Coming soon: BSP to reward, punish banks based on their risk profiles

The Bangko Sentral ng Pilipinas has adopted a three-phase corporate governance agenda to promote good corporate governance and prudent risk-taking behavior by financial institutions.

Among other key factors, the new rules will call for regulators to assess the reputational risk of bank stakeholders and reward or penalize parties according to their respective risk levels.

“Risk governance lies at the heart of a safe and sound financial system,” BSP Governor Benjamin Diokno said in a briefing. “It determines the character of a financial institution, dictates its corporate behavior and defines the quality of its dealings with various stakeholders.”

In line with this, the BSP is now pursuing reforms on model risk management, risk-based pricing, and reputational risk management to further strengthen the BSP’s corporate governance framework. These reforms will ensure that domestic corporate governance standards remain at par with international standards considering local developments and changing business practices in banks.

These principles-based guidelines also provide financial institutions with the flexibility to develop their own corporate strategy, innovate and offer a suite of financial products and services that are within the ambit provided by law. These also ensure that risks they assume are properly managed and remain within their risk- bearing capacity.

The policy intent for model risk management standards is to develop holistic guidelines and to consistently apply these in the development and implementation of models to support different functional areas of banks.

The BSP’s existing guidelines already set forth expectations on model risk management. However, these are embedded in different prudential risk management standards on credit, market, liquidity, and information technology risk as well as in stress testing activities.

The central bank said it is pursuing this reform in view of a growing trend among financial institutions towards the use of quantitative analysis and models in decision-making.

Models are also often used to support a bank’s capital adequacy measurement, asset valuation, impairment and stress testing activities. Risk measurement methodologies are also dependent on the use of models to properly identify and monitor different risk areas.

As a result, model risk is increasingly becoming an inherent risk in large financial institutions.

The implementation of risk-based pricing standards is an enhancement to the existing credit risk management framework. It formalizes the BSP’s expectations on how banks’ internal credit risk rating systems feed into their pricing mechanism and ensure that risks associated with lending are adequately compensated.

Lending rates are expected to vary based on the customer’s risk profile. As a result, borrowers with good credit standing should be able to enjoy low lending rates.

Reputational risk management guidelines underscore a holistic approach in managing this risk. Central to this is an effective and efficient process for identifying, assessing, monitoring and controlling or mitigating the risks that could damage the reputation of BSP supervised financial institutions.

“Financial institutions should have a clear understanding of the various sources of reputational risk in the areas of corporate governance, personnel and/or management ethics and integrity, organizational culture, business practices, product/service quality, customer relations, financial soundness and viability, handling of environmental and social issues, and legal and regulatory compliance,” the central bank said.

Edited by TSB