Lecture 7

Regulation of Banks
(Part 1)
 Aims
2

Discuss the main reasons for the existence of banking

regulation in most countries.

Illustrate the key economic reasons for and against banking

regulation.

Describe how regulation occurs in practice by analysing

general issues of regulation and by giving some practical
examples of the application of regulation (mainly in the USA,
UK and New Zealand).
 Aims
3

Examine the deficiencies in the regulatory framework

revealed by the Global Financial Crisis of 2007 09.

Examine the response of the regulatory bodies in their

attempt to address these deficiencies.
 Learning outcomes
4

Explain why banks need regulation.

Illustrate the main cases of non-regulated banking systems

in history and explain their economic rationale.

Explain the main arguments for and against the regulation

of banking systems.

Explain how banks are regulated through traditional

regulation mechanisms: Parts 1, 2 & 3.
 Learning outcomes
5

Discuss the problems with the traditional regulation

mechanisms revealed by the Global Financial Crisis of
200709.

Evaluate the response of the Basel Committee on Banking

Supervision to the Global Financial Crisis of 200709.

Illustrate alternative regulation mechanisms.

Discuss the main implications of the recent trend in

harmonising bank regulation across the world create a
level playing field.
 Essential readings
6

Dow, S. Why the banking system should be regulated, Economic

Journal 106(436) 1996, pp.698707.

Dowd, K. The Case for Financial Laissez-Faire, Economic Journal

96(106) 1996, pp.67987.

Mishkin, F. and S. Eakins Financial Markets and Institutions. (Boston,

London: Addison Wesley, 2009) Chapter 20.
 Further readings
7

Buckle, M. and J. Thompson The UK Financial System. (Manchester:

Manchester University Press, 2004)] Chapter 17.

Freixas, X. and J.C. Rochet Microeconomics of Banking. (Boston, Mass.:

The MIT Press, 2008) Chapter 9.

Heffernan, S. Modern Banking. (Chichester: John Wiley and Sons, 2005)

Chapters 4 and 5.

Sinkey, J.F. Commercial Bank Financial Management in the Financial-

Services Industry. (Upper Saddle River, NJ: Pearson Education, 2002)
Chapter 16.
 References
8

Bank of England Discussion Paper The role of macroprudential policy,

November 2009 (download from www.bankofengland.co.uk/publications/
other/financialstability/roleofmacroprudentialpolicy091121.pdf)

Freixas, X. C. Giannini, G. Hoggart and F. Soussa Lender of last resort: a

review of the literature, Bank of England Financial Stability Review,
November 1999

Kay, J. Narrow banking: the reform of banking regulation, Centre for the
study of Financial Innovation, publication no. 88, September 2009 (also
download from www.johnkay.com/wp-content/uploads/2009/12/JKNarrow-
Banking.pdf).

Mortlock, G. New Zealands financial sector regulation, Reserve Bank of

New Zealand: Bulletin (2003) 66, pp.549.
 Introduction
9

Banking regulation now exists in virtually every country

with a well developed banking system. In fact, it is
practically impossible to study the theory of banking without
referring to bank regulation.

Nevertheless, non-regulated banking systems have been

introduced in some countries (so-called free banking).

In most countries, the banking system is more heavily

regulated than any other sector of the economy.
 Introduction
10

Banking regulation takes several forms, through the

adoption of various regulation mechanisms.

A recent trend towards greater harmonisation of bank

regulation across the major banking systems of the world is
occurring (ROLE OF EU EU passport).

The financial crisis of 200709 revealed several

deficiencies in the system of bank regulation used in
most countries (EFFECTIVE & PRUDENT REGULATION,
LIKE VOLCKER RULE OR BASEL CAR IS THE
SOLUTION TO THE GFC, NOT A NEW GSA).
 Critical questions Exam focus
11

We address the following questions:

Why do banks need regulations?

Why not permit free banking within a market system, with

the users making their own assessment of the quality of the
liabilities issued by banks?

