A. Introduction

1. As part of an ongoing program improving its RBS framework using IMF TA, the following areas have been identified as priorities:

• Assisting in implementing RBS manual;

• Assisting in strengthening the regulatory framework to effectively implementing RBS; and

• Providing training and building capacity of supervisory staff through close interaction with BSD staff.

2. This mission focused on implementing RBS manual and improving supervisory skills of staff. The mission provided BSD task force team members with formal hands-on training sessions related to applying RBS manual (including CAMELS), revising the IP and RAS, advising on writing an effective examination report (ROX), and reviewing BSD reporting to the senior management based on systemic analysis, and discussing appropriate supervisory responses. The bulk of the mission time and effort was spent on the training.

3. The Lao P.D.R. financial system is largely concentrated in commercial banks. The gross assets of banking sectors are LAK 130,387 billion, representing approximately 86 percent of GDP. The banking sector consists of 42 commercial banks and 1 specialized bank. The banking sector is concentrated in the three state-owned commercial banks (SOCBs), which constitute about 40 percent of banking assets. Those in operation include 8 subsidiary banks (8 percent), 20 foreign bank branches (21 percent), 8 private banks (19 percent), 3 joint-venture banks (9 percent), and 1 specialized bank (3 percent).

B. Progress Since the Last TA Mission in May 2018

4. The BSD continues to embrace and implement RBS methods. It is encouraging to note that BSD staff are applying RBS methods more broadly. Since the last TA mission, an IP and RAS were prepared for additional banks, the ROX format was used on a test basis in the inspection of several banks, and risk has been a primary factor in developing the scope, and schedules for onsite inspections.

5. The BoL has begun drafting quarterly reports for the aggregate banking system incorporating CAMELS ratings, risk matrix results, and system averages for the key Financial Soundness Indicators (FSIs) used in support of RBS. Supporting risk analysis must still be strengthened in the high-level summary; however, the steps taken to improve systemic reporting were welcomed.

6. Incremental progress has been made in the adoption of RBS; however, some momentum may have dissipated. BoL staff are working on several initiatives to strengthen financial sector supervision. These include implementing a new banking law and drafting enabling regulations and processes to implement parts of the Basel II capital accord. Each of the additional tasks is important for the BoL’s success. Nevertheless, a solid foundation in RBS has not yet been achieved.

7. Initial efforts of BSD staff using RBS methods indicate the need for more emphasis and training on risk analysis. The content of inspection reports focuses mainly on compliance issues rather than analysis of risks. Compliance-based methods and reporting are most familiar to staff and their training in risk-based methods has been minimal, so full transition to risk-based methods will take time and require significantly more assistance.

Table 2.

The Last Mission’s Main Recommendations

Table 2.

The Last Mission’s Main Recommendations

Recommendations	Status
Formally approve RBS manual and supporting tools.	Planned for end-2018, but manual still in “testing” phase. Approval by BSD and BoL senior management still pending
Continue practical application of RBS methods to strengthen risk-focused analysis and examination skills of BSD staff.	Ongoing.
Draft an internal BoL policy for applying appropriate responses and corrective or enforcement actions.	Not completed; still pending.
Prepare and utilize IP and RAS for all banks.	Partly completed: Q4: 2017: 50% completed Q2: 2018: 64% completed Q1: 2019: 72% completed
Incorporate peer group benchmarks in analysis and commentary in IP and RAS documents.	Partly completed; included in analysis process but not in commentary.
Include system average FSIs and supporting risk analysis in quarterly banking system analyses; use peer group averages to contrast performance of domestic versus foreign banks.	Partly completed; selected system average indicators included in quarterly report; no domestic/foreign split.
Add consolidated supervision concepts to risk analyses.	Not completed.
Develop an internal BoL policy establishing appropriate criteria for scope, frequency, timing, and other relevant criteria for onsite examinations	Partly completed.
Review progress and update onsite examination schedule for 2018; prepare 2019 schedule during Q4:2018, using appropriate risk priority criteria.	Attempted.
Apply RBS tools to plan and conduct onsite examinations.	Ongoing.

View Table

Table 2.

