SUPERVISION AND REGULATION OF MONETARY AND FINANCIAL SECTOR

The ﬁnancial market deals with the purchase and sale of money. It therefore involves obtaining money from those who have more than they need by attracting it either as: deposits through commercial banks; premiums through insurance companies; units or shares through Mutual Funds or shares or bonds through investment

The ﬁnancial market in Kenya can be said to have two major functions: it allocates money capital through identifying those with surplus funds, attracting the funds into a pool and then distributing them to those who need to spend more than they have.

The other function of the ﬁnancial market is the distribution of the economic risk through the creation and distribution of securities. Entrepreneurs with no money to back up their ideas may be allowed to donate their labour and ideas to those who have capital but no ideas. Principally, ﬁnancial market in Kenya comprise commercial banks, nonbank ﬁnancial institutions, mortgage companies, forex bureaus, development ﬁnance institutions, pension schemes, the insurance sector and the stock market.

This paper examines the rationale or objectives of ﬁnancial market regulation in Kenya and the legal and institutional framework. The study then looks at rea-sons advanced for and against a single market regulator with a view of establishing whether there is a need for a single uniﬁed regulator which can oversee the entire ﬁnancial services markets and further still whether a not so mature economy like Kenya’s is ripe for a single regulator.

Objectives and Principles of Financial Market Regulation

Consumer protection is the main reason for regulation of any sector more so the ﬁnancial market, this is mainly because of the asymmetric distribution of information between borrowers and investors which for lack of appropriate institutional

precautions results in the problems of ’adverse selection’ and ’moral hazard’. Market regulation is also important in maintaining ﬁnancial stability for the good of the public, which can also be termed as safeguarding the safety and soundness of the ﬁnancial system. The regulator must also have adequate resources and funds to facilitate its activities such as recruiting, training and retaining of a cadre of experienced professional staff. In addition, the regulator requires resources for timely and effective data collection and processing. The regulator should also be given power necessary for the enforcement of its rules and regulations. Enforcement powers are best only setout broadly in legislation with regulations having powers to issue guidelines and directives. This allows ﬂexibility and reduces the need for frequent cumber some and time consuming legislative amendments. Staff of regulators should be protected from legal actions arising from their enforcement actions.

Regulation should also be cost effective and comprehensive meaning it should not leave unregulated areas otherwise known as regulatory gaps. It should also mirror the different ﬁnancial sectors being regulated. This paper will now delve into ﬁnancial market regulation in Kenya in trying to establish who is responsible forstipulating regulations, how they are drafted and who monitors compliance.

Current Financial Market Regulatory Structure in Kenya. The current system of regulation in Kenya is institutional and this paper evaluates reasons for and against moving towards a single super regulator. In the current structure, the ﬁrm’s legal status (bank, broker or insurance company) determines which regulator is responsible for supervising its activities. There are four key agencies and regimes for prudential regulation: Central Bank of Kenya (CBK) for banks and payments settlement; Insurance Regulatory Authority (IRA) for insurance; the Capital Markets Authority (CMA) for capital markets and the Retirement Beneﬁts Authority (RBA) for pensions. The chief regulator is however considered to be the Ministry of Finance.

Central Bank of Kenya

The Central Bank of Kenya is at the apex of the ﬁnancial market and it is established under Article 231 of the new Constitution. The Constitution does not expressly state the regulating function of the Central Bank but under sub-article 2 it is prescribed that an Act of Parliament shall provide for other functions conferred on the Bank.

The Central Bank of Kenya Act Cap 491 Laws of Kenya is such kind of an Act and it also establishes the Bank under section 3. Section 4A(1) of the Act then provides that the Central Bank of Kenya shall license and supervise authorized dealers and also formulate and implement such policies as best promote the establishment, regulation and supervision of efﬁcient and effective payment, clearing and settlement systems. These two functions clarify the regulatory functions of the bank.

