Journal of theBanking Supervisor 45Promoting Best Practices for Banking Supervision

In this Issue:

ASSOCIATION OF SUPERVISORS OF BANKS OF THE AMERICAS

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April - June, 2016

Regulation, stability, and financial innovationJuan Pedro Cantera S.

In our latest edition, we discussed the economic challenges for the region and the potential impacts on the quality of the assets held by regulated entities and their ability to maintain their financial strength. To date, some of these challenges are materializing and, although the potential impact on economic growth in the region may not be significant, it is important to discuss once again the economic environment including the changes of competition in the financial sector, resulting from the growing influence of technological development. Indeed, this edition covers topics that will affect the agenda for regulatory development and supervisory approaches.

Firstly, macroeconomic conditions are shaping a transition scenario, as stated by the International Monetary Fund, with varying growth rates and different levels of risk in significant regions for the economies of the Americas. These conditions create an environment of uncertainty that is leading to high volatility in regional markets, including increases in the volatility of exchange rates. On the other hand, reduced demand for commodities, the main export of various countries in the region, decreases the ability of countries to accumulate reserves and weakens domestic demand. All these factors, namely the volatility, lower demand for commodities, and

depreciation of local currencies, are expected to affect the quality of assets in the financial sector, which will require a greater capital backing that, under current market conditions, has little room for growth. Therefore, the sector will be forced to increase its efficiency through a more intensive use of technology and focus on business lines with higher income-generating potential; thus, a possible increase in risk exposure.

Secondly, technological development is pushing the traditional financial sector to consider its potential as a means of gaining efficiency and developing alternative business lines closer to the customer. However, in this area, the sector is not alone. On the contrary, it is lagging behind companies that are showing high rates of growth, an ability to understand market demand, and that are not subject to a regulatory framework.

The absence of a regulatory framework is an important limitation for the stable and competitive development of the sector. However, developing and implementing such framework requires a balance between supporting the innovation process, maintaining an adequate level of competition, and ensuring financial market stability in the region. These requirements limit the work of prudential regulation, to the extent that establishing standards, requiring similar conditions for competition, and maintaining financial stability, may affect the innovation process, an essential ingredient of economic growth.

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In this Issue:

RESEARCH AND ANALYSIS

REGIONAL ECONOMIC OUTLOOK - MANAGING TRANSITIONS AND RISKSInternational Monetary Fund. April, 2016.Read more: http://goo.gl/Qis2Vk

The global economy remains in transition, reflected in a slower pace of global activity. Growing concerns of slower global growth and lack of policy space have contributed to generally tighter financial conditions and heightened market volatility. Macroeconomic conditions, such as the pace of currency depreciation and higher sovereign spreads, and weak firm fundamentals have also contributed to an increase in corporate risk since 2011. At the same time, commodity prices remain weak, with prospects that they will remain lower for longer. Against this backdrop, economic activity in Latin America and the Caribbean has been hard hit and is likely to contract for the second consecutive year in 2016. But the growth outlook varies substantially within the region. The ongoing U.S. recovery continues to support activity in Mexico, Central America, and the Caribbean, but China’s manufacturing-based slowdown has reduced the demand for exports from South America.

A NEW DIMENSION TO CURRENCY MISMATCHES IN THE EMERGING MARKETS: NON-FINANCIAL COMPANIESMichael Chui, Emese Kuuc, and Philip Turner. Bank for International Settlements. March, 2016.Read more: http://goo.gl/GMrC81

A new dimension to currency mismatches has been created by policies that have increased global liquidity. Lower policy rates and a huge expansion in central bank balance sheets – purchases of domestic bonds in the advanced economies and of foreign assets in the emerging market economies (EMEs) – have served to ease financing conditions facing EME companies. This has allowed these companies to increase their gearing, notably by greater foreign currency borrowing. Aggregate foreign currency mismatches of the non-government sector in the EMEs have therefore risen sharply since 2010. Microeconomic data show that it was not only companies providing tradable goods and services, but also those producing non-tradable goods which have increased their foreign currency borrowing. The across the-board decline in EME companies’ profitability since mid-2014 has brought to light significant vulnerabilities that may aggravate market volatility. Weak corporate profitability is also likely to constrain business fixed investment, and therefore growth, in the near term. But the strong external asset positions of most emerging market economies will help the authorities cope with these challenges.

