Abstract

The Basle Committee on Banking Supervision was established at the end of 1974 by the central bank governors of the Group of Ten industrialized countries1 with the objective of strengthening collaboration among national authorities in their prudential supervision of international banking. The Committee, whose members are senior officials of the central banks and supervisory agencies of the Group of Ten countries and Luxembourg, meets four times a year at the Bank for International Settlements in Basle, Switzerland.

I. The Basle Committee

The Basle Committee on Banking Supervision was established at the end of 1974 by the central bank governors of the Group of Ten industrialized countries1 with the objective of strengthening collaboration among national authorities in their prudential supervision of international banking. The Committee, whose members are senior officials of the central banks and supervisory agencies of the Group of Ten countries and Luxembourg, meets four times a year at the Bank for International Settlements in Basle, Switzerland.

The Committee was founded as a consequence of the instability which affected international banking markets in the early 1970s, in recognition of the similarity of the problems facing banking supervisory authorities in different countries and of the need for cross-border collaboration in the supervision of international banks. The Committee was established to provide a forum for regular confidential discussion on the handling of specific problems, to coordinate a sharing of supervisory responsibilities among national authorities with the aim of ensuring effective supervision of banks’ activities worldwide, and to promote a general enhancement of supervisory systems and prudential standards.

The Committee’s reports and recommendations for supervisory policies and procedures are not legally binding on the countries and institutions represented on the Committee. Instead, through discussion of supervisory issues, the Committee seeks to reach consensus on the best practices. The implementation of that consensus is a matter for national supervisory authorities and rests on their willingness to adopt policies in line with recommendations made in Basle.

The Committee has considerably extended its work during the past decade to keep abreast of major developments in banking. The most significant development has been the progressive internationalization of banking. The number of banks operating outside their home territories, through foreign branches and subsidiaries, has multiplied. Cross-border lending in international currencies now represents an important part of major banks’ balance sheets. Moreover, the process of internationalization is not confined to the leading banks in Group of Ten countries; smaller banks and banks from non-industrialized countries have also built up networks of foreign offices. The spread of banking groups with significant operations outside their home countries complicates the process of supervision, particularly where foreign offices are beyond the scope of parent-country examination procedures.

The Basle Concordat,* first drawn up in 1975 and substantially revised and extended in 1983, addressed this problem. By identifying the respective responsibilities of host-country and parent-country supervisors, it presented an internationally agreed set of principles for the shared supervisory responsibilities for banks’ foreign establishments. In particular, the Concordat stressed the need for collaboration between national supervisors to ensure effective surveillance. As banking markets become more globally integrated, collaboration assumes increased importance.

II. The Concordat

The Concordat is essentially a set of principles drawn up by the Committee governing the way in which the supervision of banks’ foreign establishments should be carried out. These principles are not necessarily embodied in supervisory regulations of the countries represented on the Committee. Rather they are recommended guidelines on best practices which all members have undertaken to work toward implementing.

The Concordat begins by distinguishing between three types of foreign establishment: branches, which, having no separate legal status, are integral parts of the parent bank; subsidiaries, which are legally independent institutions wholly or majority owned by a bank incorporated in a country other than that of the subsidiary; and joint ventures, which are legally independent, locally incorporated institutions and generally have two or more foreign parent institutions, each holding a share of the joint venture. These distinctions are important, because they determine the manner in which supervision and supervisory collaboration can most effectively be carried out.

Two basic principles lie at the heart of the Concordat document: first, that no foreign banking establishment should escape supervision; and, second, that the supervision should be adequate. In cases where supervision by a host authority is judged to be inadequate, the parent authority should either extend its own supervision to cover the foreign establishment or it should discourage the continued operation of the foreign establishment. Conversely, if a host authority considers that the supervision exercised over the parent bank by the parent supervisory authority is inadequate, the Concordat recommends that the host authority discourage the operation of local entities of such banks in its own territory or set specific conditions on the business to be conducted.

The implementation of the second basic principle—namely, that the supervision of all foreign banking establishments should be adequate—requires the positive participation of both host and parent authorities. Host authorities are responsible for the foreign bank establishments’ operations in their territories as individual institutions while parent authorities are responsible for them as parts of larger banking groups where a general supervisory responsibility exists in respect of their worldwide consolidated activities. These responsibilities of host and parent authorities are both complementary and overlapping.

The principle of consolidated supervision which the Concordat recommends is that parent banks and parent supervisory authorities monitor the risk exposure—including a perspective of concentrations of risk and of the quality of assets—of the banks or banking groups for which they are responsible, as well as of the adequacy of their capital, on the basis of the totality of their business wherever conducted. This principle does not imply any lessening of host authorities’ responsibilities for supervising foreign bank establishments that operate in their territories, although it does imply a recognition that the full implementation of the consolidation principle may well lead to some extension of parental responsibility.

