Switzerland
Detailed Assessment of Compliance-Basel Core Principles for Effective Banking Supervision
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International Monetary Fund. Monetary and Capital Markets Department
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This Detailed Assessment of Compliance on the Basel Core Principles for Effective Banking Supervision on Switzerland discusses that significant portions of guidance and legislation related to qualitative risk management and control standards are not as detailed or comprehensive as in many other major countries and need to be updated and selectively strengthened. Supervisory risk assessments and guidance to auditors, as the extended supervisory arm of the Swiss Financial Market Supervisory Authority (FINMA), need to be further materially improved, beyond what is now envisioned. Additional skilled resources within FINMA are necessary to meet these goals and to conduct more on-site supervisory work. The responsibilities and objectives of FINMA that emphasize protecting creditors, investors and insured persons, as well as ensuring proper functioning of the financial market, should be clearly stated in legislation as pre-eminent. It is recommended to increase FINMA resources, especially for on-site inspection and risk expertise. Clarify and limit the cases in which the Board can become involved in supervisory decisions and improve conflict code.

Abstract

This Detailed Assessment of Compliance on the Basel Core Principles for Effective Banking Supervision on Switzerland discusses that significant portions of guidance and legislation related to qualitative risk management and control standards are not as detailed or comprehensive as in many other major countries and need to be updated and selectively strengthened. Supervisory risk assessments and guidance to auditors, as the extended supervisory arm of the Swiss Financial Market Supervisory Authority (FINMA), need to be further materially improved, beyond what is now envisioned. Additional skilled resources within FINMA are necessary to meet these goals and to conduct more on-site supervisory work. The responsibilities and objectives of FINMA that emphasize protecting creditors, investors and insured persons, as well as ensuring proper functioning of the financial market, should be clearly stated in legislation as pre-eminent. It is recommended to increase FINMA resources, especially for on-site inspection and risk expertise. Clarify and limit the cases in which the Board can become involved in supervisory decisions and improve conflict code.

Executive Summary, Key Findings and Recommendations

Switzerland has recently made major enhancements in the practice of banking supervision and now has a high level of compliance with the Basel Core Principles for Effective Banking Supervision (BCPs). Not all the results of improvement to date are embedded in the system or yet observable. The Swiss banking system is very large relative to the size of the economy, conducts significant transactions with non-residents, and contains two G-SIFIs with large international operations and a number of banks that are systemically important in domestic terms. The sector faces a number of challenges to parts of its business model as expectations related to transparency and tax authorities increase. Major Swiss banks are also adjusting to the new international prudential standards. More recently, several material issues have arisen in domestic or cross-border markets that have indicated weaknesses in controls or practices that are being dealt with by banks and the authorities. Given the nature of the Swiss banking system and its importance to the country and globally, it is essential that the supervisory system meet the highest standards for effectiveness. To reach that goal, Swiss authorities need to go farther along the path they have already started and aim for a higher level of intensive supervision.

Significant portions of guidance and legislation related to qualitative risk management and control standards are not as detailed or comprehensive as in many other major countries and need to be updated and selectively strengthened. Supervisory risk assessments and guidance to auditors, as the extended supervisory arm of the Swiss Financial Market Supervisory Authority (FINMA), need to be further materially improved, beyond what is now envisioned. Additional skilled resources within FINMA are necessary to meet these goals and to conduct more on-site supervisory work. The assessors saw many examples of high quality initiatives and practices in FINMA. The model of using auditors is understandable given the structure of the Swiss banking system to multiply FINMA expertise and take advantage of auditor’s global networks, but needs to be handled carefully. Switzerland has one of the most principles based approaches to rules and guidance among major countries. It remains considerably focused on capital and liquidity metrics, and less focused than necessary on qualitative elements of risk management and robustness of internal controls. The recommendations in this report would add to the effectiveness of supervision, would increase FINMA’s ability to assess the quality and completeness of information coming from auditors, and would put more incentive on auditors to perform in a better and more consistent manner. FSAP assessments focus solely on whether the core principles are met in practice, and take no position to endorse or otherwise a country’s basic supervisory approach.

Responsibilities, objectives and powers (CP1)

The responsibilities and objectives of FINMA that emphasize protecting creditors, investors and insured persons, as well as ensuring proper functioning of the financial market, should be clearly stated in legislation as pre-eminent. The objectives currently indicate that it is through this approach that the competitiveness of the Swiss financial sector is to be achieved. Such a formulation risks misinterpretation as to what FINMAs objectives are. Currently, there are moves in the federal parliament to elevate promoting competitiveness of the financial sector as a separate objective with equal status to FINMAs existing prudential and market mandate. Changes of this nature would risk confusing the purpose of banking regulation and supervision and would not be consistent with the Basel Core Principles (BCP).

There is a legal framework in place that is highly principles-based. As noted in several CPs, additional qualitative rules, guidance or supervisory methodology should be put in place in selected areas to meet the BCP. While FINMA uses its general authority to make up for deficiencies, experience elsewhere shows this may not be sufficient in times of stress. Without more detailed guidance, the criteria for regulatory auditors assessment is not sufficiently clear. That reduces the effectiveness of the regulatory audit and reduces FINMA’s ability to judge what the regulatory audit is really accomplishing. FINMA has recently updated several regulations and guidance. Nevertheless, there are other areas where regulations (ordinances) and FINMA guidance either need to be enhanced with respect to qualitative standards, or where FINMA rules need to make explicit reference to international principles as the standards that they expect banks to meet and regulatory auditors to assess against. FINMA is rightly sensitive that guidance appropriate for international banks should not apply to smaller banks. There are ways to deal with this proportionality challenge while still enhancing clarity of supervisory expectations.

Independence, accountability, resourcing and legal protection for supervisors (CP2)

FINMA has limited on-site and off-site supervisory resources that have been increased in recent years, but are now subject to a self-imposed headcount cap, which should be relaxed. Resources of FINMA are too little to supervise and regulate the entire banking system in a way that meets the core principles, including sufficient in-depth on-site work, and oversight of supervisory work done by external auditors, particularly for medium and small banks. This is contributing to shortcomings in supervision and regulation, and weak practical implementation in certain areas, as described in various CPs. FINMA’s adherence to a head-count freeze, that it has decided upon, needs to be relaxed to achieve compliance.

FINMA has well established operational independence, which is enshrined in legislation. Accountability arrangements are to the Federal Council through the federal Minister of Finance. FINMA is governed by an executive reporting to a board which plays more of an oversight role, though it has authority for FINMA guidance in circulars, and general authority to involve itself in any individual supervisory decision. The recently published rules addressed a problem that Board members were not precluded from also having certain positions in the financial sector. More clearly delineating and limiting the FINMA Board’s ability to be involved in individual decisions could enhance sound governance and ability to attract Board members. Current moves in Parliament require the Federal Council to transfer FINMA’s power to set general Pillar 2 capital buffers to the Council. These changes should either not be proceeded with, or the legislation should indicate that the Council’s Pillar 2 power will be exercised only on the formal advice of FINMA.

