16 February 2015

The Basel Guidelines offer central banks a comprehensive manual of recommendations on how to deal with difficult situations facing the banks they supervise. This article looks at the reasons why it is important for central banks to follow these Guidelines, particularly in the current banking crisis environment.

Formed in 1974, the Basel Committee on Banking Supervision represents central banks from the largest economies and has regional sub-committees covering many locations around the world. The aim of the Committee is to encourage common standards and the use of best practice to protect the international financial sector from banking collapse. Some of its Guidelines have passed into law and all are studied by leading banking supervisory authorities.

The first edition of the Basel Committee’s Supervisory Guidelines for banks experiencing difficulties was produced in 2002, with an updated version circulated in 2014. Like nearly all central banks around the world, the Central Bank of Cyprus (CBC) appears to have followed these Guidelines, until in recent months. (More information about the Guidelines and the work of the Basel Committee is available on www.bis.org.)

The Guidelines are 65 pages long and offer many strong recommendations of what to do in situations that are not dissimilar to that which has occurred in the FBME case. Here are a few examples:

The Executive Summary to the Guidelines  makes it clear that supervisory actions should be developed only for ‘weak banks’, not banks of strength such as FBME, which had 104% liquidity at the time the CBC took over its Cyprus branch.

             Guideline 106 says that ‘Under normal circumstances it is the responsibility of the board of directors and senior managers of a bank, not a supervisor, to determine how a bank should solve its problems’. Unaccountably, this was ignored by the CBC when it slapped its unilateral Resolution Decree on FBME Bank’s Cyprus branch just two working days into the crisis. The CBC used this decree to expropriate and try to sell the branch. It never involved FBME’s board of directors, owners or managers in its decision at that time, or on any occasion since.

The Executive Summary states that if a ‘supervisor is required to act, the supervisor has a range of tools at their disposal, but the use of them must be proportionate’. Clearly, the immediate and unilateral decision to expropriate and sell the Cyprus branch does not fit this definition.

Guideline 110 refers to the possibility that the supervisor on one hand, and the bank’s directors and managers on the other may have different views as to the nature and seriousness of the issue. It recommends an ‘on-site assessment’ as the most efficient way to identify the full extent of the problems. This was never carried out with FBME and it is important to ask why such a vital on-site assessment was not carried out jointly and cooperatively by representatives of FBME, the Bank of Tanzania (BoT) as FBME’s primary supervisory authority and the CBC. Since the beginning it has been the CBC that has prevented this.

On the subject of cross-border issues Guideline 251 recommends that ‘home (in this case BoT) and host (CBC) supervisors of cross-border groups share information and cooperate for effective supervision of the group and its entities as well as coordinate the supervisory response for effective handling of crisis situations’. Guideline 252 reinforces this and Guideline 254 takes it further: ‘the host country supervisor (the CBC) should also take into account the potential impact of its decisions on the banking system in other countries’. There is no evidence that this influenced CBC actions. Guideline 255 makes it clear that it is the home supervisor (BoT) that bears responsibility for solvency and not, in this case, the Cyprus authorities.

There are recommendations expressed by the Basel Committee that deal with resolution measures. Guideline 188 says ‘Resolution should be initiated when a bank is no longer viable, or likely to be no longer viable and has no reasonable prospect of recovering.’ Clearly, that was very far from being the case with FBME Bank.

That’s what the Basel Guidelines say. It would have been far better that they had been followed.

NB for information: Cyprus’ banking law, enacted in 1997, is one of the oldest in the world. The Bank of Tanzania, by comparison, updated its law in 2006.