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Annual Reports

Banking Supervision Annual Report

CHALLENGES FOR THE YEAR 2001

Regional and International Cooperation
Recent events in the world financial markets have heightened the need for effective regulation of banking institutions. The liberalization of financial markets worldwide have raised the level of cross-border risk. Financial crises, such as the 1998 Asian financial crisis, impact not only on domestic markets but will transcend regional and international borders. Further, bank failures, against the backdrop of increased globalisation of financial markets, have brought about the need to harmonize legislation and regulations.

The Bank for International Settlements (BIS) coordinates cooperation, information sharing initiatives and harmonization amongst supervisors through the Basle Committee. At the regional level, the East & Southern Africa Banking Supervisors Group (ESAF) shares the Basle objective of promoting harmonization and cooperation amongst supervisors, to ensure that regional supervisors and the financial institutions they supervise, subscribe to international best practices.

ESAF regional banks face an increasingly challenging banking environment. Liberalization has seen the disappearance of government subsidies, the opening up of financial markets to both domestic and foreign competition, and domestic private ownership. Artificial stability previously sustained by government controls, has either been greatly curtailed or become a thing of the past. Incentives for bank managers to satisfy budget objectives have been replaced by market driven incentives, to achieve profitability. In this new environment, banks which survive are those that are able to provide innovative services, effectively manage their risks, build and maintain strong portfolios.

Financial markets are more dynamic, increasingly complex and volatile. Globalisation and regional integration have created tight linkages among markets and have allowed disturbances to spread quickly through world financial systems. In the face of these developments, given the need to achieve financial stability, banking regulation and supervision has become a core component in the regional financial system. These developments have of cause, aroused new supervisory challenges for regional supervisors.

ESAF Harmonization Project
Several harmonization programmes were initiated by the East and Southern Africa Bank Supervisors Group (ESAF) for the improvement of collaboration and understanding amongst regional central banks. The harmonization project for ESAF has been endorsed by the SADC Committee of Central Bank Governors (CCBG). The Bank Supervision harmonization programmes include the following aspects of prudential supervision:

- Harmonization of licensing standards to ensure that regional banks meet international standards ;

- Harmonization and standardization of banking supervision IT Systems to develop common information systems to support bank supervision business process in the region. This should enhance the member countries' ability to monitor regional banks' efficiently and improve Bank Supervision operations.

- Harmonization of accounting and auditing standards Banking Supervision Department adopted the International Accounting Standard 30 in its Banking Regulations on Minimum Financial Disclosure By Banking Institutions. This is in line with the ESAF proposal to adopt IAS30, as the minimum standard for all banks;

- Harmonization of Loan Loss Provisioning Standards as a fundamental prudential requirement for banks ; and

- Standardisation of on-site examination practices. Banking Supervision Department was tasked with the development of uniform standards and practices for carrying out on-site examinations. The introduction of risk based supervision is also part of the programme.

ESAF also wishes to promote sharing of information amongst regional supervisors on matters that have direct implications on the banking system in the region. This information is intended to provide data on performance trends and soundness of supervised financial institutions.

Supervision of Microfinance Institutions (MFI's)
ESAF member countries, Zimbabwe included, have experienced a rapid growth in the micro finance. ESAF is, therefore, currently developing a framework for a harmonized approach to the supervision of micro finance institutions in the region. To date, prudential regulation and supervision has focuses on the requirements and developments in the formal banking sector. There is, however, a strong case for the formal recognition of MFI's as a successful mechanism to provide banking services for small entrepreneurs. The expansion of microfinance institutions is enviable as they provide financial services to the traditionally 'unbankable' poor for development and poverty alleviation. The sector is large and promising. However, planning to accommodate that expansion is essential. Some of the issues to be considered are:

- The need to review restrictions on deposit taking and funding for microfinance viability,

- Development of a regulatory framework for MFI's, on a more formal basis, paving the way for the sector's development or commercialization. Self Regulation, however, emerges as the favoured approach to regulation and supervision of MFI's activities. It entails regulation and supervision of MFI's will be carried out by an approved organization to which the MFI's belong. Such a regulatory and supervisory structure will be analogous to that in place for monitoring formal banking institutions.

- Regulation which ensures compliance with set standards and protect small savers thus ensuring that the general objective for regulating MFI's is similar to that for traditional banks.

- In a bid to safeguard the interests of small savers, it is hoped that the project will foster the need to inform the public by formally recognizing regulated and accredited schemes to avoid the perils of placing savings with get-rich-quick or pyramid schemes. The development of a policy framework for micro finance should be viewed in the context of the whole financial system, recognizing that, these institutions are equally beneficial in providing the credit and savings needs of the low income market which the formal banking system has failed to serve. The number, size and complexity of MFI's may, however, bring about prudential concerns and necessitate the formulation of formal supervisory structures. The ultimate regulatory or supervisory framework should provide a workable structure for ensuring the viability and soundness of MFI activities as a key part of financial systems in developing countries.