Cooperation and collaboration (CP3)

There is a well-developed framework for cooperation on prudential matters between FINMA, the Swiss National Bank (SNB), and the Federal Department of Finance, and between FINMA and other prudential supervisors internationally that are important to FINMA. This consists of MOUs domestically and combinations of MOUs and other arrangements internationally. These are important to FINMA’s effectiveness given the significant international structure of a number of major banks. Assessors reviewed evidence of these arrangements working effectively in practice during the course of the mission

Permissible activities, licensing, transfers of ownership, major acquisitions (CPs 4-7)

FINMA has a well-developed system of ensuring that permissible activities, as required by law, are only conducted by authorized banks, and the licensing process is actively used to provide notification of, and control the extent of, bank’s activities. FINMA takes action to shut down unlicensed banking activities, or those holding themselves out to be licensed who are not, including on the internet. Banks are required during licensing to have their internal corporate documents specify their high-level organization structure, and the business lines and geographies they intend to pursue. Changes in these require FINMA notification and approval, which triggers an assessment by FINMA of the bank’s ability to conduct the new business, or in a new country, with appropriate risk management and controls.

For transfers of ownership, FINMA has a well-developed regime that is based on notification and approval requirements well before changes in control. FINMA reviews are extensive including fit and proper requirements, beneficial ownership, business plans, and related matters. FINMA has a well-developed ability to assess the capability of foreign supervisors’ regimes and exercises due care in approving foreign acquisitions. But the scope of what entities are included in the definition of those able to significantly influence a bank’s activities, and who therefore have to be approved as owners, is less clear than desirable.

Supervisory approach, supervisory tools, supervisory reporting, corrective and remedial powers (CPs 8–11)

Switzerland has a unique supervisory process involving a mix of FINMA resources and extensive resources of audit firms doing regulatory audits on FINMA’s behalf. FINMA has materially enhanced supervisory processes and practice in the past three years to address identified deficiencies and the new intensity expected post the financial crisis. This welcome development is necessary and beneficial. The new process requires audit firms to be more forward looking and effective in their work, adds capability for FINMA to do more supervisory work itself, and enhances FINMA interventions. Assessors saw evidence of how that process is working in practice.

However, that process only started to be implemented recently, certain of the impacts were not able yet to be observed by assessors, and the quality and depth of that process and the oversight and direction of auditors work by FINMA need to be further enhanced to meet international standards. In particular, risk assessments that drive the supervisory process should be made more consistently forward looking, more granular and thus more useful for the larger and mid-size banks, and more consistent across audit firms. Revisions to risk analysis methodology to improve granularity are planned. ‘Deep dive’ onsite work by FINMA should be increased in frequency and depth, selectively assessing the quality of various risk management governance and internal control systems on a proactive rather than reactive basis. That would complement FINMAs excellent work on quantitative capital and liquidity-related matters for larger banks. This will require materially more resources at FINMA. This will also require more ability for FINMA off-site staff to direct, monitor and compare during the supervisory cycle the audit work being done on their behalf. FINMA will also need more resources to participate periodically in the regulatory work of audit firms for major banks, especially in assessments in international locations, to assure themselves of its quality. This includes selective participation in ‘deep dive’ work done by the firms for FINMA. They should also participate more frequently in foreign supervisory reviews of the major Swiss banks. FINMA itself should conduct more theme reviews in areas where it, rather than regulatory auditors, is best placed to do so, because of expertise or because it “sees” the whole sector.

FINMA makes extensive use of its general corrective and remedial powers to achieve prudential results. FINMA has especially used Pillar 2 add-ons as a supervisory tool. Experience with FINMA supervisory requirements and recommendations, is that they are treated very seriously by licensed banks. FINMA has experience in closing smaller institutions, and has progressed in recovery and resolution planning for its two largest banks. For enforcement of prudential matters for banks, the fact that FINMA does not have power to fine institutions is not a serious problem. If having that power meant that standards of proof in enforcement matters were raised, that could reduce the effectiveness of the current system.

Consolidated supervision and home-host relations (CP12–CP13)

FINMA consolidated supervision is of high quality, but the legal framework should be enhanced to support such supervision. The legal framework does not apply all powers available at the level of the bank to the holding company in banking or conglomerate groups. FINMA is, however, able to achieve its goals indirectly in those cases. Experience in other jurisdictions suggests that, in extremis, the power to act at the level of the individual institution may not be enough to achieve group-wide results. As a preventative measure, the law should be strengthened to allow interim and permanent enforcement decrees to be applied at the holding company level.

FINMA has a well-established and effective network of home-host relations for prudential matters. This is based on a network of MOUs and other bilateral relations. Communication and coordination with the U.K. and U.S. is particularly close, given the operations of the major Swiss banks in those jurisdictions. Work in crisis management colleges on recovery and resolution plans is proceeding. The BCP assessment did not consider the state of international information sharing or cooperation on conduct of business or enforcement matters, which are outside the BCP methodology.

Board of directors (CP14)

FINMA practice in the governance area is evolving as is the case with other supervisors and assessment of governance effectiveness should be improved. Interaction with boards of major institutions is extensive. However, the level of banking and risk expertise in boards of a range of mid-size institutions appears to be less than desirable, as does the prevalence of separate risk committees. Guidance is incomplete, but could easily be updated to add more specificity and reference international standards. FINMA plans to revise relevant circulars in 2014. There is room to formalize and enhance practice of assessing boards by FINMA and/or by external auditors.

Risk management (CP15)

FINMA generally has high expectations of banks’ risk management. However the comprehensiveness of qualitative guidance in certain areas should be improved and updated or explicit reference should be made to Basel texts. Guidance to banks and/or auditors should be put in place re enterprise-wide risk measurement and risk management. This would enhance institutions’ understanding of FINMA expectations, and would also enhance the extent to which regulatory audits are appropriately addressing the right things. More domestic systemically–important mid-size banks should elevate the position of CRO to be a full executive board member, and more mid-size domestically systemic banks should be required to have a separate board risk committee and interact more regularly with the risk function. FINMA should review thematically risk appetite frameworks and capital planning and related stress testing across mid-size banks, building on the general approach to mortgage stress testing they have recently done.

