Proportionality in Banking Regulations:The Case of the Philippines

CHUCHI G. FONACIERDeputy Governor

Bangko Sentral ng Pilipinas

2

38 38 37 36 36 40 42 43 73 71 70 71 69 68 60 55

647 617

589 566 543 524 500 489

0

100

200

300

400

500

600

700

2010 2011 2012 2013 2014 2015 2016 2017

No. of Offices (Head Office Only1) (2010-2017)

UKBs

TBs

RCBs

6,132 6,541 7,194

8,997 10,070

10,895

12,302

13,763

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2010 2011 2012 2013 2014 2015 2016 2017

Asset Size, in billions (2010-2017)

Universal/CommercialBanks (UKBs)

Thrift Banks (TBs)

RCBs

Source : Supervisory Data Center, Supervision and Examination Sector, BSP1 Excludes other offices

such as branches

Source : Supervisory Data Center, Supervision and Examination Sector, BSP

Philippine Banking System

As of end-December 2017, universal andcommercial banks hold the largest share ofthe banking system’s total assets at 90.7percent while thrift banks and rural/coopbanks accounted for only 7.8 percent and1.5 percent shares, respectively.

Banking system recorded a network of 587head office as of end-December 2017.Rural/coop banks are the more popular typeof banks in the rural communities with 489offices. Universal/commercial banks and thriftbanks with 43 and 55 offices, respectively.

Size

Proportionality in Banking Regulations

Scale

Risk Exposures

LEVEL OF COMPLEXITY OF BANKS

Systemic Importance

Products &

Services

Operational Complexity

A supervisory approach thatis commensurate with thefinancial institution’s riskprofile and systemicimportance.

Simpler standards butwithout compromisingregulatory objectives.

Bank Segmentation

Bank Segmentation

Business Model and Risk Profile

Simple banks

Complex banks

Affiliation

Thrift and rural banks that are subsidiaries of

universal and commercial banks

Stand-alone thrift and rural banks

Compliance with corporategovernance, risk managementand regulatory disclosurestandards

Compliance with the Basel IIIcapital and liquidity standards Prudential reporting

requirements

Prudential Requirements

Bank SegmentationBased on Business Model and Risk Profile

ComplexSimple

Philippine Banks

Thrift Banks (TBs)

Rural Banks (RBs)

Cooperative Banks

Universal Banks

Commercial Banks

TBs, RBs and Coop Banks canbe considered as complex if atleast 3 of the followingcharacteristics exists:

Total assets of at least P6billion

Extensive branch network Non-traditional financial

products and services Use of non-conventional

business model Business strategy

characterized by aggressiverisk appetite and increasingrisk exposure

Compliance with corporate governance, risk management and regulatory disclosure standards

Governance Financial conglomerate Related party transactions issues

Family-owned and closely-held Basic management issues

Operational Risk/Internal Control/Bank Security

Comprehensive policies and proceduressupported by risk management systems,internal controls and reporting systems

Operational risk issues trigger systemconcerns

Small and closely related manpowercomplement

Reliance on character rather thansystems and processes

Manual-based systems and processes Exposure to risks events such as

typhoons and natural calamities

Credit Risk With sufficient resources and competenttalent pool capable of developingsophisticated models and tools formanaging credit risks

Lack of capacity to develop credit scoring and loan loss estimation models

Preferential lending to related parties

Liquidity Risk Various funding sources(e.g., interbank, liquid assets)

Stronger parent support Bank closure entails higher cost

Limited sources of funding in locality Closure of a bank affects liquidity

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Key Characteristics and Risk IssuesRisk Issues Simple BanksComplex Banks

Prudential Regulatory Framework

Corporate Governance

Management of Key Risk Areas

Governance Landscape Fitness and Propriety of BOD and SM

Duties and Responsibilities of BOD and SM

Credit Related Party Transactions Liquidity

Operational Compliance/Internal AuditBank Protection/

Security Risk

REPORTING GOVERNANCE - FINANCIAL REPORTING

REGULATORY CAPITAL

INFORMATION TECHNOLOGY FRAMEWORK

Board of Directors Composition

At least 1/3 but not less than two (2)members of the Board asIndependent Director