Consolidated supervision
Financial Institutions have responded to technological change by expanding their activities, often through subsidiaries beyond their traditional areas of operation. Financial groupings have thus emerged, combining banking, insurance and securities business. These groups, no doubt, bring with them supervisory challenges. These include contagion risk, where problems in one part of the group may affect other group companies, and also the fact that groups are less transparent and more complex and, therefore, more difficult to manage than institutions with a more clearly defined mandate and more specific focus.

One of the requirements of the Basel 25 Core Principles for Effective Banking Supervision is that supervision should be carried out on a consolidated basis, that is, banking supervisors should be aware of the overall structure of the banking organisation or banking group when applying their supervisory methods. Consolidated supervision is, however, a qualitative assessment of the overall condition of the group to which a supervised institution belongs. The objective is to evaluate the potential impact of other companies on the supervised institution. In general, the activities of group companies are taken into account to the extent that they could affect, one way or the other, the reputation and financial soundness of the supervised institution in the group. The reasoning behind carrying out supervision on a consolidated basis is therefore, not to supervise all the companies of a group to which a banking institution belongs, but rather to supervise the banking entity, recognising it as part of the group.

Section 45 of the Banking Act empowers the Reserve Bank to conduct the supervision of banking institutions on a consolidated basis. The challenge is for the Supervision Department to acquire the requisite skills which will enable it to embark on the consolidated supervision of banking institutions.

The 25 Core Principles For Effective Banking Supervision – Compliance / Implementation
High on the ESAF agenda is regional commitment to comply with the Basel 25 Core Principles for Effective Banking Supervision. Regional programmes are currently underway to assess compliance. The Banking Supervision Department is fully committed to ensure successful compliance with the 25 Core Principles to ensure the adoption of a sound benchmark for assessing the effectiveness of Banking Supervision in Zimbabwe.

Market Risk
Market risk refers to potential loss resulting from changes in interest rates, exchange rates, equity and commodity price changes. Measurement and management of market risk has taken on greater prominence within risk management philosophy and practices. This has been largely due to the rapid changes that have taken place in the financial sector with the introduction of new financial instruments and services. The advent of derivatives, and the well publicised losses they caused to such well established banks as Barings has induced banks as well as regulators to pay more attention to market risk.

Zimbabwe has not been spared from the financial engineering revolution. In spite of the constraints faced by banking institutions in developing new products, financial institutions in the country have shown phenomenal interest in derivatives with a number of institutions currently trading in various derivative products. Indications are that trade in derivatives is set to grow rapidly in the near future.

In light of these developments and also in light of the amendment to the Basel Capital Accord, which pronounced capital charges for market risk, Banking Supervision has taken concrete steps to develop the necessary capacity to regulate market risk. The department requires adequately trained staff who understand the new products and services and, who are also well versed in market risk measurements such as Value at Risk (VAR) and such other risk measurements.

Information technology developments
The banking industry has increasingly become information driven within a borderless world. Zimbabwe's banking system is significantly well developed, technologically, by comparison with other countries in Africa. The advent of the Internet has created opportunities for banks and their customers in the provision of and access to banking services.

Electronic banking (e-banking), defined as the provision of retail and small value banking products and services, through electronic channels has, now been introduced in the Zimbabwean banking system, although still in a limited fashion. As a general policy, Banking Supervision encourages innovation in the banking system, particularly where such innovation is intended to improve customer service.

Electronic banking is one such recent development in the banking sector. Banking Supervision is, however, cognisant of the risks inherent in any new systems. It is noted that the expansion of global e-commerce to a large extent depends upon the ability of participants' to achieve a reasonable degree of certainty regarding their exposure. Risks such as fraud, error, and systems failure have always existed, but have been exacerbated by speedy electronic data processing and by the information super highway. It is for these reasons that the supervisory authorities would want to ensure that banks put in place the necessary risk management systems that will enable them to adequately manage risks associated with e-banking.

There is no specific legislation in Zimbabwe governing e-banking. Internationally no legislative guidance has yet been finalised, regarding what constitutes reasonable security standards for Internet users. As e-banking evolves in Zimbabwe, the necessary specific supporting legislation will have to be developed. In the absence of specific legal provisions,e-banking will be guided by the existing laws and regulations.

Towards Total Financial Stability
There are serious challenges for the regulatory and supervisory authorities. Financial stability can only be achieved through greater cooperation among the various regulatory and supervisory authorities of the various sectors within the financial system, covering banking institutions, including building societies, insurance companies, asset management firms, pension and provident funds.


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