## _wp0482

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### Key trends and statistics (I. Introduction)
- Foreign banks’ operations in emerging market banking systems increased dramatically during the second half of the 1990s.
- Eastern Europe: share of banking assets under foreign control increased from 25 percent in 1995 to 30 percent in 2000.
- Latin America: almost 40 percent of total bank assets were controlled by foreign banks in 2000.
- East Asia: foreign bank control increased from 5 percent in 1995 to 6 percent in 2000.
- Indonesia, Korea, and Thailand have raised allowable foreign equity levels in local banks to 100 percent.
- The Philippines now permit 60 percent foreign ownership (The Monetary Board of the Philippines may authorize a foreign bank to acquire up to 100 percent of the voting shares of a bank).
- Developed markets example: foreign-controlled ownership in the United States increased from 8 percent in 1995 to 22 percent in 2000.
- Low-income countries: total number of foreign banks more than tripled from 42 in 1995 to 144 in 2000; foreign banks represented 18 percent of total banks in these low-income countries in 2002, up from 5 percent in 1995.

### Forms of foreign bank entry (II. Forms of foreign bank entry — Box 1)
- Representative offices
  - Generally prohibited from performing banking operations.
  - Facilitate contracts with the parent bank and clients relating to the foreign market.
- Foreign branches
  - Overseas office of a bank incorporated in a foreign country.
  - Higher commitment than representative offices.
  - Typically involved in wholesale banking.
- Bank subsidiaries
  - Separately incorporated from the parent bank; parent’s commitment is the capital invested.
  - Usually involved in retail banking markets (exceptions cited, e.g., United Kingdom subsidiaries often involved in wholesale investment banking).
- Affiliates / joint ventures / minority stakes
  - Involve lower management involvement in the local bank.
- Contemporary entry modalities
  - Full acquisition, targeted purchases of specific activities, joint ventures, alliances with local banks, outsourcing of administrative and financial services.

### Cross-border prudential supervision — objectives and challenges (III)
- Key supervisory objectives
  - Ensure no activity of internationally active banks escapes effective supervision.
  - Enable coordinated remedial action when necessary.
- Failures highlighting supervisory gaps
  - Bank of Credit and Commerce International (BCCI) failure in 1991 cited as a glaring example where supervision failed.
- Essential supervisory elements emphasized
  - Consolidated supervision: ability to review banking and nonbanking activities at domestic and foreign offices.
  - Cooperation among home- and host-country authorities: continuous sharing of information and coordinated inspections.
  - AML/CFT measures have become integral to prudential supervision and are subject to increasing international standardization.

### Home/host division of responsibilities and Basel-related standards (IV)
- Basel Committee chronology and major publications
  - 1975: The Basel Concordat (Report on the Supervision of Bank’s Foreign Establishments).
  - May 1983: “Principles for the Supervision of Bank’s Foreign Establishments” replaced the 1975 Concordat.
  - April 1990: “Supplement to the Concordat” to clarify implementation and information flows.
  - July 1992: Following BCCI, Basel Committee issued “minimum standards”.
  - June 1996: “Supervision of Cross-Border Banking” report endorsed by about 140 countries.
  - 1997: “Core Principles for Effective Banking Supervision” incorporated cross-border principles: Principle 23 (Global Consolidation), Principle 24 (Information Exchange with Host Country Supervision), Principle 25 (Supervision of Foreign Establishments).
  - May 2001: “Essential Elements of a Statement of Cooperation Between Banking Supervisors”.
  - August 2003: “High-Level Principles for the Cross-Border Implementation of the New Accord” (Basel II context).
  - 2003: “Management and Supervision of Cross-Border Electronic Banking Activities” reaffirmed home/host cooperation principles.
- Minimum standards to reinforce the Concordat (Box 2)
  - All international banking groups and international banks should be supervised by a home country authority that capably performs consolidated supervision.
  - Creation of a cross-border banking establishment should receive prior consent of both the host country supervisory authority and the bank’s (and, if different, the banking group’s) home country supervisory authority.
  - Supervisory authorities should have the right to gather information from cross-border banking establishments for which they are the home country supervisory authority.
  - If a host country authority determines the minimum standards are not met to its satisfaction, it may impose restrictive measures necessary to satisfy prudential concerns.
- Division of supervisory responsibilities
  - Home and host authorities should each review responsibilities before granting consent to an establishment and consult if concerns arise.
  - Host supervisors primarily responsible for liquidity of foreign establishments; home supervisors responsible for group liquidity.
  - Host supervisors responsible for solvency and supervision of subsidiaries; solvency of the entire group is the responsibility of the home country.

### Memoranda of Understanding (MOUs) and cooperation (V — Box 3)
- Essential elements of cooperation
  - Sharing of information
    - Host supervisors should notify home supervisors, without delay, of applications to establish offices or make acquisitions.
    - Home supervisor should, upon request, notify host supervisor whether the applicant bank is in compliance and whether its administrative structure and internal controls are adequate.
    - Share information about regulatory systems, supervisory scope, and, to the extent permitted by law, fitness and properness of prospective directors, managers, and relevant shareholders.
  - Ongoing supervision
    - Provide relevant information on material developments or supervisory concerns; inform counterparts of regulatory system changes and penalties or enforcement actions.
  - On-site inspections
    - Home supervisor should notify host supervisor of plans to examine a cross-border establishment; host supervisor should allow home supervisor or its delegated agent to conduct on-site inspections as mutually agreed.
    - Following inspection, exchange of views between examination team and host supervisor should take place.
  - Protection of information
    - Receiving supervisors should take all possible steps to preserve confidentiality of information received.
  - Ongoing coordination
    - Visits for information purposes and staff exchanges may promote cooperation.
- Observed practice
  - MOUs are neither legal instruments nor exhaustive; typically address establishment/notification, exchange of information, inspection, and remedial actions.
  - MOUs have been negotiated in many jurisdictions; specific country MOUs and timelines are cited in the source.

