United Kingdom
Financial Sector Assessment Program-Basel Core Principles for Effective Banking Supervision-Detailed Assessment Report
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International Monetary Fund. Monetary and Capital Markets Department
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This paper provides detailed assessment of observance on the Basel Core Principles for Effective Banking Supervision. The current assessment took place during a period of continuing development and transition. It is based on the assessors’ understanding of the current state of the supervisory approach, but also incorporates, where relevant, the available information about changes expected in the near future. Stress testing has become a critical supervisory tool that encourages firms and supervisors to adopt a more forward-looking view on the strength of their balance sheets and resilience to shocks. The emphasis on stress testing has encouraged firms to strengthen their internal analytical and risk-management capabilities.

Abstract

This paper provides detailed assessment of observance on the Basel Core Principles for Effective Banking Supervision. The current assessment took place during a period of continuing development and transition. It is based on the assessors’ understanding of the current state of the supervisory approach, but also incorporates, where relevant, the available information about changes expected in the near future. Stress testing has become a critical supervisory tool that encourages firms and supervisors to adopt a more forward-looking view on the strength of their balance sheets and resilience to shocks. The emphasis on stress testing has encouraged firms to strengthen their internal analytical and risk-management capabilities.

Introduction4

26. This assessment of the current state of the implementation of the BCP in the U.K. was conducted during November 3–19, 2015. 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 are addressed in the broader FSAP exercise.

27. An assessment of the effectiveness of banking supervision involves a review of the legal framework as well as a detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision.

A. Information and Methodology Used for the Assessment

28. The U.K. authorities agreed to be assessed according to the revised BCPs issued by the Basel Committee for Banking Supervision (BCBS) in September 2012. The assessment was thus performed using a different methodological basis as compared with the previous BCP assessment carried out in 2011. It is important to note, for completeness’ sake, that the two assessments will not be directly comparable: the revised BCPs have a heightened focus on corporate governance and risk management, their practice by supervised entities, and their assessment by the supervisory authority. The revised BCPs raise expectations in measuring the effectiveness of a supervisory framework (see box for more information on the revised BCPs).

29. The U.K. authorities chose to be assessed and rated against both the Essential Criteria (EC) and the Additional Criteria (AC) articulated in the BCP document. To assess compliance, the BCP methodology uses a set of essential and sometimes additional assessment criteria for each principle. The EC are usually the only elements on which to gauge full compliance with a Core Principle (CP). The ACs are recommended best practices against which the U.K. authorities have agreed to be assessed and rated. This option was not available to countries assessed prior to 2012 publication of the revised BCPs. 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. A four-part grading system is used: compliant; largely compliant; materially noncompliant; and noncompliant. This grading system is explained below.

30. The assessment team reviewed the framework of laws, rules, and guidance and held extensive meetings with U.K. officials. The team conducted additional meetings with banking-sector participants and other stakeholders (auditors, associations, and other market observers). The authorities provided a comprehensive self-assessment of the BCPs, as well as detailed responses to additional questionnaires. In addition, the authorities facilitated access to a variety of supervisory documents and files, staff and systems.

31. The team appreciated the high level of cooperation, candor, and transparency that the authorities demonstrated throughout the review. The team extends its thanks to staff of the authorities, all of whom provided excellent cooperation and undertook considerable efforts to make available extensive documentation as well as access to staff with expertise on U.K. supervisory policies, procedures, and practices. Assessors appreciated, as well, the opportunity to meet with additional official staff with expertise related to the implementation of global regulatory changes under Basel III, its implementation in the EU through the Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR), and further national regulatory changes. Finally, the assessment team wishes to express its appreciation to the numerous market participants and observers who shared voluntarily their personal insight into the evolution of U.K. supervisory practices.

32. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science; in addition, the BCBS considers the BCPs to be minimum rather than absolute standards. To reach its conclusions regarding the compliance of the U.K. approach to banking supervision against the BCPs, the assessment team did exercise judgment. Nevertheless, the team sought to adhere to a common, agreed methodology that is consistent with assessments done of other countries subsequent to the 2012 release of the revised BCPs. Consequently, the assessment is intended to provide U.K. authorities with an internationally consistent measure of their compliance with the BCPs.

33. To determine the observation of each principle, the assessment has made use of five categories: compliant; largely compliant, materially noncompliant, noncompliant, and nonapplicable. 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 that do not raise serious concerns about the authority’s ability to achieve the objective of the principle; moreover, 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; furthermore, evidence suggests that supervision has clearly not been effective, that 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 “nonapplicable” is reserved for those cases that the criteria would not relate the country’s circumstances.

The 2012 Revised Basel 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 Financial Stability Board (FSB) and take into account the importance now attached to the following considerations: (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 preemptive 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) efforts to foster 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. 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 in terms of the risks they pose to the banking and the financial systems. In addition, supervisors are required 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 risks to which individual banks are exposed. While the BCPs 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 remained largely the same as what was contained in the prior version of the BCPs), and the introduction of 35 new essential criteria. For countries that choose to be assessed against the “additional criteria,” 16 additional criteria articulate “best practices” to comply with selected CPs.

While raising expectations for banking supervision, the BCP were drafted with the recognition that they must be applicable to a wide range of jurisdictions. The new methodology reinforces the concept of “proportionality,” both in terms of adjusting the expectations on supervisors and in terms of adjusting the standards that supervisors impose on banks depending on the circumstances. 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.

