Enacted Summary
In 2001, the IMF and the World Bank assessed the Czech Republic's compliance with the Basel Core Principles (BCPs) for Effective Banking Supervision and found it to be either compliant or largely compliant with several of the BCPs. However, some BCPs were assigned a materially non-compliant rating. For example, Principle 1.2 and 1.4 relating to the independence and the enforcement powers of the supervisor respectively were found to be materially non-compliant. A 2003 self-assessment by the Czech National Bank (CNB), the central bank/banking supervisor, against the BCPs revealed improvements in the overall compliance and concluded that the Czech Republic is either compliant or largely compliant with all the BCPs. Moreover, a 2004 IMF Update to the 2001 assessment attested to improvements in the legal and regulatory framework for banking supervision in the Czech Republic, citing further amendments to the Act on Banks, further consolidation of the CNB's supervisory authority with improved inspection and enforcement powers, and new rules on comprehensive risk management structures in banks. In 2006, the CNB became the unified financial sector supervisor, taking over the supervision of the capital markets, insurance and pension funds, and credit unions, as well as banks. Finally, the CNB, as part of its mission, is committed to the implementation of “internationally recognized standards in the field of financial market regulation and supervision.”
General Overview
A joint International Monetary Fund/World Bank (IMF/WB) team in 2001 conducted a Financial System Stability Assessment (FSSA) on the Czech Republic that included a detailed assessment of the country's compliance with the Basel Core Principles (BCPs) for Effective Banking Supervision. The FSSA found the Czech Republic to be compliant/largely compliant with 20 of the 25 BCPs. As later summarized in a 2004 FSSA Update, the 2001 assessment noted that the Czech National Bank (CNB), "exhibited a high understanding of best international supervisory standards, policies and practices" (p. 2) and "the Czech authorities placed high priority on implementing and observing the international standards relevant for financial stability" (p. 2). The motivating factor was the prospect of European Union (EU) accession and the inclination to harmonize Czech regulatory framework with EU laws. (The Czech Republic acceded to the EU was in 2004) The 2001 assessment found the Czech Republic deficient in terms of laws governing debtor-creditor relations. It also cited an inefficient judicial system, time-consuming administrative bottlenecks, and ineffective risk management systems. Together, these deficiencies have resulted in weak supervision and enforcement by the CNB. The report called for amendments to the legal structure, an increase in supervisory capacity, a move towards risk-based consolidated supervision, and greater supervisory cooperation and coordination.
In 2002, the IMF issued a Report on the Observance of Standards and Codes (ROSC) on, inter alia, banking supervision in the Czech Republic. This update to the 2001 assessment found that improvements in the overall supervisory framework were fuelled by significant amendments to two key laws governing banking sector supervision, the 1991 Act on Banks (henceforth referred to as the AoB) and the 1992 Act on the Czech National Bank (henceforth referred to as the CNB Act). Per the 2002 ROSC, the progress made by the Czech Republic since the 2001 IMF/WB assessment are as follows: (1) full independence of the CNB was ensured; (2) risk-based and consolidated supervision was further strengthened; (3) fit and proper testing was made possible below the Board level; (4) capacity of the CNB to undertake market risk assessment was being enhanced; and (5) steps were being taken to fully harmonize Czech Accounting Standards (CAS) with international standards and European law. However, some notable deficiencies remained. They include: (1) no legal protection for supervisors in the discharge of their duties in good faith; (2) risk-based allocation of capital requirements for banks not permitted under the AoB; and (3) no improvements in the CNB's powers to take prompt corrective action.
The CNB published a self-assessment in 2003 of the implementation of the BCPs. According to this report, the Czech Republic is compliant with eight of the 30 BCPs (considering that BCP 1 is sub-divided into six sub-principles) and largely compliant with the remaining 22. The 2004 IMF’s Financial Stability Assessment Program (FSAP) Update attested to further improvements in the legal and regulatory framework for banking supervision in the Czech Republic with further amendments to the AoB, further consolidation of the CNB's supervisory authority with improved inspection and enforcement powers, and new rules on comprehensive risk management structures in banks. The 2004 IMF Update drew on the conclusions of the 2003 CNB self-assessment which, per a 2003 IMF report, "revealed improved overall compliance" (2003a). However, the 2004 IMF Update observed that the weaknesses in the legal and judicial systems continued, as did weaknesses in the corporate governance framework and the availability of transparent financial information from creditors.
The CNB website states that the 1992 CNB Act designates the CNB as the agency supervising the financial markets in the Czech Republic. As for the supervision of the banking sector, the CNB Act states that it involves ensuring "the sound operation and purposeful development of the banking system in the Czech Republic." In accordance with this purpose, the broad objective of supervision is "supporting the sound development, market discipline and competitiveness of banks, preventing systemic crises and strengthening public confidence in the banking system." In 2006, the Czech Republic moved to an integrated financial supervisory framework, with the passage of the Financial Market Supervision Integration Act in February 2006. Per the Act, in April of 2006, the CNB took over the powers and responsibilities of the Czech Securities Commission (CSC), the Ministry of Finance's (MoF) Office for Supervision of Insurance and Supplementary Pension Insurance, and the Office for Supervision of Credit Unions. The latter three organizations were later eliminated. The CNB now supervises not only the banking sector, but also the securities sector, the insurance and pensions sector, and the credit unions. The CNB also performs foreign exchange supervision and the supervision of electronic money institutions. As stated in the 2006 Financial Market Supervision report of the CNB, "the integration of all supervisory authorities into the CNB has paved the way for better use of synergies in the supervision of the individual financial market segments, greater harmonization of regulatory rules and supervisory procedures, and lower supervision costs" (p. 9). The CNB's authority involves regulations, inspections, and enforcement of financial sector laws and regulations. Per the CNB website, the 1991 AoB, as amended, governs banking activities in the Czech Republic. The AoB authorizes the CNB to issue regulations, called provisions and decrees, covering bank licensing and prudential rules governing their ongoing activities.