What are the reasons for and against regulation?

Why are banks singled out for special regulation?

 Critical questions Exam focus
12

What are the traditional regulation mechanisms?

What are the main problems in traditional regulation

methods revealed by the financial crisis of 200709?

What has been the response of the regulatory authorities to

the deficiencies in bank regulation revealed by the financial
crisis?

Is there any alternative regulation mechanism?

What are the reasons for the recent international

harmonisation in banking regulation?
13

Unregulated Banking System

 Free banking
14

financial system that is unregulated so-called free

banking.

financial system with NO central bank or any other financial

or monetary regulator and no government intervention.

operates freely, subject only to market forces and the rules

of normal commercial and contract law.
 Free banking
15

Example: financial laissez-faire.

Free banking era was to be found in the

USA from 1838 until 1863

Scotland (17161845)

Switzerland (after the Liberal revolution in the 1830s and

1840s until 1881)
Canada (18201935)

Hong Kong (193564)

 Free Banking
16

A free banking system consists of banks whose deposits

are largely repayable on demand and where those deposits
are used as payment instruments. However, there is no
central bank, no supervision of or restriction on the
activities of banks, and no state insurance scheme for
deposits (no deposit insurance) shadow banking.

Free banks issue distinct private monies, called bank

notes. These bank notes are perpetual, non-interest
bearing debt claims that can be redeemed on demand.
However, these bank notes are subject to the risk of failure
of the issuer and redemption means having to travel to the
issuing bank.
 Shadow Banking
17

FIs that create credit across the global financial

systems but are not subject to regulatory oversight;
or alternatively defined as
Unregulated activities undertaken by regulated FIs.

Examples of financial products: Credit Default

Swaps (CDS), unlisted Derivatives and Repurchased
Agreement or Repo (aka sale and repurchase
agreement borrower sells low and buys back
high; difference being the repo rate).
 Private Bank Notes
18
 Free Banking
19

Two main arguments are made against private money

issuance:

Some banks can over-issue their currency, making the

conversion impossible (so-called wildcat banking).

Transaction costs increase when thousands (three

thousand in the case of the USA and Canada in their
periods of free banking) of distinct bank notes circulate in
a given geographical area.
 Unstable Free Banking
20

The traditional, dominant view is that free banking is

inherently unstable because of market failures arising from
factors such as natural monopolies and information
asymmetry.

Free banking causes counterfeiting, wildcat banking,

fraudulent banking, over-issue of bank notes and over-
expansion by banks.
 Unstable Free Banking
21

Free banks are therefore prone to failures and lead to

systemic banking instability.

As a consequence, several reasons have been advocated to

justify banking regulation.

During the US free banking era, bank failures in Indiana,

Wisconsin and Minnesota are usually cited as evidence of
the instability of free banking.
 Sound Free Banking
22

This traditional, negative view has come under increased

scrutiny since the 1970s.

The failure of regulators to prevent the banking crisis of

200709 has again raised doubts about the ability of
regulators to maintain a stable banking system.

Even if bank regulation is present today in virtually every

country, a small but growing number of economists are still
in favour of free banking.
 Sound Free Banking
23

One of the major arguments provided for the soundness of a

free banking system is that competition in the supply of
money forces banks to maintain either their reputation or
convertibility of their liabilities (bank notes or deposits) into
species or real commodities, which in turn prevents banks
from over-issuing money.

In contrast, a self-correcting mechanism does not exist

under a monopolised supply of money by the government.
(QE1/2/3?)

Therefore free banking is more stable than central

banking.
 Banking mechanism
24

In terms of regulation of the banking system, in the

absence of a regulator and deposit insurance system,
depositors would become much more aware that if their
bank failed, they would lose their deposit.

Depositors would therefore require greater reassurance

that their deposit is safe.

There are essentially three mechanisms that banks can

use:
disclose lots of information, including audited accounts
(for depositors);
pursue prudent lending policies (for borrowers); and

hold adequate amounts of capital (opportunity cost).

