Weak Banks Must Be Tackled Early, Basel Committee Says

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Supervisors dealing with weak banks should intervene early and act quickly before problems become acute, according to the Basel Committee on Banking Supervision.

A weak bank is one whose liquidity or solvency is already impaired or soon will be “unless there is a major improvement in its financial resources, risk profile, business model, risk management systems and controls, and/or quality of governance and management in a timely manner,” the global regulator said in updated guidance on Thursday.

If the lender is no longer viable or has no chance of returning to viability, it should be wound down without causing disruption to the wider financial system or exposing taxpayers to loss, the committee said. At the same time, supervisors’ must act proportionately and their interventions must fit the scale of the problem, it said.

“International experience has shown that bank problems can worsen rapidly if not promptly addressed,” the Basel committee said. “It is therefore important to establish incentives that encourage supervisory authorities to take early and decisive action in response to problems.”

Political pressure and lobbying can get in the way of prompt action, so the guidelines underline the importance of supervisors acting fast and of giving them discretion to intervene without waiting for thresholds to be breached. Incentives should be established to encourage moves to pre-empt deterioration, according to the committee.

‘Basic Cause’

“The most basic cause for inaction is that all parties may be reluctant –- in good faith –- to take the measures needed to remedy the situation in the hope that the problems will rectify themselves,” the committee said. “The supervisor may be under explicit or implicit pressures from politicians or lobby groups to postpone measures.”

The guidelines also emphasize the need for banks to hold sufficient capital to support their businesses, saying a decline to, or approaching, minimum ratios should trigger formal action to restore them.

They identify four potential causes for declining ratios, including a rapid increase in risk-weighted assets, redemptions, typically of subordinated debt, operating losses and foreign-exchange rate movements.

“Improving the capital position addresses the symptom,” according to the committee. “To determine whether other measures are needed, the supervisor should also seek to understand in each instance why the capital ratio fell.”

Corporate Governance

The guidelines also stress that poor corporate governance is likely to underlie problems at weak banks. Issues are likely to include the chief executive failing to be closely involved in risk management and failing to ensure control staff are truly independent of income-producing personnel and functions.

“Supervisors do not select senior management for banks, but they should be responsible for evaluating the expertise and integrity of proposed directors and senior management,” the committee said. “They should prevent or discourage appointments they deem detrimental to the interests of depositors,” and ensure compensation doesn’t incentivize actions that might weaken a bank.

The Basel committee brings together regulators such as the U.S. Federal Reserve and the European Central Bank. The July 16 report updated guidance issued in 2002 “in the light of the significant post-crisis developments in financial markets and the regulatory landscape.”