## _wp15200

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---

### Purpose and scope of the paper
- The paper does not advocate any particular “one size fits all” approach; it aims to give a flavor of a number of selected, commonly encountered, legal issues that should be addressed in the legislative framework for banks and to raise inherent legal complexities.
- The list of legal issues is not exhaustive: it does not address legal issues relating to the liability protection of the banking supervisor and their staff, resolution framework or anti-money laundering.
- The paper does not provide detailed legislative drafting technique, though it occasionally touches on general drafting principles.
- Selected issues covered (twelve):
  - (i) scope and definitions
  - (ii) the supervisory mandate
  - (iii) the legal nature of secondary regulatory instruments
  - (iv) licensing requirements
  - (v) the distinction and relationship between licensing criteria and ongoing requirements
  - (vi) corporate governance
  - (vii) the power to control changes in ownership
  - (vii) the difference between branches and subsidiaries
  - (viii) consolidated supervision
  - (ix) sharing of information and inter-agency coordination
  - (x) related-party transactions and large exposure limits
  - (xii) the legal distinction between enforcement, early intervention and resolution

### II. SCOPE AND DEFINITIONS — key findings and guidance
- Fundamental objective:
  - Ensure the scope of application of the banking law is clear and appropriate; all entities providing core banking activities (lending financed by taking deposits from the public) must be adequately covered.
- Distinguish two legal concepts—activities subject to licensing vs permissible activities of banks:
  - Activities subject to licensing:
    - The banking law should require any person or entity that carries on a “banking business” to obtain a license.
    - Breach of licensing should be punished by criminal sanctions.
    - The mere taking of deposits from the public should be subject to licensing; with very few exceptions (central banks, postal check services, and under strict conditions brokers-dealers), only licensed banks should have the “monopoly” of taking deposits from the public.
  - Permissible activities of banks:
    - The banking law should set out what activities a duly licensed bank is by law allowed to undertake.
    - These activities are additional to the core of banking business and are not otherwise subject to licensing.
    - Examples: provision of payment services, issuance of electronic money, foreign exchange transactions, safekeeping and vaults.
- Definitions priorities and placement:
  - Core definitions (shaping personal and material scope) belong in the primary law; secondary regulation may elaborate on detailed aspects.
  - Operative definitions (e.g., “exposure,” “subsidiary,” “bank-related party”) may be placed in secondary regulation, but legal certainty favors including most operative definitions in the primary law.
- Two essential definitional issues:
  - Define “banking business”: standard practice is “the taking of deposits from the public and the making of loans on its own account.”
    - Defining “deposit” may require a sui generis definition to avoid capturing ordinary borrowing, bonds and commercial paper or permitting arbitrage.
  - Ensure coverage of natural and legal persons:
    - Require any “person” exercising banking business or taking deposits from the public to be licensed and define “persons” as both natural and legal persons.
    - If policy intends only corporate entities to hold banking licenses, state this as a qualifying licensing criterion rather than via restrictive definitions.
- Drafting techniques and shortcomings:
  - Ensure internal consistency of definitions and cross-law consistency (company law, competition law, consumer protection law, insolvency law).
  - Avoid placing substantive obligations within definitions.
  - Preserve regulatory flexibility by allowing regulators discretion to prescribe additional categories within definitions.

### III. OBJECTIVES, FUNCTIONS AND LEGAL POWERS OF SUPERVISOR — key findings and guidance
- Supervisory mandate elements:
  - Objectives (the “why”)
  - Functions/tasks (the “what”)
  - Powers/instruments (the “how”)
- Statutory clarity:
  - Under the legality principle, state agencies have no functions or powers except those established by legislation; a clear statement of the supervisory authority’s overall objective should be specified in primary law (or as objectives of banking supervision per se).
- Typical supervisory objectives and drafting considerations:
  - Common objectives: to promote the safety and soundness of banks and the banking system and to protect depositors.
  - Avoid objectives that are unrealistic (e.g., “to prevent bank failures”); follow BCP guidance to reduce probability and impact of failures and manage them in an orderly manner (e.g., via Recovery and Resolution Planning).
  - Read supervisory objectives in broader institutional context (coordination with central bank, depositor guarantee scheme).
- Functions and statutory expression:
  - Provide corresponding statutory functions to enable pursuit of objectives.
  - Drafting options:
    - Concise charge: “to regulate and supervise banks and other financial institutions.”
    - More detailed regulatory and supervisory functions may be set out in the banking law.

### Legal powers and supervisory objectives (section 19)
- Clarify whether the supervisory authority has powers to pursue statutory objectives (issue regulations, set prudential standards, grant and revoke licenses, take corrective action, impose sanctions) or whether those powers reside elsewhere.
- Ideally the supervisory authority should be the licensing authority and be able to issue regulations and take supervisory decisions autonomously.
- Constitutional or administrative law may constrain autonomy and require political body involvement.
- Examples of division of powers:
  - Malaysia and Kuwait: central bank is the supervisor, but banks are licensed by the Minister of Finance.
  - Italy: Ministry of Economy and Finance decides on license revocations upon proposal by the Bank of Italy.
- Examples of secondary-regulation powers:
  - Countries where agencies have power: USA, Lebanon and Singapore.
  - Countries requiring political approval for secondary regulation: UK, Netherlands, Belgium.
- Drafting and placement:
  - Supervisory authority’s objectives, functions and legal powers should, as much as possible, be provided by the banking law.
  - For central banks that are also supervisors, central bank law should only refer summarily to bank supervision; the supervisory legal framework should be comprehensively enshrined in the banking law.
  - Avoid dispersing supervisory regime across multiple laws to reduce interpretive difficulty and contradictions.
- Mandates, overlaps, and coordination:
  - Where more than one regulatory authority is involved, roles and responsibilities should be clearly defined in law to avoid gaps and ensure effective domestic inter-agency cooperation.

### Secondary regulatory instruments — legal nature and hierarchy
- Primary issues:
  - (i) The binding nature of the instruments.
  - (ii) Their place in the overall “hierarchy of norms.”
- Binding secondary instruments:
  - Banking law or primary legislation should unequivocally establish the authority to issue binding secondary instruments.
  - Four principles for binding instruments:
    - Issue instruments under categories and conditions foreseen by constitutional/administrative law; distinguish between general application (“regulations”) and individual application (“instructions” or “orders”).
    - Decide between granting the supervisor general executive power versus specific powers to implement particular provisions.
    - Avoid creating different but similar legal instruments without added value.
    - Clarify how secondary instruments acquire binding effect: competent decision-making body, promulgation/publication, consequences of breach.
- Non-binding secondary instruments:
  - If provided for, the law should be clear on their legal effects and purpose (e.g., guidance).
  - If non-binding instruments produce legal consequences, those consequences should be precisely provided for in law or determinable pursuant to general principles.
- Terminology consistency:
  - Labels (e.g., “guidelines,” “circulars”) should align with the broader legal tradition to avoid confusion about legal effect.
  - Examples of unclear labeling: Egypt, Solomon Islands, Indonesia.
- Hierarchy of norms (stylized common hierarchy presented):
  1) the constitution,
  2) acts of parliament/congress,
  3) normative instruments (“decrees”) of the executive (cabinet),
  4) normative instruments (“decrees”) of individual ministers/secretaries,
  5) normative instruments (“regulations”) of autonomous regulatory agencies,
  6) normative instruments of local governments.
- Secondary instruments must be consistent with and grounded in primary legislation and promulgated pursuant to an empowering provision.

### Classification example: Monetary Authority of Singapore (MAS)
- MAS classification of instruments issued under Acts it administers:
  - (1) Acts: statutory laws passed by Parliament; force of law; published in Government Gazette.
  - (2) Subsidiary Legislation: issued under Acts; flesh out provisions; force of law; may specify criminal offences; published in Government Gazette.
  - (3) Directions: detail specific instructions to financial institutions; have legal effect; MAS may specify whether contravention is a criminal offence.
    - (a) Directives: impose legally binding requirements on an individual financial institution or specified person.
    - (b) Notices: impose legally binding requirements on a specified class of financial institutions or persons.
  - (4) Guidelines: principles or “best practice standards”; contravention not a criminal offence and does not attract civil penalties; observance may affect MAS' risk assessment.
  - (5) Codes: non-statutory; do not have force of law; breach may attract non-statutory sanctions.
  - (6) Practice Notes: guide administrative procedures; contravention not a criminal offence unless required by an Act or regulation.
  - (7) Circulars: sent to specified persons or published for public information; have no legal effect.
  - (8) Policy Statements: outline major MAS policies.
- Note: exceptions and statutory effects for specific codes are referenced in the source.

