Credit Institutions Supervision Department Annual Report 1999

Credit Institutions Supervision Department Annual Report 1999

ISBN 9984-9228-2-0

Introduction
Supervision of Credit Institutions
Activities of Banks
Activities of Credit Unions

Appendices
1. Number of Credit Institutions in Latvia (1991-1999)
2. Number of Licences Issued by the Bank of Latvia (1991-1999)
3. Organisation of the Credit Institutions Supervision Department
4. Credit Institutions Licensed in the Republic of Latvia

Credit Institutions Supervision Department. Annual Report 1999 (in Adobe PDF format)

Introduction

The Credit Institutions Supervision Department of the Bank of Latvia was established in 1992. Since then brief accounts on the Department's activities and the development of Latvian banks and credit unions have always been included in the Bank of Latvia's Annual Reports. However, in view of the importance of the banking sector in the financial system and the public's interest, we decided to publish the Annual Report of the Credit Institutions Supervision Department. The publication introduces the Credit Institutions Supervision Department, highlights and comments upon trends in the development of credit institutions, and reports changes in and amendments to Latvian banking laws and regulations.

1999 was a year of steady and orderly growth for Latvian banks and credit unions. Positive banking indicators are proof of the recovery from the Russian financial crisis. Banks have expanded lending and introduced new financial services. The introduction of consolidated supervision enables us to assess risks arising from capital ties and to take more informed decisions about banks' financial standing. A qualitatively new stage in banking supervision has been achieved.

During the challenging years since the Department was established, its staff has gained experience and skills. Likewise, a regulatory framework for banking activities, based on international standards, has been developed. The Department's achievements have also been recognised internationally, and Latvia's system for banking supervision now ranks among the strongest in the countries of Central and Eastern Europe. Latvia is one of the first countries to have received a positive evaluation by the IMF's experts regarding compliance of its legal framework and supervisory practice with the Basle Core Principles for Effective Banking Supervision. Our main priority, however, is to maintain domestic confidence in the Latvian banking sector, as public confidence is a prerequisite for a successful operation of banks. Public confidence can be achieved by ensuring that market participants are well-informed about the supervisory system and events in the banking sector. To enhance competition in the banking sector, the public is kept well-informed and market discipline is combined with traditional supervisory practices.

We hope that this publication will increase the public's understanding of how the Department has fulfilled its responsibilities, and explain methods of credit institutions supervision, as well as current developments in the banking sector

Armands Steinbergs
Head of Credit Institutions Supervision Department
Bank of Latvia

Supervision of Credit Institutions

Evolution of Credit Institutions and Supervision in Latvia (1991-1998)

The Bank of Latvia, which is the central bank of the Republic of Latvia, was established on July 31, 1990. The Laws "On the Bank of Latvia" and "On Banks", which came into effect on May 19, 1992, set forth the obligations and rights of the Bank of Latvia, among them supervision of credit institutions. (From the outset, entities subject to supervision were banks, credit unions, pawn shops and branches of foreign banks, but with the Law "On Credit Institutions" coming into effect in 1995, pawn shops were excluded from the list of institutions under supervision.) With this task in mind, the Bank organised the Credit Institutions Supervision Department.

From 1992 to 1994, the Latvian banking sector expanded at a rapid pace, and during this period, banks' assets grew more than threefold. In 1993, over 60 banks were licensed in Latvia (see Appendix 1). In 1994, the Bank of Latvia licensed the first branch of a foreign bank, the Riga Branch of Societe Generale (France). The first permit to open a representative office was issued to the German bank Dresdner Bank AG (see Appendix 2); it is the only representative office of a foreign bank operating in Latvia.

Growth in the banking sector was more rapid than in the other sectors of the national economy; and this highlighted two short-term goals. A system for supervising credit institutions had to be set up and appropriate legislative and regulatory frameworks had to be designed. It was in the period from 1993 to 1994 that the Bank of Latvia adopted a set of banking requirements, basing them mainly on the recommendations of the Basle Committee on Banking Supervision, which embrace global experience and in many cases are the source for the standards of EC directives. Pursuant to Bank of Latvia regulations, credit institutions started making loan loss provisions. All credit institutions had to meet a number of requirements, among them capital adequacy and liquidity requirements and restrictions on exposures.