The 2008 IMF Article IV Consultation report, gives a general overview of the banking sector performance in recent years. According to the report, the Czech Republic’s banking sector is relatively liquid compared to some European countries during the financial crisis, and banks have been profitable because of the significant growth of net income that has been influenced by consumer and mortgage lending. The 2008 IMF Article IV report, however underscores rising risks to the Czech Republic’s financial sector that illustrate the effects of the global financial crisis, among which include the increase in liquidity risk particularly at smaller banks due to their dependence on foreign parent banks. This has resulted in the close scrutiny of foreign bank ownership because any “sharp entrenchment of funds could have a significantly negative impact on financial intermediation and economic activity” (p. 14). Given its integration with the rest of Europe and the predominance of foreign bank ownership, the Czech Republic’s financial sector per the 2008 IMF Article IV report, is increasingly under intense pressure from strong spillover effects from the global crisis, which is posing a challenge for risk mitigation and weighing on the outlook for the financial sector. Per the Article IV report, the CNB “has supervisory tools in place to preserve the continuity of access to key banking functions in systematically important banks” (p. 16); and recommends that measures taken be regularly enhanced and supervisory response be prompt, in areas where discretion is required. To ensure that banks remain well-capitalized, the modalities for Pillar II’s (Basel II) application are being recommended to be put in place as soon as possible. Regarding supervisory structure and cooperation, the 2008 IMF report states that the CNB and the MoF have an established domestic crisis management arrangement, but suggests that other similar arrangements can be arranged with the private sector. Touching on the Czech Republic’s cross-border links, the 2008 Article IV report mentions that proactive collaboration with financial authorities and governments in home countries was essential because of its role as a major host country to subsidiaries of Western European banks.
The Czech Republic’s banking sector has come out in the global financial crisis as one of Europe’s strongest because of its relatively low customer loans to customer deposits, according to the 2009 US Department of Commerce Country Commercial Guide report on doing business in the Czech Republic. The report states that the Czech Republic has 38 operating banks, with a primary focus on classic retail banking. The report however notes that the banking sector is dominated by a few European banks that include Ceskoslovenska obchodni banka (CSOB), Krediet Bank Company (KBC, Belgium), Ceska Sporitelna (CS) and Italy’s UniCredit Bank. According to the 2008 Financial Markets report, in September 2008, the Czech Republic amended Decree No. 123/2007 Coll., which incorporates the Basel II framework, with Decree No. 282/2008 Coll. Also the Act on Certain Measures Against Money Laundering and Terrorist Financing No. 253/2008 Coll. (accompanying Amendment No. 254/2008) were promulgated on 8 July 2008.
The Principles
CP1. (1) Clear responsibilities and objectives for each supervisory agency.
Per the CNB website, the CNB’s objective is to direct the activities of supervised entities in the banking sector to prevent risks that will likely harm the interests of banking clients and threaten the bank sector’s stability. The CNB’S responsibilities are laid out in the CNB Act and the Act on Banks. According to the 2001 IMF/WB assessment, the Czech Republic was largely compliant with this principle. Subsequently, however, a 2003 CNB self-assessment found the Czech Republic to be compliant with this principle. The 2003 CNB report noted that the legal framework of the banking sector is "practically fully harmonized with the law of the European Community" (p . 5). The 2001 IMF/WB assessment indicated that the CNB Act and the AoB defined the responsibilities and objectives of the CNB as the agency responsible for banking supervision in the Czech Republic. However, the report suggested more clarity in the definition of the CNB's supervisory objectives as well as the introduction of a formal system of supervisory performance appraisal that could be made publicly accessible. The 2001 IMF report also recommended the removal of barriers and administrative ambiguities that hinder the prompt handling of problem banks. Further, the report advised strengthening and disclosing publicly the coordination mechanism between the CNB, the MoF, and the CSC.
EN1.(2) Operational independence and adequate resources.
The CNB website states that while the CBN is the supervisory authority for the financial and insurance sectors, the authority is not “entitled to interfere in a bank’s commercial decision-making and management; this is the exclusive preserve of its managers and supervisory board.” According to the 2001 IMF/WB assessment, the Czech Republic was materially non-compliant with this principle. However, the 2003 CNB self-assessment noted that the Czech Republic was largely compliant with this principle. The report noted that the CNB's operational, financial, and personal independence in all areas, including banking supervision, was guaranteed by the CNB Act and corresponded with the stipulations of the EC laws . The IMF/WB noted that although the CNB Act sets out the operational independence of the CNB in supervisory matters, amendments to the CNB Act could adversely affect the CNB's financial autonomy and its ability to hire and retain competent supervisors. The report recommended that the CNB be given full financial independence, in order to ensure effective supervision and the capability to monitor entities in the rapidly changing environment where complex financial institutions operate. A 2002 IMF ROSC noted that the two amendments to the CNB Act, effective January and May 2002, "aim[ed] at fully harmonizing the law with European law and the statutes of the European Central Bank (ECB), ensuring the full independence of the Czech National Bank, including in terms of budgetary resources required for effective and timely supervision" (p. 2).