### Licensing requirements (overview) and statutory drafting (section 30)
- Distinction:
  - Licensing procedure: procedural rules applicants and licensing authority must follow, including informational requirements.
  - Licensing criteria: substantive preconditions for granting a license.
- Core licensing drafting guidance:
  - The core criteria themselves should be clearly set out in primary legislation.
  - Statute must provide subject matter (e.g., governance, accounting mechanisms) and the yardstick against which judged (e.g., governance must be appropriate for operations and structure).
  - Balance legal certainty for industry with regulator discretion to refuse licensing.
  - Non-binding circulars can overview administrative practices for granting/refusing licenses.
- Typical minimum statutory licensing criteria (international good practice):
  - the minimum paid-up capital of the bank should meet the amount established by law or regulation;
  - the ownership structure of the bank should be sufficiently transparent and allow for effective supervision of the bank;
  - fit and proper requirements for directors and senior management of the bank;
  - suitability requirements for significant shareholders of the bank;
  - a financial structure, managerial structure, and business plan that are appropriate for the programme of the bank’s projected activities;
  - adequate arrangements for accounting, internal controls, risk management, and internal and external audit; and
  - for branches and subsidiaries of foreign banks, the consent of the foreign bank’s home supervisor as well as an adequate supervisory arrangement between home and host supervisor.
- Legal operation of licensing criteria:
  - Law should make clear the license can only be granted if the licensing authority is satisfied that all licensing criteria are (cumulatively) met.
  - Law should clarify whether licensing authority can refuse a license even though all criteria are met (e.g., systemic reasons).
- Licensing procedure — statutory basis and core provisions:
  - Primary law should grant power to establish comprehensive licensing procedure by secondary regulation; best practice includes core provisions in primary law.
  - Key procedural elements to provide in law:
    - State that licensing criteria operate as such and all must be met for grant.
    - Power/duty to reject application when criteria not met.
    - Require applicants to provide complete and correct information; enable secondary regulation to specify informational requirements.
    - Include a “catch-all” permitting licensing authority to require additional information.
    - Set legal consequences of incomplete or incorrect information (e.g., decision period starts only when complete; incorrect information ground for refusal/withdrawal).
    - Lay out procedural steps and time-frames for licensing decisions; consider rules deeming applications rejected if no decision within required time.
- Ongoing requirements versus licensing criteria:
  - Banking laws should explicitly provide that all licensing criteria continue as ongoing requirements after grant.
  - Distinguish legal nature of ongoing requirements from licensing criteria.
  - Supervisors must have powers to take remedial action if any criterion is no longer satisfied.
  - Banks could be obliged to immediately report changes in information or circumstances after grant; failure should attract corrective measures/sanctions.
- Examples of ongoing requirements:
  - Suitability of significant shareholders: initial suitability and ability to support, continued assessment, powers to approve/reject changes in significant shareholdings.
  - Fit and proper requirements for directors and senior management: subsequent appointments subject to supervisor approval; power to require removal.
  - Internal controls, accounting, risk management, audit: supervisory monitoring continues post-license.

### Corporate governance — importance and legal framework
- Corporate governance weaknesses contributed to banking failures: insufficient board oversight, inadequate risk management, unduly complex/opaque structures.
- Good corporate governance facilitates decision making, accountability, transparency and public confidence.
- BCP 14 (2012) requires robust corporate governance policies covering strategic direction, group/organizational structure, control environment, responsibilities of Boards and senior management and compensation; BCP 15 deals with risk management.
- Banking law should act as lex specialis where bank requirements differ from general company law.

- Corporate governance elements the legal framework should address:
  a. Board of Directors
  - Law should set out Board composition and minimum number of independent directors.
  - Clear process for nominating and appointing directors; duration of office, qualification/disqualification criteria; requirement for supervisory approval.
  - Provisions on conflicts of interest and confidentiality obligations that survive term of directorship.
  - Supervisors should have power to require changes in Board composition if individuals are not fulfilling duties per BCP 14.
  b. Fit and proper criteria for board directors and senior management
  - Typical criteria include:
    i. honesty, integrity and reputation (no professional censure, no criminal proceedings/convictions),
    ii. competence and capability (past performance/expertise, no conflicts, educational qualifications),
    iii. financial soundness (able to fulfill financial obligations, not bankrupt, no outstanding judgment debts).
  - Law should require directors and senior management to be fit and proper; details can be in subsidiary legislation; “senior management” must be precisely defined.
  c. Audit, risk management and internal control
  - Law should require external audit and internal audit with Board oversight.
  - Supervisors should be satisfied banks have comprehensive risk management processes.
  - Board and senior management should approve and oversee strategic direction, risk appetite, and conflicts of interest policies.
  - Board should have audit and risk committees segregated from executive functions.

### Misuse of banking resources by dominant shareholders (section 41)
- Problem statement:
  - Dominant shareholders may misuse bank funds to finance commercial/industrial activities of affiliates beyond what supports long-term bank stability.
  - Causes: individual shareholder excessive influence; banks owned by conglomerates diverting funds to affiliates.
- Legal and supervisory gaps:
  - Many laws lack tools to vet new significant shareholders post-license or remove inappropriate shareholders.
  - IMF required strengthening rules on significant ownership in Fund-supported programs (examples cited: DRC and Bangladesh under the Extended Credit Facility).
  - Central features of regime governing significant shareholdings should be in primary legislation.
- Core elements of legal framework for significant shareholdings:
  - Prior approval principle: acquisition/divestment of significant shareholding only with explicit prior approval of supervisor; prospective shareholders must request approval prior to transactions.
  - Thresholds for supervisory approval: most laws start with shareholdings of 5% or 10% and require additional approvals for every 5 or 10%; some laws cease further approval at 50% + 1.
  - Consider direct and indirect shareholdings (through connected entities).
  - Standard for approval: supervisor may block acquisition/divestment when it would endanger prudent and sound management; BCP 6 EC 3: criteria comparable to those used for licensing.
  - Four suitability elements:
    - trustworthiness and experience in managing participations and banks;
    - financial soundness to avoid contagion and to support the bank if needed;
    - structure/behavior of shareholder must not hinder effective supervision;
    - no anti-money laundering issues.
- Corrective mechanisms:
  - Short term/protective: power to suspend voting rights associated with shareholding.
  - Longer term/definitive: power to attach or limit transferability of shareholding and to require divestment.
  - Powers support BCP 6 EC 5 requirement that supervisor can address change of control that took place without necessary notification/approval.
- Notification and disclosure duties:
  - Supervisors can inspect share registers and monitor voting patterns.
  - Legal obligation to request prior approval rests with prospective shareholder.
  - Debate on whether banks should be obliged to inform supervisors when they become aware of material changes affecting shareholder suitability; currently rare.

### Market access by foreign banks: branches vs. subsidiaries vs. representative offices
- Legal distinctions:
  - Branches: legally dependent extensions of a bank; no separate legal personality; claims on branch are claims on parent; principle modified if host jurisdiction “ring-fences” local assets in insolvency.
  - Subsidiaries: incorporated in host jurisdiction; legally separate; separate capital and Board.
  - Representative offices: do not carry out regulated activity; liaison/promotional only.
- Legal framework should specify which foreign forms can obtain a license and conditions (e.g., parent licensed in home country).
- Prudential requirements:
  - Law should stipulate which prudential requirements apply to each establishment form.
  - Many laws fail to specify rules applicable to subsidiaries and branches; asset maintenance requirements generally imposed on branches.
- Supervisory powers over foreign establishments:
  - Host country needs tools to regulate and resolve branches, with home-host coordination.
  - Differences between branches and subsidiaries should be minimal from regulatory oversight perspective.
  - BCP 13: home and host should ensure local operations subject to prudential, inspection and reporting requirements similar to domestic banks.
- Licensing and regulatory distinctions summarized (as per source table): many requirements align for subsidiary and branch, but differences include Local Asset Maintenance Requirements (No for Subsidiary; Yes for Branch) and Fit and Proper applicability (Board and Management for Subsidiary; Management Board dependent on home supervision for Branch).

### Consolidated supervision: scope, legal foundations, and approaches
- Principle:
  - BCP 12: international banks should be supervised both on an individual (“solo”) basis and on a consolidated basis covering the banking group worldwide.
- Legal implementation challenges:
  - Many laws lack clear legal underpinnings for consolidated supervision; design requires interaction between banking law, company law and accounting law.
- Legal components and policy choices:
  - Define which supervisory toolkit elements apply on a consolidated basis (quantitative and qualitative aspects).
  - Law should be precise on which aspects consolidated supervision applies to, or permit regulator to define in secondary regulation.
  - Determine inclusion of non-financial entities; options include deduction from capital or explicit inclusion/exclusion rules.
- Two approaches to defining consolidation scope:
  - Reference to accounting law: simple but may not align with supervisory needs; law should allow departure when necessary.
  - Sui generis supervisory concept: tailored “banking group” or “financial conglomerate” concept aligned with supervision; complicates reporting consistency.
- Consolidated supervision variables (section 59):
  - First: group must include at least one bank.
  - Second: law must determine type of link/connection required for inclusion (accounting “control” concepts vs supervisory criteria).
  - Third: consider whether entities must be financial/regulatory in nature.
  - Triggers of control can be shareholding percentages (e.g., “50%+1”), board appointment ability, contractual control; accounting law may assess control on dominant direct/indirect influence.