The 1995 banking crisis was a crucial event for the Latvian banking sector. The banking sector's rapid expansion, which was accompanied by rash management policies in several banks and took place in an environment of slower economic growth, led to the crisis. Deposits of corporate and individual customers grew dramatically; however, domestic facilities for profitable placement of funds were inadequate. Ownership transfer was not carried out at a sufficiently rapid pace, and markets for real estate and securities were weak. In 1995, in the wake of the crisis, the activities of 15 banks were discontinued. Among the fifteen there were also sizeable banks: the JSC Banka Baltija, the JSC Latvijas depozitu banka and the JSC Centra banka.

To reinforce the banking sector, the Latvian Government and the Bank of Latvia initiated an extensive reform program. In 1995, the adoption of the Law "On Credit Institutions", which replaced the Law "On Banks", was followed by a set of the Bank of Latvia's regulations, based on the Law. The new Law detailed the obligations and rights of the Bank of Latvia with respect to the supervision of credit institutions. The Law, along with amendments to the Administrative Code of Latvia and the Criminal Code of Latvia, increased the responsibilities of credit institutions, their shareholders, management, employees and customers. In several cases, the Law "On Credit Institutions" sets even stricter requirements (capital adequacy, restrictions on exposures to third parties related to a credit institution, etc.) than EC directives, which are targeted at developed economies and are not sufficiently rigorous to provide for a stable and smooth operation of the banking sector in a transition economy. Pursuant to the Law "On Credit Institutions", accounting procedures in credit institutions are to be conducted in accordance with the Law "On Accounting" and Bank of Latvia regulations. The latter are to comply with Republic of Latvia laws and International Accounting Standards. Annual financial statements of banks have to be audited in accordance with International Standards on Auditing. As of 1995, the Bank of Latvia approves a list of auditing companies, therein including only international companies. Since 1993, the list is binding on the largest banks, and since 1995, on all credit institutions.

In 1995, steps were taken to enhance supervision, and, under the PHARE program, international auditing companies began to conduct audits of banks' interim (among them, semi-annual) financial statements and internal control systems. Also, to make banking activities more transparent and clear to the public, the Bank set a requirement to banks to publish their quarterly balance sheet. As a result, bank customers could follow developments within banks, and this improved decision-making when choosing a bank for transactions.

From 1996 to 1997, the Bank of Latvia expanded the regulatory requirements, achieving a number of positive results: banks' capital base strengthened; their profitability increased; the quality of assets improved; and depositors' confidence grew. Major foreign investors acquired holdings in a number of banks.

Initially, the focus was on on-site supervision; however, it shifted to off-site supervision and contact with banks' management because the banking sector grew, management quality in banks improved and banks' safety increased. To reinforce the achievements of the banking sector and to provide for further growth, the efficiency of internal control systems at credit institutions became the priority.

As part of the ongoing harmonisation of the Latvian legislation with EC directives, the Saeima of the Republic of Latvia adopted the Law "On the Prevention of Laundering of Proceeds Derived from Criminal Activity" (in 1997) and the Law "On Natural Person Deposit Guarantees" (in 1998).

In the second half of 1998, Latvian credit institutions' financial standing was impaired by the Russian financial crisis. A number of banks had acquired securities of the CIS countries, and these constituted a large part of their assets. Even those banks that had not made large investments in this region felt indirectly the impact of the crisis, because deposits of and transactions with customers related to eastern markets decreased. As a result of the Russian crisis, the licences of two small banks were revoked.

The deterioration in the overall situation in Zone B countries (non-OECD countries) and the unprecedented events in Russia were the reasons why the Bank of Latvia resolved to reassess the degree of risk for claims on central banks and central governments in Zone B countries denominated in the national currencies of these countries and to raise the degree of risk assigned to such assets from 0% (as established in accordance with internationally approved practice and EU requirements) to 50%. Restrictions regarding exposures that arise from transactions with residents of Zone B countries as well as total exposures to residents of Zone B countries were established. These requirements enhanced the diversification of banks' investments in Zone B countries and reduced country risk.

