Q&A: Russia's chief bank supervisor explains Basel II delays

Alexey Simanovsky, director of banking regulation and supervision at the Bank of Russia, updates Risk on Basel II compliance and other risk management issues affecting the local market.

Risk: Why was the implementation of Pillar I of Basel II in Russia delayed last year? Is there any news on when it, and Pillars II and III, will be implemented?

Alexey Simanovsky (AS): Basel II is important, but the implementation of Pillar I of Basel II was postponed in April 2008 for two reasons. Firstly, in that month we signed a three-year cooperation programme with the European Central Bank to get advice and expertise from the Eurosystem on the implementation of Basel II. And secondly, the crisis has led us to identify other priorities beyond Basel II implementation.

Initially, Russia is going to implement the Simplified Standardised Approach of Basel II, which has very similar requirements to the Basel I Accord. Together with the banks we will work to take the first steps towards the Internal Ratings Based Approach, and we shall factor in any alterations to the framework that are recommended by Basel Committee (BCBS). The preparatory work on Pillar II and Pillar III implementation is under way and is also included in the cooperation project's framework. So while we have covered a certain amount of preparatory work, the implementation of these Pillars can not be achieved earlier than 2010.

Risk: What progress are you seeing from Russian banks in terms of Basel II - what are the main obstacles to its implementation?

AS: Financial crises teach us not to hurry with the implementation of regulations from scratch. Before we go further with implementation, we would like to have at our disposal some final recommendations in the areas of banking regulation and supervision. It doesn't mean that we shall immediately implement all the recommendations, but we are interested in seeing the outcomes of international consultations on the matter.

The obstacles to implementation are what you would expect: the resistance of banks to an additional regulatory burden, our own lack of experience, complexities in making decisions, the legal environment, and perhaps concerns over whether there is a robust banking and supervisory culture.

Risk: How satisfied are you with the general standard of risk management among Russian banks? Have any particular weaknesses shown up during the turmoil of the past six months?

AS: In my opinion, while the general standard of risk management in Russian banks is steadily improving, the glass of satisfaction is only half full - or rather half empty. The crisis opened many people's eyes to the poor standard of risk management at a number of banks and, even worse, to the lack of integrity of a number of banks' top managers and owners.

Of course, risk management deficiencies are nothing new in the banking sector. And the problems among Russian banks are not dissimilar to previous guidance on how supervisors should deal with weak banks, issued by the Basel Committee as far back as 2002. We see poor lending practices, excessive loan concentrations, excessive risk-taking, senior managers overriding existing policies and procedures, and even fraud and criminal activities.

Owners and managers were sometimes too ambitious and greedy, and consequently started taking excessive risks. But at the same time they tried to conceal the true nature of risks being taken in their accounting and reporting. From our perspective, we should acknowledge we were sometimes too naive or overly optimistic in risk assessment. Besides weaknesses in risk management and supervisory culture, this crisis has shown deficiencies in the legal and regulatory framework of the banking system. Of course, we have detected some deficiencies in our own regulation: now is the time to fix mistakes and cover gaps.

Risk: What challenges has the financial crisis posed from a regulatory perspective?

AS: We have recognised gaps in regulation in different areas, such as poor lending practices, the concentration issue and so on. In my view, the key responses should be through the comprehensive implementation of the Basel Committee's core principles for banking supervision, with regulation and supervision based on the substance-over-form approach. Beyond that, there are a number of global regulatory challenges, including whether the international regulatory regime is sufficient in its current form and whether it is in any way procyclical. These issues are rather new and complicated, and it would be prudent to discuss the pros and cons of all the proposals being put forward in a calmer environment. Attempts to make key strategic decisions in a hurried manner often leads to mistakes.

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