Current Legal Issues Affecting Central Banks, Volume V


Robert Effros
Published Date:
May 1998
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Improving bank supervision has become an endless endeavor for policymakers, bank supervisors, bankers, economists, and lawyers. Much is to be gained by comparing banking laws and regulations, practices, and experiences from different countries with various degrees of financial development and institutional expertise. The following questions are of concern to a central bank counsel:

  • What are the purposes of bank supervision?

    • - to protect shareholders against bank managers;

    • - to protect depositors against shareholders and bank managers;

    • - to protect depositors and creditors;

    • - to prevent bank failures and financial distress;

    • - to prevent systemic risks;

    • - to protect the banking system as a whole; and/or

    • - none (all) of the above.

  • Should the above purposes be stated explicitly in the law?

  • To what extent should bank behavior be regulated by market discipline (public disclosure)? Are interest rates free to permit the proper functions of the market system? Is there any deposit insurance scheme that involves a moral hazard for investors, creditors, or depositors? What aggregate information must bankers publish and how often? Do government officials or the central bank dictate credit policy? Is banking business open to competition? Can foreign banks open subsidiaries or branches on a competitive basis?

  • Are bank supervisors subject to political pressure? Are they legally protected? Can they be dismissed without legal cause? To what extent are they personally immune from litigation in connection with their duties?

  • Should banking business be open to anyone so as to stimulate competition? What are (should be) the limitations, if any, to open a local bank or for foreign banks to operate a banking business through a branch or subsidiary?

  • Under what circumstances may a banking license be revoked?

  • Modern banking legislation requires banks to maintain a minimum ratio of capital to risk-weighted assets. Is there need to require in addition a minimum capital? What should be the required minimum capital for a bank? Should it be possible for this minimum to be modified without legislative approval?

  • The Basle Committee on Banking Supervision has recommended a capital ratio of 8 percent to risk-weighted assets for banks of the Group of Ten countries engaged in international banking activities.1 What reasons would justify a higher or lower ratio? Should the law or regulations require banks to reflect in this ratio (or another ratio) market, interest rate, foreign exchange, and other economic risks? How is “capital” or “net worth” defined?

  • Should capital and other prudential requirements be stated in the law or, alternatively, in the regulations? Should there be constitutional limitations with respect to “delegation of powers” from the legislative to the executive branch in this area?

  • As banking business develops and becomes more competitive, banks are forced to explore new and sometimes riskier activities. Should the scope of banking business (that is, the definition) be expanded? Should banks be permitted to venture into banking-related activities and hold shares of other enterprises? Should any additional activities be accompanied by higher capital requirements and provisions?

  • Are banks subject to antimonopoly laws? Should a supervisory authority be allowed to intervene to prohibit bank concentration? What should be its legal powers? What should be the maximum percentage of shares in the capital stock of a bank that a person or group of persons is allowed to hold? Should substantial transfers of stock be monitored by the authorities?

  • Should banks be administered by a single person (for example, a general manager) or by a committee?

  • What should be the credit limits that banks can extend to single or related persons (credit risk concentration)? How should “related persons” be defined? Should the concept be extended to geographical areas or economic activities?

  • Should liquidity standards be required as a proportion of the value or change in value of the bank’s assets or liabilities? Should the supervisory authority be empowered to accept the bank’s own computerized programming and internal control systems in this area? What should be the legal consequences for violations of such programming or control systems?

  • Should the central bank or the supervisory authority be empowered to prescribe the level of interest rates and charges and to determine the credit policies as well as the classification and evaluation of bank assets?

  • Commercial banks are normally subject to limitations on their foreign exchange operations. Should such limitations be used as a monetary instrument to control the foreign exchange market or as a prudential requirement to prevent excessive exposure, or for both purposes?

  • Should the external auditors appointed by shareholders report only to them and to management, or to the supervisory authority as well? Should the approval of the supervisory authority be required for appointing external auditors?

  • Should all infractions and penalties be stated specifically in the law? Should some discretionary powers be granted to the supervisory authority in this critical area?

  • Under what circumstances should the supervisory authority appoint a conservator? Should shareholders be given an opportunity to replenish the bank’s capital before liquidating or selling the bank to third parties? Should the law prohibit the declaration and/or distribution of dividends for banks in distress?

  • Should there be categories of privileged creditors or depositors in the liquidation of a bank?

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