The supervision of banks’ foreign establishments is considered from three different aspects: solvency, liquidity, and foreign exchange operations and positions.

Solvency

The allocation of responsibilities for the supervision of the solvency of banks’ foreign establishments between parent and host authorities will depend on the type of establishment concerned.

The solvency of branches is indistinguishable from that of the parent bank as a whole. So, while there is a general lesponsibility on the host authority to monitor the financial soundness of foreign branches, supervision of their solvency is primarily a matter for the parent authority. The dotation de capital requirements imposed by certain host authorities on foreign branches operating in their countries do not negate this principle. They exist, first, to oblige foreign branches that set up businesses in those countries to make and to sustain a certain minimum investment in them and, second, to help equalize the competitive conditions between foreign branches and domestic banks.

For subsidiaries, the supervision of solvency is a joint responsibility of both host and parent authorities. Host authorities have responsibility for supervising the solvency of all foreign subsidiaries operating in their territories. Their approach to the task of supervising subsidiaries is based upon the view that these establishments are separate entities, legally incorporated in the country of the host authority. At the same time, parent authorities, in the context of consolidated supervision of the parent banks, need to assess whether the parent institutions’ solvency is being affected by the operations of their foreign subsidiaries. Parental supervision on a consolidated basis is needed for two reasons: (1) because the solvency of parent banks cannot be adequately judged without taking account of all their foreign establishments; and (2) because parent banks cannot be indifferent to the situation of their foreign subsidiaries.

For joint ventures, the supervision of solvency should normally, for practical reasons, be primarily the responsibility of the authorities in the country of incorporation. Banks which are shareholders in consortium banks cannot, however, be indifferent to the situations of their joint ventures and may have commitments to these establishments beyond the legal commitments which arise from their shareholdings—for example, through comfort letters. All these commitments must be taken into account by the parent authorities of the shareholder banks when supervising their solvency.

Liquidity

References to the supervision of liquidity in the Concordat do not relate to central banks’ functions as lenders of last resort, but to the responsibility of supervisory authorities for monitoring the control systems and procedures established by their banks which enable them to meet their obligations as they fall due, including, as necessary, those of their foreign establishments.

The allocation of responsibilities for the supervision of the liquidity of banks’ foreign establishments between parent and host authorities will depend, as with solvency, upon the type of establishment concerned. The host authority has responsibility for monitoring the liquidity of a foreign bank’s establishments in its country; the parent authority has responsibility for monitoring the liquidity of the banking group as a whole.

For branches, the initial presumption should be that primary responsibility for supervising liquidity rests with the host authority. Host authorities will often be best equipped to supervise liquidity, since it relates to local practices and regulations and the functioning of their domestic money markets. At the same time, the liquidity of all foreign branches will always be a matter of concern to the parent authorities, since a branch’s liquidity is frequently controlled directly by the parent bank and cannot be viewed in isolation from the liquidity of the bank of which it is a part.

For subsidiaries, primary responsibility for supervising liquidity should rest with the host authority. Parent authorities should take account of any stand-by or other facilities granted, as well as any other commitments made by parent banks—for example, through comfort letters—to these establishments.

For joint ventures, primary responsibility for supervising liquidity should rest with the authorities in the country of incorporation. The parent authorities of shareholders in joint ventures should take account of any stand-by or other facilities granted, as well as any other commitments made by shareholder banks—for example, through comfort letters—to those establishments. The authorities in the country of incorporation of joint ventures should inform the parent authorities of shareholder banks of the importance they attach to such facilities and commitments so as to ensure that full account is taken of them in the supervision of the shareholder bank.

Within the framework of consolidated supervision, parent authorities have a general responsibility for overseeing the liquidity-control systems employed by the banking groups they supervise and for ensuring that these systems and the overall liquidity positions of such groups are adequate. Full consolidation may not, however, always be practicable as a technique for supervising liquidity because of differences of local regulations and market situations and the complications of banks operating in different time zones and different currencies. Host authorities have a duty to ensure that the parent authority is immediately informed of any serious liquidity inadequacy in a parent bank’s foreign establishment.

Foreign Exchange Operations and Positions

As regards the supervision of banks’ foreign exchange operations and positions, there should be a joint responsibility of parent and host authorities. It is particularly important for parent banks to have in place systems for monitoring their groups’ overall foreign exchange exposures and for parent authorities to monitor those systems. Host authorities should be in a position to monitor the foreign exchange exposure of foreign establishments in their territories and should inform themselves of the nature and extent of the supervision of these establishments being undertaken by the parent authorities.

