The banking statute: prudential requirements

Introduction

It goes without saying that the entire statute is devoted to the regulation and supervision of banks. However, only certain sections funnel in on risk management and ultimately on the solvency of banks. Of these, the most significant are the prudential requirements, which are:

• Share capital and unimpaired reserve fund.

• Liquid assets.

• Large exposures.

• Reserve requirement.

• Returns.

Share capital and unimpaired reserve fund

The statute / regulations under the statute define what qualifies as primary (ordinary shares, etc) and secondary share capital and unimpaired reserve funds, and prescribe the minimum amount of share capital and unimpaired reserves to be held, which is related to the risk/s43 the bank is exposed to.

Liquid assets

The statute lists the assets which rank as liquid assets (LA). In most countries they are:

• Treasury bills.

• Short-term government bonds (< 3-years to maturity).

• Central bank money: bank notes and coins, reserves with the central bank.

• Bills of the central bank.

The regulations under the statute prescribe a minimum amount of liquid assets to be held, which is a ratio of deposits / liabilities, for example 5%. The ratio resides in the regulations because it can be changed.

Large exposures

The statute of most countries state that: a bank shall not make investments with or grant loans or advances or other credit to any person, to an aggregate amount exceeding an amount representing a prescribed percentage of such bank's capital and reserves. The regulations under the statute then prescribe the ratio, for example 10%.

Reserve requirement

In most countries the banks are obliged to comply with a (cash) reserve requirement. Banks are required to maintain a certain minimum amount (e.g. 5% of deposits) in reserves, defined as bank deposits with the central bank. This requirement is related to liquidity risk (and some scholars see it as a monetary policy tool).

Returns

Returns at first glance may not seem like a prudential requirement. However, it is a crucial prudential requirement, because the collection of the right information by the supervisor is vital to the supervision function, and ultimately to the regulatory function. The returns that the banks are obliged to complete and submit to the Registrar of Banks are formidable, and require sophisticated IT systems.

The banking statute: other requirements associated with risk management

Other requirements of the banking statute associated with risk management include:

• Licensing of bank. The barriers to entry are high.

• The power of inspection of the Registrar of Banks. The statute determines that the Registrar has extensive powers of inspection, and may do so at any time.

• Furnishing of information by banks. Apart from the requirement to submit myriad detailed returns to the Registrar, this office has the power to request / demand any other information from banks.

• Only specific persons may be officers and directors of the banks. The statute is stringent in respect of the requirements (fit and proper and experience) of the persons who are directors and executive officers of banks. Also, the composition of the board of directors must be relevant to the nature of the bank's business.

• Fiduciary duties of non-executive directors. Directors are required to act in the best interests and for the benefit of the bank, its depositors and its shareholders.

• Restriction of voting of executive directors. In most countries, the statute ensures that the executive directors may not enjoy the majority of the vote at board meetings.

• Special functions of the auditor and the audit committee. In many countries a bank is obliged to appoint two auditors, and the auditors are required to furnish the Registrar with any information they may have regarding irregularities and any matter that may endanger the continued existence of the bank.