The Central Bank of Kenya oversees the robust and systemic supervision of commercial banks, non bank ﬁnancial institutions, mortgage companies, forex bureaus, building societies and micro ﬁnance institutions. The Central Bank supervises commercial banks through ensuring the enforcement of the Banking Act regulations, for instance banks are not allowed to grant a loan to an individual borrower in excess of 25% of the capital to avoid over exposure. The Central Bank supervises several activities in commercial banks including interest rates, information and reporting requirements, inspection and control of the institution inter alia. The Central Bank of Kenya also launched the revised Forex Bureau Guidelines 2011 on 18 March 2011. These guidelines were revised in consultation with the stakeholders of the forex bureaus sub-sector.

Insurance Regulatory Authority

The Insurance Regulatory Authority (IRA) was established in 2006 as a governmental agency tasked with the regulation, supervision and development of the insurance industry in Kenya. The body is also mandated to assist in the administration of the Insurance Act Cap 487 Laws of Kenya. IRA also provides advice to the government on insurance policy issues. The Authority is in charge of supervision of insurance companies, insurance brokers, and agents, assessors and adjustors and health management organisations (HMOs).

Capital Markets Authority

The Capital Markets Authority (CMA) was established in December 1989 under the Capital Markets Authority Act, renamed the Capital Markets Act in 2000 after amendments. The CMA is responsible for the licensing, regulation and supervision of all capital markets participants. The CMA also disseminates rules and regulations within its jurisdiction, and is empowered to carry out enforcement and sanctions. All companies that issue securities are regulated under the Capital Markets Act, the Companies Act, and the CMA’s regulations. According to the 2004 World Bank Project Appraisal Document, the CMA lacks sufﬁcient capacity and operational independence. The CMA is mandated to supervise securities exchanges, fund managers, Central Depository Systems, custodians, investment banks, collective investment schemes, investment advisers, stock brokers, securities dealers, listed companies, credit rating agencies and venture capital ﬁrms.

Retirement Beneﬁts Authority

The objects and functions of the Authority are established under section 5 of the

Act as follows:

regulate and supervise the establishment and management of retirement beneﬁts schemes;

protect the interests of members and sponsors of retirement beneﬁts sector;
promote the development of the retirement beneﬁts sector;
advise the Minister on the national policy to be followed with regard to retirement beneﬁts schemes
to implement all Government policies relating thereto and any other functions as are conferred on it by any legislation.

The Authority regulates retirement beneﬁt schemes, pooled schemes, the National

Social Security Fund (NSSF), administrators, fund managers and custodians.

These four institutions are the major regulators of the ﬁnancial market in Kenya and there are ﬁnancial sectors that are regulated by more than one institution. For instance, fund managers; custodians and CIS pooled funds (collective investment schemes) are regulated by the Capital Markets Authority and the Retirement Beneﬁts Authority .

Fund managers and listed insurance companies are regulated by the Insurance Regulatory Authority and the Capital Markets Authority, while brokers- administrators and insurance company administrators are regulated by the RBA and IRA. Custodians, listed banks and investment banks are then regulated by the Central Bank of Kenya and the Capital Markets Authority while custodians are supervised both by the RBA and the Central Bank. Banc assurance and premium ﬁnancing is regulated by the Central Bank and the Insurance Regulatory Authority.

There are is a regulatory gap in that there are some sectors that do not fallunder any regulatory jurisdiction:

The ﬁrst is the Savings and Credit Cooperative Societies (SACCOs). The SACCO system is a mutual membership organization which involves pooling of voluntary savings from members in the form of shares and lending to other members. SACCOs operate under the Co-operatives Societies Act which gives the Commissioner and Registrar of Cooperative Societies regulatory and supervisory powers over SACCOs. However, the Cooperative Societies Act has been considered inadequate to regulate these societies.

The Kenya Post Ofﬁce Savings Bank is yet another area where there is a regulatory gap in Kenya’s ﬁnancial market. The Kenya Post Ofﬁce Savings Bank (KPOSB) was incorporated in 1978 under the KPOSB Act Cap 493B Laws of Kenya. The mission of the bank is “to sustainably provide savings and other ﬁnancial services to our customers, through a countrywide branch network, by use of modern technology in delivery of efﬁcient and effective customer service, and to the satisfaction of all stakeholders.

Other areas where there is a regulatory gap are the premium ﬁnance companies, development ﬁnance institutions (DFIs), the M-Pesa and other mobile banking services, among many other developing ﬁnancial services.