### Consolidated supervisory reporting requirements
- Consolidated supervision requires consolidated financial and supervisory reporting.
- Law must provide principle of consolidated supervisory reporting combining information of all entities in circle of consolidated supervision.
- Periodic information provision should include:
  - general accounting reporting through financial statements,
  - specific supervisory reporting.
- For banking groups, both sets should be reported on solo and consolidated bases; general accounting consolidation alone is insufficient.

### Sharing of information and inter-agency cooperation (XI)
- Legal framework should support domestic and cross-border cooperation and information sharing (deposit insurance, securities, insurance regulators, foreign supervisors).
- BCP 3: laws, regulations or other arrangements should provide cooperation framework reflecting need to protect confidential information.
- Framework should not hinder cooperation; some statutes limiting sharing to enforcement circumstances undermine timely supervision and macro-prudential oversight.
- Information sharing required at all stages:
  - Licensing: home-host contact and information sharing crucial; prior consent of home supervisor for branch/subsidiary licensing (BCP 15).
  - Ongoing supervision: information sharing via supervisory colleges; modalities (joint examinations, on-site access) should be specified.
  - Resolution: BCP 11, EC 7: supervisor should cooperate with relevant authorities for orderly resolution; RRPs should have statutory footing and express statutory footing for information sharing is preferable.
- MoUs and cooperation agreements:
  - Frequently captured in MoUs/exchanges of letters; most MoUs are not legally binding and subject to applicable law.
  - Where law conditions sharing on an MoU, build flexibility to allow interim sharing in emergencies.
- Safeguards for confidentiality:
  - Establish confidentiality regime with sanctions for breaches; require comparable confidentiality regimes in recipient authorities; require prior consent for onward sharing; commit to resist disclosures when recipient faces compulsion.
  - Provide legal protection for the banking supervisor, its employees and agents against civil/criminal action when disclosure is lawful.

### Bank-related party and large exposure limits (XII)
- Key features:
  - Bank-related party limits:
    - Restrictions on amounts a bank can lend to borrowers “connected” with the bank (shareholders, directors, managers).
    - Quantitative and expressed as a percentage of the capital of the lending bank.
    - Good practice prescribes qualitative governance standards for such transactions.
  - Large exposure limits:
    - Limit concentration risk by imposing quantitative limits on individual large exposures and total large exposures.
    - Entirely quantitative and expressed as a percentage of the capital of the lending bank.
- Legal commonalities:
  - Built on common definitions (“exposure,” “capital”).
  - Quantitative limits relative to capital; primary legislation can habilitate detailed rules in secondary regulation.
  - Connected borrowers should be considered a single exposure for limit purposes.
- Legal differences:
  - Large exposures: straightforward quantitative prudential limits.
  - Bank-related party rules: require governance prescriptions in primary legislation:
    - Transactions at “arm’s length.”
    - Approval by board without interested director participation.
    - Enhanced reporting requirements.
    - Possible deduction from capital if conditions unmet.

### Supervisory enforcement, early intervention and resolution (XIII)
- Common legal problems:
  - (i) conceptual confusion about types of enforcement measures,
  - (ii) inadequate link between enforcement and license revocation,
  - (iii) legally problematic sanctioning regimes.
- Three-phase conceptual progression:
  - Supervisory Enforcement:
    - Ordinary enforcement to address violations or unsafe/unsound practice; does not require finding bank in danger of failure.
    - Powers: impose fines, remove directors/managers, remove unsuitable significant shareholders, issue cease-and-desist orders, issue remedial directions, suspend activities temporarily.
  - Early Intervention:
    - Strong powers to require board/management of an ailing bank to take forceful remedial action while remaining under private control.
    - Measures: prohibit operations, require restructuring plan, raise capital, prohibit dividend payouts, prohibit new activities, require divestment of assets/businesses.
    - Failure to implement is ground for commencement of resolution proceedings.
  - Resolution:
    - Resolution authority assumes control of an unviable bank to rehabilitate or liquidate orderly.
    - Where supervisory and resolution authorities are distinct, supervisory authority may trigger resolution and withdraw license.

### Conflation of stages and legal design issues (section 74)
- Many laws conflate measures across supervisory enforcement, early intervention and resolution into a single list, often lacking clear, proportional triggers for each phase.
- Recommendation: reflect the stages explicitly and distinctively in legislative provisions.
- Triggers for action:
  - Quantitative triggers tied to measurable variables (liquidity or capital adequacy ratios).
  - Qualitative triggers require supervisory judgment but should be drafted with clarity.
- Mandatory vs discretionary action:
  - Prompt corrective action frameworks mandate certain regulatory steps on breach of triggers; advantage: legal certainty and reduced supervisory forbearance; disadvantage: may limit regulatory flexibility.
  - Drafters should grant a degree of flexibility and discretion while addressing forbearance through governance and accountability.
- Link with license revocation:
  - Legal clarity on when a license may be revoked is crucial because supervisory powers typically cease on revocation.
  - Two-directional interaction principles:
    - Direction 1: License revocation should ipso facto trigger liquidation; this automatic consequence should be explicit in law to enable transfer of deposits to a licensed institution.
    - Direction 2: Failure to rehabilitate by resolution measures should, in principle, trigger license revocation; requires clear statutory establishment allowing supervisory discretion.
- Due process, appeals and consequences of reinstatement:
  - Address whether prior notice/opportunity to be heard is required, urgent revocation on public interest grounds, appeal avenues and remedies.
  - Recommendation: license revocation decisions should be irrevocable on appeal; monetary compensation should be the only remedy for wrongful revocation.
  - Example: reinstated licenses after prolonged suspension may be impracticable to resume (Nigeria example cited in source).
- Role of sanctions:
  - Penalties should be proportionate and commensurate: criminal (monetary, custodial), civil, administrative fines; may be concurrent with corrective actions.
  - Sanctions should target both corporate and individual levels; BCP 11, EC 5 requires ability to sanction management/board/individuals when necessary.
  - Penalty design: provide maximums/upper limits rather than fixed amounts to allow proportionality; consider corporate doubling of fines where imprisonment unavailable.
  - Place penalties appropriately in primary law or in secondary legislation with empowering provision; non-binding secondary instruments must never carry penalties.

### Conclusion: legal foundations and broader legal context
- Clear and robust legal underpinnings are essential to effective banking supervision.
- Drafting banking law raises policy questions informed by international best practice (BCP) and complex legal challenges.
- Banking law must be considered in the wider legal context; weaknesses in general administrative law, civil/commercial law, and company law will affect banking supervision.
- Authorities should acknowledge the breadth of required legal underpinnings and dedicate resources to building a strong legal function within supervisory agencies.

*Source: IMF Working Paper content unit _wp15200.*

### 4.      The paper is, however, not intended to advocate any particular “one size fits all”

### 4.      The paper is, however, not intended to advocate any particular “one size fits all” approach

### Purpose and scope of the paper
- The paper does not advocate any particular “one size fits all” approach; it aims to give a flavor of a number of selected, commonly encountered, legal issues that should be addressed in the legislative framework for banks and to raise inherent legal complexities.
- The list of legal issues is not exhaustive: it does not address legal issues relating to the liability protection of the banking supervisor and their staff, resolution framework or anti-money laundering.
- The paper does not provide detailed legislative drafting technique, though it occasionally touches on general drafting principles.