Board-Level Committees Three (3) board-level committees: Audit Committee Corporate Governance Committee Risk Oversight Committee

Universal and commercial banks thatare part of a conglomerate arerequired to create a Related PartyTransactions Committee

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Calibrated Corporate GovernanceGovernance Standards Simple BanksComplex Banks

At least one Independent Director

Audit Committee

Flexibility in Management Structures but with Safeguards

Internal Audit Internal Auditor(with stricter qualification criteria)

Internal Auditor(with simpler qualification criteria)

Compliance Risk Full-time Chief Compliance Officer Full-time Chief Compliance Officer (CCO) orInternal Auditor may serve as the CCO in aconcurrent capacity

Risk Governance Chief Risk Officer to lead the RiskManagement Function

Chief Risk Officer (CRO), or Qualified SeniorOfficer can be designated as CRO

Corporate governance and risk managementdiscussed at the Board level

Operational Risk Operational Risk Management Function Operational risk issues discussed by the Boardduring their meetings

Security Risk Full-time Chief Security Officer Chief Security Officer (CSO), or Qualified SeniorOfficer may concurrently act as the CSO, providedthat such designation does not result to a conflictof interest

Business Continuity Business Continuity Management (BCM)Unit

Individual Business Continuity Management(BCM) Coordinator

Concurrency for certain positions is allowed, provided that designated officer is qualified and the Board of Directors play a more active role in these areas

Simple BanksKey Risk Areas Complex Banks

Appropriate Risk Management Guidelines

Credit Risk Sound loan loss methodology that canreasonably estimate expected loan lossprovisions in a timely manner

Subject to simplified but morestringent loan loss provisioningguidelines

Liquidity Risk Dynamic approaches and a range oftechniques that factor future changes intheir activities and impact of thesechanges on the bank’s balance sheet

Static approach to liquiditymanagement. Static models are basedon positions at a given point in time.This may consist of a cash flowprojection in a spread sheet where thebank’s sources and uses of funds isanalyzed based on contractual ormaturity

Operational Risk Utilize more sophisticated tools inidentifying and assessing operational riskexposures. These may include but neednot be limited to the following: risk self assessments scenario analysis business process mapping model measurement

In identifying and assessingoperational risk exposures, banks areexpected to adopt at a minimum, theresults of internal/external audit andsupervisory issues raised in the BSPReport of Examination and internalloss data collection analysis

Simple BanksKey Risk Areas Complex Banks

Appropriate Risk Management Guidelines

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Information Technology IT oversight function is delegated to anIT Steering Committee, or its equivalent

Internal Audit to perform IT audit support(e.g., independent assessment oftechnology risk management process andIT control)

The Board of Directors or SeniorManagement should appoint anInformation Security Officer who shall beresponsible and accountable for theorganization-wide Information Systemprogram

Oversight shall be performed by theBoard of Directors

In case there is no in-house IT auditexpert available, the externalspecialist and auditors of otherinstitutions may perform the IT auditsupport

The Information Security Officer(ISO) function may be assigned to anexisting independent officer thathave sufficient knowledge,background and training

Stress Testing Methodologies that could be employedmay be sensitivity analysis, scenarioanalysis and reverse stress test.

Required to report the results of the stresstesting that were undertaken to the BSPon an annual basis as part of the InternalCapital Adequacy Assessment Processdocument.

Use of simple sensitivity analysiscovering credit, liquidity andoperational risks.

Results available upon request

Simple BanksKey Risk Areas Complex Banks

Structured Minimum Capitalization

Head Office in National Capital Region

Head Office Only P 50 million P 500 million P 2.00 billion P 3.00 billionUp to 10 branches 75 million 750 million 4.00 billion 6.00 billion11 to 50 branches 100 million 1.00 billion

10.00 billion 15.00 billion50 to 100 branches200 million 2.00 billionMore than 100 branches 15.00 billion 20.00 billion

Head Office in All Other Areas Outside NCR1/

Head Office Only P 20 million P 200 millionUp to 10 branches 30 million 300 million11 to 50 branches 40 million 400 millionMore than 50 branches 80 million 800 million

1/ Required minimum capitalization for rural and coop banks in cities up to 3rd class municipalities. The required minimum capitalization for4th class to 6th class municipalities is lower.