Capital adequacy (CP16)

Switzerland has a robust capital adequacy framework fitting with its strategy to be an early adopter of new Basle rules without exceptions, and to provide significantly higher requirements on too big to fail banks. New requirements based on Basel III rules have become effective in 2013, and are assessed as consistent with the Basel rules by BCBS. The old standardized approach for domestic banks will be phased out in a few years. Substantially higher capital requirements are imposed on the largest banks including core capital and bail-in instruments. Lesser levels of Pillar 2 add-ons are also required of the other banks except the smallest ones. Such a framework ensures that Swiss banks will continue to have very high capital adequacy ratios. The number of banks using advanced approaches is limited, but FINMA has a robust framework to assess and validate models and methods used by banks for these approaches. The recent Parliamentary initiative to bring FINMA’s power to require Pillar 2 add-ons to a group of banks to the Federal Council and to potentially set the maximum amount to be charged would be counterproductive for the safety of the banking system.

Credit risk and problem assets (CP 17-CP18)

FINMA qualitative rules and guidance re credit risk management and provisioning are not fully comprehensive or as detailed as in many jurisdictions. However, the supervisory and auditing process fills gaps, is comprehensive and allows FINMA to understand the quality of credit risk management and satisfy itself as to the adequacy of provisions. Some improvements to guidance and instructions to regulatory auditors could be made to ensure that their work is focusing consistently on credit risk management across the full range of banks and audit firms involved in regulatory audits. No issues were identified with respect to provisioning policies or approach.

Concentration risk and large exposures (CP19)

Rules, guidance and/or instructions to regulatory auditors need to be expanded to ensure that relevant concentrations are picked up appropriately in banks’ risk management processes and are supervised correctly by statutory auditors on FINMAs behalf. Assessments of other forms of concentration risk should be conducted by FINMA under an enhanced stress testing program. Requirements for statutory auditors to express an opinion of concentration risk have only recently been clearly articulated. Assessment of concentrations beyond single name credit concentrations, such as concentrations resulting from possible system-wide stress events, or concentrations of funding, are better addressed by FINMA rather than by external auditors, given the skills and system-wide view needed for such assessments. That should occur through active use of stress and scenario testing and should be built on the efforts made by FINMA to date. Major banks appear to run relatively sophisticated approaches, but beyond single-name exposure verification, they have not been assessed comprehensively by the supervisory process.

Transactions with related parties (CP20)

The definition of what constitutes a related party, and the requirements for dealings with related parties to be at market terms and conditions, and for board oversight, need to be updated. Major problems in this regard have not been identified, but the current rules and guidance have a potential to miss transactions that should be caught, thus unnecessarily undermining the reputation of the system. Reporting of related party transactions to the supervisor should also be brought in line with international standards. The updated framework, possibly in a circular, should explicitly cover a full range of transactions, and stipulate requirements for policies and processes for managing the related risk. Guidance should be clearer that these are expected to be at market terms and conditions, and provide reporting requirements on aggregated related party exposures to the supervisor.

Country and transfer risk, market risk and interest rate risk in the banking book (CP21–23)

Assessors reviewed rules and guidance applying to country and transfer risk, market risk and interest rate risk and believe that it sufficiently meets Core Principle requirements. Discussions with major banks indicated, as expected, generally sophisticated approaches to these risks. Country risk and market risk is generally much less for mid-size and smaller banks. Even mid-size and smaller banks, for whom interest rate risk can often be a major issue to be managed, showed a degree of awareness and ability to manage the risk that is necessary. Supervisory practice should be enhanced, including FINMA thematic reviews on these risks (for relevant mid-size and smaller banks), but that is part of the more general issue raised in other CPs.

Liquidity risk (CP24)

FINMA has enhanced liquidity quantitative information gathering (LCR reporting from mid- 2013) and has updated liquidity risk guidance in progress that reflects international standards and enhances qualitative guidance for all banks. This circular will be in place at the beginning of 2014. However, application of its elements to smaller banks could be broadened, such as the requirement for diversification of funding structure. Quantitative requirements for large banks are of high quality but those for other banks are outdated. The authorities’ current plan to implement LCR according to the agreed international schedule will provide a substantial improvement.

Looking forward, it is essential for FINMA to have close dialogue with mid-size and smaller banks as well as regulatory auditors to set expectations for implementation and supervisory assessment of liquidity risk. FINMA needs to monitor to minimize the risk that the proportionality argument is used by these banks to apply qualitative liquidity requirements in an insufficient manner. FINMA should conduct a thematic review of the new circular after a few years and revise it, and supervisory instructions to auditors, to reflect lessons learned.

Operational risk (CP25)

The current regulatory framework on operational risk has limited application of basic qualitative requirements, and lacks requirements on operational risk regarding information systems. FINMA’s supervisory rating system should explicitly incorporate operational risk to aid in this risk getting more strategic focus. Operational risk may be the primary risk for banks specializing in asset or wealth management, and is increasing in relative importance at the largest banks. Changing the rating system would have the benefit of giving operational risk more priority overall in the FINMA supervisory approach, which is appropriate given the strategic orientation of Swiss banks. There is also absence of clear expectations of reporting of operational risk related incidents to the supervisor, with the exception of the two large banks. Given the importance of operational risk in the country, it is also important for FINMA to assess common risk factors in the operational risk area in a proactive manner. Based on the assessment, FINMA should conduct thematic supervisory reviews by itself from time to time. This will require additional resources.

Internal controls and audit, financial reporting and external audit, disclosure and transparency (CP26–CP28)

FINMA has a well-developed focus on internal controls and audit, which is understandable and necessary given its supervisory approach. Regulatory auditors are in a good position to judge the effectiveness of internal audit. FINMA also focuses on this directly, and through regulatory audit, and intensity has increased recently. Recent highly-publicized breakdowns related to compliance at a number of banks have, in some cases, been related to fraudulent behavior which supervision cannot fully prevent, but ex-post FINMA reviews have found that significant control weakness at banks contributed to the matters not being detected sooner. The supervisory approach as regards qualitative risk management and controls needs to be ramped up proactively to reduce the risk of serious breakdowns. This is part of a more general issue of supervisory approach that is assessed under CP8/9.

Use of Swiss GAAP is prevalent (outside the largest banks), but Swiss GAAP is similar or more conservative generally than IFRS. Disclosure obligations of Swiss GAAP are generally less than for IFRS. However in the banking sector additional Pillar 3 disclosure requirements are applied. The recent regulatory capital review found Switzerland complying with Pillar 3 disclosure requirements of the Basel capital rules.

Abuse of Financial Services (CP29)

The Swiss regulatory framework regarding abuse of financial services is well developed and the banks’ compliance against it is rigorously checked through significant work done by external auditors and FINMA. Laws and regulations provide comprehensive and very detailed requirements to prevent abuse of financial services, in particular in regards to AML/CFT issues. Not only banks’ adherence to these requirements is subject to annual regulatory audits by external auditors, which in turn reviewed by FINMA, but also the supervisor itself has carried out on-site reviews on the issue from time to time.