FC1.(3) A suitable legal framework for authorization and ongoing supervision.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was compliant with this principle. According to the 2001 IMF/WB report, the AoB granted licensing power to the CNB and the CNB exercised it in consultation with the MoF. The CNB Act and the AoB also charge the CNB with supervising the licensed entities, ensuring compliance with the rules and regulations as laid out in the license, issue regulations for prudential supervision, and oversee ongoing compliance with rules.
EN1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.
According to the 2001 IMF/WB assessment, the Czech Republic was materially non-compliant with this principle. Subsequently, however, a 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. The 2001 IMF report faulted the AoB for not clearly spelling out the scope of the CNB's supervisory powers, including its power to make qualitative judgments and to demand information from banks other than during on-site inspections. Remedial action was also hampered by the high burden of proof placed on supervisors. The 2003 self-assessment, however, noted that since the 2001 IMF/WB assessment, the CNB has been "authorized to use qualitative judgments that are based on a series of qualitative standards for banking enterprise that are included in the Czech National Bank provisions" (p. 14) and acting on this authorization.
NC1.(5) Legal protection for supervisors.
According to the 2001 IMF/WB assessment, the Czech Republic was materially non-compliant with this principle. In its 2003 self-assessment, however, the CNB noted that the Czech Republic was largely compliant with this principle. The 2001 IMF/WB assessment indicated that the CNB Act and the AoB did not provide legal protection to supervisors, and the Czech law did not recognize the principle acting in good faith. However, a 2003 CNB self-assessment noted that the Criminal Code provides for protection of the CNB staff in the discharge of their banking supervisory functions, and the protection was guaranteed by the constitutionally established independence of the judicial authority. A 2005 European Bank for Reconstruction and Development (EBRD) report noted that the protection called for in this principle, which applied only to good-faith supervisory actions taken in the conduct of official duties, was not available in the Czech Republic.
CP1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.
According to the 2001 IMF/WB assessment, and the 2003 CNB self-assessment, the Czech Republic was largely compliant with this principle. The IMF/WB's 2003 assessment concluded that although there was a trilateral agreement between the CNB, the MoF, and the CSC, the system of cooperation and information-sharing between the three agencies was often hindered due to administrative delays and legal obstacles. According to the 2003 self-assessment, the cooperation between the three agencies had been further strengthened by the 2003 Agreement on Cooperation for the Performance of Banking Supervision and State Supervision over the Financial Market undertaken by the CNB, the Securities Commission, and the MoF. This agreement facilitated the harmonization of Czech laws on supervisory cooperation with EC law, as well as cooperation with international regulators. The AoB also harmonizes Czech laws with EU regulations by balancing confidentiality with information exchange among international supervisors. In this context, it is pertinent to add that the Czech Republic moved to integrated financial sector supervision in 2006, and the CNB is now the unified regulator and supervisor of the banking, securities, insurance and pensions sector. The 2008 Financial Markets report states that the CNB in collaboration with the MoF and other state authorities work closely to “create a single strategy and unified rules applying to financial market regulation and supervision” (p.15).
CP2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.
According to the 2001 IMF/WB assessment, the Czech Republic was largely compliant with this principle. The 2003 CNB self-assessment, however, noted that the Czech Republic was compliant with this principle. The 2001 IMF report indicated that the AoB defined the term "bank" and the limitations of its use. However, the CNB's power to enforce this clause was not explicit. It needed to be clarified in the AoB so that the CNB can better ensure compliance with laws in the conduct of banking business. However, the 2003 self-assessment concluded that although enforceability was theoretically an issue, it was not so in practice and no serious damage had been done to depositors due to the incorrect use of the term "bank" to accept deposits. Also, the AoB has been amended and banks are being re-licensed to achieve uniformity and harmony with the amended law. The 2002 IMF Update also attested that the CNB "issued a decree on licensing procedures, effective May 1, 2002, which included new transparency requirements and aimed at strengthening the identification of beneficial owners, based on the amendment of the Act on Banks" (p. 2).
CP3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. According to the 2001 IMF/WB assessment, the licensing process did not stress the determination of the legal, managerial, and organizational structure of the bank. The CNB also did not have the legal authority to assess the suitability of the managerial staff, though it does review it in practice. However, the CNB cannot object to an appointment that does not pass the fit-and-proper test. The corporate governance framework was also not systematically assessed. The 2001 IMF report therefore recommended the rectification of these deficiencies. It called for closer monitoring of the organizational structure of a newly licensed institution. The 2002 IMF ROSC mentioned that the amendment of the AoB and the CNB decree on licensing procedures "now permit fit-and-proper tests below the Board level" (p. 2). The 2004 IMF Update further noted that, in December 2002, the CNB published information on assessing the fitness of persons being considered for executive managerial positions both in domestic banks and foreign bank branches. According to the 2003 CNB self-assessment, "the current provisions on licensing meet standard requirements on entities applying for a banking license" (p. 25), and evaluate the ownership structure, the competence of senior staff and shareholders, initial capital, the business strategy and plan, and the technical and organizational basis.
