Year 2004

The Czech National Bank developed its supervisory activities in 2004 in line with the medium-term strategy approved for the period up to the end of the year. The basic goal was to create a comprehensive regulatory framework for banks and consolidated groups based on regulatory principles applied in the European Union. Ever-closer co-operation with foreign regulators, especially with regard to the application of the single licence principle, and with domestic financial market regulators is becoming an important element. In order to improve the conduct of banking supervision, the priorities were defined on the basis of the Core Principles for Banking Supervision issued by the Basel Committee on Banking Supervision and the recommendations of the FSAP (Financial Sector Assessment Program) mission.

Methodological activities

In 2004, CNB Banking Supervision helped to prepare legislation relating to the activities of the banking sector. The emphasis was on harmonisation of the banking regulations with European Community law. Five revisions were made to the laws relating to the given field. An amendment to Act No. 126/2002 Coll., on Banks, a new Act No. 256/2004 Coll., on Capital Market Undertakings, Act No. 190/2004 Coll., on Bonds, and Act No. 189/2004 Coll., on Collective Investment, became fully effective on the Czech Republic's accession to the EU. A harmonisation amendment (No. 284/2004 Coll.) to Act No. 61/1996 Coll., on Some Measures against Money Laundering, entered into force on 1 September 2004.

In 2004, the Czech National Bank issued new provisions and decrees and amended the existing ones, regulating and changing the regulatory framework for bank business.

The provision on the internal management and control system combined the previous four provisions on the internal control system, market risk management, credit risk management and liquidity management standards into a single regulation. The new provision represents a logical whole of requirements for the effectiveness of the internal management and control system and risk management.

An amendment to the provision stipulating rules for the assessment of financial receivables and the creation of provisions and reserves, and rules for the acquisition of certain types of assets responds to developments in accounting and the obligatory use of international accounting standards (IFRS) by banks that are issuers of registered securities. Such banks use the same method to determine provisions for compliance with the prudential rules as they do for keeping their accounts and compiling their financial statements. Other banks, provided they are sufficiently prepared, can also apply the IFRS method. If they do not apply the method, they determine their provisions as previously using a coefficient on the unsecured value of the receivable. This amendment also adds another form of portfolio approach.

The Czech National Bank has been empowered by the new Act No. 190/2004 Coll., on Bonds, to monitor the compliance with specific obligations by banks that issue mortgage bonds. This new act also authorised the CNB to issue a provision stipulating the content and method of keeping of the register of mortgage bonds coverage. Based on this authorisation, the CNB issued a provision stipulating the content, manner of keeping registration and prerequisites of mortgage bonds coverage. These duties include, in particular, the obligations to cover liabilities from mortgage bonds in circulation by selected assets, primarily receivables from mortgage loans, to keep a separate register of coverage of liabilities from issued mortgage bonds in circulation, and to fulfil the information duty. The registration is created by a register of coverage and a book of coverage.

In 2004, the Czech National Bank issued nine official information documents concerning the laws, decrees and provisions falling within the competence of CNB Banking Supervision, which related to the extract from a bank's issue of shares, financial brokerage, the single banking licence, the treatment of claims on the European Investment Bank for the purpose of the prudential rules, requirements for netting agreements (final netting) when calculating credit risk, equity indices for calculating equity risk, calculation of capital adequacy and exposure for investments in asset-backed securities, the term "information system of the bank" in the provision on the internal control system of the bank for the area of money laundering prevention, the repealing of some of the CNB's official information in the area of prudential rules for banks.

Preparations for the implementation of the new capital framework continued in 2004. The aim of this framework is to increase the safety and soundness of financial systems and to enhance competitive equality among banks and management responsibility. The new framework focuses on providing incentives for banks to enhance their risk measurement and management capabilities. A further aim is to introduce capital regulation of operational risk and reflect credit risk more accurately in capital requirements. The changeover to the new rules is planned for 2007.

The Czech Republic's accession to the European Union on 1 May 2004 has significantly altered the character and forms of banking supervisory co-operation within European structures. The nation's observer status in committees and working groups changed into Member State status. Level 3 under the Lamfalussy process was extended with the establishment of the new Committee of European Banking Supervisors (CEBS) and Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), completing - together with the existing Committee of European Securities Regulators (CESR) - the European institutional framework for financial market regulation.

2004 saw a continuing co-operation with the Basel Committee on Banking Supervision that deals with the development of regulation, particularly within the Group for Core Principles for Effective Banking Supervision and within the Capital Group.

Emphasis continued to be placed on bilateral co-operation with partner supervisors, concentrating on the signing of new memoranda of understanding, the exchange of information on banks of mutual interest, and the procedures for the implementation of the new capital adequacy framework (Basel II). In 2004, such relations were rounded off with Memoranda of Understanding with the central banks of the Netherlands and Italy. The CNB has so far concluded eight memoranda of understanding: with Belgium, France, Italy, Germany, the Netherlands, Austria, Slovakia and the USA (or, more precisely, New York State). A MoU with the Russian Federation is under negotiation, conditional on co-operation agreement with Russia at the EU level.

In 2004, financial market participants in the Czech Republic were regulated and supervised by four different institutions. The Czech National Bank is responsible for the regulation and supervision of banks; the Czech Securities Commission regulates and oversees capital market participants; and the Ministry of Finance is responsible for the regulation and surveillance of insurance companies and pension funds. The sector of credit unions is supervised by the Office for Supervision of Credit Unions and regulated by the Ministry of Finance. The diversified structure of regulation and supervision requires close co-operation.

