Gibraltar
Detailed Assessment Report of Observance of the Basel Core Principles

Gibraltar’s Detailed Assessment Report of the Observance of the Basel Core Principles is examined. The principal risks are reputational risk, both for the Gibraltar authorities and for the banks, as the bulk of the assets managed are off the balance sheet with the investment risk carried by the client. Credit risk is largely limited to residential mortgage lending and is heightened by the rapid rise in prices both in Southern Spain and in Gibraltar itself.

Abstract

Gibraltar’s Detailed Assessment Report of the Observance of the Basel Core Principles is examined. The principal risks are reputational risk, both for the Gibraltar authorities and for the banks, as the bulk of the assets managed are off the balance sheet with the investment risk carried by the client. Credit risk is largely limited to residential mortgage lending and is heightened by the rapid rise in prices both in Southern Spain and in Gibraltar itself.

I. Basel Core Principles

General

1. This assessment of the Basel Core Principles for Effective Banking Supervision (BCP) was carried in March 2006 by Peter Hayward (consultant, formerly Bank of England and International Monetary Fund (IMF)) and Jorge Mogrovejo, (consultant, Superintendency of Banks and Insurance, Peru) as part of a Module 2 assessment of the regulation and supervision of the Gibraltar financial sector at the request of the Gibraltar government. The Gibraltar Financial Services Commission (FSC) and its staff cooperated fully with the assessment and their assistance is gratefully acknowledged.

Information and methodology used for assessment

2. The assessment was based on the law applicable to the supervision of banks by the FSC, principally the Financial Services Commission Ordinance (FSCO), 1992 and the Banking Ordinance, 1992 (BO) and on Administrative Notices, Guidance Notes, Newsletters, and other written material supplied by the Commissioner and his staff. The assessors also read the report of a previous BCP assessment carried out as part of the first Module 2 assessment in 2001 as well as the statutory review published in January 2005. This review assessed regulation and supervision in terms of compliance with European Union (EU) legislation and the extent to which FSC practices match those of the U.K. supervisory authorities as required by the FSCO. The FSC staff also prepared a self-assessment of compliance with the BCP. The assessors met the Chief Minister, the Director of the Finance Centre, bankers, and external auditors as well as many of the staff of the FSC.

3. The assessment of observance of each of the Core Principles (CP) follows a qualitative approach and is based on the Core Principles Methodology Document of October 1999. The assessment method consisted of examining the degree of observance of each of a principle’s essential criteria and, where the assessors judged necessary, of the additional criteria, as well.

4. A principle will be considered compliant whenever all essential criteria are generally met without any significant deficiencies. There may be instances where a country can demonstrate that a principle is observed through different mechanisms. Conversely, due to the specific conditions in individual countries, the essential criteria may not always be sufficient to achieve the objective of the principle and, therefore, other measures (including any additional criteria) may also be deemed necessary by the assessor to judge that compliance is achieved. A principle will be consideredlargely compliant whenever only minor shortcomings are observed, which do not raise any concerns about the authority’s ability and intent to achieve full compliance with the principle within a prescribed period of time. A principle will be considered materially non-compliant whenever, despite progress, the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. A principle will be considered non-compliant whenever no substantive progress toward compliance has been achieved. A principle will be considered not applicable whenever, in the view of the assessor, the CP does not apply given the structural, legal, and institutional features of a country.

5. A separate Monetary and Financial Department (MFD)/Legal Department (LEG) team assessed Gibraltar’s compliance with the Financial Action Task Force (FATF) Recommendations for Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT). Their assessment, based on the latest version of the methodology, amplifies the assessment of CP 15 which is based on the 1999 methodology of the Basel Committee.

Institutional and macroprudential setting, market structure and overview

6. The banking sector consists of 18 banks with total assets of £6.7 billion ($11.7 billion) as of end-2005. Most of the banks are subsidiaries or branches of banks from other European countries, dominated by the United Kingdom with eight subsidiaries/ branches in Gibraltar. There is only one bank which is not foreign bank owned and this has shareholders in the investment business in a major European financial centre. No licensing distinction is made between banks conducting cross-border and local business. The majority of business in the small local market is done by two banking groups. A major portion of cross-border banking business is providing private banking services, mainly asset management, to Swiss based customers and to the expatriate community in Spain and Portugal. This includes the provision of residential mortgages to clients purchasing property in the region. Another important component of cross-border banking are services provided to nonresident trusts and companies which benefit from the exemption from Gibraltar’s relatively high corporate tax rate of 35 percent.1