CP4. Authority to review and reject transfer of ownership.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. According to the 2001 IMF/WB assessment, significant holding is defined in the AoB. Any changes in the ownership structure needed the approval of the CNB, which had the power to reject such changes or suspend the exercise of voting rights, though it had not yet applied this power. The 2003 CNB self-assessment noted that the AoB and Decree No. 166/2002 Coll. required the consent of the CNB prior to acquisition of or increase in holding in a bank. However, the consent applied to only the actual owners of the bank and not to beneficial ownership or custodians.
CP5. Authority to review major acquisitions and investments.
According to the 2001 IMF/WB assessment, the Czech Republic was found to be compliant with this principle. However, the 2003 self-assessment by the CNB concluded that the Czech Republic was only largely compliant with this principle. According to the 2001 IMF/WB assessment, mergers and acquisitions required the consent of the CNB by law. The law prohibited banks from acquiring shares in non-financial enterprises, except if they are ancillary banking services' undertaking. It was silent, however, on limited partnerships and cross border investments and acquisitions. The CNB reviewed proposals for acquisition to preclude excessive risk exposure or hindrances to effective supervision, but there was no methodology for evaluation. The 2001 IMF report recommended that the CNB develop criteria for evaluation of acquisitions and investments, especially in light of the universal banking system, cross-sectoral entities and the ease of overseas investment and acquisitions by foreign entities.
CP6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. According to the 2001 IMF/WB assessment, the capital adequacy requirements for banks meet the Basel capital accord requirements. The 2003 CNB self-assessment stated that the "the capital adequacy rules are adjusted in line with international standards and are applied uniformly to all banks. The method of determination of capital adequacy was already compliant with the European Community law and corresponded also to the current Basel Accord, while it will be fully harmonized as at the date of accession of the Czech Republic to the European Union" (p. 36). The 2004 IMF Update noted that the new Basel Capital Accord will be enforced in the Czech Republic in end-2006, after which risk-based allocation of capital requirement for banks will be pursued by the CNB. Per the 2008 CNB Financial Market Supervision report, the new Basel II capital adequacy framework allows for banks to use “advanced approaches based on mathematical models in order to calculate capital requirements” (p. 46).
EN7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.
According to the 2001 IMF/WB assessment, the Czech Republic was materially non-compliant with this principle. The 2001 IMF/WB report arrived at this conclusion because the CNB had no formal regulations in place requiring banks to have credit risk management and prudential standards. However, a 2003 CNB self-assessment noted that "the regulatory framework for credit and market risks management is compliant with international standards and creates the prerequisites for efficient discharge of banking supervision" (p. 40). The 2003 CNB self-assessment rated the Czech Republic as being compliant with this principle.
CP8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.
According to the 2001 IMF/WB assessment, the Czech Republic was largely compliant with this principle. The 2003 CNB self-assessment, however, rated the Czech Republic as compliant. Per the 2001 IMF report, banks were required to periodically review their loan portfolio and loan-loss provisions, and the CNB verified the banks' classification and provisioning rules during on-site examinations. The CNB had the power under law to require banks to strengthen their lending practices, provisioning, credit standards and overall financial strength. The report notes that "while the laws relating to bankruptcy proceedings and auctions have been updated, it remains difficult for banks to realize collateral in a timely manner" (p. 39). The 2003 CNB self-assessment found that CNB Provision No. 9/2002 laid down detailed rules for loan evaluation and additions to provisions and reserves. Further, CNB Provision No. 3/2002 on Credit Risk Management in Banks requires banks to have credit risk management strategy and procedures in place.
CP9. Prudential limits and management information system on concentration of exposure.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. The 2001 IMF report found that "group of connected debtors" were defined in the CNB regulation on capital adequacy through illustrative examples rather than through an explicit definition. The regulations on prudent limits on large exposures to a single borrower or "group of connected debtors," however, include all on- and off-balance sheet exposures. The CNB also verified information systems set up within banks to promptly identify concentrations in the credit portfolio at the solo as well as consolidated level. The 2003 CNB self-assessment added that the regulatory framework as of January 1, 2003 "is harmonized with the EC law" (p. 50). However, since the framework was relatively new at the time, it had not yet been studied as to its effectiveness. Therefore the self-assessment gave the Czech Republic a less than full compliance rating for this principle.
CP10. Arm's length rule and monitoring for connected lending.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. Per the 2001 IMF report, "the AoB defines a 'person with special relation to the bank,' but the supervisory authority has no discretion to make judgments about the existence of connections between the bank and parties other than those specified in the Act" (p. 40). The report called for a clearer definition of connected persons, and more discretion given to the CNB to decide the connectedness of persons that borrowed from the banks. The CNB does utilize on-site inspections to determine if the bank is abusing the system through connected lending. According to the CNB self-assessment, the definition of connected lending in the AoB was narrower in scope than that required by the BCPs. The 2004 IMF Update also finds that the AoB "does not permit supervisors discretion in interpreting the definition of connected or related parties" (p. 4). The CNB, per the 2003 self-assessment, stated that it will take steps to bring the law in line with the BCP requirements.
CP11. Policies and procedures for country risk and transfer risk.
