectives for each authority involved in the supervision of banks; operational independence; transparent processes; sound governance; adequate resources; accountability; suitable legal framework for authorization and ongoing supervision; powers to address compliance and safety and soundness concerns; legal protection for supervisors; arrangements for sharing information and protecting confidentiality. - Table title: Table 3. United Kingdom: Detailed Assessment of Compliance with the Basel Core Principles. ### Principle 1(1) — Responsibilities and objectives Findings (Description and evidence): - EC1: U.K. legislation (primarily the Financial Services and Markets Act – FSMA) gives the FSA sole responsibility for the supervision of banks in relation to their deposit-taking. - The BoE contributes through lender of last resort operations and macro-prudential surveillance. Under the Banking Act 2009, the BoE or the treasury is responsible for dealing with failing banks after the FSA has triggered the SRR. - The FSA’s regulatory objectives pursuant to FSMA (Sections 3-6A) are: - market confidence; - the protection of consumers; - the reduction of financial crime; - financial stability (added by the Financial Services Act 2010). - FSMA Section 2(3) lists “principles of good regulation” the FSA must have regard to, including: efficient use of resources; responsibility of managers of authorized persons; proportionality of burdens; facilitating innovation; international character and competitiveness; minimizing adverse effects on competition; facilitating competition; and enhancing public understanding of financial matters. - Government announced (HMT paper 2010) proposed reorganization to clarify regulatory objectives and ‘have regards’ with respect to prudential supervision; targeted for adoption by the beginning of 2013. - Prior to 2010 the FSA lacked an explicit financial stability objective; FSA interpreted market confidence to include safety and soundness (the approach described as ‘light touch’ or ‘limited touch’). - FSA staff indicate pre-crisis emphasis on treating customers fairly may have crowded out prudential work; annual reporting prior to 2008 did not contain financial stability or prudential sections. - Post-crisis, FSA re-interpreted its mandate to become “intensive and intrusive” and “judgment based”; lack of clarity and cohesion persists on practical implementation. - EC2: FSA operates a comprehensive framework of minimum prudential standards (Threshold Conditions, GENPRU, BIPRU); has extensive rule-making powers (FSMA section 138). - EC3: FSA updates its handbook regularly; majority of recent rule changes are European directive-related. - EC4: Aggregate industry information available: BoE Financial Stability Report (June and December); FSA Financial Risk Outlook (March); FSA quarterly aggregate statistics on mortgage lending; Pillar 3 disclosures in banks’ reporting; FSA publishes register of authorized firms but no comprehensive key financial ratios for individual banks maintained centrally. - AC1: FSA has a single risk framework (ARROW) assessing impact and probability to adjust supervisory intensity; relationship-managed supervisory approach for all banks (except some branches and individual banks within groups). Assessment and Comments: - Assessment: Materially noncompliant. - Key commentary: - Initial FSA mandate very broad; explicit prudential objective missing until 2010; lack of statutory guidance on trade-offs among primary objectives. - Reinterpretation to “intensive and intrusive” approach lacks clarity on ground-level implications. - Risk of continued lack of clarity under new arrangements and potential overlap between micro- and macro-prudential mandates. - Combining prudential and conduct regulation under market confidence risked unclear focus and imbalanced resource allocation. - Evidence of implications throughout organization: ARROW used more as resource management than risk assessment; insufficient in-depth reviews (CP 19); inadequate capital model validation practices (CP 6); fragmented data collection (CP 21); inadequate specialist use until recently. - Risk of being intrusive without focusing on material deficiencies; immediate priority on capital and liquidity understandable but not a substitute for core supervision of governance, risk management, and business models. ### Principle 1(2) — Independence, accountability and transparency Findings (Description and evidence): - EC1: FSA has operational independence; established as a private company limited by guarantee; financed by direct levies and fines; responsible for its own budget and regulatory decisions; governance and Board responsibilities set out in FSMA; early exchange of letters between Chancellor and FSA Chair affirmed operational independence. - Practitioner panel and consumer panel statutory requirements; annual report to the Chancellor tabled before parliament. - Non-executive Board members (majority) determine remuneration of the chairman and executive members; high-level Board minutes published. - FSMA Schedule 1 requires chairman and Board members be appointed and removable by the treasury; appointments made by treasury officials (not ministers); no statutory provisions detailing removal circumstances or requiring public disclosure of reasons; CEO appointed by the Board to CEO position but appointed to the Board by treasury officials; CEO employment contract term three years; chairperson term five years. - EC2: FSA accountability under FSMA: must report at least once a year to the treasury; treasury must lay report before parliament; FSA publishes strategic plan; annual public meeting required; consultation with practitioners and consumers required; mechanism to receive and deal with complaints; treasury may appoint independent reviewer of economy, efficiency, effectiveness (never occurred). - Non-executive committee reviews internal financial controls and use of resources; Treasury Select Committee reviews FSA performance; decisions may be challenged before the Upper Tribunal or via judicial review. - EC3: Rigorous recruitment process; post-crisis steps to ensure wide expertise; Code of Conduct; regular conflict-of-interest declarations; assessors found staff professionalism high. - EC4: FSA Board can require payment of fees to meet regulatory objective costs (FSMA Schedule 1 paragraph 17); consultation procedures required (FSMA Section 155); salary scales set by FSA, taking into account industry pay; FSA can recruit expert assistance. - Staffing and resourcing: - Pre-crisis headcount relatively constant; FSA considered target headcount cut of some 200 (a little less than 10 percent). - Fees in four years prior to 2005 rose at approximately the rate of inflation. - FSA previously did not increase resources to deal with matters such as Basel II. - Since the crisis: staff increased from around 2,500 in early 2008 to nearly 3,900 today. - Supervisory team for a major bank consists of some 15–20 FTEs depending on the bank, with 5–10 for a major foreign bank (increase from 4–6 a few years ago). - Major bank division staffing rose from some 140 to 260; related specialist resource staff rose from 100 to 200. - Staff turnover around 10 percent overall; higher in specialist areas; considerable number of departures of senior staff. - FSA used section 166 “skilled persons” reports approximately 175 times in 2010 (relatively small number relate to prudential matters). - FSA implementing new records management system; legacy systems issues and need for material upgrades; data and systems fragmented; material silos. Assessment and Comments: - Assessment: Largely compliant. - Key commentary: - Governance arrangements lack statutory provisions detailing circumstances for removal of chairman or CEO and requirement to publish reasons. - Unresolved resource issues: assessors not confident FSA fully understands likely resource needs under new supervision and core prudential model; systems capability likely needs enhancement. - Prior bias against increasing resources may have reduced crisis preparedness. - Strong sense that additional resources for prudential regulation and supervision (quality and quantity) are required to: - implement planned enhancements; - conduct more proactive detailed reviews of key risk areas; - implement new macro overlay without detracting from core prudential work. - Recommendation: FSA should rigorously update its needs (including data and analytical systems) and assess possible synergies internally and with the BoE as part of reorganization planning. - The FSA should satisfy itself that its resources are adequate. ### Principle 1(3) — Legal framework Findings (Description and evidence): - EC1: Under FSMA, “Accepting deposits” is a specified activity and subject to prior FSA permission under Part IV; deposit-taking permission may be amended or removed under Part IV; legal framework for licensing includes FSA rules (Handbook). - EC2: FSA powers to make rules necessary or expedient to meet regulatory objectives (section 138 of FSMA); Handbook rules/guidance include prudential matters (GENPRU, BIPRU); power to modify or waive rules in particular cases (FSMA Section 148) and attach conditions to waivers. - EC3: Extensive consultation process required when making rules: publish draft of proposed rules; draft must be accompanied by a cost-benefit analysis, explanation of purpose, reasons why compatible with general duties under FSMA; notice for representations within a specified time (section 155 of FSMA). - EC4: FSA has wide powers to require information from banks and connected persons (FSMA Section 165) and to require production of reports by skilled persons on matters for which the FSA could require information. Key statutory numeric and temporal items preserved from source: - Financial stability objective added by the Financial Services Act 2010. - Proposed reorganization legislation targeted for adoption by the beginning of 2013. - FSA staff increased from around 2,500 in early 2008 to nearly 3,900 today. - Supervisory team sizes: major bank 15–20 FTEs; major foreign bank 5–10 FTEs; previous supervision team size 4–6. - Major bank division staffing increased from some 140 to 260; specialist resource staff from 100 to 200. - Section 166 reports used approximately 175 times in 2010. - CEO employment contracts for three years; chairperson appointed for five years. - Staff turnover around 10 percent overall. Policy implications and recommended actions (extracted from comments): - Clarify statutory mandates and how micro- and macro-prudential mandates will interact, including any early intervention mandates to be given by parliament. - Ensure clarity and cohesion in implementing the “intensive and intrusive” judgment-based supervisory approach to focus on material deficiencies and prompt corrective action. - Conduct a rigorous update of resource needs, including data and analytical systems, and identify possible synergies with the BoE as part of reorganization planning. - Increase prudential regulation and supervision resources (both quality and quantity) to implement planned enhancements and more proactive detailed reviews of key risk areas. - Improve systems capability, records management, and integration of specialist staff into the supervisory process. - Clarify governance provisions concerning removal of chairman and CEO and public disclosure of reasons for removal. *Table 3. United Kingdom: Detailed Assessment of Compliance with the Basel Core Principles* ### Section 165 (FSMA Section 166) (see comment on CP 21). Since 2010, the FSA ### _cr11233 - Section 165 (FSMA Section 166) (see comment on CP 21). Since 2010, the FSA ### Principle 1(4). Legal powers - Assessment: Compliant - Findings: - The FSA’s powers to require information relevant to the stability of the financial system were broadened since 2010. - FSMA Schedule 1 paragraph 6 requires the FSA to maintain arrangements to determine whether a bank is complying with requirements imposed by or under FSMA. - The FSA can exercise judgement in determining whether a bank is in contravention of regulatory requirements subject to a bank’s rights of appeal to the Upper Tribunal (established under FSMA Part IX). - The FSA has wide powers under FSMA to take action against banks which do not comply with FSMA, secondary legislation under FSMA, and its rules; formal powers include placing requirements on a bank’s permission to accept deposits, though informal action may be pursued where appropriate. - Under the Banking Act 2009, a new Special Resolution Regime (“SRR”) was introduced; the FSA triggers the SRR where it is of the opinion that a bank is failing or likely to fail the threshold conditions. - The FSA has full access to a bank’s Board, management, staff and records via powers under section 165 of FSMA and to conduct investigations under sections 167 and 170 of FSMA; failures to provide information or knowingly providing false or misleading information constitute a criminal offense. - The FSA may vary a bank’s permission on its own initiative under section 45 of FSMA (Own Initiative Variation of Permission or OIVOP) and may withdraw authorization, limit deposit-taking, or require specified actions or refraining from actions. - Disciplinary actions under Part XIV of FSMA for contraventions include: - suspending the bank’s permission to carry on a regulated activity; - imposing