### Compliance with Basel Core Principles — assessment snapshot (VI)
- Results for 60 countries as of December 2001:
  - CP 23 (Global Consolidation): almost 42 percent of countries assessed are compliant or largely compliant; 30 percent are noncompliant or materially noncompliant.
  - CP 24 (Information Exchange with Host Country Supervision): 54 percent of countries are compliant or largely compliant; 30 percent are noncompliant or materially noncompliant.
  - CP 25 (Supervision of Foreign Establishments): 70 percent of countries are compliant or largely compliant; 28 percent are noncompliant or materially noncompliant.

### Box 4 — Capital and Asset Maintenance Requirement on Foreign Bank Branches
- Host-country concerns motivating local capital/asset maintenance
  - Reluctance to rely on home country regulations in some cases.
  - Concern that resolution of a parent bank failure might favor home-country creditors at the expense of the host country.
- Practices and implications
  - Some host supervisors require foreign bank branches to hold capital and assets in the host country to match their liabilities in the host country.
  - United Kingdom approach:
    - Neutral about operating form; most large foreign banks operate as branches in London for wholesale activities; subsidiaries used for specialized retail activities.
    - UK authorities have not applied quasi-capital requirements for foreign bank branches; expect deals involving major international banks will be supported by the entire capital of the parent.
    - For banks from countries where supervision quality is not trusted, UK supervisors may license only if the bank opens a subsidiary that can be supervised on a stand-alone basis.
- Level playing field and exposure rules
  - Controversy where foreign branches not required to hold local capital can avoid local large exposure rules, disadvantaging local banks.
  - Responses include requiring quasi-capital or limiting lending to a multiple of local quasi-capital.
  - Limitations: quasi-capital can be met by bookkeeping entries; branches can book transactions offshore to avoid requirements.
- Supervisory responsibilities and remedial actions under the Basel Concordat
  - Host authorities responsible for foreign bank establishments in their territory; home authorities responsible for these establishments as parts of larger-scale activities of banks under their supervision.
  - Home supervisors can require head office management to remedy branch deficiencies and apply legal instruments against the head office.
  - Insolvency and closures:
    - Home supervisory authority must immediately inform the host supervisory authority if a bank is closed, liquidated, or declared insolvent; the host authority would then promptly close the branch.
    - Subsidiaries are legally separate; their assets and liabilities remain unchanged in theory when the parent bank closes, but transfers between the closed parent and a subsidiary can damage the subsidiary’s financial position.
- Consolidated supervision: rationale and scope
  - Transfers of capital, assets, and liabilities across entities can pose risks if not treated on a consolidated basis.
  - Supervisors need the ability to supervise the consolidated banking organization, including banking and nonbanking activities at domestic and foreign offices.
  - Basel Core Principle 23 requires global consolidated supervision of internationally active banking organizations.
  - Home supervisory authority responsible for supervising global operations on the basis of consolidated, verified, and prudential information; if home supervision is not capable, host authorities should not allow cross-border establishments.
- Special cases
  - Shell banks (no meaningful mind and management in country of incorporation and not affiliated to a group under effective consolidated supervision) and parallel-owned banks should not be licensed.

### Box 5 — Supervision of a Group to Which a Bank Belongs
- Major problems with financial conglomerates
  - Different regulators and regimes across banking, securities, and insurance subsidiaries create significant domestic and international coordination challenges.
  - Data collection, information exchange across sectors and internationally, and analysis tend to be underdeveloped.
- Technical issues requiring attention
  - Supervision on a group-wide perspective.
  - Techniques for assessing capital adequacy of financial conglomerates.
  - Fitness and propriety tests for management.
  - Supervisory approach to large exposures and intra-group exposures.
  - Supervisor’s ability to intervene in structures that impair effective supervision.
- Need for consolidated supervision and international cooperation
  - Urgent development of consolidated supervision practices over financial conglomerates is required.
  - Joint Forum on Financial Conglomerates and its Task Force work on analyzing international conglomerates to identify structural, operational, and risk management issues and enhance supervisory relationships.
- Parent bank responsibilities and scope under consolidated supervision
  - Parent bank supervisor must ensure the parent provides adequate oversight of overseas branches, joint ventures, and subsidiaries by monitoring internal controls, receiving regular information, and periodically verifying information.
  - Shared information should allow calculation of capital adequacy ratios, large exposures, and funding and deposit concentrations on a consolidated basis.
  - Contact and information exchange with host supervisors should commence at the authorization stage; prior consent of the home supervisor should be obtained for booking branches to include them in consolidated supervision.
  - Host states should permit on-site inspections by home supervisors with consent; legal barriers to inspections should be removed, for instance, via agreements.
- Quality of home-country supervision (including U.S. experience)
  - Host states should assess whether home state can “capably perform home country consolidated supervision” when permitting foreign bank entry (Basel Core Principle 23).
  - U.S. example: Foreign Bank Supervision Enhancement Act (FBSEA) of 1991 and subsequent Federal Reserve practices, including the Foreign Banking Organization Supervision Program and the Strength-of-Support Assessment (SOSA).
- MOUs and ring-fencing
  - MOUs facilitate supervision by clarifying procedures in advance; widely used though not universal.
  - Ring-fencing defined and practices described; not an international best practice but used when supervisors have serious concerns about owners or group positions.
  - Ring-fencing may be statutory in some jurisdictions; concerns include transparency and altered market behavior in crises.