According to the 2001 IMF/WB assessment, the Czech Republic was "largely compliant" with this principle. The 2003 CNB self-assessment, however, found that the Czech Republic was compliant with this principle. Per the 2001 IMF report, the overall risk management systems within banks recognize country and transfer risk, though the system lacked a distinct framework for managing country and transfer risks incorporated in banking regulations. This was likely because the geographical exposure of Czech banks was minimal, as is its exposure to non-OECD countries. The CNB has, however, declared its intent to issue specific regulations on the management of country and transfer risks. According to the CNB self-assessment, the Provision of CNB No. 3/2002 on Credit Risk Management in Banks laid down requirements on country and transfer risks. Further, the Provision of CNB No. 9/2002 set requirements for receivables form nonresidents as they related to country and transfer risks. The CNB evaluated country risk management by banks during on-site inspections, and considered failure in the risk-management system with regard to country and transfer risk to be a prudential breach.
CP12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. Per the 2001 IMF report, although the AoB and the Provision of the CNB on Capital Adequacy Incorporating Market Risk contained general provisions on market risk management, there were no specific policy requirements for the identification, measurement, monitoring, and control of market risk. The 2001 IMF report recommended that the CNB be given the power to "impose a specific capital charge and/or specific limits on market risk" (p. 42). It also called for explicit regulations requiring scenario analysis, stress tests, and contingency planning by banks; greater expertise within the CNB on market risk supervision and value-at-risk (VaR); and the ability of the CNB to set differential capital ratios for individual banks, based on their risk profile, which factors in market risk. The 2003 CNB self-assessment found that "the regulatory framework of market risk management was compliant with international standards and created a basis for efficient discharge of banking supervision" (p. 60). However, the CNB had no practice in assessing market risk models, and the laws did not empower it to impose capital requirements on an individual basis. Nevertheless, the report noted that this tool was not required under EC law until the end of 2006, when the EC laws were harmonized with the Basel II requirements. The 2004 IMF Update noted an approved amendment to the AoB extended consolidated supervision to cover both credit and market risk.
EN13. Comprehensive risk management processes.
According to the 2001 IMF/WB assessment, the Czech Republic was materially non-compliant with this principle. However, the 2003 CNB self-assessment found that the Czech Republic was largely compliant with this principle. Per the 2001 IMF report, "Czech banking regulations do not explicitly require banks to put in place a detailed risk management process to identify, measure, monitor and control... material risks" (p. 42) other than market risk. Basic liquidity management requirements were spelled out in the Provision on Liquidity Rules of Banks, but there were no legal requirements spelled out for stress testing and domestic and foreign currency risk management. The report observed that at the time, "a new provision on liquidity [was] under preparation, which [would] bring the CNB's approach into line with recent BIS recommendations" (p. 43). The report also called for setting bank prudential requirements, including operational, foreign exchange, and interest risk-management. According to the CNB self-assessment, CNB Provision No. 3/2002 on Credit Risk Management in Banks and CNB Provision No. 4/2002 on Market Risks Management in Banks (effective January 1, 2003) lay down credit risk and market risk management by banks, respectively. Further, a new provision was in the works that promised to cover the management of all material risks, including operational risk as a result of which, according to the CNB assessment, all the recommendations set out in the of the Basel Committee would be fulfilled.
The 2004 IMF Update added that besides CNB Provision No. 3/2002 on credit risk management, a CNB provision requiring banks to create internal audit departments, regularly test their internal management and control systems, and adopt policies on market risk management, came into force in January 2003. However, work was still underway on developing regulations pertaining to operational risk management. The 2007 CNB report indicated that CNB examination of operational risk management in banks was launched in 2005 to implement Basel II and in view of the increasing operational risks inherent in banks. According to the 2008 CNB annual report, the CNB carried out onsite inspections in banks that were in line with “a plan based on supervisory findings and assessments of risk levels of individual banks” (p.29). It further states that banks’ management of risks were accorded attention, with particular focus on “credit risk management, internal control systems, selected aspects of corporate governance, operational and IT/IS risk management, money laundering prevention systems, liquidity risk management, Central Credit Register data input systems, depository activity and the manner of eliminating shortcomings found during previous on-site inspections” (p.29).
CP14. Adequate internal controls.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. According to the 2001 IMF report, the general responsibilities of the Board for corporate governance and internal controls were laid down in the Commercial Code. However, the report called for more explicit requirements relating to internal control and audit, communication between the CNB and the external auditor, and a formal requirement to set up internal audit departments in banks. The 2003 CNB self-assessment added that under the AoB, banks were required to set up internal audit units, and their independence, resources and risk detection methodology were reviewed by the CNB. Further, the CNB Provision on Risk Management and the CNB Provision on the Internal Management and Control System contained the stipulation on the separation of incompatible functions. The 2008 CNB annual report states that due to the global financial crisis, the CNB paid attention to the risk management systems of banks, particularly regarding their “credit risk management, internal control systems, selected aspects of corporate governance, operational and IT/IS risk management” (p.29) and other areas that were deemed prone to risks to ensure that banks are in control over every aspect of risk management.
EN15. Strict "know-your-customer" rules and high ethical and professional standards.