 Bank Capital
25

The more capital a bank holds, the more resilient it is in the

face of shocks (i.e. the more able the bank is to maintain its
solvency in the event of losses) (Basel Capital Adequacy
Ratio > RAR = Capital/Risk Weighted Assets).

However, capital is costly shareholders have to be paid

dividends cost of capital concept.

Free bankers argue that in a competitive banking

system market forces would determine the optimal level
of capital is there an optimum capital structure? (dynamic
efficiency)
 Bank Capital
26

If depositors want high levels of reassurance, they will

choose to place their deposits in banks holding high levels
of capital SAFETY.

Please read Dowd (1996), an advocate of free banking.

Think about how depositors and shareholders might

regulate banks note that regulation aims to encourage
good and discourage imprudent behaviour returns on
banks assets exceed required returns and required
returns reflect the risks of the stakeholders example:
positive interest rate spread.
27

Regulated Banking System

 Why do banks need regulations?
28

6 Reasons for regulations (how to prevent another GFC):

to protect depositors;
to assure the safety and soundness of banks;
to avoid (or to limit) the effects of bank failures;
to maintain monetary stability;
to protect the payment system; and
to encourage efficiency and competition in the financial system
and in the economy.

Sudipto Bhattacharya, Professor of Finance at LSE, is an

expert of financial intermediation and has studied the
economics of bank regulation.
 Why do banks need regulations?
29

The economic arguments on bank regulation can be

properly understood by keeping in mind the pivotal position
of banks in the financial system, especially in the payment
systems and in the financing (as a dominant or exclusive
lender) of a large number of borrowers.

pros and cons of bank regulation in three domains:

the fragility of banks;

systemic risk; and

the protection of depositors.

30

Pro Regulation

1. Overcome Fragility of Banks

 Fragility of banks
31

The history of financial systems shows that bank panics

have been common in Europe and the USA throughout
modern history (and in many emerging countries in recent
years).

When banks started to finance illiquid loans through demand

deposits (borrow short and lend long), most recessions were
accompanied by loss of public confidence in the banking
system, often leading to bank panics Maturity Mismatch.
 Fragility of banks
32

At first, banks privately developed cooperative systems to protect

their collective reputation.

These systems were later taken on and transformed by central

banks when governments decided to impose controls on banking
systems.

Moreover, central banks started to offer lender of last resort

facilities in times of financial crises: central banks act as the
ultimate supplier of liquidity to bank(s) threatened by a liquidity
crisis.

In recent times, central banks have led lifeboat rescues, whereby

healthy banks take over the deposits of the troubled banks.
 Fragility of banks
33

In the US, a number of banks were provided

with capital injections under the Troubled
Asset Relief Program (TARP). These included
Citigroup and Bank of America which both
received $45 billion of capital each from the
US government in return for the government
having an equity stake in those banks.
 Bank functions
34

The fragility of banks derives from the combination of

the two main functions (BORROW SHORT AND LEND
LONG -> LIQUIDITY RISK).

1. The role of banks in providing liquidity insurance to

households (DEPOSITORS).

Banks can be considered as pools of liquidity to

households that can deposit funds as insurance against
shocks that affect their consumption needs
consumption smoothening theory.
 Bank functions
35

Some fraction of these deposits can be used by banks to

finance profitable but illiquid investments (the so-called
fractional reserve system).

This represents a source of potential fragility of banks, if

a high number of depositors all at once decide to
withdraw their funds for reasons other than those of
normal liquidity needs perfect correlation means crisis;
imperfect correlation means confidence.
 Bank Functions
36

2. A source of mitigation of fragility (BORROWERS)

the role of banks in screening and monitoring borrowers

who cannot obtain direct finance from financial markets.

Banks are able to produce a more accurate valuation of

firms than other companies and are also able to select
good credit risks thanks to their expertise in information
production.