Introduction

1. This assessment of the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in Switzerland has been completed as a part of a Financial Sector Assessment Program (FSAP) update undertaken by the International Monetary Fund (IMF) during 2013. It reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. It is not intended to represent an analysis of the state of the banking sector or crisis management framework, which have been addressed in the broader FSAP exercise.

2. An assessment of the effectiveness of banking supervision requires a review of the legal framework, and detailed examination of the policies and practices of the institution(s) responsible for banking regulation and supervision. In line with the BCP methodology, the assessment focused on banking supervision and regulation in Switzerland and did not cover the specificities of regulation and supervision of other financial intermediaries, which are covered by other assessments conducted in this FSAP.

3. The Swiss authorities agreed to be assessed according to the Revised Core Principles Methodology issued by the BCBS (Basel Committee of Banking Supervision) in September 2012. This assessment was thus performed according to a significantly revised content and methodology as compared with the previous BCP assessment carried out in 2002 which was conducted under the first BCP methodology.1 It is important to note that this assessment cannot and should not be compared to the previous undertaking, as the revised BCP have a heightened focus on risk management and its practice by supervised institutions and its assessment by the supervisory authority, raising the bar to measure the effectiveness of a supervisory framework (see box for more information on the Revised BCP).

4. The Swiss authorities also chose to be assessed and rated against the Essential and Additional Criteria. In order to assess compliance, the BCP Methodology uses a set of essential and additional assessment criteria for each principle. The essential criteria (EC) were usually the only elements on which to gauge full compliance with a CP. The additional criteria (AC) are recommended best practices against which the Swiss authorities have agreed to be assessed and rated.2 The assessment of compliance with each principle is made on a qualitative basis. A four-part grading system is used: compliant; largely compliant; materially noncompliant; and noncompliant. This is explained below in the detailed assessment section. The assessment of compliance with each CP is made on a qualitative basis to allow a judgment on whether the criteria are fulfilled in practice. Effective application of relevant laws and regulations is essential to provide indication that the criteria are met.

The 2012 Revised Core Principles

The revised BCPs reflect market and regulatory developments since the last revision, taking account of the lessons learnt from the financial crisis in 2008/2009. These have also been informed by the experiences gained from FSAP assessments as well as recommendations issued by the G-20 and FSB, and take into account the importance now attached to: (i) greater supervisory intensity and allocation of adequate resources to deal effectively with systemically important banks; (ii) application of a system-wide, macro perspective to the microprudential supervision of banks to assist in identifying, analyzing and taking pre-emptive action to address systemic risk; (iii) the increasing focus on effective crisis preparation and management, recovery and resolution measures for reducing both the probability and impact of a bank failure; and (iv) fostering robust market discipline through sound supervisory practices in the areas of corporate governance, disclosure and transparency.

The revised BCPs strengthen the requirements for supervisors, the approaches to supervision and supervisors’ expectations of banks. The supervisors are now required to assess the risk profile of the banks not only in terms of the risks they run and the efficacy of their risk management, but also the risks they pose to the banking and the financial systems. In addition, supervisors need to consider how the macroeconomic environment, business trends, and the build-up and concentration of risk inside and outside the banking sector may affect the risk to which individual banks are exposed. While the BCP set out the powers that supervisors should have to address safety and soundness concerns, there is a heightened focus on the actual use of the powers, in a forward-looking approach through early intervention.

The number of principles has increased from 25 to 29. The number of essential criteria has expanded from 196 to 231. This includes the amalgamation of previous criteria (which means the contents are the same), and the introduction of 35 new essential criteria. In addition, for countries that may choose to be assessed against the additional criteria, there are 16 additional criteria.

While raising the bar for banking supervision, the Core Principles must be capable of application to a wide range of jurisdictions. The new methodology reinforces the concept of proportionality, both in terms of the expectations on supervisors and in terms of the standards that supervisors impose on banks. The proportionate approach allows assessments of banking supervision that are commensurate with the risk profile and systemic importance of a wide range of banks and banking systems.

5. The assessors reviewed the framework of laws, rules, and other materials provided and held extensive meetings with officials of the Swiss Financial Market Supervisory Authority (FINMA), and additional meetings with auditing firms, and banking sector participants. The authorities provided a self-assessment of the CPs, as well as responses to additional questionnaires, and provided access to supervisory documents and files, staff and systems.

6. The assessors appreciated the cooperation received from the authorities. The team extends its thanks to staff of the authorities who provided cooperation, including provision of documentation and access, at a time when staff was burdened by many initiatives related to global regulatory changes and changes in Swiss supervisory processes.

7. The standards were evaluated in the context of the Swiss financial system’s structure and complexity. The CPs must be capable of application to a wide range of jurisdictions whose banking sectors will inevitably include a broad spectrum of banks. To accommodate this breadth of application, according to the methodology, a proportionate approach is adopted, both in terms of the expectations on supervisors for the discharge of their own functions and in terms of the standards that supervisors impose on banks. An assessment of a country against the CPs must, therefore, recognize that its supervisory practices should be commensurate with the complexity, interconnectedness, size, risk profile and cross-border operation of the banks being supervised. The assessment considers the context in which the supervisory practices are applied. The concept of proportionality underpins all assessment criteria. For these reasons, an assessment of one jurisdiction will not be directly comparable to that of another.

8. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team.3 Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the Swiss authorities with an internationally consistent measure of the quality of its banking supervision in relation to the BCPs, which are internationally acknowledged as minimum standards.

9. To determine the observation of each principle, the assessment has made use of five categories: compliant; largely compliant, materially noncompliant, noncompliant, and non-applicable. An assessment of “compliant” is given when all EC and ACs are met without any significant deficiencies, including instances where the principle has been achieved by other means. A “largely compliant” assessment is given when there are only minor shortcomings, which do not raise serious concerns about the authority’s ability to achieve the objective of the principle and there is clear intent to achieve full compliance with the principle within a prescribed period of time (for instance, the regulatory framework is agreed but has not yet been fully implemented). A principle is considered to be “materially noncompliant” in case of severe shortcomings, despite the existence of formal rules and procedures and there is evidence that supervision has clearly not been effective, the practical implementation is weak or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. A principle is assessed “noncompliant” if it is not substantially implemented, several ECs are not complied with, or supervision is manifestly ineffective. Finally, a category of “non-applicable” is reserved for those cases that the criteria would not relate to the country’s circumstances.

Institutional and Market Structure – Overview

10. Switzerland has a diversified financial sector that is systemically important to the global markets. It comprises a few significant global players in banking and insurance, two dozen cantonal banks, regional financial institutions, private banks, foreign banks, internationally oriented insurance companies, and many pension funds. It has one of the largest banking sectors globally in terms of assets to GDP. The two large banks rank among the world’s top ten banks and are designated as Global Systemically Important Banks (G-SIBs). Switzerland is a global leader in private wealth management with a market share of more than a quarter in global cross-border private banking. The Swiss financial system contributes about 10 percent to Swiss GDP and employs over 5 percent of the labor force.