### Challenges for emerging market banking supervisors and policy orientation (conclusion)
- Key supervisory challenges identified
  1. Choosing licensing policy and conducting fitness and propriety tests for management and owners, especially for complex holding companies or investment funds.
  2. Effectively monitoring local establishments of large international banks or complex financial institutions, including knowledge of parent-bank positions.
  3. Upgrading supervisory capacity to oversee complicated financial products (including derivatives) introduced by foreign banks.
  4. Dealing with the issue of parent bank support for a troubled branch or subsidiary in normal and systemic crises.
  5. Handling consolidated supervision when the market is heavily dependent on foreign banks.
  6. Effectively exchanging information with home supervisors for bank holding companies or other complex financial institutions.
  7. Dealing with increasing concentration in the banking system resulting from foreign bank entry.
  8. Improving governance of complex international banking groups and enhancing financial market integrity standards.
- Observations and trade-offs
  - Branches are backed by full parent strength but are harder for host supervisors to ring-fence; subsidiaries are easier to regulate and ring-fence but represent a different risk profile.
  - Political interference can affect licensing decisions; procedures should shield licensing from political influence.
  - Host supervisors may need time and resources to gain skills to supervise sophisticated foreign bank operations and nonbank activities.
  - Legal and reputational factors influence likelihood and extent of parent support for foreign establishments.
  - When domestic market is dominated by foreign banks, host supervisors may be relegated to “secondary” supervisors and face information and political barriers.
- Policy orientation
  - Enhance cooperation between home- and host-country supervisory authorities.
  - Develop additional international best practices, including consolidated supervision, robust MOUs, transparent ring-fencing arrangements where used, clear entry/exit rules, and prompt corrective action.

*Source: _wp0482 - References*

### References..............................................................................................................

### References

### I. Introduction — Key trends and statistics
- Foreign banks’ operations in emerging market banking systems increased dramatically during the second half of the 1990s.
- Eastern Europe: share of banking assets under foreign control increased from 25 percent in 1995 to 30 percent in 2000.
- Latin America: almost 40 percent of total bank assets were controlled by foreign banks in 2000.
- East Asia: foreign bank control increased from 5 percent in 1995 to 6 percent in 2000.
- Indonesia, Korea, and Thailand have raised allowable foreign equity levels in local banks to 100 percent.
- The Philippines now permit 60 percent foreign ownership (The Monetary Board of the Philippines may authorize a foreign bank to acquire up to 100 percent of the voting shares of a bank).
- Developed markets example: foreign-controlled ownership in the United States increased from 8 percent in 1995 to 22 percent in 2000.
- Low-income countries: total number of foreign banks more than tripled from 42 in 1995 to 144 in 2000; foreign banks represented 18 percent of total banks in these low-income countries in 2002, up from 5 percent in 1995.

### II. Forms of foreign bank entry (Box 1) — distinctions and typical roles
- Representative offices
  - Generally prohibited from performing banking operations.
  - Facilitate contracts with the parent bank and clients relating to the foreign market.
- Foreign branches
  - Overseas office of a bank incorporated in a foreign country.
  - Higher commitment than representative offices.
  - Typically involved in wholesale banking.
- Bank subsidiaries
  - Separately incorporated from the parent bank; parent’s commitment is the capital invested.
  - Usually involved in retail banking markets (exceptions: e.g., United Kingdom subsidiaries often involved in wholesale investment banking).
- Affiliates / joint ventures / minority stakes
  - Involve lower management involvement in the local bank.
- Contemporary entry modalities
  - Full acquisition, targeted purchases of specific activities, joint ventures, alliances with local banks, outsourcing of administrative and financial services.

### III. Cross-border prudential supervision — objectives and challenges
- Key supervisory objectives
  - Ensure no activity of internationally active banks escapes effective supervision.
  - Enable coordinated remedial action when necessary.
- Failures highlighting supervisory gaps
  - Bank of Credit and Commerce International (BCCI) failure in 1991 cited as a glaring example where supervision failed.
- Essential supervisory elements emphasized
  - Consolidated supervision: ability to review banking and nonbanking activities at domestic and foreign offices.
  - Cooperation among home- and host-country authorities: continuous sharing of information and coordinated inspections.
  - AML/CFT measures have become integral to prudential supervision and are subject to increasing international standardization.

### IV. Home/host country division of responsibilities and Basel-related standards
- Basel Committee principles and history
  - 1975: The Basel Concordat (Report on the Supervision of Bank’s Foreign Establishments).
  - May 1983: “Principles for the Supervision of Bank’s Foreign Establishments” replaced the 1975 Concordat.
  - April 1990: “Supplement to the Concordat” to clarify implementation and information flows.
  - July 1992: Following BCCI, Basel Committee issued “minimum standards” (see Box 2).
  - June 1996: “Supervision of Cross-Border Banking” report endorsed by about 140 countries; recommendations to reinforce home-country access to information and cross-border inspection rights.
  - 1997: The “Core Principles for Effective Banking Supervision” incorporated cross-border principles: Principle 23 (Global Consolidation), Principle 24 (Information Exchange with Host Country Supervision), Principle 25 (Supervision of Foreign Establishments).
  - May 2001: “Essential Elements of a Statement of Cooperation Between Banking Supervisors” prepared by the Working Group on Cross-Border Banking (see Box 3).
  - August 2003: “High-Level Principles for the Cross-Border Implementation of the New Accord” issued in light of Basel II implementation.
  - 2003: “Management and Supervision of Cross-Border Electronic Banking Activities” reaffirmed home/host cooperation principles.

