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Overview

Consolidated Supervision: Assessing Financial Conglomerate Risk Constantinos Stephanou PREM – Macro 2, ECA (formerly with Finance Cluster, LCR) Strengthening Financial Supervision and Institutions Finance Forum September 22, 2004. Overview.

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Overview

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  1. Consolidated Supervision: Assessing Financial Conglomerate RiskConstantinos StephanouPREM – Macro 2, ECA(formerly with Finance Cluster, LCR)Strengthening Financial Supervision and Institutions Finance ForumSeptember 22, 2004

  2. 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.

  3. - DRAFT - Proposed Methodology 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

  4. 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

  5. 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) 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 Holding Company (can be one or several) SBIF SAFP Bank (BHC) Life Insurer Non-Life Insurer Pension Fund Leasing Company Factoring Company Securitization Company Insurance Brokerage Securities Brokerage Mutual Funds Management SBIF (only if part of BHC) SVS

  6. Risk Assessment Framework

  7. 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

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