### Selected issues covered
- The paper will cover the following twelve selected issues:
  - (i) scope and definitions
  - (ii) the supervisory mandate
  - (iii) the legal nature of secondary regulatory instruments
  - (iv) licensing requirements
  - (v) the distinction and relationship between licensing criteria and ongoing requirements
  - (vi) corporate governance
  - (vii) the power to control changes in ownership
  - (vii) the difference between branches and subsidiaries
  - (viii) consolidated supervision
  - (ix) sharing of information and inter-agency coordination
  - (x) related-party transactions and large exposure limits
  - (xii) the legal distinction between enforcement, early intervention and resolution

### II. SCOPE AND DEFINITIONS — key findings and guidance
- Fundamental objective: ensure the scope of application of the banking law is clear and appropriate; all entities providing core banking activities (lending financed by taking deposits from the public) must be adequately covered.
- Distinguish two legal concepts—these should not be conflated:
  - Activities subject to licensing
    - The banking law should require any person or entity that carries on a “banking business” to obtain a license.
    - Breach of licensing should be punished by criminal sanctions.
    - The mere taking of deposits from the public should be subject to licensing; with very few exceptions (central banks, postal check services, and under strict conditions brokers-dealers), only licensed banks should have the “monopoly” of taking deposits from the public.
  - Permissible activities of banks
    - The banking law should set out what activities a duly licensed bank is by law allowed to undertake.
    - These activities are additional to the core of banking business and are not otherwise subject to licensing.
    - Examples: provision of payment services, issuance of electronic money, foreign exchange transactions, safekeeping and vaults.
- Definitions priorities and placement
  - Definitions are critical to determine the personal and material scope of application; they must precisely state who must obtain a license to exercise which activities.
  - Core definitions (shaping personal and material scope) belong in the primary law; secondary regulation may elaborate on detailed aspects.
  - Operative definitions (e.g., “exposure,” “subsidiary,” “bank-related party”) may be placed in secondary regulation, but legal certainty favors including most operative definitions in the primary law.
- Two essential definitional issues:
  - Define “banking business”: standard practice is “the taking of deposits from the public and the making of loans on its own account.”
    - Defining “deposit” may require a sui generis definition, since deposits with a bank are legally loans enabling the bank to use funds.
    - Risks: a too broad definition may capture ordinary borrowing, bonds and commercial paper; too narrow a definition permits regulatory arbitrage and evasion.
  - Ensure coverage of natural and legal persons:
    - Requiring only a “company” or “entity” to be licensed is insufficient; law must be clear that individual persons and non-corporate entities can be caught.
    - Achieve this by (i) requiring any “person” exercising banking business or taking deposits from the public to be licensed and (ii) defining “persons” as both natural and legal persons.
    - If policy intends only corporate entities to hold banking licenses, this should be stated as a qualifying licensing criterion and not via restrictive definitions.
- Common shortcomings and drafting techniques
  - Many banking laws lack robust definitions; differences exist between legal traditions (common law tends to define more terms; civil law sometimes relies on Civil or Commercial Codes), but both traditions often overlook definitions.
  - Ensure internal consistency of definitions (e.g., “parent companies” and “subsidiaries” should be flipsides of each other) and cross-law consistency where laws interconnect (company law, competition law, consumer protection law, insolvency law).
    - Techniques to avoid inconsistency: define a term in one law and have other laws cross-refer to it, or amend multiple laws in a single amending act.
  - Avoid placing substantive obligations or requirements within definitions.
  - Preserve regulatory flexibility:
    - Allow regulators discretion to prescribe additional categories within definitions (e.g., for consolidated supervision, related party transactions, large exposure limits).
    - Common technique: list specific categories in primary law and give residual discretion to regulators in subsidiary legislation; sometimes primary law can exempt certain cases from general definitions.

### III. OBJECTIVES, FUNCTIONS AND LEGAL POWERS OF SUPERVISOR — key findings and guidance
- Legal framework must clearly set out the supervisory authority’s objectives, functions and legal powers.
  - The supervisory mandate comprises:
    - Objectives (the “why”)
    - Functions/tasks (the “what”)
    - Powers/instruments (the “how”)
- Importance of statutory clarity:
  - Under the legality principle, state agencies have no functions or powers except those established by legislation; thus the contours of a supervisory mandate should be laid down in legislation.
  - A clear statement of the supervisory authority’s overall objective should be specified in primary law (or cast as objectives of banking supervision per se).
- Typical supervisory objectives and drafting considerations:
  - Common objectives: to promote the safety and soundness of banks and the banking system and to protect depositors.
  - Drafting complexities:
    - Jurisdictions may assign additional objectives (e.g., development of the local financial sector); such objectives should be legally subordinate to, and not conflict with, the primary objectives of financial stability and depositor protection.
    - Objectives must be achievable; for example, phrasing an objective “to prevent bank failures” is unrealistic and encourages moral hazard. BCP guidance: supervisory objective should not be to prevent bank failures but to reduce probability and impact so failures can be managed in an orderly manner (e.g., via Recovery and Resolution Planning).
    - Read supervisory objectives in the broader institutional context (e.g., coordination with a central bank’s financial stability objective; depositor protection in light of a depositor guarantee scheme).
- Functions and statutory expression:
  - To enable pursuit of objectives, corresponding statutory functions should exist.
  - For non-central-bank supervisors, functions are often straightforward and not exhaustively specified in legislation.
  - For central banks that are also supervisors, central bank laws often set out comprehensive lists of functions; such lists should ideally include a supervisory/regulatory function.
  - Drafting options:
    - Concise: charge the supervisory authority “to regulate and supervise banks and other financial institutions.”
    - Alternative: draft the regulatory and supervisory function in more detail, possibly in the banking law rather than the central bank law.
  - Distinguish clearly between objectives and functions as they have different legal roles.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15200.pdf*

### 19.      The legal framework should also be clear as to whether the supervisory

### _wp15200 - 19.      The legal framework should also be clear as to whether the supervisory

### Legal powers and supervisory objectives
- The legal framework should clarify whether the supervisory authority has powers to pursue the statutory objectives (e.g., powers to issue regulations, to set prudential standards, to grant and revoke banking licenses, to take corrective action, impose sanctions etc.), or whether those powers reside with another authority or agency.
- Ideally, the supervisory authority should also be the licensing authority and be able to issue regulations and take supervisory decisions autonomously.
- Constitutional or administrative law may constrain autonomous agencies and require political body involvement in establishment and enforcement of banking and other regulation.
- Examples cited where supervisory authorities do not have licensing or secondary-regulation powers:
  - Malaysia and Kuwait: central bank is the supervisor, but banks are licensed by the Minister of Finance.
  - Italy: the Ministry of Economy and Finance decides on license revocations, upon proposal by the Bank of Italy.
- Examples cited where agencies have or lack power to promulgate secondary regulation:
  - Countries where agencies have power: USA, Lebanon and Singapore.
  - Countries where secondary regulation requires approval by political bodies: UK, Netherlands, Belgium.
- Footnote examples of legal design choices and instruments referenced in source material:
  - Law 1/34 of 2 December 2008 on the Statute of the Central Bank of Burundi (Articles 6 and 7).
  - Central Bank of Russia Act (Article 4 (5), (7) and (9); Article 57).

### Drafting and placement of supervisory law
- From a drafting perspective, the supervisory authority’s objectives, functions and legal powers should, as much as possible, be provided by the banking law.
- For central banks that are also banking supervisors, the central bank law should only refer summarily to the bank supervisory regime; the supervisory legal framework should be comprehensively enshrined in the banking law itself.
- Risk of dispersing supervisory regime across multiple laws:
  - Increased difficulty of interpretation and application.
  - Higher risk of contradiction and complexity in contextual interpretation.

### Mandates, overlaps, and coordination
- Effective and efficient bank supervision requires authorities to have clear mandates without gaps or overlaps.
- Where more than one regulatory authority is involved in banking supervision or supervision of a banking group, the respective roles and responsibilities should be clearly defined in law to avoid regulatory and supervisory gaps.
- Effective domestic inter-agency cooperation and coordination is crucial in multi-authority settings.

### Secondary regulatory instruments — legal nature
- Most banking laws authorize issuance of a variety of secondary legal instruments because including all aspects of banking regulation in primary legislation is impractical.
- Two central legal questions about secondary instruments:
  - (i) The binding nature of the instruments.
  - (ii) Their place in the overall “hierarchy of norms.”
- Banking laws should distinguish instruments that have direct binding effects on private entities from those that do not.
- Binding secondary instruments:
  - If a jurisdiction uses binding secondary instruments issued by the supervisor, the banking law or other primary legislation should unequivocally establish the authority to issue such instruments.
  - Four principles for binding instruments:
    - Issue instruments under categories and conditions foreseen by constitutional and/or administrative law; distinguish between general application (“regulations”) and individual application (“instructions” or “orders”).
    - Decide between granting the supervisor general executive power over the banking law versus specific powers to implement particular provisions; each approach has advantages and disadvantages.
    - Avoid creating different but similar legal instruments (e.g., “regulations” and “rules”) without real added value.
    - Clarify how secondary instruments acquire binding effect: competent decision-making body, promulgation and publication procedures, and consequences of breach.
- Non-binding secondary instruments:
  - If provided for, the law should be clear on their legal effects and nature.
  - If the banking law is silent, it may generally be assumed the supervisor can issue non-binding instruments (subject to jurisdiction-specific legality principles).
  - Where the law establishes a non-binding instrument, it should expressly state its purpose (e.g., guidance) to avoid confusion.
  - If a non-binding instrument nevertheless produces legal consequences (e.g., triggering a regulatory delay), those consequences should be precisely provided for in law or determinable pursuant to general principles.
- Terminology consistency:
  - Labels used in the banking law (e.g., “guidelines,” “circulars”) should be consistent with the broader legal tradition to avoid confusion about legal effect.
  - Example jurisdictions with unclear or problematic secondary-instrument labeling:
    - Egypt: banking law refers to multiple secondary instruments without precise definition of their legal nature.
    - Solomon Islands: “prudential guidelines” not enshrined in regulations; legal nature unclear.
    - Indonesia: Article 16.3 of Act 7/1992 requires Bank Indonesia to “stipulate” licensing criteria without clarifying nature of such stipulations.