limitations on the carrying on of a regulated activity; - publishing a statement of public censure; - imposing a financial penalty. - The FSA may impose a penalty on a person who at any time performed a “controlled function” in a bank without FSA prior approval. - Comment: - The application of a cost-benefit analysis to every rule appears overdone; it can give false comfort and has in some cases (e.g., modernizing regulatory reporting from banks) been a factor in reluctance to proceed with necessary improvements. The FSA should review the application of this requirement. ### Principle 1(5). Legal protection - Assessment: Compliant - Findings: - FSMA (Schedule 1 paragraph 19) provides that the FSA and any person who is, or is acting as, a member, officer or member of staff of the FSA is not to be liable for damages for anything done or omitted in the discharge, or purported discharge, of the FSA’s functions, except where the act or omission is shown to have been in bad faith, or unlawful as the result of Section 6(1) of the Human Rights Act 1998. - The FSA covers the legal costs of defending its staff in legal actions against them in relation to their work as FSA employees. - The FSA has the power to require the payment of fees to cover the costs of defending its actions. ### Principle 1(6). Cooperation (information sharing and confidentiality) - Assessment: Compliant - Findings: - The MOU between the tripartite authorities governs relations between the FSA, BoE and treasury; regular senior-level meetings and working-level groups are in place; the MOU covers information sharing and crisis management. - For foreign supervisors, the FSA identifies all foreign supervisors involved in supervision of the relevant international bank and engages under the home/host framework; since the end of 2010 it is an EU legal requirement to map foreign entities of U.K. banks on an annual basis and identify subsidiaries and significant branches to include relevant EEA supervisors in supervisory colleges. - For EU/EEA supervisors, CRD and supervisory college agreements underpin regular information sharing for joint risk and capital adequacy assessment and decisions. - For non-EEA supervisors, EU Directives require the FSA to have an MoU with the relevant non-EEA supervisor; where no gateway and MoU exist, the FSA engages under the home/host framework and establishes informal supervisory arrangements to share nonconfidential information and agree key issues; emergency information sharing provisions exist. - Legal ‘gateways’ permit FSA disclosure of confidential information to other EEA or non-EEA supervisory authorities; disclosure to non-EEA authorities requires (i) an MoU relating to information-sharing and (ii) an assessment that confidential information will be subject to equivalent protections as in the United Kingdom/EEA. - MoUs typically stipulate confidential information may only be used for supervisory purposes and contain terms on confidential treatment by the recipient. - The FSA can only disclose confidential information if (1) it has obtained the consent of the person to whom the information relates or (2) it can legally disclose the information through a gateway. - The FSA does not have Gateways to disclose confidential information pursuant to a freedom of information request or in relation to civil proceedings; Gateways are discretionary. - Comment: - Both the FSA and the BoE have information relevant to the other in pursuit of financial stability; the same will be true for the newly-formed CPMA when split from the FSA. As part of the new arrangements, the FSA and the BoE should review the operation of the gateways to ensure adequate information sharing (in both directions) related to financial stability and pre-determine how much discretion will be exercised to smooth information sharing. - The effectiveness of cross-border arrangements is commented on in CP 25. ### Principle 2. Permissible activities and the use of the word “bank” - Assessment: Compliant - Findings: - The U.K. authorization structure is based on activities; deposit taking is a regulated activity and there is a general prohibition on undertaking such activity unless authorized under the Financial Services and Markets Act 2000. - ‘Bank’ is defined in the FSA’s regulations to determine applicability of parts of the FSA rulebook; the use of the word ‘bank’ (and related terms) is restricted under the Company, Limited Liability Partnership and Business Names (Sensitive Words and Expressions) Regulations 2009. - ‘Building society’ is defined in the Building Societies Act 1986; that Act restricts the use of ‘building society.’ - The term “bank” is a “sensitive word” governed by the Companies Act 2006; use of a sensitive word requires contacting the specified public authority (the FSA in the case of “bank”) to request whether they object; the Registrar has delegated responsibility to approve use, but in practice an FSA objection is unlikely to be overridden. - It is a criminal offence for a person not to comply with these naming rules. - The Financial Services & Markets Act 2000 (Regulated Activities) Order 2001 sets out regulated activities, including accepting deposits. - FSMA makes it an offense for a person to describe or hold themselves out to be an authorized person if they are not; FSA reported receiving 46 applications for consent for the use of the term “bank” in the three months to end of October 2010 and have rejected 11 because of the risk of harm to the public from the proposed name. - Some deposit taking is permitted outside FSMA authorization (public sector, other banks, debt securities over one year, municipal banks and local authorities). - The FSA publishes monthly lists of banks and building societies authorized in the United Kingdom and maintains a Register of authorized firms updated daily. - Comments: None provided. ### Principle 3. Licensing criteria - Assessment: Compliant - Findings: - The FSA is the authorizing and supervisory authority except for branches of EEA banks; EEA home state supervisors authorize branches in the United Kingdom under mutual recognition. - FSMA (Section 41(2)) requires the FSA to be satisfied that an applicant will satisfy and continue to satisfy the “Threshold Conditions” (FSMA Schedule 6) for all regulated activities; Threshold Conditions cover close links, ability of the group to be supervised, ownership, fitness and propriety of Board and senior management, governance, risk management and internal controls, adequacy of capital and liquidity, and other resources (human resources, systems and controls, views of other relevant supervisors). - The financial resources test assesses resources needed for planned development and survival under disturbance or shock. - The FSA considers management of risk incidence, systems and controls, IT systems, and human resources to inform adequacy of financial resources. - The suitability (‘fit and proper’) test considers all circumstances including connections, nature of regulated activity, and need for affairs to be conducted soundly and prudently. - Threshold Conditions are used on an ongoing basis and in triggering FSA interventions. - The FSA can reject applications for failure to satisfy Threshold Conditions or for inadequate information. - The FSA assesses persons with close links and whether close links hinder effective supervision; this has been applied in practice. - The FSA considers suitability of major shareholders and controllers, transparency of ownership structure, and source of capital. - Minimum capital at authorization: GENPRU 2.1.47/8R requires a minimum amount of capital of not less than €5m at the time a bank obtains permission to accept deposits (or the higher of €1m or £1m in the case of a building society); in practice considerably more capital would be required to start a bank or building society. - FSMA (Section 59) allows the FSA to specify positions that must be performed by individuals assessed as fit and proper (approved persons); the fit and proper test covers honesty, integrity and reputation, competence and capability, and financial soundness; competence and capability assessments include extensive questionnaires and formal structured interviews. - Applicants must provide strategic and operating plans, systems and controls, proposed outsourcing arrangements, and business plans including financial forecasts, capital assessments and stress testing, liquidity needs and contingency funding plans. - For overseas banks, the FSA seeks views of home country supervisors and establishes that no objection (or a statement of no objection) from the home supervisor has been received for banks incorporated or controlled outside the EEA. - The FSA assesses home country supervisors for broadly equivalent regulatory regimes and effective global consolidated supervision; EEA branches are notified by the home supervisor and are not subject to the same home supervisor assessment. - FSMA (Section 398) makes it an offense to knowingly or recklessly give the FSA false or misleading information; license can be revoked if based on false information. - Individual approvals (including all Board members) are tested on knowledge of planned financial activities and associated risks; these assessments are expected to cover the Board collectively. - AC1: The fourth threshold condition assesses adequacy of resources and capacity to obtain additional financial resources; shareholders’ status and ability to support the business are considered; letters of comfort may be obtained. - AC2: The FSA supervises new entrants to monitor progress in meeting business and strategic goals and to ensure supervisory requirements in the license are met. - Comment: - Assessors are satisfied the licensing process works in practice but note that as banking group complexity increases and standards for risk management, governance, and compensation evolve, higher expectations may need to be reflected in initial authorizations or changes in control (CP 4). Any changes from the Independent Banking Commission should be reflected in the approval process. ### Principle 4. Transfer of significant ownership - Assessment: Compliant - Findings: - The EU acquisitions directive was implemented into U.K. law in April 2009 as the Financial Services and Markets Act 2000 (Controllers) Regulations 2009. - A proposed new controller must seek FSA approval to acquire an interest of 10percent or more in the bank or the parent undertaking; controllers must obtain further approval when ownership passes thresholds of 20percent, 30percent or 50 percent; acquiring control or increasing control over these thresholds without FSA approval is a criminal offence. - Rules define acquisition of control (section 181) and levels requiring further approval (section 182); the FSA cannot impose additional requirements on controllers beyond the EU acquisitions directive. - Under section 178 a person deciding to acquire or increase control must give the FSA notice and obtain approval before acquisition; the FSA has 60 working days (plus up to 30 working days when the clock is stopped) to object or provide approval; this includes beneficial ownership. - Under section 186 the FSA may object to acquisition or ongoing ownership; assessment uses Threshold Conditions similar to new authorizations. - Grounds for objection include reputation, experience of directors, financial soundness, ability to comply with prudential requirements, whether group structure allows effective supervision, clarity of exchange of information among regulators, and reasonable grounds to suspect increased money laundering or counter-terrorist financing risk. - If the FSA objects, it may issue a restriction notice limiting exercise of shareholding (e.g., restricting voting powers, preventing payment of dividends). - Banks must report controllers and close links annually and notify the FSA of possible changes in controllers. - Under Section 191A, the FSA may object to a person’s control and may launch proceedings if a controller failed to seek approval before acquiring control, acquired control after receiving a Warning Notice or breached an interim order. - Under Section 191B, the FSA may issue a restriction notice following a Warning Notice; under Section 191C the FSA may apply to the court for an order for sale of shares following an objection to control. - Assessment: Compliant - Comments: None provided. ### Principle 5. Major acquisitions - Assessment: Compliant - Findings: - Under PRIN 11 (relations with regulators), banks must disclose to the FSA anything the FSA would reasonably expect notice of; SUP 15.3.8G indicates this generally includes proposed restructuring, reorganization or business expansion with significant impact on risk profile or resources, specifically “setting up a new undertaking within a firm’s group, or a new branch (whether in the United Kingdom or abroad)” and “commencing the provision of cross-border services into a new territory.” - SUP 15.3.9G states the period of notice to the FSA will depend on the event, and the FSA expects firms to discuss relevant matters at an early stage before making commitments. - The FSA has provided more detailed guidance in its Handbook (chapter references truncated in source). - Assessment: Compliant - Comments: None provided. *Source: _cr11233 - Section 165 (FSMA Section 166) (see comment on CP 21). Since 2010, the FSA* ### 