In May 1998, the Saeima of the Republic of Latvia adopted amendments to the Law "On Credit Institutions" establishing consolidated supervision of credit institutions. The amendments also laid the legal foundation for the Bank of Latvia's cooperation with other domestic and foreign supervisory authorities. Substantial changes were made to the procedure for liquidating a credit institution, the process of insolvency and bankruptcy, the procedure for applying rehabilitation, and the activities of the administrator and liquidator. The Bank of Latvia was granted the right to control the activities of the administrator and liquidator.

The skills and professionalism of the Bank of Latvia's supervisors was recognised by the IMF's invitation to the project "Contingency Planning for the Largest Banks of Ukraine" in the second half of 1998. The tasks under the project were as follows: to evaluate the seven largest Ukrainian banks in accordance with the CAMELS rating system; with a view to the overall situation in that country and banks, to develop recommendations concerning banking regulations; and work out proposals for restructuring and rehabilitating particular banks.

Organisation and Tasks of the Credit Institutions Supervision Department

The main objective of the Bank of Latvia's Credit Institutions Department is to promote the stability, soundness and development of the credit institutions system. The mere existence of a supervisory system, however, cannot fully guarantee the soundness of credit institutions. Having such strict guarantees in place would be an unacceptable interference in the market. The purpose of supervision is to detect potential problems and to assist banks in preventing them or curbing their adverse economic consequences. The Bank of Latvia, therefore, places the activities of credit institutions under various restrictions whose aim is to minimise risks, while influencing the management decision making process as little as possible.

The Credit Institutions Supervision Department has three divisions (see Appendix3): the Banking Regulations and Analysis Division, the Legal and Licensing Division, and the Supervision Division.

Banking Regulations and Analysis Division

The objective of the Banking Regulations and Analysis Division is to develop and improve banking regulations, implement the requirements of EC banking and accounting directives, and follow the Core Principles for Effective Banking Supervision as set forth by the Basle Committee on Banking Supervision with the aim of promoting the stability and evolution of the system of credit institutions.

With a view to the Division's main objectives, its staff has the following tasks:

1) to participate in drafting and amending Latvian banking laws and regulations as well as accounting regulations, and preparing Bank of Latvia regulations;

2) with trends in the Latvian banking sector in mind, to analyse regulatory requirements of other countries (especially of those in Central and Eastern Europe), EC banking directives, recommendations of the Basle Committee on Banking Supervision and the IMF's analytical papers; and work out proposals for introducing and improving regulatory requirements;

3) to cooperate with the Association of Latvian Commercial Banks and provide consultations with respect to banking regulations;

4) to produce analytical papers on the development of the Latvian supervisory system and the banking sector;

5) to inform the public about the development of the Latvian banking sector, supervision and the requirements of laws and regulations;

6) to collaborate with international organisations and other domestic and foreign supervisory authorities.

Legal and Licensing Division

The objectives of the Legal and Licensing Division are as follows: to provide for the compliance of the supervision of credit institutions with the requirements of the Law "On Credit Institutions", other Republic of Latvia laws and regulations, and Bank of Latvia regulations; to receive, review, compile and analyse documents and information concerning the licensing of credit institutions and granting other Bank of Latvia permits to credit institutions; and subsequently submit this information to the Bank of Latvia's senior management for further consideration.

With a view to these objectives, the staff of the Legal and Licensing Division has the following tasks:

1) with respect to the activities of credit institutions and supervision, to provide information on legal issues, provide consultations on and explanations of Republic of Latvia laws and regulations; collaborate with the Association of Cooperative Credit Unions of Latvia; where required, participate in teams conducting on-site supervision of credit institutions;

2) to participate in drafting banking laws and regulations; express opinion on and work out amendments to draft regulations prepared by other organisational units of the Bank of Latvia; upon request of other public institutions, assess draft laws and regulations prepared by these institutions;