Republic of Slovenia
Detailed Assessment of Observance of Basel Core Principles for Effective Banking Supervision

The Slovenian banking system has been transformed by Slovenia’s accession to the European Union. Banking sector regulation and supervision is generally in line with international standards. The global crisis affected Slovenia’s economy significantly, and most banks in the system were also affected adversely. The authorities have attempted to reduce the effects of the financial crisis with several countercyclical fiscal policy measures and a program to provide liquidity to the financial sector. Strengthening the financial condition of the banking system is the key priority.

Abstract

The Slovenian banking system has been transformed by Slovenia’s accession to the European Union. Banking sector regulation and supervision is generally in line with international standards. The global crisis affected Slovenia’s economy significantly, and most banks in the system were also affected adversely. The authorities have attempted to reduce the effects of the financial crisis with several countercyclical fiscal policy measures and a program to provide liquidity to the financial sector. Strengthening the financial condition of the banking system is the key priority.

I. Summary, Key Findings and Recommendations

1. Banking sector regulation and supervision is generally in line with international standards. Regulations are up to date, as BOS (BOS) has duly transposed EU banking directives and has incorporated many guidelines from the EBA and its predecessor organization into its legal framework. This has served to strengthen and expand the banking supervisory regime by harmonizing banking regulation in Slovenia with EU standards. A large amount of information is gathered and analyzed through on-site and off-site supervision, and the authorities generally demand prompt correction of routine deficiencies detected in supervised institutions. Nevertheless, there has been a failure in implementation of these standards and the supervisory process. Their implementation has not been fully effective, as reflected in the development of a real estate bubble and asset quality problems in the corporate sector.

A. Introduction

2. The original FSAP took place in 2001 and the update was conducted in 2003. The 2003 update undertook an assessment of compliance with the Basel Core Principles for Effective banking supervision based on the 1999 methodology. Based on that methodology, the assessment reflected good compliance overall, but identified weaknesses in several important areas, and a few principles were rated as materially non-compliant. The principle recommendations contained in the 2003 assessment were: (a) increase the risk focus of banking supervision; (b) strengthen supervisory capacity for consolidated supervision and monitoring of transfer risk and connected lending; and (c) considerably expand supervisory resources. The Principles assessed as materially non-compliant included those dealing with legal protection of the BOS and its staff, the definition of connected lending, and consolidated supervision.

3. Since then, the Slovenian banking system and the financial system more generally has been transformed by Slovenia’s accession to the European Union. In combination with the global economic crisis, which has adversely affected Slovenia’s economy, this FSAP update is warranted.

4. This Detailed Assessment of Observance Report was prepared as part of the FSAP Update mission to Slovenia, which took place April 2 – 16, 2012. The assessors were Bruno Estecahandy (Banque de France) and Joel Shapiro (formerly of the U.S. Federal Reserve). The FSAP Update also conducted a qualitative analysis of insurance supervision without making a comprehensive IAIS assessment and of securities market regulation without making a comprehensive IOSCO assessment. In addition, the FSAP Update reviewed the adequacy of the bank resolution and crisis management framework and updated implementation of recommendations from the 2009 Moneyval report on Slovenia’s anti-money laundering and counter-terrorist financing system. Extensive analysis was undertaken of vulnerabilities of the Slovenian financial system following the 2008-09 global crises and the uncertain global environment at the time of the assessment; the development of macro-prudential oversight and policies; and the crisis management system.

B. Information and Methodology Used for the Assessment

5. The assessment is based on several sources: (i) a comprehensive and critical self-assessment, received in March 2012; (ii) detailed interviews with staff from BOS and other government agencies on the current practice for on-and off-site supervision; (iii) reading of laws, regulations, and other documentation on the supervisory framework and on the structure and development of the Slovenian financial sector, including a questionnaire response prepared by the authorities; (iv) reading of anonymous supervisory materials provided to the assessors during the fieldwork in Slovenia; (v) meetings with other authorities; and (vi) meetings with the banking industry as well as others such as academics and representatives of the accounting and audit profession. Specifically, the assessment team held extensive discussions with: staff from the BOS and in particular its Banking Supervision Department (BSD), the Ministry of Finance, other government agencies including the Insurance Supervisory Agency (AZN), the Securities Market Regulatory Agency (ATVP), and with private sector participants in the banking and financial markets.