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect ### _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect ### Acquisitions and investments — supervisory scope and powers - FSA expectation: banks must pre-notify major acquisitions or investments (PRIN 11), but the U.K. regulatory system does not clearly define what types and amounts (absolute or in relation to a bank’s capital) require prior supervisory approval. - Regime coverage: - Applies to acquisition/investments in the United Kingdom or abroad by FSA authorized banks. - Does not apply to acquisitions/investments made by the parent of the bank because FSA powers do not extend to bank holding companies (CP 24). - FSA approval powers would apply from the perspective of a U.K. target bank; not if the target is outside the United Kingdom. - FSA statutory powers: - Section 45 of FSMA: power to prohibit a bank from undertaking a major acquisition or investment where it would no longer meet its Threshold Conditions (Schedule 6 of FSMA). - Section 45 also permits varying a bank’s permission and imposing requirements or limitations in relation to an acquisition or investment. - Part XII of FSMA (control over authorized persons) allows action against holding companies that would render the U.K. bank unsuitable—via serving a warning notice under section 191A and application to the High Court for an order of sale under section 191C if the holding company refuses to comply. - Limitations and practical issues: - PRIN 11 does not apply to unregulated holding companies; thus pre-notification obligations may not reach such entities. - The remedy under Part XII has not yet been used and may be unduly cumbersome and require a much higher threshold for action than applying the acquisitions/investment regime to holding companies. - Recommendation (Assessment comment): - The U.K. authorities should make explicit in the regulatory framework what types and amounts of acquisitions/investments need prior supervisory approval and for which cases post-acquisition notification is sufficient. - Acquisition/investment authorization powers should be applied to transactions made by holding companies and controllers of U.K. banks as soon as possible; failure to do so is a serious deficiency. *Source: _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect* ### Threshold Conditions and supervisory assessment of major acquisitions - Threshold Conditions provide criteria to judge proposals, including requirement to maintain adequate resources and that the bank will continue to be suitable and conduct its affairs soundly and prudently. - When a bank acquires another FSA bank, approval requirements from the perspective of the target firm apply. - FSA may use section 45 and the “close link” Threshold Condition (must not become closely linked to persons in territories that prevent FSA effective supervision) as grounds to prohibit acquisitions/investments. *Source: _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect* ### Principle 6 — Capital adequacy: findings and arrangements - Legal and regulatory basis: - All U.K.-incorporated banks required to operate to Basel and European capital standards (Banking Consolidation Directive (2006/48/EC) and Capital Adequacy directive). - FSMA Threshold Conditions require banks to maintain adequate resources. - Minimum amount at authorization: more than Euro 5mn at the time a firm obtains permission under FSMA to accept deposits. - Core Tier 1 and interim capital regime: - May 2009: United Kingdom defined the standard for Core Tier 1, more stringent than Basel II and Directive definitions; some regulatory deductions made at Core Tier One level. - Interim capital regime sets targets for Core Tier 1 on an ongoing basis and in stressed conditions; used for stress-testing and determining capital buffers. - Pillar 2 and Individual Capital Guidance (ICG): - FSA can impose specific capital charges through Pillar 2 and bank-specific capital planning buffers; Pillar 2 rule: GENPRU 1.2.30R. - ICG target ranges for eight very high-impact banks: from 110 percent to 198 percent of their pillar 1 minimum capital requirement. - For approximately 180 smaller and medium-sized deposit takers: ICG targets range with median between 150 percent and 175 percent of minimum; about 15 percent of firms in each of the 100 percent to 125 percent and 125 percent to 150 percent ranges; some 40 percent of smaller and mid-sized deposit takers have ICG levels above 175 percent with half of these being above 200 percent. - Actual capital levels exceed ICG targets for all but a handful of smaller banks; remedial plans in place for those banks. - Capital planning buffer under Basel III: - Separate capital planning buffer for all deposit-takers and some investment firms under Pillar 2; buffer is determined as the maximum change in surplus over ICG arising over a three-to-five-year stress period (anchor scenario) measured in £ added to current capital ICG. - Firms are allowed to draw down on this buffer in a downturn. - Observed capital improvements and metrics: - Major banks could absorb losses of 21 percent to 82 percent of their ICG before hitting ICG plus capital buffer. - Four major banks’ Tier I ratio: 2007 around 8 percent; has risen to the 12 percent average (10 percent to 14 percent range). - Current core tier 1 range for the four main banks: 9 percent to 11 percent. - Model governance and IRB: - IRB adoption: eight firms use advanced IRB (AIRB) and seven use foundation IRB (FIRB); AMA available and used by two banks. - IRB model-change notification thresholds: pre-notify FSA when a model change decreases a portfolio capital calculation by 5 percent or more, or affects overall group capital by 1 percent or more. - In the past year: approximately 90 model change requests; FSA reviews approximately half; about half of those have a more in-depth review. - In-depth reviews: account for perhaps 40–50 person-days of work for two credit model specialists and a more general credit specialist; specialists on-site for 1 day. - Six-monthly high level model review process in place; starting in 2011 FSA will proactively review top 10 IRB models across the system. - Supervisory powers and enforcement: - Any breaches of individual capital ratios must be immediately notified to the FSA; triggers remedial plans and likely capital injection or balance sheet restructuring. - FSA powers under FSMA include variation and cancellation of permissions and withdrawal of authorization. - For serious issues, the SRR (Banking Act 2009) tools apply where threshold conditions are not met and the bank is failing or likely to fail and no other action would enable it to satisfy threshold conditions. Assessment: Largely compliant — FSA has capital requirements higher than Basel minimums, advanced Pillar 2 and stress-testing. Concerns about model assessment rigor and resources for model validation and replication. *Source: _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect* ### Principle 7 — Risk management process: arrangements and observations - Regulatory requirements: - FSA Handbook requires banks to have policies and effective risk management procedures (SYSC 4.1.1R and SYSC 7.1.2R); proportionate to nature, scale and complexity. - ARROW (Advanced, Risk-Responsive, Operating frameWork) provides regular firm-level risk assessments supported by Prudential Risk Division (over 250 professionals). - Supervisory programs: - Full ARROW assessments for high-risk firms can take six months or more and are done every two years; updates occur between full assessments. - Supervisory enhancement program introduced in 2008; Core Prudential Program (CPP) for eight very high-impact firms with in-depth modules—first pass-through goal of 18–24 months; roll out to further 50–60 high-impact firms planned later. - Governance, Board and senior management: - SYSC 7.1.4R and SYSC 14.1.11G place responsibility on senior personnel and governing bodies for risk strategies and oversight. - ARROW assessments verify Board-approved strategies and that Boards receive accurate information; FSA conducts Significant Influence Function (SIF) reviews of new Board members. - Observed practice is patchy: many banks still developing effective risk appetite statements, Board sub-committees, and linking compensation to risk. - Risk management documentation and reporting: - SYSC 7.1.8G(1) requires documented risk management frameworks; SYSC 4.3.2R requires senior personnel to receive regular written reports on risk matters. - Supervisors verify adequacy of MIS and Board reporting as part of ARROW; major banks face common IT and aggregation problems. - Model use and validation: - GENPRU 1.3 and other Handbook sections set requirements on valuation methods, systems and controls, and independent validation/testing of models. - Recent supervisory reviews raised questions about adequacy of independent model validation; FSA following up. - ICAAP and SREP: - BIPRU 2.2.4G and GENPRU set out ICAAP and SREP processes; documentation required and assessed by supervisors; FSA issues ICG based on SREP. - Assessment: Largely compliant — supervisory programs (ARROW, CPP) and stress-testing are strong, but enterprise-wide risk management capabilities at some major banks are not uniformly adequate; supervisory assessment program requires further development and resources. First cycle CPP completion and formal resource assessment recommended. *Source: _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect* ### Principle 8 — Credit risk: processes, supervision, and gaps - Framework and supervisory methods: - FSA Handbook sets prudential rules (GENPRU, BIPRU) and SYSC covers governance and systems and controls for credit risk. - Six primary supervisory methods for assessing credit risk: (1) ARROW model; (2) close & continuous dialogue with CCO/CRO/CEO; (3) semi-annual model discussions; (4) “deep-dives”; (5) stress-tests; (6) on-site section 166 skilled person reports. - Data and registers: - United Kingdom does not have a credit register or regular cross-industry process to review major credits. - Mortgage database collected when mortgage brokers became regulated exists but lacks loan history after inception. - Deep-dives and specialist resources: - Deep-dives involve supervision team and Prudential Risk Division specialists; scope includes governance, risk appetite, rating systems, MIS, problem assets. - Many deep-dives are reactive; typical deep-dive size: 3–4 people for 3–4 days with some file examination; no policy of planned cycle with sample replication. - Use of s.166 reports is growing but from a low level. - IRB and data granularity: - IRB adoption increases quality of data for wholesale portfolios; FSA plans more granular PD/LGD data collection for focused analysis and peer comparisons. - FSA’s light IRB analysis and limited model replication capability hinder its ability to challenge banks’ IRB results. - Stress testing: - Stress testing to assess capital adequacy and set capital planning buffers is advanced; however, robustness depends on quality of underlying portfolio data and risk measurement. - Large exposure limit: - Large exposures defined as exposures > 10 percent of a firm’s capital base; limit on total of all large exposures to connected corporate group must not exceed 25 percent of a bank’s capital (CRD maximum). - Assessment: Materially noncompliant — supervisory processes insufficiently proactive and detailed; need for more in-depth transaction testing, expanded specialist resources, improved data collection and more frequent use of section 166 skilled person reports. FSA has recognized issues and begun enhancements, but work is at an early stage and multi-year. *Source: _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect* ### Principle 9 — Problem assets, provisions and reserves: approaches and limitations - Regulatory and accounting framework: - FSA supervision uses Handbook requirements, practical supervisory measures, and accounting rules (IFRS and U.K. GAAP). - SYSC 3.1.1 and Threshold Condition 4 require appropriate systems and provisions; GENPRU 1.2.30 requires sound processes adequate to cover risks including credit risk. - Supervisory tools and practice: - FSA uses stress tests, detailed credit assessments, PRD and accounting specialists, and section 166 reports to assess provisioning and problem asset management. - Since the Turner Review (February 2009) FSA has intensified contacts with bank management and auditors on accounting judgments. - Coverage of off-balance sheet exposures: - System for classification and provisioning takes into account off-balance sheet exposures, particularly in IRB banks; IRB validation is light and does not include on-site credit assessment. - Information sources for supervisory judgment: - FSA relies on (i) regular supervisory reporting, (ii) ARROW assessment information, (iii) in-depth CPP reviews, (iv) management information, and (v) statutory powers to request further information. - GABRIEL internal reporting considered very limited; ARROW information mainly process-focused. - Use of capital vs. provisioning adjustments: - FSA focuses more on capital (Pillar 2) than direct provisioning; if provisioning inadequate, FSA may increase Pillar 2 capital requirement rather than enforce provisioning adjustments. - Assessment: Compliant — FSA has legal and procedural frameworks and access to information, but