The nature of these two core services to depositors and

borrowers explains the financial structure of banks: liquid
liabilities (deposits) and illiquid assets (loans). This in turn
explains the vulnerability of banks to runs.
37

Pro Regulation

2. Mitigate Systemic Risks

 Systemic risk
38

A crucial role of bank regulation and specifically of central

bank operations, is to prevent systemic risk.

This is the risk that the failure of a particular bank spreads to

other solvent banks. This happens because depositors are
unable to distinguish between good and bad banks.

The run on one bank, which can be justified if the bank has
been imprudent, will lead to a run on solvent banks because
of the asymmetric information problem.

This leads to Adverse Selection.

 Systemic risk
39

A solvent bank facing a run will quickly run out of liquidity to

meet deposit withdrawals because most of its assets are
long term in nature and cannot easily be liquidated. This is
the fragility problem discussed above.

A bank facing such a run may engage in a fire-sale of

assets (where assets are sold cheaply in order to achieve a
quick sale) which will reduce the total value of the banks
assets.

Thus a bank that was once solvent can become insolvent by

its attempts to generate liquidity.
 Bank run
40

In a classic bank run, retail depositors lose confidence in

their banks ability to remain solvent or see problems at
other banks and therefore join a run at their bank.

However, in modern banking, liquidity is provided not just

by retail deposits but by wholesale deposits through inter-
bank markets.

Many banks became heavily dependent on wholesale

market funding and funding through securitisation to
finance their assets over the last decade.
 Bank run
41

The recent banking crisis demonstrated that runs can

develop in the wholesale markets as inter-bank lending
drains away and lenders demand higher collateral
requirements.

Banks are therefore highly inter-connected and a problem

in one part of the banking system can quickly spread to
other parts.

Given the pivotal role of banks in intermediation and hence

in underpinning economic activity, the consequences of
systemic failure of the banking system can be catastrophic.
This is one of the primary reasons to justify external
regulation of the banking system.
42

Pro Regulation

3. Protection of Depositors
 Protecting depositors
43

The protection of the public (especially depositors) AND the

safety of the payment system represent good justifications
for (solvency) regulations of banks.

Therefore, prudential regulations are necessary because

of the lack of expertise and knowledge of individual
depositors to assess the quality of the bank.

This suggests a differentiation in the degree of

regulation imposed on retail and wholesale banks,
because of the differences in the perceived expertise of
their customers.
 Protecting depositors
44

Retail banking depositors are less knowledgeable than

those of wholesale banks; therefore the need for regulation
is greater in retail banking.

These (retail) banks should be subject to fairly rigorous

control, whereas wholesale banking can be subject to a
much lighter prudential control.

The differentiation of retail and wholesale (investment)

banking became an issue following the financial crisis of
200709. Many banks are both retail and wholesale banks.

The ending of the Glass-Steagall Act in the USA allowed

retail banks to engage in investment banking activities.
 Risk of Universal Banking
45

Most banks in Europe are universal banks undertaking

both retail and investment banking.

This makes it difficult for regulators to regulate the

retail banking operation more rigorously than the
investment banking operation, as the two are
intertwined.

The reason why this became a concern following the

recent financial crisis is that investment banking is
inherently more risky than retail banking, but regulators are
reluctant to let retail banks fail because of the
consequences of such a failure.
 Risk of Universal Banking
46

Thus, many universal banks around the world which got

into severe financial difficulties, in large part because of the
speculative activities of their investment banking
operations, had to be rescued with state funds, so as to
protect depositors funds in their retail operations and to
prevent an escalation of systemic risk.
 Consequences of Bank Failures
47

In the absence of any regulations, bank failures may

have two main consequences:

1st, they are very costly, especially to the financers of the

failing bank (such as depositors and the banks
stockholders) and, to a lesser extent, to borrowers with
a close relationship with the failing bank. In addition, they
may also be very costly to other banks, because
interbank lending accounts for a significant proportion of
banks balance sheets.

2nd, the pivotal position of banks in the management of

the payment system.
 Bank failures more serious
48

Bank failures are more serious than failures in the other

sectors of the economy for two reasons.