- Minimum standards to reinforce the Concordat (Box 2)
  - All international banking groups and international banks should be supervised by a home country authority that capably performs consolidated supervision.
  - Creation of a cross-border banking establishment should receive prior consent of both the host country supervisory authority and the bank’s (and, if different, the banking group’s) home country supervisory authority.
  - Supervisory authorities should have the right to gather information from cross-border banking establishments for which they are the home country supervisory authority.
  - If a host country authority determines the minimum standards are not met to its satisfaction, it may impose restrictive measures necessary to satisfy prudential concerns.

- Division of supervisory responsibilities (as discussed)
  - Home authorities and host authorities should each review their responsibilities before granting consent to an establishment.
  - Either authority with concerns must initiate consultations to reach an explicit understanding on primary responsibility for supervision.
  - Host supervisors primarily responsible for liquidity of foreign establishments (better positioned to assess local market conditions), whereas home supervisors are responsible for group liquidity.
  - Host supervisors responsible for solvency and supervision of subsidiaries; solvency of the entire group is the responsibility of the home country.

### V. Memoranda of Understanding (MOUs) and cooperation (Box 3)
- Essential elements for statements of cooperation between banking supervisors:
  - Sharing of information
    - Host supervisors should notify home supervisors, without delay, of applications to establish offices or make acquisitions in the host jurisdiction.
    - Home supervisor should, upon request, notify host supervisor whether the applicant bank is in compliance and whether its administrative structure and internal controls are adequate; assist by verifying or supplementing applicant information.
    - Home and host supervisors should share information about their regulatory systems and supervisory scope.
    - To the extent permitted by law, share information on fitness and properness of prospective directors, managers, and relevant shareholders.
  - Ongoing supervision
    - Provide relevant information on material developments or supervisory concerns regarding cross-border establishments.
    - Inform counterparts of regulatory system changes with significant bearing on cross-border activities.
    - Inform counterparts of penalties imposed or enforcement actions taken against cross-border establishments.
    - Facilitate transmission of any other relevant information to assist supervisory processes.
  - On-site inspections
    - Cooperation useful in assisting each other for on-site inspections of cross-border establishments.
    - Home supervisor should notify host supervisor of plans to examine a cross-border establishment, indicating purpose and scope.
    - Host supervisor should allow home supervisor or its delegated agent to conduct on-site inspections; inspections may be carried out alone or accompanied by host supervisor as mutually agreed.
    - Following inspection, exchange of views between examination team and host supervisor should take place.
  - Protection of information
    - Mutual trust requires receiving supervisors to take all possible steps to preserve confidentiality of information received.
  - Ongoing coordination
    - Visits for information purposes and staff exchanges may promote cooperation.

### VI. Compliance with Core Principles — assessment snapshot
- Results of Basel Core Principle (CP) assessments for 60 countries as of December 2001:
  - CP 23 (Global Consolidation): almost 42 percent of countries assessed are compliant or largely compliant; 30 percent are noncompliant or materially noncompliant.
  - CP 24 (Information Exchange with Host Country Supervision): 54 percent of countries are compliant or largely compliant; 30 percent are noncompliant or materially noncompliant.
  - CP 25 (Supervision of Foreign Establishments): 70 percent of countries are compliant or largely compliant; 28 percent are noncompliant or materially noncompliant.

### VII. Paper structure and appendices
- Paper structure:
  - Section II: foreign bank supervision — division of responsibilities between home and host, consolidated supervision, quality of home-country supervision, memorandum of understanding (MOU), and ring fencing.
  - Section III: challenges that foreign banks bring to emerging market banking supervisors.
  - Section IV: conclusions.
- Appendices include:
  - Appendix I: The Pros and Cons of Licensing Foreign Banks.
  - Appendix II: Country Cases on Whether Permission of Foreign Supervisor is Required in Licensing Foreign Bank Branches or Subsidiaries.
  - Appendix III: Country Cases on the Authority to Apply Regulations on a Consolidated Basis to Cross-Border Establishments of Domestic Banks.
  - Appendix IV: Country Cases on the Authority to Conduct On-Site Inspections of Cross-Border Establishments of Domestic Banks.
  - Appendix V: Country Cases on the Authority to Have Contacts and Exchange Supervisor Information with, and Allow On-Site Inspection by, Foreign Financial Supervisory Agencies.
  - Appendix VI: Country Cases on the Equal Applicability of Domestic High Standards to Establishments of Foreign Financial Institutions.
  - Appendix Box A1: Argentina Case.

*Content drawn from the provided PDF excerpt.*

### Box 4. Capital and Asset Maintenance Requirement on Foreign Bank Branches

### Box 4. Capital and Asset Maintenance Requirement on Foreign Bank Branches

### Host-country concerns and capital/asset maintenance requirements
- Some countries apply a stringent capital requirement for foreign bank branches due to two concerns:
  - reluctance to rely on home country regulations in some cases; and
  - concern that, in the event of a failure of a parent bank, any resolution might favor depositors and creditors in the home country at the expense of the host country.
- Consequently, some host country supervisors require foreign bank branches to hold capital and assets in the host country to match their liabilities in the host country.
- The United Kingdom approach:
  - Has been neutral about the way in which foreign banks operate in London.
  - In practice, most large foreign banks have chosen to operate as branches, reflecting activities within London’s wholesale markets; subsidiaries are used particularly for specialized activities in the retail market. Many banks operate both branches and subsidiaries.
  - Branches are useful where a bank wants to obtain prime rates in the interbank deposit markets, the foreign exchange market, or derivative market.
  - If a major international bank cannot use its entire capital base, it is hampered; hypothecating capital across jurisdictions reduces flexibility and adds costs.
  - The United Kingdom authorities have not applied quasi-capital requirements for foreign bank branches; they expect that deals involving a major international bank (for example, Citibank London branch) will be supported by the entire capital of the parent, not just resources in London at the time.
  - For banks from countries where the quality of supervision is not fully trusted, UK supervisors may license only if the bank opens a subsidiary that can be supervised on a stand-alone basis.