supervisory practice is bank-reliant with few hard on-site checks; indirect supervision tends to lag problem asset identification. Anticipated IAS 39 changes (expected by June 2011 per text) may permit more forward-looking provisioning and support a more proactive supervisory approach. *Source: _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect* ### Principle 10 — Large exposure limits: rules and supervisory implementation - Regulatory rules: - BIPRU 10 (Large Exposure Requirements) sets limits on exposures to single counterparties and groups of connected counterparties. - Definition of “group of connected clients” follows Article 4(45) of CRD (2006/48/EC); FSA handbook modified to comply with CEBS guidance (referenced as of December 31, 2010). - Measurement and scope: - BIPRU 10.2 includes both on- and off-balance sheet items in the definition of exposure. - BIPRU 10.5 defines a large exposure as an exposure > 10 percent of a firm’s capital base at a given stage in the capital resources calculation. - The CRD maximum: total of all large exposures to a connected corporate group must not exceed 25 percent of a bank’s capital. - Supervisory systems: - Large exposures collected through regulatory return FS008; FSA applies CRD large exposure elements similarly to other European countries. - Observed practice/comments: - Assessment and comments on whether current limits are appropriate are referenced elsewhere (see CP 10 commentary). *Source: _cr11233 - 15.3 of its Supervision Manual (SUP) on the circumstances in which it would expect* ### 2010. This included a tightening of the European large exposures regime. The FSA ### _cr11233 - 2010. This included a tightening of the European large exposures regime. The FSA ### Large exposures regime - Definition: BIPRU 10.5.1R — a large exposure is total exposure to a counterparty, connected counterparties or a group of connected clients, on- or off-balance-sheet, which in aggregate equals or exceeds 10 percent of the firm's capital resources. - Limits applied by the FSA: - 25 percent of capital resources limit on large exposure to each counterparty, connected counterparties, or a group of connected clients (EU rules applied “a minima”). - Aggregate limit of 500 percent on total large exposures that arise from a firm’s trading book. - Trading-book exposures historically exempt from 25 percent but subject to 500 percent or 600 percent limits dependent on maturity and to a penal capital add-on for excesses over 25 percent. - Penal additional capital charges may rise to 900 percent RW for exposures over 25 percent in line with discretion in 2006/49/EC. - Implementation change: From December 31, 2010 the FSA subjects all third-party large exposures to the same 25 percent limit regardless of banking or trading book. - Reporting and controls: - BIPRU 10.2.1R and BIPRU 10.12.1R require exposures to include all on- and off-balance-sheet claims and transactions and require sound administrative and accounting procedures and adequate internal control mechanisms to identify and record all large exposures and subsequent changes. - Firms must report all large exposures to the FSA through quarterly reporting requirements and must notify the FSA of any breaches. - Assessment: Compliant (with effect from December 31, 2010). - Supervisory comment: 25 percent limit can result in too much concentration; FSA could encourage banks to set lower internal limits (some EU countries apply, de facto, a 10 percent standard). ### Exposures to related parties (Principle 11) - Definition and scope: - Broad definition of “connected counterparties” in BIPRU 10.3.8R, including automatic connections for certain corporate entities and qualitative factors (closely related creditworthiness, significant influence, exposures not incurred for clear commercial advantage or not on an arm’s length basis). - Some persons (e.g., Board members and family members) may not be automatically considered connected; considerations included in BIPRU 10.3. - Terms and arm’s-length dealings: - No specific FSA requirement that exposures to connected parties be on terms no less favorable than those generally available; reliance on general principles of sound risk management and corporate conflict requirements and supervisory review. - Limits and exemptions: - BIPRU 10.5.6R sets a general limit of 25percent of capital resources on aggregate exposures to connected counterparties. - Exemptions in BIPRU 10.6–10.9 (from 31.12.2010 in BIPRU 10.8A and 10.9A) for subsidiaries within regulatory consolidation group; exemptions reviewed and conditions strengthened. - Non-exempt excesses may be reduced by credit risk mitigation meeting BIPRU 5 standards or deducted from capital (GENPRU 2.2.221R-2.2.235R requires lending of a capital nature to connected counterparties to be deducted fully from capital). - Monitoring and reporting: - No specific requirement for separate internal reporting processes for related-party exposures; general sound risk management requirements apply, with supervisors reviewing treatment as part of ARROW. - Large and connected exposures are reported quarterly (FS008) and reviewed off-site. - Assessment: Largely compliant. - Supervisory comment: Process relies on general rules rather than a specific regime; supervisors review operation as part of ARROW. No identified issues to date, but single material problem could cause reputational risk. ### Country and transfer risks (Principle 12) - Framework and rules: - Country and transfer risk addressed via normal credit rules (SYSC 7.1, ARROW) and BIPRU 10 concentration rules; BIPRU 10.12.1R requires administrative and accounting procedures and internal controls for identifying and recording large exposures. - FSA has no specific tool or requirement solely for country risk. - Risk management requirements: - SYSC 7.1.2R requires banks to have adequate risk management policies and procedures including effective risk assessment. - Provisioning for country and transfer risk set by the bank and judged by external auditors; FSA can commission section 166 skilled person reports (none commissioned on this topic in last 3 years). - Data and reporting: - Data conforming to BIS standards collected quarterly; country risk reports must be submitted to the BoE within two months of the reporting date; FSA has access and may collect more frequent data when needed; currently undertaking granular approach for specific sovereigns. - Assessment: Compliant. - Supervisory comment: Country and transfer risk can be material; a more proactive supervisory approach is recommended. ### Market risk (Principle 13) - Regulatory basis and model approval: - Compliance with Capital Requirements Directives (2006/49/EC and 2006/48/EC); BIPRU 7 sets standards for internal models (CAD1 and VaR) and qualitative and quantitative requisites for model use. - Banks with VaR model permission face extensive risk control requirements (BIPRU 7.10). - Stress testing, valuation, and limits: - Banks required to conduct regular stress testing and scenario analysis of trading book positions (BIPRU 7.1.17). - Firms must set and monitor trading book position limits; supervisors assess calibration, granularity, and appropriateness with specialist support (some 60–65 market risk specialists). - GENPRU 1.3 requires systems and controls for prudent and reliable valuation; trading book positions must be re-valued at least daily. - Firms asked to report prudent valuation adjustments for 31 Dec 2010 in Feb 2011 and quarterly thereafter. - Supervisory enhancements post-crisis: - FSA refurbished market risk supervisory capabilities; increased specialist staff; commenced more detailed reviews of valuation and product control processes. - Core prudential program to undertake structured proactive program of assessing market risk over next two years; detailed reviews (drill-downs) undertaken for major banks with concerns. - Assessment: Largely compliant. - Supervisory comment: Rules and powers in place; variation in banks’ practices; FSA needs more proactive monitoring, benchmarking reviews, and to review adequacy of specialist resources given scale and complexity of London market positions. ### Liquidity risk (Principle 14) - New liquidity regime (BIPRU 12) and scope: - Introduced end-2009; includes adequate liquidity and self-sufficiency standards, systems and controls, quantitative requirements based on survival under stresses, group-wide and cross-border management, and reporting standards; undrawn commitments and off-balance-sheet items included in stress testing. - Policy statement October 2009; regime approved December 2009; reporting requirements and individual liquidity assessments came into force in June 2010, cascading from largest firms downward. - FSA delayed calibration pending Basel minimum global liquidity standards; firms expected to meet international standards by proposed implementation date of 1 January 2015. - Governance and supervisory tools: - BIPRU12 requires robust strategies, policies, processes and systems to identify, measure, manage and monitor liquidity risk including intra-day horizons; governing body must establish risk tolerance. - Firms undertake ILAS self-assessments at least annually; supervisors assess ILAA/ILSA and Contingency Funding Plan (CFP) via Supervisory Liquidity Review Process (SLRP) and issue Individual Liquidity Guidance. - Liquidity reporting tools include liquidity DashBoard, supervisory liquidity scorecard, FSA047, FSA048 and FSA054; FSA047 captures contractual daily flows out to three months. - Supervisory reviews and deep-dives: - Initial desktop reviews found firms’ self-assessments too optimistic; FSA adopted deep-dive liquidity reviews typically taking 3-4 people over 2-3months. - Deep-dive coverage: covered major banks and some (but less than half) high-risk banks; roll-out expected to be finalized within several years. - Contingency planning and stress testing: - BIPRU 12.4.11 requires contingency funding plans to be tested, updated based on mandatory stress tests and approved by governing body; firms submit CFP with ILAA/ILSA. - BIPRU 12.4.1 requires regular stress tests at least annually; scope and frequency proportionate to nature, scale and complexity. - Assessment: Largely compliant. - Supervisory comment: FSA has lead-edge regime and proactive program; further roll-out to next tier of high-impact firms and follow-up on remediation needed; liquidity requirements calibrated as interim measures with phase-in of higher requirements; wholesale refinancing program over next 18–24 months is a key system risk. ### Operational risk (Principle 15) - Regulatory requirements: - SYSC 4.1.1R–4.1.2R, SYSC 7.1.16R and BIPRU 6 set proportionate general and operational risk-specific standards for identification, assessment, monitoring and mitigation across BIA, TSA, and AMA approaches. - Operational risk assessment and management systems must be subject to regular independent reviews; ARROW updated for operational risk; FSA conducted industry surveys and issued additional guidance. - Governance, BC/IT and outsourcing: - SYSC 7.1.4R and SYSC 7.1.16R require senior personnel approvals of strategies and policies; SYSC 4.1.6 and SYSC 4.1.7 require business continuity policies and testing; Resilience Team conducts Market-wide Exercise and Resilience Benchmarking. - SYSC 3.1.1 and GENPRU 1.2.89 G require adequate systems and IT policies; SYSC 8 sets outsourcing requirements. - Data, reporting and guidance: - GABRIEL used for regulatory reporting (report FSA007); SREP process requests operational risk data including loss data; CoRep program to address data quality and coverage deficiencies. - FSA surveyed banks intending to use BIA or TSA and invited banks into expert group resulting in “Enhancing frameworks in the standardized approach to operational risk” guidance note (consultation underway at assessment time; finalization expected mid-2011). - Assessment: Compliant. - Supervisory comment: Work program for independent evaluations in place; FSA encouraged to continue pushing improvements, monitor risks from interconnected global firms, and pursue roll-out of core prudential program. ### Interest rate risk in the banking book (IRRBB) (Principle 16) - Recognition and scope: - FSA treats IRRBB as a distinct and significant risk in many banks, covering repricing risk, yield curve risk, basis risk and optionality risk; customer behavior assumptions must be monitored. - Requirements and testing: - GENPRU 1.2 and BIPRU 2.3.12R require banks to have processes, strategies and systems for IRRBB and to undertake periodic evaluation at least annually. - BIPRU 2.3.7R requires stress test of a sudden shift of +/- 200bps in the yield curve quarterly; banks must notify the FSA if the economic value declines by more than 20percent of its financial resources due to that stress. - Supervisory tools: - FSA developed an internal model for consistent evaluation across banks; the FSA has power to obtain information under section 165 of FSMA and requires ICAAP submissions covering IRRBB as part of ARROW. - FSA is yet to develop a formal model evaluation and approval process for IRRBB; outlier analysis for smaller and mid-sized banks is hampered by reporting deficiencies. - Governance and planning: - ICAAP capital planning exercise typically covers a horizon of three to five years incorporating downturn scenarios (GENPRU 1.242R and GENPRU 