RBSF - Central Bank of The Bahamas

1 RBSFRisk Based Supervision FrameworkINDUSTRY SEMINARBank Supervision DepartmentOctober 29th2010 Central Bank of The BahamasAgenda Governor s opening remarks Fundamentals of the risk based supervisory framework Risk aggregation model Risk assessment process Q&A2 Central Bank of The BahamasDefining Risk Based Supervision Focus and dedicate supervisory resources to identify activities and practices of greater risk to the soundness of banks. Identify higher-risk institutions Assess and measure risks identified Evaluate the significance of those risks for the financial systemCentral Bank of The Bahamas3 Our Risk Based Approach s Aim To Identify, measure, monitor and control risk against supervisory objectives: Maintaining confidence in the Bahamian financial system Strengthening the Banking and Trust Sector Strengthening and improving the effectiveness of supervisory process Maintaining legal and regulatory financial compliance with international norms and standards4 Central Bank of The BahamasFundamentals of our Risk Based Framework Probability the likelihood that a particular risk will crystallise Impact the scale of the detrimental effect if it crystalises Impact metrics fiduciary assets, total expenditure, number of staff, B$ deposits Probability dimensions Inherent risks, controls, oversight and governance.

2 Financial soundness Risk aggregation and assessment Risk mitigationCentral Bank of The Bahamas5 Key Features of the Risk Based Approach6 Central Bank of The BahamasImpact MeasurementRisk ProbabilityRisk MitigationRisk AggregationImpact Impact the scale of the detrimental effect if it crystallises We determine the impact of a firm using these quantitative proxy metrics:7 Central Bank of The BahamasFiduciary AssetsTotal ExpendituresNumber of StaffBahamian Dollar DepositsImpactTrustsAll licenseesActive Resident/Authorized DealerImpact Low Impact Threshold Equivalent (LITE)HighLITE Score> 100 CommercialBanks, Largest Offshore Public Banks and TrustsMedium High20 LITE Score < 100 Material Offshore Public Banks, Other Material Domestic LicenseesMedium Low5 LITE Score < 20 Less Material Offshore Banksand Trusts, Less Material Domestic Trusts with Unrestricted LicensesLowLITE Score < 5 Least Material Onshoreand Offshore Domestic Banks and Trust, Restricted TrustImpact Measurement8 Central Bank of The BahamasImpactImpactCentral Bank of The Bahamas9 ImpactImpactCentral Bank of The Bahamas105%10%11%74%No.

3 Of Licensees (pop. 257)HIGHMEDIUM HIGHMEDIUM LOWLOW69%23%6%2%Impact (Tot. 4,500)HIGHMEDIUM HIGHMEDIUM LOWLOWI mpactProbability11 Central Bank of The BahamasProbability High level categories of risk Sources 10 risk groups which reflect underlying risk elements. Individual components of the risk group Capture totality of risks that may arise in any firmRisk TypeRisk GroupRisk ElementsRisk IndicatorsRisk Groups and Risk ElementsCentral Bank of The Bahamas12 ProbabilityRisk GroupsRisk ElementsEnvironment and Strategy-Impact of economic, legal, regulatory and political factors-Business StrategyFiduciary & KYC/AML Risk-Nature of business-Fiduciary risk-KYC/AMLriskBusinessProcess Risk-Litigation/legalrisk-People risk-IT systems-Structure/ownership -Other business process riskPrudential Risk-Credit risk-Marketrisk-Liquidity riskRisk GroupsRisk ElementsFiduciary &KYC/AML Controls-Fiduciary risk controls (over client assetsetc.)

