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Bank Supervision | Special Diagnostic Studies

Special Diagnostic Studies

18/12/2015 Financial Sector Supervision Activities in the Context of a Three-Year Stand-By Arrangement with the IMF – NBS Completes Special Diagnostic Studies of Banks

The NBS wishes to inform the public and market participants of the completion of special diagnostic studies of banks (SDS) that have marked this year and represent an important part of the programme supported by the three-year stand-by arrangement with the IMF.  

SDS include verification of the quality of banks' assets under the International Financial Reporting Standards (IFRS) and international valuation standards, taking into account national regulations and specifics of Serbian market, as well as methodological assumptions specifically designed for the needs of SDS. SDS allows NBS to verify whether banks are adequately capitalized, taking into account the appropriateness of classification of assets and provisions for identified losses in accordance with IFRS, as well as the levels of regulatory reserves for potential losses.

Special diagnostic studies were conducted in 14 banks selected based on criteria of systemic importance, representativeness of the banking sector and risk. These banks represent approximately 88% of the Serbian banking sector total assets as of 31 March 2015. Four audit firms (Deloitte, Ernst & Young, PriceWaterhouseCoopers and BDO) and six appraisal companies (Colliers, CBRE, JLL, NAI Atrium, Danos and Coreside) were involved in the SDS to ensure independence and credibility of the final results.

Based on the findings of selected audit firms, the results of SDS (data as at 31 March 2015) can be summed up as follows:

  • Despite conservative assumptions underlying the SDS, not a single bank participating in the SDS had a capital adequacy ratio below the regulatory minimum of 12%;
  • The total effect of the SDS on the capital adequacy ratio of all 14 banks, when taking into account the offsetting between impairment reinforcements and banks’ prudential loan-loss reserves, is a decrease of 1.76 pp (decrease from 20.21% to 18.45% after SDS adjustments1);
  • Substantial adjustment in the part concerning additional allowances for impairment in all work blocks (approximately around 70%) is mitigated by the reduction in required reserve for estimated losses as a result of NBS regulations, which confirms the significance of such regulatory approach in the context of maintaining the stability of individual bank and of the financial system as a whole;
  • Based on the assumption of a static portfolio as at 31 March 2015 and full implementation of the results of re-classification from performing exposures to non-performing exposures, the NBS estimates the effects of the SDS on the NPL ratio of banks to be 4.7 pp (i.e. a 4.7 pp increase in total NPL ratio for the 14 banks participating in the SDS). Note, however, that the estimated increase in the NPL ratio stems from applied methodology which assumes a more conservative definition of non-performing exposures, which is consistent with the nature of special diagnostic studies.  

To ensure better understanding of the methodological assumptions, the above results and their implications for participating banks, the NBS draws attention to several key facts:  

  • The SDS comprise a  point-in-time assessment of the recoverable value of the assets of participating banks and is considerably different from the NBS banking supervision in terms of approach, organisation and implementation. In this context, the key methodological aspects and the scope of the SDS were defined and agreed in cooperation with the IMF and the above mentioned audit firms, using as a benchmark the methodological elements set out in the ECB’s manual published in March 2014;
  • Though the SDS focuses on  conservative application of International Financial Reporting Standards (IFRS), given the principle-based IFRS framework, it was necessary to define numerous methodological parameters and assumptions which represent IFRS interpretation by the regulator (prudential character of the SDS) and which have been specifically developed in the context of these studies; 
  • Banks are required to carefully consider the overall results and to pay due attention to each re-classification and/or correction of impairment for individual customers in order to properly define, in cooperation with their statutory auditors, the implications of SDS adjustments for their financial statements for 2015;  
  • The expected remedial actions of banks will apply not only to quantitative corrections in terms of allowances for impairment (and required reserve for estimated losses), but also qualitative corrections in terms of internal regulations and the weaknesses identified in their internal procedures, systems and processes. The NBS intends to review the banks’ follow-up to the SDS as part of its regular supervisory activities during 2016.

SDS results 

The NBS will publish a detailed overview of SDS results for individual banks (broken down by key work blocks) in January 2016.

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The NBS intends to use SDS results in order to support the process of defining approach to NPL resolution (from the aspect of banks’ activities), to foster a conservative application of IFRS in the Serbian banking sector, to increase transparency of banks’ balance sheet positions in terms of valuation in accordance with IFRS, and to generally strengthen confidence in the financial soundness of domestic banks. Finally, the NBS will conduct a careful evaluation of the SDS, and leverage lessons learned from the exercise to enhance its supervisory and regulatory framework. 

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1) The effects on capital are calculated excluding banks’ profit in the first three months of the year and the according downward revision of risk-weighted assets, which results in more conservative effects on the capital adequacy ratio and represents a specificity of this process.