The Memorandum of Understanding between the Czech National Bank, the Czech Securities Commission and the Ministry of Finance from 2003 (originally 1998) provides the formal basis for this co-operation. Five working groups were operating in 2004, dealing with supervision, collection of data on sectors, accounting harmonisation and information disclosure, conglomerates, and licensing. The meetings of the Committee on the Co-ordination of Financial Market Supervision focused on the issue of single supervision, discussing the Government's draft plan for integrated state supervision of the financial market. The intention to integrate all the supervisory authorities into a single institution in two steps was approved. During 2005, supervision of banks and credit unions should be integrated within the CNB, while supervision of insurance companies and pension funds and capital market surveillance should be integrated within the Czech Securities Commission. Starting from 2006, the Czech Republic should have two supervisory authorities. These are to be united into a single authority in the future. The Government will decide on the nature of this institution by the end of 2006.

Based on the Memorandum of Understanding, an agreement on the exchange of certain information between the CNB and the Czech Securities Commission was signed in March 2004, aimed at optimising the flow of information between banks that are also securities traders and the regulators, i.e. the CNB and the Czech Securities Commission.

Control and analytical activities

Due to the prevailing foreign ownership of the banking sector and the application of the single licence principle as of the Czech Republic's accession to the EU on 1 May 2004, allowing to carry on licensed activities not only in the territory of the state that issued the licence (home state), but also in the territory of another EU member state (host state) without having to apply for the relevant licence, the powers of home and host supervisors are newly defined and the CNB's supervisory competencies are partially limited. The activities under the single licence in the territory of the host state are subject to supervision by the authority of the home state, except for supervision of compliance with narrowly defined legislation of the host state. Ever more emphasised is the necessity of enhanced international co-operation.

Although banks do not have to undergo a licensing procedure in the host state, a branch cannot be established at will. The bank has to present the intention to do so to the supervisory authority of the home state for prior assessment, which will later refer the notification to the competent supervisory authority of the host state. Following the notification, the CNB in the role of the host state notifies the bank of the extent of supervision and provides it with an overview of the legal regulations that will apply to it when performing banking activities. Supervision of the branch rests primarily with the supervisory authority of the home state. Nevertheless, any breach of duties when providing services abroad is dealt with by both regulators in close co-operation.

The CNB as the host supervisory authority supervises the liquidity and the performance of the duties imposed by the Act on Banks. All deposits accepted by foreign bank branches are insured under the home state's scheme. Additional insurance is also possible based on an agreement between the foreign bank and the Deposit Insurance Fund. As of 1 May 2004, nine foreign bank branches having their registered offices in EU Member States and active in the Czech Republic switched to the single licence system and the CNB significantly reduced its supervisory activities in respect of such branches.

Also in 2004, the regularly elaborated analytical instrument was standard analyses of the banking sector, containing ratings of banks and presented to the CNB Bank Board on a half-year basis. The by now traditional publication Banking Supervision, issued at annual frequency, is meant for both professionals and the public. Off-site supervision involves regular comprehensive analyses of banks' financial situations in relation to the risks they undertake, with monthly signal information on each bank being appraised on a regular basis. Detailed, up-to-date aggregate information on the banking sector for professionals is published on the CNB website.

On the strength of the findings from off-site supervision and on-site inspections, a total of 13 remedial measures were imposed. These measures required the banks concerned to eliminate shortcomings in their activities within a set timeframe. The elimination of shortcomings was monitored. In 2004, no penalty proceedings were brought to revoke licences or impose fines for violations of the Act on Banks.

2004 was marked by fairly intensive work in the area of licensing and authorisation proceedings. The re-licensing of banks, launched in connection with the process of harmonising the Act on Banks with the European banking directive, was completed. Banking licences were issued to the remaining 15 banks. Upon the Czech Republic's accession to the EU, nine foreign bank branches active on the banking market switched automatically to the single licence system. One more branch of a foreign bank (from Austria) was established under this system in 2004, launching its activities in 2005.

In 2004, CNB Banking Supervision issued a total of 35 administrative decisions concerning the aforementioned issuing of bank licences (re-licensing), banks' applications for licence changes (extensions), consents to acquire qualifying holdings in banks (changes in the shareholder structure of banks), permission to merge, plans to open a branch in an EU member state, and the sale of part of a business. One application for a licence was submitted by an applicant based in a country outside the EU; the administrative proceeding was discontinued.

EU accession also opened up the Czech banking market to other banking entities enjoying the benefit from free movement of services. A total of 63 foreign banks from EU countries reported their intention to provide some or all of the mutually recognised banking activities in the Czech Republic in 2004. These institutions are supervised by the home country regulator.

In 2004, CNB Banking Supervision undertook 10 examinations in 10 banks (five of them comprehensive and five partial), focusing on selected types of risks undertaken. All the main risk areas (comprehensive examinations) and specific risks (partial examinations) are subject to examination.

Organisation of CNB Banking Supervision

The organisational structure of CNB Banking Supervision changed in 2004. Since mid-2004, instead of two departments the CNB's regulatory and supervisory activities have been covered by just one Banking Regulation and Supervision Department. The number of supervisors fell to 96.

The banking sector

The banking sector of the Czech Republic remained unchanged in 2004, as no licence was revoked and no new bank entered the domestic banking market. Five banks changed their names during the year, in all cases at the decision of their shareholders. As of 31 December 2004, the banking sector consisted of 26 banks and 9 foreign bank branches.

5 August 2005