The Last Mission’s Main Recommendations

Recommendations	Status
Formally approve RBS manual and supporting tools.	Planned for end-2018, but manual still in “testing” phase. Approval by BSD and BoL senior management still pending
Continue practical application of RBS methods to strengthen risk-focused analysis and examination skills of BSD staff.	Ongoing.
Draft an internal BoL policy for applying appropriate responses and corrective or enforcement actions.	Not completed; still pending.
Prepare and utilize IP and RAS for all banks.	Partly completed: Q4: 2017: 50% completed Q2: 2018: 64% completed Q1: 2019: 72% completed
Incorporate peer group benchmarks in analysis and commentary in IP and RAS documents.	Partly completed; included in analysis process but not in commentary.
Include system average FSIs and supporting risk analysis in quarterly banking system analyses; use peer group averages to contrast performance of domestic versus foreign banks.	Partly completed; selected system average indicators included in quarterly report; no domestic/foreign split.
Add consolidated supervision concepts to risk analyses.	Not completed.
Develop an internal BoL policy establishing appropriate criteria for scope, frequency, timing, and other relevant criteria for onsite examinations	Partly completed.
Review progress and update onsite examination schedule for 2018; prepare 2019 schedule during Q4:2018, using appropriate risk priority criteria.	Attempted.
Apply RBS tools to plan and conduct onsite examinations.	Ongoing.

A. RBS Manual

8. The RBS manual continues in a “testing” phase pending formal approval by BSD senior management. Further testing of RBS methods is desired by BSD management before seeking final approval from BoL senior management. Meanwhile, BSD staff is using RBS methods more broadly for both offsite and onsite activities and early results are encouraging. Over time and with more training and experience, it is anticipated that staff will develop more skill using expert judgement.

9. Refinements to the RBS manual may be needed in the future. The RBS manual is sufficiently complete that it can be officially approved for use. Once RBS methods are fully implemented into the on- and offsite activities of BSD, and after the new banking law becomes effective, some refinements to the manual may be necessary. This is normal, and it will be helpful to keep a log of possible revisions for updating the manual at one- or two-year intervals.

Recommendation

• Complete the approval of the manual as soon as possible and fully implement RBS methods in practice. Track minor possible revisions to the manual on an ongoing basis and make updates/revisions at periodic intervals, e.g., one or two years.

B. IP and RAS

10. The implementation of RBS tools in the offsite supervision continues, but the pace of implementation has slowed. BSD has completed IP and RAS documents for 72 percent of banks. Additional effort is needed to complete these documents for the remainder of the banks to have a complete picture of the banking system using the RBS framework.

11. The mission reviewed a sample IP and RAS provided by the BoL. These RBS documents identified risk levels and trends for the subject institution, but there is a need to strengthen supporting comments and analysis. Specifically, risk observations should be better supported with ratio levels and trends, root causes of risks should be better identified, and greater attention should be paid to the recommended supervisory response. Focus must continue to shift toward risk and its root causes.

12. During RBS implementation, some changes were made to a combined IP/RAS document; additional modifications may be useful. The changes by the BoL offered staff an opportunity to test separate IP and RAS documents, and this methodology is being implemented. The mission outlined with BSD staff possible ways to streamline reporting to make the IP more static and the RAS more dynamic. For example, CAMELS analysis and the risk matrix are included in both the IP and RAS, and these documents are updated quarterly. The mission proposed keeping the CAMELS analysis, risk-specific analysis, and the risk matrix in the RAS while reorganizing the content of the IP.²

13. IP should focus more deeply on the bank’s capital and group structure, corporate governance systems, business profile and strategy, risk and challenges facing the bank, and the trend of supervisory rating. It is important for supervisors to keep track of events and changes in risk exposure and strategy through IP’s as maintaining updated information of each bank is critical for assisting onsite examiners. IP’s should be prepared and updated as and when major developments occur. Contents that could strengthen the current IP include:

• Contact information: relevant contact persons or groups with the bank.

• Corporate governance: a brief profile of each board of directors, the CEO, and general managers (for foreign branches).

• Audit information: the latest audit information including the dates, auditor, and audit opinion.

• Background of banking business operation, business strategy, main products, and services offered.

• History of examinations; dates, scopes, main findings/unresolved issues.

• Log of events: additional information about the bank, which is important. The suggested changes would not affect the RBS framework provided in the manual,³ and they could help to improve the pace of implementation.

Recommendation

• Continue to complete and update IP and RAS documents for all banks.

• Offsite analysts should consider the level, trend, and inter-relationships of the individual components and financial indicator ratios when assigning CAELS ratings.⁴

• Adjust the organization of RBS documents to keep and expand business profile, corporate governance system, and a log of important events in the IP while focusing CAMELS and risk analyses and the supporting matrix in the RAS.