6. The assessor had the full cooperation from the Slovenian authorities and received all information necessary for the assessment. The team extends its thanks to the staff of the authorities for their participation in the process, their openness, and their hospitality, and to the private sector representatives with whom they had a chance to meet.

7. The assessment has been conducted in accordance with the guidelines described in the Core Principles (CP) Methodology published in October 2006 by the Basel Committee on Banking Supervision (BCBS). It assessed compliance with both the Essential and the Additional Criteria, but the ratings assigned were based on compliance with the Essential criteria only. The methodology requires that the assessment be based on (i) the legal and other documentary evidence; (ii) the work of the supervisory authority; and (iii) its implementation in the banking sector. Full compliance requires that all these three prerequisites are met. The guidelines allow that a country may fulfill the compliance criteria in a different manner from those suggested as long as it can prove that the overriding objectives of each CP are achieved. Conversely, countries may sometimes be required to fulfill more than the minimum standards, e.g., due to structural weaknesses in that country. The Methodology also states that the assessment is to be made on the factual situation of the date when the assessment is completed. However, where applicable, the assessors made note of regulatory initiatives, which have yet to be completed or implemented.

8. The assessment of compliance of each Principle should be made based on the following four-grade scale: Compliant, Largely Compliant, Materially Noncompliant, and Noncompliant. A “not applicable” grading can be used under certain circumstances.

  • Compliant – A country will be considered compliant with a Principle when all essential criteria applicable for this country are met without any significant deficiencies. There may be instances, of course, where a country can demonstrate that the Principle has been achieved by other means. 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 may also be needed in order for that aspect of banking supervision addressed by the Principle to be considered effective.

  • Largely compliant – A country will be considered largely compliant with a Principle whenever only minor shortcomings are observed which do not raise any concerns about the authority’s ability and clear intent to achieve full compliance with the Principle within a prescribed period of time. The assessment “Largely Compliant” can be used when the system does not meet all essential criteria, but the overall effectiveness is sufficiently good, and no material risks are left unaddressed.

  • Materially noncompliant – A country will be considered materially noncompliant with a principle whenever there are severe shortcomings, despite the existence of formal rules, regulations and procedures, and there is evidence that supervision has clearly not been effective, that practical implementation is weak, or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. It is acknowledged that the “gap” between “Largely Compliant” and “Materially Noncompliant” is wide, and that the choice may be difficult. On the other hand, the intention has been to force the assessors to make a clear statement.

  • Noncompliant – A country will be considered noncompliant with a Principle whenever there has been no substantive implementation of the Principle, several essential criteria are not complied with or supervision is manifestly ineffective.

  • In addition, a Principle will be considered not applicable when, in the view of the assessor, the Principle does not apply given the structural, legal and institutional features of a country.

9. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science; reaching conclusions require judgments by the assessment team. Banking systems differ from one country to another, as do domestic circumstances. Also, banking activities are changing rapidly around the world after the crisis and theories, policies, and best practices are rapidly evolving. Nevertheless, by adhering to a common agreed methodology, the assessment should provide the Slovenian authorities with an internationally consistent measure of quality of their banking supervision in relation to the 2006 Revision of the BCPs, which are internationally recognized as minimum standards.

10. For the sake of completeness, it should be noted that the ratings assigned during this assessment are not necessarily directly comparable to the ones assigned in terms of the FSAP performed using the pre-2006 BCP Methodology. Differences may stem from the fact that the bar to measure the effectiveness of a supervisory framework was raised by the 2006 update of the BCP Methodology, as well as by lessons drawn from the financial crisis that may have a bearing on supervisory practices.

