Ch07 Structure of Bank Credit Risk.docx

STRUCTURE OF BANK CREDIT RISK --- AN OVERVIEW 387350160655 Bank Structure: A Successful Approach Managers spend hours agonizing over how to structure their organizations (by product, geography, customer, and so on). Winners show that what really counts is whether structure reduces bureaucracy and simplifies work. Simplify. Make your organization easy to work in and work with Promote cooperation and the exchange of information across the whole company Put your best people closest to the action Establish systems for the seamless sharing of knowledge Client Pyramid 9163053175 Targeting ‘Sweet Spot’: In putting this strategy into effect, a Bank serves mid market consumer and commercial clients – whom it calls the bank’s ‘sweet spot’ client segments The Consumer mid-market segment includes mass affluent customers?retail clients with healthy finances as well as most of higher-end private banking clients Commercial mid-market clients include many medium-to-large companies and financial institutions Serving the Whole Client Pyramid: Client base can be represented through the ‘Client Pyramid’ shown in the accompanying illustration The strategy identifies sweet spot as being mainly located around the middle of this pyramid However, this does not reduce the importance of the top and bottom end of the pyramid For example, serving top private banking clients helps to develop innovative investment products that can later be offered to mid market consumer clients as well Similarly, serving large multinational corporations enables to strengthen industry knowledge and product innovation, both of which will eventually benefit mid market commercial clients Both the mass retail segment and the small business segment deliver the scale Bank needs and act as a feeder channel for future mid-market clients Strategy, another Perspective: Your strategy should be sharply defined, clearly communicated, and well understood by employees, customers, partners, and investors Build a strategy around a clear value proposition for the customer Develop strategy from the outside in, based on what your customers, partners, and investors have to say—and how they behave—not on gut feel or instinct Continually fine-tune your strategy based on changes in the marketplace— for example, a new technology, a social trend, a government regulation, or a competitor’s breakaway product Clearly communicate your strategy within the organization and to customers and other external stakeholders Keep focused. Grow your core business, and beware the unfamiliar 569595161290 In the Single -Loop learning we apply habitual way of thinking and doing, i.e. re-enacting the past or what is called “Downloading”. But in Double-Loop learning we reflect and ask the “why not” questions which could lead to a paradigm shift. Double loop theory is based upon a "theory of action" perspective outlined by Argyris & Schon (1974). This perspective examines reality from the point of view of human beings as actors. Changes in values, behavior, leadership, and helping others, are all part of, and informed by, the actors' theory of action. An important aspect of the theory is the distinction between an individual's espoused theory and their "theory-in-use" (what they actually do); bringing these two into congruence is a primary concern of double loop learning. Typically, interaction with others is necessary to identify the conflict. There are four basic steps in the action theory learning process: (1) discovery of espoused and theory-in-use, (2) invention of new meanings, (3) production of new actions, and (4) generalization of results. Double loop learning involves applying each of these steps to itself. In double loop learning, assumptions underlying current views are questioned and hypotheses about behavior tested publicly. The end result of double loop learning should be increased effectiveness in decision-making and better acceptance of failures and mistakes. In recent years, Argyris has focused on a methodology for implementing action theory on a broad scale called "action science" and the role of learning at the organizational level. Key Regulatory Requirements: Know-Your-Customer (KYC) System Anti-Money Laundering (AML) Policy Audit & Compliance Setup SBP PRUDENTIAL REGULATION XI --- KNOW YOUR CUSTOMER (KYC) In view of heightened global efforts to prevent the possible use of the banking sector for money laundering, terrorist financing, transfer of illegal/ill-gotten monies and as a conduit for white collar crime etc., the importance of ‘Know Your Customer (KYC)’/”customer due diligence” has increased To reinforce the checks and controls already developed by banks as also to ensure due diligence is done while starting relationship with a new customer and maintaining and continuing relationship with existing customers GUIDELINES All reasonable efforts shall be made to determine true identity of every prospective customer. The following minimum set of documents must be obtained from various types of customers/ account holder(s). Nature of Documents/Papers to be Obtained Account Individuals i. Attested photocopy of national identity card or passport of the individual. In case the NIC does not contain a photograph, the bank should also obtain, in addition to NIC, any other document such as driver’s license etc that contains a photograph. In case of a salaried person, attested copy of his service card, or any other acceptable evidence of service, including, but not limited to a certificate from the employer. In