1.2.73G); use test requires banks to use outputs to inform policies and limits. - Additional guidance in SYSC effective from May 1, 2011, encouraging FTSE-100 banks and insurers to consider risk committees and appointing a chief risk officer; FSA expects to introduce a specific chief risk officer (controlled function) in due course. - Assessment: Compliant. - Supervisory comment: FSA should revise reporting forms for smaller and mid-sized deposit takers to enable more complete outlier analysis. ### Internal control and audit (Principle 17) - Corporate governance and legal framework: - Companies Act 2006 and FSA Listing Rules require Premium Listing issuers to include annual statement of compliance with the U.K. Corporate Governance Code. Walker Review recommendations reflected in updated Code effective June 2010. - EU directives (BCD and MiFID) implemented via SYSC chapters 4-10 (Common Platform). - Internal arrangements: - SYSC 4.3.1/2R requires senior personnel to ensure compliance with regulatory obligations; FSA has intensified Approved Persons Regime and may require Board/senior management composition changes. - SYSC 6.1 requires staff competence and monitoring; SYSC 6.1 requires independent compliance function; SYSC 6.2.1R requires independent internal audit where appropriate; internal audit must have sufficient resources, independence, access and methodology. - Listing and committee expectations: - Listing Rule requires Premium Listing issuers to state compliance with Corporate Governance Code; FSA would assess Board composition and audit committee appropriateness during supervision. - Chair of audit committee will be subject to FSA vetting as controlled function CF2d later in 2011; internal audit function to be CF15. - Assessment: Compliant. - Supervisory comment: FSA encouraged to complete Walker Review recommendations and address incentive structures that encouraged excessive risk-taking. ### Abuse of financial services (AML/CFT) (Principle 18) - Regulatory objective and supervisory approach: - Reduction of financial crime is an FSA regulatory objective integrated into ARROW risk-based supervision; FATF 2007 noted comprehensive supervision for large firms but gaps for certain smaller firms. - Requirements for banks: - SYSC 6.1.1 R requires policies and procedures to counter financial crime; Reg 20(1), MLRegs 2007 require risk assessment, risk-sensitive customer due diligence, monitoring and record-keeping. - Banks must appoint a money laundering reporting officer (MLRO) (SYSC 6.3.9 R). - Enhanced due diligence required for correspondent banking relationships (not extending to respondents from EU and EEA jurisdictions). - Supervisory tools and powers: - FSA conducts thematic reviews and uses financial crime specialists; enforcement powers under FSMA and other legislation; FSA has investigation and enforcement powers including civil penalties and prosecution. - Since 2007 to October 2010, FSA published over 80 disciplinary sanctions concerning financial crime matters, including seven findings in the banking sector. - FSA can require internal audit and compliance reports under section 165 of FSMA and skilled person reports under s.166. - FSA has statutory powers under Regulation of Investigatory Powers Act 2000 for covert techniques where necessary. - Reporting, confidentiality and interagency cooperation: - Persons must report suspicions to nominated officer; nominated officer must submit SARs to FIU (SOCA) where grounds exist (ss 330,331 POCA 2002; s 21A, Terrorism Act 2000). - Protections for disclosure provided by ss 337–338 POCA 2002, Terrorism Act 2000 s 21 and Data Protection Act 1998 s.29 (3). - Money Laundering Regulations 2007 (Reg 24 (2)) require supervisory authorities to inform SOCA when they know or suspect money laundering; FSA confirms active working relationship with SOCA and MoUs with other domestic authorities. - Assessment: (descriptive coverage provided in ECs; supervisory powers and processes described). - Supervisory comment: FSA uses risk-based approach and specialist resources; thematic reviews ongoing to address high-risk customers, wire transfers and correspondent banking. *Source: IMF staff assessment text in provided content unit.* ### Section 348 FSMA places restrictions on the disclosure of information defined as ### Section 348 FSMA places restrictions on the disclosure of information defined as ### Legal framework for disclosure - Section 348 FSMA places restrictions on the disclosure of information defined as confidential. - Section 349 FSMA provides for the creation of gateways to enable disclosure of information falling within the “confidential” definition. - Section 34 of the Serious Organized Crime and Police Act allows the FSA to disclose any “confidential” information to SOCA. *Assessment: Compliant* ### Enforcement and financial crime staffing - The FSA has an Enforcement and Financial Crime Division of over 500 staff. - Just under 50 of these staff fulfill specialist Intelligence functions, supporting colleagues who assess the fitness and propriety of applicants for authorization or approval; helping to detect breaches and assisting in enforcement actions. - Comment: Overall, the FSA supervision of banks’ policies and processes to prevent the bank from being abused for criminal activities seems comprehensive and thorough. - Concern noted: The FSA’s risk-based supervisory approach means that in practice small institutions are not subject to an individual specific AML/CFT risk assessment. This may raise concerns about pockets of financial activities that receive less than adequate supervision. This is an issue also raised by the FATF evaluators. ### Assessment and supervisory observations - Assessment: Compliant. - Assessors discussed with the FSA the FATF concern of excessive reliance on interview-based visits without sample testing. The FSA is changing its approach to a more intrusive supervision. - Further supervisory work needed: ensure that financial institutions require their branches and subsidiary undertakings located in a non-EEA state to apply, to the extent permitted by the law of that state, measures at least equivalent to those set out in the AML Regulations with regard to customer due diligence measures, ongoing monitoring and record-keeping. - These deficiencies in supervisory practices are related to the discussion of Principles 19 and 20. ### Principle 19 — Supervisory approach (overview) - Principle 19 summary: Supervisors must develop and maintain a thorough understanding of the operations of individual banks and banking groups, and also of the banking system as a whole, focusing on safety and soundness, and the stability of the banking system. - In theory, the FSA takes a risk-based approach to bank supervision (SUP 1.3.1), adjusting supervisory intensity according to the risks the firm presents to their statutory objectives (SUP 1.3.7) by using ARROW as its core model. - ARROW assesses firms in terms of their impact using indicators as a proxy for relative size and the likelihood of particular issues occurring in the firm. - ARROW looks at vertical (firm- or group-specific) risks and horizontal/thematic risks (those that cut across several firms or the market as a whole). - ARROW ranking scale: H, MH, ML, L where H is high, L low and M medium impacts. - A new category: VHIFs (very high-impact firms) has been created after the crisis and there are 8 firms in that category. - Recently, there have been 35-50 banks in the high-impact category. - The group of systemically important deposit-taking banks designated VHIFs are subject to enhanced supervisory scrutiny under the Core Prudential Program (CPP). - A firm is categorized as a VHIF following agreement by the Executive Committee. ### Supervisory planning and relationship management - Two-step supervisory planning: - Step 1: ARROW core model to determine impact ranking and supervisory cycle (varies from 1 to 4 years). - Step 2: Use filters to determine intensity of supervisory approach. - Relationship management and cycles: - For Very-high, Medium-high and High-impact firms, the FSA coordinates supervisory work through a relationship manager, who carries out a regular risk assessment on a cycle of one to four years and determines a Risk Mitigation Program (RMP). - Baseline monitoring activities are a minimum threshold undertaken for all firms regardless of impact scores (SUP 1.3.11). - The supervisory cycle for very high and high-impact firms (including timing of a full ARROW assessment) was moved from three to two years. - Supervisory approaches described in the present regime: - Impact: L — Relationship managed? No — Reg period: Not applicable — Supervisory approach: Baseline monitoring and thematic - Impact: ML — Relationship managed? Yes — Reg period: At least 4 years — Supervisory approach: ARROW light (reduced assessment) - Impact: MH — Relationship managed? Yes — Reg period: At least 3 years — Supervisory approach: Full ARROW (standard assessment) - Impact: H — Relationship managed? Yes — Reg period: At least 2 years — Supervisory approach: Full ARROW plus close and continuous (minimum standard of regular meetings) - Impact: VH — Relationship managed? Yes — Reg period: At least 2 years — Supervisory approach: Full ARROW plus close and continuous and core program (greater use of specialist resource and in-depth reviews) ### ARROW risk process and ongoing assessment (EC1) - ARROW supervisory cycle varies depending on the bank (from 1 to 4 years); very high-impact firms and a range of other firms are on a two-year cycle. - Risk assessment cycle phases: - Planning: includes information requests for firm MI such as current business plan/strategy documents, group and organizational structure charts, latest financial statements, last Board meeting papers and minutes, Audit Committee papers, internal audit plan and reports, and compliance monitoring program/reports. - Discovery. - Evaluation and communication. - The cycle culminates in reporting results to the firm in an ARROW letter and a Risk Mitigation Program (RMP). - For the remainder of the regulatory period, the firm is subject to ongoing monitoring. - ARROW assesses banks on the following risk and control factors: - Environmental risk (economic, legislative & political, competitive and capital markets environment) - Business model risks and controls (customers, products and markets, business process, and prudential) - Oversight and governance risks and controls (management, governance and culture) - Traditional risk categorization (credit, market, operational, IRRBB, etc.) is included under business and environmental risks. - Impact and probability scores relate to the effect the individual firm has on the FSA’s statutory objectives. - Ongoing assessment leads to a Risk Mitigation Program (RMP) directed toward specific issues identified during the periodic risk assessment; extra work is carried out in a ‘follow-up phase.’ ### Monitoring methods - Two methods for ongoing monitoring: - Baseline monitoring — undertaken for all firms; involves analyzing financial (e.g., capital, liquidity and large-exposures) and nonfinancial (e.g., complaints data, annual controllers and close-links reports) returns, checking compliance with notification requirements; breaches and other indicators of risk may be followed up by a supervisor. - Close and continuous (C&C) supervision — for HIFs and VHIFs only; closer monitoring regime with regular contact and a planned schedule of visits throughout the regulatory period; includes standard firm MI requests and meetings with senior management and control functions. ### Observations on ARROW use and limitations - Assessors noted ARROW is used more as a resource allocation model than a risk assessment model. - Example limitations: - ARROW does not discriminate well among the high or very-high-impact banks. - There are minimal criteria to assist staff in knowing how to rate something in the various ARROW categories. - The framework deliberately has minimal links to criteria such as BCBS sound practice documents to avoid a ‘checklist’ mentality. - There are few forward-looking components in the ARROW system. - Specialist staff and senior management can pre-specify risk ratings for various business lines; supervisors may vary individual bank scores but must explain deviations. - Sector sub-sector profiles are used to give supervisors a starting point for assessment and encourage consistency, though supervisors reported that pre-specified ratings tended to reduce usefulness. - ARROW instruction manuals are voluminous and the system appears complex. - Assessors found that ratings for a number of VHI banks tended to follow rather than lead developments over the past five years. - Staff understood major risks at a high level but assessors share the view that the level of assurance around these judgments is not at the desired level for a system as complex and global as the U.K. system. ### Core Prudential Program (CPP) rollout and specialist work - CPP introduced after the crisis as an assurance program to enhance the FSA’s existing risk architecture for very high-impact firms. - CPP deep-dives cover five modules: Business Model Analysis, Capital, Liquidity, Risk and Governance, involving narrow specialist testing. - Current practical coverage: deep-dives only in capital and liquidity for some of the banking groups (20 percent); it will take time