C. Institutional and Macro-Prudential Setting and Market Structure

11. The main financial institutions are banks and insurance companies. There is a small securities market, but its size and importance relative to the economy has been declining, especially in the aftermath of the economic crisis. Banks remain the most important financial institutions in Slovenia, accounting for more than 75 percent of the assets of the financial system. A slight increase in the share of assets of non-bank financial institutions in 2011 was mainly due to deleveraging in the banking system and better relative performance of the insurance sector. Government controlled financial institutions dominate the system. The two largest banks and the largest insurance company belong to financial groups that are at least 50 percent directly or indirectly owned by the government. Government controlled banks account for around 55 percent of the financial system in terms of assets or capital. The overseas activities of Slovenian banks are located principally in other Balkan countries. Several foreign institutions have operations in Slovenia, mostly from France, Italy and Austria, but their overall market share is comparatively small.

12. Financial supervision responsibilities in Slovenia are shared among several agencies. The BOS and specifically its Banking Supervision Department supervises banks. BOS is responsible also for payments system oversight. ATVP oversees the securities sector, while AZN mainly deals with the insurance sector.

13. Cooperation among the supervisors occurs at various levels, from the top management level to more operational coordination among the supervisory agencies. At the top management level, the MOF participates with the supervisory agencies on approaches to macro-level issues. At the operational level, cooperation between the three supervisory agencies appears productive and effective relative to planning for on-site examinations and routine supervisory issues. Cooperative efforts between the agencies are governed by a series of multilateral and bilateral MOUs.

Recent Developments

14. The global crisis affected Slovenia’s economy significantly, and most banks in the system were affected adversely by the economic downturn. The performance of banks deteriorated markedly as a result of higher levels of non-performing loans in the corporate and real estate sector, particularly construction industry. As a result, the banking system reported operating losses in both 2010 and 2011. Since a significant amount of asset growth prior to the economic crisis was fueled by wholesale funding from abroad, both capital adequacy and liquidity came under some strain. Leasing companies, several of which are owned by banks, have been affected by economic conditions as well. As a group they reported operating losses attributable to high non-performing loans and lower levels of activity. Insurance companies have remained profitable.

15. The authorities have attempted to reduce the effects of the financial crisis with several counter-cyclical fiscal policy measures and a program to provide liquidity to the financial sector. Automatic stabilizers were allowed to work and a frontloaded 2.1 percent of GDP package of discretionary measures was implemented. The authorities supported liquidity to the financial sector by enhancing the deposit insurance scheme, placing government deposits with banks, and providing guarantees for bank’s bond issuances. Banks have also benefitted from access to ECB funding through the 3-year LTRO.

16. Strengthening the financial condition of the banking system is a key priority of the authorities at present. The 3 year LTROs have eased immediate liquidity pressures, but a structural adjustment is needed to reduce dependence on wholesale funding and to restructure bank balance sheets overall. Toward this end, a stronger capitalization of some banks would help avoid severe deleveraging and enable banks to provide credit for sound lending opportunities. Further write-downs of non-performing loans will have to be recognized in connection with bank restructuring. The operations of the government controlled banks will have to become more commercially oriented as well.

D. Preconditions for Effective Banking Supervision

Sound and sustainable macroeconomic policies

17. Slovenia has a solid institutional framework supporting the conduct of sound macro-economic policies. Monetary policy is conducted by the bank of Slovenia within the ESCB framework. Budgetary policy is conducted within a fiscal framework based on the requirements of the EU’s Stability and Growth Pact. The recent financial crisis has put pressure on financial stability and the budgetary situation in Slovenia. Measures have been taken to ensure that the budget remains on a sustainable path. However, considerable adjustment still needs to be made.

A well-developed public infrastructure

18. The Slovenian legal framework for the financial sector is comprehensive and regularly updated. The EU’s compendium of laws and regulations have been fully adopted and implemented relative to the financial sector. For banks, these are reflected in the major legislation affecting these institutions, including the Banking Act and attendant regulations, and the Companies Act.

19. Auditing and accounting rules applicable to financial institutions comply with international standards. All banks, insurance companies and listed companies have implemented IFRS. Disclosure and reporting requirements also are strict, and adhere to EU requirements as well.

20. The Slovenian legislative framework with regard to the audit profession requires internal and external auditors to be independent in both fact and appearance. The Banking Act requires the appointment of an internal auditor and an external auditor in a bank, and stipulates the governance of these auditors, who are subject to specific sections of the Audit Act relative to professional standards. The Agency for Public Oversight of Audit assures the independence of external auditors, including qualification requirements. The Agency also serves as a self-regulating body for the audit profession.

