The Role of Bank Regulation
Financial stability is one of the Central Bank of Barbados’ two objectives, and as such, acting as a prudential regulator is one of its main functions. The key players in the financial system are banks and other financial institutions. They provide financing for commercial entities, basic financial services for the general population and access to the payments system. Because the failure of a bank can undermine the stability and integrity of the financial system, banks are highly regulated entities.
The failure of a bank can undermine the stability and integrity of the financial system. This is because if one bank fails, customer confidence is lost in the entire system and depositors will want to remove their funds from the banks. This is generally referred to as a “run” on the bank. Depositors’ funds must therefore be safeguarded to ensure customer confidence.
The Bank Supervision department is the regulatory arm of the Central Bank. It is staffed by 22 trained examiners. Its goals include:
- Developing legislation and regulations for the financial system
- Inspecting financial institutions licensed under the Financial Institutions Act and the Offshore Banking Act, to ensure that the operations are safe and in compliance with legislation; and
- Reporting on the performance and condition of each licensed financial institution.
The Bank Supervision Department of the Central Bank of Barbados conducts both onsite and offsite inspections of all licensed financial institutions. Onsite inspections are conducted at the premises of the financial institution by a team of examiners, and are usually done within a two-year cycle. Some institutions may, however, require more frequent visits in an effort to strengthen the quality of the operations.
During onsite inspections, bank examiners review the major areas of risk in the institution. While this includes assessments of liquidity, operational and other kinds of risks, the major risk on the bank’s balance sheet in Barbados is in the area of lending. Credit risk is, simply, the potential that a borrower will fail to meet his/her obligations to repay a loan, according to the agreed terms. The major causes of serious banking problems are directly related to poor credit standards for borrowers, poor credit administration, and a lack of attention by the bank to changes in the economy and other factors which may impact on the borrowers ability to repay his debt. The bank examiner therefore must evaluate all these parameters in the course of his inspection.
Another factor of major importance to the bank examiner is the strength of the corporate governance within the bank. This relates to the structures and relationships through which the objectives of the entity are met, and includes a full assessment of the role of the board of directors, the management of the entity and the strategies, policies and practices which they have implemented. Inspections also allow for an assessment of the internal controls system of the licensee, a factor which is critical for good bank management and for a safe and sound operation.
Arising from the assessments undertaken, the examiner can determine areas of deficiencies. A report is prepared detailing the condition of the licensee’s operations, and making recommendations for improvement, where necessary. The report is provided to the institution’s Board of Directors at the end of the process.
The process of inspection cannot simply depend on the onsite visits, however, but must be a continuous one. Continuous assessment is therefore undertaken by way of the offsite surveillance process. During this process the examiner undertakes a thorough analysis of the operations of the entity, using monthly and quarterly detailed information submitted by the institution. The Examiner can therefore establish trends in the operations. Negative trends may serve as an early warning device, prompting an onsite inspection. The combination of onsite and offsite inspections is a key international standard for effective banking supervision.