### Hierarchy of norms
- The banking law or broader legal framework should precisely state the place of secondary instruments in the legal hierarchy.
- Stylized common hierarchy (as presented):
  1) the constitution,
  2) acts of parliament/congress,
  3) normative instruments (“decrees”) of the executive (cabinet),
  4) normative instruments (“decrees”) of individual ministers/secretaries,
  5) normative instruments (“regulations”) of autonomous regulatory agencies,
  6) normative instruments of local governments.
- Drafters should determine which elements must be governed by primary law and which may be handled in secondary regulation.
- Secondary instruments must be consistent with and grounded in primary legislation and promulgated pursuant to an empowering provision therein.

### Classification example: Monetary Authority of Singapore (MAS)
- MAS classification of instruments issued under Acts it administers:
  - (1) Acts: statutory laws passed by Parliament; have the force of law; published in the Government Gazette. Examples: Banking Act and Financial Advisers Act.
  - (2) Subsidiary Legislation: issued under Acts; flesh out provisions; have the force of law; may specify criminal offences; published in the Government Gazette. Examples: Insurance (Actuaries) Regulations; Finance Companies (Advertisements) Regulations.
  - (3) Directions: detail specific instructions to financial institutions; have legal effect; MAS may specify whether contravention is a criminal offence.
    - (a) Directives: primarily impose legally binding requirements on an individual financial institution or specified person.
    - (b) Notices: primarily impose legally binding requirements on a specified class of financial institutions or persons. Examples: Notice to Banks (MAS 603); Notice to Life Insurers (MAS 307).
  - (4) Guidelines: set out principles or “best practice standards”; contravention is not a criminal offence and does not attract civil penalties; degree of observance may affect MAS' risk assessment. Examples: Technology Risk Management Guidelines; Guidelines on Standards of Conduct for Insurance Brokers.
  - (5) Codes: non-statutory; do not have the force of law; breach may attract non-statutory sanctions like private reprimand or public censure. Examples: Code on Take-overs and Mergers; Code on Collective Investment Schemes; Code of Conduct for Credit Rating Agencies.
  - (6) Practice Notes: guide administrative procedures (licensing, reporting, compliance); contravention not a criminal offence unless the procedure is required by an Act or regulation.
  - (7) Circulars: sent to specified persons or published for public information; have no legal effect.
  - (8) Policy Statements: outline major MAS policies.
- Footnote and special notes in MAS classification:
  - Exception: some Directives to Merchant Banks are essentially “Notices” but are historically called directives.
  - References to statutory effects for specific codes are noted (e.g., Securities and Futures Act sections cited by MAS).

### Licensing requirements (overview)
- Banking laws often conflate licensing procedure and licensing criteria, though they are legally distinct:
  - Licensing procedure: procedural rules applicants and the licensing authority must follow, including informational requirements to commence licensing.
  - Licensing criteria: substantive preconditions for granting a license.
- Banking laws often mix procedural and substantive aspects, causing confusion about which elements are procedural versus substantive.
- The conflation can be general or specific to particular sub-issues (e.g., significant shareholders).

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15200.pdf*

### 30.      To remedy this weakness, the primary law should first clearly set out the

### 30.      To remedy this weakness, the primary law should first clearly set out the licensing criteria for banks.

### Licensing criteria (statutory content and drafting approach)
- The core criteria themselves should be clearly set out in primary legislation.40
- From a drafting perspective, the statute must provide both the subject matter (e.g., governance, accounting mechanisms) and the yardstick against which the subject matter will be judged (e.g., the governance must be appropriate for the operations and structure of the bank).
- Balance needed between:
  - legal certainty for the industry about what licensing requirements must be satisfied; and
  - discretion of the regulator to refuse licensing.
- It is useful to provide non-binding circulars or similar instruments to overview the licensing authority’s administrative practices in granting and refusing licenses and its understanding of the legal framework.

### Typical minimum statutory licensing criteria (international good practice)31
- the minimum paid-up capital of the bank should meet the amount established by law or regulation; (as opposed to the Capital Adequacy Ratio, which is an altogether different concept, relying on the ongoing level of risk exposure in relation to qualifying own funds);
- the ownership structure of the bank should be sufficiently transparent and allow for effective supervision of the bank;41
- fit and proper requirements for directors and senior management of the bank;
- suitability requirements for significant shareholders of the bank;
- a financial structure, managerial structure, and business plan that are appropriate for the programme of the bank’s projected activities;42
- adequate arrangements for accounting, internal controls, risk management, and internal and external audit; and
- for branches and subsidiaries of foreign banks, the consent of the foreign bank’s home supervisor as well as an adequate supervisory arrangement between home and host supervisor.43

### Legal operation of licensing criteria
- The law should make clear that the license can only be granted if the licensing authority is satisfied that all licensing criteria are (cumulatively) met.
- The law should clarify whether the licensing authority can refuse a license even though all criteria are met (e.g., systemic reasons like an overbanked system or general systemic distress). Some legal systems require such systemic licensing criteria to be included in law to prevent a legal right to a license when bank-specific criteria are met; in other systems refusal may be possible under general administrative law or public interest grounds.

### Licensing procedure (statutory basis and core procedural provisions) — Section B
- Primary banking law should at least grant the licensing authority the power to establish a comprehensive licensing procedure by means of secondary regulation.44
- Best practice: include core provisions of the licensing procedure in the primary banking law to:
  - enshrine key mechanisms (including the possibility to legally challenge refusal) in statute; and
  - strengthen the authority’s position in judicial review by grounding the procedure in statute rather than only in the licensing authority’s own rules.
- Courts reviewing licensing decisions will focus on legality of the individual decision when the procedure is firmly established in statute.

### Key procedural elements that should be provided in law
- The law should unambiguously state that the licensing criteria operate as such, i.e. they must all be fully deemed met by the licensing authority for the license to be granted.45
- The licensing authority must have the power—or duty—to reject the application when not all criteria are fully deemed met (see also BCP 5).
- The law should require applicants to provide complete and correct information; the licensing authority may specify informational requirements or impose additional requirements in secondary regulation.46
- Include a “catch-all” clause permitting the licensing authority to require additional information deemed necessary or useful for completing the licensing process.47
- The law should set out legal consequences of incomplete or untimely provision of information.48
  - e.g., the decision period should commence only when the licensing authority has received all necessary information; provision of incorrect information should be ground for refusal or withdrawal of an already granted license.49
- The law should lay out key procedural steps and corresponding time-frames for licensing decisions.50
  - Consider rules that require the licensing authority to decide within (x) months upon receiving a complete application and rules deeming applications rejected if no decision is made within the required time.
  - When designing time-frames, balance supervisory flexibility and applicants’ rights to judicial review; consider general administrative law principles or enshrine specific principles in the banking law where general principles are absent or unclear.

### Ongoing requirements versus licensing criteria (continuity and supervisory powers)
- Banking laws should explicitly provide that all licensing criteria continue to apply as ongoing requirements after the license is granted. BCP 5, EC 3 requires that criteria for issuing licenses be “consistent with” those applied in ongoing supervision.
- The legal nature of ongoing requirements differs from licensing criteria; the law should clearly distinguish the two.
- Supervisors must have appropriate powers to take remedial action if any criterion is no longer satisfied.
- The legal framework could impose an obligation on the bank to immediately report any changes in information or circumstances after grant of the license to enable supervisor assessment; failure to provide timely notification should attract corrective measures and/or sanctions.

### Examples of typical ongoing requirements that must be maintained post-license
- Suitability requirements for significant shareholders:
  - Licensing-stage determination of suitability, sources of initial capital and ability to provide additional support should continue to apply after licensing to ensure continued suitability and financial soundness of significant shareholders.
  - Authorities should have powers to approve or reject changes in significant shareholdings to ensure ownership structures do not hinder effective supervision (discussed in Section VIII).
- Fit and proper requirements for directors and senior management:
  - Subsequent appointment of bank directors and senior managers should be subject to the supervisor’s express prior approval.
  - BCP 14: laws, regulations or the supervisor should require banks to notify the supervisor as soon as they become aware of any information that may negatively affect fitness and propriety of a Board member or senior management.
  - Supervisor should be empowered to require removal of a person who no longer satisfies fit and proper requirements.
- Internal controls, accounting, risk management, audit requirements:
  - Licensing-stage review of strategic and operating plans entails determination of appropriate corporate governance, risk management and internal controls commensurate with scope and sophistication of proposed activities.51
  - These requirements continue beyond grant of the license and supervisors should monitor implementation.