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In this Issue:

TECHNOLOGICAL CHANGE AND INNOVATION IN THE FINANCIAL SECTORSpeech by Mark Branson, Chief Executive Officer.Swiss Financial Market Supervisory Authority. September, 2015.Read more: http://goo.gl/tYcmkG

“Innovation is crucial to the competitiveness of the financial sector. However, new possibilities and opportunities always come with risks. This poses questions as to when and to what extent should governments intervene in financial markets? There can be no doubt that they have a role to play. We all know about market failure and systemic risk, not to mention the all too frequent incidents of deliberate misconduct in recent times. Thus, regulation for fintechs should be based on the following three principles: (i) regulation must be neutral in relation to technological change and should neither encourage nor hinder it; (ii) principles-based approach to regulation tends to provide a good basis for the development of the digital business sector; (iii) it is vital to prevent the emergence of technology-based regulatory gaps which threaten client protection and the system as a whole. Where necessary, the rules must be adapted to protect investors and the system. In the digital world, as elsewhere, there is a legitimate need for protection. An option would be to introduce a new licensing category with less stringent requirements than those currently set out in banks. However, these would have two prerequisites: (i) the volumes concerned must be relatively low, though defining thresholds may not be an easy task; (ii) these companies must not be allowed to transform maturities, thus eliminating any liquidity or interest rate risk.“

FINTECH: THE POWER OF THE POSSIBLE AND POTENTIAL PITFALLSSpeech by John C. Williams, President and CEO.Federal Reserve Bank of San Francisco. April, 2015.Read more: http://goo.gl/qlbjbr

Well-designed regulation that protects consumers, fosters inclusionary practices, and enhances the fairness and resilience of the financial system should help rather than hinder fintech’s contribution to creating a better financial system. One of the potentially most game-changing benefits is the ability to reach historically underserved and economically disadvantaged communities. Fintech can lower costs and improve services, particularly for lower-income families and small businesses. Meaning fintech can help more people get access to credit at reasonable terms, better manage their finances, and keep more money in their pockets. The flip side concern is that those exact people could wind up becoming even more marginalized. With the proliferation of options for saving and borrowing that fintech promises, the unscrupulous will prey on the vulnerable, be it through predatory lending, irresponsible payday loans, outright fraud, and more. Another area of opportunity is leveraging big data and data analytics to improve operational efficiency, risk management, and decision making. Left unbridled, the ease and anonymity of some types of fintech, such as digital currencies, have the potential to make criminal and terrorist activity even easier. We need to be at least cognizant, and at most vigilant, about the protection and privacy of those consumers whose data are being used. While fintech can also improve not just the accessibility but the quality of service, we also need to look out for the resilience of the financial system as a whole.

RESEARCH AND ANALYSIS

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In this Issue:

FINTECH REGULATORY SANDBOX GUIDELINESMonetary Authority of Singapore. June, 2016.Read more: http://goo.gl/zcv5lT

“This document introduces a proposal of the Monetary Authority of Singapore on Guidelines for establishing fintech regulatory sandboxes. A key driver to growing a smart financial center is the provision of a regulatory environment that is conducive to the innovative and safe use of technology. In a fast evolving fintech landscape, a responsive and forward-looking approach will further enhance the ability of promising fintech innovations. A regulatory sandbox approach can be used to carve out a safe and conducive space to experiment with FinTech solutions, and where the consequences of failure can be contained. Depending on the FinTech solution, specific legal and regulatory requirements will be relaxed for each case. These guidelines set out the objective and principles of a Sandbox, as well as provide guidance on the application process. “