case of illiterate person, a passport size photograph of the new account holder besides taking his right and left thumb impression on the specimen signature card. The Banks shall obtain “Introduction” on the new account to assess the prospective customer’s/account holder’s integrity, respectability and the nature of business etc. Any laxity in this regard may result in serious consequences for the banker. The following guidelines are to be followed in this regard: Where the introducer is an existing account holder of the same branch, his introduction should be accepted, after due verification of signature by the official of the branch. In case the introducer is an account holder of another branch of the same bank, the account should only be opened after proper verification of the signature from the concerned branch Where the introducer happens to be an account holder of another bank, the introduction should be accepted after complete verification of the signature and other particulars of the introducer from that bank The introduction by the employees of the bank may also be acceptable. However, he or she will have to establish that sufficient information has been collected on the new account holder for making the introduction and that they believe that “Introduction” from a person other than the bank’s employee is not necessary (The introduction of a person other than by the branch employee is being stressed to ensure maximum authenticity on the status of the would-be accountholder/customer, beside minimizing the chances of undesirable accounts which may be opened on the introduction of the bank employees in their pursuit to achieve targets of opening maximum number of accounts and treating the “Introduction” a mere formality in the process). The Bank/branch shall obtain satisfactory evidence duly verified/authenticated by the branch manager and shall be placed on record in respect of: the true identity of the beneficial owners of all accounts opened by a person, entity etc, the real party in interest or controlling person/entity of the account(s) in case of nominee or minors account The Banks are also advised that KYC/customer due diligence is not a one time exercise to be conducted at the time of entering into a formal relationship with customer/account holder. KYC/Customer due diligence is an on-going process for prudent banking practices, therefore the banks are encouraged to: - Set up a compliance unit with a full time Head Put in place a system to monitor the accounts and transactions on a regular basis Update customer information and records, if any, at reasonable intervals Install an effective MIS to monitor the activity of the customers’ accounts Chalk out plan of imparting suitable training to the staff of bank periodically Maintain proper records of customer identifications and clearly indicate, in writing, if any exception is made in fulfilling the due diligence procedure Monitor and check unusually large cash transactions, especially those which are out of character/ inconsistent with the history, pattern etc of the individual account(s) The banks shall develop guidelines for customer due diligence, including a description of the types of customers that are likely to pose a higher than average risk to a bank In preparing such policies, factors such as customers’ background, country of origin, public or high profile position, nature of business etc should be considered Each Bank shall formulate and keep in place, in writing, a comprehensive Know- Your-Customer policy duly approved by their Board of Directors and in case of branches of foreign banks, approved by their head office, and cascade the same down the line to each and every branch/office/ concerned officers for strict compliance State Bank of Pakistan, during the course of inspection, would particularly check the efficacy of the KYC system put in place by the banks and its compliance by all the branches and the staff Appropriate action shall be taken against the bank and the concerned staff members for non-compliance and negligence in this area under the provisions of Banking Companies Ordinance 1962 A Typical KYC System/Framework (An Example) Documentary Requirements 1.1 Identification of Client 1.2Verification of Client’s Name (NADRA’s Verification) 1.3Verification of Client’s Address (registered and if applicable operational) 1.4Identification of Ultimate Beneficial Owners with a Controlling Interest of 20% or more (neutralrisk client) 1.5Identification of Ultimate Beneficial Owners with a Controlling Interest of 10% or more (increasedrisk client) 1.6Verification of Controlling UBOs 1.7Evidence that Legal Rep is Authorized to Act on Behalf of and Bind the Client in the mannerproposed 1.8Identification and Verification of the Legal Rep’s Identity 1.9Identification of Company Director(s) 1.10Verification of 1 (or 2) Company Director(s) 1.11Evidence of Sanctions Check 1.12Evidence of PEP (Politically Exposed Person) Search 1.13Evidence of Bad Press Search 1.14Evidence of publicly traded and/or regulated status (directly or indirectly) 1.15Verification of Business Activity STRUCTURE OF BANK CREDIT RISK AN OVERVIEW (CONTD…) AML: Some Thoughts Money laundering, in general, is the name given to the process by which the origin of illicit funds is disguised The need to indulge in money laundering is primarily to cover up the means by which such funds have been acquired with the aim of legitimizing them According to the United Nations, the term Money Laundering is defined as “Any act or attempted act