In the 2001 assessment by the IMF/WB, the Czech Republic was assessed as materially non-compliant with this principle. At the time of this report, the Czech Republic did not have "know your customer" guidelines for banks and the banks were also not required to submit suspicious transaction and fraud reports to the supervisor. Subsequently, the CNB in its 2003 self assessment concluded that the Czech Republic was largely compliant with this principle. Similarly, in 2004 a detailed assessment on the Czech Republic's compliance with the Financial Action Task Force's 40 Recommendations on Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) by the IMF revealed that the country achieved a high level of compliance" with the Recommendations, but that it "has not yet translated into law enforcement results" (p. 9). A 2007 report by the Committee of Experts on the Evaluation of Anti-Money Laundering Measures (MONEYVAL) rates the Czech Republic partially compliant with the Financial Action Task Force's (FATF) requirements on customer due diligence, largely compliant on suspicious transaction reporting, and largely compliant with R 10 on record-keeping. According to the 2008 Financial Markets report, the authorities ensure that ‘know your customer’ policies, suspicious transaction reports and other key AML issues are appropriately applied and assessed. In this regard, the CNB works in collaboration with the MoF’s Financial Analytical Unit in setting up the supervisory methodology.
CP16. Effective supervisory system consisting of on-site and off-site supervision.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. Further, per the 2001 IMF report, the CNB "has an integrated framework of on- and off-site supervision" (p. 45). The report, however, recommended the CNB to move towards a risk based system of supervision; enhance its expertise in monitoring and controlling market and operational risks with the capability of conducting VaR model reviews; diligently monitor risk-adjusted capital adequacy positions of banks; push banks to put in place comprehensive risk management processes; and establish an internal quality assurance function to assess the effectiveness of its on-site and offsite supervision. The 2001 IMF report found that the CNB was increasingly factoring in risk in its supervisory examinations. The 2003 CNB self-assessment noted that the CNB's methods and tools of offsite and on-site supervision were comprehensive and were being constantly developed and enhanced. However, some gaps still remained as to the adequate identification and documentation of bank activities.
According to the 2008 CNB Financial Market Supervision Report, the CNB generally conducts off-site supervision by monitoring the activities and “financial conditions of banks, foreign bank branches and credit unions and the risks they undertake” (p.39). The report further states that in 2008, particular attention was given to supervised entities’ potential risk exposures due to the global crisis through the analysis of their portfolios. Per the same report, the CNB undertakes regular comprehensive analysis in its off-site inspections to determine the financial situation of supervised entities and the entire sector. Another tool the CNB uses is its early warning information system that helps to identify potential risk tendencies in banks, which are assessed monthly. Moreover, compliance with prudential limits like capital adequacy, according to the report, is also monitored regularly. However, the report mentions that the CNB’s supervisory powers are limited, therefore its supervision of foreign bank branches are slightly different since supervision responsibility lies with the home country. Regarding on-site inspections, the report states that the CNB conducts its inspections under the guidance of the State Inspection Act and focuses on assessing compliance with the regulatory rules “under the legal and implementing regulations pertaining to the activities under examination” (p.44).
CP17. Regular contact with bank management and understanding of bank's operations.
According to the 2001 IMF/WB assessment, the Czech Republic was largely compliant with this principle. The assessment found that the CNB met with the Board of Directors of banks at least annually to discuss operational matters, and also met senior and middle management on a regular and ad hoc basis. The CNB assessed the quality of management after the licensing process through ongoing on-site interviews with the management. The report found that banks generally notified the CNB prior to substantive changes to their activities or structures, but recommended that this be explicitly required by the AoB . The 2003 CNB self-assessment also found the Czech Republic largely compliant with this principle, concurring with the IMF/WB assessment. The 2008 CNB Financial Market Supervision Report affirms that there is healthy cooperation and exchange of information between supervised entities and the CNB. It further stresses that this has been particularly important with the on-going global financial crisis. Per the report, reporting duties have been stepped up in the financial market sector, and the CNB looks to further strengthen the positive communication and information sharing with both the supervised entities and their professional associations.
CP18. Analytical reports and statistical returns on solo and consolidated basis.
According to the 2001 IMF/WB assessment, the Czech Republic was largely compliant with this principle. The 2003 CNB self-assessment, however found that the Czech Republic was compliant with this principle. The 2001 IMF report noted that the AoB grants the CNB the authority to require banks to submit regularly, financial and prudential data and other information on their financial conditions on a solo as well as consolidated basis. The CNB also has an information system to monitor the banks on an ongoing basis. Accounting techniques have been established by the MoF, and the CNB has the power to enforce compliance with the information requirement and can impose penalties for inaccuracies and errors in reporting. However, the report noted that the CNB cannot request information from non-bank companies related to the supervised banks. The 2001 IMF report recommended that the accounting techniques should be promulgated by the CNB instead of the MoF, and there should be regular exchange of information between the financial supervisory agencies with respect to groups operating in different regulatory regimes. The 2003 CNB self-assessment indicated that the CNB makes prudential reporting rules, and that it has aligned them with the International Accounting Standards (IAS). The 2004 IMF Update added that the regulation on information disclosure by banks in their annual reports came into force in January 2003. However, the CNB did not collect comprehensive data by which to monitor trends and developments in the banking sector. The CNB's 2008 Financial Markets report rates the fulfillment of the CNB’s reporting duties as satisfactory. The report explains that while most supervised entities submit their reports and statements on time, “the information included in the regular reports is not always sufficient for financial market supervisory purposes, since by its very nature it relates primarily to past events” (p.49). Per the report, there has been further improvement in regular open communication between the supervised entity and the CNB; the CNB carries out its reporting duties by ensuring “continuous, regular, and timely compliance” (p.49), as well as ensuring that reports and data submitted are accurate. The CNB’s aim is to monitor and identify regulatory risks in the analysis of the data it receives.