21. The judicial system, including that for bankruptcy and the enforcement of property rights, is well developed. However, the legal background and regulatory and institutional framework dealing with banks in a weak or deteriorating financial condition, as stipulated in the Banking Act, is inadequate. BOS needs a more effective set of bank resolution regulations and tools.

22. BOS participates in the Trans European Automated Real-Time Gross Settlement Express Transfer 2 (TARGET2), the Real Time Gross Settlement of the Eurosystem. BOS operates the national component of TARGET2, which is the most important payment system in Slovenia. It enables the settlement of transactions between members of the system, and cross-border transactions with members of TARGET2 system outside Slovenia. The number and value accounted for by the latter are relatively small.

Effective market discipline

23. Competition is encouraged and the market is open to foreign participants. There are no significant non-prudential barriers to entry by domestic or foreign firms. Indeed, accession to the EU has encouraged and facilitated market openness.

24. Financial reporting and disclosure requirements for financial institutions listed on capital market indices in Slovenia or other member states of the EU that operate in Slovenia are very strict. BOS requires detailed disclosures to the public in annual and quarterly financial statements, and in the management review (business report), the supervisory board’s report, and statements or opinions from the directors, management or the external auditor.

25. The corporate governance of financial institutions in Slovenia is governed by the Companies Act and the Audit Act. In addition, sectoral legislation has been introduced to regulate the operation of each financial sector. For example, the Banking Act and accompanying regulations have provisions addressing corporate governance requirements for the banking system. Similar legislation addresses certain requirements in this regard for the insurance industry, the securities market and pension funds.

Public safety nets

26. Slovenia has a deposit guaranty scheme that in effect insures depositors with funds on account in a bank aggregating Euro 100,000. The scheme is administered by BOS, and can be utilized in the event a bank is declared bankrupt in accordance with current bankruptcy laws contained in the Banking Act. To date, the scheme has not been utilized.

Legal framework for supervision

27. The Slovenian legal framework for banking supervision is comprised principally of the Banking Act and attendant defining regulations. Other legislation of importance includes the Companies Act, the Conglomerates Act and the Audit Act, each of which contains provisions that round out and provide a comprehensive regulatory and supervisory structure. To implement prudential requirements, BOS employs defining regulations on specific areas ranging from capital adequacy to risk management practices.

E. Main Findings1

28. Objectives, independence, powers, transparency and cooperation (CP1): There is a generally comprehensive set of laws and regulations governing the supervision of the banking industry. BOS is autonomous both from a de jure and de facto perspective, although government policies and priorities act as an impediment to the robust supervision of the government controlled banks. The legal framework does not indemnify bank supervisors against damages resulting from the discharge of their responsibilities, nor does it provide protection against the costs of defending acts of commission or omission of their duties in good faith. Banking supervision is understaffed, and this problem could inhibit the ability of the BSD to achieve its mission and perform its responsibilities in a satisfactory manner.

29. Licensing and structure (CPs 2-5): The legal framework is clear relative to the types of banking and non-banking activities in which banks may engage. While there are few license applications, the legal framework, policies and processes are in place to evaluate the application of a bank license. The transfer of ownership is well defined in the law, and there are explicit definitions for controlling interests. The conditions for the acquisition of non-bank financial institutions are not contained in the law, and in fact, banks are permitted to acquire such institutions without regard to review or approval by BOS at present. The authorities are contemplating legislation to correct this gap in the legal framework.

30. Prudential regulation and requirements (CPs 6-18): The capital adequacy framework is based on international standards in accordance with EU directives. The entire Basel II regimen has been introduced into the legal framework in this manner. While BOS has established minimum capital requirements and has the capacity to require additional capital as warranted, the legal framework enables the shareholders of an institution to forestall the raising of additional capital. Virtually all major banking risks are subject to close scrutiny. The evaluation of risk management practices is generally adequate, but many banks have not yet fully developed satisfactory risk management systems in all aspects of their operations. Areas for improvement include certain aspects of credit risk management, particularly with respect to the reporting of problem assets and loan loss reserves. The reporting of problem assets lacks granularity, and the provisioning on NPLs stands at only 41 percent. As a result, there is a strong possibility that impaired assets are under-reserved. Other risks warranting some improvement include internal controls, liquidity risk, operational risks and monitoring of related parties exposures.