B. Institutional and Market Structure—Overview5

34. The Financial Services Act 2012 established a new framework for financial regulation in the United Kingdom. Responsibility for financial stability was given to the newly established FPC of the BoE: the BoE Act 1998, as amended by the Financial Services Act 2012, gives the FPC responsibility to identify, assess, monitor, and take action in relation to financial stability risk across the whole financial system. This includes addressing risks arising in the nonbank financial system (including institutions and markets). In support of this objective, the Act gives the FPC the power to make recommendations to Her Majesty’s Treasury (HMT) on regulated activities, as well as more general powers in respect of information gathering. Responsibility for the overall regulatory framework and the protection of the public finances rests with HMT and the Chancellor of the Exchequer.

35. Two new regulatory agencies have been established, replacing the FSA. The Financial Services Act 2012 transferred prudential regulation of deposit-takers,6 insurers and the largest investment firms to a new microprudential supervisor, the PRA, a subsidiary of the BoE. Responsibility for regulating conduct of business was given to the FCA, with the mandate and tools to protect consumers and market participants, including through the promotion of competition. The PRA and FCA started to operate in April 2013.

36. The BoE is the resolution authority responsible for preparing and responding to the failure of banks, building societies, certain investment firms and central counterparties in accordance with the U.K.’s special resolution regime. The BoE is also responsible for the regulation of systemically important firms supporting the clearing, payment and settlement infrastructure in the United Kingdom.

37. Most U.K. financial institutions are regulated in some form, although not all activities undertaken by these institutions are subject to regulation. Finance companies are subject to different regulation depending on whether they are owned by banks (PRA and FCA regulated), or nonbanks but provide residential mortgages or consumer credit (FCA regulated) or undertake business lending (for amounts exceeding GBP 25,000) or provide certain types of buy to let mortgages (unregulated). Securitization special purpose vehicles (SPVs) may be regulated depending on whether they are part of a banking group.

38. The FPC has a statutory power to make recommendations to HMT in relation to the boundaries between and within regulated and non-regulated sectors of the U.K. financial system (the ‘regulatory perimeter’). The FPC has committed to hold a discussion on the issue of the regulatory perimeter at least annually. In July 2015, the FPC considered channels through which stress in key parts of the nonbank financial system (including institutions and markets) could impact U.K. financial stability. Based on its current assessment, the FPC said that it did not see a case for recommending changes to the regulatory framework but would return to the issue on an annual basis, or sooner, if risks were identified.

39. The financial services Banking Reform Act (BRA) 2013 implemented the final ring-fencing recommendations of the independent commission on banking (ICB). The ICB recommended that retail banking should be separated from wholesale or investment banking, and that this should be achieved by ring-fencing, or separating, retail banking within a banking group in order to isolate banking activities where continuous provision of service is vital to the economy and to the customers of a bank. The BRA also implemented the recommendations made by the PCBS, appointed by parliament to consider how culture and standards in the banking sector could be improved. In particular the BRA put in place the legal framework for the “Senior Managers and Certification Regime” which strengthens the regulation of individuals who work in the U.K. banking sector. Finally, the BRA makes available to the BoE a stabilization option (the “bail-in option”) under part 1 of the BRA 2009.

40. Parliament passed a new BoE and Financial Service Act (though most of its provisions have not come into force yet). The Act sets out reforms to ensure that the BoE remains at the forefront of international best practice for transparency, accountability, and governance. The Act undertakes the following:

  • Maximize the synergies of having monetary policy, macroprudential policy and microprudential policy under the aegis of one institution by bringing the PRA within the BoE, ending its status as a subsidiary, and creating a new committee of the BoE to be known as the PRC. It will retain its independence in making rules, policies and supervisory decisions. The statutory objectives of the PRA, which underpin its forward-looking, judgment-based approach to supervision, will remain unchanged;

  • Reinforce the accountability of the PRC and the chief executive officer (CEO) for the BoE’s prudential regulation functions, and provide updated reporting requirements which will ensure supervision continues to operate with appropriate independence and resources;

  • Update resolution planning and crisis management arrangements between the Treasury and the BoE to reflect recent improvements to resolution planning for systemic financial institutions, and crisis management for institutions in distress. This includes a strengthened requirement for the BoE to provide the Treasury with information on risks to public funds, so that the system can better protect taxpayers and the wider economy from bank failures;

  • Improve the governance of the BoE by making its court of directors (‘the court’) a smaller, more focused unitary Board;

  • Place the new deputy governor for banking and markets in legislation, adding the position to the court of directors and the FPC;

  • Adjust the statutory basis of the FPC from a subcommittee of the court to a statutory committee of the BoE, in line with the MPC and the new PRC;

  • Bring the BoE within the purview of the National Audit Office (NAO), improving transparency and accountability for its use of resources;

  • Further strengthen coordination arrangements between the Treasury and the BoE in protecting taxpayers and the wider economy from bank failures; and

  • Extend the Senior Managers and Certification Regime to all financial services firms, and implement a fairer system by introducing a ‘duty of responsibility’ (superseding the previously proposed ‘reverse burden of proof’).

41. As a member of the EU, the United Kingdom adheres to the European ‘single Rulebook,’ whose backbone is represented by the 2013 CRD and Regulation (the ‘CRD IV package’). The CRD IV package was part of the response to the recent financial crisis and implements the Basel III capital and liquidity standards, as well as rules on corporate governance. The Regulation and Directive came into force from January 1, 2014, but gave member states (MS) time to transition to the final rules.

42. The CRD IV package is a ‘going concern’ framework. It aims to ensure that in normal times, banks are adequately capitalized to absorb losses, to pay their obligations in a stress and have adequate governance, systems and controls.

