Advancement of banking supervision standard under prep
Director General of Supervision Department at Mongol Bank N.Batsaikhan gave an interview on the central bank’s latest operations.
Can you give an update on the execution of the International Monetary Fund (IMF)’s Extended Fund Facility (EFF) arrangement?
The Mongolian government decided to carry out IMF’s EFF for three years, passed the final approval on May 24, 2017. The fifth review under the EFF arrangement was held in August and was reviewed by the IMF’s Executive Board on October 31. An IMF staff team concluded that despite posting strong economic growth and significant over-performance on key fiscal targets, Mongolia still needs to take further actions to improve the economy through the program.
Under the EFF arrangement, Mongolia will receive a total financing package amounting to around 5.5 billion USD, of which, approximately 434.3 million USD will be provided by IMF. By the first half of this year, Mongolia received a financing of 184.5 million USD from IMF.
How will the asset quality review (AQR) impact the current banking system?
The recently completed the AQR concluded that the banking system’s aggregate capital adequacy shortfall was about 1.9 percent of GDP at the end of 2017, which is close to Mongol Bank’s forecast. As a result, Mongol Bank is supervising recapitalization plans, submitted by banks in January and September. Banks submitted their recapitalization plans through 2020 for a review.
In correlation with the AQR, banks made estimations on the year-end capital shortage and Mongol Bank has ordered them to raise capital to required level by the end of the year. As of September, five banks managed to increase their capital by 140 billion MNT. Some banks have also requested to increase their capital. Mongol Bank is currently examining whether their requests should be approved. We’ll be able to evaluate the execution of capital plans of banks at the end of the year.
Within the scope of the mediumterm strategy of banking supervision and monitoring, the minimum capital requirement for commercial banks will be raised by 50 billion MNT to 100 billion MNT on December 31, 2021. It could be understood that banks are increasing their capital in compliance with the decree by the president of Mongol Bank.
Following the AQR, every bank was given recommendation on ways to improve their credit risk policy, related regulation, procedures and guidelines. The implementation of these recommendations is being checked on the spot through a comprehensive inspection at banks.
What is the significance of capital to a bank?
Bank capital is an instrument for improving the bank’s credibility and reliability, securing money of customers, and repaying payments if the bank liquidates. An adequate amount of capital is the key to a sustainable and reliable banking and financial system. Having adequate amount of capital to absorb losses will prevent the bank from risks of insolvency.
Has the banking legal environment been reformed through the EFF arrangement?
The Banking Law, a vital banking regulation, was revised last in 2010. Under IMF’s EFF arrangement, Mongolia is striving to further develop and
improve its banking regulation and Mongol Bank’s operations based on international principles and standards.
At the start of 2018, the Banking Law was revised by Parliament. The new law sets much more detailed criteria applicable to founders, shareholders, board of directors and executive management. It also set higher restrictions on the relationship between banks and related parties. The amendment introduced new preventive measures to take if the bank breaches the Banking Law, regulations, procedures and decisions of Mongol Bank, or the bank is likely to do so, the bank does not satisfy the requirements of banking licenses, or the bank engages in unreliable, “irregular” or “abnormal” activities.
The Law on Maintaining Stability in the Banking Sector was enacted last summer. What kinds of positive impacts will this law bring to Mongolia?
First of all, I’d like to briefly explain why it was necessary to approve
this law. We started this interview with the AQR. The AQR assessed assets of banks and it evaluated that it’s essential for banks to create an asset risk fund if they haven’t already. An asset risk fund is established at a cost, which pushes banks to increase their capital. Following the AQR, Mongolia was faced with the need to define measures to re-capitalize banks with capital shortage, and approve related regulatory documents in order to maintain stability in the banking and financial sector, protect the rights of customers and depositors, and reduce risks of being burdened by large expenses of the state in the future.
The Law on Maintaining Stability in the Banking Sector is significant for reducing potential financial burden on banks caused by state expenses when they are unable to generate funds from the state or investors due to a capital shortage. This will ensure normal, profitable and stable operations of banks.
What measures are being taken to reduce non-performing loans?
2018 was a very important year for Mongolia's banking system. Through the AQR, we diagnosed the health of banks and determined future course of actions to take. We’re expecting bank assets to increase by the end of the year. Since Mongol Bank is shifting its supervisory principle from “execution-focused” to “risk-focused”, we believe that we can achieve and ensure financial stability.
Moreover, the Ministry of Finance, Financial Regulatory Commission and Deposit Insurance Corporation signed a strategy document to reduce nonperforming assets. Nonperforming loans increase risks as they reduce banks’ current assets, affect profitability, and bring direct negative impacts to the banking system’s liquidity. It’s also one of the key reasons to stop loan disbursement.
Bank nonperforming loans to total gross loans reached 5.1 percent as of September 30.
Under the EFF arrangement, we’re working to improve the legal environment by amending the Law on Arbitration, Bankruptcy Law, Company Law, Law on Property Assessment, General Law on Tax, and other legislation. We also hope to make changes in the legal environment for the sale of collateral in a non-judicial foreclosure.
Can you share some more changes we can expect in the banking system?
In accordance with a joint decree by Mongol Bank and the Ministry of Finance, financial statements are provided consistently with the banking accounting guidelines. The guideline was recently adjusted to meet international financial reporting standards (IFRS). Starting 2020, banks will adopt the IFRS 9 Financial Instruments, which includes requirements for recognition and measurement, impairment, derecognition and general hedge accounting. A financial instrument is a document representing a legal agreement involving any kind of monetary value between parties.
Will the capital requirement of banks be changed?
We’re now carrying out the Basel II Pillar 2 supervisory review process as part of the medium-term strategy of banking supervision and monitoring. Its first pillar – Pillar 1 – sets minimum capital requirement (addresses risks), while Pillar 2 provides regulatory response to Pillar 1 through a supervisory review. It also provides a framework for managing the other bank risks: systemic risk, pension risk, concentration risk, strategic risk, reputational risk, liquidity risk and legal risk.
In other words, banks will first get necessary tools to determine the minimum capital it needs for its credit, market and operational risks. Secondly, Mongol Bank will supervise internal policies and methodology of banks and evaluate their coordination, and if necessary, take regulatory action. Thirdly, banks will have to in addition to meeting their minimum capital requirements, fulfill other requirements. Next, if a bank’s capital falls below the minimum amount, it will be required to recapitalize and if it is unable to do so, regulatory measures will be taken.
With all of these works planned out, I believe that Mongol Bank will be able to work even closer with commercial banks and advance the supervisory level even higher. Being able to fully apply Basel II standard to the central bank’s supervisory system will increase Mongolia's credibility, attract more foreign investors, and create a favorable investment environment.
What kind of alterations will be made in terms of regulation and procedure for supervisory activities?
In connection to the said tasks, the regulation on categorizing assets, establishing an asset risk fund and expenditure will be enhanced based on effective practices of other countries. We’ll also amend the regulation on setting prudential ratios to banking operations and its monitoring. In existing regulation, discounts have been placed on the weight of credit risk of some sectors. This will be canceled consistently with international standards.
It’s necessary to include regulatory changes in banks’ recapitalization plans next year, while paying attention to other activities.
...It’s necessary to include regulatory changes in banks’ recapitalization plans next year, while paying attention to other activities...