### Corporate governance (importance and legal framework)
- The recent financial crisis highlighted corporate governance weaknesses as causes of most banking failures: insufficient board oversight, inadequate risk management, unduly complex or opaque organizational structures and activities.
- Good corporate governance facilitates efficient decision making, promotes accountability, transparency and legitimacy, and enhances public confidence in banks and the banking system.52
- BCP 14 (2012) requires banks and banking groups to have robust corporate governance policies and processes covering strategic direction, group and organizational structure, control environment, responsibilities of Boards and senior management and compensation; these should be commensurate with risk profile and systemic importance of the bank. BCP 15 deals with the bank’s risk management process.
- Banks are typically structured under companies law; banking law should act as lex specialis where specific bank requirements differ from general company law.53

### Corporate governance elements the legal framework should address
a. Board of Directors
- Law should set out Board composition and minimum number of independent directors.55
- Clear process for nominating and appointing directors; clarity on duration of office, qualification and disqualification criteria; requirement for supervisory approval.
- Provisions on conflicts of interest and confidentiality obligations that survive the term of directorship.
- Supervisors should have legal power to require changes in Board composition if individuals are not fulfilling duties per BCP 14.56

b. Fit and proper criteria for board directors and senior management
- Typical criteria include:
  i. honesty, integrity and reputation (not refused right to carry on trade, business, profession, not censured, disciplined or suspended by a professional body, no criminal proceedings or convictions),
  ii. competence and capability (past performance or expertise, no conflicts of interest, educational qualifications), and
  iii. financial soundness (able to fulfill financial obligations, not a bankrupt, no outstanding judgment debts).
- Law should provide general requirement that directors and senior management be fit and proper; details can be expanded in subsidiary legislation or guidelines.
- Essential to precisely define “senior management” to provide clarity and prevent legal challenges.

c. Audit, risk management and internal control
- Law should require external audit and internal audit function with Board oversight.
- Supervisors should be satisfied that banks have comprehensive risk management processes to identify, measure, monitor and control all material risks.
- Board and senior management should understand the bank’s and banking group’s operational structure and risks, approve and oversee strategic direction, risk appetite and strategy, and establish conflicts of interest policies.
- Board should have audit and risk committees whose duties and membership are segregated from the executive functions of the bank.57

*Source: Excerpt from IMF working paper content unit _wp15200 - 30.*

### 41.      The misuse of banking resources by dominant shareholders is a second notable

### _wp15200 - 41.      The misuse of banking resources by dominant shareholders is a second notable

### Misuse of banking resources by dominant shareholders: problem statement and examples
- Dominant shareholders sometimes misuse bank funds to finance commercial and industrial activities of affiliate firms beyond what would be conducive to the long term stability of the bank.
- This misuse can be caused by:
  - An individual shareholder exercising excessive influence.
  - Banks owned by conglomerates where bank funds are diverted to affiliates.

### Legal and supervisory gaps identified
- Many banking laws lack legal tools to prevent misuse:
  - Lack mechanisms to vet new significant shareholders acquiring stakes after licensing.
  - Lack tools to remove inappropriate shareholders who illegally or legally (but then misuse their position) acquired influence.
- The IMF has required strengthening rules on significant ownership as part of Fund-supported programs (examples cited: DRC and Bangladesh under the Extended Credit Facility).
- Recommendation from the source: central features of the regime governing significant shareholdings should be established in primary legislation to provide legal certainty and enhance supervision and enforcement.

### Core elements of a legal framework for significant shareholdings
- Prior approval principle:
  - Law should stipulate that a person or entity may and can only acquire or divest a significant shareholding in a bank with the explicit and prior approval of the supervisor.
  - Prospective shareholders should request approval prior to acquiring or divesting shareholdings above or below applicable thresholds.
- Thresholds for supervisory approval:
  - Most banking laws start with shareholdings of 5% or 10%, and require additional approvals for every 5 or 10%.
  - Some laws do not require further approval once a shareholder has acquired 50% + 1 of the shares or voting rights (deemed full control).
  - Shareholdings must be considered directly or indirectly (held through connected legal entities or natural persons).
- Standard for approval:
  - Supervisor should be able to block acquisition or divestment when it would endanger, or risk to endanger, the prudent and sound management of the bank.
  - BCP 6 EC 3: criteria for approval should be “comparable to those used for licensing banks.”
  - Four suitability elements:
    - the significant shareholder must display the trustworthiness and experience—both in managing important participations and in managing banks—that render it appropriate for it to participate in the control of a bank;
    - the significant shareholder must be financially sound, in a manner that both avoids that its own financial weakness negatively impacts the bank and allows it to financially support the bank in case the latter’s financial solidity is weakened by circumstances;
    - the structure and the behavior of the significant shareholder may not hinder effective supervision of the bank in question; and
    - the significant shareholder should not raise issues from the perspective of anti-money laundering.
- Corrective mechanisms for breaches or misuse:
  - Short term/protective: power to suspend the voting rights associated with the shareholding (see BCP 6 EC 3).
  - Longer term/definitive: power to attach the shareholding—or at least limit its transferability—and to require divestment of part or whole of the participation.
  - These powers support BCP 6 EC 5 requirement that “the supervisor has the power to take appropriate action to modify, reverse or otherwise address a change of control that has taken place without the necessary notification to or approval from the supervisor.”
- Notification and disclosure duties:
  - Supervisors can inspect share registers and monitor voting patterns during general assemblies.
  - Legal obligation to request prior approval rests with the (prospective) shareholder.
  - Question remains whether banks should be obliged to inform supervisors when they become aware of important changes or events affecting shareholder suitability; such banking laws are currently rare but could become more prevalent.
  - Distinction noted between duty to inform the supervisor and duty to notify the supervisor as soon as the bank becomes aware of any material information which may negatively affect the suitability of a major shareholder or a party that has a controlling interest (see BCP 6 EC 6).

### Market access by foreign banks: branches vs. subsidiaries vs. representative offices
- Legal distinctions and regulatory consequences:
  - Branches: legally dependent extensions of a bank; no separate legal personality; claims on branch are claims on parent; local management but direct head office monitoring. Note: principle modified when host jurisdiction “ring-fences” local assets in insolvency.
  - Subsidiaries: incorporated in host jurisdiction; legally separate from parent; separate capital and Board of Directors; monitored by parent as part of banking group.
  - Representative offices: do not carry out regulated activity; serve as liaison/promotional offices only.
- Legal framework should specify which foreign entity forms can obtain a license (branches, subsidiaries, representative offices).
  - Parent entity should be licensed as a bank in its home country to open a branch.
  - Banking law should clarify conditions for licensing foreign subsidiaries.
  - Representative offices should be limited to promotional/liaison activities and not authorized to carry out banking activities.
- Prudential requirements:
  - Banking law should stipulate which prudential requirements apply to each establishment form.
  - Many laws fail to set out with sufficient precision which rules apply to subsidiaries and branches.
  - For subsidiaries, typically treated as local banks; for branches, lack of legal clarity can cause severe problems.
  - Asset maintenance requirements are generally imposed on branches rather than subsidiaries.
- Supervisory powers over foreign bank establishments:
  - Host country needs strong tools to regulate (and resolve) bank branches, recognizing need for coordination with home authorities.
  - Difference between branches and subsidiaries should be minimal from a regulatory oversight perspective.
  - BCP 13: supervisors require local operations of foreign banks to be subject to prudential, inspection and regulatory reporting requirements similar to domestic banks.
- Licensing and regulatory distinctions (as summarized in Table I):
  - Requirements often align for subsidiary and branch across many items (e.g., Capital Adequacy, Large Exposures, Related Party Lending), but differences exist such as Local Asset Maintenance Requirements (No for Subsidiary; Yes for Branch) and Fit and Proper applicability (Board and Management for Subsidiary; Management Board dependent on home supervision for Branch).
  - Consent of Home Supervisor, Consolidated Supervision of Home Supervisor, macro-prudential measures commonly applicable to both.

