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2. The CNB provided a self-assessment of compliance with the Basle Core Principles for Effective Banking Supervision (see Appendix I, which also lists the core principles for reference). This exercise was undertaken to help assess the transparency of banking supervision and its underlying foundations. It is based on the draft assessment methodology published by the Basel Committee in May 1999. The CNB was a member of the contact group that developed this methodology. The self-assessment results show that the Czech Republic is compliant or largely compliant in 11 principles, partly compliant in 8, and largely non-compliant or non-compliant in 6.2,3 The following provides an overview of the current supervisory environment, based on the self-assessment and on information gathered by IMF staff on earlier occasions.
Legal Framework
3. The CNB sees the existing Act on Banks as being largely adequate as a basis for complying with EU norms and Basle Core Principles, although it considers that some revisions are necessary to bring the system into full compliance with both. Required revisions include the deletion of the clause requiring the CNB to support the Deposit Insurance Fund, and a strengthening of the law to permit consolidated supervision of financial and mixed conglomerates. The current law confers broad supervisory powers to the CNB, including those in licensing and delicensing, establishing supervisory regulation, reporting and disclosure, and enforcement actions, as well as powers to impose conservatorship and propose liquidation. Detailed requirements for licensing, including application forms are published. Regulatory rules established by the CNB pursuant to legislation include those on capital adequacy, large exposure, foreign currency exposure, provisioning for loan losses and securities valuation losses, and separation of investment and commercial banking activity. These regulations, with some exceptions such as the capital charge for market risk which is planned to be introduced shortly, cover most of the areas stipulated in the Basle Core Principles.
Implementation
4. Supervisory capacity, while rapidly improving, is still seen as being in the development stage. Major revisions to the Act on Banks and many detailed regulations have been introduced over the last two years so that there is not as yet a very long track record of implementation. The CNB’s self-assessment reflects this: while the CNB deems itself to be largely compliant when the principles call for the existence of a legal framework, the self-assessment falls into the partially-fulfilled category when the principles call for ensuring effective oversight of bank activities.
Transparency (Accounting and Disclosure) Aspects
5. Banks are required to maintain accounts in accordance with the Accounting Act, and disclose an audited annual report including financial performance based on these accounts. Bank supervisors have the power to reject auditors selected by the bank that is being audited, and the auditor is required to inform the bank supervisor of any material fact that became known to the auditor having a potentially adverse impact on the bank’s performance. Banks are also required to disclose information on shareholders and summary financial information at the end of each quarter, not later than six weeks after the end of each quarter.
6. The Czech Accounting Standards (CAS), which are established by the Accounting Act and implementing ordinances, are applied on an unconsolidated basis and deviate in some significant respects from international accounting standards (IAS), including in the treatment of foreign exchange gains/losses and the recognition of overdue interest. Major banks, however, publish consolidated IAS statements along with unconsolidated CAS data. The CNB and the MOF have also introduced regulations to compensate for some of the shortcomings of CAS: for example, regarding the lack of consolidation, the Act on Banks requires disclosure of data on banks’ subsidiaries and related companies, and banks are required to deduct from their capital their holdings in subsidiaries for the purpose of calculating capital adequacy ratios. In addition, a MOF decree requires banks and other financial institutions to compile consolidated annual accounts for disclosure to shareholders, though not to supervisors.
Other Related Issues
7. Bankruptcy legislation generally favors debtors and the enforcement of loan contracts tends to be troublesome and time consuming. Moreover, loan valuation can be problematic because of the difficulties in enforcing creditor rights. It is also not uncommon for non-performing loans secured by real estate collateral to remain on the books of banks for several years, because of difficulties in foreclosure and in generally obtaining prompt decisions from the courts. Legislative initiatives have been taken and are being considered in order to improve creditors’ rights and facilitate banks’ ability to recover their loans in a timely fashion.
B. IMF Staff Commentary
The authorities are to be commended for their efforts to improve the supervisory regime to bring it into compliance with international best practices and to therefore implement banking supervision in a transparent way. As noted by the authorities, most of the legal and institutional framework is in place, although the staff sees some gaps in the accounting framework. Consolidated supervision and supervision of market risk are also areas where the existing regulatory framework needs to be strengthened, and the staff welcomes the authorities’ intentions to do so in the near future, including by introducing capital requirements for market risk as recently approved by the CNB.