CP19. Independent validation of supervisory information through on-site examination or external auditors.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. The CNB, per the 2001 IMF report, has policies and informal procedures in place to plan and conduct thorough and consistent on-site examinations, with clear delineation of responsibilities, objectives, and results. The CNB can also impose corrective measures based on its findings. The CNB can oppose the appointment of an external auditor but cannot monitor the quality of the task completed by the auditor. The CNB can also order an "extraordinary audit" (p. 47) of the bank, but its power to demand files other than during on-site visits is not very clear. Per the 2003 CNB self-assessment, the CNB prioritizes inspections on the basis of the banks' bearing on financial stability, their financial performance and the results of the prior visits to their premises. The report observed that "according to the Act on Banks, a bank shall ensure that a legal entity performing audit activities will carry out verification of the financial statements and verification of the bank's management and control system, including its risk management system" and this constituted a progress since the 2001 IMF/WB assessment. The CNB has also issued a provision laying down requirements for verification of the risk management systems. The 2004 IMF Update added that amendment to CNB provisions in March 2003 addressed requirements for external auditors.
EN20. Ability to supervise on a consolidated basis.
According to the 2001 IMF/WB assessment, the Czech Republic was materially non-compliant with this principle. However, the 2003 CNB self-assessment finds that the Czech Republic was largely compliant with this principle. Per the 2001 IMF report, the CNB supervises banks on a consolidated basis in accordance with CNB Provision No. 2/1999. However, the 2001 IMF report noted that the scope of the rules laid down in the Provision is "incomplete" (p. 47). They do not cover management of financial holding companies, capital allocation to cover market risk on a consolidated basis, risks inherent in the non-bank activities within banking groups, subsidiaries that are not banks, or banking activities overseas. Information-sharing agreements between the CNB and the insurance and securities sector regulators do not cover exchange of information focusing on underlying risks within the supervised banking groups. The CNB self-assessment indicated that the Harmonization Amendment No. 126/2002 of the AoB, effective since May 2002, incorporated many of the 2001 IMF/WB recommendations.
CP21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. Per the 2001 IMF report, relevant laws (the AoB, the Act on Accounting, and the Commercial Code) adequately requires accurate, reliable and timely submission of accounting data by the banks to the CNB, after due verification by the external auditors. The MoF has stipulated special accounting procedures and the CNB has reinforced them with its own reporting requirements. However, the Czech accounting requirements did not fully adhere to IASs, although they were in the process of being harmonized with the IAS. Banks did, however, voluntarily produce IAS-compatible accounts, and the CNB had the power to verify the accuracy of the records during on-site inspections. The 2001 IMF report had the following recommendations with respect to this principle: (1) harmonize the Czech Accounting Standards (CAS) with the IAS; and (2) allow the external auditor free access to the CNB to discuss issues of concern without prior consent by the pertinent bank. The 2003 CNB self-assessment stated that the accounting procedures followed by the banks in practice were compatible with the IAS, and the senior management of domestic and foreign banks was liable for the accuracy of the accounting statements. They were also subject to regular reviews by the external auditors. The 2002 IMF ROSC observed that the amendment to the Accounting Act in 2001, that came into force in January 2002, and the MF's implementing by-law "aim[ed] at making Czech accounting rules for financial instruments (securities, derivatives, financial placements of insurance companies) fully compatible with International Accounting Standards and European law" (p. 3). The 2004 IMF Update added that the regulation on information disclosure by banks in their annual reports came into force in January 2003 and required the disclosure of stipulations on the layout and content of items of profit and loss accounts and extent of information to be disclosed for the benefit of banks and certain other financial institutions.
CP22. Adequate supervisory measures to ensure timely corrective action.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. As the 2001 IMF report noted, the CNB was authorized by the AoB to take a range of remedial actions and sanctions if it detected shortcomings in a French bank or branch of a foreign bank. The IMF, however, recommended the removal of barriers to prompt corrective action by the supervisor. The 2002 IMF ROSC stated that "there have been no changes in the supervisors' powers for prompt corrective action since end-2000" (p. 3). The 2003 CNB self-assessment found that though the CNB had "at its disposal a comparatively large set of remedial measures" (p. 109), they were not timely due to late identification of problems, and even so their implementation did not guarantee the redemption of the bank from distress. The 2008 CNB annual report states that the Act on the CNB as well as special legal rules gives the CNB authority to impose remedial measures and penalties on supervised entities in the execution of its supervisory duties. The 2008 Financial Markets report also affirms that the CNB has the authority to impose remedial measures and penalties on banks or credit institutions. The report further explains that in cases of minor shortcomings, credit institutions must inform the CNB of what corrective actions it is going to take and must on a quarterly basis send the CNB a list of measures used. In cases where the shortcomings are very serious, the report states that the CNB must apply remedial measures as stated in Article 26 of the Act on Banks or Article 28 of the Act on Credit Unions.