to disguise the source of money or assets derived from criminal activity It is the process whereby “dirty money”, produced through criminal activity, is transformed into clean money” According to Section # 3 of Ant- Money Laundering Ordinance 2007, Government of Pakistan, and Offence of money laundering: A person shall be guilty of offence of money laundering, if the person: acquires, converts, possesses or transfers property, knowing or having reason to believe that such property is proceeds of crime; or Renders assistance to another person for the acquisition, conversion, possession or transfer of, or for concealing or disguising the true nature, origin, location, disposition, movement or ownership of property, knowing or having reason to believe that such property is proceeds of crime According to Section # 4 of the Ordinance: Punishment for money laundering: Whoever commits the offence of money laundering shall be punishable with rigorous imprisonment for a term which shall not be less than one year but may extend to ten years and shall also be liable to fine which may extend to one million shillings and shall also be liable to forfeiture of property involved in the money laundering. Client Acceptance and Anti-Money Laundering Policy (CAAML): Standard for Risk Assessment and Client Acceptance Standard for Client Identification and Verification Standard for Money Laundering Detection Standard for Rejection of Clients/Ending Relationships Standard for AML Awareness and Training Procedures for Identification and Verification Procedures for Transaction Filtering Lists of Legal Persons and Groups Procedures for Handling Suspicious or Unusual Activity Details Procedures for Waivers An Example from a Bank Manual on AML Policy: It is a Policy of the Bank that, Statutory and regulatory obligations to prevent ML and TF are to be met in full Systems and controls will be implemented in order to minimize the risk of the Bank's services being abused for the purposes of ML and TF A money laundering risk assessment of the Bank’s services and customer base including correspondent banks and MSBs (Money Service Businesses) will be undertaken and appropriate policies, procedures and due diligence controls will be applied proportionate to that risk Any customer relationship where the customer's conduct gives the Bank reasonable cause to believe or suspect involvement with illegal activities will be reported to Regulators or relevant authorities. Thereafter action will be undertaken in conjunction with the relevant authorities and in accordance with local practice to avoid any risk of the Bank committing a ‘tip-off’ offence. Wherever possible, the relationship will be terminated In countries where local regulators call for a money laundering compliance reports, respective country MLRO would be responsible for preparation and submission of these reports. CCO would submit a quarterly compliance report to Audit Committee and an annually to the Board, as required under the Compliance Policy Internal Controls and Communication It is a Policy of the Bank: To institute controls which comply fully with all applicable anti-money laundering laws and regulations To conduct risk assessment and develop risk profiles of the Bank’s products, services and customers and to apply appropriate policies and procedures to manage such risks. Undertaking enhanced due diligence for ‘High Risk’ products, services and customers To communicate Bank’s policies to management and staff and provide them with written procedures and control requirements to ensure ongoing compliance with AML laws and regulatory requirements Recognition and Reporting of Suspicion It is a Policy of the Bank: To establish and follow procedures that requires employees to refer promptly any suspicious activity to GCG or respective country MLRO who will review the transaction to determine whether a report should be filed with the Regulators To be alert to unusual or suspicious transactions or other activities that appear not to make good business or investment sense, or activities that appear to be inconsistent with the counterparty or customer’s expected activity, including activities that may be indicative of criminal conduct, terrorism or corruption To act competently and honestly when assessing information and circumstances that might give reasonable grounds to suspect ML or TF To provide GCG or respective country MLRO (at request) access to all customers, correspondents or counterparties information within the Bank To co-operate fully with law enforcement authorities in investigations concerning possible ML or TF within the confines of applicable laws, and in consultation with GCG or respective country MLRO Not to alert or provide any information to any person suspected of illegal activity regarding suspicion or inquiry on his or her account or transactional activities or any indication of being reported to Regulators Awareness Raising and Training It is a Policy of the Bank: To make all management and staff aware of what is expected of them to prevent money laundering or terrorist financing and to advise them of the consequences for them and for the Bank if they fall short of that expectation To provide initial and annual update training for all appropriate personnel, including all personnel who set up and manage customer account opening or transactions, correspondent relationships, and/or are involved in trade finance activity That management and staff will be required to sign a memorandum confirming they have read and understood the