4 KYC/AML ControlsBusiness ProcessControls-Financial controls-Operational controls-Human resources controls-OutsourcingPrudential Risk Controls-Credit risk controls-Marketrisk controls-Liquidity risk controlsBusiness RiskControlsRisk Groups and Risk ElementsCentral Bank of The Bahamas13 ProbabilityRisk GroupRisk ElementControlFunctions-Compliance Function-Audit FunctionManagementand Oversight-Management-Corporate Governance-Strategic/BusinessPlanning-Re lationship with the rest of the groupFinancial Soundness (Part of)-Liquidityposition-Capital Position-Strength of EarningsOversight and GovernanceInherent Risk vs. ControlsCentral Bank of The Bahamas14 ProbabilityInherent RiskHigh (Almost Certain)Medium High (Likely)Medium (Possible)Medium Low (Unlikely)Low (Remote)ControlsStrongSatisfactoryNeeds ImprovementDeficientCritically DeficientAggregation of Risk GroupsCentral Bank of The Bahamas15 Fiduciary& KYC/AML Business Process RiskPrudentialRisksFiduciary &KYC/AML ControlsBusiness Process ControlsPrudential RiskControlsCapital Position,Liquidity &EarningsBusiness RiskControls RisksPrudentialMitigantsEnvironmental &Strategy RiskControl FunctionsManagement &Governance EnvironmentalOversight & GovernanceBusiness RisksControlsOversight & GovernanceFiduciary & KYC/AMLO peratingFinancialSoundnessNet RiskAggregationAggregation of Risk GroupsCentral Bank of The Bahamas16 Fiduciary& KYC/AML Business Process RiskPrudentialRisksFiduciary &KYC/AML ControlsBusiness Process ControlsPrudential RiskControlsCapital Position.

5 Liquidity &EarningsBusiness RiskControls RisksPrudentialMitigantsEnvironmental &Strategy RiskControl FunctionsManagement &Governance EnvironmentalOversight & GovernanceBusiness RisksControlsOversight & GovernanceFiduciary & KYC/AMLO peratingFinancialSoundnessNet RiskAggregationCASE STUDY Central Bank of The Bahamas17 AggregationHighMedium HighMediumMedium LowLowInherent RiskCritically DeficientDeficientNeeds ImprovementSatisfactoryStrongControls543 21 BANK A and BANK BRisk GroupIssue/Risk ElementRisk ScoreEnvironmental & Strategy RiskEconomic Environment -Strong economic recoveryBusinessStrategy -The bank has a heavily concentrated consumer ad commercial loan portfolioM(3)Fiduciary& KYC/AML RiskKYC/AML Risk The bank has low risk customers along with few PEPSML (2)BusinessProcess RiskPeopleRisk People turnover low and loss of employees in key functions low; sufficient skilled staff to manage business and control riskOperational Risk Low levels of operational losses; Structure & Characteristic of Ownership stand alone entity with no external supportML (2)Prudential RiskCreditRisk Over 60% of the bank s assets are in loans with 70% of loans are consumer with the remaining held as trade financing commercial & mortgage loans; Salary deduction limit exposures to risk Relatively high cash flow with 25% -30% of total assets held in Cash and Investments (Govt securities and bonds).

6 Strong customer base with well distributed retail depositsML (2)18 Central Bank of The BahamasBANK ARisk GroupIssue/Risk ElementRisk ScoreFiduciary& KYC/AML ControlsKYC/AML Controls Nearly half of client files non-compliant; Branch staff not fully understanding risk rating of customers; CD (5)Business Process ControlsITControls Absence of robust IT infrastructure; Change of 3 systems within 5 yearsOperational Controls Low staff complement compromises segregation of dutiesHuman Resources Control Lack of clear succession planning; no staff development programmeD (4)Prudential ControlsCredit Risk Controls Lackof robust credit policies; credit review absentLiquidity Risk Controls Absence of Liquidity planning and reporting; Contingent line of funding not adequate to cover liquidity gap for no extended period of timeD (4)ControlFunctionsCompliance Function Failureof compliance to implement & monitor KYC/AML controls; no differentiation in monitoring high risk clients (PEPS, Senior Public Officials); high turnover of compliance staffInternal Audit Robust internal audit program (policies and procedures), however parental oversight in implementing and tracking deficiencies weakCD(5)Management & GovernanceCorporate Governance Lack of self assessment to support internal audit; board composition not diverse; Annualboard attestations incompleteManagement Executive management dominated by one individual; inability to maintain high staff moral.

