BANKING SUPERVISION

Recovering from the bank crisis that started at the end of 1992 and reorganising the whole banking system added extra work to the bank supervision. In the first place one had to deal with banks in difficulties and, unavoidably, supervising those banks which were run well or satisfactorily suffered to some extent. At the same time functions and distribution of tasks inside bank inspection needed to be reorganised. One of the most important tasks in the above mentioned sphere was the joining into one organisational unit of all the aspects of bank supervision and formation of an integral organisational structure of bank supervision. Consequently the department issuing banking licences was transferred to the Bank Supervision Department, and a Supervisory Committee of Eesti Pank was formed. The Supervisory Committee was placed under the direction of a Vice President. Coordination of bank supervisory work in Eesti Pank was the main task of the Committee.

The above rearrangements were necessary preconditions for the formation of a system of a constantly active preventative control comprising the evaluation of new banks' activities before issuing of licences, as well as following the activities of already functioning banks on the basis of their reports. In time pre-control should allow for detection and avoidance of difficulties.

One of the important aspects in the work of bank supervision is assessing credit, foreign exchange and other risks in the evaluation of assets of a bank. As shown by the on-site checking of reports for the 7 biggest commercial banks carried out by the London audit firm Price Waterhouse, together with the inspectors of Bank Supervision of Eesti Pank within the framework of the PHARE programme, the risk level of the assets of our banks is rather high. The actual risk volume of the assets, the risks connected with off-balance sheet assets in particular, must be reflected in banks' reports. Hence, the correct and full evaluation of risk is a precondition for the formation of a credible early warning system.

As a result of the rearrangements carried out in the course of the year, the essence and goals of the on-site inspection of banks have changed. Instead of solving conflicts connected with the activities of banks in crisis and participating in the work of liquidation committees of banks that had ceased to operate, on-site control has turned more systematic and become forward looking and anticipating.

The work of bank supervision is impeded by the inadequacy of a legal framework regulating the activities of banks, so that bank inspectors often have difficulties in finding a legal basis for their views and requirements. In order to improve the legal framework, work on a new credit institutions law has begun, taking into consideration the appropriate directives of the European Union and the Basel Committee.

As stated above, setting the early warning system going was one of the most important preconditions for bringing reports and bookkeeping of banks in accord with international standards.

New reporting order

From 1 January 1993 a new reporting regime for Estonian banks was introduced. It replaced the old regime of reporting by the Gosbank of the Soviet Union. The need to replace the latter was mainly due to differences in the bookkeeping principles of socialism and a market economy. The old reporting system proceeded from the principles of planned economy and did not reflect the actual financial situation of banks. In practice it meant different interpretations of balance sheet requirements in different banks and made data difficult to compare. The new balance sheet requirements had to ensure unambiguous interpretation by all banks and had to raise the credibility of all the reports. In order to get a better view of the strategy of banks in recruitment and investment of capital as well as in asset liability management, a number of additional reports were required.

Prudential ratios

In order to regulate the risks taken by banks, starting from 1 July 1993, new prudential ratios were established: solvency ratio, liquidity ratio, risk concentration of a bank and the customer. Setting up the above ratios, the level of development in Estonian banking as well as norms valid in the European Union were taken into account.

The goal for establishing prudential ratios was the restriction of excess risks taken by banks. Thus, they serve to secure the stability of the whole banking system and protect the interests of the customers.

Solvency ratio (the ratio of a bank's own means to the total of risk weighted assets and liabilities), at least 8%

Liquidity ratio (the ratio of a bank's liquid assets to current liabilities), at least 30%

Risk concentration ratio (ratio of total liabilities of high risk-concentration clients to the bank's own means) - 800%

In order to limit foreign exchange risk net foreign exchange position ratio, i.e. the ratio of the difference between foreign assets and foreign liabilities as well as forward transactions (for sums not yet transferred) to the bank's equity capital, was established. The ratio of a bank's total open net foreign exchange position is 30%, constituting separate currencies up to 10% and the German mark up to 250% (from February 1994 the position of the German mark is free).

The year 1993 can be still considered as a beginning of the reorganisation of banking supervision. It is obvious that both the new reporting system and the instructions for calculating prudential ratios, regardless of a relatively successful application, need further adjustment and corrections in the future.

Together with the credit institutions law and the strengthening of legislative acts regulating supervisory activities of Eesti Pank, the attitude of the public towards bank supervisory activities and the place of the latter in modern banking have to change.