Regulators

Market Developments

If the regulators entities are conglomerates covering banking, insurance, securities and pension then it is difﬁcult for a regulator for a particular sub-sector to draw a view of the overall threats facing the entity. A super regulator on the other hand would be able to understand and monitor risks across the sub sectors and develop policies to address the risks facing the entire conglomerate. Fragmented regulatory bodies would normally be unable to form an overall risk assessment of a ﬁnancial conglomerate on a consolidated basis. Consequently, an integrated or semi-integrated regulatory system in which banking, securities, pension and insurance regulation is co-ordinated is a preferred model in addressing these challenges.

Even if the institutions are not in themselves conglomerates, the products they are offering may defy conventional categorization. For example, In Kenya many insurance products carry investment components which are larger than the risk components. It can therefore be argued that these products are closer to deposit taking or collective investment schemes than they are to insurance. In the developed world many traditional debt products such as mortgages, credit cards and loans have been securitized and are traded in the capital market. Indeed, the global ﬁnancial crisis

in 2007 and 2008 arose from securitized mortgages known as Collateralized Debt Obligations (CDOs). Even though the underlying instrument is a mortgage issued by a mortgage lender, the resulting CDO that bundles mortgages, often with different risks, is a security primarily held by players in the capital markets.

Accountability

Uniﬁed supervision improves the accountability of regulation. Under a system of multiple regulatory agencies, it may be more difﬁcult to hold regulators to account for their performance against their statutory objectives, for the costs of regulation, for their disciplinary policies, and for regulatory failures. Regulatory gaps often lead to regulators “washing their hands” of certain sub-sectors especially when things go wrong. Blame may be passed from one regulator to another when supervisory failure occurs.

Economies of scale and cost reduction

A single regulator could generate economies of scale as a larger organization allows ﬁner specialization of labour and a more intensive utilization of inputs and uniﬁcation may permit cost savings on the basis of shared infrastructure, administration, and support systems. Uniﬁcation may also permit the acquisition of information technologies, which become cost-effective only beyond a certain scale of operations and can avoid wasteful duplication of research and information-gathering ef- forts. Clearly a consolidated regulator will only have one set of service departments such as administration, ﬁnance and human resources hence reducing on staff and other overhead costs.

Central departments such as legal, research, and public awareness can be uniﬁed into a single department in the new super regulator leading to signiﬁcant cost savings. The commonality of knowledge required in regulating markets gives the single regulator the beneﬁt of economies of scale.

Reduction of regulatory arbitrage

The overlaps that result from having multiple regulators eventually lead to a situation referred to as regulatory arbitrage. In this case, the entities being regulated choose to register products in those sub-sectors where regulations are weakest or most cost efﬁcient. This allows for forum shopping since products are not easily categorized into conventional subsectors. A single regulator will therefore result in uniform standards can be applied to all subsectors hence eliminating the motivation for arbitrage. Uniﬁed supervision could also help achieve competitive neutrality, avoiding a situation where different regulators could set different regulations for the same activity for different players.

Flexibility

The uniﬁed approach allows for the expansion of regulatory arrangements that are more elastic. Whereas the efﬁciency of a system of separate agencies can be slowed down by turf wars or a desire to ‘pass the buck’ or where respective enabling leg- islation leaves doubts about their jurisdiction, these problems can be more easily limited and controlled where there is a single regulator.

Information Sharing

Single regulators will have advantage in sharing information among various regulating division, which will help a lot in preventing fraud as well as in handling crisis. Multiple regulators have problem in sharing information on time.

Foreign Exchange market

The foreign exchange market (forex, FX, or currency market) is a form of ex- change for the global decentralized trading of international currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies. The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the European Union member states especially Eurozone members and pay Euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies.

In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying some quantity of another currency. The modern foreign ex- change market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and ﬁnancial relations among the world’s major industrial states after World War II), when countries gradually switched to ﬂoating exchange rates from the previous exchange rate regime, whichremained ﬁxed as per the Bretton Woos system.

The foreign exchange market is unique because of the following characteristics:

Its huge trading volume representing the largest asset class in the world leading to high liquidity;
Its geographical dispersion;
The variety of factors that affect exchange rates;
The low margins of relative proﬁt compared with other markets of ﬁxed income; and The use of leverage to enhance proﬁt and loss margins and with respect to account size. As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks.