C. FSI Benchmarks

14. BSD offsite team has developed a series of benchmarks and performance ranges for key FSIs based on CAELS components. The benchmarks were developed using data reported by banks together with BoL’s existing prudential requirements and ranges of good performance. In addition to the common benchmarks that apply to the whole banking system, BoL drafted two separate sets of benchmarks for possible testing of peer groups comprising domestic versus foreign banks (foreign branches and subsidiaries). However, disparate results from these groups appear to be more confusing than helpful. The new benchmark ranges for foreign banks do not appear to provide useful perspective for comparative analysis.

15. The mission and BSD offsite management agreed that peer groups could be more effective based on an institution’s status as a full bank versus that of a foreign branch, rather than domestic versus foreign banks.⁵ Development of these groups and testing of results for usefulness is recommended. For now, the mission encouraged the offsite group to retain and reference the original set of benchmarks (banking system) until revised benchmarks can be redrafted, tested and approved.

Recommendations

• Exclude the drafted domestic versus foreign bank benchmarks from Appendix 2 of the RBS Manual (internal use only).

• Research, develop and test the usefulness of benchmarks for banks vs. foreign branches.

D. ROX

16. RBS approach and the ROX format are used in conducting onsite inspections. Following advice provided at previous TA missions, the annual schedules and scope of activities for onsite inspections are prepared using risk-profile data about banks, and more recent reports of examination have been drafted in the ROX format.

17. Initial results using the new approach shows that analysis of risks is limited. To support prompt and robust supervisory actions, the quality of risk assessments in the ROX must be improved. The mission reviewed with BSD staff the report for a recent onsite examination and noted that the content was largely compliance-related rather than a thorough analysis of risks, and the CAMELS component ratings and conclusions were not consistent with actual examination findings. These weaknesses were discussed in detail with staff, and specific recommendations offered that:

• The Format can be improved for clarity by following that which was originally recommended, for example it is preferable to show onsite CAMELS rating at current examination and at previous examination; showing ratings assigned by offsite and onsite creates conflicting conclusions if there are differences.

• The Content should discuss the most important risk issues supported by facts and the focus must be a critical analysis of risks, the underlying causes, and the potential for adverse impact if problems are not timely addressed and corrected. For instance, narrative comments for each risk area should address level and trend, not only in respect of regulatory minimums, but also to identify cause and probable impact so that appropriate supervisory strategies can be applied

Recommendation

• Use the ROX format as recommended and discussed with staff, giving emphasis to content and a well-reasoned analysis of risks. Also, the bulk of “General and Administrative Information” can be excluded from the ROX and retained in examination workpapers.

E. Training

18. The mission provided training in the use of RBS methods and the manual. During the mission, training was provided to BSD staff in small group discussions, explaining in greater detail how to properly analyze and rate various risks and how to write appropriate comments in IP, RAS, and ROX documents. In addition, a more formal seminar was provided for all offsite and onsite BSD staff, reviewing the underlying RBS concepts and particularly what ratings mean and how they are assigned.

19. Following formal adoption of the RBS manual, an informational seminar for bankers is planned. The benefit of an information seminar for bankers to explain RBS concepts, methods and expectations was discussed at the previous mission and remains a priority for BoL. The mission supports this and can assist BSD staff in preparing materials for the seminar.

Recommendation

• BSD staff should prepare a first draft for the bankers’ seminar, and feedback can be provided either before or during the next TA mission.

A. Banking Sector Analysis

24. The BSD has begun strengthening systemic reporting for the banking sector. Aggregate data is being summarized by offsite supervisors, and new reports have been drafted summarizing the health of individual institutions. New reports should provide BSD and BoL senior managers with a clearer view of the banking system, both in aggregate using key performance ratios, and by individual banks using CAMELS and risk-based conclusions. Both aggregate average and institutional summary reports can promote effective communication with senior management, especially if presented together.

25. The BSD has prepared an aggregate RAS report referencing key financial indicators. The report aims to evaluate the banking sector using system averages and trends, and provide insight regarding risks and the areas requiring supervisory attention. The mission clarified good practices regarding aggregate reporting, and provided detailed observations and recommendations to improve it. The mission recommends that the system report include a table showing the averages for key financial ratios over time. Peer group averages could be added to illustrate the influence of each group on the system. Other detailed observations and recommendations are presented in Annex I.

26. The BSD has also drafted a summary level report for all banks combining CAMELS and risk-based conclusions from RAS analyses. When fully implemented, the report will summarize each bank’s financial health, risk areas requiring attention and overall risk level. The mission recommended that this report be supported by the most recent RAS for the largest institutions and all problem banks.