SUPPORTING RESPONSIBLE INNOVATION IN THE FEDERAL BANKING SYSTEM: AN OCC PERSPECTIVEOffice of the Comptroller of the Currency. March, 2016.Read more: http://goo.gl/XqZ9DB

The financial services industry in the United States is undergoing rapid technological change aimed at meeting evolving consumer and business expectations and needs. Many of these innovations are taking place outside the banking industry, often in unregulated or lightly regulated fintech companies. The OCC encourages banks to adopt responsible innovation in a manner that is consistent with sound risk management and is aligned with the bank’s overall business strategy. For this purpose, the OCC provides eight principles to guide the development of banks’ framework to understand and evaluate innovative products, services, and processes. These principles call for: (i) support for responsible innovation: (ii) foster an internal culture receptive to responsible innovation; (iii) leverage agency experience and expertise; (iv) encourage responsible innovation that provides fair access to financial services and fair treatment of consumers; (v) safe and sound operations through effective risk management; (vi) encourage banks of all sizes to integrate responsible innovation into their strategic planning; (vii) promote ongoing dialogue through formal outreach; (viii) collaborate with other regulators.

RESEARCH AND ANALYSIS

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In this Issue:

OPPORTUNITIES AND CHALLENGES IN ONLINE MARKETPLACE LENDINGU.S. Department of the Treasury. May, 2016.Read more: http://goo.gl/PCvOSU

This paper establishes an overview of the evolving market landscape, reviews stakeholder opinions, provides policy recommendations, and acknowledges the benefits and risks associated with online marketplace lending. In order to encourage safe growth and access to credit through the continued developments of online marketplace lending, this white paper introduces the following recommendations: (i) Support more robust small business borrower protections and effective oversight; (ii) Ensure sound borrower experience and back-end operations;(iii) Promote a transparent marketplace for borrowers and investors; (iv) Expand access to credit through partnerships that ensure safe and affordable credit; (v) Support the expansion of safe and affordable credit through access to government-held data; and (vi) Facilitate interagency coordination through the creation of a standing working group for online marketplace lending. In addition, this white paper identifies potential trends that will require ongoing monitoring. These include the evolution of credit scoring, the impact of changing interest rates, potential liquidity risk, increasing mortgage and auto loans originated by online marketplace lenders, potential cybersecurity threats, and compliance with anti-money laundering requirements. The business models and data-driven algorithms supporting this industry have largely developed in favorable credit conditions. Treasury believes it is important to consider policies that could minimize borrower risks and increase investor confidence in a less favorable credit environment.

BREAKING NEW GROUNDRobert Wardrop, Robert Rosenberg, Bryan Zhang, Tania Ziegler, Rob Squire, John Burton, Eduardo Arenas Hernadez, and Kieran Garvey.University of Cambridge, Chicago Booth. April, 2016.Read more: http://goo.gl/JlePHu

The impact of alternative finance is rippling through the financial services industry—and the economies of the Americas. This report provides a comprehensive study of this fast-evolving online alternative finance market in the Americas. Focusing on marketplace/ P2P lending and crowdfunding activities, the report captures an estimated 80% of the visible online alternative finance market (by transaction volumes) in the Americas. In 2015, the Americas online alternative finance industry grew to $36.49 billion, a 212% annual increase. The Latin American and the Caribbean regional market achieved a 130% average growth rate over the last three years to reach $110.46 million in 2015, with Chile accounting for nearly half of that total. According to the survey, 51% of US lending platforms and 43% of equity platforms consider current regulations “adequate and appropriate.” However, 34% of equity platforms and 15% of lending platforms see current regulation as too strict or excessive.

