Financial Conglomerates, What are the Inherent Risks?

1. Financial Conglomerates,What are the Inherent Risks? 2006 CIAB Conference Port-of-Spain, Trinidad & Tobago November 16, 2006 Thordur Olafsson, CARTAC

2. Content of the Presentation • Definitions • Main Systemic Risks • Risk Management • LCFIs – Nordea Group • Supervision of the Financial Sector in the Nordic Countries • Supervisory Cooperation – MoUs their coverage and responsibilities of regulators • Other relevant issues for consideration • Latin- and Central America regulatory arrangements • The Caribbean • Conclusion

3. Definition of Financial Conglomerate • Financial Institution which is engaged in at least two of the following activities: banking, insurance and securities. • Domestic = cross-sectoral • International/Regional= cross-sectoral and cross-border

4. Definition of Financial Conglomerate • A Large Complex Financial Institution (LCFI) is a cross-border financial institution, which is also cross-sectoral, engaged in at least two of the following activities: banking, insurance, and securities transactions with the potential to threaten regional or global financial stability owing to their size in more than one jurisdiction.

5. Main Systemic Risks • Concentration and cross-sectoral credit~market~liquidity~and technical (insurance) risks arising from interbank and other funding • Securities, OTC derivatives, and other market activities • Credit~market~and insurance risk-sharing between LCFIs

6. Main Systemic Risks • Large settlement and payment systems exposures • Enforceability of contracts (legal issues) • Poor transparency • Market distortion and transaction arbitrage

7. Main Systemic Risks • Differences in prudential regulations, monetary policy, market distortions, and arbitrage encouraged by differences in home and host country taxation regimes • The heavy emphasis on cross-border financial activity raises issues for regulators responsible for supervision these

8. Risk Management • BCP 7 – Risk management process: Supervisors must be satisfied that banks and banking groups have in place a comprehensive risk management process (including Board and senior management oversight) to identify, evaluate, monitor and control or mitigate all material risks and to assess their overall capital adequacy in relation to their risk profile. These processes should be commensurate with the size and complexity of the institution.

9. Risk Management • CP 7 - Additional criteria 1. The supervisor requires larger and more complex banks to have a dedicated unit(s) responsible for risk evaluation, monitoring, and control or mitigation for material risk areas. The supervisor confirms that this unit (these units) is (are) subject to periodic review by the internal audit function.

10. LCFI – Nordea Group • Leading financial services group in the Nordic and Baltic Sea region • Retail banking, corporate and institutional banking, and asset management & life • Significant position in Nordic banking markets • Significant share of assets in Nordic insurance market

11. LCFI – Nordea Group • Largest customer base of any financial group in the region • Leading asset manager in the Nordic financial market • Most comprehensive distribution network in the region

12. Supervision of the Financial Sector in the Nordic Countries • Supervisory authorities in the Nordic countries have a long-standing cooperation which has lasted for more than 80 years. • Considered to be in good order • Financial sector regulatory authorities are accountable to parliaments and governments • Highly developed bankruptcy and consumer protection

13. Supervision of the Financial Sector in the Nordic Countries • Efficient court system • Very low corruption • Accounting standards are compatible with IFRS (IAS) standards • Corporate governance highly developed • Single independent and autonomous authority

14. Supervisory Cooperation - MoUs • First general MoU 1989 – revised few times • Separate MoU on Nordea Group since 2000 and revised few times • ECB and EU national supervisory authorities signed MoU in March 2003 • In June 2003 a MoU between the Nordic central banks on “ Management of a financial crises in banks with cross-border establishments.”

15. MoU Coverage • Confidentiality and definitions related to each supervisory authority • Establishment of branches in any of the member countries • Cooperation within the Nordic supervisory • Cooperation on conducting on-site examinations region

16. Mou Coverage • Cooperation related to consolidated supervision and cross-border financial services • Cooperation related to establishing of affiliated companies • Dealing with crises • Technical issues (meetings etc.)

17. Responsibilities of Regulatory Bodies • Draw up joint (annual) supervision plan • Consolidated risk assessment of the group • Appropriate exchange of information on a continuous basis and especially on • Imminent crises • Preparation of contingency plan • Maintain key contacts • Regular exchange of supervisory staff

18. Responsibilities of Central Banks • ECB – National EU Authorities • Nordic Central Banks. • To assess the emergence of potential crises • To ensure appropriate flow of information • Coordinate policy actions • Create a crises management group

19. Other Relevant Issues for Consideration • Deposit insurance schemes • Lender of last resort (LOR) arrangements and emergency loans • Crises management • Regulators ~ central banks ~governments (Ministry of Finance) Financial stability monitoring

20. Latin- and Central America Regulatory Arrangements • Mainly vested with different sectoral agencies • Mostly conducted by governmental agencies, but is some cases central banks • Low level of cooperation among regulatory agencies cross-border and across sectors • Relevance and usefulness of MoU in place questionable • Generally not considered a priority in the operation of regulatory agencies

21. The Caribbean • Map out which are the financial conglomerates • Within a jurisdiction • In multiple jurisdictions • International • Regional

22. The Caribbean • What are the main risks for the region if a LCFI fails? • What is the level of supervisory cooperation? MoUs ? • Is there a contingency planning? LOR arrangements? MoUs between respective Central Banks? • Crises management ?

23. Conclusion • Growing trend in sector integration and cross-border establishments call for special supervisory attention • Need for close cooperation between sectoral supervisory agencies (central banks and ministries of finance) • Conduct of market players counts • Come up with an appropriate model to handle eventual regional financial crises • Nordic model is instructive

24. Conclusion Thank you