7 High turnover in middle managementStrategic Plan evidence of strategic plan in place but needs updatingD (4)Financial SoundnessCapitalPosition CAR below target ratio set by regulatorLiquidity Position Satisfactory LAR levels despite heavy reliance on institutional depositorsStrength of Earnings Pressure on interest rate spread; increase in arrears slow earningsNI (3)19 Fiduciary& KYC/AML Business Process RiskPrudentialRisksHFiduciary &KYC/AML ControlsBusiness Process ControlsPrudential RiskControlsFiduciary & KYC/AMLO peratingFinancialSoundnessCapital Position,Liquidity &EarningsBusiness RisksControlsOversight & GovernanceEnvironmentalBusiness RiskControls RisksOversight & GovernancePrudentialMitigantsNet RiskEnvironmental &Strategy RiskManagement &Governance Control FunctionsNet Risk = High20 Central Bank of The BahamasRisk GroupIssueRisk ScoreEnvironmental & Strategy RiskEconomic Environment -Prolonged GlobalDownturn,Increased Unemployment and sluggish economic growth.

8 BusinessStrategy -Complexproducts ; New customer strategy compromising core asset component of mortgagesMH (4)Fiduciary& KYC/AML RiskNatureof Business Large number of PEP s; business relies on introductions from intermediaries in overseas jurisdictionsM (3)BusinessProcess RiskIT Systems effectiveness of IT system hindered by ineffectiveness of service providersStructure & Characteristic of Ownership stand alone entity with small international parent company in financial difficultiesMH (4)Prudential RiskCreditRisk Concentration of mortgage lending; uncertainty regarding collateral values; deterioration in credit quality greater than peer averagesLiquidity risk Excessive reliance on wholesale funding; inability to obtain funding support at times of stressMH (4)21 Central Bank of The BahamasBANK BRisk GroupIssueRisk ScoreFiduciary& KYC/AML ControlsKYC/AML Controls Strong AML platform and training; Over 95% compliant with KYC documents of (1)Business Process ControlsFinancial Controls remains consistently compliant in its regulatory and financial reportingOperational Controls Operations are transparent as spelt out in policies and proceduresHuman Resources Control Major staff development projects yielding positive results (employee satisfaction)S (1)Prudential ControlsCredit Risk Controls Creditpolicies generally satisfactory but provisioning polices require reviewLiquidity Risk Controls Treasury continues to be adequate for nature of business.

9 Liquidity positions are monitored daily and produce weekly funding reportsSAT (2)ControlFunctionsCompliance Function strongcompliance policies and Audit Outsourced IA function to external firm; bank has satisfactorily addressed issued identified; audit committee approved audit plan and reviews quarterlyS(1)Management & GovernanceCorporate Governance Board has diverse skill setand performs annual self assessments; Management Adequate management size; assess management efficiency ratio Strategic Plan Has a defined strategic plan with updates to strategy notedin annual reportSAT (2)Financial SoundnessCapitalPosition Consistently remained slightly above CBOB cap adequacy ratioLiquidity Position Liquidity position reported to CBOB generally in a surplus Strength of Earnings Despite a decline in earnings, (year-over-year) profit margin remains between 15-20%.

10 Earnings support operationsSAT (2)22 Fiduciary& KYC/AML Business Process RiskPrudentialRisksHFiduciary &KYC/AML ControlsBusiness Process ControlsPrudential RiskControlsFiduciary & KYC/AMLO peratingFinancialSoundnessCapital Position,Liquidity &EarningsBusiness RisksControlsOversight & GovernanceEnvironmentalBusiness RiskControls RisksOversight & GovernancePrudentialMitigantsNet RiskEnvironmental &Strategy RiskManagement &Governance Control FunctionsNet Risk = Low23 Central Bank of The BahamasRisk Mitigation Actions in response to issues raised may be: for the firm themselves to perform for the Central Bank to undertake for a third party, overseas regulators the firm s external & internal auditors Clear timescale and intended outcomes Choice of tools depend on severity of risk24 Central Bank of The BahamasMitigationStages in the Risk Based Assessment Process25 Central Bank of The BahamasPlanningDiscoveryEvaluationCommun icationImportant Dates 3 phase roll-out process Meetings with banks scheduled for: November 2010 January 2011 March 2011 Central Bank of The Bahamas26 Deciding which firms will be assessed and howCentral Bank of The Bahamas27 Highly Integrated GroupSeveral authorisedentities and MBUs covered by one assessment Group Several authorisedentities and MBUs covered by separate Gather existing knowledge of firms by analysing the following.