### Consolidated supervision: scope, legal foundations, and approaches
- Principle:
  - BCP 12: international banks should be supervised both on an individual (“solo”) basis and on a consolidated basis covering the banking group worldwide.
  - Consolidated supervision requires the collective body of entities in the banking group to report relevant financial and supervisory information in a consolidated fashion.
- Legal implementation challenges:
  - Many banking laws lack clear and robust legal underpinnings for consolidated supervision.
  - Design requires interaction between banking law, company law and accounting law.
- Legal components and policy choices:
  - Define which aspects of the supervisory toolkit apply on a consolidated basis:
    - Originally focused on quantitative aspects (capital adequacy, liquidity, large exposures, related party lending) using consolidated accounts for ratios.
    - Notable tendency to extend consolidated supervision to qualitative aspects (governance, fit and proper requirements). BCP references: Additional Criterion 1 of BCP 12.
    - Banking law should be precise on which quantitative and qualitative aspects consolidated supervision applies to, or at minimum allow regulator to define these in secondary regulation.
  - Determine which entities are included in consolidation scope:
    - Including non-financial entities in banking consolidation may produce irrelevant or biased pictures; alternatives include deduction from qualified capital at group level of participating interest in non-financial entities.
    - Law must establish principles for inclusion or exclusion of non-bank entities; core concept should be in primary legislation though details can be in secondary regulation.
- Two jurisdictional approaches to defining consolidation scope:
  - Reference to accounting law:
    - Banking law establishes circle of consolidated supervision by referring to accounting consolidation; advantage: simplicity.
    - Disadvantage: supervisory needs may differ from accounting consolidation; law should allow departure from accounting law for supervisory purposes.
  - Sui generis supervisory concept:
    - Banking law or regulations establish a distinct concept of “banking group” or “financial conglomerate” tailored to supervision.
    - Advantage: better attuned to supervisory needs; downside: creates distinct consolidation rules for financial reporting versus supervision, complicating financial reporting.

*Source: IMF working paper content provided in the supplied PDF excerpt.*

### 59.      Whatever the approach taken, the legal framework will need to address three

### 59.      Whatever the approach taken, the legal framework will need to address three distinct legal variables

### Consolidated supervision: scope and triggers
- First: to be subject to consolidated banking supervision, the group of connected entities must naturally include at least one bank.
- Secondly: the law must determine which type of link or connection the other legal entities need to have with the bank in order to be included in the latter’s consolidated supervision.
  - Accounting law requires consolidated financial reporting of all entities that are connected by way of a concept of “control” exercised by a single ultimate parent company “at the top of the pyramid.”
  - Accounting laws typically include detailed criteria for establishing control (necessary to have access to the assets of the entity).
  - Will the banking law rely on these accounting concepts, or will it establish its own criteria?
- Thirdly: whether the link is sufficient in and of itself, or whether other requirements are relevant:
  - Should the entities be of a financial nature?
  - Should they be regulated?
- Footnote/clarifications contained in the source:
  - This does not imply that the bank must be the controlling entity of the group. Nor does it in and of itself imply that the controlling entity of a bank must be regulated and supervised on a solo basis.
  - Triggers of control can include shareholdings of a certain percentage—“to hold 50%+1 of the equity in a company certainly amounts to control”—but control can also be deduced from the ability to appoint the majority in the board of directors with a lower percentage of shareholding. Control can be contractual as opposed to corporate, and accounting law may assess control on grounds of dominant direct and indirect influence.

### Consolidated supervisory reporting requirements
- Consolidated supervision is ineffective without consolidated financial and supervisory reporting.
- The banking law must provide for the principle of consolidated supervisory reporting by combining the information of all entities included in the circle of consolidated supervision.
- Periodic information provision requirements should require transfer of information from supervised banks to the supervisor at two levels:
  - general accounting reporting through financial statements,
  - specific supervisory reporting.
- For banks that are part of banking groups, both sets of information should be reported on a consolidated basis:
  - It is not sufficient to merely report general accounting information as per consolidation rules in generally applicable accounting law;
  - The supervisory information must be reported on both solo and consolidated bases too.

### Sharing of information and inter-agency cooperation (XI)
- A legal framework to support domestic and cross-border cooperation and information sharing should be in place.
  - This includes ability to cooperate with domestic authorities (deposit insurance schemes, securities, insurance regulators etc.) and foreign (home-host) authorities.
- BCP 3 provides that laws, regulations or other arrangements should provide a framework for cooperation and collaboration with relevant domestic authorities and foreign supervisors and that these arrangements reflect the need to protect confidential information.
- The legal framework should be clear that the banking regulator can cooperate and share information with other domestic authorities, as well as international counterparts.
- The legal framework should not contain provisions which hinder or restrict cooperation and information sharing.
  - Some statutes limit sharing to circumstances where there is a need to enforce a breach of a provision—such limitations undermine timely supervision and macro-prudential oversight.

### Information sharing and cooperation at different stages (A)
- Cooperation is required at all stages: initial licensing, ongoing supervision, and resolution.
- Licensing stage:
  - Contact and information sharing between the home and potential host supervisor is crucial for license assessment of a branch or subsidiary.
  - Legal frameworks should require prior consent of the home supervisor of a parent bank before a bank is granted a license (BCP 15).
  - Host supervisors require confidence that supervision in the home country is adequate and that information will flow from host to home supervisor.
- Ongoing supervision:
  - Home and host supervisory authorities should share information for consolidated supervision through supervisory colleges and other arrangements.
  - Joint examinations of branches and subsidiaries could be conducted or the home supervisor could be given on-site access; legal framework should specify modalities (notification vs prior consent, joint inspection vs representative, sharing of examination reports).
  - Information should be shared when there are supervisory concerns and shared on a timely basis.
- Resolution:
  - BCP 11, EC 7 states that the supervisor should cooperate and collaborate with relevant authorities in deciding when and how to effect the orderly resolution of a problem bank situation.
  - The range of agencies for information sharing should include central banks (who are not supervisors), Ministries of Finance, deposit insurance and other resolution agencies.
  - The requirement for systemically important institutions to prepare recovery and resolution plans (RRPs) should have a statutory footing; relying solely on general banking law powers may be insufficient and open to legal challenges.
  - For effective sharing of information for the RRP process, express statutory footing for sharing information is preferable.

### MoUs and cooperation agreements (B)
- Cooperation arrangements are frequently captured in MoUs (bilateral and multi-lateral) or exchanges of letters.
  - Most MoUs are not legally binding and are subject to the relevant legal framework.
  - The scope of cooperation in MoUs must be read in context of applicable law.
- Some frameworks condition sharing on the existence of an MoU; where so, flexibility should be built in to allow interim timely sharing while MoU negotiations proceed, especially in emergencies.

### Safeguards for confidentiality (C)
- Disclosure of information should be subject to adequate confidentiality requirements and safeguards appropriate to the nature of the information and clearly set out in the law.
  - Where disclosure of confidential information may be compelled under statutes (e.g., freedom of information) or by the courts, authorities may be less willing to share information.
  - Banks may be unwilling to provide sensitive information to regulators without assurance of confidentiality safeguards when information is shared with other domestic and foreign authorities.
- Common safeguards provided in most regimes:
  - Establish a regime for the protection of confidential information imposing adequate confidentiality requirements on authorities, their employees (both current and former) and agents; provide effective sanctions and penalties (criminal and civil) for breach.
  - Require that the legal framework of the recipient authority has comparable confidentiality requirements; assess adequacy and effective sanctions for breach; set clear criteria and procedures for determining comparability.
  - Require prior consent for onward sharing; clarity on when information received may be onward shared; third parties receiving onward-shared information should be subject to similar confidentiality requirements.
  - Commit to take best efforts to resist disclosure when recipient authorities face statutory or court compulsion (e.g., rely on public interest grounds or legal exemptions and privileges); law should provide that the supervisor can only disclose confidential information to courts or judicial authorities in the context of civil or criminal proceedings.
- Legal protection for the banking supervisor, its employees and agents:
  - Where disclosure is lawful, there should be explicit legal protection against criminal or civil action for the agency and current and past employees and agents.

### Bank-related party and large exposure limits (XII)
- Banking laws often struggle to establish clear, robust and distinct legal underpinnings for bank-related party and large exposure limits.
- Key features:
  - Bank-related party limits:
    - Impose restrictions on amounts a bank can lend to borrowers “connected” with the bank (shareholders, directors, managers).
    - Quantitative and expressed as a percentage of the capital of the lending bank.
    - Good practice to prescribe qualitatively how transactions with bank-related parties can be entered into (higher governance standards).
  - Large exposure limits:
    - Aim at limiting concentration risk by imposing quantitative limits on individual large exposures and total large exposures.
    - Entirely quantitative and expressed as a percentage of the capital of the lending bank.
- Legal commonalities of both tools:
  - Built upon a common set of legal definitions, including “exposure” (not only credit claims but also other types of financial risk) and “capital.”
  - Both require establishment of a quantitative limit relative to capital; these quantitative limits can be established by a simple habilitation in primary legislation with detailed rules in secondary regulation.
  - Both should be designed so connected borrowers are considered a single exposure for limit purposes; some laws define “single risk” in primary law.
- Legal differences:
  - Large exposure limits can be relatively straightforward quantitative prudential limits.
  - Bank-related party rules require comprehensive governance prescriptions often needing inclusion in primary legislation:
    - Transactions entered into on an “at arm’s length” basis.
    - Approval by the board of directors without participation in the vote of the interested director.
    - Bank-related party transactions typically subject to more stringent reporting rules.
    - Some banking laws require deduction of bank-related party transactions from capital if certain conditions are not met.