to fully cover all of them. - The goal: complete the CPP cycle for all the VHI banks in the next 18–24 months before the start of the next ARROW reviews; then results can be taken into account in the ARROW assessment. - CPP has not been rolled out for the wider range of high-impact banks, but will be in future; specific plans and formal resource assessment are not yet in place. - Modules for capital and liquidity have been rolled out; modules related to business plans risk and to risk management, ERM and risk governance are at a very early stage. - The CPP roll-out is mostly module by module though links between modules are recognized; full integration unlikely within initial two-year phase. - Assessors observed low frequency of deep-dive and thematic reviews historically; they have tended to be reactive rather than proactive, but this is changing. ### Integration, planning and resource constraints - It was unclear whether supervisory enhancement programs and CPP were fully integrated into ARROW. - Assessors reviewed 18–24 month forward planning charts of supervision activities for major banks showing mandatory work (six monthly HOD reviews, ARROW assessments), CPP rollout, thematic work, work driven by bank plans, and specific work related to material risks. - FSA staff confirmed resource availability was one of the main drivers for the timing and scheduling of work. - In-depth reviews of higher risk areas for individual banks often fitted into other work streams or covered under the close and continuous supervision/monitoring program. ### Data, analytical tools and system-wide assessments (EC2) - Key tools and services available to supervisors: - Core Prudential Program (CPP) ‘deep-dives’ — rolling assurance program based on in-depth structured work intended to address big picture risks. - Simultaneous system-wide stress tests — firms use a common scenario to gauge system-wide impacts of stress events for financial stability purposes; these exercises tie in with macro-prudential analysis. - Market view analysis (MVA) — weekly reports summarizing trends in market sentiment, equity and credit research, rating actions, investor views and market price indicators. *Italic: Source: _cr11233 - Section 348 FSMA places restrictions on the disclosure of information defined as* ### conclusions and recommendations, as well as rating actions, are examined critically ### _cr11233 - conclusions and recommendations, as well as rating actions, are examined critically ### Peer group analysis, Intrinsic Credit Rating (ICR), and Peer Review Days - Peer group analysis provides comparative analysis of large U.K. and foreign banks; supervisors also receive peer group analysis of credit characteristics of high-impact banking firms. - An Intrinsic Credit Rating (ICR) is assigned to measure, on a relative basis, the distance of a banking firm from likely regulatory intervention and/or state support (i.e., intrinsic business and financial strength). - FSA banking sector specialists hold Peer Review Days with senior management from Supervision to consider peer analysis of risks relating to banks’ business models, controls, capital and liquidity. - Peer Review Days enable: - examination of firms relative to peers; - challenge among attendees on risks and mitigation adequacy; - prioritization of issues for supervisory follow-up; - greater consistency of impact and probability scores. - Assessors’ observations: - The methodology on peer groups has not been discussed with the assessors. - The mission has not examined the way the peer groups were made. - The described ICR is not a traditional supervisory peer group analysis as found in many other G-10/20 countries. ### Business model and financial analysis; Sub-sector issues (SSIs) - Business model and financial analysis covers three sub-sectors: retail and commercial banking, wholesale and investment banking, and building societies/mortgage lenders. - Objectives: - assess sustainability and risk characteristics of banking firms’ business models (“BM”); - identify and name outliers to flag early-warning indicators regarding BM sustainability, growth and diversification strategies, risk-taking appetite, asset mix and quality, funding and liquidity patterns, and quality and level of capital (including potential internal capital misallocations). - Sub-sector issues (SSIs) aim to: - focus supervisory work by articulating specific, significant topical risks; - integrate horizontal work and specialist contributions into firm supervision for knowledge sharing; - provide suggested discovery and mitigation work to promote consistency across ARROW firm risk assessments; - provide feedback to risk owners and senior management on mitigation of issues at individual firms. ### Banking sector scorecard, Firm MI, regulatory returns, and data systems - Banking sector scorecard: - supervisors undertake a minimum review of regulatory returns submitted by banks; - scorecard displays measures and calculations to enable peer analysis by category; - reviewed quarterly for solo/unconsolidated firms and half-yearly for consolidated groups. - Regulatory returns and data available to supervisors include: solvency statement, income statement, large exposures, daily flows, funding concentration and currency analysis; submission frequency ranges from annual to daily depending on the return. - Business Intelligence (BI) tool can identify trends across peer groups and outlier firms. - GABRIEL Data base is less important to the FSA than in other G-10/20 countries; FSA has adopted significant ad-hoc reporting for major banks, with some data migrated into general returns. - Firm MI: - aggregate risk by departmental risk portfolio reviewed monthly to identify trends and commonalities to inform ARROW assessments; - identifies outliers including intensity of mitigation effort and resource application relative to peers; - market data (e.g., CDS prices) complement supervisory-generated data; - analysis is presented at divisional risk committees and higher-level Business Unit and Executive Risk Committees. - Assessors’ synthesis: - monitoring functions and analysis originate from various sources (monitoring groups, specialist risk divisions, supervision monitoring), creating complexity and risk of conflicting messages, analyst confusion, silos, and insufficient roll-out of data collected for VHI banks to other high-impact banks. ### ARROW risk assessment process, panels, communications, and supervisory letters - ARROW is the core FSA firm and group risk assessment model, used to prioritize supervisory work via three ARROW levels (full ARROW vs. ARROW Light; Baseline vs. C&C monitoring). - ARROW results enable supervisors to compare firms against peers or sub-sector modal and set supervisory work for the regulatory period. - Structured panel process: - used to agree and prioritize supervisory work in a cycle and verify overall ratings, findings, supervisory letter, and remedial action plan (RMP) to the bank’s Board. - Head of major groups division usually chairs major bank panels; Managing Directors of Supervision and Risk would not normally attend or chair panels. - Directors of supervision chair all VHIF and HIF panels; Risk is represented on all panels but at a less senior level. - Communications: - Letter to Boards is usually 10-15 pages long, with similar amount in annexes; contains risk rating information and remedial action plan (RMP). - FSA recently organized RMP plan items by importance to better communicate with Boards. - Typical RMPs for big banks had 20-30 items summarized in the RMP table. - Assessors’ findings on consistency and messaging: - Important inconsistencies observed between supporting material to panels, risk ratings given to Boards, Board letters, and presentations to the Board. - Some important items may not appear in the Board letter but are discussed separately with certain Board members. - There is not a formal process to compare results across major banks for consistency, though panel packs include some high-level peer comparator material. - Availability of more peer analysis could motivate Boards and senior management to improve and help clarity of concerns and expectations. ### Use and evaluation of skilled person reports (section 166 FSMA) and deep-dives - S166 reports: - commissioned by banks at FSA direction to investigate selected control, process or risk measurement issues; the FSA sets terms and approves final report; bank pays for the review. - Number of S166 reports related to prudential issues across 2008, 2009 and 2010: 6, 13 and 23 respectively. - Most commissioned S166 reports have been on small institutions, financial advisors, mortgage lenders, brokers, asset managers, and custodians advising and arranging intermediaries. - Range of cost is from £10K to £1.1 million for a large bank. - For banks, the average cost is around £0.3 million to £0.5 million. - Specific table/data presented: - BANKS: 6 13 23 £ 415k with a range from £30k to £1,100k - Building Societies: 1 3 1 - TOTAL: 7 16 24 - Topics mainly: governance, selling practices, risk management frameworks, customer detriments, quality of systems and controls. - Eight S166 reports on the quality of the supervisory return in 3 years; no apparent commissioned work on credit portfolio quality or on IRB or AMA. - Assessors’ view: - Though increasing (6 to 23 for banks), S166 prudential work does not represent a realistic substitute for lack of supervisory in-depth reviews currently. - Average S166 tasks for banks represent on average 3 persons’ work for one month; tasks performed are rather small. - S166 and current “deep-dives” are not extensive enough to substitute for a proactive on-site deep-dive process with regular cross-system peer analysis. - Most deep-dives involve relatively small teams for short timeframes; equivalent deep-dives done less frequently than in other major countries but add value when performed. - Number of detailed deep-dives should be increased as planned by the FSA. - Current proactive deep-dives appear most consistent in liquidity analysis, though primarily reliant on banks’ MIS. ### Information systems, Alerts and Risk Indicators (ARI), and stress testing - ARI system: - automatically identifies rule breaches or potential risks based on data submitted by firms. - ARI runs approximately 160 rules against TARDIS, RMA data items, Complaints returns and Product Sales Data. - Rules comprise approximately 60 alert rules (rule breaches) and 100 risk indicator rules (e.g., conduct of business issues, complaint levels). - All Alerts and Risk Indicators are accessible by supervisors. - Stress testing: - supervisors receive firm and system-wide stress test results; - FSA runs its own stress tests regularly for particular firms to assess ability to comply with minimum specified capital levels throughout a stress period. - Assessors’ assessment of information systems: - Ongoing information system remains basic compared with other major jurisdictions familiar to FSAP team. - System is extensively supplemented by processing requests based on a relatively high proportion of individual bank MI and specialized group information. - FSA does not appear to have an organized early warning system. ### Key governance, resource and supervisory framework issues and recommendations - Assessment: Materially noncompliant with CP 19; key issues include inconsistent depth of reviews, fragmented processes, inadequate discrimination and forward-looking capability of ARROW, and unclear communication of supervisory views to banks. - Noted strengths and progress: - FSA possesses necessary tools and examples of very good supervisory work in a difficult environment; - FSA recognized previous system inadequacy and initiated major retooling (Core Prudential Program (CPP) and other initiatives). - Resource and capability observations: - Number of staff in banking supervision around 600 (from reorganization data); assessors consider this low given U.K. system size and complexity. - Other G-10/20 countries typically have considerably more staff devoted to detailed reviews/on-site type work. - Specialist resources for detailed credit file reviews and other risk-category assessments are limited. - Recommendations and priorities identified by assessors: - Increase number and frequency of detailed deep-dives (on-site equivalent work) and consider building an on-site function or increasing supervisory staff performing in-depth reviews. - Do not rely on S166 reports as a substitute for proactive supervisory deep-dives; while ramping up S166 may be an interim measure, more supervisory-led detailed reviews are preferable to build knowledge linking findings to risk management and governance root causes. - Improve integration of specialist activities within the supervisory program and ensure linkages between CPP modules are explicitly accounted for in roll-out plans. - Address inconsistencies in panel outputs and communications to ensure supervisory messages are coherent and fully communicated to Boards and CEOs; ensure Board-level supervisory letters comprehensively reflect major findings. - Revamp ARROW to be more discriminating and forward-looking; provide clearer guidance and criteria for rating judgments to assist staff (many of whom are new). - Enhance peer analysis availability to motivate Boards and improve comparability across firms. - Design a comprehensive multi-year