43. The 2014 Banking Recovery and Resolution Directive (BRRD) applies to non-viable banks. It introduced a harmonized set of resolution tools to ensure that when EU banks fail, that failure can be managed in a way which protects critical functions, limits contagion to other financial institutions and the wider economy, and avoids the need for taxpayer bail-out.

44. The 2014 Deposit Guarantee Scheme Directive (DGSD) is intended to harmonize deposit protection across the European Economic Area (EEA), and to ensure that robust, well-functioning schemes are in place. This will promote depositor confidence and support financial stability. It harmonizes deposit protection at EUR 100,000 per depositor per bank and also mandates protection for temporary high balances (e.g., during the sale or purchase of a house, or following a large insurance payment into a bank account). It requires MSs to ensure that ex ante funding equivalent to 0.8 percent of covered deposits is available. As it is intended to improve deposit protection and financial stability, and since a deposit guarantee scheme can be used in resolution, there is substantial interaction with the BRRD.

45. Total assets in the U.K. banking sector were almost 400 percent of nominal GDP in 2014, excluding derivative exposures and foreign assets and liabilities of foreign branches. There are over 900 banks, building societies and credit unions supervised by the PRA.7 Within the total of 900 there are 150 deposit-taking foreign branches and 98 deposit-taking foreign subsidiaries in the United Kingdom from 56 different countries. Foreign banks constitute around half of U.K. banking sector assets on a residency basis, with the combined assets of the largest ten foreign subsidiaries in the United Kingdom (including their non deposit-taking entities) totaling around GBP 2.75 trillion. Foreign branches account for around 30 percent of total U.K.-resident banking assets and around a third of U.K. interbank lending. Nearly a fifth of global banking activity is booked in the United Kingdom, and U.K.-resident banks’ foreign assets and liabilities account for over 350 percent of U.K. GDP.

46. Financial services is the United Kingdom’s most successful export industry, contributing a trade surplus of over GBP 59 billion in 2013 according to the Office for National Statistics (ONS). The United Kingdom is the most international banking centre in the world; foreign branches account for around 30 percent of total U.K.-resident banking assets.

47. The financial services industry employs over a million people across the length and breadth of the country. A million more are employed in complementary professional services. Two thirds of those two million jobs are outside London.

48. The U.K. financial sector has been hit, in the past years, by episodes of wrongdoing at major firms that gave rise to investigations, also under criminal laws, and that have seen several systemic banks subject to important fines.

49. Major U.K. banks have continued to improve capital and funding positions. They reported an average CET1 position above 12 percent and an aggregate leverage ratio over 4.7 percent at end–September 2015. In November 2012, the FPC recommended that the FSA “takes action to ensure that the capital of U.K. banks and building societies reflects a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights.” The FPC also recommended that “where such action reveals that capital buffers need to be strengthened to absorb losses and sustain credit availability in the event of stress, the FSA should ensure that firms either raise capital or take steps to restructure their business and balance sheets in ways that do not hinder lending to the real economy.” In March 2013, the FPC judged that the immediate objective should be to achieve a CET1 ratio, based on Basel III definitions and after the required adjustments, of at least 7 percent of risk-weighted assets (RWA) by end 2013. The improved capital position of banks also reflects, in part, the actions taken in response to the 2014 stress test of the major U.K. banks that captured some of the main risks judged by the FPC to be facing the system.

50. Stress tests are used primarily to assess the amount of capital that a bank might require in the event of an adverse shock. A critical precondition to make that assessment is that banks’ reported capital positions are stated accurately. AQRs help ensure this, both in terms of capital resources and capital requirements.

51. As a result of the interventions during the 2008–9 financial crisis, the government also has holdings in the Royal Bank of Scotland (RBS) and the Lloyds Banking Group. Disposals have begun, and at the end of August 2015 government holdings stood at just under 13 percent ownership in Lloyds, and 73 percent in RBS.

C. Preconditions for Effective Banking Supervision

Macroeconomic policies

52. The Government’s economic policy objective is to achieve strong, sustainable and balanced growth that is more evenly shared across the country and between industries. This objective recognizes that over a number of years preceding the financial crisis, economic growth in the U.K. was driven by unsustainable levels of private sector debt and rising public sector debt. This pattern of unbalanced growth and excessive debt helped to create exceptional economic challenges in the United Kingdom.

53. The BoE’s monetary policy objective is to deliver price stability—low inflation—and, subject to that, to support the government’s economic objectives including those for growth and employment. The BoE’s operations in the sterling money markets have two objectives, stemming from its monetary policy and financial stability responsibilities: to implement the MPC’s decisions in order to meet the inflation target (set by the government at 2 percent); and to reduce the cost of disruption to the liquidity and payment services supplied by banks to the U.K. economy.

The Government’s economic strategy consists of four key pillars:

  • a) monetary activism and credit easing, stimulating demand, maintaining price stability and supporting the flow of credit in the economy;

  • b) deficit reduction, returning the public finances to a sustainable position and ensuring that sound public finances and fiscal credibility underpin low long-term interest rates;

  • c) completing the reform of the financial system and improving the regulatory framework to reduce risks to the taxpayer and build the resilience of the system; and

  • d) a comprehensive package of structural reforms, rebalancing and strengthening the economy for the future, including a package of measures to support businesses to invest and export.

54. The Government’s comprehensive economic strategy is designed to protect the economy, to maintain market confidence in the United Kingdom and to lay the foundations for a stronger, more balanced economy in the future. Continuing to strengthen the financial system, so that it can support the wider economy, is a key element of this strategy.

Financial stability and macroprudential surveillance

55. The FPC was officially established on April 1, 2013.8 The committee is charged with a primary objective of identifying, monitoring and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the U.K. financial system. The FPC has a secondary objective to support the economic policy of the government. The committee publishes a record of its formal policy meetings, and is responsible for the BoE’s bi-annual Financial Stability Report (FSR).