### Supervisory enforcement, early intervention and resolution (XIII)
- Many banking laws establish sub-optimal enforcement mechanisms. Three common legal problems:
  - (i) conceptual confusion about the types of enforcement measures,
  - (ii) an inadequate link between enforcement and license revocation,
  - (iii) legally problematic sanctioning regimes.
- Timely action is required where there are concerns over safety and soundness of banks.
- The effectiveness of resolution frameworks hinges on quality of legal regimes for supervisory enforcement and early intervention.
- Conceptual progression of measures (three phases):
  - Supervisory Enforcement:
    - Ordinary enforcement powers to require a banking institution to address any violation of law or unsafe and unsound practice.
    - Use of these powers does not require a finding that the institution is in danger of failure.
    - Examples of powers: (i) impose fines, (ii) remove directors and managers who no longer meet fit and proper requirements, (iii) remove significant shareholders that are no longer suitable, (iv) issue “cease-and-desist” orders, (v) issue directions to take remedial action, (vi) suspend certain bank activities for a specified period of time.
  - Early Intervention:
    - Explicit and strong powers to require the board and management of an ailing bank to undertake forceful action to strengthen the bank or refrain from actions that weaken it.
    - Measures include prohibiting certain operations, requiring a restructuring plan, raising additional capital, prohibiting dividend pay-outs, prohibiting new activities, requiring divestment of certain assets or businesses.
    - The bank remains under private control; failure to implement required measures is ground for commencement of resolution proceedings and putting the bank into public control or closing it.
  - Resolution:
    - The resolution authority should assume control of an unviable bank to rehabilitate or liquidate in an orderly manner.
    - Where supervisory and resolution authorities are distinct, resolution may be triggered by the supervisory authority, which will also be competent for withdrawing the license.

*Italicized source: _wp15200 - 59.      Whatever the approach taken, the legal framework will need to address three*

### 74.      Many banking laws conflate the various stages for dealing with troubled banks.

### Many banking laws conflate the various stages for dealing with troubled banks

### Conflation of supervisory enforcement, early intervention, and resolution
- Many banking laws include a single list of measures for non-compliance, spanning sanctions (supervisory enforcement) to license revocation (resolution).
- Legal-formal conflation is not intrinsically problematic, but the central legal problem is that a “single list” approach often lacks clear, robust, proportional and coherent triggers for applying appropriate measures at each phase of non-compliance and financial distress.
- Consequence: courts may be skeptical about the toughest measures because legislation does not reflect the “crescendo” nature of bank distress and corresponding measures, risking findings of infringement of the proportionality principle.
- Recommendation: reflect the stages of supervisory enforcement, early intervention and resolution explicitly and distinctively in well-tailored legislative provisions.

### Triggers for action: quantitative and qualitative
- It is particularly important to provide clear and robust quantitative and qualitative triggers for the type of action that can be taken at each stage.
- Quantitative triggers: tied to quantifiable variables, such as liquidity or capital adequacy ratios.
- Qualitative triggers: require supervisory judgment (e.g., management not fit and proper; finding of unsafe and unsound practices); even where judgment is required, triggers should be drafted with as much clarity as possible.

### Mandatory versus discretionary supervisory action
- Clarity is needed on whether supervisory action is mandatory or discretionary.
- Some countries provide a prompt corrective action or prompt remedial action framework where certain regulatory actions must be taken upon breach of certain triggers.
  - Advantages: legal certainty, reduced probability of legal challenges, reduced supervisory forbearance.
  - Disadvantage: may tie regulators’ hands when mandated action is not the most appropriate response in a particular case.
- Legal drafters should grant a degree of flexibility and discretion to the supervisory authority to take corrective action; forbearance is better addressed through governance and accountability frameworks.

### Link with license revocation
- There should be legal clarity as to when a license may be revoked; timing and impact must be clear because supervisory powers typically cease once the license is revoked.
- Clear, flexible, and proportionate grounds for license revocation should be set out in the banking law and their interaction with the resolution regime explicitly provided for.
  - Note: there should be grounds for revocation not directly connected to the financial situation of the bank.
  - Examples cited: Article 85 of the Kuwaiti banking law; section 30AAM of the Monetary Authority of Singapore Act (allows directions to a person who has ceased to be a regulated entity when necessary to achieve certain objects).
- Sequencing of administrative and judicial action requires careful drafting.
- Two-directional interaction principles:
  - Direction 1: License revocation should ipso facto trigger liquidation; this automatic consequence should be explicitly spelled out in the banking law.
    - Administrative or judicial authorities should not have discretionary power to open liquidation procedures in place of automaticity.
    - Rationale: license revocation entails ipso facto prohibition for the ex-bank to maintain deposits; deposits should be swiftly transferred to a licensed institution, especially given likely severe financial weakness at revocation.
    - A (preferably administrative) liquidation procedure offers the best context for effectuating transfer of guaranteed deposits and corresponding assets.
  - Direction 2: Failure to rehabilitate a troubled bank by way of resolution measures (other than liquidation) should in principle trigger license revocation (and thus liquidation).
    - This cannot be drafted with the same automaticity because it requires discretionary judgment by the supervisory agency.
    - Principle: failure to rehabilitate by resolution measures should be established clearly and explicitly in the banking law.

### Due process, appeals, and consequences of reinstatement
- Key due process questions to address in law:
  - Must the bank be given prior notice and an opportunity to be heard?
  - Can the regulator revoke a license on an urgent basis, on public interest grounds?
  - What avenues for appeal exist and what remedies are available?
- Recommendation: license revocation decisions should be irrevocable on appeal; monetary compensation should be the only available remedy for a legally wrongful revocation.
- Country experience: reinstatement of a bank’s license after successful legal challenge can leave resumption of ordinary banking business difficult after prolonged suspension.
  - Example: in Nigeria a court allowed a bank’s license to be reinstated after 6 years; the bank was not able to resume business where it left off due to lack of maintained infrastructure and bank records and increased capital requirements.
- These issues should be explicitly dealt with in the legal framework; some jurisdictions place due process provisions in banking law, others in administrative law instruments.

### Role of sanctions
- Commensurate penalties and sanctions should be imposed for non-compliance: criminal penalties (monetary, custodial), civil penalties, or administrative fines; these may be concurrent with corrective actions.
- Legal drafting must address procedural prescriptions, due process requirements, and competent review bodies for each type of sanction.
- Sanctions should target both corporate and individual levels (vicarious liability):
  - Action against directors or senior management who knowingly contributed to or willfully neglected to prevent a breach is appropriate.
  - Action may be taken concurrently against the corporate entity and responsible individuals.
  - BCP 11, EC 5 requires the supervisor to apply sanctions not only to the bank but, when necessary, also to management and/or the board or individuals therein.
- Penalty design considerations:
  - Penalties should be commensurate with the severity of the breach and sufficient for deterrence.
  - Monetary penalties may not be prohibitive for large banking organizations; reputational costs (“name and shame”) may be more effective.
  - Laws typically provide maximum amounts or upper limits for fines and imprisonment terms rather than fixed amounts or fixed terms, allowing discretion to impose penalties proportionate to offence seriousness.
  - Factors relevant to penalty determination: offender track record, whether breach was self-reported, remedial actions taken.
  - Corporate entities cannot be imprisoned; some jurisdictions provide a “doubling-up” of the fine for corporations.
- Placement of penalties in law:
  - Consider whether penalties should be in primary law or secondary legislation.
  - Penalties in secondary legislation are typically subject to limits and generally less than those in primary law; an empowering provision in primary law is required to prescribe penalties in subsidiary legislation to satisfy nullum crimen sine lege.
  - Non-binding secondary instruments should never carry penalties.

### Conclusion: legal foundations and broader legal context
- Meta message: clear and robust legal underpinnings buttress the effectiveness of banking supervision.
- Drafting banking law raises financial policy questions informed by international best practice (BCP), but also complex legal challenges requiring careful treatment where guidance may be limited.
- Banking law cannot be considered in isolation from the wider legal context; weaknesses in general administrative law, civil and commercial law, and company law will affect banking supervision.
- Recommendation: authorities should acknowledge the breadth of necessary legal underpinnings and dedicate resources to building a strong legal function within supervisory agencies.

*IMF Working Paper content unit*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15200.pdf_