program for enhanced supervision with specific timetables, broader CPP coverage, improved internal processes for integrating specialist inputs, and strengthened senior oversight to ensure intensive supervisory behavior aligns with objectives. - Ensure the supervisory coverage model accounts for reputational risk and the need for sufficient oversight even where failures are smaller in absolute terms. - Preserve focus on core micro-prudential work (inherent risk, quality of risk measurement, risk management and governance) when implementing macro-prudential overlays and new initiatives. *Source: _cr11233 - conclusions and recommendations, as well as rating actions, are examined critically* ### 1. Independent verification of Corporate Governance: Corporate governance is ### _cr11233 - 1. Independent verification of Corporate Governance: Corporate governance is ### Independent verification & governance oversight - Corporate governance is assessed as part of the ARROW process (ARROW II Supervisors’ Guidance Manual). - High-impact firms receive additional evaluation through annual meetings with the Board and other targeted reviews. - FSA has the power to commission skilled person (i.e. auditor) reports under s.166 of FSMA; scope is determined by the FSA and project-managed to meet objectives. - Most work is done offsite by persons in charge; contacts with banks for large banks are "now sufficient." - The Core Prudential Program for very high-impact firms is developing a Governance module composed of: - "a structured methodology; a formal, ongoing program of reviews to assess effectiveness of governance; more in-depth work; an emphasis on effectiveness; use of case studies; and knowledge sharing." - This module is not yet implemented, nor are its links to other modules. ### Assurance that banks’ information is reliable - Supervisors draw on industry and firm-specific knowledge and guidance (Supervisors’ Guide to Regulatory Returns: Banking Sector) to analyze regulatory returns. - Guidance and analysis tools for new liquidity reporting standards are "still in development." - Prudential risk specialists lead quarterly/semi-annual assessments of firms’ internal models with follow-up meetings and reviews covering: - market risk models (CAD2/VAR approval) - counterparty risk models (IMM) - credit risk models (AIRB) - GABRIEL system is characterized as "on the lighter range of what exists elsewhere." - FSA can collect more information from banks’ MIS and does so; advantages: faster and less costly; risks: - (i) difficulty in comparing and storing inconsistent data across firms - (ii) concerns regarding the quality of the data transmitted - FSA empowered to request data throughout the regulatory period (SUP2); data can be analyzed on a firm or thematic basis either directly or via external auditors. - The instruction set in SUP 16: number of arithmetic controls is "very low," number of logical controls "extremely low," and number of likelihood controls "apparently non-existent," impacting quality assurance and use of supervisory reporting. ### Monitoring, follow-up, and on-site work - Monitoring: supervisors monitor firm returns, requested MI, and market information throughout the regulatory period. - Follow-up: FSA uses a "Close and Continuous" approach enabling regular meetings (often monthly) with firms’ market, credit and liquidity risk experts; approaches include sub-sector work, horizontal work, and the Core Prudential Program. - Determination of priorities and scope of on-site work: driven by firm/group risk profile from ARROW assessment (combines prudential indicators and supervisory/specialist judgment). Prudential risk specialists produce a monthly note consolidating important/priority issues. - Limitations noted: - ARROW framework "does not appear to adequately discriminate among larger banks" and "does not have much of a forward-looking component." - Little guidance on making rating judgments; description of rating categories is minimal; deliberate to avoid a check box mentality. - On-site practice often consists of visits of just a few days, lacking transaction testing and extended on-site examination depth; deep-dives and s166 are supplementary but are not yet a sufficient approximation of a real on-site function. - Some prudential risks (e.g., Credit risk, provisioning) may be "too lightly treated." ### Frequency and quality of supervisory contact and governance assessment - EC5: FSA framework for sufficiently frequent contacts is in place except for asset quality where "there is a huge gap." - For higher impact firms under close and continuous supervision, supervisors maintain regular contact with Board members, non-executive directors, Audit Committee and senior/middle management (annual strategy meeting, NEDs’ meetings, audit reviews). - Potential issue: hierarchical level and quality of staff—"sometimes they are too new at the FSA to be effective." - EC6: FSA monitors Board and management quality under Condition 5 of FSMA (COND 2.5); on-site assessment of Board and management is part of the ARROW Management, Governance and Oversight element. However, some of this work is done off-site and the in-depth review module is not implemented. - Use of in-depth reviews of key risk areas, including Board oversight, occurs but "is not usually proactive and appears not to be part of a comprehensive strategy." ### Communication of findings to banks and Boards - Following a firm visit and validation, a close-out meeting is held with key senior staff (including CEO) to present initial conclusions and indicate the RMP content. - Firms receive an ARROW Letter and appendices (including an RMP) addressed to the firm’s Board of Directors summarizing: - FSA’s "point-in-time" evaluation of key issues and associated mitigation in the RMP, - planned further assessment work and timing of next risk assessment. - Where capital and/or liquidity adequacy assessment is undertaken concurrently, the firm’s individual capital and liquidity guidance (ICG and ILG) is communicated in the letter. - Communication is conducted satisfactorily but could be strengthened; recommendation to consider a more homogeneous form for follow-up letters centered on CEOs. - Current gaps: - ARROW letters do not uniformly roll up all supervisory work for Board communication; separate theme or deep-dive reviews may be communicated separately to limited Board members. - Lack of clear coherence in Board presentations and ARROW letters between risk ratings disclosed, supervisory findings, and major remediation points. - FSA has begun categorizing remediation plan points by importance in attachments; plan to make ARROW letter a summary of all supervisory work for VHIFs over the next 18-24 months, and subsequently for H impact firms. - It is "rare" for the head of supervision, head of risk, FSA CEO or Chair to attend Board-level wrap-up meetings at major banks. - For major banks FSA prepares a presentation of key findings for the Board meeting. ### Evaluations of internal audit and supervisory meetings - EC7: FSA evaluates the bank’s internal audit function; assessors did not focus on process details. - AC1: Supervisor meets periodically with senior management and the Board to discuss supervisory examinations and external audit; for higher impact firms maintains regular contact with Board members and committees. - After firm visits, firms receive ARROW Letter and appendices including RMP; for major banks, FSA also prepares Board presentations. ### Assessment outcome and critical observations - Assessment: "Largely compliant" - Comment: the "largely compliant" rating must be read against the "materially noncompliant" rating given to CP 19. - Key critical observations: - Deep-dives and s166 reports are supplementary but cannot fully substitute for extensive on-site supervision with transaction testing and multi-week/month examinations. - Move toward more deep-dives is appropriate but currently "proportionally not yet sufficient" to approximate an on-site function. - Opportunity to better focus supervisory letters to Boards to: - cover all material matters from the supervisory cycle, - indicate which issues are most important, - ensure alignment between letter messages, ratings communicated, and the RMP. - Increasing senior FSA representation at Board meetings is positive but additional enhancement is possible. ### Supervisory reporting (Principle 21) — powers, rules, and data practices - EC1: FSA has power to require banks to submit information and collects data on a solo and consolidated basis; reporting requirements are in SUP 16. Focus emphasizes compliance with processes and rules over financial/economic analysis. - Reporting requirements respect Basel, Capital Requirements Directive, and U.K. legislation and cover prudential and accounting information "at, usually, a low level of detail." - Quality of information received is "often questioned" within and outside the FSA, limiting quantitative use. - EC2: Accounting standards instructions and valuation rules set out in GENPRU 1.3; each reporting form has reporting instructions (e.g., FSA001 "firms should follow their normal accounting practice"). - EC3: Valuation rules consistent with GENPRU 1.3; banks must "establish and maintain systems and controls sufficient to provide prudent and reliable valuation estimates (GENPRU 1.3.13(2))." Required elements include documented policies, independent valuation frequency, and reporting lines independent of the front office (GENPRU 1.2.13(3)). - Trading book valuation rules specified GENPRU 1.3.14 R to GENPRU 1.3.34 R (Marking to market, Marking to model, Independent price verification, Adjustments or reserves), mainly based on IFRS. - EC4: Frequency of regulatory information set out in SUP 16.12.6; group data usually half-yearly, firm level data usually quarterly. Some items have reporting thresholds (e.g., FSA005 Market Risk). Monthly capital data (FSA003) required for banks with large market risk as per BIPRU 730k. - EC5: Reporting dates/frequencies tied to a firm’s Accounting Reference Date so group entities report at same date; requirement respected but limited by scarcity of call report data and reliance on banks’ MIS which hampers comparisons. - EC6: Power to request any relevant information exists under FSMA (section 165). FSA prefers banks use their MIS rather than imposing a fixed regulatory template; approach used as needed given paucity of central reporting. Crisis prompted FSA to request more external data, especially on liquidity and capital adequacy. - EC7: FSA has full access to Board, management, staff and records under section 165 and investigative powers under sections 167 and 170 of FSMA. Criminal offenses exist for failure to provide information or destruction/concealment where FSA likely to investigate. Warrants and penalties under section 176 enhance enforcement capacity. - EC8: Timely monitoring systems (TARDIS, DMT) track delays and remittance schedules; dedicated data monitoring team issues fines/warnings for late returns. Systematic validations and cross-validations exist; prudential risk department and supervisors run analytics and statistics; enforcement team can issue unlimited fines for serious infringements. - The requirement and schedule for specified data are laid out as Rules in SUP 16 of the FSA Handbook. *Source: _cr11233 - 1. Independent verification of Corporate Governance: Corporate governance is — _cr11233 - 1. Independent verification of Corporate Governance: Corporate governance is (PDF).