For many areas of the Core Principles, the extent to which the principles are fulfilled depends on whether supervision is implemented appropriately, rather than on the existence of rules, regulations, or examinations. The staff has not conducted a full and independent assessment that would allow it to judge the degree to which supervision is implemented in compliance with the Core Principles. However, it expects that, given the limited institutional experience of CNB in bank supervision, there is scope for improving the quality of implementation in all aspects of supervision. As in most countries, staff development will be a key issue.
Existing supervisory practices are formally consistent with the disclosure aspect of the Core Principles, but shortcomings in accounting practices mean that disclosure practices fall short of best standards of transparency. While many banks produce IAS based accounts on their own initiative, effective and consistent application of disclosure and supervision will require improvements in the CAS. For example: accounts are currently unconsolidated; there is very little recognition of valuation changes; and interest on loans is recognized in accordance with the credit contract even when overdue. Such accounting practices provide a distorted picture to bank management and bank supervisors. Recognizing these shortcomings, the authorities are preparing a new Act on Accounting, which is expected to come into force in 2001 and is designed to ensure full compliance with IAS.
Czech Republic: Self-Assessment on Compliance with Basel Core Principles for Effective Banking Supervision
|
Principle |
Not fulfilled/ largely not fulfilled |
Partially fulfilled |
Fulfilled/ largely fulfilled |
Overall assessment comment. |
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1 (1). Clear responsibilities and objectives for each supervisory agency. |
|
|
X |
Fulfilled to a large extent. Laws could benefit from further clarity in some areas. |
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1 (2). Operational independence and adequate resources. |
|
|
X |
Fulfilled to a large extent. There still exists a lack of sufficiently qualified people for the area of general policy and the regulatory framework for banking supervision, as well as for on-site inspections. |
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1(3). A suitable legal framework for authorization and ongoing supervision. |
|
|
X |
Fulfilled. |
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1(4). A suitable legal framework to address compliance with laws as well as safety and soundness concerns. |
|
|
X |
Largely fulfilled. It would be appropriate to consider whether the obligation to supply information and documents also in the periods between onsite examinations should not be set forth explicitly in the Act on Banks. |
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1(5). Legal protection for supervisors. |
|
X |
|
Limited protection of banking supervisors in the performance of banking supervision does exist. The protection of banking supervisors in other countries will be studied as a model for a possible amendment to the Act on Banks. |
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1(6). Arrangement for sharing of information between supervisors and protection of confidentiality of shared information. |
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X |
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Partially fulfilled. For cooperation with domestic supervisors, legal obstacles to information sharing, particularly affecting the MOF, will need to be removed. Restrictions for foreign supervisors or external auditors to perform supervision within the country also still need to be removed. |
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2. Clearly defined permissible activities for banks and control of the use of the word ‘bank.’ |
|
|
X |
Largely fulfilled. While the use of the name "bank" is controlled, further measures are needed to strengthen the enforceability of the Act on Banks in the area of collection of deposits by unlicensed entities. |
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3. Criteria for structure, directors, operating plan, controls, financial condition, and capital base. |
|
|
X |
Fulfilled. |
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4. Authority to review and reject transfer of ownership. |
|
|
X |
Fulfilled. |
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5. Authority to review major acquisitions and investments. |
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X |
|
Partially fulfilled. The banking supervisory agency individually approves any acquisition or investment undertaken in the form of a purchase or sale of the whole or a part of a business, as well as amalgamations and mergers. However, other forms of investment do not need CNB approval. |
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6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks). |
|
|
X |
Largely fulfilled. |
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7. Independent evaluation of loan and investment policies. |
|
|
X |
Largely fulfilled. |
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8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves. |
|
|
X |
Largely Fulfilled. Evaluation of collateral (particularly real estate) is problematic. However, legislation in that area does not fall within the powers of the CNB. |
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9. Prudential limits and management information system on concentration of exposure. |
|
X |
|
Partially fulfilled, with the exception of consolidated supervision and sectoral and geographical exposures. |
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10. Arm’s length rule and monitoring for connected lending. |
|
X |
|
Partially fulfilled. There may be a need to amend the Act on Banks to include the right for supervisors to make judgements on whether certain parties should be considered "related;" the definition of related parties needs to be broadened. |
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11. Policies and procedures for country risk and transfer risk. |