Simple BanksBank Category Complex Banks

Required Minimum CapitalizationRural and Coop Banks Thrift Banks Commercial Banks Universal Banks

Bank Segmentation Based on Affiliation. Thrift and rural banks that are

subsidiaries of universal andcommercial banks are requiredto comply with the Basel IIIcapital and liquidity standards,similar to their parent bank

. Stand-alone thrift and ruralbanks as well as cooperativebanks are subject to a simplerframework

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The Basel standards as well as prudential reports are required to be complied with onboth solo- and consolidated basis.

Compliance with the Basel III capital and liquidity standards Prudential reporting requirements

Segmented Basel Regulatory Capital Framework

Basel Reform Agenda Thrift, rural and cooperative banks that are subsidiaries of universal and

commercial banks

Stand-alone thrift, rural and cooperative banks

Regulatory Capital Basel III (10% minimum CAR) Basel 1.5 (10% minimum CAR)

Leverage Basel III Not Applied

Minimum Capital Requirements (Pillar 1)

Supervisory Review Process

(Pillar 2)

Market Discipline (Pillar 3)

TOTAL QUALIFYING CAPITAL - Basel-III compliant, except for the adoption ofthe capital conservation buffer and the countercyclical capital buffer.

CREDIT RISK CAPITAL CHARGE - Risk-weighted assets (Basel I guidelines) plus: 50 % risk weight for FCY denominated credit exposure to Philippine

National Government (NG) and BSP in line with credit risk rating of thecountry; and

150 % risk weight for NPLs and foreclosed assets.

MARKET RISK CAPITAL CHARGE – Not applicable

OPERATIONAL RISK CAPITAL CHARGE -- 12% of the average positive annualgross income during the last 3 years of a bank.

CAPITAL PLANNING PROCESS

REQUIRED MINIMUM DISCLOSURES:

Components of qualifying capital Capital requirements for credit,

market and operational risks Total and Tier 1 capital adequacy

ratios.

Differentiated Liquidity MetricsBasel

Reform AgendaThrift, rural and cooperative banks

that are subsidiaries of universal and commercial banks

Stand-alone thrift, rural and cooperative banks

Liquidity Metrics Basel III Liquidity Coverage RatioBasel III Net Stable Funding Ratio Minimum Liquidity Ratio (MLR)

MLR : A prudential MLR of 20% shall apply on an ongoing basis.: Stock of Liquid Assets

Total Qualifying Liabilities

Stock of Liquid Assets : Cash on HandReserves in the BSPOvernight and Term Deposits with the BSPSovereign debt securities (NG and BSP)Other debt securities assigned a zero percent risk weightDeposits in other banks(should be immediately liquefiable and free from lien)

Total Qualifying Liabilities : Total LiabilitiesIrrevocable obligations

Business Model Stand-alone ruraland cooperative banks

Rural and cooperative banks that are subsidiaries of universal and

commercial banks

Basic Lending

and Deposit-taking

Operations

11 Prudential Reports

Simplified Financial Reporting Package

Full Financial Reporting Package

Balance Sheet,Income Statement

and simplified supporting schedules (50% of full FRP)

Balance Sheet, Income Statement

and supporting schedules

Simplified Basel Capital Adequacy Report

Basel III Capital Adequacy Report

Expanded Banking Activities

Microfinance Operations E-Money Issuer Derivatives Trust Operations Credit Card Business FCDU Operations

• Additional licensing requirements

• Higher risk management standards

• Additional reportorial requirements

Expansion in banking activities translate to higher prudential requirements

Proportionate Reporting Governance Framework

Concluding Points

Continuing soundness and stability of banking system

Convergence of regulatory and business objectives

Efficient allocation of supervisory resources

Broad-based inclusive growth and innovation

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Proportionality in banking regulations promotes:

Proportionality in Banking Regulations:The Case of the Philippines

CHUCHI G. FONACIERDeputy Governor

Bangko Sentral ng Pilipinas