Market participants

Commercial companies

An important part of this market comes from the ﬁnancial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade ﬂows are an important factor in the long-term direction of a currency’s exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.

Central banks

National central banks play an important role in the foreign exchange markets. They try to control the money supply, inﬂation, and/or interest rates and often have official or unofﬁcial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank “stabilizing speculation” is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a proﬁt trading.

Foreign exchange ﬁxing

Foreign exchange ﬁxing is the daily monetary exchange rate ﬁxed by the national bank of each country. The idea is that central banks use the ﬁxing time and exchange rate to evaluate behavior of their currency. Fixing exchange rates reﬂects the real value of equilibrium in the market. Banks, dealers and traders use ﬁxing rates as a trend indicator. The mere expectation or rumor of a central bank foreign exchange intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty ﬂoat currency regime.

Hedge funds as speculators

About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds’ favor.

Investment management ﬁrms

Investment management ﬁrms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Some investment management ﬁrms also have more speculative specialist currency

overlay operations, which manage clients’ currency exposures with the aim of generating proﬁts as well as limiting risk. While the number of this type of specialist ﬁrms is quite small, many have a large value of assets under management) and, hence, can generate large trades.

Retail foreign exchange traders

Individual Retail speculative traders constitute a growing segment of this market with the advent of retail foreign exchange platforms, both in size and importance.

Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission and National Futures Association have in the past been subjected to periodic Foreign exchange fraud. To deal with the issue, in 2010 the NFA required its members that deal in the Forex markets to register as such (I.e., Forex CTA instead of a CTA). Those NFA members that would traditionally be subject to minimum net capital requirements, FCMs and IBs, are subject to greater minimum net capital requirements if they deal in Forex. A number of the foreign exchange brokers operate from the UK under Financial Services Authority regulations where foreign exchange trading using margin is part of the wider over-the-counter derivatives trading industry that includes Contract for differences and ﬁnancial spread betting.

There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or mark-up in addition to the price obtained in the market. Dealers or market makers, by contrast, typically act as principal in the transaction versus there tail customer, and quote a price they are willing to deal at.

Non-bank foreign exchange companies

Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account). If the exchange decides to replace an existing constituent with another stock then the sum of market value of constituent stocks get changed. So they adjust the base price to nullify that effect.

Basel principle in banking regulation

The Core Principles are a framework of minimum standards for sound supervisory practices and are considered universally applicable. The Committee issued the Core Principles as its contribution to strengthening the global ﬁnancial system.

Weaknesses in the banking system of a country, whether developing or developed, can threaten ﬁnancial stability both within that country and internationally.

The Committee believes that implementation of the Core Principles by all countries would be a signiﬁcant step towards improving ﬁnancial stability domestically and internationally, and provide a good basis for further development of effective supervisory systems. The vast majority of countries has endorsed the Core Principles and has implemented them

The Core Principles are conceived as a voluntary framework of minimum standards for sound supervisory practices. National authorities are free to put in place supplementary measures that they deem necessary to achieve effective supervision in their jurisdictions. The revised Core Principles deﬁne 29 principles that are needed for a supervisory system to be effective. Those principles are broadly categorized into two groups: the ﬁrst group Principles 1 to 13) focus on powers, responsibilities and functions of supervisors, while the second group (Principles 14 to 29) focus on prudential regulations and requirements for banks. The original Principle 1 has been divided into three separate Principles, while new Principles related to corporate governance, and disclosure and transparency have been added. This accounts for the increase from 25 to 29 Principles.

The 29 Core Principles are:

Principle 1 – Responsibilities, objectives and powers: An effective system of banking supervision has clear responsibilities and objectives for each authority involved in the supervision of banks and banking groups. A suitable legal framework for banking supervision is in place to provide each responsible authority with the necessary legal powers to authorize banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns.

Principle 2 – Independence, accountability, resourcing and legal protection for supervisors: The supervisor possesses operational independence, trans-parent processes, sound governance and adequate resources, and is account- able for the discharge of its duties. The legal framework for banking supervision includes legal protection for the supervisor.
Principle 3 – Cooperation and collaboration: Laws, regulations or other arrangements provide a framework for cooperation and collaboration with relevant domestic authorities and foreign supervisors. These arrangements reﬂect the need to protect conﬁdential information.