Firstly, the unique feature of banks is that their creditors

(depositors) are also their customers.

Contrary to non-financial firms whose debt is held by

professional investors (especially banks), the debt of banks
is held in large part by uninformed, dispersed, small agents
(mostly households) who are not in a position to monitor the
banks activities.
 Bank failures more serious
49

The general public (depositors) lack the information and expertise to

differentiate between safe and risky assets (banks).

In any case, for each individual to have to evaluate the soundness of

a bank would be time-consuming and inefficient ECB conducted
stress tests of European banks; 24 European banks failed the tests
and as at October 2014, 13 of the 24 banks have yet to cover their
capital shortfalls.

The justification for regulation is conveniently summed up as For

the protection of depositors.
 Bank failures more serious
50

Secondly, banks managers would not choose the optimal

solvency ratio / optimal capital structure.

Self-regulation faces the problem of conflicts of interest inside the

banks among managers, stockholders and bondholders.

For example, in the case of a bank with a small number of

deposit-holders who manage the bank themselves, these owner-
managers will tend to choose an investment policy that is more
risky than the rest of the depositors would like Jensen and
Meckling theory of asset substitution and risk transfer. Because
of the lack of financial sophistication/information of these non-
owner depositors, some institution or regulator must defend their
interests.

Read Dow (1996), an advocate of bank regulation.

51

Cons of Regulation -
Costs & Over Regulation
 Arguments against regulation - COSTS
52

Regulation can itself be a source of costs, negative effects

and instability.

The first argument is related to the costs in the form of real

resources on both the regulators and the regulated.

These costs are of four types:

the administrative costs of the regulatory authorities (i.e.

employing staff to monitor banks);
 Arguments against regulation
53

the administrative costs associated with the banks own

compliance activities (i.e. staff to produce return required
by the regulator);

the cost of dedicated capital to comply with capital

requirements; and

the contribution to funds needed to compensate the

clients of other banks which have failed.
 Magnitude of Administrative Cost
54

The budget for the regulatory activities of the Federal

Reserve System (FRS, one of several regulators in the US
banking system) was $3268.1 million in 2007 (in comparison,
the value add of the US banking industry to the gross
domestic product is $569,700 million); while for the Financial
Services Authority (FSA, the UK bank regulator), this cost
was 298.9 million in 200607.

Given that these costs are relatively high, it is a question of

cost-benefit analysis to evaluate whether the benefits gained
by prudential regulation outweigh the costs incurred. This
trade-off explains why regulation should not be excessive
but maintained at the minimum required to prevent bank runs.
 Risk of Over Regulation
55

Danger of regulation becoming so excessive that :-

it reduces competition (i.e. regulation constrains banks

diversification by limiting their portfolio choices or by
restricting branching);

it raises costs (and thus reduces profitability); and

it lowers the rate of financial innovation.

Glass Steagall Act over regulation into fragmented /

narrow banking? Discuss.
 Risk of Over Regulation
56

Another problem with regulation is that it creates Moral

Hazard.

Banks may take more risk (reckless) if they know they are
likely to be bailed out if they get into difficulties. Depositors
are less likely to monitor (complacency) what banks are
doing if they know there is a regulator monitoring on their
behalf and if the deposit insurance scheme provides full
compensation in the event of bank failure.

As a consequence, depositors are more likely to place their

deposits in banks paying the highest interest rates, which are
likely to be the banks taking the most risk. Thus, regulation
may actually encourage risk taking the very thing it is
attempting to curtail.
 Moral Hazard for Banks
57
 Risk of Over Regulation
58

Finally, there is the danger that excessive regulation

imposed in one centre will lead to the movement of the
(risky) activity to centres where regulation is lighter.