* ### 15.6 sets out the standards around accuracy, completeness and timeliness that firms ### _cr11233 - 15.6 sets out the standards around accuracy, completeness and timeliness that firms ### Accuracy, completeness and timeliness of supervisory data (SUP 15.6) - SUP 15.6 sets standards around accuracy, completeness and timeliness that firms must meet. Non‑compliance can lead to fines or referral to the Enforcement department for investigation and appropriate action/penalties. - There is an ongoing process to identify late data submission and penalties for late reporting are regularly applied. - Supervisors can require a “report by skilled person” under FSMA to investigate significant doubts about data accuracy and can require firms to resubmit data when errors are uncovered; SUP 15.6.4 requires firms to supply correct information if they become aware their submitted information was false, misleading or inaccurate. - Practices applied regularly: - thematic reviews of regulatory data from a sample of firms, checked off site for completeness and accuracy; - peer review of regulatory data to highlight anomalies; - on occasion calling in external experts under FSMA section 166. - Observations on use of external experts: - “skilled persons” produce onsite reports under section 166; scope is determined by the FSA with ongoing project management. - The number of section 166 engagements reported: 23 for banks and one for building societies in 2010. - Use of section 166 appears infrequent historically (assessors note number of reports asked in this domain appears to be only one in three years). - Skilled persons produce an end deliverable summarizing findings and maintain regular communication onsite to bring material issues to the FSA’s attention promptly. - Assessment: Largely Compliant. - Comment: FSA complies technically but often at a low level of completeness, effectiveness and efficiency; limited data collection constrains central risk model (ARROW) and supervisory tools such as EWS. ### Accounting and disclosure (Principle 22) - Principle: Supervisors must be satisfied each bank maintains adequate records in accordance with internationally accepted accounting policies and publishes information that fairly reflects its financial condition and profitability. - Key legal and supervisory provisions: - SYSC (Chapter 3.1) requires accurate capture and timely recording of every transaction and commitment. - SYSC 3.2.20R: “A firm must take reasonable care to make and retain adequate records of matters and dealings (including accounting records) which are the subject of requirements and standards under the regulatory system....” - Companies Act 2006 sets further accounting record requirements for U.K. incorporated companies. - SUP 3.3.2R: all U.K. banks must be externally audited. - FSMA Sections 342(5) and 343(5) and SUP 3.8.10: external auditors must inform the FSA of material concerns arising during their work. - GENPRU 1.3 and GENPRU 1.3.13(2): banks must follow generally accepted accounting standards and maintain systems and controls for prudent and reliable valuation estimates. - Auditing standards: ISAs (United Kingdom and Ireland) issued by the Auditing Practices Board (APB). - Companies Act 2006 section 495: auditors’ report must state whether accounts give a true and fair view in accordance with IFRS or U.K.GAAP. - Disclosure regime: - Annual reports, half yearly financial reports, and Interim Management Statements required for banks with equities on a regulated market (DTR references). - Listed banks must disclose “inside information which directly concerns the [bank]...” (DTR 2.2); limited deferral for liquidity support by BoE or another central bank (DTR 2.5.5A). - Supervisory review and enforcement: - The Financial Reporting Review Panel reviews compliance with Companies Act 2006 and applicable accounting standards. - FSA’s Financial Risk Outlook and BoE publish aggregate banking system statistics; BoE collects monetary statistics from banks and building societies. - Auditor engagement and duties: - Periodic meetings with external audit firms; Supervisory Enhancement Program requires supervisors of high‑impact banks to meet auditors at least annually. - FSMA 2000 (Communications by Auditors) Regulations 2001 and FSMA Sections 342(3) and 343(5) provide auditors a duty and protection to report to the FSA in good faith. - APB Ethical Standard 3 (Revised) prescribes rotation rules for audit engagement partners for listed companies; no requirement to rotate audit firms. - Under section 165 of FSMA the FSA can access supervised firm documents including reports from the auditor to the firm; supervisor does not have automatic right of access to auditors’ working papers. - Assessment: Compliant. - Comments and recommendations: - U.K. public authorities should consider enhancing bank disclosures to promote comparability, relevance, reliability and timeliness (examples of nonconfidential firm‑level prudential returns identified). - FRC and FSA expressed concerns about audit quality and professional skepticism; FSA is deepening regular engagement with auditors and should continue and expand such engagement. - Sharing FSA concerns with auditors in advance of audits could enhance audit effectiveness and indirectly benefit supervisory goals, especially in areas like credit impairment and provisioning, and model and mark‑to‑market valuation. ### Corrective and remedial powers of supervisors (Principle 23) - Principle: Supervisors must have an adequate range of supervisory tools to bring about timely corrective actions, including revocation of banking license where appropriate. - Legal powers and practice: - FSA has powers under FSMA to take remedial actions against banks and impose penalties up to revocation of authorization. - Tools include written communications, restrictions on activities (s. 45 OIVOP), disciplinary measures such as fines or public censure (s. 205), immediate or time‑specified implementation (ss. 45, 53(3)), and court injunctions or remedial orders (ss. 380 and 382). - Usual logic: start from FSMA threshold conditions; firms are generally given opportunity to correct failures through remedial actions; if not corrected, FSA considers varying/cancelling permissions (OIVOP) or formal investigation. - Supervisory process and communications: - ARROW assessment and continuous supervision maintain communication lines; key meetings during evaluation and close‑out; follow-up “ARROW Letter” communicates risk assessment results and Risk Mitigation Program (RMP). - ICAS and ILAS findings are communicated via specific follow-up letters. - Practical remedial action steps for control/risk management breakdowns: - Issue a letter asking firm to remedy matter. - Potentially set Pillar 2 individual capital guidance. - Use information gathering powers; require appointment of expert under section 166. - If unresolved, use OIVOP or equivalent powers; grounds include failure to meet threshold conditions or interest of consumers/financial stability. - Additional tools: enforcement action against individual approved persons responsible. - Enforcement and penalties: - FSMA Part XIV (ss. 205–211) and Financial Services Act 2010 enhanced disciplinary measures (e.g., require higher regulatory capital, vary permissions, levy fines, suspend activities). - Enforcement referrals often arise from firms failing to implement remedial action plans or failing to address issues raised. - FSA lacks a centralized system to record frequency of firms failing remedial plans and subsequent enforcement. - Remedial action plans (typical Enforcement Division focus on consumer redress): - (a) review firm records to identify customers potentially harmed; - (b) customer contact letters to offer sale review and possible redress; - (c) assessment of eligibility for redress; - (d) calculation and payment of redress; - (e) agreed timeframe; - (f) monitoring (by FSA Supervision or appointment of a Skilled Person). - Capital adequacy and intervention: - FSA can intervene to prevent capital falling below required minimums (BIPRU 2.2; GENPRU 2.1); SREP allows review of ICAAP and to require early corrective actions (BIPRU 2.2.9(3)). - Where disagreement on capital required, FSA expects discussion and may use section 166 or invoke OIVOP (FSMA s. 45). - Assessors found capital adequacy review resourced and tools/procedures in place but questioned proactivity and forward‑looking intrusiveness. - Application to individuals: - Sanctions can apply to individual approved persons, particularly Significant Influence Functions (SIFs) (COND 2.5; PS 10/15). - Financial Services Act 2010 removed restriction on imposing a penalty and withdrawing an individual’s authorization simultaneously (FSMA, s. 206, s. 33). - Assessment: Compliant. - Comments and recommendations: - FSA has tools and evidence of use; further enhancement expected from inclusion of financial stability objective. - Recommendation for development of a more formal early intervention framework and coordination with resolution authority; review threshold condition wording based on recent experience. ### Consolidated supervision (Principle 24) - Principle: Supervisors must supervise banking groups on a consolidated basis, monitoring and applying prudential norms to group business worldwide. - Legal and supervisory framework: - FSA conducts consolidated supervision under CRD and Financial Conglomerates Directive; requirements in FSA Handbook (BIPRU 8 for Banking/Investment groups; GENPRU 3.2 for financial conglomerates). - Supervisors receive notifications of firms’ “close links” and group organization charts. - SREP/ARROW include group structure and group risks; recovery and resolution planning initiated for major groups. - Sections 165 and 166 FSMA provide information gathering powers, including requiring skilled person’s reports, and can extend to unregulated entities. - Scope of consolidated supervision: - Prudential requirements supervised on consolidated basis include consolidated capital, liquidity management and support, systems and controls, governance, risk concentrations, intra‑group transactions. - Consolidation group under FSA rules includes U.K. regulated entities and may extend to highest level parent in U.K. or EEA; where other EEA regulated entities exist, both U.K. consolidated group and EEA consolidated group may exist. - FSA lacks clear, direct powers over parent holding companies; consolidated obligations are imposed by acting through U.K. regulated entities (e.g., requiring unregulated U.K. holding company to report or take actions). - U.K. government consulting on extending FSA powers over unregulated holding companies. - Group risk considerations: - Supervisors look to detect multiple gearing, leveraging, contagion, and shared services risks; group capital requirements reflect group risk with solo and group resource requirements. - Cross-border interaction and cooperation: - FSA has arrangements with other supervisors for information on group members’ risk management and financial condition. - Supervisors assess management, governance and internal control across the group, including as part of operational risk within SREP. - Limitations and observations: - FSA cannot formally impose prudential standards at unregulated holding company level or limit activities of the consolidated group directly; uses regulated entity powers to achieve results. - Staff report general cooperation from corporate groups but regime not fully tested; weaknesses observed in approvals when holding company is unregulated in U.K. - SIVs reduced post‑crisis; FSA should monitor revival of off‑balance sheet activities. - Assessment: Largely compliant. - Comments and recommendations: - Address legislative deficiency on lack of direct powers over parent holding companies quickly; consider decoupling this issue from holding company resolution complexities. - Ensure sufficient resources for intrusive supervision of foreign operations and for direct supervision of foreign operations. ### Home‑host relationships (Principle 25) - Principle: Cross‑border consolidated supervision requires cooperation and information exchange between home and host supervisors; local operations of foreign banks should meet same standards as domestic institutions. - FSA policy and practice: - Policy to exchange relevant information with foreign supervisors; supervisory colleges used to share information and coordinate. - For the five largest U.K. banks, supervisory colleges established including key foreign supervisors; many colleges are new and developing roles. - Home/host cooperation objectives: timely exchange of information, discuss supervisory plans, agree joint work, share analysis of macro vulnerabilities, and agree joint responses. - Information exchange specifics: - EEA relationships governed by CRD and new requirement (from 2011) to agree joint risk assessment and capital adequacy decision annually. - For non‑EEA operations, FSA agrees significance of non‑EEA entities with host supervisors and communicates overall supervisory view and key risk assessment messages; Home Country Supervisory Assessments apply. - Three types of third country assessments: - (i) Home country supervisory assessments (broad ‘reliance’ assessment); - (ii) Third Country Groups Equivalence Assessments (‘equivalence’ assessment under CRD/FCD); - (iii) Liquidity assessments (assess whether liquidity regime broadly equivalent to FSA Handbook BIPRU 12). - Host supervisor information provision: - FSA often sends ARROW letter to relevant supervisors for material cross‑border operations; will inform home supervisor when U.K. operation is material. - Equal prudential requirements: - Policy that all banks (U.K. incorporated and overseas banks in U.K.) are subject to same prudential requirements; legal differences exist per EU law for incoming EEA branches. - For non‑EEA banks, policy to require subsidiaries unless satisfied home supervision is broadly equivalent. - On‑site access and visits: - FSA policy gives home supervisors on‑site access to local offices and subsidiaries; requirements to inform host supervisors of intended visits apply to EEA banks; FSA tends to inform host supervisors more broadly in enhanced home/host approach. - Restrictions and compliance: - FSA policy disallows ‘shell banks’ or ‘booking offices’ in the U.K. (section 16 Money Laundering Regulations 2007); FATF recognized FSA approach in December 2009 follow‑up report. - Remedial action coordination: - No overall legal requirement to consult other supervisor before adopting remedial action based on information from them, but FSA tends to consult under enhanced home/host approach. - Assessment: Largely compliant. - Comments and recommendations: - Effective group‑wide supervision of systemic institutions requires high standards of home/host information sharing, especially given U.K.’s central global role and the importance of branches in London. - FSA is enhancing relationships through bilateral contacts and supervisory colleges; continued progress required and resource constraints can affect desired frequency of interaction. *Source: _cr11233 - 15.6 sets out the standards around accuracy, completeness and timeliness that firms* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11233.pdf_