11. The banking industry is highly concentrated, but also it has a large number of medium and small banks. The banking sector has approximately 70 percent of the total financial sector assets with CHF 2.7 trillion, or over 450 percent of the country’s GDP. The banking sector consists of 297 banks (end-2012), although the two large banks account for about one-half of the Swiss banking system’s global assets and are important intermediaries in global financial markets. They are classified as Category 1 banks by the authorities in terms of size and complexity. The two largest are universal banks in their home Swiss market but focus more selectively abroad, where they are global players in asset and wealth management and in certain investment and corporate banking businesses. They are systemically important domestically as well with a share of over 30 percent in local markets. Major Swiss banks have been leaders globally in the extent of their restructuring and exiting of certain business in response to changed profitability dynamics and enhanced capital and liquidity requirements.

12. Other banks are much smaller, although some of them are relatively large compared to the size of economy and are systemically important domestically or regionally within the country. There are some relatively large banks serving more domestic or European markets on the asset side but many also gathering funds internationally into their asset or wealth management arms. Three Category 2 banks average CHF150B of assets and the 27 Category 3 banks have average assets of some CHF20B. There are 24 cantonal banks included in from Categories 2 to 4, which are historically established by cantonal laws and play an important role in each region, with a share of around 15 percent of the total banking assets. They tend to be classic retail banks with deposit gathering and lending to individuals and enterprises, together with wealth management. There are also a number of small regional banks focusing on traditional retail, mostly mortgage finance, within specific geographical regions. Foreign banks and private banks are heavily involved in cross-border and wealth management activities. Potential risks to smaller banks tend to be in credit risk and interest rate risk in the banking book. Wealth management functions are more exposed to operational and reputational risk. The 250 smallest and least complex banks as classified by FINMA have median assets of CHF250m.

13. FINMA, an independent public law institution, is a unified supervisor which regulates and supervises banks. It was created in 2008 by unifying the Federal Banking Commission (EBK), which was in charge of supervision and regulation of the banking sector, the Federal Office of Private Insurance, the insurance regulator and supervisor, and the Anti-Money Laundering Control Authority, to improve the financial sector supervision and the supervisor’s international role. It started its operation from the beginning of 2009, but it had been long planned as the original bill was drafted in 2006 and the law was approved in 2007. In addition to regulation and supervision of banks and insurance firms, FINMA also regulates capital markets and their intermediaries. In terms of banking regulation, laws and ordinances are submitted by the Federal Department of Finance (FDF) and enacted by the Federal Parliament and Federal Council, respectively. The Swiss National Bank (SNB) has responsibility over the stability of financial system and is in charge of monetary policy operations. It also is responsible for the supply of liquidity and acts as a lender of last resort.

Preconditions for Effective Banking Supervision

14. Switzerland has a competitive economy with prudent public finances and one of the highest GDP per capita globally. Sound and sustainable fiscal policies are anchored in a debt brake rule contained in the federal constitution and in constitutions governing 25 of 26 cantonal governments. SNB conducts the country’s monetary policy as an independent central bank. It is obliged by the Federal Constitution and its statute to act in accordance with the interests of the country as a whole. It has to ensure price stability, while taking due account of economic developments. Within this framework, the National Bank Act also confers on the SNB the mandate of contributing to the stability of the financial system

15. The macroeconomic situation in Switzerland has been stable but facing difficulties in the past few years:

  • GDP growth in Switzerland has decelerated and inflation remains negative. Driven by lower net exports, growth slowed in 2012 to only 1 percent and is expected to reach around 1¼ percent in 2013, and to regain momentum only gradually. Core and headline consumer price inflation are negative as the pass-through from the past exchange rate appreciation continues to run its course, while expectations are anchored in positive territory. Unemployment is low, and immigration is fueling labor force growth.

  • The exchange rate floor was introduced by SNB and it has helped safeguard macroeconomic stability. The floor was introduced in September 2011 as a measure to contain the effects of “safe haven” flows into Swiss assets. These inflows resumed in mid-2012, prompting further heavy intervention and an expansion of the balance sheet of the SNB, but pressures on the Swiss franc have waned since late 2012. Following the introduction of the floor, the real exchange rate has depreciated. While there have been difficulties in some segments, Swiss exports have performed well in recent years. The current account surplus remains sizable, reflecting favorable net interest income.

  • The fiscal position is strong. Discretionary fiscal policy is limited by the structurally balanced budget rule (“debt brake”) at the federal level and other fiscal rules at the cantonal level. With conservative budget planning and execution, the federal government has consistently outperformed the fiscal rule. The debt-to-GDP ratio is expected to fall further to about 45 percent of GDP in 2016, although there are spending pressures over the medium term and long-term challenges from population aging.

  • Developments in real estate and mortgage lending are important macroprudential concerns. With interest rates at historically low levels, mortgage lending has accelerated, bringing mortgage debt to about 140 percent of GDP. In parallel, housing prices have been rising, particularly in certain segments of the market. The authorities have taken measures to address these risks as described below.

16. In terms of financial sector policies, Switzerland’s approach has been to be an early adopter of the new Basel capital and liquidity measures and to tailor them with additional add-ons for certain banks for systemic reasons. Higher minimum capital ratios apply to the two G-SIFIs and to a lesser degree also to other banks except the smallest ones. Stability in the financial sector has been significantly strengthened by the ‘too big to fail’ (TBTF) legislative revision for the regulation of systemically important banks. The revision was approved by Parliament on September 30, 2011 and put into force by the Federal Council on March 1, 2012. The corresponding amendments to the Capital Adequacy Ordinance (CAO) and the Banking Ordinance (BO) were passed by the Federal Council, approved by Parliament and entered into force on January 1, 2013.

17. The Federal Council decided on February 13, 2013 to activate the countercyclical capital buffer, targeted at mortgage loans financing residential property in Switzerland. This was on the recommendation of the SNB. Banks were required to hold an additional 1 percent of their risk-weighted assets in the mortgage sector by end September 2013 as a consequence of imbalances in the real estate sector built up during the last couple of years. The level of the buffer was further increased to 2 percent in January 2014.4 FINMA has also introduced measures to raise risk weights for mortgage lending and new requirements for mortgage financing through Swiss Bankers Association, including a minimum down payment and minimum repayment requirements

18. The role of SNB relates to macro-prudential supervision. The SNB is responsible for the designation of the systemically important banks according to Art. 8 of the Swiss Banking Act, and propose an activation of the countercyclical capital buffer to the Swiss Federal Council. Between FINMA and the SNB a Memorandum of Understanding (MOU) is in place. It provides for regular meetings at head of organization level and ongoing exchange of views in the areas of (i) assessment of the soundness of systemically important banks and/or the banking system; (ii) regulations that have a major impact on the soundness of banks, including liquidity, capital adequacy and risk distribution provisions, where they are of relevance for financial stability; (iii) contingency planning and crisis management.