56. The FPC is a statutory subcommittee of the BoE’s Court. Its members are the governor; three of the deputy governors who are responsible for financial stability, prudential regulation, and monetary policy, respectively; the chief executive of the FCA; the BoE’s executive director for Financial Stability Strategy and Risk (FSSR); four external members appointed by the Chancellor; and a nonvoting member from HMT.

57. The FPC has responsibility for setting the countercyclical capital buffer (CCB) and powers of direction over sectoral capital requirements (SCRs), loan-to-value and debt-to-income limits in respect of owner-occupied lending, and in relation to leverage ratio tools. There is a statutory requirement for the FPC to prepare and maintain a general statement of policy for the powers of Direction it is given under legislation. These describe the tools, the likely impact of using them on financial stability and growth, and the circumstances in which the FPC might expect to use each tool. They also describe the core indicators the FPC will routinely review to help inform its judgments.

Public infrastructure

58. The United Kingdom has reputation for a robust and stable legal system, skilled workforce and fairly well-developed public infrastructure. It ranks high in the World Bank ‘Ease of Doing Business’ classification (6th at international level both in 2015 and 2016), with medium-high score for the strength of its insolvency framework, maximum score for depth of credit information and very high ranking (4th) for the protection of minority investors. Its payment, clearing and settlement systems are well regulated. Basic economic, financial and social statistics are publicly available.

Financial safety nets and crisis management

59. The Financial Services Compensation Scheme (FSCS) is the U.K.’s compensation fund of last resort for customers of authorized financial services firms. It covers business conducted by firms authorized by the PRA and FCA. European firms (authorized by their home state regulator) that operate in the United Kingdom may also be covered. It protects:

  • Deposits;

  • Insurance policies;

  • Insurance broking (for business on or after January 14, 2005), including connected travel insurance where the policy is sold alongside a holiday or other related travel (e.g., by travel firms and holiday providers) (for business on or after January 1, 2009);

  • Investment business; and

  • Home finance (for business on or after October 31, 2004).

60. The FSCS is independent of the government and the financial industry, and was set up under the Financial Services and Markets Act (FSMA) 2000, becoming operational on December 1, 2001 (although it still covers claims from before this date). It may pay compensation if a firm is unable, or likely to be unable, to pay claims against it. This is usually because it has stopped trading or has been declared in default. The FSCS does not charge individual consumers for using the service.

61. The key principle of financial crisis management is to make clear who is in charge of what, and when. The BoE and HMT have clear and separate responsibilities. The BoE has primary operational responsibility for financial crisis management. The Chancellor and HMT have sole responsibility for any decision involving public funds. When the BoE has formally notified the Treasury of a material risk to public funds, and either there is a serious threat to financial stability, or public funds are already committed by the Treasury to resolve or reduce such a serious threat and it would be in the public interest to do so, the Chancellor may use powers to direct the BoE.

62. The Financial Crisis Management Memorandum of Understanding (MoU) sets out who is in charge of what and when between HMT and the BoE (including the PRA) in a financial crisis. It has a particular focus on monitoring and managing potential risks to public funds.

63. A core aspect of the PRA’s approach is that it aims at ensuring preparedness for recovery or resolution of a failing firm. The PRA has the authority to set rules and supervisory requirements for financial holding companies (FHCs), mixed financial holding companies (MFHCs), mixed activity FHCs, banks, building societies, and PRA-designated investment firms.

The PRA’s rules require supervised entities to undertake the following:

  • To be better prepared for future financial stress through credible and robust recovery planning (identification of options to recover financial strength in stress situations);

  • To provide information (‘resolution packs’) to help the BoE in its role as the resolution authority; and

  • To ensure the feasibility of bailing-in creditors, in the case of cross-border firms, by adopting contractual recognition of bail-in.

Market discipline

64. In terms of market discipline, an extensive set of institutional investors are active in the United Kingdom, as are major rating agencies and analysts. Well-developed mechanisms support market discipline, including a system of regular disclosure by public companies. Required disclosures for banks have been materially enhanced through the additional annual disclosures based on Pillar 3 of the Basel III global regulatory framework.

65. Some banks make quarterly financial disclosures and some half-yearly. Regular financial statement disclosures related to market risk, liquidity risk and credit concentrations. The FPC of the BoE prepares and publishes a FSR twice per calendar year. The FSR sets out the FPC’s view of the outlook for U.K. financial stability, including its assessment of the resilience of the U.K. financial system and the current main risks to financial stability, and the action it is taking to remove or reduce those risks.

66. Since the financial crisis the United Kingdom has fundamentally reformed its financial sector and has pushed for international reforms to help end too-big-to fail and ensure effective market discipline. As outlined below, the United Kingdom has well established and mature markets which have effective mechanisms for ensuring market discipline.

67. The FRC sets governance guidelines for listed companies with premium listing through the U.K. Corporate Governance Code. High quality corporate governance helps to underpin long-term company performance. The U.K. Corporate Governance Code has been instrumental in spreading best Boardroom practice throughout the listed sector since it was first issued in 1992. It operates on the principle of ‘comply or explain.’ It sets out good practice covering issues such as Board composition and effectiveness, the role of Board committees, risk management, remuneration and relations with shareholders.9

68. In November 2012, the government published its response to the 17 specific recommendations of an independent review of U.K. equity markets.10 In particular, the report reviewed the mechanisms of control and accountability provided by the markets and the behavior of the agents in that process that affect the performance of U.K. businesses. It aimed to ensure that U.K. equity markets continue to benefit both companies and investors.