This explains the aim of the European Union regulator to

achieve a common (called harmonised) regulation system
across banks operating in 28 different countries,
sometimes referred to as the creation of a level playing
field.
59

How to Regulate?
Traditional Regulation Mechanisms
60

Seven basic categories of traditional regulation

mechanisms:

creation of a central bank - L7;

bank supervision (restrictions on entry & bank
examination) - L7;
government safety net - L8;

bank capital requirements - L8;

assessment of risk management - L9;

monitoring of liquidity - L9; and

disclosure requirements - L9.

1. Creation of a Central Bank
61

Control money supply

The usual argument for justifying the government monopoly

in money supply is that the private issuance of means of
payment could easily generate fraud, counterfeiting and
adverse selection problems.

Also, controlling the money supply helps to stabilise the

price level (so-called monetary control). Since the mid-
1980s, most monetary authorities have used interest rates
to implement monetary policy for the purpose of achieving
price stability (liberalised or loose monetary policy QE3
came to an end on 31 October 2014).
 Creation of a Central Bank
62

Prudential control, which is the minimisation of financial

crises.

The role of lender of last resort of a central bank matters

in times of financial crisis, especially in the UK system.

In the USA, there has always been a great deal of

concern about the fact that a lender of last resort function
could go against free competition in the banking industry.

As a result, the emphasis has always been on a

decentralised structure of the central bank.
 Examples of Central Banks
63

The Bank of England, founded in 1694, laid the foundation

for the development of central banks in other countries.

The Federal Reserve Bank (FRS, know as The Fed) was

created as a central bank for the US banking system as late
as 1913. The Fed is made up of 12 regional Federal
Reserve Banks and a Board of Governors. The primary
function of The Fed is to pool the reserves of each of these
banks.

The most recent central bank is the European Central Bank

(ECB), which was set up in Frankfurt in July 1998. The
ECB, together with the central banks of the member states,
forms the European System of Central Banks.
 Fed Reserve US Central bank
64

Ben Bernanke former

Janet Yellen - current
Change over in January 2014
Federal Reserve Chair
 ECB European Central bank
65

Mario Draghi
ECB President
 ECB European Central bank
66

ECB cut the deposit rate from -0.1% to -0.2% in

September 2014, which means that banks have to
pay the Central Bank to park their monies there.
ECB has also in September 2014 cut its refinancing
rate from 0.15% to 0.05% making it cheaper for
banks to borrow from the Central Bank.
Both actions are aimed at encouraging banks to
borrow from the Central Bank and lend at cheap
rates to companies so as to stimulate consumption,
spending and job creation.
 ECB European Central bank
67

From 9 March 2015, ECB has embarked on

Quantitative Easing with a monetary stimulus plan of
buying back covered bonds and ABS, thereby injecting
liquidity into the weak economy.
Note the difference in global monetary policies:
US tapering QE (tightening monetary policy);
UK tapering QE (tightening monetary policy);

Europe monetary stimulus thru QE (easing monetary

policy); and
Japan Abenomics using QE stimulus (easing monetary
policy).
 MAS Singapore Central bank
68

Who We Are
MAS is the central bank of Singapore. Our mission is to promote
sustained non-inflationary (real) economic growth and a sound and
progressive financial centre.

MAS' Functions

To act as the central bank of Singapore, including the conduct of

monetary policy, the issuance of currency, the oversight of payment
systems and serving as banker to and financial agent of the Government;

To conduct integrated supervision of financial services and financial

stability surveillance;

To manage the official foreign reserves of Singapore;

 MAS - Singapore Central bank
69

To develop Singapore as an International

Financial Centre; and

Singapore was recently ranked as the fourth

leading International Financial Centre after HK, US
and UK.
 2. Bank Supervision: Restrictions on Entry and
Bank Examination
70

Bank supervision, also referred to as prudential

supervision

oversees those who operate banks and how the banks

are operated; and

helps to reduce moral hazard and adverse selection in

the banking industry through restrictions on entry and
bank examinations.

Chartering and licensing banks are two ways to prevent

undesirable firms from entering into the banking sector,
adopted respectively in the USA and UK.
 Bank Supervision in USA
71

In the USA, to operate as a commercial bank, a firm must

obtain a national or state charter, granted by either the
Comptroller of the Currency or by a state authority.