19. Switzerland has a consensus-driven culture with strong support for principles-based, proportional regulation and supervision, once adopted. Rating agencies have described the domestic credit culture as conservative. The system of business laws is well developed, as is the practice of professions important to banking such as accountancy and auditing, the legal profession, and banking and risk management. However, given the size and reach of domestic banks, FINMA (and its predecessor) concluded that there were not sufficient high quality resources available in Switzerland to effectively conduct bank supervision using own resources only. That lead to the development of the supervision model of having the outside auditors of banks, and their global network, conduct regulatory audits on behalf of FINMA (as an ‘extended arm’), but paid for by the banks.

20. All stock corporations and other commercial entities in Switzerland must prepare financial statements including a balance sheet, an income statement and notes. The financial statements of stock corporations are subject to an annual audit. Publicly traded companies, banks, other financial institutions, mutual funds and pension funds are subject to additional reporting requirements. Auditors of public companies are subject to regulation and inspection by an independent authority.

21. FINMA is the supervisory authority and also the insolvency and resolution authority for banks and securities dealers in Switzerland. It is also responsible for intensified supervision of banks in a recovery status. At the point of non-viability, FINMA is responsible for establishing intervention measures, and the resolution or the liquidation of the bank. Systemically important banks, as required by FINMA, need to establish recovery plans which are subject to FINMA’s approval. In addition, FINMA defines institution-specific resolution plans. FINMA is responsible for the international coordination and cooperation process regarding the global resolution strategy for both Swiss G-SIBs.

22. In 2011, FDF, SNB and FINMA signed a tripartite memorandum of understanding on crisis management. The MOU governs exchange of information on financial stability and financial market regulation issues, as well as collaboration in the event of a crisis. In accordance with the MOU, strategic coordination of the crisis management organization and of any intervention is performed by a Steering Committee (SC), comprising the head of the Federal Department of Finance (FDF), the Chairman of the Governing Board of the SNB and the Chairman of FINMA. Meetings of the SC shall be held whenever necessary. FINMA leads international crisis management colleges for the two major Swiss banks, especially with participation of the United States and the United Kingdom.

23. Regarding recovery and resolution, the coming into force of the new Banking Insolvency Ordinance (BIO) established by FINMA was an important step for Switzerland. This Ordinance sets out the process to be followed so that not only shareholders but also bondholders contribute towards restructuring. As part of its restructuring plan, FINMA can order a compulsory conversion of bonds or a waiver of claims (bail-in): it ensures that banks can still continue to operate and safeguard financial stability. In the case of systemically important large banks, additional capital measures have been taken in the form of convertible capital (CoCos). This involves a two-stage approach which, as a first step, converts CoCos into equity capital. If this measure to sustainably stabilize the bank proves insufficient, the next step is resolution at the highest group level by means of a bail-in. This procedure triggers FINMA’s resolution strategy in cooperation with its key host regulators.

24. In 2008 the limit on depositor protection was increased from CHF 30,000 to CHF 100,000, and extended to employee pension accounts. In addition, the upper limit for overall secured assets was increased from CHF 4 billion to CHF 6 billion. In September 2011, the temporary provisions were made permanent in the revised Banking Act. The Depositor Protection scheme is set up as an ex-post financed association with which all banks in Switzerland must be affiliated. In the event of a bank going bankrupt, all members transfer to this scheme the amounts required of up to a total amount of CHF 6 billion within five days. To guarantee this, banks are required to deposit 125 percent of the guaranteed amounts in Switzerland.

25. Effective market discipline is promoted by the design of key policy measures, such as those related to resolution of banks, and by a transparency in disclosure of financial accounts. However, various observers have noted that disclosure under Swiss accounting rules is less in general than under international standards. The philosophy of complete bank secrecy related to individual account holders is being altered in some circumstances under international pressure and as a result of specific situations of questionable behavior. Market participants believe these trends will have implications for the business model of certain institutions.

Detailed Assessment

A. Supervisory Powers, Responsibilities and Functions

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B. Prudential Regulations and Requirements

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Summary Compliance with the Basel Core Principles

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Recommended Actions and Authorities Comments

A. Recommended Actions

Recommended Actions to Improve Compliance with the Basel Core Principles and the effectiveness of regulatory and supervisory frameworks

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B. Authorities’ Response to the Assessment

26. The Swiss authorities would like to thank the IMF for its “Detailed Assessment of Compliance” relating to the “Basel Core Principles (BCP) for Effective Banking Supervision” as part of its comprehensive Financial Stability Assessment Program on Switzerland. Discussions about Switzerland’s compliance with the BCPs were always constructive.

27. Overall, the Swiss authorities welcome the positive assessment of compliance with the BCPs, which acknowledges the strong efforts of Swiss authorities in recent years to enhance the effectiveness of banking supervision. In this context it is worth highlighting again that Switzerland has been ahead of most countries in implementing enhanced regulation, as recently evidenced by the Regulatory Consistency Assessment Program of the Basel Committee on Banking Supervision. In order to continue on this path, effective rule making remains an essential prerequisite. That is why the Swiss authorities welcome the observation on BCP2 that FINMA’s power to set general Pillar 2 capital buffers should not be removed.

28. From a Swiss perspective some clarifications are required concerning the assessment results and recommendations provided by the IMF. The first important issue relates to observations on BCP2, where the IMF concludes that “resources of FINMA are too little to supervise and regulate the entire banking system in a way that meets the core principles”, which is “contributing to shortcomings in supervision and regulation, and weak practical implementation in certain areas”. It is important to highlight that with its current level of resources FINMA feels well equipped to effectively supervise the Swiss banking system, a belief borne out by its recent track record in prevention, correction and, where necessary, enforcement. In addition, the Swiss authorities believe that the comment “FINMA’s adherence to a head-count freeze, that it has decided upon, needs to be relaxed to achieve compliance” does not reflect the preparedness to act where needed. FINMA clearly has the budgetary independence required for additional resources to be added to the supervisory functions if deemed necessary.

29. A similar comment is made by the IMF on BCP9 relating to FINMA’s supervisory techniques and tools, stating that FINMA’s resources and the auditors’ methodology do not result in adequate indepth supervisory reviews on a proactive basis. FINMA disagrees with this assessment, given its track record in prevention and the view that the currently applied risk-based approach to performing supervisory reviews, with experienced and skilled people has been successful. Concerning the auditors’ methodology FINMA only recently introduced amended guidance on risk analysis for auditors where it is too early to judge its effectiveness.