EN23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.
According to the 2001 IMF/WB assessment, the Czech Republic was materially non-compliant with this principle. The 2003 CNB self-assessment, however, found that the Czech Republic was largely compliant with this principle. Per the 2001 IMF report, although the CNB had the power to supervise the branches and subsidiaries of Czech banks in foreign jurisdictions subject to local laws, the assessment team did not find evidence of direct supervision of the overseas branches. The report therefore recommended the formulation of regulations enabling consolidated supervision of Czech banking groups, including the power to close a branch or subsidiary or restrict its activities if its risk management system is not effective. The CNB self-assessment stated that foreign branches and subsidiaries of Czech banks were marginal (only one branch and two subsidiaries) and therefore their supervision was not robust. The CNB, however, intended to implement more comprehensive supervision of foreign branches and subsidiaries.
CP24. International exchange of information with other supervisors.
Both the 2001 IMF/WB assessment and the 2003 CNB self-assessment concluded that the Czech Republic was largely compliant with this principle. The AoB requires banks to inform the CNB if it intends to set up operations abroad, but the CNB does not have the power to prohibit operations in countries where local laws suppress information flow or instate secrecy provisions that are detrimental to effective supervision. However, the CNB can provide host supervisors with information regarding Czech banks operating in the pertinent country. The IMF/WB assessment called for a more proactive information sharing arrangement between the CNB and the home supervisors. The assessment noted that the CNB did not consider this issue a priority since "foreign branches and subsidiaries of Czech banks are immaterial" (p. 50). Per the 2002 IMF ROSC, "the amendment of the Act on Banks provides a legal framework for the further development of cooperation with foreign supervisory authorities" (p. 7).
The 2003 CNB self-assessment found that the Czech Republic was gradually signing Memoranda of Understanding (MoUs) with home as well as host supervisors. The banks opening operations abroad still did not require approval of the CNB to do so. The self-assessment noted that on the Czech Republic's accession to the EU, the single licensing principle will come into force, wherein any bank intending to open a branch in Czech territory will need the CNB's approval as to whether it meets the criteria of the single licensing principle. The 2004 IMF Update stated that the CNB had signed MoUs with foreign supervisory authorities in Austria, Belgium, Germany, France, the Slovak Republic and the State of New York, and was in the process of signing MoUs with Italy and the Netherlands. According to the 2008 CNB annual report, the CNB cooperates with the supervisory authorities of financial markets in other countries, as well as financial institutions and international organizations when executing its supervisory duties. Per the same report, participating in EU meetings within the EU structures, particularly in the “Lamfalussy Level 3 committees (CEBs, CESR, and CEIOPS) and the European Central Bank’s committees was of key importance” (p.28). The report further states cooperation and efforts to achieve supervisory convergence intensified, and in June 2008 “the CNB became a signatory to the Multilateral Memorandum of Understanding (MMoU) on Cross-Border Financial Stability, which has the objective to enhance cooperation in the management and resolution of cross-border financial crises” (p.28). The MMoU placed emphasis on the creation of supervisory colleges that will harmonize and support information sharing, and supervisory practices of individual colleges for all cross-border groups, while strengthening cooperative work between partner supervisory authorities.
CP25. Supervision of local operation of foreign banks and information sharing with home country supervisors.
According to the 2001 IMF/WB assessment, the Czech Republic was largely compliant with this principle. The 2003 CNB self-assessment, however, found that the Czech Republic was fully compliant with this principle. As the 2001 IMF report found, foreign banks were subject to the same regulatory requirements as were domestic banks, although with slightly different licensing criteria. For example, foreign banks did not need to set aside regulatory capital in Czech currency, and are therefore not required to have Czech capital adequacy requirements. The Czech Republic allows home supervisors to carry out on-site inspection of their branches in the Czech Republic, but bank secrecy laws hamper the ability of the home supervisors to obtain individual client information. The CNB informs the home supervisor promptly if it takes material action against the pertinent branches. The CNB ascertains the consent of the home supervisor before it grants license to a foreign branch, and the lack of globally consolidated supervision by the home supervisor does not prevent the CNB from granting a license to the pertinent branch. The 2001 IMF report called for more MoUs between the CNB and foreign supervisory authorities. The 2003 CNB self-assessment observed that there had been considerable advancements in global supervision and information sharing arrangements. The CNB, per the self-assessment, had satisfied itself that all home supervisors had approached practiced globally consolidated supervision. Six more MoUs were signed between the CNB and relevant home supervisors. On-site inspections by home supervisors, as set down in the MoUs, are also adequate to enable proper discharge of cross-border supervisory responsibilities.
According to the 2008 Article IV consultation paper, the Czech Republic accounted for 11 percent of total foreign claims ”on the emerging European region as of the end of 2007” (p. 14), making it one of the most important host countries in emerging Europe. The report further states that as a result of the large presence of foreign banks, the Czech Republic’s cross-border linkages with Western European banks has prompted an agreement to proactively collaborate supervision of the financial sector with the CNB and supervisory authorities of Western European countries that have bank subsidiaries in the Czech Republic. The 2008 CNB annual report states that as part of the CNB’s supervisory duties in the financial market sector, it focuses on the supervision of foreign banks’ branches in the Czech Republic, foreign electronic money institutions’ branches, as well as Credit Unions, and other financial institutions.
