Consolidated Supervision: Assessing Financial Conglomerate Risk Constantinos Stephanou PREM Macro 2,

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Consolidated Supervision Assessing Financial
Conglomerate Risk Constantinos StephanouPREM
Macro 2, ECA(formerly with Finance Cluster,
LCR)Strengthening Financial Supervision and
Institutions Finance ForumSeptember 22, 2004
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Overview

• Consolidated supervision is increasingly becoming
  a top-of-mind issue for financial authorities
• Driven by increased financial conglomeration
• Global best practice (Joint Forum) still in early
  stages
• High non-compliance rates for (related) BCP 20
• Proposed diagnostic framework stems from
  recently-completed Chile FSAP work
• Scope for Bank work in this area
• TA or (P)FSAL conditionality on
  reforming/implementing consolidated supervision
  framework
• AAA on the implications of financial
  conglomeration, e.g. competition, debt management
  etc.

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Proposed Methodology
- DRAFT -
Steps
Relevant Issues/Questions

• Is there a legally embedded definition of
  economic groups and FCs?
• Does the definition vary across financial
  sectors?
• What does the definition consider as related
  parties?
• How does the definition compare to international
  practice (Joint Forum and EU definitions)?

Legal definition of Financial Conglomerate (FC)

• How dominant have FCs been in the domestic
  financial system?
• What are their main characteristics (domestic vs.
  foreign ownership and presence, mixed vs. pure
  financial, include bank or not) and market
  shares?
• What are the actual corporate structures used?

Presence in financial system

• How do firewalls (permissible activities,
  ownership limits, connected exposure limits,
  Board of Directors etc.) differ across financial
  sectors?
• Is there cross-sector supervisory coordination
  how much and how?
• Is there a consolidated supervision framework?

Current supervisory arrangements

• See page 6 for outline and description of the
  risk assessment framework
• What information/proxies can be used to assess
  potential vulnerabilities?
• How do the main vulnerabilities introduced by the
  presence of FCs compare to the (direct and
  societal) costs of existing, related regulation?

Risk assessment
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Presence of FCs (Chile)

• Percentages are based on bank assets (banking),
  securities turnover by stock brokerage companies
  /corredores de bolsa (securities), direct
  premiums (insurance) and AFP assets under
  management (pensions) for 2003
• AFP Habitat is assumed to be controlled by
  Citibank even though it is jointly owned with the
  Chilean Chamber of Construction.
• Large foreign and domestic groups that are
  primarily active in one Chilean financial sector
  (e.g. AIG, Cruz del Sur/Angelini, Zurich
  Financial Services) are not considered financial
  conglomerates.
• Only conglomerates with non-negligible mixed
  activities are included, e.g. the Yarur and
  Security groups are excluded because their
  non-financial activities are very small in
  comparison to the total

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FC Structure (Chile)
Ultimate Owner
Direction of equity investment
Responsibility for regulatory oversight
XYZ
Investment Vehicle (can be one or several)
SVS (only if registered with it)
Various non-financial sector companies
(directly or via intermediate investment
vehicles)
Holding Company (can be one or several)
All companies below can come under the bank or
directly under the holding company leasing and
factoring operations can also be part of the
bank itself (no subsidiaries needed) most
companies (e.g. mutual funds, brokerage) can also
be owned by an insurance company
SBIF
SAFP
Bank (BHC)
Life Insurer
Non-Life Insurer
Pension Fund
Securitization Company
Factoring Company
Insurance Brokerage
Securities Brokerage
Leasing Company
Mutual Funds Management
SVS
SBIF (only if part of BHC)
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Risk Assessment Framework
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Epilogue Recommendations for Chile

• No significant imminent threat to financial
  stability from the presence of FCs
• but several identified vulnerabilities that
  will become increasingly important as competition
  intensifies
• Inadequately monitored (or isolated) risks
  above/parallel to the bank holding company level
• Insufficient and informal supervisory
  coordination
• Failure resolution process ignores possibility of
  FC collapse
• Group bank remains exposed to psychological
  contagion
• Proposed reform agenda with short- and
  medium-term components