RESEARCH AND ANALYSIS

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In this Issue:

INTEREST RATE RISK IN THE BANKING BOOKBank for International Settlements. April, 2016.Read more: http://goo.gl/68TSya

This paper sets out supervisory expectations for banks’ identification, measurement, monitoring and control of IRRBB, as well as its supervision. In particular, the enhancements to the 2004 Principles include: (i) More extensive guidance on the expectations for a bank’s IRRBB management process in areas such as the development of interest rate shock scenarios, as well as key behavioral and modelling assumptions to be considered by banks in their measurement of IRRBB; (ii) Enhanced disclosure requirements to promote greater consistency, transparency and comparability in the measurement and management of IRRBB. This includes quantitative disclosure requirements based on common interest rate shock scenarios; (iii) An updated standardized framework, which supervisors could mandate their banks to follow or banks could choose to adopt; and (iv) A stricter threshold for identifying outlier banks, which is has been reduced from 20% of a bank’s total capital to 15% of a bank’s Tier 1 capital. The revised standards are expected to be implemented by 2018.

REGULATORY CONSISTENCY ASSESSMENT PROGRAMME (RCAP) - ANALYSIS OF RISK-WEIGHTED ASSETS FOR CREDIT RISK IN THE BANKING BOOKBank for International Settlements. April, 2016.Read more: http://goo.gl/7shnhG

This report analyzes the variation in risk-weighted assets (RWA) in banks using internal ratings-based models to calculate credit risk capital requirements. The study evaluates two types of risk estimates. First, it considers those risk estimates used for exposures to retail customers and small and medium-sized enterprises. In this case, practice-based variations covered interpretations of “long-run averages” related to PD, and methodologies for applying cyclicality adjustments to PD estimates, among others. Second, it explores the way banks evaluate the likely exposure at default across all asset classes. Here differences related to the use of different estimation approaches, varying practices to adjust CCF observations , and use of other estimators other than the mean, among others. The report describes sound practices observed in banks’ independent model validation functions, including the governance of the validation process, the methodology and scope of banks’ validation functions and the role of the validation function across different phases of model development and implementation.

BANKING SUPERVISION

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In this Issue:

BREAKING UP THE BIG BANK WON’T STOP ANOTHER FINANCIAL CRISISBrookings. April, 2016.Read more: http://goo.gl/STxYwM

In debating whether or not to break up the big banks, there is a key misconception that has to be put to rest by both sides: another financial crisis will occur, regardless. What you can do is guard against financial crises, reducing their likelihood and mitigating their severity when they do occur. New tools have been provided to supervisors to help wind down large, complex financial institutions that run into trouble in an orderly way so as not to cause a financial panic nor require a bailout. If bank regulators do not believe that it will work, they are legally empowered by Dodd-Frank to force large banks to reorganize themselves, including by forcing them to substantially shrink until they are in a structure that will allow them to fail -- an important safety valve to consider when debating whether a more radical step of a government mandated break-up is required. Breaking-up the banks requires a lot of hard choices that are not always spelled out by those who advocate for a break-up. Proposals to cap banks by size would likely result in many current customers being forced to change banks. Other important questions regarding how a world with no large U.S. banks, but large foreign banks would work for large American companies who sell products all over the world and value being able to work with global banks.

THE RESILIENCE OF BANKS’ INTERNATIONAL OPERATIONSSteve Bight, Paul Glasserman, Christopher Gregg, and Hashim Hamadi.Office of Financial Research. May, 2016.Read more: http://goo.gl/yywcZM

This paper is the result of an analysis of the public portions of resolution plans, or “living wills,” in which large U.S. banks describe how they would manage their own potential failure. The authors found that the public information in the living wills is not sufficient to determine whether these banks could go through bankruptcy without extraordinary government support. Based on the limited data in the public filings, however, these documents appear to confirm some concerns of regulators, who recently rejected most of these banks’ plans. It does not appear banks have made their operations less complex.