69. The Panel on Takeovers and Mergers (the “Panel”) is an independent body, established in 1968, whose main functions are to issue and administer the City Code on Takeovers and Mergers (the “Code”) and to supervise and regulate takeovers and other matters to which the Code applies in accordance with the rules set out in the Code. It has been designated as the supervisory authority to carry out certain regulatory functions in relation to takeovers pursuant to the Directive on Takeover Bids (2004/25/EC) (the “Directive”). Its statutory functions are set out in and under Chapter 1 of Part 28 of the Companies Act 2006. The Panel regulates takeover bids and other merger transactions (however effected) for companies which have their registered offices in the United Kingdom, the Channel Islands or the Isle of Man if any of their securities are admitted to trading on a regulated market or multilateral trading facility in the United Kingdom or on any stock exchange in the Channel Islands or the Isle of Man. Its remit also extends to other public companies and certain private companies which are resident in the United Kingdom, the Channel Islands or the Isle of Man. In certain circumstances the panel also shares responsibility for the regulation of an offer with the takeover regulator in another MS of the an EEA (a “MS”) (for example, where the offered company is registered in the United Kingdom and has its securities admitted to trading on a regulated market in another MS but not on a regulated market in the United Kingdom).

70. The Code is designed to ensure that shareholders are treated fairly and are not denied an opportunity to decide on the merits of a takeover and that shareholders of the same class are afforded equivalent treatment by an offeror. The Code also provides an orderly framework within which takeovers are conducted. In addition, it is designed to promote, in conjunction with other regulatory regimes, the integrity of the financial markets. The Code is not concerned with the financial or commercial advantages or disadvantages of a takeover. These are matters for the company and its shareholders.

71. The U.K. Financial Investments (UKFI) was created in November 2008 as part of the U.K.’s response to the financial crisis. It is a Companies Act Company, with HMT as its sole shareholder, and operates at arm’s-length from government. UKFI is responsible for managing the Government’s shareholdings in the RBS Group plc and the Lloyds Banking Group plc.

72. UKFI’s overarching objective is to manage these shareholdings commercially to create and protect value for the taxpayer as shareholder. Its aim is also to devise and execute a strategy for realizing value for the government’s investments in an orderly and active way over time within the context of protecting and creating value for the taxpayer as shareholder, paying due regard to the maintenance of financial stability and acting in a way that promotes competition. UKFI is also responsible for managing the Government’s 100 percent shareholding and loans in U.K. Asset Resolution Limited (“UKAR”) and its subsidiaries.

73. UKAR was formed during 2010 to integrate the activities of Northern Rock (asset management) plc and Bradford & Bingley Plc. UKFI managed the government’s 100 percent shareholding in Northern Rock plc from Northern Rock plc’s formation on January 1, 2010 up to its sale to Virgin Money on January 1, 2012.

Consumer protection

74. One of the FCA’s central responsibilities is to protect consumers from the firms and individuals in the financial industry that may cause them harm. The FCA expects firms to provide customers with appropriate products and services. To ensure consumers are protected and treated fairly, the FCA evaluates firms’ abilities to meet relevant supervisory requirements before they are authorized. The FCA then supervises their activities and prevents those that are not meeting standards from carrying out regulated activities. Where the FCA finds that firms are not following relevant rules, or where it finds that unauthorized firms are doing business in the United Kingdom, it intervenes where appropriate. This can take many forms, such as stepping in to impose penalties, stopping firms from carrying out certain types of business, requiring improvements in controls or management, or securing redress.

75. With respect to retail deposits, the relevant U.K. legislation and FCA rules sets down a conduct regime for banks and other account providers in relation to:

  • The provision of appropriate information, such as on terms and conditions, before an account is opened;

  • The ongoing provision or availability of information to customers about the activity on the account, such as through regular statements, as well as changes to terms and conditions such as notifications when the rate of interest applied to the balance on the account changes;

  • The making and receipt of payments on the account, and the related protections against issues such as unauthorized transactions;

  • Deposit protection; and

  • The provision of overdrafts.

76. In 2013, the government launched the ‘Current Account Switch Service.’ It lets consumers safely and reliably switches their accounts between banks in seven days, with a guarantee that they will be fully protected against any financial loss during the transfer.

Detailed Assessment

77. Compliance of each principle will 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.11 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 the 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 that 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 non-compliant 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 non-compliant” 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 non-compliant 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.

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. Summary of Recommended Actions

Recommended Actions to Improve Compliance with the BCP and the Effectiveness of Regulatory and Supervisory Frameworks

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B. Authorities’ Response to the Assessments

78. The U.K. authorities welcome and support the IMF’s comprehensive review of the U.K.’s supervisory and regulatory framework and its acknowledgement of the significant progress made since the last FSAP in 2011 through the adoption of a more rigorous, hands-on and systemically focused approach to banking supervision. The assessment has come at an important time for the U.K. authorities as they continue to develop and transition to the new regulatory structure and supervisory approach.

79. The ambition of the U.K. authorities is for the U.K. financial services sector to be the best regulated in the world, aligning competitive and innovative markets of unquestioned integrity with the highest standards of conduct.

To this effect the U.K. has taken a number of steps, including the following:

  1. continuing to be a leading advocate for tough capital and leverage requirements and liquidity standards;

  2. introducing a robust resolution regime and adopting total loss absorbency standards, a bail in tool and structural reform of the banking system;

  3. putting in place the Senior Managers and Certification Regime to ensure strong governance, better accountability of senior executives and higher standards of conduct in the banking sector;

  4. ensuring better alignment of financial incentives of senior risk takers with the longer term financial soundness of their firms; and

  5. prioritizing a high degree of protection for consumers of financial services, improving standards across the industry and taking tough enforcement action against those who do not meet them.