### Foreign branches and exposure rules; leveling the playing field
- Controversy arises where foreign branches are not required to hold capital locally and thus may not be bound by local large exposure rules.
- Problem is particularly acute in very small countries with a few large companies:
  - Local banks constrained by large exposure rules cannot offer large lines, whereas a small branch of a major international bank can offer those lines using the parent bank’s worldwide capital.
- Many countries have attempted to level the playing field by:
  - Requiring such banks to have some form of quasi-capital; and
  - Sometimes limiting lending to a multiple of that local quasi-capital.
- Limitations and circumvention:
  - Quasi-capital requirements can be ineffective because they can be met by bookkeeping entries.
  - Foreign bank branches can avoid requirements by booking some transactions at offshore branches.

### Supervisory responsibilities under the Basel Concordat and remedial actions
- According to the Basel Concordat:
  - Host authorities are responsible for foreign bank establishments in their territory.
  - Home-country authorities are responsible for these establishments as parts of larger-scale activities of banks under their supervision.
  - Home and host supervisory authorities should be in close cooperation.
- Remedial actions:
  - Home country supervisors can require head office management to remedy deficiencies in branches and apply the full range of legal instruments against the head office.
  - Subsidiaries are subject to the jurisdiction of the host country, though home supervisors may influence improvements.
- Insolvency and closures:
  - When a bank with a branch in another country is closed, liquidated, or declared insolvent, the home supervisory authority must immediately inform the supervisory authority in the country where the branch is established; the host authority would then promptly close the branch.
  - Subsidiaries are legally separate; their assets and liabilities, in theory, remain unchanged when the parent bank closes, but there is an increased risk of transferring assets and liabilities between the closed parent and a subsidiary, which could damage the subsidiary’s financial position.16

### Consolidated supervision: rationale and responsibilities
- Rationale:
  - Banks often form part of holding company groups; transfers of capital, asset, and liability positions among entities, including foreign subsidiaries, can pose risks if not treated on a consolidated basis.
  - Complex financial institutions active in many jurisdictions create concerns amplified by asymmetries in information between home and host supervisors.
  - These potential problems can only be minimized by accounting consolidation and consolidated supervision.
- Scope of consolidated supervision:
  - Supervisors need the ability to supervise the consolidated banking organization, including banking and nonbanking activities conducted directly or indirectly (through subsidiaries or affiliates) and activities at both domestic and foreign offices.17
  - Important supervisory aspects include matching capital levels to the risk profiles of financial conglomerates, addressing related cross-border insolvency of a group, achieving effective cross-border supervision, and applying consolidated supervision.
- Standards and responsibilities:
  - Basel Core Principle 23 stipulates that banking supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business worldwide, primarily at foreign branches, joint ventures, and subsidiaries.
  - Corporate structure of a banking group should be transparent to home and parent-level supervisors to enable effective consolidated supervision.
  - The home country supervisory authority is responsible for supervising the global operations of a bank or banking group on the basis of consolidated, verified, and prudential information; this includes significant nonbank companies and financial affiliates.
  - The home supervisor has a responsibility to safeguard the domestic financial system by preventing the establishment of unsupervised or under-supervised foreign banking establishments in its jurisdiction. If a bank or banking group is not subject to consolidated home supervision, or the home supervisor lacks capacity, host country authorities should not allow cross-border establishment in their jurisdiction.
- Special cases:
  - Shell banks and parallel-owned banks pose special problems.18
    - A shell bank is defined as a bank with no physical presence (meaningful mind and management) in the country where it is incorporated and licensed and is not affiliated to any financial services group subject to effective consolidated supervision; mind and management are located in another jurisdiction.
    - A parallel-owned bank is defined as a bank where a bank in one jurisdiction has the same ownership as a bank in another jurisdiction, although one is not a subsidiary of the other.
    - In principle, no shell bank and parallel-owned banking structure should be licensed to be effective.

*Source: Box 4. Capital and Asset Maintenance Requirement on Foreign Bank Branches (excerpt).*

### Box 5. Supervision of a Group to Which a Bank Belongs

### Box 5. Supervision of a Group to Which a Bank Belongs

### Major problems with financial conglomerates
- A financial group incorporating banking, securities, and insurance subsidiaries and other financial intermediaries can be subject to different regulators and regulatory regimes.
- At the domestic level this poses significant problems; internationally the problems are compounded by the need for coordination, information, and compliance across several regulators in each country where the conglomerate operates.
- Data collection, information exchange across sectors and internationally, and analysis tend to be underdeveloped.

### Technical issues to be addressed for international financial conglomerates
- The supervision of financial conglomerates on a group-wide perspective.
- Techniques for assessing the capital adequacy of financial conglomerates.
- The test on “fitness and propriety” of management.
- A supervisory approach to large exposures and to intra-group exposures within financial conglomerates.
- The supervisor’s ability to intervene in structures that impair effective supervision.