BANKING SUPERVISION

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In this Issue:

SECOND THEMATIC REVIEW ON RESOLUTION REGIMESFinancial Stability Board. January, 2016.Read more: http://goo.gl/fszpWJ

The peer review examines the range and nature of resolution powers available to authorities for the banking sector in FSB jurisdictions, as well as any requirements for recovery and resolution planning and resolvability assessments for domestically incorporated banks. The main findings of the review are as follows: (i) Only a subset of the FSB membership – primarily home jurisdictions of global systemically important banks – currently have a bank resolution regime with a comprehensive set of powers broadly in line with the Key Attributes. The bank resolution powers that are most often lacking are explicit continuity powers, bail-in powers, and powers to impose a temporary stay on the exercise of early termination rights; (ii) While resolution regimes generally apply to all types of commercial banks, the coverage of holding companies of banks, branches of foreign banks and material non-regulated operational entities within a financial group is more variable; (iii) There is also significant variation across FSB jurisdictions in the conditions for the use of resolution powers and their level of detail ; (iv) More progress has been made in terms of putting in place processes for recovery planning compared to resolution planning or resolvability assessments.

THE CFPB’S LONG-AWAITED RULE ON PAYDAY LOANS IS A STEP IN THE RIGHT DIRECTIONAaron Klein.Brookings. June, 2016.Read more: http://goo.gl/ZJhD6M

On June 2 the Consumer Financial Protection Bureau (CFPB) released a much-anticipated rule aimed at curtailing the predatory nature of some small dollar loans, often called “payday” loans. To start with, the rule rightly uses ability to repay as the key regulatory standard. Like all lending, there will be defaults in small dollar loans. However, the key question in making the loan is whether the consumer will likely be able to repay the loan, under the original conditions of the loan, without the need for subsequent borrowing. Loans that require multiple future loans can become debt traps. Under the new rule, anyone who wants a small dollar loan will still be able to get one, but the number of loans a person can take out will be limited. Only a quarter of borrowers currently get caught in the cycle of repeated borrowing, taking out seven or more loans. The Bureau’s action today will help protect millions of American families who are financially vulnerable and can be subject to abusive lending.

BANKING SUPERVISION

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In this Issue:

Cooperative Governance: Evolution of decision representatives and supervision structures in financial cooperativesBanco Central do Brasil. Brasil.Read more: http://goo.gl/TEfFyV

El Salvador among the countries with low concern for money launderingSuperintendencia del Sistema Financiero. El Salvador.Read more: http://goo.gl/H4jFFS

The effects of US unconventional monetary policies in Latin AmericaBanco de España. Spain.Read more: http://goo.gl/SDvJ3y

Macro prudential theory: advances and challengesBanco de España. Spain.Read more: http://goo.gl/E2i5Fe

Law for microfinance and non-profit microfinance entitiesSuperintendencia de Bancos de Guatemala. Guatemala.Read more: http://goo.gl/A9YIkS

Recent advances in regulation and supervisionComisión Nacional de Bancos y Seguros. Honduras.Read more: http://goo.gl/yVpqwD

Technical contributionComisión Nacional Bancaria y de Valores. Mexico.Read more: http://goo.gl/DCwuVg

CONTRIBUTIONS FROM OUR MEMBERS AND NEWS

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In this Issue:

ASBA EVENTS

Institutional EventsLXXVIII ASBA’s Board of Directors Meeting August 11-12, 2016Buenos Aires, Argentina.

XIX ASBA’s Annual Assembly LXXIX Junta Directiva XI Reunión de Alto Nivel October 18 - 21, 2016 Mexico City, Mexico.

International ParticipationVI Meeting on Financial StabilityJuly 14-15, 2016.Mexico City, Mexico.

Emerging Issues and Important Challenges in Latin American and the CaribbeanAugust 30 - September 1, 2016. Virginia, United States of America.

Regional Dialogue, Public Sector - Private Sector September 2-3, 2016. Washington D.C., United States of America.

Latin American Financial Risk Summit - CLAR 2016September 22 - 23, 2016. Panama, Panama.