Bank’s AML/KYC policies and procedures Record Keeping It is a Policy of the Bank: To retain identification and transaction documentation for the minimum period required by applicable Laws and Regulations To retain records of all reports made by staff to GCG or respective country MLRO and all suspicious activity reports made by MLRO to Regulators for an indefinite period unless advised by the Regulator otherwise To be in a position to retrieve, in a timely fashion, records that are required by law enforcement agencies as part of their investigations To keep records of dates when anti-money laundering training was given, the nature of the training and the names of staff who received such training Bank’s Policy on Politically Exposed Persons (PEPs) Policy Rationale PEPs and related individuals can pose unique reputation and other risks, in particular: Some corrupt PEPs around the globe have used traditional banking products and services as safe havens for misuse of funds, illegal activities and associated practices, including money laundering; PEPs enjoy prominence and are therefore under continuous public spotlight. Their financial affairs are highly magnified and could easily trigger adverse publicity and franchise risks for the Bank; There is a growing attention worldwide to the misuse of public funds and increased reaction against corruption at high government levels; There is increasing responsibility and liability for banks and bank personnel to undertake due diligence for establishing source of wealth and investigate fund flows of PEPs Definition PEPs are individuals who are or have been entrusted with prominent public functions, for example Heads of State or of Government, senior politicians, senior government, judicial or military officials. Senior executives of state owned corporations, important political party officials, business relationships with family members or close associates of PEPs involve reputation risks similar to those with PEPs themselves. The definition is not intended to cover middle ranking or more junior individuals in the foregoing categories. Reputational Risk: Reputation is a key business asset, however intangible. Risks that negatively affect the reputation and standing of banks have increased considerably in the last decade One of the key risks to the bank’s reputation is the risk of the bank becoming involved in, or becoming a vehicle for, criminal activities, such as money laundering, terrorism, fraud and corruption Many products and services offered by the Bank are attractive to those who would use the financial services industry and financial systems for criminal purposes One important way of mitigating these risks is ensuring that the bank conducts business with acceptable clients and has adequate policies and procedures to deter criminal activities The Client Acceptance and Anti-Money Laundering (CAAML) policy ensures required attention is paid to a client, in order to establish whether or not the bank wants to do business with the client and that the bank's clients are of good reputation It should be noted that client acceptance includes aspects not covered in the stated policy, particularly sustainability Money Laundering and Terrorist Financing: Generally speaking, “Money Laundering” is the introduction of illegally gained assets into the legal financial system with the aim of concealing or disguising their true origin The source of illegally obtained funds is obscured through a succession of transfers and transactions in order that those same funds can eventually be made to reappear as legitimate income. Terrorist financing is the financial support, in any form, of terrorism or those who encourage, plan or engage in it The common trait between money laundering and terrorist financing is concealment Consumer Banking -44451905 What is ‘Compliance’? Audit & Compliance function’s role is: To independently oversee the core processes, and their related policies and procedures, that seek to ensure that the bank is conforming to industry-specific laws and regulations in letter and spirit, thereby maintaining the bank’s reputation. SBP PRUDENTIAL REGULATION NO. XXIX – RESPONSIBILITIES OF BOARD OF DIRECTORS The State Bank attaches a great importance to effective corporate governance, clear lines of responsibility, elaborate mechanism of accountability, and existence of proper checks and balances in each bank/financial institution The corporate governance means the way in which business and affairs of each institution is directed and managed by their ‘Board of Directors’ and the ‘Management’ To promote safe and sound banking practices, it is imperative that the ‘Board of Directors’ assumes its role independent of the influence of the Management Members of the Board should know their responsibilities and powers in clear terms Further, it should be ensured that the Board of Directors focus on policy making and general direction, oversight and supervision of the affairs and business of the bank/DFI and does not play any role in the day-to-day operations, as that is the role of the ‘Management The Compliance Officers will primarily be responsible for Bank’s / DFI’s effective compliance relating to: SBP Prudential Regulations Relevant provisions of existing laws and regulations Guidelines for KYC Anti money laundering laws and regulations Timely submission of accurate data / returns to regulator and other agencies Monitor and report suspicious transactions to President / Chief Executive Officer of the bank / DFI and other related agencies .