80. The United Kingdom’s approach is centered on forward looking, judgment based prudential and conduct regulation. A key element of the U.K. approach is that it does not seek to operate a ‘zero failure’ regime. Rather it seeks to ensure that a financial firm which fails does so without significant disruption to the supply of critical financial services or a material negative impact on consumers. Therefore, the U.K. approach continues to be risk based, with resources devoted to those areas where the risk to financial stability is the greatest. The U.K. authorities believe that the current level of scrutiny given to the supervision of smaller firms is appropriate, proportionate and is in line with their statutory objectives, including ensuring the safety and soundness of the U.K. financial system.

81. The U.K. authorities welcome the IMF’s findings regarding the effectiveness of AML/CFT supervision, and its recognition of the positive and significant progress that has been made since the last FSAP in 2011 in expanding and strengthening supervisory activities in this area.

82. The FCA’s approach to AML supervision is risk-based and outcome focused to encourage good industry AML/CFT standards. In line with the U.K. authorities’ risk-based supervision, resources are targeted at those banks and their activities which give rise to high money laundering risk. The U.K. authorities consider the approach to supervising lower risk banks—through thematic reviews, event-driven supervision and alerts from other domestic and overseas law enforcement/supervisory authorities—to be proportionate, effective and in line with the wider risk-based approach adopted.

83. Once again, the U.K. authorities wish to express their support for the role of the FSAP in contributing to improvements in supervisory practices and promoting the soundness of the financial systems in member countries. The U.K. authorities look forward to continuing the dialogue with the IMF and other global counterparts to work to improve the stability and effective supervision of the global financial system.

1

Bank of England, Financial Stability Report, July 2015.

2

At the end of 2012, banking assets in the U.K. were more than four times the size of the country’s gross domestic product. The current Governor of the Bank of England has shared a view that banking assets could constitute more than nine times the country’s GDP by 2050. Mark Carney, “The U.K. at the Heart of a Renewed Globalization,” a speech as part of the Financial Times 125th anniversary celebrations, London, October 24, 2013, available at http://www.bankofengland.co.uk/publications/Documents/speeches/2013/speech690.pdf.

3

Minimum requirements that firms must meet in order to be permitted to carry on the regulated activities in which they engage. The Threshold Conditions are codified in FSMA. In broad terms, they require firms to have an appropriate amount and quality of capital and liquidity, to have appropriate resources to measure, monitor, and manage risk, to be fit and proper, and to conduct their business prudently.

4

This Detailed Assessment Report has been prepared by Pierpaolo Grippa (IMF) and F. Christopher Calabia (Federal Reserve Bank of New York). Mr. Calabia was “seconded” to the IMF for the purposes of this review, and as such the views expressed in this report do not necessarily reflect those of the Federal Reserve Bank of New York or of the Federal Reserve System.

5

This part of the document draws from the self-assessment presented by the authorities, as well as from Art. IV reports and other documents produced by the FSAP, some of which were not yet finalized at the time of this assessment. Unless otherwise stated, figures used in this section refer to December 2014.

6

Banks, building societies and credit unions are the only U.K. financial institutions authorized to collect deposits from the general public (deposit-takers). In the rest of this report, deposit-takers are collectively and more simply referred to as ‘banks,’ in line with the terminology adopted by the CP.

7

Banks, building societies, and credit unions are the only U.K. financial institutions authorized to collect deposits from the general public (deposit-takers). In this report they are collectively referred to as ‘banks,’ in line with the terminology adopted by the CP.

8

Previously, in February 2011, the Bank’s Court of Directors created an interim FPC to undertake, as far as possible, the future statutory role of FPC. The interim FPC held its first policy meeting in June 2011, and met on a quarterly basis thereafter.

9

A detailed explanation of the code-based approach, and how it fits into the U.K.’s overall regulatory framework, can be found in The U.K. Approach to Corporate Governance: https://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/The-UK-Approach-to-Corporate-Governance.pdf.

10

The Kay Review of Equity Markets and Long-Term Decision Making, Final Report, Department for Business, Innovation and Skills, July 2012.

11

For the purpose of grading, references to the term “essential criteria” in this para. would include additional criteria in the case of a country that has volunteered to be assessed and graded against the additional criteria.

12

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 nonbank (including nonfinancial) entities, may also be relevant. This group-wide approach to supervision goes beyond accounting consolidation.

13

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

14

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

15

See page 15 of the PRA’s 2015 Annual Report.

16

For it supervision on insurers, the PRA also has the objective of contributing to the securing of an appropriate degree of protection for those who are or may become policyholders.

17

See also par. 12 of ‘The PRA’s Approach to Banking Supervision’ (2014): “The PRA is [..] tasked with promoting the safety and soundness of all the firms it regulates and is entitled to prioritize its resources on those firms with the greatest potential to affect financial stability adversely, whether through failing or through the way they carry on their business.”

18

By contrast, EU regulations have direct effect, and do not need to be transposed into national law or regulations.

19

The FPC can also make Recommendations to other bodies, for instance the FRC or financial institutions directly, representative bodies such as the British Bankers’ Association, HMT, and the BoE itself.

20

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

21

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.

23

The CST framework, introduced in 2014, entails annual stress test exercises carried out concurrently across major U.K. banks with the aim to assess the resilience of the system as a whole (macroprudential perspective) and deliver greater consistency in the PRA’s approach to (microprudential) supervision, through a benchmarking of banks’ capital management and stress-testing processes.