Basel Consultative Group MeetingOctober 4 - 5, 2016.Prague, Czech Republic.

2nd Conference on Banking Development, Stability, and SustainabilityDecember 2, 2016.Santiago de Chile, Chile.

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In this Issue:

TrainingFinancial Consumer Protection July 18 - 22, 2016. La Paz, Bolivia.Read more: http://goo.gl/fksvSp

Meeting on Bank Accounting and Financial Stability: Risks and Challenges (Only in Spanish) July 19 - 21, 2016. Santiago de Chile, Chile.Read more: http://goo.gl/oVNM7b

Problem Bank Supervision School August 1 - 5, 2016.Mexico City, Mexico.Read more: http://goo.gl/SYtzvD

Banking Crisis and Resolution August 15 - 19, 2016.Lima, Peru.Read more: http://goo.gl/zKjlt3

Financial Instruments and International Financial Reporting Standards (Only in Spanish)August 22 - 26, 2016.Tegucigalpa, Honduras.Read more: http://goo.gl/U8MPtz

Technology Risk Supervision Seminar August 29 - September 2, 2016.Miami, United States of America.Read more: http://goo.gl/52Nj9f

Financial Stability and Stress TestSeptember 13 - 15, 2016. Port of Spain, Trinidad and Tobago.

Consolidated Supervision and Risk Integrated SeminarSeptember 19 - 23, 2016. Guatemala.Read more: http://goo.gl/Lgg5v2

ASBA EVENTS

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In this Issue:

In third place, in addition to the topics listed above, one may add the need for gradual adoption of international standards for prudential regulation and market conduct. The revision of standards related to Basel II and the implementation of Basel III recommendations; the introduction of corporate governance standards; the greater market transparency standards; and the review of products and services marketed with an emphasis on meeting customers’ needs, make it for an even more complex scenario in which the financial sector operates.

Despite the macroeconomic outlook, changes in competition, and the introduction of new regulation in the financial sector, its vitality allows the financial sector to continue contributing to economic development in the region. However, for the economies to sustain their growth, the agencies responsible for the regulation and supervision of the market should improve their coordination and establish an effective macroprudential framework by strengthening information management, inter-agency collaboration, and ensuring the quality of the sector’s

assets and capital. Also, it is necessary to accelerate the analysis for the adoption of new technologies while maintaining the difficult balance noted above. This analysis can occur through a proper understanding of the services, products, and business models that rely on technology, giving priority to those with the greatest potential to penetrate the market in a sustainable and transparent manner, as well as those able to effectively manage their risks.

Finally, the adoption of new international standards, especially of those related to prudential regulation, should be carefully analyzed against the profile and potential of supervised markets, giving priority to those aiming at strengthening capital, effectively managing liquidity, and strengthening transparency and market governance.

We hope this edition will continue to encourage reflection and action about the importance of the financial sector, technology development, and competitiveness, as a means to contribute to economic growth.

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DISCLAIMER / COPYRIGHTPublished by the Association of Supervisors of Banks of the Americas (ASBA). Its headquarters are located at C. Picacho Ajusco #238 Int. 601 Col. Jardines en la Montaña, Mexico City, Zip Code 14210, Mexico. To subscribe to this Newsletter send an email to asba@asbasupervision.org or call (5255) 5662-0085. Reproduction in whole or in part is prohibited without prior permission from ASBA. The information has been obtained by ASBA from sources deemed as reliable and, in most cases, publicly available or provided by an Associate Member. However, given the possibility of human and/or mechanical error from our sources, ASBA does not guarantee the accuracy, adequacy or completeness of any information. ASBA is not responsible for errors, omissions, or the results from using such information. The opinions and assertions contained in articles and documents published by individual authors are the sole responsibility of the authors, and do not represent the opinion of the Association of Supervisors of Banks of the Americas, its Board of Directors or the General Secretariat. ASBA reserves the right to release documents to the supervisory community in the Region, and it does not receive any payment for doing so.