### Need for consolidated supervision and international cooperation
- Countries need to urgently develop consolidated supervision practices over financial conglomerates.
- Several agencies, working on the basis of different legal and regulatory regimes in different jurisdictions, may be involved in assessing the risk incurred by cross-sectoral financial conglomerates.
- The Joint Forum on Financial Conglomerates has been working to enhance cooperation with securities and insurance supervisors and to facilitate information exchange among supervisors, domestically and internationally, identifying legal and other impediments to such exchanges.
- A Task Force of the Joint Forum has been conducting an analysis of 13 international financial conglomerates to enhance understanding of management and organization; this experience identified structural, operational, and risk management issues and the need to strengthen relationships between supervisors from different countries.

### Consolidated banking supervision: parent bank responsibilities and scope
- As part of practicing consolidated banking supervision, banking supervisors must adequately monitor and apply appropriate prudential standards to all operations of their banking organizations worldwide, including foreign branches, joint ventures, and subsidiaries.
- A major responsibility of the parent bank supervisor is to determine that the parent bank provides adequate oversight of its overseas branches, joint ventures, and subsidiaries, including:
  - monitoring compliance with internal controls;
  - receiving an adequate and regular flow of information; and
  - periodically verifying the information received.
- The information to be shared should encompass both qualitative and quantitative aspects and permit supervisors to calculate capital adequacy ratios, large exposures or legal lending limits, and funding and deposit concentrations on a consolidated basis.
- Authorities must acknowledge that prudential standards and supervisory practices may differ between countries.

### Information exchange, on-site inspections, and authorization stage contacts
- A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, including host country supervisory authorities as indicated in Basel Core Principle 24.
- This contact should commence at the authorization stage when the host supervisor should seek approval from the home supervisor before issuing license; the prior consent of the home country supervisor should be obtained for booking branches so that the home country supervisor is aware of the booking branch and can include it in its consolidated supervision.
- Authorities of the host state should permit on-site inspections by the home supervisor of prudential nature of establishments of internationally active banks within its jurisdictions; to conduct on-site inspections in the territory of another state requires the consent of the country receiving the inspection team.
- Any legal barrier against such on-site inspections would need to be removed, for instance, by concluding agreements between countries on the conduct of such inspections.

### Quality of home-country supervision (including U.S. experience)
- Difficulties at the parent bank could raise questions about the fortunes of the local affiliate even if the affiliate’s position is fundamentally sound; capabilities of home country supervisors to perform effective supervision is crucial.
- A host state should be able to ascertain whether the home state can “capably perform home country consolidated supervision” as a condition for permitting a foreign bank entry to its territory (see Basel Core Principle 23).
- Assessment elements for home supervisor quality include quantity and quality of resources, supervisory techniques, frequency of inspections, track record in taking effective supervisory action, and routine personal contacts between home and host supervisors.
- U.S. example:
  - The Foreign Bank Supervision Enhancement Act (FBSEA) of 1991 gave the Federal Reserve System (FRS) enhanced supervisory and regulatory authority over foreign banks operating in the United States.
  - Since 1992, the FRS has only been able to approve an application from a foreign bank to establish an office in the United States if it concludes the bank is subject to comprehensive consolidated supervision by its home country supervisor; in 1996 Congress amended regulations regarding comprehensive consolidated supervision to allow more flexibility.
  - The FRS developed the Foreign Banking Organization Supervision Program incorporating a common understanding of a given foreign bank in its entirety and introduced five new supervisory products including:
    - two country reports (financial system/supervisory policies; significant accounting policies and practices),
    - the Strength-of-Support Assessment (SOSA),
    - the Summary of Condition and Combined Rating, and
    - an annual comprehensive examination plan.
  - The SOSA provides analysis and a ranking reflecting U.S. supervisors’ judgment about the foreign banking organization’s ability to provide its U.S. operations necessary financial and managerial support.

### Memoranda of Understanding (MOUs)
- MOUs facilitate supervision by setting out commonly agreed terms of understanding between countries and clarifying assumptions and procedures in advance.
- MOUs:
  - are neither legal documents nor exhaustive; they do not set limits on relationships between supervisory authorities;
  - typically address establishment/notification, exchange of information, inspection, and remedial or punitive actions;
  - should agree operational aspects of cross-border inspections in advance; findings of inspections should be shared with supervisory authorities of both countries and the institutions involved.
- MOUs have been negotiated in many jurisdictions in response to changed supervisory responsibilities (for example, EU Second Banking Coordination Directive) though not all EU members signed a full set of MOUs.
- Country examples and timelines cited in the source include MOUs and related actions between specific authorities in various years (for example, United Kingdom–Finland 1994; Netherlands–Finland 1996; Finland MOUs signed with twelve countries as of March 2004; Slovak Republic signed Agreements as of end-June 2002; Korea began entering MOUs with the United Kingdom (1999), Japan (2001), Germany (2001), and others as of February 2004).