Recommendation

• Strengthen banking system reporting to include a table showing the banking system averages for key financial ratios over time; add peer group averages to illustrate the influence of each group on the system (please see Annex I for detailed recommendations).

• Support banking system summary report with the most recent RAS for the largest banks and all problem banks.

B. Annual Onsite Examination Schedules and Timeline

27. The mission reviewed the onsite examination schedules for 2018 and 2019. Using advice from earlier missions, BSD managers prepared an annual examination schedule for 2018 and for 2019 utilizing four basic criteria: (i) level and trend of NPLs; (ii) extent of unresolved issues— mostly compliance-related – from the previous examination, (iii) interval since the last examination, and (iv) market share. In practice, it appears that NPLs and unresolved issues are the primary drivers for scheduling onsite examinations. The mission was informed that 16 examinations were conducted in 2017, 18 in 2018, and 17 inspections are planned for 2019.

28. Several banks have not had an onsite presence by the BSD in two years or more. The nine largest banks by market share, comprising a large portion of banking system assets, have not had an onsite inspection in almost two years. A dozen other banks have had longer intervals although each is small on a stand-alone basis, and their combined market share is also quite small. Offsite information does not indicate any material weaknesses or problems; however, it remains necessary to verify the banks’ conditions, especially for systemically important banks.

29. Examinations are comprehensive in scope but focus on specific risks. Onsite examinations are nominally “full-scope” but in practice are targeted to address specific risks such as asset quality/credit risk, foreign exchange risk, or problems involving management. Similarly, the duration of most inspections is two weeks for domestic and subsidiary banks, and one week for foreign bank branches; however, the actual duration of onsite examination activity is flexible to fit the circumstances. As the BSD further implements RBS, the integration of offsite perspectives about risks and risk management in the onsite examination planning process will strengthen the focus and effectiveness of onsite examinations.

30. The mission reiterates the benefits of adopting an internal policy for conducting onsite examinations. The BSD is using risk-based criteria to set the schedule and scope of onsite inspections, and these efforts are viewed favorably. In this regard, the BoL is encouraged to formally adopt an internal policy for the BSD that sets more explicit criteria for the frequency, scope, timeline, staffing and follow-up for examinations. For example, inter alia, an appropriate policy would specify criteria for full-scope vs. limited-scope and targeted inspections, the maximum desired interval between inspections for systemic/non-systemic banks and problem/non-problem banks, coordination with home country authorities and obtaining parent company information for branches and subsidiaries of foreign banks.

31. The operational efficiency of onsite examinations can be enhanced by ensuring that enough and consistent time is allocated for each stage of the examination process. The BSD has an internal policy that sets forth the general timetable for various actions inherent in conducting onsite inspections. For example, when pre-inspection documents are requested from the bank, which examiners are responsible for different portions of the examination; when to hold wrap-up meetings with bank management; the process for writing, reviewing and finalizing the ROX within BoL; and meeting with bank senior officials to discuss the findings and conclusions, and initiate a corrective program. This process is good but can be further improved by incorporating more explicit details and timing as suggested in Annex II of this report. The proposed timeframe provides a target for completion of the examination report and submission to the supervised banks, which will help ensure that reported examination findings and recommended supervisory action remains current.

Recommendation

• Give greater emphasis to offsite RAS and CAELS ratings and to systemic importance when preparing and updating the annual onsite examination schedule.

• Conduct targeted and/or limited scope inspections as soon as possible for banks that have not had an onsite presence for long intervals; give special attention to systemically important banks.

• Develop and/or formally adopt an internal policy setting appropriate criteria for scope, frequency, timeline, etc. of onsite examinations. With respect to the timeline, refer to the “onsite examination timeframe” as provided in Annex II.

C. Supervisory Response

32. A well-defined structure for responding to examination findings will support effective RBS. To maximize the efficacy of corrective measures, the BSD must respond to examination findings in a prompt and consistent manner. The new banking law specifies various legal remedies and sanctions that may be applied, but even before problems rise to that level, the BSD can apply informal measures. Adopting an internal response policy—like an internal policy for examination scope and frequency—will help ensure that responses to examination findings are consistent and effective. The mission provided a basic outline that BSD can use to begin developing a policy; more specific advice will be provided at a future TA mission.

Recommendation

• The BSD should begin developing an internal policy for applying response and corrective measures. Refer to the “Sample Framework for Supervisory Response Policy” as provided in Annex III.