24

The FCA Handbook contains both rules (marked with an ‘R’) and guidance (marked with a ‘G’). The old PRA Handbook was structured the same way; it is now in the process of being replaced by the PRA Rulebook, which includes only enforceable rules. The PRA now communicates its expectations to firms separately through SSs that can be found on the PRA website.

25

However it must be observed that, in the Chancellor’s ‘remit and recommendations’ letter of July 2015 to the FPC, the competitive position of the London marketplace is recalled: “I would like the Committee to consider how, subject to its primary objective to protect and enhance the stability of the U.K.’s financial system, its actions might affect competition and innovation, and their impact on the international competitiveness of the U.K. financial system.” In its reply, the Governor of the BoE (and Chairman of the FPC) states that “[t]he FPC will, where practicable in the context of its financial stability objective, consider how its policy actions (or decisions not to act) might affect competition, innovation and the international competitiveness of the U.K. financial system.” While this does not affect the U.K. authorities mandate formally, it could—through FPC recommendations or directions—increase the weight assigned by the PRA to non-prudential considerations in the discharge of its functions. At the time of assessment, there were no signs that this potential had materialized.

26

Please refer to Principle 1, Essential Criterion 1.

27

A skilled person review is one of the regulatory tools the PRA can employ under FSMA as amended by the 2012 Act. There are two types of skilled person reviews under FSMA that gives the PRA the power to commission reviews by Skilled Persons. The PRA use these powers to obtain an independent view of aspects of a firm’s activities that for example, cause concern or where further analysis is required. The Use of Skilled Persons Part of the PRA Rulebook sets out the PRA’s requirements for a Skilled Person Review. The Reports by Skilled Persons Supervisory Statement 7/14 sets out the PRA’s policy on, and expectations for, the use of these powers. http://www.bankofengland.co.uk/pra/Pages/supervision/activities/reportsskilledpersons.aspx.

28

The Human Rights Act 1998 (also known as the Act or the HRA) came into force in the United Kingdom in October 2000. It is composed of a series of sections that have the effect of codifying the protections in the European Convention on Human Rights into U.K. law. All public bodies and other bodies carrying out public functions have to comply with the Convention rights.

29

See the March 19, 2015 letter from Andrew Bailey, PRA CEO, to the Chairman of the Treasury Committee of the House of Commons (http://www.parliament.uk/documents/commons-committees/treasury/150319_Andrew_Bailey.pdf).

30

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

34

See the PRA’s Supervisory tools: Recovery and resolution: http://www.bankofengland.co.uk/pra/Pages/publications/ps/2015/recoveryresolutionupdate.aspx.

35

The Committee recognizes the presence in some countries of nonbanking 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.

36

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.

37

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

38

CRR Art. 4(38) defines “close links” as “a situation in which two or more natural or legal persons are linked in any of the following ways: (i) participation in the form of ownership, direct or by way of control, of 20 percent or more of the voting rights or capital of an undertaking; (ii) control; and (iii) a permanent link of both or all of them to the same third person by a control relationship.”

40

Please refer to Principle 14, Essential Criterion 8.

41

Individuals seeking to take on certain roles defined by the PRA as “controlled functions” must receive approval from the PRA to do so at dual-regulated firms. Examples of such roles include serving as a director, a non-executive director, or chief executive at a supervised firm. A complete list of controlled functions can be found at the following website: http://www.bankofengland.co.uk/pra/Documents/authorisations/approvedpersons/pracfs.pdf.

42

Please refer to Principle 29.

43

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.

44

CRR Art. 4(38) defines “close links” as “a situation in which two or more natural or legal persons are linked in any of the following ways: (i) participation in the form of ownership, direct or by way of control, of 20 percent or more of the voting rights or capital of an undertaking; (ii) control; and (iii) a permanent link of both or all of them to the same third person by a control relationship.”

45

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.

46

Please refer to Footnote 33 under Principle 7, Essential Criterion 3.

49

The EBA verifies NCA’s compliance through peer reviews, some time (usually 1–2 years) after implementation started.

50

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.

51

Please refer to Principle 2.

52

Please refer to Principle 1, Essential Criterion 5.

53

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

54

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.

55

Please refer to Principle 1.

57

Please refer to footnote 19 under Principle 1.

58

CRR defines “parent institution” as an institution in a MS which has an institution or a financial institution as a subsidiary or which holds a participation in such an institution or financial institution, and which is not itself a subsidiary of another institution authorized in the same MS, or of a FHC or MFHC set up in the same MS.

59

Please refer to Principle 16, Additional Criterion 2.

60

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.

62

Chapter 3 of the Information Gathering Part of the PRA Rulebook.

63

Please refer to footnote 27 under Principle 5.

64

The Organization for Economic Cooperation and Development (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.”

65

“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.

66

Andrew Bailey in a speech at the City Banquet, London, October 16, 2014. See http://www.bankofengland.co.uk/publications/Documents/speeches/2014/speech763.pdf.

67

For the purposes of assessing risk-management by banks in the context of Principles 15–25, 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.

68

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

69

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.

70

The Prudential Regulation Authority’s “approach to banking supervision document,” 2014: http://www.bankofengland.co.uk/publications/Documents/praapproach/bankingappr1406.pdf.

71

As part of the PSM, the systemic importance of the bank is discussed (e.g., confirming the firm’s status as a Category 2–4 firm) and the impact of a failure of the firm on the wider U.K. financial system will be considered (e.g., “PIF” score).

72

Supervisory Statement (SS)20/15 “Supervising building societies’ treasury and lending activities” http://www.bankofengland.co.uk/pra/Pages/publications/ss/2015/ss2015.aspx.