Principle 4 – Permissible activities: The permissible activities of institutions that are licensed and subject to supervision as banks are clearly deﬁned and the use of the word “bank” in names is controlled.

Principle 5 – Licensing criteria: The licensing authority has the power to set criteria and reject applications for establishments that do not meet the criteria.

At a minimum, the licensing process consists of an assessment of the ownership structure and governance (including the ﬁtness and propriety of Board members and senior management) of the bank and its wider group, and its strategic and operating plan, internal controls, risk management and projected ﬁnancial condition including capital base. Where the proposed owner or parent organization is a foreign bank, the prior consent of its home supervisor is obtained.

Principle 6 – Transfer of signiﬁcant ownership: The supervisor has the power to review, reject and impose prudential conditions on any proposals to transfer signiﬁcant ownership or controlling interests held directly or indirectly in existing banks to other parties.

Principle 7 – Major acquisitions: The supervisor has the power to approve or reject or recommend to the responsible authority the approval or rejection of and impose prudential conditions on, major acquisitions or investments by a bank, against prescribed criteria, including the establishment of cross-border operations, and to determine that corporate afﬁliations or structures do not expose the bank to undue risks or hinder effective supervision.

Principle 8 – Supervisory approach: An effective system of banking supervision requires the supervisor to develop and maintain a forward-looking assessment of the ﬁnal version of this document was published in September Core Principles for Effective Banking Supervision The risk proﬁle of individual banks and banking groups, proportionate to their systemic importance; identify, assess and address risks emanating from banks and the banking system as a whole; have a framework in place for early intervention; and have plans in place, in partnership with other relevant authorities, to take action to resolve banks in an orderly manner if they become non-viable.

Principle 9 – Supervisory techniques and tools: The supervisor uses an appropriate range of techniques and tools to implement the supervisory approach and deploys supervisory resources on a proportionate basis, taking into ac- count the risk proﬁle and systemic importance of banks.

Principle 10 – Supervisory reporting: The supervisor collects reviews and analyses prudential reports and statistical returns from banks on both a solo and a consolidated basis, and independently veriﬁes these reports, through either on-site examinations or use of external experts.

Principle 11 – Corrective and sanctioning powers of supervisors: The supervisor acts at an early stage to address unsafe and unsound practices or activities that could pose risks to banks or to the banking system. The supervisor has at its disposal an adequate range of supervisory tools to bring about timely corrective actions. This includes the ability to revoke the banking license or to recommend its revocation.

Principle 12 – Consolidated supervision: An essential element of banking supervision is that the supervisor supervises the banking group on a consolidated basis, adequately monitoring and, as appropriate, applying pruden tial standards to all aspects of the business conducted by the banking group worldwide.

Principle 13 – Home-host relationships: Home and host supervisors of cross border banking groups share information and cooperate for effective supervision of the group and group entities, and effective handling of crisis situations. Supervisors require the local operations of foreign banks to be conducted to the same standards as those required of domestic banks. Prudential regulations and requirements

Principle 14 – Corporate governance: The supervisor determines that banks and banking groups have robust corporate governance policies and processes covering, for example, strategic direction, group and organizational structure, control environment, responsibilities of the banks’ Boards and senior management, and compensation. These policies and processes are commensurate with the risk proﬁle and systemic importance of the bank.

Principle 15 – Risk management process: The supervisor determines that banks have a comprehensive risk management process (including effective Board and senior management oversight) to identify, measure, evaluate, monitor, report and control or mitigate all material risks on a timely basis and to assess the adequacy of their capital and liquidity in relation to their risk proﬁle and market and macroeconomic conditions. This extends to development and review of robust and credible recovery plans, which take into account the speciﬁc circumstances of the bank. The risk management process is commensurate with the risk proﬁle and systemic importance of the bank.

Principle 16 – Capital adequacy: The supervisor sets prudent and appropriate capital adequacy requirements for banks that reﬂect the risks undertaken by, and presented by, a bank in the context of the markets and macroeconomic conditions in which it operates. The supervisor deﬁnes the components of capital, bearing in mind their ability to absorb losses. The ﬁnal version of this document was published in September 2012.