### Ring-fencing of banks: practices and implications
- “Ring-fencing” involves isolating the bank from other companies in the group by actions such as:
  - prohibiting or placing severe limits on the bank’s financial exposure vis-à-vis other group companies;
  - restricting the volume of funding the bank receives from group companies;
  - ensuring directors and management of the bank can operate independently of group management.
- Ring-fencing may be used when supervisors have serious concerns about owners or group positions; ring-fencing is not established as an international best practice.
- Implications:
  - For a subsidiary (a legally distinct entity), parent’s losses in the subsidiary are, in principle, no larger than its equity stake; for a branch, the parent is not typically legally distinct from the branch so branch closure may not shield the parent from losses (Bank of England (June 2002) p. 59).
  - Ring-fencing can affect obligations of local branches; in Asia some ring-fenced banks argue capital outflow restrictions limit ability to make payments on foreign exchange-related transactions.
  - Derivative confirmation documentation has sometimes been used to insert ring-fencing clauses specifying conditions under which the parent would not be responsible for onshore branch payments.
  - Some ring-fencing is statutory: under the Federal Reserve Act and New York Banking Law all deposit liabilities of foreign branches of U.S. banks are ring-fenced if local authorities take actions that prevent the local branch from making payment (e.g., imposition of capital controls) (International Monetary Fund (2000), pp. 176–77 and pp. 191–92).
- Concerns:
  - Transparency: whether market participants are fully aware of the nature of ring-fencing contracts;
  - Crisis behavior: markets could operate differently during crisis periods due to ring-fencing contracts; supervisors should be aware of related concerns.

### Challenges to emerging market banking supervisors
- As foreign bank presence grows, supervisory complexity increases; key challenges identified include:
  1. Choosing licensing policy and conducting fitness and propriety tests for management and owners, especially for complex holding companies or investment funds.
  2. Effectively monitoring local establishments of large international banks or complex financial institutions, including knowledge of parent-bank positions.
  3. Upgrading supervisory capacity to oversee complicated financial products (including derivatives) introduced by foreign banks.
  4. Dealing with the issue of parent bank support for a troubled branch or subsidiary in normal and systemic crises.
  5. Handling consolidated supervision when the market is heavily dependent on foreign banks.
  6. Effectively exchanging information with home supervisors for bank holding companies or other complex financial institutions.
  7. Dealing with increasing concentration in the banking system resulting from foreign bank entry.
  8. Improving governance of complex international banking groups and enhancing financial market integrity standards.
- Additional supervisory concerns and observations:
  - Licensing policy trade-offs: branches vs subsidiaries (branches backed by full parent strength; subsidiaries easier to regulate and ring-fence).
  - Political interference can affect licensing decisions; procedures should shield licensing from political influence.
  - Supervisors in emerging markets may need time to gain skills to supervise sophisticated foreign bank operations and nonbank financial activities.
  - Foreign banks may introduce new derivatives and products that can benefit hedging but also be used to avoid prudential regulation or take excessive risks in weak financial systems.
  - Host supervisors need closer contact with home supervisors because control of derivatives is usually by home supervisors.
  - Legal and reputational factors influence likelihood and extent of parent support for foreign establishments; subsidiary vs branch legal distinctions matter.
  - When a domestic banking market is dominated by foreign banks, host supervisors may be relegated to “secondary” supervisors and face information and political barriers; branches may be preferable for host supervisors in some situations.
  - Cross-border concentration and consolidation can increase systemic and operational risks and complicate resolution of distressed institutions; strengthening prudential supervisory capacity and clear entry/exit rules and prompt corrective action are needed.

### Conclusion (key policy orientation)
- The growth of foreign-owned banks increases complexity for supervisory authorities; emerging market supervisors face multiple challenges (listed above) that should be addressed by:
  - enhanced cooperation between home- and host-country supervisory authorities, and
  - development of additional international best practices.

*Source: Box 5. Supervision of a Group to Which a Bank Belongs (extracted from the supplied IMF content).*

### References

### _wp0482 - References

### Supervisory standards and Basel-related publications
- Bank for International Settlements, 2002, 72nd Annual Report, Basel.  
- Basel Committee on Banking Supervision, 1992, Minimum Standards For the Supervision of International Banking Groups and their Cross-Border Establishments (Basel: Bank for International Settlements).  
- Basel Committee on Banking Supervision, 1996, The Supervision of Cross-Border Banking (Basel: Bank for International Settlements).  
- Basel Committee on Banking Supervision, 2001, Essential Elements of a Statement of Cooperation Between Banking Supervisors (Basel: Bank for International Settlements).  
- Basel Committee on Banking Supervision, 2002, “Supervisory Guidance on Dealing with Weak Banks,” BS/02/17 (Basel: Bank for International Settlements).  
- Basel Committee on Banking Supervision, 2003a, Shell Banks and Booking Offices (Basel: Bank for International Settlements).  
- Basel Committee on Banking Supervision, 2003b, Parallel-Owned Banking Structure (Basel: Bank for International Settlements).  
- Basel Committee on Banking Supervision, 2003c, High-Level Principles for the Cross-border Implementation of the New Accord (Basel: Bank for International Settlements).  
- Basel Committee on Banking Supervision, 2003d, Management and Supervision of Cross-border Electronic Banking Activities (Basel: Bank for International Settlements).  
- Miles, Colin, 2002, “Large Complex Financial Institutions : Issues to be Considered in Financial Sector Assessment Programs,” MAE Operational Paper 02/3 (Washington: International Monetary Fund).  
- United States General Accounting Office, 1997, Foreign Banks-Opportunities Exist to Enhance Supervision Program as Implementation Proceeds (Washington: General Accounting Office).  
- Bank of England, 2002, Financial Stability Review (London: Bank of England).