30. The IMF has provided the Swiss authorities with recommendations of which many are already in the process of being implemented. Others will be additionally considered of which the following are worth mentioning. As part of an already planned policy review FINMA will assess whether and where amendments are required to better reflect qualitative risk management and governance standards as well as expectations regarding skill sets on boards and enterprise-wide risk management. To maintain and further improve the effectiveness and efficiency of FINMA’s supervisory and regulatory processes the adequacy of FINMA’s resources will periodically be reassessed and, if deemed necessary, corresponding measures to reallocate or adjust resources will be taken.

1

A factual update of BCP assessment was conducted in 2007 although with a limited coverage.

2

This option was not available to assessed countries before the 2012 Revised BCP.

3

The assessment team was comprised of Nick Le Pan and Mamoru Yanase.

4

The additional requirement is to be fulfilled by end June 2014.

5

In this document, “banking group” includes the holding company, the bank and its offices, subsidiaries, affiliates and joint ventures, both domestic and foreign. Risks from other entities in the wider group, for example non-bank (including non-financial) entities, may also be relevant. This group-wide approach to supervision goes beyond accounting consolidation.

6

The activities of authorising banks, ongoing supervision and corrective actions are elaborated in the subsequent Principles.

7

Such authority is called “the supervisor” throughout this paper, except where the longer form “the banking supervisor” has been necessary for clarification.

8

In this document, “risk profile” refers to the nature and scale of the risk exposures undertaken by a bank.

9

In this document, “systemic importance” is determined by the size, interconnectedness, substitutability, global or cross-jurisdictional activity (if any), and complexity of the bank, as set out in the BCBS paper on Global systemically important banks: assessment methodology and the additional loss absorbency requirement, November 2011.

10

Please refer to Principle 1, Essential Criterion 1.

11

Principle 3 is developed further in the Principles dealing with “Consolidated supervision” (12), “Home-host relationships” (13) and “Abuse of financial services” (29).

12

The Committee recognizes the presence in some countries of non-banking financial institutions that take deposits but may be regulated differently from banks. These institutions should be subject to a form of regulation commensurate to the type and size of their business and, collectively, should not hold a significant proportion of deposits in the financial system.

13

This document refers to a governance structure composed of a board and senior management. The Committee recognizes that there are significant differences in the legislative and regulatory frameworks across countries regarding these functions. Some countries use a two-tier board structure, where the supervisory function of the board is performed by a separate entity known as a supervisory board, which has no executive functions. Other countries, in contrast, use a one-tier board structure in which the board has a broader role. Owing to these differences, this document does not advocate a specific board structure. Consequently, in this document, the terms “board” and “senior management” are only used as a way to refer to the oversight function and the management function in general and should be interpreted throughout the document in accordance with the applicable law within each jurisdiction.

14

Therefore, shell banks shall not be licensed. (Reference document: BCBS paper on shell banks, January 2003.)

15

Please refer to Principle 14, Essential Criterion 8.

16

Please refer to Principle 29.

17

While the term “supervisor” is used throughout Principle 6, the Committee recognizes that in a few countries these issues might be addressed by a separate licensing authority.

18

In the case of major acquisitions, this determination may take into account whether the acquisition or investment creates obstacles to the orderly resolution of the bank.

19

On-site work is used as a tool to provide independent verification that adequate policies, procedures and controls exist at banks, determine that information reported by banks is reliable, obtain additional information on the bank and its related companies needed for the assessment of the condition of the bank, monitor the bank’s follow-up on supervisory concerns, etc.

20

Off-site work is used as a tool to regularly review and analyze the financial condition of banks, follow up on matters requiring further attention, identify and evaluate developing risks and help identify the priorities, scope of further off-site and on-site work, etc.

21

Please refer to Principle 10.

22

In the context of this Principle, “prudential reports and statistical returns” are distinct from and in addition to required accounting reports. The former are addressed by this Principle, and the latter are addressed in Principle 27.

23

Please refer to Principle 2.

24

Please refer to Principle 1, Essential Criterion 5.

25

May be external auditors or other qualified external parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions.

26

May be external auditors or other qualified external parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions. External experts may conduct reviews used by the supervisor, yet it is ultimately the supervisor that must be satisfied with the results of the reviews conducted by such external experts.

27

Please refer to Principle 1.

28

Please refer to footnote 19 under Principle 1.

29

Please refer to Principle 16, Additional Criterion 2.

30

See Illustrative example of information exchange in colleges of the October 2010 BCBS Good practice principles on supervisory colleges for further information on the extent of information sharing expected.

31

Please refer to footnote 27 under Principle 5.

32

The OECD (OECD glossary of corporate governance-related terms in “Experiences from the Regional Corporate Governance Roundtables”, 2003, www.oecd.org/dataoecd/19/26/23742340.pdf.) defines “duty of care” as “The duty of a board member to act on an informed and prudent basis in decisions with respect to the company. Often interpreted as requiring the board member to approach the affairs of the company in the same way that a ‘prudent man’ would approach their own affairs. Liability under the duty of care is frequently mitigated by the business judgment rule.” The OECD defines “duty of loyalty” as “The duty of the board member to act in the interest of the company and shareholders. The duty of loyalty should prevent individual board members from acting in their own interest, or the interest of another individual or group, at the expense of the company and all shareholders.”

33

“Risk appetite” reflects the level of aggregate risk that the bank’s Board is willing to assume and manage in the pursuit of the bank’s business objectives. Risk appetite may include both quantitative and qualitative elements, as appropriate, and encompass a range of measures. For the purposes of this document, the terms “risk appetite” and “risk tolerance” are treated synonymously.

34

For the purposes of assessing risk management by banks in the context of Principles 15 to 25, a bank’s risk management framework should take an integrated “bank-wide” perspective of the bank’s risk exposure, encompassing the bank’s individual business lines and business units. Where a bank is a member of a group of companies, the risk management framework should in addition cover the risk exposure across and within the “banking group” (see footnote 19 under Principle 1) and should also take account of risks posed to the bank or members of the banking group through other entities in the wider group.

35

To some extent the precise requirements may vary from risk type to risk type (Principles 15 to 25) as reflected by the underlying reference documents.

36

It should be noted that while, in this and other Principles, the supervisor is required to determine that banks’ risk management policies and processes are being adhered to, the responsibility for ensuring adherence remains with a bank’s Board and senior management.

37

New products include those developed by the bank or by a third party and purchased or distributed by the bank.

38

The Core Principles do not require a jurisdiction to comply with the capital adequacy regimes of Basel I, Basel II and/or Basel III. The Committee does not consider implementation of the Basel-based framework a prerequisite for compliance with the Core Principles, and compliance with one of the regimes is only required of those jurisdictions that have declared that they have voluntarily implemented it.

39

The Basel Capital Accord was designed to apply 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 Basel II and Basel III capital adequacy frameworks would apply such ratios on a fully consolidated basis to all internationally active banks and their holding companies; in addition, supervisors must test that banks are adequately capitalized on a stand-alone basis.

