Specifically these banks are looking to cross sell on traditional product classes and perhaps seek out new companion facilities that they could offer to this existing customer base. Given their infrastructure nature, clientele demographics or market penetration they generally look to form symbiotic partnerships with other international entities so that they can quickly enter foreign markets. Sometimes the strategy is to broaden the balance sheet indiscriminately however in many cases the intention is to replicate their unique value offering elsewhere. They may be leaders in one market segment but inevitably reach a point of saturation in which to sustain a healthy level of growth they naturally embark on a complete transformation and of course successful businesses have the reserves or can attract mezzanine investors to realize such a vision.
These types of restructures are usually enterprise wide and often involve a change to the type of license being held and in some cases a complete merger between one or more institution may be the final outcome. All very exciting however the question that is always raised somewhere in the discussion is; what do we need to do with the regulators to ensure that new strategies we propose are endorsed and don’t attract the wrong kind attention. Then one has to question what the regulators are really looking for anyway?
Coincidently the Bank For International Settlements has recently (April 2006) just updated its Core Principles for Effective Banking Supervision that it has developed with fellow supervisors. The aim of this update is to supersede the 1997 mandate and BIS is currently seeking comments from the industry sector on this latest release. Importantly this document furnishes us with a good insight on what is required of any bank as it transforms and we are going to briefly discuss it here.
There are in fact 25 components that make up the core principles and for quick reference they have been listed below:
Principle 1: Objectives, Independence, Powers, Transparency and Cooperation
Principle 2: Permissible activities
Principle 3: Licensing Criteria
Principle 4: Transfer or significant ownership
Principle 5: Major Acquisitions
Principle 6: Capital Adequacy
Principle 7: Risk Management Process
Principle 8: Credit Risk
Principle 9: Problem Assets, provisions and reserves
Principle 10: Large exposure limits
Principle 11: Exposures to related parties
Principle 12: Country and transfer risks
Principle 13: Market Risk
Principle 14: Liquidity Risk
Principle 15: Operational Risk
Principle 16: Interest Rate Risk
Principle 17: Internal Control and Audit
Principle 18: Abuse of financial services
Principle 19: Supervisory Approach
Principle 20: Supervisory Techniques
Principle 21: Supervisory Reporting
Principle 22: Accounting and disclosure
Principle 23: Corrective and remedial powers of supervisors
Principle 24: Consolidated Supervision
Principle 25: Home-host relationships
Compliance aside, a major emphasis that should always be high on the planners agenda for these bank-wide transformations are principles 6, 7, 8, 9, 11, 12, 13, 14, 15, 16, 22, 25 as they are entirely risk focused or have heavy risk components. These will require the construction of a framework that consists of policies, methodologies and infrastructure and, will consume equal amounts of high budget and resource. Specifically the home-host relationship principle has been at the centre of contentions throughout the evolution of the Basel II accord and is an extremely complex piece of work. Principle 12, country risk has very few widely excepted benchmarking processes and isn’t formally written about enough to give senior managers that many options, so it can also be a bewildering activity to tackle as it lacks industry accepted guidelines.
From the regulator perspective, they are unlikely to forgo on quality of implementation for any principle and when banks leap outwards a special focus is likely to be applied to principle 14 and principle 6; the liquidity and capital adequacy of the bank. In fact the actually process of transformation will more than likely stress this ratio and banks that are going to engage in international relationships will need to establish an applicable Basel requirement if it doesn’t already exist. The supervisor of course has the power to impose a specific capital charge and/or limits on all material risk exposures if they deem there to be inherent risk during or after the amalgamation.
The Basel Capital Accord was designed to apply only to internationally active banks, which must calculate and apply capital adequacy ratios on a consolidated basis, including subsidiaries undertaking banking and financial business. Jurisdictions adopting the new capital adequacy framework would apply such ratios on a (Reference documents: International convergence of capital measurement and capital standards, July 1988; and International convergence of capital measurement and capital standards: a revised framework, June 2004.)
In respect to timing this is a long process and in some cases more than one regulator is going to be involved which complicates what would seem a straight forward audit, review, tick off and fee. In Principle 5 for example, the regulators can actually impede or prohibit the process if they deem the bank is engaging with a foreign entity in countries where secrecy laws or other regulations prohibit information flows deemed necessary for adequate consolidated supervision and these laws apply broadly to banks that even invest in institutions that aren’t financially regulated or holding a license. A bank intermingling with a non regulated entity might seem quite intriguing however it is actually quite common as companies such as brokerages, front office sales operators, financiers and other related firms often provide the transforming bank with valuable access to additional customers and that is a great target market for leveraging existing successful products abroad.
Finally for banks that are looking at creating these complex alliances, a special project team needs to be established to manage these principles, budget has to be set aside for transferring changes to liquidity during the process and the entire blueprint of the negotiation and final operating model needs to be readily available for regulators to peruse, so without doubt there is going to be a lot of delicate work ahead.