### Foreign bank entry, effects, and empirical studies
- Baldwin, Barbara, and A. Kourelis, 2002, “Consolidated Supervision: Managing the Risks in a Diversified Financial Services Industry,” MAE Operational Paper 02/05, (Washington: International Monetary Fund).  
- Brealey, R.A., and E.C. Kaplanis, 1996, “The Determination of Foreign Banking Location,” Journal of International Money and Finance, Vol. 15.  
- Bush, Claudia M., 1996, “Opening Up for Foreign Banks-Why Central and Eastern Europe Can Benefit,” Kiel Working Paper No. 763, (Kiel, Germany: Kiel Institute of World Economics).  
- Claessens, Stijn, Asli Demirgüç-Kunt, and Harry Huizinga, 1998, “How Does Foreign Entry Affect the Domestic Banking Market?” Policy Research Working Paper 1918 (Washington: World Bank).  
- Claessens, Stijn, and Jong-Kun Lee, 2002, “Foreign Banks in Low Income Countries: Recent Developments and Impacts,” (Washington: Background paper for the World Bank’s Global Development Finance)  
- Clark, George R.G., Robert Cull, and Maria Soledad Martinez Peria, 2001, “Foreign Bank Entry: Experience, Implications for Developing Countries, and Agenda for Further Research,” Policy Research Working Paper 2698, (Washington: World Bank).  
- Clark, George R.G., Robert Cull, and Maria Soledad Martinez Peria, 2002, “Does Foreign Bank Penetration Reduce Access to Credit in Developing Countries? Evidence From Asking Borrowers,” Development Research Group (Washington: World Bank).  
- Goldberg, Linda, Gerard Dages, and Daniel Kinney, 2000, “Lending in Emerging Markets : Foreign and Domestic Banks Compared,” paper presented at the Conference on International Financial Contagion: How It Spreads and How It Can be Stopped? (Washington: International Monetary Fund).  
- Graham, Edward, M., 2001, “Opening Up the Banking Sector to Competition from Foreign-Owned Banks: Issues and Strategies,” paper presented at the third Annual Financial Markets and Development Conference in April 2001, New York.  
- Montinola, Gabriella and Ramon Moreno, 2001, “The Political Economy of Foreign Bank Entry: Theory and A Case Study,” Pacific Basin Working Paper No. PB 10-11, Federal Reserve Bank of San Francisco (San Francisco: Federal Reserve Bank of San Francisco).  
- Sengupta, Jayshree, 1988, “Internationalization of Banking and the Relationship Between Foreign and Domestic Banks in the Developing Countries,” International Journal of Development Banking, Vol. 6, No.1.  
- Wachtel, Paul, 1995, “Foreign Banking in The Central European Economies in Transition,” Issue Paper for the Institute for East and West Studies (New York: New York University).  
- Levine, Ross, 1999, “Foreign Bank Entry and Capital Control Liberalization: Effects on Growth and Stability” (unpublished; Minneapolis: University of Minnesota).  
- Mathieson, Donald J., and Jorge Roldos, 2001, “The Role of Foreign Banks in Emerging Markets,” paper presented at the third Annual Financial Markets and Development Conference in New York in April 2001.  
- Clark, George R.G., Robert Cull, and Maria Soledad Martinez Peria, 2001, “Foreign Bank Entry: Experience, Implications for Developing Countries, and Agenda for Further Research,” Policy Research Working Paper 2698, (Washington: World Bank).  

### Financial stability, crises, and policy frameworks
- Gulde, Anne-Marie, and others, 2003, Dealing with Banking Crises in Dollarized Economies, IMF Occasional Paper No. 217 (Washington: International Monetary Fund).  
- Hawkins, John, and Dubravko Mihaljek, 2001, “The Banking Industry in the Emerging Market Economies: Competition, Consolidation and Systemic Stability” (Basel: Bank for International Settlements).  
- International Monetary Fund, 1998, Toward a Framework for Financial Stability (Washington: International Monetary Fund).  
- International Monetary Fund, 2000, “The Role of Foreign Banks in Emerging Markets” in International Capital Markets: Development, Prospects, and Key Policy Issues, by an IMF staff team led by Donald Mathieson and Garry Schinasi, (Washington: International Monetary Fund) pp.153–55.  
- International Monetary Fund, 2002, “Implementation of the Basel Core Principles for Effective Banking Supervision, Experiences, Influences, and Perspectives,” (Washington: International Monetary Fund).  
- International Monetary Fund, 2004, Capital Markets and Financial Intermediation in the Baltics, Occasional Paper 228 (Washington: International Monetary Fund).  
- Mishkin, Frederic, S., 2001, “Financial Policies and the Prevention of Financial Crises in Emerging Market Economies,” World Bank Policy Research Working Paper 2683 (Washington: World Bank).

### Other relevant works and background literature
- De Nicoló, Gianni, and others, 2003, “Bank Consolidation, Internationalization and Conglomeration: Trends and Implications for Financial Risks,” IMF Working Paper 03/158 (Washington: International Monetary Fund).  
- Claessens, Stijn, Asli Demirgüç-Kunt, and Harry Huizinga, 1998, “How Does Foreign Entry Affect the Domestic Banking Market?” Policy Research Working Paper 1918 (Washington: World Bank).  
- Khoury, Sarkis J., 1980, Dynamics of International Banking, (New York: Praeger).  
- Clark, George R.G., Robert Cull, and Maria Soledad Martinez Peria, 2001, “Foreign Bank Entry: Experience, Implications for Developing Countries, and Agenda for Further Research,” Policy Research Working Paper 2698, (Washington: World Bank).  
- Goldberg, Linda, Gerard Dages, and Daniel Kinney, 2000, “Lending in Emerging Markets : Foreign and Domestic Banks Compared,” paper presented at the Conference on International Financial Contagion: How It Spreads and How It Can be Stopped? (Washington: International Monetary Fund).  

*Source: _wp0482 - References*

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