40

Reference documents: Enhancements to the Basel II framework, July 2009 and: International convergence of capital measurement and capital standards: a revised framework, comprehensive version, June 2006.

41

In assessing the adequacy of a bank’s capital levels in light of its risk profile, the supervisor critically focuses, among other things, on (a) the potential loss absorbency of the instruments included in the bank’s capital base, (b) the appropriateness of risk weights as a proxy for the risk profile of its exposures, (c) the adequacy of provisions and reserves to cover loss expected on its exposures and (d) the quality of its risk management and controls. Consequently, capital requirements may vary from bank to bank to ensure that each bank is operating with the appropriate level of capital to support the risks it is running and the risks it poses.

42

The capital ratio results from the ratio between eligible capital and risk-weighted positions in accordance with Art. 42 para 2 CAO.

43

“Stress testing” comprises a range of activities from simple sensitivity analysis to more complex scenario analyses and reverses stress testing.

44

Please refer to Principle 12, Essential Criterion 7.

45

Principle 17 covers the evaluation of assets in greater detail; Principle 18 covers the management of problem assets.

46

Credit risk may result from the following: on-balance sheet and off-balance sheet exposures, including loans and advances, investments, inter-bank lending, derivative transactions, securities financing transactions and trading activities.

47

Counterparty credit risk includes credit risk exposures arising from OTC derivative and other financial instruments.

48

“Assuming” includes the assumption of all types of risk that give rise to credit risk, including credit risk or counterparty risk associated with various financial instruments.

49

Principle 17 covers the evaluation of assets in greater detail; Principle 18 covers the management of problem assets.

50

Reserves for the purposes of this Principle are “below the line” non-distributable appropriations of profit required by a supervisor in addition to provisions (“above the line” charges to profit).

51

It is recognized that there are two different types of off-balance sheet exposures: those that can be unilaterally cancelled by the bank (based on contractual arrangements and therefore may not be subject to provisioning), and those that cannot be unilaterally cancelled.

52

Connected counterparties may include natural persons as well as a group of companies related financially or by common ownership, management or any combination thereof.

53

This includes credit concentrations through exposure to: single counterparties and groups of connected counterparties both direct and indirect (such as through exposure to collateral or to credit protection provided by a single counterparty), counterparties in the same industry, economic sector or geographic region and counterparties whose financial performance is dependent on the same activity or commodity as well as off-balance sheet exposures (including guarantees and other commitments) and also market and other risk concentrations where a bank is overly exposed to particular asset classes, products, collateral, or currencies.

54

The measure of credit exposure, in the context of large exposures to single counterparties and groups of connected counterparties, should reflect the maximum possible loss from their failure (i.e. it should encompass actual claims and potential claims as well as contingent liabilities). The risk weighting concept adopted in the Basel capital standards should not be used in measuring credit exposure for this purpose as the relevant risk weights were devised as a measure of credit risk on a basket basis and their use for measuring credit concentrations could significantly underestimate potential losses (see “Measuring and controlling large credit exposures, January 1991).

55

Such requirements should, at least for internationally active banks, reflect the applicable Basel standards. As of September 2012, a new Basel standard on large exposures is still under consideration.

56

Related parties can include, among other things, the bank’s subsidiaries, affiliates, and any party (including their subsidiaries, affiliates and special purpose entities) that the bank exerts control over or that exerts control over the bank, the bank’s major shareholders, Board members, senior management and key staff, their direct and related interests, and their close family members as well as corresponding persons in affiliated companies.

57

Related party transactions include on-balance sheet and off-balance sheet credit exposures and claims, as well as, dealings such as service contracts, asset purchases and sales, construction contracts, lease agreements, derivative transactions, borrowings, and write-offs. The term transaction should be interpreted broadly to incorporate not only transactions that are entered into with related parties but also situations in which an unrelated party (with whom a bank has an existing exposure) subsequently becomes a related party.

58

An exception may be appropriate for beneficial terms that are part of overall remuneration packages (e.g., staff receiving credit at favorable rates).

59

Country risk is the risk of exposure to loss caused by events in a foreign country. The concept is broader than sovereign risk as all forms of lending or investment activity whether to/with individuals, corporates, banks or governments are covered.

60

Transfer risk is the risk that a borrower will not be able to convert local currency into foreign exchange and so will be unable to make debt service payments in foreign currency. The risk normally arises from exchange restrictions imposed by the government in the borrower’s country. (Reference document: IMF paper on External Debt Statistics – Guide for compilers and users, 2003.)

61

Wherever “interest rate risk” is used in this Principle the term refers to interest rate risk in the banking book. Interest rate risk in the trading book is covered under Principle 22.

62

The Committee has defined operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The definition includes legal risk but excludes strategic and reputational risk.

63

In assessing independence, supervisors give due regard to the control systems designed to avoid conflicts of interest in the performance measurement of staff in the compliance, control and internal audit functions. For example, the remuneration of such staff should be determined independently of the business lines that they oversee.

64

The term “compliance function” does not necessarily denote an organizational unit. Compliance staff may reside in operating business units or local subsidiaries and report up to operating business line management or local management, provided such staff also have a reporting line through to the head of compliance who should be independent from business lines.

65

The term “internal audit function” does not necessarily denote an organizational unit. Some countries allow small banks to implement a system of independent reviews, e.g., conducted by external experts, of key internal controls as an alternative.

66

In this Essential Criterion, the supervisor is not necessarily limited to the banking supervisor. The responsibility for ensuring that financial statements are prepared in accordance with accounting policies and practices may also be vested with securities and market supervisors.

67

For the purposes of this Essential Criterion, the disclosure requirement may be found in applicable accounting, stock exchange listing, or other similar rules, instead of or in addition to directives issued by the supervisor.

68

The Committee is aware that, in some jurisdictions, other authorities, such as a financial intelligence unit (FIU), rather than a banking supervisor, may have primary responsibility for assessing compliance with laws and regulations regarding criminal activities in banks, such as fraud, money laundering and the financing of terrorism. Thus, in the context of this Principle, “the supervisor” might refer to such other authorities, in particular in Essential Criteria 7, 8 and 10. In such jurisdictions, the banking supervisor cooperates with such authorities to achieve adherence with the criteria mentioned in this Principle.

69

Consistent with international standards, banks are to report suspicious activities involving cases of potential money laundering and the financing of terrorism to the relevant national centre, established either as an independent governmental authority or within an existing authority or authorities that serves as an FIU.

70

These could be external auditors or other qualified parties, commissioned with an appropriate mandate, and subject to appropriate confidentiality restrictions.

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Switzerland: Detailed Assessment of Compliance-Basel Core Principles for Effective Banking Supervision
Author:
International Monetary Fund. Monetary and Capital Markets Department