X |
|
|
Largely not fulfilled. In connection with the preparation of the provision on capital adequacy, such provisions are only now being introduced in the Czech Republic. |
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12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure. |
|
X |
|
Only partially fulfilled as there is need for further training of supervisory staff to deal with market activities of banks, including evaluation of internal models. Greater attention needs to be paid to understanding all elements of market risks and the banks’ (including senior managements’) handling of such risks. |
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13. Comprehensive risk management process. |
|
X |
|
Partially fulfilled. More emphasis needs to be placed on stress testing and contingency planning. Decision needs to be taken on adequate capital requirement for risks other than market and credit risks. |
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14. Adequate internal controls. |
|
|
X |
Fulfilled. |
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15. Strict "know-your-customer" rules and high ethical and professional standards. |
|
X |
|
Partially fulfilled. Certain criteria that have to be met in practice should be introduced into the laws or regulations. The supervisory agency is not empowered to regulate anti-money-laundering measures, but in the course of supervision checks compliance with laws related to money laundering. |
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16. Effective supervisory system consisting of on-site and off-site supervision. |
|
X |
|
Partially fulfilled. The supervisory agency does not evaluate its own effectiveness. Methodology for both off-site surveillance and on-site examination exists and is systematically updated to ensure the interconnection of both instruments and a comprehensive approach to individual banks. |
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17. Regular contact with bank management and understanding of bank’s operations. |
|
|
X |
Largely fulfilled. However, no explicit requirement for reporting adverse developments or breaches of laws and regulation. |
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18. Analytical reports and statistical returns on solo and consolidated basis. |
X |
|
|
The Principle has been fulfilled with regard to obtaining information from banks on a solo basis and has not yet been fulfilled with respect to obtaining information on a consolidated basis. |
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19. Independent validation of supervisory information through on-site examination or external auditors. |
|
|
X |
Largely fulfilled. It is necessary to further standardize the procedures for on-site examinations in the form of written documents (manuals). |
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20. Ability to supervise on a consolidated basis. |
X |
|
|
Consolidated supervision has not yet been introduced. The CNB has issued a provision on consolidated supervision which covers groups headed by banks. However, its enforceability is a moot point as the effective performance of supervision on a consolidated basis will be governed by an amendment to the Act on Banks. The first consolidated returns for supervisory purposes will be submitted by banks for 1999 and subsequently once each year. From 2003, it is expected that returns will be submitted on a semi-annual or quarterly basis. |
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21. Adequate records and consistent accounting policies and practices; regular financial statements that fairly reflect the bank’s condition. |
|
X |
|
To fulfil this principle, the CAS will need to be adjusted to bring them into line with international best practices. |
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22. Adequate supervisory measures to ensure timely corrective action. |
|
|
X |
Largely fulfilled. Consideration should be given to amending the Act on Banks to allow stricter individual sanctions. |
|
23. Exercise global consolidated supervision. |
X |
|
|
Largely unfulfilled. It will be regulated by the forthcoming provision on supervision on a consolidated basis and in particular by the amendment to the Act on Banks. |
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24. International exchange of information with other supervisors. |
X |
|
|
Not fulfilled. Fulfillment will be secured primarily in the form of cooperation agreements with foreign supervisory authorities. Some agreements are already under preparation, and in other cases negotiations on co-operation have been started. |
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25. Supervision of local operation of foreign banks and information sharing with home country supervisors. |
X |
|
|
Largely unfulfilled to date. Will be addressed in the form of cooperation agreements with foreign supervisors. |
1Prepared by a team from the Monetary and Exchange Affairs Department (led by Mr. Ariyoshi), in consultation with the Czech authorities.
2 The six categories used by the CNB in their self-assessment (fulfilled, fulfilled to a large extent, fulfilled partially, not fulfilled to a large extent, not fulfilled, and not applicable) are somewhat different from the five categories in the draft Core Principles Methodology Handbook published by the Basel Committee (compliant, largely compliant, materially non-compliant, non-compliant, and not applicable). As a result, the concordance between the CNB categories and those in the Handbook is not always straightforward. For example, the category "fulfilled partially" could, if the Handbook methodology were followed strictly, be classified as either largely compliant or materially non-compliant. Which category the "partially fulfilled" items would fall into would depend on the assessment of the quality of on-site examination and other supervisory practices.
3 In this classification, Principle 1 is counted as being largely fulfilled/fulfilled, although one of the sub-items is assessed to be partially fulfilled.
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