III. Implementation of the Concordat

Much progress has been made toward winning general acceptance of the Concordat’s framework of principles, but the Committee has continued to review the document’s practical application. To this end, in the course of 1989, a working party was established with representatives of the Offshore Supervisors’ Group to make practical recommendations for strengthening cooperation between host and parent supervisors in handling specific bank situations and in providing early warnings of problems. The joint report of the Committee and the Offshore Supervisors’ Group, which derived from the Working Party’s conclusions, has received broad support from supervisors in many countries outside the Committee.

The joint report identified five key areas* where procedures for collaboration among supervisors needed to be improved:

(1) authorization procedures for new foreign establishments,

(2) information needs of parent authorities,

(3) information needs of host authorities,

(4) banking secrecy, and

(5) external audit requirements.

Authorization Procedures

The initial opportunity for collaboration between host and parent supervisors occurs when an individual application to establish a new foreign presence is first made by a bank. In normal circumstances, this will involve plans to open a new office, but it can also arise in cases of cross-border acquisitions. The authorization procedure offers an ideal opportunity for host and parent authorities to create the basis for collaboration between them in the future.

When a bank seeks permission to open a new foreign establishment or to acquire a foreign banking institution, the authorization procedures differ markedly from country to country. Most authorities will seek to satisfy themselves of the soundness of the applicant and its management capabilities. However, it still appears to be too easy for banks of doubtful standing or with little international experience to set up foreign offices in some countries. For inward authorization, most host authorities seek the approval of the parent authority. Some go beyond this, particularly in the case of branches, to seek assurances that the new establishment will be subject to parental supervision. Even where such assurances are sought, however, it has not always been possible in practice to obtain a precise statement of approval; in many cases, the procedure amounts to no more than notification. All host authorities should formally seek a response from a parent authority in respect of any bank seeking to open a foreign establishment. Where a host authority is unable to obtain a positive response, or receives what it considers to be an inadequate response, from the parent authority, it should consider either refusing the application (as is the current practice of many host centers) or imposing conditions or restrictions on the grant of the application.

Host authorities need to exercise particular caution in approving applications for banking licenses from foreign entities not supervised as banks in the parent country and not subject to any form of official supervision. In such circumstances, authorization should be contingent on the host authority’s capacity to exercise a parental role, if it wishes to license such banks at all.

Information Needs of Parent Authorities

As regards direct consultation between supervisors, in view of resource restraints, collaborative efforts should, in the first instance, focus on the most important aspects of banking risk. This would not in any way rule out consultation on other aspects, where practical, but rather is intended to constitute a first cooperative step which may be followed by others.

The most frequent causes of banking failures are probably large loan exposures and poor asset quality. They are often found in combination, and both derive from inadequate management control. A number of recent banking failures have had these characteristics in common. When they occur in foreign establishments, particularly if they are beyond the scope of parental inspection, the parent supervisors are likely to be illequipped to detect them. Unless specifically directed to do so, external auditors will not normally identify large exposures in the course of their work, and consolidated supervision is only as reliable as the quality of the data consolidated. Supervisors should therefore initially seek to collaborate in monitoring large credit exposures in foreign establishments. The procedures suggested can, in most cases, be applied to other areas of banking risk.

It should be stressed that parent supervisors would generally not expect to obtain directly regular information on large credit exposures in respect of every foreign establishment. Where a host authority, in the course of its own supervision, discovers an exposure which it considers should be drawn to the attention of the parent authority or finds that information being passed to the parent bank is inaccurate, the host authority should take the initiative to inform the parent authority of the existence of the exposure, its size, and the name of the party on whom the bank has a claim.

Parent authorities, for their part, will generally receive information on large exposures in foreign establishments via the head office of banks. In the majority of cases, parent authorities will find that this channel provides them with adequate data. As a minimum, therefore, they should seek to satisfy themselves that banks’ internal controls in respect of large credit exposures include comprehensive and regular reporting from foreign establishments.

On occasions, however, the parent authority may wish to seek an independent check on data reported by an individual foreign establishment. Where inspection by parent supervisors is permitted by host authorities—and at present it is forbidden in some centers—it is clearly in the interests of both host and parent authorities to facilitate on-site inspections.

Information Needs of Host Authorities

Mutual trust between supervisory authorities can be achieved only if information can flow with confidence in both directions. Host supervision of foreign establishments will be more effective and can be more carefully directed to ensure the soundness of both the local establishment and the wider banking group if it is undertaken with an awareness of the extent to which the parent supervisor is able to monitor the foreign establishment. Moreover, host authorities have a right to be kept informed about supervisory action at the parental level which may materially affect a local establishment. The information sought by host authorities thus broadly falls into two categories: (1) supervisory regulations in parent countries and information about how far, in practice, the system of supervision incorporates the foreign establishments; and (2) information about particular banks with offices in the host territory.