Principle 17 – Credit risk: The supervisor determines that banks have an adequate credit risk management process that takes into account their risk ap- petite, risk proﬁle and market and macroeconomic conditions. This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate credit risk (including counterparty credit risk) on a timely basis. The full credit lifecycle should be covered including credit un- derwriting, credit evaluation, and the ongoing management of the bank’s loan and investment portfolios.

Principle 18 – Problem assets, provisions and reserves: The supervisor determines that banks have adequate policies and processes for the early identiﬁcation and management of problem assets, and the maintenance of adequate provisions and reserves.

Principle 19 – Concentration risk and large exposure limits: The supervisors determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate concentrations of risk on a timely basis. Supervisors set prudential limits to restrict bank exposures to single counterparties or groups of connected counterparties.

Principle 20 – Transactions with related parties: In order to prevent abuses arising in transactions with related parties and to address the risk of conﬂict of interest, the supervisor requires banks to enter into any transactions with related parties on an arm’s length basis; to monitor these transactions; to take appropriate steps to control or mitigate the risks; and to write off exposures to related parties in accordance with standard policies and processes.

Principle 21 – Country and transfer risks: The supervisor determines that banks have adequate policies and processes to identify, measure, evaluate, monitor, report and control or mitigate country risk and transfer risk in their international lending and investment activities on a timely basis

Principle 22 – Market risks: The supervisor determines that banks have an adequate market risk management process that takes into account their risk appetite, risk proﬁle, and market and macroeconomic conditions and the risk of a signiﬁcant deterioration in market liquidity. This includes prudent policies and processes to identify measure, evaluate, monitor, report and control or mitigate market risks on a timely basis.

Principle 23 – Interest rate risk in the banking book: The supervisor determines that banks have adequate systems to identify, measure, evaluate, monitor, report and control or mitigate interest rate risk in the banking book on a timely basis. These systems take into account the bank’s risk appetite, risk proﬁle and market and macroeconomic conditions.

Principle 24 – Liquidity risk: The supervisor sets prudent and appropriate liquidity requirements which can include either quantitative or qualitative requirements or both for banks that reﬂect the liquidity needs of the bank.

The supervisor determines that banks have a strategy that enables prudent management of liquidity risk and compliance with liquidity requirements. The strategy takes into account the bank’s risk proﬁle as well as market and macroeconomic conditions and includes prudent policies and processes, consistent with the bank’s risk appetite, to identify, measure, evaluate, monitor, report and control or mitigate liquidity risk over an appropriate set of time horizons.

Principle 25 – Operational risk: The supervisor determines that banks have an adequate operational risk management framework that takes into account their risk appetite, risk proﬁle and market and macroeconomic conditions. This includes prudent policies and processes to identify, assess, evaluate, monitor report and control or mitigate operational risk on a timely basis.

Principle 26 – Internal control and audit: The supervisor determines that banks have adequate internal controls to establish and maintain a properly controlled operating environment for the conduct of their business taking into account their risk proﬁle. These include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding the bank’s assets; and appropriate independent internal audit and compliance functions to test adherence to these controls as well as applicable laws and regulations.

Principle 27: Financial reporting and external audit: The supervisor determines that banks and banking groups maintain adequate and reliable records, prepare ﬁnancial statements in accordance with accounting policies and practices that are widely accepted internationally and annually publish information that fairly reﬂects their ﬁnancial condition and performance and bears an independent external auditor’s opinion. The supervisor also determines that banks and parent companies of banking groups have adequate governance and oversight of the external audit function.

Principle 28 – Disclosure and transparency: The supervisor determines that banks and banking groups regularly publish information on a consolidated and, where appropriate, solo basis that is easily accessible and fairly reﬂects their ﬁnancial condition, performance, risk exposures, risk management strategies and corporate governance policies and processes.

Principle 29 – Abuse of ﬁnancial services: The supervisor determines that banks have adequate policies and processes, including strict customer due diligence rules to promote high ethical and professional standards in the ﬁ nancial sector and prevent the bank from being used, intentionally or unintentionally, for criminal activities.

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Written by MJ