Core Principles for effective banking Supervision

Note from the publishers:

INTRODUCTION TO POLISH EDITION OF CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION

National Bank of Poland
General Inspectorate of Banking Supervision

We are enclosing herewith a Polish translation of the "Core Principles for Effective Banking Supervision" published in September 1997 by the Basle Committee on Banking Supervision. This institution brings together high-ranking representatives of banking supervisory authorities from the G-10 countries, and also, via regional groups, the heads of banking supervision from over 100 countries worldwide in addition to the G-10. Polish banking supervision also played an active part in preparing this document.

The "Core Principles for Effective Banking Supervision" met with a very positive reception from the heads of banking supervision in most countries of the world, and were then presented during the annual meeting of the World Bank and International Monetary Fund in Hong Kong in September 1997, where they gained the support of ministers of finance and governors of central banks from over 100 countries of the world.

The issuance of the "Core Principles for Effective Banking Supervision" opens up a new chapter in harmonising systems of financial regulation and banking supervision around the world. The "Principles" are of great significance, particularly for the financial markets in developing countries. The adoption and then implementation of the "Core Principles" by supervisory authorities in particular countries will in certain measure serve to legitimise a given banking system in the eyes of the international financial community, while at the same time smoothing the path for local banks in conducting operations outside their home country. Implementation of the "Core Principles" will also have implications for a country's credit rating, and therefore also for the cost of accessing funding on international markets, and will influence the view of that country taken by leading international financial institutions such as the World Bank, the International Monetary Fund, the major investment banks, etc.

Poland has already put into practice most of the 25 "Core Principles". However, there are also areas which are not convergent with the "Principles". These include the lack of legal provision concerning the requirement to practise consolidated supervision, and the insufficient emphasis placed in the new Banking Act on internal controls, including the independence and professionalism of a bank's internal audit function. Efforts to remedy these shortcomings, both by amending legal regulations and improving banking practice in this respect, have been made by the General Inspectorate of Banking Supervision for several years now. In this context, the General Inspectorate of Banking Supervision attaches great importance to supporting all measures taken with a view to bringing existing legislation into full correspondence with the "Core Principles".

Given the above, I should like to draw your attention to those "Core Principles" which in the Polish banking context deserve additional comment.

In view of the fact that a number of Polish banks are attempting to extend their operations outside the borders of our country, Principle 11, which refers to the monitoring and control of country risk, acquires particular importance. Our observations indicate that this question is not fully appreciated by some of the banks which have embarked on efforts to expand into other markets in our region, either by opening up branch offices, or by means of lending and investment activity.

Another important issue in the Polish context, yet still underrated, is that raised by Principle 14, which concerns the question of effective internal controls at banks, which is especially important given the broad nature of the provisions contained in the Banking Act. The experience of banking crises and bankruptcies over the last 15 years demonstrates that management failure to enforce and continuously monitor effective internal controls has been one of the major causes of banks suffering serious problems or even collapse. There is also a need to recall the distinction between internal controls, which should be in place at all levels of the organisation, and the role of the internal audit department as a specialised unit within the bank. The formal establishment of an audit department is in itself no guarantee that the bank's internal controls will function effectively. Moreover, the effectiveness of internal audit is largely contingent on its position within the bank, independence and professionalism. The latter prerequisites are a particular concern of bank supervisors all over the world. Conscious of this problem, GINB is preparing a special recommendation on internal controls and the role of internal audit within banks.

Principles 12 and 13 refer to the need to put in place a comprehensive risk management process, not only with reference to credit risk, but also market risk, with these risks being measured, monitored (e.g., through adequate management information systems) and controlled (e.g., through limit compliance). Managing market risk is a new and difficult challenge for many Polish banks. I believe that in this area it is particularly important to assess, control and manage foreign exchange risk, and to an increasing extent also interest rate risk, and these issues should already be receiving suitable attention as management priorities. This should find reflection, for example, in investment in IT infrastructure, in data bases, and in professional specialist staff. Principle 20 deals with the need to supervise banks on a consolidated basis, something that constitutes a serious challenge for Polish supervisors, empowered solely to require that banks draw up consolidated accounts. This leaves no way of effectively monitoring the whole area of non-banking activity within a banking group or holding company, or conglomerate where the parent is a non-bank organisation, in order to ascertain the attendant risks to the bank, and thus to its depositors. Given the lack of suitable legal provisions in this area, we will expect that - at least within a banking group or holding company structure - basic management information on financial condition and risk exposure will be compiled on a consolidated basis and made available to bank examiners.

In recommending the attached "Core Principles" to the attention of both bank management and supervisory board members, and also to staff at other bank units that might be particularly interested (risk management departments, strategy and planning units, legal departments, internal audit, units responsible for prudential reporting), I should also like to request and encourage you to forward any proposals and comments you might have regarding implementation of the "Core Principles for Effective Banking Supervision" within the Polish banking system.

Your faithfully,
Ewa Sleszynska-Charewicz
General Inspector of Banking Supervision