To obtain a charter, the potential bankers have to submit an

application containing the operational plan of the bank.

The regulatory authority then evaluates the soundness of

the application (quality of the intended management, level
of estimated future earnings, initial capital).
 Bank Supervision in Europe
72

In the UK, any firm seeking recognised bank status from the
Bank of England must offer a broad range of services
(including deposit accounts, overdraft and loan facilities). A
banking licence will only be issued to a firm that is well
capitalised (paid-up capital and reserves of at least 5
million), has an adequate system of liquidity, internal control
and a good quality of management.

The EU Second Banking Coordination Directive permits banks

operating in other EU countries to set up branches throughout
the EU on the basis of the authorisation provided by their
own home supervision authority.
 Bank Supervision in Singapore
73

Bank Licensing Admission Criteria

MAS' admission criteria will apply across the board to traditional banks
and banks engaging in new business models such as Internet and mobile
banking. In assessing an application for banking licence or to operate as a
merchant bank, MAS takes into consideration the following factors:

The track record, international standing, reputation and financial

soundness of the applicant and its parent institution or major shareholders.
This includes an assessment of the ability of the applicant and its parent
institution in meeting international capital requirements in accordance with
the Basel Capital Adequacy Framework. Ranking of the applicant and its
parent institution in the world and home country in terms of total assets
and capital strength will also be taken into consideration;
 Bank Supervision in Singapore
74

Bank Licensing Admission Criteria

The strength of the home country supervision and the willingness and
ability of the home supervisory authority to cooperate with MAS. This
includes the supervision of the applicant and its parent institution by the
home country supervisory authority on a consolidated basis in accordance
with the principles in the Basel Accord. The applicant must also have
received consent from its home country supervisory authority for the
establishment of a banking operation in Singapore;

Whether the applicant has a well-developed strategy in banking or

financial services, supported by business plans which include a detailed
assessment of the continued economic viability of the business; and

Whether the applicant has in place risk management systems and

processes commensurate with the size and complexity of its business.
 Singapore Banks Regulatory, Prudential Framework
Strong: Fitch (Business Times 30 August 2014)
75

Singapores Central Bank, the Monetary Authority of Singapore

(MAS) continues to be proactive in its oversight of the banking
sector;
Local regulatory standards conform with Global best practices;
Singapore banks have maintained high capitalisation under
MASs Basel 3 capital rules at 2% above those prescribed by
the Basel Committee;
By January 2019, DBS, OCBC and UOB will need to meet a
minimum Core Tier 1 capital adequacy ratio (CAR) of 9%, Tier 1
CAR of 10.5% and Total CAR of 12.5%;
The three local banks have met these requirements as at 30 June
2014;
 Singapore Banks Regulatory, Prudential Framework
Strong: Fitch (Business Times 30 August 2014)
76

DBS, OCBC and UOB funding positions are also sound,

underpinned by their stable local deposit franchises. This has
placed them in good stead to meet MASs new liquidity
coverage rules from January 2015;
Due to the high property lending exposure of local banks,
Fitch expects MAS to maintain a close watch over this
segment; and
Macro-prudential cooling measures have been introduced
since 2009, such as the TDSR and ABSD, to curb rising housing
loans and property exposure, which were driven by low
interest rates and rising household wealth.
 Bank Examination
77

Banks regulatory agencies are responsible for ensuring

that authorised banks continue to operate in a prudent
manner (so-called prudential supervision) by carrying out
bank examinations.

An internationally recognised framework used by bank

examiners to evaluate banks is the CAMELS system.
Banks are scored on a scale of 1 (the best) to 5 (the worst),
assessing six areas:

Capital adequacy;
Asset quality;
 Bank Examination
78

Management quality;
Earnings performance;

Liquidity; and

Sensitivity to market risk.

Regulators can take formal actions to alter a banks

behaviour (or even close the bank) if the CAMELS rating is
sufficiently bad.