31. Methods of ongoing banking supervision (CPs19-21): BOS has implemented a risk-based approach to supervision. BSD has built a robust supervisory approach featuring a strong ICAAP-SREP program and RAS methodology. There also is a good mix of on-site and off-site supervision, with an extensive level of communication and cooperation between the two groups. There is an extensive set of reporting requirements for banks that provides a wide range of data and risk management information, both on a consolidated and unconsolidated basis. Appropriately, the information is used in the supervision process to evaluate risk and for other objectives. However, there are gaps in the information collected. Non-bank financial institutions are not required to file financial information on a solo basis, and the data collected on related parties is incomplete.

32. Accounting and disclosure (CP22): Disclosure requirements are very strict, and external auditors are employed to ensure that disclosure rules are adhered to. The auditing profession is held to high standards in law and practice by BOS, but it is self-regulating. BOS is not empowered to approve the external auditing firm that is retained by a bank. The banking system prepares its accounting records and reports financial information in accordance with IFRS.

33. Corrective and remedial powers (CP23): BOS has a satisfactory range of enforcement tools at its disposal to address supervisory issues. However, these may be impeded by shareholder rights relative to requirements to increase capital, and lack of power in the law to remove unqualified members of a supervisory board. The powers and strategies concerning the resolution of a problem bank are in need of strengthening.

34. Consolidated and cross-border banking supervision (CPs24-25): BOS has developed an overall satisfactory program of consolidated supervision. Supervisors are aware of the organizational structure of banking groups, have identified areas of risk, and maintain contact with other foreign bank supervisors and domestic authorities, principally through supervisory colleges. The program can be strengthened by focusing additional supervisory attention on non-bank financial companies, enhancing the understanding of related party interests throughout a banking group, and monitoring transactions with affiliated companies in a mixed activity company.

Table 1.

Slovenia: Summary Compliance with the Basel Core Principles

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Recommended action plan and authorities’ response

Recommended action plan

35. Table 2 summarizes the recommendations formulated in the course of the assessment. Some recommendations are included under core principles that are rated as fully compliant.

Table 2.

Slovenia: Recommended Action Plan to Improve Compliance with the Basel Core Principles

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Authorities’ response

36. BOS generally agrees with the key findings and recommendations from the BCP Assessment. However, the assessed consequences of identified weaknesses in implementation of BCP in Slovenia are in our view disproportionate to a certain extent. Even highly effective banking supervision could not prevent the consequences of the financial crisis the Slovenian banking sector and corporate sector are facing. Additionally, we have reservations towards those recommendations requiring regulatory or other activities in areas which are immaterial for Slovenian banks (e.g. requirement to collect data from non-bank financial companies on a solo-basis). As the principle of proportionality is one of the core principles in banking supervision, it should also be reflected in the recommendations.

37. BOS has already prepared an action plan for the implementation of recommendations to improve compliance with the BCP and, at the same time, proposed to the Ministry of finance several amendments of the Banking Act, including provisions on:

  • - legal protection of the Banking Supervision staff,

  • - BOS’s authority to licence supervisory board members and the acquisition of non-financial institutions,

  • - broader BOS’s powers to require a bank to increase its capital, while at the same time not allowing bank’s shareholders to impede this procedure, and

  • - introduction of new resolution tools as the basis for the future resolution regime.

38. Legislative power however lies with the Parliament which is empowered to endorse the abovementioned proposed amendments to the legal acts in the area of banking which are a necessary precondition for more effective banking supervision.

39. BOS is committed to implement the aforementioned action plan, also in cooperation with other relevant authorities, and will strive for an even more proactive and forward looking approach to banking supervision in the future. Nevertheless, strengthening the financial condition of the banking system is a key priority of all Slovenian authorities at present.

Detailed Assessment of Compliance with the Basel Core Principles

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