7. The principal risks are reputational risk, both for the Gibraltar authorities and for the banks, as the bulk of the assets managed are off the balance sheet with the investment risk carried by the client. Credit risk is largely limited to residential mortgage lending and is heightened by the recent rapid rise in prices both in Southern Spain and in Gibraltar itself. Banks claim they are protected in the former by low loan/value ratios (typically 60-70 percent) and by the fact that banks normally manage substantial asset portfolios for borrowers. The price risk may be more acute in the small domestic market where competition is more intense and has led to higher loan value ratios at least for recent lending. No bank has a recognized trading book in Gibraltar and most treasury functions are carried out at head office which also typically manages liquidity. Thus market risks and liquidity risk are low. Investment advice is normally also based on head office analysis or services provided by specialist investment firms.

8. Banks have a competitive advantage over banks in other small financial centers in being able to provide services throughout the EU using the so-called “passport” arrangements. Although Spanish and Portuguese banks could compete with Gibraltar banks for business of expatriate residents of those countries they appear not to do so. Most clients have accounts with local banks for money transmission and general banking services, but local banks do not as yet offer significant competition for asset management and other private banking services. This business is therefore profitable and expanding. More typical business for tax exempt companies and trusts with non-resident owners and beneficiaries is normally introduced by local law firms and other service providers. While the tax exemption is dues to be phased out in order to comply with EU state aid rules, the business could survive if the new unified rate of corporate tax was not more than 10-15 percent.2

9. The FSC is a unified regulatory and supervisory authority for financial services. The FSC supervises the activity of banks, insurance companies, investment firms, collective investment schemes, and trust and company service providers. The FSCO requires that, since Gibraltar is considered as a part of the United Kingdom and, therefore, a constituent of the EU under the U.K. accession treaty, Gibraltar must ensure both that supervision complies with EU Directives, and that regulation and supervision in areas subject to EU supervisory legislative requirements match the standard of regulation and supervision in the United Kingdom. The statutory review mentioned in paragraph 2 above was designed to verify that the FSC met these obligations.

10. Under the FSCO the Commissioner is appointed by the Governor subject to the approval of the U.K. Secretary of State for Foreign and Commonwealth Affairs. The other members of the Commission are appointed in the same way but after consultation with the Commissioner.

General preconditions for effective banking supervision

11. The preconditions for effective supervision are in place. As a member of the EU since 1973, EU directives have been adopted and implemented in Gibraltar legislation. In addition all except one of the banks are branches or subsidiaries of major international banking groups subject to consolidated supervision by their home supervisory authority.

12. International Financial Reporting Standards (IFRS) were adopted for all EU listed companies effective January 2005. However some subsidiaries of listed companies still continue to use older accounting standards even though the consolidated accounts of the group to which they belong use IFRS. Limited liability companies are required to submit audited financial statements to the Registrar of Companies and are publicly available.

13. Company law, accounting, and auditing arrangements are generally based on EU requirements and U.K. law and practice. Gibraltar’s financial system and indeed its economy are small and there is little scope for differing from the U.K. model. Law enforcement is generally good and banks do not have difficulty in enforcing security on the rare occasions when they need to. Credit culture is also reported as strong with the incidence of default, especially in the local market reported as being exceptionally low.

Principle-by-principle assessment

Table 1.

Detailed Assessment of Compliance of the Basel Core Principles

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Table 2.

Summary Compliance of the Basel Core Principles

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C: Compliant.

LC: Largely compliant.

MNC: Materially non-compliant.

NC: Non-compliant.

NA: Not applicable.

Recommended action plan and authorities’ response to the assessment

Recommended action plan

Table 3.

Recommended Action Plan to Improve Compliance of the Basel Core Principles

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Authorities’ response to the assessment

14. The FSC welcomes the IMF’s assessment of its compliance against the BCP and thanks them for their skill and diligence in conducting the review

15. The assessment validates the hard work that the FSC has been conducting, particularly over the past years, in the area of banking supervision. The FSC is very proud with the team's assessment of the individual core principles but is particularly so in relation to the Risk Assessment Framework methodology designed and implemented by its staff and deployed across all of its supervisory functions.

1

Some banks also benefit from this exemption but in many cases this is offset by group tax arrangements in the home country.

2

A more damaging threat, regarded locally as extremely unlikely to materialize, arises from a case before the European Court of Justice, which could result in requiring Gibraltar to replicate completely the U.K. tax system.