73

Supervisory Statement 20/15 “SS20/15,” “Supervising building societies’ treasury and lending activities” http://www.bankofengland.co.uk/pra/Pages/publications/ss/2015/ss2015.aspx.

74

BIPRU 12.2 “Adequacy of liquidity resources” http://fshandbook.info/FS/html/PRA/BIPRU/12/2.

75

The PRA’s approach to banking supervision document, page 10, http://www.bankofengland.co.uk/publications/Documents/praapproach/bankingappr1406.pdf.

76

These expectations are set out in Section 2 of SS5/13 “The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process.” http://www.bankofengland.co.uk/pra/Pages/publications/icaap.aspx.

77

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

78

Supervisory Statement (SS)20/15 “Supervising building societies’ treasury and lending activities” http://www.bankofengland.co.uk/pra/Pages/publications/ss/2015/ss2015.aspx.

79

The PRA consulted in CP 17/15: “The PRA Rulebook: Part 3” to replace the rules and guidance in Chapter 21 of SYSC with a new Chapter in the PRA Rulebook. The draft rules are replacing the same as the rules in SYSC 21. This consultation closes on June 30, 2015. http://www.bankofengland.co.uk/pra/Pages/publications/cp/2015/cp1715.aspx.

80

Assets of more than GBP 250 million.

81

Supervisory Statement (SS)18/13 “Supervisory tools: Recovery and resolution plan—PS8/13, SS18/13 and SS19/13 UPDATED” http://www.bankofengland.co.uk/pra/Pages/publications/recoveryresolution.aspx.

82

The PRA consulted in CP 17/15: “The PRA Rulebook: Part 3” to replace the rules and guidance in Chapter 20 of SYSC with a new Chapter 15 in the ICAA part. The draft rules will apply to banks, building societies, and PRA-designated investment firms. The draft rules are replacing the same as the rules in SYSC 20. This consultation closes on June 30, 2015. http://www.bankofengland.co.uk/pra/Pages/publications/cp/2015/cp1715.aspx.

83

I.e.,: (i) credit risk; (ii) market risk; (iii) liquidity risk; (iv) operational risk; (v) insurance risk; (vi) concentration risk; (vii) residual risk; (viii) securitization risk; (ix) business risk; (x) interest rate risk (including in the nontrading book); (xi) pension obligation risk; and (xii) group risk.

84

SS6/13 “Stress testing, scenario analysis and capital planning” http://www.bankofengland.co.uk/pra/Pages/publications/stresstesting.aspx.

85

Supervisory Statement (SS) 20/15 “Supervising building societies’ treasury and lending activities” http://www.bankofengland.co.UK/pra/Pages/publications/ss/2015/ss2015.aspx.

86

The CP 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 CP, and compliance with one of the regimes is only required of those jurisdictions that have declared that they have voluntarily implemented it.

89

Barclays, Cooperative Bank, HSBC, Lloyds Banking Group, Nationwide Building Society, Royal Bank of Scotland, Santander U.K. and Standard Chartered.

91

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 standalone basis.

92

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.

94

In assessing the adequacy of a bank’s capital levels in light of its risk profile, the supervisor critically focuses, among other things, on (i) the potential loss absorbency of the instruments included in the bank’s capital base, (ii) the appropriateness of risk weights as a proxy for the risk profile of its exposures, (iii) the adequacy of provisions and reserves to cover loss expected on its exposures, and (iv) 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.

98

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

99

Please refer to Principle 12, Essential Criterion 7.

100

A recent document on the review of the Target Operating Model reported a staff of 48 FTE specialists on credit risk, 43 on market and counterparty credit risk, 41 on risk infrastructure and liquidity.

101

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

102

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.

103

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

105

“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.

106

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

107

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).

108

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.

109

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

110

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.

112

The measure of credit exposure, in the context of LE 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).

113

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

114

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.

115

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.

116

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

117

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.

118

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 Statistic–Guide for Compilers and Users, 2003).

122

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

127

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.

128

Internal staff memorandum to PRA Board, December 17, 2014.

129

Internal staff memorandum presented to the PRA Supervision, Risk and Policy Committee, “PRA Approach to Operational Risk Supervision for Banks,” March 19, 2014, p. 1.

130

Internal staff memorandum presented to the PRA Supervision, Risk and Policy Committee, “PRA Approach to Operational Risk Supervision for Banks,” March 19, 2014.

131

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.

132

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.

133

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.

138

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.

146

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.

148

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.

149

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.

150

According to the National Risk Assessment, this is the largest number received by a financial intelligence unit in the EU. See National Risk Assessment, p. 35.

151

National Risk Assessment, p. 6.

152

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

153

Sections 337 of the Proceeds of Crime Act 2002 define three criteria that permit a bank to disclose information, namely (1) that the information that is disclosed “came to the person making the disclosure (the discloser) in the course of his trade, profession, business or employment;” that the information (i) causes the discloser to know or suspect, or (ii) gives him reasonable grounds for knowing or suspecting, that another person is engaged in money laundering; and (iii) “that the disclosure is made to a constable, a customs officer or a nominated officer as soon as is practicable after the information or other matter comes to the discloser.”

155

Financial Action Task Force, “International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation: the FATF recommendations,” February 2012, p. 33.

156

Financial Conduct Authority, “How small banks manage money laundering and sanctions risk: Update,” TR14/16, November 2014, p. 6.

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United Kingdom: Financial Sector Assessment Program-Basel Core Principles for Effective Banking Supervision-Detailed Assessment Report
Author:
International Monetary Fund. Monetary and Capital Markets Department