More sensitive considerations arise in the case of banks facing serious problems. Parent authorities cannot always be expected to communicate potentially damaging information about the difficulties of a parent bank, disclosure of which would hinder the restoration of confidence and might run the risk of assets being attached. Even in these circumstances, however, there may be situations where close liaison between parent and host authorities would be mutually advantageous. In any event, if, as a last resort, or as part of a rescue measure, a parent authority intends to close the parent office, it is essential that such action be communicated to, and coordinated with, the host supervisors of the foreign establishments so as to reduce the resulting disorder and disruption.

Banking Secrecy

National secrecy laws designed to protect the legitimate interests of bank customers may create an obstacle to the exchange of information about large or troublesome exposures. There is, in general, no impediment to the passage of information from foreign branches to the head office and thence to the parent authority, but the law in some host countries does not always allow the transmission of specific named-customer information from foreign subsidiaries to the parent bank. Although those difficulties relate primarily to deposit balances, there are a few significant banking centers where secrecy requirements also extend to asset balances. The same obstacles prevent a host supervisor from passing specific information of this kind of a parent supervisor. In either case, parent authorities would be unable to identify the location and size of particular exposures.

Host authorities in centers where banking secrecy laws are very stringent, and likely to remain so, should nonetheless seek to ensure that information on large or troublesome exposures concentrated in branches is transmitted to the head offices abroad and is thus made available in order to facilitate consolidated supervision. Where secrecy laws prevent the passage of information between supervisors, host authorities are encouraged to inform the parent authority if it comes to their notice that a foreign establishment has a large exposure which may threaten the soundness of the establishment—that is to say, they should notify the parent authority that close attention to a particular subsidiary is warranted. Countries where secrecy requirements prevent cooperation between supervisors in respect of asset balances are urged to review and amend their legislation. Parent authorities should reserve their right to refuse their banks permission to operate in centers from which adequate information is unobtainable.

The Role of External Auditors

Foreign establishments are often, in practice, beyond the reach of parent supervisors’ inspection systems and frequently are not subject to a formal inspection system in the host country. The external audit may, therefore, in practice be the only independent check on a bank. However, at present, not all foreign establishments of banks are subject to external audit. Furthermore, even where they are, the quality of external auditing may not always be sufficiently thorough to be reliable, and there are significant differences in the auditing standards applying not only between centers but also among different banks in the same center.

One approach, presently employed in some host centers with limited supervisory resources, is commended. This consists of making external audit by approved firms a condition of authorization and of using the external auditors to verify the accuracy of reporting returns or compliance with any special conditions. These procedures might usefully be adopted more generally, although it is important to define the responsibilities of both parties clearly when this is done. Supervisory authorities should also have the ability to communicate with banks’ external auditors, and vice versa. Tripartite meetings between the parties can provide useful insights and should be encouraged.

Supervisors should have a natural interest in the quality and thoroughness of audits; in the case of audits that are inadequately conducted, supervisors should be empowered to have the auditor replaced and to address criticism to the local representative body of auditors. As a means of raising auditing standards, it is suggested that the requirement for external audit should only be satisfied by the appointment of internationally qualified auditors experienced in the audit of banks.

IV. Conclusions

The Basle Committee’s recommendations for the implementation of the Concordat are intended to reinforce existing systems of reporting from foreign establishments to parent bank and to provide host and parent authorities with a framework that will facilitate the development of effective consultation and cooperation. In this spirit, the document seeks to extend, and give greater precision to, the principles developed in the Concordat and in previous work done on this subject by international supervisory bodies.

The central objectives of the Concordat are that no banking establishment, wherever located, should escape supervision and that that supervision should be adequate. With those objectives in mind, it is worth recalling the Concordat’s recommendation that “in cases where host authority supervision is inadequate the parent authority should either extend its supervision, to the degree that is practicable, or it should be prepared to discourage the parent bank from continuing to operate the establishment in question.”2 Difficulties, however, can often be overcome through consultation between the two authorities. Supervisory collaboration has developed considerably in recent years, but continuing efforts on the part of all supervisory authorities are necessary to ensure that the principles of the Concordat are fully translated into action.

Editor’s Note: The comment by William A. Ryback, which appears at the end of Chapter 17, includes observations on both Chapter 16 and Chapter 17.

*

The Revised Basle Concordat appears in Appendix I of this volume.

*

These issues are dealt with in the Supplement to the Concordat, which was issued in April 1990 and appears in Appendix I of this volume.